You should read the selected consolidated financial data set forth below in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and accompanying notes included elsewhere in this filing. We derived the financial information as of December 31, 2003 and 2002 and for each of the years ended December 31, 2003, 2002 and 2001 from our audited financial statements and the related notes included elsewhere in this filing. Financial information as of December 31, 2001, 2000 and 1999 and for the years ended December 31, 2000 and 1999 was derived from audited financial statements and related notes that are not included in this filing. In 2003, 2000 and 1999 we acquired the assets or stock of 6, 2 and 13 businesses, respectively. As a result, the financial data for each of the five years set forth below are not directly comparable. There is no single acquisition that materially affects the comparability of the financial information presented.
(d) At December 31, 2002, we had approximately 2.2 million shares of Common Stock outstanding on which the owners had put rights. These shares, and the related put obligation, were reclassified to equity and liabilities, respectively, upon the adoption of SFAS No. 150 in 2003. 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. See “Forward Looking Statements” included in this report. 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 herein.
We are a distributor of insurance and financial products and services to approximately 60,000 small and mid-sized business clients.
• commissions paid by insurance companies on the placement of property & casualty (P&C) and individual and group health, life, and disability insurance, which we refer to as Group Employee Benefits, on behalf of our clients;
Commissions on P&C, health, group life and group disability insurance, are typically calculated as a percentage, ranging from approximately 3% to 20%, of the annual premium. These commissions generally recur at the same rate as long as the insurance is in force. Commissions earned from the placement of individual and corporate-owned life and individual disability insurance are calculated as a percentage of corresponding premiums over the duration or term of the underlying policies. Traditionally, most of the commission revenue on these life and individual products, as well as on other traditional voluntary benefit products such as critical illness insurance, is recognized in the first year the insurance is placed, with the commissions paid in renewal years being relatively insignificant. We also receive contingent commissions, which are incremental compensation for achieving specified premium volume and/or loss experience goals set by the insurance companies for the business we place with them. Contingent commissions are recorded on the earlier of receipt of cash or when we receive data from the insurance companies that allow us to reasonably determine the amount. Fee-based revenues related to employee benefits services are generally billed as services are rendered and may vary with factors such as the client’s headcount or assets under management.
The majority of our operating expenses relate to compensation and employee benefits, which amounted to approximately 56% of consolidated revenues in 2003. We refer to the balance of our operating expenses as other operating expenses, which includes selling-related expenses, rent, communication expenses and other items. Other operating expenses were approximately 22% of consolidated revenues in 2003.
Approximately 58% of our consolidated revenues in 2003 related to P&C business.
Premium pricing within the commercial P&C insurance industry has historically been cyclical, based on the underwriting capacity of the insurance industry and economic conditions. From 1987 through 1999, the commercial P&C insurance industry was in a “soft market,” which is an insurance market characterized by a period of flat to declining premium rates, which negatively affected commissions earned by insurance brokers. Years of underwriting losses for insurance companies combined with the downward turn in the equity markets and interest rates caused insurers to increase premium rates starting in mid- to late 2000, creating what we call a “hard market”. A hard market is an insurance market characterized by a period of rising premium rates which, absent other changes, positively affects commissions earned by insurance brokers. Additionally, the insurance industry was affected by the events of September 11, 2001, resulting in the largest insurance loss in America’s history, which accelerated increases in premium rates for particular lines of commercial P&C insurance. In response to rising premiums, some of our customers increased their deductibles and/or reduced their insurance coverage in order to reduce the impact of the premium increases, which negatively impacted our revenues. The hard market, for many lines of coverage, began to slow in the second half of 2002 and throughout 2003. In the second half of 2003, we began seeing premiums in most lines of coverage flatten and for some, even a decrease. We are not able to predict whether this trend of moderating or declining premiums will continue, however, if it does, our P&C brokerage revenues may be negatively impacted.
Approximately 42% of our consolidated revenues in 2003 related to Health & Welfare business.
Premium rates in the health insurance industry have generally realized a consistent upward trend due to increasing health care delivery costs. In recent years, however, the upward trend in health care insurance premiums has been somewhat offset by the impact of the economic downturn and its resulting negative impact on employment levels of our customers. Additionally, reduced discretionary spending by our corporate clients has led to benefit cut-backs and lower expenditures on consulting and other fee-based services. Decreases in balances of assets invested within our clients’ retirement benefit plans and on new investments into those plans, on which we are paid commissions, has negatively impacted our retirement services business. Our Health & Welfare business is most affected by employment levels and by the strength of the economy. Factors such as a tight labor market increase employers’ spending on benefits; high employment increases the numbers of lives covered within the benefit plans that we broker; and a strong stock market increases both existing assets under management and new investments. In 2003 and into 2004, we have seen the signs of an improving economy, although we have yet to see the benefits of increasing labor ranks or spending on benefits. While we can not predict whether the economy will continue to improve or if employment and spending on employee benefits will increase, if they do, then our Health & Welfare revenue may be positively impacted.
