Solera Holdings 10-K 2007
Documents found in this filing:
Washington, DC 20549
x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
for the fiscal year ended June 30, 2007
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
for the transition period from to .
COMMISSION FILE NUMBER: 001-33461
Solera Holdings, Inc.
(Exact name of registrant as specified in its charter)
Securities registered pursuant to Section 12(b) of the Act:
Securities registered pursuant to Section 12(g) of the Act: None.
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No x
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No x
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that it was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the Registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act. (Check one):
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x
The registrant consummated its initial public offering on May 16, 2007. Accordingly, as of December 31, 2006, the last day of the registrants most recently completed second fiscal quarter, the registrants common stock was not publicly traded. As of September 14, 2007, the aggregate market value of the registrants common stock, par value $0.01 per share, held by non-affiliates of the registrant was approximately $535.2 million (based upon the closing sale price of the common stock on that date on The New York Stock Exchange). For this purpose, all shares held by directors, executive officers and stockholders beneficially owning five percent or more of the registrants common stock have been treated as held by affiliates.
The number of shares of the registrants common stock outstanding as of as of September 14, 2007 was 64,793,563.
Our operations began in 1966, when Swiss Re Corporation founded our predecessor. Solera Holdings, LLC was founded in March 2005 by Tony Aquila, our Chief Executive Officer, and affiliates of GTCR Golder Rauner II, L.L.C., or GTCR, a private equity firm. On April 13, 2006, subsidiaries of Solera Holdings, LLC acquired our predecessor, the Claims Services Group, from Automatic Data Processing, Inc., or ADP, for approximately $1.0 billion. We refer to this acquisition in this Annual Report on Form 10-K as the Acquisition. In connection with our initial public offering in May 2007, we converted from Solera Holdings, LLC, a Delaware limited liability company, into Solera Holdings, Inc., a Delaware corporation.
The terms we, us, our, our company and our business collectively refer to: (1) the combined operations of the Claims Services Group for periods prior to the Acquisition, (2) the consolidated operations of Solera Holdings, LLC for the periods following the Acquisition and prior to the completion of its corporate reorganization in May 2007 and (3) the consolidated operations of Solera Holdings, Inc. as of and following the corporate reorganization in May 2007. Our fiscal year ends on June 30 of each year. Fiscal years are identified in this Annual Report on Form 10-K according to the calendar year in which they end. For example, the fiscal year ended June 30, 2007 is referred to as fiscal 2007. Our financial information disclosed in this Annual Report on Form 10-K under Item 1 (Business) and Item 7 (Managements Discussion and Analysis of Financial Condition and Results of Operations) is based on the following:
We are the leading global provider of software and services to the automobile insurance claims processing industry. Our customers include insurance companies, collision repair facilities, independent assessors and automotive recyclers. We help our customers:
· estimate the costs to repair damaged vehicles;
· determine pre-collision fair market values for vehicles damaged beyond repair;
· automate steps of the claims process;
· improve their ability to monitor and manage their businesses through data reporting and analysis.
As of June 30, 2007, we served more than 55,000 customers and had operations in 49 countries with over 2,000 full-time employees. Our customers include more than 900 automobile insurance companies, 33,000 collision repair facilities, 7,000 independent assessors and 3,000 automotive recyclers. We derive revenues from many of the worlds largest automobile insurance companies, including each of the ten largest automobile insurance companies in Europe and each of the ten largest automobile insurance companies in North America.
The Automobile Insurance Claims Process
An overview of the automobile insurance claims process and its complexities provides a framework for understanding how our customers can derive value from our software and services. The automobile insurance claims process generally begins following an automobile collision and consists of the following steps:
Each of these steps consists of multiple actions requiring significant and complex interaction among several parties. For example, the investigation step generally involves insurance companies, assessors, collision repair facilities and automotive recyclers and includes conducting interviews, taking and examining photographs, obtaining and reviewing police reports and estimating repair costs. When performed manually, many of these tasks, such as the mailing of vehicle photographs or the estimating of vehicle repair costs, can be time-consuming. In addition, without an efficient means of communication that facilitates real-time access to data, claim-related negotiations can result in substantial delays and unnecessary costs.
The primary participants in the automobile insurance claims processing industry are automobile insurance companies, collision repair facilities, independent assessors and automotive recyclers. We believe that our business is affected by trends associated with each of the following:
Automobile Insurance Industry
We estimate that the global automobile insurance industry processes more than 100 million claims each year, representing over $150 billion in repair costs. We believe the industry is relatively concentrated with a number of large automobile insurance companies accounting for the majority of global automobile insurance premiums. In the U.S., of the approximately 470 companies offering automobile insurance, the twenty largest providers accounted for over 70% of all automobile insurance premiums in 2006, 2005, and in 2004, the top 15 European non-life insurance companies accounted for 84% of total non-life insurance premiums.
We believe that this industry is growing due to an increasing number of vehicles on the road and an increasing percentage of vehicles that have insurance. According to industry sources, from 2003 to 2006, the worldwide number of personal and commercial vehicles grew an average of 3.5% per year, to an estimated 928 million vehicles in 2006. From 2006 to 2016, the number of worldwide personal and commercial vehicles is estimated to grow 2% to 3% per year, with forecasted annual growth of 8% in Asia-Pacific countries.
In some insurance markets, such as North America and Western Europe, automobile insurance is generally government-mandated and automated claims processing is widespread. Automobile insurance companies achieve growth in these highly competitive markets by gaining additional market share, and generally compete on price and quality of policyholder service. To remain competitive, insurance companies increasingly seek additional automated claims processing products and services to minimize costs and improve policyholder service.
In other markets, such as Eastern Europe, Latin America, China and India, automobile insurance companies are growing due primarily to an increase in the number of vehicles and emerging government regulations that require vehicles to be insured. Many automobile insurance companies in these markets process claims manually, presenting significant opportunities for them to increase their operational efficiencies.
The cost of automated claims processing software and services generally represents a relatively small portion of automobile insurance companies claims costs. We believe automobile insurance companies will increase their spending on automated claims processing software and services because incremental investments can result in significant cost reductions.
Collision Repair Industry
The collision repair industry is highly fragmented. We estimate there are approximately 100,000 collision repair facilities in our markets. The operating costs of these facilities have increased substantially over the past decade due to continued increases in vehicle diagnostic and repair technologies and changes in environmental regulations. In addition, collision repair facilities have increasingly established preferred relationships with insurance companies. These arrangements, known in the U.S. as direct repair programs, allow collision repair facilities to generate increased repair volumes through insurance company referrals. Insurance companies benefit by establishing a trusted network of collision repair facilities across which they can implement standard procedures and best practices. Insurance companies often require collision repair facilities to use specified automated claims processing software and related services to participate in their programs. We believe the combination of these factors will increase demand for our software and services that help collision repair facilities manage their workflow and increase their efficiency.
Independent assessors are often used to estimate vehicle repair costs, particularly where automobile insurance companies have chosen not to employ their own assessors or do not have a sufficient number of employee assessors and where governments mandate the use of independent assessors.
In some markets, we believe changing government regulations and improved claims technology will result in a decrease in the number of independent assessors. However, in other markets, insurance companies are reducing their employee assessor staff to contain costs, which we believe will lead to a growth in the number of independent assessors. We believe the combination of these offsetting factors will result in a modest overall increase in the number of independent assessors and, therefore, the demand for automobile insurance claims processing software and services.
Automotive Recycling Industry
The automotive recycling industry is highly fragmented with over $25 billion in estimated worldwide annual sales by over 15,000 independent salvage and recycling facilities. Participants in the automotive recycling industry are a valuable source of economical and often hard-to-find used vehicle replacement parts. In addition, this industry has become more sophisticated and technology-driven in order to keep pace with innovations in vehicle technology. Additionally, insurance companies are increasingly mandating the use of aftermarket and recycled parts to lower the costs to repair damaged vehicles. We believe these factors will result in increased demand for automobile insurance claims processing software and services, as automotive recyclers seek to manage their workflows, maximize the value of their inventories and increase efficiency.
We believe that the principal drivers of demand for our software and services are:
Inefficiencies in the Automobile Insurance Claims Process
Claims Process Fragmentation. The automobile insurance claims process involves many parties and consists of many steps, which are often managed through paper, fax and other labor intensive processes. In a June 2004 poll conducted by a leading provider of statistical claims data to the property and casualty insurance industry, approximately 75% of U.S. insurance companies identified improving claims-handling processes as their most important goal. Key areas for improvement identified by the survey included lowering operating costs, reducing fraud and improving claims-handling efficiency. By simplifying and streamlining the claims process, insurance companies can process claims faster and reduce costs.
Unequal Access to Information. Collision repair facilities typically have more information about vehicles in their shops than do insurance companies who often must make their damage estimates remotely or with limited information. Through access to detailed information about vehicle damage and replacement costs, insurance companies can more accurately estimate fair settlement values and reduce overpayment on claims.
Disparate Claims Data. Claims-related data generated by automobile insurance companies often is not stored, shared with other parties or captured in a format that is easily transferable to other applications. This, combined with the inability to transfer and manipulate data easily across multiple applications, hinders comparisons of repairs and claims. Increased access to data from industry participants generates more accurate repair estimates and allows automobile insurance companies to identify top-performing collision repair facilities.
Conflicting Interests of Industry Participants. Collision repair facilities benefit from high repair costs, which increase their revenues. Conversely, insurance companies benefit from low repair costs, which reduce their expenses. This conflict can result in high settlement costs and delays. Repair cost estimates that rely on common data sources can reduce these costs and delays.
Inefficient Collision Repair Facility Workflow. Many collision repair facilities manage their complex workflows manually or without specialized software. Manual workflow management leads to increased processing time, higher costs and more errors, problems that generally intensify as a facility grows. With claims processing software and services, collision repair facilities can more effectively manage their workflows and obtain detailed part availability and pricing information.
Growth in the Automobile Insurance Claims Industry
Growth in the Number of Worldwide Vehicles. According to industry sources, from 2003 to 2006, the number of personal and commercial vehicles in use has increased an average of 3.5% per year, driven primarily by a 4% per year increase in sales of new vehicles. Additional growth of 2% to 3% per year is expected through 2016. As the number of vehicles on the road continues to expand, we believe the need for automobile insurance claims processing products and services will continue to grow to handle increased claims activity.
Adoption of Automated Claims Processing Software and Services. Many markets have only recently begun to adopt automated claims processing software and services to reduce inefficiencies. We anticipate that increased adoption of automated claims processing software and services in these markets will be a key driver of our growth.
Our software and services can be organized into five general categories: estimating and workflow software, salvage and recycling software, business intelligence and consulting services, shared services and other.
Estimating and Workflow Software
Our core offering is our estimating and workflow software. Our estimating and workflow software helps our customers manage the overall claims process, estimate the cost to repair a damaged vehicle, and calculate the pre-collision fair market value of a vehicle. Key functions of our estimating and workflow software include:
· capturing first notice of loss information;
· assigning, managing and monitoring claims and claim-related events;
· accessing and exchanging claims-related information;
· calculating, submitting, tracking and storing repair and total loss estimates;
· reviewing, assessing and reporting estimate variations based upon pre-set rules;
· scheduling repairs.
Salvage and Recycling Software
Our salvage and recycling software helps automotive recyclers manage their inventories in order to facilitate the location, sale and exchange of vehicle parts for use in the repair of a damaged vehicle. Key functions of our salvage and recycling software include:
· managing inventory;
· connecting to collision repair facilities to facilitate the use of recycled parts in the repair of a damaged vehicle;
· locating vehicle parts by price, year, model and/or geographic area;
· determining the interchangeability of automobile parts across vehicle models;
· exchanging vehicle parts with other recyclers;
· generating management reports.
Business Intelligence and Consulting Services
Our business intelligence and consulting services help our insurance company customers monitor and assess their performance through customized data, reports and analyses. Key elements of our business intelligence and consulting services include:
· analyzing claims amounts and payments;
· creating customized statistical reports on claims data and activity;
· measuring our customers performance against industry standards; and
· monitoring key performance indicators.
We have developed our shared services to help our insurance company customers outsource claims-related tasks. The key components of our shared services include:
· reviewing repair estimates prepared by collision repair facilities;
· reviewing decisions to repair or replace damaged parts;
· auditing and facilitating settlement of repair prices with collision repair facilities;
· reviewing medical and workers compensation bills; and
· communicating with policyholders.
We provide additional services and products to our customers, which include selling hardware for use with our software, training, and call center technical support services. We also offer services that allow our customers to access operational and technical support in times of high demand following natural disasters and software that helps detect fraudulent activity. We also provide software and services that are not directly related to the automobile insurance claims process.
At the core of our software and services are our proprietary databases. Each of our databases has been adapted for use in our local markets. We have invested over $200 million in the last ten years to maintain and expand our proprietary databases. Our primary databases include our repair estimating database, our total loss database, our claims database and our parts salvage databases.
Repair Estimating Database. We have created our repair estimating database over 35 years through the development, collection, organization and management of automobile-related information. The data in this database enables our customers to estimate the cost to repair a damaged vehicle. This database:
· contains detailed cost data for each part and the required labor operations needed to complete repairs on over 3,100 vehicle types;
· covers over 95% of the vehicle models in our core markets;
· includes vehicles data dating back to 1970;
· includes over 3.3 million parts for vehicles with multiple model years, editions, option packages and country-specific variations; and
· includes over one million aftermarket parts.
We update this database with data provided to us by third parties, including OEMs and aftermarket part suppliers, along with data we develop through our proprietary analyses of local labor repair times and damage repair techniques. The quality and accuracy of the database, which are very important to each of our customers, are continuously monitored and maintained using rigorous quality control processes, which include validating up to 20 million data points every month.
Total Loss Database. Our total loss database helps our customers determine the pre-collision fair market values of vehicles that have been damaged beyond the point where repair is economically feasible, as well as the amounts they pay policyholders for total losses. Additionally, our employees use this database to provide total loss estimating service to our customers. This database has been designed to accurately reflect the local fair market value of a vehicle rather than simply delivering a market value based on national or regional averages. Each year, we collect more than 20 million vehicle purchase and sale records from over 11,000 automobile dealerships, which we have combined with local market purchase and sale data collected from over 3,500 different sources, including websites, local newspapers, magazines and private listings. We update this database by incorporating nearly two million data points per week which include the latest vehicle purchase and sale information including specific models, option packages, vehicle condition and mileage.
Claims Database. Our claims database enables our customers to evaluate their internal claims process performance, as well as measure the performance of their business partners. Our employees also use this database to provide consulting services to our customers and develop new software and services. Customers use this database to benchmark their performance against their local peer group through detailed analyses of comprehensive industry data. Compiled over the past 15 years, this database contains approximately two billion data points representing over 100 million automobile repair claims and over
190 billion in claims payments. We update this database by incorporating approximately 150,000 additional repair estimates every week.
Parts Salvage Databases. Our parts salvage databases contain data on approximately 130 million automobile parts through a network of approximately 3,000 automotive recyclers. These databases are used by our customers to quickly find locally available automobile parts and identify interchangeable parts across different vehicles.
We have operations in 49 countries on five continents. We have organized our operations into two regional operating segments, EMEA and Americas.
Our EMEA operating segment accounted for 59.3% of our revenues during fiscal 2007. EMEA comprises our operations in 34 countries in Europe, the Middle East, Africa and Asia. Our EMEA segment comprises our operations and licensed independent providers in Austria, Belarus, Belgium, Bosnia, Bulgaria, China, Croatia, the Czech Republic, Denmark, Estonia, France, Germany, Greece, Hungary, India, Israel, Japan, Latvia, Lebanon, Lithuania, the Netherlands, Poland, Portugal, Romania, Russia, Serbia-Montenegro, Slovakia, Slovenia, South Africa, Spain, Switzerland, Turkey, Ukraine and the United Kingdom.
Our Americas operating segment accounted for 40.7% of our revenues during fiscal 2007. Americas comprises our operations in 15 countries in North and South America: Brazil, Canada, Chile, Colombia, Costa Rica, the Dominican Republic, Ecuador, El Salvador, Guatemala, Honduras, Mexico, Nicaragua, Panama, the U.S. and Venezuela.
Geographic Financial Information
The table below sets forth the revenues we derived from the following geographic areas during each of the previous three fiscal years.
The table below sets forth the long-lived assets we held in the following geographic areas during each of the previous three fiscal years.
