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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ________________ TO _________________.
Commission file number 0-2500111
21st Century Holding Company
----------------------------
(Exact name of registrant as specified in its charter)
FL 65-0248866
- ------------------------------ ----------
(State or Other Jurisdiction of (IRS Employer
Incorporation or Organization) Identification No.)
4161 N.W. 5th Street, Plantation, FL 33317
------------------------------------------
(Address of principal executive offices) (Zip Code)
954-581-9993
------------
(Registrant's telephone number, including area code)
(Former name, former address and former fiscal year,
if changed since last report)
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 period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [x] No [ ]
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date.
Common Stock, $.01 par value - 3,124,955 outstanding as of August 12,
2003.
21ST CENTURY HOLDING COMPANY
INDEX
PART I: FINANCIAL INFORMATION PAGE
----
ITEM 1:
FINANCIAL STATEMENTS (UNAUDITED)
Consolidated Balance Sheets
as of June 30, 2003
and December 31, 2002................................................ 3
Consolidated Statements of Operations
for the three and six months ended June 30, 2003
and 2002............................................................. 4
Consolidated Cash Flow Statements
for the six months ended June 30, 2003
and 2002............................................................. 5
Notes to Consolidated Financial Statements................................ 6
ITEM 2:
Management's Discussion and Analysis
of Financial Condition and Results of Operations..................... 13
ITEM 3
Quantitative and Qualitative Disclosures About Market Risk................ 22
ITEM 4
Controls and Procedures................................................... 23
PART II: OTHER INFORMATION
ITEM 1
Legal Proceedings......................................................... 23
ITEM 2
Changes in Securities..................................................... 24
ITEM 3
Defaults upon Senior Securities........................................... 25
ITEM 4
Submission of Matters to a Vote of Security Holders....................... 25
ITEM 5
Other Information......................................................... 25
ITEM 6
Exhibits and Reports on Form 8-K.......................................... 26
Signatures................................................................ 27
2
PART I
ITEM I. FINANCIAL INFORMATION
21ST CENTURY HOLDING COMPANY
CONSOLIDATED BALANCE SHEETS
June 30, 2003 December 31, 2002
Unaudited (See Note 1)
------------ ------------
ASSETS
Investments
Fixed maturities, available for sale, at fair value $ 31,975,949 $ 24,693,047
Equity securities 4,248,423 539,706
Mortgage loans 140,506 145,043
------------ ------------
Total investments 36,364,878 25,377,796
------------ ------------
Cash and cash equivalents 4,662,430 4,478,383
Finance contracts, net of allowance for credit
losses of $383,481 in 2003 and $404,356 in 2002 4,886,007 7,217,873
Prepaid reinsurance premiums 8,733,522 11,251,193
Premiums receivable, net of allowance for credit losses of $257,000 and
$210,000, respectively 8,411,807 8,373,104
Reinsurance recoverable, net 12,081,875 7,856,972
Deferred acquisition costs, net 829,042 7,721
Deferred income taxes 2,256,445 2,691,309
Property, plant and equipment, net 4,876,547 4,819,617
Goodwill, net 1,739,715 1,789,353
Other assets 1,346,008 1,454,690
------------ ------------
Total assets $ 86,188,276 $ 75,318,011
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Unpaid losses and loss adjustment expenses $ 24,127,582 $ 16,983,756
Unearned premiums 28,998,579 28,934,486
Premiums deposits 977,393 655,713
Revolving credit outstanding 3,765,476 4,312,420
Bank overdraft 906,895 844,947
Income taxes payable 1,064,067 1,676,020
Accounts payable and accrued expenses 2,787,733 3,764,751
Drafts payable to insurance companies 48,310 48,254
------------ ------------
Total liabilities 62,676,035 57,220,347
------------ ------------
Commitments and contingencies
Shareholders' equity:
Common stock of $0.01 par value. Authorized 25,000,000 shares;
issued 3,535,371 and 3,411,667 shares, respectively;
Outstanding 3,113,905 and 2,990,201 shares, respectively 35,354 34,117
Additional paid-in capital 14,127,047 12,855,543
Accumulated other comprehensive income (deficit) (4,642) (227,091)
Retained earnings 10,452,256 6,521,027
Treasury stock, 421,466 and 421,466 shares, respectively, at cost (1,097,774) (1,085,932)
------------ ------------
Total shareholders' equity 23,512,241 18,097,664
------------ ------------
Total liabilities and shareholders' equity $ 86,188,276 $ 75,318,011
============ ============
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
3
21ST CENTURY HOLDING COMPANY
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
2003 2002 2003 2002
------------ ------------ ------------ ------------
Revenue:
Gross premiums written $ 17,578,594 $ 17,736,724 $ 34,190,574 $ 30,811,709
Gross premiums ceded (5,803,990) (7,497,560) (10,202,865) (13,390,990)
------------ ------------ ------------ ------------
Net premiums written 11,774,604 10,239,164 23,987,709 17,420,719
Decrease in unearned premiums, net
of prepaid reinsurance premiums (825,603) (3,753,201) (2,581,764) (5,500,262)
------------ ------------ ------------ ------------
Net premiums earned 10,949,001 6,485,963 21,405,945 11,920,457
Commission income 315,478 650,071 748,517 1,078,417
Finance revenue 1,135,203 1,192,221 2,263,029 2,253,652
Managing general agent fees 621,316 536,578 1,253,863 879,202
Net investment income 350,465 362,909 715,670 697,531
Net realized investments gains (losses) 1,068,818 (1,513,517) 1,419,700 (1,459,736)
Other income 504,498 639,504 2,000,065 1,874,830
------------ ------------ ------------ ------------
Total revenue 14,944,779 8,353,729 29,806,789 17,244,353
Expenses:
Loss and loss adjustment expenses 7,493,747 3,330,196 14,281,456 6,514,827
Operating and underwriting expenses 2,767,863 2,571,109 5,449,141 5,416,634
Salaries and wages 2,211,484 1,943,354 4,357,819 3,946,244
Amortization of deferred acquisition costs, net (677,311) (414,321) (1,037,492) (1,100,979)
------------ ------------ ------------ ------------
Total expenses 11,795,783 7,430,338 23,050,924 14,776,726
Income before provision for income tax expense 3,148,996 923,391 6,755,865 2,467,627
Provision for income tax expense 1,035,062 891,350 2,333,530 1,444,216
------------ ------------ ------------ ------------
Net income $ 2,113,934 $ 32,041 $ 4,422,335 $ 1,023,411
============ ============ ============ ============
Basic net income per share $ 0.69 $ 0.01 $ 1.46 $ 0.34
============ ============ ============ ============
Weighted average number of common shares outstanding 3,063,105 3,017,526 3,034,220 3,023,226
============ ============ ============ ============
Fully diluted net income per share $ 0.66 $ 0.01 $ 1.41 $ 0.34
============ ============ ============ ============
Weighted average number of common shares outstanding
(assuming dilution) 3,194,747 3,020,126 3,125,479 3,023,226
============ ============ ============ ============
Dividends declared per share $ 0.09 $ 0.02 $ 0.16 $ 0.04
============ ============ ============ ============
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
4
21ST CENTURY HOLDING COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
SIX MONTHS ENDING JUNE 30,
2003 2002
------------- -------------
Cash flow from operating activities:
Net income (loss) $ 4,422,335 $ 1,023,411
Adjustments to reconcile net income to net cash (used in)
provided by operating activities:
Amortization (accretion) of investment premium (discount), net 105,772 (43,290)
Depreciation and amortization of property plant and equipment 8,442 172,164
Amortization of goodwill
Deferred income tax expense 434,864 741,672
Net realized investment (gains) losses (1,419,700) 1,459,736
Amortization of deferred acquisition costs, net (1,037,492) (221,479)
Provision for credit losses, net 487,246 795,440
Provision for uncollectible premiums receivable 22,627 103,854
Extraordinary gain
Exercised stock options 1,272,741 12,304
Changes in operating assets and liabilities:
Premiums receivable (61,330) (3,234,160)
Prepaid reinsurance premiums 2,517,671 (5,229,410)
Reinsurance recoverable, net (4,224,903) (464,027)
Deferred acquisition costs, net 216,171 1,208,426
Goodwill (220,362) --
Finance contracts receivable, consumer loans and pay
advances receivable 1,844,620 (3,347,564)
Other assets 108,682 1,198,804
Unpaid losses and loss adjusting expenses 7,143,826 2,149,280
Unearned premiums 64,093 10,738,670
Premium deposits 321,680 264,015
Unearned commissions -- (632,504)
Income taxes payable (611,953) --
Accounts payable and accrued expenses (958,297) 422,792
Drafts payable to insurance companies 56 230,987
------------- -------------
Net cash provided by operating activities 10,436,789 7,349,121
------------- -------------
Cash flow from investing activities:
Proceeds from sale of investment securities available for sale 115,612,596 9,871,793
Purchases of investment securities available for sale (125,067,838) (16,836,867)
Mortgage loans
Sale of and collection of mortgage loans 4,537 444,670
Purchases of property and equipment (262,277) (127,216)
Net cash used in acquisitions
Proceeds from sale of assets 270,000 199,687
------------- -------------
Net cash used in investing activities (9,442,982) (6,447,933)
------------- -------------
Cash flow from financing activities:
Bank overdraft 61,948 (112,378)
Dividends paid (491,106) (121,177)
Purchases of treasury stock (11,842) (134,035)
Revolving credit outstanding (546,944) (293,236)
------------- -------------
Net cash used in financing activities (987,944) (660,826)
------------- -------------
Net (decrease) increase in cash and cash equivalents 5,863 240,362
Cash and cash equivalents at beginning of period 4,478,383 775,699
------------- -------------
Cash and cash equivalents at end of period $ 4,484,246 $ 1,016,061
============= =============
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest $ 109,884 $ 198,371
============= =============
Income taxes $ 2,450,000 $ 1,150,258
============= =============
Non-cash investing and financing activities:
Accrued dividends payable $ 279,527 $ 60,309
============= =============
Stock issued to employees $ -- $ --
============= =============
Stock received for sale of agency
Notes receivable, net of deferred gains, received for sale of agencies $ 14,304 --
============= =============
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
5
21ST CENTURY HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) ORGANIZATION AND BUSINESS
The accompanying unaudited consolidated financial statements of 21st
Century Holding Company (the "Company") have been prepared in accordance with
generally accepted accounting principles ("GAAP") for interim financial
information and with the instructions for Form 10-Q and Rule 10-01 of Regulation
S-X. These financial statements do not include all information and notes
required by generally accepted accounting principles for complete financial
statements, and should be read in conjunction with the audited consolidated
financial statements and notes thereto included in the Company's annual report
on Form 10-K for the year ended December 31, 2002. The December 31, 2002
year-end balance sheet data was derived from audited financial statements but
does not include all disclosures required by generally accepted accounting
principles. The financial information furnished reflects all adjustments,
consisting only of normal recurring accruals, which are, in the opinion of
management, necessary for a fair presentation of the financial position, results
of operations and cash flows for the periods presented. The results of
operations are not necessarily indicative of results of operations, which may be
achieved in the future.
