We lease our principal corporate office in San Francisco, California, and our operating unit offices in various states. Information regarding our lease commitments is set forth in Note 9 “Lease Commitments” in the Notes to Consolidated Financial Statements included in Part II, Item 8 of this report. The disclosure set forth in Note 9 “Lease Commitments” is incorporated herein by reference.
In March 1999, we recorded a charge of $1.5 million, net of a related tax benefit of $1.0 million, as an extraordinary loss to reflect a prepayment penalty on senior subordinated debt and the write-off of debt issuance costs.
On October 25, 2002, we completed our initial public offering of 9.0 million common shares at a price of $10 per share. Upon the consummation of the initial public offering, all outstanding shares of Preferred Stock were split adjusted (two-for-five reverse stock split) and converted into approximately 23.1 million shares of our Common Stock. The accretion dividends, with respect to the Preferred Stock, were converted to approximately 9.1 million shares of our Common Stock at the initial public offering price of $10 per share. At December 31, 2002, we had approximately 42.4 million shares of Common Stock outstanding. At December 31, 2001, 2000, 1999 and 1998, we had approximately 0.8 million shares of Common Stock outstanding. The initial public offering proceeds, net of the underwriting discount and expenses, of approximately $78.4 million was used to repay indebtedness under our credit facility.
At December 31, 2002, we had approximately 2.2 million shares of Redeemable Common Stock outstanding. For a description of put rights relating to our Common Stock and Preferred Stock and our Common Stock Warrants please read “Note 7-Redeemable Securities” in our consolidated financial statements and accompanying footnotes included in Part 2 - Item 8.
The following discussion and analysis should be read in conjunction with our consolidated financial statements and accompanying notes included in Part II-Item 8. Certain information contained in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” are forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from the results discussed in the forward-looking statements because of various factors, including those discussed above and elsewhere.
fees paid directly by clients for related Specialized Benefits Services; and
The financial measures that we use to evaluate our performance on a consolidated basis are:
EBITDA Margin, which we define as EBITDA as a percentage of Total Revenues; and
We present EBITDA because we believe that it is a relevant and useful indicator of our operating profitability and our ability to incur and service debt. We believe EBITDA is relevant owing to our leveraged approach to our capital structure and resulting significant amount of interest expenses, and our accounting for all acquisitions using the purchase method of accounting and resulting significant amount of amortization of intangible assets. We present EBITDA Margin because we believe it is a relevant and useful indicator in understanding how we view our operating efficiency. We present Net Income (Loss) plus Amortization of Intangible Assets because we believe that it is a relevant and useful indicator in understanding our ability to generate earnings. We believe Net Income (Loss) plus Amortization of Intangible Assets is relevant owing to the significant amount of our amortization of intangible assets resulting from accounting for all acquisitions using the purchase method of accounting.
Between 1994 and 1999, we pursued an acquisition strategy with a vision of building a national organization capable of distributing a broad range of insurance and financial products and services. The majority of our over 90 acquisitions were completed prior to December 31, 1999.
In most acquisitions, we issued a combination of cash, seller notes and preferred stock. Effective with our initial public offering, we discontinued the practice of offering preferred stock as consideration in acquisitions and started the practice of offering common stock. We also structured our acquisition agreements to include contingent purchase price payments, commonly referred to as “earn-outs,” which we treated as adjustments to
In the latter part of 2001, we completed a strategic and financial review of our company and concluded that USIA was no longer core to our mission, vision or strategy. Consequently, in January 2002, we announced our intention to sell USIA and subsequently sold the business in April 2002. The cash proceeds from the disposition of USIA were used to repay a portion of our bank borrowings, seller notes associated with the business and related transaction expenses. USIA is reflected in our financial statements as a Discontinued Operation in accordance with Statement of Financial Accounting Standards, or SFAS, No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” Accordingly, the assets, liabilities and results of operations for USIA have been disaggregated in our financial statements. USIA accounted for $74.8 million of total revenues for the year ended December 31, 2001 and had approximately 1,100 employees. Discontinued operations had net losses of $13.8 million, $61.8 million, and $8.3 million for the years ended December 31, 2002, 2001 and 2000, respectively. In the fourth quarter of 2001, following the provisions of SFAS No. 121, “Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed of,” we recorded an impairment charge of $46.9 million against USIA’s goodwill and expiration rights. The net loss for the year ended December 31, 2002 includes a $7.2 million pre-tax loss on the sale of USIA in April 2002. For further detail on the losses incurred at USIA in 2001 please read Note 16, “Discontinued Operations,” in our annual financial statements, under “USIA Litigation Matters-Fireman’s Fund Litigation” and “-Mutual of Omaha Litigation.”
We incurred $1.0 million, $2.5 million and $1.2 million in legal fees and other expenses associated with the defense of claims against us, the pursuit of claims made by us and payment of claims by us relating to USIA for the years ended December 31, 2002, 2001 and 2000, respectively. These expenses were incurred in connection with litigation matters related to USIA, but are reflected in the results of our corporate segment under Other Operating Expenses, consistent with our accounting practices.
Please read the information under the caption “-Integration Efforts and Other Charges” below for more details.
Revenues. Revenues increased $16.6 million, or 5.3%, to $328.2 million in 2002 from $311.6 million in 2001. In 2002, we experienced positive net new business and increased premium rates on renewals. In addition, we generated increased revenues from the sales production of recently hired sales professionals. Offsetting the increase in revenues from new business production, increasing premium rates and additional sales production from recently hired sales professionals in 2002, was a $7.7 million reduction in revenues from eliminating low margin business, which contributed $1.1 million in 2002 versus $8.8 million in 2001. Revenues before this item increased approximately 8% in 2002.
