In the insurance industry, the underwriting cycle is often said to be in either a “soft” or “hard” market. A soft market generally results when insurance companies focus more on increasing their premium income and focus less on controlling underwriting risks. A soft market often occurs in conjunction with strong financial markets or in a period with a lack of catastrophe losses. Insurance companies often attempt to derive a significant portion of their earnings from their investment portfolios, and their focus may turn to collecting more premium income to invest under the assumption that increased investment income and gains will offset higher claim costs that usually result from relaxed underwriting standards. Due to competition in the industry during periods in which a soft market exists, insurance companies usually concentrate on growing their premium base by increasing the number of policies in force instead of raising individual policy premiums. When the insurance underwriting market is soft, insurance companies are generally more aggressive in the risks they underwrite, and insurance premiums and policy deductibles typically decline. This usually results in an increase in industry-wide claim referrals which generally will increase claim referrals to us provided that we are able to maintain our existing market share. However, if a soft market coincides with a period of low catastrophic claims activity, industry-wide claim volumes may not increase.
A transition from a soft to a hard market is usually caused by one or two key factors, or sometimes a combination of both: weak financial markets or unacceptable losses from policy holders. When investments held by insurance companies begin to perform poorly, insurance companies typically turn their focus to attempting to better control underwriting risks and claim costs. However, even if financial markets perform well, the relaxed underwriting standards in a soft market can lead to unacceptable increases in the frequency and cost of claims, especially in geographic areas that are prone to frequent weather-related catastrophes. During a hard insurance underwriting market, insurance companies generally become more selective in the risks they underwrite, and insurance premiums and policy deductibles typically increase. This usually results in a reduction in industry-wide claim volumes, which generally reduces claim referrals to us unless we are able to offset the decline in claim referrals with growth in our market share. For the past several years and continuing through 2011, the insurance industry underwriting cycle could be characterized as being in a soft market. Because the underwriting cycle can change suddenly due to unforeseen events in the financial markets and catastrophic claims activity, we cannot predict what impact the current soft market may have on us in the future or the timing of when the market may harden in the future.
Net income attributable to Crawford & Company was $45.4 million in 2011, compared with net income of $28.3 million in 2010 and a net loss of $115.7 million in 2009. During 2011, we recorded a total pretax credit of $2.4 million in special charges and credits, consisting of a gain of $7.0 million related to the final settlement of an arbitration award (discussed below), partially offset by a $3.4 million write-off of deferred financing costs related to the repayment of our then-outstanding Term Loan B and $1.2 million in severance expense related to the Broadspire segment. The Company also recorded a tax benefit of $5.5 million related to a change in the valuation allowance for foreign tax credits. The after-tax impact on net income was $8.5 million. Net income (loss) for 2010 and 2009 included goodwill and intangible asset impairment charges of $10.8 million and $140.9 million, respectively. Consolidated net income for 2010 also included restructuring and other costs of $4.7 million, or approximately $2.9 million after tax, consisting of $2.0 million in severance costs for administrative staff reductions and $2.7 million related to the sublease of a Broadspire facility in Plantation, Florida. In 2009, we incurred a loss on the partial sublease of that Broadspire facility and other restructuring costs totaling $4.1 million, or approximately $2.6 million after income tax. The 2009 net loss was reduced by certain foreign tax benefits totaling $5.7 million as a result of an internal restructuring of certain of the Company’s international operations.
Operating earnings (a measure of segment operating performance used by our management that is defined and discussed in more detail below) increased substantially for Legal Settlement Administration in 2011 and 2010 compared with 2009 resulting from a special project, and improved in our EMEA/AP segment in 2011 compared with 2010 primarily resulting from weather-related events in Asia-Pacific. Our Broadspire segment saw a sharp increase in its operating loss from 2009 to 2010 as a result of declining case volumes and the loss of a significant customer. This operating loss continued in 2011. Operating earnings for our Americas segment declined from 2009 to 2010 primarily due to lower revenue resulting from fewer weather-related events in 2010 and declined in 2011 compared with 2010 due to an unfavorable shift in the mix of cases received as well as higher costs incurred to service claims from Hurricane Irene.
We believe that a discussion and analysis of the operating earnings (loss) of our four operating segments is helpful in understanding the results of our operations. Operating earnings is our segment measure of profitability as discussed in Note 12, “Segment and Geographic Information," to the accompanying audited consolidated financial statements contained in Item 8 of this Annual Report on Form 10-K. Operating earnings is the primary financial performance measure used by our senior management and CODM to evaluate the financial performance of our operating segments and make resource allocation decisions. Unlike net income, our segment operating earnings measure is not a standard performance measure found in GAAP. However, since it is our segment measure of profitability presented in conformity with the Financial Accounting Standards Board’s (“FASB”) Accounting Standards Codification (“ASC”) Topic 280 “Segment Reporting,” it is not considered a non-GAAP measure requiring reconciliation pursuant to Securities and Exchange Commission (“SEC”) guidance contained in Regulation G and Item 10(e) of Regulation S-K. We believe this measure is useful to others in that it allows them to evaluate segment operating performance using the same criteria our management and CODM use. Operating earnings represent segment earnings (loss) before certain unallocated corporate and shared costs, goodwill and intangible asset impairment charges, net corporate interest expense, stock option expense, amortization of customer-relationship intangible assets, special charges and credits, income taxes, and net income attributable to noncontrolling interests.
Income tax expense, net corporate interest expense, amortization of customer-relationship intangible assets, and stock option expense are recurring components of our net income or loss, but they are not considered part of our segment operating earnings because they are managed on a corporate-wide basis. Income tax expense is calculated for the Company on a consolidated basis based on statutory rates in effect in the various jurisdictions in which we provide services, and varies significantly by jurisdiction. Net corporate interest expense results from capital structure decisions made by senior management and affecting the Company as a whole. Amortization expense is a non-cash expense for customer-relationship intangible assets resulting from business combinations. Stock option expense represents the non-cash costs generally related to stock options and employee stock purchase plan expenses which are not allocated to our operating segments. None of these costs relate directly to the performance of our services or operating activities and, therefore, are excluded from segment operating earnings in order to better assess the results of each segment’s operating activities on a consistent basis.
Unallocated corporate and shared costs represent expenses and credits related to our chief executive officer and Board of Directors, certain provisions for bad debt allowances or subsequent recoveries such as those related to bankrupt clients, defined benefit pension costs or credits for our frozen U.S. pension plan, and certain self-insurance costs and recoveries that are not allocated to our individual operating segments.
Additional discussion and analysis of our income taxes, net corporate interest expense, amortization of customer-relationship intangible assets, stock option expense, unallocated corporate and shared costs, and special charges and credits follows the discussion and analysis of the results of operations of our four operating segments.
Operating results for our Americas, EMEA/AP, Broadspire, and Legal Settlement Administration segments reconciled to pretax income (loss) and net income (loss) attributable to shareholders of Crawford & Company, were as follows:
Operating earnings for our Americas segment decreased from $20.7 million in 2010 to $19.9 million in 2011, representing an operating margin of 5.5% in 2011 compared with 6.2% in 2010. The decrease in 2011 was primarily due to declines in operating earnings in Canada and Latin America.
Reimbursements for out-of-pocket expenses included in total revenues for our Americas operations were $16.6 million in 2011, increasing from $14.6 million in 2010. The increase in 2011 was due primarily to increases in billable expenses related to catastrophe cases.
Americas unit volumes by underlying case category, as measured by cases received, for 2011 and 2010 were as follows:
The 2011 increase in cases in Canada was due to an increase in appraisal cases and weather-related activity. The 2011 decrease in cases in Latin America and the Caribbean was primarily due to the loss of high-volume, low-severity affinity programs that were taken in-house by a client.
Americas direct compensation and fringe benefits expense, as a percent of segment revenues before reimbursements, decreased to 63.5% in 2011 compared with 63.8% in 2010. This decrease in 2011 was due primarily to an increase in revenues as expenses increased 6.3%. There was an average of 2,844 full-time equivalent employees ("FTEs") (including 172 catastrophe adjusters) in 2011 compared with an average of 2,901 (including 68 catastrophe adjusters) in 2010.
