MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Effective January 1, 1998, the Company entered into written service agreements with BIG which modified the existing arrangements to (i) expand the services provided by the Company to include policy administration for certain automobile lines of business, (ii) recognize claims outsourcing revenue based not on a cost reimbursement basis, but rather on a percentage of earned premiums and, with respect to certain types of claims, a percentage of incurred losses, and (iii) implement a change in fee structure from a percentage of incurred loss to a percentage of earned premiums with respect to homeowners claims services. These changes were negotiated in order to effect more uniform revenue recognition. To obtain BIG's agreement to such changes, the Company, in turn, agreed to the revised fee structure with respect to homeowners claims services. BIG presently accounts for approximately 79.5% of the Company's outsourcing services revenues and is
Outsourcing Services Revenues. Outsourcing services revenues increased 37.1% to $52.2 million in 1999 from $38.1 million in 1998. The increase was primarily attributable to (i) incremental revenues from Colonial Claims, which was acquired in January, 1999, (ii) revenue generated under an affiliated technical support services arrangement for both personal and commercial lines of insurance entered into on April 1, 1999, (iii) claims fee income recognized during 1999 associated with the settlement of flood and wind damage claims resulting from Hurricane Georges in late September, 1998, and from Hurricanes Floyd and Irene during 1999 and, (iv) incremental revenues from the Company's direct marketing subsidiary, which was formed in August, 1998. Effective April 1, 1999, the Company amended its existing service agreements with affiliated insurers to provide for minimum aggregate quarterly service fee payments through December 31, 1999 with respect to certain lines of business. If such minimum service fee requirements with respect to said lines of business under the agreements had not been implemented as of April 1, 1999, aggregate affiliated outsourcing services revenues, which totaled $41.5 million in 1999, would have been $39.7 million in accordance with the terms of the affiliated service agreements as in effect prior to April 1, 1999. For the year ended December 31, 1999, the Company will not recognize approximately $500,000 of additional affiliated service fees under the minimum service fee agreement as the Company did not meet certain specified milestones on a timely basis. Such minimums were established to compensate the Company for maintaining an infrastructure to process certain lines of business of affiliated insurers that have not grown as rapidly as originally forecasted.
Flood Zone Determination Services Revenues. Flood zone determination services revenues decreased 25.5% to $19.2 million in 1999 from $25.7 in 1998. The decrease in flood zone determination services revenues was primarily attributable to increases in interest rates from the corresponding period of the prior year and a
Cost of Flood Zone Determination Services. Cost of flood zone determination services decreased 27.2% to $8.1 million in 1999 from $11.1 million in 1998. The decrease in cost of flood zone determination services is primarily due to (i) a decrease in flood zone determination services revenue from the corresponding period in 1998, (ii) the merger of BHDS and Geotrac in July, 1998 and a subsequent elimination of certain duplicated functions and facilities, and (iii) a redesign of certain production workflows in April, 1999 that enabled the Company to increase employee productivity and reduce expenses.
Depreciation and Amortization Expense. Depreciation and amortization expense increased 27.5% to $5.5 million in 1999 from $4.3 million in 1998. The increase was primarily related to (i) additional goodwill amortization recognized during 1999 as a result of the purchase of the remaining 51% of Geotrac, Inc. in July, 1998, (ii) goodwill amortization resulting from the purchase of Colonial Claims in January, 1999, (iii) amortization of software costs capitalized in accordance with SOP 98-1, which the Company began amortizing in January, 1999 and (iv) depreciation related to assets, consisting of telephone equipment and computer hardware and software, that were purchased by the Company from BIG in April, 1998 for use in its business. Prior to April 1, 1998, the depreciation for such equipment, which totaled $282,015 during the three months ended March 31, 1998, was charged to the Company under an arrangement similar to an operating lease and was included in cost of outsourcing services.
Minority Interest. During July, 1998, the Company purchased the remaining 51% of Geotrac. However, the Company has elected to reflect the operations of Geotrac prior to the July, 1998 acquisition on a
consolidated basis with the Company, with the net income of Geotrac allocable to the 51% interest held by the prior majority stockholders reflected as minority interest.