Leading Global Provider
We are the leading global provider of software and services to the automobile insurance claims processing industry. We have operations in 49 countries across five continents. In each of our markets, we believe we are either the largest or second-largest provider of automobile insurance claims processing software and services based on total revenues except for four countries that we have recently entered. The large number of geographic regions in which we operate provides us with a strategic advantage when expanding into new markets by enabling us to utilize our database and vehicle coverage already present in adjacent or nearby markets. As insurance companies continue to expand their businesses globally, our international leadership position should further position us as a single provider of automobile insurance claims processing software and services to our customers on a global basis.
Significant Barriers to Entry
We believe that our proprietary databases pose barriers to entry due to the significant capital investment and time that would be required to develop a similar set of integrated databases and customize them for use in local markets. Our proprietary databases have been built through 35 years of developing, collecting, organizing and managing automobile-related information and data. We have invested over $200 million in the last ten years in developing and maintaining our proprietary databases, and customizing them for use in local markets.
Long-Standing Relationships with Customers
We have long-standing relationships with many of the worlds largest automobile insurance companies. For example, our relationships with our ten largest customers in Europe and North America date back, on average, 16 and 17 years, respectively. Our software and services are typically integrated into our customers systems, operations and processes, often making it costly and time-consuming for our customers to switch to another provider. These long-standing relationships have also allowed us to better understand our customers needs and further expand these relationships over time, both with additional software and by increasing our customer support and training services. Additionally, several of our customers own minority interests in five of our local operating subsidiaries. We have found these partnerships to be effective when entering new markets as they have allowed us to collaborate more closely with our insurance company customers and rely on their local expertise to introduce, customize and market our software and services quickly and efficiently.
History of Developing New Software and Services
Since our inception, we have consistently developed and marketed new software and services in order to meet the needs of our customers. We work closely with our customers in order to determine the features
and functions that they may require in the future. We have developed and introduced new software and services to the market through both internal development as well as through the acquisition and licensing of products and technology owned by third parties. For example, we recently introduced an auditing tool that allows insurance companies to identify repair estimates that should be further reviewed. We believe our focus on software development and customization creates incremental revenue opportunities as we expand the number and sophistication of the software and services that we offer.
Attractive Operating Model
We believe we have an attractive operating model due to the recurring nature of our revenues, the scalability of our databases and software and the significant operating cash flow we generate.
Contract-Based Revenues. A substantial portion of our revenues is derived from customers who have been under contract with us for several years. For fiscal 2007, we generated over 95% of our revenues from subscription-based contracts (where we charge a monthly fee), transaction-based contracts (where we charge a fee per transaction), and subscription-based contracts with additional transaction-based fees (where we charge both a monthly fee and a fee per transaction), all of which generate recurring revenues from our customers.
Scalable Databases and Software. Our databases and software have been designed to accommodate significant additional transaction- and subscription-based volumes with limited incremental costs. The ability to generate additional revenues from increased subscription and transaction volumes without incurring substantial incremental costs provides us with opportunities to improve our operating margins.
Significant Operating Cash Flow Generation. We believe we are able to generate significant operating cash flows due to our operating margins and the relatively moderate working capital required to grow our business. The operating cash flow we generate may be used to repay debt, finance acquisitions, expand geographically or further invest in database and software innovation.
Broaden the Scope of our Software and Services
We intend to further broaden the capabilities, features and functionality of our claims processing software, as well as the breadth of our service offerings. We believe that expanding the breadth of our offerings will allow us to retain and strengthen our relationships with our existing customers by helping them improve the efficiency of their claims process. We also intend to develop new software and services for our insurance company customers that can help them process claims in areas other than automobile insurance.
Expand Customer Base in Existing Markets
We seek to expand our customer base in existing markets by competing on the quality of our software and services, our industry expertise, and our strong industry relationships. In some markets, such as North America and Western Europe, we intend to seek new customers by competing favorably on both price and service, as well as by providing a complete suite of claims processing software and services that optimize each step of the claims process. In other markets, such as Eastern Europe, Latin America, China and India, we intend to use the combination of our local expertise with our global presence and comprehensive databases to serve new automobile insurance companies and other customers who can use our software and services to reduce claims-related costs and increase their operational efficiencies.
Expand into New Markets
As a result of recent growth in vehicle usage, regulatory and market developments, increasing penetration of automobile insurance, and rising adoption of automated claims processing by insurance companies, we believe that new markets represent significant opportunities for future growth. We have a history of successfully entering markets that previously had not used automated claims processing software and services. We intend to use this expertise to further expand in markets where we have recently established operations, such as China and India, and enter markets where we currently have no operations.
Improve Operational Efficiencies
We seek to operate more efficiently, reduce costs and improve our operating margins. We intend to pursue substantial operating margin improvements over the next two years. Major elements of this plan include productivity and technological enhancements and reduction of overhead. We have identified and targeted several operational initiatives that we plan to implement over the next year, including the elimination of database and infrastructure redundancies productivity and technology enhancements and reduction of overhead. If implemented, we expect that these initiatives will improve our operating margins.
Pursue Strategic Acquisitions
We plan to supplement our organic growth by acquiring businesses or technologies that allow us to expand our range of services, increase our customer base and enter new markets. When evaluating these opportunities, we will consider characteristics such as recurring revenues, strong operating and financial performance, enhanced products and services, long-standing customer relationships and strong management personnel.
Sales and Marketing
As of June 30, 2007, our sales and marketing staff included 222 full-time professionals. Our sales and marketing personnel identify and target specific sales opportunities and manage customer relationships. They also design and plan launch strategies for new software and services, and plan and facilitate customer conferences and tradeshows. Our country managers are also involved in the sales and marketing process, though they are not counted as full-time sales professionals.
Customer Support and Training
We believe that providing high quality customer support and training services is critical to our success. As of June 30, 2007, we had 395 full-time customer support and training personnel, who provide telephone support, as well as on- and off-site implementation and training. Our customer support and training staff generally consists of individuals with expertise in both our software and services and in the automobile insurance and collision repair industries.
Software and Database Development
We devote significant resources to the continued development of our software and databases. We have created sophisticated processes and tools to achieve high-quality software development and data accuracy. Our ability to maintain and grow our leading position in the automobile insurance claims processing industry is dependent upon our ability to enhance and broaden the scope of our software and services, as well as continuing to expand and improve our repair estimating, total loss, claims and parts salvage databases. We often collaborate with our customers in the development process to focus on addressing their specific needs. We then incorporate what we have learned from our customers workflow experiences and needs to deliver quality, workflow-oriented software and services to the marketplace
quickly. We believe these efforts provide a significant competitive advantage in the development of new software and services.
As of June 30, 2007, our software development staff consisted of 402 full-time professionals across six international software development centers. As of the same date, our database staff consisted of 379 full-time professionals across five international database development centers.
We compete primarily on the functionality of our software, the integrity and breadth of our data, customer service and price. The competitive dynamics of the global automobile insurance claims processing industry vary by region, and many of our competitors are present in only a limited number of markets in which we operate. In Europe, our largest competitors include DAT, GmbH and EurotaxGlasss Group, with whom we compete in multiple countries. In North America, our largest competitors include CCC Information Services Group Inc. in the U.S. and Mitchell International Inc. in the U.S. and Canada.
Intellectual Property and Licenses
We enter into license agreements with our customers, granting each customer a license to use our software and services while ensuring the protection of our ownership and the confidentiality of the embedded information and technology contained in our software. As a general practice, employees, contractors and other parties with access to our confidential information sign agreements that prohibit the unauthorized use or disclosure of our proprietary rights, information and technology.
We own registered trademarks and service marks that we use in connection with our software and services, including their advertising and marketing. For example, our trademark Audatex is registered in over 50 countries. In the U.S. and Canada, we market our collision damage estimating and total loss valuation software under the registered trademarks Penpro, Shoplink and Autosource.
We license much of the data used in our software and services through short-term contracts with third parties, including OEMs, aftermarket parts suppliers, data aggregators, automobile dealerships and vehicle repair facilities, to whom we pay royalties.
As of June 30, 2007, we had 2,067 full-time employees, 1,033 of whom were based in our EMEA operating segment and 1,034 of whom were based in our Americas operating segment. None of our employees is subject to a collective bargaining agreement. We consider our relationships with our employees to be good.
Investing in our common stock involves a high degree of risk. You should carefully consider the following risk factors and all other information contained in this Annual Report on Form 10-K before making a decision to invest in our common stock. If any of the following risks occur, our business, results of operations and financial condition may be materially and adversely affected. In that event, the trading price of our common stock could decline, and you could lose all or part of your investment.
We depend on a limited number of customers for a substantial portion of our revenues, and the loss of, or a significant reduction in volume from, any of these customers would harm our financial results.
We derive a substantial portion of our revenues from sales to large insurance companies. In fiscal 2007, we derived 16.2% of our revenues from our ten largest insurance company customers. The largest three of these customers accounted for 3.6%, 3.0% and 1.8%, respectively, of our revenues during this
period. A loss of one or more of these customers would result in a significant decrease in our revenues, including the business generated by collision repair facilities associated with those customers. We lost a customer contract in April 2006 during its renewal phase that accounted for revenues in fiscal 2006 of approximately $4.3 million and earlier this year lost our principal shared services contract, which accounted for approximately $5.8 million of revenue in fiscal 2007. Furthermore, many of our arrangements with European customers are terminable by them on short notice or at any time. In addition, disputes with customers may lead to delays in payments to us, terminations of agreements or litigation. Additional terminations or non-renewals of customer contracts or reductions in business from our large customers would harm our business, financial condition and results of operations.
Competitive pressures may require us to significantly lower our prices.
Pricing pressures have required us to significantly lower prices for some of our software and services in several of our markets. We may be required to implement further price reductions in response to the following:
· price reductions by competitors;
· the consolidation of property and casualty insurance companies;
· the introduction of competing software or services; and
· a decrease in the frequency of accidents.
If we are required to accept lower prices for our software and services, it would result in decreased revenues and harm our business, financial condition and results of operations.
Changes in or violations by us or our customers of, applicable government regulations could reduce demand for or limit our ability to provide our software and services in those jurisdictions.
Our insurance company customers are subject to extensive government regulations, mainly at the state level in the U.S. and at the country level in our non-U.S. markets. Some of these regulations relate directly to our software and services, including regulations governing the use of total loss and estimating software. If our insurance company customers fail to comply with new or existing insurance regulations, including those applicable to our software and services, they could lose their certifications to provide insurance and/or reduce their usage of our software and services, either of which would reduce our revenues. Also, we are subject to direct regulation in some markets, and our failure to comply with these regulations could significantly reduce our revenues or subject us to government sanctions. In addition, future regulations could force us to implement costly changes to our software and/or databases or have the effect of prohibiting or rendering less valuable one or more of our offerings. Moreover, some states in the U.S. have changed their regulations to permit insurance companies to use book valuations for total loss calculations, making our total loss software potentially less valuable to insurance companies in those states. Some states have adopted total loss regulations, that, among other things, require that insurers use a methodology deemed acceptable to the respective government agency. We submit our methodology to such agencies, and if they do not approve our methodology, we will not be able to perform total loss valuations in their respective states. In addition, some states are considering legislation that would require insurers to use estimates from two independent services to provide total loss calculations for a damaged vehicle and would provide authority to the state insurance commissioner to determine which services qualify as independent. If passed, this legislation may prohibit us from or limit our ability to provide our products and services in those states and/or may have the effect of making our products and services less desirable to our customers. Other states are considering legislation that would limit the data that our software can provide to our insurance company customers. In the event that demand for or our ability to provide our software
and services decreases in particular jurisdictions due to regulatory changes, our revenues and margins may decrease.
In addition, the Belgian Competition Department recently notified us that it has chosen to continue to investigate a complaint originally brought by a trade association representing collision repair facilities that was withdrawn by the trade association in 2005, relating to estimates generated by our software of the costs to repair damaged vehicles. Pursuant to the European Union competition laws, the Belgian Competition Department is asserting its authority to conduct this investigation as it relates to the Western European region.
Our industry is highly competitive, and our failure to compete effectively could result in a loss of customers and market share, which could harm our revenues and operating results.
The markets for our automobile insurance claims processing software and services are highly competitive. In the U.S., our principal competitors are CCC Information Services Group Inc. and Mitchell International Inc. In Europe, our principal competitors are EurotaxGlasss Group and DAT, GmbH. If one or more of our competitors develop software or services that are superior to ours or are more effective in marketing its software or services, our market share could decrease, reducing our revenues. In addition, if one or more of our competitors retain existing or attract new customers for which we have developed new software or services, we may not realize expected revenues from these new offerings, reducing our profitability.
Some of our current or future competitors may have or develop closer customer relationships, develop stronger brands, have greater access to capital, lower cost structures and/or more attractive system design and operational capabilities than we have. In addition, consolidation within our industry could result in the formation of competitors with substantially greater financial, management or marketing resources than we have and such competitors could utilize their substantially greater resources and economies of scale to develop and market competing products, divert sales away from us by offering their products at lower prices, or hire away our key employees by offering more lucrative compensation packages. Moreover, many insurance companies have historically entered into agreements with automobile insurance claims processing service providers like us and our competitors whereby the insurance company agrees to use that provider on an exclusive or preferred basis for particular products and services and agrees to require collision repair facilities, independent assessors and other vendors to use that provider. If our competitors are more successful than we are at negotiating these exclusive or preferential arrangements, we may lose market share even in markets where we retain other competitive advantages.
In addition, our insurance company customers have varying degrees of in-house development capabilities, and one or more of them have expanded and may seek to further expand their capabilities in the areas in which we operate. Many of our customers are larger and have greater financial and other resources than we do and could commit significant resources to product development. Our software and services have been, and may in the future be, replicated by our insurance company customers in-house, which could result in our loss of those customers and their associated repair facilities, independent assessors and other vendors, resulting in decreased revenues and net income.
The time and expense associated with switching from our competitors software and services to ours may limit our growth.
The costs for an insurance company to switch providers of claims processing software and services can be significant and the process can sometimes take 12-18 months to complete. As a result, potential customers may decide that it is not worth the time and expense to begin using our software and services, even if we offer competitive and economic advantages. If we are unable to convince these customers to
switch to our software and services, our ability to increase market share will be limited, which could harm our revenues and operating results.
Our industry is subject to rapid technological changes, and if we fail to keep pace with these changes, our market share and revenues will decline.
Our industry is characterized by rapidly changing technology, evolving industry standards and frequent introductions of, and enhancements to, existing software and services, all with an underlying pressure to reduce cost. Industry changes could render our offerings less attractive or obsolete, and we may be unable to make the necessary adjustments to our offerings at a competitive cost, or at all. We also incur substantial expenses in researching, developing, designing and marketing new software and services. The development or adaptation of these new technologies may result in unanticipated expenditures and capital costs that would not be recovered in the event that our new software or services are unsuccessful. The research, development, production and marketing of new software and services are also subject to changing market requirements, as well as the satisfaction of applicable regulatory requirements and customers approval procedures and other factors, each of which could prevent us from successfully marketing any new software and services or responding to competing technologies. The success of new software in our industry also often depends on the ability to be first to market, and our failure to be first to market with any particular software project could limit our ability to recover the development expenses associated with that project. If we cannot develop new technologies, software and services or any of our existing software or services are rendered obsolete, our revenues and income could decline and we may lose market share to our competitors, which would impact our future operations and financial results.
We have a very limited operating history as a stand-alone company, which may make it difficult to compare our current operating results to prior periods.
Prior to the Acquisition, our predecessor operated as a business unit of ADP. Our predecessor relied on ADP during this period for many of its internal functions, including accounting, tax, payroll, technology and administrative and operational support. In connection with the Acquisition, ADP agreed to continue providing us with systems, network, programming and operational support and other administrative services for periods ranging from three to six months following the date of the Acquisition. Although we have replaced these services either through third-party contracts or internal sources, we may not be able to perform any or all of these services in a cost-effective manner. If we are unable to maintain substitute arrangements on terms that are favorable to us or effectively perform these services internally, our business, financial condition and results of operations would be adversely affected.
In addition, the historical financial information of our predecessor included in this Annual Report on Form 10-K may not reflect what our results of operations, financial position and cash flows would have been had we operated as a separate stand-alone company without the shared resources of ADP for the periods presented and are not necessarily indicative of our future results of operations, financial position and cash flows. For example, ADP allocated expenses and other centralized operating costs to our predecessor for periods prior to the Acquisition, and the allocated costs included in our predecessors historical financial statements could differ from amounts that we would have incurred if we had operated on a stand-alone basis.