• Organic Revenue Growth, which excludes the first twelve months total revenues generated from acquisitions;
You should not consider these financial measures as alternatives to other financial measures determined in accordance with accounting principles generally accepted in the United States of America, which we refer to as
• Organic Revenue Growth of 5% - 10% over the long-term;
• Cross selling across all of our major product categories within our business segments; and
Each year, our goal is to acquire companies with revenues equal to at least 10% of our prior year’s consolidated total revenues.
In most acquisitions, we issue a combination of cash, seller notes and common stock. We also frequently structure our acquisition agreements to include contingent purchase price payments (contingent upon reaching specified financial targets), commonly referred to as “earn-outs,” which are paid in a combination of cash, seller notes and equity and are treated as adjustments to purchase price when the contingency is resolved. Additionally, many of our acquisitions have provisions for reduced consideration based on the failure to meet certain revenue and EBITDA targets. All acquistions require approval of our board of directors and, if greater than $1.5 million in aggregate purchase price, also require the approval of our bank lenders. Please read Note 2, “Acquisitions” to our consolidated financial statements for more information on acquisitions.
• a significant percentage of commissions and fees in our Specialized Benefits Services segment is typically earned and recorded in the fourth quarter;
We record premiums and commissions receivable from clients, premiums payable to insurance companies and the related commissions income, on the later of the effective date of the policy or the billing date. We record installment premiums and related commissions periodically as billed. Commissions earned from the placement of individual and corporate-owned life and individual disability insurance are calculated as a percentage of corresponding premiums over the duration or term of the underlying policies. Traditionally, most of the commission revenue on these life and individual products, as well as on other traditional voluntary benefit products, such as critical illness insurance, is recorded in the first year the insurance is placed, with the commissions recorded in renewal years being relatively insignificant.
We assess the recoverability of our goodwill and other intangible assets at least once a year or as required based on triggering events. A triggering event is a change in business circumstances that indicates that the carrying value of the assets may not be recoverable. Examples of a triggering event include poor financial results or projections, deterioration of client base, loss of key employees or changes in the marketplace. Reviews for triggering events are performed at the operating company level, one level below our segments, and require the use of management’s judgment. Upon identification of a triggering event we perform an analysis to determine the fair value of the operating unit using either market valuation data, such as recent transaction multiples of revenue or EBITDA, or present value techniques. Both methods require substantial judgment. If, as a result of an
impairment review, we find that the carrying value of an asset is in excess of the fair value, we would be required to take a charge against current earnings. The results of our reviews disclosed no such asset impairments in 2003 and 2002.
All of our acquisitions have been accounted for using the purchase method, and the net assets and results of operations of the acquired companies were included in our financial statements on their respective acquisition dates. Frequently, our acquisitions have provisions for a reduction in consideration if the acquired company does not meet targeted financial results. Additionally, the acquisitions frequently have provisions for contingent additional consideration if the acquired company achieves financial targets. Additional or reduced consideration related to acquisition contingency provisions is reflected as an adjustment to goodwill when the contingency is resolved.
For significant acquisitions, we obtain an independent appraisal of the fair value of intangible assets acquired. For others, we use a methodology based on an estimate of discounted future cash flows derived from acquired client lists and attrition rates to estimate the fair value of the expiration rights and other intangible assets at the date of the acquisition. The methodology is derived from independent appraisals obtained in connection with our earlier 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. Non-compete agreements are typically valued at their stated contractual amount and are amortized on a straight-line basis over the terms of the agreements, which range from four to seven years. Goodwill is not subject to amortization. Both the allocation of purchase price and estimation of useful lives require management’s judgment. If historical fact patterns were to change, such as the rate of attrition of acquired client accounts, we may be required to allocate more purchase price to goodwill or accelerate the amortization of expiration rights, which may have a material impact on our financial position or results of operations.
Determining the consolidated provision for income tax expense, deferred tax assets and liabilities and any related valuation allowance involves judgment. GAAP requires deferred tax assets and liabilities (“DTAs” and “DTLs,” respectively) to be recognized for the estimated future tax effects attributed to temporary differences and carry-forwards based on provisions of the enacted tax law. The effects of future changes in tax laws or rates are not anticipated. Temporary differences are differences between the tax basis of an asset or liability and its reported amount in the financial statements. For example, we have a DTA because the tax bases of our accrued liabilities are smaller than their book bases. Similarly, we have a DTL because the book basis of our goodwill exceeds its tax basis. Carry-forwards primarily include items such as net operating losses (“NOLs”), which can be carried forward subject to certain limitations. A summary of the significant DTAs and DTLs relating to our temporary differences and carry-forwards is included in Note 10, “Income Taxes” to our consolidated financial statements.
