8-K 1 form8-k.txt FORM 8-K FOR JULY 1, 2002 ================================================================================ SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ----------- FORM 8-K CURRENT REPORT Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 Date of Report: July 1, 2002 (Date of earliest event reported) HILB, ROGAL AND HAMILTON COMPANY (Exact Name of Registrant as Specified in its Charter) Virginia 0-15981 54-1194795 (State or Other Jurisdiction (Commission File Number) (IRS Employer of Incorporation) Identification No.) 4951 Lake Brook Drive, Suite 500 Glen Allen, Virginia 23060 (Address of Principal Executive Offices) (Zip Code) Registrant's telephone number, including area code: (804) 747-6500 ================================================================================ Item 2. Acquisition or Disposition of Assets. On July 1, 2002, Hilb, Rogal and Hamilton Company (the "Company") acquired (i) all of the issued and outstanding membership interest units of Hobbs Group, LLC ("Hobbs") other than those owned by Hobbs IRA Corp. ("HIRAC"), and (ii) all of the issued and outstanding capital stock of HIRAC (collectively, the "Acquisition") pursuant to a Purchase Agreement (the "Purchase Agreement"), dated May 10, 2002, by and among the Company, Hobbs, the members of Hobbs (other than HIRAC) and the shareholders of HIRAC. HIRAC was created by Hobbs to permit certain of its investors and employees to own interests in Hobbs through individual retirement accounts. Hobbs, which is based in Atlanta, Georgia, is one of the nation's premier independent insurance brokers serving upper middle-market and top-tier clients and provides property and casualty insurance brokerage, risk management, executive compensation and employee benefits services. As a result of the Acquisition, each of Hobbs and HIRAC became a wholly-owned subsidiary of the Company. The purchase price that the Company paid in connection with the Acquisition consists of (i) approximately $114.2 million in cash, which includes the Company's assumption and retirement of certain debt of Hobbs, and (ii) the issuance to the members of Hobbs (other than HIRAC) and the shareholders of HIRAC of an aggregate of 719,729 shares of the Company's common stock ("Common Stock"). In addition, the Company has agreed to pay up to approximately $101.9 million in cash and shares of Common Stock contingent on Hobbs' achieving certain financial performance goals within the next two years. The Company has further agreed to assume and satisfy certain existing earn-out and deferred compensation obligations of Hobbs from Hobbs' prior acquisitions estimated to approximate a net present value of $30 million. The various components of the purchase price were determined by arms-length negotiations between the parties. Based upon a value for the 719,729 shares of Common Stock of $31.6 million, the aggregate purchase price paid by the Company to the members of Hobbs (other than HIRAC) and the shareholders of HIRAC at the closing of the Acquisition was approximately $146.6 million, excluding potential earn-out and other future payments. For information on the estimated aggregate acquisition cost to be recorded by the Company for accounting purposes, see footnote 1 to the Pro Forma Condensed Combined Financial Statements set forth in "Item 7(b), Pro Forma Financial Information" below. In connection with the consummation of the Acquisition, the Company agreed to increase the size of the Board of Directors from 13 to 14 and to elect Thomas A. Golub, who serves as President and Chief Executive Officer of Hobbs, as a director and Executive Vice President of the Company. As of the close of business on July 1, 2002, the total number of shares of Common Stock issued and outstanding was 29,311,009. The 719,729 shares of Common Stock acquired by the members of Hobbs (other than HIRAC) and the shareholders of HIRAC at the closing of the Acquisition represent approximately 2.45% of the issued and outstanding shares of Common Stock as of that date. In addition, on July 1, 2002, the Company entered into a Second Amended and Restated Credit Agreement (the "Amended Credit Agreement"), dated as of July 1, 2002, among the Company, as Borrower; the lenders named therein; Wachovia Bank, National Association (formerly known as First Union National Bank), as administrative agent; PNC Bank, National Association, as documentation agent; and Bank of America Securities, LLC, as syndication agent. The Amended Credit Agreement amends and restates an Amended and Restated Credit Agreement, dated as of April 6, 2001, among the parties, and provides for a credit facility of up to an aggregate of $260.0 million. In particular, the Amended Credit Agreement (i) maintains the availability to the Company of a revolving credit facility in the aggregate principal amount of $100.0 million and (ii) increases the availability to the Company of a term loan facility from an aggregate principal amount of $60.0 million to an aggregate principal amount of $160.0 million. Pursuant to the Amended Credit Agreement, the increased term loan facility was made available (i) to finance the $114.2 million cash payment in connection with the Acquisition and (ii) for working capital and general corporate purposes. The Amended Credit Agreement contains certain covenants that restrict, or may have the effect of restricting, the payment of dividends or distributions, and the purchase or redemption by the Company of its capital stock. Management does not believe that the restrictions contained in the Amended Credit Agreement will, in the foreseeable future, adversely affect the Company's ability to pay cash dividends at the current dividend rate. However, there can be no assurance in this regard. Item 7. Financial Statements, Pro Forma Financial Information and Exhibits. (a) Financial Statements of Businesses Acquired. The following financial statements of Hobbs and its subsidiaries are included in this report: (i) Report of Independent Auditors Combined Balance Sheets as of December 31, 2001 and 2000 Combined Statements of Operations for the Years Ended December 31, 2001, 2000 and 1999 Combined Statements of Changes in Shareholders' Equity (Deficit) for the Years Ended December 31, 2001, 2000 and 1999 Combined Statements of Cash Flows for the Years Ended December 31, 2001, 2000 and 1999 Notes to Combined Financial Statements (ii) Combined Balance Sheets as of March 31, 2002 (unaudited) and December 31, 2001 Combined Statements of Operations for the Quarters Ended March 31, 2002 and 2001 (unaudited) Combined Statements of Cash Flows for the Quarters Ended March 31, 2002 and 2001 (unaudited) Notes to Combined Interim Financial Statements (unaudited) COMBINED FINANCIAL STATEMENTS Hobbs Group, LLC Years ended December 31, 2001, 2000 and 1999 with Report of Independent Auditors Hobbs Group, LLC Combined Financial Statements Years ended December 31, 2001, 2000 and 1999 Contents Report of Independent Auditors.................................................1 Combined Financial Statements Combined Balance Sheets........................................................2 Combined Statements of Operations..............................................4 Combined Statements of Changes in Shareholders' Equity (Deficit)...............5 Combined Statements of Cash Flows..............................................7 Notes to Combined Financial Statements.........................................8 Report of Independent Auditors Board of Directors Hobbs Group, LLC We have audited the accompanying combined balance sheets as of December 31, 2001 and 2000, of the entities listed in Note 1, and the related combined statements of operations, changes in shareholders' equity (deficit) and cash flows for each of the three years in the period ended December 31, 2001. These financial statements are the responsibility of the Companies' management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the combined financial position at December 31, 2001 and 2000, of the entities listed in Note 1, and the combined results of their operations and their cash flows for each of the three years in the period ended December 31, 2001 in conformity with accounting principles generally accepted in the United States. /s/ Ernst & Young LLP Atlanta, Georgia February 15, 2002 1 Hobbs Group, LLC Combined Balance Sheets
December 31 2001 2000 -------------------------------------------- Assets Current assets: Cash and cash equivalents $ 6,155,350 $ 3,134,814 Cash and cash equivalents held in a fiduciary capacity 23,899,571 22,755,903 Premiums and commissions receivable, less allowance for doubtful accounts - (2001 - $589,000; 2000 - $401,000) 61,027,107 33,143,246 Accounts receivable 987,813 685,849 Prepaid assets 986,015 1,097,149 Income taxes receivable - 76,157 -------------------------------------------- Total current assets 93,055,856 60,893,118 Investments 68,843 68,843 Furniture, equipment and leasehold improvements, less accumulated depreciation - (2001 - $4,166,000; 2000 - $2,966,000) 2,567,818 3,041,971 Goodwill and other intangible assets, less accumulated amortization - (2001 - $16,838,000; 2000 - $11,573,000) 63,355,545 67,203,160 Other assets 555,852 434,754 -------------------------------------------- Total assets $159,603,914 $131,641,846 ============================================
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December 31 2001 2000 -------------------------------------------- Liabilities and shareholders' deficit Current liabilities: Premiums due to insurance companies $ 69,016,144 $ 49,122,915 Commissions expense payable 3,441,127 1,376,679 Accounts payable and accrued expenses 12,989,980 4,712,177 Income taxes payable 39,292 - Current portion of long-term debt 6,520,456 335,282 Unearned commission income 2,439,365 1,966,723 -------------------------------------------- Total current liabilities 94,446,364 57,513,776 Long-term debt, less current portion 36,801,022 52,092,749 Other long-term liabilities 2,536,830 1,167,193 -------------------------------------------- Total liabilities 133,784,216 110,773,718 Minority interests 436,697 150,843 Commitments and contingencies Redeemable preferred shares; no par value: Issued and outstanding shares - (2001 - 363,196; 2000 - 363,196) 25,819,567 20,243,573 Special common shares; no par value: Issued and outstanding shares - (2001 - 7,867; 2000 - 50,000) 550,690 1,750,000 Shareholders' deficit: Voting common shares; no par value: Issued and outstanding shares - (2001 - 346,881; 2000 - 361,829) 4,072,428 3,439,225 Nonvoting common shares, no par value: Issued and outstanding shares - (2001 - 913,640; 2000 - 876,303) 13,201,914 12,568,006 Texas and Canada common shares, $1 par value: Issued and outstanding shares - (2001 - 1,029; 2000 - 1,029) 1,029 1,029 Additional paid-in-capital 1,000 1,000 Accumulated other comprehensive income 13,276 84,709 Deferred compensation (1,384,339) (581,258) Retained earnings (deficit) (16,892,564) (16,788,999) -------------------------------------------- Total shareholders' deficit (987,256) (1,276,288) -------------------------------------------- Total liabilities and shareholders' deficit $159,603,914 $131,641,846 ============================================
See accompanying notes. 3 Hobbs Group, LLC Combined Statements of Operations
