Back to GetFilings.com

Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington D.C. 20549

Form 10-K

(Mark One)

For the fiscal year ended December 31, 2002

Or

For the transition period from         to         .

Commission file number 000-50041

U.S.I. Holdings Corporation

(Exact name of registrant as specified in its charter)

50 California Street, 24^th Floor

San Francisco, California 94111

(Address of principal executive offices, including zip code)

(415) 983-0100

(Registrant’s telephone number, including area code)

Securities Registered Pursuant to Section 12(b) of the Act:

None

Securities Registered Pursuant to Section 12(g) of the Act:

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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act) Yes ¨ No [X].

The aggregate market value of the Registrant’s voting common stock held by non-affiliates of the Registrant, computed by reference to the closing price of such stock on March 27, 2003, was approximately $356,796,330.

As of March 27, 2003, the number of outstanding shares of the Registrant’s common stock, $.01 par value, was 44,584,194 shares.

Portions of the Registrant’s definitive Proxy Statement to be filed for its 2003 annual meeting of stockholders are incorporated by reference into Part III of this Form 10-K.

Table of Contents

U.S.I. HOLDINGS CORPORATION

INDEX

Table of Contents

Forward Looking Statements

This report contains forward-looking statements within the meaning of that term in the Private Securities Litigation Reform Act of 1995 found at Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Additional written or oral forward-looking statements may be made by us from time to time in filings with the Securities Exchange Commission, press releases, or otherwise. Statements contained in this report that are not historical facts are forward-looking statements made pursuant to the safe harbor provisions of the Act. Forward-looking statements may include, but are not limited to, discussions concerning revenues, expenses, earnings, cash flow, capital structure, financial losses, as well as market and industry conditions, premium rates, financial markets, interest rates, contingencies and matters relating to our operations and income taxes. In addition, when used in this report, the words “anticipates,” “believes,” “should,” “estimates,” “expects,” “intends,” “plans” and variations thereof and similar expressions are intended to identify forward-looking statements. Such forward-looking statements are based on available current market and industry material, experts’ reports and opinions and long-term trends, as well as management’s expectations concerning future events impacting us.

Forward-looking statements made by us or on our behalf are subject to risks and uncertainties, including but not limited to the following: general economic conditions around the country; downward commercial property and casualty premium pressures; the competitive environment; the integration of our operations with those businesses or assets we have acquired or may acquire in the future and the failure to realize the expected benefits of such integration; future regulatory actions and conditions in the states in which we conduct business; our level of indebtedness and debt service requirements; and our ability to attract and retain key sales and management professionals. Our ability to grow has been enhanced through acquisitions, which may or may not be available on acceptable terms in the future and which, if consummated, may or may not be advantageous to us. Accordingly, actual results may differ materially from those set forth in the forward-looking statements.

Readers are cautioned not to place undue reliance on any forward-looking statements contained in this report, which speak only as of the date set forth on the signature page hereto. We undertake no obligation to publicly release the result of any revisions to these forward-looking statements that may be made to reflect events or circumstances after such date or to reflect the occurrence of anticipated or unanticipated events.

3

Table of Contents

PART I

Item 1.    Business

We are a distributor of insurance and financial products and services to small and mid-sized businesses. Founded in 1994, we have grown organically and through acquisitions to become the eighth largest insurance broker in the United States and a provider of employee health and welfare products and related consulting and administration services. We currently have approximately 60,000 small and mid-sized business clients. Our sales and marketing efforts are focused primarily on serving middle-market businesses. We have two operating segments: Insurance Brokerage and Specialized Benefits Services segment. The products and services we distribute and offer through our two operating segments can be categorized as:

Insurance Brokerage Segment

Specialized Benefits Services Segment

Approximately 84% of our revenues for the year ended December 31, 2002 was derived from our Insurance Brokerage segment. Within this segment, approximately 66% relates to P&C insurance and 34% to group employee benefits insurance. The remaining approximate 16% of our revenues was derived from our Specialized Benefits Services segment. Within this segment, approximately 52% relates to core benefits, 30% to benefits enrollment and communication and 18% to executive and professional benefits.

Our sales and marketing efforts are primarily focused on distributing insurance and financial products and services to middle-market businesses. We have approximately 350 sales professionals and product specialists based in 61 offices in 20 states.

Our History

Since our inception in 1994, we have built a national distribution system through the acquisition, consolidation and integration of over 90 insurance brokers and related businesses. Substantially all of these acquisitions were completed before December 31, 1999. Our early acquisition growth strategy was financed primarily by equity investments by private investment firms and large insurance and financial services companies, or their respective affiliates, some of which entered into strategic marketing agreements with us and designated representatives to serve on our board of directors.

In the past two years, we have shifted our focus mostly toward integrating these operations. We have committed significant resources to establishing operating and financial reporting standards and conforming the technology platforms utilized by our various business units.

In 1998 and 1999, we raised equity capital from Zurich Financial Services Group and Capital Z Financial Services Fund II, L.P., and its affiliates (Capital Z), along with other investors, the proceeds of which were used towards managing our capital structure and funding the growth of our business.

4

Table of Contents

On October 25, 2002, we completed an initial public offering of 9,000,000 shares of our common stock at a price of $10.00 per share. The proceeds from our initial public offering, net of the underwriting discount and expenses, of approximately $78.4 million were used to repay indebtedness under our credit facility.

Capital Z is our largest investor. Capital Z is a leading private equity investment firm focused on the financial services sector, with significant experience in the insurance area. Capital Z, together with Capital Z’s representatives on our board, own 23.9% of our common stock at December 31, 2002. Two members of our board of directors are Capital Z partners.

Operations

We are currently organized into five geographic reporting units and one product line reporting unit. Each of these businesses is managed by a chief executive officer and a chief financial officer. Through this organizational structure, we seek to maintain day-to-day management responsibility and controls at the reporting unit level, enabling employees at that level to be responsive to our clients’, product manufacturers’ and employees’ needs. At the same time, however, through the policies and procedures we instituted, senior management is able to monitor effectively our nationwide operations. These policies and procedures include preparing monthly operating, financial and sales reports for each region to corporate management.

Sales

Our sales strategy is to be a single distribution point to middle-market businesses, serving their insurance and financial products and services needs. Of our approximately 350 sales professionals, 316 are in the Insurance Brokerage segment and 34 are in the Specialized Benefits Services segment. We evaluate our sales professionals by measuring the revenues they generate from new business and cross-selling and the revenues they are able to retain from existing clients. We utilize sales force automation, or SFA, software to manage and track the progression and status of sales prospects.

We originate sales opportunities through a number of channels. We focus primarily on selling products and services to new and existing clients on a direct basis. In addition, we sell through approximately 160 professional associations and affinity groups. We have also found that forming practice groups focused on specific industries, such as environment, entertainment and construction, generates sales opportunities by virtue of the recognition we develop in those industries.

Products and Services

Our Insurance Brokerage segment includes the placement of general and specialty P&C insurance, as well as group employee benefits insurance. Through our Specialized Benefits Services segment, we offer related core benefits (health and welfare), enrollment and communications services and executive and professional benefits. A description of how we are compensated for these services can be found under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Part II, Item 7, General.”

5

Table of Contents

The chart below lists a selection of the principal insurance and financial products and services that we distribute and offer.

Insurance Brokerage Segment

Specialized Benefits Services Segment

Property and Casualty Insurance.    We place P&C insurance, including general commercial liability, workers’ compensation, fidelity and surety bonds, professional liability and personal lines. Revenues generated from the sales of these products and services accounted for approximately 55% of our revenues for the year ended December 31, 2002.