Other Operating Expenses. Other Operating Expenses decreased $7.6 million, or 9.9%, to $68.8 million in 2002 from $76.4 million in 2001. In 2002, we had integration efforts and other charges of $1.6 million compared to $11.3 million in 2001. Excluding the effect of these charges, Other Operating Expenses increased $2.1 million or 3.3% in 2002. As a percentage of revenues, Other Operating Expenses were 21.0% in 2002 compared to 24.5% in 2001, primarily due to the charges. Excluding the effect of these charges, Other Operating Expenses as a percentage of revenues were 20.5% in 2002 compared to 20.9% in 2001.
Compensation and Employee Benefits. Compensation and Employee Benefits increased $28.1 million, or 16.3%, to $200.2 million in 2001 from $172.1 million in 2000. In 2001, we had integration efforts and other charges of $11.2 million compared to $2.9 million in 2000. Excluding the effect of these charges, Compensation and Employee Benefits increased $19.8 million or 11.7% in 2001, primarily as a result of the increase in revenues. As a percentage of revenues, Compensation and Employee Benefits were 64.3% in 2001 as compared to 59.2% in 2000, primarily due to the charges. Excluding the effect of these charges and non-recurring revenues in 2000, Compensation and Employee Benefits as a percentage of revenues were 60.7% in 2001 as compared to 59.8% in 2000. In an effort to reduce compensation expense, we terminated 96 employees and renegotiated compensation arrangements for 29 sales professionals during the fourth quarter of 2001.
Other Operating Expenses. Other Operating Expenses increased $14.0 million, or 22.4%, to $76.4 million in 2001 from $62.4 million in 2000. In 2001, we had integration efforts and other charges of $11.3 million compared to $0.8 million in 2000. Excluding the effect of these charges, Other Operating Expenses increased $3.4 million or 5.6% in 2001. As a percentage of revenues, Other Operating Expenses were 24.5% in 2001 as compared to 21.5% in 2000, primarily due to the charges. Excluding the effect of these charges and non-recurring revenues in 2000, Other Operating Expenses as a percentage of revenues were 20.9% in 2001 as compared to 21.8% in 2000.
General and specialty property and casualty insurance, which we refer to as P&C insurance; and
We evaluate segment performance based on revenues, EBITDA and EBITDA margin. EBITDA and EBITDA margin are not substitutes for other financial measures determined in accordance with GAAP. Because not all companies calculate these non-GAAP measures in the same fashion, these measures as presented are not likely to be comparable to other similarly titled measures of other companies.
The Insurance Brokerage segment results reflect the following integration efforts and other charges: $4.6 million, $16.3 million and $2.0 million in years 2002, 2001 and 2000, respectively.
Revenues in the Insurance Brokerage segment increased 6.3% and 7.4% in 2002 and 2001, respectively, due to net new business production, increasing premium rates and additional sales production from recently hired sales professionals. Offsetting the increase in revenues in 2002 was a $7.7 million reduction in revenues from eliminating low margin business, which contributed $1.1 million of revenues in 2002 versus $8.8 million in 2001. Insurance Brokerage revenues before this item increased approximately 10% in 2002. Property & Casualty revenues represented 55.1%, 53.7% and 51.8% of our total consolidated revenues in 2002, 2001 and 2000, respectively, and Group Employee Benefits revenues represented 28.5%, 29.2% and 30.8% of our total consolidated revenues in 2002, 2001 and 2000, respectively.
EBITDA in the Insurance Brokerage segment increased $24.4 million or 55.5% to $68.4 million in 2002 from $44.0 million in 2001, and decreased $8.3 million or 15.8% to $44.0 million in 2001 from $52.2 million in 2000. EBITDA Margin in the Insurance Brokerage segment was 24.9%, 17.0% and 21.7% in 2002, 2001 and 2000, respectively. Excluding the effect of the integration efforts and other charges, EBITDA and EBITDA Margin in the Insurance Brokerage segment were $73.0 million and 26.6%, $60.2 million and 23.3% and $54.2 million and 22.6% in 2002, 2001 and 2000, respectively. The increase in EBITDA and EBITDA Margin in 2002 is due to (i) a decrease in Compensation and Employee Benefits and Other Operating Expenses, as a percent of revenues, due to the positive affects of our integration efforts and (ii) improvement in performance in our operations.
Income From Continuing Operations Before Income Taxes in the Insurance Brokerage segment was $41.9 million, $7.2 million and $16.8 million for the years ended December 31, 2002, 2001 and 2000, respectively. The increase in 2002 is due to (i) the items discussed above, and (ii) a decrease in amortization of intangible assets, principally due to our adoption of SFAS No. 142. Please read Note 1, “Nature of Operations and Summary of Significant Accounting Policies” in our annual financial statements under “Intangible Assets.” The reduction in 2001 is due to the negative impact of the integration effort and other charges in 2001 compared to 2000.
The Specialized Benefits Services segment results reflect the following integration efforts and other charges: $1.1 million, $1.7 million and $0.7 million in years 2002, 2001 and 2000, respectively.
Specialized Benefits Services revenues increased $0.3 million, or 0.5%, to $53.3 million in 2002 and $3.4 million, or 6.8%, to $53.0 million in 2001. Excluding the effect of businesses acquired by adjusting 2000 revenues by $4.4 million and excluding $8.0 million of non-recurring revenues in 2000 as previously discussed, revenues increased approximately 1% and 15% in 2002 and 2001, respectively, in the Specialized Benefits Services segment. The flat revenue growth in 2002 is due to a reduction in core benefit product sales and executive and professional benefit product sales resulting from difficult market conditions, offset by increases in enrollment and communication product sales. Specialized Benefits Services revenues represented 16.2%, 17.0% and 17.1% of our total consolidated revenues in 2002, 2001 and 2000, respectively.