Year ended December 31 2001 2000 1999 ------------------------------------------------------------- Revenues: Net commissions and fees $94,232,835 $72,281,363 $55,718,035 Interest income 833,802 1,130,075 1,110,224 Other 158,030 200,099 779,156 ------------------------------------------------------------- 95,224,667 73,611,537 57,607,415 Operating expenses: Employee compensation and benefits 55,614,459 41,209,700 34,153,970 Travel and entertainment expense 4,108,033 4,776,456 3,595,931 Management, legal and accounting services 1,727,702 2,979,412 3,780,214 Office equipment leases and supplies 2,073,261 2,030,691 1,710,525 Rent and utilities 5,293,256 4,566,795 3,489,084 Other 3,448,907 3,667,847 3,276,997 ------------------------------------------------------------- 72,265,618 59,230,901 50,006,721 ------------------------------------------------------------- 22,959,049 14,380,636 7,600,694 Other expenses: Interest expense 4,316,309 5,848,182 3,520,700 Depreciation 1,200,258 1,179,019 926,135 Amortization of goodwill and other intangible assets 5,298,460 5,280,064 3,692,618 ------------------------------------------------------------- Income (loss) before income taxes, extraordinary item and minority interests 12,144,022 2,073,371 (538,759) Income tax expense 1,390,191 815,035 643,640 ------------------------------------------------------------- Income (loss) before extraordinary item and minority interests 10,753,831 1,258,336 (1,182,399) Extraordinary item - loss on extinguishment of debt - - 1,380,862 ------------------------------------------------------------- Income (loss) before minority interests 10,753,831 1,258,336 (2,563,261) Minority interests 594,882 242,405 378,202 ------------------------------------------------------------- Net income (loss) $10,158,949 $ 1,015,931 $(2,941,463) =============================================================
See accompanying notes. 4 Hobbs Group, LLC Combined Statements of Changes in Shareholders' Equity (Deficit)
Accumulated Total Additional Other Retained Shareholders' Common Shares Paid-In-Capital Comprehensive Deferred Earnings Equity (Deficit) Income (Loss) Compensation (Deficit) --------------------------------------------------------------------------------------------- Balance at January 1, 1999 $11,043,479 $1,000 $ 9,276 $ - $ (1,733,382) $ 9,320,373 Comprehensive loss net of tax: Net loss - - - - (2,941,463) (2,941,463) Foreign currency translation - - 118,191 - - 118,191 -------------- Comprehensive loss (2,823,272) Issuance of common shares 4,704,220 - - - - 4,704,220 Redemption and forfeiture of common shares (1,086,180) - - - (3,214,923) (4,301,103) Redeemable preferred shares issuance cost amortization - - - - (105,327) (105,327) Accretion of redeemable preferred shares - - - - (2,249,999) (2,249,999) Distributions declared to shareholders - - - - (1,660,643) (1,660,643) --------------------------------------------------------------------------------------------- Balance at December 31, 1999 14,661,519 1,000 127,467 - (11,905,737) 2,884,249 Comprehensive income net of tax: Net income - - - - 1,015,931 1,015,931 Foreign currency translation - - (42,758) - - (42,758) --------------- Comprehensive income 973,173 Issuance of common shares 1,620,041 - - - - 1,620,041 Deferred compensation: Shares restricted - vesting - - - (915,270) - (915,270) Amortization - - - 334,012 - 334,012 ----------------- --------------- Deferred compensation (581,258) (581,258) Redemption and forfeiture of common shares (273,300) - - - (136,840) (410,140) Redeemable preferred shares issuance cost amortization - - - - (140,437) (140,437) Accretion of redeemable preferred shares and special common shares - - - - (4,699,998) (4,699,998) Distributions declared to shareholders - - - - (921,918) (921,918) --------------------------------------------------------------------------------------------- Balance at December 31, 2000 16,008,260 1,000 84,709 (581,258) (16,788,999) (1,276,288)
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Accumulated Total Additional Other Retained Shareholders' Common Shares Paid-In-Capital Comprehensive Deferred Earnings Equity (Deficit) Income (Loss) Compensation (Deficit) -------------------------------------------------------------------------------------------- Comprehensive loss net of tax: Net income - - - - 10,158,949 10,158,949 Foreign currency translation - - (71,433) - - (71,433) --------------- Comprehensive income - - - - - 10,087,516 Issuance of common shares 1,692,138 - - - - 1,692,138 Deferred compensation: Shares restricted - vesting - - - (1,390,133) - (1,390,133) Amortization - - - 587,052 - 587,052 ----------------- --------------- Deferred compensation - - - (803,081) - (803,081) Redemption and forfeiture of common shares (425,027) - - - (671,941) (1,096,968) Redeemable preferred shares issuance cost amortization - - - - (140,437) (140,437) Accretion of redeemable preferred shares and special common shares - - - - (5,710,902) (5,710,902) Redemption of special common shares - - - - 337,064 337,064 Distributions declared to shareholders - - - - (4,076,298) (4,076,298) --------------------------------------------------------------------------------------------- Balance at December 31, 2001 $17,275,371 $1,000 $ 13,276 $(1,384,339) $(16,892,564) $ (987,256) ============================================================================================= See accompanying notes.
6 Hobbs Group, LLC Combined Statements of Cash Flows
Year ended December 31 2001 2000 1999 ------------------------------------------------------------- Operating activities Net income (loss) $ 10,158,949 $ 1,015,931 $ (2,941,463) Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation and amortization 6,498,718 6,459,083 4,618,753 Extraordinary item - loss on extinguishment of debt - - 1,380,862 Minority interests - net of distributions 285,854 1,959 90,310 Expenses related to share issuance 587,052 386,490 2,629,638 Amortization of debt issuance costs 211,762 210,266 135,126 Gain on disposition of business - - (502,242) Changes in operating assets and liabilities: Premiums and commissions receivable (27,883,861) (9,730,476) 4,007,154 Prepaid assets 46,633 (306,852) 477,214 Accounts receivable (301,964) 350,830 (641,543) Premiums due to insurance companies 19,893,229 15,927,939 (1,752,545) Commissions expense payable 2,064,448 (655,934) 1,474,165 Accounts payable and accrued expenses 7,148,923 (1,147,866) 573,669 Other assets and other liabilities 1,198,892 (2,187,909) 308,789 ------------------------------------------------------------- Net cash provided by operating activities 19,908,635 10,323,461 9,857,887 Investing activities Purchase of businesses, net of cash acquired (191,032) (7,755,528) (24,348,776) Disposition of business 37,296 - 1,253,000 Purchase of investments - - - Purchase of furniture, equipment and leasehold improvements (726,105) (1,665,274) (1,049,117) ------------------------------------------------------------- Net cash used in investing activities (879,841) (9,420,802) (24,144,893) Financing activities Proceeds from issuance of long-term debt 4,000,000 4,764,872 46,704,761 Repayments of long-term debt (13,335,282) (5,266,757) (28,409,437) Proceeds from issuance of redeemable preferred shares - - 14,297,812 Proceeds from issuance of common shares - - 744,556 Redemption of common shares (1,080,000) (107,020) (4,301,103) Redemption of special common shares (1,137,591) - - Distributions to shareholders (3,311,717) (732,087) (1,158,613) ------------------------------------------------------------- Net cash (used in) provided by financing activities (14,864,590) (1,340,992) 27,877,976 Net increase (decrease) in cash and cash equivalents 4,164,204 (438,333) 13,590,970 Cash and cash equivalents at beginning of period 25,890,717 26,329,050 12,738,080 ------------------------------------------------------------- Cash and cash equivalents at end of period $ 30,054,921 $25,890,717 $26,329,050 =============================================================
See accompanying notes. 7 Hobbs Group, LLC Notes to Combined Financial Statements December 31, 2001 1. Basis of Presentation and Significant Accounting Policies Basis of Presentation The combined financial statements include the accounts of Hobbs Group, LLC and its majority-owned subsidiaries, Hobbs Group, Inc. (a Texas corporation) and Hobbs Group (Canada) Insurance Brokers Ltd. (hereafter collectively referred to as the "Company"). The Company is engaged in the insurance brokerage, risk management and benefits consulting business. All significant intercompany accounts and transactions have been eliminated in combination. Hobbs Group, LLC is a limited liability company formed under the Delaware Limited Liability Company Act (the "Act") in 1997. Hobbs Group, Inc. is owned by an employee of that corporation, but controlled by Hobbs Group, LLC through contractual agreements. A majority of the voting stock of Hobbs Group (Canada) Insurance Brokers Ltd. ("Hobbs Group (Canada)") is held by a director of Hobbs Group (Canada). By written agreement, a subsidiary of Hobbs Group, LLC has the right, among other things, to reacquire the shares of the director at their original cost to the director and has retained operating control over Hobbs Group (Canada). On March 30, 1999, the Company approved a Second Amended and Restated Limited Liability Company Agreement ("the LLC Agreement") which supersedes the two previous agreements dated October 20, 1997 and October 24, 1997. The LLC Agreement established five classes of membership interests, including preferred shares, with varying voting and economic rights. Use of Estimates Preparation of the combined financial statements requires management to make estimates and assumptions that affect the amounts reported in the combined financial statements and accompanying notes. Actual results could differ from those estimates. 8 1. Basis of Presentation and Significant Accounting Policies (continued) Cash and Cash Equivalents All highly liquid investments with maturities of three months or less when purchased are classified as cash equivalents. Fiduciary Funds In its capacity as an insurance broker, the Company may collect premiums from insureds and, after deducting its commissions, remit the premiums to the respective insurance underwriters. Premiums which are due from insureds are reported as assets and as a corresponding liability to the insurance carriers. Premiums received from insureds but not remitted to the carriers are included in cash and cash equivalents held in a fiduciary capacity. Furniture, Equipment and Leasehold Improvements Furniture, equipment and leasehold improvements are recorded at cost. Depreciation is computed principally by the straight-line method over the estimated useful lives (generally three to seven years) of the assets. Goodwill and Other Intangible Assets Goodwill and other intangible assets primarily represent the excess of the cost over the fair value of net assets acquired. Generally, the Company records any contingent payments to be made in connection with an acquisition at the date of the contingent payment. Generally, these assets are being amortized using the straight-line method over a fifteen-year life. The carrying value of goodwill and other intangible assets is continually evaluated for impairment. If the undiscounted cash flows estimated to be generated by these assets are less than the carrying amounts, an impairment loss is recognized. As of December 31, 2001, the Company has not recorded an impairment loss. 9 1. Basis of Presentation and Significant Accounting Policies (continued) Income Taxes Generally, federal or state income taxes are not payable by Hobbs Group, LLC, because as a limited liability company income taxes are the liability of the members, and their respective pro rata share of net income or net loss is included in the members' tax returns. The Company has certain entities which are C-corporations under the Internal Revenue Code and, accordingly, file and pay federal and state income taxes. Income taxes for these entities are accounted for using the provisions of Statement of Financial Accounting Standards (SFAS) No. 109, Accounting for Income Taxes. Accordingly, for these entities, deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using current enacted tax rates. Long-Term Debt In connection with obtaining certain long-term financing, the Company has incurred certain loan origination costs. The loan origination costs are being amortized using the effective interest method over the term of the debt. Revenue Recognition Commissions are reported net of sub-broker commissions and are recognized as of the later of the billing date or effective date of the insurance policy except for commissions on installment premiums which are recognized periodically as billed. Any subsequent commission adjustments, including policy cancellations, are recognized upon notification from the insurance carriers. Contingent commissions represent a profit-sharing commission from the insurance carrier, the amount of which depends on, among other things, the profitability of the business produced by the agent/broker. Contingent commissions are recognized when received. Fee income is recognized when services are rendered. Interest income from investments is recognized on the accrual basis. 10 1. Basis of Presentation and Significant Accounting Policies (continued) Equity Compensation The Company has elected to follow APB 25, Accounting for Stock Issued to Employees and related Interpretations in accounting for its equity compensation and adopted the disclosure-only provisions of SFAS No. 123, Accounting for Stock-Based Compensation. The Company has issued equity capital securities to key employees for no cash consideration which contain a base price (the value that does not inure to the holder of the security). For these equity capital securities granted, compensation expense is recognized based on the fair value on the measurement date. The measurement date is the first date both the number of shares that the employee is entitled to receive the shares and the fair value of the shares is known. Compensation expense is recognized over the vesting period. Accordingly, the Company has established a deferred compensation account to record the unvested compensation expense. The fair value of these equity capital securities was determined to be from $2.50 per share to $29 per share in 2001, $2.17 per share in 2000 and $1.50 per share in 1999. The Company has also issued equity capital securities for no cash consideration which do not contain a base price ("zero-based capital securities") to key employees and business advisors. The Company recognizes compensation expense based on the fair value of the zero-based capital securities issued to the key employees at the date of grant, and is recognized over the vesting period. The unvested compensation expense is recorded in the deferred compensation account. The Company records loan origination fees and equity issuance fees based on the fair value of the zero-based capital securities issued to business advisors at the date of grant. The fair value of the zero-based capital securities granted in 1999 was determined to be $41.30 per share based on the proceeds received by the Company for the redeemable preferred shares. In 2000, the fair value ranged from the $40.00 per share to $46.20 per share based on the valuation of the Company at the time shares were awarded. Using the same valuation technique in 2001, the fair value ranged from $35.00 per share to $40.00 per share at the time these shares were awarded. 11 1. Basis of Presentation and Significant Accounting Policies (continued) Common Share Redemptions The Company has redeemed certain common shares at amounts in accordance with the LLC Agreement. Common shares are reduced at the stated value of the shares redeemed using a specific identification method. Redemption amounts differing from the stated value are reflected in retained earnings. Redeemable Preferred Shares and Special Common Shares In connection with the issuance of the redeemable preferred shares, the Company has incurred certain issuance costs. The issuance costs are being amortized into retained earnings using the straight-line method over a five-year period. The redeemable preferred shares are carried at the current redemption amount less unamortized issuance costs of $316,000 at December 31, 2001 and $457,000 at December 31, 2000. The special common shares are carried at the current redemption amount. Adjustments in the redemption amount for the redeemable preferred shares and special common shares are reflected in retained earnings. Redemption amounts differing from the stated value are reflected in retained earnings. Foreign Currency Translation In general, foreign revenues and expenses are translated at average exchange rates. Foreign assets and liabilities are translated at year-end exchange rates. Net foreign exchange gains and losses on translation are reported in shareholders' equity. 12 1. Basis of Presentation and Significant Accounting Policies (continued) Pending Accounting Pronouncements In June 2001, the Financial Accounting Standards Board issued Statements of Financial Accounting Standards No.141, Business Combinations, and No. 142, Goodwill and Other Intangible Assets. Statement 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001. Statement 141 also includes guidance on the initial recognition and measurement of goodwill and other intangible assets arising from business combinations completed after June 30, 2001. Statement 142 prohibits the amortization of goodwill and intangible assets with indefinite useful lives. Statement 142 requires that these assets be reviewed for impairment at least annually. Intangible assets with finite lives will continue to be amortized over their estimated useful lives. The Company will apply Statement 142 beginning in the first quarter of 2002. The Company will test goodwill for impairment using the two-step process prescribed in Statement 142. The first step is a screen for potential impairment, while the second step measures the amount of the impairment, if any. The Company expects to perform the first of the required impairment tests of goodwill and indefinite lived intangible assets as of January 1, 2002. Any impairment charge resulting from these transitional impairment tests will be reflected as the cumulative effect of a change in accounting principle in 2002. The Company has not yet determined what the effect of these tests will be on the earnings and financial position of the Company. Reclassifications Certain reclassifications have been made to prior year balances to conform to the current year presentation. 13 2. Fair Values Cash and cash equivalents, premiums and commissions receivable, accounts receivable, premiums due to insurance companies, accounts payable and accrued expenses, and long-term debt are considered financial instruments. The carrying amount for all these items approximates their fair value. The fair values used to determine the carrying amount of redeemable preferred shares, special common shares, and the equity capital securities issued as compensation to key employees and business advisors was determined by a valuation consulting organization that owns approximately 3% of the Company's Voting and Nonvoting Common Shares. The fair value of (the Class B Junior Common Shares) was determined using an option valuation model. 3. Acquisitions, Formations and Dispositions of Subsidiaries AVA Insurance Agency On February 1, 1998, the Company purchased certain assets and the business of AVA Insurance Agency, Inc. ("AVA") for $1,900,000. A contingent payment, not to exceed $1,000,000, will be payable to AVA should the purchased business exceed certain financial thresholds over a five-year period. Westport On April 1, 1998, the Company acquired 51% of the outstanding membership interests of Westport Worldwide, LLC ("Westport"). On November 16, 1999, Westport's 49% minority shareholders exchanged their minority stake for a contingent payment based upon future operating results of Westport. No goodwill was recorded related to this step acquisition. 14 3. Acquisitions, Formations and Dispositions of Subsidiaries (continued) EBG On November 17, 1999, Westport purchased certain assets and the business of Executive Benefits Group, Inc. and EBG Insurance Agency, Inc. (together, "EBG"). This executive benefits consulting business was purchased for $16,320,000 in cash and a contingent payment based upon future operating results. Goodwill established with this purchase relating to the excess purchase price over the fair value of tangible net assets acquired amounted to approximately $16,853,000. Commencing March 2006 (with provisions for acceleration in certain liquidity events), the owners of the contingent obligations associated with the purchases of Westport and EBG have the right to have the contingent payments calculated and paid based upon a pre-agreed formula. If this right had been exercisable at December 31, 2001, the contingent payments would have totaled approximately $13,119,000. The maximum cash obligation associated with these contingent payments is $13,800,000, with the Company retaining the right to pay the remaining amount in cash and/or shares of the Company. OFJ On December 1, 1998, the Company, through a series of transactions, purchased a 66.625% ownership interest in Hobbs/OFJ Acquisition Corp ("OFJ Acquisition Corp."), which in turn owns 100% of O'Neill, Finnegan & Jordan Insurance Agency, Inc. ("OFJ"), a benefits consulting organization. Commencing December 2003, the non-Company stockholders of OFJ Acquisition Corp. have the right to require OFJ Acquisition Corp. to purchase their OFJ Acquisition Corp. stock based on a pre-agreed formula. Additionally, in connection with certain liquidity events, OFJ Acquisition Corp. has either the obligation or the option to exchange the non-Company OFJ Acquisition Corp. stock for the Company's equity based on a pre-agreed formula. If the put option was exercised or the exchange right was triggered on December 31, 2001, the cost to the Company to make the purchase or exchange would have been approximately $10,759,000. 