Group Employee Benefits Insurance.    We place individual and group health, life, disability and dental insurance, as well as individual long-term care insurance. These policies are underwritten by life and health insurance carriers and health maintenance organizations, or HMOs. Revenues generated from the sales of these products and services accounted for approximately 29% of our revenues for the year ended December 31, 2002.

Core Benefits.    Core Benefits covers a broad spectrum of benefit and retirement plan related consulting and administration services. Employee benefits services include plan design and related outsourcing services and related legal and compliance consulting. Retirement plan services include plan design, communication and administration (both defined contribution and defined benefit). Revenues generated from the sales of these products and services accounted for approximately 8% of our revenues for the year ended December 31, 2002.

Benefits Enrollment and Communication.    We administer the annual employee benefits open enrollment function for our business clients. In conjunction with the administrative services we provide, our enrollment counselors sell voluntary supplementary insurance products such as additional life or disability insurance to our clients’ employees. Revenues generated from the sales of these products and services accounted for approximately 5% of our revenues for the year ended December 31, 2002.

6

Table of Contents

Executive and Professional Benefits.    Our Executive and Professional Benefits division provides consulting, administration and funding strategies for executive benefits programs. Our primary line of business is in the design and implementation of supplemental executive retirement plans and other non-qualified executive benefits programs. We are also a distributor of bank-owned life insurance programs. Lastly, we provide other executive benefits services to individuals or corporate clients such as executive disability benefits planning, estate planning, individual financial planning and executive benefits communications. Revenues generated from the sales of these products and services accounted for approximately 3% of our revenues for the year ended December 31, 2002.

Insurance Carriers

We maintain relationships with over 200 insurance carriers in the United States and no single insurance carrier’s products represented a material portion of our total commissions and fees in 2002.

Customers

We currently have approximately 60,000 small and mid-sized business clients. Revenues generated by our ten largest clients accounted for 4.9% of our commissions and fees in 2002, while no single client in this group represented more than 1.0% of our commissions and fees in 2002.

Competition

The insurance brokerage industry is highly competitive. We face competition from other brokerages, insurance companies, banks and other financial services companies. In addition to direct competition from the insurance companies, new sources of competition are emerging as commercial banks accelerate their efforts to diversify their financial services to include insurance brokerage services (often through the acquisition of established insurance brokerages) for greater flexibility to create and market insurance products.

We compete for clients on the basis of reputation, client service, program and product offerings and the ability to tailor our products and risk management services to the specific needs of a client. We believe that most of our competition is from numerous local and regional insurance brokerage firms and, to a lesser extent, from national insurance brokerage firms that pursue a similar strategy, which include Arthur J. Gallagher, Brown & Brown and Hilb, Rogal and Hamilton.

Our Specialized Benefits Services segment competes with consulting firms, brokers, third-party administrators, producer groups and insurance companies. A number of our competitors offer attractive alternative programs. We believe that most of our competition is from large, diversified financial services organizations that are willing to expend significant resources to enter our markets.

Regulation

Our activities in connection with insurance brokering and related administrative and other services are subject to regulation and supervision by state authorities. Although the scope of regulation and form of supervision may vary from jurisdiction to jurisdiction, insurance laws are often complex and generally grant broad discretion to supervisory authorities in adopting regulations and supervising regulated activities. This supervision generally includes the licensing of insurance brokers and agents and the regulation of the handling and investment of client funds held in a fiduciary capacity. Our continuing ability to provide insurance products and related employee benefits services in the jurisdictions in which we currently operate is dependent upon our compliance with the rules and regulations promulgated from time to time by the regulatory authorities in each of these jurisdictions.

Governmental regulation may eliminate the federal tax law advantages or otherwise limit the sale of split dollar life insurance policies. We design and implement supplemental executive retirement plans that use split dollar life insurance as a funding source. In recent years, the Internal Revenue Service, or IRS, has proposed

7

Table of Contents

regulations relating to the tax treatment of split dollar life insurance arrangements. The IRS recently proposed regulations that treat premiums paid by the employer in connection with some split dollar life insurance arrangements as loans to the employee for tax purposes and taxes them as loans under the Internal Revenue Code. In addition, the recently enacted Sarbanes-Oxley Act may affect these arrangements. Specifically, the Sarbanes-Oxley Act includes a provision that prohibits loans from public companies to their directors and/or executives. Because a split dollar life insurance arrangement between a public company and its directors and/or executives could be viewed as a personal loan, we may face a reduction in sales of split dollar life insurance policies to some of our clients. Moreover, members of Congress have proposed, from time to time, other laws reducing the tax incentive or otherwise impacting these arrangements. The Executive and Professional Benefits division of our Specialized Benefits Services segment designs and implements supplemental executive retirement plans that use split dollar life insurance as a funding source. Our Executive and Professional Benefits division is one of our highest margin operations and, in 2002, represented approximately $10 million, or 3%, of our revenues.

USI Securities, Inc., our subsidiary, is a broker/dealer for mutual funds and a securities and investment adviser regulated by the National Association of Securities Dealers, Inc. and the SEC. Under SEC regulations, USI Securities, Inc. must maintain minimum net capital reserves.

Employees

At December 31, 2002, we had approximately 2,000 employees, of which approximately 350 are sales professionals. We are not involved in any material disputes with employees and believe that relations with our employees are good.

The ten top revenue producing sales professionals during 2002 represented 9.7% of our commissions and fees for the year. No single salesperson was responsible for more than 2.2% of our commissions and fees in 2002.

Risks Related to Our Business

We face a number of risks in our business. If any of the following risks develop into actual events, our business, financial condition or results could be negatively affected, the market price or your shares could decline and you may lose all or part of your investment.

8

Table of Contents

Website

We maintain a website at www.usi.biz. Our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and related amendments are available free of charge through our website as soon as reasonably practicable after such reports are filed or furnished electronically with the SEC. Our website and the information contained in it and connected to it shall not be deemed incorporated by reference into this Form 10-K.

Item 2.    Properties.

We lease our principal corporate office in San Francisco, California, and our operating unit offices in various states. Information regarding our lease commitments is set forth in Note 9 “Lease Commitments” in the Notes to Consolidated Financial Statements included in Part II, Item 8 of this report. The disclosure set forth in Note 9 “Lease Commitments” is incorporated herein by reference.

Item 3.    Legal Proceedings.

Information regarding legal proceedings is set forth in Note 14 “Contingencies” in the Notes to Consolidated Financial Statements included in Part II, Item 8 of this report. The disclosure set forth in Note 14 “Contingencies” is incorporated herein by reference.

Item 4.    Submission of Matters to a Vote of Security Holders.

Pursuant to a Written Consent in Lieu of a Meeting of Stockholders dated October 9, 2002, holders of the requisite majority of our then outstanding shares of series H and I preferred stock voting together as a single class and a majority of our total outstanding voting securities approved resolutions to amend the certificate of designations for series H and I preferred stock eliminating the per share and aggregate proceeds dollar amount from the definition of “Public Offering” therein. On October 11, 2002, the holders of the requisite majority of our then outstanding shares of series G preferred stock and a majority of our total outstanding voting securities approved a substantively identical resolution to remove the per share and aggregate proceeds dollar amount from the definition of “Public Offering” in the series G preferred stock certificate of designations. On October 16, 2002, the holders of the requisite majority of our then outstanding shares of series F preferred stock and a majority of our total outstanding voting securities approved a substantively identical resolution as described above, to remove the per share and aggregate proceeds dollar amount from the definition of “Public Offering” in the series F preferred stock certificate of designations.

