Gevity HR 10-K 2009
Documents found in this filing:
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Commission File No. 0-22701
GEVITY HR, INC.
(Exact name of registrant as specified in its charter)
(Registrants Telephone Number, Including Area Code):
Securities Registered Pursuant to Section 12(b) of the Act:
Securities Registered Pursuant to Section 12(g) of the Act:
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No x
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No x
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 o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrants 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. o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes £ No x
As of June 30, 2008, the last business day of the registrants most recently completed second fiscal quarter, the aggregate market value of the registrants common stock held by non-affiliates, based upon the closing price per share for the registrants common stock as reported on the Nasdaq Global Select Market, was approximately $106.5 million.
The number of shares of the registrants common stock, outstanding as of February 28, 2009, was 24,725,617.
DOCUMENTS INCORPORATED BY REFERENCE
PART III Portions of the registrants definitive Proxy Statement relating to the 2009 Annual Meeting of Shareholders of Gevity HR, Inc. are incorporated herein by reference in Part III of this report or will be provided by an amendment to this report.
CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
Statements made in this report, including under the section titled Managements Discussion and Analysis of Financial Condition and Results of Operations, that are not purely historical may be forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 (Securities Act) and Section 21E of the Securities Exchange Act of 1934 (Exchange Act), including without limitation, statements regarding the Companys expectations, hopes, beliefs, intentions or strategies regarding the future. Words such as may, will, should, could, would, predicts, potential, continue, expects, anticipates, future, intends, plans, believes, estimates, and similar expressions, as well as statements in future tense, identify forward-looking statements. Forward-looking statements are based on the Companys current expectations and beliefs concerning future developments and their potential effects on the Company. There can be no assurance that future developments affecting the Company will be those that the Company has anticipated. Forward-looking statements involve a number of risks, uncertainties (some of which are beyond the Companys control) or other assumptions that may cause actual results or performance to be materially different from those expressed or implied by forward-looking statements, including those described in Item 1A. Risk Factors and the risks that are described in the reports that the Company files with the Securities and Exchange Commission (SEC).
The Company cautions that the risk factors described in Item 1A. Risk Factors 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 these factors. Further, management cannot assess the impact of each factor on the Companys 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 HR, Inc. (Gevity or the Company) specializes in providing small- and medium-sized businesses nationwide with a wide-range of competitively priced payroll, insurance and human resource (HR) outsourcing services. Businesses partner with Gevity to focus their resources on what matters most running a profitable business. Our commitment to Service First supports our delivery of solutions that enable businesses to:
· Improve their bottom line by stabilizing and controlling costs;
· Manage and reduce compliance risk;
· Retain and develop the right employees; and
· Save time by reducing payroll and administrative workload.
Our solutions are designed to serve the needs of these businesses and are delivered with a personal touch through our team of local and national HR professionals. Our HR professionals provide each employee with support previously only available at much larger companies.
Gevity is a professional employer organization (PEO), which means the Company provides certain HR-related services and functions for clients under what is referred to as a co-employment arrangement. Under the co-employment arrangement, Gevity assumes certain HR/employment-related responsibilities, as provided for by a professional services agreement (PSA) and as may be required under certain state laws. The co-employment relationship allows the PEO to become an employer of record and administrator for matters such as employment tax and insurance-related paperwork as well as relieving the client of these time-consuming administrative burdens. Because a PEO can aggregate a number of small clients into a larger pool, the PEO is able to create economies of scale enabling smaller businesses to get competitively priced benefits.
The core services typically provided by a PEO are payroll processing, access to health and welfare benefits and workers compensation coverage. In addition to these core offerings, the Companys Gevity Edge PEO solution provides value-adding HR services such as employee retention programs, new hire support, employment practices liability insurance coverage and performance management programs, all designed to help clients effectively grow their businesses. Gevity is one of few PEOs with dedicated field-based
HR Consultants. The Companys HR Consultants work directly with clients to provide HR expertise and HR strategies that can help drive their business forward, while lowering potential exposure to HR-related claims.
Gevity also provided services to its clients through a non co-employment relationship program, which was subsequently discontinued. The non co-employment relationship between Gevity and its clients was also governed by a PSA. Under the non co-employment PSA, the employment related liabilities remained with the client and the client was responsible for its own workers compensation insurance and health and welfare plans. The Company assumed responsibility for payroll administration (including payroll processing, payroll tax filing and W-2 preparation) and provided access to all of its HR services. This option became known as Gevity Edge Select and prior to 2007 did not have a significant impact on the Companys results of operations or financial position. During 2007 the Company increased its investment in Gevity Edge Select beginning with the acquisition of the payroll processing firm HRAmerica, Inc. (HRA) on February 16, 2007 for approximately $9.5 million. The Company acquired from HRA certain assets, including its client portfolio of approximately 145 clients (as measured by Federal Employer Identification Number (FEIN) with approximately 16,000 client employees. Approximately 14,700 non co-employed client employees were acquired as of the date of the acquisition and approximately 1,300 co-employed client employees (8 clients) were acquired with an effective date of April 1, 2007. The acquisition provided the Company with technology and processes to enhance its non co-employment model, Gevity Edge Select. In addition to the purchase of HRA, contracts with a national provider for benefits administration and with national and regional brokers for insurance distribution had been signed in support of Gevity Edge Select.
After completion of a comprehensive strategic review, the Company decided to focus on the growth of its core co-employment offering, Gevity Edge. As such, on February 25, 2008, the board of directors of the Company approved a plan to discontinue the Companys non co-employment offering, Gevity Edge Select. Clients that existed at February 25, 2008, were notified of this decision and given until June 30, 2008 to transition to other service providers. The Company completed its transition of all remaining Gevity Edge Select clients during the second quarter of 2008, processing the final payrolls dated June 30, 2008. The Company has determined that the exit from the Gevity Edge Select business meets the criteria of discontinued operations in accordance with Statement of Financial Accounting Standards No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. Accordingly, the results of operations and related exit costs associated with Gevity Edge Select have been reported as discontinued operations for all periods presented.
The Company serves a diverse client base of small and medium-sized businesses in a wide variety of industries. The Companys clients have employees located in all 50 states and the District of Columbia. As of December 31, 2008, these clients and their employees were served by a network of 32 offices in Arizona, California, Colorado, Florida, Georgia, Illinois, Minnesota, Nevada, New Jersey, New York, North Carolina, Tennessee and Texas. In addition, the Company has internal employees located onsite at certain client facilities. As of December 31, 2008, the Company served approximately 5,800 clients, as measured by individual client FEIN, with approximately 101,000 active client employees. For the year ended December 31, 2008, the Companys top 25 clients accounted for less than 10% of its client billings, with no single client representing more than 2.2% of its client billings.
The Companys operations are conducted through a number of wholly-owned subsidiaries. The terms Company or Gevity as used in this report includes Gevity HR, Inc. and its subsidiaries.
The Company was incorporated in Florida and consummated its initial public offering in 1997.
Potential Acquisition of Gevity
On March 4, 2009, Gevity, TriNet Group, Inc. (TriNet) and Gin Acquisition, Inc., a wholly owned subsidiary of TriNet (Merger Sub), entered into a Merger Agreement (the Merger Agreement). Under the Merger Agreement, Merger Sub will be merged with and into Gevity (the Merger) with Gevity surviving the Merger as a wholly owned subsidiary of TriNet. Pursuant to the Merger Agreement, at the effective time of the Merger, each share of common stock of Gevity issued and outstanding immediately prior to the effective time (other than common shares held by TriNet or Merger Sub or any of their affiliates) will be automatically converted into the right to receive $4.00 in cash. The transaction is not subject to a financing condition.
The consummation of the Merger is subject to various customary conditions, including Gevity shareholder approval, the expiration or termination of the applicable waiting periods under the Hart-Scott-Rodino Antitrust Improvements Act of 1976 and the receipt of certain other state regulatory approvals. The Merger Agreement contains customary representations and warranties between Gevity, TriNet and Merger Sub. The Merger Agreement also contains customary covenants and agreements, including covenants relating to (a) the conduct of Gevitys business between the date of the signing of the Merger Agreement and the closing of the Merger, (b) non-solicitation of competing acquisition proposals and (c) the efforts of the parties to cause the Merger to be completed. The Merger Agreement contains certain termination rights and provides that, upon or following the termination of the Merger Agreement, under
specified circumstances involving a competing acquisition proposal, Gevity may be required to pay TriNet a termination fee of $2.95 million and up to $1.0 million of expenses.
Concurrently with the execution and delivery of the Merger Agreement, ValueAct Capital Management, LP and certain of its affiliates (ValueAct) entered into a voting agreement (the Voting Agreement) with TriNet whereby ValueAct committed to vote for the approval of the Merger. The Voting Agreement will terminate in the event the Merger Agreement is terminated.
On March 4, 2009, Gevity and certain subsidiaries of Gevity (the Guarantors) entered into the Fourth Amendment to Amended and Restated Credit Agreement (the Fourth Amendment) with Bank of America, N.A., as administrative agent (BOA) and certain other lenders parties thereto (together with BOA, the Lenders). The Fourth Amendment amends the definition of Change of Control that was set forth in the Amended and Restated Credit Agreement, dated as of August 30, 2006, among Gevity, the Guarantors and the Lenders, as amended (the Credit Agreement), to provide that the entry into the Merger Agreement and the execution of the Voting Agreement, in and of themselves, shall not constitute a Change of Control for purposes of the Credit Agreement.
Human Resource Outsourcing Industry
The Company believes that small and medium-sized businesses are the primary drivers of economic growth and the chief source of job growth. These businesses are also potential HR outsourcing customers since many desire to outsource non-core business functions, reduce regulatory compliance risk, rationalize the number of service providers that they use, enhance their benefit offerings and reduce costs by integrating HR systems and processes.
The National Association of Professional Employer Organizations (NAPEO) defines the PEO industry as follows:
Professional employer organizations (PEOs) enable clients to cost-effectively outsource the management of human resources, employee benefits, payroll and workers compensation. PEO clients focus on their core competencies to maintain and grow their bottom line.
Businesses today need help managing increasingly complex employee related matters such as health benefits, workers compensation claims, payroll, payroll tax compliance, and unemployment insurance claims. They contract with a PEO to assume these responsibilities and provide expertise in human resources management. This allows the PEO client to concentrate on the operational and revenue-producing side of its operations.
A PEO provides integrated services to effectively manage critical human resource responsibilities and employer risks for clients. A PEO delivers these services by establishing and maintaining an employer relationship with the employees at the clients worksite and by contractually assuming certain employer rights, responsibilities, and risk.
· Relief from the burden of employment administration;
· A wide range of personnel management solutions through a team of professionals;
· Improved employment practices, compliance and risk management to reduce liabilities;
· Access to a comprehensive employee benefits package, allowing clients to be competitive in the labor market; and
· Assistance to improve productivity and profitability.
Professional Services Provided by the Company
The Company provides a broad range of tools and services to its clients. These tools and services are primarily offered to the Companys clients on a bundled or all-inclusive basis. In addition to the Companys core services, clients may elect to offer health and welfare and retirement programs to their employees. The Company provides these core tools and services to its clients through the following methods:
Payroll(1) + Payroll Administration
Benefits(1) + Benefits Administration
New Hire Support
Policies + Procedures/Risk Management
Employee Development + Retention
(1) Oracles Human Resource Management System (HRMS).
The Company had clients classified in over 500 Standard Industrial Classification (SIC) codes. The following table shows the Companys client distribution by major SIC code industry grouping for the years indicated, ranked as a percentage of client billings:
(1) The Other Trade category consists principally of motor vehicle dealers, motor vehicle supplies and parts stores, gasoline service stations, household appliance and home furnishing stores, apparel and accessory stores, sporting goods stores, hardware stores, furniture stores, grocery stores and various other retail stores and dealers.
(2) The Other Services/Other category consists principally of personal services (e.g., laundry and dry cleaning, beauty and barber shops), hotel and lodging services, building cleaning and maintenance, car washes, amusement and recreation services, child day care services and miscellaneous repair services.
(3) The Construction category consists principally of general contracting and other trade work, such as heating, ventilation, air-conditioning, plumbing, electrical and flooring. This category does not include workers engaged in roofing or other high-elevation exposure risk activities.
As part of its current approach to client selection, the Company offers its Gevity Edge full service HR solution to businesses within specified industry codes. All prospective clients are 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 underwriting requirements must be met before the Company agrees to provide Gevity Edge or co-employment related services to the potential client. This process may include an on-site inspection and review of workers compensation and unemployment claims experience for the last three years.
The Company considers industries to be high risk if there is a likelihood of a high frequency of on-the-job accidents involving client employees or a likelihood that such accidents will be severe. In addition, under the terms of the Companys workers compensation agreement, prospective clients operating in certain industries or with historically high workers compensation insurance claims experience must also be approved by the Companys insurance carrier before the Company enters into a contract to provide services.