15 3. Acquisitions, Formations and Dispositions of Subsidiaries (continued) Campbell On February 1, 1999, OFJ purchased certain assets and the employee benefits consulting business of David J. Campbell for $533,000. Goodwill established with this purchase relating to the excess purchase price over the fair value of tangible net assets acquired amounted to approximately $533,000. Commencing February 2003, Mr. Campbell has the right to receive a contingent payment based upon the future operating results of his former business and calculated using a pre-agreed formula. The contingent payments will be paid over a three-year period. This contingent amount was calculated to be $1,233,000 and was recorded during 2001 as goodwill as the contingency was determined to be a liability to Mr. Campbell beyond a reasonable doubt. Kirklin On March 31, 1999, the Company purchased certain assets and the business of Kirklin and Company, Inc. ("Kirklin") for $1,953,000 in cash. Goodwill established in conjunction with this purchase relating to the excess of purchase price over the fair value of tangible net assets acquired amounted to approximately $2,039,000. Mills On April 15, 1999, the Company, through a series of transactions, purchased 100% of the stock of Timothy S. Mills Insurance Services, Inc. ("Mills") for $4,189,000 and a contingent obligation based upon future operating results. The purchase price included cash payments of $3,169,000, two subordinated promissory notes totaling $770,000 and 6,054 Nonvoting Common Shares. Goodwill established in conjunction with this purchase relating to the excess purchase price over the fair value of the tangible net assets acquired amounted to approximately $3,812,000. 16 3. Acquisitions, Formations and Dispositions of Subsidiaries (continued) Mills (continued) Commencing June 2004 (with provision for acceleration in certain liquidity events), the owner of the contingent obligation associated with the Mills transaction has the right to have the contingent payment calculated and paid based upon a pre-agreed formula. If this right had been exercisable at December 31, 2001, the contingent payment would have been approximately $1,200,000. The maximum cash obligation associated with a contingent payment is $730,000, with any remaining amount to be paid in shares of the Company. Linden On August 4, 1999, the Company, through a series of transactions, purchased 100% of the stock of The Linden Company ("Linden") for $5,139,000 and a contingent obligation based upon future operating results. The purchase price included cash payments of $2,889,000 and two subordinated promissory notes totaling $2,250,000. Goodwill established in conjunction with this purchase relating to the excess purchase price over the fair value of tangible net assets acquired amounted to approximately $4,967,000. Commencing December 2002 (with provisions for acceleration in certain liquidity events), the owner of the contingent obligation associated with the Linden transaction has the right to have the contingent payment calculated and paid based upon a pre-agreed formula. If this right had been exercisable at December 31, 2001, the contingent payment would have been approximately $1,767,000. The maximum cash obligation associated with a contingent payment is $1,100,000, with the Company retaining the right to pay any remaining amount in cash or shares of the Company. Integrated Risk On September 1, 1999, the Company purchased the remaining 49% ownership interest of Integrated Risk Solutions Insurance Services, LLC ("Integrated Risk") previously owned by its joint venture partner for $421,000 in cash. During 2000 and 2001, the Company made additional contingent payments of $300,000 and $104,000, respectively, to its former joint venture partner pursuant to the purchase agreement. Goodwill established as a result of this purchase amounted to approximately $276,000, $300,000 and $104,000 in 1999, 2000, and 2001, respectively. 17 3. Acquisitions, Formations and Dispositions of Subsidiaries (continued) Pro-Form On June 30, 1999, the Company disposed of its 51% majority ownership of Pro-Form Insurance Services, Inc. for $1,253,000 in cash. The transaction resulted in a gain totaling $502,000 and is recorded in other revenues. JTK On April 1, 2000, the Company purchased certain assets and the business of JTK, LLC ("JTK"), a benefits consulting organization, for $4,570,000 in cash, 10,811 Nonvoting Common Shares and a contingent obligation based upon future operating results. Goodwill established with this purchase relating to the excess purchase price over the fair value of tangible net assets acquired amounted to approximately $5,249,000. Commencing March 2007 (with provisions for acceleration in certain liquidity events), the owner of the contingent obligation associated with the JTK transaction has the right to have the contingent payment calculated and paid based upon a pre-agreed formula. If this right had been exercisable at December 31, 2001, the contingent payment would have been approximately $2,109,000. The maximum cash obligation associated with a contingent payment is $3,380,000, with the Company retaining the right to pay any remaining amount in cash or shares of the Company. Other 2000 Acquisitions During 2000, the Company made several additional acquisitions. The purchase prices of these acquisitions totaled $2,629,000 in cash and also included contingent obligations based upon future operating results. Goodwill established with these purchases relating to the excess purchase price over the fair value of tangible net assets acquired amounted to approximately $2,854,000. The contingent obligations associated with these acquisitions became payable at various times beginning August 2001. Payments totaling $120,000 were paid in 2001. If the contingent obligations had been payable at December 31, 2001, the contingent payments would have totaled approximately $792,000. 18 3. Acquisitions, Formations and Dispositions of Subsidiaries (continued) Other 2000 Acquisitions (continued) All of the acquisitions have been accounted for as purchases, and the financial position and results of operations are included in the combined financial statements from their respective date of purchase. Substantially all of the cash payments and share issuances required to be made in the future relating to the contingent obligations will result in additional goodwill at the time of payment or issuance. Generally, cash payments made in connection with the acquisitions were financed by long-term debt or redeemable preferred share issuances. The purchase price allocations were finalized within one year of the acquisition date. 4. Long-Term Debt A summary of long-term debt is as follows:
December 31 2001 2000 ----------------------------------------- Term note, final payment April 1, 2002 with interest at prime plus 2% (6.75% at December 31, 2001) $ 13,333 $ 53,333 Debentures, due August 4, 2002 with interest at 7% 1,250,000 1,250,000 Debentures, due December 1, 2003 with interest at 10.5% 1,910,000 1,910,000 Debenture, due in quarterly installments through January 31, 2003 with interest at 8% 403,564 698,846 Debentures, due in 2004 with interest at 8% 770,000 770,000 Bank of America revolving credit agreement 39,500,000 48,500,000 Less loan origination costs (525,419) (754,148) ----------------------------------------- 43,321,478 52,428,031 Less current portion 6,520,456 335,282 ----------------------------------------- $36,801,022 $52,092,749 =========================================
19 4. Long-Term Debt (continued) The 10.5% Debentures are secured by certain current and future assets of a subsidiary of the Company. Interest is payable monthly on the first of each month. The Company may pre-pay this debenture at any time prior to maturity at 103% of the face value plus accrued and unpaid interest to the date of redemption. Additionally, the 10.5% Debentures may be converted by the holders, at any time before redemption or maturity, into the Company's equity at fair market value at the date of conversion. The 8% Debenture is secured by certain current and future assets of a subsidiary of the Company. Principal and interest are paid in 20 quarterly consecutive equal installments of $86,000 until maturity. The Company may pre-pay the principal balance at any time without penalty. For the remaining debentures, accrued interest is payable quarterly, annually or at maturity based on the terms of the respective agreements. The Company may pre-pay these debentures at any time prior to maturity at face value plus accrued and unpaid interest to the date of redemption. In August 1999 the Company entered into a new revolving credit facility with Bank of America and First Union National Bank ("Bank of America") for a total commitment of $50,000,000. In March 2000, the commitment was increased to $60,000,000 with the addition of Wachovia Bank, N.A. The total amount outstanding under this facility at December 31, 2001 and 2000 was $39,500,000 and $48,500,000, respectively. Approximately $29,600,000 of the outstanding amount was used during 1999 to pre-pay the outstanding balance on a term loan. This pre-payment resulted in the recognition of a $1,381,000 extraordinary charge related to unamortized loan origination costs and pre-payment penalties. Based on the Company's current outstanding balance under the Bank of America revolving credit facility, quarterly installments are due starting in November 2002, with a final payment due February 2004. The interest rate is determined either as a function of LIBOR (30, 60, 90 and 120 days) or a base rate published by Bank of America (resembling the prime rate). The interest rate on the outstanding balance at December 31, 2001 and 2000 was 5.2% and 10.3%, respectively. 20 4. Long-Term Debt (continued) In addition to the interest expense related to the outstanding debt, the Company also pays a commitment fee ranging from 25 to 75 basis points on any unused portion of the Bank of America facility. The rate used in determining this fee ranged from 50 to 75 basis points in 2001, and was 75 basis points in 2000. The scheduled maturities of debt are as follows: Long-Term Debt --------------------- 2002 $ 6,520,456 2003 21,743,941 2004 15,582,500 2005 - 2006 - --------------------- $43,846,897 ===================== Total interest paid was $4,330,000, $5,332,000 and $3,126,000 in 2001, 2000 and 1999, respectively. 21 5. Income Taxes The provision for income taxes for the taxpaying entities of the Company is as follows: 2001 2000 1999 ------------------------------------------------------------ Current: Federal $1,182,000 $ 628,000 $298,000 State 174,000 337,000 45,000 Foreign - - 239,000 Deferred: Federal 48,000 (132,000) 54,000 State (14,000) (18,000) 8,000 ----------------------------------------------------------- $1,390,000 $ 815,000 $644,000 =========================================================== The following table summarizes the principal elements which cause the effective tax rate to vary from the statutory corporate rate for the Company's tax-paying entities: 2001 --------------------------------------- --------------------------------------- Percent of Income Income Tax Before Income Expense Taxes --------------------------------------- Income tax on income before income taxes $ 995,000 34.0% Effect of state taxes 122,000 4.2% Effect of permanent items 273,000 9.3% --------------------------------------- Income tax expense $1,390,000 47.5% ======================================= 22 5. Income Taxes (continued) 2000 --------------------------------------- --------------------------------------- Percent of Income Income Tax Before Income Expense Taxes --------------------------------------- Income tax on income before income taxes $249,000 34.0% Effect of state taxes 25,000 3.4% Effect of permanent items 303,000 41.3% --------------------------------------- Income tax expense $577,000 78.7% ======================================= 1999 --------------------------------------- --------------------------------------- Percent of Income Income Tax Before Income Expense Taxes --------------------------------------- Income tax on income before income taxes $193,000 34.0% Effect of state taxes 35,000 6.2% Effect of permanent items 246,000 43.4% Effect of other items 113,000 19.9% Effect of foreign taxes 57,000 10.0% --------------------------------------- Income tax expense $644,000 113.5% ======================================= In addition to the foregoing, Hobbs Group, LLC recorded $238,000 in tax expense in 2000 relating to amounts payable to certain states. Total income taxes paid in 2001, 2000 and 1999 were $1,256,000, $1,258,000 and $303,000, respectively. 