The Company and its subsidiaries occupy a 7 story office building located at 233 Main Street, in New Britain, Connecticut. ACMAT leases approximately 45% of the building to unaffiliated tenants. The office building is suitable and adequate for ACMAT's current and future requirements.
Management's Discussion and Analysis of Financial Condition and Results of Operations:
This report contains certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are statements other than historical information or statements of current condition. Words such as "expects", "anticipates", "intends", "plans", "believes", "seeks", or "estimates", or variations of such words, and similar expressions are intended to identify forward-looking statements.
- Changes in the demand for, pricing of, or supply of our products;
- The cyclicality of the property-liability insurance industry causing fluctuations in our results.
The Company's discussions related to all items, other than net earnings, are presented on a pretax basis, unless otherwise noted.
Net earnings were $1,613,994 or $.70 per share basic and $.69 per share diluted in 2003 compared to $3,156,893 or $1.33 per share basic and $1.32 per share diluted in 2002. The decrease in net earnings for 2003 compared to 2002 is primarily due to the absence of a one-time benefit from life insurance proceeds, net of related obligations, and the related tax benefits due to the death of the former Chairman and President of the Company in 2002. Net earnings for 2003 reflected the continuing favorable rate environment and lower unfavorable prior year loss development. Construction contracting revenues exceeded the cost of the construction contracts by $83,680 in 2003 compared to contract costs exceeding contract revenues by ($2,050,208) in 2002 due to additional remediation expenses incurred on a construction project that significantly exceeded the original estimate. Investment income was $2,668,940 in 2003 compared to $3,553,565 in 2002 and was offset by the decrease in interest expense of $1,059,974 in 2003 from $1,928,084 in 2002. Realized capital gains were $361,542 in 2003 compared to $25,971 in 2002.
Contract revenues decreased $13,307,129 or 82% in 2003 due primarily to the timing of three large projects that were completed in 2002. The significant decrease in contract revenues in 2003 reflects the impact of a significant number of contractors competing for a limited number of projects available in our market place. Contract revenues increased $2,214,448 or 16% in 2002 due to the timing of three large projects in 2002. Contract revenue depends greatly on the successful securement of contracts bid and execution. The backlog at December 31, 2003 was $9,680,000 compared to $430,000 at December 31, 2002. The significant increase in backlog reflects the four contracts successfully bid during 2003.
Net realized capital gains were $361,542 in 2003 compared to $25,971 in 2002. During 2003, the Company sold most of its tax-exempt investments in order to accelerate the use of an alternative minimum tax credit carryforward generated with the recognition of net life insurance proceeds in 2002 that were exempt for income tax purposes. Net realized gains of $374,301 were generated in 2001 as a result of selling primarily fixed maturity investments.
Losses and loss adjustment expenses increased $922,592 or 23% in 2003 primarily due to the 62% increase in earned premiums primarily offset by lower adverse development. Losses and loss adjustment expenses increased $2,535,377 or 165% in 2002 primarily due to the strengthening of loss reserves due to adverse
The Company has three reportable operating segments: ACSTAR Bonding, United Coastal Liability Insurance and ACMAT Contracting. The Company's reportable segments are primarily the three main legal entities of the Company which offer different products and services. The accounting policies of the segments are the same as those described in the summary of significant accounting policies. The adjustments and eliminations required to arrive at consolidated amounts shown above consist principally of the elimination of the intersegment revenues related to the performance of certain services and rental charges.
Operating earnings for the ACSTAR Bonding segment increased $1,414,072 or 116% in 2003. The operating earnings in 2003 benefited from a 64% increase in earned premiums and a 23.9 point improvement in the GAAP combined ratio in 2003. Operating earnings decreased $880,830 or 42% in 2002. The decrease in 2002 operating earnings reflect the addition of $500,000, net of recoveries, to loss reserves for a large loss reported in current year, flat revenue from earned premiums and a decrease in investment income and realized capital gains.
Net realized capital gains were $272,565 in 2003 compared to $5,737 in 2002. During 2003, the Company sold most of its tax-exempt investments in order to accelerate the use of an alternative minimum tax credit carryforward generated with the recognition of net life insurance proceeds by the parent company in 2002 that were exempt for income tax purposes. Net realized gains of $191,670 were generated in 2001 as a result of selling primarily fixed maturity investments.
Other income (expense) relates primarily to fees related to funds administration services. Funds administration fees charged to bonding customers for administering payments to subcontractors and venders fluctuates depending on the terms and conditions offered and accepted for the bonding programs each year.