The Company also maintains a client review program that includes a detailed profitability and risk analysis of all of its existing 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 not contribute to its long-term profitability or otherwise be detrimental to its business.
The Companys overall client retention rate from continuing operations for 2008 was approximately 76%. This rate 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 small businesses and the number of clients that were terminated by the Company as part of its client review program. During 2008, the Company terminated approximately 240 unprofitable clients. Excluding these managed terminations, the client retention rate related to continuing operations for 2008 was approximately 78%.
All of the Companys clients are required to enter into a professional services agreement, which generally provides for an initial one-year term, subject to termination by the Company or the client at any time upon either 30 or 45 days prior written notice. Following the initial term, the contract may be renewed, terminated or continued on a month-to-month basis. Under the co-employment business service
model, the Company and the client each becomes a co-employer of the clients employees and employment-related liabilities relating to the clients employees are contractually allocated between the Company and the client. Through Gevity Edge Select, clients were also offered the option to use the Companys services without the Company becoming a co-employer of the clients employees, in which case tax filings were made under the clients FEIN and the client provided its own workers compensation insurance and health and welfare plans. As discussed in Business General, the Company ceased operations of the Gevity Edge Select business during 2008.
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 Companys client selection process and its right to terminate the client and the co-employment relationship with the client employees.
The Company operates as a licensed professional employer organization. Under the professional services agreement applicable to the co-employment model, 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 clients employee payroll obligations, including the liability for payment of salaries and wages to each client employee, the payment of payroll taxes and, at the clients option, responsibility for providing group health, welfare and retirement benefits to such individuals. These Company obligations are fixed, whether or not the client makes timely payment of the associated service fee. In this regard, unlike payroll processing service providers, the Company issues to each of the client employees payroll checks drawn on the Companys bank accounts. The Company also reports and remits all required employment information and taxes to the applicable federal and state agencies and issues a federal Form W-2 to each client employee under the Companys FEIN.
Under the co-employment model, the Company assumes the responsibility for compliance with employment-related governmental regulations that can be effectively managed away from the clients worksite. The Company provides workers compensation insurance coverage to each client employee under the Companys master insurance policy. The client, on the other hand, contractually retains the general day-to-day responsibility to direct, control, hire, terminate, set the wages and salary of, and manage each of the clients employees. The client employee services are performed for the exclusive benefit of the clients 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 typical division of responsibilities for employment-related regulatory compliance under the Companys professional services agreement applicable to the co-employment model:
* The Company and the client are each responsible for certain provisions under the terms of the act.
Under the co-employment model, 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 HR services provided to the client. The component of the professional service fee related to HR 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 clients historical claims experience. In addition, the client may choose to offer certain health, welfare and retirement benefits to its employees. The Company invoices each client for the service fee and costs of selected benefit plans, as well as 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.
Service Delivery and Information Technology
The Company delivers services using the power of local and national resources, on the clients terms, by using these delivery components:
· Gevity OnSiteTM. Local HR consultants are available to work with clients onsite, either full time or on a regularly scheduled basis.
· Gevity OnCallTM. A dedicated team of HR professionals is available by telephone to address payroll, benefits and general HR needs for clients and their employees at a designated number.
· Gevity OnLineTM. Gevity clients and their employees have online access to view and update their information anytime via gevity.com. The Ask Gevity link on gevity.com provides up-to-date critical HR, compliance and regulatory information.
In order to provide proactive client relationship management, each of the Companys clients is assigned a single HR consultant to serve as the client relationship manager. This allows the client to interface with the Company through a single point person.
As of December 31, 2008, the Company had over 130 HR consultants with significant experience in the HR industry. Many of the Companys HR consultants hold industry recognized certifications from organizations such as the Society for Human Resource Management.
In 2008, the Company continued to invest in both client service and technology improvement initiatives, including a Computer Telephony Integration (CTI) and Integrated Voice Response (IVR) pilot, enhancing the technology aspects of its Business Continuity Plan (BCP), strengthening the information technology security infrastructure and, automating the technology services management processes. These investments are intended to better serve the Companys client base, achieve a high level of client satisfaction and allow the Company to improve both the efficiency and effectiveness of its business operations.
The Company processes payroll for the majority of its client employees using Oracles HRMS and Payroll processing applications. The Oracle systems enable 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 Companys information systems manage all data relating to client employee enrollment, payroll processing, 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 configured appropriately for its clients.
The Company continues to improve its Gevity OnLine self-service capabilities, which allow clients to input their payroll related information directly into the Companys payroll applications via the Internet. Clients can regularly add or delete employees, view reports, and change payroll information. Gevity OnLine is integrated with the Companys Oracle HRMS, Payroll systems, and financial reporting system, Salesforce.com, (customer relationship management solution) as well as the Companys comprehensive line of online tools and services. The Company believes that this full integration results in improved client satisfaction, as well as improved efficiencies and operating margins for the Company. Oracles portal software provides the foundation, enabling a client configurable online experience, and the Companys custom-developed software provides additional ease of use and service capabilities. The combination of the Oracle systems for access and functionality and Gevitys proprietary online capabilities provides a unique solution capable of growing and adapting to the evolving needs of the Companys clients.
The Companys information technology staff consisted of 82 employees at December 31, 2008. 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.
Sales and Marketing
The Company markets its services through a direct sales force which, as of December 31, 2008, consisted of 111 business development managers distributed throughout its 32 field offices. During 2008, the Company closed 11 field offices after the determination that sales and service coverage could be maintained in a more cost effective manner. The Companys business development managers are compensated through a combination of salary and commission.
The Companys 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 territory methodology promotes a focused and efficient approach to market penetration and facilitates a collaborative environment among business development managers.
The Company generates sales leads from various external sources as well as from direct sales efforts and inquiries. Each business development manager visits his or her clients on-site 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.
Gevity provides a comprehensive, full-service HR solution delivered through dedicated HR professionals and an advanced information technology platform. Gevitys HR consultants complement its total employment management solution, providing the resources and tools found in HR departments of large companies. The Company believes this model allows it to compete favorably in the highly fragmented industry of HR outsourcing for small and medium-sized businesses in which the primary bases of competition are the scope and quality of services delivered.
The Company views its primary competitors in two categories. The first is single-point solution providers that offer only one, or a few, facets of the solution the Company provides its clients. These providers typically complement a business in-house HR resources. This type of competitor is exemplified by information technology outsourcers and broad-based consulting and outsourcing firms that now provide, or seek to provide, HR outsourcing services. Another example of this type of competitor is consulting companies that perform narrowly defined, individual HR related projects, such as the development of HR strategy or the installation of an HR information system. The Company believes the breadth and integrated nature of its solution positions it well against this type of competitor.
The second type of competitor identified by the Company is one that provides a more comprehensive HR solution and typically includes Administrative Service Organizations (ASOs), PEOs and other comprehensive HR outsourcers. These providers typically may be used in conjunction with a business in-house HR resources, or they may be used in replacement of a business in-house HR resources. The Company believes its on-site delivery model, the cost savings it can pass along to its clients due to its size, and the breadth of its service offering create competitive advantages and allow it to compete favorably with other PEOs and HR outsourcers.
The Company believes that it operates one of the largest PEOs in the United States in terms of active client employees and revenues. Many of the businesses that utilize the co-employment business model, especially the larger ones such as Administaff, Inc. and the PEO division of Automatic Data Processing, Inc., are capitalizing on the co-employment
insurance model while offering additional core HR services. The Company expects competition to increase, and competitors to develop broader service capabilities.
The Company provides its services to its client employees under arrangements with a number of providers as described below.
Workers Compensation Insurance
The following is a description of the Companys workers compensation insurance program, which covers all clients who are serviced under the co-employment model (unless such clients have elected to maintain their own coverage pursuant to the professional services agreement):
The Company has had a loss sensitive workers compensation insurance program since January 1, 2000. The program is insured by CNA Financial Corporation (CNA) for the 2000-2002 policy years and is insured by member insurance companies of American International Group, Inc. (AIG) under AIGs Commercial Insurance Group (AIG CI) for the 2003-2008 policy years. These programs provide insurance coverage for claims incurred in each policy year but which may be paid out over future periods dependent upon the nature and extent of the worksite injury. In states where private insurance is not permitted, client employees are covered by state insurance funds.
Gevity purchased fully insured workers compensation policies from AIG CI with varying deductible amounts (ranging from $0.5 million to $2.0 million) for the 2003 through 2008 policy years whereby AIG CI is responsible for paying the claims and the Company is responsible for paying to AIG CI the per occurrence deductible amount. In addition, during 2004, the Company purchased insurance from AIG CI to cover its workers compensation claims liability up to the $1.0 million per occurrence deductible level for policy years 2000-2002 (CNA remains the insurer on the underlying claims for these years).
The workers compensation program with AIG CI for policy years 2003-2008 consists primarily of two components. The first component consists of cash paid to AIG CI during each policy year related to policy expenses and program costs. This includes premium charges (for insurance of claims in excess of the deductible and certain stop loss coverage), taxes and administration costs. The amounts charged by AIG CI are generally based upon the volume and classification of workers compensation payroll. Except for the policy true-up provisions that occur 18 months after policy inception and are based upon the actual volume and classification of payrolls, as well as the claims administration cost based upon the volume of claims processed, this component is fixed and there is no return of premium. The second component of the workers compensation program relates to the policy deductible. The Company, through its wholly-owned Bermuda-based insurance subsidiary, remits premiums to AIG CI to cover claims to be paid within the Companys per occurrence deductible layer. AIG CI deposits the premiums into interest bearing loss fund collateral accounts for reimbursement of paid claims up to the per occurrence deductible amount. Interest on the loss fund collateral accounts (which will be reduced as the reimbursement of claims are paid out over the life of the policy) accrues to the benefit of the Company at fixed annual rates as long as the program, and the interest accrued under the program, remain with AIG CI as indicated in the table below. Information relating to the AIG CI policy years is as follows:
If a program policy year is terminated prior to the end of the guarantee period, the interest rate is adjusted downward based upon a sliding scale. The 2003-2008 program years provide for an initial loss fund collateral true-up 18 months after the program inception and annually thereafter. The true-up is calculated as the product of a pre-determined loss factor and the amount of incurred claims in the deductible layer as of the date of the true-up. The true-up may result in funds being released from the AIG CI loss fund collateral accounts to the Company or may require additional loss fund collateral payments by the Company to AIG CI. During 2008, AIG CI released approximately $35.1 million, net, primarily related to the annual loss fund collateral true-up and also returned $4.7 million related the true-up of outstanding prior year premium expense audits. The Company expects to receive approximately $25.3 million from AIG CI during 2009 in connection with the June 2009 annual true-up of policy years 2003-2008.
In 2004, the Company entered into agreements with AIG CI and CNA whereby the Company paid $102.0 million to purchase insurance from AIG CI to cover the Companys workers compensation claims liability up to the $1.0 million per occurrence deductible level for policy years 2000-2002. Of the total premium paid to AIG CI, AIG CI deposited $88.9 million into an interest bearing loss fund account held by AIG CI and $5.5 million into an interest bearing escrow account held by CNA. The AIG CI loss fund account will be used by AIG CI to fund all claims under the program up to AIG CIs aggregate limit. Interest on the AIG CI loss fund (which will be reduced as claims are paid out over the life of the policy) will accrue to the benefit of the Company at a fixed annual rate of 3.0% until all claims are closed. The CNA escrow account bears an interest rate based upon the rate as provided for in the facility into which it is deposited. Any agreed upon reduction in the escrow account between CNA and AIG CI will be deposited into the AIG CI loss fund account. During 2008 and 2007, CNA released $0.5 million and $3.8 million, respectively, of the escrow account which was deposited into the AIG CI loss fund account. AIG CI will return to the Company that portion of the loss fund account, if any, not used or retained to pay claims, including interest earned, at intervals of 36, 60, 84 and 120 months from the date of the inception of the agreement. The maximum return amount, which is based upon a pre-determined formula, at 36 and 60 months was initially limited to $5.5 million for each payment due, with no limit as to the return amount at 84 and 120 months. During 2007, AIG CI released $5.5 million to the Company in connection with the 36 month true-up. During 2008, AIG CI, CNA and the Company amended their agreement with respect to the 60 month true-up which was to occur June 30, 2009. AIG CI agreed to replace the 60 month true-up (limited to a maximum of $5.5 million) with a 54 month true-up (with no maximum). This amendment resulted in a revised true-up amount of $26.6 million, which was received by the Company in January 2009. The amendment was a result of favorable claims development and excess collateral amounts held in the loss fund.
In December 2008, the Company renewed its AIG CI workers compensation insurance policy for the 2009 program year. Under the 2009 program, the Company will be required to deposit $39.2 million into an interest bearing loss fund with a guaranteed interest rate of 0.48% (which will reset annually) and be used by AIG CI to fund losses up to the $1.0 million per occurrence deductible level.