23 6. Employee Benefit Plans At December 31, 2001 and 2000, the Company had one 401(k) Savings Plan (the "401(k) Plan"), a qualified cash and deferred profit sharing plan covering all employees meeting certain eligibility requirements. At December 31, 1999, the Company had five such plans. The Company provides a matching contribution of 100% of the participants' contributions up to a maximum of 4.5% of the participants' annual compensation. Certain key executive employees of the Company are eligible to participate in the Hobbs Group, LLC Executive Officers Non-Qualified Deferred Compensation Plan (the "Deferred Compensation Plan"). The Deferred Compensation Plan was established to provide unfunded non-qualified deferred compensation for a select group of management and other highly compensated employees. Eligible participants may elect to defer no more than 6% of their compensation in excess of the compensation limitations of the Internal Revenue Code. The Company provides a dollar for dollar matching contribution provided that combined matching contributions under the 401(k) Plan and the Deferred Compensation Plan do not exceed 5% of the participants' annual compensation. Expenses recognized by the Company relating to the 401(k) Plans and the Deferred Compensation Plan were approximately $1,332,000, $1,051,000 and $907,000 for 2001, 2000, and 1999, respectively. The Company also provides for other post retirement benefits other than pensions under a terminated plan for 7 employees of the Company that are fully vested under this plan. The total liability for these post retirement benefits was $586,000 at December 31, 2001 and $500,000 at December 31, 2000. 24 7. Preferred Equity Redeemable Preferred Shares During March 1999, the Company issued 363,196 preferred membership interests ("Redeemable Preferred Shares") at a purchase price of $41.30 per share, resulting in gross proceeds of $14,999,995. As of December 31, 2001, the holders of the Redeemable Preferred Shares are entitled to voting privileges equivalent to approximately 98,670 Voting Common Shares which, when combined with the total Voting Common Shares represents 22.1% of the voting rights of the Company. These preferred shares are redeemable no earlier than March 30, 2004 at the request of at least a majority of the preferred shareholders. The Company is obligated to redeem these shares not less than 180 days from the date of the request, but such obligation is subordinate to the Company's debt obligation with Bank of America. The redemption price, which is to be paid in cash, shall be the greater of the fair market value per share as of the date of the request or the original purchase price per share plus a 20% annual compound rate of return. In the event of a liquidation, dissolution or winding up of the Company, the holders of preferred shares shall be entitled to be paid first out of the assets of the Company at an amount equal to the redemption price defined above. The holders of preferred shares also have conversion rights with respect to the conversion of preferred shares into voting shares. The number of voting shares a holder of preferred shares is entitled to receive is the applicable conversion rate, as defined in the LLC Agreement, multiplied by the number of preferred shares. In the event of default (noncompliance) as defined in the "Preferred Share Purchase Agreement" dated March 23, 1999, the preferred shareholders may remove three of the five management directors, and replace these vacancies with individuals of their choice. Directors shall then use their best efforts to remedy the event of noncompliance. As of March 30 for each of the stated years, the minimum aggregate redemption amounts are as follows: 2002 $25,920,000 2003 31,104,000 2004 37,325,000 25 7. Preferred Equity (continued) Special Common Shares Special Common Shares are entitled to normal distributions in accordance with the LLC Agreement and do not have the right to vote on any matter except as required by the Act. Under certain circumstances, the capital account balance attributable to each Special Common Share will be reduced by a maximum of $5 upon liquidation. On October 24, 1997, 50,000 Special Common Shares were issued to Bank of America (formerly NationsCredit) representing $500,000 of loan origination costs. During 2001, 42,133 of the Special Common Shares were redeemed at $27 per share. In addition, Bank of America transferred ownership of the remaining 7,867 shares to two former employees of Bank of America. Commencing October 2002, these two individuals have the right to require the Company to purchase the 7,867 Special Common Shares at the fair value (as defined) of the Company's equity. Additionally, commencing October 2003, the Company has the option to repurchase the Special Common Shares at 110% of the fair value of the Company's equity. 8. Shareholders' Equity (Deficit) Under the Company's LLC Agreement, as of December 31, 2001, Hobbs Group, LLC had three classes of membership interests classified as shareholders' equity in the accompanying financial statements. The classes are divided between voting and nonvoting classes. Voting shares are shares directly held by certain employee Directors of the Company. Voting shares have the right to vote on all matters on which the members are entitled to vote pursuant to the Act and the LLC Agreement. The income tax consequences for the shareholders related to each of the classes of membership equity vary based on the initial capital account balances at time of issuance. 26 8. Shareholders' Equity (Deficit) (continued) Common Shares Common Shares are shares entitled to normal distributions in accordance with the LLC Agreement, and have been purchased for cash or property at the then current fair market value. The initial capital account balance of the Common Shares is equal to the purchase price paid. Class A Junior Common Shares Class A Junior Common Shares ("Class A Shares") are entitled to normal distributions in accordance with the LLC Agreement. The initial capital account balance of the Class A Shares is zero. During 2001, 52,852 Class A Shares were transferred from a Director of the Company with voting privileges to a non-Director without voting privileges pursuant to the LLC Agreement. Class B Junior Common Shares Class B Junior Common Shares ("Class B Shares") are entitled to normal distributions in accordance with the LLC Agreement. The initial capital account balance of the Class B Shares upon issuance is zero. During 2001, 2,273 Class B Shares were transferred from a Director of the Company with voting privileges to a non-Director without voting privileges pursuant to the LLC Agreement. Hobbs Group, Inc. and Hobbs Group (Canada) Hobbs Group, Inc. (a Texas corporation) has 1,000 shares of common stock outstanding with a par value of $1 per share and Hobbs Group (Canada) has 29 shares of common stock outstanding with a par value of $1 per share. 27 8. Shareholders' Equity (Deficit) (continued) A summary of the activity for each class of membership interest as reported in the accompanying financial statements as of December 31, 2001, 2000 and 1999 follows:
Common Shares ------------------------------------------------------------------------ Voting Non-Voting Shares Value Shares Value ------------------------------------------------------------------------ Balance at January 1, 1999 36,799 $ 367,990 558,280 $5,582,800 Issued during 1999 - - 24,082 994,587 Redeemed during 1999 ($41.30/share) (36,799) (367,990) (21,418) (214,180) ------------------------------------------------------------------------ Balance at December 31, 1999 - - 560,944 6,363,207 Issued during 2000 - - 12,433 575,026 Redeemed during 2000 ($27.02/share) - - (2,100) (21,000) ------------------------------------------------------------------------ Balance at December 31, 2000 - - 571,277 6,917,233 Redeemed during 2001 ($27/share) - - (40,000) (400,000) ------------------------------------------------------------------------ Balance at December 31, 2001 - $ - 531,277 $6,517,233 ======================================================================== Class A Junior Common Shares ------------------------------------------------------------------------ Voting Non-Voting Shares Value Shares Value ------------------------------------------------------------------------ Balance at January 1, 1999 379,666 $3,796,660 129,500 $1,295,000 Issued during 1999 - - 87,297 3,605,366 Redeemed during 1999 ($41.30/share) (38,901) (389,010) (6,500) (65,000) Forfeited during 1999 - - (5,000) (50,000) ------------------------------------------------------------------------ Balance at December 31, 1999 340,765 3,407,650 205,297 4,785,366 Issued during 2000 - - 20,340 937,600 Redeemed during 2000 ($32.38/share) - - (6,211) (100,015) Forfeited during 2000 - - (3,300) (136,290) ------------------------------------------------------------------------ Balance at December 31, 2000 340,765 3,407,650 216,126 5,486,661 Issued during 2001 - - 12,818 502,005 Transferred during 2001 (52,852) (528,520) 52,852 528,520 Redeemed during 2001 ($28/share) - - (606) (25,027) ------------------------------------------------------------------------ Balance at December 31, 2001 287,913 $2,879,130 281,190 $6,492,159 ========================================================================
28 8. Shareholders' Equity (Deficit) (continued)
Class B Junior Common Shares ------------------------------------------------------------------- Voting Non-Voting Shares Value Shares Value ------------------------------------------------------------------- Balance at January 1, 1999 - $ - - $ - Issued during 1999 21,064 31,575 48,500 72,693 ------------------------------------------------------------------- Balance at December 31, 1999 21,064 31,575 48,500 72,693 Issued during 2000 - - 49,500 107,415 Forfeited during 2000 - - (9,100) (15,996) ------------------------------------------------------------------- Balance at December 31, 2000 21,064 31,575 88,900 164,112 Issued during 2001 40,177 1,165,133 10,000 25,000 Transferred during 2001 (2,273) (3,410) 2,273 3,410 ------------------------------------------------------------------- Balance at December 31, 2001 58,968 1,193,298 101,173 192,522 ------------------------------------------------------------------- Total all classes at December 31, 2001 346,881 $4,072,428 913,640 $13,201,914 ===================================================================
