1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1997
COMMISSION FILE NUMBER 000-23343
NOVACARE EMPLOYEE SERVICES, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 23-2866146
(State of incorporation) (I.R.S. Employer Identification No.)
2621 VAN BUREN AVENUE, NORRISTOWN, PA 19403
(Address of principal executive office) (Zip code)
Registrant's telephone number: (610) 650-4700
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 X * No
------ ------
* The Company consummated its initial public offering on November 11, 1997
and until this filing has not been obligated to file reports under the
Securities Exchange Act of 1934, as amended.
As of December 5, 1997, NovaCare Employee Services, Inc. had 25,613,187 shares
of common stock, $.01 par value, outstanding.
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NOVACARE EMPLOYEE SERVICES, INC. AND SUBSIDIARIES
FORM 10-Q - QUARTER ENDED SEPTEMBER 30, 1997
INDEX
PART NO. ITEM NO. DESCRIPTION PAGE NO.
- -------- -------- ----------- --------
I FINANCIAL INFORMATION
1 Financial Statements
- Condensed Consolidated Balance Sheets as of
September 30, 1997 and June 30, 1997 1
- Condensed Consolidated Statements of
Operations for the Three Months Ended
September 30, 1997 2
- Condensed Consolidated Statements of Cash Flows
for the Three Months Ended September 30, 1997 3
- Notes to Condensed Consolidated Financial
Statements 4-9
2 Management's Discussion and Analysis of Financial
Condition and Results of Operations 10-13
II OTHER INFORMATION
4 Submission of Matters to a Vote of Security Holders 14
6 Exhibits and Reports on Form 8-K 14
Signature 15
i
3
NOVACARE EMPLOYEE SERVICES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
AS OF SEPTEMBER 30, 1997 AND JUNE 30, 1997
(In thousands, except per share data)
SEPTEMBER 30, June 30,
1997 1997
---------------- -----------------
ASSETS (UNAUDITED) (See Note 1)
Current assets:
Cash and cash equivalents ................................................ $ 2,428 $ 1,782
Accounts receivable:
Related party ........................................................ 30,524 27,607
Unbilled ............................................................. 7,292 7,215
Third parties, net of allowance for doubtful accounts at September 30,
1997 and at June 30, 1997 of $64 and $26,
respectively ....................................................... 5,234 1,910
Other current assets ..................................................... 1,551 1,365
--------- --------
Total current assets ................................................. 47,029 39,879
Property and equipment, net ................................................. 2,148 1,326
Excess cost of net assets acquired, net ..................................... 53,081 53,691
Other assets, net ........................................................... 1,902 1,102
--------- --------
$ 104,160 $ 95,998
========= ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current portion of financing arrangements ................................ $ 296 $ 298
Accounts payable and accrued expenses .................................... 5,786 6,172
Accrued salaries, wages and payroll taxes ................................ 27,408 28,159
Current portion of accrued workers' compensation and health claims ....... 13,122 5,423
Note payable to related party ............................................ 28,382 28,382
Current portion of deferred purchase price obligations ................... 18,905 18,905
Income taxes payable ..................................................... 2,194 1,382
--------- --------
Total current liabilities ............................................ 96,093 88,721
Financing arrangements, net of current portion ........................... 994 1,068
Other .................................................................... 3,221 3,177
--------- --------
Total liabilities .................................................... 100,308 92,966
--------- --------
Mandatorily redeemable common stock ......................................... 3,586 2,731
Commitments and contingencies ............................................... -- --
Shareholders' equity:
Preferred stock, $.01 par value; authorized 1,000 shares; no shares
issued or outstanding .................................................. -- --
Common stock, $.01 par value; authorized 60,000 shares; issued
20,393 shares at September 30, 1997 and issued 19,193 shares at
June 30, 1997 .......................................................... 204 192
Additional paid-in capital ............................................... 1,226 1,189
Retained earnings ........................................................ 82 --
--------- --------
1,512 1,381
Less:Common stock in treasury (at cost), 563 shares at September 30, 1997
and June 30, 1997 ................................................ (1,080) (1,080)
Deferred compensation, net .......................................... (166) --
--------- --------
Total shareholders' equity .......................................... 266 301
--------- --------
$ 104,160 $ 95,998
========= ========
The accompanying Notes to Consolidated Financial Statements are an integral part
of these statements.