9

Table of Contents

PART II

Item 5.    Market for Registrant’s Common Equity and Related Stockholder Matters.

Market Information and Holders

Our common stock is quoted on the Nasdaq Stock Market under the symbol “USIH.” The following table sets forth the intra-day high and low sales prices for our common stock on the Nasdaq Stock Market for the periods indicated since our initial public offering on October 22, 2002:

As of March 27, 2003, there were 44,584,194 shares of our common stock outstanding, held by approximately 242 stockholders of record. The closing sale price of our common stock on March 27, 2003 was $10.25 per share.

Under our existing credit facility we are currently prohibited from paying dividends on or repurchasing shares of our capital stock, with the limited exception of repurchasing shares held by terminated employees.

Recent Sales of Unregistered Securities

In January 2002, the Company sold 357,143 shares at $7.00 per share (pre-split) of its Series Y preferred stock for gross proceeds of $2,500,000. Our issuance of these securities was not registered under the Securities Act of 1933, as amended (the “Securities Act”), because such private placement was exempt under Section 4(2) of the Securities Act.

In June 2002, the Company issued 353,572 shares at $7.00 per share (pre-split) of Series Y preferred stock in exchange for a release of liability of $2,475,000. The private placement of these securities was exempt from registration under the Securities Act pursuant to Section 4(2).

In October 2002, concurrent with our initial public offering, we issued 34,772,835 shares of our common stock to the holders of our series A, B, C, D, E, F, G, H, I, J, K, L, M, N, O, P, Q, R, T, U, V, W, X and Y preferred stock upon the automatic conversion of such series. Our issuance of these securities was not registered under the Securities Act, because such exchange was exempt pursuant to Section 3(a)(9) thereof.

On November 27, 2002, we issued approximately 2,818,420 options to purchase our common stock and 9,138 shares of common stock in exchange for our outstanding share appreciation rights. Such issuance was exempt from registration under the Securities Act pursuant to Section 3(a)(9) thereof.

10

Table of Contents

Item 6.    Selected Financial Data.

You should read the selected consolidated financial data set forth below in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our financial statements and the related notes included elsewhere in this filing. We derived the financial information for each of the years ended and as of December 31, 2002, 2001, 2000, 1999 and 1998 from our audited financial statements and the related notes included elsewhere in this filing. Between 1994 and 1999, we pursued an acquisition strategy with a goal of building a national organization capable of distributing a broad range of insurance and financial products and services. The majority of our over 90 acquisitions were completed prior to December 31, 1999. As a result of our acquisitions, the results in the years 1998 through 2000 are not directly comparable. There is no single acquisition that materially affects the comparability of the financial information presented.

(Table continued on following page)

11

Table of Contents

(Continued from previous page)

12

Table of Contents

Item 7.    Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis should be read in conjunction with our consolidated financial statements and accompanying notes included in Part II-Item 8. Certain information contained in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” are forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from the results discussed in the forward-looking statements because of various factors, including those discussed above and elsewhere.

General

We generate revenues primarily from:

Commissions we earn on the placement of insurance products other than individual life and individual disability, i.e., P&C, health, group life and group disability insurance, are typically calculated as a percentage, ranging from approximately 3% to 20%, of the annual premium but can be influenced by a number of other factors including the type of insurance and amount of the premium. We recognize commission revenues on the later of the effective date of the policy or the billing date. Installment premiums and related commissions are recorded periodically as billed. Commissions earned from the placement of individual life and individual disability insurance are calculated as a percentage of corresponding premiums and the duration or term of the underlying policies. The majority of commissions from individual life and individual disability insurance sales are earned and recognized during the first year the insurance is placed, with the balance earned and recognized over the following two to ten years. We also often receive contingent commissions from insurance carriers, which are designed to provide us incremental incentive compensation for achieving specified premium volume goals set by carriers and/or the loss experience of the insurance we place with them. Contingent commissions are recorded when we receive data from the insurance companies that allow us to reasonably estimate the amount. Non-commission revenues related to Specialized Benefits Services are generally calculated as a percentage of assets under administration or on an hourly basis.

We have two operating segments: Insurance Brokerage and Specialized Benefits Services. Approximately 84% of our revenues, for the year ended December 31, 2002, was derived from our Insurance Brokerage segment. Within this segment, approximately 66% relates to P&C insurance and 34% to group employee benefits insurance. The remaining approximate 16% of our revenues was derived from our Specialized Benefits Services segment. Within this segment, approximately 52% relates to core benefits, 30% to benefits enrollment and communication and 18% to executive and professional benefits.

The majority of our operating expenses relates to Compensation and Employee Benefits, which equated to approximately 61% of revenues in 2002. We refer to the balance of our operating expenses as “Other Operating Expenses,” which includes selling-related expenses, rent, communication expenses and other items. Other Operating Expenses were approximately 21% of total revenues in 2002.

Primary Financial Measures

The financial measures that we use to evaluate our performance on a consolidated basis are:

13

Table of Contents

We present EBITDA because we believe that it is a relevant and useful indicator of our operating profitability and our ability to incur and service debt. We believe EBITDA is relevant owing to our leveraged approach to our capital structure and resulting significant amount of interest expenses, and our accounting for all acquisitions using the purchase method of accounting and resulting significant amount of amortization of intangible assets. We present EBITDA Margin because we believe it is a relevant and useful indicator in understanding how we view our operating efficiency. We present Net Income (Loss) plus Amortization of Intangible Assets because we believe that it is a relevant and useful indicator in understanding our ability to generate earnings. We believe Net Income (Loss) plus Amortization of Intangible Assets is relevant owing to the significant amount of our amortization of intangible assets resulting from accounting for all acquisitions using the purchase method of accounting.

You should not consider these financial measures as alternatives to other financial measures determined in accordance with accounting principles generally accepted in the United States, which we refer to as GAAP. You should not consider EBITDA as an alternative to cash flows from operating activities, investing activities or financing activities as a measure of liquidity. In addition, please note that because not all companies calculate these financial measures similarly, the presentation of these measures in this filing is not likely to be comparable to those of other companies. Additionally, under our existing credit facility we are currently prohibited from paying dividends on or repurchasing shares of our capital stock, with the limited exception of repurchasing shares held by terminated employees.

Industry Conditions

Premium pricing within the commercial P&C insurance industry has historically been cyclical, based on the underwriting capacity of the insurance industry and economic conditions. From 1987 through 1999, the commercial P&C insurance industry was in a “soft market,” which is an insurance market characterized by a period of flat to declining premium rates, which negatively affected commissions earned by insurance brokers. Years of underwriting losses for insurance companies combined with the downward turn in the equity markets caused insurers to increase premium rates starting in mid- to late 2000. Additionally, the insurance industry was affected by the events of September 11, 2001, which resulted in the largest insurance loss in America’s history and accelerated increases in premium rates for particular lines of commercial P&C insurance. The current “hard market,” which is an insurance market characterized by a period of rising premium rates, is, in general, positively affecting commissions earned by insurance brokers. Approximately 48% of our revenues in 2002 relates to commercial P&C insurance, which is the line of business most impacted by the “hard market.” However, the longevity of this cycle cannot be accurately predicted. In response to rising premiums, some of our customers have increased their deductibles and/or reduced their insurance coverage in order to reduce the impact of the premium increases. These factors have negatively impacted our revenues.

