(Mark One)
ý Annual
Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the fiscal
year ended December 31, 2003.
o Transition
Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For
the transition period from ________________ to__________________
Commission File No. 0-22701
| Florida (State or other jurisdiction of incorporation or organization) |
65-0735612 (I.R.S. Employer Identification No.) | |
| 600 301 Blvd West, Suite 202 Bradenton, FL (Address of principal executive offices) |
34205 (Zip Code) |
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes ý No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ý
Indicate
by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2).
Yes ý
No o
The aggregate market value of the voting stock of Gevity HR, Inc. held by non-affiliates (based upon the June 30, 2003, $11.78 closing sale price for the Common Stock on the Nasdaq National Market) was approximately $168.7 million.
The number of shares of the Registrant’s common stock, $.01 par value per share outstanding, as of February 27, 2004 was 19,322,440.
PART III – Portions of the Registrant’s definitive Proxy Statement relating to the annual meeting of shareholders to be held May 20, 2004, are incorporated herein by reference in Part III.
In connection with the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 (the “Reform Act”), Gevity HR, Inc. (the “Company”) hereby provides cautionary statements identifying important factors that could cause the Company’s actual results to differ materially from those projected in forward-looking statements (as such term is defined in the Reform Act) made by or on behalf of the Company herein, in other filings made by the Company with the Securities and Exchange Commission, in press releases or other writings, or orally, whether in presentations, in response to questions or otherwise. Any statements that express, or involve discussions as to, expectations, beliefs, plans, objectives, assumptions or future events or performance (often, but not always, through the use of words or phrases such as “will result,” “are expected to,” “anticipated,” “plans,” “intends,” “will continue,” “estimated,” and “projection”) are not historical facts and may be forward-looking and, accordingly, such forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause the actual results or performance of the Company to be materially different from any future results or performance expressed or implied by such forward-looking statements. Such known and unknown risks, uncertainties and other factors include, but are not limited to, the following:
| (i) | volatility of costs of workers’ compensation insurance coverage and profit generated from the workers’ compensation component of the Company’s service offering under its loss sensitive workers’ compensation programs; |
| (ii) | volatility of state unemployment taxes; |
| (iii) | the uncertainties relating to the collateralization, loss retention requirements, availability and renewal of the Company’s healthcare programs and workers’ compensation insurance programs for client employees and the general insurance policies of the Company as such may be affected, positively or negatively, by various factors such as claims development trends, projected losses, claims paid and the Company’s credit risk; |
| (iv) | uncertainties as to the amount the Company will pay to subsidize the costs of medical benefit plans; |
| (v) | possible adverse application of certain federal and state laws and the possible enactment of unfavorable laws or regulation; |
| (vi) | litigation and other claims against the Company and its clients including the impact of such claims on the cost, availability and retention amounts of the Company’s general insurance coverage programs; |
| (vii) | impact of competition from existing and new businesses offering human resources outsourcing services; |
| (viii) | risks associated with expansion into additional markets where the Company does not have a presence or significant market penetration; |
| (ix) | risks associated with the Company’s dependence on key vendors and the ability to obtain or renew benefit contracts and general insurance policies at rates and with retention amounts acceptable to the Company; |
| (x) | an unfavorable determination by the Internal Revenue Service or Department of Labor regarding the status of the Company as an “employer”; |
| (xi) | the possibility of client attrition due to increasing prices for client services, including healthcare programs; |
| (xii) | risks associated with geographic market concentration; |
| (xiii) | the financial condition of clients; |
| (xiv) | the effect of economic conditions in the United States generally on the Company’s business; |
| (xv) | the failure to properly manage growth and successfully integrate acquired companies and operations, including particularly the risk of attrition of clients acquired in acquisitions; |
| (xvi) | risks associated with providing new service offerings to clients; |
| (xvii) | the ability to secure external financing at rates acceptable to the Company; |
| (xviii) | risks associated with third party claims related to the acts, errors or omissions of client employees; and |
| (xix) | other factors which are described in further detail in the Company’s Annual Report on this Form 10-K and in other filings by the Company with the Securities and Exchange Commission. |
The Company cautions that the factors described above could cause actual results or outcomes to differ materially from those expressed in any forward-looking statements made by or on behalf of the Company. Any forward-looking statement speaks only as of the date on which such statement is made, and the Company undertakes no obligation to update any forward-looking statement or statements to reflect events or circumstances after the date on which such statement is made or to reflect the occurrence of unanticipated events. New factors emerge from time to time, and it is not possible for management to predict all of such factors. Further, management cannot assess the impact of each such factor on the business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements.
Gevity is a leading provider of end to end human capital management solutions that create business value and promote employee excellence by putting people first. The Company’s high-impact outsourcing services provide a competitive advantage to clients by helping them to find, develop and retain talent, manage the paperwork, and protect their business. Employee focused solutions are delivered by professionals in the Company's branch offices, supplemented by the industry’s leading Web-based technology. These solutions are provided to small and medium-sized businesses in the United States. The Company’s more than 900 company employees are dedicated to providing businesses with typically between 5 and 100 employees, or larger employers with multiple locations, access to a broad range of outsourced professional human resource services and to effectively become the ‘in-sourced’ human resources department for each such business. The Company has assembled, developed and deployed a very capable team of human resource professionals who have the human resource expertise necessary to deliver to the Company’s clients and their employees a comprehensive, fully integrated human resource solution that is generally available only to larger businesses.