At December 31, 2003, our DTAs total $13.4 million, and our DTLs total $8.2 million. We are required to reduce DTAs (but not DTLs) by a valuation allowance to the extent that, based on the weight of available evidence, it is “more likely than not” (i.e., a likelihood of more than 50%) that any DTAs will not be realized. Recognition of a valuation allowance would decrease reported earnings on a dollar-for-dollar basis in the year in which any such recognition was to occur. The determination of whether a valuation allowance is appropriate requires the exercise of management’s judgment. In making this judgment, management is required to weigh the positive and negative evidence as to the likelihood that the DTAs will be realized.
utilize our DTA. In the fourth quarter of 2003, based on five consecutive quarters of profitability, our improved financial condition following our initial public offering, restructuring our credit facility and on forecasted future results, management determined that it is more likely than not that our DTA will be realized in future periods so we reversed the valuation allowance resulting in a deferred income tax benefit of $8.1 million in 2003. In the event of adverse developments in our projections of taxable income or if our estimates and assumptions were to change, management might be required to reach a different conclusion about the realization of our DTA and re-establish a valuation allowance through a charge to earnings.
We understand that analysts and investors regularly rely on non-GAAP financial measures, such as EBITDA and EBITDA Margin to provide a financial measure by which to compare a company’s assessment of its operating profitability against that of its peers. Additionally, investors use Organic Revenue Growth to provide a financial measure by which to compare a company’s internally generated (as opposed to acquired) revenue growth to that of its peers. EBITDA and EBITDA Margin may be helpful in more clearly reflecting our operating performance that may not otherwise be apparent when relying solely on GAAP financial measures, because EBITDA and EBITDA Margin eliminate from earnings financial items that have less bearing on our operating performance. Organic Revenue Growth may be helpful by eliminating the impact of acquired revenue from revenue growth.
Please read the information under the caption “Integration Efforts and Other Charges” below for more details.
Compensation and Employee Benefits Expenses. Compensation and Employee Benefits Expenses decreased $0.8 million, or 0.4%, to $200.2 million in 2003 from $201.0 million in 2002. In 2003, we had integration efforts and other charges of $0.4 million compared to $8.1 million in 2002. Also in 2003, we had $6.1 million of Compensation and Employee Benefits Expenses attributable to the impact of acquisitions, compared to zero in 2002. As a percentage of revenues, Compensation and Employee Benefits Expenses were 56.4% in 2003 compared to 61.2% in 2002. The decrease in 2003, as a percentage of revenues, is primarily due to the $8.1 million integration efforts and other charges in 2002, the positive affects of our integration efforts and improvements in performance in our Insurance Brokerage segment. To reduce compensation expense, in the first quarter of 2002, we terminated 32 employees and renegotiated compensations arrangements for four sales professionals.
Other Operating Expenses. Other Operating Expenses increased $8.7 million, or 12.7%, to $77.5 million in 2003 from $68.8 million in 2002. The increase is primarily attributable to (i) $2.9 million in expenses related to the move of our corporate offices from San Francisco to New York and for consulting fees related to Sarbanes-Oxley Section 404 compliance preparation, (ii) the increase in costs generally associated with being a public company and (iii) $1.6 million of other operating expense attributable to the impact of businesses acquired in 2003, partially offset by (iv) integration efforts and other charges of $1.6 million in 2002, compared to zero in 2003. As a percentage of revenues, Other Operating Expenses were 21.8% in 2003 compared to 21.0% in 2002.
Compensation and Employee Benefits Expenses. Compensation and Employee Benefits Expenses increased $0.8 million, or 0.4%, to $201.0 million in 2002 from $200.2 million in 2001. In 2002, we had integration efforts and other charges of $8.1 million compared to $11.2 million in 2001. As a percentage of revenues, Compensation and Employee Benefits Expenses were 61.2% in 2002 compared to 64.3% in 2001. The decrease, as a percentage of revenues, in 2002 was primarily due to the positive affects of our integration efforts and improvements in performance in our operations. Further, we terminated 32 employees and renegotiated four sales professionals compensation arrangements during the first quarter of 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. As a percentage of revenues, Other Operating Expenses were 21.0% in 2002 compared to 24.5% in 2001, primarily due to the charges.
Income (Loss) From Continuing Operations. Income (Loss) From Continuing Operations increased $45.6 million to $10.9 million in 2002 from a loss of $34.7 million in 2001, due to (i) a reduction in Other Operating Expenses principally due to the integration efforts in the fourth quarter of 2001, (ii) improvement in performance of operations, (iii) the gain from the reduction in the book value of the redeemable common stock warrants and the stock appreciation rights, (iv) a decrease in interest expense as a result of lower interest rates and a reduction in debt, and (v) a decrease in amortization of intangible assets principally due to the elimination of amortization on goodwill-please read Note 1, “Nature of Operations and Summary of Significant Accounting Policies” in our consolidated financial statements under “Goodwill and Other Intangible Assets.” The effective tax rate from continuing operations in 2002 was (5.0)% compared to (11.8)% in 2001. The increase in the effective tax rate and corresponding reduced benefit in 2002 resulted from the increase in the tax valuation allowance established in 2001, offset by the impact of state income taxes.
• Individual and group health, life and disability insurance, which we refer to as Group Employee Benefits insurance.