See further discussion of the Companys workers compensation policies at Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Estimates - Workers Compensation Receivable/Reserves.
Employee Benefit Plans
Following is a description of the Companys health plans, which are offered to all clients who are served under the co-employment model who meet the minimum participation and contribution requirements:
Blue Cross and Blue Shield of Florida Blue Cross Blue Shield of Florida, Inc. and its subsidiary Health Options, Inc. (together BCBSF/HOI) is the Companys primary healthcare partner in Florida, delivering medical care benefits to approximately 17,500 Florida-based client employees. The Companys policy with BCBSF/HOI is a minimum premium policy expiring September 30, 2009. Pursuant to this policy, the Company is obligated to reimburse BCBSF/HOI 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 in the agreement and aggregate loss coverage is provided to the Company at the level of 115% of projected claims. The Company is required to pre-fund the estimated monthly expenses and claim liability charges of the plan by the first of each calendar month. The estimated monthly expenses are based upon the Minimum Premium Rate and the Annual Excess liability rate, as set forth in the agreement, times the number of insureds. The monthly estimated claim liability charge is based upon an average of monthly paid claims as determined by BCBSF/HOI based on three month periods specified in the agreement. Differences between the pre-funded amounts and actual amounts subsequently determined shall be settled in the following month. As part of the Companys obligation to BCBSF/HOI, the Company posted an irrevocable letter of credit in favor of BSBSF/HOI in an initial amount of $5.0 million on October 1, 2008, which shall be increased monthly by approximately $1.0 million over a seven month period until it reaches $11.8 million on May 1, 2009. As of December 31, 2008, the outstanding letter of credit balance was $7.0 million.
Aetna Health, Inc. Outside of the state of Florida, Aetna Health, Inc. (Aetna) is the Companys largest medical care benefits provider for approximately 17,000 client employees. The Companys 2008/2009 policy with Aetna provides for an HMO and PPO
offering to plan participants. The Aetna HMO and PPO medical benefit plans are subject to a guaranteed cost contract that caps the Companys annual liability.
UnitedHealthcare In 2006, the Company announced the addition of UnitedHealthcare as an additional health plan option. As of December 31, 2008, UnitedHealthcare provided medical care benefits to approximately 2,000 client employees as well as the Companys internal employees. The UnitedHealthcare plan is a fixed cost contract. Effective May 1, 2008, UnitedHealthcare and the Company amended their agreement to extend coverage availability through September 30, 2009 for internal employees and those clients covered by UnitedHealthcare as of May 1, 2008. As such, UnitedHealthcare is no longer available as an option to those clients not covered by UnitedHealthcare as of May 1, 2008.
Other Medical Benefit Plans 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. and Harvard Pilgrim Healthcare. These regional medical plans are subject to fixed cost.
Other Health Benefit Plans The Companys dental plans, which include both a PPO and HMO offering, are provided by Aetna for all client employees who elect coverage. All dental plans are subject to guaranteed cost contracts that cap the Companys 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 health care, dependent care and a qualified transportation fringe benefit program.
Part-time client employees are eligible to enroll in limited benefit programs from Star HRG. These plans include fixed cost sickness and accident and dental insurance programs, and a vision discount plan.
The Company offers to clients served under the co-employment model a 401(k) retirement plan, designed to be a multiple employer plan under Section 413(c) of the Internal Revenue Code of 1986, as amended (the Code). Generally, employee benefit plans are subject to provisions of both the Code and the Employee Retirement Income Security Act (ERISA).
Internal Company Employees
As of December 31, 2008, the Company employed approximately 745 internal employees of whom approximately 400 were located at the Companys headquarters in Bradenton, Florida. The remaining employees were located in the Companys field offices or in some cases onsite at client locations. None of the Companys internal employees are covered by a collective bargaining agreement.
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 professional employer organizations, temporary employment and other employment-related outsourcing arrangements and, therefore, do not specifically address the obligations and responsibilities of a professional employer organization.
Other federal and state laws and regulations are relatively new, and administrative agencies and federal and state courts have not yet interpreted or applied these regulations to the Companys business or its industry. The development of additional regulations and interpretation of those regulations 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.
Thirty-four states have passed laws that have licensing, registration or other regulatory requirements for professional employer organizations, and several other states are currently considering similar regulations. Such laws vary from state to state, but generally codify the requirements that a professional employer organization must reserve a right to hire, terminate and discipline client employees and secure workers compensation insurance coverage. The Company delegates or assigns such rights to the client where
allowed under state law. The laws also generally provide for monitoring the fiscal responsibility of professional employer organizations and, in many cases, the licensure of the controlling officers of the professional employer organization.
In addition, some states through legislative or other regulatory action may propose to modify the manner in which the Company is allowed to provide services to its clients. Such regulatory action could increase the administrative cost associated with providing such services.
Subject to the issues discussed below, 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 Internal Revenue Service (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 individuals 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.
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 individuals benefits status. A definitive judicial interpretation of employer in the context of a professional employer organization or employee leasing arrangement has not been established.
If the Company were found not to be an employer for ERISA, Code purposes, or the tax qualification requirements of the Code, 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 clients 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.
Federal Employment Taxes
As a co-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 FICA, governed by Code Section 3101, et seq.; and (iii) obligations under FUTA, governed by Code Section 3301, 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 professional employer organizations 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 exception to apply to both FICA and FUTA taxes as well. 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. 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 professional employer organizations, 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 Companys knowledge, discouraged clients from utilizing the Companys services, there can be no assurance that a definitive adverse resolution of this issue would not do so in the future.
Significant Transactions in 2008
Discontinuation of Gevity Edge Select.
As discussed in Business - General, in the first quarter of 2008, the Company decided to focus on the growth of its core co-employment offering, Gevity Edge, and the Companys board of directors approved a plan to discontinue the Companys non co-employment offering, Gevity Edge Select. The Company completed its transition of all remaining Gevity Edge Select clients during the second quarter of 2008, processing the final payrolls dated June 30, 2008. The operations of Gevity Edge Select are shown as discontinued operations for all periods presented.
During the fourth quarter of 2008, the Companys market capitalization dropped below the net book value of its equity. In addition, forecasted cash flows decreased reflecting continued deterioration of macroeconomic conditions which accelerated and became apparent during the fourth quarter of 2008. As a result and in connection with the Companys annual test for goodwill impairment, the Company determined that the fair value of the Company was less than its carrying value and that the implied fair value of the goodwill was zero. Accordingly, the Company recorded a goodwill impairment loss of $8.7 million, which eliminated goodwill in its entirety. The fair value of the Company was based on a combination of the discounted cash flow method, the guideline company method, and the similar transaction method. In conjunction with the goodwill impairment testing, the Company analyzed the valuation of its other long-lived and intangible assets (including deferred tax assets) and, based upon the weighted probability of alternative scenarios that existed as of December 31, 2008, concluded that the carrying value of long-lived assets was recoverable and no other impairments or additional valuation allowances were required as of December 31, 2008.
AIG Early Release of Loss Fund Collateral
As discussed in Business - Vendor Relationships - Workers Compensation Insurance, during the fourth quarter of 2008, the Company, AIG CI and CNA, amended their workers compensation insurance agreement related to policy years 2000-2002. The amendment provided for an early release of $26.6 million of loss fund collateral held by AIG CI in January 2009. This return of funds reflects the favorable relationship between the amount of funding held for these policy years, the relative low number of open claims and the maturing values of the estimated future costs for such claims. In addition, during the fourth quarter of 2008, AIG CI agreed to defer $13.9 million of the 2008 loss fund collateral pay-in until after the June 2009 true-up when it will be determined whether or not the payment is required.
Executive Officers of the Registrant
The following table sets forth certain information with respect to each person who is an executive officer of the Company as of March 11, 2009:
Michael J. Lavington, a citizen of the United Kingdom, has served as Chairman of Gevity since October of 2007 and as a director of Gevity since September 2006. In October of 2007, the Companys board of directors announced that Mr. Lavington was the boards choice for appointment as the Companys Chief Executive Officer, subject to the obtainment of all necessary immigration approvals. In September 2008, Mr. Lavington received his work authorization from the United States government and became the Chief Executive Officer of Gevity. Prior to joining Gevity, Mr. Lavington acted as an independent business consultant serving clients
in the United Kingdom and the United States since 2003. From 2000 to 2002, Mr. Lavington served as the Senior Vice President of Human Resources and Property for Global Telesystems, Inc. From 1999 to 2000, Mr. Lavington served as a Senior Consultant with Garner International, an executive recruitment and business consultancy firm. From 1991 to 1999, Mr. Lavington worked for the Rank Group, PLC, initially as the Group Human Resource Director and later as President and Chief Executive Officer of their US subsidiary, Resorts USA, Inc.
Garry J. Welsh joined Gevity as Interim Chief Financial Officer in May 2007. Mr. Welsh was appointed Senior Vice President and Chief Financial Officer in August 2007. Additionally, from November 2007 to September 2008, the board of directors appointed Mr. Welsh the Companys Chief Executive Officer to serve on an interim basis. Prior to joining the Company, Mr. Welsh was managing director of Sheridan Blake Consulting Limited during 2006 and GJW Consulting during 2006 and 2007. From September 2002 to March 2005, Mr. Welsh was the Global Chief Operating Officer of Barclays Private Bank in London.
Paul E. Benz joined Gevity in June 2006 as Senior Vice President and Chief Information Officer and is responsible for the Companys information technology and service center organization. Prior to joining the Company, Mr. Benz held several executive information technology and finance positions with PricewaterhouseCoopers and Pepsico. From 2004 to 2006 he directed the Southeast region of PricewaterhouseCoopers Information Technology Effectiveness practice. From 2001 to 2004, Mr. Benz served in various executive roles with Pepsico including Vice President, Finance and Information Technology and Vice President, Merger Integration.
James E. Hardee joined Gevity in August 2007 as Senior Vice President and Chief Sales and Marketing Officer. Prior to that, Mr. Hardee held various sales, marketing, management and executive positions with IBM Corporation. Among his positions at IBM were VP of Sales, VP of Services, VP of ibm.com, VP of Worldwide Sales, Director of Operations/Marketing and Business Unit Executive.
Edwin E. Hightower, Jr. became Senior Vice President and Chief Legal Officer of Gevity in July 2008. Mr. Hightower has been with Gevity since 2002. Mr. Hightower focuses on the Companys legal and compliance affairs. He also serves as Secretary of the Board of Directors. Mr. Hightowers career before joining Gevity included having his own solo law practice as well as serving as litigation counsel for Carnival Cruise Lines. Mr. Hightower earned his J.D. from the University of Miami School of Law.
You may read and copy any document the Company files with the SEC at the SECs public reference room located at 100 F Street, NE, Washington, DC 20549. Please call the SEC at 1-800-SEC-0330 to obtain more information regarding the public reference room. The SEC also maintains an Internet site at www.sec.gov that contains periodic and current reports, proxy statements and other information filed electronically by public issuers (including the Company) with the SEC.
The Company also makes available all reports and other documents it files or furnishes pursuant to the Exchange Act free of charge through the Investor Relations page on its website, www.gevity.com, as soon as reasonably practicable after such reports are electronically filed with the SEC.
The Company has adopted a Code of Business Conduct and Ethics, which applies to all employees and members of the board of directors of the Company, including the Chief Executive Officer, Chief Financial Officer and other senior financial officers of the Company, a copy of which is available through the Investor Relations page on the Companys website, www.gevity.com. The Company intends to disclose any amendments of, or waivers to, the Code of Business Conduct and Ethics on the Investor Relations page of its website. In addition, the Company makes available, through its website, statements of beneficial ownership of the Companys equity securities filed by its directors, executive officers and 10% beneficial holders under Section 16 of the Exchange Act. The Company also posts on its website the charters for its Audit Committee, Compensation Committee, Nominating/Corporate Governance Committee and Executive Committee.
Copies of these documents may also be obtained from the Company, excluding exhibits, at no cost, by writing to the Company at 9000 Town Center Parkway, Bradenton, FL 34202, Attention: Investor Relations, by telephoning the Company at 1-800-2GEVITY or by sending the Company an email via the Investor Relations page of its website, www.gevity.com.
The information on the Companys website and its content are for your convenience only. The information contained on or connected to our website is not incorporated by reference into this report or filed with the SEC.
In addition to other information contained in this filing, the following risk factors should be considered carefully in evaluating our business. Each of these risks is subject to many factors beyond our control. If we are not successful in managing our operating strategy and each of its elements, we expect our results of operations will be adversely affected and, as a consequence, our stock price may decline.
Current economic conditions, particularly in our Florida markets, may inhibit new sales growth and negatively impact our current clients, causing them to reduce staffing levels or cease operations.