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NOVACARE EMPLOYEE SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1997
(In thousands, except per share data)
(Unaudited)
FOR THE THREE
MONTHS ENDED
SEPTEMBER 30,
1997
--------------
Revenues:
Related party ........................................................ $ 176,092
Third parties ........................................................ 90,665
---------
Total revenues ................................................... 266,757
Direct Costs:
Related party:
Salaries, wages and employment taxes of worksite employees ....... 161,437
Healthcare and workers' compensation, state unemployment and other 10,689
Third parties:
Salaries, wages and employment taxes of worksite employees ....... 81,063
Healthcare and workers' compensation, state unemployment and other 5,240
---------
Gross profit ................................................... 8,328
Selling, general and administrative expenses ............................ 5,592
Provision for uncollectible accounts .................................... 38
Amortization of excess cost of net assets acquired ...................... 572
---------
Income from operations ........................................... 2,126
Investment income ....................................................... 58
Interest expense ........................................................ (19)
Interest expense -- related party ....................................... (414)
---------
Income before income taxes ...................................... 1,751
Income taxes ............................................................ 814
---------
Net income ....................................................... $ 937
=========
Historical information (Note 3):
Net income applicable to common stock ............................ $ 82
=========
Net income per common share ...................................... $ --
=========
Weighted average shares outstanding .............................. 20,574
=========
Pro Forma information:
Pro Forma net income ............................................. $ 937
=========
Pro Forma net income per share ................................... $ .05
=========
Weighted average shares outstanding .............................. 20,574
=========
Supplemental pro forma information:
Supplemental pro forma net income ................................ $ 1,122
=========
Supplemental pro forma net income per share ...................... $ .04
=========
Supplemental pro forma weighted average shares outstanding ....... 25,574
=========
The accompanying Notes to Consolidated Financial Statements are an integral part
of these statements.
2
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NOVACARE EMPLOYEE SERVICES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(In thousands, except per share data)
(Unaudited)
FOR THE THREE
MONTHS ENDED
SEPTEMBER 30,
1997
--------------
CASH FROM OPERATING ACTIVITIES:
Net income ..................................................................... $ 937
Adjustments to reconcile net income to net cash flows from operating activities,
net of effects from acquisitions:
Depreciation and amortization .............................................. 790
Provision for uncollectible accounts ....................................... 38
Changes in assets and liabilities, net of effects from acquisitions:
Accounts receivable -- third parties .................................... (1,669)
Accounts receivable -- related party .................................... (5,138)
Other current assets .................................................... (161)
Accounts payable and accrued expenses ................................... (343)
Accrued salaries, wages, and payroll taxes .............................. (751)
Accrued interest -- related party ....................................... 414
Accrued workers compensation and health claims .......................... 7,199
Income taxes payable .................................................... 789
Other, net .............................................................. (105)
-------
Net cash flows provided by operating activities ...................... 2,000
-------
CASH FROM INVESTING ACTIVITIES:
Payments for businesses acquired, net of cash acquired ......................... 20
Additions to property and equipment ............................................ (438)
Other, net ..................................................................... (454)
-------
Net cash flows (used in) investing activities ........................ (872)
-------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payment of long-term debt and credit arrangements .............................. (76)
Other, net ..................................................................... (406)
-------
Net cash flows (used in) financing activities ........................ (482)
-------
Net increase in cash and cash equivalents ...................................... 646
Cash and cash equivalents, beginning of period ................................. 1,782
-------
Cash and cash equivalents, end of period ....................................... $ 2,428
=======
Supplemental disclosures of cash flow information:
Interest paid .............................................................. $ 15
=======
Income taxes paid .......................................................... $ 25
=======
The accompanying Notes to Consolidated Financial Statements are an integral part
of these statements.
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NOVACARE EMPLOYEE SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1997
(In thousands, except per share data)
(Unaudited)
1. BASIS OF PRESENTATION
NovaCare Employee Services, Inc. (the "Company") is a national
professional employer organization ("PEO") that provides small and
medium-sized businesses with comprehensive, fully integrated outsourcing
solutions to human resource issues, including payroll management, risk
management, benefits administration, unemployment services, rehabilitation
temporary staffing and human resource consulting services.
The Company was established by NovaCare, Inc. (the "Parent") in
September 1996 as a subsidiary and began operation in October 1996 with the
acquisition of one PEO business. In February 1997, the Company acquired
three additional PEO businesses and entered into a contract with the Parent
to co-employ substantially all of the Parent's workforce (the "NovaCare
Contract").
