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United States
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
for the quarterly period ended September 30, 2005
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
for the transition period from ______ to ______
COMMISSION FILE NUMBER 1-10356
CRAWFORD & COMPANY
(Exact name of Registrant as specified in its charter)
GEORGIA 58-0506554
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
5620 GLENRIDGE DRIVE, N.E.
ATLANTA, GEORGIA 30342
(Address of principal executive offices) (Zip Code)
(404) 256-0830
(Registrant's telephone number, including area code)
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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 by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act).
YES NO X
----- -----
The number of shares outstanding of each of the issuer's classes of common
stock, as of October 31, 2005 was as follows:
CLASS A COMMON STOCK, $1.00 PAR VALUE: 24,288,459
CLASS B COMMON STOCK, $1.00 PAR VALUE: 24,697,172
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CRAWFORD & COMPANY
QUARTERLY REPORT ON FORM 10-Q
SEPTEMBER 30, 2005
TABLE OF CONTENTS
Page
----
Part I. Financial Information
Item 1. Financial Statements:
Condensed Consolidated Statements of Income (unaudited)
Nine Months ended September 30, 2005 and 2004................. 3
Condensed Consolidated Statements of Income (unaudited)
Quarters ended September 30, 2005 and 2004.................... 4
Condensed Consolidated Balance Sheets
September 30, 2005 (unaudited) and December 31, 2004.......... 5
Condensed Consolidated Statements of Cash Flows (unaudited)
Nine Months ended September 30, 2005 and 2004................. 7
Notes to Condensed Consolidated Financial Statements
(unaudited)................................................... 8
Report of Independent Registered Public Accounting Firm.......... 17
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations......................................... 18
Item 3. Quantitative and Qualitative Disclosures about Market Risk....... 35
Item 4. Controls and Procedures.......................................... 36
Part II. Other Information:
Item 1. Legal Proceedings................................................ 37
Item 6. Exhibits......................................................... 38
2
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CRAWFORD & COMPANY
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
UNAUDITED
(IN THOUSANDS, EXCEPT PER SHARE DATA)
NINE MONTHS ENDED
-----------------------------
SEPTEMBER 30, SEPTEMBER 30,
2005 2004
------------- -------------
REVENUES:
Revenues before reimbursements $555,056 $527,741
Reimbursements 57,588 61,036
-------- --------
TOTAL REVENUES 612,644 588,777
-------- --------
COSTS AND EXPENSES:
Cost of services provided, before reimbursements 438,538 407,599
Reimbursements 57,588 61,036
-------- --------
Cost of services 496,126 468,635
Selling, general, and administrative expenses 101,576 100,946
Special credit (gain on undeveloped parcel of land) -- (8,573)
Corporate interest expense, net of interest income of
$436 and $2,081, respectively 4,216 2,269
-------- --------
TOTAL COSTS AND EXPENSES 601,918 563,277
-------- --------
INCOME BEFORE INCOME TAXES 10,726 25,500
PROVISION FOR INCOME TAXES 3,797 8,046
-------- --------
NET INCOME $ 6,929 $ 17,454
======== ========
NET INCOME PER SHARE:
Basic $ 0.14 $ 0.36
Diluted $ 0.14 $ 0.36
======== ========
WEIGHTED-AVERAGE SHARES OUTSTANDING:
Basic 48,911 48,748
Diluted 49,416 48,829
======== ========
CASH DIVIDENDS PER SHARE:
Class A Common Stock $ 0.18 $ 0.18
Class B Common Stock $ 0.18 $ 0.18
======== ========
(See accompanying notes to condensed consolidated financial statements)
3
CRAWFORD & COMPANY
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
UNAUDITED
(IN THOUSANDS, EXCEPT PER SHARE DATA)
QUARTER ENDED
-----------------------------
SEPTEMBER 30, SEPTEMBER 30,
2005 2004
------------- -------------
REVENUES:
Revenues before reimbursements $184,720 $185,870
Reimbursements 21,500 31,638
-------- --------
TOTAL REVENUES 206,220 217,508
-------- --------
COSTS AND EXPENSES:
Cost of services provided, before reimbursements 146,284 144,339
Reimbursements 21,500 31,638
-------- --------
Cost of services 167,784 175,977
Selling, general, and administrative expenses 34,181 33,160
Special credit (gain on undeveloped parcel of land) -- (8,573)
Corporate interest expense, net of interest income of
$193 and $56, respectively 1,334 1,466
-------- --------
TOTAL COSTS AND EXPENSES 203,299 202,030
-------- --------
INCOME BEFORE INCOME TAXES 2,921 15,478
PROVISION FOR INCOME TAXES 1,034 5,953
-------- --------
NET INCOME $ 1,887 $ 9,525
======== ========
NET INCOME PER SHARE:
Basic $ 0.04 $ 0.20
Diluted $ 0.04 $ 0.20
======== ========
WEIGHTED-AVERAGE SHARES OUTSTANDING:
Basic 48,978 48,796
Diluted 49,462 48,917
======== ========
CASH DIVIDENDS PER SHARE:
Class A Common Stock $ 0.06 $ 0.06
Class B Common Stock $ 0.06 $ 0.06
======== ========
(See accompanying notes to condensed consolidated financial statements)
4
CRAWFORD & COMPANY
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
(UNAUDITED) *
SEPTEMBER 30, DECEMBER 31,
2005 2004
------------- ------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 36,176 $ 43,571
Accounts receivable, less allowance for doubtful
accounts of $19,512 in 2005 and $21,859 in 2004 168,502 173,123
Unbilled revenues, at estimated billable amounts 108,932 106,650
Prepaid expenses and other current assets 15,459 22,546
--------- ---------
TOTAL CURRENT ASSETS 329,069 345,890
--------- ---------
PROPERTY AND EQUIPMENT:
Property and equipment, at cost 151,361 154,553
Less accumulated depreciation (116,228) (120,054)
--------- ---------
NET PROPERTY AND EQUIPMENT 35,133 34,499
--------- ---------
OTHER ASSETS:
Intangible assets arising from acquisitions, net 110,169 109,410
Capitalized software costs, net 32,572 32,894
Deferred income tax asset 32,150 32,172
Other 16,641 16,395
--------- ---------
TOTAL OTHER ASSETS 191,532 190,871
--------- ---------
TOTAL ASSETS $ 555,734 $ 571,260
========= =========
* derived from the audited Consolidated Balance Sheet
(See accompanying notes to condensed consolidated financial statements)
5
CRAWFORD & COMPANY
CONDENSED CONSOLIDATED BALANCE SHEETS - CONTINUED
(IN THOUSANDS)
(UNAUDITED) *
SEPTEMBER 30, DECEMBER 31,
2005 2004
------------- ------------
LIABILITIES AND SHAREHOLDERS' INVESTMENT
CURRENT LIABILITIES:
Short-term borrowings $ 35,968 $ 37,401
Accounts payable 40,778 41,730
Accrued compensation and related costs 46,552 46,308
Deferred revenues 20,875 22,682
Self-insured risks 16,949 17,489
Accrued income taxes 17,399 22,760
Other accrued liabilities 22,116 24,053
Current installments of long-term debt and capital leases 1,080 1,900
-------- --------
TOTAL CURRENT LIABILITIES 201,717 214,323
-------- --------
NONCURRENT LIABILITIES:
Long-term debt and capital leases, less current installments 50,972 50,875
Deferred revenues 10,516 10,179
Self-insured risks 8,129 10,958
Minimum pension liabilities 76,488 73,893
Postretirement medical benefit obligation 5,213 5,544
Other 10,122 10,655
-------- --------
TOTAL NONCURRENT LIABILITIES 161,440 162,104
-------- --------
SHAREHOLDERS' INVESTMENT:
Class A common stock, $1.00 par value; 50,000 shares
authorized; 24,282 and 24,157 shares issued and
outstanding in 2005 and 2004, respectively 24,282 24,157
Class B common stock, $1.00 par value; 50,000
shares authorized; 24,697 shares issued and
outstanding in 2005 and 2004 24,697 24,697
Additional paid-in capital 6,255 5,606
Retained earnings 199,337 201,213
Accumulated other comprehensive loss (61,994) (60,840)
-------- --------
TOTAL SHAREHOLDERS' INVESTMENT 192,577 194,833
-------- --------
TOTAL LIABILITIES AND SHAREHOLDERS' INVESTMENT $555,734 $571,260
======== ========
* derived from the audited Consolidated Balance Sheet
(See accompanying notes to condensed consolidated financial statements)
6
CRAWFORD & COMPANY
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
UNAUDITED
(IN THOUSANDS)
NINE MONTHS ENDED
-----------------------------
SEPTEMBER 30, SEPTEMBER 30,
2005 2004
------------- -------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 6,929 $ 17,454
Reconciliation of net income to net cash provided by
operating activities:
Depreciation and amortization 14,335 13,512
Deferred income taxes 22 (28)
Stock-based compensation 181 --
Loss (gain) on sales of property and equipment, net 75 (8,435)
Changes in operating assets and liabilities,
net of effects of acquisitions:
Accounts receivable, net 3,858 (28,984)
Unbilled revenues (2,771) (3,655)
Accrued or prepaid income taxes (5,391) 9,827
Accounts payable and accrued liabilities (3,606) 250
Deferred revenues (1,802) 7,160
Accrued pension costs 386 (369)
Prepaid expenses and other assets (990) 2,371
-------- --------
Net cash provided by operating activities 11,226 9,103
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisitions of property and equipment (10,869) (7,567)
Capitalization of computer software costs (4,796) (5,214)
Proceeds from 2004 sale of undeveloped land 7,562 2,028
Payment for prior acquisitions (121) (617)
Proceeds from sales of property and equipment 516 178
-------- --------
Net cash used in investing activities (7,708) (11,192)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Dividends paid (8,805) (8,776)
Proceeds from exercises of stock options and ESPP plans 593 683
Increase in short-term borrowings 2,280 1,928
Payments on short-term borrowings (3,240) (9,327)
Payments on long-term debt and capital leases (1,397) (841)
Capitalized loan costs -- 61
-------- --------
Net cash used in financing activities (10,569) (16,272)
-------- --------
Effect of exchange rate changes on cash and cash equivalents (344) 444
-------- --------
DECREASE IN CASH AND CASH EQUIVALENTS (7,395) (17,917)
Cash and cash equivalents at beginning of period 43,571 45,805
-------- --------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 36,176 $ 27,888
======== ========
(See accompanying notes to condensed consolidated financial statements)
7
CRAWFORD & COMPANY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION
The unaudited condensed consolidated financial statements of Crawford & Company
(the "Company") included herein have been prepared pursuant to the rules and
regulations of the United States ("U.S.") Securities and Exchange Commission
("SEC"). Certain information and footnote disclosures normally included in
financial statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted pursuant to such rules and
regulations. However, except as disclosed herein, there has been no material
change in the information disclosed in the notes to the consolidated financial
statements included in the Company's Annual Report on Form 10-K for the year
ended December 31, 2004. The condensed consolidated balance sheet as of December
31, 2004 presented herein was derived from the audited consolidated balance
sheet included in the Company's Annual Report on Form 10-K for the year ended
December 31, 2004.