A summary of the impact of the preceding activity on compensation expense, acquisition costs and equity issuance costs related to membership interest issuances is as follows: Year Compensation Acquisition Equity Expense Costs Issuance Costs ----------------------------------------------------------------- 1999 $2,623,000 $1,130,000 $200,000 2000 539,000 500,000 - 2001 889,000 - - Share issuances and forfeitures for Class A Shares and Class B Shares relate to compensation for key employees, except for 26,150 Class A Shares issued in 1999 which relate to acquisition and equity issuance costs. No member of the Company is obligated personally for any debt, obligation or liability of the Company or of any other member, solely by reason of being a member of the Company. No member has any fiduciary or other duty to another member with respect to the business and affairs of the Company and no member is liable to the Company or any other member for acting in good faith reliance upon the provisions of the Company's LLC Agreement. No member has any responsibility to restore any negative balance in its capital account or to contribute to or in respect of the liabilities or obligations of the Company or to return distributions made by the Company. 29 9. Equity Compensation The Company grants Class A Shares and Class B Shares to certain key employees as compensation. Generally, each class of shares vests over a period ranging from two to four years and is subject to forfeiture upon termination of service. The base price for all Class B Shares granted in 2001 was $41.00 per share, in 2000 the range was $40.00 to $46.25 per share and in 1999 was $41.30. The base price for Class A Shares granted is zero. At December 31, 2001, 9,949 of the Class A Shares remain subject to forfeiture with a weighted average remaining contractual life of 2.6 years, and 90,458 Class B Shares remain subject to forfeiture with a weighted average remaining contractual life of 2.8 years. The fair value method utilized to account for the Class A Shares and Class B Shares granted in 2001, 2000, and 1999 approximates the Minimum Value method prescribed by SFAS No. 123 with the following weighted average assumptions: risk-free interest rate of 4.46%; expected vesting period of 4 years; and a dividend yield of 0%. 10. Related Party Transactions At December 31, 2001 and 2000, the Company had loans receivable due from officers of the Company totaling $90,000 and $39,000, respectively. Additionally at December 31, 2001, the Company had $119,000 due from other employees. 30 11. Commitments and Contingencies The Company is involved in various legal actions incident to the nature of its business. The Company maintains a program of commercial insurance to lessen its exposure to such actions. Management is of the opinion that none of the litigation will have a material effect on the Company's financial position or operating results. The Company has entered into various agreements to lease office space and office equipment using operating leases expiring on various dates through October 2007. Total rental expense for all operating leases for 2001, 2000 and 1999 was $3,364,000, $2,941,000 and $2,180,000, respectively. Future minimum lease payments for all non-cancelable operating leases with initial or remaining terms in excess of one year are as follows: 2002 $2,922,000 2003 2,297,000 2004 1,761,000 2005 1,067,000 2006 and thereafter 446,000 --------------- $8,493,000 =============== Amounts in the above schedule are shown gross of any sub-leases. 31 Hobbs Group, LLC Combined Financial Statements Quarters ended March 31, 2002 and 2001 (Unaudited) Contents Combined Balance Sheets....................................................33-34 Combined Statements of Operations.............................................35 Combined Statements of Cash Flows.............................................36 Notes to Combined Financial Statements.....................................37-39 32 Hobbs Group, LLC Combined Balance Sheets
(Unaudited) 3/31/2002 12/31/2001 --------------------------------- Assets Current assets: Cash and cash equivalents $ 5,433,795 $ 6,155,350 Cash and cash equivalents held in a fiduciary capacity 16,948,310 23,899,571 Premiums and commissions receivable, less allowance for doubtful accounts - (2002 - $609,000; 2001 - $589,000) 46,818,263 61,027,107 Accounts receivable 748,194 987,813 Prepaid assets 1,109,716 986,015 Income taxes receivable - - ----------------------------------- Total current assets 71,058,278 93,055,856 Investments 68,843 68,843 Furniture, equipment and leasehold improvements, less accumulated depreciation - (2002 - $4,482,000; 2001 - $4,166,000) 2,388,864 2,567,818 Goodwill and other intangible assets, less accumulated amortization - (2002 - $16,845,000; 2001 - $16,838,000) 63,348,986 63,355,545 Other assets 502,916 555,852 ----------------------------------- Total assets $137,367,887 $159,603,914 ===================================
33
(Unaudited) 3/31/2002 12/31/2001 --------------------------------- Liabilities and shareholders' deficit Current liabilities: Premiums due to insurance companies $ 52,764,915 $ 69,016,144 Commissions expense payable 2,237,513 3,441,127 Accounts payable and accrued expenses 7,993,311 12,989,980 Income taxes payable 183,091 39,292 Current portion of long-term debt 10,704,348 6,520,456 Unearned commission income 2,402,629 2,439,365 ----------------------------------- Total current liabilities 76,285,807 94,446,364 Long-term debt, less current portion 29,586,764 36,801,022 Other long-term liabilities 1,891,067 2,536,830 ----------------------------------- Total liabilities 107,763,638 133,784,216 Minority interests 472,728 436,697 Commitments and contingencies Redeemable preferred shares; no par value: Issued and outstanding shares - (2002 - 363,196; 2001 - 363,196) 29,588,327 25,819,567 Special common shares; no par value: Issued and outstanding shares - (2002 - 7,867; 2001 - 7,867) 629,360 550,690 Shareholders' deficit: Voting common shares; no par value: Issued and outstanding shares - (2002 - 359,640; 2001 - 346,881) 4,072,428 4,072,428 Nonvoting common shares, no par value: Issued and outstanding shares - (2002 - 940,569; 2001 - 913,640) 13,406,943 13,201,914 Texas and Canada common shares, $1 par value: Issued and outstanding shares - (2002 - 1,029; 2001 - 1,029) 1,029 1,029 Additional paid-in-capital 1,000 1,000 Accumulated other comprehensive income 3,279 13,276 Deferred compensation (1,242,724) (1,384,339) Retained earnings (deficit) (17,328,121) (16,892,564) ------------------------------------ Total shareholders' deficit (1,086,166) (987,256) ------------------------------------ Total liabilities and shareholders' deficit $137,367,887 $159,603,914 ====================================
See accompanying notes. 34 Hobbs Group, LLC Combined Statements of Operations (Unaudited) Quarter ended March 31, 2002 2001 ---------------------------------------- Revenues: Net commissions and fees $24,607,326 $21,490,779 Interest income 138,330 315,045 Other 52,272 76,821 ---------------------------------------- 24,797,928 21,882,645 Operating expenses: Employee compensation and benefits 13,994,421 13,175,159 Travel and entertainment expense 1,128,780 1,061,641 Management, legal and accounting services 670,517 565,926 Office equipment leases and supplies 475,704 461,184 Rent and utilities 1,318,234 1,154,724 Other 927,077 715,778 ---------------------------------------- 18,514,733 17,134,412 ---------------------------------------- 6,283,195 4,748,233 Other expenses: Interest expense 815,016 1,280,121 Depreciation 316,255 261,998 Amortization of goodwill and other intangible assets 6,175 1,274,270 ---------------------------------------- Income before income taxes and minority interests 5,145,749 1,931,844 Income tax expense 174,703 153,229 ---------------------------------------- Income before minority interests 4,971,046 1,778,615 Minority interests 36,031 59,752 ---------------------------------------- Net income $4,935,015 $1,718,863 ======================================== See accompanying notes. 35 Hobbs Group, LLC Combined Statements of Cash Flows
(Unaudited) Quarter ended March 31, 2002 2001 ---------------------------------------- Operating activities Net income $ 4,935,015 $ 1,718,863 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 322,430 1,449,560 Minority interests - net of distributions 36,031 59,752 Expenses related to share issuance 141,615 79,374 Amortization of debt issuance costs 57,182 60,957 Changes in operating assets and liabilities: Premiums and commissions receivable 14,208,843 2,906,203 Prepaid assets (123,701) (208,719) Accounts receivable 239,620 35,763 Premiums due to insurance companies (16,251,230) (8,522,631) Commissions expense payable (1,203,613) 490,949 Accounts payable and accrued expenses (5,172,920) 234,542 Other assets and other liabilities (114,736) (307,892) ---------------------------------------- Net cash used in operating activities (2,925,464) (2,003,279) Investing activities Purchase of furniture, equipment and leasehold improvements (137,301) (130,905) ---------------------------------------- Net cash used in investing activities (137,301) (130,905) Financing activities Proceeds from issuance of long-term debt - 4,000,000 Repayments of long-term debt (3,087,548) (4,581,642) Proceeds from issuance of common shares - 60,000 Distributions to shareholders (1,522,503) (70,733) ---------------------------------------- Net cash used in financing activities (4,610,051) (592,375) Net decrease in cash and cash equivalents (7,672,816) (2,726,559) Cash and cash equivalents at beginning of period 30,054,921 25,890,717 ---------------------------------------- Cash and cash equivalents at end of period $ 22,382,105 $23,164,158 ========================================
See accompanying notes. 36 Hobbs Group, LLC Notes to Combined Quarter Ended Interim Financial Statements March 31, 2002 (Unaudited) NOTE A - BASIS OF PRESENTATION The accompanying unaudited combined financial statements of Hobbs Group, LLC and its majority-owned subsidiaries, Hobbs Group, Inc. (a Texas corporation) and Hobbs Group (Canada) Insurance Brokers Ltd. (the Company) have been prepared in accordance with generally accepted accounting principles for interim financial information. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three month period ended March 31, 2002, are not necessarily indicative of the results that may be expected for the year ending December 31, 2002. NOTE B - INTANGIBLE ASSETS In June 2001, the Financial Accounting Standards Board issued Statements of Financial Accounting Standards No. 141, "Business Combinations (Statement 141) and No. 142, "Goodwill and Other Intangible Assets" (Statement 142). Statement 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001. Statement 141 also included guidance on the initial recognition and measurement of goodwill and other intangible assets arising from business combinations completed after June 30, 2001. Under Statement 142, goodwill is no longer amortized, but is subject to annual impairment tests. Intangible assets with finite lives will continue to be amortized over their useful lives. The Company adopted Statement 142 effective January 1, 2002. The Company will test goodwill for impairment using the two-step process prescribed in Statement 142. The first step is a screen for potential impairment, while the second step measures the amount of the impairment, if any. The Company does not anticipate these tests will have a material impact on the earnings or financial position of the Company as a result of the acquisition of the Company by Hilb, Rogal and Hamilton Company (see Note C). 37 NOTE B--INTANGIBLE ASSETS - Continued The following table provides a reconciliation of the March 31, 2002 and 2001 reported net income to adjusted net income had Statement 142 been applied as of January 1, 2001: For the Three Months Ended March 31, 2002 2001 ---- ---- Net income - as reported $4,935,015 $1,718,863 Goodwill amortization, net of tax - 1,255,209 --------------------------------- Adjusted net income $4,935,015 $2,974,072 ================================= Intangible assets consist of the following:
As of March 31, 2002 As of December 31, 2001 -------------------- ----------------------- Gross Carrying Accumulated Gross Carrying Accumulated Amount Amortization Amount Amortization Amortizable intangible assets: Expirations $122,244 $36,539 $122,244 $33,489 Non-compete agreement 50,408 50,408 50,408 47,283 Other intangible assets 1,290,000 1,290,000 1,290,000 1,290,000 Indefinite-lived intangible assets: Goodwill, net $63,263,281 $63,263,665
Aggregate amortization expense for the three months ended March 31, 2002 and 2001 was $6,175 and $1,274,000, respectively. Estimated amortization expense: For year ended December 31, 2002 $14,451 For year ended December 31, 2003 11,326 For year ended December 31, 2004 11,326 For year ended December 31, 2005 11,326 For year ended December 31, 2006 11,326 The changes in the net carrying amount of goodwill for the three months ended March 31, 2002 are as follows: Balance as of December 31, 2001 $63,263,665 Accumulated Amortization adjustment (384) ---------------- Balance as of March 31, 2002 $63,263,281 ================ 38 NOTE C - SIGNIFICANT CHANGES AND EVENTS On May 10, 2002, the Company signed a definitive agreement to be acquired by Hilb, Rogal and Hamilton, Inc. (HRH); a Virginia based insurance brokerage company. The transaction closed on July 1, 2002. At closing, HRH paid $142 million in a combination of cash and stock for the Company. An additional $102 million will be paid contingent upon the Company attaining certain financial performance goals within the next two years. Also, HRH assumed certain existing earnouts from the Company's prior acquisitions, estimated to approximate a net present value of $30 million. The closing payment of $142 million included HRH's assumption, and subsequent retirement of, approximately $55 million in debt and merger related expenses. NOTE D - COMPREHENSIVE INCOME The following table identifies the components of comprehensive net income, net of tax, for the periods ended March 31, 2002 and 2001, respectively. 2002 2001 ---- ---- Net income $4,935,015 $1,718,863 Foreign currency translation (9,997) (66,659) -------------- ------------- Comprehensive income, net of tax $4,925,018 $1,652,204 ============== ============= At March 31, 2002 and December 31, 2001, the sole component of accumulated other comprehensive income is foreign currency translation. NOTE E - CONTINGENCIES The Company is involved in various legal actions incident to the nature of its business. The Company maintains a program of commercial insurance to lessen its exposure to such actions. Management is of the opinion that none of the litigation will have a material effect on the Company's financial position or operating results. 39 (b) Pro Forma Financial Information. HILB, ROGAL AND HAMILTON COMPANY, INC. AND SUBSIDIARIES PRO FORMA CONDENSED COMBINED FINANCIAL STATEMENTS (Unaudited) The following unaudited Pro Forma Condensed Combined Balance Sheet as of March 31, 2002 and the unaudited Pro Forma Condensed Combined Statements of Income for the three months ended March 31, 2002 and the year ended December 31, 2001 (the "Pro Forma Financial Statements") are based upon the respective financial statements of the Company and of Hobbs. The acquisition of Hobbs will be accounted for under the purchase method of accounting in accordance with the Statement of Financial Accounting Standards ("SFAS") No. 141, "Business Combinations." Under the purchase method of accounting, the purchase price is allocated to the assets acquired and liabilities assumed based on their estimated fair values. The estimated fair values contained herein are preliminary in nature, and may not be indicative of the final purchase price allocation, which will be based on an assessment of fair value to be performed by an independent appraiser. Such preliminary estimates of fair values of the assets and liabilities of Hobbs have been consolidated with the recorded values of the assets and liabilities of the Company in the Pro Forma Financial Statements. Since the purchase accounting information is preliminary, it has been solely prepared for the purpose of developing such unaudited pro forma combined condensed financial information. SFAS No. 142, "Goodwill and Other Intangible Assets", provides that goodwill resulting from a business combination completed subsequent to June 30, 2001 will not be amortized but instead is required to be tested for impairment at least annually. The consolidated financial statements of the Company for the three months ended March 31, 2002 were filed with the Company's Quarterly Report on Form 10-Q for the three months ended March 31, 2002 on May 9, 2002. The consolidated financial statements of the Company for the year ended December 31, 2001 were filed with the Company's Annual Report on Form 10-K for the year ended December 31, 2001 on March 29, 2002. The financial statements of Hobbs are included in this current report. See "Item 7(a), Financial Statements of Businesses Acquired." The Pro Forma Condensed Combined Balance Sheet as of March 31, 2002 is presented as if the Acquisition had occurred on March 31, 2002. The Pro Forma Condensed Combined Statements of Income for the three months ended March 31, 2002 and the year ended December 31, 2001 are presented as if the Acquisition had occurred on January 1, 2001. The Pro Forma Financial Statements are presented for comparative purposes only and are not necessarily indicative of what the actual financial position of the Company would have been at March 31, 2002 had the Acquisition occurred at that date or of what the actual results of the Company would have been if the Acquisition had occurred on January 1, 2001 nor indicative of the results of operations in future periods. The Pro Forma Financial Statements should be read in conjunction with, and are qualified in their entirety by, the respective historical financial statements and notes thereto of the Company and of Hobbs for the three months ended March 31, 2002 and for the year ended December 31, 2001. The Pro Forma Financial Statements presented do not reflect future events that may occur after the Acquisition has been consummated. The Company believes that operating expense 40 synergies of the combined operations of the Company and Hobbs will be realized post-Acquisition. However, for the purposes of the Pro Forma Financial Statements presented herein, these synergies have not been reflected because their realization cannot be assured. 41 HILB, ROGAL AND HAMILTON COMPANY AND SUBSIDIARIES PRO FORMA CONDENSED COMBINED BALANCE SHEET March 31, 2002 (Unaudited)
Hilb, Rogal and Hamilton Company Hobbs Pro Forma Historical Historical Adjustments Pro Forma ASSETS CURRENT ASSETS Cash and cash equivalents $56,143,796 $22,382,105 ($62,357,825) (1b) $81,362,172 (3,000,000) (1d) (51,805,904) (1e) 120,000,000 (3) Investments 2,887,117 2,887,117 Receivables, net 115,466,210 47,566,457 163,032,667 Prepaid expenses and other current assets 6,946,695 1,109,716 8,056,411 ------------------------------------------------------------------- TOTAL CURRENT ASSETS 181,443,818 71,058,278 2,836,271 255,338,367 INVESTMENTS 1,343,080 68,843 1,411,923 PROPERTY & EQUIPMENT, NET 18,546,207 2,388,864 20,935,071 GOODWILL, NET 250,147,951 63,260,760 (63,260,760) (2) 342,345,131 92,197,180 (2) INTANGIBLE ASSETS, NET 22,428,864 88,226 (88,226) (2) 77,428,864 55,000,000 (2) OTHER ASSETS 10,046,576 502,916 10,549,492 ------------------------------------------------------------------ TOTAL ASSETS $483,956,496 $137,367,887 $ 86,684,465 $708,008,848 ================================================================== LIABILITIES AND SHAREHOLDERS' EQUITY CURRENT LIABILITIES Premiums payable to insurance companies $142,866,676 $52,764,915 195,631,591 Accounts payable 7,865,284 4,039,267 11,656,923 (2) 12,687,602 (10,873,872) (1e, 1f) Accrued Expenses 18,634,000 8,777,277 4,157,510 (2) 31,568,787 Premiums deposits and credits due customers 27,020,959 27,020,959 Current portion of long-term debt 6,166,779 10,704,348 (10,704,348) (2) 6,166,779 -------------------------------------------------------------------- TOTAL CURRENT LIABILITIES 202,553,698 76,285,807 (5,763,787) 273,075,718 LONG-TERM DEBT 108,260,236 29,586,764 (29,586,764) (2) 228,260,236 120,000,000 (3) OTHER LONG-TERM LIABILITIES 12,156,835 1,891,067 14,047,902 -------------------------------------------------------------------- TOTAL LIABILITIES 322,970,769 107,763,638 84,649,449 515,383,856 MINORITY INTEREST 472,728 (472,728) (2) 0 REDEEMABLE PREFERRED SHARES - 29,588,327 (29,588,327) (4) 0 SPECIAL COMMON SHARES - 629,360 (629,360) (4) 0 SHAREHOLDERS' EQUITY (DEFICIT) Common Stock 56,857,748 17,480,400 (17,480,400) (4) 88,497,013 31,639,265 (1a) Additional paid in capital 1,000 (1,000) (4) 0 Retained earnings 105,238,634 (17,328,121) 28,985,044 (4) 105,238,634 (11,656,923) (2) Deferred compensation (1,242,724) 1,242,724 (4) 0 Accumulated other comprehensive income (loss) (1,110,655) 3,279 (3,279) (4) (1,110,655) -------------------------------------------------------------------- TOTAL SHAREHOLDERS' EQUITY (DEFICIT) 160,985,727 (1,086,166) 32,725,431 192,624,992 -------------------------------------------------------------------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT) $483,956,496 $137,367,887 $ 86,684,465 $708,008,848 ====================================================================
See notes to the pro forma condensed combined financial statements. Bracketed numbers to the right of the "Pro Forma Adjustments" column refer to such notes. 42 HILB, ROGAL AND HAMILTON COMPANY AND SUBSIDIARIES PRO FORMA CONDENSED COMBINED STATEMENT OF INCOME For the Three Months Ended March 31, 2002 (Unaudited)
Hilb, Rogal and Hamilton Company Hobbs Pro Forma Historical Historical Adjustments Pro Forma REVENUES Commissions and fees $98,648,085 $24,607,326 $123,255,411 Investment income 513,848 138,330 652,178 Other 691,863 52,272 744,135 -------------------------------------------------------------------- 99,853,796 24,797,928 - 124,651,724 OPERATING EXPENSES Compensation and employee benefits 53,259,020 13,994,421 67,253,441 Other operating expenses 18,549,156 4,836,567 $ (183,540) (6) 23,202,183 Amortization of intangibles 521,618 6,175 1,368,825 (5) 1,896,618 Interest expense 1,883,374 815,016 814,984 (8) 3,513,374 --------------------------------------------------------------------- 74,213,168 19,652,179 2,000,269 95,865,616 --------------------------------------------------------------------- INCOME BEFORE INCOME TAXES, MINORITY INTEREST AND CUMULATIVE EFFECT OF ACCOUNTING CHANGE 25,640,628 5,145,749 (2,000,269) 28,786,108 Income Taxes 10,457,391 174,703 1,330,199 (7) 11,962,293 --------------------------------------------------------------------- INCOME BEFORE MINORITY INTEREST 15,183,237 4,971,046 (3,330,468) 16,823,815 AND CUMULATIVE EFFECT OF ACCOUNTING CHANGE Minority interest 0 36,031 (36,031) 0 --------------------------------------------------------------------- NET INCOME BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGE $15,183,237 $ 4,935,015 $ (3,294,437) $ 16,823,815 ===================================================================== NET INCOME BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGE PER SHARE: BASIC $0.54 $0.58 ===================================================================== ASSUMING DILUTION $0.48 $0.52 ===================================================================== WEIGHTED AVERAGE SHARES OUTSTANDING: BASIC 28,187,723 719,729 28,907,452 ===================================================================== ASSUMING DILUTION 32,203,151 719,729 32,922,880 =====================================================================
See notes to the pro forma condensed combined financial statements. Bracketed numbers to the right of the "Pro Forma Adjustments" column refer to such notes. 43 HILB, ROGAL AND HAMILTON COMPANY AND SUBSIDIARIES PRO FORMA CONDENSED COMBINED STATEMENT OF INCOME For the Year Ended December 31, 2001 (Unaudited)
Hilb, Rogal and Hamilton Company Hobbs Pro Forma Historical Historical Adjustments Pro Forma REVENUES Commissions and fees $323,078,357 $94,232,835 $417,311,192 Investment income 2,584,600 833,802 3,418,402 Other 4,604,383 158,030 4,762,413 -------------------------------------------------------------------- 330,267,340 95,224,667 - 425,492,007 OPERATING EXPENSES Compensation and employee benefits 182,397,310 55,614,459 238,011,769 Other operating expenses 68,210,873 17,851,417 $ (629,632) (6) 85,432,658 Amortization of intangibles 13,867,645 5,298,460 201,540 (5) 19,367,645 Interest expense 9,061,585 4,316,309 2,271,691 (8) 15,649,585 -------------------------------------------------------------------- 273,537,413 83,080,645 1,843,599 358,461,657 -------------------------------------------------------------------- INCOME BEFORE INCOME TAXES AND MINORITY INTEREST 56,729,927 12,144,022 (1,843,599) 67,030,350 Income Taxes 24,381,412 1,390,191 3,703,731 (7) 29,475,334 -------------------------------------------------------------------- INCOME BEFORE MINORITY INTEREST 32,348,515 10,753,831 (5,547,330) 37,555,016 Minority interest 0 594,882 (594,882) 0 --------------------------------------------------------------------- NET INCOME $32,348,515 $ 10,158,949 $ (4,952,448) $ 37,555,016 ==================================================================== NET INCOME PER SHARE: BASIC $1.18 $1.33 ==================================================================== ASSUMING DILUTION $1.07 $1.21 ==================================================================== WEIGHTED AVERAGE SHARES OUTSTANDING: BASIC 27,411,472 719,729 28,131,201 ==================================================================== ASSUMING DILUTION 31,160,149 719,729 31,879,878 ====================================================================
See notes to the pro forma condensed combined financial statements. Bracketed numbers to the right of the "Pro Forma Adjustments" column refer to such notes. 44 HILB, ROGAL AND HAMILTON COMPANY AND SUBSIDIARIES PRO FORMA CONDENSED COMBINED FINANCIAL STATEMENTS Notes to Pro Forma Financial Statements The unaudited pro forma condensed consolidated balance sheet and unaudited pro forma consolidated statements of income reflect the acquistion of Hobbs under the purchase method of accounting. Under the purchase method of account the preliminary purchase price is allocated to the assets acquired and the liabilities assumed based on their estimated fair values. 1 This pro forma adjustment reflects the issuance of Common Stock and Cash in connection with the acquisition of Hobbs by the Company resulting in:
Preliminary Value a. The issuance of 719,729 shares of Common Stock at a price of $43.96 per share. The assumed Common Stock issuance price of $43.96 per share represents the average closing Common Stock price on the NYSE calculated in accordance with EITF 99-12. $ 31,639,265 b. The cash payment of the purchase price. 62,357,825 c. The assumption of tangible net worth deficit of Hobbs is assumed to be zero. 0 d. Estimated transaction costs of $3,000,000. 3,000,000 e. Payment of certain indebtedness ($40,932,032 at July 1, 2002), transaction costs, severance and other related merger liabilities incurred by Hobbs 51,805,904 f. Assumed merger liabilities of Hobbs not paid at closing 783,050 -------------- $ 149,586,044 ============== 2 The unallocated excess of purchase price over net assets acquired and estimated identifiable intangible assets has been preliminarily allocated to goodwill. The Company is in the process of valuing the net assets acquired, including the identification of intangibles other than goodwill. Accordingly, the purchase accounting information is preliminary. The final allocation of purchase price to intangible assets other than goodwill could result in increased amortization and decreased income and earnings per share in subsequent period The value preliminarily assigned to goodwill is calculated as follows: Total Preliminary Purchase Price $ 149,586,044 Book value of Hobbs (29,131,521) Record transaction costs, severance and other merger related liabilities incurred by Hobbs 11,656,923 -------------- Adjusted book value of Hobbs $ (17,474,598) Adjustments: Eliminate certain indebtedness, transaction costs, severance and other related merger liabilities incurred by Hobbs paid or assumed by the Company (excluding $640,940 of debt incurred subsequent to March 31, 2002) (51,948,034) Adjust minority interest to contractual buy-out (472,728) Additional amounts due shareholders under tangible net worth provisions of the contract 4,157,510 Eliminate historical intangible assets 63,348,986 -------------- Total Adjustments 15,085,734 Identifiable intangible assets 55,000,000 -------------- Goodwill $ 92,197,180 ============== 45 HILB, ROGAL AND HAMILTON COMPANY AND SUBSIDIARIES PRO FORMA CONDENSED COMBINED FINANCIAL STATEMENTS Notes to Pro Forma Financial Statements 3 This pro forma adjustment reflects the new $160,000,000 Senior Term Loan B under the existing amended bank credit facility used for funding the acquistion. This new term loan was also used to refinance a portion of existing bank debt of the Company of $40,000,000. The facility will mature five years from closing with pricing set at LIBOR + 275bps. Net new borrowings: $120,000,000 4 This pro forma adjustment eliminates historical preferred equity and shareholders' equity (deficit) of Hobbs. March 31, 2002 December 31, 2001 5 This pro forma adjustment reflects the elimination of historical amortization of Hobbs and the amortization of other identifiable $ 6,175 $ 5,298,460 intangibles acquired at the time of the Acquisition ($55,000,000) over a period of 10 years. $ 1,375,000 $ 5,500,000 6 This pro forma adjustment reflects the elimination of historical depreciation expense of Hobbs and recording of depreciation expense based upon the fair values of property, plant and equipment acquired in the Acquisition. 7 This pro forma adjustment reflects the income tax effect of the pro forma adjustments at an effective tax rate of 40.75%, reduced for the tax impact of nondeductible intangible asset amortization. This adjustment also eliminates historical Hobbs taxes and adjusts Hobbs' taxes to the Company's effective tax rate. 8 This pro forma adjustment eliminates historical interest expense of Hobbs and records interest expense under the new debt structure as follows: Interest on debt incurred in the acquisition, at an assumed interest rate of 4.63%, the London Interbank Offered Rate ("LIBOR") at the acquistion date plus 2.75%. The adjustment also includes additional loan fee amortization. A change of .125% in the assumed interest rate would increase or decrease interest expense annually by approximately March 31, 2002 December 31, 2001 $200,000. $ 1,630,000 $ 6,588,000 9 Contingent Consideration: The transaction is structured with a two-year earn-out provision of as much as $76,875,000, and $25,000,000 of contingent installment payments to be determined based on future earnings pursuant to the terms of the purchase agreement. The Hobbs' two year earn-out provision is due after years 1 and 2 with a combined payment not to exceed a maximum of $76,875,000. The $25,000,000 contingent installment consists of two payments of $12.5 million each which are due after years 1 and 2,if minimum EBITDA targets are met. In addition, the Company has agreed to assume and satisfy certain of Hobbs' existing earn-outs and deferred compensation liabilities with an agreed upon value of $30,000,000. 10 Effective January 1, 2002, the Company changed its method of accounting for commissions on premiums billed and collected directly by insurance carriers on middle market property and casualty business. For the three months ended March 31,2002, the cumulative effect adjustment was $3.9 million, net of tax. No pro forma adjustment has been presented for the year ended December 31, 2001 to reflect the effect of the retroactive application as it is not practical for the Company to compute prior period pro forma amounts due to the lack of prior period data.
46 (c) Exhibits. Exhibit No. Description ----------- ----------- 2.1 Purchase Agreement, dated May 10, 2002, by and among the Company, Hobbs, LLC ("Hobbs"), the members of Hobbs (other than Hobbs IRA Corp. ("HIRAC")) and the shareholders of HIRAC. 23.1 Consent of Ernst & Young LLP. 99.1 Second Amended and Restated Credit Agreement, dated as of July 1, 2002, among the Company, as Borrower; the lenders named therein; Wachovia Bank, National Association (formerly known as First Union National Bank), as administrative agent; PNC Bank, National Association, as documentation agent; and Bank of America Securities, LLC, as syndication agent. 99.2 Press release dated July 1, 2002. 99.3 Senior Executive Employment Agreement with Thomas A. Golub entered into May 10, 2002. 47 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized. HILB, ROGAL AND HAMILTON COMPANY (Registrant) Date: July 16,2002 By: /s/Carolyn Jones --------------------------------- Carolyn Jones Senior Vice President and Chief Financial Officer 48 Exhibit Index Exhibit No. Description ----------- ----------- 2.1 Purchase Agreement, dated May 10, 2002, by and among the Company, Hobbs, LLC ("Hobbs"), the members of Hobbs (other than Hobbs IRA Corp. ("HIRAC")) and the shareholders of HIRAC. 23.1 Consent of Ernst & Young LLP. 99.1 Second Amended and Restated Credit Agreement, dated as of July 1, 2002, among the Company, as Borrower; the lenders named therein; Wachovia Bank, National Association (formerly known as First Union National Bank), as administrative agent; PNC Bank, National Association, as documentation agent; and Bank of America Securities, LLC, as syndication agent. 99.2 Press release dated July 1, 2002. 99.3 Senior Executive Employment Agreement with Thomas A. Golub entered into May 10, 2002.