The accompanying condensed consolidated financial statements of the
Company are unaudited. The balance sheet as of June 30, 1997 is condensed
from the audited balance sheet of the Company at that date. These
statements have been prepared in accordance with the rules and regulations
of the Securities and Exchange Commission and should be read in conjunction
with the Company's consolidated financial statements and notes thereto for
the period ended June 30, 1997 contained in the Company's final prospectus
dated November 11, 1997. Certain information and footnote disclosures
normally in the financial statements prepared in accordance with generally
accepted accounting principles have been condensed or omitted pursuant to
such rules and regulations. In the opinion of Company management, the
condensed consolidated financial statements for the unaudited interim
periods presented include all adjustments (consisting of only normal
recurring adjustments) necessary to present a fair statement of the
Company's financial position and results of operations as of and for the
three months ended September 30, 1997.
Operating results for the three-month period ended September 30, 1997
are not necessarily indicative of the results that may be expected for a
full year or any portion thereof.
2. INITIAL PUBLIC OFFERING AND PRO FORMA INFORMATION
On November 11, 1997, the Company completed an initial public offering
of its common stock selling 5,000 shares (the "Offering"). The Company will
use the majority of the net proceeds of the Offering, along with borrowings
under the Company's revolving credit agreement described below, to pay (i)
the Company's outstanding revolving credit loan of approximately $28,382
from the Parent, (ii) $1,000 to an affiliate of the Company who is a former
owner of a business acquired by the Company, and (iii) $16,500 to retire
deferred purchase obligations. Simultaneously with the completion of the
Offering, the Company's mandatorily redeemable common stock was converted
into 813 shares of the Company's common stock.
Immediately subsequent to the consummation of the Offering, the Company
entered into a $25,000 three-year revolving credit agreement with a group
of financial institutions. The credit agreement provides for interest at a
variable rate, depending on certain financial ratios, equal to (a) the
EuroDollar rate plus a range of 1.375 % to 2.50% or (b) the lead bank's
prime rate plus a range of .125% to 1.25%. Loans made under the credit
agreement are collaterized by a pledge of all of (i) the Company's interest
in the common stock of its subsidiaries, (ii) the assets of the Company and
its subsidiaries, and (iii) the Parent's interest in the common stock of
the Company.
4
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NOVACARE EMPLOYEE SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1997
(In thousands, except per share data)
(Unaudited)
2. INITIAL PUBLIC OFFERING AND PRO FORMA INFORMATION (CONTINUED)
The following pro forma information gives effect to the Offering, the
distributions to the Parent and affiliate, retirement of deferred purchase
obligations and the conversion of mandatorily redeemable stock as if such
transactions occurred as of September 30, 1997:
HISTORICAL ADJUSTMENTS PRO FORMA
---------------- -------------- --------------
ASSETS
Current assets:
Cash and cash equivalents .................................. $ 2,428 $ -- $ 2,428
Accounts receivable ........................................ 43,050 -- 43,050
Other current assets ....................................... 1,551 -- 1,551
--------- --------- ---------
Total current assets .................................. 47,029 -- 47,029
Other assets, net .......................................... 57,131 (945)(1) 56,186
--------- --------- ---------
$ 104,160 $ (945) $ 103,215
========= ========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current portion of financing arrangements .................. $ 296 $ -- $ 296
Accounts payable and accrued expenses ...................... 48,510 48,510
Notes payable to related party ............................. 28,382 (28,382)(2) --
Current portion of deferred purchase price obligations ..... 18,905 (17,500)(2) 1,405
--------- --------- ---------
Total current liabilities .......................... 96,093 (45,882) 50,211
Financing arrangements, net of current portion ............. 994 4,307(2) 5,301
Other ...................................................... 3,221 -- 3,221
--------- --------- ---------
Total liabilities .................................. 100,308 (41,575) 58,733
--------- --------- ---------
Mandatorily redeemable common stock .......................... 3,586 (3,586)(3) --
Commitments and contingencies ................................ -- -- --
Shareholders' equity:
Preferred stock, $.01 par value; authorized 1,000 shares; no
shares issued or outstanding ............................. -- -- --
Common stock, $.01 par value; authorized 60,000 shares;
issued 20,393 shares (pro forma 26,206) .................. 204 58(4) 262
Additional paid-in capital ................................. 1,226 44,158(4) 45,384
Retained earnings .......................................... 82 -- 82
--------- --------- ---------
1,512 44,216 45,728
Less: Common stock in treasury (at cost), 563 shares ....... (1,080) -- (1,080)
Deferred compensation, net ........................... (166) -- (166)
--------- --------- ---------
Total shareholders' equity ........................... 266 44,216 44,482
--------- --------- ---------
$ 104,160 $ (945) $ 103,215
========= ========= =========
- -----------
(1) Represents the reclassification of certain costs, previously incurred
related to the Offering of the Company's common stock, to additional
paid-in capital.
