ITEM 1. BUSINESS
GENERAL
The Enstar Group, Inc., a Georgia corporation (the "Company"), currently holds assets, aggregating approximately $99.6 million at December 31, 2001, consisting primarily of cash, cash equivalents, short-term certificates of deposit and partially owned equity affiliates. The Company is actively engaged in the search for one or more additional operating businesses which meet the Company's acquisition criteria. See "-- Strategy for Business Acquisitions."
In November 2001, the Company, together with Trident II, L.P. ("Trident") and the shareholders and senior management (the "Castlewood Principals") of Castlewood Limited ("Castlewood"), completed the formation of a new venture, Castlewood Holdings Limited ("Castlewood Holdings"), to acquire and manage insurance and reinsurance companies, including companies in run-off, and provide management, consulting and other services to the insurance and reinsurance industry (the "Castlewood Holdings Transaction"). The Castlewood Principals contributed at closing all the shares of Castlewood to Castlewood Holdings and received in exchange a 33 1/3% economic interest in the newly-formed Castlewood Holdings, plus notes and cash totaling $4.275 million. As part of the transaction, the Company and Trident made capital commitments of $39.5 million each, totaling $79 million, in exchange for their 33 1/3% economic interests in Castlewood Holdings. The Company received 50% of the voting stock of Castlewood Holdings and the Castlewood Principals and Trident each received 25% of Castlewood Holdings' voting stock. Castlewood is a private Bermuda-based firm, experienced in managing and acquiring reinsurance operations. The Company's ownership in Castlewood Holdings is accounted for using the equity method of accounting.
Immediately following the closing of the Castlewood Holdings Transaction, the Company and Trident each contributed $12.5 million to Castlewood Holdings. The Company's capital contribution to Castlewood Holdings was derived from cash on hand; the Company expects to use internal funds to satisfy its remaining commitment to Castlewood Holdings.
In conjunction with the closing of the Castlewood Holdings Transaction, the Company also transferred its shares in Revir Limited ("Revir"), a newly-formed Bermuda holding company, at cost to Castlewood Holdings. Revir then completed the acquisition of two reinsurance companies, River Thames Insurance Company Limited, based in London, England, and Overseas Reinsurance Corporation Limited, based in Bermuda, (collectively, the "River Thames Transaction") from Rivers Group Limited and Sedgwick Group Limited.
In July 2000, the Company, through B.H. Acquisition Limited ("B.H. Acquisition"), a newly-formed joint venture with Castlewood and an entity controlled by Trident, acquired as an operating business, two reinsurance companies of Petrofina S.A., a subsidiary of TotalFina Elf S.A. The reinsurance companies, Brittany Insurance Company, Ltd., incorporated under the laws of Bermuda ("Brittany"), and Compagnie Europeenne d'Assurances Industrielles S.A., a Belgium corporation ("CEAI"), were purchased by B.H. Acquisition for approximately $28.5 million. In exchange for a capital contribution of approximately $9.6 million, the Company received 50% of the voting stock and a 33% economic interest in B.H. Acquisition. As part of the transaction, Castlewood received 33% of the voting stock and a 45% economic interest in B.H. Acquisition. Brittany and CEAI are principally engaged in the active management of books of reinsurance business from the international markets.
As a result of the contribution of Castlewood's outstanding stock to Castlewood Holdings, the Company's 33% direct economic interest in B.H. Acquisition increased by an additional 15% indirect economic interest through Castlewood Holdings. The Company has retained its 50% voting interest in B.H. Acquisition.
ORGANIZATIONAL STRUCTURE
The Company's executive offices are located at 401 Madison Avenue, Montgomery, Alabama 36104, and its telephone number is (334) 834-5483. The Company has seven employees whose principal duties currently
include managing the assets of the Company, seeking and evaluating potential acquisition candidates, fulfilling reporting requirements associated with being a publicly traded company, and handling various other accounting and tax matters. The Company is a Georgia corporation and successor by a 1996 merger to a Delaware corporation of the same name.
SUBSIDIARIES
The Company has one wholly-owned subsidiary, Enstar Financial Services, Inc., a Florida corporation, which currently is inactive.
STRATEGY FOR BUSINESS ACQUISITIONS
The Company's strategy for making a suitable acquisition is to utilize the considerable experience, knowledge and business contacts of the Company's executive officers and directors. Each of the Company's directors has been asked by management to assist the Company actively in its pursuit of additional acquisitions. Management follows up on the leads and meets with various prospective targets. This pursuit occupies a significant amount of the time of the Company's senior officers. The Company conducts rigorous financial and legal due diligence with respect to any entity about which it has a strong interest.
The Company primarily focuses on the financial services industry in a global market which would complement its current operating businesses, investigating acquisition opportunities both within and outside the United States when management believes that such opportunities might be attractive. The Company may pay consideration in the form of cash, securities of the Company or some combination of both. The Company may also borrow money in connection with an acquisition. In that event, the Company's shareholders would be subject to the risks normally associated with leveraged transactions. Depending upon the level of indebtedness, a leveraged transaction could have important consequences to the Company, including the following: (i) if the acquired business is unable to achieve satisfactory operating results, the Company could prove unable to service such indebtedness; (ii) a substantial portion of the Company's cash flow from operations may be dedicated to the payment of principal and/or interest on its indebtedness and would not be available for other purposes; (iii) the Company's ability to obtain additional financing in the future for working capital, capital expenditures or other acquisitions may be limited; and (iv) the Company's level of indebtedness could limit its flexibility in planning for, or reacting to, changes in its industry.
COMPETITION
The Company faces intense competition in its search for one or more additional operating businesses. See "-- Strategy for Business Acquisitions." In this regard, the Company competes with strategic buyers, financial buyers and others who are looking to acquire suitable operating businesses, many of whom have greater financial resources than the Company or have greater flexibility in structuring acquisition transactions or strategic relationships.
HISTORY
In May 1991, the Company filed for bankruptcy under Chapter 11 of the United States Bankruptcy Code (the "Bankruptcy Code") and operated as a reorganized debtor pursuant to its Second Amended Plan of Reorganization, as modified (the "Reorganization Plan"), until July 1997 when the United States Bankruptcy Court for the Middle District of Alabama (the "Bankruptcy Court") closed the Company's Chapter 11 proceedings by final order. Prior to its bankruptcy filing, the Company was a publicly traded holding company with subsidiaries operating primarily in the specialty retail business and the financial services business. Prior to November 1989, the Company's name was Kinder-Care, Inc., and prior to January 1987, the Company's name was Kinder-Care Learning Centers, Inc. The Company originally was incorporated in October 1970 in the state of Delaware.
ITEM 2.
ITEM 2. PROPERTIES
The Company does not currently own any real property. In June 1999, the Company signed a three year lease on an office building at 401 Madison Avenue, Montgomery, Alabama which serves as the corporate headquarters. Additionally, pursuant to an oral agreement, the Company leases space in a warehouse at 703 Howe Street, Montgomery, Alabama on a month-to-month basis. The Company leases the office building and warehouse space from unaffiliated third parties for $2,500 and $350 per month, respectively. The Company believes the rental amounts are competitive with market rates. The cancellation or termination of either of these leases would not have a material adverse effect on the Company's results of operations.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
In February 1997, fifteen former shareholders of the Company filed a lawsuit against the Company in the Circuit Court of Montgomery County, Alabama (the "Circuit Court") styled Peter N. Zachary, et al. v. The Enstar Group, Inc., Case No. CV-97-257-Gr. The complaint, which dealt with actions occurring prior to the Company's filing for bankruptcy in 1991, alleged that the Company along with its then principal officers and others defrauded the plaintiffs in violation of the Alabama Securities Act and other Alabama statutory provisions. The plaintiffs sought compensatory damages in the amount of their alleged losses of approximately $2 million and unspecified punitive damages. The complaint was virtually identical to a complaint brought by these plaintiffs against the Company's former chairman, former president and others in December 1991, during the pendency of the Company's bankruptcy case and prior to the confirmation of the Reorganization Plan. The plaintiffs alleged that the Bankruptcy Court issued an order in January 1997, allowing them to litigate their claims against the Company. The Bankruptcy Court's order actually held that the plaintiffs could not bring a late claim against the Company in its bankruptcy case and then went on to state that because of facts relating to these particular plaintiffs, they were not bound by the provisions of the Reorganization Plan and their claims were not subject to discharge under the Bankruptcy Code. In March 1997, the Company filed a motion to dismiss and/or for summary judgment in response to the complaint on the basis that the claims asserted were barred by the applicable statute of limitations. In November 2000, the Circuit Court granted the Company's motion and dismissed the plaintiffs' claims. In December 2000, the plaintiffs appealed the Circuit Court's judgment to the Alabama Supreme Court. In October 2001, the Alabama Supreme Court affirmed the decision of the Circuit Court, dismissing the plaintiffs' claims.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of shareholders of the Company during the quarter ended December 31, 2001.
SUPPLEMENTARY ITEM. CERTAIN RISK FACTORS
See "The Enstar Group, Inc. Private Securities Litigation Reform Act of 1995 Safe Harbor Compliance Statement For Forward-Looking Statements," included as Exhibit 99.1 to this Form 10-K and incorporated herein by reference.
PART II
ITEM 5.
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's common stock (the "Common Stock" or "Shares") is traded in the over-the-counter market on the OTC Bulletin Board maintained by the National Association of Securities Dealers, Inc. The
following table reflects the range of high and low selling prices of the Company's Common Stock by quarter for 2001 and 2000, as reflected in the OTC Bulletin Board Daily Trade and Quote Summary Report:
At March 21, 2002, there were approximately 3,091 holders of record of the Company's Common Stock.
The Company has not declared or paid a cash dividend on any of its securities since 1989. The Company currently intends to retain its earnings to finance the growth and development of its future business and does not anticipate paying cash dividends in the foreseeable future. The payment of cash dividends in the future will depend upon such factors as the Company's earnings, capital requirements, financial condition, contractual restrictions and other factors deemed relevant by the Board of Directors. See "Management's Discussion and Analysis of Financial Condition and Results of Operations."
