Certain prior years amounts have been reclassified to conform to the current year’s presentation.
interest earned on premiums held prior to remittance to insurance companies.
Commissions we earn on the placement of insurance products other than individual life and individual disability, i.e., P&C, health, group life and group disability insurance, are typically calculated as a percentage, ranging from approximately 3% to 20%, of the annual premium but can be influenced by a number of other factors including the type of insurance and amount of the premium. We recognize commission revenues on the later of the effective date of the policy or the billing date. Installment premiums and related commissions are recorded periodically as billed. Commissions earned from the placement of individual life and individual disability insurance are calculated as a percentage of corresponding premiums and the duration or term of the underlying policies. The majority of commissions from individual life and individual disability insurance sales are earned and recognized during the first year the insurance is placed, with the balance earned and recognized over the following two to ten years. We also often receive contingent commissions from insurance carriers, which are designed to provide us incremental incentive compensation for achieving specified premium volume goals set by carriers and/or the loss experience of the insurance we place with them. Contingent commissions are recorded when we receive data from the insurance companies that allow us to reasonably estimate the amount. Non-commission revenues related to Specialized Benefits Services are generally calculated as a percentage of assets under administration or on an hourly basis.
We have two operating segments: Insurance Brokerage and Specialized Benefits Services. Approximately 84% of our revenues, for the year ended December 31, 2002, was derived from our Insurance Brokerage segment. Within this segment, approximately 66% relates to P&C insurance and 34% to group employee benefits insurance. The remaining approximate 16% of our revenues was derived from our Specialized Benefits Services segment. Within this segment, approximately 52% relates to core benefits, 30% to benefits enrollment and communication and 18% to executive and professional benefits.
You should not consider these financial measures as alternatives to other financial measures determined in accordance with accounting principles generally accepted in the United States, which we refer to as GAAP. You should not consider EBITDA as an alternative to cash flows from operating activities, investing activities or financing activities as a measure of liquidity. In addition, please note that because not all companies calculate these financial measures similarly, the presentation of these measures in this filing is not likely to be comparable to those of other companies. Additionally, under our existing credit facility we are currently prohibited from paying dividends on or repurchasing shares of our capital stock, with the limited exception of repurchasing shares held by terminated employees.
Premium pricing within the commercial P&C insurance industry has historically been cyclical, based on the underwriting capacity of the insurance industry and economic conditions. From 1987 through 1999, the commercial P&C insurance industry was in a “soft market,” which is an insurance market characterized by a period of flat to declining premium rates, which negatively affected commissions earned by insurance brokers. Years of underwriting losses for insurance companies combined with the downward turn in the equity markets caused insurers to increase premium rates starting in mid- to late 2000. Additionally, the insurance industry was affected by the events of September 11, 2001, which resulted in the largest insurance loss in America’s history and accelerated increases in premium rates for particular lines of commercial P&C insurance. The current “hard market,” which is an insurance market characterized by a period of rising premium rates, is, in general, positively affecting commissions earned by insurance brokers. Approximately 48% of our revenues in 2002 relates to commercial P&C insurance, which is the line of business most impacted by the “hard market.” However, the longevity of this cycle cannot be accurately predicted. In response to rising premiums, some of our customers have increased their deductibles and/or reduced their insurance coverage in order to reduce the impact of the premium increases. These factors have negatively impacted our revenues.
Premium rates in the health insurance industry, however, have generally realized a consistent upward trend due to increasing health care delivery costs. However, the upward trend in health care insurance premiums has been somewhat offset by the impact of the economic downturn and its resulting negative impact on employment levels of our customers. In addition, some of our customers have reduced benefits for their employees resulting in a reduction of costs and related insurance premium. This factor has negatively impacted our revenues.
purchase price and paid in a combination of cash, seller notes and preferred stock and capitalized upon determination. In some cases, acquisitions included annual cash bonuses, which we refer to as “Growth Based Bonuses,” that were payable upon achieving agreed upon performance targets, and are expensed as incurred and are classified in Compensation and Employee Benefits. Effective January 2000, we discontinued the practice of offering Growth Based Bonuses. We incurred $1.6 million, $2.3 million and $3.8 million of Growth Based Bonus Expense in 2002, 2001 and 2000, respectively. We expect that all of our Growth Based Bonus obligations related to completed acquisitions will expire by December 31, 2004. The Growth Based Bonus expense for the years ending December 31, 2003 and 2004 is estimated to be $0.3 million and $0.1 million, respectively.
Historically, our revenues and EBITDA for the fourth quarter of the year have been higher relative to the preceding three quarters because a significant portion of commissions and fees earned from our Specialized Benefits Services segment is typically recorded at that time. In addition, we are subject to quarterly earnings fluctuations attributable to the timing of sales of Specialized Benefits Services products.
Net cash from continuing operating activities was $36.6 million, $21.9 million and $29.9 million for the years ended December 31, 2002, 2001 and 2000, respectively.
Compensation and Employee Benefits. Compensation and Employee Benefits increased $0.8 million, or 0.4%, to $201.0 million in 2002 from $200.2 million in 2001. In 2002, we had integration efforts and other charges of $8.1 million compared to $11.2 million in 2001. Excluding the effect of these charges, Compensation and Employee Benefits increased $3.8 million or 2.0% in 2002. As a percentage of revenues, Compensation and Employee Benefits was 61.2% in 2002 compared to 64.3% in 2001, primarily due to the charges. Excluding the effect of these charges, Compensation and Employee Benefits as a percentage of revenues was 58.8% in 2002 compared to 60.7% in 2001. The decrease, as a percentage of revenues, in 2002 is primarily due to the positive affects of our integration efforts and improvements in performance in our operations. In an effort to reduce compensation expense, we terminated 32 employees and renegotiated compensation arrangements for four sales professionals during the first quarter of 2002.
Net Income (Loss) From Continuing Operations. Net Income (Loss) From Continuing Operations increased $45.6 million to $10.9 million in 2002 from a loss of $34.7 million in 2001, due to (i) a reduction in Other Operating Expenses principally due to the integration efforts in the fourth quarter of 2001, (ii) improvement in performance of operations, (iii) the gain from the reduction in the book value of the redeemable common stock warrants and the stock appreciation rights, (iv) a decrease in interest expense as a result of lower interest rates and a reduction in debt, and (v) a decrease in amortization of intangible assets principally due to our adoption of SFAS No. 142. Please read Note 1, “Nature of Operations and Summary of Significant Accounting Policies” in our annual financial statements under “Intangible Assets.” The effective tax rate from continuing operations in 2002 was (5.0)% compared to (11.8)% in 2001. The decrease in the effective tax rate and corresponding reduced benefit in 2002 resulted from the increase in the tax valuation allowance established in 2001, offset by the impact of state income taxes.