Losses and loss adjustment expenses increased $666,718 or 51% in 2003 primarily due to the 64% increase in earned premiums offset in part by a 23.9 point decrease in the GAAP combined ratio for 2003. The improvement in the GAAP combined ratio for 2003 is the result of improved loss experience and an increase in earned premium. Losses and loss adjustment expenses increased $895,977 or 222% in 2002 primarily due to the strengthening of loss reserves due to adverse development in prior years. During 2002, the Company increased reserves by $500,000, net of recoveries, due to a large loss reported in current year.
General and administrative expenses decreased $146,034 or 11% in 2003 primarily due to a decrease in rental expense and depreciation expense. General and administrative expenses decreased by $104,980 or 8% in 2002 due primarily to no further amortization expense related to intangibles and a one-time rent recovery from an affiliate.
Expenses increased $926,195 or 19% in 2003 and $1,227,632 or 35% in 2002.
Contract revenues decreased $13,307,129 or 82% in 2003 due primarily to the timing of three large projects that were completed in 2002. The significant decrease in contract revenues in 2003 reflects the affect of a significant number of contractors competing for a limited number of projects available in our market place. Contract revenues increased $2,214,448 or 16% in 2002 due to the timing of three large projects in 2002. Contract revenue depends greatly on the successful securement of contracts bid and execution. The backlog at December 31, 2003 was $9,680,000 compared to $430,000 at December 31, 2002. The significant increase in backlog reflects four contracts successfully bid during 2003.
Inter-segment revenues consists primarily of rental income and underwriting services fees and agency commissions. Rental income decreased $517,854 or 40% in 2003 as a result of a reduction in rent charged to ACSTAR and United Coastal effective January 1, 2003. Rental income increased $8,206 or 1% in 2002 primarily due to a slight increase in operating expense increases related to the rental property.
Underwriting services fees and agency commissions increased $773,954 or 68% in 2003 due primarily to a 76% increase in net written premiums. Underwriting services fees and agency commissions decreased $60,615 or 5% in 2002 due primarily to the timing of premiums written.
The Company considers its most significant accounting estimates to be those applied to reserves for losses and loss adjustment expenses and revenue recognition on construction projects using the percentage of completion method.
Reserves for losses and loss adjustment expenses were $20,848,566 at December 31, 2003. The Company maintains reserves to cover estimated ultimate unpaid liability for losses and loss adjustment expenses with respect to both reported and incurred but not reported claims for insured risks incurred as of the end of each accounting period. The amount of loss reserves for reported claims is primarily based upon a case-by-case evaluation of the type of risk involved, knowledge of the circumstances surrounding each claim and the policy provisions relating to the type of claim. As part of the reserving process, historical data is reviewed and consideration is given to the anticipated impact of various factors such as legal developments and economic conditions, including the effects of inflation. Reserves are monitored and evaluated periodically using current information on reported claims. This is a critical accounting policy for the insurance operations.
The Company's principal source of cash for repayment of long-term debt is dividends from its two insurance companies. During 2003, ACMAT received $2,990,000 as dividends from its subsidiaries. Under applicable insurance regulations, ACMAT's insurance subsidiaries are restricted as to the amount of dividends they may pay to their respective holding companies, without the prior approval of their domestic state insurance department. For 2004, the amount of dividends ACMAT's insurance subsidiaries may pay, without prior approval of their domestic state insurance departments, is limited to approximately $3,920,000.
Risk-based capital requirements are used as early warning tools by the National Association of Insurance Commissioners and the states to identify companies that require further regulatory action. The ratio for each of the Company's insurance subsidiaries as of December 31, 2003 was above the level which might require regulatory action.
Consolidated Statements of Stockholders' Equity for the years ended December 31, 2003, 2002 and 2001
Consolidated Schedules included in Part II of this Report - Years ended December 31, 2003, 2002 and 2001
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of ACMAT Corporation and subsidiaries as of December 31, 2003 and 2002, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2003, in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the related financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.
Certain reclassifications have been made to prior years financial statements to conform to the current year presentation.
The United Coastal Liability Insurance operating segment offers specific lines of liability insurance as an approved non-admitted excess and surplus lines insurer in forty-seven states, Puerto Rico, the Virgin Islands and the District of Columbia. United Coastal offers claims made and occurrence policies for specific specialty lines of liability insurance through certain excess and surplus lines brokers who are licensed and regulated by the state insurance department(s) in the state(s) in which they operate. United Coastal provides specialty general, environmental and professional liability insurance primarily to general contractors, specialty trade and environmental contractors, property owners, storage and treatment facilities and allied professionals. United Coastal also offers products liability policies to manufacturers. In addition, the company offers professional liability coverage to architects, consultants and engineers.
During 2003, 2002 and 2001, customers who individually accounted for more than 10% of consolidated construction contracting revenue are as follows; in 2003 - five customers provided 21%, 19%, 15%, 13% and 12%, respectively; in 2002 - four customers provided 31%, 26%, 19% and 18%, respectively; and in 2001 - three customers provided 33%, 27%, and 20%, respectively. One customer accounted for more than 10% of the United Coastal insurance revenues in 2001.