Revenues in the Insurance Brokerage segment increased $27.4 million, or 10.0%, to $301.7 million in 2003 from $274.3 million in 2002, and increased $16.2 million, or 6.3%, to $274.3 million in 2002 from $258.1 million in 2001. In 2003, revenues were positively impacted by approximately $11.0 million due to acquisitions. There were no businesses acquired in 2002 or 2001. Organic Revenue Growth in 2003 and 2002 was 6.0% and 6.3%, respectively, comprised of new business written and the positive impact of higher premium rates on renewal commissions, partially offset by the impact of lost and non-recurring business. Also, contingent commissions were $3.1 million greater in 2003 than in 2002. P&C revenues represented 57.8%, 55.1% and 53.7% of our total consolidated revenues in 2003, 2002 and 2001, respectively, and Group Employee Benefits revenues represented 27.2%, 28.5% and 29.2% of our total consolidated revenues in 2003, 2002 and 2001, respectively.
The Insurance Brokerage segment results reflect the following integration efforts and other charges: zero, $4.6 million and $16.3 million in 2003, 2002 and 2001, respectively.
The Specialized Benefits Services segment results reflect the following integration efforts and other charges: zero, $1.1 million and $1.7 million in years 2003, 2002 and 2001, respectively.
Loss From Continuing Operations Before Income Taxes in the Corporate segment was $33.0 million, $34.2 million and $51.5 million in 2003, 2002 and 2001, respectively. The decrease in 2003 is primarily attributable to a $6.0 million decrease in interest expense in 2003, the result of lower borrowings and more favorable interest rates, combined with the reasons noted above. The decrease in 2002, compared to 2001, is primarily due to (i) a $6.3 million decrease in interest expense as a result of lower interest rates and a reduction in debt, (ii) a $4.1 million gain from the reduction in the book value of redeemable common stock warrants, and (iii) a $3.0 million gain from the reduction in the book value of the stock appreciation rights.
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 and 96 during the first quarter of 2002 and for 2001, 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 and $4.7 million in the first quarter of 2002 and in 2001, 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, we terminated lease arrangements at one and eight locations, respectively. The early termination of lease commitments resulted in charges of $0.1 million and $1.9 million in the first quarter of 2002 and in 2001, respectively.
In 1999, we sold a brokerage operation that generated revenues from commissions and fees on the sale of life insurance products primarily through third-party agents, which we call wholesale distribution. The wholesale distribution strategy of this operation did not fit with our focus on retail distribution; as a result, we sold the operation to the former owners of that operation and recorded a loss of $3.2 million on the sale of the business. Included in the consideration received for the operation was a note receivable based on a future revenue sharing arrangement. Upon review of the current and future revenue streams generated and to be generated from the sold brokerage operation, we determined that the note was impaired by $1.4 million. The note receivable, originally issued for $1.5 million, was written down by $1.0 million in the second quarter of 2001, written down by $0.3 million in the fourth quarter of 2001 and written down by $0.1 million in the first quarter of 2002.
In 2000, in an effort to provide a simplified and common medical and dental insurance program to our employees, we decided to consolidate our insurance program into one self-insured medical and dental plan. Prior to this plan, many of our acquired businesses had purchased their medical insurance on an individual basis. These medical contracts were placed with a number of different regional and/or national insurance companies principally on a fully insured basis. These insurance brokerage businesses had an employment size that placed them into the insurance carriers’ “community rated” programs. Community rated programs are for businesses that do not have a sufficient employee size, generally less than 100 employees, for the insurance carriers to evaluate their claim history and, therefore, the insurance carriers rate history on an individual basis. In accordance with GAAP, we were required to establish a liability for incurred but not yet reported claims. Since the prior insurance carriers categorized these acquired businesses as community rated, they could not provide us with historical claims information. Therefore, we could not reasonably estimate this liability at the end of 2000. Our historical experience indicated that our average monthly claims were approximately $1.0 million and the lag in reporting claims was approximately three and one-half months. In the first quarter of 2001, we recorded a $3.5 million charge to establish this self-insurance plan liability. We have purchased a specific and aggregate insurance policy to minimize our future exposure. In the fourth quarter of 2002, we changed from the self-insured plan to a fully insured medical and dental plan. The impact of this change did not have a material impact on our financial position or results of operations.
In December 2001, we entered into a services agreement with Ceridian Corporation. The agreement stipulated that Ceridian Corporation will provide administrative services to our customers and us. We estimated that the conversion cost associated with this service agreement would be $1.2 million and we accrued this amount in the fourth quarter of 2001. In March 2002, the original service agreement was amended due to our announcement to sell USIA. Please read “-Discontinued Operations” below. The amendment eliminated USIA as a party to the service agreement, which resulted in the accrual of an additional $1.0 million in the first quarter of 2002.
