The Company believes that its existing facilities and additional or alternate space available to it are adequate to meet its requirements for the foreseeable future.
Effective January 1, 1998, the Company entered into a written service agreement (collectively, the "Service Agreements") with each of BIC, BSIC and FCIC, all direct or indirect subsidiaries of BIG. These service agreements modified the existing arrangements to (i) expand the services provided by the Company to include policy administration for certain automobile lines of business, (ii) recognize claims outsourcing revenue based not on a cost reimbursement basis, but rather on a percentage of earned premiums and, with respect to certain types of claims, a percentage of incurred losses, and (iii) implement a change in fee structure from a percentage of incurred loss to a percentage of earned premiums with respect to homeowners claims services. These changes were negotiated in order to effect more uniform revenue recognition. To obtain BIG's agreement to such changes, the Company, in turn, agreed to the revised fee structure with respect to homeowners claims services.
On April 13, 2001, the Company entered into a Letter Agreement with BIG, BIC, BSIC, and FCIC (the "Letter Agreement"). Pursuant to the Letter Agreement, the Service Agreements were amended effective June 1, 2001 to, among other things, modify certain of the service fees payable thereunder and eliminate data and technical support services from the administrative services to be provided by the Company thereunder. If the amendments to the Service Agreements had been in effect for the fiscal year ended December 31, 2000, the Company's affiliated outsourcing revenues, which totaled approximately $38 million on an actual basis, would have been approximately $30 million on a pro forma basis. See "Certain Relationships and Related Transactions - Letter Agreements".
Outsourcing service revenues are principally derived from written and earned insurance premiums. Such premiums are affected by seasonal fluctuations in volume of new and renewal policies received. Outsourcing service revenues generated from the flood and homeowners lines of business increased in the late second quarter and peaked during the third quarter in conjunction with home sales. In the Company's experience, increased levels of flood insurance purchases occur in the Southeastern United States during the second and third quarters in anticipation of the onset of the hurricane season.
Management services from Parent were previously charged to the Company under an administration agreement with BIG for common costs that were incurred by BIG. These common costs included human resources, legal, corporate planning and communications, cash management, certain executive management and rent. On April 13, 2001, the Company and BIG entered into the Letter Agreement. Pursuant to the Letter Agreement, the administration agreement was terminated effective April 1, 2001.
During the year ended December 31, 2001, the Company's outsourcing services business segment generated operating income of approximately $4.0 million. This operating income was primarily due to an increase in revenue from the impact of Tropical Storm Allison, which storm occurred in June 2001. In an effort to improve the operating results of its outsourcing services
business segment, the Company reduced its workforce by approximately 50 employees in February 2001.
Under the New Service Agreement, each entity pays the Company as follows: (1) for its policy administration services a monthly fee based upon direct written premiums for the flood, homeowners and automobile insurance programs; (2) for its claims administration services a monthly fee based upon direct earned premiums for the property, casualty, automobile property, automobile casualty and flood insurance programs (in addition, a monthly fee based upon direct incurred losses is charged for flood claims administration and a reimbursement not to exceed 5% of direct incurred losses from a single event in excess of $2 million is charged to property claims); (3) for its data processing services, a monthly fee based upon direct written premiums for all insurance programs; and (4) for certain customer services such as mailroom, policy assembly, records management and cash office a monthly fee based upon direct written premiums (except, if provided in connection with their flood, homeowner and automobile insurance lines, where no such fees are imposed). The New Service Agreement is for an initial term of five years, subject to termination thereafter upon 90 days written notice. The New Service Agreement further provides for the renegotiation of rates in good faith after the first three years of the initial term.