In the normal course of business, the Company assumes and cedes reinsurance with other companies. Reinsurance ceded primarily represents excess of loss reinsurance with companies with "A" ratings from the insurance rating organization, A.M. Best Company, Inc. Reinsurance ceded also includes a facultative reinsurance treaty which is applicable to excess policies written over a primary policy issued by the Company for specific projects. Reinsurance is ceded to limit losses from large exposures and to permit recovery of a portion of direct losses; however, such a transfer does not relieve the originating insurer of its liability.
Effective November 1, 2002 through April 30, 2004, the Company cedes 80% of its exposure in excess of $1,000,000 up to $5,000,000 on a per principal/insured basis. Prior to October 31, 2002, reinsurance was applicable on a per principal/insured basis for 100% of the losses in excess of $1,000,000 up to $8,000,000. From May 1, 2000 to April 30, 2002, the Company also reinsured surety losses on a per principal basis for losses in excess of $8,000,000 up to $13,000,000.
Ceded incurred losses and loss adjustment expenses totaled $682,155, $6,549,843 and $148,557 for the years ended December 31, 2003, 2002 and 2001, respectively.
As of January 1, 2002, the Company had an unamortized asset in the amount of $1,920,360 which was subject to the transition provisions of FAS No. 142. The Company stopped amortizing intangibles on January 1, 2002. Net earnings and earnings per share adjusted to exclude intangible amortization for the year ended December 31, 2001 are as follows:
In December, 2002, the FASB issued Statement of Financial Accounting Standards No. 148 "Accounting for Stock-Based Compensation-Transition and Disclosure" (FAS 148), an amendment to FASB Statement No. 123 "Accounting for Stock-Based Compensation" (FAS 123). It amends the disclosure provisions of FAS 123 to require prominent annual disclosure about the effects on reported net earnings of stock-based compensation in the Summary of Significant Accounting Policies and also requires disclosure about these effects in interim financial statements. These provisions are effective for financial statements for fiscal years ending after December 15, 2002. Accordingly, the Company has adopted the applicable disclosure requirements of this statement for year-end reporting.
The pro forma fair value of stock-based compensation in the Company's Class A Shares for the year ended December 31, 2003, 2002 and 2001 is as follows:
In December 2003, the FASB issued Revised Interpretation No. 46R, "Consolidation of Variable Interest Entities" (FIN 46R). FIN 46R clarifies the application of Accounting Research Bulletin No. 51, "Consolidated Financial Statements", to certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46R separates entities into two groups: (1) those for which voting interests are used to determine consolidation and (2) those for which variable interests are used to determine consolidation. FIN 46R clarifies how to identify a variable interest entity and how to determine when a business enterprise should include the assets, liabilities, non-controlling interests and results of activities of a variable interest entity in its consolidated financial statements. FIN 46R is effective for public companies that have VIEs or potential VIEs that are special-purpose entities for periods ending after December 15, 2003. Application by public companies for all other types of entities is required for periods ending after March 15, 2004.
Actual maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
The Company's portfolio is comprised primarily of fixed maturity securities rated AA or better by Standard and Poor's and includes mostly U.S. Treasuries and tax-free municipal securities
An investment in debt or equity security is impaired if its fair value falls below its book value and the decline is considered to be other-than temporary. Factors considered in determining whether a decline is other-than-temporary include the length of time and the extent to which fair value has been below cost, the financial condition and the near-term prospects of the issuer; and the Company's ability and intent to hold the investment for a period of time sufficient to allow for any anticipated recovery. Additionally, for certain securitized financial assets with contractual cash flows (including asset backed securities), EITF 99-20 requires the Company to periodically update its best estimate of cash flows over the life of the security. If management determines that the fair value of its securitized financial asset is less than its carrying amount and there has been a decrease in the present value of the estimated cash flows since the last revised estimate, considering both timing and amount, then an other-than-temporary impairment charge is recognized. A debt security is impaired if it is probable that the Company will not be able to collect all amounts due under the security's contractual terms. Equity investments are impaired when it becomes apparent that the Company will not recover its cost over the expected holding period and consideration given to the financial condition of the issue. Further, for securities expected to be sold, an other-than-temporary impairment charge is recognized if the Company does not expect the fair value of a security to recover the cost prior to the expected date of sale.
- Identification and evaluation of investments which have possible indications of impairment;
- Analysis of investments with gross unrealized investment losses that have fair value less than 80% of amortized cost during successive quarterly periods over a rolling one-year period;
- - Determination of the status of each analyzed investment as other-than-temporary or not.
