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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
(Mark One)
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 1999
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE TRANSITION PERIOD FROM N/A TO N/A
--- ---
Commission file number 2-93426-D
UNISTAR FINANCIAL SERVICE CORP.
(Exact name of small business issuer as specified in its charter)
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Delaware 87-0419568
- -------------------------------------------------------------- -----------------------------------
(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.)
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4635 McEwen Road, Dallas, Texas 75244
- --------------------------------------- --------------------------
(Address of principal executive offices) (Zip Code)
(972) 720-7110
--------------------------
(Issuer's telephone number)
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days: Yes [X] No[ ]
State the number of shares outstanding of each of the issuer's classes of
common equity, as of the latest practicable date: Common Stock, par value $.01
per share - 24,370,422 shares outstanding as of April 30, 1999.
Transitional Small Business Disclosure Format: Yes [ ] No [X]
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UNISTAR FINANCIAL SERVICE CORP.
TABLE OF CONTENTS
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Page
Item Number
- ---- ------
PART I - FINANCIAL INFORMATION
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1. Financial Statements .......................................... 1
2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.......................................... 1
PART II - OTHER INFORMATION
1. Legal Proceedings ............................................. 4
2. Changes in Securities and Use of Proceeds ..................... 5
3. Defaults Upon Senior Securities ............................... 5
4. Submission of Matters to a Vote of Security Holders ........... 5
5. Other Information ............................................. 5
6. Exhibits and Reports on Form 8-K .............................. 5
Appendix A - Unaudited consolidated financial statements of Unistar
Financial Service Corp. as of and for the Quarter Ended
March 31, 1999................................................. F-1
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PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
The financial statements of the Company are annexed to this report as
Appendix A, beginning on page F-1.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
OVERVIEW
Unistar Financial Service Corp. (the "Company"), through its subsidiaries,
is primarily engaged in the distribution, premium financing, reinsurance,
claims processing and other ancillary areas of the personal lines auto
insurance business. As of May 10, 1999, the Company has over 140 company-owned
("captive") retail auto insurance agencies and over 400 appointed independent
auto insurance agencies that generate income from policy fees, commissions,
premium financing and the marketing of ancillary services. The Company's
premium finance subsidiary, Eagle Premium Finance Company, generates revenue
from premium financing provided to the Company's customers. The Company's
several managing general agencies generate revenue through commissions, policy
fee income and other administrative fees from the marketing and administration
of the Company's insurance products through the Company's auto insurance agency
distribution network. Unistar Insurance Company, the Company's insurance
subsidiary, generates revenues from reinsurance retrocessions and the
collection and investment of premiums.
The Company completed several significant acquisitions late in 1998. These
transactions represented significant steps in transforming the Company from a
dormant public shell into a vertically integrated insurance and financial
service holding company, specializing in wholesale and retail auto insurance,
premium financing, and insurance claims management.
FIRST QUARTER ACQUISITION ACTIVITY
During the first quarter of 1999, the Company continued its strategy of
expanding its insurance product distribution system by acquiring certain assets
from the following companies:
* AMSCOT Auto Insurance Agency, with 19 locations throughout Florida, on
January 15, 1999;
* First Grampian Premium Finance Company, based in Tampa, Florida, on
February 15, 1999;
* 7/24 Insurance Services, Inc., based in San Diego, California, and Allied
Auto Insurance and Accurate Insurance Services d/b/a Mr. Auto Insurance,
based in Florida, on March 31, 1999.
The above acquisitions, due to their size and timing, did not have a
material effect on the Company's results of operations or financial condition
for the first quarter of 1999. The Company expects to continue such acquisition
activity for the remainder of 1999, but there can be no assurance of its
ability to do so.
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RESULTS OF OPERATIONS
THREE MONTHS ENDED MARCH 31, 1999 COMPARED TO YEAR ENDED DECEMBER 31, 1998
The Company did not acquire its present core business operations until
August-September of 1998, therefore a comparison of first quarter 1999 to first
quarter 1998 would not provide meaningful information. The Company believes that
the most appropriate comparison for the first quarter of 1999 is to the year
ended December 31, 1998, which consisted primarily of the results of the
Company's operations during the fourth quarter of 1998. The following discussion
should be read in conjunction with the consolidated financial statements and
related notes included in this report and in the Company's Annual Report on Form
10-KSB.