Premium rates in the health insurance industry, however, have generally realized a consistent upward trend due to increasing health care delivery costs. However, the upward trend in health care insurance premiums has been somewhat offset by the impact of the economic downturn and its resulting negative impact on employment levels of our customers. In addition, some of our customers have reduced benefits for their employees resulting in a reduction of costs and related insurance premium. This factor has negatively impacted our revenues.

Acquisitions

Between 1994 and 1999, we pursued an acquisition strategy with a vision of building a national organization capable of distributing a broad range of insurance and financial products and services. The majority of our over 90 acquisitions were completed prior to December 31, 1999.

In most acquisitions, we issued a combination of cash, seller notes and preferred stock. Effective with our initial public offering, we discontinued the practice of offering preferred stock as consideration in acquisitions and started the practice of offering common stock. We also structured our acquisition agreements to include contingent purchase price payments, commonly referred to as “earn-outs,” which we treated as adjustments to

14

Table of Contents

purchase price and paid in a combination of cash, seller notes and preferred stock and capitalized upon determination. In some cases, acquisitions included annual cash bonuses, which we refer to as “Growth Based Bonuses,” that were payable upon achieving agreed upon performance targets, and are expensed as incurred and are classified in Compensation and Employee Benefits. Effective January 2000, we discontinued the practice of offering Growth Based Bonuses. We incurred $1.6 million, $2.3 million and $3.8 million of Growth Based Bonus Expense in 2002, 2001 and 2000, respectively. We expect that all of our Growth Based Bonus obligations related to completed acquisitions will expire by December 31, 2004. The Growth Based Bonus expense for the years ending December 31, 2003 and 2004 is estimated to be $0.3 million and $0.1 million, respectively.

Discontinued Operations

In the latter part of 2001, we completed a strategic and financial review of our company and concluded that USIA was no longer core to our mission, vision or strategy. Consequently, in January 2002, we announced our intention to sell USIA and subsequently sold the business in April 2002. The cash proceeds from the disposition of USIA were used to repay a portion of our bank borrowings, seller notes associated with the business and related transaction expenses. USIA is reflected in our financial statements as a Discontinued Operation in accordance with Statement of Financial Accounting Standards, or SFAS, No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” Accordingly, the assets, liabilities and results of operations for USIA have been disaggregated in our financial statements. USIA accounted for $74.8 million of total revenues for the year ended December 31, 2001 and had approximately 1,100 employees. Discontinued operations had net losses of $13.8 million, $61.8 million, and $8.3 million for the years ended December 31, 2002, 2001 and 2000, respectively. In the fourth quarter of 2001, following the provisions of SFAS No. 121, “Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed of,” we recorded an impairment charge of $46.9 million against USIA’s goodwill and expiration rights. The net loss for the year ended December 31, 2002 includes a $7.2 million pre-tax loss on the sale of USIA in April 2002. For further detail on the losses incurred at USIA in 2001 please read Note 16, “Discontinued Operations,” in our annual financial statements, under “USIA Litigation Matters—Fireman’s Fund Litigation” and “—Mutual of Omaha Litigation.”

Litigation Costs Related to Discontinued Operations

We incurred $1.0 million, $2.5 million and $1.2 million in legal fees and other expenses associated with the defense of claims against us, the pursuit of claims made by us and payment of claims by us relating to USIA for the years ended December 31, 2002, 2001 and 2000, respectively. These expenses were incurred in connection with litigation matters related to USIA, but are reflected in the results of our corporate segment under Other Operating Expenses, consistent with our accounting practices.

Quarterly Fluctuations

Historically, our revenues and EBITDA for the fourth quarter of the year have been higher relative to the preceding three quarters because a significant portion of commissions and fees earned from our Specialized Benefits Services segment is typically recorded at that time. In addition, we are subject to quarterly earnings fluctuations attributable to the timing of sales of Specialized Benefits Services products.

15

Table of Contents

Results of Operations

Year Ended December 31, 2002 Compared with Year Ended December 31, 2001

Please read the information under the caption “—Integration Efforts and Other Charges” below for more details.

Revenues.    Revenues increased $16.6 million, or 5.3%, to $328.2 million in 2002 from $311.6 million in 2001. In 2002, we experienced positive net new business and increased premium rates on renewals. In addition, we generated increased revenues from the sales production of recently hired sales professionals. Offsetting the increase in revenues from new business production, increasing premium rates and additional sales production from recently hired sales professionals in 2002, was a $7.7 million reduction in revenues from eliminating low margin business, which contributed $1.1 million in 2002 versus $8.8 million in 2001. Revenues before this item increased approximately 8% in 2002.

Compensation and Employee Benefits.    Compensation and Employee Benefits increased $0.8 million, or 0.4%, to $201.0 million in 2002 from $200.2 million in 2001. In 2002, we had integration efforts and other charges of $8.1 million compared to $11.2 million in 2001. Excluding the effect of these charges, Compensation and Employee Benefits increased $3.8 million or 2.0% in 2002. As a percentage of revenues, Compensation and Employee Benefits was 61.2% in 2002 compared to 64.3% in 2001, primarily due to the charges. Excluding the effect of these charges, Compensation and Employee Benefits as a percentage of revenues was 58.8% in 2002 compared to 60.7% in 2001. The decrease, as a percentage of revenues, in 2002 is primarily due to the positive affects of our integration efforts and improvements in performance in our operations. In an effort to reduce compensation expense, we terminated 32 employees and renegotiated compensation arrangements for four sales professionals during the first quarter of 2002.

16

Table of Contents

Other Operating Expenses.    Other Operating Expenses decreased $7.6 million, or 9.9%, to $68.8 million in 2002 from $76.4 million in 2001. In 2002, we had integration efforts and other charges of $1.6 million compared to $11.3 million in 2001. Excluding the effect of these charges, Other Operating Expenses increased $2.1 million or 3.3% in 2002. As a percentage of revenues, Other Operating Expenses were 21.0% in 2002 compared to 24.5% in 2001, primarily due to the charges. Excluding the effect of these charges, Other Operating Expenses as a percentage of revenues were 20.5% in 2002 compared to 20.9% in 2001.

Net Income (Loss) From Continuing Operations.    Net Income (Loss) From Continuing Operations increased $45.6 million to $10.9 million in 2002 from a loss of $34.7 million in 2001, due to (i) a reduction in Other Operating Expenses principally due to the integration efforts in the fourth quarter of 2001, (ii) improvement in performance of operations, (iii) the gain from the reduction in the book value of the redeemable common stock warrants and the stock appreciation rights, (iv) a decrease in interest expense as a result of lower interest rates and a reduction in debt, and (v) a decrease in amortization of intangible assets principally due to our adoption of SFAS No. 142. Please read Note 1, “Nature of Operations and Summary of Significant Accounting Policies” in our annual financial statements under “Intangible Assets.” The effective tax rate from continuing operations in 2002 was (5.0)% compared to (11.8)% in 2001. The decrease in the effective tax rate and corresponding reduced benefit in 2002 resulted from the increase in the tax valuation allowance established in 2001, offset by the impact of state income taxes.