In November 2001, the Company sold 200,000 shares of common stock (100,000 per individual) to Nimrod T. Frazer, the Company's Chairman and Chief Executive Officer, and John J. Oros, the Company's President and Chief Operating Officer for approximately $3.7 million, pursuant to Regulation D promulgated under the Securities Act of 1933. See Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Related Party Transactions."
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth selected financial information with respect to the Company for each of the five years in the period ended December 31, 2001 and is derived in part from the audited consolidated financial statements of the Company. The data set forth below should be read in conjunction with Management's Discussion and Analysis of Financial Condition and Results of Operations (Item 7) and the audited consolidated financial statements, including the related notes thereto.
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(1) Pro forma amounts per common share assuming that all shares issued (4,549,060) as of December 31, 1997 had been outstanding for all of 1997.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the Selected Financial Data (Item 6) and the audited consolidated financial statements, including the related footnotes thereto. Historical results of operations and the percentage relationships among any amounts included in the Consolidated Statements of Income, and any trends which might appear to be inferable therefrom, should not be taken as being necessarily indicative of trends in operations or the results of operations for any future period. See "Business" for a description of the business of the Company.
RECENT ACQUISITIONS
In November 2001, the Company, together with Trident and the Castlewood Principals, completed the formation of a new venture, Castlewood Holdings, to acquire and manage insurance and reinsurance companies, including companies in run-off, and provide management, consulting and other services to the insurance and reinsurance industry. The Castlewood Principals contributed at closing all the shares of Castlewood to Castlewood Holdings and received in exchange a 33 1/3% economic interest in the newly-formed Castlewood Holdings, plus notes and cash totaling $4.275 million. As part of the transaction, the Company and Trident made capital commitments of $39.5 million each, totaling $79 million, in exchange for their 33 1/3% economic interests in Castlewood Holdings. The Company received 50% of the voting stock of Castlewood Holdings and the Castlewood Principals and Trident each received 25% of Castlewood Holdings' voting stock. Castlewood is a private Bermuda-based firm, experienced in managing and acquiring reinsurance operations. The Company's ownership in Castlewood Holdings is accounted for using the equity method of accounting.
Immediately following the closing of the Castlewood Holdings transaction, the Company and Trident each contributed $12.5 million to Castlewood Holdings. The Company's capital contribution to Castlewood Holdings was derived from cash on hand; the Company expects to use internal funds to satisfy its remaining commitment to Castlewood Holdings.
In conjunction with the closing of the Castlewood Holdings Transaction, the Company also transferred its shares in Revir, a newly-formed Bermuda holding company, at cost to Castlewood Holdings. Revir then completed the River Thames Transaction.
In July 2000, the Company, through B.H. Acquisition, a newly-formed joint venture with Castlewood and an entity controlled by Trident, acquired as an operating business, two reinsurance companies of Petrofina S.A., a subsidiary of TotalFina Elf S.A. The reinsurance companies, Brittany, incorporated under the laws of Bermuda, and CEAI, a Belgium corporation, were purchased by B.H. Acquisition for approximately $28.5 million. In exchange for a capital contribution of approximately $9.6 million, the Company received 50% of the voting stock and a 33% economic interest in B.H. Acquisition. As part of the transaction, Castlewood received 33% of the voting stock and a 45% economic interest in B.H. Acquisition. Brittany and CEAI are principally engaged in the active management of books of reinsurance business from the international markets.
As a result of the contribution of Castlewood's outstanding stock to Castlewood Holdings, the Company's 33% direct economic interest in B.H. Acquisition increased by an additional 15% indirect economic interest through Castlewood Holdings. The Company has retained its 50% voting interest in B.H. Acquisition.
LIQUIDITY AND CAPITAL RESOURCES
The Company's assets, aggregating approximately $99.6 million at December 31, 2001, consist primarily of approximately $73.4 million in cash and cash equivalents, approximately $4.0 million in certificates of deposit and approximately $20.9 million in partially owned equity affiliates.
The Company is currently engaged in the active search for one or more additional operating businesses. The Company primarily focuses on the financial services industry in a global market which would complement its current operating businesses, investigating acquisition opportunities both within and outside the United
States when management believes that such opportunities might be attractive. The Company may pay consideration in the form of cash, securities of the Company or some combination of both. The Company may also borrow money in connection with an acquisition. With the exception of various expenses incurred in connection with the Company's search for one or more suitable acquisitions, its only needs are to fund normal operating expenses and its remaining commitment to Castlewood Holdings.
FINANCIAL CONDITION
The Company had total assets of approximately $99.6 million at December 31, 2001 compared to approximately $93.3 million at December 31, 2000. The increase in total assets was due in part to the receipt of approximately $3.7 million from two of the Company's executive officers in connection with the purchase of 200,000 shares of the Company's Common Stock. See "-- Related Party Transactions." In addition, total assets increased $2.1 million from the earnings of partially owned equity affiliates.
The Company's total liabilities were approximately $2.0 million at December 31, 2001 compared to approximately $1.9 million at December 31, 2000.
In March 2000, Mr. J. Christopher Flowers, Vice Chairman of the Board of Directors of the Company, repaid a $15 million note with accrued interest to the Company. The note was originally due in December 2000, and resulted from the Company's sale of 1,158,860 newly issued shares of the Company's Common Stock to Mr. Flowers in December 1998 (the "Flowers Transaction"). In connection with the early repayment, the Company reversed the unamortized discount on the note of approximately $411,000.
RESULTS OF OPERATIONS
2001 Compared to 2000
Interest income was approximately $3.3 million in 2001 compared to approximately $4.6 million in 2000. Interest income was earned from cash, cash equivalents, certificates of deposit and in 2000, the note receivable from Mr. Flowers. Interest income decreased due to a reduction in 2001 of interest rates earned on the Company's cash, cash equivalents and certificates of deposit.
Earnings of partially owned equity affiliates were approximately $2.1 million in 2001 compared to $6.7 million in 2000. The Company recorded equity in earnings of $1.6 million and $6.3 million from B.H. Acquisition in 2001 and 2000, respectively. The Company's equity in earnings from B-Line LLC ("B-Line") was $657,000 in 2001 compared to $393,000 in 2000. In addition, the Company recorded equity in losses of $136,000 from Castlewood Holdings in 2001.
In 2001, the Company recorded net litigation expense of $25,000 compared to $5,000 in 2000. Litigation expense arose from a lawsuit filed against the Company by fifteen former shareholders in February 1997. In October 2001, all claims against the Company in this case were dismissed.
General and administrative expenses were approximately $3.5 million in 2001 compared to approximately $2.5 million in 2000. The Company recorded approximately $1.1 million in non-cash compensation expense in 2001 relating to stock purchase and stock option agreements (see "-- Related Party Transactions"). This increase was partially offset by a substantial decrease in the expense for Alabama shares tax in 2001 due to a change in Alabama tax law. In addition, 2000 reflects a $411,000 decrease in general and administrative expenses resulting from the reversal of the unamortized portion of the discount recorded on the note receivable in the Flowers Transaction. General and administrative expenses also include legal and professional fees as well as travel expenses incurred in connection with the Company's search for one or more additional operating companies. Most variances in legal and professional fees and travel expenses can be attributed to the number of potential acquisition candidates the Company locates as well as the degree of interest the Company may have in such candidates. The stronger the interest in a candidate, the more rigorous financial and legal due diligence the Company will incur with respect to that candidate.
Income tax expense was $299,000 in 2001 compared to $530,000 in 2000. The Company's effective tax rate remains substantially less than statutory rates primarily due to the availability of net operating loss carryforwards ("NOLs") for federal tax purposes.
Consolidated net income was approximately $1.6 million in 2001 compared to approximately $8.3 million in 2000. The decrease in 2001 from 2000 can primarily be attributed to reduced interest rates in 2001, resulting in a decrease in interest income; a decrease in earnings of partially owned equity affiliates; and an increase in general and administrative expenses resulting primarily from non-cash compensation in 2001.
2000 Compared to 1999
Interest income was approximately $4.6 million in 2000 compared to approximately $4.4 million in 1999. Interest income was earned from cash, cash equivalents, certificates of deposit and the note receivable from Mr. Flowers.
Earnings of partially owned equity affiliates were approximately $6.7 million in 2000 compared to $37,000 in 1999. This increase can primarily be attributed to the Company's investment in B.H. Acquisition in July 2000 and an increase in earnings of B-Line. The Company recorded equity in earnings of $6.3 million from B.H. Acquisition in 2000. The Company's equity in earnings from B-Line was $393,000 in 2000 compared to $37,000 in 1999.
In 2000, the Company recorded net litigation expense of approximately $5,000 compared to net litigation income of approximately $244,000 in 1999. The 1999 litigation income resulted from the receipt of additional proceeds from the earlier settlement of the Company's claim against a former officer of the Company.
General and administrative expenses were approximately $2.5 million in 2000 compared to approximately $2.4 million in 1999. In connection with the early repayment of the note in the Flowers Transaction, the Company reversed the unamortized portion of the discount recorded on the note. This reversal resulted in a decrease of approximately $411,000 in general and administrative expenses in 2000. This decrease was offset by additional expense resulting from a new shares tax imposed by the State of Alabama. In addition to these and other normal operating expenses, general and administrative expenses include legal and professional fees as well as travel expenses incurred in connection with the Company's search for one or more additional operating companies. Most variances in legal and professional fees and travel expenses can be attributed to the number of potential acquisition candidates the Company locates as well as the degree of interest the Company may have in such candidates. The stronger the interest in a candidate, the more rigorous financial and legal due diligence the Company will incur with respect to that candidate.
Income tax expense was $530,000 in 2000 compared to $124,000 in 1999. The Company's effective tax rate remains substantially less than statutory rates primarily due to the availability of NOLs for federal tax purposes.
Consolidated net income was approximately $8.3 million in 2000 compared to approximately $2.1 million in 1999. The increase in 2000 from 1999 is primarily due to the increase in earnings of partially owned equity affiliates.