EBITDA in the Specialized Benefits Services segment decreased $3.2 million, or 24.6%, to $9.7 million in 2002 from $12.9 million in 2001 and decreased $5.9 million, or 31.3%, to $12.9 million in 2001 from $18.8 million in 2000. EBITDA Margin in the Specialized Benefits Services segment was 18.2%, 24.3% and 37.8% in 2002, 2001 and 2000, respectively. Excluding the effect of the integration efforts and other charges and non-recurring revenues in 2000, EBITDA and EBITDA Margin in the Specialized Benefits Services segment were $10.8 million and 20.3%, $14.6 million and 27.4% and $11.5 million and 27.7% in 2002, 2001 and 2000, respectively. EBITDA and EBITDA Margin in the Specialized Benefits Services segment in 2002 were negatively impacted by (i) decrease in new business and an increase in lost business in our Core Benefits division, (ii) decrease in new business in our Executive and Professional Benefit division, and (iii) expenses incurred to expand and support our sales distribution capacity and infrastructure.
Upon completion of the majority of our acquisitions, we undertook initiatives to determine the following: (i) positions within the organization that could be eliminated without resulting in loss of revenues or detriment to service; (ii) sales professionals contracts that should be renegotiated because they were in excess of our standard compensation practices; and (iii) accretive benefits that could be derived from the early termination of lease commitments. Upon completion of the analysis we reduced the number of our employees by 32, 96 and 11, during the first quarter of 2002 and for 2001 and 2000, respectively, and such persons were given various levels of severance depending on their length of service with us. This process resulted in severance charges of $3.6 million, $4.7 million and $2.9 million in the first quarter of 2002 and in 2001 and 2000, respectively. In addition, in the first quarter of 2002 and in 2001, we renegotiated the compensation arrangements of four and 29 sales professionals, respectively, whose compensation arrangements were in excess of our standard compensation practices. The renegotiation of these contracts resulted in an expense of $1.8 million in the first quarter of 2002 and $3.0 million in 2001. Finally, in the first quarter of 2002, and in 2001 and 2000, we terminated lease arrangements at one, eight and four locations, respectively. The early termination of lease commitments resulted in charges of $0.1 million, $1.9 million and $0.5 million in the first quarter of 2002, in 2001 and 2000, respectively. Additionally, in 2000, $0.3 million in claims expense was recorded.
In 2001, several insurance carriers notified us that differences existed between insurance coverages placed and the corresponding premiums remitted. After a comprehensive review, we determined that in prior periods coverage had been placed with the carriers without the establishment of the corresponding receivable from the client and payable to the carriers on the general ledger. Thus, after obtaining the necessary information from the carriers in 2001, we were able to reasonably estimate and record the corresponding payables and receivables, net of commission revenues. As the receivables related to the years 1997 through 2001 and collection would entail pursuing numerous former clients, we determined in the fourth quarter of 2001 that the collection of these receivables was remote. In accordance with GAAP, since the collection of the receivables was highly uncertain and the amount of the loss was known, we wrote off the $2.8 million receivables in the fourth quarter of 2001. We have since strengthened our internal controls and systems to minimize the risk of similar discrepancies occurring in subsequent periods.
In 2000, we entered into an agreement with a company, which agreement was terminated by mutual consent in the fourth quarter of 2001, resulting in an accrual of $0.8 million.
In 1995, we adopted a Long-Term Incentive Plan to provide a means to attract, retain and motivate employees. As part of the Long-Term Incentive Plan we issued stock appreciation rights, which we refer to as SARs. SARs generally vest over a five-year period, although accelerated vesting is possible under specified circumstances. Upon exercise of a SAR, the holder generally is entitled to receive, in cash, the excess of the fair market value per share of our common stock on the date of exercise over the grant price of the SAR. The valuation of SARs is based on the estimated fair value of a share of our common stock. In accordance with GAAP, compensation expense, or a reduction of compensation expense, for SARs is recorded over the vesting period based on the change in fair value from grant date to each balance sheet date. Please read Note 6, “Stockholders’ Equity-Long-Term Incentive and Share Award Plan,” in our annual financial statements. We recorded a net reduction in SAR-related compensation expense of $3.0 million in 2002, resulting from a reduction in the fair market value of our common stock. We recorded SAR-related compensation expense of $3.1 million and $0.3 million in 2001 and 2000, respectively.
Upon the consummation of our initial public offering in October 2002, the Long-Term Incentive Plan was terminated and replaced with the 2002 Equity Incentive Plan. Also, after the consummation of our initial public offering, we made an offer to exchange all outstanding SARs for stock options or stock under our 2002 Equity Incentive Plan. On November 27, 2002, the SARs exchange was completed, the SARs tendered in the exchange were canceled, and the related compensation expense for 2002 was finalized. As of December 31, 2002, there were no SARs outstanding.
1996 senior subordinated debt offering that was repaid in 1999, agreed to terminate the put rights associated with the Redeemable Common Stock Warrants concurrent with the consummation of the initial public offering. The aggregate value of the warrants was $4.3 million and was reported as Redeemable Common Stock warrants on our balance sheet prior to the consummation of our initial public offering. The change in value of the warrants, which is recorded as change in value of redeemable common stock warrants in our statements of operations, was $(4.1) million and $1.4 million for 2002 and 2001, respectively.
On October 25, 2002, we completed our initial public offering of 9.0 million shares at a price of $10 per share. The cash proceeds of the offering after the underwriting discount were $83.7 million. After deducting offering expenses of $5.3 million, $78.4 million was used to pay down our indebtedness under the credit facility. In connection with the debt repayment, we wrote-off $1.9 million in deferred financing costs in the fourth quarter of 2002.
In April 2002, we completed the sale of USIA for $19.9 million. We received cash proceeds of $18.2 million with the remaining consideration of $1.7 million in the form of an account receivable. Of the $18.2 million in cash proceeds, $16.3 million was used to reduce our term loan and $1.9 million was used to pay selling costs. In connection with the debt repayment, we wrote-off $0.7 million in deferred financing costs in the second quarter of 2002.
