The following table sets forth certain information with respect to the principal facilities used in the Company's operations:
(1) Each of these facilities is leased or subleased from BIG. (2) The Company has the option to renew each of these leases for an additional two-year period. (3) The Company is currently negotiating with BIG to reassign this lease to BIG as of the summer of 1999. No assurances can be given that such assignment will occur. (4) The Company has the option to renew each of these leases for an additional five-year period.
Insurance Management Solutions Group, Inc. (together with its subsidiaries, the "Company") is a holding company that was incorporated in the State of Florida in December, 1996 by Bankers Insurance Group, Inc. (together with its subsidiaries, "BIG"), which contributed to the Company two of its wholly-owned operating subsidiaries, Insurance Management Solutions, Inc. ("IMS") and Bankers Hazard Determination Services, Inc. ("BHDS"), that were previously formed in August, 1991 and June, 1988, respectively. BIG is a diversified group of P&C insurance companies with premium writings in all fifty states. BIG's principal lines of business include flood, homeowners and automobile insurance lines. From 1994 to 1998, BIG experienced substantial growth in total written premiums from $131 million to $284 million.
Effective January 1, 1998, the Company entered into written service agreements with BIG which modified the existing arrangements to (i) expand the services provided by the Company to include policy administration for certain automobile lines of business, (ii) recognize claims outsourcing revenue based not on a cost reimbursement basis, but rather on a percentage of earned premiums and, with respect to certain types of claims, a percentage of incurred losses, and (iii) implement a change in fee structure from a percentage of incurred loss to a percentage of earned premiums with respect to homeowners claims services. These changes were negotiated in order to effect more uniform revenue recognition. To obtain BIG's agreement to such changes, the Company, in turn, agreed to the revised fee structure with respect to homeowners claims services. BIG presently accounts for approximately 95% of the Company's outsourcing services revenues and is
The cost of outsourcing services primarily includes wages and related benefits associated with personnel who perform policy and claims administration services, as well as postage and telephone charges, data processing and other direct costs associated with providing service to customers.
Cost of flood zone determination services primarily includes wages and related benefits associated with personnel who perform flood zone determination services, telephone expenses, general liability insurance, data processing and other direct costs associated with providing service to customers. Due to the ongoing automation of the Company's flood zone database, a gradual increase in the number of automated flood zone determinations, versus manually determined flood zones, has occurred. Automated flood zone determinations cost less for the Company to perform than manually generated determinations.
Selling, general and administrative expenses include the wages and related benefits of sales and marketing, executive, finance and accounting personnel, as well as other general operating costs. In addition, wages and related benefits of the management staff of each processing department (i.e. Customer Service, Claims, and Information Services) are included in selling, general and administrative expenses.
The Company presently purchases certain services, including human resources, internal audit and legal services, from BIG. If the Company develops the capability to provide these services internally, certain sales and administrative support costs may fluctuate.
Depreciation and Amortization Expense. Depreciation and amortization expense increased $3.6 million, or 530.6%, to $4.3 million in 1998 from $684,000 in 1997 primarily as a result of depreciation related to assets consisting of telephone equipment and computer hardware and software, transferred and assigned to the Company in April, 1998 for use in its business. Prior to April 1, 1998, the depreciation for such equipment, which totaled $282,015 and $762,260 during 1998 and 1997, respectively, was charged to the Company under an arrangement similar to an operating lease and is included in cost of outsourcing services. Also, 1998 reflects amortization of additional goodwill related to the purchase of the remaining 51% of Geotrac in July, 1998, as well as amortization of goodwill and depreciation related to the inclusion of both Geotrac and BHDS for 1998 as compared with the expenses of BHDS only for 1997.
Provision for Income Taxes. The Company's effective income tax rates were 44.1% and 38.3%, in 1998 and 1997, respectively. Income before income taxes in 1998, excluding minority interest, resulted in an effective income tax rate of 41.3%. This effective rate reflects the impact of a minority interest presented net of tax and other items discussed in Note 10 to the Consolidated Financial Statements of the Company.
Flood Zone Determination Services Revenues. Flood zone determination services revenues increased $1.1 million, or 14.1%, to $8.8 million in 1997 from $7.7 million in 1996. The increase in revenues was due to the increase in determinations performed, offset by a decrease of approximately 6.0% in the average fee per determination as a result of competitive pressures.
Management Services from Parent. Management services from Parent increased $1.3 million, or 122.4%, to $2.3 million in 1997 from $1.1 million in 1996. The increase is primarily related to the expansion of the Company's services during 1997 to include policy and claims administration. Prior to 1997, the Company mainly provided data processing services to its affiliates. The expansion of services resulted in a significant need for additional space and human resource services, which were included in the management services allocation.