A summary of net investment income for the years ended December 31, 2003, 2002 and 2001 follows:
A summary of receivables at December 31, 2003 and 2002 follows:
The balances billed but not paid by customers pursuant to retainage provisions in construction contracts will be due upon completion of the contracts and acceptance by the owner. In management's opinion, the majority of contract retainage is expected to be collected in 2004.
A summary of property and equipment at December 31, 2003 and 2002 follows:
Useful lives for depreciation purposes are five years for equipment and vehicles, fifteen years for furniture and fixtures and forty years for the building. Depreciation expense in 2003, 2002 and 2001 was $711,507, $775,906 and $772,519, respectively.
Future minimum rental income to be generated by leasing a portion of the building under non-cancelable operating leases as of December 31, 2003 are estimated to be $417,304 for 2004, $364,104 for 2005, $364,104 for 2006, $364,104 for 2007 and $280,104 for 2008. Rental income earned in 2003, 2002 and 2001 was $496,820, $607,097 and $593,573, respectively.
At December 31, 2003, the Company has a $10,000,000 bank line of credit with two financial institutions. The line of credit does not require the Company to maintain a compensating balance. There were no outstanding borrowings under this line of credit at December 31, 2003 and 2002. Under the terms of the line of credit, interest on the outstanding balance is calculated based upon the London Inter-Bank Offering Rate (LIBOR) plus 160 basis points in effect during the borrowing period. The Company pays an annual commitment fee of .25% of the unused portion of the bankline.
On December 17, 2001, the Company obtained a $5,000,000 term loan from a financial institution, which is payable in quarterly installments of $250,000 which is to commence March 1, 2004. The term loan, due 2009 has a balance of $5,000,000 at December 31, 2003. The interest rate varies based on LIBOR plus 190 basis points in effect during the borrowing period. The interest rate cannot exceed 5.5%. The loan agreement contains certain limitations on borrowings, minimum statutory capital levels and requires maintenance of certain ratios. The proceeds were used to prepay $5,005,000 of the Convertible Notes due 2022.
On September 1, 1999, the Company obtained a $4,500,000 term loan from a financial institution, which is payable in quarterly installments of $250,000 which commenced December 1, 1999. The term loan, due 2004 has a balance of $250,000 at December 31, 2003. The interest rate is fixed at 7.25%. The loan agreement contains certain limitations on borrowings, minimum statutory capital levels and requires maintenance of certain ratios. The proceeds were used to replace a $5,000,000, five year term loan obtained on December 9, 1998.
On December 23, 1998, the Company obtained a permanent mortgage loan from a financial institution. The $7,800,000 mortgage note, with interest fixed at 6.95% is payable in monthly installments of principal and interest over 10 years. The mortgage note, due 2009, has a balance of $4,579,515 at December 31, 2003. The loan agreements contain certain limitations on borrowings, minimum statutory capital levels and require maintenance of certain ratios.
The fair value at December 31, 2003 of the mortgage and the term loans approximate carrying value.
The Company participated in various multi-employer defined contribution plans for its union employees. Upon withdrawal from these plans, the Company may be liable for its share of the unfunded vested liabilities of the plans. Such obligations, if any, of the Company are not determinable at December 31, 2003.
The Company's insurance subsidiaries, United Coastal Insurance and ACSTAR, are domiciled in Arizona and Illinois, respectively. The statutory financial statements of United Coastal Insurance and ACSTAR are prepared in accordance with accounting practices prescribed by the Arizona Department of Insurance and the Illinois Department of Insurance, respectively. Prescribed statutory accounting practices include a variety of publications of the National Association of Insurance Commissioners (NAIC), as well as the state laws, regulations, and general administrative rules. Permitted statutory accounting practices encompass all accounting practices not so prescribed of which the Company has none.
The following is a reconciliation of the numerators and denominators of the basic and diluted earnings per share ("EPS") computations for the years ended December 31, 2003, 2002 and 2001:
The fair value effect of stock options reported in Note 1, Stock-Based Compensation, is derived by application of a variation of the Black-Scholes option pricing model. No options were granted in 2003 and 2001.
The significant assumptions used during the year in estimating the fair value on the date of the grant for original options and reload options granted in 2002 were as follows:
Annual earnings per share for 2002 does not equate to the sum of the quarters due to the timing of stock repurchases.
Condensed Financial Information of Registrant (Parent Company Only) As of December 31, 2003 and 2002 and for the years ended December 31, 2003, 2002 and 2001
The following presents the condensed financial position of ACMAT Corporation (parent company only) as of December 31, 2003 and 2002 and its condensed statements of earnings and cash flows for the years ended December 31, 2003, 2002 and 2001.
The accompanying condensed financial statements should be read in conjunction with the Consolidated Financial Statements and Notes thereto in the Company's 2003 Annual Report.