Delivered through a combination of centralized and local human resource consultants, as well as through leading edge, Oracle-based, web-enabled technology, the Company’s tools and services are designed to positively impact each client’s business in two important ways. First, the Company believes that its client and their employees benefit from the Company’s offering through increased work satisfaction that generally leads to higher productivity. Second, the Company expects that the general profitability of client businesses will be positively impacted since the Company’s services allow their clients’ managers to concentrate on revenue producing activities rather than having to deal with the time consuming and increasingly complex burdens associated with employee administration.
As of December 31, 2003, the Company served more than 7,500 clients, as measured by individual client Federal Employer Identification Numbers (“FEIN”), with approximately 106,000 active client employees, and maintained offices in Alabama, Arizona, California, Colorado, Florida, Georgia, Massachusetts, Minnesota, New Jersey, New York, North Carolina, Tennessee and Texas.
The Company’s operations are currently conducted through a number of wholly-owned limited partnerships and wholly-owned limited liability companies. The consolidated operations of the Company exclude intercompany accounts and transactions that have been eliminated in consolidation. Certain reclassifications have been made to the 2002 consolidated financial statements to conform to the current period presentation.
References in this report to the “Company” or “Gevity” include Gevity HR, Inc. and its consolidated wholly-owned subsidiaries, unless the context indicates otherwise. The Company was incorporated in Florida and consummated its initial public offering in 1997 after acquiring all of the interest in a limited partnership originally organized in 1993 to acquire the assets of the Company’s predecessor PEO business. In May 2002, the Company’s shareholders voted to change the Company’s name from “Staff Leasing, Inc.” to “Gevity HR, Inc.”
The human resource outsourcing industry is rapidly growing in the United States. Gartner Dataquest estimates the worldwide human resource outsourcing industry will grow from $50.6 billion in 2003 to $58.9 billion by 2005. This represents an approximate 7.9% percent annual growth rate. Small and medium-sized employers, those with between 1 to 100 employees, are a large part of this market. According to Dun and Bradstreet, there are over 10 million small and medium-sized businesses in the United States.
Many small and medium-sized employers do not have sufficient internal resources to focus on time consuming human resource activities. A typical small to medium-sized business may use multiple vendors to provide employee administration services such as payroll and benefits administration. As a result, there is little consistency or integration of these important processes. Finally, few of these employee administration services include important people-management activities such as recruiting and selection, employee training and development, employee retention and workplace regulatory and safety compliance.
Many small to medium-sized businesses outsource discrete, non-core functions of their operations. The market for multi-process human resource outsourcing for small to medium-sized businesses is relatively new. The Company believes there are approximately 300 territories available in its current markets where it has branch offices. The Company also believes there are approximately 1,000 businesses with between 20 and 100 employees in each territory that would qualify to become clients of the Company. Relatively few of these businesses currently outsource their human resource functions. Comprehensive human resource outsourcing for small to medium-sized businesses requires a well-developed service delivery infrastructure and significant expertise in analyzing, providing and managing human resource processes across many third party vendors, and the use of policies, procedures, operations and technologies that yield superior performance as measured by productivity, cost, quality and client satisfaction metrics.
There is a large body of study describing the positive impact of human resource practices on key financial outcomes such as productivity, revenue growth and profitability. However, most of the data concentrates on large employers. There is little study available regarding this important topic that focuses on small and medium-sized employers.
As a result, Gevity has established the Gevity Institute to identify and quantify the direct correlation between human resource practices and the performance of small and medium-sized businesses. The goal of the Gevity Institute is to become a unique and recognized authority on how professional human resource management impacts small to medium-sized business success, both financially and strategically.
The Gevity Institute is currently working in collaboration with Cornell University on a study that examines the financial impact of small-employer human resource practices.
The Company provides a broad range of tools and services to its clients. These tools and services are primarily offered to the Company’s clients on a “bundled” or all-inclusive basis. In addition to the Company’s core services, clients may elect to offer to their employees health and welfare and retirement programs. The Company provides these tools and services to its clients through the following core activities:
Find the Right People. The Company assists its clients in finding the right people by providing:
| • | recruitment best practices |
| • | job description development |
| • | salary information |
| • | interview guidelines and assistance |
Develop and Manage People. The Company assists its clients in developing and managing their people by providing:
| • | on-line employee information management |
| • | performance management solutions |
Retain the Best Employees. The Company assists its clients in retaining the best employees for their businesses by providing:
| • | health benefits (medical, dental and vision) |
| • | retirement plans - 401(k) and IRAs |
| • | welfare benefits (voluntary life insurance, AD&D, short-term and long-term disability) |
| • | flexible spending account |
| • | employee assistance programs |
Manage the Paperwork. The Company assists its clients in managing employment related paperwork by providing:
| • | 401(k) plan administration |
| • | Section 125, FMLA and COBRA administration |
| • | payroll processing, employment related tax filings and administration |
Protect our Clients' Business. The Company assists its clients in protecting their businesses from employment related claims by providing:
| • | workers' compensation insurance |
| • | HR policies forms and best practices |
| • | employment related regulatory compliance and guidance |
As of December 31, 2003, the Company’s client base consisted of over 7,500 client companies, as measured by individual client FEIN’s, with an average of 14.1 employees per client.
The Company had clients classified in over 500 Standard Industrial Classification (“SIC”) codes. The following table shows the Company’s client distribution by major SIC code industry grouping for the years indicated, ranked as a percentage of gross billings to clients:
| PERCENTAGE OF CLIENT BILLINGS BY INDUSTRY |
2003 |
2002 |
2001 | ||||
|---|---|---|---|---|---|---|---|
| Services(1) | 37.7 | % | 34.8 | % | 28.2 | % | |
| Construction | 14.6 | 17.5 | 26.1 | ||||
| Manufacturing | 12.6 | 12.9 | 12.6 | ||||
| Finance/Insurance/Real Estate | 11.6 | 7.8 | 5.1 | ||||
| Retail Trade | 9.1 | 10.3 | 9.2 | ||||
| Wholesale Trade | 7.1 | 6.8 | 4.7 | ||||
| Restaurants | 2.9 | 4.5 | 6.3 | ||||
| Agriculture | 2.4 | 3.0 | 4.1 | ||||
| Transportation | 2.0 | 2.1 | 3.4 | ||||
| Other | - | 0.3 | 0.3 | ||||
| Total | 100.0 | % | 100.0 | % | 100.0 | % | |
| (1) | The “Services” category consists principally of clients in the following industries: health services, business services, personal services (e.g., laundry and dry cleaning, beauty and barber shops), hotel and lodging services, computer services, legal services, building maintenance, social services and miscellaneous repair services. |
As part of its current client selection strategy, the Company offers its services to businesses within specified industry codes. All prospective clients are also evaluated individually on the basis of total predicted profitability. This analysis takes into account workers’ compensation risk and claims history, unemployment claims history, payroll adequacy, and credit status. With respect to potential clients operating in certain industries believed by the Company to present a level of risk exceeding industry norms, more rigorous approval requirements must be met before the Company agrees to provide services to the client. This process may include an on-site inspection and review of workers’ compensation and unemployment claims experience for the last three years. In addition, under the terms of the Company’s workers’ compensation agreement, prospective clients operating in certain industries or with historically high workers’ compensation insurance claims experience must also be approved by the Company’s insurance carrier before the Company enters into a contract to provide services.
The Company maintains a client review program that includes a detailed profitability and risk analysis of all its clients. Based on the results of these analyses, the Company may modify its pricing or, if necessary, terminate certain clients that the Company believes would otherwise be detrimental or not contribute to its long-term profitability.
The Company’s client retention rate for 2003 was 80.0% The Company uses the NAPEO standard for measuring client retention, which is computed by dividing the number of clients at the end of the period by the sum of the number of clients at the beginning of the period plus the number of clients added during the period. The client retention rate is affected by a number of factors including the natural instability of the small to medium-sized business market and the number of clients that were terminated by the Company for reasons that include unacceptable risk and low profitability to the Company.
The Company delivers its services through a combination of dedicated human resource consultants located in the field offices and at the Company’s headquarters, as well as through Gevity Central, a proprietary web-based, self-service payroll and human resource portal. In order to provide proactive client relationship management, each of the Company’s clients has been assigned a single human resource consultant to serve as the client relationship manager. This allows the client to interface with the Company through a single point of contact.
The Company currently has 125 human resource consultants with an average of 8 years of experience in the human resource industry. Additionally, human resource consultants hold industry recognized certifications from such organizations as the Society of Human Resource Management.
The Company has invested approximately $44 million and is continuing to invest capital resources in the development and enhancement of its information and technology infrastructure. This investment is intended to better serve the Company’s client base, achieve a high level of client satisfaction and to allow the Company to improve efficiencies in its operations.
The Company processes payroll for all of its client employees using Oracle’s Human Resource Management System (“HRMS”) and Payroll processing application. The Oracle system enables the Company to effectively manage its existing operations and maintain appropriate controls. The Oracle HRMS and Payroll systems provide the Company with the capability to promptly and accurately deliver HR services and generate comprehensive management reports. The Company’s information systems manage all data relating to client employee enrollment, payroll processing, benefits administration, management information and other requirements of the clients’ operations. The current systems have high-volume processing capabilities that allow the Company to produce and deliver payrolls to its clients, each customized to the needs of such clients.
The Company continues its development and deployment of Gevity Central. Gevity Central allows clients to input their payroll data directly into the Company’s payroll applications via the Internet. Clients can regularly add or delete employees, view reports, and change payroll information. Gevity Central provides real time, 24x7 access to the Company’s entire suite of human resource tools and services. Gevity Central is fully integrated with the Company’s HRMS and Payroll applications, Customer Relationship Management solution and financial suite, as well as the Company’s comprehensive line of online tools and services. This full integration results in improved client satisfaction, as well as improved efficiencies and operating margins for the Company. Oracle’s portal software provides the foundation, enabling a robust, client configurable portal, while the Company’s custom-developed software provides additional ease of use and service capabilities.
At the end of 2003, approximately 77% of the client employee base interacted with the Company via Gevity Central. Usage of this technology is expected to increase in 2004 as over 95% of new clients enrolled in 2003 registered to use Gevity Central.
The combination of the Oracle systems for access and functionality and the Gevity Central online capabilities provides a unique solution capable of growing and adapting to the evolving needs of the Company’s clients.
The Company’s information technology staff consisted of 64 associates at December 31, 2003. The Company believes the development of its information technology is an integral part of achieving its growth objectives and intends to continue to invest in its technology infrastructure.
The Company markets its services through a direct sales force which, as of December 31, 2003, consisted of approximately 215 sales associates. In order to exercise more control over the client selection process, the Company uses a direct sales force rather than selling through agents. The Company’s sales force is distributed throughout its branch offices. The Company plans to expand its national coverage and add sales offices in selected major metropolitan areas over the next few years. The Company’s sales associates are compensated by a combination of salary and commission that has, for top producers, generated annual earnings in excess of $250,000.
As the Company’s focus has shifted to selling human resource tools and services rather than discounted insurance offerings, an associated change has been required in the profile of the sales force. As a result, the Company has revised the profile of its targeted sales candidates and has also restructured its hiring practices.
The new sales candidate profile typically includes attributes such as: strong analytical skills; knowledge of technology; experience working with small business owners; good business acumen; proven high performance and strong prospective sales skills. Generally the candidate will also have prior employment experience in the field of outsourcing, human resource consulting, benefits consulting or human resource information systems.
As a result of the Company’s aggressive sales associate hiring efforts during 2003, many regions of the country have relatively inexperienced Company sales associates. For example, the average tenure of the sales force in California, the Midwest and the Northeast is less than 12 months. This group makes up more than one-third of the overall sales force.
In addition, the Company expanded and improved its training and orientation programs. For many years, the Company provided a formal one-week training program for new sales associate hires, together with on-the-job training. In 2003, the Company implemented a comprehensive and expanded training program for all new sales associates and also designed a new training program for all existing sales associates. Both training courses emphasize the advantages available to clients through the Company’s expansive technology-based service delivery model and also include substantial focus on the Company’s sales process.
The Company also restructured the compensation system of its sales force. Historically, sales associates had no defined sales territory and earned commissions based entirely on their individual production levels. In certain instances, this led to internal competition as sales associates competed against each other for the same potential clients. The new client acquisition model subdivides all markets into individually assigned and identified sales territories and is intended to result in the development of market share by territory. The new compensation structure pays a higher base salary to attract more qualified sales candidates and provides an incentive based on the output of the full market, thus facilitating a collaborative environment between sales associates.
The Company generates sales leads from various external sources as well as from direct sales efforts and inquiries. Each sales associate visits his or her clients periodically in order to maintain an ongoing relationship and to seek new business referrals. The Company also generates sales leads from independent referral relationship partners and an information database of small businesses. The Company uses a referral incentive program with its relationship partners to encourage increased referral activity. Further, the Company generates sales leads through contacts produced by its telesales group, which makes calls to prospective clients identified from industry data, purchased lists and other sources.
The human resource outsourcing industry is highly fragmented. The Company seeks to compete through its ability to provide a full-service human resource solution to its clients through its advanced information technology solutions. The Company believes its primary competitors to be single point solution providers who offer segments of the entire service offering that the Company provides to its clients in an all-inclusive offering. These third parties include certain information technology outsourcers and broad-based outsourcing and consultancy firms that are now providing or may seek to provide human resource business process outsourcing services, companies that provide a discrete group of transactional services, such as payroll or benefits administration and aspire to provide additional services and other consulting companies that perform individual projects, such as development of human resource strategy and human resource information systems. Historically, most of these vendors have focused upon discrete processes, but many of them are now promoting integrated process management offerings that may be viewed as competitive with the Company’s offerings. The Company expects competition to increase, and competitors to develop broad service capabilities that match the Company’s.
The Company believes that it is one of the largest co-employers of client employees in the United States in terms of active client employees and revenues. Many of the businesses that operate under the co-employment business model, especially the larger ones such as Administaff and ADP Total Source, are capitalizing on the co-employment model and transforming their businesses into full-service human resource outsourcing companies while still offering workers’ compensation and group health benefit insurance programs.
The Company provides its services to its client employees under arrangements with a number of partners. The maintenance of insurance plans, including workers’ compensation plans and health benefit plans that cover client employees, is a significant part of the Company’s business. If the Company were required to obtain replacement contracts, such replacement could cause a significant disruption to the Company’s business and possible dissatisfaction with the Company’s service offering, leading to a decrease in client retention and an adverse effect on the Company’s future results of operations or financial condition.
Blue Cross Blue Shield of Florida (“BCBS”) is the Company’s primary partner in Florida, delivering medical care benefits to approximately 22,000 Florida client employees. The Company’s policy with BCBS is a minimum premium policy expiring September 30, 2005. Pursuant to this policy, the Company is obligated to reimburse BCBS for the cost of the claims incurred by participants under the plan, plus the cost of plan administration. The administrative costs per covered client employee associated with this policy are specified by year and aggregate loss coverage is provided to the Company at the level of 115% of projected claims. The Company’s obligation to BCBS, related to incurred but not reported claims, is secured by a letter of credit. As of December 31, 2003, the amount of the letter of credit for BCBS securing such obligations was $6.0 million. The amount of the letter of credit is intended to approximate one month’s claims payments. The policy allows for an adjustment to the letter of credit amount based on premium volume and for increases to the claims payment factor to a maximum of two months of expected claims payments.
Aetna is the Company’s primary medical care benefits provider for approximately 16,000 client employees throughout the remainder of the country including client employees acquired in the November 17, 2003 acquisition of the client service agreements of TeamStaff, Inc. (see “Recent Events – TeamStaff Acquisition”).The Company’s 2004 policy with Aetna provides for an HMO and PPO offering to plan participants. The Aetna HMO medical benefit plans are subject to a guaranteed cost contract that caps the Company’s annual liability. The Aetna PPO medical benefit plan is a retrospective funding arrangement whereby the PPO plan is subject to a 7.5% additional premium if actual claims are greater than projected at the inception of the policy year. Client employees acquired in the TeamStaff acquisition continue to be provided medical care benefits under existing Aetna medical benefit plan policies that are subject to guaranteed cost contracts that cap the Company’s annual liability.
The Company provides coverage under various regional medical benefit plans to approximately 1,000 client employees in various areas of the country. Included in the list of medical benefit plan providers are Kaiser Foundation Health Plan, Inc. in California, Health Partners (Minnesota) in Minnesota, Harvard Pilgrim Healthcare in Massachusetts and Capital Health Plans in the Tallahassee, Florida region.
The Company’s dental plans, which include both a PPO and HMO offering, are primarily provided by Aetna for all client employees who elect coverage. In addition, Delta Dental provides dental coverage for certain client employees acquired in the TeamStaff acquisition. All dental plans are subject to guaranteed cost contracts that cap the Company’s annual liability.
In addition to dental coverage, the Company offers various other guaranteed cost insurance programs to client employees such as vision care, life, accidental death and dismemberment, short-term disability and long-term disability. The Company also offers a flexible spending account for healthcare and dependent care costs.
The Company offers a 401(k) retirement plan, designed to be a “multiple employer” plan under the Internal Revenue Code of 1986, as amended (the “Code”) Section 413(c). This plan design enables owners of clients and highly-compensated client employees, as well as highly-compensated internal employees of the Company, to participate. These persons were previously excluded from the single employer 401(k) retirement plan offered by the Company prior to April 1, 1997, in order to avoid issues of discrimination in favor of highly compensated employees. Generally, employee benefit plans are subject to provisions of both the Code and the Employee Retirement Income Security Act (“ERISA”).
In connection with the TeamStaff acquisition, the Company assumed certain of the TeamStaff employee benefit plans, including a multiple employer 401(k) plan.
The Company has had a loss sensitive workers’ compensation insurance program since January 1, 2000. The program was insured by CNA Financial Corporation (“CNA”) through December 31, 2002 and is currently insured by member insurance companies of American International Group, Inc. (“AIG”) effective January 1, 2003. The insured loss sensitive programs provide insurance coverage for claims incurred in each plan year but which will be paid out over future periods. In states where private insurance is not permitted, client employees are covered by state insurance funds.
The insured loss sensitive programs provide a sharing of risk between the Company and the respective carriers. As part of these programs, the Company has individual stop loss coverage at $1.0 million per occurrence. In addition, the Company has aggregate stop loss coverage for individual claims that in total exceed the aggregate stop loss amount of 175% of expected losses as determined by AIG for the 2003 policy year and 130% of expected losses as determined by CNA for the policy years from January 1, 2000 through December 31, 2002. The actual premium payable is determined based on the industries serviced by the Company, estimated wages and the losses incurred under the program
The 2003 AIG workers’ compensation insurance program provides for a sharing of risk between the Company and AIG whereby AIG assumes risk in at least three areas within the program: (i) individual claim stop loss insurance risk; (ii) aggregate claim stop loss insurance risk; and (iii) premium payment credit risk.
The Company, through its wholly-owned Bermuda-based insurance company, assumes risk related to claims not subject to the individual claim stop loss insurance amount and claims not subject to the aggregate claim stop loss insurance amount.
With respect to the individual claim stop loss insurance risk, the Company is responsible for paying, through AIG, claim amounts related to the first $1 million per occurrence. Claim amounts in excess of $1.0 million per occurrence are insured through the AIG program. The Company, through its Bermuda-based insurance company, remits premiums to AIG to cover AIG’s estimate of claims related to the first $1.0 million per occurrence. Under the 2003 workers’ compensation insurance program, of the $85.0 million of such premiums paid, the Company is guaranteed by AIG to receive a 2.42% per annum fixed return on $73.5 million and 1.85% on the remaining amount so long as the premiums remain with AIG for at least 7 years. If excess premium payments are withdrawn prior to the 7-year period, the interest rate is adjusted downward based upon a sliding scale.
With respect to the aggregate claim stop loss insurance risk, claims amount in excess of 175% of the insurance company’s estimate of expected losses for the policy year are insured through the AIG program. The amount of the expected losses is established at the beginning of the policy year based on an expected volume of payroll. If the payroll volume varies during the year, the amount of the aggregate claim stop loss insurance risk changes proportionately. The Company generally does not pay additional premiums during the policy year unless payroll volume or actual losses exceed certain estimated amounts established at the beginning of the policy year. This results in premium payment credit risk to AIG. Additionally, AIG does not require collateral equal to the limits of the aggregate claim stop loss amount. The absence of this additional collateral requirement results in credit risk to AIG.
Finally, with respect to the premium payment credit risk, this program is a fully insured policy written by AIG. If the Company were to fail to make premium payments to AIG as scheduled, then AIG would be responsible for the payment of all losses under the terms of the policy. AIG required the Company to provide $17.0 million of collateral related to premium payment credit risk. The required collateral is provided in the form of cash and short-term investments placed into a trust account. The Company has reached an agreement with AIG whereby the $17.0 million of collateral related to premium payment credit risk for the 2003 plan year will serve as collateral for the 2004 plan year.
With respect to the CNA programs, the Company retained liability for claims paid during the first year of each program. For the 2000 and 2001 programs, the Company guarantees that the premiums paid during the 2000 and 2001 plan years will earn an annual rate of return equal to seven percent. For the 2002 program the guaranteed rate of return on paid premiums is four and one-quarter percent. The Company is required to pay additional premiums to CNA if the actual return earned by the paid premiums is less than the guaranteed rate of return applicable to each CNA program. The Company has made guaranteed payments in prior years and may do so in the future. Additional premium calls may be made by CNA in later years if the premiums paid by the Company in the first year of each program are not sufficient to fund all claims to be paid under such program, subject to the aggregate stop loss coverage amount and the per occurrence stop loss coverage amount.
The Company is required to provide collateral to each of the insurance carriers based on the carrier’s total projected claims covered under each program. The payment of first year claims by the Company and premium payments to fund claims to be paid by the carriers reduce the total collateral required to be provided by the Company. The required collateral can be provided in the form of deposits paid to the carriers, cash and short-term investments placed into a trust account, letters of credit, and surety bond collateral provided by independent surety bond providers.
The following table summarizes the adjusted specific financial provisions related to the workers’ compensation program for the open program years and includes investment guarantee payments paid to CNA which will ultimately be used to fund claims if needed:
| |
2003 Program Year |
2002 Program Year |
2001 Program Year |
2000 Program Year | |||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| (in thousands) | |||||||||||||||||
| Retained losses | |||||||||||||||||
| and insurance | |||||||||||||||||
| premiums paid | $ | 85,000 | $ | 55,600 | $ | 73,079 | $ | 78,874 | |||||||||
Collateral | |||||||||||||||||
| requirements | $ | 17,000 | $ | 20,696 | $ | 23,998 | $ | 34,000 | |||||||||
The 2003 program year is subject to final audit in 2004, and may be subject to further collateral adjustments at that time.
Prior to January 1, 2000, the Company’s workers’ compensation coverage was provided on a guaranteed cost basis. The Company has no liability for periods prior to January 1, 2000.
As of December 31, 2003, the Company had 954 internal employees of whom 477 were located at the Company’s headquarters in Bradenton, Florida. The remaining employees were located in the Company’s branch offices. None of the Company’s internal employees is covered by a collective bargaining agreement.
In order to utilize the Company’s professional services, all clients are required to enter into the Company’s Professional Services Agreement (“PSA”). The PSA generally provides for an initial one-year term, subject to termination by the Company or the client at any time upon 30 days prior written notice. Following the initial term, the contract may be renewed, terminated or continued on a month-to-month basis. In this context, the client and the Company are each viewed as and become a “co-employer” of the client’s employees. In this regard, the Company operates as a licensed Professional Employer Organization (“PEO”).
The Company retains the ability to immediately terminate the client and co-employment relationship upon non-payment by a client. The Company manages its credit risk through the periodic nature of payroll, client credit checks, owner guarantees, the Company’s client selection process and its right to terminate the PSA and the co-employment relationship with the client employees.
Under the PSA, employment-related liabilities are contractually allocated between the Company and the client. For instance, the Company assumes responsibility for, and manages the risks associated with, each client’s employee payroll obligations, including the liability for payment of salaries and wages (including payroll taxes) to each client employee and, at the client’s option, responsibility for providing group health, welfare, and retirement benefits to such individuals. These obligations of the Company are fixed, whether or not the client makes timely payment of the associated service fee. In this regard, it is important to understand that, unlike payroll processing service providers, the Company issues to each of the client employees Company payroll checks drawn on the Company’s bank accounts. The Company also reports and remits all required employment information and taxes to the Internal Revenue Service (“IRS”) and issues a Federal Form W-2 to each client employee under the appropriate Company FEIN. The Company assumes the responsibility for compliance with those employment-related governmental regulations that can be effectively managed away from the client’s worksite. The Company provides workers’ compensation insurance coverage to each client employee under the Company’s master insurance policy. The client, on the other hand, contractually retains the general day-to-day responsibility to direct, control, hire, terminate and manage each of the client’s employees. The client employee services are performed for the exclusive benefit of the client’s business. The client also remains responsible for compliance with those employment-related governmental regulations that are more closely related to the day-to-day management of client employees.
In some cases, employment-related liabilities are shared between the Company and the client. The following table summarizes the general division of responsibilities for employment related regulatory compliance under the PSA:
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CLIENT
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• All rules and regulations governing the reporting, collection and payment of federal and state payroll taxes on wages, including: (i) federal income tax withholding provisions of the Internal Revenue Code; (ii) state and/or local income tax withholding provisions; (iii) FICA; (iv) FUTA; and (v) applicable state unemployment tax provisions, including managing claims • Appicable workers' compensation laws that cover: (i) procuring workers' compensation insurance; (ii) completing and filing all required reports; and (iii) claims processing • COBRA (Consolidated Omnibus Budget Reconciliation Act of 1986) continuation coverage for employees covered under health plans sponsored by Gevity • Laws governing the garnishment of wages, including Title III of the Consumer Credit Protection Act • All rules and regulations governing administration, procurement and payment of all Company sponsored employee benefit plans elected by the client or worksite employee • Fair Labor Standars Act and the Family and Medical Leave Act of 1993* |
• Worksite and employee safety under the Occupational Safety and Health Act ("OSHA") and related or similar Federal, state or local regulations • Government contracting requirements as regulated by, including, but not limited to: (i) Executive Order 11246; (ii) Vocational Rehabilitation Act of 1973; (iii) Vietnam Era Veteran's Readjustment Assistance Act of 1974; (iv) Walsh-Healy Public Contracts Act; (v) Davis-Bacon Act; (vi) the Service Contract Act of 1965; and (vii) any and all similar, related or like Federal, state or local laws, regulations, ordinances and statutes • Professional licensing and liability • Internal Revenue Code Sections 414(m), (n) and (o) relating to client maintained benefit plans • Laws affecting the assignment and ownership of intellectual property rights • Worker Adjustment and Retraining Notification Act • Laws affecting the maintenance, storage and disposal of hazardous materials • Title VII (Civil Rights Act of 1964, as amended), Immigration Reform and Control Act, the Americans with Disabilities Act, the Age Discrimination in Employment Act, Older Workers Benefit Protection Act • All other federal, state, county or local laws, regulations, ordinances and statutes which regulate employees' wage and hour matters, prohibit discrimination in the workplace or govern the employer/employee relationship • Fair Labor Standards Act and the Family and Medical Leave Act of 1993* |
* Gevity and the client are each responsible for certain provisions under the terms of each act.
The Company charges its clients a professional service fee that is designed to yield a profit and to cover the cost of certain employment-related taxes, workers’ compensation insurance coverage and human resource services provided to the client. The component of the professional service fee related to human resource management varies according to the size of the client, the amount and frequency of the payroll payments and the method of delivery of such payments. The component of the service fee related to workers’ compensation and unemployment insurance is based, in part, on the client’s historical claims experience. In addition, the client may choose to offer certain health, welfare and retirement benefits to its client employees. The Company invoices each client for the service fee and costs of selected benefit plans and the wages and other employment-related taxes of each client employee. The gross billings are invoiced at the time that each periodic payroll is delivered to the client.
Numerous federal and state laws and regulations relating to employment matters, benefit plans and employment taxes affect the operations of the Company or specifically address issues associated with co-employment. Many of these federal and state laws were enacted before the development of non-traditional employment relationships, such as PEOs, temporary employment and other employment-related outsourcing arrangements and, therefore, do not specifically address the obligations and responsibilities of a PEO.
Furthermore, because some of these regulations are relatively new, their interpretation and application of these regulations by administrative agencies and Federal and state courts are limited or non-existent. The development of additional regulations and interpretation can be expected to evolve over time. In addition, from time to time, states have considered, and may in the future consider, imposing certain taxes on gross revenues or service fees of the Company and its competitors.
Twenty-two states, including five states where the Company has offices (Florida, New York, Texas, Colorado, Tennessee and Minnesota), have passed laws that have licensing, registration or other regulatory requirements for PEOs, and several other states are currently considering similar regulation. Such laws vary from state to state, but generally codify the requirements that a PEO must reserve the right to hire, terminate and discipline client employees and secure workers’ compensation insurance coverage. In certain instances, the Company delegates or assigns such rights to the client. The laws also generally provide for monitoring the fiscal responsibility of PEOs and, in many cases, the licensure of the controlling officers of the PEO.
The Company believes that its operations are currently in compliance in all material respects with applicable Federal and state statutes and regulations.
In order to qualify for favorable tax treatment under the Code, 401(k) plans must be established and maintained by an employer for the exclusive benefit of its employees. Generally, an entity is an “employer” of certain workers for federal employment tax purposes if an employment relationship exists between the entity and the workers under the common law test of employment. In addition, the officers of a corporation are deemed to be employees of that corporation for federal employment tax purposes. The common law test of employment, as applied by the IRS, involves an examination of many factors to ascertain whether an employment relationship exists between a worker and a purported employer. Such a test is generally applied to determine whether an individual is an independent contractor or an employee for federal employment tax purposes and not to determine whether each of two or more companies is a “co-employer.” Substantial weight is typically given to the question of whether the purported employer directs and controls the details of an individual’s work. The courts have provided that the common law employer test applied to determine the existence of an employer-employee relationship for federal employment tax purposes can be different than the common law test applied to determine employer status for other federal tax purposes. In addition, control and supervision have been held to be less important factors when determining employer status for ERISA purposes.