The Company is a vertically integrated insurance holding company,
which, through its subsidiaries, controls substantially all aspects of the
insurance underwriting, distribution and the claims process. The Company
underwrites personal automobile insurance, homeowners insurance, general
liability (as of June 2003), and mobile home property and casualty insurance in
the State of Florida through its wholly-owned subsidiaries, Federated National
Insurance Company ("Federated National") and American Vehicle Insurance Company
("American Vehicle"). The Company internally processes claims made by its own
and third party insureds through a wholly-owned claims adjusting company,
Superior Adjusting, Inc. ("Superior"). The Company also offers premium financing
to its own and third-party insureds through its wholly-owned subsidiary,
Federated Premium Finance, Inc. ("Federated Premium").
The Company markets and distributes its own and third-party insurers'
products and its other services primarily in South Florida, through a network of
23 agencies, owned by Federated Agency Group, Inc. ("Federated Agency Group"), a
wholly-owned subsidiary, 42 franchised agencies and approximately 125
independent agents. The Company, through its wholly-owned subsidiary, FedUSA,
Inc. ("FedUSA"), franchises agencies under the FedUSA name. As of June 30, 2003,
franchises were granted for 42 Fed USA agencies, of which 36 were operating. The
Company intends to focus its future expansion efforts for its agency network on
franchised agencies.
The Company offers electronic tax filing services through Express Tax
Service, Inc., ("EXPRESSTAX"), an 80%-owned subsidiary, as well as franchise
opportunities for these services. As of June 30, 2003 there were 141 EXPRESSTAX
franchises granted in ten states. Revenue is generated through franchise sales,
collection of royalties on tax preparation fees, incentives from business
partners as well as fees from the preparation of income tax returns and bank
related products. In addition, EXPRESSTAX offers tax preparation services
through more than 500 licensees nationwide, acting as sales representatives of
EXPRESSTAX.
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND PRACTICES
(A) CRITICAL ACCOUNTING POLICIES
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions about future events that affect the
amounts reported in the financial statements and accompanying notes. Future
events and their effects cannot be determined with absolute certainty.
Therefore, the determination of estimates requires the exercise of judgment.
Actual results inevitably will differ from those estimates, and such differences
may be material to the financial statements.
The most significant accounting estimates inherent in the preparation
of the Company's financial statements include estimates associated with
management's evaluation of the determination of liability for unpaid losses and
loss adjustment expense and the recoverability of goodwill. In addition,
significant estimates form the
6
21ST CENTURY HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND PRACTICES (CONTINUED)
(A) CRITICAL ACCOUNTING POLICIES (CONTINUED)
bases for the Company's reserves with respect to finance contracts, premiums
receivable, deferred income taxes and the related valuation allowance, deferred
policy acquisition costs and loss contingencies. Various assumptions and other
factors underlie the determination of these significant estimates. The process
of determining significant estimates is fact specific and takes into account
factors such as historical experience, as well as current and expected economic
conditions. Management periodically re-evaluates these significant factors and
makes adjustments where facts and circumstances dictate.
(B) IMPACT OF NEW ACCOUNTING PRONOUNCEMENTS
In July 2002, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standard No.146, "Accounting for Costs Associated with
Exit or Disposal Activities." Statement of Financial Accounting Standard No. 146
supersedes Emerging Issues Task Force Issue No. 94-3, "Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring)." Statement of Financial
Accounting Standard No. 146 requires that, in certain instances, costs
associated with an exit or disposal plan be recognized when incurred rather than
at the date of a commitment to an exit or disposal plan. Statement of Financial
Accounting Standard No. 146 is to be applied prospectively to exit or disposal
activities initiated after December 31, 2002. The adoption of Statement of
Financial Accounting Standard No. 146 has no effect on the Company's financial
statements.
In October 2002, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standard No. 147, "Acquisitions of Certain
Financial Institutions," which clarifies the accounting treatment for
acquisitions of financial institutions. In addition, this Statement amends
Statement of Financial Accounting Standard No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets," to include in its scope long-term
customer-relationship intangible assets of financial institutions such as
depositor and borrower relationship intangible assets and credit cardholder
intangible assets. Statement of Financial Accounting Standard No. 147 is
effective on October 1, 2002. The adoption of Statement of Financial Accounting
Standard No. 147 has no effect on the Company's financial statements.
In December 2002, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standard No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure," which amended Statement of Financial
Accounting Standard No. 123, "Accounting for Stock-Based Compensation." The new
standard provides alternative methods of transition for a voluntary change to
the fair value based method of accounting for stock-based employee compensation.
Additionally, the statement amends the disclosure requirements of
Statement of Financial Accounting Standard No. 123 to require prominent
disclosures in the annual and interim financial statements about the method of
accounting for stock-based employee compensation and the effect of the method
used on reported results. This statement is effective for financial statements
for fiscal years ending after December 15, 2002. In compliance with Statement of
Financial Accounting Standard No. 148, the Company has elected to continue to
follow the intrinsic value method in accounting for the Company's stock-based
employee compensation arrangement as defined by Accounting Principles Board
Opinion No. 25, "Accounting for Stock Issued to Employees."
(C) EARNINGS PER SHARE
Basic earnings per share ("Basic EPS") is computed by dividing net
income by the weighted average number of common shares outstanding during each
period presented. Diluted earnings per share ("Diluted EPS") is computed by
dividing net income by the weighted average number of common stock and common
stock equivalents during the period presented; outstanding warrants and stock
options are considered common stock equivalents and are included in the
calculation using the treasury stock method. Diluted EPS for the year ended
December 31, 2002
7
21ST CENTURY HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(C) EARNINGS PER SHARE (CONTINUED)
excluded the impact of warrants and stock options as their effect would have
been anti-dilutive.
(D) RECLASSIFICATIONS
Certain amounts in 2002 financial statements have been reclassified to
conform with 2003 presentation.
(3) REVOLVING CREDIT OUTSTANDING
Federated Premium's operations are funded by a revolving loan agreement
("Revolving Agreement"). The Revolving Agreement is structured as a sale of
contracts receivable under a sale and assignment agreement with the lender,
which gives the lender the right to sell or assign these contracts receivable.
Federated Premium, which services these contracts, has recorded transactions
under the Revolving Agreement as secured borrowings. The Revolving Agreement,
which was amended and revised in September 2001, allowed for a maximum credit
commitment of $7.0 million plus an initial additional amount of $700,000 for the
transition from September 30, 2001 when the previous agreement expired. The line
declined by $100,000 each month beginning November 1, 2001. In September 2002
the line was amended and revised allowing for a maximum credit commitment of
$4.0 million. The decline in the required credit commitment is due primarily to
Federated National's and American Vehicle's newly developed direct bill program.
Direct billing is where the insurance company accepts from the insured, as a
receivable, a promise to pay the premium, as opposed to requiring the full
amount of the policy, either directly from the insured or from a premium finance
company. The amount of the lender's advance is subject to availability under a
borrowing base calculation, with maximum advances outstanding not to exceed the
maximum credit commitment. The annual interest rate on advances under the
Revolving Agreement is the prime rate plus additional interest varying from
1.25% to 3.25% based on the prior month's ratio of contracts receivable related
to insurance companies with an A. M. Best rating of B or worse to total
contracts receivable. The Company's effective interest rate on this line of
credit, based on the Company's average outstanding borrowings under the
Revolving Agreement, was 6.23% and 7.84% for the years ended December 31, 2002
and 2001, respectively. Currently, the effective rate of interest for this
arrangement is approximately 5.5%. The Revolving Agreement contains various
operating and financial covenants, with which the Company was in compliance at
June 30, 2003 and December 31, 2002. The Revolving Agreement, as amended,
expires September 30, 2004. Outstanding borrowings under the Revolving Agreement
as of June 30, 2003 and December 31, 2002 were approximately $3.8 million and
$4.3 million, respectively. Outstanding borrowings in excess of the $4.0 million
commitment totaled $312,420 for December 31, 2002 and are permissible by reason
of a compensating cash balance held for the benefit of the lender. Interest
expense on this revolving credit line for the six months ending June 30, 2003
and the year ended December 31, 2002 totaled approximately $110,000 and
$342,000, respectively.
(4) COMMITMENTS AND CONTINGENCIES
The Company is involved in various claims and legal actions arising in
the ordinary course of business. In the opinion of management, the ultimate
disposition of these matters will not have a material adverse effect on the
Company's consolidated financial position, results of operations, or liquidity.
In June 2000, a lawsuit was filed against the Company and its directors
and executive officers seeking compensatory damages in an undisclosed amount on
the basis of allegations that the Company's amended registration statement dated
November 4, 1998 was inaccurate and misleading concerning the manner in which
the Company recognized ceded insurance commission income, in violation of
Sections 11 and 15 of the Securities Act of 1933 and Sections 10(b) and 20(a) of
the Securities Exchange Act of 1934. Specifically, the plaintiffs allege that
the Company recognized ceded commission income on a written basis, rather than
amortized on a pro rata basis. The plaintiffs allege that this was contrary to
the Statement of Financial Accounting Concepts Nos. 1, 2 and 5. The Company has
since accounted for ceded commission on a pro rata basis and has done so since
these matters were brought to the Company's attention in 1998. Nevertheless, the
Company believes that the lawsuit is without merit and is vigorously defending
the action, as the Company reasonably relied upon outside subject matter experts
to
8
21ST CENTURY HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(4) COMMITMENTS AND CONTINGENCIES (CONTINUED)
make these determinations at the time. The lawsuit was filed in the United
States District Court for the Southern District of New York and seeks class
action status. The plaintiff class purportedly includes purchasers of the
Company's common stock between November 5, 1998 and August 13, 1999. The Court
recently denied the Company's Motion to Dismiss the plaintiffs' First Amended
Complaint and the Company filed an Answer and Affirmative Defenses.
Prior to its acquisition by the Company in 2001, American Vehicle was
involved in litigation with a former officer and director. The litigation was
adjudicated and American Vehicle, among others, was found liable and paid the
final judgment. A petition was filed seeking costs of $136,000 and appellate
attorneys fees in excess of $2.0 million. To secure this obligation, American
Vehicle's previous owners have agreed to indemnify the Company against any award
of fees and costsand the $500,000 purchase price for American Vehicle was placed
in escrow. On February 26, 2003, the 11th Judicial Circuit in Miami, Florida
entered an amended final judgment awarding the plaintiffs $1,140,387 in attorney
fees and costs. Both parties are appealing this judgment. Management anticipates
that there will be no costs associated with the resolution of this case,
consequently, no liability for fees and costs has been accrued.
The Company, as a direct premium writer in the State of Florida, is
required to participate in certain insurer solvency pools under Florida Statutes
Section 631.57(3)(a). Participation in these pools is based on the Company's
written premiums by line of business to total premiums written statewide by all
insurers. Participation may result in assessments against the Company. The
Company was assessed $258,000 and $203,000 for the years ended December 31, 2002
and 2001, respectively. Should there be a 2003 assessment, the Company is
generally notified in December. During 2002, the Company recovered $180,000 of
the 2001 assessment and is entitled to recover all of these assessments as
permitted by the State of Florida through policy surcharges in 2003. During the
first six months of 2003, the Company has recovered the balance of the 2001
assessment and has recovered $92,000 of the 2002 assessment.
Federated National and American Vehicle are also required to
participate in an insurance apportionment plan under Florida Statutes Section
627.351 referred to as a Joint Underwriting Association Plan ("JUA Plan"). The
JUA Plan provides for the equitable apportionment of any profits realized, or
losses and expenses incurred, among participating insurers. In the event of an
underwriting deficit incurred by the JUA Plan which is not recovered through the
policyholders in the JUA Plan, such deficit shall be recovered from the
companies participating in the JUA Plan in the proportion that the net direct
written premiums of each such member during the preceding calendar year bear to
the aggregate net direct premiums written in this state by all members of the
joint underwriting JUA Plan.
No assessments by have been incurred by either insurance company
through the date of issuance of this report.
(5) COMPREHENSIVE INCOME
For the three and six months ended June 30, 2003 and 2002,
comprehensive income consisted of the following:
Three months ended June 30, Six months ended June 30,
2003 2002 2003 2002
----------- ----------- ----------- -----------
Net income $ 2,113,934 $ 32,041 $ 4,422,335 $ 1,023,411
Change in net unrealized losses on
investments held for resale (373,706) $(1,655,708) 159,461 $(2,126,397)
----------- ----------- ----------- -----------
Other comprehensive income, before tax 1,740,228 $(1,623,667) 4,581,796 $(1,102,986)
Income tax expense related to items of
other comprehensive income 94,030 $ 962,943 (62,987) $ 889,706
----------- ----------- ----------- -----------
Comprehensive income (loss) $ 1,834,258 $ (660,724) $ 4,518,809 $ (213,280)
=========== =========== =========== ===========
9
21ST CENTURY HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(6) SEGMENT INFORMATION
The Company and its subsidiaries operate principally in two business
segments consisting of insurance and financing. The insurance segment consists
of underwriting through Federated National and American Vehicle, managing
general agent operations through Assurance MGA, claims processing through
Superior, and marketing and distribution through Federated Agency Group. The
insurance segment sells personal automobile, general liability and homeowner
insurance and includes substantially all aspects of the insurance, distribution
and claims process. The financing segment consists of premium financing through
Federated Premium. The financing segment provides premium financing to the
Company's insureds and is marketed through the Company's distribution network of
Company-owned agencies and franchised agents.
The accounting policies of the segments are the same as those described
in the summary of significant accounting policies and practices. The Company
evaluates its business segments based on GAAP pretax operating earnings.
Corporate overhead expenses are allocated to business segments. Transactions
between reportable segments are accounted for at fair value.
Operating segments that are not individually reportable, based on the
extent of the current operations in such segments, are included in the "All
Other" category. The "All Other" category currently includes the operations of
21st Century Holding Company, franchise operations and income tax return
preparation.
Information regarding components of operations for the three months and
six months ended June 30, 2003 and 2002 follows:
Three months ended June 30, Six months ended June 30,
2003 2002 2003 2002
------------ ------------ ------------ ------------
Total revenue
Insurance segments $ 14,264,666 $ 7,525,014 $ 29,714,031 $ 15,096,003
Financing segment 600,427 1,075,743 1,280,241 2,076,507
All other segments 2,306,362 410,610 3,491,122 1,624,062
------------ ------------ ------------ ------------
Total operating segments 17,171,455 9,011,367 34,485,394 18,796,572
Intercompany eliminations (2,226,676) (657,638) (4,678,605) (1,552,219)
------------ ------------ ------------ ------------
Total revenues $ 14,944,779 $ 8,353,729 $ 29,806,789 $ 17,244,353
============ ============ ============ ============
Earnings before income taxes
Insurance segments $ 2,061,813 $ 236,465 $ 5,183,083 $ 637,879
Financing segments 72,176 411,065 270,849 570,299
All other segments 1,015,007 275,861 1,301,933 1,259,449
------------ ------------ ------------ ------------
Total earnings before income taxes $ 3,148,996 $ 923,391 $ 6,755,865 $ 2,467,627
============ ============ ============ ============
Information regarding total assets as of June 30, 2003 and
December 31, 2002:
2003 2002
------------ ------------
Total assets
Insurance segments $ 79,335,230 $ 66,663,775
Financing segment 6,392,136 7,548,841
All other segments 2,156,370 3,003,827
------------ ------------
Total operating segments 87,883,736 77,216,443
Intercompany eliminations (1,695,460) (1,898,432)
------------ ------------
Total assets $ 86,188,276 $ 75,318,011
10
21ST CENTURY HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(7) REINSURANCE AGREEMENTS
The quota-share reinsurance treaties include loss corridors with
varying layers of coverage based on ultimate incurred loss ratio results.
Additionally, the most current of these treaties contain conversion features
that may diminish the Company's ability to collect for loss experience at the
election of the reinsurer for loss experience between 66% and 86%. Despite the
conversion features, the reinsurer assumes significant insurance risk under the
reinsured portions of the underlying insurance contracts and it is reasonably
possible that the reinsurer may realize a significant loss from the transaction.
The Company also participates in the Florida Hurricane Catastrophe Fund
to protect its interest in insurable risks associated with its homeowner and
mobile home owner policies against catastrophic losses. Additionally, the
Company has purchased "Excess of Loss" insurance to further protect itself from
potential catastrophic events.
(8) STOCK COMPENSATION PLANS
On December 1998, the Company issued warrants to two employees to
purchase 62,500 shares of common stock of the Company at $9.00 per share. The
warrants vested immediately and are exercisable between December 1999 and
December 2004, at which time if they have not been exercised, they will be
canceled. The estimated fair value of these warrants at the date issued was
approximately $226,000 using a Black-Scholes option pricing model and
assumptions similar to those used for valuing the Company's stock options as
described below. During the six months ended June 30, 2003 exercised warrants
totaled 19,700 at an average price of approximately $15.00 per share. As of
December 31, 2002, no warrants were exercised.
The Company implemented a stock option plan in November 1998 that
provides for the granting of stock options to officers, key employees and
consultants. The objectives of this plan include attracting and retaining the
best personnel, providing for additional performance incentives, and promoting
the success of the Company by providing employees the opportunity to acquire
common stock. Options outstanding under this plan have been granted at prices,
which are either equal to or above the market value of the stock on the date of
grant, vest over a four-year period, and expire ten years after the grant date.
Under this plan, the Company is authorized to grant options to purchase up to
600,000 common shares, and, as of June 30, 2003 and December 31, 2002, the
Company had granted options (net of options granted, exercised and cancelled) to
purchase 444,841 and 534,338 shares, respectively.
In 2001, the Company implemented a franchisee stock option plan that
provides for the granting of stock options to individuals purchasing Company
owned agencies which are then converted to franchised agencies. The purpose of
the plan is to advance the interests of the Company by providing an additional
incentive to encourage managers of Company owned agencies to purchase the
agencies and convert them to franchises. Options outstanding under the plan have
been granted at prices that are above the market value of the stock on the date
of grant, vest over a ten-year period, and expire ten years after the grant
date. Under this plan, the Company is authorized to grant options to purchase up
to 689,000 common shares, and as of June 30, 2003 and December 31, 2002, the
Company had granted options (net of options granted, exercised and cancelled) to
purchase 53,278 and 78,155 shares, respectively.