We have a large amount of goodwill and other intangible assets as a result of the Aacquisition. Our earnings will be harmed if we suffer an impairment of our goodwill or other intangible assets.
We have a large amount of goodwill and other intangible assets and are required to perform an annual assessment for possible impairment for accounting purposes. At June 30, 2007, we had goodwill and other intangible assets of $932.2 million. If we do not achieve our planned operating results or other
factors impair these assets, we may be required to incur a non-cash impairment charge. Any impairment charges in the future will adversely affect our results of operations.
We have experienced net losses since the Acquisition, and future net losses may cause our stock price to decline.
We had a net loss of $80.9 million for fiscal 2007. We expect to continue to incur net losses in the future, due primarily to amortization of the remaining $363.0 million of intangible assets that we had as of June 30, 2007 and interest expense associated with our indebtedness. We cannot assure you that we will become or remain profitable, and future net losses may reduce our stock price.
We may incur significant restructuring and severance charges over the next 12 months, which would harm our operating results and cash position or increase debt.
We incurred restructuring charges (benefits) of $5.5 million in fiscal 2005 (Predecessor), $(0.5) million during the period from July 1, 2005 through April 13, 2006, $2.9 million in fiscal 2006 and $6.0 million in fiscal 2007. These charges consisted primarily of termination benefits paid or to be paid to employees. As of June 30, 2007, we had remaining liabilities associated with these restructuring charges of $5.6 million. We continue to evaluate our existing operations and capacity, and expect to incur additional restructuring charges as a result of future personnel reductions, related restructuring and productivity and technology enhancements, which may exceed the levels of our historical charges. We are currently evaluating several plans that, if all implemented, would result in restructuring and severance charges of approximately $3.0 million to $4.0 million over the next twelve months. These potential charges, consisting primarily of termination benefits, would significantly reduce our cash position or increase debt.
Our software and services rely on information generated by third parties and any interruption of our access to such information could materially harm our operating results.
We believe that our success depends significantly on our ability to provide our customers access to data from many different sources. For example, a substantial portion of the data used in our repair estimating software is derived from parts and repair data provided by, among others, original equipment manufacturers, or OEMs, aftermarket parts suppliers, data aggregators, automobile dealerships and vehicle repair facilities. We obtain much of our data about vehicle parts and components and collision repair labor and costs through license agreements with OEMs, automobile dealers, and other providers. EurotaxGlasss Group, one of our primary competitors in Europe, provides us with valuation and paint data for use in our European markets pursuant to a similar arrangement. Many of the license agreements through which we obtain data are for terms of one year and/or may be terminated without cost to the provider on short notice. If one or more of our licenses are terminated or if we are unable to renew one or more of these licenses on favorable terms or at all, we may be unable to access alternative data sources that would provide comparable information without incurring substantial additional costs. Recently, some OEM sources have indicated to us that they intend to materially increase the licensing costs for their data. While we do not believe that our access to any individual source of data is material to our operations, prolonged industry-wide price increases or reductions in data availability could make receiving certain data more difficult and could result in significant cost increases, which would materially harm our operating results.
System failures, delays and other problems could harm our reputation and business, cause us to lose customers and expose us to customer liability.
Our success depends on our ability to provide accurate, consistent and reliable services and information to our customers on a timely basis. Our operations could be interrupted by any damage to or failure of:
· our computer software or hardware or our customers or third-party service providers computer software or hardware;
· our networks, our customers networks or our third-party service providers networks; and
· our connections to and outsourced service arrangements with third parties, such as Acxiom, which hosts data and applications for us and our customers.
Our systems and operations are also vulnerable to damage or interruption from:
· power loss or other telecommunications failures;
· earthquakes, fires, floods, hurricanes and other natural disasters;
· computer viruses or software defects;
· physical or electronic break-ins, sabotage, intentional acts of vandalism and similar events; and
· errors by our employees or third-party service providers.
These risks will be exacerbated by our planned migration of our systems and operations to a more centralized platform. Because many of our services play a mission-critical role for our customers, any damage to or failure of the infrastructure we rely on, including those of our customers and vendors, could disrupt our ability to deliver information to and provide services for our customers in a timely manner, which could result in the loss of current and/or potential customers. In addition, we generally indemnify our customers to a limited extent for damages they sustain related to the unavailability of, or errors in, the software and services we provide; therefore, a significant interruption of, or errors in, our software and services could expose us to significant customer liability.
Security breaches could result in lost revenues, litigation claims and/or harm to our reputation.
Our databases contain confidential data relating to our customers, policyholders and other industry participants. Security breaches, particularly those involving connectivity to the Internet, and the trend toward broad consumer and general public notification of such incidents, could significantly harm our business, financial condition or results of operations. Our databases could be vulnerable to physical system or network break-ins or other inappropriate access, which could result in claims against us and/or harm our reputation. In addition, potential competitors may obtain our data illegally and use it to provide services that are competitive to ours.
We operate in 49 countries, where we are subject to country-specific risks that could adversely impact our business and results of operations.
We generated approximately 69.0% of our revenues during fiscal 2007 outside the U.S., and we expect sales from non-U.S. markets to continue to represent a majority of our total sales. Sales and operations in individual countries are subject to changes in local government regulations and policies, including those related to tariffs and trade barriers, investments, taxation, currency exchange controls and repatriation of earnings. Our results are also subject to the difficulties of coordinating our operations across 49 different countries. Furthermore, our business strategy includes expansion of our operations into new and developing markets, which will require even greater international coordination, expose us to additional
local government regulations and involve markets in which we do not have experience or established operations. In addition, our operations in each country are vulnerable to changes in socio-economic conditions and monetary and fiscal policies, intellectual property protection disputes, the settlement of legal disputes through foreign legal systems, the collection of receivables through foreign legal systems, exposure to possible expropriation or other governmental actions, unsettled political conditions and possible terrorist attacks. These and other factors may harm our operations in those countries and therefore our business and results of operations.
Our operating results may vary widely from period to period, which may cause our stock price to decline.
Our contracts with insurance companies generally require time-consuming authorization procedures by the customer, which can result in additional delays between when we incur development costs and when we begin generating revenues from those software or services offerings. Our quarterly and annual revenues and operating results may fluctuate significantly in the future. In addition, we incur significant operating expenses while we are researching and designing new software and related services, and we typically do not receive corresponding payments in those same periods. As a result, the number of new software and services offerings that we are able to implement, successfully or otherwise, can cause significant variations in our cash flow from operations, and we may experience a decrease in our net income as we incur the expenses necessary to develop and design new software and services. We also may experience variations in our earnings due to other factors beyond our control, such as the introduction of new software or services by our competitors, customer acceptance of new software or services, the volume of usage of our offerings by existing customers and competitive conditions in our industry generally. We may also incur significant or unanticipated expenses when contracts expire, are terminated or are not renewed. Any of these events could harm our financial condition and results of operations and cause our stock price to decline.
Our future operating results may be subject to volatility as a result of exposure to foreign currency exchange risks.
We derive most of our revenues, and incur most of our costs, in currencies other than the U.S. dollar, principally the Euro. We currently do not hedge our exposure to foreign currency risks. In our historical financial statements, we re-measure our local currency financial results into U.S. dollars based on average exchange rates prevailing during a reporting period or the exchange rate at the end of that period. These re-measurements resulted in foreign currency translation adjustments of $10.9 million in fiscal 2005 (Predecessor), $3.8 million in fiscal 2006 and $4.8 million in fiscal 2007. Further fluctuations in exchange rates against the U.S. dollar could decrease our revenues, increase our costs and expenses and therefore harm our future operating results.
Future acquisitions and joint ventures or dispositions may require significant resources and/or result in significant unanticipated losses, costs or liabilities.
We have grown in part, and in the future may continue to grow, by making acquisitions or entering into joint ventures or similar arrangements. Acquisitions and joint ventures require significant investment and managerial attention, which may be diverted from our other operations, and could entail a number of additional risks, including:
· problems with effective integration of operations and/or management;
· loss of key customers, suppliers or employees;
· increased operating costs; and
· exposure to unanticipated liabilities.
Furthermore, we participate in joint ventures in some countries. Our partners in these ventures may have interests and goals that are inconsistent with or different from ours, which could result in the joint venture taking actions that negatively impact our growth in the local market and consequently harm our business or financial condition. If we are unable to find suitable partners or if suitable partners are unwilling to enter into joint ventures with us, our growth into new geographic markets may slow, which would harm our results of operations.
Additionally, we may finance future acquisitions and/or joint ventures with cash from operations, additional indebtedness and/or the issuance of additional securities, any of which may impair the operation of our business or present additional risks, such as reduced liquidity or increased interest expense. We may seek also to restructure our business in the future by disposing of certain of our assets, which may harm our future operating results, divert significant managerial attention from our operations and/or require us to accept non-cash consideration, the market value of which may fluctuate.
We may require additional capital in the future, which may not be available on favorable terms, or at all.
Our future capital requirements depend on many factors, including our ability to develop and market new software and services and to generate revenues at levels sufficient to cover ongoing expenses. If we need to raise additional capital, equity or debt financing may not be available at all or may be available only on terms that are not favorable to us. In the case of equity financings, dilution to our stockholders could result, and in any case such securities may have rights, preferences and privileges that are senior to those of the shares offered hereby. If we cannot obtain adequate capital on favorable terms or at all, we may be unable to support future growth or operating requirements and, accordingly, our business, financial condition and results of operations could be harmed.
Privacy concerns could require us to exclude data from our software and services, which may reduce the value of our offerings to our customers, damage our reputation and deter current and potential users from using our software and services.
In the European Union and other jurisdictions, there are significant restrictions on the use of personal data. Violations of these laws would harm our business. In addition, concerns about our collection, use or sharing of automobile insurance claims information or other privacy-related matters, even if unfounded, could damage our reputation and operating results.
Our business depends on our brands, and if we are not able to maintain and enhance our brands, our business and operating results could be harmed.
We believe that the brand identity that we have developed has significantly contributed to the success of our business. We also believe that maintaining and enhancing our brands, such as Audatex, ABZ, Hollander, Informex, Sidexa and IMS, are critical to the expansion of our software and services to new customers in both existing and new markets. Maintaining and enhancing our brands may require us to make substantial investments and these investments may not be successful. If we fail to promote and maintain our brands or if we incur excessive expenses in this effort, our business, operating results and financial condition will be harmed. We anticipate that, as our markets become increasingly competitive, maintaining and enhancing our brands may become increasingly difficult and expensive. Maintaining and enhancing our brands will depend largely on our ability to be a technology innovator and to continue to provide high quality software and services, which we may not do successfully. To date, we have engaged in relatively little direct brand promotion activities, and we may not successfully implement brand enhancement efforts in the future.
Third parties may claim that we are infringing upon their intellectual property rights, and we could be prevented from selling our software or suffer significant litigation expense even if these claims have no merit.
Our competitive position is driven in part by our intellectual property and other proprietary rights. Third parties, however, may claim that we, our software or operations or any products or technology, including claims data or other data, we obtain from other parties are infringing upon the intellectual property rights of others, and we may be unaware of intellectual property rights of others that may cover some of our assets, technology, software and services. Any litigation initiated against us regarding patents, trademarks, copyrights or other intellectual property rights, even litigation relating to claims without merit, could be costly and time-consuming and could divert our management and key personnel from operating our business. In addition, if any third party has a meritorious or successful claim that we are infringing upon its intellectual property rights, we may be forced to change our software or enter into licensing arrangement with third parties, which may be costly or impractical. These claims may also require us to stop selling our software and/or services as currently designed, which could harm our competitive position. We also may be subject to significant damages or injunctions that prevent the further development and sale of certain of our software or services and may result in a material loss in revenue.
We may be unable to protect our intellectual property and property rights, either without incurring significant costs or at all, which would harm our business.
We rely on a combination of patents, copyrights, know-how, trademarks, license agreements and contractual provisions, as well as internal procedures, to establish and protect our intellectual property rights. The steps we have taken and will take to protect our intellectual property rights may not deter infringement, duplication, misappropriation or violation of our intellectual property by third parties. In addition, any of the intellectual property we own or license from third parties may be challenged, invalidated, circumvented or rendered unenforceable. Furthermore, the laws of some of the countries in which products similar to ours may be developed may not protect our software and intellectual property to the same extent as U.S. laws or at all. We may be unable to protect our rights in trade secrets and unpatented proprietary technology in these countries. We may also be unable to prevent the unauthorized disclosure or use of our technical knowledge or trade secrets by consultants, vendors, former employees and current employees, despite the existence of nondisclosure and confidentiality agreements and other contractual restrictions. If our trade secrets become known, we may lose our competitive advantages. If we fail to protect our intellectual property, we may not receive any return on the resources expended to create the intellectual property or generate any competitive advantage based on it.
Pursuing infringers of our intellectual property could result in significant litigation costs and diversion of management resources, and any failure to pursue or successfully litigate claims against infringers could result in competitors using our technology and offering similar products and services, potentially resulting in loss of competitive advantage and decreased revenues.
Currently, we believe that one or more of our customers in our EMEA segment may be infringing our intellectual property by making and distributing unauthorized copies of our software. Enforcement of these intellectual property rights may be difficult and may require considerable resources.
We depend on a limited number of key personnel who would be difficult to replace. If we lose the services of these individuals, or are unable to attract new talent, our business will be adversely affected.
We depend upon the ability and experience of our key personnel, who have substantial experience with our operations, the rapidly changing automobile insurance claims processing industry and the markets in which we offer our software and services. The loss of the services of one or more of our senior executives or key employees, such as our Chief Executive Officer, Tony Aquila, could harm our business and
operations. Our success also depends on our ability to continue to attract, manage and retain other qualified management, sales and technical personnel as we grow. We may not be able to continue to attract or retain such personnel in the future.
We require a significant amount of cash to service our indebtedness, which reduces the cash available to finance our organic growth, make strategic acquisitions and enter into alliances and joint ventures.
We have a significant amount of indebtedness. As of June 30, 2007, our indebtedness, including current maturities, was $613.3 million, and we would have been able to borrow an additional $41.9 million under our amended and restated senior credit facility. During fiscal 2007, our aggregate interest expense was $69.7 million, and the cash paid for interest was $66.8 million.
Our indebtedness could:
· make us more vulnerable to unfavorable economic conditions and a reduction in our revenues;
· make it more difficult to obtain additional financing in the future for working capital, capital expenditures or other general corporate purposes;
· require us to dedicate or reserve a large portion of our cash flow from operations for making payments on our indebtedness, which would prevent us from using it for other purposes, including software development;
· make us susceptible to fluctuations in market interest rates that affect the cost of our borrowings to the extent that our variable rate debt is not covered by interest rate derivative agreements; and
· make it more difficult to pursue strategic acquisitions, joint ventures, alliances and collaborations.
Our ability to service our indebtedness will depend on our future performance, which will be affected by prevailing economic conditions and financial, business, regulatory and other factors. Some of these factors are beyond our control. If we cannot generate sufficient cash flow from operations to service our indebtedness and to meet our other obligations and commitments, we may be required to refinance our debt or to dispose of assets to obtain funds for such purpose. We cannot assure you that debt refinancings or asset dispositions could be completed on a timely basis or on satisfactory terms, if at all, or would be permitted by the terms of our debt instruments.
Our amended and restated senior credit facility limits our ability to pay dividends, incur additional debt, make acquisitions and make other investments.
Our amended and restated senior credit facility contains covenants that restrict our and our subsidiaries ability to make certain distributions with respect to our capital stock, prepay other debt, encumber our assets, incur additional indebtedness, make capital expenditures above specified levels, engage in business combinations or undertake various other corporate activities. These covenants may require us also to maintain certain specified financial ratios, including those relating to total leverage and interest coverage.
Our failure to comply with any of these covenants could result in the acceleration of our outstanding indebtedness. If acceleration occurs, we would not be able to repay our debt and it is unlikely that we would be able to borrow sufficient additional funds to refinance our debt. Even if new financing is made available to us, it may not be available on acceptable or reasonable terms. An acceleration of our indebtedness would impair our ability to operate as a going concern.
Current or future litigation could have a material adverse impact on us.
We have been and continue to be involved in legal proceedings, claims and other litigation that arise in the ordinary course of business. For example, we have been and are currently involved in disputes with collision repair facilities, acting individually and as a group in some situations that claim that we have colluded with our insurance company customers to depress the repair time estimates generated by our repair estimating software. In addition, we are currently one of the defendants in a putative class action lawsuit alleging that we have colluded with our insurance company customers to cause the estimates of vehicle fair market value generated by our total loss estimation software to be unfairly low. Furthermore, we are also subject to assertions by our customers that we have not complied with the terms of our agreements with them, which could in the future lead to arbitration or litigation. While we do not expect the outcome of any such pending or threatened litigation to have a material adverse effect on our financial position, litigation is unpredictable and excessive verdicts, both in the form of monetary damages and injunction, could occur. In the future, we could incur judgments or enter into settlements of claims that could harm our financial position and results of operations.
If we are not able to implement the requirements of Section 404 of the Sarbanes-Oxley Act in a timely manner or with adequate compliance, we may be subject to sanctions by regulatory authorities.
Section 404 of the Sarbanes-Oxley Act requires that we evaluate and determine the effectiveness of our internal control over financial reporting for our annual report for fiscal 2008. If we have a material weakness in our internal control over financial reporting, we may not detect errors on a timely basis and our financial statements may be materially misstated. We will continue to evaluate our internal controls systems to allow management to report on, and our independent auditors to attest to, our internal controls. We will continue to perform the system and process evaluation and testing (and any necessary remediation) required to comply with the management certification and auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act. While we anticipate being able to fully implement the requirements relating to internal controls and all other aspects of Section 404 by the above deadline, we cannot be certain as to the timing of completion of our evaluation, testing and remediation actions or the impact of the same on our operations. If we are not able to implement the requirements of Section 404 in a timely manner or with adequate compliance, we may be subject to sanctions or investigation by regulatory authorities, such as the Securities and Exchange Commission, or SEC, or the New York Stock Exchange, or NYSE. Any such action could adversely affect our financial results or investors confidence in us and could cause our stock price to fall. In addition, the controls and procedures that we will implement may not comply with all of the relevant rules and regulations of the SEC and NYSE. If we fail to develop and maintain effective controls and procedures, we may be unable to provide financial information in a timely and reliable manner, subjecting us to sanctions and harm to our reputation.
Requirements associated with being a public company increase our costs significantly, as well as divert significant company resources and management attention.
Prior to our initial public offering, we were not subject to the reporting requirements of the Securities Exchange Act of 1934, as amended, or the Exchange Act, or the other rules and regulations of the SEC or any securities exchange relating to public companies. We are working with our legal, independent accounting and financial advisors to identify those areas in which changes should be made to our financial and management control systems to manage our growth and our obligations as a public company. These areas include corporate governance, corporate control, internal audit, disclosure controls and procedures and financial reporting and accounting systems. We have made, and will continue to make, changes in these and other areas. However, the expenses that are required as a result of being a public company could be material. Compliance with the various reporting and other requirements applicable to public companies also require considerable time and attention of management. We cannot predict or estimate the amount of
the additional costs we may incur, the timing of such costs or the degree of impact that our managements attention to these matters will have on our business. In addition, the changes we make may not be sufficient to allow us to satisfy our obligations as a public company on a timely basis.
In addition, being a public company could make it more difficult or more costly for us to obtain certain types of insurance, including directors and officers liability insurance, and we may be forced to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage. The impact of these events could also make it more difficult for us to attract and retain qualified persons to serve on our board of directors, our board committees or as executive officers.
Our certificate of incorporation and by-laws contain provisions that could discourage another company from acquiring us and may prevent attempts by our stockholders to replace or remove our current management.
Some provisions of our certificate of incorporation and by-laws may have the effect of delaying, discouraging or preventing a merger or acquisition that our stockholders may consider favorable, including transactions in which stockholders may receive a premium for their shares. In addition, these provisions may frustrate or prevent any attempts by our stockholders to replace or remove our current management by making it more difficult for stockholders to replace or remove our board of directors. These provisions include:
· authorization of the issuance of blank check preferred stock without the need for action by stockholders;
· the removal of directors only by the affirmative vote of the holders of two-thirds of the shares of our capital stock entitled to vote;
· any vacancy on the board of directors, however occurring, including a vacancy resulting from an enlargement of the board, may only be filled by vote of the directors then in office;
· inability of stockholders to call special meetings of stockholders and limited ability of stockholders to take action by written consent; and
· advance notice requirements for board nominations and proposing matters to be acted on by stockholders at stockholder meetings.
We currently do not intend to pay dividends on our common stock, and as a result, your only opportunity to achieve a return on your investment is if the price of our common stock appreciates.
We currently do not expect to declare or pay dividends on our common stock in the foreseeable future. In addition, our amended and restated senior credit facility limits our ability to declare and pay cash dividends on our common stock. As a result, your only opportunity to achieve a return on your investment in us will be if the market price of our common stock appreciates and you sell your shares at a profit. We cannot assure you that the market price for our common stock will ever exceed the price that you pay.
Our corporate headquarters are located in San Ramon, California, where we lease approximately 107,000 square feet of space and have subleased approximately 54,000 square feet of this space.
Our principal leased EMEA facilities include Zurich, Switzerland and Zeist, the Netherlands. Our principal leased Americas facilities include San Diego, California, Ann Arbor, Michigan, Plymouth, Minnesota and Milwaukie, Oregon. We also lease a number of other facilities across the regions where we operate. We own real estate in Minden, Germany, Brussels, Belgium and Reading, United Kingdom.
We believe that our existing space is adequate for our current operations. We believe that suitable replacement and additional space will be available in the future on commercially reasonable terms
As a normal incident of the business in which we are engaged, various claims, charges and litigation are asserted or commenced against us. We believe that final judgments, if any, which may be rendered against us in current litigation, are adequately reserved for, covered by insurance or would not have a material adverse effect on our financial position. We have from time to time been the subject of allegations that our repair estimating and total loss software and services produced results that favored our insurance company customers. In addition, we are currently one of the defendants in a putative class action lawsuit alleging that we have colluded with our insurance company customers to cause the estimates of vehicle fair market value generated by our total loss estimation products to be unfairly low.
Prior to the completion of our initial public offering on May 16, 2007, we had 45,523,175 shares of common stock outstanding, 91.2% of which was owned by entities affiliated with GTCR, and the rest of which was owned by our directors, executive officers and certain other employees.
On May 10, 2007, holders of 44,426,880 shares of our common stock, or 97.6% of our then-outstanding common stock, executed a written consent in accordance with our then-existing certificate of incorporation in order to approve our amended and restated certificate of incorporation, our amended and restated by-laws, the Solera Holdings, Inc. 2007 Employee Stock Purchase Plan, the Solera Holdings, Inc. 2007 Long Term Equity Incentive Plan, indemnification agreements with our directors, the election of Jerrell Shelton and Stuart J. Yarbrough as directors and the selection of Deloitte & Touche LLP as independent public accountants.
Our common stock has been listed on The New York Stock Exchange under the symbol SLH since May 11, 2007. Prior to that time, there was no public market for our common stock. The initial public offering price of our common stock was $16.00 per share, and the initial public offering closed on May 16, 2007. The closing sale price of our common stock on The New York Stock Exchange was $17.28 per share on September 14, 2007. From May 11, 2007 through June 30, 2007, the range of the high and low sale prices of our common stock was $15.41 to $19.69 per share. As of September 14, 2007, there were approximately 42 holders of record of our common stock. The transfer agent and registrar for our common stock is Computershare Trust Company N.A.
Unregistered Sales of Equity Securities
In January 2007, we sold an aggregate of 690,081 Class A Common Units to 22 of our employees at $0.30 per unit for aggregate proceeds of $207,027. In February 2007, we sold an aggregate of 50,000 Class A Common Units to two of our employees at $0.30 per unit for aggregate proceeds of $15,000. These issuances were made without registration in reliance upon Rule 701 of the Securities Act and did not involve any underwriters, underwriting discounts or commissions or any public offering. The persons and entities who received such securities represented that they acquired these securities for investment only and not with a view for sale or in connection with any distribution thereof, and appropriate legends were affixed to any share certificates issued. All recipients had adequate access through their relationship with us to information about us.
Securities Authorized for Issuance under Equity Compensation Plans
See Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters for information regarding securities authorized for issuance under our equity compensation plans.
The following graph compares our cumulative total stockholder return since the date our common stock began trading on The New York Stock Exchange, May 11, 2007, with the Russell 2000 Index and an aggregate of peer issuers in the information services industry. The peer issuers used for this graph are The Thomson Corporation, Equifax Inc., The Dun & Bradstreet Corporation, ChoicePoint Inc., FactSet Research Systems Inc., Fair Isaac Corporation, DealerTrack Holdings, Inc. and CoStar Group, Inc. Each peer issuer was weighted according to its respective capitalization on May 11, 2007.
The graph assumes that the value of the investment in our common stock and each index was $100 on May 11, 2007.
The information in the graph and table above is not soliciting material, is not deemed filed with the Securities and Exchange Commission and is not to be incorporated by reference in any of our filings under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, whether made before or after the date of this annual report, except to the extent that we specifically incorporate such information by reference.
Issuer Purchases of Equity Securities
We did not repurchase any of our common stock during the fourth quarter of the fiscal year ended June 30, 2007.
The following table sets forth selected historical financial information regarding our business and should be read in conjunction with Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations and our consolidated financial statements and the related notes included elsewhere in this Annual Report on Form 10-K.
The selected historical consolidated financial data as of and for the fiscal years ended June 30, 2007 and 2006 are derived from the audited consolidated financial statements of Solera Holdings, Inc. that are included elsewhere in this Annual Report on Form 10-K. The historical combined balance sheet data as of June 30, 2003, 2004 and 2005 and the combined statements of operations and cash flows data for fiscal 2003, 2004 and 2005 and the period from July 1, 2005 through April 13, 2006 are derived from the audited combined financial statements of the Claims Services Group, which are not included in this Annual Report on Form 10-K.
(1) The Claims Services Group was owned by ADP until subsidiaries of Solera Holdings, LLC acquired it on April 13, 2006.
(2) The statement of operations data for fiscal 2006 include the results of operations for our predecessor from April 14, 2006 and the results of operations for Solera Holdings, LLC for all of fiscal 2006. Financial information presented reflects adjustment of assets and liabilities to then fair value at the date of the Acquisition, which is used as the basis for amounts included in our results of operations from April 14, 2006 until June 30, 2006. Prior to the Acquisition, Solera Holdings, LLCs operations consisted primarily of developing our business plan, recruiting personnel, providing consulting services, raising capital and identifying and evaluating operating assets for acquisition.
(3) All unit and per unit amounts give effect to a one-for-three reverse split of our common units, which was completed on April 30, 2007.
You should read the following discussion and analysis of our financial condition and results of operations in conjunction with the information set forth under Item 6. Selected Financial Data and our consolidated financial statements and the notes to those statements included elsewhere in this Annual Report on Form 10-K. The statements in this discussion regarding industry outlook, our expectations regarding our future performance, liquidity and capital resources and other non-historical statements in this discussion are forward-looking statements. These forward-looking statements are subject to numerous risks and uncertainties, including, but not limited to, those described under Item 1A. Risk Factors, and elsewhere in this Annual Report on Form 10-K. Our actual results could differ materially from the results described in or implied by the forward-looking statements contained in the following discussion and analysis.
We are the leading global provider of software and services to the automobile insurance claims processing industry. Our customers include more than 900 automobile insurance companies, including each of the ten largest automobile insurance companies in Europe and each of the ten largest automobile insurance companies in North America. We also provide our software and services to over 33,000 collision repair facilities, 7,000 independent assessors and 3,000 automotive recyclers. Our software and services help our customers: estimate the costs to repair damaged vehicles; determine pre-collision fair market values for vehicles damaged beyond repair; automate steps of the claims process; outsource steps of the claims process that insurance companies have historically performed internally; and improve their ability to monitor and manage their businesses through data reporting and analysis. We have operations in 49 countries and derive most of our revenues from our estimating and workflow software.
Solera Holdings, LLC was initially formed in March 2005. On April 13, 2006, subsidiaries of Solera Holdings, LLC acquired the Claims Services Group, or CSG, a business unit of ADP, for approximately $1.0 billion. Prior to the Acquisition, Solera Holdings, LLCs operations consisted primarily of developing our business plan, recruiting personnel, providing consulting services, raising capital and identifying and evaluating operating assets for acquisition. For a discussion of the accounting basis for our financial disclosures, see Item 1BusinessGeneral.
We accounted for the Acquisition using the purchase method of accounting. As a result, the Acquisition has and will continue to affect our results of operations significantly. We allocated the aggregate acquisition consideration to the tangible and intangible assets acquired and liabilities assumed based on their respective fair values as of the date of the Acquisition, which resulted in an increase in the accounting bases of some of our assets. This has resulted in a significant increase in our annual depreciation and amortization expenses. In addition, due to the effects of the increased borrowings to finance the Acquisition, our interest expense has increased significantly in the periods following the acquisition. As a result, the financial information for periods beginning on or after July 1, 2006 is not comparable to the information prior to this date.
Prior to the Acquisition, our business was operated as CSG, a business unit of ADP. As a result, the combined financial information of CSG is presented on a carve-out basis and reflects the assets, liabilities, revenues and expenses that were attributed or allocated to it as a business unit of ADP. The historical financial results in the combined financial statements may not be indicative of the results that would have been achieved had we operated as a stand-alone entity. These combined financial statements include costs for facilities, functions and services used by CSG at ADP sites that it shared with other ADP business units
and costs for certain functions and services performed by centralized ADP organizations and directly charged to CSG based on usage. The combined statements of earnings for CSG include allocations of certain expenses of ADP, including general corporate overhead, insurance, stock compensation and pension plans, royalty fees, facilities and other expenses. These allocations were based on a variety of factors.
On May 10, 2007, in connection with our initial public offering, we converted from a limited liability company into a Delaware corporation, and all of our Class A Common Units and Class B Preferred Units were converted into shares of our common stock.
We operate our business using two reportable segments: EMEA and Americas. Our EMEA segment consists of our operations in Europe, the Middle East, Africa and Asia. Our Americas segment consists of our operations in North, Central and South America. Prior to December 1, 2006, we organized our business using three reportable segments: EMEA, Americas and the Netherlands. Since that date, we have reorganized our operations into two regional operating segments (EMEA and Americas) by incorporating our Netherlands operations into our EMEA segment. In addition, for periods prior to the Acquisition, we included our Latin American operations in our EMEA segment. We have recast the financial information in this Annual Report on Form 10-K, other than the information relating to our predecessor, to conform to our current segments.
The table below sets forth our revenues by regional operating segment and as a percentage of our total revenues for the periods indicated.
Set forth below is our percentage of revenues for the periods presented from each of our principal customer categories:
For fiscal 2007, the United States, the Netherlands and the United Kingdom were the only countries that individually represented more than 10% of total revenues.
The accounting policies for each of our segments are the same. We evaluate the operating performance of our segments based primarily upon their respective revenues and EBITDA. For the most part, we do not evaluate our costs and expenses on a per segment basis.
We generate revenues from the sale of software and services to our customers pursuant to negotiated contracts or pricing agreements. Pricing for our software and services is set forth in these agreements and negotiated with each customer. We generally bill our customers monthly under one or more of the following bases:
· price per transaction;
· fixed monthly amount for a prescribed number of transactions;
· fixed monthly subscription rate;
· price per set of services rendered; or
· price per system delivered.
Our software and services are often sold as packages, without individual pricing for each component. Our revenues are reflected net of customer sales allowances, which we estimate based on both our examination of a subset of customer accounts and historical experience.
Elsewhere in this Annual Report on Form 10-K, solely for ease of understanding, we have grouped our software and services into five general categories: estimating and workflow software, salvage and recycling software, business intelligence and consulting services, shared services and other. See BusinessOur Software and Services. Our core offering is our estimating and workflow software, which is used by our insurance company, collision repair facility and independent assessor customers and which we believe represents the majority of our revenues. We believe that our salvage and recycling software, business intelligence and consulting services, shared services and other offerings represent in the aggregate a smaller portion of our revenues. We currently derive an insubstantial portion of our revenues from our shared services offerings. We believe that our estimating and workflow software will continue to represent a majority of our revenue for the foreseeable future.
Cost of Revenues (excluding depreciation and amortization)
Our costs and expenses applicable to revenues represent the total of operating expenses and systems development and programming costs, which are discussed below.
Our operating expenses include compensation and benefit costs for our operations, database development and customer service personnel; other costs related to operations, database development and customer support functions; third-party data and royalty costs; and costs related to computer software and hardware used in the delivery of our software and services.