Interest Expense. Interest expense increased $303,000 or 402.5%, to $379,000 in 1997 from $75,000 in 1996 as a result of increased borrowings used to fund the Company's capital expenditures.
Equity in Earnings of Geotrac, Inc. During July 1997, the Company purchased a 49% interest in Old Geotrac. Equity in earnings of Old Geotrac contributed $201,000 to the earnings of the Company in 1997.
The Company has historically funded its operations through cash generated from operations and receipt of service fees advanced from BIG. Bank borrowings have been used to finance fixed asset purchases. Net cash provided by operating activities during 1996, 1997 and 1998 was $963,000, $7.7 million and $2.4 million, respectively. The significant increase in net cash provided by operating activities in 1997 was primarily attributable to the increased level of net income, employee-related accrued expenses and income taxes payable to BIG.
Net cash used in investing activities during 1996, 1997 and 1998 was $1.0 million, $8.2 million and $237,000, respectively. In July 1997, BHDS issued $6.75 million in non-cumulative, 8% Preferred Stock. The proceeds from the sale of the Preferred Stock were used to fund the purchase of the Company's 49% interest in Old Geotrac. In May 1998, the Company repurchased the outstanding Preferred Stock in exchange for a note. The note is currently payable in its entirety on August 25, 2002 and accrues interest at a rate of 8.566%. A portion of the net proceeds from the initial public offering was used to repay the note.
Net cash provided by (used in) financing activities during 1996, 1997 and 1998 was $12,000, $681,000 and $(425,000), respectively. During 1996, 1997 and 1998, the Company paid cash dividends to BIG totaling $1.0 million, $3.5 million and $1.1 million, respectively. Additionally, during 1998, the Company repaid $5.3 million in debt. Net advances (from) to BIG were $(35,000), $(5.1) million and $6.7 million during 1996, 1997 and 1998, respectively.
The Company believes that cash flows from operations and net proceeds from its initial public offering completed in February, 1999 will not only satisfy working capital needs for 1999 but will also be sufficient to retire or redeem most existing debts of the Company. Unanticipated rapid expansion, business or systems development, or potential acquisitions may cause the Company to require additional funds. In addition, prior to the initial public offering, the Company at times relied upon advances against the service fees it charges its affiliates to support working capital needs, which included payroll, particularly with respect to certain members of the management team who had previously allocated or divided their duties between the Company and the affiliates. Since the initial public offering, the Company has discontinued this practice. The Company is in the process of negotiating a revolving line of credit with a bank that will be used to refinance existing debt and to provide bridge financing for working capital or acquisition needs. The Company identifies and assesses, in the normal course of its business, technologies or businesses which it believes to strategically fit its business plan. The Company has no current commitments with respect to any such transaction. The Company may, however, enter into such transactions should opportunities present themselves in the future.
The Company is currently addressing a universal situation commonly referred to as the "Year 2000 Problem." The Year 2000 Problem relates to the inability of certain computer software programs to properly recognize and process date-sensitive information relative to Year 2000 and beyond, and the inability of non-information technology systems to function properly when the Year 2000 arrives.
Outsourcing Operations. With respect to both information technology ("IT") and non-information technology ("non-IT") systems associated with its outsourcing operations, the Company has developed a detailed Year 2000 Project Plan (the "Plan") and is in the process of carrying out the Plan. An independent accounting firm has been engaged to validate the Plan. The Plan calls for testing, validation and modification of the Company's systems in order to ensure Year 2000 compliance. For IT hardware systems, the Plan addresses the Year 2000 Problem with respect to: production servers; imaging servers; communication servers;
development servers; Q&A servers; wide-area network and network infrastructure; AS/400 processors and tape drives; desk-top personal computers; telecommunications equipment, including voice, fax and modems; and printers. For IT software systems, this Plan addresses the Year 2000 Problem with respect to: AS/400 operating and applications systems; personal computer applications software, including spreadsheets, "macros," "uploads" and "downloads"; and electronic forms. Testing has commenced and is expected to continue through the first three quarters of 1999. The Company is already issuing policies with terms extending beyond the Year 2000 and believes it will not experience any difficulty in processing business on its core processing systems.
For non-IT Systems, the Plan provides for testing of elevators, generators, utilities, card key access, alarms, uninterrupted power source, air conditioning/heating units and thermostats. Non-IT systems testing is underway and is expected to be completed during the third quarter of 1999.