The current economic downturn is negatively impacting small and medium size businesses, which constitute our primary markets, inhibiting their growth as well as their access to capital, particularly in terms of credit availability. In turn, these businesses are cutting costs, including reducing employee headcount, or ceasing operations altogether. This negatively impacts our revenues, as we rely on a per employee professional service fee from our clients and could potentially materially impact the amount of our bad debt expense. In addition, businesses are more reluctant to enter into new service agreements because of the uncertainty regarding the timing of any economic recovery. If these trends continue, our operations, financial condition, and cash flows could be materially and adversely affected.
The financial markets have recently experienced significant turmoil which may negatively impact our liquidity, our ability to obtain financing and our ability to process transactions through the banking system.
Our liquidity and our ability to obtain financing may be negatively impacted if one of our Lenders under our credit facility, or another financial institution, suffers liquidity issues or ceases operations. In such an event, we may not be able to draw on all, or a substantial portion of, our credit facility or timely process payroll and collection transactions through the banking system. Also, if we attempt to obtain future financing, in addition to our current credit facility, we may be unable to obtain such financing which could materially adversely affect our operations, financial condition and cash flows.
We rely on one financial institution to handle direct deposit payroll. Should this financial institution delay or stop processing these transactions, our business could suffer.
We currently have a banking relationship with one financial institution to electronically transfer all of our payroll that is delivered to client employees by direct bank deposit through the automated clearing house, or ACH, system with this bank. If this bank were to terminate its services, delay the processing of transfers or cease operating and we were not able to obtain these services in a timely manner or on acceptable terms from other banks, our business could materially suffer.
Our short-term results may be negatively impacted due to changes in health insurance claims, state unemployment tax rates and workers compensation rates, which we may not be able to immediately pass through to our clients.
Health insurance costs, workers compensation and employment practices liability insurance rates and state unemployment taxes are primarily determined by our claims experience and comprise a significant portion of our actual costs. Should we experience a significant increase in claims activity, due to the current economic downturn or otherwise, we may experience a substantial increase in our health insurance premiums, unemployment taxes, or workers compensation and employment practices liability insurance rates. Our ability to pass such increases through to our clients on a timely basis may be delayed and our clients may not agree to the increases, which could have a material adverse effect on our financial condition, results of operations and cash flows.
Our insurance-related loss reserves may be inadequate to cover our ultimate liability for losses and as a result our financial results could be materially and adversely affected.
We maintain loss reserves to cover our liabilities for the costs of our health care and workers compensation programs. These reserves are not an exact calculation of our liability, but rather are estimates based on a number of factors including but not limited to actuarial calculations, current and historical loss trends and payment patterns, the number of open claims, developments relating to the actual claims incurred, medical trend rates and the impact of acquisitions, if any. Variables in the reserve estimation may be affected by both internal and external factors, such as changes in claims handling procedures, fluctuations in the administrative costs associated with the program, economic conditions, fiscal policies, interest rates, legal determinations and legislative and regulatory changes. Although our reserves estimates are regularly refined as historical loss experience develops and additional claims are reported and settled, because of the uncertainties of estimating loss reserves, we cannot assure you that our reserves are adequate, and actual costs
and expenses may exceed our reserves. If our reserves are insufficient to cover actual losses we may incur potentially material charges to our earnings.
Our results of operations may be adversely affected if insurance coverage for workers compensation or medical benefits is not available or if we lose relationships with our key providers or if our key providers are unable to pay our claims.
As part of our full range of services, we offer medical benefits coverage and workers compensation insurance to our clients. We depend on a small number of key providers for the majority of our medical benefits and workers compensation coverage, including AIG CI, BCBSF/HOI, UnitedHealthcare and Aetna. If any of our insurance providers discontinue coverage or cease operations, the time and expense of providing replacement coverage could be disruptive to our business and could adversely affect our operating results, financial condition and cash flows. Replacement coverage could lead to client dissatisfaction and attrition (especially since most clients may terminate with either 30 or 45 days notice) due to the lack of continuity between coverage providers and the difference in the terms and conditions of their respective coverage plans. In addition, if at any time we are unable to renew our existing policies on financial terms and premium rates acceptable to us, our ability to provide such insurance and benefits to our clients would be adversely impacted, which could lead to significant client attrition, and our results of operations could be adversely affected. Our inability to renew existing policies may jeopardize compliance with state regulatory requirements and subject us to fines and extra costs to satisfy the state requirements or, at worst, eliminate our ability to provide services in those states. The loss of our ability to provide services, even for a short period, would negatively impact our image with our clients and could lead to the termination of our service agreements and our results of operations may be adversely affected. Additionally, disruptions in the financial markets, exposure to sub-prime mortgage securities and adverse action by rating agencies could adversely affect the financial stability of certain insurance companies. As a result the ability of the insurance companies to pay claims could be significantly impaired.
We are required to provide significant cash collateral or letters of credit for our obligations to our insurance providers and the amount of cash or letter of credit necessary to provide that collateral may increase in the future.
Our workers compensation provider and one of our primary health care insurance providers require cash collateralization of our insurance plans either by way of a cash deposit or delivery of a letter of credit. In the future our other health care insurance providers may require cash collateral or letters of credit as a condition of renewing their respective programs. The extent of such requirements is dependent upon several factors such as our financial condition, as well as the workers compensation and health insurance claims experience of our clients. We have little control over our clients claims experience except in the decision to initially accept and retain such clients. These collateral requirements may affect our need for capital, as well as our profitability. We may not be able to raise or provide the additional capital or collateral, if needed. In addition, we may be required to post additional collateral for the benefit of our insurance providers as a result of growing our business, which amounts could be significant, and may cause a significant amount of our cash to be restricted from other uses. We may not be able to raise, access or provide the additional capital or letters of credit as collateral, if needed which could materially adversely impact our results of operation, financial condition and cash flows.
Our workers compensation coverage is provided by AIG CI. Our workers compensation receivable from AIG CI represents a significant concentration of credit risk. If AIG CI were unable to pay our claims or return our excess loss fund collateral that comprises our workers compensation receivable, our results of operation, financial condition and cash flows would be materially and adversely affected.
As of December 31, 2008, we have a net workers compensation receivable from AIG CI of $115.3 million for premium payments and the related accrued interest receivable on those payments made to AIG CI for program years 2000-2008 in excess of the present value of the estimated claims liability. If AIG CI were to cease operations or otherwise default on their obligations, we may not be able to recover our receivable and the payment of our claims could be significantly impaired. This would have a material and adverse effect on our results of operations, financial condition and cash flows.
Disruptions in the financial markets, the current economic downturn, exposure to sub-prime mortgage securities and adverse action by rating agencies could adversely affect the financial stability of certain insurance companies. As a result, the ability of the insurance companies to pay claims could be significantly impaired. AIG has been negatively impacted by the current economic crisis. However, AIG has publicly stated that its regulated member insurance company subsidiaries remain well capitalized and financially secure and current insurance agency ratings are strong. We do not believe that the current financial condition of AIG will have a material adverse effect on the ability of its regulated insurance company subsidiaries to pay out claims or return excess collateral.
Our ability to manage health care costs affects our profitability.
Our profitability depends in part on our ability to appropriately predict and manage future health care costs through underwriting criteria and negotiation of favorable contracts with health care plan providers. The aging of the population and other demographic characteristics, the introduction of new or costly treatments resulting from advances in medical technology and other factors continue to contribute to rising health care costs. Government-imposed limitations on Medicare and Medicaid reimbursements have also caused the private sector to assume a greater share of increasing health care costs. Changes in health care practices, inflation, new technologies, increases in the cost of prescription drugs, direct-to-consumer marketing by pharmaceutical companies, clusters of high cost cases, utilization levels, changes in the regulatory environment, health care provider or member fraud, and numerous other factors affecting the cost of health care can be beyond any health plan providers control and may adversely affect our ability to predict and manage health care costs, as well as our business, financial condition and operating results.
We use actuarial data to assist us in analyzing and projecting these amounts, however, we and our carriers may not be successful in managing the cost of our plans. Accordingly, our costs under our health benefit plans may exceed our estimates, requiring us to fund the difference. Any significant funding obligation may have a material adverse effect on our financial condition, results of operations and liquidity.
Our business is subject to risks associated with vendor agreements.
We rely on certain vendors to provide services to our clients. If these vendors cease operations, are sold or cancel/do not renew their service agreements with us, it may cause potential service interruptions while replacement providers are located, in addition to potential increases in costs of obtaining these services.
Our business is subject to risks associated with geographic market concentration.
While we currently have offices in 13 states and client employees all 50 states and the District of Columbia, billings from our Florida operations accounted for approximately, 56% in 2006, 50% in 2007 and 56% in 2008. As a result of the size of our base of client employees in Florida and anticipated continued growth from our Florida operations, our profitability over the next several years is expected to be largely dependent on economic and regulatory conditions in Florida and other states representing more than 5% of our billings. As the Florida economy or the economies of other key states experience economic downturns and their growth rates slow, our profitability and growth prospects, or perception of these things, may be adversely affected. In addition, there is no assurance that we will be able to duplicate in other markets the revenue growth and operating results experienced in Florida.
Our quarterly results of operations may fluctuate, and we may not be able to grow as we have planned.
Our revenue, margins and results from operations generally have fluctuated in the past and may continue to fluctuate in the future. Quarterly variations in our operating results occur as a result of a number of factors beyond our control, including:
· competition for, and winning and maintaining, new clients with large employee counts;
· market acceptance of new services;
· market acceptance of our pricing;
· our ability to achieve our strategy and long-term performance standards, including our ability to pass through costs of our products and services, such as rising health insurance premiums and state unemployment taxes, among other elements of our strategy;
· charges due to workers compensation claims, health insurance claims, and state unemployment taxes;
· new product introductions or announcements by us or our competitors;
· client attrition;
· effectively controlling our operating and other expenses;
· the costs of hiring and training of additional staff; and
· general economic conditions.
Due to the presence of any of these factors, we may not be able to sustain our level of total revenue or our historical rate of revenue growth on a quarterly or annual basis. Our operating results could fall below our targets and the expectations of stock market analysts and investors, which could cause the price of our common stock to decline significantly.
We may find it difficult to expand or maintain our business in certain states due to varying state regulatory requirements and the existing competitive environment.
We currently operate primarily in Arizona, California, Colorado, Florida, Georgia, Illinois, New Jersey, New York, North Carolina, Tennessee and Texas. Future growth or maintenance of our operations in these states or additional states depends, in part, on the regulatory and competitive environment in such states. In order to operate effectively in a state, we must obtain all necessary regulatory approvals, adapt our procedures to that states regulatory requirements and adapt our service offerings to local market conditions. In certain states, we may determine that the costs of doing business exceeds our actual or anticipated financial performance resulting in a reduction or cessation of operations within such state or decision not to expand into a state. We are also subject to additional competition from regional and local competitors in the markets in which we expand. In the event that we expand into additional states, we may not be able to duplicate in other markets the financial performance experienced in our current markets and could experience losses as a result.
We operate in a complex regulatory environment and failure to comply with applicable laws and regulations could adversely affect our business.
The HR outsourcing and PEO environment is subject to a number of federal and state laws and regulations, including those applicable to payroll practices, taxes, benefits administration, insurance, wage and hour, employment practices and data privacy. As many of these laws do not specifically address the obligations and responsibilities of a professional employer organization, assuring compliance with such laws and assessing the financial impact of such compliance can be difficult. For example, the American Recovery and Reinvestment Act of 2009, enacted on February 17, 2009, includes significant modifications of the COBRA continuation coverage rules including an additional period of sixty days for eligible employees to elect to continue their benefit coverage and a subsidy of 65% of the applicable COBRA premium for up to nine months for employees involuntarily terminated by their employer between September 1, 2008 and December 31, 2009. At this time it is unclear how these modifications will be applied where a co-employer sponsors the benefit plans and has been contractually allocated responsibility for compliance with the COBRA continuation rules. The Company anticipates that it will incur additional costs associated with compliance with these new rules but the amount of such costs and the impact of these new rules on the Companys business are currently unclear.
Because our clients have employees in states throughout the United States, we must also perform our services in compliance with the legal and regulatory requirements of multiple jurisdictions. Some of these laws and regulations may be difficult to ascertain or interpret, may conflict and may change over time, and the addition of new services may subject us to additional laws and regulations. Many of these laws and regulations were instituted prior to the development of the professional employer organization industry, and therefore can be difficult to interpret or assess and may change over time. As a result of uncertainty and inconsistency in the interpretation and application of many of these laws and regulations, from time to time we have had disagreements with regulatory agencies in various states, some of which have resulted in administrative proceedings between a state agency and us. If we are unable to continue to provide certain contractual obligations, such as the payment of employment taxes on the salaries and wages paid to client employees, due to an adverse determination regarding our regulatory status as an employer, our clients may be held jointly and severally liable for such payments. Violation of these laws and regulations could subject us to fines and penalties, damage our reputation, constitute breach of our client contracts and impair our ability to do business in various jurisdictions or in accordance with established processes.