In 2002, the Company implemented its 2002 Option Plan. The purpose of
this Plan is to advance the interests of the Company by providing an additional
incentive to attract, retain and motivate highly qualified and competent persons
who are key to the Company, including key employees, consultants, independent
contractors, officers and directors, upon whose efforts and judgment the success
of the Company and its subsidiaries is largely dependent, by authorizing the
grant of options to purchase Common Stock of the Company to persons who are
eligible to participate hereunder, thereby encouraging stock ownership in the
Company by such persons, all upon and subject to the terms and conditions of the
Plan. Options outstanding under the Plan have been granted at prices that are
above the market value of the stock on the date of grant, vest over a five-year
period, and expire six years after the grant date. Under this Plan, the Company
is authorized to grant options to purchase up to 1,200,000 common shares, and,
as of June 30, 2003 and December 31, 2002, the Company had granted options (net
of options granted, exercised and cancelled) to purchase 751,000 and 727,000
shares, respectively.
11
21ST CENTURY HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(8) STOCK COMPENSATION PLANS (CONTINUED)
Activity in the Company's stock option plans for the period from
January 1, 2000 to June 30, 2003, is summarized below:
------------------------- -------------------------- ------------------------
1998 PLAN 2001 FRANCHISEE PLAN 2002 PLAN
------------------------- -------------------------- ------------------------
Weighted Weighted Weighted
Number of Average Option Number of Average Option Number of Average Option
Shares Exercise Price Shares Exercise Price Shares Exercise Price
------ -------------- ------ -------------- ------ --------------
Outstanding at December 31, 2000 487,971 $ 10.00 --
Granted 20,000 $ 10.00 83,830 $ 10.00
Exercised --
Cancelled (95,399) $ 10.00 --
------- ------
Outstanding at December 31, 2001 412,572 $ 10.00 83,830 $ 10.00 --
Granted 228,265 $ 10.00 783,000 $ 13.35
Exercised (1,000) -- --
Cancelled (105,499) $ 10.00 (5,675) (56,000) $ 13.35
------- ------ -------
Outstanding at December 31, 2002 534,338 $ 10.00 78,155 $ 10.00 727,000 $ 13.35
Granted -- $ 10.00 10,000 $ 10.00 61,000 $ 14.08
Exercised (71,097) $ 10.00 (34,877) $ 10.00 --
Cancelled (18,400) $ 10.00 -- (37,000) $ 13.85
------- ------ -------
Outstanding at June 30, 2003 444,841 $ 10.00 53,278 $ 10.00 751,000 $ 13.38
======= ====== =======
Options outstanding as of June 30, 2003 are exercisable as follows:
------------------------- -------------------------- ------------------------
1998 PLAN 2001 FRANCHISEE PLAN 2002 PLAN
------------------------- -------------------------- ------------------------
Weighted Weighted Weighted
Number of Average Option Number of Average Option Number of Average Option
Options Exercisable At: Shares Exercise Price Shares Exercise Price Shares Exercise Price
- ----------------------- ------ -------------- ------ -------------- ------ --------------
June 30, 2003 271,403 $ 10.00 14,842 $ 10.00 127,800 $ 13.35
December 31, 2003 19,000 $ 10.00 29,617 $ 10.00 7,300 $ 13.35
December 31, 2004 63,305 $ 10.00 378 $ 10.00 149,800 $ 13.35
December 31, 2005 47,316 $ 10.00 378 $ 10.00 149,800 $ 13.35
December 31, 2006 43,817 $ 10.00 378 $ 10.00 149,800 $ 13.35
December 31, 2007 -- 378 $ 10.00 149,800 $ 13.35
Thereafter -- 7,307 $ 10.00 16,700 $ 14.08
The Company continues to account for stock-based compensation using the
intrinsic value method prescribed by Accounting Principles Board Opinion No. 25,
under which no compensation cost for stock options is recognized for stock
option awards granted to employees at or above fair market value. Had
compensation expense for the Company's stock compensation plans been determined
based upon fair values at the grant dates for awards under the plan in
accordance with SFAS No. 123, the Company's net income (loss) and net income
(loss) per share would have been reduced (increased) to the pro forma amounts
indicated below. Additional stock option awards are anticipated in future years.
Net income (loss) June 30, 2003 December 31, 2002 December 31, 2001
------------- ----------------- -----------------
As reported $ 4,422,335 $ 4,570,201 $ (992,090)
Pro forma $ 4,161,775 $ 2,819,673 $ (1,181,855
Net income (loss) per share
As reported - Basic $ 1.46 $ 1.52 $ (0.31)
As reported - Diluted $ 1.41 $ 1.52 $ (0.31)
Pro forma - Basic $ 1.37 $ 0.94 $ (0.37)
Pro forma - Diluted $ 1.33 $ 0.94 $ (0.37)
The weighted average fair value of options granted during 2002, 2001
and 2000 estimated on the date of grant using the Black-Scholes option-pricing
model was $2.17 to $8.06 in 2002; $2.38 to $2.92 in 2001; and $2.79 to $6.23 in
2000. The fair value of options granted is estimated on the date of grant using
the following assumptions:
12
21ST CENTURY HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(8) STOCK COMPENSATION PLANS (CONTINUED)
June 30, 2003 December 31, 2002 December 31, 2001
------------- ----------------- -----------------
Dividend yield 1.38%-2.25% .073%-3.5% 2.68%-3.20%
Expected volatility 112.73% 120.22% 136%-152%
Risk-free interest rate 5.62% 4.49%-5.82% 4.89%-5.29%
Expected life (in years) 4.14-6.50 4.83-7.02 10
Summary information about the Company's stock options outstanding at
June 30, 2003:
Weighted Average Weighted
Range of Outstanding Contractual Average Exercisable
Exercise Price at 06/30/03 Periods in Years Exercise Price at 06/30/03
-------------- ----------- ---------------- -------------- -----------
1998 Plan $10.00 444,841 4.1 $10.00 271,403
2001 Franchise Plan $10.00 53,278 6.5 $10.00 14,842
2002 Plan $12.50-$13.75 751,000 4.5 $13.35 127,800
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATION
ITEM 2:
FORWARD-LOOKING STATEMENTS
Statements in this report that are not historical fact are
"forward-looking" statements that are subject to certain risks and uncertainties
that could cause actual events and results to differ materially from those
discussed herein. Without limiting the generality of the foregoing, words such
as "may," "will," "expect," "believe," "anticipate," "intend," "could," "would,"
"estimate," or "continue," or the negative other variations thereof or other
comparable terminology, are intended to identify forward-looking statements. The
risks and uncertainties include, without limitation, uncertainties related to
estimates, assumptions and projections generally; inflation and other changes in
economic conditions (including changes in interest rates and financial markets);
pricing competition and other initiatives by competitors; ability to obtain
regulatory approval for requested rate changes and the timing thereof;
legislative and regulatory developments; the outcome of litigation pending
against the Company; risks related to the nature of the Company's business;
dependence on investment income and the composition of the Company's investment
portfolio; the adequacy of its liability for loss and loss adjustment expense
("LAE"); insurance agents; claims experience; ratings by industry services;
catastrophe losses; reliance on key personnel; weather conditions (including the
severity and frequency of storms, hurricanes, tornadoes and hail); changes in
driving patterns and loss trends; acts of war and terrorist activities; courts
decisions and trends in litigation and health care and auto repair costs; and
other matters described from time to time by the Company in this report and its
other filings with the SEC.
13
21ST CENTURY HOLDING COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATION
FORWARD-LOOKING STATEMENTS (CONTINUED)
You are cautioned not to place reliance on these forward-looking statements,
which are valid only as of the date they were made. The Company undertakes no
obligation to update or revise any forward-looking statements to reflect new
information or the occurrence of unanticipated events or otherwise. In addition,
readers should be aware that generally accepted accounting principles prescribe
when a company may reserve for particular risks, including litigation exposures.
Accordingly, results for a given reporting period could be significantly
affected if and when a reserve is established for a major contingency. Reported
results may therefore appear to be volatile in certain accounting periods.
OVERVIEW
The Company is a vertically integrated insurance holding company,
which, through its subsidiaries, controls substantially all aspects of the
insurance underwriting, distribution and the claims process. The Company
underwrites general liability, personal automobile insurance, homeowners
insurance and mobile home property and casualty insurance in the State of
Florida through its wholly-owned subsidiaries, Federated National and American
Vehicle. The Company internally processes claims made by its own and third party
insureds through a wholly-owned claims adjusting company, Superior. The Company
also offers premium financing to its own and third-party insureds through its
wholly-owned subsidiary, Federated Premium.
The Company markets and distributes its own and third-party insurers'
products and its other services primarily in South Florida, through a network of
23 agencies, owned by Federated Agency Group, a wholly-owned subsidiary, 42
franchised agencies and approximately 125 independent agents. The Company,
through its wholly-owned subsidiary, FedUSA, franchises agencies under the
FedUSA name. As of June 30, 2003, franchises were granted for 42 Fed USA
agencies, of which 36 were operating. The Company intends to focus its future
expansion efforts for its agency network on franchised agencies.
The Company offers electronic tax filing services through Express Tax
Service, Inc., ("EXPRESSTAX"), an 80%-owned subsidiary, as well as franchise
opportunities for these services. As of June 30, 2003 there were 141 EXPRESSTAX
franchises granted in ten states. Revenue is generated through franchise sales,
collection of royalty on tax preparation fees, incentives from business partners
as well as fees from the preparation of income tax returns and bank related
products. In addition, EXPRESSTAX offers Tax Preparation services through more
than 500 licensees nationwide, acting as sales representatives of EXPRESSTAX.
The Company believes that it can be distinguished from its competitors
because it generates revenue from substantially all aspects of the insurance
underwriting, distribution and claims process. The Company provides quality
service to both its agents and insureds by utilizing an integrated computer
system, which links the Company's insurance and service entities. The Company's
computer and software systems allow for automated premium quotation, policy
issuance, billing, payment and claims processing and enables the Company to
continuously monitor substantially all aspects of its business. Using these
systems, the Company's agents can access a customer's driving record, quote a
premium, offer premium financing and, if requested, generate a policy on-site.