Our existing credit facility is comprised of (i) a $75.0 million revolving credit facility, expiring on September 17, 2004, and (ii) a $125.0 million term loan payable in quarterly installments, which commenced on December 31, 1999. The last quarterly installment is due on September 17, 2004, the maturity date of the term loan. The revolving credit facility is available on a revolving basis for loans denominated in U.S. dollars and for letters of credit.
As of December 31, 2002, the significant financial covenants of our existing credit facility were as follows:
With the consummation of the initial public offering and the net proceeds used to reduce bank borrowings, we are currently evaluating our debt structure in light of our available sources of funding. Upon completing this evaluation, we expect to be in a position to make a judgment as to what the debt component of our capital structure should be to best support our business and acquisition strategy. This may or may not result in a decision to replace our existing credit facility with either a new credit facility, publicly or privately offered notes, some other form of debt financing, or some combination of the foregoing or request an amendment to our existing credit facility. In the event that we replace our existing credit facility, we will be required to pay a fee equal to 1.00% of the revolving credit commitment and the outstanding borrowings under the term loan as determined 30 days prior to repayment. In the event our existing credit facility is not replaced by March 31, 2004, and depending on our results of operations, we may be required to request from our current lenders a waiver or modification of the shareholders’ equity covenant, and possibly other covenants, in the existing credit facility. Failure to comply with financial covenants in our existing credit facility could cause all or a portion of our debt to become immediately due and payable.
On October 31, 2002, Standard & Poor’s removed us from CreditWatch and affirmed its single-”B”-plus rating on our company with a positive outlook, after we successfully completed our initial public offering.
Cash and cash equivalents from continuing operations (decreased) increased by $(9.5) million, $29.2 million and $8.7 million for the years ended December 31, 2002, 2001 and 2000, respectively. Net cash provided by operating activities totaled $36.6 million, $21.9 million and $29.9 million for the years ended December 31, 2002, 2001 and 2000, respectively, and is principally dependent upon the timing of collection of premiums receivable and payments of premiums payable.
Net loss from continuing operations per share (basic and diluted) was $(0.87), $(74.16) and $(41.56) for the years ended December 31, 2002, 2001 and 2000, respectively. Our per share data was significantly impacted by the 43.8 million increase in our common shares outstanding, which was a result of (i) 34.8 million shares of our common stock issued to the holders of our preferred stock concurrent with our initial public offering and (ii) 9.0 million shares of our common stock issued as part of the initial public offering. As of December 31, 2002, we had 44.6 million shares of our common stock outstanding; that is, 42.4 million shares are included in
stockholders’ equity and 2.2 million shares are included in redeemable securities. As of December 31, 2001 and 2000, we had 0.8 million shares of our common stock outstanding.
We have structured our acquisition agreements to include contingent purchase price payments to be treated as adjustments to purchase price and capitalized when determined. At December 31, 2002, we estimate the future significant contingent purchase price payments to be $6.6 million, which would be payable in a combination of cash, common stock and debt. Because of the contingent nature of this liability, under GAAP this amount has not been recorded as a liability in our financial statements. This amount primarily relates to one acquisition and will be reflected on our financial statements as a liability and additional purchase price within 90 days of the measurement date. The 90-day period from the measurement date allows us to calculate the contingent purchase price. Approximately $6.6 million of the future contingent purchase price payments have measurement dates of December 31, 2003. Please read “-Acquisitions” above and Note 3, “Acquisitions and Divestitures,” to our annual financial statements.
We follow very specific and detailed guidelines in measuring revenue; however, judgments we make affect the application of our revenue policy. Premiums and commissions receivable from clients, premiums payable to insurance companies and the related commissions income are recorded on the later of the effective date of the policy or the billing date. Installment premiums and related commissions are recorded periodically as billed. Commissions earned from the placement of individual life and individual disability insurance are calculated as a percentage of corresponding premiums and the duration or term of the underlying policies. The majority of commissions from individual life and individual disability insurance sales are earned and recognized during the first year the insurance is placed, with the balance earned and recognized over the following two to ten years. Commissions on premiums billed and collected directly by insurance companies and contingent commissions are recorded when we receive data from the insurance companies that allows us to reasonably estimate these amounts. We are able to reasonably estimate these amounts when we receive the cash, notification of the amount due from the insurance companies or the insurance policy detail from the insurance companies. Contingent commissions are received from insurance companies as additional incentive for achieving specified premium volume goals and/or the loss experience of the insurance placed by us. We record commission adjustments, including policy cancellations and override commissions, when the adjustments become reasonably estimable. Fees for consulting and administrative services are recognized over the period when the respective services are rendered. Revenue results are difficult to predict, and any shortfall in projected revenue or delay in recognizing revenue could cause our operating results to vary significantly from quarter to quarter.
In connection with these acquisitions, we recorded intangible assets, which represent expiration rights, non-compete agreements and the excess of costs over the fair value of identifiable net assets acquired (goodwill). Expiration rights are records and files obtained from acquired businesses that contain information on insurance policies and clients and other information that is essential to policy renewals. Expiration rights are being amortized on a straight-line basis over their estimated lives, which in most cases is 10 years. The costs of non-compete agreements are amortized on a straight-line method over the terms of the agreements, which in most cases is seven years. Goodwill was amortized on a straight-line basis over 25 years. We stopped amortizing goodwill on January 1, 2002, when we adopted SFAS No. 142. Please read Note 1, “Nature of Operations and Summary of Significant Accounting Policies” in our annual financial statements under “Intangible Assets.”
We assess the recoverability of our goodwill and other intangibles based on assumptions regarding estimates of future cash flows and fair value based on current and projected revenues, EBITDA, business prospects, market trends and other economic factors.