In addition, many states in which we operate have enacted laws that require licensing or registration of professional employer organizations, including Florida, our largest market, and Texas, and additional states are considering such legislation. We may not be able to satisfy the licensing requirements or other applicable regulations of any particular state, or we may be unable to renew our licenses in the states in which we currently operate upon expiration of such licenses, which could prevent us from providing services to client employees in a certain state. In addition, many of these states have reciprocal disciplinary arrangements under which disciplinary action in one state can be the basis for disciplinary action in one or more other states. Future changes in or additions to these requirements may require us to modify the manner in which we provide services to our clients, which may increase our costs in providing such services.
We are also increasingly affected by legal requirements relating to privacy of information. We anticipate that additional federal and state privacy laws and regulations beyond the federal Health Insurance Portability and Accountability Act of 1996 and the regulations
promulgated thereunder will continue to be enacted and implemented. The scope of any such new laws and regulations may be very broad and entail significant costs for us to be in compliance.
If our captive insurance subsidiary is not recognized as an insurance company we may be subject to additional and/or accelerated income tax payments and/or penalties.
When delivering our HR outsourcing solution to clients through a co-employment relationship, we are usually responsible for providing workers compensation coverage to our clients employees. Since 2003, a portion of this coverage is arranged through a wholly-owned captive insurance subsidiary (the Captive). We recognize the Captive as an insurance company for income tax purposes with respect to our income tax returns. While we have determined it is more likely than not the Captive qualifies as an insurance company, in the event the taxing authorities were to assert that the Captive does not qualify as an insurance company and were such assertion ultimately upheld, we could be required to make additional income tax payments and/or accelerate income tax payments that we otherwise would have deferred until future periods.
We face direct and overlapping competition from a number of other companies which may affect our ability to retain existing clients and attract new clients.
In order to acquire new clients, we must first convince potential clients that a HR outsourcing provider is a superior option as compared to their current internal HR solutions. For potential clients that choose to outsource these services, we then face direct competition from a number of providers that also operate on a co-employment platform, such as Administaff, Inc., as well as companies that primarily provide payroll processing services in addition to co-employment services such as Automatic Data Processing Inc. We also face competition from certain information technology outsourcing firms and broad-based outsourcing and consultancy firms that provide or may seek to provide HR outsourcing services in addition to consulting companies that perform individual projects, such as development of HR strategy and information systems. Historically, most of these vendors have focused on discrete processes, but many are now promoting integrated process management offerings that may compete with our offerings. We expect that market experience to date and the predicted growth of the HR outsourcing market will continue to attract and motivate more competitors.
Certain of our existing or potential competitors may have substantially greater financial, technical and marketing resources, larger customer bases, greater name recognition and more established relationships with their clients and key product and service suppliers than we do. This may enable them to develop and expand their delivery infrastructure and service offerings more quickly, which could adversely affect our ability to attain new clients.
Certain of our existing or potential competitors may have substantially greater financial, technical and marketing resources, larger customer bases, greater name recognition and more established relationships with their clients and key product and service suppliers than we do. This may enable them to develop and expand their delivery infrastructure and service offerings more quickly and:
· achieve greater scale and cost efficiencies; adapt more quickly to new or emerging technologies and changing client needs;
· take advantage of acquisitions and other opportunities more readily; establish operations in new markets more rapidly;
· devote greater resources to the marketing and sale of their services; and
· adopt more aggressive pricing policies and provide clients with additional benefits at lower overall costs in order to gain market share or in anticipation of future improvements in delivery costs.
If our competitive advantages are not compelling or sustainable and we are not able to effectively compete with competitors, then we may not be able to increase or maintain our clients at profitable levels or at all.
The market for our services and our revenue growth depends on our ability to use the Internet as a means of delivering HR services and this exposes us to various security risks.
We rely on the Internet as a primary mechanism for delivering services to our clients and use public networks to transmit and store extremely confidential information about our clients and their employees. Our target clients may not continue to be receptive to HR services delivered over the Internet because of concerns over transaction security, user privacy, the reliability and quality of Internet service and other reasons. A security breach could disrupt our operations, damage our reputation and expose us to litigation and possible liability. We may be required to expend significant capital and other resources to address security breaches, and we cannot be certain that our security measures will be adequate. In addition, emerging or uncertain laws and regulations relating to Internet user
privacy, property ownership, consumer protection, intellectual property, export of encryption technology, and libel could impair our existing Internet usage. This could decrease the popularity or impede the expansion of the Internet and decrease demand for our services. If we become subject to the application of laws and regulations from jurisdictions whose laws do not currently apply to our business, or the application of existing laws and regulations to the Internet and other online services, our profitability and growth prospects may be adversely affected.
We are dependent upon technology services, and any damage, interruption, security breach or failure in our computer and telecommunications systems could adversely affect our existing client relationships and our ability to attract new clients.
Our business could be interrupted and we may lose data as a result of damage to or disruption of our computer and telecommunications equipment and software systems from natural disasters, floods, fire, power loss, hardware or software malfunctions, penetration by computer hackers, terrorist acts, vandalism, sabotage, computer viruses, vendor performance failures or insolvency, and other causes. Our business involves the storage and transmission of sensitive information about our clients and their employees and any system or equipment failure or security breach we experience could adversely affect our clients businesses, and could expose us to a risk of loss of this sensitive information, damage to our goodwill and reputation, litigation and possible liability. If our security measures are breached as a result of third-party action, employee error, malfeasance or otherwise and, as a result, someone obtains unauthorized access to client data, our reputation will be damaged, our business may suffer and we could incur significant liability. The precautions that we have taken to protect ourselves and minimize the impact of such events (such as our disaster recovery plans and encryption of sensitive information) may not be adequate, and we may be unable to recover data used in our operations or prevent unauthorized access to our client and employee data. Techniques used to obtain unauthorized access or to sabotage systems change frequently and generally are not recognized until launched against a target. As a result, we may be unable to anticipate these techniques or implement adequate preventative measures. If an actual or perceived breach of our security occurs, the market perception of our security measures could be harmed, and we could lose sales and clients.
We may not be able to keep pace with changes in technology.
To maintain our growth strategy, we must adapt and respond to technological advances and technological requirements of our clients. Our future success will depend on our ability to enhance capabilities and increase the performance of our internal use systems, particularly our systems that meet our clients requirements. We continue to make significant investments related to the development of new technology. If our systems become outdated, we may be at a disadvantage when competing in our industry. There can be no assurance that our efforts to update and integrate systems will be successful. If we do not timely integrate and update our systems, or if our investments in technology fail to provide the expected results, there could be an adverse impact to our business and results of operations.
We depend on third-party technology licenses and the loss or inability to maintain these licenses or errors in the software we license could result in increased costs, reduced service levels and delayed sales of our products and services.
We rely on third-party vendors for software, and if their products are not available, or are inadequate, our business could be seriously harmed. For example, we process payroll for most of our client employees using Oracles Human Resources Management System (HRMS) and Payroll processing applications. Our service delivery capability incorporates and relies on Oracle software that we license directly from Oracle. If Oracle or our other software vendors change or fail to maintain a product that we are using or do not permit use of that product by our clients or us, or if our licensing agreements are terminated or not renewed, we could be forced to delay or discontinue our services until substitute technology can be found, licensed and installed. We could also be forced to pay significantly higher licensing fees with respect to such substitute technology. In addition, our products depend upon the successful operation of third-party services and products, and any undetected errors in these products could prevent the implementation or impair the functionality of our products, delay new product introductions, and harm our reputation and sales.
Our business depends on the confidentiality, integrity and availability of the data in our technology infrastructure.
Our ability to provide effective and efficient service to our customers, and to accurately report our financial results, depends on the confidentiality, integrity and availability of the data in our technology infrastructure including our service delivery system. As a result of technology initiatives, changes in our system platforms and integration of new business acquisitions, we operate a number of different systems requiring frequent maintenance, expansion, replacement and upgrades. If the information we rely upon to run our business were found to be inaccurate or unreliable, or if such information were to be lost or corrupted in the process of consolidating, upgrading, expanding or replacing all or part of our technology infrastructure, or if we otherwise fail to maintain our information systems and data integrity effectively, we could face damage to our reputation and ability to attract and retain clients, have increases in operating expenses or suffer other adverse consequences. In addition, failure to consolidate, upgrade, expand or replace all or part of
the components of our technology infrastructure successfully could result in higher than expected costs and diversion of managements time and energy, which could materially impact our business, financial condition and operating results.
Our professional services agreement allows clients to terminate their relationship with us upon either 30 or 45 days notice, and as a result, we could lose a significant number of customers in a short period of time.
In order to utilize our professional services, each of our clients is required to enter into our professional services agreement, which generally provides for an initial one-year term, subject to termination by our client or us at any time upon either 30 or 45 days prior written notice. Following the initial term, the contract may be renewed, terminated or continued on a month-to-month basis. As a result, a significant number of our clients may terminate their agreement with us at any time. In particular, they may decide to discontinue our services or their relationship with us due to our attempts to increase our services fees or increase our medical or workers compensation insurance charges. Clients may also be unwilling to pay for broadened service offerings if additional or increased fees accompany such changes. These termination provisions could cause us to lose a significant number of customers in a short period of time or make it difficult for us to increase our prices, thereby adversely affecting our results of operations.
As a result of our co-employment relationship with most of our clients and client employees, we may be subject to liabilities as a result of their acts or omissions.
We enter into a contractual relationship with each of our clients, whereby the client transfers certain employment-related risks and liabilities to us and retains other risks and liabilities. Many federal and state laws that apply to the employer-employee relationship do not specifically address the obligations and responsibilities of this co-employment relationship. Consequently, we may be subject to liability for violations of employment or discrimination laws, including violations of federal and state wage and hour laws, by our clients despite the contractual division of responsibilities between us, even if we do not participate in such violations. This risk is increased with respect to clients serviced by our HR consultants who are located on-site at our clients offices and who are designated service representatives of one or two clients because of their greater presence on a clients premises and potential involvement in client employee relations. In addition, our client employees may also be deemed to be acting as our agents, subjecting us to further liability for the acts or omissions of such client employees. Although our professional services agreement provides that the client will indemnify us for any liability attributable to its own or its employees conduct, we may not be able to effectively enforce or collect such contractual indemnification. Any such liability imposed upon us could have a material adverse impact on our results of operations, financial condition and cash flows.
Because we assume the obligation to make wage, tax and regulatory payments on behalf of our clients, we are exposed to certain credit risks with respect to our clients.
Under the terms of our professional services agreement, for clients serviced on a co-employed basis we generally assume responsibility for and manage the risks associated with each of our clients employee payroll obligations, including the payment of salaries, wages and associated taxes, and, at the clients option, the responsibility for providing group health, welfare and retirement benefits to each client employee. In this co-employment relationship, we directly assume these obligations, and unlike payroll processing service providers, we issue payroll checks to each client employee drawn on our own bank accounts. In several states, we are required to pay wages, payroll taxes and other amounts related to payroll regardless of whether the client timely funds such payments to us. For clients serviced either on a co-employed or non co-employed basis, who meet certain financial underwriting requirements, Gevity may issue payroll to a clients employees prior to irrevocable receipt of payroll, taxes and associated service fees. If we are unable to collect these payments from our larger clients, there may be a material adverse effect on our results of operations, financial condition and cash flows.
We may make errors and omissions in performing our services, which could subject us to losses and fines and harm our reputation.
Our payroll processing and related administrative services are subject to various risks resulting from errors and omissions in filing tax returns covering employment-related taxes, paying tax liabilities with respect to those returns, transmitting funds to benefit plans, billing clients and paying wages to our clients employees. Tracking, processing and paying such amounts and administering retirement and other benefit plans is complex. Errors and omissions have occurred in the past and may occur in the future in connection with these services. We and our clients are subject to cash penalties imposed by tax authorities for late filings or underpayment of taxes or required plan contributions. We may also transfer to or withdraw funds from the wrong party in error or transfer or withdraw incorrect amounts and may not be able to correct the error or retrieve the funds. These penalties could, in some cases, be substantial and could harm our business and operating results. Our human resources consulting services also entail the risk of
errors and omissions. Additionally, our failure to fulfill our obligations under our professional service agreements could harm our reputation, our relationship with our clients and our ability to gain new clients.
If we are determined not to be an employer pursuant to applicable ERISA and IRS rules and regulations, we may be subject to additional regulations and liabilities.