The New Service Agreement modified the existing arrangements under the Service Agreements by, among other things: (i) reducing the base fees charged for certain lines of business; (ii) providing for tiered pricing based on the volume of business processed electronically rather than manually; (iii) providing for the pass-through to BIG of flood loss adjustment expenses for outsourcing services; and (iv) providing for the pass-through to BIG of all postage expenses and third-party information services incurred by the Company in connection with its performance under the New Service Agreement. For financial statement purposes these expense pass-throughs are considered revenues. If the New Service Agreement had not been in effect, the Company's affiliated outsourcing service fee and pass-through revenue for the fourth quarter of 2001, which totaled approximately $5.9 and $1.1 million on an actual basis, would have been approximately $6.5 and $-0- million under the previous agreement on a pro forma basis. The Company believes that any anticipated reduction in affiliated outsourcing service fee revenues resulting from the implementation of such service fee changes under the New Service Agreement will be largely offset by the corresponding increase in revenues from the pass-through (reimbursement) of flood loss adjustment expenses, postage expenses and third-party information services, although no assurances can be given in this regard. Moreover, as of October 1, 2002, the Company will again become directly responsible for the payment of postage expenses under the terms of the New Service Agreement. If the New Service Agreement had not been in effect for the fourth quarter of 2001, such postage expenses, which totaled $475,000 and were passed through to BIG, would have been expenses borne by the Company.
Over the past year, BIG has experienced several changes in its business and operations, certain of which are expected to reduce the need for the Company's services for the foreseeable future. In November 2001, BIG ceased writing further workers compensation insurance altogether. Although the Company will continue to provide services in connection with the run-off of this business, such run-off business is not expected to generate material revenues for the Company in 2002.
The Company anticipates making further staffing and other related expense reductions in response to the foregoing changes in BIG's business. Nevertheless, if the Company is unable to replace these revenues or reduce its expenses accordingly, the loss or material decrease in business from BIG could have a material adverse effect on the Company's business, financial condition and results of operations.
Outsourcing Services Revenues. Outsourcing services revenues increased 21.7% to $57.1 million in 2001 from $46.9 million in 2000. The increase was primarily attributable to the impact of Tropical Storm Allison, which storm occurred during June 2001. The increase in revenue related to processing for this storm was approximately $12.0 million, including an increase of $2.2 million in Affiliated Revenue and an increase of $9.8 million in Unaffiliated Revenue (of which $7.8 million related to Colonial Claims, the Company's claims catastrophe subsidiary). Additionally, revenues from the Company's automobile line of business increased approximately $1.2 million in 2001 as compared to 2000 due principally to significant volume increases in new affiliated business from its non-standard automobile line. The foregoing increases were partially offset by a decrease in revenue from a third-party outsourcing customer for which the Company has only been processing run-off business since the beginning of 2001.
Cost of Outsourcing Services. Cost of outsourcing services increased 11.1% to $41.9 million in 2001 from $37.7 million in 2000. As a percentage of outsourcing services revenues, cost of outsourcing services decreased to 73.4% in 2001 from 80.4% in 2000. The increase in the dollar amount of cost of outsourcing services was primarily attributable to an increase in revenue from the Company's claims catastrophe subsidiary, which pays approximately 70% of each dollar of revenue received to the independent adjusters who adjust the claims on such subsidiary's behalf. The increase also resulted from the addition of a new document imaging system and the opening of a new document output center in late 2000, with related new costs for equipment and services. The increase was partially offset by a decrease of $3.8 million in payroll costs due to two staff reductions completed in late 2000 and early 2001 and the reduction of the Company's information technology staff in June 2001, coupled with a decrease in contract labor/consulting costs of $779,000.
Interest Expense. Interest expense decreased 90.2% to $6,000 in 2001 from $61,000 in 2000. This decrease resulted primarily from the payment of substantially all of the Company's remaining outstanding debt obligations during 2000 and 2001. The nominal amount booked for the period relates to expenses for capital leases for information technology equipment; these leases expired during the fourth quarter of 2001.