Our existing credit facility requires us to maintain financial covenants. Future operating results and continued compliance with our debt covenants cannot be assured and our lenders’ actions are not controllable by us. If our projections of future operating results are not achieved, which may result in a violation of our financial covenants, and our lenders do not provide a waiver or amendment, we could experience a material adverse effect on our reported financial position and results of operations for any particular quarterly or annual period.
We are subject to various claims, lawsuits and proceedings that arise in the normal course of business. We do not believe we are a party to any claims, lawsuits or legal proceedings that will have a material adverse effect on our reported financial position and results of operations. As further discussed in Note 14 “Contingencies,” in our annual financial statements, we have accrued a liability for our best estimate of the probable cost of the resolution of these claims. This estimate has been developed in consultation with internal and external counsel that is handling our defense in these matters and is based upon a combination of litigation and settlement strategies. To the extent additional information arises or our strategies change, it is possible that our best estimate of our accrued liability in these matters may change, which could have a material adverse effect on our financial position and results of operations for any particular quarterly or annual period.
In June 2001, the Financial Accounting Standards Board, or FASB, issued SFAS No. 141, “Business Combinations,” which eliminates the pooling-of-interests method of accounting for all business combinations initiated after June 30, 2001, and addresses the initial recognition and measurement of goodwill and other intangible assets acquired in a business combination. We did not initiate any business combinations after June 30, 2001, so SFAS No. 141 had no impact on our annual financial statements.
In July 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities.” SFAS No. 146 nullifies Emerging Issues Task Force, or EITF, Issue No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring).” SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. Under EITF 94-3, a liability for an exit cost as defined in EITF 94-3 was recognized at the date of an entity’s commitment to an exit plan. SFAS No. 146 also establishes that fair value is the objective for initial measurement of the liability. SFAS No. 146 is effective for exit or disposal activities initiated after December 31, 2002. We do not expect that the adoption of this statement will have a significant impact on our financial position or results of operations.
employee compensation. SFAS No. 148 also amends the disclosure provisions of SFAS No. 123 and APB Opinion No. 28, “Interim Financial Reporting,” to require disclosure in the summary of significant accounting policies of the effects on an entity’s accounting policy with respect to stock-based employee compensation on reported net income and earnings per share in annual and interim financial statements. While the Statement does not amend SFAS No. 123 to require companies to account for employee stock options using the fair value method, the disclosure provisions of SFAS No. 148 are applicable to all companies with stock-based employee compensation, regardless of whether they account for that compensation using the fair value method of SFAS No. 123 or the intrinsic value method of APB No. 25. We adopted the disclosure provisions of SFAS No. 148 at December 31, 2002.
Consolidated Financial Statements at December 31, 2002 and 2001 and for the three years in the period ended December 31, 2002:
We have audited the accompanying consolidated balance sheets of U.S.I. Holdings Corporation and subsidiaries at December 31, 2002 and 2001, and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2002. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
U.S.I. Holdings Corporation, a Delaware corporation, and subsidiaries (collectively, the Company) is a distributor of insurance and financial products and services to small and mid-sized businesses. Founded in 1994, the Company has grown organically and through acquisitions. The Company’s sales and marketing efforts are focused primarily on serving middle-market businesses.
The Company recognizes fees for consulting and administrative services over the period when the respective services are rendered. The Company recognizes investment income as earned.
The Company establishes an allowance for bad debts (allowance) on its premiums and commissions receivable through a charge to other operating expenses. This allowance is determined based on estimates and assumptions using historical data to project future experience. After all collection efforts have been exhausted, the Company reduces the allowance for write-offs of accounts receivable that have been deemed uncollectible. The Company periodically reviews the adequacy of the allowance and makes adjustments as necessary. Future additions to the allowance may be necessary based on changes in the general economic conditions and the clients’ financial conditions.
The use of premiums collected from clients but not yet remitted to insurance companies is restricted by laws in certain states in which the Company’s subsidiaries operate. These unremitted amounts are reported as fiduciary funds-restricted cash, with the related liability reported as premiums payable to insurance companies in the accompanying consolidated balance sheets.
Property and equipment are stated at cost, less accumulated depreciation and amortization. Depreciation is recorded using the straight-line method over the estimated useful lives of the related assets, which range from three to seven years. Assets recorded under capital leases are amortized using the straight-line method over the term of the related lease.
Intangible assets represent expiration rights, non-compete agreements and the excess of costs over the fair value of identifiable net assets acquired (goodwill). Expiration rights are records and files obtained from acquired businesses that contain information on insurance policies, clients, and other information that is essential to policy renewals (expiration rights). The Company utilizes a methodology based on an estimate of discounted future cash flows derived from existing client lists and attrition rates to estimate the fair value of the expiration rights at the date of the acquisition. The methodology was derived from independent appraisals obtained in connection with the Company’s initial acquisitions. Expiration rights are amortized on a straight-line basis over their estimated lives of five to ten years (with ten years used in most cases), based on historical attrition that has generally been consistent year over year. The costs of non-compete agreements are amortized on a straight-line method over the terms of the agreements, which range from four to seven years.
Effective January 1, 2002, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 142 “Goodwill and Other Intangible Assets” (SFAS No. 142), which addresses the financial accounting and reporting standards for the acquisition of intangible assets outside of a business combination and for goodwill and other intangible assets subsequent to their acquisition. This accounting standard requires that goodwill be separately disclosed from other intangible assets in the statement of financial position, and no longer be amortized but tested for impairment on a periodic basis. Prior to January 1, 2002, goodwill was amortized on a straight-line basis over 25 years. The Company tests goodwill for impairment using the two-step process prescribed in SFAS No. 142. The first step is a screen for potential impairment, while the second step measures the amount of the impairment, if any. In the fourth quarter of 2002, the Company completed its impairment test, which indicated that there was no goodwill impairment at October 1, 2002. The Company has no intangible assets with indefinite lives (see Note 2-Goodwill and Other Intangible Assets).