RELATED PARTY TRANSACTIONS
In connection with the Castlewood Holdings Transaction, the Company had entered into stock purchase and stock option agreements with Nimrod T. Frazer, the Company's Chairman and Chief Executive Officer, and John J. Oros, the Company's President and Chief Operating Officer. The agreements proposed to (a) sell a total of 100,000 shares (50,000 per individual) of the Company's Common Stock at $19.25 per share and (b) grant options under the 1997 Amended Omnibus Incentive Plan, as amended (the "Incentive Plan") to purchase a total of 100,000 additional shares (50,000 per individual) at $19.25 per share to Messrs. Frazer and Oros. The options vest on various dates from the date of consummation of the Castlewood Holdings Transaction through July 2004 and may not be exercised prior to September 2002.
The Company had also entered into agreements with Messrs. Frazer and Oros to (a) sell a total of 100,000 shares (50,000 per individual) of the Company's Common Stock at $18.00 per share and (b) grant options under the Incentive Plan to purchase a total of 100,000 additional shares (50,000 per individual) at $18.00 per share in connection with the River Thames Transaction. These options vest on various dates from the date of consummation of the River Thames Transaction through July 2004 and may not be exercised prior to June 2002.
After the closing of the Castlewood Holdings Transaction and the River Thames Transaction in November 2001, the Company received a total of approximately $3.7 million from Messrs. Frazer and Oros in payment for the 200,000 shares (100,000 per individual) under the above mentioned agreements. Since the market price per share of the Company's Common Stock on the closing date of the Castlewood Holdings Transaction and the River Thames Transaction exceeded the selling prices, the Company recognized a charge to earnings in 2001 of approximately $855,000 relating to these shares. In addition, the market price per share of the Company's Common Stock on the date of grant of the above mentioned stock options exceeded the exercise prices, resulting in a charge to earnings in 2001 of approximately $232,000. The Company will recognize additional charges to earnings over the remaining vesting period of these options totaling approximately $623,000.
CONTRACTUAL OBLIGATIONS AND COMMITMENTS
Pursuant to the Castlewood Holdings Transaction, the Company made a capital commitment of $39.5 million in exchange for its 33 1/3% economic interest in Castlewood Holdings. Following the closing of the Castlewood Holdings Transaction, the Company contributed $12.5 million to Castlewood Holdings from cash on hand. The remaining commitment of the Company is to be paid, in part or in whole, within 21 days of receipt of a resolution of the board of directors of Castlewood Holdings for the purpose of funding future investments and/or providing working capital. The Company expects to use internal funds to satisfy its remaining commitment to Castlewood Holdings.
In June 1999, the Company signed a three year lease on an office building which serves as the corporate headquarters. Additionally, pursuant to an oral agreement, the Company leases space in a warehouse at 703 Howe Street, Montgomery, Alabama on a month-to-month basis. The Company leases the office building and warehouse space from unaffiliated third parties for $2,500 and $350 per month, respectively. The Company believes the rental amounts are competitive with market rates. The cancellation or termination of either of these leases would not have a material adverse effect on the Company's results of operations.
RECENT ACCOUNTING PRONOUNCEMENTS
In July 2001, the FASB issued SFAS 141, "Business Combinations", which eliminates the pooling-of-interests method of accounting for transactions initiated after June 30, 2001. Additionally, goodwill and intangibles that arise as a result of purchase transactions initiated during the period July 1, 2001 to December 31, 2001 follow the guidance prescribed by SFAS 142, described below.
In July 2001, the FASB also issued SFAS 142, "Goodwill and Other Intangible Assets." This statement is effective for fiscal years beginning after December 15, 2001 and prescribes that goodwill should no longer be amortized upon adoption of the standard. Instead, goodwill will be tested annually for impairment, and on an interim basis if certain impairment indicators are present. It requires the Company to perform a transitional assessment of whether there is an indication that goodwill is impaired as of the date of adoption. Any goodwill impairment loss will be recognized as the cumulative effect of a change in accounting principle no later than the end of the fiscal year of adoption. Additionally, intangible assets with an indefinite, economic useful life may not be amortized. The Company will adopt this statement on January 1, 2002 and is currently evaluating the impact of adoption on its financial statements. In addition, BH Acquisition, a partially owned equity affiliate, expects to recognize a one time pre-tax gain of $2,969,394 upon adoption of this statement as a result of the reversal of negative goodwill. The Company expects to record its proportionate share of this gain upon adoption of this statement. The Company had approximately $552,000 of unamortized goodwill included in
partially owned equity affiliates at December 31, 2001 and had recorded amortization expense of approximately $80,000 in 2001 as part of general and administrative expense.
CRITICAL ACCOUNTING POLICIES
In the ordinary course of business, the Company has made a number of estimates and assumptions relating to the reporting of results of operations and financial condition in the preparation of its financial statements in conformity with accounting principles generally accepted in the United States of America. Actual results could differ significantly from those estimates under different assumptions and conditions. The most significant accounting estimates inherent in the preparation of the Company's consolidated financial statements include estimates associated with its evaluation of income tax reserves.
Income Tax Valuation Reserve -- The Company recognizes deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements or tax returns. The effect of temporary differences on the financial statements includes certain operating loss carryforwards and tax credit carryforwards. The Company has established a valuation allowance for the uncertainty of the realization of these and any other net deferred tax assets. However, utilization of the remaining deferred tax assets at December 31, 2001 is based on management's assessment of the Company's earnings history, expectations of future taxable income, and other relevant considerations.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS
The Company is exposed to market risk from changes in interest rates. The Company had cash and cash equivalents of approximately $73.4 million in interest bearing accounts (interest at floating rates) and approximately $4.0 million of short-term certificates of deposit (interest at fixed rates) at December 31, 2001. Accordingly, each one percent change in market interest rates would change interest income by approximately $774,000 per annum. However, any future transactions affecting the Company's cash and cash equivalents and certificates of deposit will change this estimate. Additionally, although interest rate changes would affect the fair value of the Company's certificates of deposits, the weighted average original term of certificates held by the Company at December 31, 2001 was approximately six months. The short-term nature of these certificates limits the Company's risk of changes in the fair value of these certificates.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEPENDENT AUDITORS' REPORT
Board of Directors and Shareholders of The Enstar Group, Inc.:
We have audited the accompanying consolidated balance sheets of The Enstar Group, Inc. and Subsidiary (the "Company") as of December 31, 2001 and 2000, and the related consolidated statements of income, comprehensive income, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 2001. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatements. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company at December 31, 2001 and 2000, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2001 in conformity with accounting principles generally accepted in the United States of America.
/s/ Deloitte & Touche LLP
Atlanta, Georgia March 25, 2002
THE ENSTAR GROUP, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS (DOLLARS IN THOUSANDS)
The accompanying notes are an integral part of the consolidated financial statements.
THE ENSTAR GROUP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
The accompanying notes are an integral part of the consolidated financial statements.
THE ENSTAR GROUP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (DOLLARS IN THOUSANDS)
The accompanying notes are an integral part of the consolidated financial statements.
THE ENSTAR GROUP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (DOLLARS IN THOUSANDS)
The accompanying notes are an integral part of the consolidated financial statements.
THE ENSTAR GROUP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS (DOLLARS IN THOUSANDS)
The accompanying notes are an integral part of the consolidated financial statements.
THE ENSTAR GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1: NATURE OF BUSINESS
The Enstar Group, Inc., (the "Company"), is a publicly traded company engaged in the active search for one or more additional operating businesses which meet its acquisition criteria.
In July 2000, the Company, through B.H. Acquisition Limited ("B.H. Acquisition"), a joint venture, acquired as an operating business, two reinsurance companies of Petrofina S.A., a subsidiary of TotalFina Elf S.A. The two companies are principally engaged in the active management of books of reinsurance business from the international markets. In November 2001, the Company, together with Trident II, L.P. ("Trident") and the shareholders and senior management (the "Castlewood Principals") of Castlewood Limited ("Castlewood"), completed the formation of a new venture, Castlewood Holdings Limited ("Castlewood Holdings"), to acquire and manage insurance and reinsurance companies, including companies in run-off, and provide management, consulting and other services to the insurance and reinsurance industry (the "Castlewood Holdings Transaction") (Note 3).
NOTE 2: SIGNIFICANT ACCOUNTING POLICIES
(a) Principles of Consolidation -- The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary, Enstar Financial Services, Inc., an inactive company. All significant intercompany balances and transactions have been eliminated in consolidation.
(b) Use of Estimates -- The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and 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.
(c) Cash Equivalents -- Cash equivalents consist of short term, highly liquid investments with original purchased maturities of three months or less.
(d) Partially Owned Equity Affiliates -- The Company accounts for its 8.34% interest in B-Line LLC ("B-Line"), its 33% economic interest in B.H. Acquisition and its 33 1/3% economic interest in Castlewood Holdings under the equity method (Note 3).
(e) Property and Equipment -- Property and equipment is stated at cost less accumulated depreciation and is depreciated using the straight line method over the estimated useful lives of the related assets, principally 5 to 7 years.
(f) Financial Instruments -- The Company invests in certificates of deposit ("CDs") offered by commercial banks. These certificates, which had a weighted average maturity of approximately six months at December 31, 2001, are classified by the Company as "held to maturity" securities. The estimated fair value of CDs at December 31, 2001 and 2000, based on interest rates available on CDs of comparable amounts, maturities, and credit quality, was approximately equal to their carrying values.
(g) Income Taxes -- The Company computes deferred tax assets and liabilities based on the differences between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the years in which the differences are expected to reverse. Valuation allowances are established when necessary to reduce deferred tax assets to the amounts expected to be realized.
(h) Comprehensive Income -- The Company recognizes its proportionate share of other comprehensive income as reported by its partially owned equity affiliates. As of December 31, 2001, the Company has recognized other comprehensive income relating to unrealized holding losses on investments arising during the period and a currency translation adjustment of Castlewood Holdings.
THE ENSTAR GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(i) Derivative Instruments -- In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS 133, "Accounting for Derivative Instruments and Hedging Activities." SFAS 133, as amended by SFAS 137 and 138, became effective January 1, 2001. SFAS 133 establishes accounting and reporting standards for derivative instruments including certain derivative instruments embedded in other contracts, and for hedging activities. SFAS 133 requires the Company to recognize all derivatives as either assets or liabilities in the balance sheet measured at fair value. The Company's January 1, 2001 adoption of SFAS 133, as amended, had no impact on the Company's consolidated financial position or results of operations as the Company has no derivative instruments.