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
In August 2003, we completed a $155.0 million senior secured credit facility, further described below under “Long-Term Debt.” The proceeds from borrowings under the credit facility were drawn, in part, to repay all
totaled $35.9 million, $36.6 million and $21.9 million for the years ended December 31, 2003, 2002 and 2001, respectively, and is principally dependent upon our results of operations and the timing of collection of premiums receivable and payments of premiums payable. Cash provided by operating activities was negatively impacted in 2003 by the pay-down of approximately $13.8 million in liabilities existing at December 31, 2002 in our Corporate segment related to pre-initial public offering obligations. These obligations did not exist at December 31, 2003, so we do not expect to see a similar drain on cash flows from operations in 2004.
Net cash provided by (used in) financing activities totaled $9.9 million, $(42.7) million and $36.9 million for the years ended December 31, 2003, 2002 and 2001, respectively, as we made debt payments and continued to issue both debt and equity. In the third quarter of 2003, we refinanced our credit facility resulting in gross proceeds from the issuance of debt of $125.0 million and costs paid of $3.8 million. With the proceeds, we paid down our previously existing revolver and term loan of $70.9 million and $27.3 million, respectively and other acquisition-related debt of $5.0 million. In the first quarter of 2002, we received $2.5 million from the issuance of our preferred stock to Sovereign Bancorp. In the second quarter of 2002, we used $16.3 million of the proceeds from the sale of USIA to reduce our term loan. In the fourth quarter of 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 our previous credit facility. In the fourth quarter of 2001, we received $30.0 million from the issuance of our preferred stock. Of the $30.0 million issued, $15.0 million was issued to UnumProvident Corporation and $15.0 million was issued to Ceridian Corporation. Please read Note 12, “Related Party Transactions” to our annual financial statements.
Income (loss) per share from continuing operations on a basic and diluted basis was $0.78 and $0.77, respectively, for the year ended December 31, 2003 and $(0.87) and $(74.16) for the years ended December 31, 2002 and 2001 on a basic and diluted basis, 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. Shares of our common stock outstanding as of December 31, 2003, 2002 and 2001, were 46.7 million, 42.4 million and 0.8 million, respectively.
Our net losses have resulted in net operating loss carry-forwards for federal and state income tax purposes. At December 31, 2003, we had $22.6 million of net operating loss carry-forwards for federal tax purposes that will expire during the period 2011 through 2022. Our ability to use these net operating loss carry-forwards to offset future taxable income, if any, may be subject to limitations under Section 382 of the Internal Revenue
Code of 1986, as amended and similar state provisions. The provisions of Section 382 are triggered by specific ownership changes of our stock. We do not believe Section 382 will limit us in utilizing our net operating loss carry-forwards in 2004. However, if limited, the unused portion may then be carried forward to future years. We expect to utilize our remaining net operating loss carry-forwards in the first half of 2004 and then to become a full taxpayer for both federal and state income taxes. In 2003 and 2002 we paid $3.4 million and $2.4 million, respectively, primarily for state income taxes. In 2004, this amount is likely to be substantially higher depending on our results of operations and the composition of our taxable income by state.
On February 12, 2004, we filed a $300.0 million universal shelf registration statement on Form S-3 with the Securities and Exchange Commission pursuant to which we may offer up to $150.0 million of securities in the future and selling shareholders may offer up to $150.0 million of common stock in the future. Securities offered by us may be common stock, preferred stock, debt securities, warrants to purchase common stock, preferred stock or debt securities, stock purchase contracts, stock purchase units or any combination of such securities. Upon effectiveness of the registration, one or more of these securities may be offered in amounts, prices, and on terms to be announced when and if the securities are offered. The timing, structure and nature of any funds raised under this shelf registration statement, as well as the use of such funds, are at the discretion of our management and board of directors.
The revolving credit facility is available for loans denominated in U.S. dollars and for letters of credit. Borrowings under the revolving credit facility bear interest, at our option, at either a base rate plus an applicable margin ranging from 1.5% to 2.5% per annum or the Eurodollar rate plus an applicable margin ranging from 2.5% to 3.5% per annum, depending on our credit ratings as determined by Standard & Poor’s and Moody’s credit rating services at the time of borrowing. Borrowings under the term loan bear interest, at our option, at a base rate plus 2.0% per annum or the Eurodollar rate plus 3.0% per annum. The base rate and the Eurodollar rate are effectively the prime rate and the London Interbank Offering Rate, respectively. Additionally, there is a commitment fee on the unused portion of the revolving credit facility of 0.50% per annum. The revolving credit facility may be used for acquisition financing and general corporate purposes.
The table below summarizes our contractual obligations as of December 31, 2003:
At December 31, 2003 our other debt of $28.7 million consisted primarily of notes payable issued in conjunction with acquisitions. Some of these notes payable may be subject to reduction based on future performance of the acquired company. At December 31, 2003, our capital lease obligations of $6.6 million related to purchases of furniture and equipment. In the past, we have used external financing to fund such purchases and plan on continuing to do so in the future.
The table below summarizes our off-balance sheet commitments as of December 31, 2003:
The amount above is comprised of two letters of credit established as collateral for our workers’ compensation insurance program. Letters of credit represent a reduction to the borrowing availability on our revolving credit facility.