EMEA/AP operating earnings increased to $28.4 million in 2011, an increase of 14.5% from 2010 operating earnings of $24.8 million for the reasons described below. The operating margin declined from 8.7% in 2010 to 8.4% in 2011.
As a percent of segment revenues before reimbursements, direct compensation expense, including related payroll taxes and fringe benefits, decreased to 65.3% in 2011 from 67.0% in 2010. The percentage decrease primarily reflected increased utilization of our staff as a result of the increase in the number of cases received. The dollar amount of these expenses increased in 2011 by $30.8 million. Approximately $12.1 million of the increase was due to changes in exchange rates, with the remainder of the increase primarily due to an increase in the number of FTEs needed to handle the increased activity. There was an average of 3,114 EMEA/AP FTEs in 2011, an increase from 2,775 in 2010.
Broadspire segment expenses other than reimbursements, direct compensation and fringe benefits increased as a percent of segment revenues before reimbursements to 46.9% in 2011 from 45.5% in 2010. This percentage increase was primarily due to lower revenue, as total 2011 expenses declined by $1.5 million.
Legal Settlement Administration revenues are primarily derived from securities, product liability and other legal settlements, and bankruptcy claim administration, primarily in the U.S. Legal Settlement Administration revenues before reimbursements increased 17.3% to $192.6 million in 2011, compared with $164.2 million in 2010. Legal Settlement Administration revenues are project-based and can fluctuate significantly due primarily to the timing of projects awarded. The growth in Legal Settlement Administration revenues was due primarily to a special project. This project continues to wind down, and we currently expect revenues and operating earnings therefrom to decline significantly from 2011 levels through the first half of 2012, and to thereafter continue to decline through the currently expected project end date of August 2013, although no assurances of timing of the project end date and, therefore, continued revenues, can be provided.
At December 31, 2011, we had an estimated backlog of awarded projects totaling approximately $64.0 million, compared with approximately $90.0 million at December 31, 2010. Of the $64.0 million backlog at December 31, 2011, an estimated $58.8 million is expected to be included in revenues within the next 12 months.
The nature and volume of work performed in our Legal Settlement Administration segment typically requires more reimbursable out-of-pocket expenditures than our other operating segments. Reimbursements for out-of-pocket expenses included in total revenues for Legal Settlement Administration were $30.5 million in 2011, decreasing from $38.8 million in 2010. The decrease in 2011 was primarily due to the start up of the special project work in 2010, which required a significant amount of out-of-pocket reimbursable expenses, which did not continue into 2011.
Legal Settlement Administration direct compensation expense, including related payroll taxes and fringe benefits, as a percent of segment revenues before reimbursements, increased to 37.4% in 2011, compared with 33.3% in 2010. There was an average of 542 FTEs in 2011, compared with an average of 390 in 2010.
One of our most significant expenses in Legal Settlement Administration is outsourced services due to the variable, project-based nature of our work. Legal Settlement Administration expenses other than reimbursements, direct compensation and fringe benefits decreased as a percent of related segment revenues before reimbursements to 36.0% in 2011 from 37.7% in 2010. During 2011, a larger portion of the workload was fulfilled by Legal Settlement Administration FTEs rather than utilizing outsourced services. As a result, 2011 expenses other than reimbursements, direct compensation and related payroll taxes and fringe benefits were lower as a percent of related segment revenues before reimbursements as compared with 2010.
YEAR ENDED DECEMBER 31, 2010 COMPARED WITH YEAR ENDED DECEMBER 31, 2009
Operating earnings for our Americas segment decreased from $29.4 million in 2009 to $20.7 million in 2010, representing an operating margin of 6.2% in 2010 compared with 8.6% in 2009. The decrease in 2010 was primarily due to a decrease in revenues as discussed below.
The improvement in Canada's revenue from 2009 to 2010 is entirely due to a positive impact from exchange rate movements. On a constant dollar basis, Canada's revenue declined by 2.0% and would have been $118.9 million.
The 2010 decrease in U.S. Property & Casualty cases was due primarily to lower industry-wide claims volumes, which resulted in fewer cases referred to us from our clients. This included a reduction in vehicle cases due primarily to general economic conditions which we believe resulted in fewer miles driven and thus fewer cases, and also due to decisions by certain insurance companies to reduce third-party adjuster involvement in handling vehicle-related claims. The 2010 increase in Contractor Connection cases was due to the ongoing expansion of our contractor network and due to the trend of insurance carriers moving high-frequency, low-severity property claims directly to repair networks. The 2010 decrease in U.S. Technical Services cases was due primarily to decreases in weather-related cases. The 2010 decrease in U.S. Catastrophe Services cases was due primarily to decreases in weather-related claims and also to a reduction in warranty services claims which resulted from the expiration of several long-running class action contracts, which were not replaced by new, similar claims.
Americas direct compensation and fringe benefits expense, as a percent of segment revenues before reimbursements, decreased to 63.8% in 2010 compared with 64.0% in 2009. This decrease in 2010 was due primarily to a reduction in FTEs and lower incentive compensation expense. There was an average of 2,901 FTEs (including 68 catastrophe adjusters) in 2010 compared with an average of 3,201 (including 90 catastrophe adjusters) in 2009.
Americas salaries and wages decreased 2.7%, to $180.7 million in 2010 from $185.8 million in 2009. The decrease in 2010 compared with 2009 was due primarily to the reduction in FTEs and lower incentive compensation expense. Payroll taxes and fringe benefits for Americas totaled $32.9 million in 2010, increasing 2.8% from 2009 expenses of $32.0 million. The increase in 2010 compared with 2009 was due primarily to higher defined contribution retirement plan expense.
EMEA/AP operating earnings increased to $24.8 million in 2010, an increase of 6.1% from 2009 operating earnings of $23.4 million for the reasons described below. The operating margin declined from 9.0% in 2009 to 8.7% in 2010.
EMEA/AP unit volume, measured by cases received, increased 17.5% in 2010 compared with 2009. This increase primarily reflected increased case referrals during 2010 in all regions, as discussed below. Average revenue per claim decreased 11.6% from changes in the mix of services provided and in the rates charged for those services. The net increase in 2010 of high-frequency, low-severity cases, primarily in the U.K. and CEMEA, lowered the average revenue per claim in 2010, as discussed below.
The 2010 increase in the U.K. was due primarily to an increase in weather-related activity. The increase in CEMEA resulted primarily from growth in our high-frequency, low-severity claims management business in Belgium, Germany and Scandinavia. The increase in Asia-Pacific was due to weather-related activity in Australia.
Salaries and wages of EMEA/AP segment personnel increased 8.1% to $157.4 million in 2010 compared with $145.6 million in 2009, decreasing as a percent of revenues before reimbursements from 56.2% in 2009 to 55.1% in 2010. Payroll taxes and fringe benefits increased 8.3% to $34.0 million in 2010 compared with $31.4 million in 2009. These increases were primarily related to a weaker U.S. dollar during 2010.
Expenses other than reimbursements, direct compensation and fringe benefits increased as a percent of segment revenues before reimbursements from 22.6% in 2009 to 24.3% in 2010 and the dollar amount of these expenses increased by $11.0 million. The increase in 2010 was due primarily to the weaker U.S. dollar and to the increased use of outsourced services to assist in servicing the increased volume of activity.
Our Broadspire segment recorded an operating loss of $11.7 million, or (4.8)% of segment revenues before reimbursements in 2010 compared with an operating loss of $1.6 million, or (0.6)% of segment revenues before reimbursements in 2009. Broadspire's 2010 operating results were negatively impacted by declining workers' compensation case volumes, the weakened labor market in the U.S., the loss of a major customer at the end of 2009, and a $1.3 million charge resulting from the loss of a major customer in 2010.
The 2010 declines in workers’ compensation cases reflected a continuing decline in reported workplace injuries in the U.S primarily as a result of the continued overall level of employment due to the then-current economic climate, as well as the loss of a significant client discussed below. The significant increase in casualty cases in 2010 over 2009 was due to services provided in connection with a special project for one of our customers. The 2010 increases in other cases were primarily due to increases in health management services resulting from employers that added such services to their employee benefits programs. In 2009, we were notified by a major client that the client would not renew its existing contract with us effective on the scheduled expiration of that contract in December 2009. Revenues related to this client in 2009 were $21.1 million.
At December 31, 2010 we had an estimated backlog of awarded projects totaling approximately $90.0 million, compared with approximately $55.0 million at December 31, 2009.
Legal Settlement Administration direct compensation expense, including related payroll taxes and fringe benefits, as a percent of segment revenues before reimbursements, decreased to 33.3% in 2010 compared with 43.7% in 2009. The 2010 percentage decrease was primarily due to operating efficiencies achieved as a result of the increase in revenues. The increase in the 2010 dollar amount of these expenses was due primarily to higher incentive compensation expense and the increased number of FTEs in 2010. There was an average of 390 FTEs in 2010, compared with an average of 347 in 2009.
Our most significant deferred tax asset is related to the unfunded liability of our defined benefit pension plans. The tax deduction for defined benefit pension plans generally occurs upon the timing of funding of plan liabilities. Assuming that the estimated minimum funding requirements for the defined benefit pension plans are met, the deferred tax asset should be realized. In accordance with GAAP, we have considered the four possible sources of taxable income that may be available to realize a tax benefit for deductible temporary differences and carryforwards and have recorded a $4.5 million valuation allowance on certain net operating loss carryforwards in our international operations. In 2011, we determined that we no longer needed a $5.5 million valuation allowance on certain foreign tax credits in our domestic operations, and we have reduced our tax expense accordingly. Management believes that it is more likely than not that we will realize our net deferred tax assets based on our forecast of future taxable income. Future changes in the valuation allowance, if required, should not affect our liquidity or our compliance with any existing debt covenants.
On October 27, 2010, the independent arbitrator arbitrating a portion of the matters relating to our acquisition of BMSI (the "Broadspire Accounting Arbitration") issued a decision and determination in connection therewith, which is described more fully in Note 3, "Goodwill and Intangible Assets," to the accompanying audited consolidated financial statements. As a result of this determination, we made payments to Platinum Equity, LLC ("Platinum") totaling $13.5 million during 2010, representing additional purchase price consideration for the acquisition of BMSI. All of the goodwill in the Broadspire segment was previously impaired and the fair value of the Broadspire segment does not support additional goodwill. Accordingly, we recorded additional goodwill impairment charges of $14.8 million in 2010. All but the interest portion of the charge was nondeductible for tax purposes.
Special charges and credits in 2011 consisted of three items. In addition to the Accounting Arbitration discussed above, we had asserted claims for damages against Platinum due to breaches in the representations and warranties contained in the Stock Purchase Agreement (the "Legal Arbitration"). On July 25, 2011, the panel arbitrating the Legal Arbitration issued a final decision, resulting in our recognizing a pretax arbitration award of $7.0 million ($5.9 million, net of tax). Portions of the award are considered to be adjustments of the purchase price. We also recorded a $3.4 million write-off of deferred financing costs related to the repayment of our then-outstanding Term Loan B and $1.2 million in severance expense related to the Broadspire segment.
We continue to evaluate current and forecasted economic conditions and their potential implications for us, including, among other things, estimating the fair value of our financial instruments, asset impairments, liquidity, compliance with our debt covenants, cash funding requirements under our defined benefit pension plans, and relationships with our financing agreement counterparties and customers.
On December 8, 2011, we entered into a senior secured credit agreement (the "Credit Facility") with Crawford & Company Risk Services Investments Limited, a limited company incorporated under the laws of England and Wales and a wholly-owned subsidiary of the Company (the "UK Borrower"), Crawford & Company (Canada) Inc., a corporation incorporated under the laws of Canada and a wholly-owned subsidiary of the Company (the "Canadian Borrower"), and Crawford & Company (Australia) Pty. Ltd., a proprietary limited company organized in Australia and a wholly-owned subsidiary of the Company (the "Australian Borrower" and, together with the UK Borrower and the Canadian Borrower, the "Foreign Borrowers"), as borrowers (the Foreign Borrowers together with the Company, the "Borrowers"), the lenders party thereto, Wells Fargo Bank, National Association ("Wells Fargo"), as Administrative Agent, Australian Security Trustee, and UK Security Trustee for the lenders, Bank of America, N.A., as Syndication Agent, RBS Citizens, N.A., as Documentation Agent, and Wells Fargo Securities, LLC, and Merrill Lynch, Pierce, Fenner & Smith Incorporated, as Joint Lead Arrangers and Joint Lead Bookrunners.
Borrowings under the Credit Facility may be made in U.S. dollars, Euros, the currencies of Canada, Japan, Australia or United Kingdom and, subject to the terms of the Credit Facility, other currencies. Borrowings under the Credit Facility bear interest, at the option of the applicable Borrower, based on the Base Rate (as defined below) or the London Interbank Offered Rate ("LIBOR"), in each case plus an applicable interest margin based on our leverage ratio (as defined in the Credit Facility), provided that borrowings in foreign currencies may bear interest based on LIBOR only. The interest margin for LIBOR loans ranges from 1.75% to 2.50% and for Base Rate loans ranges from 0.75% to 1.50%. Base Rate is defined as the highest of (i) the Federal Funds Rate, as published by the Federal Reserve Bank of New York, plus 1/2 of 1%, (ii) the prime commercial lending rate of the Administrative Agent and (iii) LIBOR for a one month interest period plus 1.0%.
In May 2010, the three-year interest rate swap agreement that effectively converted the LIBOR-based portion of the interest rate under our Terminated Credit Agreement on an initial notional amount of $175.0 million of our floating-rate debt to a fixed rate of 5.25% expired. In 2009, this interest rate swap was discontinued as a cash flow hedge of exposure to changes in cash flows due to changes in interest rates and future changes to the fair value of this swap agreement were recorded by us as an expense adjustment rather than a component of our accumulated other comprehensive loss. This amount was $1.6 million for the year ended December 31, 2010. In November 2009, we entered into a two-year forward-starting interest rate swap agreement that was effective beginning on June 30, 2010. The swap effectively converted the LIBOR-based portion of the interest rate on an initial notional amount of $90.0 million of our floating-rate debt to a fixed rate of 3.05% plus the applicable credit spread. We designated the interest rate swap as a cash flow hedge of exposure to changes in cash flows due to changes in interest rates on an equivalent amount of debt. The notional amount of the swap was reduced to $85.0 million on March 31, 2011 to match the expected repayment of our outstanding debt. The swap expires on September 30, 2012. As a result of entering the Credit Facility, this interest rate swap was discontinued as a cash flow hedge of exposure to changes in cash flows due to changes in interest rates and future changes to the fair value of this swap agreement are recorded as an expense adjustment rather than a component of our accumulated other comprehensive loss. Such amount was insignificant at December 31, 2011. Because it is still probable that the forecasted transactions that were hedged will occur, the amount in accumulated other comprehensive loss related to the interest rate swap agreement will be reclassified into earnings as an increase to interest expense over the remaining life of the interest rate swap agreement as the forecasted transactions occur. At December 31, 2011, the fair value of the interest rate swap was a liability of $667,000, with the entire amount expected to be reclassified from accumulated other comprehensive loss into earnings during the next 12 months.
We continue the ongoing monitoring of our customers’ ability to pay us for the services that we render to them. Based on historical results, we currently believe there is a low likelihood that write-offs of our existing accounts receivable will have a material impact on our financial results. However, if one or more of our key customers files bankruptcy or otherwise becomes unable to make required payments to us, or if overall economic conditions deteriorate, we may need to make material provisions in the future to increase our allowance for accounts receivable. In December 2010, we were notified by a major client of our Broadspire segment that the client was in bankruptcy and would terminate its relationship with us during the first quarter of 2011. As a result, we increased our allowance for doubtful accounts by $1.3 million for all pre-petition accounts receivable of the client that are not expected to be recovered.