In June 2001, the Financial Accounting Standards Board (FASB) issued SFAS No. 141, “Business Combinations,” which eliminates the pooling-of-interests method of accounting for all business combinations initiated after June 30, 2001, and addresses the initial recognition and measurement of goodwill and other intangible assets acquired in a business combination. The Company did not initiate any business combinations during the period July 1, 2001 through December 31, 2002, so SFAS No. 141 had no impact on the accompanying financial statements.
does not meet the criteria in APB No. 30 for classification as an extraordinary item shall be reclassified. The Company will adopt SFAS No. 145 beginning January 1, 2003. The Company does not expect that the adoption of this statement will have a significant impact on its financial position or results of operations.
The changes in the carrying amount of goodwill by reportable segment are as follows:
The acquisitions were all accounted for using the purchase method, and their related net assets and results of operations were included in the Company’s consolidated financial statements on their respective acquisition dates. The acquisitions generally have provisions for a reduction in consideration if the acquired company does not meet future financial results. Additionally, the acquisitions generally have provisions for contingent additional consideration if the acquired company achieves future financial targets. Additional or a reduction in consideration resulting from acquisition contingency provisions is recorded as an adjustment to intangible assets when the contingency is determinable.
In some cases, acquisitions included annual cash bonuses (Growth Based Bonuses), which are expensed as incurred. Effective January 2000, the Company discontinued the practice of offering Growth Based Bonuses. The Company expects that all of its Growth Based Bonus obligations related to completed acquisitions will expire by December 31, 2004. The Growth Based Bonus expense for the years ending December 31, 2003 and 2004 is estimated to be $307,000 and $124,000, respectively.
On October 25, 2002, the Company completed its initial public offering (IPO) of 9,000,000 shares at a price of $10 per share. The cash proceeds of the offering after the underwriting discount were $83,700,000. After deducting offering expenses of $5,264,000, $78,436,000 was used to pay down the Company’s indebtedness under the existing credit facility. In connection with the debt repayment, the Company wrote off $1,950,000 in deferred financing costs, which was recorded in the fourth quarter of 2002.
In April 2002, the Company completed the sale of USIA for $19,900,000. The Company received cash proceeds of $18,200,000 with the remaining consideration of $1,700,000 in the form of an account receivable. Of the $18,200,000 in cash proceeds, $16,300,000 was used to reduce the Company’s term loan and $1,900,000 was used to pay selling costs. In connection with the debt repayment, the Company wrote off $660,000 in deferred financing costs, which was recorded in the second quarter of 2002.
In January 2003, the Company amended the credit facility to adjust the covenants for 2003. In connection with this amendment, in the event the revolving credit commitment and the outstanding borrowings under the term loan have not been repaid and all related commitments terminated as of October 1, 2003, the Company will be required to pay a fee in an amount equal to 1.00% of the sum of the total of the revolving credit commitment and the outstanding borrowings under the term loan as of October 1, 2003. The fee is due and payable on October 1, 2003. The Company accrued the additional fee of $1,012,000 in the first quarter of 2003. However, if the Company, by July 31, 2003, retain the lenders to structure and arrange a new senior credit facility, then the amount of any refinancing fee that is subsequently paid to the lenders shall be credited towards any fees otherwise payable in connection with a new senior credit facility.
At December 31, 2002, future maturities of long-term debt were as follows (dollars in thousands):
At December 31, 2002, the Company had approximately 42,440,000 shares of Common Stock and no shares of non-voting Common Stock outstanding.
The Company’s Board of Directors and a requisite majority of the stockholders approved a new 2002 Equity Incentive Plan that became effective and replaced the Long-Term Incentive Plan with the consummation of the IPO. The 2002 Equity Incentive Plan reserves approximately 10,270,000 shares of the Company’s Common Stock for issuance to directors, executive officers, employees and non-employee contributors.
Awards may consist of options, SARs, restricted shares, dividend equivalents or other share-based awards and are granted to eligible participants under the plan (see Note 18-Stock Option Plan). Upon the consummation of the IPO, approximately 104,000 restricted stock units, which were fully vested, were granted to nine executive officers with a value of $1,042,000 that was recorded as an expense in the fourth quarter of 2002.
The Company adopted the Employee Stock Purchase Plan (ESPP) effective on the consummation of the IPO. The ESPP is intended to promote broad-based employee ownership with the Company. The ESPP will provide for the purchase of up to 1,600,000 shares of the Company’s Common Stock by its employees. The Company will deliver repurchased and/or newly issued shares under this plan. Eligible employees will be entitled to purchase the Company’s Common Stock at a 15% discount, contributing a maximum of 20% of their gross compensation. There were 25,000 shares issued under the plan in 2002. All shares purchased under this plan must be retained for a period of one year.
The following table summarizes certain information about the Company’s Preferred Stock at December 31, 2002, 2001 and 2000:
The Preferred Stockholders of Series A through Y were generally entitled to the number of votes equal to the number of shares of Common Stock into which such shares of Preferred Stock could be converted and have voting rights and powers equal to the voting rights and powers of the Common Stockholders. The Company’s Preferred Stock had a liquidation preference that was at least equal to the original issuance price. Each of Series A through Q carried a liquidation preference equal to the original issuance price plus 10% per year. Series R, T, W and Y carried a liquidation preference equal to the original issuance price plus 5% per year. Series U, V and X carried a liquidation preference equal to the original issuance price.
While shares of Preferred Stock are outstanding, dividends may only be declared by unanimous consent of the Board of Directors, and the holders of Preferred Stock are entitled to share proportionately in any dividend declared on the Common Stock.
prices are equal to the estimated fair value of the Company’s Common Stock at the grant date. Compensation expense, or a reduction of compensation expense, in 2002, 2001 and 2000 related to the SARs was $(2,995,000), $3,092,000 and $250,000, respectively. At December 31, 2002, 2001 and 2000, there were zero, 1,393,200 and 964,800 vested SARs outstanding, respectively.