If it is determined that we are not the employer for purposes of ERISA or the Code, we could be subject to liabilities, including penalties, with respect to our cafeteria benefits plan operated under Section 125 of the Code, as amended, for failure to withhold and pay taxes applicable to salary deferral contributions by our client employees. As a result of such a finding, we and our plans may not enjoy, with respect to our client employees, the preemption of state laws provided by ERISA, and we could be subject to additional varying state laws and regulation, as well as to claims based upon state common law. In addition, if it were determined that we are not an employer for purposes of IRS rules and regulations we may be unable to either make certain payroll tax payments or take certain tax credits which could have a material adverse impact on our results of operations, financial condition and cash flows.
Laws and regulations relating to verifying individuals eligibility for employment could subject us to significant penalties and compliance costs.
Federal law requires employers to verify that all persons employed by them in the United States have established both their identity and their eligibility to accept such work. Employers that knowingly employ unauthorized persons can be subject to significant civil and criminal sanctions. We rely on our clients to verify their employees identity and eligibility for employment and the responsibility for such verification is allocated to our clients in the professional services agreement. The treatment of PEOs for such purposes, including whether the PEO, its client, or both might be regarded as an employer of a worksite employee, has not been definitively established.
We may be liable for 401(k) testing failures and any such liability may have an adverse effect on our results of operations and financial condition.
Our 401(k) plan is structured as a multiple employer plan. Each participating client is considered a participating employer within the plan and is separately tested for compliance with certain participation-related legal requirements (commonly referred to as discrimination testing). Failure of any portion of the plan relating to one participating employer could jeopardize the qualified status of, and our ability to continue to operate the entire plan.
Our credit agreement contains restrictive covenants that may restrict our financial and operating flexibility.
Our credit agreement, which is fully secured by liens on substantially all the property and assets of the Company (with agreed upon carveouts and exceptions), restricts us and our subsidiaries from various actions, including the following, in each case subject to various specified exceptions and limits:
· incurring liens and debt;
· making acquisitions;
· repurchasing shares of the Companys stock;
· making capital expenditures;
· making investments;
· entering into a merger, sale of all or substantially all of our assets or undergoing a change of control;
· selling assets;
· paying dividends and making other restricted payments;
· entering into transactions with affiliates;
· entering into agreements that limit the ability of our subsidiaries from paying dividends, debt, loans or entering into other restrictions;
· amending the terms of other debt of ours;
· entering into sale and leaseback transactions; and
· materially modifying our workers compensation arrangements.
We are also required to maintain financial covenants regarding leverage, coverage and fixed charges. These restrictions may limit our financial and operating flexibility and, as a result, reduce our ability to grow and execute on our strategic objectives. Our level of compliance with the financial covenants determines the maximum amount of the credit facility available to us. Additionally, if we fail to meet the minimum requirements of the financial covenants, and we are unable to obtain a waiver or amendment, the lender would have the right to terminate the credit agreement and require us to immediately repay all outstanding amounts. If we are unable to make borrowings under the credit agreement or were required to immediately repay all outstanding amounts, our cash flows, financial condition and results of operations could be materially and adversely affected.
Our acquisition strategy subjects us to numerous risks.
Subject to the Merger Agreement, one important component of our growth strategy is to pursue selective acquisitions. This strategy entails numerous risks, including the following:
Integration & Operational Risks. We face risks associated with integrating new organizations, including their management, personnel and clients, into our established business. An inability to successfully integrate acquired businesses into our operations could cause attrition of acquired personnel and clients. An acquisition may not provide the benefits originally anticipated by management while we continue to incur operating expenses to provide the services provided formerly by the acquired company.
Financial Risks. We may finance an acquisition with cash, by issuing equity securities (which could be dilutive to existing shareholders) or by incurring debt (which would increase our leverage and interest expense and could impose additional restrictive covenants). We cannot assure you that we will be able to access the capital markets for these transactions, and, even if we were able to do so, we cannot assure you we would be able to obtain commercially reasonable terms for any such financing.
Legal Risks. An acquired company may have liabilities that are difficult to assess, for which there are inadequate reserves and that may be significant. For example, employee benefit plans of an acquired company could result in liability due to the plans failure to comply with applicable laws and regulations. Further, there may be acquisition-related disputes, including disputes over earn-outs, indemnities and escrows.
Completion Risks. Even if we pursue possible acquisition candidates, we cannot assure you that we will be able to close on them at attractive prices or at all. As a result, we may expend considerable resources (such as management time and money) on pursuing acquisitions without successfully acquiring any new businesses.
Many of these risks are beyond our ability to control. As a result, there can be no assurances that we will be able to achieve this component of our growth strategy. These risks could also have a material adverse impact on our results of operations. In addition, these risks could be compounded if we complete several acquisitions within a relatively short period of time.
We are dependent upon key personnel, and the recruitment and retention of key employees may be difficult and expensive.
We believe that the successful operation of our business is dependent upon our retention of key personnel including our executive team. In general, the employment of our key personnel may be terminated by either the employee or us at any time, without cause or advance notice, subject to severance obligations under specified circumstances. If any of these individuals were unable or unwilling to continue working for us, we could have difficulty finding a replacement, and our operations and profitability could be adversely affected, which would likely have an adverse impact on the price of our common stock. In addition, we are not the beneficiary under any life insurance contracts covering any of our key personnel. We also rely heavily upon stock options to supplement compensation for many of our key employees, and if we continue to grant options to these employees, the treatment of options as an expense in response to regulatory requirements may significantly increase our reported costs.
If we cannot attract and retain qualified individuals, the quality of our services may deteriorate and our results of operations could be adversely affected.
Our success depends upon our ability to attract and retain qualified personnel including HR consultants and business development managers (BDMs) who possess the specific skills and experience necessary to identify, acquire and retain clients. Finding and retaining qualified personnel is difficult because of the specific skill set that we require in order for us to adequately operate in the
complex HR regulatory environment. We compete for qualified personnel not only with other HR service providers, but also with internal HR departments. Our ability to attract and retain qualified personnel including HR consultants and BDMs could be impaired by any diminution of our reputation, decrease in compensation levels, restructuring of our compensation system, or competition from our competitors.
Anti-takeover provisions in our organizational documents and Florida law may limit the ability of our shareholders to control our policies and effect a change of control of our company, which may not be in your best interests.
There are provisions in our articles of incorporation that may discourage a third party from making a proposal to acquire us, even if some of our shareholders might consider the proposal to be in their best interests. For example, our articles of incorporation authorize our board of directors to issue one or more classes or series of preferred stock that could discourage or delay a tender offer or change in control. In addition, we have entered into a shareholder rights plan, commonly known as a poison pill, that may delay or prevent a change of control.
Additionally, we are subject to statutory anti-takeover provisions under Florida law. Section 607.0901 of the Florida Business Corporation Act (the FBCA) imposes restrictions upon acquirers of 10% or more of our outstanding voting shares and requires approval by the corporations disinterested directors or a supermajority of uninterested shareholders for certain business combinations and corporate transactions with the interested shareholder or any entity or individual controlled by the interested shareholder, unless certain statutory exemptions apply. Section 607.0902 of the FBCA eliminates the voting rights of common stock acquired by a party who, by such acquisition, controls at least 20% of all voting rights of the corporations issued and outstanding stock.
Our headquarters, many of our clients headquarters, and the facilities of many of the third parties on which we rely to provide us and our clients with critical services are located in an area of the United States that is susceptible to hurricane damage and other natural disasters.
Our Florida facilities, including our principal executive offices and field support offices, as well as certain of our vendors and a significant number of our clients are located in an area prone to natural disasters such as hurricanes, floods, tornadoes, and other adverse weather conditions. A hurricane or other disaster could significantly disrupt our services, particularly if it results in prolonged disruptions to the Internet and telecommunications services on which we heavily rely. The precautions that we have taken to protect ourselves and minimize the impact of such events (such as our disaster recovery plans) may not be adequate, and we may lose, not be able to access, or be unable to recover data, hardware, software and other systems used in our operations. In addition, our regional clients could also suffer the effects of a significant natural disaster and not be able to fulfill their contractual requirements pursuant to the terms of our professional services agreement. Our business could be materially and adversely affected should our ability to provide services and products, or our ability to collect our service fees, be impacted by such an event.
The pending merger transaction, pursuant to which TriNet would acquire all of our outstanding common stock, may be delayed or may not close.
We have announced that the pending transaction with TriNet is expected to close in the second quarter of 2009. The consummation of the Merger is subject to various customary conditions, including Gevity shareholder approval, the expiration or termination of the applicable waiting periods under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, and the receipt of certain other state regulatory approvals. The timing of such events and the completion of the Merger are subject to factors beyond our control. In addition, while our board of directors has recommended that shareholders approve the transaction, we cannot predict the outcome of the shareholder vote.
On June 6, 2005, the Company entered into a lease agreement with Osprey-Lakewood Ranch Properties, LLC, to relocate the Companys corporate facility within Bradenton, Florida. Under the terms of the lease agreement, the Company has leased from the landlord approximately 97,000 square feet in the office building located at 9000 Town Center Parkway, Bradenton, Florida 34202. The lease is for a term of 10 years, unless sooner terminated or extended as provided in the lease agreement and commenced on December 1, 2005. The lease agreement provides for commercially reasonable base rent in consideration of the size and type of building and the surrounding area. The base rent will increase 3% each year beginning on the first anniversary of the commencement
date of the term of the lease. The Company has the option to renew the lease for two additional five-year terms on the same terms and conditions as are applicable to the initial term, except that the base annual rent during each renewal term will be equal to the fair market base annual rent for the leased property determined in accordance with the lease agreement; provided, however, that the base annual rent during each year of a renewal term will not be less than the base annual rent during the last year of the immediately preceding term. The Company began operating out of this facility in January 2006.
As of December 31, 2008, the Company leased space for its 32 field offices located in Arizona, California, Colorado, Florida, Georgia, Illinois, Minnesota, New Jersey, New York, Nevada, North Carolina, Tennessee and Texas. The Company believes that its field office leases, which generally have terms of one to five years, can either be renewed on acceptable terms or that other, comparable space can be located upon the expiration of any field office lease without significant additional cost to the Company. The Company considers its facilities to be adequate for its current and prospective operations.
The Company is a party to certain pending claims that have arisen in the ordinary course of business, none of which, in the opinion of management, is expected to have a material adverse effect on the consolidated financial position, results of operations, or cash flows if adversely resolved. However, the defense and settlement of these claims may impact the future availability of, and retention amounts and cost to the Company for applicable insurance coverage.
From time to time, the Company is made a party to claims based upon the acts or omissions of its clients employees for the acts or omissions of such client employees and vigorously defends against such claims.
On March 13, 2009, a putative class action was commenced in the Circuit Court for Manatee County, Florida against the Company, each of the Companys directors and TriNet alleging that Gevitys board of directors breached its fiduciary duties to the Companys shareholders in approving and adopting a merger agreement that contains preclusive deal protection measures and allegedly unfair merger consideration. The complaint further alleges that the Company and TriNet aided and abetted Gevitys directors in this alleged breach of fiduciary duty. The complaint seeks to enjoin the completion of the merger, an award of unspecified monetary damages and to recover certain costs incurred by the plaintiff. The Company believes the complaint to be entirely without merit and intends to defend it vigorously.
No matters were submitted to a vote of the Companys stockholders during the fourth quarter of 2008.
The Companys common stock is traded on the NASDAQ Global Select Market under the ticker symbol GVHR. The following table sets forth the high and low sales prices for the common stock as reported on the NASDAQ Stock Market and dividends per share of common stock paid during the last two fiscal years:
The Company did not pay any cash dividends prior to the first quarter of 2001. The Company paid a cash dividend of $0.05 per share of common stock for that quarter and for each subsequent quarter through the first quarter of 2004. Beginning in the second quarter of 2004, the Company increased its quarterly cash dividend payment to $0.06. Beginning the second quarter of 2005, the Company increased its quarterly cash dividend to $0.07. In the second quarter of 2006, the Company increased its quarterly cash dividend payment to $0.09. The Company decreased its quarterly cash dividend to $0.05 in the second quarter of 2008. The Company reduced its dividend payment to reflect an appropriate level of payout in relation to earnings, to allow sustainability, and to allow for investment in client facing aspects of its technology platform. On March 4, 2009, the board of directors declared a quarterly cash
dividend of $0.05 per share of common stock, payable on April 30, 2009 to holders of record on April 16, 2009. Subject to the Merger Agreement, any future determination as to the payment of dividends will be made at the discretion of the Companys board of directors and will depend upon the Companys operating results, financial condition, capital requirements, general business conditions and such other factors as the board deems relevant.
As of February 11, 2009, there were 458 holders of record of the Companys common stock. The number of holders of record does not include beneficial owners of the common stock whose shares are held in the names of various dealers, clearing agencies, banks, brokers and other fiduciaries.