The Company believes that these systems have facilitated its ability to market
and underwrite insurance products on a cost-efficient basis, allow Company-owned
and franchised agencies to be a "one stop" shop for insurance, tax preparation
and other services, and enhance the Company's ability to expand in Florida and
to other states.
The Company's primary products are standard and nonstandard personal
automobile insurance. The former is principally provided to insureds who present
an average risk profile in terms of payment history, driving record, vehicle and
other factors. The latter is principally provided to insureds who are unable to
obtain preferred or standard insurance coverage because of their payment
history, driving record, age, vehicle type or other factors, including market
conditions for preferred or standard risks. The Company's experience has been
that Underwriting
14
21ST CENTURY HOLDING COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATION
OVERVIEW (CONTINUED)
criteria in the industry generally for standard insurance coverage have become
more restrictive, thereby requiring more drivers to seek coverage in the
nonstandard automobile insurance market. The Company believes that these factors
have contributed to an increase in the size of the nonstandard personal
automobile insurance market. Additionally other insurance products offered
include property insurance for the home and mobile home and, in June of 2003,
American Vehicle has launched a new general liability insurance product designed
for the small artisan.
The Company currently underwrites and sells insurance only in Florida;
however, the Company intends to expand to other selected states. American
Vehicle has applied to obtain a license to underwrite and sell personal
automobile insurance in Alabama. The Company will select additional states for
expansion based on a number of criteria, including the size of the personal
automobile insurance market, statewide loss results, competition and the
regulatory climate. The Company's ability to expand into other states will be
subject to the prior regulatory approval of each state. Certain states impose
operating requirements upon licensee applicants, which may impose burdens on the
Company's ability to obtain a license to conduct insurance business in those
other states. There can be no assurance that the Company will be able to obtain
the required licenses, and the failure to do so would limit the Company's
ability to expand geographically.
The Company's executive offices are located at 4161 N.W. Fifth Street,
Plantation, Florida and its telephone number is (954) 581-9993.
ANALYSIS OF FINANCIAL CONDITION
AS OF JUNE 30, 2003 AS COMPARED TO DECEMBER 31, 2002
INVESTMENTS. Investments increased $11.0 million, or 43.3.7%, to $36.4
million as of June 30, 2003 as compared to $25.4 million as of December 31,
2002. Cash generated from operations provided $10.6 million during the six
months ended June 30, 2003. For further detail, see the section titled ITEM 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
FINANCE CONTRACTS AND PAY ADVANCES RECEIVABLE. Finance contracts
decreased $2.3 million, or 32.3%, to $4.9 million as of June 30, 2003. The
continued decrease is due to the direct-bill feature offered by the insurance
companies wherein the policyholder can renew and pay premiums directly to the
insurance companies.
PREPAID REINSURANCE PREMIUMS. Prepaid reinsurance premiums decreased
$2.5 million, or 22.4%, to $8.7 million as of June 30, 2003 from $11.3 million
as of December 31, 2002. The decrease is the result a decrease in American
Vehicle ceded quota-share reinsurance from 70% of its premiums written to 40%
effective November 1, 2002. Federated National's ceded quota-share reinsurance
changed from 40% of automobile premiums written in 2002 to 30% for automobile
premiums written in the first quarter of 2003. Subsequent to the first quarter
of 2003, the cession for Federated National was changed to 40%.
REINSURANCE RECOVERABLE. Reinsurance recoverable increased $4.2 million
to $12.1 million as of June 30, 2003 from $7.9 million as of December 31, 2002.
This increase is the result of the increase in loss and loss adjustment expenses
incurred and, to a lesser extent, the timing of settlements between the Company
and its reinsurer. All amounts are considered current.
DEFERRED ACQUISITION COSTS, NET. Deferred acquisition costs increased
from $7,721 as of December 31, 2002 to $829,042 as of June 30, 2003. The
December 31, 2002 balance was composed of commission expense offset by ceded
commissions income of approximately $(422,920) and other expenses connected with
the writing of premiums such as salaries, payroll taxes and premium taxes, and
offset by policy fees of $430,641. At June 30, 2003, commission expense and
commissions income, net were $ 417,351 and expenses connected with the writing
of premiums such as salaries and premium taxes, net of policy fees totalled
$411,691. Deferred policy acquisition costs, net, increased primarily due to the
decrease in ceded unearned commissions. The decrease in ceded unearned
15
21ST CENTURY HOLDING COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATION
DEFERRED ACQUISITION COSTS, NET (CONTINUED)
commissions relates to the decline in the decreased reliance of quota-share
reinsurance associated with the insurance company's automobile premiums.
UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES. Unpaid losses and loss
adjustment expenses increased $7.1 million from $17.0 million as of December 31,
2002 to $24.1 June 30, 2003. The increase is associated with an increase in
frequency and severity of claims activity associated with our automobile
business. Federated National's reserves increased by $3.1 million and represent
44.19% of the total reserve increase. American Vehicle's reserves increased by
$4.0 million and represent 55.81% of the total reserve increase. Factors that
affect unpaid losses and loss adjustment expenses include the estimates made on
a claim-by-claim basis known as case reserves coupled with bulk estimates known
as "incurred but not reported" (IBNR). Interim estimates of the ultimate costs
required to settle all claim files are based on all available information
encompassing prior loss trends and current payment patterns.
PREMIUM DEPOSITS. Premium deposits represent premiums collected in
advance of the policy's effective date of coverage and are generally associated
with the Company's home and mobile home insurance policies. Premium deposits
increased from $656,000 as of December 31, 2002 to $1.0 million as of June 30,
2003 primarily due to the additional home owners' policies written.
ACCOUNTS PAYABLE AND ACCRUED EXPENSES. Accounts payable and accrued
expenses decreased by $ 1.0 million primarily due to the Company's payment of
its premium taxes and to a lesser extent a scheduled payment of contingent
commissions.
RESULTS OF OPERATIONS
THREE MONTHS ENDED JUNE 30, 2003 COMPARED TO THREE MONTHS ENDED JUNE 30, 2002
GROSS PREMIUMS WRITTEN. Gross premiums written decreased $158,000, or
0.9%, to $17.6 million for the three months ended June 30, 2003, as compared to
$17.7 million for the comparable period in 2002. The following table denotes
gross premiums written by major product line.
Three months ended June 30,
2003 2002
------------------------ ------------------------
Automobile $12,189,273 69.4% $13,944,967 78.7%
Homeowners 4,891,436 27.8% 3,253,480 18.3%
Mobile home owners 497,885 2.8% 538,277 3.0%
----------- ----- ----------- -----
Gross written premiums $17,578,594 100.0% $17,736,724 100.0%
=========== ===== =========== =====
GROSS PREMIUMS CEDED. Gross premiums ceded decreased $1.7 million to
$5.8 million for the three months ended June 30, 2003, from $7.5 million for the
three months ended June 30, 2002. The decrease is primarily due to the decline
in the Company's ceded quota-share reinsurance associated with its automobile
insurance.
DECREASE IN UNEARNED PREMIUMS, NET OF PREPAID REINSURANCE PREMIUMS. The
decrease in unearned premiums, net of prepaid reinsurance premiums, was $0.8
million for the three months ended June 30, 2003 compared to $3.8 million for
the three months ended June 30, 2002. The decrease is due primarily to American
Vehicle having its first full twelve consecutive months of business .
NET REALIZED INVESTMENTS GAINS (LOSSES). The Company experienced net
gains of $1.1 million for the three-month period ended June 30, 2003 compared to
net losses of $1.5 million for the same period in 2002. Realized gains for the
quarter ending June 30, 2003 totaled $1.2 million and realized losses for the
same period were $0.1 million. In June 2002, the Company recorded an
other-than-temporary loss of $1.5 million on its $2.5 million investment in
WorldCom bonds.
16
21ST CENTURY HOLDING COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATION
RESULTS OF OPERATIONS
THREE MONTHS ENDED JUNE 30, 2003 COMPARED TO THREE MONTHS ENDED JUNE 30, 2002
(CONTINUED)
LOSSES AND LAE. The Company's loss ratio, as determined in accordance
with GAAP, for the three-month period ended June 30, 2003 was 68.4% compared
with 49.5% for the same period in 2002. Losses and LAE incurred increased $4.2
million to $7.5 million for the three-month period ended June 30, 2003 from $3.2
million for the same period in 2002. The table below reflects the loss ratios by
product line.
Three months ending June 30,
2003 2002
---- ----
Automobile 86.96% 73.73%
Home owners 15.83% 9.89%
Mobile home owners 19.98% 9.94%
Totals 68.44% 49.48%
Losses and LAE, the Company's most significant expense, represent actual
payments made and changes in estimated future payments to be made to or on
behalf of its policyholders, including expenses required to settle claims and
losses. The Company attributes the overall increase in the loss ratio primarily
to its liability lines of insurance associated with automobile claims and the
related estimates of the costs necessary to settle the claim files. The
estimated cost to close all claim files, for accident years other than the
current year and net of reinsurance recoveries, has increased by a total of $1.2
million over the ultimate estimates made as of December 31, 2002 primarily due
to an increase of claim frequency and claim severity.
AMORTIZATION OF DEFERRED POLICY ACQUISITION COSTS. Amortization of
deferred policy acquisition costs decreased from a credit of $1,031,000 for the
three-month period ended June 30, 2002 to a credit of $677,000 for the same
period in 2003. Amortization of deferred policy acquisition costs consists of
the actual policy acquisition costs, including commissions, payroll and premium
taxes, less commissions earned on reinsurance ceded and policy fees earned. The
decline is attributable to the decrease in ceded unearned commissions. The
decrease in ceded unearned commissions relates to the decline in the decreased
reliance of quota-share reinsurance associated with the Company's automobile
premiums.