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THREE MONTHS ENDED YEAR ENDED
MARCH 31, 1999 DECEMBER 31, 1998
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(UNAUDITED)
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Revenue:
GROSS WRITTEN PREMIUMS ................ $44,209,000 $35,926,000
=========== ===========
Net commissions and fees earned ....... 14,590,000 11,417,000
Finance revenue ....................... 4,469,000 3,390,000
Other income, net ..................... 501,000 201,000
----------- -----------
Total revenues and other income ....... 19,560,000 15,008,000
Expenses:
Commissions and loss adjustment
expenses .......................... 8,946,000 6,526,000
Other operating expenses .............. 6,560,000 4,989,000
----------- -----------
Total operating expenses .............. 15,506,000 11,515,000
----------- -----------
EBITDA ................................. 4,054,000 3,493,000
Amortization of customer lists ........ 551,000 538,000
Depreciation expense .................. 107,000 78,000
Interest expense ...................... 1,129,000 852,000
----------- -----------
Total non-operating expenses .......... 1,787,000 1,468,000
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Income before income taxes ............ 2,267,000 2,025,000
Income tax expense .................... 896,000 978,000
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NET INCOME ............................. $ 1,371,000 $ 1,047,000
=========== ===========
EARNINGS PER SHARE ..................... $ 0.06 $ 0.05
=========== ===========
Weighted average shares outstanding .... 24,110,729 21,014,262
=========== ===========
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NOTE: THE RESULTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1998 WERE
DERIVED PRIMARILY FROM FOURTH QUARTER OPERATIONS, THEREFORE THE FOLLOWING
COMPARISONS AND PERCENTAGES OF INCREASE OR DECREASE ARE ESSENTIALLY BETWEEN THE
FIRST QUARTER OF 1999 AND THE FOURTH QUARTER OF 1998.
Gross written premiums. The Company's top-line revenue is measured by gross
written premiums ("GWP"). GWP of $44.2 million for first quarter of 1999
represented a 23.1% increase over 1998. This increase was mainly due to the
increase in the number of captive agencies acquired at the end of 1998 and
during the first quarter of 1999. Additionally, the Company's marketing efforts
in the development of name recognition in the nonstandard auto insurance
industry continued to contribute organic growth in GWP.
Net commissions and fees earned. The Company earned net commissions and
fees of $14.6 million during the first quarter of 1999, a 27.8% increase over
1998. The Company earns fees and commissions by placing insurance business with
third-party insurers. The increase in net commissions and fees earned was also
due to the additional captive agencies and marketing efforts of the Company.
2
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Finance revenue. Finance revenue of $4.5 million during the first quarter
of 1999 exceeded 1998 by 31.8%, due to the additional insurance volume
increasing the number of premium contracts financed by Eagle Premium Finance
Company. The acquisition of First Grampian Premium Finance Company also
contributed to the increase in finance revenue. (See "First Quarter Acquisition
Activity" above.)
Commissions and loss adjustment expenses. Commissions and loss adjustment
expenses of $8.9 million for the first quarter of 1999 represented a 37.1%
increase over 1998. Commissions and loss adjustment expenses, the Company's
most significant expense, represent actual payments made and changes in
estimated future payments to be made to or on behalf of its policyholders,
including expenses required to settle claims and losses. The increase
corresponded with the additional premiums written by the Company during the
first quarter.
Other operating expenses. Other operating expenses of $6.6 million were
31.5% higher than 1998, due to the higher volume of insurance business. Also,
the Company expects this amount to remain higher than normal as costs are added
to support the organic and acquisition-driven growth of the Company's
operations.
Interest expense. The 32.5% increase in interest expense, $1.1 million for
the first quarter of 1999 versus $.9 million in 1998, was the result of a
higher balance of the credit facility that funds the Company's premium finance
operations, due to the greater number of premium finance contracts.
LIQUIDITY AND CAPITAL RESOURCES
The Company's existing capital resources consist of cash, equity securities
available for sale and funds available under credit facilities for premium
financing. The Company's cash and equity securities available for sale
increased to $18.2 million at March 31, 1999 from $6.2 million at December 31,
1998.