Year Ended December 31, 2001 Compared with Year Ended December 31, 2000

Revenues.    Revenues increased $20.8 million, or 7.2%, to $311.6 million in 2001 from $290.7 million in 2000. The increase was primarily due to a combination of new business production and increasing premium rates. Excluding the effect of businesses acquired by adjusting 2000 revenues by $4.4 million and excluding $8.0 million of non-recurring revenues in 2000, revenues increased approximately 9% in 2001. In 2000, we received non-recurring revenues of $8.0 million paid to our Specialized Benefits Services segment. $5.0 million of the non-recurring revenues relate to a one-time management-consulting fee related to a technology project. As we are not in the business of information technology management consulting and we do not expect that this sort of consulting services agreement will occur again, we consider these revenues to be non-recurring. The other $3.0 million of the non-recurring revenues were paid by an insurance carrier primarily for acquisition-related and other services provided to consummate our acquisition of one of the insurance carrier’s independent distributors. We do not expect to receive a fee for the performance of these types of services in the future. Accordingly, we consider this payment non-recurring.

Compensation and Employee Benefits.    Compensation and Employee Benefits increased $28.1 million, or 16.3%, to $200.2 million in 2001 from $172.1 million in 2000. In 2001, we had integration efforts and other charges of $11.2 million compared to $2.9 million in 2000. Excluding the effect of these charges, Compensation and Employee Benefits increased $19.8 million or 11.7% in 2001, primarily as a result of the increase in revenues. As a percentage of revenues, Compensation and Employee Benefits were 64.3% in 2001 as compared to 59.2% in 2000, primarily due to the charges. Excluding the effect of these charges and non-recurring revenues in 2000, Compensation and Employee Benefits as a percentage of revenues were 60.7% in 2001 as compared to 59.8% in 2000. In an effort to reduce compensation expense, we terminated 96 employees and renegotiated compensation arrangements for 29 sales professionals during the fourth quarter of 2001.

Other Operating Expenses.    Other Operating Expenses increased $14.0 million, or 22.4%, to $76.4 million in 2001 from $62.4 million in 2000. In 2001, we had integration efforts and other charges of $11.3 million compared to $0.8 million in 2000. Excluding the effect of these charges, Other Operating Expenses increased $3.4 million or 5.6% in 2001. As a percentage of revenues, Other Operating Expenses were 24.5% in 2001 as compared to 21.5% in 2000, primarily due to the charges. Excluding the effect of these charges and non-recurring revenues in 2000, Other Operating Expenses as a percentage of revenues were 20.9% in 2001 as compared to 21.8% in 2000.

17

Table of Contents

Net Loss From Continuing Operations.    Net Loss From Continuing Operations increased $24.8 million to $34.7 million in 2001 from $9.9 million in 2000, primarily due to the items described under the heading “Integration Efforts and Other Charges,” below. This was partially offset by an increase in the Income Tax Benefit of $2.0 million. The Income Tax Benefit recorded in 2001 was reduced by the accrual of an $8.0 million tax valuation allowance against our net deferred tax assets recorded in 2001. In accordance with GAAP, a deferred tax asset valuation allowance must be established to the extent it is more likely than not that an entity will not fully realize the deferred tax asset in the near future. The effective tax rate from continuing operations in 2001 was (11.8)% compared to (21.3)% in 2000. The decrease in the effective tax rate and corresponding reduced benefit in 2001 resulted from the establishment of the valuation allowance in 2001 offset by a reduction in permanent differences relating to non-deductible goodwill and state income taxes.

Our Segments

We have three reporting segments: Insurance Brokerage, Specialized Benefits Services and Corporate.

The Insurance Brokerage segment offers:

The Specialized Benefits Services segment offers:

We evaluate segment performance based on revenues, EBITDA and EBITDA margin. EBITDA and EBITDA margin are not substitutes for other financial measures determined in accordance with GAAP. Because not all companies calculate these non-GAAP measures in the same fashion, these measures as presented are not likely to be comparable to other similarly titled measures of other companies.

Insurance Brokerage

Comparisons for Years Ended December 31, 2002, 2001 and 2000

The Insurance Brokerage segment results reflect the following integration efforts and other charges: $4.6 million, $16.3 million and $2.0 million in years 2002, 2001 and 2000, respectively.

18

Table of Contents

Revenues in the Insurance Brokerage segment increased 6.3% and 7.4% in 2002 and 2001, respectively, due to net new business production, increasing premium rates and additional sales production from recently hired sales professionals. Offsetting the increase in revenues in 2002 was a $7.7 million reduction in revenues from eliminating low margin business, which contributed $1.1 million of revenues in 2002 versus $8.8 million in 2001. Insurance Brokerage revenues before this item increased approximately 10% in 2002. Property & Casualty revenues represented 55.1%, 53.7% and 51.8% of our total consolidated revenues in 2002, 2001 and 2000, respectively, and Group Employee Benefits revenues represented 28.5%, 29.2% and 30.8% of our total consolidated revenues in 2002, 2001 and 2000, respectively.

EBITDA in the Insurance Brokerage segment increased $24.4 million or 55.5% to $68.4 million in 2002 from $44.0 million in 2001, and decreased $8.3 million or 15.8% to $44.0 million in 2001 from $52.2 million in 2000. EBITDA Margin in the Insurance Brokerage segment was 24.9%, 17.0% and 21.7% in 2002, 2001 and 2000, respectively. Excluding the effect of the integration efforts and other charges, EBITDA and EBITDA Margin in the Insurance Brokerage segment were $73.0 million and 26.6%, $60.2 million and 23.3% and $54.2 million and 22.6% in 2002, 2001 and 2000, respectively. The increase in EBITDA and EBITDA Margin in 2002 is due to (i) a decrease in Compensation and Employee Benefits and Other Operating Expenses, as a percent of revenues, due to the positive affects of our integration efforts and (ii) improvement in performance in our operations.

Income From Continuing Operations Before Income Taxes in the Insurance Brokerage segment was $41.9 million, $7.2 million and $16.8 million for the years ended December 31, 2002, 2001 and 2000, respectively. The increase in 2002 is due to (i) the items discussed above, and (ii) a decrease in amortization of intangible assets, principally due to our adoption of SFAS No. 142. Please read Note 1, “Nature of Operations and Summary of Significant Accounting Policies” in our annual financial statements under “Intangible Assets.” The reduction in 2001 is due to the negative impact of the integration effort and other charges in 2001 compared to 2000.

Specialized Benefits Services

Comparisons for Years Ended December 31, 2002, 2001 and 2000

The Specialized Benefits Services segment results reflect the following integration efforts and other charges: $1.1 million, $1.7 million and $0.7 million in years 2002, 2001 and 2000, respectively.

Specialized Benefits Services revenues increased $0.3 million, or 0.5%, to $53.3 million in 2002 and $3.4 million, or 6.8%, to $53.0 million in 2001. Excluding the effect of businesses acquired by adjusting 2000 revenues by $4.4 million and excluding $8.0 million of non-recurring revenues in 2000 as previously discussed, revenues increased approximately 1% and 15% in 2002 and 2001, respectively, in the Specialized Benefits Services segment. The flat revenue growth in 2002 is due to a reduction in core benefit product sales and executive and professional benefit product sales resulting from difficult market conditions, offset by increases in enrollment and communication product sales. Specialized Benefits Services revenues represented 16.2%, 17.0% and 17.1% of our total consolidated revenues in 2002, 2001 and 2000, respectively.