The continued high level of unemployment in the U.S. has resulted in a further industry-wide reduction in the number of employment-related claim referrals, such as workers’ compensation claims. Our Broadspire segment has been negatively impacted by this, resulting in a 1.2% decrease in workers’ compensation claim referrals in 2011 compared with 2010. We are unable to predict future claim referral trends, which will be dependent upon, among other things, future employment levels and changes in workplace safety guidelines. In addition, we continue to experience a decade-long trend in the U.S. of a decline in the number of reported injuries in the workplace, which we attribute to the shift of the U.S. economy to service-related industries from manufacturing-related industries. This trend has also significantly contributed to the reduction in the occurrence of workers’ compensation claims, and this may continue to occur in future periods.
At December 31, 2011, our working capital balance (current assets less current liabilities) was approximately $83.1 million, compared with $82.6 million at December 31, 2010. Cash and cash equivalents at the end of 2011 totaled $77.6 million, compared with $93.5 million at the end of 2010. The decreased cash balance reflects borrowings held at the end of 2010 that were used to make a $20 million contribution to the frozen U.S. defined benefit pension plan in January 2011.
Cash and cash equivalents as of December 31, 2011 consisted of $16.4 million held in the U.S. and $61.2 million held in our foreign subsidiaries. All of the cash and cash equivalents held by our foreign subsidiaries is available for general corporate purposes. Our current intent is to permanently reinvest funds held in our foreign subsidiaries outside of the U.S., with the possible exception of repatriation of funds that have been previously subject to U.S. federal and state taxation or when it would be tax effective through the utilization of foreign tax credits. Our current expectation for funds held in our foreign subsidiaries is to use the funds to finance foreign organic growth, to pay for potential future foreign acquisitions, to fund our foreign underfunded defined benefit plans, and to repay any foreign borrowings that may arise from time to time. We currently believe that funds generated from our U.S. operations, along with potential borrowing capabilities in the U.S., will be sufficient to fund our U.S. operations for the foreseeable future, and therefore do not foresee a need to repatriate cash held by our foreign subsidiaries in a taxable transaction to fund our U.S. operations. However, if at a future date or time these funds are needed for our operations in the U.S. or we otherwise believe it is in our best interests to repatriate all or a portion of such funds, we may be required to accrue and pay U.S. taxes to repatriate these funds. No assurances can be provided as to the amount or timing thereof, the tax consequences related thereto or the ultimate impact any such action may have on our results of operations or financial condition.
Cash used in investing activities decreased by $7.6 million in 2011, from $42.5 million in 2010 to $34.9 million in 2011. Cash used to acquire property and equipment and capitalized software, including capitalization of internal software development costs, was $29.9 million in 2011 compared with $27.8 million in 2010. We forecast that our property and equipment additions in 2012, including capitalized software, will approximate $28.2 million.
Cash used in investing activities increased by $11.4 million in 2010, from $31.2 million in 2009 to $42.5 million in 2010. Cash used to acquire property and equipment and capitalized software, including capitalization of internal software development costs, was $27.8 million in 2010 compared with $24.7 million in 2009. In addition, we incurred $14.8 million of additional purchase price consideration for the previous acquisition of BMSI.
As disclosed in Note 4, “Short-Term and Long-Term Debt, Including Capital Leases,” to our accompanying audited consolidated financial statements in Item 8 of this Annual Report on Form 10-K, we have two principal financial covenants in our Credit Facility. The leverage ratio covenant requires us to comply with a maximum leverage ratio, defined in our Credit Facility as the ratio of (i) consolidated total funded debt minus unrestricted cash to (ii) consolidated earnings before interest expense, income taxes, depreciation, amortization, stock-based compensation expense, and certain other charges and expenses (“EBITDA”). This ratio must not be greater than (i) for any fiscal quarter ending on or before December 31, 2012, 3.25 to 1.00, or (ii) for any fiscal quarter ending thereafter, 3.00 to 1.00. The fixed charge coverage ratio covenant requires us to comply with a minimum fixed charge coverage ratio, defined as the ratio of (i)(A) consolidated EBITDA minus (B) aggregate income tax expense to the extent paid in cash minus (C) unfinanced capital expenditures to (ii) the sum of: (A) consolidated interest expense to the extent paid (or required to be paid) in cash, plus (B) the aggregate of all scheduled payments of principal on funded debt (including the principal component of payments made in respect of capital lease obligations) required to have been made (whether or not such payments are actually made), plus (C) the aggregate of all restricted payments (as defined) paid, plus (D) the aggregate of all earnouts paid or required to be paid, must not be less than 1.50 to 1.00 for the four-quarter period ending at the end of each fiscal quarter. At December 31, 2011, we were in compliance with all required ratios under our Credit Facility. Based on our financial plans, we expect to be able to remain in compliance with all required covenants throughout 2012. Our compliance with the leverage ratio and fixed charge coverage ratio is particularly sensitive to changes in our EBITDA, and if our financial plans for 2012 or other future periods do not meet our current projections, we could fail to remain in compliance with these financial covenants in our Credit Facility.
As of December 31, 2011, the impact that our contractual obligations, including estimated interest payments, are expected to have on our liquidity and cash flow in future periods is as follows:
(Note references in the following table refer to the note in the accompanying audited consolidated financial statements in Item 8 of this Annual Report on Form 10-K)
Approximately $19.3 million of operating lease obligations included in the table above are expected to be funded by sublessors under existing sublease agreements. See Note 6, “Commitments under Operating Leases” to the audited consolidated financial statements in Item 8 of this Annual Report on Form 10-K.
Borrowings under our Credit Facility bear interest at a variable rate, based on LIBOR or a Base Rate, in either case plus an applicable margin. Interest amounts are based on projected borrowings under our Credit Facility and interest rates in effect on December 31, 2011, and the actual interest payments may differ significantly from estimates due to, among other things, changes in outstanding borrowings and prevailing interest rates in the future.
At December 31, 2011, we had approximately $1.8 million of unrecognized income tax benefits related to uncertain tax positions. We cannot reasonably estimate when all of these unrecognized income tax benefits may be settled. However, it is reasonably possible that a reduction in a range of $250,000 to $950,000 of unrecognized income tax benefits may occur within the next 12 months as a result of projected resolutions of income tax uncertainties.
Gross deferred income tax liabilities as of December 31, 2011 were approximately $122.0 million. This amount is not included in the contractual obligations table because we believe this presentation would not be meaningful. Deferred income tax liabilities are calculated based on temporary differences between the tax basis of assets and liabilities and their respective book basis, which will result in taxable amounts in future years when the liabilities are settled at their reported financial statement amounts. The results of these calculations do not have a direct connection with the amount of cash taxes to be paid in any future periods. As a result, we believe scheduling deferred income tax liabilities as payments due by period could be misleading, because this scheduling would not relate to liquidity needs.
We sponsor defined benefit pension plans in the U.S. and U.K. Future cash funding of our defined benefit pension plans will depend largely on future investment performance, interest rates, changes to mortality tables, and regulatory requirements. Effective December 31, 2002, we froze our U.S. defined benefit pension plan. The aggregate deficit in the funded status of all of our defined benefit pension plans totaled $137.7 million and $168.5 million at the end of 2011 and 2010, respectively. The 2011 decrease in the funding deficit of our defined benefit pension plans primarily resulted from additional contributions we made in 2011. During 2011, we made contributions of $20.0 million and $22.8 million to our U.S. and U.K. defined benefit pension plans, respectively. In 2010, we made contributions of $55.3 million and $6.5 million to our U.S. and U.K. defined benefit pension plans, respectively.
We maintain funds in trusts to administer claims for certain clients. These funds are not available for our general operating activities and, as such, have not been recorded in the accompanying consolidated balance sheets. We have concluded that we do not have material off-balance sheet financial risk related to these funds at December 31, 2011.
Significant changes in our consolidated balance sheet as of December 31, 2011, compared with our consolidated balance sheet as of December 31, 2010, are as follows:
Noncurrent deferred income tax assets decreased approximately $7.5 million primarily due to changes in the valuation allowance related to tax credit carryforwards. Current deferred income tax liabilities decreased by $9.9 million primarily due to temporary differences in revenue recognition for book and tax purposes.