The results of operations for the nine months ended September 30, 2005 are not
necessarily indicative of the results to be expected during the balance of the
year ending December 31, 2005. These condensed consolidated financial statements
should be read in conjunction with the audited consolidated financial statements
and related notes contained in the Company's Annual Report on Form 10-K for the
fiscal year ended December 31, 2004.
The preparation of financial statements in conformity with accounting principles
generally accepted in the U.S. requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities,
disclosure of contingent assets and liabilities at the date of the financial
statements, and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
There have been no material changes to the Company's major accounting and
reporting policies as disclosed in the Notes to Consolidated Financial
Statements in the Company's Annual Report on Form 10-K for the year ended
December 31, 2004.
In the opinion of management, all adjustments (consisting of normal recurring
accruals) considered necessary for a fair presentation have been included.
Certain previously reported amounts have been reclassified to conform to the
current presentation.
During 2002, the Company recorded in Other Comprehensive Income (Loss) a tax
benefit of $4.165 million related to exercises of stock options. During the
third quarter 2005, the Company reclassified this $4.165 million tax benefit
from Accumulated Other Comprehensive Loss to Additional Paid-In Capital within
Shareholders' Investment as required by Accounting Principles Board ("APB")
Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25"). This
reclassification, which is a correction of a prior error, had no net impact on
the Company's net income, shareholders' investment, or cash flows. This
reclassification has been reflected in the Condensed Consolidated Balance Sheets
presented herein for September 30, 2005 and December 31, 2004.
8
CRAWFORD & COMPANY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Related to this reclassification, the following revisions have been made to the
Company's Consolidated Statements of Shareholders' Investment and Consolidated
Balance Sheets:
Accumulated Other
Additional Paid-In Capital Comprehensive Loss
-------------------------- -------------------------
Balance at, As originally As originally
(in thousands) reported Revised reported Revised
- --------------- ------------- ------- ------------- ---------
December 31, 2002 $ 523 $4,688 $(81,481) $(85,646)
December 31, 2003 840 5,005 (64,717) (68,882)
December 31, 2004 1,441 5,606 (56,675) (60,840)
March 31, 2005 1,673 5,838 (54,691) (58,856)
June 30, 2005 1,719 5,884 (54,218) (58,383)
As previously reported in the notes to the Company's consolidated financial
statements for the year ended December 31, 2004, the portion of Note 1, Major
Accounting and Reporting Policies, related to Accumulated Other Comprehensive
Loss, has been revised below to reflect this reclassification:
AS REVISED:
(in thousands) 2004 2003 2002
- --------------- --------- --------- ---------
Minimum pension liability $(107,281) $(103,741) $(113,109)
Tax benefit on minimum pension liability 39,083 37,761 41,171
--------- --------- ---------
Minimum pension liability, net of tax benefit (68,198) (65,980) (71,938)
Cumulative translation adjustment 7,358 (2,902) (13,708)
--------- --------- ---------
Total accumulated other comprehensive (loss) $ (60,840) $ (68,882) $ (85,646)
========= ========= =========
2. NEW ACCOUNTING PRONOUNCEMENTS
In December 2004, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") 123 (revised 2004), "Share
Based Payments" ("SFAS 123R"), which is a revision of SFAS 123, "Accounting for
Stock Compensation." SFAS 123R supersedes SFAS 123 and APB 25 and amends SFAS
95, "Statement of Cash Flows." Generally, the approach in SFAS 123R is similar
to the approach described in SFAS 123. However, SFAS 123R requires companies to
measure compensation cost for all share-based payments based on the fair value
of the shares, including employee stock options. Pro forma disclosure will not
be permitted under SFAS 123R. When originally issued, SFAS 123R was to be
effective for public companies for the first interim or annual period beginning
after June 15, 2005. However, in April 2005 the SEC amended Regulation S-X to
allow public companies that had not yet adopted SFAS 123R to delay adoption of
the Standard until the beginning of the first annual period beginning after June
15, 2005. Accordingly, the Company expects to adopt SFAS 123R at the beginning
of 2006.
9
CRAWFORD & COMPANY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
SFAS 123R permits public companies to adopt its requirements using one of two
methods: 1) a "modified prospective" method in which compensation cost is
recognized beginning with the effective date (a) based on the requirements of
SFAS 123R for all share-based payments granted after the effective date, and (b)
based on the requirements of SFAS 123 for all awards granted to employees prior
to the effective date of SFAS 123R that remain unvested on the effective date,
or 2) a "modified retrospective" method which includes the requirements of the
modified prospective method described above, but also permits companies to
restate based on the amounts previously recognized under SFAS 123 for purposes
of pro forma disclosures either (a) all prior periods presented, or (b) prior
interim periods of the year of adoption. The Company plans to adopt SFAS 123R
using the "modified prospective" method.
As permitted by SFAS 123, the Company currently accounts for share-based
payments to employees using APB 25's intrinsic value method. Under APB 25, the
Company recognizes compensation cost for stock grants, but generally recognizes
no compensation cost for its employee stock option and employee stock purchase
plans due to the terms of those plans.
Accordingly, the adoption of SFAS 123R's fair value method will have an impact
on the Company's results of operations, although it will have no net impact on
the Company's financial position. The future impact of adoption of SFAS 123R
cannot be predicted at this time because it will depend on levels of share-based
payments granted in the future. However, had the Company adopted SFAS 123R in
prior periods, the impact of that Standard would have approximated the impact of
SFAS 123 as described in the disclosure of pro forma net income and earnings per
share under "Accounting for Stock-Based Compensation" in Note 5 to these
condensed consolidated financial statements. Based on stock-based compensation
issued through September 30, 2005, adoption of SFAS 123R at the beginning of
2006, and use of the "modified prospective" method, the Company expects the
adoption of SFAS 123R to reduce net income by approximately $912,000 in the year
of adoption, or $0.02 per share.
SFAS 123R also requires the benefits of tax deductions in excess of recognized
compensation cost to be reported as a financing cash flow, rather than as an
operating cash flow as required under current generally accepted accounting
principles. Any additional impact on the Company's future net income or cash
flows cannot be predicted at this time because it will depend on levels of
share-based payments granted in the future and on employee exercises of stock
options.
In May 2005, the FASB issued SFAS 154, "Accounting Changes and Error
Corrections" ("SFAS 154"). SFAS 154 provides guidance on the accounting for and
reporting of accounting changes and errors corrections. SFAS 154 requires
retrospective application for reporting a change in accounting principle in the
absence of explicit transition requirements specific to the newly adopted
accounting principle. SFAS 154 also states that a correction of an error in
previously issued financial statements is not an accounting change. However, the
reporting of an error correction under SFAS 154 will involve adjustments to
previously issued financial statements similar to those generally applicable to
reporting an accounting change retrospectively. SFAS 154 is effective for
accounting changes and corrections of errors made in fiscal years beginning
after December 15, 2005. The Company does not expect the adoption of SFAS 154 to
have a material impact on its consolidated financial statements. SFAS 123R,
which the Company plans
10
CRAWFORD & COMPANY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
to adopt at the beginning of 2006, contains explicit transitional guidance.
Accordingly, the transition requirements of SFAS 154 will not apply to the
Company's pending adoption of SFAS 123R.
3. NET INCOME PER SHARE
Basic net income per share is computed based on the weighted-average number of
total common shares outstanding during the respective periods. Diluted net
income per share is computed based on the weighted-average number of total
common shares outstanding plus the dilutive effect of outstanding stock options,
shares issuable under employee stock purchase plans, and contingently issuable
shares under the stock bonus program, if any, using the "treasury stock" method.
Below is the calculation of basic and diluted net income per share for the
quarters and nine months ended September 30, 2005 and 2004:
Quarter ended Nine months ended
----------------------------- -----------------------------
September 30, September 30, September 30, September 30,
(in thousands, except per share data) 2005 2004 2005 2004
- ------------------------------------- ------------- ------------- ------------- -------------
Net income available to common shareholders $ 1,887 $ 9,525 $ 6,929 $17,454
======= ======= ======= =======
Weighted-average common shares outstanding - Basic 48,978 48,796 48,911 48,748
Dilutive effect of stock-based compensation 484 121 505 81
------- ------- ------- -------
Weighted-average common shares outstanding - Diluted 49,462 48,917 49,416 48,829
======= ======= ======= =======
Basic net income per share $ 0.04 $ 0.20 $ 0.14 $ 0.36
======= ======= ======= =======
Diluted net income per share $ 0.04 $ 0.20 $ 0.14 $ 0.36
======= ======= ======= =======
Additional options to purchase 3,260,715 shares of the Company's Class A common
stock at exercise prices ranging from $7.00 to $19.50 per share were outstanding
at September 30, 2005, but were not included in the computation of diluted net
income per share because the options' exercise prices were greater than the
average market price of the common shares. To include them would have been
antidilutive.
4. COMPREHENSIVE INCOME (LOSS)
For the quarters and nine months ended September 30, 2005 and 2004,
comprehensive income (loss) for the Company consisted of the total of net income
and foreign currency translation adjustments. Below is the calculation of
comprehensive income (loss) for the quarters and nine months ended September 30,
2005 and 2004:
11
CRAWFORD & COMPANY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Quarter ended Nine months ended
----------------------------- -----------------------------
September 30, September 30, September 30, September 30,
(in thousands) 2005 2004 2005 2004
- -------------- ------------- ------------- ------------- -------------
Net income $ 1,887 $ 9,525 $ 6,929 $17,454
Foreign currency translation adjustment (3,611) 4,213 (1,154) 3,827
-------- ------- ------- -------
Comprehensive income (loss) ($1,724) $13,738 $ 5,775 $21,281
======== ======= ======= =======
5. ACCOUNTING FOR STOCK-BASED COMPENSATION
As permitted by SFAS 123, the Company accounts for stock-based compensation
utilizing the intrinsic value method in accordance with the provisions of APB 25
and related interpretations. Accordingly, no compensation cost has been
recognized for the Company's stock option plans because the exercise prices of
the stock options equal the market prices of the underlying stock on the dates
of grant. The Company's employee stock purchase plans are also considered
noncompensatory under APB 25.
The Company's executive stock bonus plan ("the Plan") is considered compensatory
under APB 25. From the Plan's 2005 inception through September 30, 2005, the
Company recognized pretax compensation cost of approximately $181,000 for the
Plan. Compensation cost for the year ended December 31, 2005 is estimated to
approximate the annualized amount recognized during the first nine months of
2005, but could vary based on potential changes in the quoted price of the
Company's Class A common stock, achievement rates for the corporate and
participant goals contained in the Plan, and participant attrition rates.
Had compensation cost for all of the Company's stock-based compensation plans
been determined based on the fair value at the grant dates for awards under
those plans consistent with SFAS 123, the Company's net income and net income
per share would have been reduced to the pro forma amounts indicated below:
12
CRAWFORD & COMPANY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Quarter ended Nine months ended
----------------------------- -----------------------------
September 30, September 30, September 30, September 30,
(in thousands, except per share data) 2005 2004 2005 2004
- ------------------------------------- ------------- ------------- ------------- -------------
Net income as reported $1,887 $9,525 $ 6,929 $17,454
Add: Stock-based employee compensation
expense included in reported net
income, net of tax 53 -- 117 --
Less: Stock-based compensation expense
using the fair value method, net of tax (355) (253) (1,092) (649)
------ ------ ------- -------
Pro forma net income $1,585 $9,272 $ 5,954 $16,805
====== ====== ======= =======
Net income per share - basic:
As reported $ 0.04 $ 0.20 $ 0.14 $ 0.36
====== ====== ======= =======
Pro forma $ 0.03 $ 0.19 $ 0.12 $ 0.34
====== ====== ======= =======
Net income per share - diluted:
As reported $ 0.04 $ 0.20 $ 0.14 $ 0.36
====== ====== ======= =======
Pro forma $ 0.03 $ 0.19 $ 0.12 $ 0.34
====== ====== ======= =======
The fair value of options is estimated on the date of grant using the
Black-Scholes option-pricing model.
13
CRAWFORD & COMPANY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
6. RETIREMENT PLANS
The Company and its subsidiaries sponsor various defined benefit and defined
contribution retirement plans covering substantially all employees. Effective
December 31, 2002, the Company elected to freeze its U.S. defined benefit
pension plan and replace it with a discretionary, non-contributory defined
contribution plan. Net periodic benefit cost related to the U.S. and United
Kingdom ("U.K.") defined benefit pension plans for the quarters and nine months
ended September 30, 2005 and 2004 included the following components:
Quarter ended Nine months ended
----------------------------- -----------------------------
September 30, September 30, September 30, September 30,
(in thousands) 2005 2004 2005 2004
- -------------- ------------- ------------- ------------- -------------
Service cost $ 514 $ 430 $ 1,543 $ 1,290
Interest cost 7,843 7,485 23,528 22,455
Expected return on assets (8,122) (7,757) (24,368) (23,270)
Recognized net actuarial loss 1,875 1,757 5,626 5,270
------- ------- -------- --------
Net periodic benefit cost $ 2,110 $ 1,915 $ 6,329 $ 5,745
======= ======= ======== ========
The Company is not required to make any contributions to its frozen U.S. defined
benefit pension plan during 2005. During the quarter and nine months ended
September 30, 2005, cash contributions of approximately $756,000 and $2,766,000,
respectively, were made to the Company's U.K. defined benefit pension plans.
7. SEGMENT INFORMATION
The Company has two reportable segments, one which provides claims services
through branch offices located in the United States ("U.S. Operations") and the
other which provides similar services through branch or representative offices
located in 62 other countries ("International Operations"). The Company's
reportable segments represent components of the business for which separate
financial information is available that is evaluated regularly by the chief
decision maker in deciding how to allocate resources and in assessing
performance.
Inter-segment sales are recorded at cost and are not material. The Company
measures segment profit based on operating earnings, defined as earnings before
net corporate interest expense, income taxes, and special credits and charges.
Financial information for the quarters and nine months ended September 30, 2005
and 2004 covering the Company's reportable segments is presented below:
14
CRAWFORD & COMPANY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Quarter ended Nine months ended
----------------------------- -----------------------------
September 30, September 30, September 30, September 30,
(in thousands) 2005 2004 2005 2004
- -------------- ------------- ------------- ------------- -------------
REVENUES:
U.S., before reimbursements $114,482 $123,466 $341,343 $342,372
International, before reimbursements 70,238 62,404 213,713 185,369
-------- -------- -------- --------
Total Revenues before Reimbursements 184,720 185,870 555,056 527,741
Reimbursements 21,500 31,638 57,588 61,036
-------- -------- -------- --------
TOTAL REVENUES $206,220 $217,508 $612,644 $588,777
======== ======== ======== ========
SEGMENT OPERATING EARNINGS:
U.S $ 1,236 $ 7,023 $ 4,882 $ 13,741
International 3,019 1,348 10,060 5,455
-------- -------- -------- --------
TOTAL SEGMENT OPERATING EARNINGS $ 4,255 $ 8,371 $ 14,942 $ 19,196
======== ======== ======== ========
8. COMMITMENTS AND CONTINGENCIES
The Company normally structures its acquisitions to include earnout payments,
which are contingent upon the acquired entity reaching certain revenue and
operating earnings targets. The amount of the contingent payments and length of
the earnout period varies for each acquisition, and the ultimate payments when
made will vary, as they are dependent on future events. Based on projected
levels of revenues and operating earnings, additional payments after September
30, 2005 under existing earnout agreements would approximate $2.4 million
through 2009, as follows:
2006 2007 2008 2009
------- ------- ---------- --------
$78,000 $78,000 $2,011,000 $266,000
In the normal course of the claims administration services business, the Company
is named as a defendant in suits by insureds or claimants contesting decisions
made by the Company or its clients with respect to the settlement of claims.
Additionally, clients of the Company have brought actions for indemnification on
the basis of alleged negligence by the Company, its agents, or its employees in
rendering service to clients. The majority of these claims are of the type
covered by insurance maintained by the Company. However, the Company is
self-insured for the deductibles under various insurance coverages. In the
opinion of Company management, adequate reserves have been provided for such
self-insured risks.
The Company has received a subpoena from the State of New York, Office of the
Attorney General, requesting various documents relating to the Company's
operations. The subpoena
15
CRAWFORD & COMPANY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
does not apply to the operations of the Company's international segment or the
GCG class action administration unit. The Company has responded to the subpoena.
The Company cannot predict when the Attorney General's investigation will be
completed, its ultimate outcome or its effect on the Company's financial
condition, results of operations, or cash flows.
The Company is currently the subject of an audit under California Labor Code
Sections 129 and 129.5 by the Audit Unit, Division of Workers' Compensation,
Department of Industrial Relations, State of California ("Audit Unit"). The
Audit Unit is auditing workers' compensation files which the Company handled on
behalf of clients in its El Segundo, California office in 2001 and 2002. This
audit relates to a previous audit that the Company underwent in El Segundo in
2000 wherein the Company agreed to the imposition of a civil penalty pursuant to
California Labor Code Section 129.5 and submission to this current follow-up
audit, among other items. With respect to this current audit, the Company cannot
predict when it will be completed, its ultimate outcome, or its effect on the
Company's financial condition, results of operations, or cash flows.
9. SHORT-TERM BORROWINGS AND LONG-TERM DEBT
The agreements related to the Company's $70.0 million revolving line of credit
and $50.0 million, 6.08% senior notes payable were amended on September 30,
2005. Both agreements contain amended provisions requiring the Company to
maintain certain defined leverage ratios, fixed charge coverage ratios, and
minimum net worth thresholds, none of which are expected to restrict future
operations. The expiration date of the revolving line of credit was extended to
September 30, 2010, but no changes were made to the interest rate terms or the
dollar amount of the revolving credit line. The interest rate and repayment
terms of the $50.0 million, 6.08% senior notes payable were not amended.
16
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Shareholders and Board of Directors of
Crawford & Company:
We have reviewed the condensed consolidated balance sheet of Crawford & Company
as of September 30, 2005, and the related condensed consolidated statements of
income for the three-month and nine-month periods ended September 30, 2005 and
2004, and the condensed consolidated statements of cash flows for the nine-month
periods ended September 30, 2005 and 2004. These financial statements are the
responsibility of the Company's management.
We conducted our review in accordance with the standards of the Public Company
Accounting Oversight Board (United States). A review of interim financial
information consists principally of applying analytical procedures and making
inquiries of persons responsible for financial and accounting matters. It is
substantially less in scope than an audit conducted in accordance with the
standards of the Public Company Accounting Oversight Board, the objective of
which is the expression of an opinion regarding the financial statements taken
as a whole. Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that should
be made to the condensed consolidated financial statements referred to above for
them to be in conformity with U.S. generally accepted accounting principles.
We have previously audited, in accordance with the standards of the Public
Company Accounting Oversight Board (United States), the consolidated balance
sheet of Crawford & Company as of December 31, 2004, and the related
consolidated statements of income and cash flows for the year then ended (not
presented herein) and in our report dated March 11, 2005, we expressed an
unqualified opinion on those consolidated financial statements. In our opinion,
the information set forth in the accompanying condensed consolidated balance
sheet as of December 31, 2004, is fairly stated, in all material respects, in
relation to the consolidated balance sheet from which it has been derived.
/s/ Ernst & Young LLP
Atlanta, Georgia
November 8, 2005
17
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING STATEMENTS
This quarterly report contains and incorporates by reference forward-looking
statements within the meaning of that term in the Private Securities Litigation
Reform Act of 1995 (the "1995 Act"). We desire to take advantage of the "safe
harbor" provisions of the 1995 Act. The 1995 Act provides a "safe harbor" for
forward-looking statements to encourage companies to provide information without
fear of litigation so long as those statements are identified as forward-looking
and are accompanied by meaningful cautionary statements identifying important
factors that could cause actual results to differ materially from those
projected.
Statements contained in this report that are not historical in nature are
forward-looking statements made pursuant to the "safe harbor" provisions of the
1995 Act. These statements are included throughout this report, and in the
documents incorporated by reference in this report, and relate to, among other
things, projections of revenues, earnings, earnings per share, cash flows,
capital expenditures, working capital or other financial items, output,
expectations, or trends in revenues or expenses. These statements also relate to
our business strategy, goals and expectations concerning our market position,
future operations, margins, case volumes, profitability, contingencies, debt
covenants, liquidity and capital resources. The words "anticipate", "believe",
"could", "would", "should", "estimate", "expect", "intend", "anticipate", "may",
"plan", "goal", "strategy", "predict", "project", "will" and similar terms and
phrases identify forward-looking statements in this report and in the documents
incorporated by reference in this report.
Additional written and oral forward-looking statements may be made by us from
time to time in information provided to the Securities and Exchange Commission,
press releases, our website, or otherwise.
Although we believe the assumptions upon which these forward-looking statements
are based are reasonable, any of these assumptions could prove to be inaccurate
and the forward-looking statements based on these assumptions could be
incorrect. Our operations and the forward-looking statements related to our
operations involve risks and uncertainties, many of which are outside our
control, and any one of which, or a combination of which, could materially
affect our results of operations and whether the forward-looking statements
ultimately prove to be correct. Included among, but not limited to, the risks
and uncertainties outside our control are global economic conditions, interest
rates, foreign exchange rates, regulations and practices of various governmental
authorities, the competitive environment, financial conditions of our customers,
man-made disasters and natural disasters.
Actual results and trends in the future may differ materially from those
suggested or implied by the forward-looking statements. We undertake no
obligation to publicly release the results of any revisions to these
forward-looking statements that may be made to reflect events anticipated or
unanticipated. All future written and oral forward-looking statements
attributable to the Company or persons acting on behalf of the Company are
expressly qualified in their entirety by the cautionary statements made herein.
18
BUSINESS OVERVIEW
Crawford & Company provides claims management services to insurance companies,
self-insured entities and class action settlement funds. Major service lines
include workers' compensation claims administration and healthcare management
services, property and casualty claims management, class action services and
risk management information services.
Insurance companies, which represent the major source of our revenues,
customarily manage their own claims administration function but require limited
services which we provide, primarily field investigation and evaluation of
property and casualty insurance claims. Self-insured entities typically require
a broader range of services from us. In addition to field investigation and
evaluation of their claims, we may also provide initial loss reporting services
for their claimants, loss mitigation services such as medical case management
and vocational rehabilitation, risk management information services, and
administration of the trust funds established to pay their claims. Finally, we
also perform the administrative functions related to securities, product
liability, bankruptcy and other class action settlements, including identifying
and qualifying class members, determining and dispensing settlement payments,
and administering the settlement funds.
The claims management services market, both in the United States ("U.S.") and
internationally, is highly competitive and comprised of a large number of
companies of varying size and scope of services. The demand from insurance
companies and self-insured entities for services provided by independent claims
service firms like us is largely dependent on industry-wide claims volumes,
which are affected by the insurance underwriting cycle, weather-related events,
general economic activity, and overall employment levels and associated
workplace injury rates.
We generally earn our revenues on an individual fee per claim basis.
Accordingly, the volume of claim referrals to us is a key driver of our
revenues. When the insurance underwriting market is soft, insurance companies
are generally more aggressive in the risks they underwrite, and insurance
premiums and policy deductibles decline. This usually results in an increase in
industry-wide claim referrals which will increase claim referrals to us provided
we maintain at least our existing share of the overall claim services market.
During a hard insurance underwriting market, as we have experienced since the
September 11, 2001 terrorist attacks, insurance companies become very selective
in the risks they underwrite, and insurance premiums and policy deductibles
increase, sometimes dramatically. This results in a reduction in industry-wide
claims volumes, which reduces claims referrals to us unless we can offset the
decline in claim referrals with growth in our share of the overall claims
services market. Our ability to grow our market share in such a highly
fragmented, competitive market is primarily dependent on the delivery of
superior quality service and effective, properly focused sales efforts.
RESULTS OF CONSOLIDATED OPERATIONS
Consolidated net income was approximately $1.9 million and $9.5 million for the
quarters ended September 30, 2005 and 2004, respectively, and approximately $6.9
million and $17.5 million for the nine months ended September 30, 2005 and 2004,
respectively. Net income in the 2004 third quarter included a special credit of
$5.2 million, net of related income taxes, resulting from the sale of an
undeveloped parcel of real estate during the quarter. There was no such land
sale in 2005.
19
We evaluate our consolidated operations by segregating our operating earnings
from the other components of net income. We define our operating earnings as net
income excluding income taxes, net corporate interest expense, and special
charges and credits. Operating earnings is a key performance measure our senior
management and chief decision maker use to evaluate the operating performance of
our business, set incentive compensation targets, and make resource allocation
decisions. We believe this measure is useful to investors in that it allows them
to evaluate our operating performance using the same criteria management uses.
Following is a reconciliation of consolidated net income on a generally accepted
accounting principles (GAAP) basis to operating earnings for the quarters and
nine months ended September 30, 2005 and 2004 and the related margins as a
percentage of revenues before reimbursements:
Quarter ended Nine months ended
----------------------------------------------- -----------------------------------------------
September 30, % September 30, % September 30, % September 30, %
(in thousands) 2005 Margin 2004 Margin 2005 Margin 2004 Margin
-------------- ------------- ------ ------------- ------ ------------- ------ ------------- ------
Net income $1,887 1.0% $ 9,525 5.1% $ 6,929 1.2% $17,454 3.3%
Add/(deduct):
Special credit -- -- (8,573) (4.6) -- -- (8,573) (1.6)
Net corporate interest 1,334 0.7 1,466 0.8 4,216 0.8 2,269 0.4
Income taxes 1,034 0.6 5,953 3.2 3,797 0.7 8,046 1.5
------ --- ------- ---- ------- --- ------- ----
Operating earnings $4,255 2.3% $ 8,371 4.5% $14,942 2.7% $19,196 3.6%
====== === ======= ==== ======= === ======= ====
Our operating earnings are evaluated at the segment level for our two reportable
segments: U.S. Operations and International Operations. These two reportable
segments represent components of our business for which separate financial
information is available that is evaluated regularly. Net corporate interest
expense and income taxes are recurring components of our net income, but they
are not considered part of our operating earnings since they are managed on a
corporate-wide basis. Net corporate interest expense results from capital
structure decisions made by us, and income taxes are based on statutory rates in
effect in each of the locations where we provide services and vary throughout
the world. Neither of these costs relates directly to the performance of our
services and are therefore excluded in order to accurately assess the results of
our operating activities on a consistent basis. Special credits and charges
represent nonrecurring events that are not considered part of our operating
earnings since they historically have not impacted our operating performance and
are not expected to impact our performance within the next two years. A
discussion and analysis of our operating earnings by reportable segment follows
the sections below on income taxes, net corporate interest expense, and special
credits.
Income Taxes
During June 2004, we settled a tax credit refund claim with the Internal Revenue
Service and recorded a receivable of $3.5 million, which is comprised of a tax
refund of $1.7 million and associated interest of $1.8 million.
Our effective tax rate was 35.4% of pretax income for the quarter and nine
months ended September 30, 2005, compared to 38.4% of pretax income for the
quarter and nine months ended September 30, 2004. Our effective tax rates for
the 2004 periods exclude $1.7 million related to the tax credit refund claim
discussed above. Taxes on income totaled $1.0 million and $3.8 million for the
quarter and nine months ended September 30, 2005, respectively, as compared to
$6.0 million and $8.0 million, including the expected tax refund, for the
comparable 2004 periods. We perform a quarterly evaluation of our effective tax
rate expected for the year. Based
20
on operating results through the first nine months of 2005 and a projection of
operating results for the remainder of the year, we estimate that our effective
tax rate will be 35.4% for the calendar year 2005. The change in our estimated
effective tax rate for 2005 was primarily due to a change in the mix of income
expected from our various international operations.
Generally, it is our policy to consider the undistributed earnings of our
foreign subsidiaries to be indefinitely reinvested. The American Jobs Creation
Act of 2004 ("the Act") allows a special one-time dividends received deduction
on the repatriation of certain foreign earnings to a U.S. tax payer. This
deduction is elective by the tax payer. Recently, the Treasury Department
provided clarification on key elements of the repatriation provisions of the
Act. After review of the Act and the related clarifications from the Treasury
Department, we have concluded that no material changes are warranted to our
current policy on undistributed earnings of our foreign subsidiaries.
Net Corporate Interest Expense
Net corporate interest expense increased to $1.3 million and $4.2 million for
the quarter and nine months ended September 30, 2005, respectively, from $1.5
million and $2.3 million in the comparable 2004 periods. Net corporate interest
expense for the 2004 year-to-date period included interest income of $1.8
million associated with the tax credit refund claim discussed above.
Special Credits
During September 2004, we completed the sale of an undeveloped parcel of real
estate. We received net cash of $2.0 million and a $7.6 million first lien
mortgage note receivable, at an effective interest rate of approximately 4% per
annum, due in its entirety in 270 days. A pretax gain of $8.6 million was
recognized on the sale. After reflecting income taxes, this special credit
increased 2004 net income by $5.2 million, or $0.11 per share. The note
receivable has been paid in its entirety.
SEGMENT OPERATING EARNINGS
We believe the discussion and analysis of our consolidated operating earnings is
more meaningful when presented separately for our U.S. Operations and
International Operations. Our reportable segments represent components of our
business for which separate financial information is available that is evaluated
regularly by our chief decision maker in deciding how to allocate resources and
in assessing performance.
In the normal course of our business, we sometimes pay for certain out-of-pocket
expenses that are reimbursed to us by our clients. Under GAAP, these
out-of-pocket expense reimbursements are reported as revenues and expenses in
our Condensed Consolidated Statements of Income. In some of the discussion and
analysis that follows, we do not believe it is informative to include the
GAAP-required gross up of our revenues and expenses for these reimbursed
expenses. The amounts of reimbursed expenses and related revenues offset each
other in our Condensed Consolidated Statements of Income with no net impact to
our net income. Except where noted, revenue amounts exclude reimbursements for
out-of-pocket expenses. Expense amounts exclude reimbursed out-of-pocket
expenses, special credits and charges, net corporate interest expense, and
income taxes.
21
Our discussion and analysis of operating expenses is comprised of two
components. Compensation and Fringe Benefits include all compensation, payroll
taxes, and benefits provided to our employees which, as a service company,
represents our most significant and variable expense. Expenses Other than
Reimbursements, Compensation and Fringe Benefits include outsourced services,
office rent and occupancy costs, other office operating expenses, amortization
and depreciation, and cost of risk.
This discussion and analysis should be read in conjunction with our condensed
consolidated financial statements and the accompanying notes.
Operating results for our U.S. and international operations for the quarters and
nine months ended September 30, 2005 and 2004 were as follows:
Quarter ended Nine months ended
----------------------------- -----------------------------
September 30, September 30, September 30, September 30,
(in thousands) 2005 2004 2005 2004
- -------------- ------------- ------------- ------------- -------------
REVENUES:
U.S., before reimbursements $114,482 $123,466 $341,343 $342,372
International, before reimbursements 70,238 62,404 213,713 185,369
-------- -------- -------- --------
Total revenue before reimbursements 184,720 185,870 555,056 527,741
Reimbursements 21,500 31,638 57,588 61,036
-------- -------- -------- --------
TOTAL REVENUES $206,220 $217,508 $612,644 $588,777
COMPENSATION & FRINGE BENEFITS:
U.S $ 72,552 $ 71,922 $218,868 $208,397
% of Revenues before reimbursements 63.4% 58.2% 64.1% 60.9%
International 48,547 43,829 149,014 129,065
% of Revenues before reimbursements 69.1% 70.2% 69.7% 69.6%
-------- -------- -------- --------
TOTAL $121,099 $115,751 $367,882 $337,462
% of Revenues before reimbursements 65.6% 62.3% 66.3% 64.0%
EXPENSES OTHER THAN COMPENSATION & FRINGE BENEFITS:
U.S., before reimbursements $ 40,694 $ 44,521 $117,593 $120,234
% of Revenues before reimbursements 35.5% 36.1% 34.5% 35.1%
International, before reimbursements 18,672 17,227 54,639 50,849
% of Revenues before reimbursements 26.6% 27.6% 25.6% 27.5%
-------- -------- -------- --------
Total, before reimbursements 59,366 61,748 172,232 171,083
% of Revenues before reimbursements 32.1% 33.2% 31.0% 32.4%
Reimbursements 21,500 31,638 57,588 61,036
-------- -------- -------- --------
TOTAL $ 80,866 $ 93,386 $229,820 $232,119
% of Total revenues 39.2% 42.9% 37.5% 39.4%
-------- -------- -------- --------
OPERATING EARNINGS (1):
U.S $ 1,236 $ 7,023 $ 4,882 $ 13,741
% of Revenues before reimbursements 1.1% 5.7% 1.4% 4.0%
International 3,019 1,348 10,060 5,455
% of Revenues before reimbursements 4.3% 2.2% 4.7% 2.9%
-------- -------- -------- --------
TOTAL $ 4,255 $ 8,371 $ 14,942 $ 19,196
% of Revenues before reimbursements 2.3% 4.5% 2.7% 3.6%
(1) Earnings before special credit, net corporate interest expense and income
taxes.
22
U.S. OPERATIONS
REVENUES BEFORE REIMBURSEMENTS
U.S. revenues before reimbursements by market type, for the quarters and nine
months ended September 30, 2005 and 2004 were as follows:
Quarter ended Nine months ended
---------------------------------------- ----------------------------------------
September 30, September 30, September 30, September 30,
(in thousands) 2005 2004 Variance 2005 2004 Variance
- -------------- ------------- ------------- -------- ------------- ------------- --------
Insurance companies $ 50,291 $ 58,000 (13.3%) $152,259 $156,822 (2.9%)
Self-insured entities 37,562 39,483 (4.9%) 115,722 120,245 (3.8%)
Class action services 26,629 25,983 2.5% 73,362 65,305 12.3%
-------- -------- -------- --------
Total U.S. Revenues
before Reimbursements $114,482 $123,466 (7.3%) $341,343 $342,372 (0.3%)
======== ======== ======== ========
Revenues before reimbursements from insurance companies decreased 13.3% from
$58.0 million in the 2004 third quarter to $50.3 million in the 2005 third
quarter, which reflects a $5.7 million decline in catastrophe-related revenues
from the 2004 period when we were responding to the hurricanes which struck the
southeastern United States. Revenues before reimbursements from insurance
companies decreased 2.9% to $152.3 million for the nine months ended September
30, 2005, compared to $156.8 million for the 2004 period, reflecting lower
catastrophe-related revenues and a continued softening in our U.S. insurance
company referrals for high-frequency, low-severity claims. Due to the timing,
location, and nature of the damages caused by hurricanes Katrina and Rita at the
end of the 2005 third quarter, claims from these hurricanes are not expected to
have an impact until the fourth quarter 2005. Revenues from self-insured clients
decreased 4.9% and 3.8% from the third quarter and nine months ended September
30, 2004, respectively, to $37.6 million and $115.7 million in the comparable
2005 periods, due primarily to a reduction in claim referrals from our existing
clients, only partially offset by net new business gains. See the following
analysis of U.S. cases received. Class action services revenues, including
administration and inspection services, increased 2.5% and 12.3% from the 2004
third quarter and nine-month periods, respectively, to $26.6 million and $73.4
million in the corresponding 2005 periods. Class action services revenues can
fluctuate significantly depending on the timing and size of project awards.
REIMBURSEMENTS INCLUDED IN TOTAL REVENUES
Reimbursements for out-of-pocket expenses included in total revenues for our
U.S. operations were $14.2 million and $36.4 million for the quarter and nine
months ended September 30, 2005, respectively, declining from $24.9 million and
$41.8 million in the comparable 2004 periods. These declines are primarily
attributable to our class action services unit which had higher out-of-pocket
costs in the 2004 third quarter related to noticing work performed on certain
class action settlements.
Case Volume Analysis
Excluding the impact of class action services, which has project-based revenues
that are not denominated by individual cases, U.S. unit volume, measured
principally by cases received, decreased 20.4% in the third quarter of 2005
compared to the same 2004 quarter. This decrease was partially offset by a 12.6%
revenue increase from changes in the mix of services provided
23
and in the rates charged for those services, resulting in a net 7.8% decrease
in U.S. revenues before reimbursements for the third quarter of 2005, excluding
revenues from class action services. Referrals of high-frequency, low-severity
claims declined in the 2005 third quarter compared to the 2004 third quarter,
primarily due to the high volume of property claims in the 2004 third quarter
associated with the hurricanes which struck the southeastern United States in
2004. This decrease in high-frequency, low-severity claims has increased our
average revenue per claim in the 2005 third quarter. Growth in class action
services increased U.S. revenues by 0.5% in the quarter ended September 30,
2005, compared to the same quarter in 2004.
For the nine month period ended September 30, 2005, U.S. unit volume decreased
10.3%, compared to the same 2004 period. This decrease was partially offset by a
7.6% revenue increase from changes in the mix of services provided and in the
rates charged for those services, resulting in a net 2.7% decrease in U.S.
revenues before reimbursements for the first nine months of 2005, excluding
revenues from class action services. The decrease in referrals of
high-frequency, low-severity claims has increased our average revenue per claim
in the 2005 year-to-date period. Growth in class action services increased U.S.
revenues before reimbursements by 2.4% in the 2005 nine-month period, compared
to the same period in 2004.
Excluding the impact of class action services, U.S. unit volume by major service
line, as measured by cases received, for the quarters and nine months ended
September 30, 2005 and 2004 was as follows:
Quarter ended Nine months ended
---------------------------------------- ----------------------------------------
September 30, September 30, September 30, September 30,
(whole numbers) 2005 2004 Variance 2005 2004 Variance
- --------------- ------------- ------------- -------- ------------- ------------- --------
Casualty 48,111 53,760 (10.5%) 141,899 155,439 (8.7%)
Property 58,228 90,238 (35.5%) 150,280 180,296 (16.6%)
Vehicle 32,186 38,371 (16.1%) 95,990 106,420 (9.8%)
Workers' Compensation 35,716 37,388 (4.5%) 108,716 115,208 (5.6%)
Other 4,982 5,531 (9.9%) 16,369 15,105 8.4%
------- ------- ------- -------
TOTAL U.S. CASES RECEIVED 179,223 225,288 (20.4%) 513,254 572,468 (10.3%)
======= ======= ======= =======
Conservative underwriting by insurance companies, including significant
increases in policy deductibles, and the absence of significant catastrophic
claims activity during 2005, contributed to an industry-wide decline in property
and casualty claims frequency during the 2005 third quarter and year-to-date
periods. Due to the timing, location, and nature of the damages caused by
hurricanes Katrina and Rita at the end of the 2005 third quarter, claims from
these hurricanes are not expected to have an impact until the fourth quarter
2005. During the 2004 periods, property claims were impacted significantly by
the four hurricanes that struck Florida and other southeastern states during
August and September of 2004. The decline in vehicle claims during the quarter
and nine months ended September 30, 2005 was due to a decline in referrals of
high-frequency, low-severity claims from our insurance company clients. The
declines in workers' compensation and casualty claims during the quarter and
nine months ended September 30, 2005 were due to a reduction in claims from our
existing clients and reflects continued weakness in the growth of U.S.
employment levels and associated workplace injuries.
COMPENSATION AND FRINGE BENEFITS
Our most significant expense is the compensation of employees, including related
payroll taxes and fringe benefits. U.S. compensation expense as a percent of
revenues before reimbursements increased to 63.4% in the third quarter of 2005
as compared to 58.2% in the same 2004 quarter.
24
For the nine month period ended September 30, 2005, U.S. compensation expense
as a percent of revenues before reimbursements increased to 64.1% compared to
60.9% in the 2004 period. These increases primarily reflect an increase in
capacity in our U.S. claims management operations and spending in support of
improving our work product, training and developing our employees, and growing
our market share. There was an average of 4,210 full-time equivalent employees
in the first nine months of 2005, compared to an average of 4,200 in the same
2004 period.
U.S. salaries and wages totaled $60.7 million and $177.8 million for the quarter
and nine months ended September 30, 2005, respectively, increasing 2.0% for the
quarter and 4.4% for the nine month period, from $59.5 million and $170.3
million in the comparable 2004 periods, primarily as a result of merit salary
increases granted during the period. Payroll taxes and fringe benefits for U.S.
operations totaled $11.8 million and $41.1 million in the third quarter and
first nine months of 2005, respectively. These costs decreased 5.6% for the
quarter but increased 7.9% for the nine month period, from 2004 costs of $12.5
million and $38.1 million for the comparable periods. The decline in the 2005
third quarter is primarily related to lower costs in our self-insured workers'
compensation programs. The increase for the 2005 year-to-date period is
primarily due to higher costs in our self-insured workers' compensation programs
during the first six months of 2005 and increased expenses in our employee
medical group benefit programs.
EXPENSES OTHER THAN REIMBURSEMENTS, COMPENSATION AND FRINGE BENEFITS
U.S. expenses other than reimbursements, compensation and related payroll taxes
and fringe benefits were 35.5% of revenues before reimbursements for the quarter
ended September 30, 2005, down from 36.1% for the same quarter in 2004. U.S.
expenses other than reimbursements, compensation and related payroll taxes and
fringe benefits were 34.5% of revenues before reimbursements for the nine-month
period ended September 30, 2005, down from 35.1% for the same period in 2004.
These decreases are primarily due to lower self-insured professional indemnity
costs.
REIMBURSED EXPENSES
Reimbursed out-of-pocket expenses in our U.S. operations were $14.2 million and
$36.4 million for the quarter and nine months ended September 30, 2005,
respectively, declining from $24.9 million and $41.8 million in the comparable
2004 periods. These declines are primarily attributable to our class action
services unit which had higher out-of-pocket costs in the 2004 third quarter
related to noticing work performed on certain class action settlements.
INTERNATIONAL OPERATIONS
REVENUES BEFORE REIMBURSEMENTS
Substantially all international revenues were derived from the insurance company
market. Revenues before reimbursements from our international operations
increased 12.6%, from $62.4 million in the third quarter of 2004 to $70.2
million in the 2005 third quarter. Revenues before reimbursements for the first
nine months of 2005 totaled $213.7 million, a 15.3% increase from $185.4 million
reported in the first nine months of 2004. International unit volume, measured
principally by cases received, increased 23.4% and 20.8% in the current quarter
and nine months ended September 30, 2005, respectively, compared to the same
periods in 2004. Our third quarter
25
2004 acquisition of the net assets of Cabinet Mayousseir, Cabinet Tricaud, and
TMA in France increased international revenues by 1.1% in the nine months ended
September 30, 2005. Revenues per claim decreased 14.9% and 12.2% during the
quarter and nine months ended September 30, 2005, respectively, due to changes
in the mix of services provided and in the rates charged for those services.
Growth in high-frequency, low-severity claim referrals in the United Kingdom
("U.K.") and Continental Europe, Middle East and Africa ("CEMEA") from new
contracts entered into during 2004 and 2005 reduced the average revenue per
claim during the first nine months of 2005. Revenues before reimbursements
reflect a 4.1% and 5.6% increase during the quarter and nine months ended
September 30, 2005, respectively, due to the positive effect of a weak U.S.
dollar, primarily as compared to the British pound and the euro.
REIMBURSEMENTS INCLUDED IN TOTAL REVENUES
Reimbursements for out-of-pocket expenses included in total revenues for our
international operations increased to $7.3 million and $21.2 million for the
quarter and nine months ended September 30, 2005, respectively, from $6.7
million and $19.2 million in the same 2004 periods. These increases were
primarily due to a decline in the value of the U.S. dollar against other major
currencies, primarily the British pound and the euro.
Case Volume Analysis
International unit volume by region for the quarters and nine months ended
September 30, 2005 and 2004 was as follows:
Quarter ended Nine months ended
-------------------------------- --------------------------------
September September September September
(whole numbers) 30, 2005 30, 2004 Variance 30, 2005 30, 2004 Variance
- --------------- --------- --------- -------- --------- --------- --------
United Kingdom 31,910 27,075 17.9% 105,094 78,384 34.1%
Americas 35,891 31,820 12.8% 92,829 84,487 9.9%
CEMEA 32,611 21,759 49.9% 79,866 64,070 24.7%
Asia/Pacific 9,697 8,545 13.5% 29,780 27,588 7.9%
------- ------ ------- -------
TOTAL INTERNATIONAL CASES RECEIVED 110,109 89,199 23.4% 307,569 254,529 20.8%
======= ====== ======= =======
The increases in the Americas were primarily due to flood-related claims
activity in Canada during the 2005 third quarter. The increases in CEMEA were
primarily due to weather-related claims in Sweden received from two new clients.
The increases in Asia/Pacific were due to weather-related claims in Australia
and Taiwan. The increases in the U.K. during the 2005 third quarter and
year-to-date period were due to claims received from new contracts entered into
during 2004 and 2005.
COMPENSATION AND FRINGE BENEFITS
As a percent of revenues before reimbursements, compensation expense, including
related payroll taxes and fringe benefits, decreased to 69.1% for the quarter
ended September 30, 2005 from 70.2% for the same quarter in 2004. For the
nine-month period ended September 30, 2005, compensation, payroll taxes and
fringe benefits increased slightly as a percentage of revenues before
reimbursements to 69.7% from 69.6% in 2004. The decrease in the 2005 third
quarter is primarily a result of a reduction in operating capacity in our
Canadian operations where we are responding to an influx of flood-related
losses. There was an average of 3,228 full-time
26
equivalent employees in the first nine months of 2005 compared to an average of
3,137 in the same 2004 period.
Salaries and wages of international personnel increased to $40.7 million for the
quarter ended September 30, 2005, from $36.8 million in the same 2004 quarter.
For the nine-month periods, salaries and wages increased to $125.0 million in
2005 from $108.3 million in 2004. Payroll taxes and fringe benefits for
international operations totaled $7.8 million and $24.1 million for the quarter
and nine months ended September 30, 2005, respectively, compared to $7.0 million
and $20.8 million for the same periods in 2004. The increases in these costs
were largely the result of staffing increases in the U.K. and CEMEA to handle
claims referred under new contracts entered into during 2004 and 2005, and a
decline in the value of the U.S. dollar against other major currencies,
primarily the British pound and the euro.
EXPENSES OTHER THAN REIMBURSEMENTS, COMPENSATION AND FRINGE BENEFITS
Expenses other than compensation and related payroll taxes and fringe benefits
were 26.6% and 25.6% of international revenues before reimbursements for the
quarter and nine months ended September 30, 2005, respectively, down from 27.6%
and 27.5% for the same periods in 2004, primarily due to a reduction of
operating capacity within our U.K. and Canadian units.
REIMBURSED EXPENSES
Reimbursed out-of-pocket expenses in our international operations increased to
$7.3 million and $21.2 million for the quarter and nine months ended September
30, 2005, respectively, from $6.7 million and $19.2 million in the same 2004
periods. These increases were primarily due to a decline in the value of the
U.S. dollar against other major currencies, primarily the British pound and the
euro.
LIQUIDITY, CAPITAL RESOURCES, AND FINANCIAL CONDITION
At September 30, 2005, our working capital balance (current assets less current
liabilities) was $127.4 million, a decrease from the December 31, 2004 balance
of $131.6 million. Cash and Cash Equivalents totaled $36.2 million at September
30, 2005 and $43.6 million at December 31, 2004. Cash was generated primarily
from operating activities. Cash provided by operations during the nine months
ended September 30, 2005 totaled $11.2 million and reflected collections of
accounts receivable generated from the hurricane-related claims administered in
late 2004 and early 2005. The principal uses of cash were for acquisitions of
property and equipment, dividends paid to shareholders, and investments in
computer software.
Cash dividends paid to shareholders were 127.1% of net income in the first nine
months of 2005, compared to 50.3% for the same period in 2004. Our Board of
Directors declares cash dividends to shareholders each quarter based on an
assessment of current and projected earnings and cash flows.
During the first nine months of 2005, we did not repurchase any of the Company's
Class A or Class B common stock. As of September 30, 2005, there are 705,863
shares eligible for repurchase under the discretionary 1999 share repurchase
program authorized by our Board of Directors. We believe it is unlikely that we
will repurchase shares under this program in the foreseeable future due to the
funded status of our defined benefit pension plans.
27
We maintain a $70.0 million committed revolving credit line with a syndication
of banks in order to meet seasonal working capital requirements and other
financing needs that may arise. This committed revolving credit line was renewed
on September 30, 2005 and the expiration date of the credit line was extended to
September 2010. The renewal did not change the dollar amount of the credit line
or interest rate terms. As a component of this credit line, we maintain a letter
of credit facility to satisfy certain of our own contractual obligations.
Including $13.7 million committed under the letter of credit facility, the
balance of our unused line of credit totaled $22.4 million at September 30,
2005. Our short-term debt obligations typically peak during the first quarter
and generally decline during the balance of the year. Short-term borrowings
outstanding, including bank overdraft facilities, as of September 30, 2005
totaled $36.0 million, decreasing from $37.4 million at December 31, 2004.
Long-term borrowings outstanding, excluding current installments, as of
September 30, 2005 totaled $51.0 million compared to $50.9 million at December
31, 2004. We have historically used the proceeds from our long-term borrowings
to finance business acquisitions, primarily in our international segment. Refer
to the Debt Covenants discussion under the Factors that May Affect Future
Results section of this report for a further discussion of our borrowing
capabilities. We believe that our current financial resources, together with
funds generated from operations and existing and potential borrowing
capabilities, will be sufficient to maintain our current operations for the next
twelve months.
We have not engaged in any hedging activities to compensate for the effect of
exchange rate fluctuations on the operating results of our foreign subsidiaries.
Foreign currency denominated debt serves to hedge the currency exposure of our
net investment in foreign operations.
Shareholders' investment at September 30, 2005 was $192.6 million, compared with
$194.8 million at December 31, 2004. This decrease was a result of net income
and a positive foreign currency translation adjustment, which were offset by
dividends paid to shareholders during the first nine months of 2005.
APPLICATION OF CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Management's Discussion and Analysis of Financial Condition and Results of
Operations addresses our condensed consolidated financial statements, which have
been prepared in accordance with accounting principles generally accepted in the
U.S. The preparation of these financial statements requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities, the disclosure of contingent assets and liabilities at the date of
the financial statements, and the reported amounts of revenues and expenses
during the reporting period. On an ongoing basis, management evaluates these
estimates and judgments based upon historical experience and on various other
factors that are believed to be reasonable under the circumstances. The results
of these evaluations form the basis for making judgments about the carrying
values of assets and liabilities that are not readily apparent from other
sources. Actual results may differ from these estimates under different
assumptions or conditions.
We believe the following critical accounting policies for revenue recognition,
allowance for doubtful accounts, valuation of goodwill and other long-lived
assets, defined benefit pension plans, determination of our effective tax rate,
and self-insured reserves require significant judgments and estimates in the
preparation of the condensed consolidated financial statements. Changes in these
underlying estimates could potentially materially affect consolidated results of
operations, financial position and cash flows in the period of change. Although
some variability
28
is inherent in these estimates, the amounts provided for are based on the best
information available to us and we believe these estimates are reasonable.
We have discussed the development and selection of the following critical
accounting policies and estimates with the Audit Committee of our Board of
Directors, and the Audit Committee has reviewed our related disclosure in this
Management's Discussion and Analysis of Financial Condition and Results of
Operations.
REVENUE RECOGNITION
Our revenues are primarily comprised of claims processing or program
administration fees. Fees for professional services are recognized in unbilled
revenues at the time such services are rendered at estimated collectible
amounts. Substantially all unbilled revenues are billed within one year.
Out-of-pocket costs incurred in administering a claim are passed on to our
clients and included in our revenues. Deferred revenues represent the estimated
unearned portion of fees related to future services under certain fixed-fee
service arrangements. Deferred revenues are recognized based on the estimated
rate at which the services are provided. These rates are primarily based on an
historical evaluation of actual claim closing rates by major lines of coverage.
Additionally, recent claim closing rates are evaluated to ensure that current
claim closing history does not indicate a significant deterioration or
improvement in the longer-term historical closing rates used.
Our fixed-fee service arrangements typically call for us to handle claims on
either a one- or two-year basis, or for the lifetime of the claim. In cases
where we handle a claim on a non-lifetime basis, we typically receive an
additional fee on each anniversary date that the claim remains open. For service
arrangements where we provide services for the life of the claim, we are only
paid one fee for the life of the claim, regardless of the ultimate duration of
the claim. As a result, our deferred revenues for claims handled for one or two
years are not as sensitive to changes in claim closing rates since the revenues
are ultimately recognized in the near future and additional fees are generated
for handling long-lived claims. Deferred revenues for lifetime claim handling
are considered more sensitive to changes in claim closing rates since we are
obligated to handle these claims to their ultimate conclusion with no additional
fees for long-lived claims.
Based upon our historical averages, we close approximately 99% of all cases
referred under lifetime claim service arrangements within the first five years
from the date of referral. Also, within that five-year period, the percentage of
claims remaining open in any one particular year has remained relatively
consistent from period to period. Each quarter we evaluate our historical claim
closing rates by major line of insurance coverage and make adjustments as
necessary. Any changes in estimates are recognized in the period in which they
are determined.
The estimate for deferred revenues is a critical accounting estimate for our
U.S. segment.
ALLOWANCE FOR DOUBTFUL ACCOUNTS
We maintain allowances for doubtful accounts for estimated losses resulting from
the inability of our clients to make required payments and adjustments clients
may make to invoiced amounts. Losses resulting from the inability of clients to
make required payments are accounted for as bad debt expense, while adjustments
to invoices made by clients are accounted for as reductions to revenues. These
allowances are established by using historical write-off information to project
future experience and by considering the
29
current credit worthiness of our clients, any known specific collection
problems, and our assessment of current property and casualty insurance industry
conditions. Each quarter we evaluate the adequacy of the assumptions used in
determining these allowances and make adjustments as necessary. Changes in
estimates are recognized in the period in which they are determined.
The estimate for the allowance for doubtful accounts is a critical accounting
estimate for both our U.S. and international segments.
VALUATION OF GOODWILL AND OTHER LONG-LIVED ASSETS
We regularly evaluate whether events and circumstances have occurred which
indicate that the carrying amounts of goodwill and other long-lived assets
(primarily property and equipment, deferred income tax assets, and capitalized
software) may warrant revision or may not be recoverable. When factors indicate
that such assets should be evaluated for possible impairment, we perform an
impairment test in accordance with SFAS 142, "Goodwill and Other Intangible
Assets" ("SFAS 142"), for goodwill, SFAS 109, "Accounting for Income Taxes"
("SFAS 109"), for deferred income tax assets, and SFAS 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets" ("SFAS 144"), for other long-lived
assets.
We perform an annual impairment analysis of goodwill in accordance with SFAS 142
where we compare the book value of our operating segments to the estimated
market value of those units as determined by discounting future projected cash
flows. The estimated market values of our segments are based upon certain
assumptions made by management. If the growth or weighted average cost of
capital assumptions used to calculate the market value of our operating segments
changed, impairment could result.
The valuation of goodwill and other long-lived assets is a critical accounting
estimate for both our U.S. and international segments.
DEFINED BENEFIT PENSION PLANS
We sponsor various defined benefit pension plans in the U.S. and U.K. which
cover a substantial number of employees in each location. Our U.S. defined
benefit retirement plan was frozen on December 31, 2002 to new employees and for
additional accrual of benefits for existing participants. Our U.K. defined
benefit retirement plans have also been frozen for new employees, but existing
participants may still accrue additional benefits. Benefits payable under our
U.S. defined benefit retirement plan are generally based on career compensation,
while the U.K. plans are generally based on an employee's final salary. Our
funding policy is to make cash contributions in amounts sufficient to maintain
the plans on an actuarially sound basis, but not in excess of deductible amounts
permitted under applicable income tax regulations. Plan assets are invested in
equity and fixed income securities, with a target allocation of approximately 60
percent to equity securities and 40 percent to fixed income investments.
The estimated liability for our defined benefit pension plans is sensitive to
changes in the underlying assumptions for the expected return on plan assets and
the discount rate used to determine the present value of projected benefits
payable under the plans.
The estimates for our defined benefit pension plans are critical accounting
estimates for both our U.S. and international segments.
30
DETERMINATION OF EFFECTIVE TAX RATE
We account for certain income and expense items differently for financial
reporting and income tax purposes. Provisions for deferred taxes are made in
recognition of these temporary differences. The most significant differences
relate to minimum pension liability, unbilled and deferred revenues,
self-insurance, and depreciation and amortization.
For financial reporting purposes, in accordance with the liability method of
accounting for income taxes as specified in SFAS 109, the provision for income
taxes is the sum of income taxes both currently payable and deferred. Currently
payable income taxes represent the liability related to our income tax returns
for the current year, while the net deferred tax expense or benefit represents
the change in the balance of deferred tax assets or liabilities as reported on
the Condensed Consolidated Balance Sheets. The changes in deferred tax assets
and liabilities are determined based upon changes between the basis of assets
and liabilities for financial reporting purposes and the basis of assets and
liabilities for income tax purposes, measured by the statutory tax rates that
management estimates will be in effect when these differences reverse.
In addition to estimating the future tax rates applicable to the reversal of tax
differences, management must also make certain assumptions regarding whether tax
differences are permanent or temporary. If the differences are temporary,
management must estimate the timing of their reversal, and whether taxable
income in future periods will be sufficient to fully recognize any gross
deferred tax assets. Other factors which influence the effective tax rate
include changes in the composition of taxable income from the countries in which
we operate and our ability to recover prior net operating losses in certain of
our international subsidiaries.
The estimate for income taxes is a critical accounting estimate for both our
U.S. and international segments.
SELF-INSURANCE LIABILITIES
We self-insure certain insurable risks consisting primarily of professional
liability, employee medical and disability, workers' compensation, and auto
liability. Insurance coverage is obtained for catastrophic property and casualty
exposures (including professional liability on a claims-made basis) as well as
those risks required to be insured by law or contract. The estimated liability
is calculated based on historical claim payment experience, the expected life of
the claims, and the liabilities previously established on the claims. In
addition, liabilities are established for losses that have occurred but have not
been reported and for the adverse development of reserves on reported losses.
Provision for claims under the self-insured program is made based on our
estimate of the aggregate liability for claims incurred. The liability for
claims incurred under our self-insured workers' compensation and employee
disability programs is discounted at the prevailing risk-free rate for
government issues of an appropriate duration. All other self-insurance
liabilities are undiscounted. Each quarter we evaluate the adequacy of the
assumptions used in developing these losses and make adjustments as necessary.
Changes in estimates are recognized in the period in which they are determined.
We believe the provision for self-insured losses is adequate to cover the
ultimate net cost of losses incurred; however, this provision is an estimate and
amounts ultimately settled may be significantly greater or less than the
provision established.
The estimate for self-insured liabilities is a critical accounting estimate for
our U.S. segment.
31
FACTORS THAT MAY AFFECT FUTURE RESULTS
FORWARD LOOKING STATEMENTS
Certain information presented in "Management's Discussion and Analysis of
Financial Condition and Results of Operations" may include forward-looking
statements, the accuracy of which is subject to a number of risks, uncertainties
and assumptions. Our Annual Report on Form 10-K for the year ended December 31,
2004 discusses such risks, uncertainties and assumptions and other key factors
that could cause actual results to differ materially from those expressed in
such forward-looking statements.
LEGAL PROCEEDINGS
As disclosed in Note 8, "Commitments and Contingencies," to the condensed
consolidated financial statements, we have potential exposure to certain legal
and regulatory matters.
CONTINGENT PAYMENTS
We normally structure acquisitions to include earnout payments, which are
contingent upon the acquired entity reaching certain revenue and operating
earnings targets. The amount of the contingent payments and length of the
earnout period varies for each acquisition, and the ultimate payments when made
will vary, as they are dependent on future events. Based on projected levels of
revenues and operating earnings, additional payments after September 30, 2005
under existing earnout agreements would approximate $2.4 million through 2009,
as follows: 2006 - $78,000; 2007 - $78,000; 2008 - $2,011,000; and 2009 -
$266,000.
At September 30, 2005, we have committed $13.7 million under letters of credit
to satisfy certain of our own contractual requirements. As noted in our
discussion of Debt Covenants, these letters of credit commitments are a
component of our $70.0 million Amended Revolving Credit Agreement.
DEBT COVENANTS
In October 2003, we entered into a committed $70.0 million revolving credit line
pursuant to a revolving credit agreement (the "Revolving Credit Agreement") and
issued $50.0 million in 6.08% senior notes pursuant to a notes purchase
agreement (the "Notes Purchase Agreement"). As of September 30, 2005, there was
$33.9 million outstanding on the revolving credit line with an average variable
interest rate of 4.7%. In addition, letters of credit of $13.7 million were also
committed under this revolving credit line. The $50.0 million senior notes have
scheduled principal repayments of approximately $5.6 million beginning October
2006 and continuing semi-annually through 2009 with the final payment due
October 2010. The stock of Crawford & Company International, Inc. is pledged as
security under these agreements and our U.S. subsidiaries have guaranteed our
obligations under these agreements.
On September 30, 2005, we executed a First Amended and Restated Credit Agreement
("Amended Revolving Credit Agreement") to our existing $70.0 million Revolving
Credit Agreement dated October, 2003. The Amended Revolving Credit Agreement
does not change the dollar amount of the credit line or interest rate terms. The
expiration date is extended to September 29, 2010.
32
On September 30, 2005, we also executed a Waiver and Amendment (the "Amended
Note Purchase Agreement") to our original Note Purchase Agreement of October,
2003 involving our $50.0 million 6.08% senior notes payable. The Amended Note
Purchase Agreement does not change the interest rate, payment schedule, or
maturity date of the 6.08% senior notes.
Both the original Revolving Credit Agreement (see Exhibit 10.2, incorporated by
reference) and the original Note Purchase Agreement (see Exhibit 10.4,
incorporated by reference) contained various provisions which required us to
maintain defined leverage ratios, fixed charge coverage ratios, and minimum net
worth thresholds.
As a result of the amended agreements, the material provisions in the original
agreements have been modified at September 30, 2005 as follows:
1) We must maintain, on a rolling four quarter basis, a leverage ratio of
consolidated debt to earnings before interest expense, income taxes,
depreciation, amortization, certain non-recurring charges, and
capitalization of internally developed software costs ("EBITDA") of no
more than 2.75 times EBITDA. This ratio is reduced to 2.50 times
EBITDA effective for the quarter ended September 30, 2006, and to 2.25
times EDITDA effective for the quarter ended September 30, 2007.
2) We must also maintain, on a rolling four quarter basis, a fixed charge
coverage ratio of EBITDA plus lease expenses ("EBITDAR") to total
fixed charges, consisting of interest expense and lease expense, of no
less than 1.5 times fixed charges through the quarter ended September
30, 2007. Effective the quarter ended December 31, 2007, this ratio
changes to no less than 1.75 times fixed charges.
3) We are also required to maintain a minimum net worth equal to
$167,200,000 plus 50% of our cumulative positive consolidated net
income earned after June 30, 2005, plus 100% of the net proceeds from
any equity offering, subject to terms and conditions. For purposes of
determining minimum net worth, any non-cash adjustments after June 30,
2005 related to our pension liabilities, goodwill, or foreign currency
translation are excluded.
4) During 2006, we are authorized to pay dividends to holders of our
common stock up to an amount not to exceed the sum of 2005
consolidated net income plus $4,000,000. All other original provisions
regarding the payments of dividends during the terms of these original
and amended agreements remain unchanged.
We were in compliance with these debt covenants as of September 30, 2005. If we
do not meet the covenant requirements in the future, we would be in default
under these agreements. In such an event, we would need to obtain a waiver of
the default or repay the outstanding indebtedness under the agreements. If we
could not obtain a waiver on satisfactory terms, we could be required to
renegotiate this indebtedness. Any such renegotiations could result in less
favorable terms, including higher interest rates and accelerated payments. Based
upon our annualized operating results for the first nine months of 2005, we
expect to remain in compliance with the financial covenants contained in the
Amended Revolving Credit Agreement and the Amended Notes Purchase Agreement
throughout 2005. However, there can be no assurance that our actual financial
results will match our planned results or that we will not violate the
covenants.
33
RECENT ACCOUNTING PRONOUNCEMENTS
In December 2004, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") 123 (revised 2004), "Share
Based Payments" ("SFAS 123R"), which is a revision of SFAS 123, "Accounting for
Stock Compensation." SFAS 123R supersedes SFAS 123 and Accounting Principles
Board ("APB") Opinion 25 "Accounting for Stock Issued to Employees" ("APB 25")
and amends SFAS 95, "Statement of Cash Flows."
Generally, the approach in SFAS 123R is similar to the approach described in
SFAS 123. However, SFAS 123R requires companies to measure compensation cost for
all share-based payments based on the fair value of the shares, including
employee stock options. Pro forma disclosure will not be permitted under SFAS
123R. When originally issued, SFAS 123R was to be effective for public companies
for the first interim or annual period beginning after June 15, 2005. However,
in April 2005 the SEC amended Regulation S-X to allow public companies that had
not yet adopted SFAS 123R to delay adoption of the Statement until the beginning
of the first annual period beginning after June 15, 2005. Accordingly, we expect
to adopt SFAS 123R at the beginning of 2006.
SFAS 123R permits public companies to adopt its requirements using one of two
methods: 1) a "modified prospective" method in which compensation cost is
recognized beginning with the effective date (a) based on the requirements of
SFAS 123R for all share-based payments granted after the effective date, and (b)
based on the requirements of SFAS 123 for all awards granted to employees prior
to the effective date of SFAS 123R that remain unvested on the effective date,
or 2) a "modified retrospective" method which includes the requirements of the
modified prospective method described above, but also permits companies to
restate based on the amounts previously recognized under SFAS 123 for purposes
of pro forma disclosures either (a) all prior periods presented, or (b) prior
interim periods of the year of adoption. We plan to adopt SFAS 123R using the
"modified prospective" method.
As permitted by SFAS 123, we currently account for share-based payments to our
employees using APB 25's intrinsic value method. Under APB 25, we recognize
compensation cost for stock grants, but we generally recognize no compensation
cost for our employee stock option and employee stock purchase plans due to the
terms of those plans. Accordingly, the adoption of SFAS 123R's fair value method
will have an impact on our results of operations, although it will have no net
impact on our financial position. The future impact of adoption of SFAS 123R
cannot be predicted at this time because it will depend on levels of share-based
payments granted in the future. However, had we adopted SFAS 123R in prior
periods, the impact of that Standard would have approximated the impact of SFAS
123 as described in the disclosure of pro forma net income and earnings per
share under "Accounting for Stock-Based Compensation" in Note 5 to the condensed
consolidated financial statements. Based on stock-based compensation issued
through September 30, 2005, adoption of SFAS 123R at the beginning of 2006, and
use of the "modified prospective" method, we expect the adoption of SFAS 123R to
reduce net income by approximately $912,000 in the year of adoption, or $0.02
per share.
SFAS 123R also requires the benefits of tax deductions in excess of recognized
compensation cost to be reported as a financing cash flow, rather than as an
operating cash flow as required under current generally accepted accounting
principles. Any additional impact on our future net income or cash flows cannot
be predicted at this time because it will depend on levels of share-based
payments granted in the future and on employee exercises of stock options.
34
In May 2005, the FASB issued SFAS 154, "Accounting Changes and Error
Corrections" ("SFAS 154"). SFAS 154 provides guidance on the accounting for and
reporting of accounting changes and errors corrections. SFAS 154 requires
retrospective application for reporting a change in accounting principle in the
absence of explicit transition requirements specific to the newly adopted
accounting principle. SFAS 154 also states that a correction of an error in
previously issued financial statements is not an accounting change. However, the
reporting of an error correction under SFAS 154 will involve adjustments to
previously issued financial statements similar to those generally applicable to
reporting an accounting change retrospectively. SFAS 154 is effective for
accounting changes and corrections of errors made in fiscal years beginning
after December 15, 2005. We do not expect the adoption of SFAS 154 to have a
material impact on our consolidated financial statements. SFAS 123R, which we
plan to adopt at the beginning of 2006, contains explicit transitional guidance.
Accordingly, the requirements of SFAS 154 will not apply to our pending adoption
of SFAS 123R.
PENDING LEGISLATION
We are aware of possible future Congressional legislation that may impact the
Pension Benefit Guaranty Corporation ("PBGC") and the Employee Retirement Income
Security Act of 1974 ("ERISA") as they relate to defined benefit pension plans
in the U.S. Our frozen U.S. defined benefit pension plan is regulated by both
the PBGC and ERISA. We understand that this pending legislation, if enacted,
could significantly alter future pension funding requirements and actuarial
formulas used by sponsors of defined benefit pension plans that are regulated by
the PBGC and ERISA. Our plan, including the related critical accounting policies
and estimates, could be impacted by any such future legislation. This pending
legislation has not been finalized or enacted into law. Accordingly, we cannot
yet estimate the potential impact, if any, this possible legislation may have on
our financial position, results of operations, or cash flows.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
DERIVATIVES
We have not entered into any transactions using derivative financial instruments
or derivative commodity instruments as of September 30, 2005.
FOREIGN CURRENCY EXCHANGE
Our international operations expose us to foreign currency exchange rate changes
that can impact translations of foreign-denominated assets and liabilities into
U.S. dollars and future earnings and cash flows from transactions denominated in
different currencies. Revenues before reimbursements from our international
operations were 38.5% and 35.1% of total consolidated revenues before
reimbursements for the nine months ending September 30, 2005 and 2004,
respectively. Except for borrowing in foreign currencies, we have not engaged in
any hedging activities to compensate for the effect of exchange rate
fluctuations on the net assets or operating results of our foreign subsidiaries.
We measure currency earnings risk related to our international operations based
on changes in foreign currency rates using a sensitivity analysis. The
sensitivity analysis measures the potential loss in earnings based on a
hypothetical 10% change in currency exchange rates. Exchange rates and currency
positions as of September 30, 2005 were used to perform the sensitivity
analysis.
35
Such analysis indicates that a hypothetical 10% change in foreign currency
exchange rates would have increased or decreased pretax income by approximately
$698,000, or $0.01 per share, during the first nine months of 2005, had the U.S.
dollar exchange rate increased or decreased relative to the currencies with
which we had exposure.
INTEREST RATES
We are exposed to interest rate fluctuations on certain of our variable rate
borrowings. Depending on general economic conditions, we use variable rate debt
for short-term borrowings and fixed rate debt for long-term borrowings. At
September 30, 2005, we had $36.0 million in short-term borrowings outstanding,
including bank overdraft facilities, with an average variable interest rate of
4.7%. If the average interest rate increased or decreased by 1%, the impact to
pretax income for the nine months ended September 30, 2005 would have been
approximately $283,000, or less than $0.01 per share.
Changes in the projected benefit obligations of our defined benefit pension
plans are largely dependent on changes in prevailing interest rates as of the
measurement dates we use to value these obligations under SFAS 87. If our
assumption for the discount rate changed by 0.25%, representing either an
increase or decrease in the rate, the projected benefit obligation of our U.S.
and U.K. defined benefit plans would have changed by approximately $19.0
million. The impact of this change to pretax income for the nine months ended
September 30, 2005 would have been approximately $1,346,000, or $0.02 per share.
CREDIT RISK
We process payments for claims settlements, primarily on behalf of our
self-insured clients. The liability for the settlement cost of claims processed,
which is generally pre-funded, remains with the client. Accordingly, we do not
incur significant credit risk in the performance of these services.
ITEM 4. CONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
We maintain disclosure controls and procedures that are designed to ensure that
information required to be disclosed in our Exchange Act reports is recorded,
processed, summarized and reported within the time periods specified in the
Securities and Exchange Commission's rules and forms, and that such information
is accumulated and communicated to management, including the Chief Executive
Officer and Chief Financial Officer, as appropriate, to allow timely decisions
regarding required disclosure. Management necessarily applied its judgment in
assessing the costs and benefits of such controls and procedures, which, by
their nature, can provide only reasonable assurance regarding management's
control objectives. The Company's management, including the Chief Executive
Officer and Chief Financial Officer, does not expect that our disclosure
controls can prevent all possible errors or fraud. A control system, no matter
how well conceived and operated, can provide only reasonable, not absolute,
assurance that the objectives of the control system are met. There are inherent
limitations in all control systems, including the realities that judgments in
decision-making can be faulty, and that breakdowns can occur because of simple
errors or mistakes. Additionally, controls can be circumvented by the individual
acts of one or more persons. The design of any system of controls is based in
part upon certain assumptions about the likelihood of future events, and, while
our disclosure controls
36
and procedures are designed to be effective under circumstances where they
should reasonably be expected to operate effectively, there can be no assurance
that any design will succeed in achieving its stated goals under all potential
future conditions. Because of the inherent limitations in any control system,
misstatements due to possible errors or fraud may occur and not be detected.
As of the end of the period covered by this report, we performed an evaluation,
under the supervision and with the participation of management, including the
Chief Executive Officer and Chief Financial Officer, of the effectiveness of the
design and operations of our disclosure controls and procedures pursuant to
Exchange Act Rules 13a-15(b) and 15d-15(b). Based upon the foregoing, the Chief
Executive Officer along with the Chief Financial Officer concluded that our
disclosure controls and procedures are effective at providing reasonable
assurance that all material information relating to the Company (including
consolidated subsidiaries) required to be included in our Exchange Act reports
is reported in a timely manner.
CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING
We have identified no changes in our internal control over financial reporting
that occurred during the period covered by this report that have materially
affected, or are reasonably likely to materially affect, our internal control
over financial reporting.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Subsequent to our filing of Form 10-K for the year ended December 31, 2004,
developments identified below have occurred in the following legal proceedings.
For other information on legal matters, see Note 8, "Commitments and
Contingencies" to the condensed consolidated financial statements included in
this Form 10-Q.
We previously disclosed that we had received a subpoena from the State of New
York, Office of the Attorney General, requesting various documents relating to
our operations. We received notice that the subpoena does not apply to the
operations of our international division or our GCG class action administration
unit.
We previously disclosed that we had received notice and anticipated that we
would be the subject of an audit by the Audit Unit, Division of Workers'
Compensation, Department of Industrial Relations, State of California ("Audit
Unit"). We are now being audited by the Audit Unit. The Audit Unit is auditing
workers' compensation files which we handled on behalf of certain clients in our
El Segundo, California office in 2001 and 2002.
We previously disclosed that we had received and complied with two federal grand
jury subpoenas which we understood were both issued as part of a conflicts of
interest investigation involving a public entity client of one of our New York
offices for Risk Management Services and Healthcare Management. These subpoenas
did not relate to our billing practices. The Department of Justice has advised
our attorneys that this federal investigation is closed insofar as it relates to
us or any other individuals.
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ITEM 6. EXHIBITS
See Index to Exhibits beginning on page 40.
38
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.
CRAWFORD & COMPANY
(Registrant)
Date: November 9, 2005 /s/ Thomas W. Crawford
----------------------------------------
Thomas W. Crawford
President and Chief Executive Officer
(Principal Executive Officer) and
Director
Date: November 9, 2005 /s/ John F. Giblin
----------------------------------------
John F. Giblin
Executive Vice President - Finance
(Principal Financial Officer)
Date: November 9, 2005 /s/ W. Bruce Swain, Jr.
----------------------------------------
W. Bruce Swain, Jr.
Senior Vice President and Controller
(Principal Accounting Officer)
39
INDEX TO EXHIBITS
Exhibit
No. Description Page
- ------- ----------- ----
3.1 Restated Articles of Incorporation of the Registrant, as
amended April 23, 1991 (incorporated by reference to Exhibit
4.1 to the Registrant's Form S-8 filed with the Securities and
Exchange Commission on June 6, 2005) -
3.2 Restated By-laws of the Registrant, as amended (incorporated by
reference to Exhibit 3.1 to the Registrant's quarterly report
on Form 10-Q for the quarter ended March 31, 2004) -
10.1 First Amended and Restated Credit Agreement, dated as of
September 30, 2005 (incorporated by reference to Exhibit 10.1
to the Registrant's Form 8-K filed with the Securities and
Exchange Commission on October 5, 2005) -
10.2 Revolving Credit Agreement, dated as of September 30, 2003
(incorporated by reference to Exhibit 10.11 to the Registrant's
Annual Report on Form 10-K for year ended December 31, 2004) -
10.3 Waiver and Amendment to Note Purchase Agreement, dated as of
September 30, 2005 (incorporated by reference to Exhibit 10.2
to the Registrant's Form 8-K filed with the Securities and
Exchange Commission on October 5, 2005) -
10.4 Note Purchase Agreement, dated as of September 30, 2003
(incorporated by reference to Exhibit 10.12 to the Registrant's
Form 10-K for the year ended December 31, 2004) -
15.1 Letter from Ernst & Young LLP 42
31.1 Certification of principal executive officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002 43
31.2 Certification of principal financial officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002 44
32.1 Certification of principal executive officer pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 45
40
INDEX TO EXHIBITS, continued
Exhibit
No. Description Page
- ------- ----------- ----
32.2 Certification of principal financial officer pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 46
41