In March, 1999, the Company entered into a credit facility with Eurostar
Interests, Ltd. that provided a term loan of $10 million due in March, 2003
(the "Term Loan"). The proceeds of the Term Loan will be used to fund
acquisitions and otherwise expand operations. The Term Loan bears interest at
10% per annum and is unsecured.
Typically the Company maintains cash levels between $4 million and
$6 million for general corporate needs, with any excess used to reduce
borrowings under the Company's premium financing facility. In the first quarter
of 1999, the Company's operations used $10.1 million of cash compared to $4.7
million in 1998. The primary use of cash was $12.1 million that was used to
finance premium contract receivables. The Company's financing activities for the
first quarter of 1999 provided $23.3 million of net cash, compared to $6.6
million in 1998. The increase was primarily due to the $10 million proceeds from
the Term Loan in March, 1999. The Company's investing activities used $1.2
million of net cash in the first quarter of 1999, compared to $3.2 million
provided in 1998, which was mostly from acquired businesses.
The Company's cash requirements consist of working capital needs,
obligations under its leases and promissory notes and the funding of potential
acquisitions. Management believes that the Company's cash and funds available
under premium financing facilities are sufficient to meet its anticipated cash
requirements, subject to raising additional capital as necessary for
acquisitions. The Company is seeking to raise additional capital by issuing
straight or convertible equity securities in a private placement. There can be
no assurance that the Company will be able to issue its securities to coincide
with the funding of certain capital requirements.
Finance contracts receivable at March 31, 1999 increased to $52.3 million
from $38.5 million at year-end 1998, after deducting an allowance for credit
losses of approximately $1.0 million on each date. The
3
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increase reflects increased business from existing operations and the addition
of AMSCOT Auto Insurance Agency and First Grampian Premium Finance Company.
Notes payable increased to $58.2 million at March 31, 1999 from $38.6 million
at year-end 1998, primarily due to the Term Loan and increased premium finance
facility.
In February, 1999, the Company converted $4 million of debt into equity.
(See "Item 2. Changes in Securities and Use of Proceeds" below.)
YEAR 2000 MATTERS
In 1998, the Company began converting its computer systems to be year 2000
compliant. The Company has evaluated its internal systems, both hardware and
software, facilities, and interactions with business partners in relation to
year 2000 issues. The Company believes that it has completed its efforts to
bring the systems in compliance. The total cost incurred to modify these
existing systems, which include both internal and external costs of
programming, coding and testing, was not material. The Company continually
evaluates computer hardware and software upgrades and, therefore, many of the
costs to replace existing items with year 2000 compliant upgrades are not
likely to be incremental costs to the Company. During 1999, the Company will
continue to contact its business partners (including agents, banks, motor
vehicle departments and rating agencies) to determine the status of their
compliance and to assess the impact of noncompliance on the Company. The
Company believes that it is taking the necessary measures to mitigate issues
that may arise relating to the year 2000. To the extent that any additional
issues arise, the Company will evaluate the impact on its business, results of
operations and financial condition and, if material, make the necessary
disclosures and take appropriate remedial action.
RISKS ASSOCIATED WITH FORWARD-LOOKING STATEMENT INCLUDED IN THIS FORM 10-QSB
This Form 10-QSB contains certain forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Exchange Act of 1934, which are intended to be covered by the safe
harbors created thereby. These statements include the plans and objectives of
management for future operations, including plans and objectives relating to
future growth of the Company's business activities and availability of funds.
The forward-looking statements included herein are based on current
expectations that involve numerous risks and uncertainties. Assumptions
relating to the foregoing involve judgments with respect to, among other
things, future economic, competitive and market conditions, regulatory
framework, and future business decisions, all of which are difficult or
impossible to predict accurately and many of which are beyond the control of
the Company. Although the Company believes that the assumptions underlying the
forward-looking statements are reasonable, any of the assumptions could be
inaccurate and, therefore, there can be no assurance that the forward-looking
statements included in this Form 10-QSB will prove to be accurate. In light of
the significant uncertainties inherent in the forward-looking statements
included herein, the inclusion of such information should not be regarded as a
representation by the Company or any other person that the objectives and plans
of the Company will be achieved.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
The Company is subject to routine legal proceedings in the ordinary course
of business. The Company believes that the ultimate resolution of these
lawsuits will not have a material adverse effect on its business, financial
condition or results of operations. The Company provides for a liability for
both the amount of estimated damages attributable to these lawsuits and the
estimated costs of litigation.