Accrued compensation and related costs increased approximately $5.9 million due to increased expense accruals in 2011 under various performance-based incentive compensation plans as a result of growth in revenues and operating earnings.
Deferred revenues increased by $3.5 million. Substantially all of this increase is in our Broadspire segment due to additional deferred revenues generated by new cases in 2011, net of the completion of certain open cases assumed in the acquisition of BMSI.
As of December 31, 2011 and 2010, our allowance for doubtful accounts totaled $10.6 million and $10.5 million, respectively, or approximately 6.2% and 6.9%, respectively, of gross billed receivables. If the financial condition of our clients deteriorates, resulting in an inability to make required payments to us, or if economic conditions deteriorate, additional allowances may be deemed to be appropriate or required. If the allowance for doubtful accounts changed by 1% of gross billed receivables, reflecting either an increase or decrease in expected future write-offs, the impact to consolidated pretax income would have been approximately $1.7 million in 2011, and $1.5 million in each of 2010 and 2009.
As a result of the continued weakness in the operating results for our Broadspire reportable segment, the indefinite-lived intangible asset consisting of the Broadspire trade name, with a carrying value of $29.1 million, is exposed to potential impairment. We updated our annual impairment test at December 31, 2011 and concluded that the indefinite-lived intangible asset consisting of the Broadspire trade name was not impaired.
The value of the Broadspire trade name is sensitive to changes in the assumptions used above. Revenue growth of less than 1.0%, or a decline in the U.S. royalty rate to 1.2%, in conjunction with an increase in the discount rate to 13.0% could potentially trigger an impairment. In addition, an increase to the discount rate above 14.5%, assuming no changes in the other key inputs, could potentially trigger an impairment. We will continue to monitor the value of the Broadspire trade name during 2012.
The rules for pension accounting are complex and can produce tremendous volatility in our results, financial condition and liquidity. Our pension expense is primarily a function of the value of our plan assets and the discount rate used to measure our pension liability at a single point in time at the end of our fiscal year (the measurement date). Both of these factors are significantly influenced by the stock and bond markets, which in recent years have experienced substantial volatility.
The major assumptions used in accounting for our defined benefit pension plans are the discount rate and the expected long-term return on plan assets. The discount rate assumptions reflect the rates at which the benefit obligations could be effectively settled. Our discount rates were determined with the assistance of actuaries, who calculate the yield on a theoretical portfolio of high-grade corporate bonds (rated Aa or better) with cash flows that generally match our expected benefit payments in future years. At December 31, 2011, the discount rate used to compute the benefit obligations of the U.S. and U.K plans were 4.92% and 5.0%, respectively.
We review the expected long-term rate of return on an annual basis and revise it as appropriate. To support our conclusions, we periodically commission asset/liability studies performed by third-party professional investment advisors and actuaries to assist us in our reviews. These studies project our estimated future pension payments and evaluate the efficiency of the allocation of our pension plan assets into various investment categories. These studies also generate probability-adjusted expected future returns on those assets. As a result of the transition to a liability-driven investment strategy described previously, the expected long-term rates of return on plan assets assumption used to determine 2012 net periodic pension cost were lowered to 7.25% and 7.85% for the U.S. and U.K. plans, respectively.
Pension expense is also affected by the accounting policy used to determine the value of plan assets at the measurement date. We apply our expected return on plan assets using fair market value as of the annual measurement date. The fair market value method results in greater volatility to our pension expense than the calculated value method. The amounts recognized in the balance sheet reflect a snapshot of the state of our long-term pension liabilities at the plan measurement date and the effect of mark-to-market accounting on plan assets. At December 31, 2011, we recorded a decrease to equity through other comprehensive income ("OCI") of $2.5 million (net of tax) to reflect unrealized actuarial losses during 2011. At December 31, 2010, we recorded a decrease to equity through other comprehensive income ("OCI") of $0.7 million (net of tax) to reflect unrealized actuarial losses during 2010. Those losses are subject to amortization over future years and may be reflected in future income statements unless they are recovered.
As of December 31, 2011 and 2010, our estimated liabilities for self-insured risks totaled $28.9 million and $33.4 million, respectively. The estimated liability is most sensitive to changes in the ultimate liability for a claim and, if applicable, the interest rate used to discount the liability. We believe our provisions for self-insured losses are adequate to cover the expected net cost of losses incurred. However, these provisions are estimates and amounts ultimately settled may be significantly greater or less than the provisions established. We used a discount rate of 0.91% to determine the present value of our self-insured workers’ compensation liabilities as of December 31, 2011. If the average discount rate was reduced to 0% or increased by 1%, reflecting either an increase or decrease in underlying interest rates, our estimated liabilities for these self-insured risks at December 31, 2011 would have been impacted by approximately $539,000, resulting in an increase or decrease to 2011 consolidated net income of approximately $335,000.
See Note 1, “Significant Accounting and Reporting Policies,” of our accompanying audited consolidated financial statements in Item 8 of this Annual Report on Form 10-K for a description of recent accounting pronouncements including the dates, or expected dates of adoption, and effects, or expected effects, on our disclosures, results of operations and financial condition.
The accompanying consolidated financial statements were prepared in accordance with accounting principles generally accepted in the U.S. (“GAAP”) and include the accounts of the Company, its majority-owned subsidiaries, and variable interest entities in which the Company is deemed to be the primary beneficiary. Significant intercompany transactions are eliminated in consolidation. Financial results from the Company's subsidiaries outside of the U.S., Canada and the Caribbean are reported and consolidated on a two-month delayed basis in accordance with the provisions of Accounting Standards Codification ("ASC") 810, “Consolidation,” in order to provide sufficient time for accumulation of their results. Accordingly, the Company's December 31, 2011, 2010, and 2009 consolidated financial statements include the financial position of such subsidiaries as of October 31, 2011 and 2010, respectively, and the results of those subsidiaries’ operations and cash flows for the fiscal periods ended October 31, 2011, 2010 and 2009, respectively.
The Company uses the purchase method of accounting for all acquisitions where the Company is required to consolidate the acquired entity into the Company’s financial statements. Results of operations of acquired businesses are included in the Company’s consolidated results from the acquisition date.
The Company has controlling ownership interests in several entities that are not wholly-owned by the Company. The financial results and financial positions of these controlled entities are included in the Company’s consolidated financial statements, including both the controlling interests and the noncontrolling interests. The noncontrolling interests represent the equity interests in these entities that are not attributable, either directly or indirectly, to the Company. Noncontrolling interests are reported as a separate component of the Company’s Shareholders’ Investment. On the Company’s Consolidated Statements of Operations, net income (or loss) is attributed to the controlling interests and the noncontrolling interests separately.
Both the Americas segment and the EMEA/AP segment earn revenues by providing field investigation and evaluation of property and casualty claims for insurance companies. The Company’s Broadspire segment earns revenues by providing field investigation and claims evaluation of workers’ compensation and liability claims, initial loss reporting services for its clients' claimants, loss mitigation services such as medical bill review, medical case management and vocational rehabilitation, administration of trust funds established to pay claims, and risk management information services. The Legal Settlement Administration segment earns revenues by providing administration services related to settlements of securities cases, product liability cases, Chapter 11 bankruptcy noticing and distribution, and other legal settlements by identifying and qualifying class members, determining and dispensing settlement payments, and administering settlement funds.
In the normal course of business, the Company incurs certain out-of-pocket expenses that are thereafter reimbursed by the Company’s clients. Under GAAP, these out-of-pocket expenses and associated reimbursements are required to be included when reporting expenses and revenues, respectively, in the Company’s consolidated results of operations. The amounts of reimbursed expenses and related revenues from reimbursements offset each other in the Company’s consolidated statements of operations with no impact to its net income (loss).
Cash and cash equivalents consist of cash on hand and marketable securities with original maturities of three months or less. The fair value of cash and cash equivalents approximates carrying value due to their short-term nature. At December 31, 2011, cash and cash equivalents included time deposits of approximately $1,698,000 that were in financial institutions outside the U.S.