5
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NOVACARE EMPLOYEE SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1997
(In thousands, except per share data)
(Unaudited)
2. INITIAL PUBLIC OFFERING AND PRO FORMA INFORMATION (CONTINUED)
(2) Reflects the retirement of certain liabilities by applying the estimated
net proceeds of the Offering and borrowing under the Company's credit
agreement as if the Offering and borrowing had occurred at September 30,
1997. The remaining deferred purchase price obligations relate to
guaranteed payments due at specified dates subsequent to the Offering.
Shares offered in the Offering
(5,000 shares at $9.00 public offering price).................. $ 45,000
Less:
Offering costs incurred to date................................ (945)
Additional costs estimated..................................... (3,425)
------------
Net proceeds.............................................. 40,630
Payment of deferred purchase price obligations................. (17,500)
Plus: Offering costs incurred to date......................... 945
------------
Cash from the Offering used to reduce note payable to
shareholder............................................ 24,075
Borrowing under the Company's credit agreement................. 4,307
------------
Cash paid to retire note payable to related party......... $ 28,382
============
(3) Reflects the conversion of the 813 shares of mandatorily redeemable
common stock to permanent equity.
(4) The adjustment to common stock and additional paid-in capital is as
follows:
ADDITIONAL
PAID-IN
COMMON STOCK CAPITAL
------------ -----------
Shares offered in the Offering..................................... $ 50 $ 40,580
Conversion of mandatorily redeemable common stock.................. 8 3,578
--------- ----------
Adjustment..................................................... $ 58 $ 44,158
========= ==========
3. HISTORICAL, PRO FORMA AND SUPPLEMENTAL PRO FORMA NET INCOME PER SHARE
Net income per share has been computed in accordance with Securities
and Exchange Commission Staff Accounting Bulletin No. 83 ("SAB 83"). SAB 83
requires that common shares issued by the Company in the twelve months
immediately preceding a proposed public offering plus the number of common
equivalent shares which became issuable during the same period pursuant to
the grant of stock options at prices substantially less than the initial
public offering price be included in the calculation of common stock and
common stock equivalent shares, using the treasury stock method, as if they
were outstanding for all periods presented.
Historical net income per share is computed by dividing net income, net
of accretion of mandatorily redeemable common stock, by the number of
common stock and common stock equivalents outstanding at September 30,
1997.
Pro forma net income per share is computed by dividing net income,
without giving consideration to the accretion of mandatorily redeemable
common stock, by the number of shares of common stock and common stock
equivalents outstanding as of September 30, 1997.
6
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NOVACARE EMPLOYEE SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1997
(In thousands, except per share data)
(Unaudited)
3. HISTORICAL, PRO FORMA AND SUPPLEMENTAL PRO FORMA NET INCOME PER SHARE
(CONTINUED)
The Company used the majority of the net proceeds from the Offering to
retire certain indebtedness, and therefore has presented supplemental pro
forma net income per common share in the accompanying financial statements.
Supplemental net income per share is computed by dividing net income,
adjusted for the elimination of applicable interest expense, net of related
income tax effect, by total outstanding shares as of September 30, 1997
plus the additional shares sold at the Offering, to retire outstanding
debt.