Income from discontinued operations, net of income tax, increased 41.2% to $2.4 million in 2001 from $1.7 million in 2000 and is comprised of the following:
Flood Zone Determination Services Revenue. Flood zone determination services revenue increased 28.1% to $21.9 million in 2001 from $17.1 million in 2000. The increase was primarily attributable to an increase in the number of flood zone determinations processed by Geotrac during 2001 as compared to 2000. The increase in the number of flood zone determinations processed was primarily due to a continued low mortgage interest rate market. These attractive interest rates resulted in a corresponding increase in mortgage refinancing activity and loan originations, which historically drive the demand for flood zone determinations.
The decrease in outsourcing services revenues was also due to a decrease in the volume of flood and wind damage claims administered by the Company's outsourcing operations during the year 2000 as compared to 1999. During 2000, the Company recognized revenues of approximately $4.6 million primarily from the administration of property damage claims resulting from a tropical depression that caused extensive flooding, which storm occurred during the fourth quarter of 2000. In comparison, the Company recognized revenues totaling approximately $9.6 million during 1999 from the administration of property damage claims resulting from Hurricane Georges, which storm occurred in September 1998, and from Hurricanes Floyd and Irene, which storms occurred during the fourth quarter of 1999. Additionally, a decline in the volume of automobile premium processed on behalf of the Company's affiliated customers contributed to the decrease in outsourcing services revenues during 2000. These decreases in outsourcing services revenues were partially offset by (i) an increase in outsourcing services revenues generated under an automobile claims processing agreement, entered into April, 2000, with an unaffiliated customer, (ii) an increase in flood premium processed on behalf of the Company's unaffiliated customers,
Cost of Outsourcing Services. Cost of outsourcing services decreased 3.1% to $37.7 million in 2000 from $38.9 million in 1999. As a percentage of outsourcing services revenues, however, cost of outsourcing services increased to 80.4% in 2000 from 73.7% for the corresponding period in 1999 primarily as a result of the decrease in the dollar amount of outsourcing services revenues in 2000 as compared to 1999. The decrease in the dollar amount of cost of outsourcing services was primarily attributable to a decrease in revenue from the Company's claims catastrophe subsidiary, which pays approximately 70% of each dollar of revenue received to the independent adjusters who adjust the claims on such subsidiary's behalf. The decrease in the dollar amount of expenses from the Company's claims catastrophe subsidiary was partially offset by (i) increases in the Company's personnel costs due to staff additions and the use of contract programmers to develop and staff new unaffiliated programs and (ii) an increase in facilities costs due to the occupancy of the Company's new operating and call center facility.
Selling, General and Administrative Expenses. Selling, general and administrative expenses increased 12.1% to $7.4 million in 2000 from $6.6 million in 1999. The increase in selling, general and administrative expenses was primarily attributable to (i) the continued assumption of certain administrative services, including human resource, agency accounting, cash management and legal services that were previously provided to the Company under the management service agreement with BIG, and (ii) the recognition of $338,000 in additional compensation expense (of which approximately $102,000 relates to 1999) resulting from the vesting of benefits payable to certain current and former officers and directors of the Company under the Amended and Completely Restated Phantom Stock Plan (the "BFC Plan") of Bankers Financial Corporation ("BFC"), the parent corporation of BIG, and the Amended and Restated Phantom Stock Plan (the "VCC Plan") of Venture Capital Corporation ("VCC"). The foregoing compensation charge is a non-recurring, non-cash item to the Company, as all such benefits under such plans were fully vested as of September 30, 2000 and constitute the respective obligations of BFC and VCC, not the Company. In addition, the offset to such compensation expense is an increase to additional paid-in capital, since the ultimate cash obligations under these plans are that of BFC and VCC, respectively, and not of the Company.
Management Services from Parent. Management services from Parent decreased 13.6% to $1.9 million in 2000 from $2.2 million in 1999. This decrease was primarily related to the continued assumption by the Company of certain administrative services, including human resources, agency accounting, cash management and legal services, that were previously provided to the Company under the management service agreement with BIG. Such decrease was partially offset by both an increase in rent expense from BIG as a result of an annual rent escalation and an increase in the square footage being leased.