19

Table of Contents

EBITDA in the Specialized Benefits Services segment decreased $3.2 million, or 24.6%, to $9.7 million in 2002 from $12.9 million in 2001 and decreased $5.9 million, or 31.3%, to $12.9 million in 2001 from $18.8 million in 2000. EBITDA Margin in the Specialized Benefits Services segment was 18.2%, 24.3% and 37.8% in 2002, 2001 and 2000, respectively. Excluding the effect of the integration efforts and other charges and non-recurring revenues in 2000, EBITDA and EBITDA Margin in the Specialized Benefits Services segment were $10.8 million and 20.3%, $14.6 million and 27.4% and $11.5 million and 27.7% in 2002, 2001 and 2000, respectively. EBITDA and EBITDA Margin in the Specialized Benefits Services segment in 2002 were negatively impacted by (i) decrease in new business and an increase in lost business in our Core Benefits division, (ii) decrease in new business in our Executive and Professional Benefit division, and (iii) expenses incurred to expand and support our sales distribution capacity and infrastructure.

Income From Continuing Operations Before Income Taxes in the Specialized Benefit Services Segment was $2.7 million, $5.0 million and $12.3 million for the years ended December 31, 2002, 2001 and 2000, respectively. The decrease in 2002 is due to the items discussed above, partially offset by a decrease in amortization of intangible assets principally due to our adoption of SFAS No. 142. Please read Note 1, “Nature of Operations and Summary of Significant Accounting Policies” in our annual financial statements under “Intangible Assets.”

Corporate

Comparisons for Years Ended December 31, 2002, 2001 and 2000

The Corporate segment results reflect the following integration efforts and other charges: $3.9 million, $4.6 million and $0.9 million in years 2002, 2001 and 2000, respectively.

Revenues at the Corporate segment represent interest income. Net Corporate expenses were $19.7 million, $21.9 million and $14.8 million in 2002, 2001 and 2000, respectively. As a percentage of total consolidated revenues, net Corporate expenses were 6.0%, 7.0% and 5.1% in 2002, 2001 and 2000, respectively. Included in net Corporate expenses is $1.0 million, $2.5 million and $1.2 million in 2002, 2001 and 2000, respectively, in legal fees and other expenses associated with the defense of claims against us, the pursuit of claims made by us and payment of claims by us relating to USIA, a discontinued operation. Excluding the effect of the integration efforts and other charges and the legal fees discussed above, net Corporate expenses were $14.7 million, $14.8 million and $12.7 million in 2002, 2001 and 2000, respectively, and as a percentage of total consolidated revenues, net Corporate expenses were 4.5%, 4.7% and 4.5% in 2002, 2001 and 2000, respectively. Included in the Corporate segment in 2002 was a $0.8 million charge related to the Missigman liability. Please read Note 14, “Contingencies” in our annual financial statements under “Gary J. Missigman Litigation.”

Net Loss From Continuing Operations in the Corporate segment was $34.2 million, $51.5 million and $41.6 million in 2002, 2001 and 2000, respectively. The decrease in 2002 is primarily due to (i) a $6.3 million decrease in interest expense as a result of lower interest rates and a reduction in debt, (ii) a $4.1 million gain from the reduction in the book value of redeemable common stock warrants, and (iii) a $3.0 million gain from the

20

Table of Contents

reduction in the book value of the stock appreciation rights. The increase in 2001 is primarily a result of the integration efforts and other charges in 2001 compared to 2000.

Integration Efforts and Other Charges

Integration Efforts

Upon completion of the majority of our acquisitions, we undertook initiatives to determine the following: (i) positions within the organization that could be eliminated without resulting in loss of revenues or detriment to service; (ii) sales professionals contracts that should be renegotiated because they were in excess of our standard compensation practices; and (iii) accretive benefits that could be derived from the early termination of lease commitments. Upon completion of the analysis we reduced the number of our employees by 32, 96 and 11, during the first quarter of 2002 and for 2001 and 2000, respectively, and such persons were given various levels of severance depending on their length of service with us. This process resulted in severance charges of $3.6 million, $4.7 million and $2.9 million in the first quarter of 2002 and in 2001 and 2000, respectively. In addition, in the first quarter of 2002 and in 2001, we renegotiated the compensation arrangements of four and 29 sales professionals, respectively, whose compensation arrangements were in excess of our standard compensation practices. The renegotiation of these contracts resulted in an expense of $1.8 million in the first quarter of 2002 and $3.0 million in 2001. Finally, in the first quarter of 2002, and in 2001 and 2000, we terminated lease arrangements at one, eight and four locations, respectively. The early termination of lease commitments resulted in charges of $0.1 million, $1.9 million and $0.5 million in the first quarter of 2002, in 2001 and 2000, respectively. Additionally, in 2000, $0.3 million in claims expense was recorded.

In the fourth quarter of 2001, we reorganized an administrative affinity group marketing operation, included as part of the insurance brokerage segment, after it lost its principal revenue source, commissions and fees generated from the sale of retiree military supplemental medical insurance. This source of revenue was negatively impacted by federal legislation that changed the retiree military medical insurance program. This operation was reorganized into three distinct units. Two of the three units were transferred to then existing operations. Operations at the third unit were terminated. This decision resulted in a write-off of receivables of $2.4 million and a write-off of other assets of $0.8 million for a total charge of $3.2 million in the fourth quarter of 2001.

In 1999, we sold a brokerage operation that generated revenues from commissions and fees on the sale of life insurance products primarily through third-party agents, which we call wholesale distribution. The wholesale distribution strategy of this operation did not fit with our current focus on retail distribution; as a result, we sold the operation to the former owners of that operation and recorded a loss of $3.2 million on the sale of the business. Included in the consideration received for the operation was a note receivable based on a future revenue sharing arrangement. Upon review of the current and future revenue streams generated and to be generated from

21

Table of Contents

the sold brokerage operation, we determined that the note was impaired by $1.4 million. The note receivable, originally issued for $1.5 million, was written down by $1.0 million in the second quarter of 2001, written down by $0.3 million in the fourth quarter of 2001 and written down by $0.1 million in the first quarter of 2002.

Other Charges

In January 2002, Bernard H. Mizel retired as our chairman and chief executive officer. David L. Eslick, who has been president and chief operating officer since July 1998, succeeded Mr. Mizel. In the first quarter of 2002, we recorded a charge of $2.8 million related to the retirement.

In the first quarter of 2002, we accrued $0.3 million related to the Royal Indemnity Company Claim. Please read Note 14 “Contingencies,” in our annual financial statements under “Royal Indemnity Company Claim.”

In 2000, in an effort to provide a simplified and common medical and dental insurance program to our employees, we decided to consolidate our insurance program into one self-insured medical and dental plan. Prior to this plan, many of our acquired businesses had purchased their medical insurance on an individual basis. These medical contracts were placed with a number of different regional and/or national insurance companies principally on a fully insured basis. These insurance brokerage businesses had an employment size that placed them into the insurance carriers “community rated” programs. Community rated programs are for businesses that do not have a sufficient employee size, generally less than 100 employees, for the insurance carriers to evaluate their claim history and, therefore, the rate history on an individual basis. In accordance with GAAP, we were required to establish a liability for incurred but not yet reported claims. Since the prior insurance carriers categorized these acquired businesses as community rated, they could not provide us with historical claims information. Therefore, we could not reasonably estimate this liability at the end of 2000. Our historical experience indicated that our average monthly claims were approximately $1.0 million and the lag in reporting claims was approximately three and one-half months. In the first quarter of 2001, we recorded a $3.5 million charge to establish this self-insurance plan liability. We have purchased a specific and aggregate insurance policy to minimize our future exposure. In the fourth quarter of 2002, we changed from the self-insured plan to a fully insured medical and dental plan. We do not believe the financial statement impact of the change will be material.

In 2001, several insurance carriers notified us that differences existed between insurance coverages placed and the corresponding premiums remitted. After a comprehensive review, we determined that in prior periods coverage had been placed with the carriers without the establishment of the corresponding receivable from the client and payable to the carriers on the general ledger. Thus, after obtaining the necessary information from the carriers in 2001, we were able to reasonably estimate and record the corresponding payables and receivables, net of commission revenues. As the receivables related to the years 1997 through 2001 and collection would entail pursuing numerous former clients, we determined in the fourth quarter of 2001 that the collection of these receivables was remote. In accordance with GAAP, since the collection of the receivables was highly uncertain and the amount of the loss was known, we wrote off the $2.8 million receivables in the fourth quarter of 2001. We have since strengthened our internal controls and systems to minimize the risk of similar discrepancies occurring in subsequent periods.

In December 2001, we entered into a services agreement with Ceridian Corporation. The agreement stipulates that Ceridian Corporation will provide administrative services to our customers and us. We estimated that the conversion cost associated with this service agreement will be $1.2 million and we have accrued this amount in the fourth quarter of 2001. In March 2002, the original service agreement was amended due to our announcement to sell USIA. Please read “—Discontinued Operations” above. The amendment eliminated USIA as a party to the service agreement, which resulted in the accrual of an additional $1.0 million in the first quarter of 2002.

In 2000, we entered into an agreement with a company, which agreement was terminated by mutual consent in the fourth quarter of 2001, resulting in an accrual of $0.8 million.

22

Table of Contents

Stock Appreciation Rights

In 1995, we adopted a Long-Term Incentive Plan to provide a means to attract, retain and motivate employees. As part of the Long-Term Incentive Plan we issued stock appreciation rights, which we refer to as SARs. SARs generally vest over a five-year period, although accelerated vesting is possible under specified circumstances. Upon exercise of a SAR, the holder generally is entitled to receive, in cash, the excess of the fair market value per share of our common stock on the date of exercise over the grant price of the SAR. The valuation of SARs is based on the estimated fair value of a share of our common stock. In accordance with GAAP, compensation expense, or a reduction of compensation expense, for SARs is recorded over the vesting period based on the change in fair value from grant date to each balance sheet date. Please read Note 6, “Stockholders’ Equity—Long-Term Incentive and Share Award Plan,” in our annual financial statements. We recorded a net reduction in SAR-related compensation expense of $3.0 million in 2002, resulting from a reduction in the fair market value of our common stock. We recorded SAR-related compensation expense of $3.1 million and $0.3 million in 2001 and 2000, respectively.

Upon the consummation of our initial public offering in October 2002, the Long-Term Incentive Plan was terminated and replaced with the 2002 Equity Incentive Plan. Also, after the consummation of our initial public offering, we made an offer to exchange all outstanding SARs for stock options or stock under our 2002 Equity Incentive Plan. On November 27, 2002, the SARs exchange was completed, the SARs tendered in the exchange were canceled, and the related compensation expense for 2002 was finalized. As of December 31, 2002, there were no SARs outstanding.

2002 Equity Incentive Plan

Our Company’s board of directors adopted and a requisite majority of our stockholders approved a new 2002 Equity Incentive Plan that became effective and replaced the Long-Term Incentive Plan, upon the consummation of the initial public offering. The 2002 Equity Incentive Plan reserves approximately 10.3 million shares of our common stock for issuance to directors, executive officers, employees and non-employee contributors. Awards may consist of options, SARs, restricted shares, dividend equivalents or other share-based awards and are granted to eligible participants under the plan.

After the consummation of our initial public offering, we made an offer to exchange all our outstanding SARs for stock options or stock under our 2002 Equity Incentive Plan. On November 27, 2002, all SAR holders formally agreed to exchange their SARs for stock options and the number of options that each individual employee was entitled to receive and the option exercise price, was known. The historical accounting treatment of SARs was finalized and all SARs tendered in the exchange were cancelled. In accordance with GAAP, that type of stock compensation plan is accounted for as a fixed plan, and compensation expense was measured by the difference between the quoted market price and the price, if any, to be paid by the employee. The corresponding accrual for SAR-related compensation expense was reversed and offset compensation expense that was recognized upon the conversion to a stock option. Our stock price did not increase significantly prior to the consummation of the exchange of SARs for options, therefore the financial statement impact of the transaction in which the SARs were ultimately exchanged for stock options was a $1.3 million expense which was recorded in the fourth quarter of 2002. Upon the consummation of the exchange of all SARs for options or stock, no further expense will be recognized under our 2002 Equity Incentive Plan in connection with the exchange.

Upon the consummation of the initial public offering, approximately 0.1 million of restricted stock units, which were fully vested, were granted to nine executive officers. A $1.0 million expense was recorded for the value of the grant of restricted stock units during the fourth quarter of 2002.

Redeemable Common Stock Warrants

In March 1996, we issued warrants to purchase 0.7 million shares of common stock issued at an exercise price of $11.125 per share. Holders of the Redeemable Common Stock Warrants, issued in conjunction with a

23

Table of Contents

1996 senior subordinated debt offering that was repaid in 1999, agreed to terminate the put rights associated with the Redeemable Common Stock Warrants concurrent with the consummation of the initial public offering. The aggregate value of the warrants was $4.3 million and was reported as Redeemable Common Stock warrants on our balance sheet prior to the consummation of our initial public offering. The change in value of the warrants, which is recorded as change in value of redeemable common stock warrants in our statements of operations, was $(4.1) million and $1.4 million for 2002 and 2001, respectively.

Early Retirement of Debt

On October 25, 2002, we completed our initial public offering of 9.0 million shares at a price of $10 per share. The cash proceeds of the offering after the underwriting discount were $83.7 million. After deducting offering expenses of $5.3 million, $78.4 million was used to pay down our indebtedness under the credit facility. In connection with the debt repayment, we wrote-off $1.9 million in deferred financing costs in the fourth quarter of 2002.

In April 2002, we completed the sale of USIA for $19.9 million. We received cash proceeds of $18.2 million with the remaining consideration of $1.7 million in the form of an account receivable. Of the $18.2 million in cash proceeds, $16.3 million was used to reduce our term loan and $1.9 million was used to pay selling costs. In connection with the debt repayment, we wrote-off $0.7 million in deferred financing costs in the second quarter of 2002.

Liquidity and Capital Resources

Our debt consists of the following:

Our existing credit facility is comprised of (i) a $75.0 million revolving credit facility, expiring on September 17, 2004, and (ii) a $125.0 million term loan payable in quarterly installments, which commenced on December 31, 1999. The last quarterly installment is due on September 17, 2004, the maturity date of the term loan. The revolving credit facility is available on a revolving basis for loans denominated in U.S. dollars and for letters of credit.

From the inception of our existing credit facility on September 17, 1999 through December 31, 2002, we amended the facility five times to adjust financial covenants. Without these amendments, we would have been in default under the facility. Failure to comply with financial covenants in our existing credit facility could cause all or a portion of our debt to become immediately due and payable. As of December 31, 2002 we were in compliance with the facility as amended.

24

Table of Contents

As of December 31, 2002, the significant financial covenants of our existing credit facility were as follows:

On January 31, 2003, we amended the facility for the sixth time to adjust the financial covenants in 2003. Without this amendment, we may have defaulted under the facility in the first quarter of 2003.