(j) Recent Accounting Pronouncements -- In July 2001, the FASB issued SFAS 141, "Business Combinations", which eliminates the pooling-of-interests method of accounting for transactions initiated after June 30, 2001. Additionally, goodwill and intangibles that arise as a result of purchase transactions initiated during the period July 1, 2001 to December 31, 2001 follow the guidance prescribed by SFAS 142, described below.
In July 2001, the FASB also issued SFAS 142, "Goodwill and Other Intangible Assets." This statement is effective for fiscal years beginning after December 15, 2001 and prescribes that goodwill should no longer be amortized upon adoption of the standard. Instead, goodwill will be tested annually for impairment, and on an interim basis if certain impairment indicators are present. It requires the Company to perform a transitional assessment of whether there is an indication that goodwill is impaired as of the date of adoption. Any goodwill impairment loss will be recognized as the cumulative effect of a change in accounting principle no later than the end of the fiscal year of adoption. Additionally, intangible assets with an indefinite, economic useful life may not be amortized. The Company will adopt this statement on January 1, 2002 and is currently evaluating the impact of adoption on its financial statements. In addition, BH Acquisition, a partially owned equity affiliate, expects to recognize a one time pre-tax gain of $2,969,394 upon adoption of this statement as a result of the reversal of negative goodwill. The Company expects to record its proportionate share of this gain upon adoption of this statement. The Company had approximately $552,000 of unamortized goodwill included in partially owned equity affiliates at December 31, 2001 and had recorded amortization expense of approximately $80,000 in 2001 as part of general and administrative expense.
(k) Reclassifications -- Certain prior year amounts have been reclassified in the financial statements to conform with the current year presentation.
NOTE 3: PARTIALLY OWNED EQUITY AFFILIATES
(a) B-Line -- In November 1998, the Company purchased membership units of B-Line for $965,000 including expenses. Based in Seattle, Washington, B-Line provides services to credit card issuers and other holders of similar receivables. B-Line also purchases credit card receivables and recovers payments on these accounts.
At the time of the purchase, the Company's membership units represented approximately 8.77% of the outstanding units of B-Line. The Company also purchased a one-year warrant to acquire additional B-Line units, with an aggregate exercise price of $950,000. Other investors also purchased membership units and warrants in B-Line. In November 1999, the Company's warrants expired unexercised while certain other warrant holders exercised their warrants. As a result, the Company's ownership percentage decreased to approximately 7.99%. As a result of B-Line repurchasing one of its member's interests, the Company's ownership percentage was approximately 8.34% at December 31, 2001.
The Company's B-Line membership units are accounted for under the equity method. The operations of B-Line are reported by the Company three months in arrears. Approximately $803,000 of the original $950,000 paid was recorded as goodwill and was being amortized over a period of 10 years. Approximately
THE ENSTAR GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
$251,000 of the original $803,000 recorded as goodwill had been amortized at December 31, 2001. Upon the adoption by the Company of SFAS 142 in January 2002, goodwill will no longer be amortized. (Note 2).
(b) B.H. Acquisition -- In July 2000, the Company, through B.H. Acquisition, a newly-formed joint venture with Castlewood and an entity controlled by Trident, acquired as an operating business, two reinsurance companies of Petrofina S.A., a subsidiary of TotalFina Elf S.A. The reinsurance companies, Brittany Insurance Company Ltd. ("Brittany") and Compagnie Europeenne d'Assurances Industrielles S.A. ("CEAI") were purchased by B.H. Acquisition for $28.5 million. Brittany and CEAI are principally engaged in the active management of books of reinsurance business from international markets. In exchange for a capital contribution of approximately $9.6 million, the Company received 50% of the voting stock and a 33% economic interest in B.H. Acquisition. As part of the transaction, Castlewood received 33% of the voting stock and a 45% economic interest in B.H. Acquisition. In October 2000, the Company received $3.9 million representing the Company's proportionate share of a capital distribution from B.H. Acquisition. In March 2001, the Company received approximately $6.3 million from B.H. Acquisition representing the Company's proportionate share of a dividend from B.H. Acquisition. The Company's ownership in B.H. Acquisition is accounted for using the equity method of accounting. The acquisition of the two reinsurance companies has been accounted for by B.H. Acquisition using the purchase method of accounting.
(c) Castlewood Holdings Limited -- In November 2001, the Company, together with Trident and the Castlewood Principals, completed the formation of a new venture, Castlewood Holdings, to acquire and manage insurance and reinsurance companies, including companies in run-off, and provide management, consulting and other services to the insurance and reinsurance industry. The Castlewood Principals contributed at closing all the shares of Castlewood to Castlewood Holdings and received in exchange a 33 1/3% economic interest in the newly incorporated Castlewood Holdings, plus notes and cash totaling $4.275 million. As part of the transaction, the Company and Trident made capital commitments of $39.5 million each, totaling $79 million, in exchange for their 33 1/3% economic interests in Castlewood Holdings. The Company received 50% of the voting stock of Castlewood Holdings and the Castlewood Principals and Trident each received 25% of Castlewood Holdings' voting stock. Castlewood is a private Bermuda-based firm, experienced in managing and acquiring reinsurance operations.
As a result of the contribution of Castlewood's outstanding stock to Castlewood Holdings, the Company's 33% direct economic interest in B.H. Acquisition increased by an additional 15% indirect economic interest through Castlewood Holdings. The Company has retained its 50% voting interest in B.H. Acquisition. The Company's ownership in Castlewood Holdings is accounted for using the equity method of accounting.
Immediately following the closing of the Castlewood Holdings Transaction, the Company and Trident each contributed $12.5 million to Castlewood Holdings. The Company's capital contribution to Castlewood Holdings was derived from cash on hand; the Company expects to use internal funds to satisfy its remaining commitment to Castlewood Holdings.
In conjunction with the closing of the Castlewood Holdings Transaction, the Company also transferred its shares in Revir Limited ("Revir"), a newly formed Bermuda holding company, at cost to Castlewood Holdings. Revir then completed the acquisition of two reinsurance companies, River Thames Insurance Company Limited ("River Thames"), based in London, England, and Overseas Reinsurance Corporation Limited ("Overseas Reinsurance"), based in Bermuda, (collectively, the "River Thames Transaction") from Rivers Group Limited and Sedgwick Group Limited. The acquisition of the two reinsurance companies has been accounted for by Revir using the purchase method of accounting.
THE ENSTAR GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following unaudited pro forma information of the Company for the years ended December 31, 2001 and 2000 gives effect to the Company's 33% economic interest in B.H. Acquisition and its 33 1/3% economic interest in Castlewood Holdings as if the acquisitions had occurred on January 1, 2000:
The unaudited pro forma consolidated information is not necessarily indicative of the results that would have been reported had such acquisitions occurred on such dates, nor is it indicative of the Company's future operations.
(d) Summarized Financial Information -- In accordance with Accounting Principles Board ("APB") Opinion No. 18, "The Equity Method of Accounting for Investments in Common Stock", the Company prepared summarized financial information for B-Line, B.H. Acquisition and Castlewood Holdings as of and for the years ended December 31, 2001 and 2000. Such information is derived from the unaudited financial statements of B-Line and the audited financial statements of B.H. Acquisition and Castlewood Holdings.
This summarized financial information reflects the results of B-Line for all years presented. The results of B.H. Acquisition and Castlewood Holdings are presented from their respective dates of ownership. The purchase of Brittany and CEAI by B.H. Acquisition and the acquisition of River Thames and Overseas Reinsurance by Castlewood Holdings, through Revir, are recorded as purchases in accordance with APB Opinion No. 16, "Business Combinations."
NOTE 4: COMMITMENTS AND CONTINGENCIES
In February 1997, fifteen former shareholders of the Company filed a lawsuit against the Company. The complaint, which dealt with actions occurring prior to the Company's filing for bankruptcy in 1991, alleged that the Company along with its then principal officers and others defrauded the plaintiffs in violation of the Alabama Securities Act and other Alabama statutory provisions. The plaintiffs sought compensatory damages in the amount of their alleged losses of approximately $2.0 million and unspecified punitive damages. The Company filed a motion to dismiss and/or for summary judgment in March 1997. The motion filed by the Company contended that the claims asserted are barred by the applicable statutes of limitations. In November
THE ENSTAR GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
2000, the Circuit Court granted the Company's motion and dismissed the plaintiffs' claims. In December 2000, the plaintiffs appealed the Circuit Court's judgment to the Alabama Supreme Court. In October 2001, the Alabama Supreme Court affirmed the decision of the Circuit Court, dismissing the plaintiffs' claims.
Pursuant to the Castlewood Holdings Transaction, the Company made a capital commitment of $39.5 million in exchange for its 33 1/3% economic interest and 50% voting control in Castlewood Holdings. Following the closing of the Castlewood Holdings Transaction, the Company contributed $12.5 million to Castlewood Holdings from cash on hand. The remaining commitment of the Company is to be paid, in part or in whole, within 21 days of receipt of a resolution of the board of directors of Castlewood Holdings for the purpose of funding future investments and/or providing working capital. The Company expects to use internal funds to satisfy its remaining commitment to Castlewood Holdings. (Note 3).
In June 1999, the Company signed a three year lease on an office building at 401 Madison Avenue, Montgomery, Alabama which serves as the corporate headquarters. Future minimum payments under this lease total $12,500 in 2002. At the expiration of this lease on May 31, 2002, the Company has an option to renew for an additional 24 months at $2,750 per month. Additionally, pursuant to an oral agreement, the Company leases space in a warehouse at 703 Howe Street, Montgomery, Alabama on a month-to-month basis. The Company also leases certain office equipment on a month-to-month basis. Rent expense was approximately $38,000, $38,000 and $36,000 in 2001, 2000 and 1999, respectively.