Interest Expense. Interest expense decreased 76.1% to $61,000 in 2000 from $255,000 in 1999. This decrease was primarily related to the early repayment of most of the Company's debt obligations during 1999 from the net proceeds received by the Company from its initial public offering in February 1999.
Provision for Income Taxes. The Company's effective income tax rates were 25.1% and 42.5% in 2000 and 1999, respectively. The decrease in the effective tax rate during 2000 reflects lower pretax income as well as various non-deductible items, including goodwill recognized in connection with the acquisition of Colonial Claims in January 1999.
Flood Zone Determination Services Revenues. Flood zone determination services revenues decreased 10.9% to $17.1 million in 2000 from $19.0 million in 1999. This decrease was primarily attributable to the termination of the Company's "life-of-loan" insurance policy, effective April 1, 1999, under which, prior to the termination of the policy, the Company was compensated for performing flood zone re-determinations for certain existing customers. Prior to the termination of the life-of-loan policy, the Company paid an insurance premium for every flood zone determination issued which required life-of-loan tracking. In exchange for the premium, the Company received a fixed amount for every flood zone determination that had to be reissued as a result of a change in the underlying flood zone classification of a property. Additionally, a decrease in the average selling price per flood zone determination, resulting from (i) increased pricing pressures and (ii) an increase in the number of automated flood zone determinations processed by the Company on behalf of other flood zone vendors at reduced rates, contributed to the decrease in flood zone determination services revenues during 2000. These decreases in flood zone determination services revenues were partially offset by an increase in number of flood zone determinations processed during 2000 as compared to 1999.
Cost of Flood Zone Determination Services. Flood zone determination services decreased 4.9% to $7.7 million in 2000 from $8.1 million in 1999. As a percentage of Flood zone determination services revenues, cost of Flood zone determination services increased to 45.0% in 2000 from 42.2% in 1999. The increase resulted primarily from the decrease in the dollar amount of flood zone determination services revenues during 2000 as compared to 1999, partially offset by (i) various production workflow changes made during 1999 that enabled the Company to increase employee productivity and reduce operating expenses, primarily personnel related costs, and (ii) increased utilization of a flood zone determination vendor, located in India, which has been able to perform manual flood zone determinations at costs significantly below U.S. market rates.
The Company received net cash proceeds of approximately $18.2 million as a result of the sale of its Geotrac subsidiary in late December 2001. Prior to the consummation of the sale of Geotrac, the Company was party to a Corporate Governance Agreement, dated July 31, 1998, with Geotrac and Daniel J. White ("Mr. White"), setting forth certain terms and conditions pertaining to the operation of Geotrac. Pursuant to this Corporate Governance Agreement, Mr. White could impede the Company's ability to access excess cash balances retained by its Geotrac subsidiary.
The Line of Credit is secured by (i) a first lien security interest in all accounts and contract rights of Bankers Underwriters, Inc., a wholly-owned subsidiary of BIG ("BUI"), with insurance agents (including but not limited to general agents with respect to the sale of federal flood insurance) (collectively, the "Flood Book"), and (ii) an option (the "Option") to purchase from BIG the outstanding capital stock, consisting of 10,898 shares (the "Option Shares") of common stock $318 par value per share, of FCIC, a New York insurance company licensed in all fifty states. As of March 31, 2002, management of the Company believes the fair market value of the Flood Book exceeds the aggregate principal amount of the Line of Credit.
The Company has been advised by BIG that it is considering various methods of satisfying its obligations under the Line of Credit, including the possible sale of certain of its assets. No assurances can be given, however, that payment in full of all amounts due and owing under the Line of Credit will be received on a timely basis. See "Item 13. Certain Relationships and Related Transactions-Secured Line of Credit".
Consolidated Statements of Income for the years ended December 31, 1999, 2000 and 2001
Consolidated Statements of Cash Flows for the years ended December 31, 1999, 2000 and 2001