Issuer Purchases of Equity Securities
The following table provides information about Company purchases of equity securities during the fourth quarter of 2008 that are registered by the Company pursuant to Section 12 of the Securities Exchange Act of 1934:
(1) On August 15, 2006, the Company announced that the board of directors had authorized the purchase of up to $75.0 million of the Companys common stock under a new share repurchase program. Share repurchases under the new program are to be made through open market repurchases, block trades or in private transactions at such times and in such amounts as the Company deems appropriate based upon a variety of factors including price, regulatory requirements, market conditions and other corporate opportunities.
(2) On April 20, 2007, the Companys board of directors authorized an increase to its current share repurchase program of approximately $36.5 million, which brought the current repurchase amount authorized back up to $75.0 million.
(3) The Company has suspended its stock repurchase program for the time being in order to invest available cash in its business.
Share Performance Graph
The following graph shows the cumulative total return to the Companys shareholders beginning as of December 31, 2003 and for each year of the five years ended December 31, 2008, in comparison to the NASDAQ Composite and to an index of peer group companies that the Company has selected.
The peer group consists of Administaff, Inc., Automatic Data Processing, Inc., Barrett Business Services, Inc., CBIZ, Inc., Convergys Corporation, Hewitt Associates, Inc., and Paychex, Inc.
The information in the foregoing graph and table is not soliciting material, is not deemed filed with the SEC and is not to be incorporated by reference in any of our filings under the Securities Act or the Exchange Act, whether made before or after the date hereof and irrespective of any general incorporation language in any such filings.
The following table sets forth certain selected historical financial and operating data of the Company as of the dates and for the periods indicated. The historical statement of operations data and the statistical operating data have been revised for comparative purposes to reflect information from continuing operations. The following selected financial data are qualified by reference to, and should be read in conjunction with, the consolidated financial statements beginning on page F-1, related notes and other financial information included as Part II, Item 8 of this Annual Report on Form 10-K, as well as Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations.
The following discussion contains forward-looking statements that are subject to known and unknown risks, uncertainties (some of which are beyond the Companys control), other factors and other assumptions that may cause actual results or performance to be materially different from those expressed or implied by such forward-looking statements. Factors that could cause or contribute to such differences include those discussed below and elsewhere in this Annual Report on Form 10-K. See Cautionary Note Regarding Forward-Looking Statements above. The following discussion should be read in conjunction with the Companys consolidated financial statements and related notes beginning on page F-1 of this report. Historical results are not necessarily indicative of trends in operating results for any future period.
Gevity HR, Inc. (Gevity or the Company) specializes in providing small- and medium-sized businesses nationwide with a wide-range of competitively priced payroll, insurance and human resource (HR) outsourcing services.
Gevity is a professional employer organization (PEO) that provides certain HR-related services and functions for clients under a co-employment arrangement. Under the co-employment arrangement, Gevity assumes certain HR/employment-related responsibilities, as provided for by a professional services agreement (PSA) and as may be required under certain state laws. The co-employment relationship allows the PEO to become an employer of record and administrator for matters such as employment tax and insurance-related administration, as well as relieving the client of these time-consuming administrative burdens. Because a PEO can aggregate a number of small clients into a larger pool, the PEO is able to create economies of scale - enabling smaller businesses to get competitively priced benefits.
The core services typically provided by a PEO are payroll processing, access to health and welfare benefits and workers compensation coverage. In addition to these core offerings, the Companys Gevity Edge offering provides value-adding HR services such as employee retention programs, new hire support, employment practices liability insurance coverage and performance management programs, all designed to help clients effectively grow their businesses. Gevity is one of few PEOs with dedicated field-based HR consultants. The Companys HR consultants work directly with clients to provide HR expertise and HR strategies that can help drive their business forward, while lowering potential exposure to HR-related claims.
Previously, Gevity also provided service to its clients through a non co-employment relationship. The non co-employment relationship between Gevity and its clients was also governed by a PSA. Under the non co-employment PSA, the employment related liabilities remained with the client and the client was responsible for its own workers compensation insurance and health and welfare plans. The Company assumed responsibility for payroll administration (including payroll processing, payroll tax filing and W-2 preparation) and provided access to all of its HR services. This non co-employment offering was known as Gevity Edge Select. As previously discussed under Business - General, the Company discontinued its non-coemployment offering after June 30, 2008. The Company has determined that the exit from the Gevity Edge Select business meets the criteria of discontinued operations in accordance with Statement of Financial Accounting Standards No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. Accordingly, the results of operations and related exit costs associated with Gevity Edge Select have been reported as discontinued operations for all periods presented The impact of this decision on the results of operations of the Company is included in the Results of Operations discussion that follows under Discontinued Operations.
The Company believes that the primary challenges to its ability to increase the overall number of client employees serviced are:
· the amount of time required for sales personnel to acquire new client employees may be longer than anticipated;
· the current client employee retention levels may decrease if clients decide to use alternative providers to service their HR outsourcing needs;
· other HR outsourcing client employee portfolios or service providers may not be available for acquisition due to price or quality;
· the Company (under its co-employed service option) may not be able to continue to provide insurance-related products of a quality to acquire new client employees and to retain current client employees; and
· the impact of the economy, especially in Florida.
Potential Acquisition of Gevity
On March 4, 2009, Gevity, TriNet Group, Inc. (TriNet) and Gin Acquisition, Inc., a wholly owned subsidiary of TriNet (Merger Sub), entered into a Merger Agreement (the Merger Agreement). Under the Merger Agreement, Merger Sub will be merged with and into Gevity (the Merger) with Gevity surviving the Merger as a wholly owned subsidiary of TriNet. See additional discussion of this transaction under Business - General.
The Company follows the provisions of Statement of Financial Accounting Standards No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. The proceeds from the proposed merger are expected to be less than the carrying value of the Companys net assets. During the quarter ending March 31, 2009, the Company will consider any related impairment issues caused by the proposed transaction.
The client billings that the Company charges its clients under its professional services agreements include each client employees gross wages, a consolidated service fee and, to the extent elected by the clients, health and welfare benefit plan costs. The Companys consolidated service fee, which is primarily computed on a percentage of payroll basis, is intended to yield a profit to the Company and to cover the costs of the HR outsourcing services provided by the Company to the client, as well as certain employment-related taxes and workers compensation insurance coverage. The professional service fee component of the consolidated service fee related to HR outsourcing varies according to a number of factors, such as the size and the location of the client. The component of the consolidated service fee related to workers compensation and unemployment insurance is based, in part, on the clients historical claims experience. All charges by the Company are invoiced along with each periodic payroll provided to the client. The Companys long-term profitability is largely dependent upon the Companys success in generating professional service fees by providing value to its clients.
The Company accounts for its revenues using the accrual method of accounting. Under the accrual method of accounting, the Company recognizes its revenues in the period in which the client employee performs work. The Company accrues revenues and unbilled receivables for consolidated service fees relating to work performed by client employees but unpaid at the end of each period. In addition, the related costs of services are accrued as a liability for the same period. Subsequent to the end of each period, those wages are paid and the related service fees are billed.
The Company reports revenues from consolidated service fees in accordance with Emerging Issues Task Force (EITF) No. 99-19, Reporting Revenue Gross as a Principal versus Net as an Agent. The Company reports as revenues, on a gross basis, the total amount billed to clients for professional service fees, and, to the extent applicable, health and welfare benefit plan fees, workers compensation and unemployment insurance fees. The Company reports revenues on a gross basis for these fees because the Company is the primary obligor and deemed to be the principal in these transactions under EITF No. 99-19. The Company reports revenues on a net basis for the amount billed to clients for client employee salaries, wages and certain payroll-related taxes less amounts paid to client employees and taxing authorities for these salaries, wages and taxes.
The Companys revenues are impacted by the number of client employees it serves, the number of client employees paid each period and the related wages paid, and the number of client employees participating in the Companys benefit plans. Because a portion of the consolidated service fee charged is computed as a percentage of gross payroll, revenues are affected by fluctuations in the gross payroll caused by the composition of the employee base, inflationary effects on wage levels and differences in the local economies in the Companys markets.
Cost of Services
Cost of services for Gevity Edge include health and welfare benefit plan costs, workers compensation insurance costs and state unemployment tax costs. Additionally, costs of services include other direct costs associated with the Companys revenue generating activities, such as employer liability insurance coverage, drug screenings and background checks.
Health and welfare benefit plan costs are comprised primarily of medical benefit costs, but also include costs of other employee benefits such as dental, vision, disability and group life insurance. Benefit claims incurred by client employees under the benefit plans are expensed as incurred according to the terms of each contract. In addition, for certain contracts, liability reserves are established for benefit claims reported and not yet paid and claims that have been incurred but not reported.
In certain instances, the Company decides to make a contribution toward the medical benefit plan costs of certain Gevity Edge clients. The contribution is referred to as a health benefit subsidy. The addition of the client employees of these clients as participants in the Companys medical benefit plans helps to stabilize the overall claims experience risk associated with those plans. An aggregate health benefit subsidy in excess of a planned amount may occur when the medical cost inflation exceeds expected medical cost trends or when medical benefit plan enrollment of those who qualify for a subsidy exceeds expectations. Conversely, a health benefit surplus may occur when the medical cost inflation is less than expected medical cost trends or when medical benefit plan enrollment of those who qualify for a subsidy is less than expected.
The Company offers its medical benefit plans through partnerships with premier health care companies. See Item 1. Business - Vendor Relationships - Employee Benefit Plans. These companies have extensive provider networks and strong reputations in the markets in which the Company operates. The Company seeks to manage its health and welfare benefit plan costs through appropriately designed benefit plans that encourage client employee participation and efficient risk pooling.
Substantially all of the Companys client employees are covered under the Companys workers compensation program with AIG CI, which was effective January 1, 2003. Under this program, workers compensation costs for the year are based on premiums paid to AIG CI for the current year coverage, estimated total costs of claims to be paid by the Company that fall within the programs deductible, the administrative costs of the program, the return on investment earned with respect to premium dollars paid as part of the program and the discount rate used in determining the present value of future payments to be made under the program. Additionally, any revisions to the ultimate loss estimates of the prior years loss sensitive programs are recognized in the current year. In states where private insurance is not permitted, client employees are covered by state insurance funds. Premiums paid to state insurance funds are expensed as incurred.
On a quarterly basis, the Company reviews the current and prior year claims information. The current accrual rate and overall workers compensation expense may be adjusted based on changes in the ultimate claim liability estimate as a result of current and historical loss trends, fluctuations in the administrative costs associated with the program, and actual returns on investment earned with respect to premium dollars paid. The final costs of coverage will be determined by the actual claims experience over time as claims close, by the final administrative costs of the program and by the final return on investment earned with respect to premium dollars paid. See Item 1. Business - Vendor Relationships - Workers Compensation Insurance.
The Company manages its workers compensation costs through the use of carriers who the Company believes efficiently manage claims administration and through the Companys internal risk assessment and client risk management programs.
State unemployment taxes are generally paid as a percentage of payroll costs and expensed as incurred. Rates vary from state to state and are generally based upon the employers claims history. The Company actively manages its state unemployment taxes by:
· actively reviewing unemployment claims and, if warranted, contesting claims it believes are improper;
· avoiding unemployment tax rate increases through the use of voluntary contributions where available;
· using multiple state accounts for the classification of its workers where available;
· electing to report under its clients rates whenever possible; and
· using state successorship rules for its acquisitions of client portfolios of other companies.
Operating expenses consist primarily of salaries, wages and commissions associated with the Companys internal employees and general and administrative expenses. Sales and marketing commissions and client referral fees are expensed as incurred. The Company expects that future revenue growth, if any, would result in increased operating leverage as the Companys fixed operating
expenses are spread over a larger revenue base. The Company continues to review its overhead cost structure to ensure alignment with its business development.
The Company records income tax expense using the asset and liability method of accounting for deferred income taxes.
RESULTS OF OPERATIONS
Year Ended December 31, 2008 Compared to Year Ended December 31, 2007
The following table presents certain information related to the Companys revenues from continuing operations for the years ended December 31, 2008 (2008) and December 31, 2007 (2007):
(1) Clients measured by individual client Federal Employer Identification Number (FEIN).
(2) The average number of client employees paid is calculated based upon the sum of the number of paid client employees at the end of each month divided by the number of months in the period.
(3) Workers compensation wages exclude the wages of clients electing out of the Companys workers compensation program.
(4) Manual premium rate data is derived from tables of AIG CI in effect for 2008 and 2007, respectively.
For 2008, total revenues were $520.5 million compared to $601.6 million for 2007, representing a decrease of $81.1 million or 13.5%. This decrease was a result of the reduction in all revenue components as described below.
As of December 31, 2008, the Company served 5,779 clients, as measured by each clients FEIN, with 101,014 active client employees. This compares to 6,728 clients, as measured by each clients FEIN, with 115,580 active client employees at December 31, 2007. The average number of client employees paid was 96,938 for 2008 compared to 113,094 for 2007. The declines in client and client employee metrics were attributable to the impact of higher than expected client and client employee attrition levels during 2007 and 2008 primarily as a result of the economy and lower than expected production levels during 2007 and 2008. In addition, during the year ended December 31, 2008, the Company terminated approximately 240 unprofitable clients (impacting approximately 4,500
client employees) in an effort to improve overall earnings in the long-term.