On May 13, 2002, the IRS released guidance applicable solely to the tax-qualified status of defined contribution retirement plans maintained by PEOs. In that guidance, the IRS declared that it would not assert a violation of the exclusive benefit rule under Section 401(a) of the Code if a PEO that maintains a single employer 401(k) retirement plan for client employees takes certain remedial action by the last day of the first plan year beginning on or after January 1, 2003.
The Company previously maintained a frozen single employer 401(k) retirement plan benefiting certain client employees and took remedial action to qualify for the relief provided under the IRS guidance within the applicable deadline. As part of the remedial action, all of the plan’s assets (approximately $0.9 million) were transferred out of the plan, as directed by participants, and the plan was terminated.
The status of the active multiple employer 401(k) retirement plans maintained by the Company are unaffected by the IRS guidance.
Employee pension and welfare benefit plans are also governed by ERISA. ERISA defines an “employer” as “any person acting directly as an employer, or indirectly in the interest of an employer, in relation to an employee benefit plan.” ERISA defines the term “employee” as “any individual employed by an employer.” The courts have held that the common law test of employment must be applied to determine whether an individual is an employee or an independent contractor under ERISA. However, in applying that test, control and supervision are less important for ERISA purposes when determining whether an employer has assumed responsibility for an individual’s benefits status. A definitive judicial interpretation of “employer” in the context of a PEO or employee leasing arrangement has not been established.
If the Company were found not to be an employer for ERISA purposes, its former 401(k) retirement plan would not comply with ERISA and could be subject to retroactive disqualification by the IRS. Further, the Company would be subject to liabilities, including penalties, with respect to its cafeteria benefits plan for failure to withhold and pay taxes applicable to salary deferral contributions by its client employees. In addition, as a result of such a finding, the Company and its plans would not enjoy, with respect to client employees, the preemption of state laws provided by ERISA and could be subject to varying state laws and regulation, as well as to claims based upon state common laws.
As an employer, the Company assumes responsibility and liability for the payment of Federal and state employment taxes with respect to wages and salaries paid to client employees. There are essentially three types of Federal employment tax obligations: (i) withholding of income tax governed by Code Section 3401, et seq.; (ii) obligations under the Federal Income Contributions Act (“FICA”), governed by Code Section 3101, et seq.; and (iii) obligations under the Federal Unemployment Tax Act (“FUTA”), governed by Code Section 3101, et seq. Under these Code sections, employers have the obligation to withhold and remit the employer portion and, where applicable, the employee portion of these taxes.
Among other employment tax issues related to whether PEOs are employers of client employees are issues under the Code provisions applicable to Federal employment taxes. The issue arises as to whether the Company is responsible for payment of employment taxes on wages and salaries paid to such client employees. Code Section 3401(d)(1), which applies to Federal income tax withholding requirements, contains an exception to the general common law test applied to determine whether an entity is an “employer” for purposes of Federal income tax withholding. The courts have extended this common law employer exception to apply for both FICA and FUTA tax purposes. Code Section 3401(d)(1) states that if the person for whom services are rendered does not have control of the payment of wages, the “employer” for this purpose is the person having control of the payment of wages. The Treasury Regulations issued under Code Section 3401(d)(1) state that a third party can be deemed to be the employer of workers under this Section for income tax withholding purposes where the person for whom services are rendered does not have legal control of the payment of wages. Although several courts have examined Code Section 3401(d)(1) with regard to PEOs, its ultimate scope has not been delineated. Moreover, the IRS has, to date, relied extensively on the common law test of employment in determining liability for failure to comply with Federal income tax withholding requirements.
Accordingly, while the Company believes that it can assume the withholding obligations for client employees, if the Company fails to meet these obligations, the client may be held jointly and severally liable. While this interpretive issue has not, to the Company’s knowledge, discouraged clients from utilizing the Company’s services, there can be no assurance that a definitive adverse resolution of this issue would not do so in the future.
On November 17, 2003, the Company acquired the human resource outsourcing client portfolio of TeamStaff, Inc., a New Jersey corporation (“TeamStaff”) together with certain other assets. The transaction was accomplished through an assignment by TeamStaff (and its subsidiaries) to the Company of all of its client service agreements, which covered over 1,500 clients and over 16,000 client employees. The other assets acquired consisted primarily of a proprietary benefits reconciliation software program and leases of certain office space occupied by TeamStaff. In addition, approximately 70 internal employees of TeamStaff became employees of the Company.
The purchase price for the acquired assets was $9.7 million (including direct acquisition costs of approximately $0.2 million), which the Company paid in cash from its internal funds. Of this amount, $2.5 million is being held in an escrow account and will be disbursed based upon the retention of clients acquired by the Company from TeamStaff and new clients obtained by former sales personnel of TeamStaff. Retention will be measured by the comparison of annualized professional service fees for the transferred clients as of November 17, 2003, to the annualized professional service fees for the total of all former TeamStaff clients and new clients obtained by former TeamStaff sales personnel that process a payroll after February 14, 2004. To the extent that the annualized professional fee for those client payrolls after February 14, 2004, is less than the November 17, 2003 annualized professional fee, the amount of such difference will be paid from the escrow account (up to a maximum of $2.5 million) to the Company. The remaining escrow balance, if any, will be paid to TeamStaff. The Company estimates that client retention during the measurement period will be in excess of 90%. See the further discussion at Note 8 to the Consolidated Financial Statements.