In the latter part of 2001, we completed a strategic and financial review of our company and concluded that USIA, a third-party administrator, 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 income (losses) of $0.2 million, $(13.8) million and $(61.8) million for the years ended December 31, 2003, 2002 and 2001, 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 17, “Discontinued Operations” to our annual financial statements.
We incurred zero, $1.0 million and $2.5 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, 2003, 2002 and 2001, 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.
We have audited the accompanying consolidated balance sheet of U.S.I. Holdings Corporation and subsidiaries at December 31, 2002 and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the two 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.
As further described in Note 1 to the consolidated financial statements, during the year ended December 31, 2002, the Company changed its method of accounting for goodwill and intangible assets.
February 12, 2003, except for Note 20, as to which the date is March 1, 2003
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. The Company has two operating segments: Insurance Brokerage and Specialized Benefits Services, and a third administrative segment: Corporate. The Insurance Brokerage segment focuses primarily in general and specialty property and casualty insurance and individual and group health, life and disability insurance. The Specialized Benefits segment focuses primarily on retirement services, including defined benefit and defined contribution plan design, consulting and recordkeeping, benefits enrollment and communication services and executive and professional benefits. The Corporate segment provides corporate management, acquisition processes, marketing, human resources, legal, capital planning, financial and reporting support.
As an insurance broker, the Company directly collects premiums from its clients and, after deducting its commissions and/or fees, remits these premiums to insurance companies. Unremitted insurance premiums are held in a fiduciary capacity until disbursed by the Company. The Company earns interest on these unremitted funds, which is reported as investment income in the accompanying consolidated statements of operations.
The use of premiums collected from clients but not yet remitted to insurance companies is restricted by law 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.
Intangible assets represent expiration rights and non-compete agreements. 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.
For significant acquisitions, we obtain an independent appraisal of the fair value of intangible assets acquired. The Company utilizes a methodology based on an estimate of discounted future cash flows derived from acquired client lists and attrition rates to estimate the fair value of the expiration rights and other intangible assets at the date of the acquisition. 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. Non-compete agreements are typically valued at their stated contractual amount and are amortized on a straight-line method over the terms of the agreements, which range from four to seven years.
The following table illustrates the effect on the Company’s operating results and earnings per share as if the Company had applied the fair value recognition provisions of SFAS No. 148 to stock-based compensation.
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
arrangements and concluded that it had no such material guarantees requiring recognition or disclosure pursuant to FIN 45 as of December 31, 2003.
In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity” (SFAS No. 150). SFAS No. 150 establishes standards for classifying and measuring as liabilities certain financial instruments that embody obligations of a company and have characteristics of both liabilities and equity. SFAS No. 150 is effective for instruments entered into or modified after May 31, 2003, and to all other instruments that exist as of the beginning of the first interim financial reporting period beginning after June 15, 2003. On July 1, 2003, in connection with the effective date of SFAS No. 150, the Company reviewed the classification of its redeemable common stock and reclassified these shares to common stock and additional paid-in-capital. Additionally, the Company separately recognized the value of the put rights in liabilities (see Note 7-Redeemable Securities). The Company did not issue or modify any instruments after May 31, 2003.
During 2003, the Company acquired the stock of four insurance brokerage operations and the assets and certain liabilities of two insurance brokerage operations. The aggregate purchase price of $43,770,000 included shares of the Company’s common stock and restricted stock valued at $21,341,000, cash of $15,699,000 and notes payable of $6,730,000. Common shares issued by the Company, including restricted stock, in connection with these acquisitions were valued at an amount approximating the fair market value based on an average daily closing price over a short period of time just prior to the effective date of the acquisition. The following amounts were allocated to covenants-not-to-compete, expiration rights and net tangible liabilities, respectively: $1,970,000, $17,873,000, and $5,346,000; and the balance of $29,273,000 was recognized as goodwill. Expiration rights and covenants-not-to-compete are being amortized over 10 and 7 years, respectively. All acquisitions were made within the Company’s Insurance Brokerage segment.
The acquisitions were all accounted for using the purchase method, and their related net assets and results of operations are included in the Company’s consolidated financial statements from their respective acquisition dates forward. The Company’s acquisitions frequently have provisions for a reduction in consideration if the acquired company does not meet future financial results. Additionally, the acquisitions frequently have provisions for contingent additional consideration if the acquired company achieves future financial targets. Additional or reduced consideration related to acquisition contingency provisions is recorded as an adjustment to goodwill when the contingency is resolved. In 2003 and 2002, an aggregate of $7,143,000 and $10,583,000, respectively, was recorded as additional consideration for acquisitions completed in prior years. In 2001 there were no significant adjustments to the original purchase price of acquisitions.
As of December 31, 2003, the estimated unrecorded future contingent payments related to acquisitions totals $10,696,000.
At December 31, 2003, other intangible assets are comprised of deferred financing costs related to the Company’s credit facility-see Note 5-Long-Term Debt. In 2003 and 2002, the Company charged $1,894,000 and $2,437,000 to interest expense for the amortization of these costs.