Revenues. Revenues increased $20.8 million, or 7.2%, to $311.6 million in 2001 from $290.7 million in 2000. The increase was primarily due to a combination of new business production and increasing premium rates. Excluding the effect of businesses acquired by adjusting 2000 revenues by $4.4 million and excluding $8.0 million of non-recurring revenues in 2000, revenues increased approximately 9% in 2001. In 2000, we received non-recurring revenues of $8.0 million paid to our Specialized Benefits Services segment. $5.0 million of the non-recurring revenues relate to a one-time management-consulting fee related to a technology project. As we are not in the business of information technology management consulting and we do not expect that this sort of consulting services agreement will occur again, we consider these revenues to be non-recurring. The other $3.0 million of the non-recurring revenues were paid by an insurance carrier primarily for acquisition-related and other services provided to consummate our acquisition of one of the insurance carrier’s independent distributors. We do not expect to receive a fee for the performance of these types of services in the future. Accordingly, we consider this payment non-recurring.
Individual and group health, life and disability insurance, which we refer to as Group Employee Benefits insurance.
Income From Continuing Operations Before Income Taxes in the Specialized Benefit Services Segment was $2.7 million, $5.0 million and $12.3 million for the years ended December 31, 2002, 2001 and 2000, respectively. The decrease in 2002 is due to the items discussed above, partially offset by a decrease in amortization of intangible assets principally due to our adoption of SFAS No. 142. Please read Note 1, “Nature of Operations and Summary of Significant Accounting Policies” in our annual financial statements under “Intangible Assets.”
The Corporate segment results reflect the following integration efforts and other charges: $3.9 million, $4.6 million and $0.9 million in years 2002, 2001 and 2000, respectively.
Revenues at the Corporate segment represent interest income. Net Corporate expenses were $19.7 million, $21.9 million and $14.8 million in 2002, 2001 and 2000, respectively. As a percentage of total consolidated revenues, net Corporate expenses were 6.0%, 7.0% and 5.1% in 2002, 2001 and 2000, respectively. Included in net Corporate expenses is $1.0 million, $2.5 million and $1.2 million in 2002, 2001 and 2000, respectively, in legal fees and other expenses associated with the defense of claims against us, the pursuit of claims made by us and payment of claims by us relating to USIA, a discontinued operation. Excluding the effect of the integration efforts and other charges and the legal fees discussed above, net Corporate expenses were $14.7 million, $14.8 million and $12.7 million in 2002, 2001 and 2000, respectively, and as a percentage of total consolidated revenues, net Corporate expenses were 4.5%, 4.7% and 4.5% in 2002, 2001 and 2000, respectively. Included in the Corporate segment in 2002 was a $0.8 million charge related to the Missigman liability. Please read Note 14, “Contingencies” in our annual financial statements under “Gary J. Missigman Litigation.”
reduction in the book value of the stock appreciation rights. The increase in 2001 is primarily a result of the integration efforts and other charges in 2001 compared to 2000.
In 1999, we sold a brokerage operation that generated revenues from commissions and fees on the sale of life insurance products primarily through third-party agents, which we call wholesale distribution. The wholesale distribution strategy of this operation did not fit with our current focus on retail distribution; as a result, we sold the operation to the former owners of that operation and recorded a loss of $3.2 million on the sale of the business. Included in the consideration received for the operation was a note receivable based on a future revenue sharing arrangement. Upon review of the current and future revenue streams generated and to be generated from
the sold brokerage operation, we determined that the note was impaired by $1.4 million. The note receivable, originally issued for $1.5 million, was written down by $1.0 million in the second quarter of 2001, written down by $0.3 million in the fourth quarter of 2001 and written down by $0.1 million in the first quarter of 2002.
In January 2002, Bernard H. Mizel retired as our chairman and chief executive officer. David L. Eslick, who has been president and chief operating officer since July 1998, succeeded Mr. Mizel. In the first quarter of 2002, we recorded a charge of $2.8 million related to the retirement.
In the first quarter of 2002, we accrued $0.3 million related to the Royal Indemnity Company Claim. Please read Note 14 “Contingencies,” in our annual financial statements under “Royal Indemnity Company Claim.”
In 2000, in an effort to provide a simplified and common medical and dental insurance program to our employees, we decided to consolidate our insurance program into one self-insured medical and dental plan. Prior to this plan, many of our acquired businesses had purchased their medical insurance on an individual basis. These medical contracts were placed with a number of different regional and/or national insurance companies principally on a fully insured basis. These insurance brokerage businesses had an employment size that placed them into the insurance carriers “community rated” programs. Community rated programs are for businesses that do not have a sufficient employee size, generally less than 100 employees, for the insurance carriers to evaluate their claim history and, therefore, the rate history on an individual basis. In accordance with GAAP, we were required to establish a liability for incurred but not yet reported claims. Since the prior insurance carriers categorized these acquired businesses as community rated, they could not provide us with historical claims information. Therefore, we could not reasonably estimate this liability at the end of 2000. Our historical experience indicated that our average monthly claims were approximately $1.0 million and the lag in reporting claims was approximately three and one-half months. In the first quarter of 2001, we recorded a $3.5 million charge to establish this self-insurance plan liability. We have purchased a specific and aggregate insurance policy to minimize our future exposure. In the fourth quarter of 2002, we changed from the self-insured plan to a fully insured medical and dental plan. We do not believe the financial statement impact of the change will be material.
In December 2001, we entered into a services agreement with Ceridian Corporation. The agreement stipulates that Ceridian Corporation will provide administrative services to our customers and us. We estimated that the conversion cost associated with this service agreement will be $1.2 million and we have accrued this amount in the fourth quarter of 2001. In March 2002, the original service agreement was amended due to our announcement to sell USIA. Please read “-Discontinued Operations” above. The amendment eliminated USIA as a party to the service agreement, which resulted in the accrual of an additional $1.0 million in the first quarter of 2002.