NOTE 5: INCOME TAXES
The provision for income taxes consists of the following components:
The reconciliation of income taxes computed at statutory rates to the actual tax provision is as follows:
THE ENSTAR GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amount of assets and liabilities for financial reporting purposes and the amounts reported for income tax purposes. The following items comprise the Company's deferred taxes at December 31, 2001 and 2000:
The Company has established a valuation allowance for the uncertainty of the realization of deferred tax assets which is dependent on future taxable income of sufficient amounts to utilize the net operating loss carryforwards ("NOLs"), tax credit carryforwards and other deferred tax assets. In addition, because there are possible applications of certain provisions of the Internal Revenue Code of 1986, as amended that may limit the Company's use of the NOLs in future tax returns, there can be no assurance that the Company will be able to utilize its NOLs fully. During 2001, 2000 and 1999, the Company decreased the valuation allowance by approximately $1.9 million, approximately $4.9 million and $1.3 million, respectively, to approximately $13.6 million, approximately $15.5 million and approximately $20.4 million, respectively.
At December 31, 2001, the Company had federal NOLs of approximately $36.9 million, which, if not utilized, expire in various years from 2004 through 2011.
NOTE 6: SHAREHOLDERS' EQUITY
(a) Note Receivable -- In October 1998, the Company and J. Christopher Flowers ("Flowers") entered into an agreement whereby the Company agreed to sell to Flowers 1,158,860 newly issued shares of the Company's common stock at a price of $12.94375 per share, for a total purchase price of $15.0 million, in exchange for a full recourse promissory note from Flowers (the "Flowers Transaction"). In December 1998, the Company consummated the sale of the shares to Flowers, resulting in Flowers owning approximately 23% of the outstanding common stock of the Company at that time. Since the interest rate on the note was less than the rate an independent lender would have charged Flowers, the note was recorded at a discount so as to yield a then current "market rate" of interest. The discount was being amortized over the term of the note. The note was repaid in full with accrued interest in March 2000. In connection with the repayment, the Company reversed the unamortized discount on the note of approximately $411,000.
(b) Share Purchase Rights Plan -- In January 1997, the Board of Directors of the Company adopted a Share Purchase Rights Plan (the "Rights Plan"). The Rights Plan entitles shareholders to a right to purchase one share of common stock for each outstanding share of common stock of the Company (a "Right").
Until the occurrence of a "Distribution Triggering Event" as described below, all future issuances of common stock by the Company will also carry the Rights. The Rights will have no dividend or voting rights and will expire on the tenth anniversary of their issuance unless exercised or redeemed prior to that time.
THE ENSTAR GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Rights may not be exercised and are not detached from the common stock until ten days after the occurrence of a Distribution Triggering Event. The exercise price of the Rights is fixed at $40. The Rights generally are redeemable by the Board of Directors of the Company at a nominal price of $.01 per Right at any time prior to the time that they are detached from the common stock and separate certificates evidencing the Rights are delivered. As of December 31, 2001, no Rights were exercised.
Distribution Triggering Events. Shortly after a person or group acquires beneficial ownership of a fifteen percent (15%) interest or announces its intention to commence a tender or exchange offer, the consummation of which would result in beneficial ownership of fifteen percent (15%) of the Company's common stock (a "Distribution Triggering Event"), the Rights will separate from the common stock. Upon distribution of the Rights, they become exercisable and are transferable separately from the Company's common stock. Each Right (other than Rights beneficially owned by the acquiror) is then immediately converted into the right to buy that number of shares of common stock of the Company (or in certain circumstances, shares of stock of the acquiring company) that has a market value of two times the exercise price of the Right.
In connection with the Flowers Transaction described above, the Board of Directors approved an amendment to the Rights Plan for the sole purpose of exempting the Flowers Transaction from being a Distribution Triggering Event.
(c) Treasury Stock -- In April 1998, the Company announced a stock repurchase program under which the Company could repurchase up to $5.0 million of its common stock in the open market at prices per share deemed favorable from time to time by the Company. The Company has repurchased 54,525 shares of its common stock for approximately $815,000 as part of this plan. Through this plan and a similar plan completed in the first quarter of 1998, the Company has repurchased a total of 442,351 shares for approximately $5.8 million as of December 31, 2001.
NOTE 7: STOCK COMPENSATION
(a) Deferred Compensation and Stock Plan for Non-Employee Directors -- In September 1997, the Company adopted a Deferred Compensation and Stock Plan for Non-Employee Directors. The purposes of this plan are to enable the Company to attract and retain qualified persons to serve as non-employee directors, to solidify the common interests of its non-employee directors and shareholders by enhancing the equity interest of non-employee directors in the Company, and to encourage the highest level of non-employee director performance by providing such non-employee directors with a proprietary interest in the Company's performance and progress by permitting non-employee directors to receive all or a portion of their retainer and meeting fees in common stock and to defer all or a portion of their retainer and meeting fees in stock units.
All non-employee directors have elected to receive 100% of their compensation in stock units in lieu of cash payments for the retainer and meeting fees. Approximately $464,000 and $352,000 in stock compensation has been deferred under this plan as of December 31, 2001, and 2000, respectively.
(b) Long-Term Incentive Program -- In January 1997, the Company adopted a long-term incentive program made up of three stock option/incentive plans. Under the program, the Company established the 1997 Amended CEO Stock Option Plan (the "CEO Plan"), the 1997 Amended Outside Directors' Stock Option Plan (the "1997 Directors' Plan"), and the 1997 Amended Omnibus Incentive Plan (the "Incentive Plan"). In May 2001, the Company adopted the 2001 Outside Directors' Stock Option Plan (the "2001 Directors' Plan") and amended certain provisions of the Incentive Plan.
Under the CEO Plan, Nimrod T. Frazer, the Company's Chief Executive Officer and Chairman, was granted options for 150,000 shares of common stock with an exercise price of $10.50 in 1997. The options granted under the CEO Plan vested in four equal installments of 37,500 options through January 1, 2000, and expire in January 2007.
THE ENSTAR GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Under the 1997 Directors' Plan, each of the Company's four outside directors was granted options for 25,000 shares of common stock in 1997. The options have an exercise price of $10.8125 and vested in five equal installments of 5,000 options through January 1, 2001. The options granted under the 1997 Directors' Plan expire in January 2007.
The Incentive Plan was established for the benefit of key employees and directors which provides generally for stock appreciation awards, incentive stock options and nonqualified stock options. In March 2000, John J. Oros, the Company's President and Chief Operating Officer, was granted options for 100,000 shares of common stock with an exercise price of $12.75. These options vest in three installments: 50,000 on March 2, 2001 and 25,000 each on March 2, 2002 and 2003. These options expire in February 2010.
In connection with the consummation of the River Thames Transaction in November 2001, Messrs. Frazer and Oros were granted options under the Incentive Plan to purchase a total of 100,000 shares (50,000 per individual) at $18.00 per share. These options vest on various dates through July 2004 and may not be exercised prior to June 2002. The options expire in June 2011. Since the market price per share of the Company's common stock on the date of grant exceeded the exercise price, the Company recognized a charge to earnings in 2001 of approximately $133,000. The Company will recognize additional charges to earnings totaling approximately $357,000 through July 2004 relating to these options.
In connection with the consummation of the Castlewood Holdings Transaction in November 2001, Messrs. Frazer and Oros were granted options under the Incentive Plan to purchase a total of 100,000 shares (50,000 per individual) at $19.25 per share. These options vest on various dates through July 2004 and may not be exercised prior to September 2002. The options expire in September 2011. Since the market price per share of the Company's common stock on the date of grant exceeded the exercise price, the Company recognized a charge to earnings in 2001 of approximately $99,000. The Company will recognize additional charges to earnings totaling approximately $266,000 through July 2004 relating to these options.
Under the 2001 Directors' Plan, the Company's three current outside (non-employee) directors were each granted options in June 2001 for 15,000 shares of common stock with an exercise price of $18.90 per share. Options granted to each of the three outside directors under the plan will vest in three equal installments of 5,000 shares in each of January 2002, January 2003 and January 2004; provided, however, that such shares will vest only so long as the recipient remains a director of the Company. The options granted under this plan must be exercised no later than January 2011, or 60 days after the director ceases to be a director of the Company other than by reason of death, mandatory retirement or disability.
As of December 31, 2001, a total of 595,000 options have been issued or reserved for issuance under the long-term incentive program, none of which have been exercised.
THE ENSTAR GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The fair values for options granted under the Company's stock option plans were calculated using the Black-Scholes option pricing model, as modified. The fair values, along with the assumptions used in their calculation are as follows:
The Company applies APB Opinion No. 25, "Accounting for Stock Issued to Employees", in accounting for its stock option plans. Under the provisions of APB 25, the Company recognizes compensation expense on stock option plans where the fair market values of the common shares exceed the option prices on the dates of grant. Had compensation cost for grants under the Company's stock option plans been determined based on the fair value at the date of grant consistent with the method of SFAS 123, "Accounting for Stock-Based Compensation," the Company's pro forma net income and net income per share for 2001, 2000 and 1999 would have been as follows:
(c) Stock Purchase Agreements -- In June 2001, the Company entered into agreements with Messrs. Frazer and Oros to sell a total of 100,000 shares (50,000 per individual) of the Company's common stock at $18.00 per share, the closing trading price on the date of the agreements, to Messrs. Frazer and Oros, subject to the consummation of the River Thames Transaction on or before December 31, 2001. After the closing of the River Thames Transaction in November 2001, the Company received $900,000 each from Messrs. Frazer and Oros in payment of their shares. Since the market price per share of the Company's common stock on the closing date of the transaction exceeded the selling price, the Company recognized a charge to earnings in 2001 of approximately $490,000 relating to these shares.
In addition, the Company entered into stock purchase agreements with Messrs. Frazer and Oros relating to the Castlewood Holdings Transaction. The agreements proposed to sell a total of 100,000 shares (50,000 per individual) of the Company's common stock at $19.25 per share, the closing trading price on September 28, 2001, to Messrs. Frazer and Oros, subject to the consummation of the Castlewood Holdings Transaction on or before December 31, 2001. After the closing of the Castlewood Holdings Transaction in November 2001, the Company received $962,500 each from Messrs. Frazer and Oros in payment of their shares. Since the market price per share of the Company's common stock on the closing date of the transaction exceeded the selling price, the Company recognized a charge to earnings in 2001 of approximately $365,000 relating to these shares.
NOTE 8: INCOME PER SHARE
The table below illustrates the reconciliation between net income per common share -- basic and net income per common share -- assuming dilution for 2001, 2000 and 1999. Net income per common share -- basic is computed by dividing net income by the weighted average shares outstanding. Net income per
THE ENSTAR GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
common share -- assuming dilution is computed by dividing net income by the sum of the weighted average shares outstanding and common share equivalents. Common share equivalents consist of stock units deferred under the Deferred Compensation and Stock Plan for Non-Employee Directors and stock options granted under the Long-Term Incentive Program (Note 7).
NOTE 9: SEGMENT INFORMATION
The Company evaluates the performance of B-Line, B.H. Acquisition and Castlewood Holdings, the Company's only operating segments, based on 100% of their financial results. The consolidated financial information for B-Line is reported for all years presented. The consolidated financial information for B.H. Acquisition and Castlewood Holdings are reported from July 3, 2000 and November 29, 2001, their respective dates of acquisition by the Company. A reconciliation of B-Line's, B.H. Acquisition's and Castlewood
THE ENSTAR GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Holdings' consolidated financial information to the Company's consolidated financial statements as of and for the years ended December 31, 2001 and 2000 is as follows:
The operations of B-Line are reported by the Company three months in arrears. The Company's ownership percentage in B-Line has varied between 7.99% and 8.77% from September 30, 1999 to September 30, 2001, the periods reported in the above tables. The Company's ownership percentages for
THE ENSTAR GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
B-Line used in the above tables represent weighted averages. The Company's ownership percentages in B-Line were 8.34% and 7.99% at December 31, 2001 and 2000, respectively.
NOTE 10: UNAUDITED QUARTERLY FINANCIAL INFORMATION
A summary of the Company's unaudited quarterly results of operations for the years ended December 31, 2001 and 2000 are as follows:
General and administrative expenses for the fourth quarter of 2001 include non-cash compensation expense of approximately $1.1 million. General and administrative expenses for the first quarter of 2000 include a reversal of a $411,000 discount on the note receivable from the Flowers Transaction offset by a $500,000 expense resulting from a new shares tax imposed by the State of Alabama.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this Item with respect to directors and executive officers of the Registrant, is included under the sections entitled, "Election of Directors", "Executive Officers" and "Other Matters -- Section 16(a) Beneficial Ownership Reporting Compliance" of the Proxy Statement for the 2002 Annual Meeting of Shareholders and such sections are deemed incorporated herein by reference.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item is included under the sections entitled, "Employment Agreements", "Executive Compensation", "Stock Option Grants", "Stock Option Exercises", "Election of Directors -- Compensation of Directors", and "Compensation Committee Interlocks and Insider Participation" of the Proxy Statement for the 2002 Annual Meeting of Shareholders and such sections are deemed incorporated herein by reference.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item is included under the sections entitled, "Common Stock Ownership by Management" and "Principal Shareholders" appearing in the Proxy Statement for the 2002 Annual Meeting of Shareholders and such sections are deemed incorporated herein by reference.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item is included under the sections entitled, "Certain Transactions", "Election of Directors -- Compensation of Directors" and "Executive Compensation" appearing in the Proxy Statement for the 2002 Annual Meeting of Shareholders and such section is deemed incorporated herein by reference.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) 1. Financial Statements
The following financial statements included in Item 8 of this Annual Report are for the fiscal period ended December 31, 2001 and are incorporated herein by reference.
Independent Auditors' Report. Consolidated Balance Sheets as of December 31, 2001 and 2000. Consolidated Statements of Income for the years ended December 31, 2001, 2000 and 1999. Consolidated Statements of Comprehensive Income for the years ended December 31, 2001, 2000 and 1999. Consolidated Statements of Shareholders' Equity for the years ended December 31, 2001, 2000 and 1999. Consolidated Statements of Cash Flows for the years ended December 31, 2001, 2000 and 1999. Notes to Consolidated Financial Statements.
2. Financial Statement Schedules
The following financial statements of Castlewood Holdings included in this Annual Report are for the fiscal period ended December 31, 2001.
The following financial statements of B.H. Acquisition included in this Annual Report are for the fiscal period ended December 31, 2001.
3. Exhibits
(b) Reports on Form 8-K
On December 13, 2001, the Company filed a Current Report on Form 8-K pursuant to Item 2 -- Acquisition or Disposition of Assets.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
THE ENSTAR GROUP, INC.
By: /s/ NIMROD T. FRAZER ------------------------------------ Nimrod T. Frazer Chairman of the Board of Directors, and Chief Executive Officer
April 1, 2002
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
CASTLEWOOD HOLDINGS LIMITED
CONSOLIDATED FINANCIAL STATEMENTS AND INDEPENDENT AUDITORS' REPORT
DECEMBER 31, 2001
INDEPENDENT AUDITORS' REPORT
To the Shareholders of Castlewood Holdings Limited
We have audited the accompanying consolidated balance sheet of Castlewood Holdings Limited and subsidiaries as at December 31, 2001 and the related consolidated statements of loss and deficit, comprehensive loss, shareholders' equity and cash flows for the period from August 16, 2001 (date of incorporation) to December 31, 2001. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Castlewood Holdings Limited and subsidiaries as at December 31, 2001 and the results of their operations and their cash flows for the period from August 16, 2001 (date of incorporation) to December 31, 2001 in conformity with accounting principles generally accepted in the United States of America.
/S/ DELOITTE & TOUCHE
Hamilton, Bermuda March 18, 2002
CASTLEWOOD HOLDINGS LIMITED
CONSOLIDATED BALANCE SHEET AS AT DECEMBER 31, 2001 (EXPRESSED IN THOUSANDS OF U.S. DOLLARS)
See accompanying notes to the consolidated financial statements
Approved by the Board of Directors
CASTLEWOOD HOLDINGS LIMITED
CONSOLIDATED STATEMENT OF LOSS AND DEFICIT FOR THE PERIOD FROM AUGUST 16, 2001 (DATE OF INCORPORATION) TO DECEMBER 31, 2001 (EXPRESSED IN THOUSANDS OF U.S. DOLLARS)
See accompanying notes to the consolidated financial statements
CASTLEWOOD HOLDINGS LIMITED
STATEMENT OF COMPREHENSIVE LOSS FOR THE PERIOD FROM AUGUST 16, 2001 (DATE OF INCORPORATION) TO DECEMBER 31, 2001 (EXPRESSED IN THOUSANDS OF U.S. DOLLARS)
See accompanying notes to the consolidated financial statements
CASTLEWOOD HOLDINGS LIMITED
STATEMENT OF SHAREHOLDERS' EQUITY FOR THE PERIOD FROM AUGUST 16, 2001 (DATE OF INCORPORATION) TO DECEMBER 31, 2001 (EXPRESSED IN THOUSANDS OF U.S. DOLLARS)
See accompanying notes to the consolidated financial statements
CASTLEWOOD HOLDINGS LIMITED
CONSOLIDATED STATEMENT OF CASH FLOWS FOR THE PERIOD FROM AUGUST 16, 2001 (DATE OF INCORPORATION) TO DECEMBER 31, 2001 (EXPRESSED IN THOUSANDS OF U.S. DOLLARS)
See accompanying notes to the consolidated financial statements
CASTLEWOOD HOLDINGS LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2001 (Expressed in thousands of U.S. dollars)
1. DESCRIPTION OF BUSINESS
Castlewood Holdings Limited ("Castlewood Holdings") was incorporated under the laws of Bermuda on August 16, 2001, and on November 29, 2001, acquired 100% of the common shares of Castlewood Limited ("Castlewood"), for consideration of $46,637 in shares, cash and notes payable. Castlewood Holdings did not operate prior to November 29, 2001.
Castlewood Holdings and its subsidiaries (the "Company") acquire and manage insurance and reinsurance companies in run-off, and provide management, consultancy and other services to the insurance and reinsurance industry.
The acquisition of Castlewood by Castlewood Holdings has been accounted for using the purchase method of accounting, which requires that the acquirer record the assets and liabilities acquired at their estimated fair value.
The purchase price and fair value of assets acquired are as follows:
Immediately after the acquisition of Castlewood, a wholly owned subsidiary of Castlewood Holdings, Revir Limited ("Revir") completed the acquisition of two reinsurance companies, River Thames Insurance Company Limited, ("River Thames") based in London, England, and Overseas Reinsurance Corporation Limited, ("Overseas Re") based in Bermuda and an underwriting agency, Regis Agencies Limited ("Regis"), from Sedgwick Group Limited.
The acquisitions have been accounted for using the purchase method of accounting, which requires that the acquirer record the assets and liabilities acquired at their estimated fair value.
CASTLEWOOD HOLDINGS LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The purchase price and fair value of assets acquired are as follows:
2. SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PREPARATION
The consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and 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.
BASIS OF CONSOLIDATION
The consolidated financial statements include the assets, liabilities and results of operations of Castlewood Holdings from its incorporation date of August 16, 2001 to December 31, 2001, and for its wholly owned subsidiaries from November 29, 2001 to December 31, 2001. From its incorporation date of August 16, 2001 to November 29, 2001, the Company did not engage in any significant activities. Intercompany transactions are eliminated on consolidation.
CASH AND CASH EQUIVALENTS
For purposes of the consolidated statement of cash flows, the Company considers all highly liquid debt instruments purchased with an initial maturity of three months or less to be cash and cash equivalents.
INVESTMENTS
Debt and equity securities are classified as available-for-sale securities and are carried at fair value, with unrealized holding gains and losses excluded from net income and reported as a separate component of accumulated other comprehensive income.
Realized gains and losses on sales of securities classified as available-for-sale are recognized in net investment income on the specific identification basis.
INVESTMENT IN PARTLY-OWNED COMPANY
Investment in partly-owned company is carried on the equity basis whereby the investment is initially recorded at cost and adjusted to reflect the Company's share of after-tax earnings or losses and reduced by dividends received.
CASTLEWOOD HOLDINGS LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
PREMIUMS
Premiums are recognized as revenue on a pro-rata basis over the periods of the respective policies and contracts of reinsurance. Premiums which are subject to adjustments are estimated based upon available information. Any variances from the estimates are recorded in the periods in which they become known.
LOSSES AND LOSS ADJUSTMENT EXPENSES
The liability for losses and loss adjustment expenses includes an amount determined from loss reports and individual cases and an amount, based on historical loss experience and industry statistics, for losses incurred but not reported. These estimates are continually reviewed and are necessarily subject to the impact of future changes in such factors as claim severity and frequency. While the directors and management believe that the amount is adequate, the ultimate liability may be significantly in excess of, or less than, the amounts provided. Any adjustments will be reflected in the periods in which they become known.
REINSURANCE
Reinsurance premiums ceded are accounted for on a pro-rata basis over the terms of the respective reinsurance contracts. Commissions on reinsurance ceded are deferred and amortized over the terms of the contracts of reinsurance to which they relate.
CONSULTING FEES
Fixed fees are recognized on a straight-line basis over the term of the agreement. Fees based on hourly charge rates are recognized as incurred. Performance fees are recognized upon completion of all the requirements as specified in the agreement.
TRANSLATION OF FOREIGN CURRENCIES
At each balance sheet date, recorded balances that are denominated in a currency other than the functional currency of the Company are adjusted to reflect the current exchange rate. Revenue and expense items are translated into U.S. dollars at average rates of exchange for the years. The resulting exchange gains or losses are included in net income.
Assets and liabilities of subsidiaries are translated into U.S. dollars at the year-end rates of exchange. Revenues and expenses of subsidiaries are translated into U.S. dollars at the average rates of exchange for the years. The resultant translation adjustment is classified as a separate component of other comprehensive income.
FAIR VALUE OF FINANCIAL INSTRUMENTS
Estimated fair value of financial instruments held by the Company approximates carrying value except for the note payable to shareholders. As the Company does not have financial instruments with third parties with similar qualities with regards to repayment term and security it is not practicable to determine the fair value of the note payable to shareholders. The estimated value of the investments is based on quoted market value.
GOODWILL
Starting January 1, 2002, the Company will complete a goodwill impairment test on an annual basis or more frequently if certain indicators are encountered.
For the purpose of testing goodwill for impairment, acquired assets and assumed liabilities shall be assigned to a reporting unit as of the acquisition date if the asset will be employed in or the liability relates to
CASTLEWOOD HOLDINGS LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
the operations of a reporting unit and the asset or liability will be considered in determining the fair value of the reporting unit. The excess goodwill over the fair value of these assets will be recorded in net income.
3. PLEDGED ASSETS
Cash and cash equivalents in the amount of $ 5,189 as of December 31, 2001 are pledged as collateral against letters of credit in the same amounts.
4. INVESTMENTS
The amortized cost and estimated fair value of investments in debt securities available-for-sale are as follows:
Mutual funds invest in high credit quality securities (minimum "A") including fixed income and money market securities denominated in US dollars, with an average duration of nine months target.
The amortized cost and estimated fair values of debt securities classified as available-for-sale by contractual maturity are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Major categories of net investment income are summarized as follows:
5. INVESTMENT IN PARTLY-OWNED COMPANY
Castlewood Holdings holds 45% of the common shares of BH Acquisition Ltd. ("BH"). The common shares held by Castlewood Holdings have 33% of BH's voting rights. BH wholly owns two insurance
CASTLEWOOD HOLDINGS LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
companies in run-off, Brittany Insurance Company Ltd., incorporated in Bermuda, and Compagnie Europeenne d'Assurances Industrielles S.A. incorporated in Belgium.
As of December 31, 2001, consolidated retained earnings includes $389 undistributed earnings of companies accounted for by the equity method.
6. REINSURANCE BALANCES RECEIVABLE
The Company uses retrocessional agreements to reduce its exposure to the risk of reinsurance assumed. The Company remains liable to the extent the retrocessionaires do not meet their obligations under these agreements, and therefore the Company evaluates and monitors concentration of credit risk. Provisions are made for amounts considered potentially uncollectable. The allowance for uncollectable reinsurance recoverable was $13,059 at December 31, 2001.
At December 31, 2001, reinsurance receivables with a carrying value of $53,377 were associated with three single reinsurers, each of whom represented 10% or more of total reinsurance recoverables. In the event that all or any of the reinsuring companies are unable to meet their obligations under existing reinsurance agreements, the Company will be liable for such defaulted amounts.
7. LIABILITY FOR LOSSES AND LOSS ADJUSTMENT EXPENSES
Activity in the liability for unpaid losses and loss adjustment expenses is summarized as follows:
CASTLEWOOD HOLDINGS LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The Company's reserve for unpaid losses and loss adjustment expenses as of December 31, 2001 included $66,067 that represents an estimate of its net ultimate liability for asbestos and environmental claims. The gross liability for such claims as at December 31, 2001 was $194,069.
In establishing the liability for unpaid claims and claim adjustment expenses related to asbestos and environmental claims, management considers facts currently known and the current state of the law and coverage litigation. Liabilities are recognized for known claims (including the cost of related litigation) when sufficient information has been developed to indicate the involvement of a specific insurance policy, and management can reasonably estimate its liability. In addition, liabilities have been established to cover additional exposures on both known and unasserted claims. Estimates of the liabilities are reviewed and updated continually. Developed case law and adequate claim history do not exist for such claims, especially because significant uncertainty exists about the outcome of coverage litigation and whether past claim experience will be representative of future claim experience.
8. NOTES PAYABLE TO SHAREHOLDERS
Notes payable, bearing interest of 5% per annum, were issued as part of the purchase consideration for Castlewood Limited (see Note 1), and are repayable after May 1, 2002.
9. DUE TO SHAREHOLDERS
Due to shareholders represents pre-acquisition costs and structuring fees in relation to the acquisition of Castlewood. Structuring fees are due for payment on May 1, 2002.
10. SHARE CAPITAL
Authorized, issued, fully paid shares of par value $1 each
Class E non-voting redeemable shares are held by Class C shareholders and will be redeemed based upon distributions to Class A and Class B shareholders.
11. CONTRIBUTED SURPLUS
During the period, shareholders of the Company have made contributions to surplus in the amount of $24,988.
As part of the acquisition of Castlewood (see Note 1), certain of the shareholders of the Company made commitments to contribute capital of $79,000 upon request of the Board of Directors of the Company. As of December 31, 2001, the remaining capital commitments of these shareholders amount to $54,012.
CASTLEWOOD HOLDINGS LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
12. RELATED PARTY TRANSACTIONS
During the period ended December 31, 2001, Castlewood earned consulting fees of $104 from subsidiaries of its partly-owned company.
13. TAXATION
Under current Bermuda law, the Company and its Bermuda subsidiaries are not required to pay taxes in Bermuda on either income or capital gains. The Company and its Bermuda subsidiaries have received an undertaking from the Bermuda government that, in the event of income or capital gains taxes being imposed, the Company and its Bermuda subsidiaries will be exempted from such taxes until the year 2016.
United Kingdom subsidiaries have recorded income taxes based upon their graduated statutory rate of 30%. Deferred income taxes arise from the recognition of temporary differences between income determined for financial reporting purposes and income tax purposes. Such differences result from differing bases of depreciation and amortization for tax and book purposes.
River Thames' effective tax rate is approximately 30%. River Thames has tax loss carry-forwards of approximately $43,750, which do not expire. A valuation allowance has been provided for the tax benefit of these loss carry-forwards as follows:
14. STATUTORY REQUIREMENTS
The reinsurance subsidiaries are required to file annual statements with insurance regulatory authorities prepared on an accounting basis prescribed or permitted by such authorities ("statutory basis"), maintain minimum levels of solvency and liquidity, and comply with risk-based capital requirements and licensing rules. As at December 31, 2001, the reinsurance subsidiaries', solvency, liquidity, surplus and risk based capital amounts were in excess of the minimum levels required.
B.H. ACQUISITION LTD.
CONSOLIDATED FINANCIAL STATEMENTS AND INDEPENDENT AUDITORS' REPORT
DECEMBER 31, 2001 AND 2000
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of B.H. Acquisition Ltd.
We have audited the accompanying consolidated balance sheets of B.H. Acquisition Ltd. as of December 31, 2001 and 2000, and the related consolidated statements of income and retained earnings and cash flows for the year ended December 31, 2001 and for the period from April 3, 2000 (date of incorporation) to December 31, 2000. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of B.H. Acquisition Ltd. as of December 31, 2001 and 2000, and the results of its operations and its cash flows for the year ended December 31, 2001 and for the period from April 3, 2000 (date of incorporation) to December 31, 2000, in conformity with accounting principles generally accepted in the United States of America.
/S/ DELOITTE & TOUCHE
Hamilton, Bermuda March 8, 2002
B.H. ACQUISITION LTD.
CONSOLIDATED BALANCE SHEETS AS OF DECEMBER 31, 2001 AND 2000 (EXPRESSED IN U.S. DOLLARS)
See accompanying notes to the consolidated financial statements.
B.H. ACQUISITION LTD.
CONSOLIDATED STATEMENTS OF INCOME AND RETAINED EARNINGS FOR THE YEAR ENDED DECEMBER 31, 2001 AND THE PERIOD FROM APRIL 3, 2000 (DATE OF INCORPORATION) TO DECEMBER 31, 2000 (EXPRESSED IN U.S. DOLLARS)
See accompanying notes to the consolidated financial statements.
B.H. ACQUISITION LTD.
CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEAR ENDED DECEMBER 31, 2001 AND THE PERIOD FROM APRIL 3, 2000 (DATE OF INCORPORATION) TO DECEMBER 31, 2000 (EXPRESSED IN U.S. DOLLARS)
See accompanying notes to the consolidated financial statements.
B.H. ACQUISITION LTD.
NOTES TO THE FINANCIAL STATEMENTS DECEMBER 31, 2001 AND 2000 (EXPRESSED IN U.S. DOLLARS)
1. NATURE OF OPERATIONS
B.H. Acquisition Ltd. ("B.H.") was incorporated under the laws of Bermuda on April 3, 2000, and on July 3, 2000, acquired 100% of the common shares of Brittany Insurance Company Ltd. ("Brittany") and Compagnie Europeenne d'Assurances Industrielles S.A. ("CEAI") (collectively "the Company") for cash consideration of $20,500,000 and $8,000,000, respectively. B.H. did not operate prior to July 3, 2000.