The average wage per average number of client employees paid for 2008 increased 2.3% to $44,598 from $43,586 in 2007. This increase was due to inflation as well as the Companys strategy of focusing on clients that pay higher wages to their employees.
Revenues from professional service fees decreased to $113.5 million for the year ended December 31, 2008, from $141.5 million for the year ended December 31, 2007, representing a decrease of $28.0 million or 19.8%. The decrease was primarily due to the overall decrease in the average number of client employees paid as discussed above. Professional service fees per average number of client employees paid decreased by 6.4%, from $1,251 for the year ended December 31, 2007 to $1,171 for the year ended December 31, 2008. This decrease was primarily attributable to general market dynamics and the impact of the 2008 terminations of unprofitable clients which, despite having a negative impact on gross profit, generally had higher professional service fee levels.
Revenues for providing health and welfare benefits for the year ended December 31, 2008 were $325.3 million as compared to $351.0 million for the year ended December 31, 2007, representing a decrease of $25.7 million or 7.3%. Health and welfare benefit plan revenues decreased due to the decrease in the average number of participants in the Companys health and welfare benefit plans of approximately 13.8% and was partially offset by the increase in health insurance premiums as a result of higher costs to the Company to provide such coverage for client employees and the Companys approach to pass along all insurance-related cost increases.
Revenues for providing workers compensation insurance coverage decreased to $61.1 million for the year ended December 31, 2008, from $84.5 million for the year ended December 31, 2007, representing a decrease of $23.4 million or 27.7%. Workers compensation billings, as a percentage of workers compensation wages for 2008, were 1.58% as compared to 1.92% for 2007, representing a decrease of 17.7%. Workers compensation revenue decreased in 2008 primarily due to a decrease in billings for Florida clients reflecting a reduction in Florida manual premium rates beginning in January 2008 and a decrease in the number of clients that participate in the Companys workers compensation program. The manual premium rates for workers compensation applicable to the Companys clients decreased 18.3% during 2008 as compared to 2007. Manual premium rates are the allowable rates that employers are charged by insurance companies for workers compensation insurance coverage. The decrease in the Companys manual premium rates primarily reflects the reduction in the Florida manual premium rates.
Revenues from state unemployment taxes and other revenues decreased to $20.6 million for the year ended December 31, 2008 from $24.6 million for the year ended December 31, 2007, representing a decrease of $4.0 million or 16.2%. The decrease was primarily due to the decrease in wages that provide unemployment tax revenue to the Company.
Cost of Services
The following table presents certain information related to the Companys cost of services from continuing operations for 2008 and 2007:
(1) The average number of client employees paid is calculated based upon the sum of the number of paid client employees at the end of each month divided by the number of months in the period.
(2) Workers compensation wages exclude the wages of clients electing out of the Companys workers compensation program.
(3) The number of workers compensation claims reflects the number of claims reported by the end of the respective period and does not include claims with respect to a specific policy year that are reported subsequent to the end of such period. For information regarding claims reported after the end of each respective year, see the first table set forth below in this Item 7 under Critical Accounting Estimates.
Cost of services, which includes the cost of the Companys health and welfare benefit plans, workers compensation insurance, state unemployment taxes and other costs, was $375.2 million for 2008, compared to $415.6 million for 2007, representing a decrease of $40.4 million or 9.7%. This decrease was due to the reduction in all of the cost of services components as described below.
The cost of providing health and welfare benefits to clients employees for 2008 was $319.3 million as compared to $347.8 million for 2007, representing a decrease of $28.5 million or 8.2%. This decrease was primarily attributable to the decrease in the number of client employees participating in the health and welfare benefit plans and was partially offset by higher cost of health benefits. In addition, 2008 and 2007 were favorably impacted by the recognition of a health benefit surplus of $6.0 million and $3.1 million, respectively, based upon favorable claims experience.
Workers compensation costs were $26.4 million for 2008, as compared to $39.4 million for 2007, representing a decrease of $13.0 million or 33.0%. Workers compensation costs decreased in 2008 primarily due to the approximate 14.3% reduction in the average number of client employees paid and related reduction in wages and claims. Also, reductions in the prior years workers compensation loss estimates of approximately $19.6 million and $19.8 million, respectively, as a result of continued favorable claims development for those prior open policy years, favorably impacted workers compensation costs during 2008 and 2007.
State unemployment taxes and other costs were $29.5 million for 2008, compared to $28.4 million for 2007, representing an increase of $1.2 million or 4.1%. The decrease in the Companys client employees and related taxable wages were substantially offset by an increase in state unemployment tax rates beginning January 1, 2008, that were not passed along to clients. In addition, during 2008, the Company recorded $1.2 million of state unemployment tax expense related to a settlement offer with the State of California as described below in this Item 7 under Critical Accounting Estimates - State Unemployment Taxes - California Unemployment Tax Assessment.
The following table presents certain information related to the Companys operating expenses from continuing operations for 2008 and 2007:
Total operating expenses were $146.1 million for 2008 as compared to $155.0 million for 2007, representing a decrease of $8.9 million or 5.7%.
Salaries, wages and commissions were $75.3 million for 2008 as compared to $83.7 million for 2007, representing a decrease of $8.5 million or 10.1%. The decrease is primarily a result of the net effect of the reduction in management and support personnel that occurred throughout 2007 and 2008 and was partially offset by the annual increase in wages. Total severance related costs during 2008 approximated $2.3 million (including approximately $2.1 million of severance costs related to cost alignment initiatives throughout 2008) compared to severance costs incurred during 2007 of approximately $5.3 million (including $1.6 million related to
the severance agreement with our former Chief Executive Officer).
Other general and administrative expenses were $48.1 million for 2008 as compared to $55.9 million for 2007, representing a decrease of $7.8 million or 14.0%. The decrease occurred across most major components of general and administrative expenses and is attributable to cost alignment measures taken during 2007 and 2008. Included in other general and administrative expenses for 2008 are approximately $1.8 million of expenses related to cost alignment initiatives including employee outplacement benefits and costs associated with field office consolidations.
During the fourth quarter of 2008, the Companys market capitalization dropped below the net book value of its equity. In addition, forecasted cash flows decreased reflecting continued deterioration of macroeconomic conditions which accelerated and became apparent during the fourth quarter of 2008. As a result and in connection with the Companys annual test for goodwill impairment, the Company determined that the fair value of the Company was less than its carrying value and that the implied fair value of the goodwill was zero. Accordingly, the Company recorded a goodwill impairment loss of $8.7 million which eliminated goodwill in its entirety.
During the fourth quarter of 2008, the Company received cash of $2.0 million related to a reinsurance contract previously written off in 2006, in connection with ongoing liquidation proceedings of the reinsurer. Of this amount, $1.7 million was recorded as a recovery of the reinsurance contract premium previously written off and the remaining $0.3 million was included in other general and administrative expense as a reduction in recovery related costs that were previously incurred. Future amounts recovered (related to costs incurred for pursuit of recovery), if any, will be recognized in income when realization is assured beyond a reasonable doubt. See further discussion below in this Item 7 under Year Ended December 31, 2007 Compared to Year Ended December 31, 2006 - Operating Expenses.
Depreciation and amortization expense totaled $15.7 million for 2008 compared to $15.3 million for 2007, representing an increase of $0.4 million or 2.7%. The increase is primarily attributable to the amortization of technology assets capitalized during 2007 and 2008.
For the year ended December 31, 2008, the Company had an income tax benefit of $1.6 million compared to income tax expense of $10.5 million for the year ended December 31, 2007. The change is primarily due to an operating loss for 2008 compared to operating income in 2007. The Companys effective tax rate for 2008 and 2007 was 54.3% and 36.7%, respectively. The Companys effective tax rates differed from the statutory federal tax rates primarily because of state taxes and federal tax credits.
Gross Profit, Operating (Loss) Income, (Loss) Income From Continuing Operations and Diluted (Loss) Earnings Per Share From Continuing Operations
As a net result of the factors described above, the following table summarizes the changes in gross profit, operating (loss) income, (loss) income from continuing operations and diluted (loss) earnings per share from continuing operations:
The loss from discontinued operations was $5.6 million ($3.5 million net of income tax) for the year ended December 31, 2008 compared to $13.1 million ($8.1 million net of income tax) for the year ended December 31, 2007. The decrease in the loss of $7.5
million was primarily the result of the $8.5 million impairment charge for long-lived assets recorded in 2007. The impairment charge in 2007 and the decision to exit the Gevity Edge Select business in 2008 were primarily a result of the poor performance of the business and the integration challenges experienced in 2007. As a result of the exit decision, the remaining goodwill that originated in the HRA acquisition was impaired in 2008 resulting in a charge of $0.5 million. The Companys operations related to Gevity Edge Select ceased on June 30, 2008. The Company does not expect to incur any further significant costs related to the exit.
Year Ended December 31, 2007 Compared to Year Ended December 31, 2006
The following table presents certain information related to the Companys revenues from continuing operations for the years ended December 31, 2007 (2007) and December 31, 2006 (2006):
(1) Clients measured by individual client Federal Employer Identification Number (FEIN).
(2) The average number of client employees paid is calculated based upon the sum of the number of paid client employees at the end of each month divided by the number of months in the period.
(3) Workers compensation wages exclude the wages of clients electing out of the Companys workers compensation program.
(4) Manual premium rate data is derived from tables of member insurance companies of AIG CI in effect for 2007 and 2006, respectively.
For 2007, total revenues were $601.6 million compared to $647.5 million for 2006, representing a decrease of $45.9 million or 7.1%. This decrease was a result of the reduction in all revenue components as described below.
As of December 31, 2007, the Company served 6,728 clients, as measured by each clients FEIN, with 115,580 active client employees. This compares to 7,397 clients, as measured by each clients FEIN, with 127,813 active client employees at December 31, 2006. The average number of client employees paid was 113,094 for 2007 compared to 125,905 for 2006. The declines in client and client employee metrics were attributable to the Companys 2006 initiative to bring healthcare premiums up to retail rates, lower than expected production levels during 2007, and the impact in 2007 of the economy on clients in Florida and clients in the financial and business service sectors.
The average wage per average number of client employees paid for 2007 increased 6.7% to $43,586 from $40,843 in 2006. This increase was due to inflation as well as the Companys strategy of focusing on clients that pay higher wages to their employees.
Revenues from professional service fees decreased to $141.5 million for the year ended December 31, 2007, from $162.6 million for the year ended December 31, 2006, representing a decrease of $21.1 million or 13.0%. The decrease was primarily due to the overall decrease in the average number of client employees paid as discussed above. Professional service fees per average number of client employees paid decreased by 3.1%, from $1,291 for the year ended December 31, 2006 to $1,251 for the year ended December 31, 2007. This decrease was primarily attributable to general market dynamics.
Revenues for providing health and welfare benefits for the year ended December 31, 2007 were $351.0 million as compared to $352.0 million for the year ended December 31, 2006, representing a decrease of $1.1 million or 0.3%. Health and welfare benefit plan revenues decreased due to the decrease in the average number of participants in the Companys health and welfare benefit plans of approximately 10.1% and was partially offset by the increase in health insurance premiums as a result of higher costs to the Company to provide such coverage for client employees and the Companys approach to pass along all insurance-related cost increases.
Revenues for providing workers compensation insurance coverage decreased to $84.5 million for the year ended December 31, 2007, from $106.1 million for the year ended December 31, 2006, representing a decrease of $21.6 million or 20.3%. Workers compensation billings, as a percentage of workers compensation wages for 2007, were 1.92% as compared to 2.30% for 2006, representing a decrease of 16.5%. Workers compensation revenue decreased in 2007 primarily due to the combined effects of a decrease in billings for Florida clients reflecting a reduction in Florida manual premium rates beginning in January 2007 and a decrease in the number of clients that participate in the Companys workers compensation program. The manual premium rates for workers compensation applicable to the Companys clients decreased 20.5% during 2007 as compared to 2006. Manual premium rates are the allowable rates that employers are charged by insurance companies for workers compensation insurance coverage. The decrease in the Companys manual premium rates primarily reflects the reduction in the Florida manual premium rates.
Revenues from state unemployment taxes and other revenues decreased to $24.6 million for the year ended December 31, 2007, from $26.9 million for the year ended December 31, 2006, representing a decrease of $2.2 million or 8.3%. The decrease was primarily due to the decrease in wages that provide unemployment tax revenue to the Company and was partially offset by increases in the state unemployment tax rates that were passed along to clients.
Cost of Services
The following table presents certain information related to the Companys cost of services from continuing operations for 2007 and 2006: