10-Q 1 form10q.txt FORM 10-Q FOR QUARTER ENDING SEPTEMBER 30, 2002 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For Quarter Ended September 30, 2002 Commission file number 0-15981 HILB, ROGAL AND HAMILTON COMPANY (Exact name of registrant as specified in its charter) Virginia 54-1194795 (State or other jurisdiction of (I.R.S.Employer incorporation or organization) Identification No.) 4951 Lake Brook Drive, Suite 500, Glen Allen, VA 23060 (Address of principal executive offices) (Zip Code) (804) 747-6500 (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- --- Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes X No --- --- Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Class Outstanding at November 1, 2002 -------------------------- ------------------------------- Common stock, no par value 29,422,983 HILB, ROGAL AND HAMILTON COMPANY INDEX Page ---- Part I. FINANCIAL INFORMATION Item 1. Financial Statements Statement of Consolidated Income for the three months and nine months ended September 30, 2002 and 2001 ....................... 3 Consolidated Balance Sheet, September 30, 2002 and December 31, 2001 ................... ............................ 4 Statement of Consolidated Shareholders' Equity for the nine months ended September 30, 2002 and 2001 ............................. 5 Statement of Consolidated Cash Flows for the nine months ended September 30, 2002 and 2001 ....................................... 6 Notes to Consolidated Financial Statements ............................................7-15 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations ...................... 16-21 Item 3. Qualitative and Quantitative Disclosures About Market Risk ............................. 21 Item 4. Controls and Procedures ....................... 21 Part II. OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K ............21-22 Signatures ................................................................. 23 Certifications ...........................................................24-25 2 PART I - FINANCIAL INFORMATION Item 1. FINANCIAL STATEMENTS STATEMENT OF CONSOLIDATED INCOME HILB, ROGAL AND HAMILTON COMPANY AND SUBSIDIARIES (UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, 2002 2001 2001 2002 ---- ---- ---- ---- Revenues Commissions and fees $126,834,193 $86,322,607 $320,221,578 $237,627,788 Investment income 632,848 682,198 1,606,477 1,978,585 Other 1,023,301 604,672 2,233,361 3,704,445 --------- ------- --------- ----------- 128,490,342 87,609,477 324,061,416 243,310,818 Operating expenses Compensation and employee benefits 69,794,938 47,362,028 175,848,657 132,885,941 Other operating expenses 21,923,639 15,699,868 56,479,205 44,114,833 Depreciation 1,997,753 1,686,561 5,438,196 4,706,904 Amortization of intangibles 1,919,575 3,490,364 3,004,173 10,260,966 Interest expense 3,785,927 2,392,443 7,488,537 7,052,015 --------- --------- --------- --------- 99,421,832 70,631,264 248,258,768 199,020,659 ---------- ---------- ----------- ----------- INCOME BEFORE INCOME TAXES AND CUMULATIVE EFFECT OF ACCOUNTING CHANGE 29,068,510 16,978,213 75,802,648 44,290,159 Income taxes 11,819,609 7,300,745 30,868,020 19,044,881 ---------- --------- ---------- ---------- INCOME BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGE 17,248,901 9,677,468 44,934,628 25,245,278 Cumulative effect of accounting change, net of tax - - 3,944,484 - ----------- --------- --------- ---------- NET INCOME $ 17,248,901 $ 9,677,468 $ 48,879,112 $ 25,245,278 ============ =========== ============ ============ Net Income Per Share - Basic: Income before cumulative effect of accounting change $0.59 $0.35 $1.58 $0.93 Cumulative effect of accounting change, net of tax - - 0.13 - ----- ----- ----- ----- Net income $0.59 $0.35 $1.71 $0.93 ===== ===== ===== ===== Net Income Per Share - Assuming Dilution: Income before cumulative effect of accounting change $0.53 $0.31 $1.41 $0.84 Cumulative effect of accounting change, net of tax - - 0.12 - ----- ----- ----- ----- Net income $0.53 $0.31 $1.53 $0.84 ===== ===== ===== =====
See notes to consolidated financial statements. 3 CONSOLIDATED BALANCE SHEET HILB, ROGAL AND HAMILTON COMPANY AND SUBSIDIARIES
SEPTEMBER 30, DECEMBER 31, 2002 2001 ---- ---- (UNAUDITED) ASSETS CURRENT ASSETS Cash and cash equivalents $114,077,275 $ 51,580,095 Investments 1,636,959 3,499,421 Receivables: Premiums and commissions, less allowance for doubtful accounts of $5,398,342 and $3,374,285, respectively 161,204,177 116,219,367 Other 37,966,570 17,672,780 ------------ ------------ 199,170,747 133,892,147 Prepaid expenses and other current assets 10,432,202 8,435,944 ------------ ------------ TOTAL CURRENT ASSETS 325,317,183 197,407,607 INVESTMENTS 1,200,608 1,335,798 PROPERTY AND EQUIPMENT, NET 20,324,803 19,484,705 GOODWILL 406,073,766 286,554,839 OTHER INTANGIBLE ASSETS 89,676,884 33,516,884 Less accumulated amortization 56,543,312 53,821,407 ------------ ------------ 439,207,338 266,250,316 OTHER ASSETS 12,498,317 9,764,122 ------------ ------------ $798,548,249 $494,242,548 ============ ============ LIABILITIES AND SHAREHOLDERS' EQUITY CURRENT LIABILITIES Premiums payable to insurance companies $247,931,323 $169,501,575 Accounts payable 9,027,972 7,303,804 Accrued expenses 42,226,966 20,302,435 Premium deposits and credits due customers 31,972,137 20,940,410 Current portion of long-term debt 5,515,326 6,996,423 ------------ ------------ TOTAL CURRENT LIABILITIES 336,673,724 225,044,647 LONG-TERM DEBT 220,716,831 114,443,224 OTHER LONG-TERM LIABILITIES 22,983,300 11,953,338 SHAREHOLDERS' EQUITY Common Stock, no par value; authorized 50,000,000 shares; outstanding 29,376,583 and 28,310,568 shares, respectively 89,589,974 55,542,485 Retained earnings 129,775,732 88,604,274 Accumulated other comprehensive income (loss): Unrealized loss on derivative contracts, net of deferred tax benefit of $1,074,000 and $955,000, respectively (1,611,387) (1,433,296) Other 420,075 87,876 ------------ ------------ 218,174,394 142,801,339 ------------ ------------ $798,548,249 $494,242,548 ============ ============
See notes to consolidated financial statements. 4 STATEMENT OF CONSOLIDATED SHAREHOLDERS' EQUITY HILB, ROGAL AND HAMILTON COMPANY AND SUBSIDIARIES (UNAUDITED)
ACCUMULATED OTHER COMMON RETAINED COMPREHENSIVE STOCK EARNINGS INCOME (LOSS) --------- -------- ------------- Balance at January 1, 2002 $55,542,485 $ 88,604,274 $(1,345,420) Issuance of 1,066,015 shares of Common Stock 34,047,489 Payment of dividends ($.2675 per share) (7,707,654) Net income 48,879,112 Derivative loss arising during 2002, net of tax (178,091) Other - - 332,199 ----------- ------------ ----------- Balance at September 30, 2002 $89,589,974 $129,775,732 $(1,191,312) =========== ============= =========== Balance at January 1, 2001 $22,361,312 $ 65,860,654 $ - Issuance of 1,609,906 shares of Common Stock 29,398,366 Purchase of 10,000 shares of Common Stock (211,080) Payment of dividends ($.26 per share) (7,127,647) Net income 25,245,278 Cumulative effect of accounting change related to derivatives, net of tax (516,600) Derivative loss arising during 2001, net of tax - - (1,141,745) ----------- ------------ ----------- Balance at September 30, 2001 $51,548,598 $ 83,978,285 $(1,658,345) =========== ============ ===========
See notes to consolidated financial statements. 5 STATEMENT OF CONSOLIDATED CASH FLOWS HILB, ROGAL AND HAMILTON COMPANY AND SUBSIDIARIES (UNAUDITED)
NINE MONTHS ENDED SEPTEMBER 30, 2002 2001 ---- ---- OPERATING ACTIVITIES Net income $ 48,879,112 $ 25,245,278 Adjustments to reconcile net income to net cash provided by operating activities: Cumulative effect of accounting change, net of tax (3,944,484) - Depreciation 5,438,196 4,706,904 Amortization of intangible assets 3,004,173 10,260,966 ------------- ------------ Net income plus amortization, depreciation and cumulative effect of accounting change, net of tax 53,376,997 40,213,148 Provision for losses on accounts receivable 923,085 817,815 Provision for deferred income taxes 2,870,482 - Loss (gain) on sale of assets 115,181 (2,602,422) Changes in operating assets and liabilities net of effects from insurance agency acquisitions and dispositions: Increase in accounts receivable (14,079,469) (8,693,132) Increase in prepaid expenses (610,908) (164,355) Increase in premiums payable to insurance companies 14,555,086 5,882,996 Increase in premium deposits and credits due customers 11,020,726 4,912,293 Decrease in accounts payable (193,731) (1,315,156) Increase in accrued expenses 10,509,335 5,945,392 Other operating activities (3,592,385) 4,359,960 ------------- ------------ NET CASH PROVIDED BY OPERATING ACTIVITIES 74,894,399 49,356,539 INVESTING ACTIVITIES Proceeds from maturities of held-to-maturity investments 2,629,242 857,867 Purchase of investments (611,080) (692,034) Purchase of property and equipment (4,405,420) (3,684,278) Purchase of insurance agencies, net of cash acquired (105,559,164) (38,808,587) Proceeds from sale of assets 1,492,107 4,400,627 Other investing activities 576,857 912,518 ------------- ------------ NET CASH USED IN INVESTING ACTIVITIES (105,877,458) (37,013,887) FINANCING ACTIVITIES Proceeds from long-term debt 160,000,000 37,074,109 Principal payments on long-term debt (57,684,306) (20,810,603) Debt issuance costs (2,356,075) - Proceeds from issuance of Common Stock 1,228,274 2,484,325 Repurchase of Common Stock - (211,080) Dividends (7,707,654) (7,127,647) ------------- ------------ NET CASH PROVIDED BY FINANCING ACTIVITIES 93,480,239 11,409,104 ------------- ------------ INCREASE IN CASH AND CASH EQUIVALENTS 62,497,180 23,751,756 Cash and cash equivalents at beginning of period 51,580,095 28,880,784 ------------- ------------ CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 114,077,275 $ 52,632,540 ============= ============
See notes to consolidated financial statements. 6 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS HILB, ROGAL AND HAMILTON COMPANY AND SUBSIDIARIES September 30, 2002 (UNAUDITED) NOTE A--BASIS OF PRESENTATION The accompanying unaudited consolidated financial statements of Hilb, Rogal and Hamilton Company (the Company) have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. 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 nine month period ended September 30, 2002, are not necessarily indicative of the results that may be expected for the year ending December 31, 2002. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company's Form 10-K for the year ended December 31, 2001. Certain amounts for the prior period have been reclassified to conform to current year presentation. NOTE B--CHANGES IN ACCOUNTING METHOD Effective January 1, 2002, the Company changed its method of accounting for commissions on premiums billed and collected directly by insurance carriers on its middle-market property and casualty business. Prior to 2002, this revenue was recognized when received. Beginning January 1, 2002, this revenue is recorded on the later of the billing date or the effective date, consistent with the revenue recognition policy for agency billed business. This is the predominant practice followed in the industry. Management believes that this new methodology is preferable and that it better matches the income with the related expenses. For the three months ended September 30, 2002, the effect of this change to net income was less than $5,000. For the nine months ended September 30, 2002, the effect of this change was to increase net income by $5.5 million ($0.17 per share), which included the cumulative effect adjustment of $3.9 million ($0.12 per share), net of income taxes of $2.6 million. No prior period pro forma amounts have been presented to reflect the effect of retroactive application of the change as it is not practical for the Company to compute prior period pro forma amounts due to the lack of prior period data. 7 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS HILB, ROGAL AND HAMILTON COMPANY AND SUBSIDIARIES September 30, 2002 (UNAUDITED) NOTE C--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 will no longer be amortized but will be 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 has tested 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 completed the first of the required impairment tests of goodwill as of January 1, 2002. No impairment charge resulted from this test. The following table provides a reconciliation of the September 30, 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 For the Nine Months Ended September 30, September 30, 2002 2001 2002 2001 ---- ---- ---- ---- Net Income - as reported $17,248,901 $ 9,677,468 $48,879,112 $25,245,278 Goodwill amortization, net of tax - 2,202,702 - 6,271,256 ----------- ------------ ----------- ----------- Adjusted net income $17,248,901 $11,880,170 $48,879,112 $31,516,534 =========== ============ ============ =========== Net Income Per Share - Basic: Net income - as reported $0.59 $0.35 $1.71 $0.93 Goodwill amortization, net of tax - 0.07 - 0.23 ------ ------ ----- ----- Adjusted net income $0.59 $0.42 $1.71 $1.16 ====== ====== ===== ===== Net Income Per Share - Assuming Dilution: Net income - as reported $0.53 $0.31 $1.53 $0.84 Goodwill amortization, net of tax - 0.07 - 0.21 ------ ------ ----- ----- Adjusted net income $0.53 $0.38 $1.53 $1.05 ====== ====== ===== =====
8 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS HILB, ROGAL AND HAMILTON COMPANY AND SUBSIDIARIES September 30, 2002 (UNAUDITED) NOTE C--INTANGIBLE ASSETS-Continued Intangible assets consist of the following:
As of September 30, 2002 As of December 31, 2001 ------------------------ ----------------------- Gross Carrying Accumulated Gross Carrying Accumulated Amount Amortization Amount Amortization ------ ------------ ------ ------------ Amortizable intangible assets: Acquired identifiable intangibles $55,000,000 $ 1,375,000 $ - $ - Non-compete agreements 29,227,000 7,503,000 27,932,000 6,138,000 Expiration rights 4,950,000 4,696,000 5,085,000 4,601,000 Tradename 500,000 68,000 500,000 53,000 ----------- ----------- ----------- ----------- Total $89,677,000 $13,642,000 $33,517,000 $10,792,000 =========== =========== =========== =========== Indefinite-lived intangible assets: Goodwill, net $363,172,000 $243,526,000
The acquired identifiable intangibles relate to the Hobbs Group, LLC acquisition (see Note E). Aggregate amortization expense for the nine months ended September 30, 2002 and 2001 was $3,004,000 and $10,261,000, respectively. Estimated amortization expense: For year ended December 31, 2002 $4,956,000 For year ended December 31, 2003 7,519,000 For year ended December 31, 2004 7,411,000 For year ended December 31, 2005 7,355,000 For year ended December 31, 2006 7,345,000 For year ended December 31, 2007 7,342,000 9 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS HILB, ROGAL AND HAMILTON COMPANY AND SUBSIDIARIES September 30, 2002 (UNAUDITED) NOTE C--INTANGIBLE ASSETS-Continued The changes in the net carrying amount of goodwill for the nine months ended September 30, 2002, are as follows: Balance as of December 31, 2001 $243,526,000 Goodwill acquired 120,728,000 Goodwill disposed (1,082,000) ------------- Balance as of September 30, 2002 $363,172,000 ============ NOTE D--INCOME TAXES Deferred taxes result from temporary differences between the carrying amounts of assets and liabilities for financial statement purposes and the amounts used for income tax purposes. The Company's effective rate varies from the statutory rate primarily due to state income taxes and non-deductible amortization. NOTE E--ACQUISITIONS On July 1, 2002 the Company acquired all of the issued and outstanding membership interest units of Hobbs Group, LLC ("Hobbs") other than those owned by Hobbs IRA Corp. ("HIRAC"), and all of the issued and outstanding capital stock of HIRAC pursuant to a Purchase Agreement, dated May 10, 2002, by and among the Company, Hobbs, the members of Hobbs (other than HIRAC) and the shareholders of HIRAC. Hobbs is an insurance broker serving upper middle-market and top-tier clients and provides property and casualty insurance brokerage, risk management and executive and employee benefits services. This acquisition allows the Company to expand its capabilities in the upper middle-market and top-tier businesses. In addition, Hobbs will provide the Company with additional market presence and expertise in the employee benefits services area and an increased presence into executive benefits. Hobbs will also bring increased depth to the geographic reach of the Company's existing national platform. 10 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS HILB, ROGAL AND HAMILTON COMPANY AND SUBSIDIARIES September 30, 2002 (UNAUDITED) NOTE E--ACQUISITIONS-Continued The amount the Company paid in connection with the acquisition consisted of approximately $116.5 million in cash, which included acquisition costs of $2.3 million and the Company's assumption and retirement of certain debt of Hobbs, and 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") valued at $31.6 million. The value of the 719,729 shares issued was determined based on the average market price of the Company's stock over the period including two days before and after the date at which the number of shares to be issued in accordance with the Purchase Agreement became fixed. 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 contingent earn-out and deferred compensation obligations of Hobbs from Hobbs' prior acquisitions estimated to approximate a net present value of $30 million. The contingent payments and assumed existing earn-outs will be recorded when their respective contingencies are resolved and consideration is paid. The assets and liabilities of Hobbs have been revalued to their respective estimated fair values. Intangible assets subject to amortization were estimated at $55.0 million with an estimated amortization period of 10 years. The excess purchase price over fair market value of the allocated assets and liabilities of $100.6 million was allocated to goodwill. The Company is in the process of obtaining a third-party valuation of certain intangible assets; thus, the allocation of the purchase price is preliminary and subject to refinement. The Company's financial statements include the results of Hobbs operations since the closing date of the acquisition. The following unaudited pro forma results of operations of the Company give effect to the acquisition of Hobbs as though the transaction had occurred on January 1, 2002 and 2001, respectively. 11 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS HILB, ROGAL AND HAMILTON COMPANY AND SUBSIDIARIES September 30, 2002 (UNAUDITED) NOTE E--ACQUISITIONS-Continued
Three Months Ended Nine Months Ended September 30, September 30, 2002 2001 2002 2001 ---- ---- ---- ---- Total Revenues $128,490,000 $107,943,000 $375,006,000 $308,227,000 Income before cumulative effect of accounting change and extraordinary item $ 17,249,000 $ 10,402,000 $ 47,395,000 $ 28,519,000 ============= ============= ============= ============= Net Income $ 17,249,000 $ 10,402,000 $ 50,929,000 $ 28,519,000 ============= ============= ============= ============= Income per share before cumulative effect of accounting change and extraordinary item: Basic $0.59 $0.36 $1.62 $1.02 ===== ===== ===== ===== Assuming Dilution $0.53 $0.33 $1.45 $0.93 ===== ===== ===== ===== Net Income Per Share: Basic $0.59 $0.36 $1.74 $1.02 ===== ===== ===== ===== Assuming Dilution $0.53 $0.33 $1.55 $0.93 ===== ===== ===== =====
The pro forma net income results for the nine months ended September 30, 2002 include a cumulative effect of accounting change of $3.9 million ($0.12 per share) related to the Company's change in revenue recognition policy (see Note B) and an extraordinary loss of $0.4 million ($0.01 per share) related to Hobbs' debt extinguishment. 12 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS HILB, ROGAL AND HAMILTON COMPANY AND SUBSIDIARIES September 30, 2002 (UNAUDITED) NOTE E--ACQUISITIONS-Continued In addition, the Company entered into a Second Amended and Restated Credit Agreement (the Amended Credit Agreement), dated as of July 1, 2002. The Amended Credit Agreement amends and restates an Amended and Restated Credit Agreement, dated as of April 6, 2001, and provides for a credit facility of up to an aggregate of $290.0 million. In particular, the Amended Credit Agreement maintains the availability to the Company of a revolving credit facility in the aggregate principal amount of $100.0 million and a term loan facility with an aggregate principal amount of $190.0 million. Pursuant to the Amended Credit Agreement, the increased term loan facility was made available to finance the cash payment in connection with the Hobbs acquisition and for working capital and general corporate purposes. During the first nine months of 2002, the Company also acquired certain assets and liabilities of five other insurance agencies for approximately $10,961,000 ($9,639,000 in cash and $1,322,000 in other guaranteed future payments) in purchase accounting transactions. The purchase price may be increased based on agency profitability per the contracts. These acquisitions are not material to the consolidated financial statements individually or in aggregate. NOTE F--SALE OF ASSETS AND OTHER GAINS During the nine months ended September 30, 2002 and 2001, the Company sold certain insurance accounts and other assets resulting in a loss of approximately $115,000 and a gain of $2,602,000, respectively, including a $94,000 gain and a $20,000 loss during the third quarters of 2002 and 2001, respectively. Revenues, expenses, assets and liabilities related to these dispositions were not material to the consolidated financial statements. 13 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS HILB, ROGAL AND HAMILTON COMPANY AND SUBSIDIARIES September 30, 2002 (UNAUDITED) NOTE G--NET INCOME PER SHARE The following table sets forth the computation of basic and diluted net income per share.
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, 2002 2001 2002 2001 ----------- ----------- ----------- ----------- Numerator for basic net income per share - net income $17,248,901 $ 9,677,468 $48,879,112 $25,245,278 Effect of dilutive securities: 5.25% convertible debenture 273,185 271,626 818,363 813,759 ----------- ----------- ----------- ----------- Numerator for dilutive net income per share - net income available after assumed conversions $17,522,086 $ 9,949,094 $49,697,475 $26,059,037 =========== =========== =========== =========== Denominator Weighted average shares 29,096,224 27,899,942 28,491,332 27,116,188 Effect of guaranteed future shares to be issued in connection with an agency acquisition 28,030 89,208 30,935 62,650 ----------- ----------- ----------- ----------- Denominator for basic net income per share 29,124,254 27,989,150 28,522,267 27,178,838 Effect of dilutive securities: Employee stock options 1,060,423 814,048 1,050,152 744,086 Employee non-vested stock 133,067 118,838 149,978 98,214 Contingent stock - acquisitions 39,480 56,126 33,073 34,810 5.25% convertible debenture 2,813,186 2,813,186 2,813,186 2,813,186 ----------- ----------- ----------- ----------- Dilutive potential common shares 4,046,156 3,802,198 4,046,389 3,690,296 ----------- ----------- ----------- ----------- Denominator for diluted net income per share - adjusted weighted average shares and assumed conversions 33,170,410 31,791,348 32,568,656 30,869,134 =========== =========== =========== =========== Net Income Per Share: Basic $0.59 $0.35 $1.71 $0.93 ===== ===== ===== ===== Assuming Dilution $0.53 $0.31 $1.53 $0.84 ===== ===== ===== =====
14 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS HILB, ROGAL AND HAMILTON COMPANY AND SUBSIDIARIES September 30, 2002 (UNAUDITED) NOTE H--SUBSEQUENT EVENT In November 2002, pursuant to a Form S-3 registration statement filed with the Securities and Exchange Commission, the Company sold 1,150,000 shares of its Common Stock for net proceeds of approximately $41.2 million. The Company intends to use the proceeds to repay indebtedness, for acquisitions and for other general corporate purposes. Concurrent with this sale, The Phoenix Companies, Inc., agreed to convert all of the Company's Convertible Subordinated Debentures that it held into 2,813,186 shares of the Company's Common Stock. These debentures were included in the September 30, 2002 balance sheet at $29.0 million, net of discount, with a 5.25% interest rate and maturity date of 2014. In connection with the conversion, the Company amended the voting and standstill agreement with The Phoenix Companies, Inc. and its subsidiaries. 15 Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS On July 1, 2002 the Company acquired all of the issued and outstanding membership interest units of Hobbs Group, LLC ("Hobbs") other than those owned by Hobbs IRA Corp. ("HIRAC"), and all of the issued and outstanding capital stock of HIRAC pursuant to a Purchase Agreement, dated May 10, 2002, by and among the Company, Hobbs, the members of Hobbs (other than HIRAC) and the shareholders of HIRAC. The assets and liabilities of Hobbs have been revalued to their respective fair market values. Certain fair value estimates used in the determination of intangible assets are preliminary and are subject to refinement. The financial statements of the Company reflect the combined operations of the Company and Hobbs from the closing date of the acquisition. Results of Operations: ---------------------- Three Months Ended September 30, 2002 Net income for the three months ended September 30, 2002 was $17.2 million, or $0.53 per share, compared with $9.7 million, or $0.31 per share for the comparable period last year. Excluding net non-recurring gains and adjusting amortization to a pro forma basis in 2001 as if the new accounting standards related to goodwill had been adopted as of January 1, 2001, net income was $17.2 million for the quarter, a 44.6% increase from $11.9 million last year. Net income per share on the same basis was $0.53, compared with $0.38 last year. See "Note C - Intangible Assets" of Notes to Consolidated Financial Statements. Commissions and fees were $126.8 million, an increase of 46.9% from commissions and fees of $86.3 million during the comparable period of the prior year. Approximately $32.7 million of commissions were derived from purchase acquisitions of new insurance agencies. This increase was offset by decreases of approximately $0.4 million from the sale of certain offices and accounts in 2002 and 2001. Excluding the effect of acquisitions and dispositions, commissions and fees increased 9.5%. This reflects new business production and continued industry-wide premium increases. Expenses for the quarter increased $28.8 million or 40.8%. Compensation and benefits, other operating expenses and depreciation expense increased $22.4 million, $6.2 million and $0.3 million, respectively, primarily due to purchase acquisitions of insurance agencies and increased revenue production. Amortization of intangibles decreased approximately $1.6 million due primarily to the adoption of Statement 142 partially offset by new amortization for intangibles acquired in the Hobbs transaction. Interest expense increased by $1.4 million due to increased borrowings, primarily related to the Hobbs acquisition. The Company's overall tax rate for the three months ended September 30, 2002 was 40.7% compared to 43.0% for the same period of the prior year. The decrease is primarily related to the non-amortization of goodwill resulting from the adoption of Statement 142. 16 Nine Months Ended September 30, 2002 For the nine months ended September 30, 2002, net income was $48.9 million, or $1.53 per share, compared to $25.2 million, or $0.84 per share last year. Excluding the effect of gains and the 2002 cumulative effect of an accounting change relating to revenue recognition and adjusting 2001 amortization to a pro forma basis, net income was $45.0 million, or $1.41 per share, up from $30.0 million or $1.00 per share a year ago. Commissions and fees were $320.2 million, an increase of 34.8% from commissions and fees of $237.6 million during the comparable period of the prior year. Approximately $60.6 million of commissions were derived from purchase acquisitions of new insurance agencies. This increase was offset by decreases of approximately $1.8 million from the sale of certain offices and accounts in 2002 and 2001. Commissions and fees, excluding the effect of acquisitions and dispositions, increased 10.0%. This increase principally reflects new business production and a continued strong rate environment. Investment income decreased $0.4 million, or 18.8%, primarily due to a lower interest rate environment. Other income decreased $1.5 million or 39.7% from the prior year primarily due to the net impact of nonrecurring gains from the sale of an agency in 2001, certain insurance accounts and other assets. Expenses increased by $49.2 million or 24.7%. Increases include $43.0 million in compensation and benefits, $12.4 million in other operating expenses and $0.7 million in depreciation expense, primarily due to purchase acquisitions of new insurance agencies and increased revenue production. Amortization of intangibles decreased approximately $7.3 million due primarily to the adoption of Statement 142. Interest expense increased by $0.4 million due to increased bank borrowings related primarily to the Hobbs acquisition, offset somewhat, by declines in interest rates. The Company's overall tax rate was 40.7% for the nine months ended September 30, 2002 compared to the rate of 43.0% for the nine months ended September 30, 2001. The decrease was primarily related to the non-amortization of goodwill resulting from adoption of Statement 142. Other For the three months ended September 30, 2002, net income as a percentage of revenues did not vary significantly from the three months ended June 30, 2002. Commission income was higher during the third quarter due to acquisitions during the quarter, primarily Hobbs. The timing of contingent commissions, policy renewals, acquisitions and dispositions may cause revenues, expenses and net income to vary significantly from quarter to quarter. As a result of the factors described above, operating results for the nine months ended September 30, 2002 should not be considered indicative of the results that may be expected for the entire year ending December 31, 2002. 17 Liquidity and Capital Resources: -------------------------------- Net cash provided by operations totaled $74.9 million and $49.4 million for the nine months ended September 30, 2002 and 2001, respectively, and is primarily dependent upon the timing of the collection of insurance premiums from clients and payment of those premiums to the appropriate insurance underwriters. The Company has historically generated sufficient funds internally to finance capital expenditures for property and equipment. Cash expenditures for the acquisition of property and equipment were $4.4 million and $3.7 million for the nine months ended September 30, 2002 and 2001, respectively. The timing and extent of the purchase and sale of investments is dependent upon cash needs and yields on alternate investments and cash equivalents. The purchase of insurance agencies utilized cash of $105.6 million and $38.8 million in the nine months ended September 30, 2002 and 2001, respectively. Cash expenditures for such insurance agency acquisitions have been primarily funded through operations and long-term borrowings. In addition, a portion of the purchase price in such acquisitions may be paid through the Company's Common Stock and deferred cash payments. Cash proceeds from the sale of accounts and other assets amounted to $1.5 million and $4.4 million in the nine months ended September 30, 2002 and 2001, respectively. The Company did not have any material capital expenditure commitments as of September 30, 2002. Financing activities provided cash of $93.5 million and $11.4 million in the nine months ended September 30, 2002 and 2001, respectively. The Company has consistently made scheduled debt payments and annually increased its dividend rate. The Company is currently authorized to purchase 748,200 shares. The Company anticipates the continuance of its dividend policy. As of September 30, 2002, the Company had a bank credit agreement for $286.4 million under which loans are due in various amounts through 2007, including $152.4 million due in 2007, and 5.25% Convertible Subordinated Debentures with a $32.0 million face value due 2014. At September 30, 2002, there were loans of $186.4 million outstanding under the bank agreement, with $100.0 million available under the revolving portion of the facility for future borrowings. During the quarter, the Company signed the Second Amended and Restated Credit Agreement (Amended Credit Agreement). The new agreement amends and restates an Amended and Restated Credit Agreement dated April 6, 2001. The new agreement provides a $190.0 million term loan facility ($30.0 million of which was retained from the previous credit agreement) under which borrowings are due in various amounts through 2007 including $152.4 million due 2007. The Amended Credit Agreement also maintains the availability to the Company of a revolving credit facility in the aggregate principal amount of $100.0 million. The proceeds were used in part, to fund the cash portion of the Hobbs Group, LLC acquisition. 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. 18 In November 2002, pursuant to a Form S-3 registration statement filed with the Securities and Exchange Commission, the Company sold 1,150,000 shares of its Common Stock for net proceeds of approximately $41.2 million. The Company intends to use the proceeds to repay indebtedness, for acquisitions and for other general corporate purposes. Concurrent with this sale, The Phoenix Companies, Inc., agreed to convert all of the Convertible Subordinated Debentures that it held into 2,813,186 shares of the Company's Common Stock. These debentures were included in the September 30, 2002 balance sheet at $29.0 million, net of discount, with a 5.25% interest rate and maturity date of 2014. In connection with the conversion, the Company amended the voting and standstill agreement with The Phoenix Companies, Inc. and its subsidiaries. The Company had a current ratio (current assets to current liabilities) of 0.97 to 1.00 as of September 30, 2002. Shareholders' equity of $218.2 million at September 30, 2002, is improved from $142.8 million at December 31, 2001. The debt to equity ratio of 1.01 to 1.00 is increased from the ratio at December 31, 2001 of 0.80 to 1.00 due to increased borrowings offset, in part, by the issuance of Common Stock and increased net income. The Company believes that cash generated from operations, together with proceeds from borrowings, will provide sufficient funds to meet the Company's short and long-term funding needs. Business Acquisition -------------------- On July 1, 2002 the Company acquired all of the issued and outstanding membership interest units of Hobbs other than those owned by HIRAC, and all of the issued and outstanding capital stock of HIRAC pursuant to a Purchase Agreement, dated May 10, 2002, by and among the Company, Hobbs, the members of Hobbs (other than HIRAC) and the shareholders of HIRAC. Hobbs, which is based in Atlanta, Georgia, is one of the nation's premier insurance brokers serving upper middle-market and top-tier clients and provides property and casualty insurance brokerage, risk management, and executive and employee benefits services. This acquisition allows the Company to expand its capabilities in the upper middle-market and top-tier businesses. In addition, Hobbs will provide the Company with additional market presence and expertise in the employee benefits services area and an increased presence in executive benefits. Hobbs will also bring increased depth to the geographic reach of the Company's existing national platform. The amount the Company paid in connection with the acquisition consisted of approximately $116.5 million in cash, which included acquisition costs of $2.3 million and the Company's assumption and retirement of certain debt of Hobbs, and 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 valued at $31.6 million. 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 19 value of $30 million. In addition, on July 1, 2002, the Company granted 625,000 stock options to key employees of Hobbs. The options have an exercise price equal to the fair market value at date of grant, expire in seven years and vest at a rate of 25% a year for four years. Market Risk ----------- The Company has certain investments and utilizes (on a limited basis) derivative financial instruments which are subject to market risk; however, the Company believes that exposure to market risk associated with these instruments is not material. New Accounting Standard ----------------------- The Company adopted Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets" (Statement 142), effective January 1, 2002, which, among other things, ends the practice of amortizing goodwill. Net income for the three months and nine months ended September 30, 2001 would have increased by $0.07 and $0.21 per share, respectively, on a pro forma basis, assuming adoption of Statement 142 as of January 1, 2001. The Company has tested 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 completed the first of the required impairment tests of goodwill as of January 1, 2002. No impairment charge resulted from this test. Change in Accounting Principle ------------------------------ Effective January 1, 2002, the Company changed its method of accounting for commissions on premiums billed and collected directly by insurance carriers on its middle-market property and casualty business. Prior to 2002, this revenue was recognized when received. Beginning January 1, 2002, this revenue is recorded on the later of the billing date or the effective date, consistent with the revenue recognition policy for agency billed business. This is the predominant practice followed in the industry. Management believes that this new methodology is preferable and that it better matches the income with the related expenses. For the three months ended September 30, 2002, the effect of this change to net income was less than $5,000. For the nine months ended September 30, 2002, the effect of this change was to increase net income by $5.5 million ($0.17 per share), which included the cumulative effect adjustment of $3.9 million ($0.12 per share), net of income taxes of $2.6 million. No prior period pro forma amounts have been presented to reflect the effect of retroactive application of the change as it is not practical for the Company to compute prior period pro forma amounts due to the lack of prior period data. Forward-Looking Statements -------------------------- The Company cautions readers that the foregoing discussion and analysis includes "forward-looking statements" within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, and are subject to the safe harbor created by that Act. These forward-looking statements are believed by the Company to be reasonable based upon management's current knowledge and assumptions about future events, but are subject to the uncertainties generally 20 inherent in any such forward-looking statement, including factors discussed above as well asother factors that may generally affect the Company's business, financial condition or operating results. Reference is made to the discussion of "Forward-Looking Statements" contained in "Management's Discussion and Analysis of Financial Condition and Results of Operations" in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2001, regarding important risk factors and uncertainties that could cause actual results, performance or achievements to differ materially from future results, performance or achievements expressed or implied in any forward-looking statement made by or on behalf of the Company. Item 3. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK The information required by this item is set forth under the caption "Market Risk" in Item 2 -- Management's Discussion and Analysis of Financial Condition and Results of Operations. Item 4. CONTROLS AND PROCEDURES Within 90 days of the filing of this report on Form 10-Q, the Company's management, including the chief executive officer and the chief financial officer, performed an evaluation of the effectiveness of the design and operation of the Company's disclosure controls and procedures (as defined in Rules 13a-14(c) and 15d-14(c) promulgated under the Securities Exchange Act of 1934, as amended). Based on that evaluation, the Company's management, including the chief executive officer and chief financial officer, concluded that the Company's disclosure controls and procedures were effective as of that evaluation date. There have been no significant changes in the Company's internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation. PART II - OTHER INFORMATION Item 6. EXHIBITS AND REPORTS ON FORM 8-K a) Exhibits Exhibit No. Document ----------- -------- 10.1 Amended and Restated Voting and Standstill Agreement, dated November 7, 2002, by and among the Company, The Phoenix Companies, Inc., Phoenix Life Insurance Company and PM Holdings, Inc. 99.1 Certification Statement of Chief Executive Officer pursuant to 18 U.S.C. Section 1350 21 Exhibit No. Document ----------- -------- 99.2 Certification Statement of Chief Financial Officer pursuant to 18 U.S.C. Section 1350 b) Reports on Form 8-K Information required by this item was previously reported in the Company's Form 10-Q for the quarter ended June 30, 2002. 22 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Hilb, Rogal and Hamilton Company -------------------------------- (Registrant) Date November 13, 2002 By: /s/Andrew L. Rogal --------------------------- ----------------------------------- Chairman and Chief Executive Officer (Principal Executive Officer) Date November 13, 2002 By: /s/Carolyn Jones --------------------------- ----------------------------------- Senior Vice President, Chief Financial Officer and Treasurer (Principal Financial Officer) Date November 13, 2002 By: /s/Robert W. Blanton, Jr. --------------------------- ----------------------------------- Vice President and Controller (Chief Accounting Officer) 23 CERTIFICATIONS I, Andrew L. Rogal, Chief Executive Officer of Hilb, Rogal and Hamilton Company, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Hilb, Rogal and Hamilton Company; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: (a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; (b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and (c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): (a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and (b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: November 13, 2002 /s/Andrew L. Rogal ------------------ -------------------------------------------- Andrew L. Rogal Chief Executive Officer 24 I, Carolyn Jones, Senior Vice President, Chief Financial Officer and Treasurer of Hilb, Rogal and Hamilton Company, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Hilb, Rogal and Hamilton Company; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: (a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; (b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and (c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): (a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and (b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: November 13, 2002 /s/Carolyn Jones ------------------ -------------------------------------------- Carolyn Jones Senior Vice President, Chief Financial Officer and Treasurer 25 HILB, ROGAL AND HAMILTON COMPANY EXHIBIT INDEX Exhibit No. Document ----------- -------- 10.1 Amended and Restated Voting and Standstill Agreement, dated November 7, 2002, by and among the Company, The Phoenix Companies, Inc., Phoenix Life Insurance Company and PM Holdings, Inc. 99.1 Certification Statement of Chief Executive Officer pursuant to 18 U.S.C. Section 1350 99.2 Certification Statement of Chief Financial Officer pursuant to 18 U.S.C. Section 1350