Brittany is incorporated under the laws of Bermuda and is in run-off. Prior to run-off, its principal activity was to reinsure property, casualty and excess liability risks, such as environmental and health exposures, of its former affiliates and third parties. Brittany novated its entire book of related party business prior to the acquisition.
CEAI is incorporated under the laws of Belgium and is in run-off. Its principal activity is the run-off of its insurance and reinsurance risks throughout the world.
Both acquisitions have been accounted for using the purchase method of accounting, which requires that the acquirer record the assets and liabilities acquired at their estimated fair value at the date of acquisition.
Negative goodwill on the purchase of Brittany and CEAI is calculated as follows:
2. SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PREPARATION
The consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and 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.
BASIS OF CONSOLIDATION
The accompanying consolidated balance sheets include the accounts and operations of B.H. and its wholly owned subsidiaries, Brittany and CEAI. All significant intercompany accounts and transactions have been eliminated upon consolidation
CASH AND CASH EQUIVALENTS
For purposes of the statements of cash flows, the Company considers all money market funds and highly liquid debt instruments purchased with a maturity of three months or less to be cash equivalents.
B.H. ACQUISITION LTD.
NOTES TO THE FINANCIAL STATEMENTS -- (CONTINUED)
INVESTMENTS
Debt and equity securities are classified as trading securities and are carried at fair value, with unrealized holding gains and losses included in net income. Realized gains and losses on sales of securities are recognized in net income on the specific identification basis.
NEGATIVE GOODWILL
Negative goodwill represents the excess of the fair value of the net assets acquired over the purchase price of Brittany and CEAI. The Company amortizes goodwill over five years on the straight-line basis. Accumulated amortization as of December 31, 2001 and 2000 was $1,272,600 and $424,200, respectively.
RUN-OFF PROVISION
Run-off provision is amortized over the five-year period estimated to complete the run-off.
PREMIUMS
Premiums are recognized as revenue on a pro-rata basis over the periods of the respective policies and contracts of reinsurance.
Premiums which are subject to adjustments are estimated based upon available information. Any variances from the estimates are recorded in the periods in which they become known.
LOSSES AND LOSS ADJUSTMENT EXPENSES
The liability for losses and loss adjustment expenses includes an amount determined from loss reports and individual cases and an amount, based on historical loss experience and industry statistics, for losses incurred but not reported. These estimates are continually reviewed and are necessarily subject to the impact of future changes in such factors as claim severity and frequency. While the directors and management believe that the amount is adequate, the ultimate liability may be significantly in excess of, or less than, the amounts provided and any adjustments will be reflected in the periods in which they become known.
TRANSLATION OF FOREIGN CURRENCIES
At each balance sheet date, recorded balances that are denominated in a currency other than the functional currency of the company are adjusted to reflect the current exchange rate. Revenue and expense items are translated into U.S. dollars at average rates of exchange for the years. The resulting exchange gains or losses are included in net income.
FAIR VALUE OF FINANCIAL INSTRUMENTS
Estimated fair value of financial instruments held by the Company approximates carrying value. The estimated fair value of investments is based on quoted market value.
ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instrument and Hedging Activities" (SFAS 133). SFAS 133, which became effective in the first quarter of 2001, establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. The adoption of SFAS 133 did not have a material impact on the Company's financial position or results from operations.
B.H. ACQUISITION LTD.
NOTES TO THE FINANCIAL STATEMENTS -- (CONTINUED)
On July 20, 2001, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standard No. 141 "Business Combinations" (SFAS 141) and Statement of Financial Accounting Standards No. 142 "Goodwill and Other Intangible Assets" (SFAS 142). The statements will change the accounting for business combinations and goodwill in two significant ways.
SFAS 141 requires that the purchase method of accounting be used for all business combination initiated after June 30, 2001. Use of the pooling-of-interests method will be prohibited.
SFAS 142 changes the accounting for goodwill from an amortization method to an impairment-only approach. For the purpose of testing goodwill for impairment, acquired assets and assumed liabilities shall be assigned to a reporting unit as of the acquisition date if the asset will be employed in, or the liability relates to the operations of a reporting unit and the asset or liability will be considered in determining the fair value of the reporting unit. The excess goodwill over the fair value of these assets will be recorded in net income. In the case of negative goodwill, negative goodwill shall be recorded in net income and recognized as the effect of a change in accounting principle upon adoption of that statement, which for the Company will be January 1, 2002.
The adoption of SFAS 142 will result in the recognition of a gain of $2,969,394 on January 1, 2002.
3. PLEDGED ASSETS
Cash equivalents and investments in the amount of $13,854,925 and $16,142,265 as of December 31, 2001 and 2000, respectively, are pledged as collateral against letters of credit in the amount of $12,389,762 and $14,074,233 as of December 31, 2001 and 2000, respectively.
4. INVESTMENTS
Estimated fair values of trading investments are as follows:
The mutual funds invest in high credit quality sectors (minimum "A") including US Treasury, US Government Agency, corporate and asset backed and money market instruments denominated in US dollars.
Major categories of net investment income are summarized as follows:
B.H. ACQUISITION LTD.
NOTES TO THE FINANCIAL STATEMENTS -- (CONTINUED)
5. LOSSES AND LOSS ADJUSTMENT EXPENSES RECOVERABLE FROM REINSURERS
The fair value adjustment, determined based upon the estimated timing of loss and loss adjustment expense recoveries and an assumed interest rate of 3.5%, is amortized over the estimated recovery period using the constant yield method.
The Company used retrocessional agreements to reduce its exposure to the risk of reinsurance assumed. The Company remains liable to the extent the retrocessionaires do not meet their obligations under these agreements, and therefore the Company evaluates and monitors concentration of credit risk. Provisions are made for amounts considered potentially uncollectable. The allowance for uncollectable reinsurance recoverable was $4,594,491 and $8,130,292 at December 31, 2001 and 2000 respectively.
At December 31, 2001 and 2000, reinsurance receivables with a carrying value of $12,994,000 and $16,897,034 respectively, were associated with two reinsurers, each of whom represented 10% or more of total reinsurance recoverables. In the event that all or any of the reinsuring companies are unable to meet their obligations under existing reinsurance agreements, the Company will be liable for such defaulted amounts.
6. LIABILITY FOR LOSSES AND LOSS ADJUSTMENT EXPENSES
Activity in the liability for losses and loss adjustment expenses is summarized as follows:
The fair value adjustment, determined based on the estimated timing of loss and loss adjustment expense payments and an assumed interest rate of 3.5%, is amortized over the estimated payout period using the constant yield method.
B.H. ACQUISITION LTD.
NOTES TO THE FINANCIAL STATEMENTS -- (CONTINUED)
Run-off costs provision represents the Company's estimate of the future administrative costs of managing the run-off of Brittany and CEAI.
The Company's reserve for unpaid losses and loss expenses as of December 31, 2001 and 2000 included $13,091,270 and $11,829,277, respectively, that represents an estimate of its net ultimate liability for asbestos and environmental claims. The gross liability for such claims as at December 31, 2001 and 2000 was $22,864,268 and $22,832,763, respectively.
In establishing the liability for unpaid claims and claim adjustment expenses related to asbestos and environmental claims, management considers facts currently known and the current state of the law and coverage litigation. Liabilities are recognized for known claims (including the cost of related litigation) when sufficient information has been developed to indicate the involvement of a specific insurance policy, and management can reasonably estimate its liability. In addition, liabilities have been established to cover additional exposures on both known and unasserted claims. Estimates of the liabilities are reviewed and updated continually. Developed case law and adequate claim history do not exist for such claims, especially because significant uncertainty exists about the outcome of coverage litigation and whether past claim experience will be representative of future claim experience.
7. DUE TO SHAREHOLDERS
Due to shareholders at December 31, 2000 represented direct costs of the acquisitions paid by the shareholders on behalf of B.H., and was repaid during 2001. The balance was unsecured and interest free.
8. RELATED PARTY TRANSACTIONS
The Company was charged administration fees and expenses for the years ended December 31, 2001 and, 2000 amounting to $1,250,000 and $800,000, respectively, by one of the shareholders.
9. CONTRIBUTED SURPLUS
On July 3, 2000, B.H.'s shareholders injected contributed surplus in the amount of $29,141,900 into the Company. On October 6, 2000, the Company returned contributed surplus in the amount of $11,900,000 to its shareholders.
10. CONTINGENCIES
On or about July 8, 1997, Brittany was informed by correspondence that an underwriting agency company who provided underwriting agency and run off services has claimed that they are owed run-off remuneration totaling $2,321,000 for the period January 1, 1984 to December 31, 1996. The parent of the underwriting agency is currently in liquidation. Brittany continues to deny any liability under this claim, and will vigorously defend this position.
11. TAXATION
Under current Bermuda law, B.H. and Brittany are not required to pay taxes in Bermuda on either income or capital gains. B.H. and Brittany have received an undertaking from the Bermuda government that, in the event of income or capital gains taxes being imposed, they will be exempted from such taxes until the year 2016.
B.H. ACQUISITION LTD.
NOTES TO THE FINANCIAL STATEMENTS -- (CONTINUED)
CEAI's effective tax rate is approximately 40%. CEAI has tax loss carry-forwards at December 31, 2001 and 2000 of approximately $30,800,000 and $33,400,000, respectively, which do not expire. A valuation allowance has been provided for the tax benefit of these loss carry-forwards as follows:
12. STATUTORY REQUIREMENT
B.H.'s ability to pay dividends and its operating expenses is dependent on cash dividends from its reinsurance subsidiaries Brittany and CEAI.
The reinsurance subsidiaries are required to file annual statements with insurance regulatory authorities prepared on an accounting basis prescribed or permitted by such authorities ("statutory basis"), maintain minimum levels of solvency and liquidity, and comply with risk-based capital requirements and licensing rules. As of December 31, 2001 and 2000, the reinsurance subsidiaries solvency, liquidity, surplus and risk based capital amounts were in excess of the minimum levels required.
13. COMPARATIVE FIGURES
Certain of the 2000 figures have been reclassified to conform to the presentation adopted in 2001.