Upon consummation of the IPO, all Redeemable Preferred Stock was either converted to Common Stock or Redeemable Common Stock.
In 1997, in connection with a former joint venture with JP Morgan Chase, the Company sold 923,000 shares of Series N Preferred Stock to CBC Holding Ltd. (CBC), an affiliate of JP Morgan Chase, for $6,000,000. In connection with this transaction, JP Morgan Chase received the right to designate a nominee of the Company’s Board of Directors. In October 1998, the Company sold 3,300,000 shares of Series T Preferred Stock to CBD Holdings Ltd. (CBD), another affiliate of JP Morgan Chase, for $25,000,000, and CBC transferred its holdings of Series N Preferred Stock to CBD. In connection with this transaction, JP Morgan Chase received the right to designate a member of the executive committee of the Company’s Board of Directors.
In connection with the Series N Preferred Stock purchase by CBC (which was subsequently transferred to CBD, along with all the related put rights), the Company granted CBC the right to put the Preferred Stock back to the Company if any of the following occurs:
Any bank or its affiliate acquires a 25% or greater equity interest in the Company;
Any other entity, other than Zurich Centre Investments Limited and its affiliates (Zurich), a current stockholder of the Company, acquires a 40% or greater equity interest in the Company; or
Upon consummation of the IPO, the puts rights were terminated and the Redeemable Preferred Stock was converted to shares of Common Stock. The put price was the greatest of (a) the original purchase price paid by CBC for the series N Preferred Stock, (b) 95% of the fair market value as determined by the Company’s board of directors or an independent appraiser of the series N Preferred Stock on the date CBD delivers a put exercise to the Company, and (c) 95% of the per share purchase price paid by the entity or group whose action triggers the right to exercise the put. The put price was $6,138,000 at December 31, 2001, and is reported as Redeemable Preferred Stock in the accompanying 2001 balance sheet. The change in the put price is recorded as an adjustment to retained deficit and is reflected as an adjustment to the net loss in the computation of basic and diluted earnings per share (EPS). The change in the put price recorded as an adjustment to the Company’s retained deficit was $(138,000), $138,000 and zero for the years ended December 31, 2002, 2001 and 2000, respectively.
Income taxes recorded by the Company related to continuing operations differ from the amounts computed by applying the statutory U.S. federal tax rate to the income (loss) before income taxes. Significant reconciling items are as follows:
At December 31, 2002, the Company had a net operating loss carryforward of approximately $48,141,000 for federal tax purposes that will expire during the period 2011 through 2022. In addition, as a result of certain acquisitions, the Company had a preacquisition net operating loss carryforward of approximately $1,262,000. To the extent not utilized, the preacquisition net operating loss has expiration dates from 2011 through 2013.
Total rental expense in 2002, 2001 and 2000 was $14,418,000, $15,984,000 and $14,088,000, respectively.
The Company established a 401(k) Plan (the Plan) covering substantially all employees with at least six months of service. Under the Plan, the first 4% of a participant’s contribution will be eligible for a discretionary employer match of $0.75 for each dollar contributed. The maximum employer match is 3% of a participant’s annual compensation.
Following an acquisition, the Company may maintain the existing savings plans of acquired entities for a short period of time. During 2002, 2001 and 2000, a number of such plans were maintained by the Company prior to being merged into the Plan.
Company contributions to all 401(k) plans for 2002, 2001 and 2000 were $3,527,000, $3,374,000 and $3,353,000, respectively.
The Company paid $2,240,000, $1,144,000 and $101,000 to JP Morgan Securities Inc., an affiliate of J.P. Morgan Chase & Co., in fees relating to financing and other professional services for the years ended December 31, 2002, 2001 and 2000, respectively. JP Morgan Chase Bank is the syndicating agent and a significant participant on the existing credit facility which includes the $75,000,000 revolving credit facility and the $29,521,000 term loan (see Note 5-Long-Term Debt). CBD and CB Capital Investors, L.P. are affiliates of J.P. Morgan Chase & Co. and JP Morgan Chase Bank, and are stockholders of the Company.
conversion costs if their revenue from administrative services provided to the Company’s customers fails to meet specific semi-annual requirements. The Company determined that it was probable that the revenue targets would not be met and, accordingly, reserved for $1,182,000 in the fourth quarter of 2002. In March of 2002, the original service agreement was amended due to our announcement to sell USIA (see Note 16-Discontinued Operations). The amendment eliminated USIA as a party to the service agreement, which resulted in the accrual of an additional $990,000. Ceridian is a stockholder of the Company.
In May 1999, the Company purchased an excess professional liability policy from CNA Pro, an affiliate of CNA Financial Corporation (see Note 5-Long-Term Debt). Continental Casualty Company, an affiliate of CNA Financial Corporation, is a stockholder of the Company.
The Company was in dispute with Royal & Sun Alliance Insurance Group plc, an affiliate of one of the Company’s stockholders (see Note 14-Contingencies).
In connection with the decision to discontinue the operations of USIA, the Company renamed its administration and other services segment the specialized benefits services segment. The Company has three reportable segments: insurance brokerage, specialized benefits services and corporate. The insurance brokerage segment offers general and specialty property and casualty insurance, medical plan insurance and group life insurance. The specialized benefits services segment offers health and welfare products, benefits enrollment and communication and other related consulting services. The corporate segment is responsible for managing the following: acquisition processes, marketing, human resources, legal, capital, financial and reporting.