The Plan also provides for certification of Year 2000 compliance by the Company's business partners. Such partners provide office supplies, paper supplies, copy center support, off-site tape management and disaster recovery services. The Plan also provides for detailed questionnaires and follow-up letters to be sent to all outside software vendors requiring responses, and ultimately certification, as to their Year 2000 readiness. A review of these responses by Company management will lead to decisions regarding the retention or replacement of vendors and/or their products. Such decisions are expected to be made prior to June 30, 1999. The Company will replace such vendors and products if it believes their state of Year 2000 readiness poses a risk to the Company sufficient to warrant doing so. The Company does not anticipate any difficulty in securing adequate replacements for such vendors or products.
Costs associated with addressing the Year 2000 Problem were immaterial prior to 1998. For internally built applications software, the Company has consistently accounted for the Year 2000 date as a normal part of program development. Nearly all costs associated with addressing the Year 2000 Problem are internal expenses, with the exception of the costs of engaging the independent accounting firm. The Company currently estimates direct costs associated with addressing the Year 2000 Problem for its outsourcing operations to be in the range of $300,000 to $400,000. The Company does not anticipate the total replacement of any core system. In the event an outside vendor's software is targeted for replacement, the Company may incur additional costs relating to the purchase price of new software (which may be inflated if demand is high), conversion of data to the new system, and training of personnel on the new system. Management does not expect these costs to materially adversely affect the Company's business or financial condition.
The most reasonably likely worse case scenario for the Company's outsourcing operation is the possibility that the Company will be required to process manually applications for insurance, which will result in increased costs of issuing insurance policies. Manually-processed applications would increase data entry and also increase customer service intervention as representatives of the Company seek to obtain complete and accurate customer information in order to issue correct insurance policies. These increased responsibilities may require overtime on the part of customer service representatives and supervisors. Moreover, the Company may be required to perform additional internal cash processing if its lockbox vendor is required to operate in a manual environment. The flood insurance product may require manual flood zone searches in lieu of automatic determinations in the event such automated flood zone processes become unavailable. In addition, the Company may be required, for a period of time, to issue manual checks for return premiums, claims payments and producers' commissions as well as to perform manual policy assembly. Such activities may result in a substantial increase in overtime wages for a significant percentage of the Company's workforce as well as require the addition of a significant number of temporary employees. Non-computer generated forms, manual check stock, retrieval of physical records rather than electronic facsimiles and manual processing would supplant computer processing until such systems are adapted to address the Year 2000 Problem. Risks associated with a manual environment as described above could have a material adverse effect on the Company's business, financial condition or results of operations.
The Company will develop a contingency plan to deal with situations which may require manual processing. This plan, expected to be developed in the first half of 1999, will incorporate each processing department's needs in the event it must convert to manual systems from automated systems. Such needs may
Flood Zone Determination Operations. The Company has also adopted a detailed plan (the "Project Plan") to address the Year 2000 Problem with respect to its flood zone determination operations. The Project Plan also calls for testing, validation and modification of the IT and non-IT systems associated with the Company's flood zone determination operations in order to ensure Year 2000 compliance.
The non-IT systems used in the Company's flood zone determination operations include: internal telephone systems, auxiliary power supplies, security systems, environmental control systems, and postal equipment. The Company has contacted the various vendors providing such systems regarding validation of their systems. This project is expected to be completed by July 31, 1999.
The Company has a number of flood zone determination clients with which it electronically exchanges data. The clients that use a proprietary method for communicating data have been contacted by the Company regarding their need to upgrade their interfaces. Most of the Company's flood zone determination clients utilize its Compass product line. Version 3.x of that software has been tested and verified for Year 2000 compliance. Users of non-compliant versions of such software are expected to be upgraded to Year 2000 compliant versions by September 30, 1999.
The Company is in the process of developing a contingency plan relating to manual preparedness in the event of the impairment of its flood zone determination IT systems. This plan involves construction of adequate staffing models that provide an accurate indication of the number of additional employees required to process determinations manually on a short-term basis. The plan also addresses potential alternative forms of data exchange, such as faxes and data tapes.
The following financial statements of Geotrac, Inc. (formerly YoSystems, Inc.) ("Old Geotrac") and its independent certified public accountants' report are set forth on pages 60 through 72 of this report:
Report of Independent Certified Public Accountants. Balance Sheet as of December 31, 1997. Statement of Income for the year ended December 31, 1997. Statement of Shareholders' Equity for the year ended December 31, 1997. Statement of Cash Flows for the year ended December 31, 1997. Notes to Financial Statements.