The calculation of historical net income per share applicable to common
stock, pro forma net income per share and supplemental pro forma net income
per share is as follows:
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 1997
-----------------------------------------------------
SUPPLEMENTAL
HISTORICAL PRO FORMA PRO FORMA
----------------- -------------- --------------
Net income .................................................. $ 937 $ 937 $ 937
ADJUSTMENT TO NET INCOME:
Deduct - Accretion of mandatorily redeemable common stock . (855) -- --
Add - Elimination of interest, net of tax, upon assumed
payment of debt ......................................... -- -- 185
-------- ------- -------
Net income attributable to common stock ................... $ 82 $ 937 $ 1,122
======== ======= =======
WEIGHTED AVERAGE SHARES OUTSTANDING (1):
Shares issued ............................................ 19,326 19,326 19,326
Mandatorily redeemable common stock ...................... 662 662 662
Common equivalent - guaranteed stock payments to be issued 301 301 301
Common equivalent - stock options ........................ 285 285 285
Common equivalent - debt retired ......................... -- -- 5,000
-------- ------- -------
Weighted average shares outstanding ...................... 20,574 20,574 25,574
-------- ------- -------
Net income per share ..................................... $ -- $ .05 $ .04
======== ======= =======
- -------
(1) Calculated using the treasury stock method, in accordance with SAB 83.
4. RELATED PARTY TRANSACTIONS
Effective July 1, 1997, the Company issued 1,200 shares of its common
stock, valued at $5,400, to acquire the assets and liabilities of NovaPro,
formerly a business of the Parent, in a transaction accounted for as a
purchase. Because the transaction occurred between companies under common
control, the transfer of assets and liabilities was recorded at the
historical cost basis of the Parent. The excess paid over the historical
cost has been treated as a reduction of additional paid-in capital.
7
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NOVACARE EMPLOYEE SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1997
(In thousands, except per share data)
(Unaudited)
4. RELATED PARTY TRANSACTIONS (CONTINUED)
Information with respect to the business acquired in a purchase
transaction for the three months ended September 30, 1997 is as follows:
Stock issued....................................................... $ 5,400
Liabilities assumed and other consideration........................ 2,458
------------
7,858
Less: Historical cost basis of assets acquired, principally
accounts receivable and property and equipment.................. (2,334)
------------
Excess paid over the historical cost recorded as a reduction of
additional paid-in capital...................................... $ 5,524
============
The terms of the aforementioned related party transactions are
equivalent to those that would result from transactions among unrelated
parties.
5. PROPERTY AND EQUIPMENT
The components of property and equipment were as follows:
SEPTEMBER 30, June 30,
1997 1997
------------- ----------
Land and buildings ............................. $ 70 $ 70
Property, equipment and furniture .............. 1,954 1,019
Leasehold improvements ......................... 198 162
Capitalized software ........................... 249 240
------- -------
2,471 1,491
Less: Accumulated depreciation and amortization (323) (165)
------- -------
$ 2,148 $ 1,326
======= =======
7. ACCRUED WORKERS' COMPENSATION AND HEALTH CLAIMS
The Company's accruals for claims are summarized as follows:
SEPTEMBER 30, June 30,
1997 1997
------------- -----------
Accrued health benefit premiums payable and claims reserves ............... $ 11,249 $ 3,756
Accrued workers' compensation premiums payable and claims reserves ........ 3,737 3,577
-------- -------
14,986 7,333
Less: Workers' compensation claims expected to be settled in more than one
year ............................................................... (1,864) (1,910)
-------- -------
$ 13,122 $ 5,423
======== =======
8
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NOVACARE EMPLOYEE SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1997
(In thousands, except per share data)
(Unaudited)
7. MANDATORILY REDEEMABLE COMMON STOCK
In connection with fiscal 1997 acquisitions, mandatorily redeemable
common stock was issued which provides certain registration and valuation
rights. On November 11, 1997, all 813 shares of mandatorily redeemable
stock were automatically converted into common stock (see note 2).
8. DEFERRED COMPENSATION
On August 8 and September 5, 1997, the Company granted options to
purchase shares of common stock at an exercise price of $4.50 per share.
There was no trading market for the common stock as of each respective
date. For financial statement purposes, a fair market value for the common
stock of $7.12 on August 8, 1997, and $9.00 on September 5, 1997, has been
determined by the Board of Directors based on a straight line increase from
$4.50 at July 1, 1997, to the public offering price of $9.00.
Accordingly, the Company has recorded deferred compensation expense,
based on the difference between the exercise price and the fair market
value of the common stock on the date of grant, in the aggregate amount of
$172. This amount is recognized as compensation expense, on a straight line
basis, over the vesting period of five years. The unamortized portion of
deferred compensation is recorded as a reduction to shareholders' equity.
9. COMMITMENTS AND CONTINGENCIES
The Company is subject to legal proceedings and claims which arise in
the ordinary course of its business. In the opinion of management, the
amount of ultimate liability, if any, with respect to these actions will
not have a materially adverse effect on the financial position or results
of operations of the Company.