PROVISION FOR INCOME TAX EXPENSE. Effective rate for the income tax
expense is 32.1% for the three months ended June 30, 2003, compared with 96.5%
for the same period in 2002. The decreased rate reflects the Company's ability
to absorb its capital losses recognized in prior years. The rate recognized in
the comparable period last year was due to the Company's inclusion of a
valuation allowance for its deferred tax asset.
RESULTS OF OPERATIONS
SIX MONTHS ENDED JUNE 30, 2003 COMPARED TO SIX MONTHS ENDED JUNE 30, 2002
GROSS PREMIUMS WRITTEN. Gross premiums written increased $3.4 million,
or 11%, to $34.1 million for the six months ended June 30, 2003, as compared to
$30.8 million for the comparable period in 2002. The increase is primarily due
to additional marketing of its home owners' insurance product. The following
table denotes gross premiums written by major product line.
Six months ended June 30,
2003 2002
------------------------ ------------------------
Automobile $25,954,630 75.9% $24,854,334 80.6%
Homeowners 7,258,461 21.2% 4,917,591 16.0%
Mobile home owners 977,483 2.9% 1,039,784 3.4%
----------- ----- ----------- -----
Gross written premiums $34,190,574 100.0% $30,811,709 100.0%
=========== ===== =========== =====
17
21ST CENTURY HOLDING COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATION
RESULTS OF OPERATIONS
SIX MONTHS ENDED JUNE 30, 2003 COMPARED TO SIX MONTHS ENDED JUNE 30, 2002
(CONTINUED)
GROSS PREMIUMS CEDED. Gross premiums ceded decreased from $13.4 million
for the six months ended June 30, 2002, to $10.2 million for the six months
ended June 30, 2003. For 2002, Federated National reinsured through a
quota-share agreement 40% of its automobile premiums and American Vehicle
reinsured 70% of its written premiums. In 2003, Federated National and American
Vehicle reinsure 40% of its automobile premiums. The amount of quota share
reinsurance maintained by Federated National is determined by management, based
on estimated annual written premiums and estimated year-end surplus, in order to
comply with insurance regulations.
DECREASE IN UNEARNED PREMIUMS, NET OF PREPAID REINSURANCE PREMIUMS. The
decrease in unearned premiums, net of prepaid reinsurance premiums, was $2.6
million for the six months ended June 30, 2003 compared to $5.5 million for the
six months ended June 30, 2002. This change relates primarily to the increase in
written premiums offset by the reduction of ceded premiums to the Company's
reinsurer
COMMISSION INCOME. Commission income is generated from the sale of
other insurance company products by our captive agents. The decline in
commission income is primarily due to the Company's emphasis on selling its own
insurance products.
MANAGING GENERAL AGENT FEES. MGA fees increased $374,000 to $1.3
million for the six-month period ended June 30, 2003 from $879,000 for the same
period in 2002. The increase can be attributed to increased volume in the
American Vehicle's automobile program and Federated National's homeowner program
as compared to the same period last year.
NET SECURITIES GAINS (LOSSES). The Company experienced net losses of
$1.5 million for the six-month period ended June 30, 2002 compared to net gains
of $1.4 million for the same period in 2003. Realized gains for the six months
ending June 30, 2003 totaled $1.6 million and realized losses for the same
period were $0.2 million. In June 2002, the Company recorded a loss of $1.5
million on its $2.5 million investment in WorldCom bonds.
LOSSES AND LAE. The Company's loss ratio, as determined in accordance
with GAAP, for the six-month period ended June 30, 2003 was 66.7% compared with
54.7% for the same period in 2002. Losses and LAE incurred increased $7.8
million to $14.3 million for the six-month period ended June 30, 2003 from $6.5
million for the same period in 2002. The Company attributes the overall increase
in the loss ratio primarily to its liability lines of insurance associated with
automobile claims and the related estimates of the costs necessary to settle the
claim files. The estimated cost to close all claim files, for accident years
other than the current year and net of reinsurance recoveries has increased by a
total of $2.3 million over the ultimate estimates made as of December 31, 2002
primarily due to an increase in claim frequency and claim severity. The table
below reflects the loss ratios by product line.
Six months ending June 30,
2003 2002
---- ----
Automobile 83.77% 79.38%
Home owners 14.64% 20.12%
Mobile home owners 27.39% 11.80%
Totals 66.72% 54.65%
Losses and LAE, the Company's most significant expense, represent actual
payments made and changes in estimated future payments to be made to or on
behalf of its policyholders, including expenses required to settle claims and
losses.
18
21ST CENTURY HOLDING COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATION
RESULTS OF OPERATIONS
SIX MONTHS ENDED JUNE 30, 2003 COMPARED TO SIX MONTHS ENDED JUNE 30, 2002
(CONTINUED)
AMORTIZATION OF DEFERRED POLICY ACQUISITION COSTS. Amortization of
deferred policy acquisition costs decreased from a credit of $1.1 million for
the six-month period ended June 30, 2002 to a credit $1.0 million for the same
period in 2003. Amortization of deferred policy acquisition costs consists of
the actual policy acquisition costs, including commissions, payroll and premium
taxes, less commissions earned on reinsurance ceded and policy fees earned. The
decline is attributable to the decrease in ceded unearned commissions. The
decrease in ceded unearned commissions relates to the decline in the decreased
reliance of quota-share reinsurance associated with the insurance company's
automobile premiums.
PROVISION FOR INCOME TAX EXPENSE. Effective rate for income tax expense
is 33.5% for the six months ended June 30, 2003 compared with 58.5% for the same
period in 2002. The change to the effective rate reflects the Company's ability
to generate realized gains and the benefit of netting capital losses incurred in
2001.
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary sources of capital are revenues generated from
operations, sales of debt securities, investment income and borrowings under the
Revolving Agreement, described below. Because the Company is a holding company,
it is largely dependent upon dividends and fees from its subsidiaries for cash
flow.
Federated Premium's operations are funded by a revolving loan agreement
("Revolving Agreement"). The Revolving Agreement is structured as a sale of
contracts receivable under a sale and assignment agreement with the Lender,
which gives the Lender the right to sell or assign these contracts receivable.
Federated Premium, which services these contracts, has recorded transactions
under the Revolving Agreement as secured borrowings. The Revolving Agreement,
which was amended and revised in September 2001, allowed for a maximum credit
commitment of $7.0 million plus an initial additional amount of $700,000 for the
transition from September 30, 2001 when the previous agreement expired. The line
declined by $100,000 each month beginning November 1, 2001. In September 2002
the line was amended and revised allowing for a maximum credit commitment of
$4.0 million. The decline in the required credit commitment is due primarily to
Federated National and American Vehicle's newly developed direct bill program.
Direct billing is where the insurance company accepts from the insured, as a
receivable, a promise to pay the premium, as opposed to requiring the full
amount of the policy, either directly from the insured or from a premium finance
company. The amount of the Lender's advance is subject to availability under a
borrowing base calculation, with maximum advances outstanding not to exceed the
maximum credit commitment. The annual interest rate on advances under the
Revolving Agreement is the prime rate plus additional interest varying from
1.25% to 3.25% based on the prior month's ratio of contracts receivable related
to insurance companies with an A. M. Best rating of B or worse to total
contracts receivable. The Company's effective interest rate on this line of
credit, based on the Company's average outstanding borrowings under the
Revolving Agreement, was 6.23% and 7.84% for the years ended December 31, 2002
and 2001, respectively.
Currently the effective rate of interest for this arrangement is
approximately 5.5%. The Revolving Agreement contains various operating and
financial covenants, with which the Company was in compliance at June 30, 2003
and December 31, 2002. The Revolving Agreement, as amended, expires September
30, 2004. Outstanding borrowings under the Revolving Agreement as of June 30,
2003 and December 31, 2002 were approximately $3.8 million and $4.3 million,
respectively. Outstanding borrowings in excess of the $4.0 million commitment
totaled $312,420 for December 31, 2002 and are permissible by reason of a
compensating cash balance held for the benefit of FPF, Inc. Interest expense on
this revolving credit line for the six months ending June 30, 2003 and the year
ended December 31, 2002 totaled approximately $110,000 and $342,000,
respectively.
On July 31, 2003, the Company completed a private placement of its 6%
Senior Subordinated Notes (the "Notes"), which were offered and sold to
accredited investors as units consisting of one Note with a principal
19
21ST CENTURY HOLDING COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATION
LIQUIDITY AND CAPITAL RESOURCES (CONTINUED)
amount of $1,000 and one warrant (a "Warrant") to purchase one-half of one share
of the Company's Common Stock. The Company sold an aggregate of $7.5 million of
Notes in this placement, which resulted in proceeds to the Company (net of
placement agent fees of $450,723.83 and offering expenses of $110,778.10) of
$6,938,498.07.
The Notes pay interest at the annual rate of 6%, are subordinated to
senior debt of the Company, and mature on July 31, 2006. Quarterly payments of
principal and interest due on the Notes may be made in cash or, at the Company's
option, in shares of the Company's Common Stock. If paid in shares of Common
Stock, the number of shares to be issued shall be determined by dividing the
payment due by 95% of the weighted-average volume price for the Common Stock on
Nasdaq as reported by Bloomberg Financial Markets ("Bloomberg") for the 20
consecutive trading days preceding the payment date.
The Company issued Warrants to purchase shares of the Company's Common
Stock to the purchasers of the Notes and to the placement agent in the offering,
J. Giordano Securities Group ("J. Giordano"), . Each Warrant entitles the holder
to purchase one-half of one share of the Company's Common Stock. The total
number of shares issuable upon exercise of Warrants issued to the purchasers of
the Notes and to J. Giordano shall be determined after the expiration of 60
consecutive trading days following July 31, 2003, which was the date of closing
of the offering. The number of shares issuable upon exercise of the Warrants
issued to purchasers shall equal $7.5 million divided by the exercise price of
the Warrants. The number of shares issuable upon exercise of the Warrants issued
to J. Giordano shall equal $300,000 divided by the exercise price of the
Warrants. The exercise price of the Warrants shall equal 115% of the
weighted-average volume price of the Common Stock on Nasdaq as reported by
Bloomberg for the 60 consecutive trading days following July 31, 2003, with a
maximum of $25.00 per share and a minimum of $15.00 per share. The terms of the
Warrants provide for adjustment of the exercise price and the number of shares
issuable thereunder upon the occurrence of certain events typical for private
offerings of this type. The Warrants will be exercisable until July 31, 2006.