Systems Development and Programming Costs
Systems development and programming costs include compensation and benefit costs for our product development and product management personnel, other costs related to our product development and product management functions and costs related to external software consultants involved in systems development and programming activities.
Selling, General and Administrative Expenses
Our selling, general and administrative expenses include compensation and benefit costs for our sales, marketing, administration and corporate personnel; other costs related to our sales, marketing, administrative and corporate functions; costs related to our facilities; and professional and legal fees.
Depreciation and Amortization
Depreciation includes depreciation attributable to buildings, leasehold improvements, data processing and computer equipment, furniture and fixtures. Amortization includes amortization attributable to software purchases and software developed or obtained for internal use and our intangible assets, the majority of which were acquired in the Acquisition.
Interest expense consists primarily of payments of interest on our credit facilities and amortization of related debt issuance costs.
Other (Income) Expense-Net
Other (income) expense-net consists of foreign exchange gains and losses on notes receivable and notes payable to affiliates as well as other miscellaneous income and expense.
Minority Interests in Net Income of Consolidated Subsidiaries
Several of our customers own minority interests in our local operating subsidiaries. Minority interests in net income of consolidated subsidiaries reflect such customers proportionate interest in the earnings of such operating subsidiaries. In April 2004, we increased our ownership interest in a Spanish entity from 25% to 75%, which resulted in such entity being consolidated with our results of operations.
Income Tax Provision (Benefit)
Prior to our corporate reorganization on May 10, 2007, we were a limited liability company and, therefore, we were not subject to entity-level federal income taxation. However, even as a limited liability company, we incurred income taxes on our operations as they were held by taxable entities in the U.S. and in foreign jurisdictions. Historical financial statements for our predecessor, which was a C corporation for federal income tax purposes, are based on corporate tax rates for the periods presented. Prior to our corporate reorganization, our income taxes were payable by our equity holders at rates applicable to them. Following our conversion to a C corporation, transactions recorded by us are subject to federal income taxation for which we do not expect a significant impact to our overall income tax liability. Income taxes have been provided for all items included in the statements of income (loss) included herein, regardless of when such items were reported for tax purposes or when the taxes were actually paid or refunded.
As part of the Acquisition, a portion of the purchase price was allocated to intangible assets and goodwill. For most jurisdictions in which we operate, the amortization charges and impairment charges will not be deductible for income tax purposes. The net deferred tax liability as shown on our balance sheet is primarily the result of the difference between book and tax basis of the acquired intangible assets.
Overview. The automobile insurance claims processing industry is influenced by growth and trends in the automobile insurance industry. Demand for our software and services is generally related to automobile usage and the penetration of automobile insurance in our markets. A large portion of our
operating costs are fixed and we generate a large percentage of our revenues from periodic-and transaction-based fees related to software and ongoing claims processing services.
Our operating results are and will be influenced by a variety of factors, including:
· gain and loss of customers;
· pricing pressures;
· expansions into new markets, which requires us to incur costs prior to generating revenues;
· expenses to develop new software or services;
· restructuring charges related to efficiency initiatives;
· the Acquisition in April 2006, including the debt we incurred; and
· our corporate reorganization and the refinancing transactions.
Foreign currency. During the fiscal year ended June 30, 2007, we generated approximately 69% of our revenues, and incurred a majority of our costs, in currencies other than the U.S. dollar, primarily the Euro. We currently do not hedge our exposure to foreign currency risks. In our historical financial statements, we re-measure our local currency financial results in U.S. dollars based on average exchange rates prevailing during a reporting period or the exchange rate at the end of that period. These re-measurements resulted in foreign currency translation adjustments of $3.8 million in fiscal 2006 and $4.8 million in fiscal 2007 in our consolidated financial statements.
In February 2006, we entered into a foreign exchange option that gave us the right to call $200.0 million in U.S. dollars at a strike price of 1.1646 per U.S. dollar at any time up to February 8, 2011. We paid approximately $7.9 million for this option. The fair value of this option was approximately $4.0 million as of June 30, 2006 and $1.0 million as of June 30, 2007, and was recorded in other assets in our consolidated balance sheet. Decreases in fair value of approximately $3.9 million, and $3.0 million were recognized in other expense in the statement of operations during fiscal 2006 and 2007, respectively.
Non-cash charges. On July 25, 2006, November 8, 2006 and January 26, 2007, we granted the right to purchase Class A common units to certain employees. Under these and other arrangements, we issued an aggregate of 625,429 Class A common units to 20 of our employees for $0.2 million in January 2007 and an aggregate of 50,000 Class A common units to two of our employees for $15,000 in February 2007. In May 2007, we issued restricted stock units covering an aggregate of 304,730 shares to certain of our employees. We expect to incur a pre-tax, non-cash charge of approximately $7.6 million in connection with these issuances, expensed ratably over vesting periods of up to 60 months. During fiscal 2007, we have recognized approximately $2.3 million as compensation expense. In the fourth quarter of fiscal 2007, we incurred an additional pre-tax, non-cash charge of approximately $35.7 million on the early extinguishment of debt associated with the completion of our initial public offering and the refinancing of debt. This relates primarily to the write-off of unamortized debt issuance costs and a prepayment premium on our second lien credit facility and our subordinated unsecured credit facility.
Restructuring charges. We have incurred restructuring charges (or reversal) in each period presented and also expect to incur additional restructuring charges, primarily relating to severance costs, over the next several quarters as we work to improve efficiencies in our business. We are currently evaluating several plans that would eliminate redundant personnel in each of our segments, as well as reduce our need for certain facilities. If all of these plans were to be executed upon, we would expect to incur restructuring charges of approximately $3.0 million to $4.0 million over the next twelve months. These potential charges, consisting primarily of termination benefits, will significantly reduce our cash balances. The resulting benefit of these restructuring plans, if implemented, would reduce our cost of revenues and our selling, general and administrative expenses by approximately $2.5 million to $4.0 million on an annual
basis. We do not expect reduced revenues or an increase in other expenses as a result of any of these restructuring plans.
The table below sets forth our results of operations data expressed as a percentage of revenues for the periods indicated:
The table below sets forth statement of operations data, including the amount and percentage changes for the periods indicated:
Revenues. Revenues increased $41.7 million due to higher revenues in both our EMEA and Americas segments. Our EMEA revenues increased $36.8 million, or 15.1%, to $280.1 million due to growth in transaction and subscription revenues in several countries from both existing as well as several new customers, and a $3.5 million increase resulting from the completion of a small acquisition in the Netherlands. Our Americas revenues increased $4.9 million, or 2.6%, to $191.8 million due to growth in transaction and subscription revenues in the U.S., Canada, Brazil and Mexico, partially offset by the loss of several significant U.S. insurance customer contracts, and a reduction in contract pricing terms given to a large U.S. insurance customer. Revenue growth for each of our customer categories was as follows:
Operating expenses. Operating expenses increased $8.5 million, or 6.6%, due to higher operating expenses in both our EMEA and Americas segments. Operating expenses increased $0.9 million in our Americas segment due to a $0.7 million increase in third party license and royalty fees and a $0.4 million increase in personnel costs, offset by a $0.2 million decrease in other operating expenses. Operating expenses increased $7.6 million in our EMEA segment due to a $10.8 million increase in data center and external support and maintenance costs and a $2.0 million increase in third party license and royalty costs, offset by a $4.0 million decrease in personnel costs and a $1.2 million decrease in other operating expenses. We continually evaluate our operating costs in order to identify inefficiencies and eliminate unnecessary costs. We anticipate that, although our operating expenses will continue to increase, they will decline as a percentage of revenues over the next several years.
Systems development and programming costs. Systems development and programming costs increased $0.7 million, or 1.1%, due to a $3.6 million increase in costs in our EMEA segment, offset by a $2.9 reduction in costs in our Americas segment The increased costs in our EMEA segment were related to additional expenses associated with the development of software updates and new software releases. The lower costs in our Americas segment were due to reductions in the number of full-time systems development and programming personnel and lower external software consultant costs. Our systems development and programming costs fluctuate based upon the levels and timing of product releases. We expect our systems development and programming costs to remain relatively stable over the next several quarters.
Selling, general and administrative expenses. Selling, general and administrative expenses increased $23.6 million, or 21.3%, due to increased costs of $13.4 million in our EMEA segment and increased costs of $10.2 million in our Americas segment. The increased costs in our Americas segment were the result of an increase in professional and legal fees, facilities costs, and severance and acquisition transition costs. The increased costs in our EMEA segment were the result of an increase in personnel costs, facilities costs, advertising costs and severance and acquisition transition costs. A portion of these costs increases in our EMEA segment were the result of our expansion efforts into new markets, such as Eastern Europe, India and China. We expect these expenses to continue to increase as we incur additional costs associated with being a public company and as we continue to expand our business into new markets.
Depreciation and amortization. Depreciation and amortization decreased by $18.1 million primarily due to lower intangibles amortization expense resulting from the Acquisition. We amortize these intangible assets on an accelerated basis to reflect the pattern in which economic benefits of the intangible assets are consumed. Although we expect to experience significant depreciation and amortization in the future as we amortize intangible assets purchased in the Acquisition, we anticipate that the amount of total depreciation and amortization expense will continue to decline over the next several years.
Restructuring charges. Restructuring charges of $6.0 million were incurred during fiscal 2007 as a result of operational reviews conducted after the Acquisition and relate almost entirely to one-time termination benefits. We expect to incur additional restructuring charges, relating primarily to severance costs, over the next several quarters as we work to improve efficiencies in our business.
Interest expense. Interest expense decreased $1.7 million due to lower borrowings under our credit facilities, which were in part due to the refinancing transactions completed on May 16, 2007 in conjunction with our initial public offering. We expect that our annual interest expense will continue to decrease as we repay outstanding indebtedness.
Other (income) expense, net. Total other (income) expense, net increased $32.7 million due to a $35.7 million write-off of deferred financing fees associated with our prior credit facilities that were amended and restated on May 16, 2007 in conjunction with our initial public offering, offset by lower net realized and unrealized losses on our derivative instruments and other (income) and expenses.
Income tax provision. We recorded an income tax benefit of $0.8 million for fiscal 2007. Factors that impact our income tax provision include (but are not limited to) the mix of jurisdictional earnings, establishment of valuation allowances in certain jurisdictions, and varying jurisdictional income tax rates that are applied.
Fiscal Year Ended June 30, 2006 (Acquisition Pro Forma) Compared to Fiscal Year Ended June 30, 2005 (Predecessor)
Revenues. Revenue growth in fiscal 2006 (Acquisition pro forma) was due to a significant increase in revenues in our EMEA segment and a small increase in revenues in our Americas segment. Our EMEA revenues grew $16.3 million, or 7.2%, to $243.3 million due to a $16.3 million increase in revenues resulting from the inclusion of a full twelve months of operations of our Spanish subsidiary, which we began consolidating in May 2005, and a $1.8 million increase due to the acquisition of two German entities in fiscal 2006. These increases were partially offset by reduced sales in several of our European countries resulting from prior price reductions offered to several customers. Our Americas revenues increased $1.6 million, or 0.8%, to $186.9 million due to growth in Canada, Brazil and Mexico, partially offset by the loss of several significant U.S. insurance company customer contracts and a reduction in contract pricing terms given to a large U.S. insurance customer.
Operating expenses. The $12.5 million increase in operating expenses was due to an increase of approximately $7.5 million in costs of customer support, operations, and database development personnel and approximately $5.0 million as a result of the inclusion of a full twelve months of operations of our Spanish subsidiary, which we began consolidating in May 2005.
Systems development and programming costs. Systems development and programming costs increased $1.7 million due to increases of $0.6 million in systems development and programming personnel and external software consultant costs related to the development of software version updates and new product releases in certain of our markets and approximately $1.1 million related to inclusion of a full twelve months of operations of our Spanish subsidiary.
Selling, general and administrative expenses. Selling, general and administrative expenses decreased due to reduced costs of executive, administrative and sales personnel, which resulted from a workforce
reduction, partially offset by an increase of approximately $2.4 million due to the inclusion of a full twelve months of operations of our Spanish subsidiary.
Depreciation and amortization. Depreciation and amortization increased significantly due to the amortization of intangibles associated with the Acquisition. The depreciation and amortization corresponded to the value allocated to our assets as a result of the Acquisition.
Restructuring charges. We recorded restructuring charges, which consisted primarily of one-time termination benefits, of approximately $2.4 million during fiscal 2006 (Acquisition pro forma) as a result of restructuring initiatives related to operational reviews conducted after the Acquisition. These restructuring initiatives were designed to achieve efficiencies and reduce costs in response to changes in projected demand for certain of our services and include one-time termination benefits related to the termination of approximately 45 employees. We recorded restructuring charges, which primarily consisted of one-time termination benefits, of approximately $5.5 million during fiscal 2005 (Predecessor) as a result of similar restructuring initiatives. These one-time termination benefits related to the termination of approximately 125 employees.
Interest expense. Interest expense increased significantly as a result of borrowings under our credit facilities in connection with the Acquisition.
Other (income) expense, net. Other expense in fiscal 2006 (Acquisition pro forma) included a $3.9 million write-down in the fair value of our foreign currency exchange option offset by a $1.1 million unrealized gain related to two interest rate swaps.
Income tax provision. Income taxes were a provision of $1.0 million in fiscal 2006 (Acquisition pro forma) compared to $24.0 million in fiscal 2005 (Predecessor) as a result of amortization expense and interest expense associated with the Acquisition. Pro forma fiscal 2006 reflects a pro forma tax rate of 1.3% and fiscal 2005 (Predecessor) reflects an actual tax rate of 28.7%. The fiscal 2006 (Acquisition pro forma) tax expense is primarily due to losses of $51.4 million resulting from interest charges related to Acquisition indebtedness occurring in jurisdictions for which we have not recorded a tax benefit due to uncertainty regarding the realizability of such losses.
Prior to the Acquisition, our predecessors principal sources of liquidity were capital contributions from ADP and cash generated from operations. Since the Acquisition, our principal sources of cash have included cash generated from operations and bank borrowings. Our principal uses of cash have included debt service, capital expenditures and working capital. We expect that these will remain our principal uses of cash in the future; however, we may use additional cash to pursue additional acquisitions. We expect our cash needs to service debt will decrease in future periods as a result of the application of proceeds from the refinancing transactions completed in conjunction with our initial public offering which were used to repay debt.
We believe that cash flow from operating activities and borrowings under our amended and restated senior credit facility will be sufficient to fund currently anticipated working capital, planned capital spending and debt service requirements for the foreseeable future, including at least the next twelve months. We regularly review acquisition and other strategic opportunities, which may require additional debt or equity financing. We currently do not have any pending agreements or understandings with respect to any acquisition or other strategic opportunity.
Cash and Cash Equivalents
As of June 30, 2007, we had cash and cash equivalents of $89.9 million. We fund our operations, working capital and capital expenditures with our cash on hand and short-term borrowings under our
credit facility. Our cash on hand and short-term borrowings vary significantly based on our cash flows as set forth below.
The following summarizes our primary sources and uses of cash in the periods presented:
Operating activities. Cash provided by operating activities was $46.1 million and $45.4 million during fiscal 2007 and 2006, respectively. The increase in cash provided by operating activities during fiscal 2007 was primarily the result of an increase in the non-cash adjustments, such as depreciation and amortization and loss on debt extinguishment, to reconcile net loss to cash, partially offset by the changes in operating assets and liabilities. Cash provided by operations decreased in fiscal 2006 due primarily to the fact that our figure for fiscal 2006 incorporates the results of our predecessor only for the period from April 14, 2006 through June 30, 2006 and our figure for fiscal 2005 represents a full twelve months of our predecessors operations.
Investing activities. Cash used in investing activities in fiscal 2005 included acquisition of 50% interest in an affiliate in Spain for approximately $31.5 million. Cash used in investing activities in fiscal 2006 included $924.4 million net cash amount used to complete the Acquisition on April 13, 2006. In fiscal 2007, we acquired a small operating entity in the Netherlands for approximately $1.0 million. We also paid approximately $13.2 million to ADP as final working capital payment for the Acquisition.
For fiscal 2007, capital expenditures were $27.2 million, consisting of computers, computer software, leasehold improvements and furniture and fixtures. Capital expenditures were $7.7 million and $4.1 million in fiscal 2005 and 2006, respectively, and were for the purchase of computers, computer software, leasehold improvements and furniture and fixtures. Our predecessors capital expenditures were $9.7 million during the period from July 1, 2005 through the date of the Acquisition.
Financing activities. Cash used in financing activities was $6.4 million during fiscal 2007 and cash provided by financing activities was $978.0 million during fiscal 2006. Cash used during fiscal 2007 was the net result of our initial public offering and debt refinancing proceeds offset by payments on the original debt incurred for the Acquisition. Cash provided by financing activities during fiscal 2006 consisted primarily of issuances of debt, offset by the payment of principal on our long-term borrowings.
Financing activities in fiscal 2005 included amounts received from ADP, the parent of our predecessor. Financing activities in fiscal 2006 included proceeds raised by us to finance the Acquisition on April 13, 2006. The aggregate purchase price for the Acquisition was approximately $1.0 billion, including costs attributable to the Acquisition. The Acquisition was financed through:
· borrowings under our senior secured credit facility of approximately $714.6 million;
· borrowings under our subordinated unsecured credit facility of approximately $95.2 million; and
· the sale of equity securities to investment funds managed by GTCR and other related investors and certain members of our senior management for approximately $207.8 million.
We received $281.8 million in net proceeds from our initial public offering, which we completed on May 16, 2007, after deducting underwriting discounts, commissions and expenses of approximately $25.4 million, and $610.7 million in net proceeds under our amended and restated credit facility, after debt issuance costs of approximately $4.4 million. $889.2 million of the $892.5 million of combined net proceeds were used to repay (1) $538.6 million under our then existing first lien credit facility, (2) $226.2 million under our then existing second lien credit facility, and (3) $124.4 million under our then existing subordinated unsecured credit (mezzanine) facility.
Amended and Restated Senior Credit Facility
In connection with our initial public offering, we entered into an amended and restated senior credit facility. Our amended and restated senior credit facility consists of a $50.0 million revolving credit facility, a $230.0 million domestic term loan and a 280.0 million European term loan. As of June 30, 2007, we had $8.1 million, $229.4 million and $375.8 million (279.3 million) in outstanding loans under the revolving credit facility, domestic term loan and European term loan, respectively, with interest rates of 6.375%, 7.360% and 6.164%, respectively. The amended and restated senior credit facility contains a leverage ratio, which is applicable only to the revolving loans and applies only if at least $10.0 million of revolving loans, net of outstanding letters of credit, are outstanding for at least 10 days during the prior fiscal quarter.
In addition, the amended and restated senior credit facility contains covenants restricting us from undertaking specified corporate actions, including asset dispositions, acquisitions, payment of dividends and other specified payments, changes of control, incurrence of indebtedness, creation of liens, making loans and investments and transactions with affiliates.
The following table reflects our contractual obligations as of June 30, 2007:
(1) Represents principal maturities and includes the effects of interest and interest rate swaps.
Our off-balance sheet arrangements comprise our operating leases. As of June 30, 2007, we had no outstanding letters of credit.
We believe inflation has not had a material effect on our financial condition or results of operations in recent years. Our business does not experience any material level of seasonality.
The accompanying consolidated financial statements of Solera Holdings, Inc., have been prepared in accordance with generally accepted accounting principles. The preparation of these financial statements requires us to make estimates and judgments that affect the amounts reported in those financial
statements. On an ongoing basis, we evaluate estimates. We base our estimates on historical experiences and assumptions which we believe to be reasonable under the circumstances. Those estimates form the basis for our judgments that affect the amounts reported in the financial statements. Actual results could differ from our estimates under different assumptions or conditions. Our significant accounting policies, which may be affected by our estimates and assumptions, are more fully described in Note 2 to the consolidated financial statements of Solera Holdings, Inc. and the accompanying consolidated financial statements.
Goodwill and other intangible assets. We account for goodwill and other intangible assets in accordance with Statement of Financial Accounting Standards, or SFAS, No. 142, Goodwill and Other Intangible Assets, which states that goodwill and intangible assets with indefinite useful lives should not be amortized, but instead be tested for impairment at least annually at the reporting unit level. If an impairment exists, a write-down to fair value (normally measured by discounting estimated future cash flows) is recorded. Intangible assets with finite lives are amortized over their estimated useful lives based on expected revenues to be generated from the use of such assets and are reviewed for impairment in accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. As of June 30, 2007, we had goodwill of $569.2 million and intangible assets of $363.0 million.
Revenue recognition. We consider the guidance in Staff Accounting Bulletin Topic 13, Revenue Recognition, or SAB 104, American Institute of Certified Public Accountants, or AICPA, Statement of Position 97-2, Software Revenue Recognition, as amended, or SOP 97-2, SFAS No. 13, Accounting for Leases, Emerging Issues Task Force, or EITF, Issue No. 00-03, Application of AICPA Statement of Position 97-2 to Arrangements That Include the Right to Use Software Stored on Another Entitys Hardware, and Emerging Issues Task Force Issue No. 00-21, Revenue Arrangements with Multiple Deliverables, or EITF 00-21, in accounting for our revenue arrangements. Revenues are recognized only after services are provided, when persuasive evidence of an arrangement exists, the fee is fixed and determinable, and when collectibility is reasonably assured. Our multiple element arrangements primarily include a combination of software licenses, hosted database and other services, installation and set-up services, hardware, maintenance services and transaction-based deliverables.
We generate a significant majority of our revenue from subscription-based contracts (where a monthly fee is charged), transaction-based contracts (where a fee per transaction is charged) and subscription-based contracts with additional transaction-based fees (where a monthly fee and a fee per transaction are charged).
Subscription-based and transaction-based contracts generally include the delivery of software, access to software through a hosted service, or hosted database, upfront fees for the implementation and set-up activities necessary for the client to use/access the software, or implementation services, and maintenance. Under a subscription arrangement, delivery of software, access to the hosted database and maintenance are considered a single element or a combined unit of accounting, and related revenues are recognized at the end of each month upon the completion of the monthly service. Revenues under transaction-based contracts are recognized based on the guidance in AICPA Technical Practice Aid 5100.76, Fair value in multiple-element arrangements that include contingent usage based fees and software revenue recognition, or TPA 5100.76. The transaction-based fee represents payment for the right to use the software, access to the hosted database and maintenance. The fee is considered fixed and determinable only at the time actual usage occurs. Revenue is recognized-based on actual usage. Implementation services are considered a separate element or unit of accounting and the related revenue recognition is described below.
Subscription-based contracts with additional fees for certain types of transactions generally include all deliverables discussed in the above paragraph and also include an additional element, which is the option to access specialized queries on the hosted database. Revenue under subscription-based contracts with additional fees for certain types of transactions is accounted for based on the guidance in TPA 5100.76.
Under these arrangements, the delivery of software, access to software through the hosted database, and maintenance are considered a combined unit of accounting and the related fee is recognized at the end of each month upon the completion of the monthly service. The transaction-based fee is recognized at the time of actual usage. Implementation services are considered a separate element or unit of accounting and the related revenue recognition is described below.
When we are required to perform setup and implementation activities necessary for the client to receive services and/or software, up-front fees billed during the setup/implementation phase are deferred and amortized on a straight-line basis over the estimated customer life. The upfront fees represent fair value of the implementation services based on vendor specific objective evidence. The amortization of this deferred revenue will commence upon the start of the monthly service. Setup costs that are direct and incremental to the contract are capitalized and amortized on a straight-line basis over the estimated customer life.
In a limited number of revenue arrangements described above, we also provide generic computer equipment as part of the sales arrangement. Based on guidance in EITF Issue No. 03-5, Applicability of AICPA Statement of Position 97-2, Software Revenue Recognition, to Non-Software Deliverables in an Arrangement Containing More-than-Incidental Software, the generic computer equipment is considered a non-software deliverable since our software is not essential to the functionality of the generic computer equipment. Based on guidance in EITF No. 01-8, Determining Whether an Arrangement Contains a Lease, EITF 00-21, Revenue Arrangements with Multiple Deliverables, and SFAS 13, Accounting for Leases, or SFAS 13, we account for the sale of generic equipment as a direct finance lease. The related revenue is recognized over the term of the contract using the effective interest rate method. We allocate revenue to SFAS 13 elements (equipment leases) and the non-SFAS 13 elements of its arrangements on a relative fair value basis using our best estimate of the fair value of the elements. Revenue from leased computer equipment represents approximately 1% of our consolidated revenue.
Revenues are reflected net of customer sales allowances, which are based on both specific identification of certain accounts and a predetermined percentage of revenue based on historical experience.
Stock-Based Compensation. Effective July 1, 2006, we adopted SFAS No. 123 (revised 2004), Share-Based Payment, or SFAS 123(R), which requires the measurement and recognition of compensation expense for all stock-based payment awards made to employees and directors, including employee stock options and share awards, based on estimated fair values recognized over the requisite service period. Prior to adoption of SFAS 123(R), pursuant to SFAS No. 123 Accounting for Stock-Based Compensation, we accounted for employee share awards under Accounting Principles Board, or APB, No. 25, Accounting for Stock Issued to Employees, or APB Opinion No. 25, and followed the DisclosureOnly Provisions of SFAS No. 123.
We made the following grants of, or granted the following rights to purchase, common units/shares or restricted common units/shares from January 1, 2006 to June 30, 2007:
As of June 30, 2007, we had 1,996,760 shares outstanding from the grants made on April 13, July 25, November 8, 2006, January 26, 2007, and May 11, 2007. Based on the initial public offering price of $16.00 per share, the aggregate intrinsic value of these outstanding shares as of June 30, 2007, was $31.4 million, of which $11.7 million related to 743,388 vested shares and $19.7 million related to 1,253,372 unvested shares. At the Acquisition date, and at each subsequent date that we granted equity awards to our employees, we were required to determine the fair value of our aggregate equity, as well as the individual fair value of each of our preferred and common units. The terms of the preferred units provided that such units could be redeemed by us at any time at their redemption value, which was equal to the unreturned capital contributions made in respect of such preferred units, plus accrued and unpaid yield of 8% per annum. As a result, a significant portion of any subsequent increase in our aggregate equity value, as determined at each subsequent measurement date, was attributed to the common units as opposed to the preferred units. The fixed-return nature of the preferred units was demonstrated by the formula we used to convert our preferred units into shares of common stock in our corporate reorganization: the liquidation value of the preferred units plus accrued and unpaid yield divided by the initial public offering price.
We acquired the Claims Services Group from ADP on April 13, 2006 based on a competitive auction process. We therefore believe that the enterprise value and aggregate equity value derived from this transaction were representative of their respective fair values. The enterprise fair value was validated by using market multiple and discounted cash flow methods. We used an internal rate of return, or IRR, method to allocate our aggregate equity value between our preferred and common units. The IRR method is similar to the Probability Weighted Expected Return Method described in the AICPA Audit and Accounting Practice Aid for Valuation of Privately-Held Company Equity Securities Issued as Compensation. We determined that the IRR method was the most appropriate method to use because it enabled us to directly determine the value of our preferred units based upon an expected return method using market rates, and thus to allocate any remaining aggregate equity value to our common units. The IRR method is based upon the value we assign to various future outcomes or exit events. The per unit values are based on the probability weighted present value of expected future returns, considering each of the possible future outcomes available to us, as well as the rights of each class of our equity securities. On April 13, 2006, using the IRR method described above, we determined that the value of each preferred unit was equal to $600.40 per unit and that the value of each common unit was equal to $2.94 per unit. We assumed a 5.2 year holding period based upon a hypothetical exit event in June 2011, which we considered reasonable at the time based on typical targeted holding periods for private equity funds. Because we had just acquired the Claims Services Group and assembled a new management team, we considered an exit event that is typical for private equity funds as the most appropriate outcome for us. We assigned a 100% probability to this expected outcome. A 19.0% IRR was targeted for the preferred units based on the median IRR of various preferred spread studies we determined to be relevant. Based on the targeted return for the preferred units, we derived an implied return on our common equity of 36.0%. The aggregate equity return was derived based on EBITDA exit multiples of 8.0x. These exit multiples were deemed appropriate based on comparable company multiples and our financial projections at the time. We determined that the aggregate equity return of approximately 27.2% was consistent with expected returns of financial sponsors in similar situations.
On July 25, 2006, we determined that there was no change in the fair value of the common units from April 13, 2006, and therefore used a value of $2.94 per common unit to determine the compensation expense for the rights to purchase common units we granted on that date. We believed that there was no change in fair value between April 13, 2006 and July 25, 2006 due to the following factors: (1) the relative valuation metrics of the selected comparable publicly traded companies increased as much as 2.8% and decreased by as much as 26.8%, with an average decrease of 12.2% during this period; and we searched for and were unable to find any acquisitions of comparable businesses during the period from April 13, 2006 to July 25, 2006, causing us to determine that there was no change in the acquisition multiples of comparable businesses contained in the April 13, 2006 report; (2) our financial projections, growth and cash flow
forecasts on July 25, 2006 had not changed significantly from those used in the April 13, 2006 discounted cash flows method of valuation due to the limited passage of time; (3) we experienced no significant developments between April 13, 2006 and July 25, 2006, such as significant contract wins that would have impacted relative valuations; and (4) we had no discussions with external parties, including investment banks, regarding our prospects during this period.
On November 8, 2006, we determined that our aggregate equity value had increased by approximately $360 million as a result of an increase in our enterprise value of approximately $310 million and a reduction in our net debt of approximately $50 million since the prior measurement date of July 25, 2006. We used the IRR method described above to allocate this increase to our preferred and common units. We used a holding period of approximately 4.6 years, as we still considered an exit event in June 2011 to be a reasonable assumption. This assumption was unchanged from the April 13, 2006 assumption, except for the passage of time. As a result, we assigned a 100% probability to this expected outcome. We used a targeted 11.8% IRR for the preferred units based on the median of various preferred spread studies we determined to be relevant. Based on the targeted return for the preferred units, we derived an implied return on our common equity of 21.6%. The aggregate equity return was derived based on EBITDA exit multiples of 10.0x. These exit multiples were deemed appropriate based on comparable company multiples and our financial projections at that time. We determined that an aggregate equity return of approximately 18.8% was consistent with expected returns of financial sponsors in similar situations. Due to the redemption price of our preferred units being fixed, approximately $300 million of the $360 million increase was ascribed to common units and approximately $60 million was ascribed to preferred units. The approximately $300 million increase in the value of our common units consisted of approximately $214 million attributed to the use of a comparable public company EBITDA multiple that was 24.4% higher than the implied purchase price multiple paid in the Acquisition for valuation purposes; approximately $44 million attributed to an increase in our adjusted EBITDA for the last twelve months of approximately $5.0 million; and approximately $42 million attributed to a reduction in our net debt. As a result, the approximately 30% increase in our enterprise value resulted in a more than 300% increase in the value of our common equity. On November 8, 2006, using the IRR method described above, we determined that the value of each preferred unit was equal to $902.37 per unit and the value of each common unit was equal to $12.36 per unit.
On February 5, 2007, we determined that our aggregate equity value had increased by approximately $110 million as a result of an increase in our enterprise value of approximately $135 million, offset by an increase in our net debt of approximately $25 million since the prior measurement date of November 8, 2006. To derive the aggregate equity value, we used the IRR method with two holding period scenarios: (1) a scenario involving an initial public offering, or IPO, within three months, and (2) a 4.4 year holding period resulting in an exit event in June 2011 similar to our assumptions of April 13, 2006 and November 8, 2006. We applied a 70% probability to the IPO scenario and a 30% probability to the 4.4 year holding period scenario. We considered the three-month scenario to be reasonable given our progress towards making a filing with the SEC regarding an initial public offering. We applied a greater probability to the three-month holding period approach as the probability of a filing for an IPO was estimated to be high. For both exit scenarios, an IPO and a sale, an 11.8% IRR was targeted for the preferred units based on the median of various preferred spread studies we determined to be relevant. Based on the targeted return for the preferred units, we derived implied returns on the common equity of 21.3% using a 4.4 year holding period and 52.5% using three-month period. The aggregate equity returns were derived based on EBITDA exit multiples of 10.0x (4.4 year holding period) and 11x (three-month holding period). These exit multiples were deemed appropriate based on comparable company multiples and our financial projections at that time. The aggregate equity returns of approximately 19% (4.4 year holding period) and 39% (three-month holding period) are consistent with expected returns of financial sponsors in similar situations. Due to the redemption price of our preferred units being fixed, approximately $90 million of the $110 million increase was ascribed to common units and approximately $20 million was ascribed to preferred units. On
February 5, 2007, using the IRR method described above, we determined that the value of each preferred unit was equal to $997.36 per unit and the value of each common unit was equal to $15.30 per unit.