With the consummation of the initial public offering and the net proceeds used to reduce bank borrowings, we are currently evaluating our debt structure in light of our available sources of funding. Upon completing this evaluation, we expect to be in a position to make a judgment as to what the debt component of our capital structure should be to best support our business and acquisition strategy. This may or may not result in a decision to replace our existing credit facility with either a new credit facility, publicly or privately offered notes, some other form of debt financing, or some combination of the foregoing or request an amendment to our existing credit facility. In the event that we replace our existing credit facility, we will be required to pay a fee equal to 1.00% of the revolving credit commitment and the outstanding borrowings under the term loan as determined 30 days prior to repayment. In the event our existing credit facility is not replaced by March 31, 2004, and depending on our results of operations, we may be required to request from our current lenders a waiver or modification of the shareholders’ equity covenant, and possibly other covenants, in the existing credit facility. Failure to comply with financial covenants in our existing credit facility could cause all or a portion of our debt to become immediately due and payable.

In the event the revolving credit commitment and the outstanding borrowings under the term loan have not been repaid and all related commitments terminated as of October 1, 2003, we will be required to pay a fee in an amount equal to 1.00% of the sum of the total of the revolving credit commitment and the outstanding borrowings under the term loan as of October 1, 2003. The fee is due and payable on October 1, 2003. However, if we, by July 31, 2003, retain the lenders to structure and arrange a new senior credit facility, then the amount of any refinancing fee that is subsequently paid to the lenders shall be credited towards any fees otherwise payable in connection with a new senior credit facility.

On October 31, 2002, Standard & Poor’s removed us from CreditWatch and affirmed its single-”B”-plus rating on our company with a positive outlook, after we successfully completed our initial public offering.

In addition to our debt service requirements, we will require liquidity for capital expenditures and working capital needs. Capital Expenditures for the years ended December 31, 2002, 2001 and 2000 were $7.0 million, $8.5 million and $10.3 million, respectively. For the years ended December 31, 2002, 2001 and 2000, $4.6 million, $5.6 million and $5.7 million, respectively, of our total Capital Expenditures related to management information systems. We have funded our capital expenditures with cash generated internally from operations and from external financing and expect to continue to do so in the future. Our total Capital Expenditures are expected to be approximately $10.9 million in 2003.

We believe that cash and cash equivalents on hand of $21.4 million and our availability under our revolving credit facility of $17.5 million as of December 31, 2002, together with cash flow generated from operations, should be sufficient to fund our estimated $32.9 million in debt principal repayment, working capital needs and budgeted $10.9 million in capital expenditures through December 31, 2003. Our liquidity thereafter will depend on our financial results and future available sources of additional equity or debt funding and our results of operations. The revolving credit facility provides us with availability of up to $75.0 million, all of which is

25

Table of Contents

available for general corporate purposes, including acquisitions. As of December 31, 2002 borrowings outstanding under the revolving credit facility were $56.1 million. Additionally, we had $1.4 million outstanding under letters of credit. Our future operating performance and ability to service our debt will be subject to economic conditions and to financial, business and other factors, many of which are beyond our control.

We hold cash in a fiduciary capacity as a result of premiums received from clients that have not yet been paid to insurance carriers. The fiduciary cash is recorded as an asset on our balance sheet with a corresponding liability, net of commissions, to insurance carriers. We earn interest on these funds during the time between receipt of the cash and payment to insurance carriers. In some states, fiduciary cash must be kept in separate bank accounts subject to specific guidelines, which generally emphasize capital preservation and liquidity, and is not generally available to service debt or for other corporate purposes. Insurance brokerage transactions typically generate large cash flows, and the timing of such cash flows can significantly affect the net cash balances held at month end.

Cash and cash equivalents from continuing operations (decreased) increased by $(9.5) million, $29.2 million and $8.7 million for the years ended December 31, 2002, 2001 and 2000, respectively. Net cash provided by operating activities totaled $36.6 million, $21.9 million and $29.9 million for the years ended December 31, 2002, 2001 and 2000, respectively, and is principally dependent upon the timing of collection of premiums receivable and payments of premiums payable.

Net cash provided by (used in) continuing investing activities totaled $5.6 million, $(14.9) million and $(12.1) million for the years ended December 31, 2002, 2001 and 2000, respectively, which principally reflects acquisition activities and Capital Expenditures. Included in the net cash provided by continuing investing activities for the year ended December 31, 2002 is $18.2 million in proceeds from the sale of USIA. Please read “Discontinued Operations.” Cash expenditures for acquisitions amounted to $5.7 million, $6.9 million and $2.4 million for the years ended December 31, 2002, 2001 and 2000, respectively. We made no acquisitions in 2002 or 2001. The $5.7 million for the year ended December 31, 2002, reflects the payment of additional purchase price and retention based acquisition payments. The $6.9 million for the year ended December 31, 2001, reflects the payment of additional purchase price on retention based acquisitions, as well as the payment of the cash portion of an acquisition effective in 2000 but paid in the first quarter of 2001. Cash expenditures for Capital Expenditures amounted to $7.0 million, $8.5 million and $10.3 million for the years ended December 31, 2002, 2001 and 2000, respectively. Investments in “Discontinued Operations” amounted to $8.9 million, $14.8 million and $11.1 million for the years ended December 31, 2002, 2001 and 2000, respectively.

Net cash (used in) provided by financing activities totaled $(42.7) million, $36.9 million and $2.0 million for the years ended December 31, 2002, 2001 and 2000, respectively, as we made debt payments and continued to issue both debt and equity. In the first quarter of 2002, we received $2.5 million from the issuance of our preferred stock to Sovereign Bancorp. In the second quarter of 2002, we used $16.3 million of the proceeds from the sale of USIA to reduce our term loan. In the fourth quarter of 2002, we received $90.0 million from the issuance of common stock in our initial public offering. Of the $90.0 million in gross proceeds from our initial public offering, we used $78.4 million to reduce our term loan and revolving credit facility and we used $11.6 million to pay issuance costs related to our initial public offering. In the fourth quarter of 2001, we received $30.0 million from the issuance of our preferred stock. Of the $30.0 million issued, $15.0 million was issued to UnumProvident Corporation and $15.0 million was issued to Ceridian Corporation. Please read Note 5, “Long-Term Debt,” and Note 6, “Stockholders’ Equity,” to our annual financial statements.

Net loss from continuing operations per share (basic and diluted) was $(0.87), $(74.16) and $(41.56) for the years ended December 31, 2002, 2001 and 2000, respectively. Our per share data was significantly impacted by the 43.8 million increase in our common shares outstanding, which was a result of (i) 34.8 million shares of our common stock issued to the holders of our preferred stock concurrent with our initial public offering and (ii) 9.0 million shares of our common stock issued as part of the initial public offering. As of December 31, 2002, we had 44.6 million shares of our common stock outstanding; that is, 42.4 million shares are included in

26

Table of Contents

stockholders’ equity and 2.2 million shares are included in redeemable securities. As of December 31, 2001 and 2000, we had 0.8 million shares of our common stock outstanding.

Net Operating Loss Carryforwards

Our net losses have resulted in net operating loss carryforwards for federal and state income tax purposes. At December 31, 2002, we had $48.1 million of net operating loss carryforwards for federal tax purposes that will expire during the period 2011 through 2022. Our ability to use these net operating loss carryforwards to offset future taxable income, if any, may be subject to limitations under Section 382 of the Internal Revenue Code of 1986, as amended and similar state provisions. The provisions of Section 382 are triggered by specific ownership changes of our stock. We do not believe Section 382 will limit us in utilizing our net operating loss carryforwards in 2003. However, if limited, the unused portion may then be carried forward to future years. In any event, we have established a 100% valuation allowance against the carrying value of the net operating loss to reduce its carrying value to zero as it is more likely than not that it will not be realized in the near future.