The Company maintains an allowance for doubtful accounts for estimated losses resulting primarily from the inability of clients to make required payments and for adjustments to invoiced amounts. Losses resulting from the inability of clients to make required payments are accounted for as bad debt expense, while adjustments to invoices are accounted for as reductions to revenue. These allowances are established using historical write-off information to project future experience and by considering the current creditworthiness of clients, any known specific collection problems, and an assessment of current industry and economic conditions. Actual experience may differ significantly from historical or expected loss results. The Company writes off accounts receivable when they become uncollectible, and any payments subsequently received are accounted for as recoveries. A summary of the activities in the allowance for doubtful accounts for the years ended December 31, 2011, 2010, and 2009 is as follows:
For the years ended December 31, 2011, 2010, and 2009, the Company’s adjustments to revenues associated with client invoice adjustments totaled $3,124,000, $2,669,000, and $3,151,000, respectively.
For step 1 of goodwill impairment testing, the carrying value of each of the Company’s reporting units is compared with the estimated fair value of the reporting unit as determined utilizing an income approach. The income approach is based on projected debt-free cash flow which is discounted to the present value using discount factors that consider the timing and risk of the cash flows. The Company believes that this approach is appropriate because it provides a fair value estimate based upon the reporting unit’s expected long-term operating cash flow performance. The discount rate used reflects the Company’s assessment of a market participant’s view of the risks associated with the projected cash flows. Other significant assumptions include terminal value growth rates, terminal value margin rates, future capital expenditures and changes in future working capital requirements. While there are inherent uncertainties related to the assumptions used and to management’s application of these assumptions, the Company believes that the income approach provides a reasonable estimate of the fair value of its reporting units.
Additions to property and equipment under capital leases totaled $808,000, $545,000, and $81,000 for 2011, 2010, and 2009, respectively. Additions to property and equipment that were funded directly by lessors totaled $0, $875,000 and $100,000 for 2011, 2010, and 2009 respectively.
Depreciation on property and equipment, including property under capital leases and amortization of leasehold improvements, was $15,233,000, $14,741,000, and $14,433,000 for the years ended December 31, 2011, 2010, and 2009, respectively.
For operations outside the U.S. that prepare financial statements in currencies other than the U.S. dollar, results of operations and cash flows are translated into U.S. dollars at average exchange rates during the period, and assets and liabilities are translated at end-of-period exchange rates. The resulting translation adjustments are included in comprehensive income (loss) in the Company’s Consolidated Statements of Shareholders’ Investment, Noncontrolling Interests, and Comprehensive Income (Loss), and the accumulated translation adjustment is reported as a component of "Accumulated other comprehensive loss" in the Company’s Consolidated Balance Sheets.
Since ASU 2010-06 is a disclosure-only standard, its adoption had no impact on the Company’s results of operations, financial condition, or cash flows.
In April 2010, the FASB issued ASU 2010-13, “Compensation-Stock Compensation (Topic 718) - Effect of Denominating the Exercise Price of a Share-Based Payment Award in the Currency of the Market in Which the Underlying Equity Security Trades - a Consensus of the FASB Emerging Issues Task Force.” ASU 2010-13 addresses whether an entity should classify a share-based payment award as equity or a liability if the award’s exercise price is denominated in the currency in which the underlying security trades and that currency is different from the 1) entity’s functional currency, 2) functional currency of the foreign operation for which the employee provides services, and 3) payroll currency of the employee. Under the previous guidance in ASC 718-10, “Compensation-Stock Compensation,” the Company did not classify any of its stock-based compensation as a liability. ASU 2010-13 was effective for the Company beginning on January 1, 2011. The adoption of ASU 2010-13 did not change the Company’s accounting for its stock-based compensation awards as equity since ASU 2010-13’s application contains an exception for share-based payments that, like the Company’s, use exercise prices denominated in the currency of the market in which the entity’s equity securities trade.
Since ASU 2011-04 is a disclosure-only standard, its adoption will not affect the Company's results of operations, financial condition, or cash flows.
Although none of the acquisitions in 2011 was individually material, we believe the summaries below are helpful in understanding the impact on goodwill and intangible assets in Note 3, "Goodwill and Intangible Assets."
In October 2011, the Company's Garden City Group subsidiary acquired the capital stock of Settlement Services, Inc. ("SSI") for $3,600,000 cash, less $100,000 cash acquired. In connection therewith, the former owner became an employee of the Company and the Company entered into an earnout agreement with the former owner that may require the Company to pay up to an additional $2,000,000 in acquisition consideration, based on a multiple of excess EBITDA achieved by SSI for 2012 and 2013. Net assets acquired totaled $302,000, and the remainder of the purchase price was allocated $1,730,000 to customer relationship intangibles, $200,000 to trade name intangibles with a finite life of three years, and $3,368,000 to goodwill.
The 2010 adjustment for prior years' acquisitions is comprised of $14,803,000 paid as additional purchase price consideration for the purchase of Broadspire Management Services, Inc. ("BMSI"), less $4,015,000 recorded as a reduction to an estimated tax payable accrued as part of the BMSI acquisition. See "Goodwill Impairment Charge" below for further discussion.
The following is a summary of intangible assets at December 31, 2011 and 2010:
In connection with the Broadspire goodwill impairment noted above, the Company also recorded a noncash intangible asset impairment charge of $600,000 during 2009. This intangible asset related to the value of a trade name indefinite-lived intangible asset used in a small portion of the Broadspire reporting unit. This impairment charge was not reflected in Broadspire’s segment operating loss in any period.
Amortization of intangible assets was $6,918,000, $6,434,000, and $6,433,000 for the years ended December 31, 2011, 2010, and 2009, respectively. For the years ended December 31, 2011, 2010, and 2009, amortization expense for customer-relationship and finite-lived trade name intangible assets in the amounts of $6,177,000, $5,995,000, and $5,994,000, respectively, were excluded from operating earnings (see Note 12, “Segment and Geographic Information”). Intangible assets subject to amortization are amortized on a straight-line basis over lives ranging from 5 to 15 years. At December 31, 2011, annual estimated aggregate amortization expense for intangible assets subject to amortization is $7,175,000 for 2012; $7,150,000 for 2013; $7,133,000 for 2014; $7,083,000 for 2015 and $6,689,000 for 2016.
At December 31, 2011, a total of $211,130,000 was outstanding under the Credit Facility, and at December 31, 2010, $222,575,000 was outstanding under the Terminated Credit Agreement. In addition, undrawn commitments under letters of credit totaling $18,819,000 and $20,319,000 were outstanding at December 31, 2011 and 2010, respectively, under the letters of credit subfacility of the applicable agreements. These letter of credit commitments were for the Company’s own obligations. Including the amounts committed under the letters of credit subfacility, the unused balance of the revolving credit portion of the applicable agreement totaled $95,051,000 and $79,681,000 at December 31, 2011 and 2010, respectively.
Interest expense, including any impact from the Company’s interest rate hedge and amortization of capitalized loan origination costs, on the Company’s short-term and long-term borrowings was $16,931,000, $15,683,000, and $15,229,000 for the years ended December 31, 2011, 2010, and 2009, respectively. Interest paid on the Company’s short-term and long-term borrowings was $14,117,000, $14,193,000, and $14,339,000 for the years ended December 31, 2011, 2010, and 2009, respectively.
Scheduled principal repayments of long-term debt, including current portions and capital leases, as of December 31, 2011 are as follows:
In 2011, the term loan under the Terminated Credit Agreement required minimum principal repayments of $650,000 at the end of each calendar quarter. Interest was payable quarterly on the term loan. For the Terminated Credit Agreement's revolving credit facility, interest was payable at least quarterly. During 2011, the Company made three required quarterly repayments of $650,000 on the term loan, plus a voluntary additional payment of $2,000,000 prior to the termination thereof. During 2010, the Company made required quarterly repayments of $525,000 on the term loan, plus a required excess cash flow payment of $5,875,000, related to results for the year ended December 31, 2009. The Company did not make any excess cash flow payments in 2011.