Our Company’s board of directors adopted and a requisite majority of our stockholders approved a new 2002 Equity Incentive Plan that became effective and replaced the Long-Term Incentive Plan, upon the consummation of the initial public offering. The 2002 Equity Incentive Plan reserves approximately 10.3 million shares of our common stock for issuance to directors, executive officers, employees and non-employee contributors. Awards may consist of options, SARs, restricted shares, dividend equivalents or other share-based awards and are granted to eligible participants under the plan.
After the consummation of our initial public offering, we made an offer to exchange all our outstanding SARs for stock options or stock under our 2002 Equity Incentive Plan. On November 27, 2002, all SAR holders formally agreed to exchange their SARs for stock options and the number of options that each individual employee was entitled to receive and the option exercise price, was known. The historical accounting treatment of SARs was finalized and all SARs tendered in the exchange were cancelled. In accordance with GAAP, that type of stock compensation plan is accounted for as a fixed plan, and compensation expense was measured by the difference between the quoted market price and the price, if any, to be paid by the employee. The corresponding accrual for SAR-related compensation expense was reversed and offset compensation expense that was recognized upon the conversion to a stock option. Our stock price did not increase significantly prior to the consummation of the exchange of SARs for options, therefore the financial statement impact of the transaction in which the SARs were ultimately exchanged for stock options was a $1.3 million expense which was recorded in the fourth quarter of 2002. Upon the consummation of the exchange of all SARs for options or stock, no further expense will be recognized under our 2002 Equity Incentive Plan in connection with the exchange.
Upon the consummation of the initial public offering, approximately 0.1 million of restricted stock units, which were fully vested, were granted to nine executive officers. A $1.0 million expense was recorded for the value of the grant of restricted stock units during the fourth quarter of 2002.
In March 1996, we issued warrants to purchase 0.7 million shares of common stock issued at an exercise price of $11.125 per share. Holders of the Redeemable Common Stock Warrants, issued in conjunction with a
On January 31, 2003, we amended the facility for the sixth time to adjust the financial covenants in 2003. Without this amendment, we may have defaulted under the facility in the first quarter of 2003.
In the event the revolving credit commitment and the outstanding borrowings under the term loan have not been repaid and all related commitments terminated as of October 1, 2003, we will be required to pay a fee in an amount equal to 1.00% of the sum of the total of the revolving credit commitment and the outstanding borrowings under the term loan as of October 1, 2003. The fee is due and payable on October 1, 2003. However, if we, by July 31, 2003, retain the lenders to structure and arrange a new senior credit facility, then the amount of any refinancing fee that is subsequently paid to the lenders shall be credited towards any fees otherwise payable in connection with a new senior credit facility.
In addition to our debt service requirements, we will require liquidity for capital expenditures and working capital needs. Capital Expenditures for the years ended December 31, 2002, 2001 and 2000 were $7.0 million, $8.5 million and $10.3 million, respectively. For the years ended December 31, 2002, 2001 and 2000, $4.6 million, $5.6 million and $5.7 million, respectively, of our total Capital Expenditures related to management information systems. We have funded our capital expenditures with cash generated internally from operations and from external financing and expect to continue to do so in the future. Our total Capital Expenditures are expected to be approximately $10.9 million in 2003.
We believe that cash and cash equivalents on hand of $21.4 million and our availability under our revolving credit facility of $17.5 million as of December 31, 2002, together with cash flow generated from operations, should be sufficient to fund our estimated $32.9 million in debt principal repayment, working capital needs and budgeted $10.9 million in capital expenditures through December 31, 2003. Our liquidity thereafter will depend on our financial results and future available sources of additional equity or debt funding and our results of operations. The revolving credit facility provides us with availability of up to $75.0 million, all of which is
available for general corporate purposes, including acquisitions. As of December 31, 2002 borrowings outstanding under the revolving credit facility were $56.1 million. Additionally, we had $1.4 million outstanding under letters of credit. Our future operating performance and ability to service our debt will be subject to economic conditions and to financial, business and other factors, many of which are beyond our control.
We hold cash in a fiduciary capacity as a result of premiums received from clients that have not yet been paid to insurance carriers. The fiduciary cash is recorded as an asset on our balance sheet with a corresponding liability, net of commissions, to insurance carriers. We earn interest on these funds during the time between receipt of the cash and payment to insurance carriers. In some states, fiduciary cash must be kept in separate bank accounts subject to specific guidelines, which generally emphasize capital preservation and liquidity, and is not generally available to service debt or for other corporate purposes. Insurance brokerage transactions typically generate large cash flows, and the timing of such cash flows can significantly affect the net cash balances held at month end.
Net cash provided by (used in) continuing investing activities totaled $5.6 million, $(14.9) million and $(12.1) million for the years ended December 31, 2002, 2001 and 2000, respectively, which principally reflects acquisition activities and Capital Expenditures. Included in the net cash provided by continuing investing activities for the year ended December 31, 2002 is $18.2 million in proceeds from the sale of USIA. Please read “Discontinued Operations.” Cash expenditures for acquisitions amounted to $5.7 million, $6.9 million and $2.4 million for the years ended December 31, 2002, 2001 and 2000, respectively. We made no acquisitions in 2002 or 2001. The $5.7 million for the year ended December 31, 2002, reflects the payment of additional purchase price and retention based acquisition payments. The $6.9 million for the year ended December 31, 2001, reflects the payment of additional purchase price on retention based acquisitions, as well as the payment of the cash portion of an acquisition effective in 2000 but paid in the first quarter of 2001. Cash expenditures for Capital Expenditures amounted to $7.0 million, $8.5 million and $10.3 million for the years ended December 31, 2002, 2001 and 2000, respectively. Investments in “Discontinued Operations” amounted to $8.9 million, $14.8 million and $11.1 million for the years ended December 31, 2002, 2001 and 2000, respectively.
Net cash (used in) provided by financing activities totaled $(42.7) million, $36.9 million and $2.0 million for the years ended December 31, 2002, 2001 and 2000, respectively, as we made debt payments and continued to issue both debt and equity. In the first quarter of 2002, we received $2.5 million from the issuance of our preferred stock to Sovereign Bancorp. In the second quarter of 2002, we used $16.3 million of the proceeds from the sale of USIA to reduce our term loan. In the fourth quarter of 2002, we received $90.0 million from the issuance of common stock in our initial public offering. Of the $90.0 million in gross proceeds from our initial public offering, we used $78.4 million to reduce our term loan and revolving credit facility and we used $11.6 million to pay issuance costs related to our initial public offering. In the fourth quarter of 2001, we received $30.0 million from the issuance of our preferred stock. Of the $30.0 million issued, $15.0 million was issued to UnumProvident Corporation and $15.0 million was issued to Ceridian Corporation. Please read Note 5, “Long-Term Debt,” and Note 6, “Stockholders’ Equity,” to our annual financial statements.
Our net losses have resulted in net operating loss carryforwards for federal and state income tax purposes. At December 31, 2002, we had $48.1 million of net operating loss carryforwards for federal tax purposes that will expire during the period 2011 through 2022. Our ability to use these net operating loss carryforwards to offset future taxable income, if any, may be subject to limitations under Section 382 of the Internal Revenue Code of 1986, as amended and similar state provisions. The provisions of Section 382 are triggered by specific ownership changes of our stock. We do not believe Section 382 will limit us in utilizing our net operating loss carryforwards in 2003. However, if limited, the unused portion may then be carried forward to future years. In any event, we have established a 100% valuation allowance against the carrying value of the net operating loss to reduce its carrying value to zero as it is more likely than not that it will not be realized in the near future.
Some of our common stockholders have various put rights that are exercisable upon specific events. Please read Note 7, “Redeemable Securities” in our annual financial statements.
Our discussion and analysis of our financial condition and results of operations are based upon our financial statements, which have been prepared in accordance with GAAP. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. We continually evaluate our estimates, which are based on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
Premiums and commissions receivable in the consolidated balance sheets are net of allowances for bad debts. The allowance for bad debts, or allowance, is established through a charge to Other Operating Expenses. The allowance is based on estimates and assumptions using historical data to project future experience. After all collection efforts have been exhausted, we reduce the allowance for write-offs of accounts receivable that have been deemed uncollectible. We periodically review the adequacy of this allowance and make adjustments as necessary. The use of different estimates or assumptions could produce different results.
We have completed over 90 acquisitions. All of these acquisitions have been accounted for using the purchase method, and their related net assets and results of operations were included in our financial statements on their respective acquisition dates. A majority of the acquisitions have provisions for a reduction in consideration if the acquired company does not meet targeted financial results. Additionally, a majority of the acquisitions have provisions for contingent additional consideration if the acquired company achieves financial targets. Additional consideration or a reduction in consideration resulting from acquisition contingency provisions is reflected as an adjustment to intangible assets when the contingency is determined.
On January 1, 2002, we adopted SFAS No. 142, which addresses the financial accounting and reporting standards for the acquisition of intangible assets outside of a business combination and for goodwill and other intangible assets subsequent to their acquisition. This accounting standard requires that goodwill be separately disclosed from other intangible assets in the statement of financial position, and no longer be amortized but tested for impairment on a periodic basis. Intangible assets deemed to have indefinite lives are no longer amortized but are subject to impairment tests at least annually. Other intangible assets will continue to be amortized over their useful lives. In May 2002, we completed the transitional impairment test, which indicated that there was no goodwill impairment as of January 1, 2002. In the fourth quarter of 2002, we completed the annual impairment test, which indicated that there was no goodwill impairment as of October 1, 2002. We have no intangible assets with indefinite lives.
In the fourth quarter of 2001, we believed that the intangible assets of USIA were impaired after considering USIA’s actual and projected EBITDA margins. Following the provisions of SFAS No. 121, we considered the sum of the undiscounted cash flows to be derived from USIA over the remaining amortization period and reduced the carrying value of USIA’s intangible assets to the estimated fair value. This resulted in an impairment charge of $46.9 million against goodwill and expiration rights in the fourth quarter of 2001.
We account for income taxes in accordance with SFAS No. 109, “Accounting for Income Taxes,” which requires that deferred tax assets and liabilities be recognized using enacted tax rates for the effect of temporary differences between the book and tax bases of recorded assets and liabilities. SFAS No. 109 also requires that deferred tax assets be reduced by a valuation allowance if it is more likely than not that some portion or all of the deferred tax asset will not be realized after considering all relevant evidence.
We evaluate the recoverability of our net deferred tax assets on a quarterly basis and adjust, as necessary, the valuation allowance if it is determined that the deferred tax asset is more likely than not to be realized. In assessing the valuation allowance, we consider all available evidence, which includes our historical losses and projected future taxable income. In 2002 and 2001, we recorded a valuation allowance of $17.5 million and $8.0 million, respectively, to eliminate our net deferred tax assets generated from continuing operations as it was determined that it is more likely than not that we would not be able to realize any of our net deferred tax assets. In the event we were to determine that we would be able to realize our net deferred tax assets in the future, an adjustment to our net deferred tax assets would increase income in the period such determination was made.
In addition, under the provisions of our existing credit facility, we are generally prohibited from repurchasing shares of our capital stock, subject to specified permitted monetary thresholds. As a result, if the put rights, described in Note 7 “Redeemable Securities” in our annual financial statements, are exercised, we may be required to repurchase the related shares in excess of the monetary thresholds provided for under our existing credit facility. If the lenders under our existing credit facility do not waive the applicable limitations, we may be in default under our obligations to repurchase the shares put to us, or, if we effected the repurchase, we may be in default under our existing credit facility.
On December 31, 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation-Transition and Disclosure,” which amends SFAS No. 123, “Accounting for Stock-Based Compensation,” to provide alternative methods of transition to SFAS No. 123’s fair value method of accounting for stock-based
The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (GAAP). The consolidated financial statements include the accounts of U.S.I. Holdings Corporation and its wholly-owned subsidiaries. The accompanying financial statements reflect the Company’s decision to discontinue the operations of its third-party administration business (USIA) in January 2002 as further discussed in Note 16-Discontinued Operations. All significant intercompany transactions and balances have been eliminated in consolidation.
The Company records premiums and commissions receivable from clients, premiums payable to insurance companies and the related commissions income on the later of the effective date of the policy or the billing date. The Company records installment premiums and related commissions periodically as billed. Commissions earned from the placement of individual life and individual disability insurance are calculated as a percentage of corresponding premiums and the duration or term of the underlying policies. The majority of commissions from individual life and individual disability insurance sales are earned and recognized during the first year the insurance is placed, with the balance earned and recognized over the following two to ten years.
The Company records commissions on premiums billed and collected directly by insurance companies and contingent commissions when the Company receives data from the insurance companies that allows the Company to reasonably estimate these amounts. The Company is able to reasonably estimate these amounts when it receives the cash, the notification of the amount due from the insurance companies or the insurance policy detail from the insurance companies. The Company receives contingent commissions from insurance companies as additional incentive for achieving specified premium volume goals and/or the loss experience of the insurance placed by the Company. The Company records commission adjustments, including policy cancellations and override commissions, when the adjustments become reasonably estimable.
Cash and cash equivalents includes highly liquid investments, such as money market accounts and certificates of deposit, with original maturities of three months or less. The carrying amounts reported on the consolidated balance sheets approximate fair value.
For the year ended December 31, 2001, the Company recorded an impairment charge under SFAS No. 121, “Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets to Be Disposed Of” (SFAS No. 121), which is reflected in the net loss from discontinued operations, of $46,900,000 against goodwill and expiration rights related to USIA (see Note 16-Discontinued Operations). Under SFAS No. 121, the intangible assets were reviewed using the undiscounted cash flows of the entity acquired over the remaining amortization period. If such a review indicates that the intangibles will not be recoverable, the Company’s carrying value of the intangibles will be reduced to fair value. The 2001 impairment charge was due to deteriorating operating results with low margin and high capital expenditures, which were expected to continue in the indefinite future.
At December 31, 2002, the Company has an incentive and nonqualifed stock option plan, which is described more fully in Note 18-Stock Option Plan. The Company accounts for its employee stock options using the intrinsic value method prescribed in Accounting Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued to Employees,” and related Interpretations (APB No. 25). Under APB No. 25, no stock-based employee compensation cost is reflected in the statement of operations, as all options granted had an exercise price equal to the market value of the underlying common stock on the date of grant.
SFAS No. 123, “Accounting for Stock-Based Compensation” (SFAS No. 123), established accounting and disclosure requirements using the fair value based method of accounting for employee stock options. The following table illustrates the effect on the Company’s operating results and earnings per share as if the Company had applied the fair value recognition provisions of SFAS No. 123 to stock-based employee compensation.
The Company files a consolidated federal income tax return. Deferred tax assets and liabilities are determined based on the differences between financial statement and tax bases of assets and liabilities using enacted rates in effect for the year the differences are expected to reverse. In 2002 and 2001, deferred tax assets were reduced through the establishment of a valuation allowance, as it is more likely than not that the deferred tax assets will not be realized in the near future.
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
In April 2002, the FASB issued SFAS No. 145, “Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections,” (SFAS No. 145). SFAS No. 145 rescinds SFAS No. 4, “Reporting Gains and Losses from Extinguishment of Debt,” which required all gains and losses from extinguishment of debt to be aggregated and, if material, classified as an extraordinary item, net of related income tax effect. As a result, the criteria in APB No. 30 will now be used to classify those gains and losses. Any gain or loss on extinguishment of debt that was classified as an extraordinary item in prior periods presented that
In July 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities,” (SFAS No. 146). SFAS No. 146 nullifies Emerging Issues Task Force (EITF) Issue No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring),” (EITF 94-3). SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. Under EITF 94-3, a liability for an exit cost as defined in EITF 94-3 was recognized at the date of an entity’s commitment to an exit plan. SFAS No. 146 also establishes that fair value is the objective for initial measurement of the liability. SFAS No. 146 is effective for exit or disposal activities initiated after December 31, 2002. The Company does not expect that the adoption of this statement will have a significant impact on its financial position or results of operations.
On December 31, 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation-Transition and Disclosure” (SFAS No. 148), which amends SFAS No. 123, to provide alternative methods of transition to SFAS No. 123’s fair value method of accounting for stock-based employee compensation. SFAS No. 148 also amends the disclosure provisions of SFAS No. 123 and APB Opinion No. 28, “Interim Financial Reporting,” to require disclosure in the summary of significant accounting policies of the effects of an entity’s accounting policy with respect to stock-based employee compensation on reported net income and earnings per share in annual and interim financial statements. While the Statement does not amend SFAS No. 123 to require companies to account for employee stock options using the fair value method, the disclosure provisions of SFAS No. 148 are applicable to all companies with stock-based employee compensation, regardless of whether they account for that compensation using the fair value method of SFAS No. 123 or the intrinsic value method of APB No. 25. The Company adopted the disclosure provisions of SFAS No. 148 at December 31, 2002.
A reconciliation of reported net income (loss) from continuing operations to adjusted net income (loss) from continuing operations had SFAS No. 142 been applied beginning January 1, 2000 is as follows for the years ended December 31:
The adjustments to goodwill relate to contingent purchase price payments on previous acquisitions. The Company treats contingent purchase price adjustments to the original purchase price and capitalizes them when resolved.
The Company’s amortizable intangible assets by asset class are as follows at December 31:
The amortization expense for the years ended December 31, 2002, 2001 and 2000 was $21,326,000, $32,908,000 and $32,678,000, respectively. The amortization expense for amortizable intangible assets for the years ending December 31, 2003, 2004, 2005, 2006 and 2007 is estimated to be $20,146,000, $17,691,000, $14,653,000, $11,568,000 and $8,829,000, respectively.
For the year ended December 31, 2001, the Company recorded a $46,900,000 impairment charge against goodwill and expiration rights related to its discontinued operations (see Note 16-Discontinued Operations).
During 2002 and 2001, the Company made no acquisitions. In July 2001, the Company sold certain insurance accounts and other assets of one insurance brokerage operation resulting in a pre-tax gain of $2,000. Revenues, expenses and assets of this operation were not material to the consolidated financial statements.
During 2000, the Company acquired the assets of one insurance brokerage operation and all of the outstanding common stock of one specialized benefits services business within the United States. The aggregate purchase price of $14,613,000 included cash of $3,815,000, notes payable to sellers of $7,991,000, 389,000 shares of the Company’s Preferred Stock valued at $2,410,000 and associated costs capitalized of $397,000. The excess of the purchase price over the tangible net assets assumed of $2,102,000 was $12,511,000, $5,827,000 of which related primarily to expiration rights, and $6,684,000 of which was recorded as goodwill.
In 2002, an aggregate of $10,583,000 in additional consideration was recorded for three acquisitions. There were no significant adjustments in 2001 and 2000 to the original purchase price of acquisitions.
As of December 31, 2002, the estimated unrecorded future significant contingency payments related to acquisitions totaled $6,610,000.
In May 2001, the Company entered into a term loan with Zurich Services Corporation (Zurich) in the amount of $3,000,000. The principal amount has a maturity date of September 20, 2004, and bears an interest rate based on the prime rate plus .50% (4.75% at December 31, 2002).
On September 17, 1999, the Company amended and restated the Credit Facility with a $200,000,000 credit facility (Existing Credit Facility). The Existing Credit Facility is structured as follows: a $75,000,000 revolving credit facility expiring on September 17, 2004, and a $125,000,000 term loan payable in quarterly installments commencing on December 31, 1999. The last quarterly installment is due on September 17, 2004, the maturity date of the term loan. However, there is a 1.00% fee payable if the Existing Credit Facility is not repaid by October 1, 2003. Proceeds from borrowings under the Existing Credit Facility were drawn to (i) refinance amounts outstanding under the Credit Facility, (ii) repay all or a portion of certain notes issued for acquisitions, (iii) pay accrued interest on the repaid or refinanced notes issued for acquisitions and Credit Facility and (iv) pay fees and expenses in connection with the Existing Credit Facility.
The Company is required to pay a fee upon termination of the credit facility equal to 1.00% of the revolving credit commitment and the outstanding borrowings under the term loan determined 30 days prior to termination.
In April 1999, the Company entered into a finite risk and excess liability policy with CNA Pro, an affiliate of CNA Financial Corporation, with a coverage effective date of January 1, 1999. The policy expires on December 31, 2003, with premiums being paid quarterly. The coverage is in excess of the Company’s primary professional liability insurance and is bifurcated as follows: $17,200,000 in the aggregate in respect of the Nassau County litigation (see Note 16-Discontinued Operations) and up to $20,000,000 aggregate professional liability coverage for all other claims besides the Nassau County litigation. In June 1999, the Company utilized the $17,200,000 of coverage to pay the Nassau County litigation settlement and related expenses. The $17,200,000 has been recorded as debt bearing interest at 13.44% on the consolidated balance sheets and is amortized quarterly as a portion of premiums paid. The final quarterly installment is due July 1, 2003.
As of December 31, 2002, the Company’s authorized capital stock under the Company’s certificate of incorporation was 397,000,000 shares, of which 300,000,000 shares were common stock, par value $.01 per share, 10,000,000 shares were non-voting common stock, par value $.01 per share, and 87,000,000 shares were voting preferred stock, par value $.01 per share.
In April 2002, the Company’s Board of Directors and stockholders approved to increase the number of authorized common shares from 135,000,000 to 300,000,000. The Board of Directors and stockholders also authorized a two-for-five reverse stock split for its common shares issued and outstanding or held in treasury immediately prior to October 16, 2002 (reverse stock split). The par value of the common stock was maintained at the pre-split amount of $0.01 per share. All references to common shares, common stock warrants, stock options, stock appreciation rights (SARs) and per share amounts in the accompanying consolidated financial statements have been restated to reflect the reverse stock split on a retroactive basis, exclusive of fractional shares.
Upon consummation of the Company’s IPO, all outstanding shares of Preferred Stock were split adjusted (two-for-five reverse stock split) and converted into approximately 23,083,000 shares of the Company’s Common Stock. The accretion dividends, with respect to the Preferred Stock, were converted to approximately 9,112,000 shares of the Company’s Common Stock at the IPO price of $10 per share.
At December 31, 2002, the Company had no shares of Preferred Stock outstanding. As noted above, upon the consummation of the Company’s IPO, all outstanding shares of Preferred Stock were converted into the Company’s Common Stock, and the related accretion dividends were converted to the Company’s common stock at the IPO price of $10 per share.
The Preferred Stock was convertible into Common Stock at either the option of the Company upon the occurrence of certain events, or at the option of the stockholder at any time. The per share conversion rate is equal to one plus an amount equal to the excess of the liquidation preference over the original issuance price divided by the fair market value of one share of Common Stock on the conversion date. The per share conversion rate was also adjusted for stock splits or dividends.
In September 1999, Series W stockholders were issued warrants convertible into shares of Series W Preferred Stock. As of December 31, 2002, 6,250,002 warrants were outstanding and exercisable into an aggregate of 2,499,997 shares of common stock at an exercise price of $15.00 per share. The warrants expire on September 17, 2004.
As noted above, upon consummation of the IPO, the 2002 Equity Incentive Plan replaced the Long-Term Incentive and Share Award Plan. SARs held by former employees were settled in cash. SARs held by current employees and consultants were either 1) exchanged for stock options or Common Stock or 2) paid out in a combination of cash and Common Stock. On November 27, 2002, the SARs exchange was completed, the SARs tendered in the exchange were canceled and the related compensation expense for 2002 was finalized. As of December 31, 2002, there were no SARs outstanding. The information below is provided for historical purposes.
In 1995, the Company adopted the Long-Term Incentive and Share Award Plan (the Incentive Plan). The intention of the Incentive Plan was to provide a means to attract, retain and motivate employees and directors of the Company, upon whose judgment, initiative and efforts, the continued success, growth and development of the Company was dependent. The Incentive Plan provided that the Company may, at its discretion, grant an award, including options, SARs, restricted shares, and other share-based awards, to any eligible employee. The only type of award issued under this plan was SARs. These SARs generally vested at a rate of 20% per year over a five-year period, provided that the SAR holder remained associated with the Company. The SARs were not exercisable until the occurrence of an event that triggered the rights of holders to exercise their SARs. The valuation of SARs was based upon the estimated fair value of a share of Common Stock.
Upon consummation of the IPO, all Redeemable Preferred Stock, for which the holders still had put rights, was converted to Redeemable Common Stock (see description of put rights under Redeemable Preferred Stock below). These same put rights carried over to the Redeemable Common Stock.
The original issuance cost of $21,302,000 at December 31, 2002, is reported as Redeemable Common Stock in the accompanying 2002 balance sheet. Since the Company is obligated to repurchase shares from its employees only in an amount equal to their original issuance cost, changes in the fair value of such shares are not required to be recognized in the Company’s statements of operations or stockholders’ equity.
Warrants to purchase 739,999 shares of the Company’s voting Common Stock, issued in conjunction with a 1996 senior subordinated debt offering that was repaid in 1999 were outstanding and exercisable at December 31, 2002. In 2002, the holders of the warrants agreed to terminate the put rights associated with the Common Stock Warrants concurrent with the consummation of the IPO. The Company had the right, which it did not exercise, to repurchase all, but not less than all, the warrants issued in 1996 and shares issuable upon the exercise of these warrants until January 2003. The warrants have a strike price of $11.125 per share and expired on January 30, 2003. Since prior to the termination of the put rights, the holders had the right to put the warrants or warrant shares back to the Company, the change in the value of the warrants is reported in the accompanying statements of operations. The value of the warrants is $230,000 and $4,300,000 at December 31, 2002 and 2001, respectively. Since the put rights were terminated, the values of the warrants were transferred from Redeemable Common Stock to Common Stock in the fourth quarter of 2002. At December 31, 2001, the value of the warrants is reported as Redeemable Common Stock Warrants. The change in the value of the warrants was $(4,070,000), $1,406,000 and zero for the years ended December 31, 2002, 2001 and 2000, respectively.
The following schedule summarizes certain information about the Company’s Redeemable Preferred Stock at December 31, 2001 and 2000:
Substantially all of the Company’s employees who held Preferred Stock from prior acquisitions could put to the Company the number of shares owned by them that had a fair value equal to the employee’s original investment in those shares upon the (a) termination of employment by the Company without cause, (b) employee’s resignation for good reason or (c) disability or death of the employee. The original issuance cost of $18,663,000 at December 31, 2001, is reported as Redeemable Preferred Stock in the accompanying balance sheets. As the Company is obligated to repurchase Preferred Stock from its employees only in an amount equal to the original issuance cost of their Preferred Stock, changes in the fair value of such series are not required to be recognized in the Company’s statements of operations or stockholders’ equity.
On December 1, 1999, the Company agreed to extend the put option held by a former employee. The former employee may require the Company to repurchase $3,000,000, the original issuance cost (see above), of Preferred Stock shares owned by him during a 60-day period beginning November 30, 2004. The $3,000,000 is reported as Redeemable Common Stock and Redeemable Preferred Stock in the accompanying balance sheets at December 31, 2002 and 2001, respectively.
Zurich acquires a 51% or greater equity interest in the Company.
The series T Preferred Stock does not have a put option or warrants.
For the years ended December 31, the provision (benefit) for income taxes related to continuing operations consists of the following:
The Company leases various facilities and equipment under noncancelable operating leases. These leases generally contain renewal and/or purchase options and escalation clauses. Minimum aggregate rental commitments at December 31, 2002, under noncancelable operating leases having an initial term of more than one year, are as follows (dollars in thousands):
Seven insurance carriers are stockholders of the Company. For the years ended December 31, 2002, 2001 and 2000, commissions earned on policies placed through these insurance carriers were approximately $43,644,000, $34,958,000 and $31,300,000, respectively.
On December 21, 2001, the Company entered into a service agreement with Ceridian Corporation (Ceridian) whereby Ceridian will provide certain administrative services to the Company and its customers. The service agreement with Ceridian includes a provision whereby Ceridian can recover up to $1,182,000 in expected
For the year ended December 31, 2002, a substantial portion of the Company’s commissions and fees were received from clients in the states of New York and California. Accordingly, the occurrence of adverse economic conditions or an adverse regulatory climate in New York or California could have a material adverse effect on the Company. However, the Company believes, based on its diversified customer base and product lines within the states it operates in, that there is minimal risk of a material adverse occurrence due to the concentration of operations in New York and California.
The Company is subject to various claims, lawsuits and proceedings that arise in the normal course of business. These matters principally consist of alleged errors and omissions in connection with the placement of insurance and rendering administrative or consulting services and are covered in whole or in part by insurance. On the basis of present information, anticipated insurance coverage and advice received from counsel, it is the opinion of the Company’s management that the disposition or ultimate determination of these claims, lawsuits or proceedings will not have a material adverse effect on the Company’s consolidated financial position or results of operations.
Brian D. Whitney Litigation. The Company and its retired Chairman and Chief Executive Officer, Bernard H. Mizel, and the Company’s current Chairman and Chief Executive Officer, David L. Eslick, were involved in a dispute with Brian D. Whitney, the former President and Chief Executive Officer of one of the Company’s subsidiaries. On January 18, 2000, the Company terminated the employment agreement of Mr. Whitney. On May 26, 2000, Mr. Whitney commenced arbitration before the American Arbitration Association against the Company asserting certain claims arising out of the termination of his employment. With the arbitration, Mr. Whitney sought damages in excess of $20,000,000. The arbitration hearings commenced in July 2001 and concluded on January 3, 2002. On January 30, 2002, the panel issued an award of $528,000 to Mr. Whitney. Also, on May 26, 2000, Mr. Whitney commenced an action in the United States District Court for the District of Connecticut against Mr. Mizel and Mr. Eslick. Mr. Whitney asserted a claim of tortious interference with his employment contract, arising from the same facts at issue in his arbitration and seeking the same damages. The Company accrued a $700,000 liability in 2001 as a result of the arbitration and litigation.
All claims in this litigation were settled pursuant to a settlement agreement dated as of February 27, 2002 and effective as of March 21, 2002. Pursuant to the settlement agreement, the parties have executed and filed with the court a stipulation of dismissal with prejudice, and the Company paid Mr. Whitney $250,000. The Company’s insurer paid the Company $200,000 toward the settlement of this action.
Near North Insurance Litigation. Plaintiffs, affiliated companies which are competitors of the Company in the insurance brokerage and risk management business, filed this action against the Company and three of its officers and employees who previously worked for plaintiffs. Plaintiffs sought compensatory damages of at least $18,000,000, plus punitive damages and injunctive relief. The Company and its officers and employees asserted various defenses to this action; the Company and its officers have also filed an action against plaintiffs. The Company tendered this action to its comprehensive liability, errors and omissions, and directors and officers insurers.
Gary J. Missigman Litigation. USI Northeast, Inc. (USI Northeast), a subsidiary of the Company, was a defendant in an action pending in the United States District Court for the Southern District of New York, Gary J. Missigman v. USI Northeast and The Zurich American Insurance Company, No. 99 CIV, 4763. Mr. Missigman alleged in his complaint that USI Northeast wrongfully terminated his employment on or about March 5, 1999, and he asserted various causes of action stemming from that allegation, including breach of contract, breach of implied contract, unjust enrichment, fraud and joint venture to commit fraud. USI Northeast maintained that Mr. Missigman’s termination was justified and filed an answer, in which it denied all of the complaint’s allegations, asserts numerous affirmative defenses and asserts counterclaims for breach of contract and implied contract. On February 7, 2001, the court granted USI Northeast’s motion for summary judgment as to Mr. Missigman’s contract, implied contract, fraud and joint venture to commit fraud claims and denied USI Northeast’s motion for summary judgment as to Mr. Missigman’s only remaining claim, a claim for unjust enrichment. The court denied Mr. Missigman’s motion for summary judgment as to USI Northeast’s counterclaims. In his complaint, Mr. Missigman alleged that his damages under the remaining unjust enrichment claim are “believed to exceed $3,000,000.” In April 2001, Mr. Missigman served a report of an expert witness opining that the damages under the unjust enrichment claim are between $25,500,000 and $43,500,000. USI Northeast denied having any liability under the unjust enrichment claim, but in the even such liability were found, the expert witness retained by USI Northeast has calculated damages would have been $93,600. On October 9, 2002, the parties entered into a settlement agreement. The settlement agreement provided for, among other things, the payment of $750,000 by USI Northeast to the Missigman bankruptcy estate, an exchange of releases and dismissal of the action with prejudice. The Company accrued $300,000 in the first quarter of 2002 towards this liability and an additional
$450,000 in the third quarter of 2002 as a result of this settlement agreement. The $750,000 settlement payment was paid in January 2003.
In efforts to integrate its business acquisitions, the Company continues to focus on operating expense reductions. As a result, for the years ended December 31, 2002, 2001 and 2000, the Company recorded charges of $5,511,000, $9,642,000 and $3,429,000, respectively, related to future compensation costs for terminated employees, future producer compensation restructuring and future lease costs for terminated office leases.
The employee termination benefits and the future producer compensation restructuring costs reflected above are included in compensation and employee benefits in the accompanying statements of operations. The terminated office lease costs are included in other operating expenses in the accompanying statements of operations.
The Company determined that USIA was no longer core to the Company’s mission, vision, or strategy and in January 2002, the Company announced its intention to sell USIA. USIA was part of the Company’s administration and other services reportable segment and offers third-party administration of employee benefit plans to its clients. In April 2002, the Company completed the sale of USIA for $19,900,000. The Company received and recorded cash proceeds of $18,200,000 with the remaining consideration of $1,700,000 in the form of an account receivable. The receivable is due to the Company no later than May 16, 2003. In connection with the sale, the Company recorded a pre-tax loss of $7,219,000. The Company also received a $13,000,000 note receivable that bears interest at 8% due in June 2003 that is subject to certain post-closing revenue and other adjustments included in the purchase agreement. These potential adjustments cannot be reasonably determined as of December 31, 2002; therefore, the accompanying financial statements do not reflect the note receivable. These adjustments are expected to be resolved in June 2003. Of the $18,200,000 in cash proceeds, $16,300,000 was used to reduce the Company’s term loan and $1,900,000 was used to pay selling costs.
In the fourth quarter of 2001, the Company determined that the intangible assets of USIA were impaired after considering USIA’s actual and projected operating results. Following the provisions of SFAS No. 121, the Company considered USIA’s undiscounted cash flows over the remaining amortization period and reduced the carrying value of USIA’s intangible assets to the estimated fair value. At December 31, 2001, the Company determined that the fair value of the long-lived assets of USIA approximated $22,500,000 based on historical multiples of EBITDA that were paid for similar businesses. The carrying amount of the long-lived assets approximated $69,400,000 prior to the impairment charge at December 31, 2001. Following the provisions of SFAS No. 121, the Company wrote-off all existing goodwill of $37,500,000. Additionally, the Company reduced related expiration rights by $9,400,000. Together, these two write-offs resulted in the impairment charge of $46,900,000.
Since early 1999, offices of the United States Attorney for the Eastern District of New York and the District Attorney of Nassau County have been conducting a joint investigation into possible wrongdoing in the procurement and administration of contracts for third-party health care administrative services for employees of
The following table sets forth the computation of basic and diluted EPS giving effect to the reverse stock split (see Note 6):
Pro-forma net loss per share (basic and diluted) for the years ended December 31, 2002 and 2001 assuming the conversion of all Preferred Stock into Common Stock had taken place at the beginning of each year would have been $(0.09) and $(3.42), respectively.
For the years ended December 31, 2002, 2001, 2000, dilutive shares of 17,000, 30,698,000 and 29,868,000, respectively, were not included in diluted weighted average shares outstanding because the effects would have been antidilutive.
SFAS No. 123 requires disclosure of pro forma information regarding net earnings and net earnings per share, using pricing models to estimate the fair value of stock options grants. Had compensation expense for the Company’s stock option plans been determined based on the estimated fair value at the date of grant consistent with the methodology prescribed under SFAS No. 123, approximate net earnings and net earnings per share would have been as follows:
Pro forma information regarding net loss and net loss per share is required by SFAS No. 123, and has been determined as if the Company had accounted for its employee stock options under the fair value method of that statement. The fair value for these options was estimated at the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions for 2002: risk-free interest rate of 4.0%; dividend yields of 0.0%; volatility factor of the expected market price of the Company’s common stock of .26; and a weighted-average expected life of the option of 6 years.
The weighted-average fair value of options granted during the year was $3.43 and the weighted-average contract life was 10 years.
On November 27, 2002, the Company exchanged all SARs for 2,820,000 stock options under the 2002 Equity Incentive Plan. In connection with this exchange, the Company recorded $1,269,000 of compensation expense in the fourth quarter of 2002 and is reported as the value of stock options exchanged for stock appreciation rights in the accompanying 2002 statements of operations. The stock options that were exchanged for the SARs maintained the original vesting schedule of the SARs. At December 31, 2002, the 1,748,000 options exercisable were a result of this arrangement.
The increase in the net loss for the quarter ended December 31, 2001 was predominantly the result of the 2001 efficiency initiative charge of $9,642,000 (see Note 15) and a $3,092,000 compensation charge resulting from Company’s Incentive Plan (see Note 6).