The Company will not issue shares in payment of principal or interest
on the Notes, nor will it issue shares upon exercise of the Warrants, and the
Warrant exercise price will not be adjusted, if any of the foregoing would cause
the Company to issue shares of Common Stock exceeding the number of shares that
the Company could then issue in compliance with Section 4350(i) of the rules and
regulations of Nasdaq, or any successor rule or regulation (the "Nasdaq Rule").
Under the Nasdaq Rule, a company may not issue shares, and may not issue
securities convertible into shares, where the shares issued could in the
aggregate equal 20% or more of the voting power of the shares outstanding,
without obtaining shareholder approval. The Company has agreed to include a
proposal for the issuance of the foregoing shares in the proxy statement for its
2004 annual meeting of shareholders. If, because the Company has not obtained
the requisite shareholder approval and the Warrant exercise price and number of
shares issuable upon exercise cannot be adjusted under the anti-dilution
provisions of the Warrants as a result of specified issuances of Common Stock at
less than fair market value, then the exercise price of the Warrants will be
reduced to the issuance price of the Common Stock that triggered the
anti-dilution adjustment.
For the six months ended June 30, 2003, operations generated operating
cash flow of $10.6 million, which was primarily attributable to the increase in
unpaid loss and LAE ($7.1 million), the decline of outstanding finance contracts
receivable ($1.8 million) and the exercise of stock options ($1.3 million). Uses
of cash include $4.2 million for the settlement of claims subject to
reimbursement from the Company's reinsurer, $1.0 million to reduce accounts
payable and $1.0 million for policy acquisition. The other uses of cash were
offset by other provisions of cash, including $2.5 million for the collection of
premiums that are subject to reinsurance.
Operating cash flow is currently expected to be positive in both the
short-term and the reasonably foreseeable future. In addition, the Company's
investment portfolio is highly liquid as it consists almost entirely of easily
marketable securities. Cash flow used in net investing activities was $9.4
million for the six months ended June 30, 2003 as the Company invested the cash
flow from operating activities. In the future, the Company expects a continued
cash flow deficit from investing activities as the Company invests cash from
operations. Cash deficit from
20
21ST CENTURY HOLDING COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATION
LIQUIDITY AND CAPITAL RESOURCES (CONTINUED)
financing activities was $1.0 million for the six months ended June 30, 2003, as
the Company paid $0.5 million in dividends and reduced the amount outstanding
under its Revolving Agreement by $0.5 million. The Company believes that its
current capital resources, including the net proceeds from the sales of its
Notes described above, together with cash flow from the Company's operations,
will be sufficient to meet its currently anticipated working capital
requirements. There can be no assurances, however, that such will be the case.
To retain its certificate of authority, Florida insurance laws and
regulations require that Federated National and American Vehicle maintain
capital surplus equal to the greater of 10% of its liabilities or the 2002
statutory minimum capital and surplus requirement of $3.25 million as defined in
the Florida Insurance Code. The insurance companies are also required to adhere
to prescribed premium-to-capital surplus ratios.
Under Florida law, a domestic insurer may not pay any dividend or
distribute cash or other property to its shareholders except out of that part of
its available and accumulated capital surplus funds which is derived from
realized net operating profits on its business and net realized capital gains. A
Florida domestic insurer may not make dividend payments or distributions to
shareholders without prior approval of the Florida Department of Financial
Services if the dividend or distribution would exceed the larger of (i) the
lesser of (a) 10.0% of its capital surplus or (b) net income, not including
realized capital gains, plus a two-year carryforward, (ii) 10.0% of capital
surplus with dividends payable constrained to unassigned funds minus 25% of
unrealized capital gains or (iii) the lesser of (a) 10.0% of capital surplus or
(b) net investment income plus a three-year carryforward with dividends payable
constrained to unassigned funds minus 25.0% of unrealized capital gains.
Alternatively, a Florida domestic insurer may pay a dividend or distribution
without the prior written approval of the Florida Department of Financial
Services (i) if the dividend is equal to or less than the greater of (a) 10.0%
of the insurer's capital surplus as regards policyholders derived from realized
net operating profits on its business and net realized capital gains or (b) the
insurer's entire net operating profits and realized net capital gains derived
during the immediately preceding calendar year, (ii) the insurer will have
policy holder capital surplus equal to or exceeding 115.0% of the minimum
required statutory capital surplus after the dividend or distribution, (iii) the
insurer files a notice of the dividend or distribution with the Florida
Department of Financial Services at least ten business days prior to the
dividend payment or distribution and (iv) the notice includes a certification by
an officer of the insurer attesting that, after the payment of the dividend or
distribution, the insurer will have at least 115% of required statutory capital
surplus as to policyholders. Except as provided above, a Florida domiciled
insurer may only pay a dividend or make a distribution (i) subject to prior
approval by the Florida Department of Financial Services or (ii) 30 days after
the Florida Department of Financial Services has received notice of such
dividend or distribution and has not disapproved it within such time.
Under these laws, Federated National would be permitted to pay
dividends of approximately $207,000 to the Company in 2003, and American Vehicle
would be permitted to pay $73,000 in dividends in 2003. Although the Company
believes that amounts required for it to meet its financial and operating
obligations will be available from sources other than dividends from insurance
subsidiaries, there can be no assurance in this regard. Further, there can be no
assurance that, if requested, the Florida Department of Financial Services will
allow any dividends in excess of the amount available, to be paid by Federated
National or American Vehicle to the Company in the future. No dividends were
paid by Federated National or American Vehicle in 2002, 2001 or 2000, and none
are anticipated in 2003. The maximum dividends permitted by state law are not
necessarily indicative of an insurer's actual ability to pay dividends or other
distributions to a parent company, which also may be constrained by business and
regulatory considerations, such as the impact of dividends on capital surplus,
which could affect an insurer's competitive position, the amount of premiums
that can be written and the ability to pay future dividends. Further, state
insurance laws and regulations require that the statutory capital surplus of an
insurance company following any dividend or distribution by it be reasonable in
relation to its outstanding liabilities and adequate for its financial needs.
21
21ST CENTURY HOLDING COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATION
LIQUIDITY AND CAPITAL RESOURCES (CONTINUED)
Insurance companies are required to comply with the risk-based capital
requirements of the NAIC. The NAIC's risk-based capital requirements are a
method of measuring the amount of capital appropriate for an insurance company
to support its overall business operations in light of its size and risk
profile. NAIC's risk-based capital standards are used by regulators to determine
appropriate regulatory actions relating to insurers who show signs of weak or
deteriorating condition. As of March 31, 2003, based on calculations using the
appropriate NAIC formula, the Company's total adjusted capital is in excess of
ratios that would require regulatory action. GAAP differs in some respects from
reporting practices prescribed or permitted by the Florida Department of
Financial Services. Federated National's and American Vehicle's statutory
capital surplus levels as of June 30, 2003 were approximately $10.4 million and
$6.0 million, respectively, and their statutory net income for the six months
ended June 30, 2003 was $1.4 million and $0.8 million, respectively.
During 2002, Federated National entered into a 10% quota-share
agreement with its affiliate American Vehicle. The agreement ceded 10% of its
premium and losses on all policies with an effective date of 2002. For
presentation purposes and in accordance with the principles of consolidation,
the agreement between the two affiliated insurance companies has been
eliminated.
IMPACT OF INFLATION AND CHANGING PRICES
The consolidated financial statements and related data presented herein
have been prepared in accordance with GAAP which requires the measurement of
financial position and operating results in terms of historical dollars without
considering changes in the relative purchasing power of money over time due to
inflation. The primary assets and liabilities of the Company are monetary in
nature. As a result, interest rates have a more significant impact on the
Company's performance than the effects of general levels of inflation. Interest
rates do not necessarily move in the same direction or with the same magnitude
as the cost of paying losses and LAE.
Insurance premiums are established before the Company knows the amount
of loss and LAE and the extent to which inflation may affect such expenses.
Consequently, the Company attempts to anticipate the future impact of inflation
when establishing rate levels. While the Company attempts to charge adequate
rates, the Company may be limited in raising its premium levels for competitive
and regulatory reasons. Inflation also affects the market value of the Company's
investment portfolio and the investment rate of return. Any future economic
changes which result in prolonged and increasing levels of inflation could cause
increases in the dollar amount of incurred loss and LAE and thereby materially
adversely affect future liability requirements.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Information related to quantitative and qualitative disclosures about
market risk was included under Item 7a, "Quantitative and Qualitative
Disclosures about Market Risk" in the Company's Annual Report on Form 10-K as of
December 31, 2002. No material changes have occurred in market risk since this
information was disclosed except as discussed below.
The Company's investment portfolio is available for sale and is carried
at fair value. Gains, that represent securities with a fair value in excess of
amortized cost, and losses (amortized cost is in excess of fair value) that are
deemed temporary by management are recorded in shareholders' equity in
accumulated other comprehensive income. Losses that are deemed other than
temporary by management are recorded as net realized losses in the consolidated
statement of operations.