In connection with a 2009 amendment to the Company’s Terminated Credit Agreement, that interest rate swap was discontinued as a cash flow hedge of exposure to changes in cash flows due to changes in interest rates. Accordingly, future changes in the fair value of this swap agreement were recorded by the Company as an expense adjustment rather than a component of the Company’s accumulated other comprehensive loss. The pretax amount in accumulated other comprehensive loss at the time the hedge was discontinued was $2,652,000 and was $1,593,000 at December 31, 2009. Because it was still probable that the forecasted transactions that were hedged would occur, the amount in accumulated other comprehensive loss related to the interest rate swap agreement was reclassified into earnings as an increase to interest expense over the remaining life of the interest rate swap agreement as the forecasted transactions occurred. As of December 31, 2010, all amounts had been reclassified from accumulated other comprehensive loss into earnings and the associated liability was reduced to zero upon expiration and settlement of the swap agreement.
The losses reclassified from accumulated OCL into income (effective portion) are reported in "Corporate interest expense, net" on the Company’s Consolidated Statements of Operations.
The balances and changes in accumulated OCL related to the effective portions of the Company’s interest rate hedges for the years ended December 31, 2011 and 2010 were as follows:
The Company’s swap agreements contain a provision providing that if the Company is in default under its Credit Facility (see Note 4, "Short-Term and Long-Term Debt, Including Capital Leases"), the Company may also be deemed to be in default under its swap agreements. If there were such a default, the Company could be required to contemporaneously settle some or all of the obligations under the swap agreements at values determined at the time of default. At December 31, 2011, no such default existed, and the Company had no assets posted as collateral under its swap agreements.
Effective August 1, 2006, the Company entered into an 11-year operating lease agreement for the lease of approximately 160,000 square feet of office space in Atlanta, Georgia for use as the Company’s corporate headquarters. Included in the future minimum lease payments noted above are total lease payments of $24,129,000 related to this lease. Additionally, the Company is responsible for certain property operating expenses, which are excluded from the table above. Leasehold improvements totaling $4,921,000 were funded by the lessor.
Included in the acquired commitments of BMSI was a long-term operating lease for a two-building office complex in Plantation, Florida. The term of this lease ends in December 2021. Included in the future minimum office lease payments for operating leases noted above are total lease payments of $43,135,000 related to this Plantation, Florida lease. A majority of this office space was subleased at December 31, 2011. Under executed sublease arrangements at December 31, 2011 between the Company and sublessors, as described below, the sublessors are obligated to pay the Company minimum sublease payments as follows:
In 2009 and 2010, the Company entered into separate sublease agreements with another sublessor to sublease three of the four floors of our other leased building in Plantation, Florida. The subleases are for the remaining term of the Company’s lease on this building (expiring December 2021). The Company recognized pretax losses of $2,663,000 and $1,810,000 on these subleases, which are included in "Special charges and credits" in the Company's Consolidated Statements of Operations for the years ended December 31, 2010 and 2009, respectively.
The Company does not provide for additional U.S. and foreign income taxes on undistributed earnings of foreign subsidiaries because they are considered to be indefinitely reinvested. The Company’s intent is for such earnings to be reinvested by the subsidiaries or to be repatriated only when it would be tax effective through the utilization of foreign tax credits. At December 31, 2011, such undistributed earnings totaled $99,531,000. Determination of the deferred income tax liability on these unremitted earnings is not practicable since such liability, if any, is dependent on circumstances existing when remittance occurs.
Deferred income taxes consisted of the following at December 31, 2011 and 2010:
At December 31, 2011, the Company had deferred tax assets related to net operating loss carryforwards of $13,249,000. An estimated $5,703,000 of the deferred tax assets will not expire, and $7,546,000 will expire over the next 20 years if not utilized by the Company. A valuation allowance is provided when it is deemed more-likely-than-not that some portion or all of a deferred tax asset will not be realized. At December 31, 2011, the Company has a $4,459,000 valuation allowance related to certain net operating loss carryforwards generated in its international operations. The remaining net operating loss deferred tax asset of $8,790,000 is expected to be fully utilized by the Company.
In 2011, the Company's projections of U.S. taxable income indicated that all foreign tax credit carryforwards should be utilized prior to their expiration period. Accordingly, the Company recorded a tax benefit of $5,462,000 ($0.10 per diluted CRDB share) for the reduction in the valuation allowance on such foreign tax credit carryforwards. Other changes to the valuation allowance for the years ended December 31, 2011, 2010, and 2009 were primarily due to losses in our international operations.
The Company accrues interest and, if applicable, penalties related to unrecognized tax benefits in income tax expense. For the years ended December 31, 2011, 2010, and 2009, the Company recorded net interest income related to unrecognized tax benefits of $1,000, $16,000, and $248,000, respectively. Total accrued interest expense at December 31, 2011, 2010, and 2009, was $634,000, $635,000, and $651,000, respectively.
Legislation enacted on November 6, 2009 contained a provision that allowed U.S. businesses with net operating losses (“NOLs”) in 2008 or 2009 to carry those losses back five years and obtain tax refunds. We filed a carryback claim for our 2008 U.S. NOL and received a $4.2 million tax refund in 2010. The 2008 carryback claim is currently under examination by the Internal Revenue Service.
Net unrecognized actuarial losses included in accumulated other comprehensive loss and expected to be recognized in net periodic benefit costs during the year ending December 31, 2012 for the U.S. and U.K. plans are $9,288,000 ($5,988,000 net of tax).
Net periodic benefit cost related to the Company’s defined benefit pension plans recognized in the Company’s Consolidated Statements of Operations for the years ended December 31, 2011, 2010, and 2009 included the following components:
Over the next ten years, the following benefit payments are expected to be required to be made from the Company’s U.S. and U.K. defined benefit pension plans:
The discount rate assumptions reflect the rates at which the Company believes the benefit obligations could be effectively settled. The discount rates were determined based on the yield for a portfolio of investment grade corporate bonds with maturity dates matched to the estimated future payments of the plans’ benefit obligations. The expected long-term rates of return on plan assets were based on the plans’ asset mix, historical returns on equity securities and fixed income investments, and an assessment of expected future returns. Because of the reallocation of the portfolios’ mix of return-seeking assets and liability-hedging assets described below, the expected long-term rates of return on plan assets assumption used to determine 2012 net periodic pension cost were lowered to 7.25% and 7.85% for the U.S. and U.K. plans, respectively. If actual long-term rates of return differ from those assumed or if the Company used materially different assumptions, actual funding obligations could differ materially from estimates. Due to the frozen status of the U.S. plan and closed status of the U.K. plans, increases in compensation rates are not material to the computations of benefit obligations or net periodic benefit cost.
Alternative strategies include funds that invest in derivative instruments such as futures, forward contracts, options and swaps and funds that invest in real estate. These investments are used to help manage risks.
During the quarter ending March 31, 2012, we declared cash dividends of $0.03 per share on CRDA and $0.02 per share on CRDB, which dividends are payable to shareholders of record at the close of business on March 7, 2012.
The following details the shares excluded from the denominator in the above computation of diluted EPS for CRDA because their inclusion would have been antidilutive:
The pretax compensation expense recognized for all stock-based compensation plans was $3,756,000, $3,651,000 and $5,510,000 for the years ended December 31, 2011, 2010, and 2009, respectively.
The total income tax benefit recognized in the Consolidated Statements of Operations for stock-based compensation arrangements was approximately $1,273,000, $1,070,000, and $1,709,000 for the years ended December 31, 2011, 2010, and 2009, respectively. Some of the Company’s stock-based compensation awards are granted under plans which are designed not to be taxable as compensation to the recipient based on tax laws of the U.S. or the applicable country. Accordingly, the Company does not recognize tax benefits on all of its stock-based compensation expense.
During 2011, 2010 and 2009, the Company recognized no adjustments to additional paid-in capital for differences between deductions taken on its income tax returns related to stock-based compensation plans and the related income tax benefits previously recognized for financial reporting purposes.