The amortization expense for amortizable intangible assets for the years ending December 31, 2004, 2005, 2006, 2007 and 2008 is estimated to be $20,345,000, $17,081,000, $13,871,000, $10,977,000 and $8,631,000, respectively.
Property and equipment consists of the following as of December 31:
The revolving credit facility is available for loans denominated in U.S. dollars and for letters of credit. Borrowings under the revolving credit facility bear interest, at the Company’s option, at either a base rate plus an applicable margin ranging from 1.5% to 2.5% per annum or the Eurodollar rate plus an applicable margin ranging from 2.5% to 3.5% per annum, depending on the Company’s credit ratings as determined by Standard & Poors and Moody’s Investors Service credit rating services at the time of borrowing. Additionally, there is a commitment fee on the unused portion of the revolving credit facility of 0.50% per annum. The revolving credit facility may be used for acquisition financing and general corporate purposes. At December 31, 2003, availability under the revolving credit facility was reduced by $1,725,000 for outstanding letters of credit.
The credit facility contains various limitations, including limitations on the payment of dividends and other distributions to stockholders, borrowings and acquisitions. The credit facility also contains various financial covenants that must be met, including those with respect to fixed charges coverage and limitations on consolidated debt, net worth and capital expenditures. Failure to comply with the covenants may result in an acceleration of the borrowings outstanding under the facility. All of the stock of the Company’s subsidiaries and certain other identified assets of the Company are pledged as collateral to secure the credit facility. Additionally, each subsidiary guarantees the obligations of the Company under the credit facility. As of December 31, 2003 the Company is in compliance with all such covenants.
In September 1999, Series W stockholders were issued warrants convertible into shares of Series W preferred stock. As of December 31, 2003, 6,250,002 warrants were outstanding and exercisable into an aggregate of 2,499,997 shares of common stock at an exercise price of $15.00 per share. The warrants expire on September 17, 2004.
Upon consummation of the IPO, all redeemable preferred stock, for which the holders still had put rights, was converted to common stock. After the conversion, the holders of the redeemable preferred stock retained the right to put their common stock to the Company upon the occurrence of certain events as described below.
The individuals who hold the put rights may, in the event of death, disability or involuntary termination, put to the Company the number of shares owned by them having a fair market value equal to their original investment in those shares. The put rights generally continue as long as the original holders own the stock and remain employed by the Company. The put rights are not transferable. Therefore, if these original holders sell any of the stock, the put rights with respect to the shares sold are extinguished.
Upon consummation of the IPO, the puts rights were terminated and the redeemable preferred stock was converted to shares of common stock.
The Company maintains a 401(k) Plan covering substantially all employees with at least six months of service. Under the 401(k) Plan, the first 4% of a participant’s contribution will be eligible for a discretionary
Company contributions to all 401(k) plans for 2003, 2002 and 2001 were $2,913,000, $3,527,000 and $3,374,000, respectively.
The Company’s Board of Directors and a requisite majority of the stockholders approved a new 2002 Equity Incentive Plan (EIP) that became effective and replaced the Long-Term Incentive and Share Award Plan with the consummation of the IPO. The EIP has reserved up to 10,270,000 shares of the Company’s common stock for issuance to directors, executive officers, employees and non-employee contributors.
The EIP provides for the direct award of shares of the Company’s common stock or stock units, the sale of shares of the Company’s common stock and for the grant of options to purchase shares of the Company’s common stock. Options granted under the EIP may be non-qualified or incentive stock options. See Note 9-Stock Option Plan.
As noted above, the EIP replaced the Long-Term Incentive and Share Award Plan. SARs held by former employees were settled in cash. SARs held by current employees and consultants were either exchanged for stock options or common stock or paid out in a combination of cash and common stock. In the fourth quarter of 2002, the Company recorded a charge of $1,269,000 related to the SAR exchange.
Compensation expense, or a reduction of compensation expense, for SARs was recorded based on the change in fair value of the Company’s common stock from grant date to each balance sheet date. Reference 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 2003, 2002 and 2001 related to the SARs was zero, $(2,995,000) and $3,092,000, respectively.
As discussed in Note 8-Employee Benefit Plans, the Company sponsors the 2002 Equity Incentive Plan.
The following is a summary of all of the Company’s stock option activity and related information:
The weighted-average fair value of options granted during the year was $3.57 and $3.43 for 2003 and 2002, respectively. The weighted-average contract life of options outstanding at December 31, 2003 and 2002 was 9 and 10 years, respectively.
On November 27, 2002, the Company exchanged all SARs for stock options under the 2002 Equity Incentive Plan, which totaled 2,820,000 shares. In connection with this exchange, the Company recorded $1,269,000 of compensation expense in the fourth quarter of 2002 and is reported as the value of stock options exchanged for stock appreciation rights in the accompanying 2002 statements of operations. The stock options under the SARs exchange were vested if the SARs for which they were exchanged were vested.