The Company’s reportable segments are strategic business units that offer different products and services. They are managed separately because each business has different clients and requires different marketing strategies. Most of the businesses were acquired as a unit, and the management at the time of the acquisition was retained. The Company evaluates performance based on the following measurements: (1) revenues and (2) earnings before interest, taxes, depreciation and amortization.
On April 15, 2002, the Company and all named parties in the litigation entered into a settlement agreement pursuant to which mutual releases were granted and a stipulation for dismissal with prejudice was filed with the court. Pursuant to such settlement agreement, plaintiffs received a payment in the amount of $1,875,000, of which the Company contributed $225,000. In October 2000, the Company entered into an agreement to purchase a book of business in the entertainment industry. The agreement to purchase the business indicates that the purchase price will include the amount of any settlement paid and incurred as a result of the acquisition. Therefore, the $225,000 was reflected as an adjustment to the purchase price. Pursuant to a separate settlement agreement entered into between the Company and its insurers, the Company’s insurers paid an amount of $1,650,000 toward the settlement in exchange for mutual releases.
In 2002, 2001 and 2000, the Company expected to and eliminated 32, 96 and 11 positions, respectively, across all of its operating offices. In addition, the Company renegotiated the compensation arrangements of four and 29 sales professionals in 2002 and 2001, respectively, in connection with these expense reductions.
In January 2002, the Company announced that Bernard H. Mizel, Chairman and Chief Executive Officer since the Company was founded in 1994, would retire as Chairman and Chief Executive Officer. David L. Eslick, who had been President and Chief Operating Officer since July 1998, succeeded Mr. Mizel. In the first quarter of 2002, the Company took a compensation charge of $2,800,000 related to the retirement. This compensation charge consisted of $1,935,000 for severance, $295,000 for bonus and $570,000 for benefits.
Nassau County Litigation. In January 1999, USIA was named as defendant in a lawsuit filed by County of Nassau, New York (Nassau County). USIA was the third-party administrator of health benefits for the employees of Nassau County. At December 31, 1998, USIA had established a $16,000,000 reserve for this matter. USIA also established a $1,500,000 reserve at December 31, 1998, to cover the related wind down costs of the contract. The Nassau County litigation was settled pursuant to a settlement agreement in March 1999. Under the settlement agreement, USIA paid Nassau County $16,000,000 on June 1, 1999, plus approximately $350,000 thereafter in actual expenses incurred by Nassau County in connection with the Nassau County litigation and for payment of premiums for a new insurance policy issued to Nassau County. USIA also assisted Nassau County in transferring its self-insured benefit plan to a fully insured plan, and USIA’s contract with Nassau County terminated on March 31, 1999. At the time of the establishment of the $16,000,000 reserve, USIA recorded a receivable of $10,000,000 from Fireman’s Fund Insurance Company (Fireman’s Fund) under its insurance policy at December 31, 1998 (see Fireman’s Fund Litigation below).
Nassau County. None of the Company, USIA or any of their current management or employees has been informed that such person is a target of the investigation. The Company and USIA have, from the outset, cooperated fully with this investigation. In October 2001, the United States Attorney brought an indictment against several individuals connected with the Nassau County controversy, including the former CEO of USIA. Based on the facts and the cooperation of the Company and USIA in the government’s investigation, the United States Attorney issued a press release in October 2001 that included, among other matters, a statement that neither the Company nor USIA was responsible for any wrongdoing alleged in the indictment. In March 2002, a second superseding indictment was made public. This indictment added the former CFO of USIA as a defendant, charging him with aiding the coordination and cover-up of the payment of secret commissions in violation of the contract with Nassau County and altering USIA’s records. The former CFO of USIA was added to a number of charges, including the charge of conspiracy to defraud Nassau County. The second superseding indictment also added income tax evasion charges against several people, including the former CEO of USIA, and accused him of causing the Company to file a false tax return. The trial started in January 2003 and is expected to be completed in April 2003. The Company continues to cooperate fully with the United States Attorney’s office.
Fireman’s Fund Litigation. During 1998 and 1999, USIA was insured under an errors and omissions policy issued by Fireman’s Fund. With respect to the Nassau County litigation, USIA asserted a claim for indemnification under the policy in the amount of $10,000,000 (the policy limit) plus the cost of defense. On March 8, 1999, Fireman’s Fund filed a complaint for declaratory judgment against USIA. The complaint sought a declaration that Fireman’s Fund was not obligated to indemnify USIA with respect to the Nassau County litigation. On March 19, 1999, USIA commenced an action against Fireman’s Fund that sought a declaration that USIA was entitled to indemnification under the Fireman’s Fund policy in the amount of $10,000,000 plus reimbursement of legal expenses. In November 2001, USIA settled this litigation with Fireman’s Fund with the exchange of mutual releases of liability and a payment by Fireman’s Fund to USIA in the amount of $2,067,000. As a result of the settlement, the Company reduced its receivable for the claim by $7,933,000. This write down is reflected in the results from discontinued operations included in the accompanying statement of operations for the year ended December 31, 2001.
For additional disclosures regarding the aggregate liquidation preference of Preferred Stock and the Series N put options (see Note 6 and Note 7).
The Company has elected to follow APB No. 25 and, accordingly, recognizes no compensation expense for the stock options that are granted to employees at the fair value of the underlying shares at the date of grant.
The pro forma disclosures above only include the effect of options granted subsequent to October 25, 2002, the Company’s IPO date. Accordingly, the effects of applying the SFAS No. 123 pro forma disclosures to future periods may not be indicative of future effects.
The net loss in the quarter ended March 31, 2002 was predominantly the result of the 2002 efficiency initiative charge of $5,511,000 (see Note 15).
On March 1, 2003, the Company acquired one insurance brokerage operation in exchange for cash, seller note payable, the assumption of certain liabilities and Common Stock. The aggregate preliminary purchase price of approximately $7,200,000 will be allocated primarily to goodwill and other intangible assets.