Provision for Income Taxes. The Company's effective income tax rates were 44.2% and 44.1% in 1999 and 1998, respectively. The effective tax rates reflect non-deductible goodwill recognized in connection with the acquisition of Geotrac in July, 1998 and Colonial Claims in January, 1999. Income before provision for income taxes in 1998, excluding minority interest which is presented net of tax in the accompanying consolidated financial statements, resulted in an effective income tax rate of 41.3% in 1998.
Flood Zone Determination Services Revenues. Flood zone determination services revenues increased $16.9 million, or 192.7%, to $25.7 million in 1998 from $8.8 million in 1997. The revenue growth was primarily attributable to the inclusion of the consolidated revenues of both Geotrac and BHDS for 1998 as compared with the revenues of BHDS only for 1997. This was partially offset by a continued decline in the volume of flood zone determinations performed in the second half of 1998 as the demand for refinancing of existing mortgage loans decreased.
Cost of Flood Zone Determination Services. Cost of flood zone determination services increased $6.4 million, or 133.7%, to $11.1 million in 1998 from $4.8 million in 1997. The increase in cost of flood zone determinations was primarily attributable to the inclusion of the consolidated expenses of both Geotrac and BHDS for 1998 as compared with the expenses of BHDS only for 1997. As a percentage of flood zone determination services revenue, the decrease in cost of flood zone determination services resulted primarily from a reduction during 1998 of approximately $822,000 in insurance costs due to the Company terminating its insurance policy associated with its life of loan program effective June 1, 1998. Consequently, from such date forward, the Company deferred a portion of each life of loan fee received in order to account for its obligation to perform future flood zone redeterminations.
Provision for Income Taxes. The Company's effective income tax rates were 44.1% and 38.3%, in 1998 and 1997, respectively. Income before income taxes in 1998, excluding minority interest, resulted in an effective income tax rate of 41.3%. This effective rate reflects the impact of a minority interest presented net of tax and other items discussed in Note 9 to the Consolidated Financial Statements of the Company.
At December 31, 1999, the Company's principal sources of liquidity consisted of cash on-hand, cash flows from operations and available borrowings under the Company's revolving credit facility. Prior to 1999, the Company funded its operations through cash generated from operations and receipt of service fees advanced from BIG. Bank borrowings were used to finance fixed asset purchases.
In June, 1999, the Company entered into a revolving line of credit agreement ("LOC") with a financial institution that provides for borrowings of up to two times the rolling four quarter earnings before interest, taxes, depreciation and amortization ("EBITDA"), but in no event more than $12,000,000. The LOC bears interest at a specified percentage over LIBOR (8.23% at December 31, 1999) based on the ratio of funded debt (as defined) to EBITDA. Interest payments are payable monthly and the remaining unpaid principal balance is due in full in July, 2001. The LOC is collateralized by substantially all of the Company's assets and is subject to certain quarterly financial covenants requiring the Company to maintain the following minimum
The Company believes that cash on-hand, cash flows from operations and available borrowings under the Company's LOC facility will be sufficient to satisfy currently anticipated working capital and capital expenditure requirements for the next twelve months. Unanticipated rapid expansion, business or systems development, or potential acquisitions may cause the Company to require additional funds. The Company identifies and assesses, in the normal course of business, potential acquisitions of technologies or businesses which it believes to strategically fit is business plan. The Company may enter into such transactions should opportunities present themselves in the future.
To date, nearly all costs associated with addressing the Year 2000 Problem have been internal expenses, with the exception of the costs of engaging an independent accounting firm to validate the Company's Year 2000 remediation plan. The Company estimates that total costs incurred to date regarding the Year 2000 Problem to be in the range of $500,000 to $900,000. The remaining estimated costs to address any additional Year 2000 Problems is not expected to be significant, although no assurances can be given in this regard.
The following financial statements of the Company and its independent certified public accountants' report are set forth on pages 36 through 61 of this report: