(a) Certain prior years’ amounts have been reclassified to conform to the current year’s presentation.
(b) We sold USIA in April 2002. In accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” we reflect USIA in our financial statements as a Discontinued Operation. In the fourth quarter of 2001, following the provisions of SFAS No. 121, “Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets to Be Disposed Of,” we reduced the carrying value of USIA’s intangible assets to their estimated fair value. This resulted in an impairment charge of $46.9 million against USIA-related goodwill and expiration rights. For the years ended December 31, 2003, 2002, 2001, 2000 and 1999, the income (loss) from discontinued operations is reported net of income tax expense (benefit) of $0.1 million, zero, $(4.5) million, $0.3 million and $0.9 million, respectively. Please read “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Discontinued Operations.”
(c) On October 25, 2002, we completed our initial public offering of 9.0 million common shares at a price of $10 per share. Upon the consummation of the initial public offering, all outstanding shares of Preferred Stock were split adjusted (two-for-five reverse stock split) and converted into approximately 23.1 million shares of our Common Stock. The accretion dividends, with respect to the Preferred Stock, were converted to approximately 9.1 million shares of our Common Stock at the initial public offering price of $10 per share. At December 31, 2003, 2002, 2001, 2000 and 1999 we had approximately 46.7 million, 42.4 million, 0.8 million, 0.8 million and 0.8 million shares of Common Stock outstanding, respectively. The initial public offering proceeds, net of the underwriting discount and expenses, of approximately $78.4 million was used to repay indebtedness under our credit facility.
• fees paid directly by clients and other third-party remuneration for employee benefit-related services (which we refer to as Health & Welfare when combined with Group Employee Benefits); and
We have two operating segments: Insurance Brokerage and Specialized Benefits Services, and a third administrative segment: Corporate. For 2003, approximately 85% of our revenues were derived from our Insurance Brokerage segment. Within this segment, approximately 68% related to P&C insurance and 32% to Group Employee Benefits. Approximately 15% of our revenues in 2003 were derived from our Specialized Benefits Services segment. Within this segment, approximately 47% related to core benefits (retirement and Health & Welfare services), 30% to benefits enrollment and communication and 23% to executive and professional benefits (deferred compensation and executive benefit programs). All of Specialized Benefits Services revenue and our Group Employee Benefits revenue are considered Health & Welfare. Our Corporate segment had less than 0.2% of our revenues in 2003.
For more discussion on our business please refer to Item 1. “-Business” in this report.
The financial measures that we use to evaluate our performance are:
• EBITDA, which is income (loss) from continuing operations plus interest expense, income tax expense, depreciation and amortization of intangibles; and
• EBITDA Margin, which we define as EBITDA as a percentage of total revenues.
GAAP or as alternatives to cash flows from operating activities, investing activities or financing activities or 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 report is not necessarily comparable to those of other companies.
We strongly urge investors or potential investors in our stock to review the calculation of EBITDA and EBITDA Margin and the related reconciliation to Net Income (Loss) presented in accordance with GAAP in “Results of Operations”, below.
Our business strategy focuses on generating organic growth in revenues, creating efficiencies in our operations and making disciplined and accretive acquisitions. Specifically, our stated goals are as follows:
• EBITDA margin improvement to at least 28% on a consolidated basis; and
We believe that internally generated growth is more valuable than acquired growth. Our strategy for achieving our long-term goal of 5% - 10% organic growth includes:
• Maintaining a balanced mix of P&C and Health & Welfare revenues as a hedge against market cycles.
Our EBITDA margins are currently among the lowest of our peers. We have publicly stated that we believe we can improve our margins by 100 - 200 basis points per year up to a consolidated margin, including corporate, of at least 28%. We currently benchmark all expense categories and work with operating management to develop and implement remediation plans for business units performing below our standards. We are focused on increasing margins by restructuring the mix of incentive versus guaranteed compensation, consolidation of office space, implementation of best practices in operations and lowering the cost of our information technology by the consolidation of data centers. Additionally, we continue to capitalize on opportunities to leverage our fixed costs across a greater revenue base by acquiring “fold-in” and other accretive businesses within our current geographic footprint.
We centrally manage our acquisition pipeline from the point of initial contact through to integration within our operations. We only consider deals that are accretive to our earnings per share, and sellers must take a portion of their purchase price in our common stock. All acquisitions are subject to a rigorous due diligence process, including an introduction to our culture and business strategy and the seller’s commitment to both our sales and client service model and to a post-acquisition integration plan. Currently, we are looking to expand only within our current geographic footprint of operations to maximize efficiencies and continue to build-out the balanced revenue mix of P&C and Health & Welfare business.
In 2003, we completed six acquisitions of retail insurance brokers. In the first year of ownership we expect these acquisitions to add in excess of $25.0 million in revenues, $7.7 million in EBITDA and $2.6 million in Net Income in accordance with GAAP.
• the timing of executive benefits and enrollment sales with significant first year commissions; and
• the impact of variations or timing in recording contingent commissions in our Insurance Brokerage segment.
Our consolidated financial statements are prepared in accordance with GAAP, which require management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Some of our accounting policies require management’s judgment to estimate values of assets, liabilities, revenues or expenses. In addition, it may require significant judgment to apply complex principles of accounting to certain transactions, such as acquisitions, to determine the most appropriate accounting treatment. We believe the following significant accounting estimates and policies are material to our financial condition or results of operations and are subject to a higher degree of subjectivity and/or complexity. 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. If actual performance should differ from historical experience or if our assumptions were to change, it may materially impact our financial condition and results of operations.
Please read Note 1, “Nature of Operations and Summary of Significant Accounting Policies” to our consolidated financial statements for a description of other significant accounting policies.
We record commissions on premiums billed and collected directly by insurance companies and contingent commissions when we receive data from the insurance companies that allows us to reasonably determine these amounts. We are able to reasonably determine these amounts when we receive the cash, the notification of the amount due or the insurance policy detail from the insurance companies. We receive contingent commissions from insurance companies based on premium volume goals and/or the loss experience of the insurance placed with the insurance company.
We record fees and/or commissions related to benefit enrollment services when earned. We consider the earnings cycle complete when we have substantially completed our obligations under the service contract, we can reasonably estimate the revenue earned and when there is no significant collection risk. At the completion of an enrollment we record an estimate of first year fee and/or commission income less an estimate of policy cancellations.
We maintain an allowance for bad debts and estimated policy cancellations based on our premiums and commissions receivable. The policy cancellations component represents a reserve for future reversals of commission revenue on insurance policies in force at year-end and is established through a charge to revenues, while the bad debt component is established through a charge to other operating expenses. The allowance is determined based on estimates and assumptions using historical data to project future experience, and, in the case of bad debts, a specific identification of questionable items. We periodically review the adequacy of the allowance and make adjustments as necessary. Future additions to the allowance may be necessary based on changes in the trend of write-offs or cancellations which could increase due to changes in economic conditions and/or our clients’ financial condition and which may have a negative impact on our financial position or results of operations.
Future events could cause us to conclude that impairment of our goodwill or other intangible assets exists, which may have a material adverse effect on our financial position or results of operations.
We are subject to various claims, lawsuits and proceedings that arise in the normal course of business. We do not believe we are a party to any claims, lawsuits or legal proceedings that will have a material adverse effect on our reported financial position and results of operations. As further discussed in Note 15, “Contingencies” to our annual financial statements, we have accrued a liability for our best estimate of the probable cost of the resolution of these claims. This estimate has been developed in consultation with internal and external counsel that is handling our defense in these matters and is based upon a combination of litigation and settlement strategies. It requires management’s judgment to establish reserves for claims and litigation. To the extent additional information arises or our strategies change, it is possible that our estimate of our accrued liability in these matters may change, which could have a material adverse effect on our financial position and results of operations for any particular quarterly or annual period.
Our existing credit facility requires us to maintain financial covenants, which we set, with our lenders, based on our estimates of future operating results at that time. Future operating results and continued compliance with our debt covenants cannot be assured and our lenders’ actions are not controllable by us. Currently, based on our projections of future operating results, we do not expect to violate any such covenants. If our projections of future operating results are not achieved, resulting in a violation of our financial covenants for which our lenders do not provide a waiver or amendment, we could experience a material adverse effect on our reported financial position and results of operations for any particular quarterly or annual period.
Please read Note 1, “Nature of Operations and Summary of Significant Accounting Policies” to our consolidated financial statements for a discussion on the impact of the adoption of new accounting pronouncements.
(a) Please read the information under the caption “Integration Efforts and Other Charges” below for more details.
We present EBITDA because we believe that it is a relevant and useful indicator of our operating profitability. We believe EBITDA is relevant due to our leveraged capital structure and resulting significant amount of interest expense and due to our acquisition strategy and resulting significant amount of amortization of intangible assets. We present EBITDA Margin because we believe it is a relevant and useful indicator in understanding how we view our operating efficiency. We present Organic Revenue Growth and feel it is relevant because it allows us to discern year-over-year growth in revenues related to the success or failure of our ability to execute on our sales and client retention strategies.
Revenues. Revenues increased $26.6 million, or 8.1%, to $354.8 million in 2003 from $328.2 million in 2002. In 2003, Organic Revenue Growth was 4.7%, comprised of new business written, the positive impact of
higher premium rates on renewal commissions and increased contingent commissions of $3.1 million in our Insurance Brokerage segment, partially offset by the impact of lost and non-recurring business. The impact of acquisitions contributed approximately $11.0 million and zero to revenues in 2003 and 2002, respectively.
Income From Continuing Operations. Income from Continuing Operations increased $24.4 million, or 222.9%, to $35.3 million in 2003 from $10.9 million in 2002, due to (i) a reduction in Compensation and Employee Benefits Expenses principally due to the expenses attributable to our integration efforts and other charges in 2002, (ii) continued improvement in performance in our Insurance Brokerage segment, (iii) the reduction in interest expense principally due to the restructuring of our credit facility and lower borrowings in 2003, (iv) the net increase in income tax benefit due to the reversal of the valuation allowance on our net deferred tax asset in 2003, and (v) the positive impact of acquisitions, partially offset by (vi) a $7.7 million gain recorded in the third quarter of 2002 related to our pre-IPO capital structure. The effective tax rate from continuing operations in 2003 was (12.4)% compared to (5.0)% in 2002. The decrease in the effective tax rate and corresponding increased benefit in 2003 resulted from the reversal of the deferred tax asset valuation allowance, offset by the impact of state income taxes.
• General and specialty property and casualty insurance, which we refer to as P&C insurance; and
• Corporate management, acquisition processes, marketing, human resources, legal, capital planning, financial and reporting support.
For the year ended December 31, 2003, no segment had any material dependence on a single client or group of similar clients. Please see Note 13, “Business Concentrations” to our consolidated financial statements.
Specialized Benefits Services revenues decreased $0.7 million, or 1.4%, to $52.6 million in 2003 from $53.3 million in 2002, and increased $0.3 million, or 0.5%, to $53.3 million in 2002 from $53.0 million in 2001. The decrease in revenues in 2003 was due to a decrease in our core benefits product line primarily due to lost business, offset by an increase in our executive and professional benefits product line, principally due to the impact of one large case. The flat revenue growth in 2002 is due to a reduction in core benefit product sales and executive and professional benefit product sales resulting from difficult market conditions, offset by increases in enrollment and communication product sales. Specialized Benefits Services revenues represented 14.8%, 16.2% and 17.0% of our total consolidated revenues in 2003, 2002 and 2001, respectively.
EBITDA in the Specialized Benefits Services segment increased $0.6 million, or 5.7%, to $10.3 million in 2003 from $9.7 million in 2002 and decreased $3.2 million, or 24.6%, to $9.7 million in 2002 from $12.9 million in 2001. EBITDA Margin in the Specialized Benefits Services segment was 19.6%, 18.2% and 24.3% in 2003, 2002 and 2001, respectively. EBITDA and EBITDA Margin in the Specialized Benefits Services segment in 2003 increased primarily due to the integration efforts and other charges in 2002. EBITDA and EBITDA Margin in the Specialized Benefits Services segment in 2002 were negatively impacted by (i) a decrease in new business and an increase in lost business in our core benefits product sales and (ii) a decrease in new business in our executive and professional benefit product sales.
Income From Continuing Operations Before Income Taxes in the Specialized Benefit Services segment was $4.3 million, $2.7 million and $5.0 million for the years ended December 31, 2003, 2002 and 2001, respectively. The increase in 2003 was primarily due to the integration efforts and other charges in 2002. The decrease in 2002, compared to 2001, is due to the reasons noted 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 consolidated financial statements under “Goodwill and Other Intangible Assets.”
(a) Excludes the early retirement of debt (interest adjustment) in 2003 and 2002.
The Corporate segment results reflect the following integration efforts and other charges: $0.4 million, $3.9 million and $4.6 million in 2003, 2002 and 2001, respectively.
Revenues at the Corporate segment represent interest income. Net Corporate expenses were $19.1 million, $14.9 million and $26.4 million in 2003, 2002 and 2001, respectively. As a percentage of total consolidated revenues, net Corporate expenses were 5.4%, 4.5% and 8.5% in 2003, 2002 and 2001, respectively. In 2003 we recorded $2.9 million in expense related to the corporate office move and to consulting fees related to Sarbanes-Oxley Section 404 compliance preparation. Also, included in net Corporate expenses is zero, $1.0 million and $2.5 million in 2003, 2002 and 2001, 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. The increase in net Corporate expenses in 2003, compared to 2002, was primarily due to (i) the $7.1 million gain in 2002 from the change in value of redeemable common stock warrants and stock appreciation rights related to our pre-IPO capital structure, (ii) the move and Sarbanes-Oxley-related expenses in 2003, noted above and (iii) the increase in costs generally associated with being a public company, offset primarily by (iv) the integration efforts and other charges in 2002, (v) the expense on the value of stock options exchanged for stock appreciation rights in 2002 and (vi) the expense on the grant of restricted stock in 2002.
In 2000, we entered into a strategic marketing agreement with a technology company. The agreement was terminated by mutual consent in the fourth quarter of 2001, resulting in an accrual of $0.8 million.
valuation of SARs is based on the estimated fair value of a share of our common stock. In accordance with GAAP, compensation expense, or a reduction of compensation expense, for SARs is recorded over the vesting period based on the change in fair value from grant date to each balance sheet date. Please read Note 8, “Employee Benefit Plans” to our annual financial statements. We recorded a net reduction in SAR-related compensation expense of $3.0 million in 2002, resulting from a reduction in the fair market value of our common stock. We recorded SAR-related compensation expense of $3.1 million in 2001.
Upon the consummation of our initial public offering in October 2002, the Long-Term Incentive Plan was terminated and replaced with the 2002 Equity Incentive Plan.
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 our initial public offering. The 2002 Equity Incentive Plan reserves up to 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.
Upon the consummation of our initial public offering, approximately 0.1 million shares of restricted stock, 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 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 1996 senior subordinated debt offering that was repaid in 1999, agreed to terminate the put rights associated with the Redeemable Common Stock Warrants concurrent with the consummation of our initial public offering. The aggregate value of the warrants was $4.3 million and was reported as Redeemable Common Stock warrants on our balance sheet prior to the consummation of our initial public offering. The change in value of the warrants, which was recorded as change in value of redeemable common stock warrants in our statements of operations, was $(4.1) million and $1.4 million for 2002 and 2001, respectively.
amounts under our previously existing credit facility. As a result of repaying the previously existing credit facility, we recorded an expense of $4.0 million as early retirement of debt to reflect the prepayment penalty and the write-off of remaining deferred financing costs in the third quarter of 2003.
When considering our liquidity, it is important to note that 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. Additionally, the seasonality of some of our businesses, particularly in the Specialized Benefits segment, can create period-to-period fluctuations in our cash flows.
We believe that cash and cash equivalents on hand of $46.1 million and our availability under our revolving credit facility of $28.3 million as of December 31, 2003, together with cash flows generated from operations, should be sufficient to fund our estimated $18.7 million in debt principal repayments, working capital needs, acquisitions and budgeted $9.9 million in capital expenditures through December 31, 2004. Our liquidity thereafter will depend on our financial results and results of operations and future available sources of additional equity or debt financing. Our revolving credit facility provides us with availability of up to $30.0 million, all of which is available for general corporate purposes, including acquisitions. As of December 31, 2003 availability under the revolving credit facility was reduced by $1.7 million for outstanding 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-please review our “Risks Related to Our Business” in Item 1 of this report.
Cash and cash equivalents at year-end increased (decreased) $24.8 million, $(9.5) million and $29.2 million for the years ended December 31, 2003, 2002 and 2001, respectively. Net cash provided by operating activities
In August 2003, we completed a $155.0 million senior secured credit facility with several lending institutions. The credit facility is structured as follows: a $30.0 million revolving credit facility maturing on August 11, 2007, and a $125.0 million term loan payable in quarterly installments which commenced on October 31, 2003. The last quarterly installment is due on August 11, 2008, the maturity date of the term loan. The proceeds from borrowings under the credit facility were drawn to (i) repay all amounts under the previously existing credit facility, (ii) repay a portion of certain notes issued for acquisitions, (iii) pay fees and expenses in connection with the credit facility including a prepayment penalty in connection with the prepayment of the previously existing credit facility and (iv) for general corporate purposes. As a result of repaying the previously existing credit facility, we recorded an expense of $4.0 million as early retirement of debt to reflect the prepayment penalty and the write-off of remaining deferred financing costs in the third quarter of 2003.
The credit facility contains various limitations, including limitations on our ability to pay dividends and make other distributions to stockholders, borrowings and acquisitions. The credit facility also contains various financial covenants that must be met, including those with respect to fixed charges coverage and limitations on consolidated debt, net worth and capital expenditures. Failure to comply with the covenants may result in an acceleration of the borrowings outstanding under the facility. All of the stock of our subsidiaries and certain other identified assets are pledged as collateral to secure the credit facility. Additionally, each subsidiary guarantees our obligations under the credit facility. As of December 31, 2003 we had $1.7 million outstanding under letters of credit, which reduced the availability of our revolving credit facility to $28.3 million as of that date.
As a result of the new credit facility, we have improved our working capital position and improved our near term available cash flows. Working capital increased by $63.3 million to $70.6 million at December 31, 2003, compared to $7.3 million at December 31, 2002, principally due to the net cash proceeds received from the new credit facility and the reduction in current portion of long-term debt. The scheduled repayment of bank debt over the next twelve months was reduced by $19.5 million to $1.3 million at December 31, 2003, compared to $20.8 million at June 30, 2003.
As of December 31, 2003, we were in compliance with the covenants in our new credit facility. The significant financial covenants of our new credit facility were as follows:
We have structured our acquisition agreements to include contingent purchase price payments to be treated as adjustments to purchase price and capitalized when the contingency is resolved. At December 31, 2003, we estimate the future significant contingent purchase price payments to be $10.7 million, which would be payable in a combination of cash, common stock and debt. This amount primarily relates to one acquisition and will be reflected on our financial statements as a liability and additional purchase price when the contingency is resolved. Approximately $2.8 million of the future contingent purchase price payments have measurement dates of December 31, 2004. Please read “Acquisitions” above and Note 2, “Acquisitions” to our annual financial statements.
We routinely enter into employment agreements with management and executive level employees. Some of these contracts may provide for severance benefits in the event that we terminate the employment relationship without cause. Severance costs are expensed as incurred in accordance with GAAP.
Some of our common stockholders have various put rights that are exercisable upon specific events. Please read Note 7, “Redeemable Securities” to our annual financial statements.
We have audited the accompanying consolidated balance sheet of U.S.I. Holdings Corporation and subsidiaries as of December 31, 2003, and the related consolidated statements of operations, stockholders’ equity, and cash flows for the year then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audit.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of U.S.I. Holdings Corporation and subsidiaries at December 31, 2003, and the results of their operations and their cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of U.S.I. Holdings Corporation and subsidiaries at December 31, 2002 and the consolidated results of their operations and their cash flows for each of the two years in the period ended December 31, 2002 in conformity with accounting principles generally accepted in the United States.
The accompanying audited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP) and with the instructions to Form 10-K and Article 3 of Regulation S-X, and include all normal recurring adjustments, which the Company considers necessary for a fair presentation of the financial statements of such periods. The accompanying audited financial statements reflect the Company’s decision to discontinue the operations of its third-party administration business (USIA) in January 2002, as discussed further in Note 17-Discontinued Operations. The consolidated financial statements include the accounts of U.S.I. Holdings Corporation and its wholly owned subsidiaries. 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 and corporate-owned life and individual disability insurance are calculated as a percentage of corresponding premiums over the duration or term of the underlying policies. Traditionally, the majority of the commission revenue on these life and individual products, as well as on other traditional voluntary benefit products such as critical illness insurance, is recorded in the first year the insurance is placed, with the commissions recorded in renewal years being relatively insignificant.
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 allow the Company to reasonably determine these amounts. The Company is able to reasonably determine these amounts when it receives the cash, 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 based on premium volume goals and/or the loss experience of the insurance placed with the insurance company.
The Company records fees for consulting and administrative services over the period in which services are rendered.
The Company records fees and/or commissions related to benefit enrollment services when earned. The Company considers the earnings cycle complete when it has substantially completed its obligations under the service contract, it can reasonably estimate the revenue earned and when there is no significant collection risk. At the completion of an enrollment the Company records an estimate of first year fee and/or commission income less an estimate of policy cancellations.
The Company maintains an allowance for bad debts and estimated policy cancellations based on its premiums and commissions receivable. The policy cancellations component represents a reserve for future reversals of commission revenue on insurance policies in force at year-end and is established through a charge to revenues, while the bad debt component is established through a charge to other operating expenses. The allowance is determined based on estimates and assumptions using historical data to project future experience, and, in the case of bad debts, a specific identification of questionable items. The Company periodically reviews the adequacy of the allowance and makes adjustments as necessary. Future additions to the allowance may be necessary based on changes in the trend of write-offs or cancellations which could increase due to changes in economic conditions and/or the Company’s clients’ financial condition.
Depreciation of furniture and equipment is recorded using the straight-line method over the estimated useful lives of the related assets, which range from three to seven years. Leasehold improvements are amortized over the lesser of the life of the asset or the remaining lease term. Assets recorded under capital leases are amortized using the straight-line method over the lesser of the life of the asset or the term of the related lease.
Effective January 1, 2002, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 142 “Goodwill and Other Intangible Assets” (SFAS No. 142), which 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. Prior to January 1, 2002, goodwill was amortized on a straight-line basis over 25 years. The Company tests goodwill for impairment at least once per year, or if circumstances require, more frequently, using the two-step process prescribed in SFAS No. 142. The first step is a screen for potential impairment, while the second step measures the amount of the impairment, if any (see Note 3-Goodwill and Other Intangible Assets).
The Company accounts for stock-based compensation using the intrinsic value method prescribed by APB No. 25. Under the intrinsic value method, compensation cost is recognized only to the extent the fair market value of the stock at grant date is in excess of the amount that the employee must pay to acquire the stock.
The pro forma disclosures above only include the effect of options granted subsequent to October 25, 2002, the Company’s initial public offering date. Accordingly, the effects of applying the SFAS No. 148 pro forma disclosures to future periods may not be indicative of future effects.
The fair value for these options was estimated at the date of grant using the Black-Scholes option valuation model with the following weighted-average assumptions for 2003 and 2002:
The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company’s employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management’s opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee and director stock options.
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 2003, the Company eliminated the valuation allowance because it is more likely than not that all of the net deferred tax assets will be realized in the near future.
Cash and cash equivalents, fiduciary funds, premiums and commissions receivable, premiums payable to insurance companies, other current liabilities, current portion of long-term debt and long-term debt are considered financial instruments. Due to the short duration of certain financial instruments, specifically cash and cash equivalents, fiduciary funds, premiums and commissions receivable, premiums payable to insurance companies, other current liabilities and current portion of long-term debt, the carrying amounts approximate fair value. For long-term debt, the Company uses the present value of future cash flows, discounted at the Company’s current incremental rate of borrowing on similar debt, to ascertain a fair value. The fair value of the Company’s long-term debt approximates the carrying value of such debt because substantially all of the borrowings are at floating interest rates.
In April 2002, the Financial Accounting Standards Board (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. The Company adopted SFAS No. 145 on January 1, 2003 with no significant impact on its financial position or results of operations.
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 adopted SFAS No. 146 on January 1, 2003, which resulted in immaterial timing differences of when certain costs related to exit or disposal activities were recognized in 2003.
In January 2003, the FASB issued FIN 46, “Consolidation of Variable Interest Entities,” which clarified the application of Accounting Research Bulletin No. 51, “Consolidated Financial Statements.” FIN 46 defines a variable interest entity (VIE) as a corporation, partnership, trust or any other legal structure used for business purposes that has (i) an insufficient amount of equity for the entity to carry on its principal operations without additional subordinated support from other parties, (ii) a group of equity owners that do not have the authority to make decisions about the entity’s activities, or (iii) equity holders that do not absorb the entity’s losses or receive the residual returns of the entity. For new entities, FIN 46 was effective January 31, 2003. In October 2003, the FASB agreed to defer the effective date of FIN 46 for arrangements with VIEs existing prior to February 1, 2003 to fiscal periods ending after December 15, 2003. Subsequently, in December 2003, the FASB issued a revision of FIN 46 (FIN 46R), which replaced FIN 46, to address certain technical corrections and implementation issues that have arisen. The adoption of FIN 46R had no impact on the Company’s financial position or results of operations.
The basic structure for an acquisition by the Company generally includes employment agreements with the employee shareholders of the acquired company. Compensation under these agreements is generally in the form of a guaranteed salary plus an incentive-based bonus. Such amounts are expensed as incurred.
A reconciliation of reported income (loss) from continuing operations to adjusted net income (loss) from continuing operations and related basic and diluted earnings per share had SFAS No. 142 been applied beginning January 1, 2001 is as follows for the years ended December 31:
The adjustments to goodwill relate primarily to acquisitions and contingent purchase price payments on previous acquisitions. The Company records contingent purchase price payments as adjustments to goodwill when resolved.
In 2003 and 2002, the Company completed its annual impairment test and concluded that that the fair value of its net assets including goodwill exceeded its carrying value determined on a segment basis, hence no impairment charges were recorded for the years ended December 31, 2003 and 2002, respectively.
With the exception of goodwill, the Company has no intangible assets with indefinite lives.
Due to deteriorating operating results with low margins and high capital expenditure requirements, in the fourth quarter of 2001, the Company recorded a $46,900,000 impairment charge against goodwill and expiration rights related to its discontinued operations (see Note 17-Discontinued Operations).
Substantially all of the assets of the Company are pledged as collateral against long-term debt.
In August 2003, the Company completed a $155,000,000 senior secured credit facility with several lending institutions that replaced a $200,000,000 credit facility that was to expire on September 17, 2004. The credit facility is structured as follows: a $30,000,000 revolving credit facility maturing in August 2007, and a $125,000,000 term loan, payable in quarterly installments that commenced on October 31, 2003. The last quarterly installment is due in August 2008, the maturity date of the term loan. The proceeds from borrowings under the credit facility were drawn to (i) repay all amounts under the previously existing credit facility, (ii) repay a portion of certain notes issued for acquisitions, (iii) pay fees and expenses in connection with the credit facility including a prepayment penalty in connection with the prepayment of the previously existing credit facility, and (iv) for general corporate purposes. The Company incurred approximately $3,766,000 in fees and expenses related to the credit facility, which have been capitalized and are being recorded to interest expense over the term of the credit facility. Additionally, as a result of repaying the previously existing credit facility, the Company recorded an expense of $4,049,000 in the third quarter of 2003 related to the early extinguishment of debt. The expense reflected the prepayment penalty and the write-off of remaining deferred financing costs.
Borrowings under the term loan bear interest, at the Company’s option, at either a base rate plus 2.0% per annum or the Eurodollar rate plus 3.0% per annum. The base rate and the Eurodollar rate are effectively the prime rate and the London Interbank Offering Rate for the applicable period, respectively. The interest rate on the term loan was 4.13% at December 31, 2003.
On October 25, 2002, the Company completed its IPO of 9,000,000 shares at a price of $10.00 per share. The cash proceeds of the offering after the underwriting discount were $83,700,000. After deducting offering expenses of $5,264,000 the Company used $78,436,000 to pay down indebtedness under the previous credit facility. In connection with the debt repayment, the Company wrote off $1,950,000 in deferred financing costs, which was recorded in the fourth quarter of 2002.
In April 2002, after the Company completed the sale of USIA, discussed further in Note 17-Discontinued Operations, the Company repaid $16,300,000 of the term loan. In connection with the debt repayment, the Company wrote-off $660,000 in deferred financing costs, which was recorded in the second quarter of 2002.
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 interest based on the prime rate plus 0.50%, or 4.5% at December 31, 2003.
At December 31, 2003, future maturities of long-term debt, including obligations under capital leases, were as follows (dollars in thousands):
As of December 31, 2003, the authorized capital stock under the Company’s certificate of incorporation was 397,000,000 shares, of which 300,000,000 shares were voting common stock, par value $0.01 per share, 10,000,000 shares were non-voting common stock, par value $0.01 per share, and 87,000,000 shares were voting preferred stock, par value $0.01 per share.
At December 31, 2003, the Company had approximately 46,681,000 shares of voting common stock and zero shares of non-voting common stock outstanding.
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 $10.00 per share.
At December 31, 2003, 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 $10.00 per share (see Footnote 7-Redeemable Securities).
The following table summarizes certain information about the Company’s preferred stock at December 31, 2003, 2002 and 2001:
The original issuance cost of $21,302,000 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.
On July 1, 2003, in conjunction with the effective date of SFAS No. 150, the Company reviewed the classification of its redeemable common stock and reclassified these shares to common stock and additional paid-in capital. Additionally, the Company separately recognized the fair value of the put rights in liabilities (see Note 1-“Nature of Operations and Summary of Significant Accounting Policies”).
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 expired on March 14, 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 was $230,000 at December 31, 2002. Since the put rights were terminated, the value of the warrants was transferred from redeemable common stock to common stock in the fourth quarter of 2002. The change in the value of the warrants was $(4,070,000) and $1,406,000 for the years ended December 31, 2002 and 2001, respectively.
Upon consummation of the IPO, all redeemable preferred stock was converted to common stock.
In 1997, in connection with a former joint venture with JP Morgan Chase, the Company sold 923,000 shares of series N preferred stock to CBC Holding Ltd. (CBC), an affiliate of JP Morgan Chase, for $6,000,000. In October 1998, the Company sold 3,300,000 shares of series T preferred stock to CBD Holdings Ltd. (CBD), another affiliate of JP Morgan Chase, for $25,000,000, and CBC transferred its holdings of series N preferred stock to CBD.
In connection with the series N preferred stock purchase by CBC (which was subsequently transferred to CBD, along with all the related put rights), the Company granted CBC the right to put the preferred stock back to the Company upon the occurrence of certain events surrounding material changes in ownership of the Company.
The change in the put price is recorded as an adjustment to retained deficit and is reflected as an adjustment to the net loss in the computation of basic and diluted earnings per share (EPS) in 2002 and 2001. The change in the put price recorded as an adjustment to the Company’s accumulated deficit was $(138,000) and $138,000 the years ended December 31, 2002 and 2001, respectively.
employer match of $0.75 for each dollar contributed. The maximum employer match is 3% of a participant’s annual compensation.
Upon the consummation of the IPO, approximately 104,000 shares of restricted stock, which were fully vested, were granted to nine executive officers with a value of $1,042,000 that was recorded as an expense in the fourth quarter of 2002.
The following table summarizes certain information about the Company’s Incentive Plan:
The Company has granted non-qualified stock options to officers, employees and non-employee directors of the Company and its subsidiaries. The options are primarily granted at the fair value of the underlying shares at the date of grant. Options granted under the non-qualified plan become fully exercisable at the end of four years of continued employment. Options expire ten years from the date of grant, or earlier in the event of termination of the employee.
Total rental expense in 2003, 2002 and 2001 was approximately $15,595,000, $14,418,000 and $15,984,000, respectively.
At December 31, 2003, five insurance carriers were stockholders of the Company. For the year ended December 31, 2003, commissions earned on policies placed through these insurance carriers were approximately $34,401,000. At December 31, 2002 and 2001 seven insurance carriers were stockholders of the Company. For the years ended December 31, 2002 and 2001, commissions earned on policies placed through these insurance carriers were approximately $43,644,000 and $34,958,000, respectively.
The Company paid approximately $1,198,000, $2,240,000 and $1,144,000 to JP Morgan Securities Inc., an affiliate of J.P. Morgan Chase & Co., in fees relating to financing and other professional services for the years ended December 31, 2003, 2002 and 2001, respectively. JP Morgan Chase Bank is the syndicating agent and a significant participant on the existing credit facility which includes the $30,000,000 revolving credit facility and the $125,000,000 term loan (see Note 5-Long-Term Debt). CBD and JP Morgan Partners are affiliates of J.P. Morgan Chase & Co. and JP Morgan Chase Bank, and are stockholders of the Company.
In May 2001, the Company entered into a term loan agreement with its affiliate Zurich Services Corporation (see Note 5-Long-Term Debt). Zurich is a stockholder of the Company.
Additionally, a majority of the Company’s acquisition-related debt is payable to current employees of the Company.
For the year ended December 31, 2003, 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 has three reportable segments: insurance brokerage, specialized benefits services and corporate. The Company’s reportable segments are separately managed strategic business units that offer different products and services to different target markets.
USIA Litigation Matters. In 1997 and 1998, USIA, through its former subsidiary division Benefit Plan Administrators, Inc., (BPA), was the third-party administrator of health benefits for the employees of Nassau County, New York. In October 2001, the United States Attorney brought an indictment against several individuals, including the former CEO of BPA, alleging possible wrongdoing in the procurement and administration of contracts for third-party health care administrative services for employees of Nassau County. The Company and USIA, from the outset, cooperated fully with this investigation. Based on the facts and the cooperation of the Company and USIA in the government’s investigation, the United States Attorney issued a press release in October 2001 that included, among other matters, a statement that neither the Company nor USIA was responsible for any wrongdoing alleged in the indictment. In March 2002, a second superseding indictment was made public. The second superseding indictment added income tax evasion charges against several people, including the former CEO of BPA, and accused him of causing the Company to file false tax returns. In July 2003, the former CEO of BPA was charged in a new indictment with violating certain tax and currency transaction reporting laws. A superseding tax indictment was filed in October 2003. The Company cooperated fully in this investigation and none of the Company, USIA or any current management or employees was informed that such person was a target of this new investigation. The trial on these tax charges resulted in a conviction against the former CEO of BPA on all charges. On January 27, 2004, the former CEO of BPA pleaded guilty to conspiracy to bribe a Nassau County official and to launder money, which fully resolved this matter. After discussions with outside counsel, the Company understands that all of the matters addressed above are now fully resolved with no liability to the Company, USIA or any of its current management or employees.
In an effort to reduce operating expenses, in 2002 and 2001, the Company recorded charges of $5,511,000 and $9,642,000, respectively, related to future compensation costs for terminated employees, future producer compensation restructuring and future lease costs for terminated office leases. Additionally, in 2003, the Company recorded a charge of $396,000 for severance costs related to its corporate office move from San Francisco to New York.
In August 2003, the Company received and recorded cash proceeds of $3,250,000 in connection with the settlement of the $1,700,000 account receivable and the $13,000,000 note receivable. As a result of the terms of the settlement and after transaction costs, the Company recorded a gain in discontinued operations of $772,000 in the third quarter of 2003.
Mutual of Omaha Litigation. USIA, as the third-party administrator of health benefits for the employees of Nassau County, New York, placed stop-loss insurance with the Mutual of Omaha Insurance Company (Mutual). In 1999, Mutual brought an action against USIA asserting breach of contract, breach of warranty, fraud and negligent misrepresentation on the part of USIA arising out of contracts between Mutual and USIA. All claims in this litigation were settled pursuant to a settlement agreement dated as of November 30, 2001 and dismissed with prejudice pursuant to a stipulation of dismissal with prejudice filed with the court on December 17, 2001. Pursuant to the settlement agreement, USIA’s insurer, Fireman’s Fund, paid Mutual $2,216,667. No payment by USIA was required. However, as a result of the settlement in 2001, USIA wrote off a $1,000,000 commission receivable from Mutual recorded over a four-year period from 1995 through 1999. This write-off is reflected in the results from discontinued operations included in the accompanying statement of operations for the year ended December 31, 2001.
The following table sets forth the computation of basic and diluted earnings per share giving effect to the reverse stock split (see Note 6):
For additional disclosures regarding the aggregate liquidation preference of preferred stock and the series N put options (see Note 6-Stockholders’ Equity and Note 7-Redeemable Securities).
For the years ended December 31, 2002 and 2001 dilutive shares of 17,000 and 30,698,000, respectively, were not included in diluted weighted-average shares outstanding because the effects would have been
antidilutive. Additionally, for each of years ended December 31, 2003, 2002 and 2001, the 2,500,000 warrants were not included in diluted weighted-average shares outstanding because the effects would have been antidilutive.
(1) The quarterly earnings per share amounts, when added, may not coincide with the full year earnings per share reported on the Consolidated Statements of Operations due to differences in the computed weighted-average shares outstanding as well as rounding differences.
The net loss in the quarter ended March 31, 2002 was predominantly the result of the 2002 efficiency initiative charge of $5,511,000 (see Note 16-Efficiency Initiative and Other Accruals).
stock, preferred stock or debt securities, stock purchase contracts, stock purchase units or any combination of such securities. Upon effectiveness of the registration, one or more of these securities may be offered in amounts, prices, and on terms to be announced when and if the securities are offered. The specifics of any future underwritten offerings, along with the use of proceeds of any securities offered, will be described in detail in a prospectus supplement at the time of any such offering.