With respect to acquisitions completed in fiscal 1997, certain purchase
agreements require additional payments if specific financial targets and
non-financial conditions are met. Aggregate contingent payments in
connection with these acquisitions at September 30, 1997 of approximately
$2,100 in cash and 100 shares of common stock have not been included in the
initial determination of cost of the businesses acquired since the amount
of such contingent consideration, if any, is not presently determinable.
The Company's operations are subject to numerous Federal, state and
local laws related to employment, taxes and benefit plan matters.
Generally, these regulations affect all companies in the United States.
However, the regulatory environment for professional employer organizations
is an evolving area due to uncertainties resulting from the non-traditional
employment relationships. Many Federal and state laws relating to tax and
employment matters were enacted prior to the development of PEO companies
and do not specifically address the obligations and responsibilities of
these co-employer relationships. The Internal Revenue Service (the "IRS")
is conducting a market segment study of the PEO industry (the "Market
Segment Study") focusing on selected PEOs (not including the Company) in
order to examine the relationship among PEOs, their clients, worksite
employees, and the owners of clients. The IRS has indicated that the Market
Segment Study is expected to be completed by January 1998. If the IRS
concludes that PEOs are not "employers" of certain worksite employees for
purposes of the Code, the Company's cafeteria plan may lose its favorable
tax status, and the Company may no longer be able to assume its clients'
Federal employment tax withholding obligations.
9
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NOVACARE EMPLOYEE SERVICES, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
(In thousands, except per share data)
OVERVIEW
NovaCare Employee Services, Inc. (the "Company") is one of the largest
professional employer organizations ("PEO"s) in the United States. The
Company commenced operations on October 1, 1996, concurrent with the
acquisition of one PEO business. In February 1997, the Company acquired
three additional PEO businesses and signed an agreement with NovaCare, Inc.
(the "Parent") to provide traditional PEO services to principally all of
the Parent's worksite employees (the "NovaCare Contract"). On July 1, 1997,
the Company acquired NovaPro, a rehabilitation temporary staffing business,
from the Parent. As of September 30, 1997, the Company served 1,763
organizations with 36,666 employees at over 3,000 worksites in 45 states,
principally in 10 different industries. The Company is an employee services
company which provides small and medium-sized businesses with
comprehensive, fully integrated outsourcing solutions to human resource
issues, including payroll management, risk management, benefits
administration, unemployment services and human resource consulting
services.
RESULTS OF OPERATIONS
Because the Company commenced operations on October 1, 1996, it had no
comparative results for the corresponding quarter in fiscal 1997.
The following table sets forth certain income statement and statistical
data for the quarter ended September 30, 1997, compared with the quarter
ended June 30, 1997.
FOR THE PERIOD FROM:
-----------------------------------------------------------------------------
JULY 1, TO APRIL 1, TO
SEPTEMBER 30, 1997 JUNE 30, 1997
OPERATING RESULTS: $ % $ %
---------------- ---------------- ---------------- ----------------
Revenues ............................ $ 266,757 100.0% $ 232,223 100.0%
Direct costs:
Salaries, wages and employment taxes
of worksite employees ............ 242,500 90.9% 211,425 91.0%
Health care, workers' compensation,
state unemployment taxes and other 15,929 6.0% 14,130 6.1%
--------- ----- --------- -----
Gross profit ...................... 8,328 3.1% 6,668 2.9%
Selling, general and administrative
expenses .......................... 5,630 2.1% 4,397 1.9%
Amortization of excess cost of net
assets acquired ................... 572 0.2% 567 0.2%
--------- ----- --------- -----
Income from operations ............ 2,126 0.8% 1,704 0.8%
Interest expense, net ............... (375) (0.1)% (405) (0.2)%
--------- ----- --------- -----
Income before income taxes ........ 1,751 0.7% 1,299 0.6%
Income tax expense .................. 814 0.3% 888 0.4%
--------- ----- --------- -----
Net income ........................ $ 937 0.4% $ 411 0.2%
========= ===== ========= =====
10
13
NOVACARE EMPLOYEE SERVICES, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
(In thousands, except per share data)
FOR THE PERIOD FROM
(IN THOUSANDS EXCEPT STATISTICAL DATA):
---------------------------------------
JULY 1, TO APRIL 1, TO
SEPTEMBER 30, JUNE 30,
1997 1997
------------- -----------
STATISTICAL DATA:
EBITDA (in thousands) (1) ........................................... $ 2,916 $ 2,407
Number of clients at period end ..................................... 1,763 1,742
Worksite employees at period end:
Third parties .................................................... 21,531 18,634
Related party .................................................... 15,135 16,394
------- -------
Total .......................................................... 36,666 35,028
======= =======
Weighted average worksite employees paid during the period:
Third parties .................................................... 20,313 16,656
Related party .................................................... 14,889 16,061
Weighted average ................................................. 35,202 32,717
Quarterly and year-to-date gross profit per weighted average worksite
employee (in whole $'s):
Third parties .................................................... $ 215 $ 190
Related party .................................................... 266 218
Weighted average ................................................. 237 204
- ----------
(1) EBITDA is defined as earnings before interest, income taxes, depreciation
and amortization. EBITDA is presented because it is a widely accepted
financial indicator of a company's ability to incur and service debt.