No stock options were granted in 2009, 2010, or 2011. The intrinsic value of all outstanding stock options at December 31, 2011 and 2010 was zero since the per share market price of CRDA was less than the exercise price of all outstanding stock options. The options exercised in 2009 had no intrinsic value. No options were exercised in 2010. The options exercised in 2011 had an intrinsic value of less than $1,000. The total fair value of stock options vested during the years ended December 31, 2011, 2010, and 2009 was $221,000, $236,000, and $484,000, respectively.
At December 31, 2011, there was no unrecognized compensation cost related to unvested stock options for employee stock option awards. Directors’ stock options had no unrecognized compensation cost since directors’ options were vested when granted, and the grant-date fair values were fully expensed on grant date.
Performance share grants are made to key employees of the Company. Such employees are eligible to earn shares of CRDA upon the achievement of certain individual and corporate objectives. Grants of performance shares are made at the discretion of the Company’s Board of Directors, or the Board’s Compensation Committee, and are subject to graded vesting over periods typically ranging from three to five years. Shares are not issued until the vesting requirements have been met. Dividends are not paid or accrued on unvested/unissued shares. The grant-date fair value of a performance share grant is based on the market value of CRDA on the date of grant, reduced for the present value of any dividends expected to be paid on CRDA shares but not paid to holders of unvested/unissued performance grants. Compensation expense for each vesting tranche in the award is recognized ratably from the grant date to the vesting date for each tranche.
A summary of the status of the Company’s nonvested performance shares as of December 31, 2011, and changes in 2011, 2010, and 2009, is presented below:
Under the U.S. Plan, the Company is authorized to issue up to 1,500,000 shares of CRDA to eligible employees. Participating employees can elect to have up to $21,000 of their eligible annual earnings withheld to purchase shares at the end of the one-year withholding period which starts each July 1 and ends each June 30. The purchase price of the stock is 85% of the lesser of the closing price for a share of such stock on the first day or the last day of the withholding period. Participating employees may cease payroll withholdings during the withholding period and/or request a refund of all amounts withheld before any shares are purchased.
During the years ended December 31, 2011 and 2010, a total of 240,923 and 226,512 shares, respectively, of CRDA were issued under the U.S. Plan to the Company’s employees at purchase prices of $2.17 and $2.09, respectively. At December 31, 2011, an estimated 117,000 shares will be purchased under the U.S. Plan in 2012. During the years ended December 31, 2011, 2010, and 2009, compensation expense of $226,000, $406,000, and $372,000, respectively, was recognized for the U.S. Plan.
At December 31, 2011, an estimated 1,536,000 shares will be eligible for purchase under the U.K. Plan at the end of the current withholding periods. This estimate is subject to change based on future fluctuations in the value of the British pound against the U.S. dollar, future changes in the market price of CRDA, and future employee participation rates. The purchase price for a share of CRDA under the U.K. Plan ranges from $1.87 to $5.05. For the years ended December 31, 2011, 2010, and 2009, compensation cost of $153,000, $130,000, and $124,000, respectively, was recognized for the U.K. Plan. During 2011, 2010, and 2009, a total of 20,363 shares, 0 shares and 2,478 shares of CRDA were issued under the U.K. Plan, respectively.
The following table presents the Company’s assets and liabilities that are measured at fair value on a recurring basis and are categorized using the fair value hierarchy.
The fair value hierarchy is also applied to certain other assets that directly impact our consolidated financial statements. Assets contributed by the Company for our defined benefit pension plans become the property of the individual plans. Even though the Company no longer has control over these assets, we are indirectly impacted by subsequent fair value adjustments to these assets. The actual return on these assets impacts the Company's future net periodic benefit cost, as well as amounts recognized in our consolidated balance sheets. The Company uses the fair value hierarchy to measure the fair value of assets held by our various defined benefit pension plans.
The following table summarizes the level within the fair value hierarchy used to determine the fair value of our pension plan assets for our U.K. plans at December 31, 2011 and 2010:
Fixed income securities consists of money market funds, government securities, corporate bonds and debt securities, mortgage-backed securities and and other common collective funds. Government securities are valued by third-party pricing sources. Mortgage backed security holdings consist primarily of agency-rated holdings. The fair value estimates for mortgage securities are calculated by third-party pricing sources chosen by the custodian’s price matrix. Corporate bonds are valued using either the yields currently available on comparable securities of issuers with similar credit ratings or using a discounted cash flows approach that utilizes observable inputs, such as current yields of similar instruments, but includes adjustments for certain risks that may not be observable, such as credit and liquidity risks.
Real estate funds are primarily reported by the fund manager and are based on valuation of the underlying investments which include inputs such as cost, discounted cash flows, independent appraisals and market-based comparable data. The fair values may, due to the inherent uncertainty of valuation for those investments, differ significantly from the values that would have been used had a ready market for the investments existed, and the differences could be material.
Operating earnings is the primary financial performance measure used by the Company’s senior management and the CODM to evaluate the financial performance of the Company’s four operating segments. The Company believes this measure is useful to investors in that it allows investors to evaluate segment operating performance using the same criteria used by the Company’s senior management. Operating earnings will differ from net income computed in accordance with GAAP since operating earnings represent segment earnings (loss) before certain unallocated corporate and shared costs, goodwill and intangible asset impairment charges, net corporate interest expense, stock option expense, amortization of customer-relationship intangible assets, special charges and credits, income taxes, and net income attributable to noncontrolling interests.
Segment operating earnings include allocations of certain corporate and shared costs. If the Company changes its allocation methods or changes the types of costs that are allocated to its four operating segments, prior periods are adjusted to reflect the current allocation process.
Financial information as of and for the years ended December 31, 2011, 2010, and 2009 covering the Company’s reportable segments was as follows:
Excludes amortization expense of customer-relationship intangible assets and finite-lived trade names.
Legal Settlement Administration considers all of its revenues to be derived from one service line. For the year ended December 31, 2011, it had revenues before reimbursements related to a special project that exceeded 10% of the Company's consolidated revenues before reimbursements. Revenues from this special project were $121.1 million in 2011.
The Company’s reportable segments’ total operating earnings reconciled to consolidated income (loss) before income taxes for the years ended December 31, 2011, 2010, and 2009 were as follows:
Revenues and long-lived assets for the countries in which revenues or long-lived assets represent more than 10 percent of the consolidated totals are set out in the two tables below. For the purposes of these geographic area disclosures, long-lived assets include items such as property and equipment and capital lease assets and exclude intangible assets, including goodwill. In the Americas segment, only the U.S. and Canada are considered material for disclosure.
The Company maintains funds in custodial accounts at financial institutions to administer claims for certain clients. These funds are not available for the Company’s general operating activities and, as such, have not been recorded in the accompanying Consolidated Balance Sheets. The amount of these funds totaled $234,830,000 and $205,371,000 at December 31, 2011 and 2010, respectively. In addition, the Company’s Legal Settlement Administration segment administers funds in noncustodial accounts at financial institutions that totaled $391,097,000 and $406,958,000 at December 31, 2011 and 2010, respectively.
As part of the Company’s Credit Facility, the Company maintains a letter of credit facility to satisfy certain of its own contractual requirements. At December 31, 2011, the aggregate amount committed under the facility was $18,819,000.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Crawford & Company at December 31, 2011 and 2010, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2011, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Crawford & Company’s internal control over financial reporting as of December 31, 2011, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 2, 2012 expressed an unqualified opinion thereon.
We have audited Crawford & Company’s internal control over financial reporting as of December 31, 2011, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Crawford & Company’s management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Report of Management on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.
In our opinion, Crawford & Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2011, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Crawford & Company as of December 31, 2011 and 2010, and the related consolidated statements of operations, shareholders’ investment, noncontrolling interests and comprehensive income (loss), and cash flows for each of the three years in the period ended December 31, 2011, and our report dated March 2, 2012 expressed an unqualified opinion thereon.
(5) Beginning in the 2011 third quarter, the Company paid a higher dividend on its CRDA commons stock than on its CRDB shares. This dividend differential can result in different earnings per share for each class of stock due to the two-class method of computing EPS as required by current accounting guidance. Only CRDB is shown here, as that presents a more dilutive measure.