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ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
During the first quarter of 1999, the Company issued the following shares
of its Common Stock without registration under the Securities Act of 1933:
1. In February, 1999, the Company issued 222,222 shares of Common Stock
to Belmad Enterprises, L.P., a family partnership partially owned by
Mr. Morris Belzberg, a director of the Company, and 55,555 shares to
Mr. Leonard Feldman, another director of the Company, to convert
certain debt owed to such individuals into equity (See "Management's
Discussion and Analysis of Financial Condition and Results of
Operations-Liquidity and Capital Resources.");
2. On March 31, 1999, the Company issued 115,263 shares of Common Stock
in multiple stock-for-asset transactions.
The above issuances were unregistered, as the Company was relying on the
exemption from registration contained in Section 4(2) of the Securities Act on
the basis that such transactions did not involve public offerings.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
ITEM 5. OTHER INFORMATION.
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits
3.1 Articles of Incorporation, as amended.(1)
3.2 Bylaws of the Registrant, as amended.(1)
3.3 Certificate of Amendment to Certificate of Incorporation authorizing
one-for-fifteen reverse stock split, filed with the Secretary of
State of Delaware on August 17, 1998.(2)
10.1* Registrant's 1998 Stock Option Plan.(2)
27.0 Financial Data Schedule.(3)
* Denotes management contract or compensatory plan.
(1) Incorporated by reference to the Registrant's Form 10-KSB for the year
ended December 31, 1997.
(2) Incorporated by reference to the Registrant's Report on Form 8-K filed
September 2, 1998.
(3) Filed herewith.
(b) Reports on Form 8-K
None.
5
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SIGNATURES
In accordance with the requirements of the Exchange Act, the Registrant
caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized.
UNISTAR FINANCIAL SERVICE CORP.
Dated: May 13, 1999 By /s/ MARC A. SPARKS
--------------------------------------
Marc A. Sparks
Chairman and Chief Executive Officer
Dated: May 13, 1999 By /s/ F. JEFFREY NELSON
--------------------------------------
F. Jeffrey Nelson
President and Chief Financial Officer
6
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APPENDIX A
UNAUDITED FINANCIAL STATEMENTS OF
UNISTAR FINANCIAL SERVICE CORP.
AS OF AND FOR THE QUARTER ENDED MARCH 31, 1999
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UNISTAR FINANCIAL SERVICE CORP.
CONSOLIDATED BALANCE SHEETS
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March 31, December 31,
1999 1998
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(Unaudited)
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ASSETS
Equity securities available for sale, at fair value $ 294,557 $ 346,932
Cash 17,877,177 5,865,430
Finance contracts receivable, net of allowance for
credit losses of $1,008,445 and $996,146, respectively 52,313,074 38,453,842
Premiums due from agents and policyholders 1,137,709 1,684,575
Property and equipment, net 4,795,332 3,535,328
Customer lists, net of accumulated amortization 86,682,612 86,175,838
License, Bermuda reinsurance 5,025,064 5,000,000
Investments 8,328,276 6,283,155
Other assets 2,901,523 1,987,992
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TOTAL ASSETS $ 179,355,324 $ 149,333,092
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Reserve for commissions and loss adjustment expenses $ 6,313,605 $ 5,340,000
Unearned commissions and policy fees 3,727,965 6,179,651
Amount due reinsurer 6,987,467 1,923,256
Notes payable 58,168,236 38,571,437
Accounts payable and accrued liabilities 8,786,612 9,425,598
Income tax payable 2,927,092 2,928,944
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TOTAL LIABILITIES 86,910,977 64,368,886
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Commitments and contingencies
STOCKHOLDERS' EQUITY
Preferred stock, $.01 par value, authorized
5,000,000 shares; no shares issued or outstanding -- --
Common stock, $.01 par value, authorized 50,000,000
shares; 24,370,422 and 24,009,372 issued and
outstanding, respectively 244,025 240,094
Additional paid-in capital 91,359,952 85,202,702
Accumulated other comprehensive income (909,816) (857,441)
Retained earnings 1,923,946 552,601
Less treasury stock, at cost (63,333 shares) (173,750) (173,750)
------------- -------------
TOTAL STOCKHOLDERS' EQUITY 92,444,357 84,964,206
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TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 179,355,334 $ 149,333,092
============= =============
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See notes to consolidated financial statements.
F-1
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UNISTAR FINANCIAL SERVICE CORP.
CONSOLIDATED STATEMENT OF INCOME
FOR THE THREE MONTHS ENDED MARCH 31, 1999
(UNAUDITED)
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REVENUE
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GROSS WRITTEN PREMIUMS $44,208,701
-----------
Net commissions and fees earned $14,590,177
Finance revenue 4,469,189
Other income, net 500,428
-----------
Total revenues and other income 19,559,794
-----------
EXPENSES
Commissions and loss adjustment expenses 8,946,231
Other operating expenses 6,560,209
Amortization of customer lists 550,576
Depreciation expense 106,709
Interest expense 1,129,383
-----------
Total expenses 17,293,108
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INCOME BEFORE PROVISION FOR INCOME TAX 2,266,686
PROVISION FOR INCOME TAX 895,341
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NET INCOME $ 1,371,345
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Basic earnings per share $ .06
Diluted earnings per share $ .06
Weighted average number of common shares outstanding:
Basic 24,110,729
Diluted 24,110,729
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See notes to consolidated financial statements.
F-2
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UNISTAR FINANCIAL SERVICE CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDED MARCH 31, 1999
(UNAUDITED)
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Cash flows from operating activities:
Net income $ 1,371,345
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 657,285
Finance contract receivables (12,097,839)
Amount due reinsurers 5,386,134
Reserve for commissions and loss expenses (2,507,448)
Unearned commissions and policy fees (1,770,364)
Other, net (1,110,545)
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Net cash used in operating activities (10,071,432)
------------
Cash flows from investing activities:
Businesses acquired in purchase transactions net of
cash acquired (344,683)
Purchases of property and equipment (929,633)
Other 76,942
------------
Net cash used in investing activities (1,197,374)
------------
Cash flows from financing activities:
Proceeds from notes payable 23,280,553
------------
Net cash provided by financing activities 23,280,553
------------
Net increase in cash 12,011,747
Cash, beginning of period 5,865,430
------------
Cash, end of period $ 17,877,177
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See notes to consolidated financial statements.
F-3
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UNISTAR FINANCIAL SERVICE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Unistar Financial Service Corp. ("Unistar" or "the Company")is a vertically
integrated insurance holding company which, through its subsidiaries controls
substantially all aspects of the auto insurance underwriting, distribution and
claims process. Through its insurance subsidiaries (U.S. Fidelity Insurance
Services), Unistar provides non-standard personal lines automobile insurance.
The Company internally processes claims made by its customers through its
claims adjusting company, Eagle Claims Corp, and offers premium financing to
its own insureds through Eagle Premium Finance Company. The Company also
provides reinsurance brokerage services, renter's insurance, collision repair,
appraisal services and other ancillary services pertinent to its operations
through other wholly-owned subsidiaries. Unistar Insurance Company operates as
a property and casualty insurance company domiciled in the State of Texas and
reinsures non-standard automobile insurance produced and underwritten by
affiliated companies in Texas.
The accompanying consolidated financial statements include the accounts of
Unistar and its wholly owned subsidiaries. All significant intercompany
balances and transactions have been eliminated in consolidation.
On August 17, 1998, the stockholders of the Company approved: (i) a Stock
Purchase Agreement, dated as of July 7, 1998 (the "IFHC Acquisition"), whereby
the Company purchased all of the issued and outstanding shares of common stock
of International Fidelity Holding Corporation, a Texas insurance holding
corporation ("IFHC"), in exchange for 19,777,000 shares of common stock, $.01
par value per share ("Common Stock"), of the Company on a post-Reverse Stock
Split basis, as defined below, (ii) an amendment to the Certificate of
Incorporation authorizing a one-for-fifteen reverse stock split of the
Company's outstanding Common Stock (the "Reverse Stock Split") and (iii) an
amendment to the Certificate of Incorporation to change the name of the Company
to Unistar Financial Service Corp. Following the closing of the IFHC
Acquisition on August 17, 1998, IFHC became a wholly-owned subsidiary of the
Company. The Company, through its sole ownership of IFHC, controls IFHC's
insurance subsidiary, Unistar Insurance Company, a Texas property and casualty
insurance corporation.
On September 30, 1998, the Company completed the acquisition (the "USFH
Acquisition") of the assets and operations of U.S. Fidelity Holding Corp. and
its subsidiaries (collectively, "USFH"). USFH participates in the auto
insurance industry by providing multiple non-standard auto insurance products,
premium financing and claims administration and auto collision appraisal and
repair services. The USFH Acquisition was structured as a stock-for-assets
exchange, valued at approximately $75 million, with the Company issuing
3,975,000 shares of Common Stock in exchange for substantially all of the
assets of USFH.
The IFHC Acquisition was accounted for as a reverse-takeover, meaning that for
accounting purposes IFHC was the acquirer of the Company. Therefore, the
financial results of IFHC for all of 1998 are included in the Company's
consolidated financial statements contained herein. The USFH Acquisition,
however, was accounted for as an asset purchase, therefore only the financial
results of USFH subsequent to September 30, 1998 are included in the Company's
consolidated financial statements contained herein.
Reclassifications - Certain reclassifications have been made to the prior year
financial statements to conform with the current year presentation.
Securities Available for Sale - Equity securities are classified as
"available-for-sale" as defined by SFAS 115. In accordance with that Statement,
they are reported at aggregate fair value with unrealized losses excluded from
earnings and reported as other comprehensive income, net of deferred taxes. The
cost of securities sold was determined by the average cost method.
F-4
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UNISTAR FINANCIAL SERVICE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Property, Plant and Equipment - Property, plant and equipment are stated at
cost. Depreciation of plant and equipment is provided over the estimated useful
lives of the respective assets using the straight-line method, generally from
five to forty years.
Expenditures for additions, major renewals and betterments are capitalized and
expenditures for maintenance and repairs are charged to earnings as incurred.
When property, plant and equipment are retired or otherwise disposed of, the
cost thereof and the applicable accumulated depreciation are removed from the
respective accounts and the resulting gain or loss is reflected in earnings.
Use of Estimates - The preparation of financial statements in conformity with
generally accepted accounting principles ("GAAP") 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.
Risks - The following is a description of the most significant risks facing the
Company and how it mitigates those risks:
Legal/regulatory risks - the Company utilizes third party policy-issuing
insurance companies to write premium which the Company produces. These
companies are subject to legal and regulatory risks. The risk that changes in
the regulatory environment in which insurer operates will create additional
expenses not anticipated by the insurer in pricing its products. That is,
regulatory initiatives designed to reduce insurer profits, restrict
underwriting practices and risk classifications, mandate rate reductions and
refunds, and new legal theories or insurance company insolvencies through
guaranty fund assessments may create costs for the insurer beyond those
recorded in the financial statements. The Company attempts to mitigate this
risk by monitoring proposed regulatory legislation and by assessing the impact
of new laws.
Credit risk - the Company is subject to several credit risks, some of which
are the ability of agents to refund unearned commissions in the event that a
policy cancels, the ability of a premium finance customer to adhere to their
installment agreement, and solvency of its reinsurers. The Company is in the
practice of reserving a portion of each agent's commission as a contingency for
the refund of unearned commission, which reduces its exposure. In addition,
agents which do not timely remit unearned commissions lose their authority with
the Company. Premium finance contracts are strictly monitored and, via systems
automation, policies are promptly canceled for non-payment of premium finance
contracts, thereby eliminating exposure to the Company, for uncollectible
balances. The Company attempts to minimize reinsurance risk by maintaining
sound reinsurance agreements with a number of reinsurers, and by providing for
any amounts deemed uncollectible.
Interest rate risk - the risk that interest rates will change and cause a
decrease in the value of an insurer's investments. To the extent that
liabilities come due more quickly than assets mature, an insurer might have to
sell assets prior to maturity and potentially recognize a gain or a loss. The
Company attempts to mitigate this risk by attempting to match the maturity
schedule of its assets with the expected payouts of its liabilities.
Customer Lists - Customer lists are amortized on a straight-line basis over 40
years. Management reviews, on an annual basis, the carrying value of customer
lists in order to determine whether an impairment has occurred. Impairment is
based on several factors including the Company's projection of future
undiscounted operating cash flows. If an impairment of the carrying value were
to be indicated by this review, the Company would adjust the carrying value of
customer lists to their estimated fair value.
Long-Lived Assets - The Company reviews its long-lived assets and certain
identifiable intangibles to be held and used for impairment whenever events or
changes in circumstances indicate that the carrying amount of an asset may not
be recoverable. If such events or changes in circumstances are present, a loss
is recognized to the extent the carrying value
F-5
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UNISTAR FINANCIAL SERVICE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
of the asset is in excess of the sum of the undiscounted cash flows expected to
result from the use of the asset and its eventual disposition.
Premium Finance - Premium finance contracts are carried at unpaid balances.
Management, considering current information and events regarding the borrowers'
ability to repay their obligations, considers a loan to be impaired when it is
probable that Unistar will be unable to collect all amounts due according to
the original contractual terms of the note agreement. When a loan, in
management's judgment, becomes impaired, interest income is subsequently
recognized only to the extent of cash payments received.
Management maintains allowances for premium finance contracts at a level which
management believes is adequate to absorb potential losses in the portfolios.
The allowances are based on an evaluation of the notes, past loss experience,
current economic conditions, volume, growth and other relevant factors.
Reserve For Unpaid Commissions And Loss Adjustment Expenses - The reserve for
unpaid commissions and loss expenses is undiscounted and represents cash-basis
estimates of reported losses and estimates based on certain actuarial
assumptions regarding the past experience of unreported losses. Estimated
amounts of salvage and subrogation are deducted from the reserve for unpaid
commissions and loss expenses. Management believes that the reserve for unpaid
commissions and loss expenses is adequate to cover the ultimate liability.
However, such estimate may be more or less than the amount ultimately paid when
the claims are finally settled.
Revenue Recognition - Premium commissions are recognized upon the approval and
payment of the insurance policy. Policy fee income are recognized ratably over
the related policy terms, based upon the estimated ultimate amounts to be paid.
Finance charges are recorded as unearned income at the beginning of installment
finance contracts with customers. Unistar recognizes finance charge income
using the effective interest rate method over the life of each contract that
typically approximates eleven months.
Reinsurance arrangements are short-duration prospective contracts for which
prepaid reinsurance premiums are amortized ratably over the related policy
terms based on the estimated ultimate amounts to be paid. Premiums ceded for
contracts with retrospective adjustment features are calculated based upon the
related estimated incurred losses and loss expenses including a provision for
unreported losses.
Contingent Reinsurance Commission - The Company's reinsurance contracts provide
ceding commissions for premiums written which are subject to adjustment. The
amount of ceding commissions is determined by the loss experience for the
reinsurance agreement term. The reinsurer provides commissions on a sliding
scale with maximum and minimum achievable levels. The reinsurer provides the
Company with the provisional commissions. The Company has recognized the
commissions based on the current loss experience for the policy year premiums.
This results in establishing a contingent liability, included in due from
reinsurers, for the excess of provisional commissions retained compared to
amounts recognized, which is subject to variation until the ultimate loss
experience is determinable.
Fair Value - The fair value of the Company's investments are estimated based on
bid prices published by financial services or quotations received from
securities dealers and is reflective of the interest rate environment that
existed as of the close of business on December 31, 1998. Changes in interest
rates subsequent to December 31, 1998 may affect the fair value of the
Company's investments.
The carrying amounts for the following financial instrument categories
approximate their fair values at December 31, 1998 because of their short-term
nature: cash and cash equivalents, finance contracts receivable, due from
reinsurers, prepaid reinsurance premiums, unearned premiums, finance contracts
payable and notes payable.
Income Taxes - Deferred income tax has been provided for the effects of
temporary differences between financial reporting and tax bases assets and
liabilities and has been measured using the enacted marginal tax rates and laws
that are currently in effect.
F-6
<PAGE> 16
UNISTAR FINANCIAL SERVICE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Cash Equivalents - Unistar considers all certificates of deposit, United States
government securities and commercial paper with original maturities of three
months or less to be cash equivalents.
Earnings per Share - Earnings per share is computed in accordance with the
Financial Accounting Standards Board (FASB) Statement No 128 "Earnings per
Share." Basic earnings per share is computed based on the weighted average
number of common shares outstanding, excluding any dilutive effects of options,
awards and convertible securities. Dilutive earnings per share is computed
based on the weighted average number of common shares outstanding plus the
dilutive effects of options, awards and convertible securities.
Other Comprehensive Income - In June 1997, the FASB issued SFAS 130, "Reporting
Comprehensive Income," which requires transactions that are currently reported
directly to stockholders' equity be reported in a financial statement that is
displayed as prominently as other financial statements. SFAS 130, which is
effective for fiscal years beginning after December 15, 1997, impacts
disclosure requirements only. Therefore, SFAS 130 will have no impact on the
Company's financial condition, cash flows or results of operations.
Segment Information - In June 1997, the FASB issued SFAS 131, "Disclosures
about Segments of an Enterprise and Related Information." SFAS 131 supersedes
SFAS 14, "Financial Reporting for Segments of a Business Enterprise," and
requires companies to report financial and descriptive information about their
reportable operating segments. The financial information is required to be
reported on the basis that is used internally for evaluating segment
performance and deciding how to allocate resources to segments. SFAS 131
requires disclosure only and will have no impact on the Company's financial
condition, cash flows or results of operations.
BUSINESS ACQUISITIONS
Effective September 30, 1998, the Company acquired substantially all of the
assets and assumed certain liabilities of U.S. Fidelity Holding Corp. The
purchase price exceed the fair value of net assets by approximately $84.1
million and has been included in customer lists. Effective December 31, 1998,
Unistar acquired the operations of independent insurance agencies in Texas.
These acquisitions were contributed to the Company by Unistar Insurance
Agencies, LLC, owned by significant stockholders of the Company and valued at
approximately $10.6 million based upon cash and note considerations. Included
in this amount is $5 million value assigned to Talon Financial Services, LTD.
("Talon"), a Bermuda-based reinsurance brokerage company.
STATUTORY INSURANCE ACCOUNTING PRINCIPLES
Statutory regulations generally limit the payment of cash dividends in any one
year to an amount equal to the greater of net investment income reported for
the previous calendar year or 10% of surplus as regards policyholders as of the
previous year-end. Surplus in excess of this limitation is not available for
dividends without special approval of the regulatory authorities.
Since August 26, 1997, Unistar Insurance Company ("UIC") has operated under
Regulatory Administrative Oversight by the Texas Department of Insurance (the
"TDI"). The more significant requirements were for UIC to provide certain
financial statements, projections and business plans for approval and review.
The TDI also required UIC to adopt and amend certain policies and procedures.
UIC responded to the Texas Department of Insurance on November 3, 1997
regarding the aforementioned issues. As of March 31, 1999, management believes
they have adequately addressed all of the significant issues.
F-7
<PAGE> 17
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
- ------- -----------
<S> <C>
3.1 Articles of Incorporation, as amended.(1)
3.2 Bylaws of the Registrant, as amended.(1)
3.3 Certificate of Amendment to Certificate of Incorporation
authorizing one-for-fifteen reverse stock split, filed with the
Secretary of State of Delaware on August 17, 1998.(2)
10.1* Registrant's 1998 Stock Option Plan.(2)
27.0 Financial Data Schedule.(3)
</TABLE>
- -------------
* Denotes management contract or compensatory plan.
(1) Incorporated by reference to the Registrant's Form 10-KSB for the year
ended December 31, 1997.
(2) Incorporated by reference to the Registrant's Report on Form 8-K filed
September 2, 1998.
(3) Filed herewith.
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
COMPANY'S UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS AS OF END FOR THE QUARTER
ENDED MARCH 31, 1999 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-END> MAR-31-1999
<CASH> 17,877
<SECURITIES> 295
<RECEIVABLES> 52,313
<ALLOWANCES> 1,008
<INVENTORY> 0
<CURRENT-ASSETS> 0
<PP&E> 4,795
<DEPRECIATION> 0
<TOTAL-ASSETS> 179,355
<CURRENT-LIABILITIES> 0
<BONDS> 58,168
0
0
<COMMON> 244
<OTHER-SE> 92,200
<TOTAL-LIABILITY-AND-EQUITY> 179,355
<SALES> 0
<TOTAL-REVENUES> 19,560
<CGS> 0
<TOTAL-COSTS> 15,506
<OTHER-EXPENSES> 658
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 1,129
<INCOME-PRETAX> 2,267
<INCOME-TAX> 896
<INCOME-CONTINUING> 1,371
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,371
<EPS-PRIMARY> .06
<EPS-DILUTED> .06
</TABLE>