However, EBITDA should not be considered in isolation or as a substitute for
net income or cash flow data prepared in accordance with generally accepted
accounting principles or as a measure of a company's profitability or
liquidity. Also, the EBITDA definition used herein may not be comparable to
similarly titled measures reported by other companies.
RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED SEPTEMBER 30, 1997
Revenues increased from the fourth quarter of fiscal 1997 to the first
quarter of fiscal 1998, as reflected in the table above, primarily from the July
1 NovaPro acquisition, an increase in the number of clients and worksite
employees and service fees earned from the payment of annual bonuses paid in
connection with the NovaCare Contract. The number of clients increased to 1,763
from 1,742 over the respective quarterly periods and the weighted average number
of worksite employees increased to 35,202 from 32,717 over the same periods,
respectively.
Salaries, wages and employment taxes of worksite employees increased to
$242,500 for the quarter ended September 30, 1997 from $211,425 for the quarter
ended June 30, 1997. As a percentage of revenues, salaries, wages and employment
taxes of worksite employees decreased from 91.0% to 90.9% for the same periods,
respectively. The primary reason for this decrease is the impact of NovaPro
which has a higher gross profit margin.
Health care, workers' compensation, state unemployment taxes and other
increased to $15,929 for the quarter ended September 30, 1997 from $14,130 for
the quarter ended June 30, 1997. As a percentage of revenues, health care,
workers' compensation, state unemployment taxes and other decreased to 6.0% from
6.1% over the respective quarterly periods, principally due to lower state
unemployment taxes.
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14
NOVACARE EMPLOYEE SERVICES, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
(In thousands, except per share data)
Gross profit as a percentage of revenues increased to 3.1% for the quarter
ended September 30, 1997 from 2.9% during the quarter ended June 30, 1997,
resulting principally from NovaPro, which has a higher gross profit margin.
Selling, general and administrative expenses increased to $5,630 for the
quarter ended September 30, 1997 from $4,397 for the quarter ended June 30, 1997
due to increased administrative staff in support of the Company's marketing
efforts and the Company's growth in worksite employees and number of clients. As
a percentage of revenues, selling, general and administrative expenses were
2.1%, and 1.9%, respectively.
Amortization of excess cost of net assets acquired increased to $572 for the
quarter ended September 30, 1997 from $567 for the quarter ended June 30, 1997
as a result of additional contingent consideration paid for fiscal 1997
acquisitions.
Interest expense, net decreased to $375 for the quarter ended September 30,
1997 from $405 for the quarter ended June 30, 1997 primarily from interest
earned on excess cash invested.
Income taxes as a percentage of pretax income decreased to 46.5% for the
three months ended September 30, 1997, from 68.4% for the three months ended
June 30, 1997. The principal reason for the change was a decrease of
nondeductible amortization of excess cost of net assets acquired as a percentage
of pretax income.
LIQUIDITY AND CAPITAL RESOURCES
The Company had $2,428 in cash and cash equivalents as of September 30,
1997. As of the same date, the Company had negative working capital of $49,064
primarily as a result of (i) $28,382 due to the Parent for amounts borrowed
under a line of credit which is due at the earlier of an initial public offering
or November 1999 and (ii) $18,905 of deferred purchase price obligations
incurred in connection with the Company's acquisitions, of which $17,500 is due
upon the earlier of an initial public offering or December 31, 1997. The
Company's primary short-term liquidity requirements relate to the payment of
accrued payroll and payroll taxes of its worksite and internal employees,
accounts payable and the payment of accrued workers' compensation expense and
health benefit plan premiums.