Foreign currency translation. The assets and liabilities of our foreign subsidiaries are translated into U.S. dollars based on exchange rates in effect at the end of each period, and revenues and expenses are translated at average exchange rates during the periods. Functional currencies of significant foreign subsidiaries include Euros, British pounds, Swiss francs, and Canadian dollars. Currency transaction gains or losses, which are included in the results of operations, totaled $3.8 million and $4.8 million in fiscal 2006 and 2007, respectively. Gains or losses from balance sheet translation are included in stockholders equity within accumulated other comprehensive income on the consolidated balance sheets.
Internal use software. Expenditures for software purchases and software developed or obtained for internal use are capitalized and amortized over a three- to five-year period on a straight-line basis. For software developed or obtained for internal use, we capitalize costs in accordance with the provisions of Statement of Position No. 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use. Our policy provides for the capitalization of external direct costs of materials and services associated with developing or obtaining internal use computer software. In addition, we also capitalize certain payroll and payroll-related costs for employees who are directly associated with internal use computer software projects. The amount of capitalizable payroll costs with respect to these employees is limited to the time directly spent on such projects. Costs associated with preliminary project stage activities, training, maintenance, and all other post-implementation stage activities are expensed as incurred. We also expense internal costs related to minor upgrades and enhancements as it is impractical to separate these costs from normal maintenance activities.
Income taxes. We use the asset and liability method of accounting for income taxes in accordance with SFAS No. 109, Accounting for Income Taxes. Under this method, income tax expenses or benefits are recognized for the amount of taxes payable or refundable for the current year and for deferred tax liabilities and assets for the future tax consequences of events that have been recognized in our consolidated financial statements or tax returns. We also account for any income tax contingencies in accordance with SFAS No. 5, Accounting for Contingencies. The measurement of current and deferred tax assets and liabilities are based on provisions of currently enacted tax laws. The effects of future changes in tax laws or rates are not contemplated.
In addition, the calculation of our tax liabilities involves dealing with uncertainties in the application of complex tax regulations. We recognize liabilities for anticipated tax audit issues in the United States and other tax jurisdictions based on our estimate of whether, and the extent to which, additional tax payments are probable. If we ultimately determine that payment of these amounts is unnecessary, we reverse the liability and recognize a tax benefit during the period in which we determine that the liability is no longer necessary. This may occur for a variety of reasons, such as the expiration of the statute of limitations with respect to a particular tax return or the signing of a final settlement agreement with the respective tax authority. We record an additional charge in our provision for taxes in the period in which we determine that the recorded tax liability is less than we expect the ultimate assessment to be.
As part of the process of preparing consolidated financial statements, we are required to estimate our income taxes and tax contingencies in each of the jurisdictions in which we operate prior to the completion and filing for tax returns for such periods. This process involves estimating actual current tax expense together with assessing temporary differences, or reversing book-tax differences, resulting from differing treatment of items, such as deferred revenue, for tax and accounting purposes. These differences result in net deferred tax assets and liabilities. We must then assess the likelihood that the deferred tax assets will be realizable and to the extent we believe that realizability is not likely, we must establish a valuation allowance. To the extent we establish a valuation allowance in a period, we must include a tax expense or benefit within the tax provision in the statement of operations. In the event that actual results differ from
these estimates or we adjust these estimates in future periods, we may need to adjust our valuation allowances, which could impact our results of operations in the quarter in which such determination is made.
At June 30, 2007, our deferred tax assets of approximately $45 million are comprised of $29 million of net operating losses and the remainder pertaining to temporary differences. Approximately $12 million and $16 million of our net operating losses are generated in the United States and the Netherlands, respectively, and are attributed primarily to interest expense under our debt arrangements. We have established a full valuation allowance against our net operating losses in the Netherlands as we do not believe it is more likely than not that we will generate sufficient income after interest expenses to realize the benefits of the Netherlands net operating losses within the nine-year carryforward period under Netherlands law. While we are continuing to generate net operating losses in the US, we believe it is more likely than not that we will generate sufficient income after interest expense in the US to realize the benefits of these losses within the 20-year carryforward period under US tax law. We considered the following factors in not establishing a valuation allowance against net operating losses generated in the United States:
· a solid history of operating profits and no expiration of unused tax attributes for the U.S. group;
· a future taxable income based on adjusted EBITDA using managements forecast; and
· potential tax planning strategy to increase U.S. taxable income.
On December 16, 2004, the Financial Accounting Standards Board, or the FASB, issued SFAS 123(R), which eliminates the alternative of applying the intrinsic value measurement provisions of Accounting Principles Board, or APB, No. 25, Accounting for Stock Issued to Employees, or APB Opinion No. 25, to stock-based compensation awards issued to employees. Rather, SFAS 123(R) requires enterprises to measure the cost of employee services received in exchange for an award of equity instruments generally based on the grant-date fair value of the award. That cost will be recognized over the period during which an employee is required to provide services in exchange for the award, known as the requisite service period (usually the vesting period). Effective July 1, 2006, we adopted SFAS 123(R), which requires the measurement and recognition of compensation expense for all share-based payment awards made to employees and directors, including employee stock options and share awards, based on estimated fair values recognized over the requisite service period. Prior to adoption of SFAS 123(R), pursuant to SFAS No. 123 Accounting for Stock-Based Compensation, or SFAS 123, we accounted for employee unit awards under APB Opinion No. 25 and followed the disclosure-only provisions of SFAS No. 123.
We adopted SFAS 123(R) using the prospective transition method. Under this method, SFAS 123(R) is applied to new awards and to awards modified, repurchased or cancelled after the adoption date of July 1, 2006. Compensation cost that was previously recorded under APB Opinion No. 25 for awards outstanding at the adoption date, such as unvested options, will continue to be recognized as the options vest. Accordingly, for the year ended June 30, 2007, we recorded $2.3 million in stock/unit-based compensation expense which includes compensation cost related to estimated fair values of awards granted after the date of adoption of SFAS 123(R) and compensation costs related to unvested awards at the date of adoption based on the intrinsic values as previously recorded under APB Opinion No. 25.
In June 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes, an interpretation of FAS 109, Accounting for Income Taxes, or FIN 48, to create a single model to address accounting for uncertainty in tax positions. FIN 48 clarifies the accounting for income taxes by prescribing a minimum recognition threshold a tax position is required to meet before being recognized in the
financial statements. FIN 48 also provides guidance on derecognition, measurement, classification, interest and penalties, accounting in interim periods, disclosure, and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. We will adopt FIN 48 as of July 1, 2007, as required. The cumulative effect of adopting FIN 48 will be recorded in retained earnings and other accounts as applicable. We have not determined the effect, if any, that the adoption of FIN 48 will have on our financial position and results of operations. As a result of FIN 48, we could have greater volatility in our effective tax rate in the future.
In September 2006, the FASB issued SFAS No. 158, Employers Accounting for Defined Benefit Pension and Other Postretirement Plansan amendment of FASB Statements No. 87, 88, 106 and 132(R), or SFAS No. 158. This statement requires a company to (a) recognize in its statement of financial position an asset for a plans overfunded status or a liability for a plans underfunded status, (b) measure a plans assets and its obligations that determine its funded status as of the end of the employers fiscal year, and (c) recognize changes in the funded status of a defined benefit plan in the year in which the changes occur (reported in comprehensive income). The requirement to recognize the funded status of a benefit plan and the related disclosure requirements were effective for us as of the end of fiscal 2007 and we adopted the statement at that time. The adoption of SFAS No. 158 resulted in a $0.5 million reduction in stockholders equity, net of income taxes. The measurement date for all plans is June 30, 2007, and as such no additional impact is expected.
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements, or SFAS 157. This statement clarifies the definition of fair value, establishes a framework for measuring fair value, and expands the disclosures on fair value measurements. SFAS 157 is effective for fiscal years beginning after November 15, 2007. We are currently evaluating the effect that the adoption of SFAS 157 will have, if any, on its consolidated results of operations and financial condition.
In September 2006, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 108, or SAB 108. SAB 108 considers the effects of prior year misstatements when quantifying misstatements in current year financial statements. It is effective for fiscal years ending after November 15, 2006. We applied the guidance in SAB 108 as of July 1, 2006. The application of SAB 108 did not have a significant effect on our consolidated financial statements.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, or SFAS 159, which permits companies to choose to measure certain financial instruments and certain other items at fair value. The standard requires that unrealized gains and losses on items for which the fair value option has been elected be reported in earnings. SFAS No. 159 is effective for us beginning in the first quarter of fiscal year 2009 although earlier adoption is permitted. We are currently evaluating the impact that SFAS 159 will have on our consolidated financial statements.
In March 2007, the FASB ratified EITF Issue No. 06-11, Accounting for Income Tax Benefits of dividends on Share-Based Payment Awards, or EITF 06-11. EITF 06 11 requires companies to recognize the income tax benefit realized from dividends or dividend equivalents that are charged to retained earnings and paid to employees for non-vested equity-classified employee share-based payment awards as an increase to additional paid-in capital. EITF 06-11 is effective for fiscal years beginning after September 15, 2007. We do not expect that EITF 06-11 will have a material impact on our results of operations or cash flows.
This section and other parts of this Annual Report on Form 10-K contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, or the Securities Act, and Section 21E of the Exchange Act. In some cases, forward-looking statements can be identified by words such as anticipates, expects, believes, plans, predicts, and similar terms. Such forward-looking statements are based on current expectations, estimates and projections about our industry, managements
beliefs and assumptions made by management. Forward-looking statements are not guarantees of future performance and our actual results may differ significantly from the results discussed in the forward-looking statements. Factors that might cause such differences include, but are not limited to those discussed in Part I, Item 1A, Risk Factors. Unless otherwise required by law, we expressly disclaim any obligation to update publicly any forward-looking statements, whether as result of new information, future events or otherwise.
Our internet website address is www.solerainc.com. Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13 or 15(d) of the Exchange Act will be available free of charge through our website as soon as reasonably practicable after they are electronically filed with, or furnished to, the Securities and Exchange Commission. Our website and the information contained or incorporated therein are not intended to be incorporated into this report.
We conduct operations in many countries around the world. Our results of operations are subject to both currency transaction risk and currency translation risk. We incur currency transaction risk when we enter into either a purchase or sale transaction using a currency other than our functional currency. With respect to currency translation risk, our financial condition and results of operations are measured and recorded in the relevant domestic currency and then translated into U.S. dollars for inclusion in our consolidated financial statements. Exchange rates between these currencies and U.S. dollars have fluctuated significantly over the last few years and may continue to do so in the future. A substantial portion of our revenues and costs are denominated in or effectively indexed to U.S. dollars, but the majority of our revenues and costs are denominated in Euros, British pounds, Swiss francs, Canadian dollars and other currencies. Historically, we have not undertaken hedging strategies to minimize the effect of currency fluctuations on our results of operations and financial condition; however, we may decide this is necessary in the future.
We are exposed to interest rate risks primarily through borrowings under our revolving loan arrangement and term loans. Interest on these borrowings is based upon variable interest rates. Our weighted-average borrowings outstanding under the revolving loan arrangement and term loans during fiscal 2007 was $822 million and the weighted-average interest rate in effect at June 30, 2007 was 6.614%. We terminated the interest rate collar related to our old senior credit agreement on December 18, 2006. Based on the foregoing, a hypothetical 1% increase or decrease in interest rates would have resulted in a $8.2 million change to our interest expense in fiscal 2007.
During the fourth quarter of fiscal 2006, we entered into two interest rate swaps with maturities on July 13, 2011. One swap had a notional amount of $195.0 million and required us to pay a fixed rate of 5.35%. The other swap had a notional amount of 368.4 million and required us to pay, on a quarterly basis, a fixed rate of 3.72%. These swaps had an estimated fair value of $1.1 million as of June 30, 2006, and we recognized an increase in fair value of $1.1 million during fiscal 2006. During fiscal 2007, we recognized net gains of $6.7 million in other (income) related to these swaps, which were terminated on June 25, 2007 for a total cash settlement of $7.7 million.
Effective on June 29, 2007, we entered into three USD-based interest rate swaps with notional amounts of $50.0 million, $81.0 million and $75.0 million with maturities on June 30, 2011 which require us to pay fixed rates of 5.445%, 5.418% and 5.445%, respectively. We also entered into three Euro-based interest rate swaps with notional amounts of 69.8 million, 50.0 million, and 60.0 million with maturities on June 30, 2011 which require us to pay fixed rates of 4.603%, 4.679%, and 4.685%, respectively. These interest rate swaps are designated and documented at the inception of the hedge as cash flow hedges and are evaluated for effectiveness quarterly. The effective portion of the gain or loss on these hedges is reported as a component of accumulated other comprehensive income/(loss) in stockholders equity and reclassified into earnings when the hedged transaction affects earnings. The ineffective portion on these cash flow hedges is recognized as other (income)/expense. The estimated fair value of $0.8 million on USD-based swaps, net of tax, and 0.4 million ($0.6 million) on Euro-based swaps was recorded in other liabilities in the consolidated balance sheet as of June 30, 2007. The change of $1.1 million in the fair value of swaps reflects the effective portion of loss on these hedges and is reported as a component of accumulated other comprehensive loss in stockholders equity.
Our consolidated financial statements, together with the related notes and the report of independent registered public accounting firm, are set forth on the pages indicated in Item 15 in this Annual Report on Form 10-K.
There were no changes in or disagreements with accountants on accounting and financial disclosure.
We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in its reports pursuant to the Exchange Act, is recorded, processed, summarized and reported within the time periods specified Rule 13a-15 under the Exchange Act, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. Management is responsible for establishing and maintaining adequate internal control over financial reporting.
As required by Rule 13a-15(b) under the Exchange Act, we carried out an evaluation, under the supervision and with the participation of our management, including the Chief Executive Officer and the Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based on the foregoing, our Chief Executive Officer and Chief Financial Officer determined that disclosure controls and procedures were effective at a reasonable assurance level as of the end of the period covered by this report.
There has been no change in internal controls over financial reporting during the most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, internal controls over financial reporting.
This annual report does not include a report of managements assessment regarding internal control over financial reporting or an attestation report of our registered public accounting firm due to a transition period established by rules of the SEC for newly public companies.
Set forth below are the name, age, position and a description of the business experience of each of our executive officers and directors.
Tony Aquila has served as our President and Chief Executive Officer since our formation in April 2005, as a member of our board of managers between April 2005 and May 2007 and as a member of our board of directors since the completion of our corporate reorganization on May 10, 2007. From September 2001 until December 2004, Mr. Aquila held various positions, including President and Chief Operating Officer, at Mitchell International Inc., a provider of software and services to the automobile insurance, collision repair, medical claim and glass replacement industries. Mr. Aquila joined Mitchell when it acquired Ensera, Inc., an automotive claims workflow and software processing company Mr. Aquila founded in 1999. Prior to Ensera, Mr. Aquila was the Chief Executive Officer and founder of MaxMeyer America, Inc., an importer and distributor of European automotive refinishing products formed in partnership with MaxMeyer-Duco S.p.A.
Jack Pearlstein has served as our Chief Financial Officer since April 2006. From September 2001 to November 2004, Mr. Pearlstein served as the Chief Financial Officer, Treasurer and Secretary of DigitalNet Holdings, Inc., a leading provider of network, security, information and application services to U.S. defense and intelligence agencies. From September 2000 until July 2001, Mr. Pearlstein served as Chief Financial Officer of Commerce One, Inc.s Global Services division, which he joined in September 2000 when Commerce One, Inc. acquired AppNet, Inc., a leading provider of Internet- and electronic commerce-based professional services and solutions. Mr. Pearlstein also serves as a director of Syniverse Technologies, Inc., a NYSE-listed enabler of wireless voice and data communications for telecommunications companies, which is controlled by GTCR. Mr. Pearlstein has a B.S. in Accounting from New York University and an M.B.A. in Finance from George Washington University.
John Schwinn has served as our Senior Vice President since April 2005 and leads the consulting and business analytics services groups. From September 2001 until December 2004, Mr. Schwinn served as Vice President of Corporate Development of Mitchell International Inc., which he joined in September 2001 when Mitchell International Inc. acquired Ensera, Inc., an automotive claims workflow and software processing company. From September 2000 until September 2001, Mr. Schwinn was Enseras Chief Operating Officer and from January 1994 until September 2000, Mr. Schwinn was Vice President of Business Development for ADPs Claims Services Group. Mr. Schwinn has a B.S. in Economics from the Wharton School at the University of Pennsylvania, an M.S. in Economics from the London School of Economics and an M.B.A. from Harvard Business School.