In the fourth quarter of 2003, upon determination that it is more likely than not that the Company’s deferred tax asset will be realized in future periods, the Company reversed the valuation allowance for its net deferred tax asset. This determination was made based on the Company’s profitability since the IPO, the positive impacts of the Company’s new credit facility and on management’s expectations of the Company’s ability to realize the benefits of its deferred tax asset in the future.
Deferred income taxes reflect the impact of temporary differences between the values recorded for financial reporting purposes and values utilized for measurement in accordance with current tax laws. The tax effects of the significant temporary differences giving rise to the Company’s deferred tax assets (liabilities) from continuing operations at December 31 are as follows:
The Company leases various facilities and equipment under non-cancelable operating leases. These leases generally contain renewal and/or purchase options and escalation clauses. Minimum aggregate rental commitments at December 31, 2003, under non-cancelable operating leases having an initial term of more than one year, are as follows:
On December 21, 2001, the Company entered into a service agreement with Ceridian Corporation (Ceridian), a stockholder of the Company, whereby Ceridian was to provide certain administrative services to the Company and its customers. The service agreement with Ceridian included a provision whereby Ceridian could recover up to $1,182,000 in conversion costs if their revenue from administrative services provided to the Company’s customers failed 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 2002, the original service agreement was amended due to our announcement to sell USIA (see Note 17-Discontinued Operations). The amendment eliminated USIA as a party to the service agreement, which resulted in the accrual of an additional $990,000 in termination costs.
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 insurance brokerage segment offers general and specialty property and casualty and employee benefit-related insurance. The specialized benefits services segment offers health and welfare products, retirement services such as 401(k) plan administration and defined benefit actuarial services, benefits enrollment and communication, executive benefits 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 following table shows the income (loss) from continuing operations before income taxes for the years ended December 31, 2003, 2002 and 2001.
The total assets by segment at December 31 are as follows:
The Company is subject to various claims, lawsuits and proceedings that arise in the normal course of business. These matters principally consist of alleged errors and omissions in connection with the placement of insurance and rendering administrative or consulting services and are generally covered in whole or in part by insurance. On the basis of present information, anticipated insurance coverage and advice received from counsel, it is the opinion of the Company’s management that the disposition or ultimate determination of these claims, lawsuits or proceedings will not have a material adverse effect on the Company’s consolidated financial position or results of operations.
In December 2003, plaintiffs filed an amended complaint, and the Company has filed another motion to dismiss all claims asserted against the Company and its officers and employees based on several grounds including the grounds previously accepted by the court.
The Company is vigorously defending this action as it believes the plaintiff’s allegations against the Company have no merit.
The employee termination benefits and the future producer compensation restructuring charges reflected above are included in compensation and employee benefits expenses in the accompanying statements of operations. The terminated office lease charges are included in other operating expenses in the accompanying statements of operations. Substantially all of the remaining liabilities will be paid by the end of 2004.
In January 2002, the Company announced that Bernard H. Mizel, Chairman and Chief Executive Officer since the Company was founded in 1994, would retire. David L. Eslick, who had been President and Chief Operating Officer since July 1998, would succeed 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.
The assets and liabilities of discontinued operations at December 31 are as follows:
The results of operations of discontinued operations for the years ended December 31 are as follows:
In the fourth quarter of 2001, the Company determined that the intangible assets of USIA were impaired after considering USIA’s actual and projected operating results. Using undiscounted cash flows over the remaining amortization period, the Company estimated that the fair value of the long-lived assets of USIA approximated $22,500,000. The carrying amount of the long-lived assets approximated $69,400,000 prior to the impairment charge at December 31, 2001, so the Company wrote-off all existing goodwill of $37,500,000. Additionally, the Company reduced related expiration rights by $9,400,000. Together, these two write-offs resulted in the impairment charge of $46,900,000.
(2) Revenues and income from continuing operations in the fourth quarter are generally higher than the preceding three quarters due primarily to the seasonality of business in our specialized benefits segment.
On February 12, 2004, the Company filed a $300,000,000 universal shelf registration statement on Form S-3 with the Securities and Exchange Commission pursuant to which USI may offer up to $150,000,000 of USI securities in the future and selling shareholders may offer up to $150,000,000 of USI common stock in the future. Securities offered by USI may be common stock, preferred stock, debt securities, warrants to purchase common
On January 5, 2004, the Company announced that it had reached an agreement in principle to acquire all the issued and outstanding capital stock of Los Angeles, California based Dodge, Warren & Peters Insurance Services, Inc. (DWP). DWP provides retail property & casualty and employee benefits insurance brokerage services through its four offices in California. Terms of the transaction are subject to final negotiation and execution of definitive agreements. The consummation of the transaction is expected to occur in the second quarter of 2004.
In the first quarter of 2004, the Company completed a strategic review of the business units within its operating segments and effective January 1, 2004 reorganized the management and reporting of two business units within its Specialized Benefits Services segment into the Insurance Brokerage segment. The change was made based on the determination that these business units’ focus is on a similar target market and product set to that of the Insurance Brokerage segment. Beginning with the first quarter of 2004, the Company will report segment information under the new operating structure and prior periods will be reclassified to conform to the new presentation.