The Company's cash flows provided by operating activities for the first
quarter of fiscal 1998 were $2,000 resulting primarily from net income and
amortization of $1,727 and a $7,199 increase in the liability for workers'
compensation and health claims, caused by the timing of the payment of these
liabilities, offset by a $6,807 net cash use for an increase in accounts
receivable. Accounts receivable, accrued salaries, wages, payroll taxes, and
health benefit premiums payable are subject to fluctuations depending on the
proximity of the financial reporting cycle to that of the payroll cycle.
Cash expended for investing activities during the same period was $872
primarily resulting from additions to furniture, equipment and other assets.
Although the Company currently has no significant capital commitments, the
Company anticipates acquiring PEOs and other employee services businesses in
strategic markets during the remainder of fiscal 1998.
Net cash used for financing activities was $482 for the three months ended
September 30, 1997, primarily related to the payment of initial public offering
costs.
In November 1997, the Company completed its initial public offering and
received proceeds of $41,850, net of $3,150 of underwriting discounts and
commissions, from the sale of 5,000 shares of common stock of the Company. The
Company used the majority of its proceeds, along with borrowings under the
Company's revolving credit agreement, to retire debt due to the Parent of
$28,382 and to pay $17,500 of purchase price obligations related to fiscal 1997
acquisitions.
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15
NOVACARE EMPLOYEE SERVICES, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
(In thousands, except per share data)
CAUTIONARY STATEMENT
Except for historical information, matters discussed above including, but not
limited to, statements concerning future growth, are forward-looking statements
that are based on management's estimates, assumptions and projections. Important
factors that could cause results to differ materially from those expected by
management include management retention and development, management's success in
integrating acquired businesses, in developing and introducing new products and
lines of business and in entering new markets, adverse Internal Revenue Service
rulings with respect to the employer status of employee services businesses and
the Company's ability to implement its employee services business model.
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16
NOVACARE EMPLOYEE SERVICES, INC. AND SUBSIDIARIES
PART II - OTHER INFORMATION
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
During the three months ended September 30, 1997, the Company submitted
the following matters to a vote of security holders:
On July 10, 1997, by consent of the holder of 19,400,000 shares of the
Company's common stock, $.01 par value ("Common Stock"), a majority of
the issued and outstanding shares of Common Stock, the shareholders
approved an amendment to the Company's certificate of incorporation
increasing the Company's authorized Common Stock from 30,000,000 shares
to 60,000,000 shares. No proxies or other consents were solicited.
On September 23, 1997, in lieu of an annual meeting of shareholders, by
consent of the holder of 19,400,000 shares of Common Stock, a majority
of the issued and outstanding shares of Common Stock, John H. Foster,
Timothy E. Foster, Stephen E. O'Neil, E. Martin Gibson, Loren J. Hulber
and Harvey V. Fineberg, M.D., Ph.D. were removed and re-elected as
directors, and the board's selection of Price Waterhouse LLP to serve
as independent accountants for the Company for the fiscal year ending
June 30, 1998 was ratified and affirmed. No proxies or other consents
were solicited.
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K
(A) Exhibit
Number Exhibit Description Page Number
------ ------------------- -----------
10(a) $25,000,000 Revolving Credit Facility Credit
Agreement by and Among NovaCare Employee Services,
Inc., and Certain of Its Subsidiaries and The Banks
Party Hereto and PNC Bank, National Association, As
Agent, Dated as of November 17, 1997.
27 Financial Data Schedule
(B) The Company filed no reports on Form 8-K during the quarter ended September
30, 1997.
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17
NOVACARE EMPLOYEE SERVICES, INC. AND SUBSIDIARIES
SIGNATURES
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THE
REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED ON ITS BEHALF BY THE
UNDERSIGNED THEREUNTO DULY AUTHORIZED.
NOVACARE EMPLOYEE SERVICES, INC.
(REGISTRANT)
DECEMBER 18, 1997 BY/s/ THOMAS D. SCHUBERT
--------------------------------------------
THOMAS D. SCHUBERT
SENIOR VICE PRESIDENT,
CHIEF FINANCIAL OFFICER AND PRINCIPAL
ACCOUNTING OFFICER
15