22
21ST CENTURY HOLDING COMPANY
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK (CONTINUED)
A summary of the investment portfolio as of June 30, 2003 follows:
Unrealized
Amortized cost Fair value Gain (Loss)
---------------------- --------------------- -----------
Corporate securities
Communications industry $ 1,177,031 3.23% $ 1,451,223 3.99% $ 274,192
Financial industry 3,814,797 10.47% 3,867,057 10.63% 52,260
All other industries 3,492,847 9.59% 3,651,354 10.04% 158,507
----------- ------ ----------- ------ -----------
Total corporate securities 8,484,675 23.29% 8,969,634 24.67% 484,959
Obligations of state and municipal subdivisions 6,559,538 18.00% 6,568,904 18.06% 9,366
United States government and agencies 16,924,909 46.45% 16,437,411 45.20% (487,498)
----------- ------ ----------- ------ -----------
Total fixed maturities 31,969,122 87.74% 31,975,949 87.93% 6,827
----------- ------ ----------- ------ -----------
Common stocks 4,327,858 11.88% 4,248,423 11.68% (79,435)
Mortgage loan 140,506 0.39% 140,506 0.39% --
----------- ------ ----------- ------ -----------
Total investments $36,437,486 100.00% $36,364,878 100.00% $ (72,608)
=========== ====== =========== ====== ===========
As of June 30, 2003, there were no concentrations greater than 5% of
total investments in any single investment other than United States government
obligations.
ITEM 4. CONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES. An evaluation of the
effectiveness of the design and operation of the Company's disclosure controls
and procedures within 90 days of this report was carried out by the Company
under the supervision and with the participation of the Company's management,
including the Chief Executive Officer and Chief Financial Officer. Based on that
evaluation, the Chief Executive Officer and Chief Financial Officer concluded
that the Company's disclosure controls and procedures have been designed and are
being operated in a manner that provides reasonable assurance that the
information required to be disclosed by the Company in reports filed under the
Securities Exchange Act of 1934 is recorded, processed, summarized and reported
within the time periods specified in the SEC's rules and forms. Nevertheless,
the controls system, no matter how well designed and operated, cannot provide
absolute assurance that the objectives of the controls system are met, and no
evaluation of controls can provide absolute assurance that all control issues
and instances of fraud, if any, within a company have been detected.
CHANGES IN INTERNAL CONTROLS. Subsequent to the date of the most recent
evaluation of the Company's internal controls, there were no significant changes
in the Company's internal controls or in other factors that could significantly
affect the internal controls, including any corrective actions with regard to
significant deficiencies and material weaknesses.
PART II. OTHER INFORMATION
ITEM 1
LEGAL PROCEEDINGS
In June 2000, a lawsuit was filed against the Company and its directors and
executive officers seeking compensatory damages in an undisclosed amount on the
basis of allegations that the Company's amended registration statement dated
November 4, 1998 was inaccurate and misleading concerning the manner in which
the Company recognized ceded insurance commission income, in violation of
Sections 11 and 15 of the Securities Act of 1933 and Sections 10(b) and 20(a) of
the Securities Exchange Act of 1934. Specifically, the plaintiffs allege that
the Company
23
21ST CENTURY HOLDING COMPANY
OTHER INFORMATION
LEGAL PROCEEDINGS (CONTINUED)
recognized ceded commission income on a written basis, rather than amortized on
a pro rata basis. The plaintiffs allege that this was contrary to the Statement
of Financial Accounting Concepts Nos. 1, 2 and 5. The Company has since
accounted for ceded commission on a pro rata basis and has done so since these
matters were brought to the Company's attention in 1998. Nevertheless, the
Company believes that the lawsuit is without merit and is vigorously defending
the action, as the Company reasonably relied upon outside subject matter experts
to make these determinations at the time. The lawsuit was filed in the United
States District Court for the Southern District of New York and seeks class
action status. The plaintiff class purportedly includes purchasers of the
Company's common stock between November 5, 1998 and August 13, 1999. The Court
recently denied the Company's Motion to Dismiss the plaintiffs' First Amended
Complaint and the Company filed an Answer and Affirmative Defenses.
Prior to its acquisition by the Company in 2001, American Vehicle was
involved in litigation with a former officer and director. The litigation was
adjudicated and American Vehicle, among others, was found liable and paid the
final judgment. A petition was filed seeking costs of $136,000 and appellate
attorneys fees in excess of $2.0 million. To secure this obligation, American
Vehicle's previous owners have agreed to indemnify the Company against any award
of fees and costs and the $500,000 purchase price for American Vehicle was
placed in escrow. On February 26, 2003, the 11th Judicial Circuit in Miami,
Florida entered an amended final judgment awarding the plaintiffs $1,140,387 in
attorney fees and costs. Both parties are appealing this judgment. Management
anticipates that there will be no costs associated with the resolution of this
case, consequently, no liability for fees and costs has been accrued.
ITEM 2
CHANGES IN SECURITIES
During the quarter ended June 30, 2003, the Company issued 2,000 shares
of Common Stock to an officer representing their bonus in accordance with his
employment contract. The foregoing shares were issued without registration
pursuant to the exemption afforded by Section 4(2) of the Securities Act of
1933.
On July 31, 2003, the Company completed a private placement of its
Notes, which were offered and sold to accredited investors as units consisting
of one Note with a principal amount of $1,000 and one Warrant to purchase
one-half of one share of the Company's Common Stock. The Company sold an
aggregate of $7.5 million of Notes in this placement, which resulted in proceeds
to the Company (net of placement agent fees of $450,723.83 and offering expenses
of $110,778.10) of $6,938,498.07.
The Notes pay interest at the annual rate of 6%, are subordinated to
senior debt of the Company, and mature on July 31, 2006. Quarterly payments of
principal and interest due on the Notes may be made in cash or, at the Company's
option, in shares of the Company's Common Stock. If paid in shares of Common
Stock, the number of shares to be issued shall be determined by dividing the
payment due by 95% of the weighted-average volume price for the Common Stock on
Nasdaq as reported by Bloomberg for the 20 consecutive trading days preceding
the payment date.
The Company issued Warrants to purchase shares of the Company's Common
Stock to the purchasers of the Notes and to the placement agent in the offering,
J. Giordano. Each Warrant entitles the holder to purchase one-half of one share
of the Company's Common Stock. The total number of shares issuable upon exercise
of Warrants issued to the purchasers of the Notes and to J. Giordano shall be
determined after the expiration of 60 consecutive trading days following July
31, 2003, which was the date of closing of the offering. The number of shares
issuable upon exercise of the Warrants issued to purchasers shall equal $7.5
million divided by the exercise price of the Warrants. The number of shares
issuable upon exercise of the Warrants issued to J. Giordano shall equal
$300,000 divided by the exercise price of the Warrants. The exercise price of
the Warrants shall equal 115% of the weighted-average volume price of the Common
Stock on Nasdaq as reported by Bloomberg for the 60 consecutive trading
24
21ST CENTURY HOLDING COMPANY
OTHER INFORMATION
CHANGES IN SECURITIES (CONTINUED)
days following July 31, 2003, with a maximum of $25.00 per share and a minimum
of $15.00 per share. The terms of the Warrants provide for adjustment of the
exercise price and the number of shares issuable thereunder upon the occurrence
of certain events typical for private offerings of this type. The Warrants will
be exercisable until July 31, 2006.
The Company will not issue shares in payment of principal or interest
on the Notes, nor will it issue shares upon exercise of the Warrants, and the
Warrant exercise price will not be adjusted, if any of the foregoing would cause
the Company to issue shares of Common Stock exceeding the number of shares that
the Company could then issue in compliance with Section 4350(i) of the rules and
regulations of Nasdaq, or any successor rule or regulation (the "Nasdaq Rule").
Under theNasdaq Rule, a company may not issue shares, and may not issue
securities convertible into shares, where the shares issued could in the
aggregate equal 20% or more of the voting power of the shares outstanding,
without obtaining shareholder approval. The Company has agreed to include a
proposal for the issuance of the foregoing shares in the proxy statement for its
2004 annual meeting of shareholders. If, because the Company has not obtained
the requisite shareholder approval and the Warrant exercise price and number of
shares issuable upon exercise cannot be adjusted under the anti-dilution
provisions of the Warrants as a result of specified issuances of Common Stock at
less than fair market value, then the exercise price of the Warrants will be
reduced to the issuance price of the Common Stock that triggered the
anti-dilution adjustment.
ITEM 3
DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4
SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On June 10, 2003, the Company held its Annual Meeting of Shareholders
(the "Meeting"). At the Meeting, the shareholders elected Bruce F. Simberg
(incumbent), Richard W. Wilcox, and James DePelisi to the Board of Directors.
For Mr. Simberg, there were 2,811,699 votes in favor, 42,051 votes withheld, and
161,051 abstentions. For Messrs. Wilcox and DePelisi there were 2,817,300 votes
in favor, 36,400 votes withheld, and 161,051 abstentions. There were 52,099
broker non-votes. Directors whose terms of office continued after the meeting
were: Edward J. Lawson, Richard Widdicombe, Charles Hart, and Carl Dorf.
ITEM 5
OTHER INFORMATION
None
25
21ST CENTURY HOLDING COMPANY
OTHER INFORMATION
ITEM 6
EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
4.1 Form of 6% Senior Subordinated Note due July 31, 2006.
4.2 Form of Redeemable Warrant dated July 31, 2006
31.1. Certification of Chief Executive Officer pursuant to
Section 302 of the Sarbanes-Oxley Act
31.2 Certification of Chief Financial Officer pursuant to
Section 302 of the Sarbanes-Oxley Act.
32.1 Certification of Chief Executive Officer pursuant to
Section 906 of the Sarbanes-Oxley Act.
32.2 Certification of Chief Financial Officer pursuant to
Section 906 of the Sarbanes-Oxley Act.
(b) Reports on Form 8-K.
Form 8-K filed on August 4, 2003, filing as Exhibit 99.1
thereto the press release of the Company, dated August 4,
2003, reporting the Company's financial results for the second
quarter of 2003.
26
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
21ST CENTURY HOLDING COMPANY
By: /s/ Richard A. Widdicombe
---------------------------------------------
Richard A. Widdicombe, Chief Executive Officer
/s/ James G. Jennings III
---------------------------------------------
James G. Jennings III, Chief Financial Officer
Date: August 12, 2003
27