Michael D. Conway has served as our Vice President since April 2005. From September 2000 to December 2004, Mr. Conway held various positions at Mitchell International Inc., including Senior
Director of Sales Operations and Senior Director of Business Development. From 1998 to 2000, Mr. Conway held various positions with OnHealth Network Company, a publicly-traded Internet health company, including Chief Financial Officer, Vice President of Finance, Controller and Secretary. Mr. Conway has a B.A. in Economics and Accounting from Claremont McKenna College and an M.B.A. from Claremont Graduate Schools Peter Drucker School of Management.
Philip A. Canfield has been a member of our board of directors since the completion of our corporate reorganization on May 10, 2007 and served as a member of our board of managers between April 2005 and May 2007. Mr. Canfield has been a principal at GTCR Golder Rauner, L.L.C. since 1997. Mr. Canfield has a B.S. in Finance from the Honors Business Program at the University of Texas at Austin and an M.B.A. from the University of Chicago. Mr. Canfield also serves as a board member of several private GTCR portfolio companies.
Craig A. Bondy has been a member of our board of directors since the completion of our corporate reorganization on May 10, 2007 and served as a member of our board of managers between April 2005 and May 2007. He is a principal of GTCR, which he joined in July 2000. He previously worked in the investment banking department of Credit Suisse First Boston. Mr. Bondy has a B.B.A. in Finance from the Honors Business Program at the University of Texas at Austin and an M.B.A. from the Stanford Graduate School of Business. Mr. Bondy serves on the board of directors of VeriFone Holdings, Inc. and several private GTCR portfolio companies.
Garen Staglin has been a member of our board of directors since the completion of our corporate reorganization on May 10, 2007 and served as a member of our board of managers between April 2005 and May 2007. From 2001 to 2004, Mr. Staglin served as the President and Chief Executive Officer of eONE Global LP, an emerging payments company. From 1993 to 1999, Mr. Staglin served as Chairman and Chief Executive Officer of Safelite Glass Corporation, a manufacturer of replacement autoglass and related insurance services. Mr. Staglin also serves as a director of Global Document Solutions, Inc., a digital printing, imaging and customer relationship management outsourcing company, ExlService Holdings, Inc., a provider of offshore business process outsourcing solutions, and Bottomline Technologies, Inc., a leading provider of collaborative payment and invoice automation solutions. Mr. Staglin has a B.S. in engineering from UCLA and an M.B.A. from the Stanford Graduate School of Business.
Roxani Gillespie has been a member of our board of directors since the completion of our corporate reorganization on May 10, 2007 and served as a member of our board of managers between April 2005 and May 2007. Ms. Gillespie is a partner in the law firm of Barger & Wolen LLP, where she has worked since 1997. From 1986 to 1991, Ms. Gillespie served as the Commissioner of Insurance for the State of California. Ms. Gillespie also serves on the board of directors of 21st Century Insurance Group.
Stuart J. Yarbrough has been a member of our board of directors since the completion of our initial public offering on May 16, 2007. Mr. Yarbrough is the chief executive officer of 3Point Capital Partners, LLC, a private equity firm focusing on the building products sector, where he has worked since February 2007. From 1994 through February 2007, Mr. Yarbrough was a principal at CrossHill Financial Group Inc., a company he co-founded, which provides debt financing to growth companies. Mr. Yarbrough has a B.A. in management sciences from Duke University.
Jerrell W. Shelton has been a member of our board of directors since the completion of our initial public offering on May 16, 2007. Mr. Shelton is an advisor to Medley Capital LLC, a private investment management firm. From June 2004 to May 2006, Mr. Shelton served as the chairman and chief executive officer of Wellness, Inc., a company that designs, manufacturers and installs healthcare equipment for hospitals and other clinical customers. From November 2000 to June 2004, Mr. Shelton served as a visiting executive, and then advisory director, for the Research Division of IBM Corporation, a provider of, among other things, business and information technology consulting and implementation services. Mr. Shelton has
a B.S. in business administration from the University of Tennessee and an M.B.A. from Harvard University.
Our certificate of incorporation provides that our board of directors shall consist of such number of directors as determined from time to time by resolution adopted by a majority of the total number of directors then in office. Our board of directors consists of seven members, three of whom, Ms. Gillespie and Messrs. Shelton and Yarbrough, qualify as independent according to the rules and regulations of the SEC and NYSE. Any additional directorships resulting from an increase in the number of directors may only be filled by the directors then in office. The term of office for each director will be until his or her successor is elected and qualified or until his or her earlier death, resignation or removal. Stockholders will elect directors each year at our annual meeting.
The composition, duties and responsibilities of our audit committee, compensation committee and nominating and corporate governance committee are set forth below. Committee members hold office for a term of one year. In the future, our board may establish other committees, as it deems appropriate, to assist with its responsibilities.
Audit Committee. The audit committee is responsible for (1) selecting the independent auditors, (2) approving the overall scope of the audit, (3) assisting the board in monitoring the integrity of our financial statements, the independent auditors qualifications and independence, the performance of the independent auditors and our internal audit function and our compliance with legal and regulatory requirements, (4) annually reviewing an independent auditors report describing the auditing firms internal quality-control procedures and any material issues raised by the most recent internal quality-control review, or peer review, of the auditing firm, (5) discussing the annual audited financial and quarterly statements with management and the independent auditor, (6) discussing earnings press releases, as well as financial information and earnings guidance provided to analysts and rating agencies from time to time, (7) discussing policies with respect to risk assessment and risk management, (8) meeting separately, periodically, with management, internal auditors and the independent auditor, (9) reviewing with the independent auditor any audit problems or difficulties and managements response, (10) setting clear hiring policies for employees or former employees of the independent auditors, (11) handling such other matters that are specifically delegated to the audit committee by the board of directors from time to time and (12) reporting regularly to the full board of directors.
Our audit committee consists of Ms. Gillespie and Messrs. Shelton and Yarbrough. Our board of directors has determined that Ms. Gillespie and Messrs. Shelton and Yarbrough are independent directors according to the rules and regulations of the SEC and the NYSE and that Mr. Yarbrough qualifies as an audit committee financial expert as such term is defined in Item 407(d) of Regulation S-K.
Compensation Committee. The compensation committee is responsible for (1) reviewing key employee compensation policies, plans and programs, (2) reviewing and approving the compensation of our executive officers, (3) reviewing and approving employment contracts and other similar arrangements between us and our executive officers, (4) reviewing and consulting with our Chief Executive Officer on the selection of officers and evaluation of executive performance and other related matters, (5) administration of stock plans and other incentive compensation plans and (6) such other matters that are specifically delegated to the compensation committee by the board of directors from time to time. Our compensation committee consists of Ms. Gillespie and Messrs. Shelton and Bondy. Our board of directors has determined that Mr. Bondy is not an independent director according to the rules and regulations of the SEC and the NYSE.
Nominating and Corporate Governance Committee. Our nominating and corporate governance committees purpose is to assist our board by identifying individuals qualified to become members of our board of directors consistent with criteria set by our board and to develop our corporate governance principles. This committees responsibilities include: (1) evaluating the composition, size and governance of our board of directors and its committees and making recommendations regarding future planning and the appointment of directors to our committees, (2) establishing a policy for considering stockholder nominees for election to our board of directors, (3) evaluating and recommending candidates for election to our board of directors, (4) overseeing the performance and self-evaluation process of our board of directors and developing continuing education programs for our directors, (5) reviewing our corporate governance principles and providing recommendations to the board regarding possible changes and (6) reviewing and monitoring compliance with our code of ethics and our insider trading policy. Our nominating and corporate governance committee consists of Ms. Gillespie and Messrs. Canfield and Shelton. Our board of directors has determined that Mr. Canfield is not an independent director according to the rules and regulations of the SEC and the NYSE.
Compensation Committee Interlocks and Insider Participation
No member of our compensation committee is an officer or employee of us, and no member has been an officer or employee of us at any prior time. There are no interlocking relationship between any of our executive officers and compensation committee, on the one hand, and the executive officers and compensation committee of any other companies, on the other hand.
Code of Ethics
Our code of ethics applies to our principal executive, financial and accounting officers and all persons performing similar functions and is available on our internet website at www.solerainc.com. The code of ethics contains general guidelines for conducting the business of our company consistent with the highest standards of business ethics, and is intended to qualify as a code of ethics within the meaning of Section 406 of the Sarbanes-Oxley Act of 2002 and Item 406 of Regulation S-K. We intend to disclose amendments to, or waivers from, provisions of our code of ethics that apply to our principal executive, financial and accounting officers by posting such information on our website.
Compensation Discussion and Analysis
This Compensation Discussion and Analysis focuses on the compensation arrangements we have with our named executive officers as required under the rules of the SEC. The SEC rules require disclosure for the Chief Executive Officer and Chief Financial Officer regardless of compensation level, and the three most highly compensated executive officers other than the Chief Executive Officer and Chief Financial Officer. During fiscal 2007, we had four executive officers, including our Chief Executive Officer and Chief Financial Officer. All of these executive officers, including the Chief Executive Officer and Chief Financial Officer, are sometimes referred to herein as the named executive officers or the executive officers.
Role of the Compensation Committee
In May 2007, our board of directors established a compensation committee consisting of Mr. Bondy, an employee of affiliates of GTCR, and Ms. Gillespie. Mr. Shelton was appointed to the compensation committee following the completion of our initial public offering. The compensation committee is responsible for (1) reviewing key employee compensation policies, plans and programs, (2) reviewing and approving the compensation of our executive officers, (3) reviewing and approving employment contracts and other similar arrangements between us and our executive officers, (4) reviewing and consulting with our Chief Executive Officer on the selection of officers and evaluation of executive performance and other
related matters, (5) administration of stock plans and other incentive compensation plans and (6) such other matters that are specifically delegated to the compensation committee by the board of directors from time to time. In light of our recent initial public offering, the compensation committee expects to undertake a substantial review of our existing compensation programs, objectives and philosophy and determine whether such programs, objectives, and philosophy are appropriate for our company as a public company.
Prior to our conversion into a corporation and initial public offering in May 2007, we existed as a limited liability company. In November 2006, the board of managers established a compensation committee consisting of Mr. Bondy and Ms. Gillespie. Prior to November 2006, compensation matters were handled by our entire board of managers. In general, the compensation of our named executive officers for fiscal 2006 and 2007 was established in agreements we entered into with them in connection with our formation in April 2005 and the Acquisition in 2006. Such agreements were determined by negotiations between our named executive officers and GTCR, our private equity sponsor and, until our initial public offering, our majority equity holder. Thus, much of our compensation policies and practices for fiscal 2006 and 2007 were determined by GTCR, as the majority equity holder, based on its past practice and experience with other of its portfolio companies, and negotiated with our executive officers. Going forward, executive compensation matters will be evaluated, determined and handled by our compensation committee.
The compensation committee is responsible for designing and evaluating our compensation plans for directors and executive officers, including the Chief Executive Officer, making recommendations to the board of directors and management regarding those plans, awarding incentive compensation to executive officers and administering other compensation programs as authorized by the board of directors. The compensation committee is also tasked with producing the annual report on executive officer compensation for inclusion in our annual report or proxy materials in accordance with applicable SEC rules. The compensation committee solely determines the salary and overall compensation of our Chief Executive Officer. When establishing the compensation of the other named executive officers, the compensation committee takes into consideration the recommendations of the Chief Executive Officer.
Consistent with our performance-based compensation philosophy, the compensation committee reviews and approves our compensation programs to effectively balance executive officers salaries with incentive compensation that is performance-based as well as to reward annual performance while maintaining a focus on longer-term objectives. We believe that it serves the needs of our stockholders and key executives to provide incentives commensurate with individual management responsibilities and past and future contributions to corporate objectives. The mix of compensation elements varies based on an executive officers position and responsibilities.
To maximize stockholder value, we believe that it is necessary to deliver consistent, long-term sales and earnings growth. Accordingly, the compensation committee reviews not only the individual compensation elements, but the mix of individual compensation elements that make up the aggregate compensation and attempts to structure the total compensation package between short-term and long-term compensation, and currently paid cash and equity compensation, each in a way that meets the objectives set forth above.
The compensation committee has the authority to retain the services of outside advisors, experts and compensation and benefits consultants to assist in the evaluation of the compensation of the Chief Executive Officer, the other executive officers, the board of directors and our compensation framework generally. Neither we nor our compensation committee benchmarked our executive compensation nor engaged outside consultants in fiscal 2007 to review our executive or director compensation policies and procedures or to advise us on compensation matters.
To continue to establish competitive levels of compensation, and an appropriate balance of base salary, performance-based compensation and equity compensation, the compensation committee intends
to retain the services of an independent, third party consultant during fiscal 2008 to benchmark and assess its compensation framework. The financial objectives of its compensation framework will be the budget approved by our board of directors for fiscal 2008.
Objectives of Our Compensation Programs
The key objectives of our executive compensation programs are (1) to attract, motivate, reward and retain the best possible executive officers with the skills necessary to successfully manage and grow our business, (2) to achieve accountability for performance by linking annual cash incentive compensation to the achievement of measurable performance objectives and (3) to align the interests of the executive officers and our stockholders through incentive and long-term compensation programs. For our named executive officers, our annual and long-term incentives are designed to support these objectives by providing a significant financial correlation between our financial results and total compensation.
The compensation committee will determine annually whether the compensation programs have met the objectives outlined above by assessing (1) the retention level or level of attrition among performing key executive officers year-over-year and (2) the relationship between our financial performance year over year and increases or decreases in executive compensation.
What Our Compensation Programs are Designed to Reward
A significant portion of the compensation paid to executive officers is designed to reward them based on our financial performance and growth, and increased stockholder value, as reflected in increases in our equity value. As discussed elsewhere in Executive CompensationCompensation Discussion and Analysis, the compensation policies applicable to our named executive officers are reflective of our Companys pay-for-performance philosophy, whereby a significant portion of compensation is contingent upon achievement of measurable operating and financial targets and enhanced equity value, as opposed to current cash compensation and perquisites not directly linked to objective financial performance. This compensation mix is consistent with our performance-based philosophy that the role of executive officers is to enhance stockholder value over the long term and allows management to participate in the upside rewards of our positive objective-driven performance.
Elements of Compensation
The elements of our compensation program are:
· Base salary;
· Annual cash incentives;
· Long-term incentives;
· Equity ownership;
· Post-termination benefits, including severance and retirement benefits; and
· Certain additional executive benefits and perquisites.
Each element of compensation was evaluated in terms of its contribution to each executives overall total compensation package for the year, and whether the total compensation was appropriate.
These components, individually and in the aggregate, are designed to accomplish one or more of the compensation objectives described above. For this reason, no single element dominates the compensation package of a named executive officer. Amounts of base salary and annual bonuses for fiscal 2007 were fixed by employment agreements entered into with each of the named executive officers in connection with the Acquisition, although these amounts were increased in certain cases pursuant to action by our board of
directors in response to our financial and operating performance. For periods following fiscal 2007, these amounts will be established pursuant to the procedures set forth below, based on amounts paid to executives from comparable companies (which companies our compensation committee has not yet determined) and based upon our financial performance.
We provide a base salary to our executive officers to compensate them for their full-time services during the year. Base salary is established based on our expectations of the respective executive officers contributions to substantially contributing to the growth in the value of our company. Therefore, the compensation committee considers the experience, skills, knowledge, past performance and responsibilities required of the executive officers in their roles. When establishing the base salaries of the executive officers for the fiscal year ended June 30, 2007, a number of factors were considered, including the years of service of the individual, individuals duties and responsibilities, the ability to replace the individual, the base salary at the individuals prior employment, market data on similar positions with competitive companies as information becomes available to us informally through recruitment/search consultants in connection with our recent hiring efforts, and through our directors experience with other affiliated portfolio companies. We seek to maintain base salaries that are competitive with the marketplace, to allow us to attract and retain executive talent.
On April 13, 2006, we entered into an amended and restated senior management agreement with each of our named executive officers, other than Mr. Pearlstein, with whom we entered into an employment agreement. The base salaries for the fiscal years ended June 30, 2006 and 2007 are set forth below.