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 SEPTEMBER 30, 2004
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)
Florida 65-0248866
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(State or Other Jurisdiction of (IRS Employer
Incorporation or Organization) Identification No.)
3661 West Oakland Park Boulevard, Suite 300, Lauderdale Lakes, Florida 33313
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(Address of principal executive offices) (Zip Code)
954-581-9993
----------------------------------------------------
(Registrant's telephone number, including area code)
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 by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes |_| No |X|
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 - 6,006,460 outstanding as of November 11, 2004.
1
21ST CENTURY HOLDING COMPANY
INDEX
PART I: FINANCIAL INFORMATION PAGE
----
ITEM 1
FINANCIAL STATEMENTS (UNAUDITED)
Consolidated Balance Sheets as of September 30, 2004 and December 31, 2003 .................. 3
Consolidated Statements of Operations for the three and nine months
ended September 30, 2004 and 2003 ................................................... 4
Consolidated Cash Flow Statements for the nine months ended September 30, 2004 and 2003 ..... 5
Notes to Consolidated Financial Statements .................................................. 6
ITEM 2
Management's Discussion and Analysis of Financial Condition and Results of Operations .......16
ITEM 3
Quantitative and Qualitative Disclosures About Market Risk ..................................32
ITEM 4
Controls and Procedures .....................................................................32
PART II: OTHER INFORMATION
ITEM 1
Legal Proceedings ...........................................................................33
ITEM 2
Unregistered Sales of Equity Securities and Use of Proceeds .................................33
ITEM 3
Defaults upon Senior Securities .............................................................33
ITEM 4
Submission of Matters to a Vote of Security Holders .........................................33
ITEM 5
Other Information ...........................................................................34
ITEM 6
Exhibits ....................................................................................34
Signatures ..................................................................................35
2
PART I: FINANCIAL INFORMATION
ITEM I.
FINANCIAL STATEMENTS
21ST CENTURY HOLDING COMPANY
CONSOLIDATED BALANCE SHEETS
September 30, 2004 December 31, 2003
Unaudited See Note 1
------------- -------------
ASSETS
Investments
Fixed maturities, available for sale, at fair value $ 82,696,625 $ 43,489,598
Equity securities 6,980,404 3,663,251
Mortgage loans -- 137,571
------------- -------------
Total investments 89,677,029 47,290,420
------------- -------------
Cash and cash equivalents 17,348,162 6,770,169
Receivable for investments sold 124,906 2,118,595
Finance contracts, net of allowance for credit
losses of $447,470 in 2004 and $562,558 in 2003 7,834,719 9,891,642
Prepaid reinsurance premiums 3,080,174 8,415,095
Premiums receivable, net of allowance for credit losses of
$451,537 and $123,000, respectively 5,843,612 7,328,256
Reinsurance recoverable, net 34,517,590 11,053,747
Deferred policy acquisition costs 7,014,774 1,739,685
Income taxes recoverable 7,202,225 824,787
Deferred income taxes 4,381,365 3,030,183
Property, plant and equipment, net 4,076,085 4,153,643
Goodwill, net 1,739,715 1,739,715
Other assets 1,821,721 2,339,656
------------- -------------
Total assets $ 184,662,077 $ 106,695,593
============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY
Unpaid losses and loss adjustment expenses $ 76,653,620 $ 24,570,198
Unearned premiums 48,464,926 34,122,663
Premiums deposits 2,525,695 621,777
Revolving credit outstanding 1,281,521 4,098,786
Funds held under reinsurance treaties 9,108,429 --
Subordinated debt 17,500,000 6,875,000
Accounts payable and accrued expenses 4,441,543 4,360,793
------------- -------------
Total liabilities 159,975,734 74,649,217
------------- -------------
Commitments and contingencies
Shareholders' equity:
Common stock, $0.01 par value. Authorized 37,500,000 shares;
issued 6,632,209 and 6,133,386 shares, respectively;
Outstanding 5,936,260 and 5,437,587, respectively 66,323 61,333
Additional paid-in capital 25,308,295 20,434,473
Accumulated other comprehensive income (deficit) (796,272) (324,881)
Retained earnings 1,877,968 13,643,225
Treasury stock, 695,949 shares and 695,799 shares, at
cost, respectively (1,769,971) (1,767,774)
------------- -------------
Total shareholders' equity 24,686,343 32,046,376
------------- -------------
Total liabilities and shareholders' equity $ 184,662,077 $ 106,695,593
============= =============
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
3
21ST CENTURY HOLDING COMPANY
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
Three Months Ended Nine Months Ended
------------------------------ -----------------------------
September 30, September 30, September 30, September 30,
2004 2003 2004 2003
------------ ------------ ------------ ------------
Revenue:
Gross premiums written $ 24,301,800 $ 22,369,229 $ 73,929,571 $ 56,559,803
Gross premiums ceded 71,385 (5,627,904) 975,429 (15,830,769)
------------ ------------ ------------ ------------
Net premiums written 24,373,185 16,741,325 74,905,000 40,729,034
------------ ------------ ------------ ------------
Increase (decrease) in prepaid
reinsurance premiums 760,823 (2,486,527) (5,334,921) (2,550,620)
Decrease (increase) in unearned
premiums 156,954 (2,404,301) (14,342,263) (4,921,972)
------------ ------------ ------------ ------------
Net change in prepaid reinsurance
premiums and unearned premiums 917,777 (4,890,828) (19,677,184) (7,472,592)
------------ ------------ ------------ ------------
Net premiums earned 25,290,962 11,850,497 55,227,816 33,256,442
Commission income 476,421 394,599 1,785,290 1,143,116
Finance revenue 784,584 984,644 2,824,568 3,247,673
Managing general agent fees 501,225 640,661 1,488,405 1,894,524
Net investment income 839,641 513,515 2,141,686 1,229,185
Net realized investment gains 80,959 33,765 261,386 1,453,465
Other income 459,345 603,740 2,849,555 2,603,805
------------ ------------ ------------ ------------
Total revenue 28,433,137 15,021,421 66,578,706 44,828,210
------------ ------------ ------------ ------------
Expenses:
Loss and loss adjustment expenses 42,292,556 6,322,281 56,385,548 20,603,737
Operating and underwriting expenses 7,444,310 2,969,326 13,894,977 8,308,583
Salaries and wages 2,467,014 2,356,613 7,107,344 6,714,432
Interest expense 186,902 177,466 631,824 287,350
Policy acquisition costs, net of
amortization 2,521,738 123,080 4,645,906 (914,412)
------------ ------------ ------------ ------------
Total expenses 54,912,520 11,948,766 82,665,599 34,999,690
Income (loss) before provision (benefit)
for income tax expense (26,479,383) 3,072,655 (16,086,893) 9,828,520
Provision (benefit) for income tax expense (9,533,125) 1,081,824 (5,739,420) 3,415,354
------------ ------------ ------------ ------------
Net income (loss) $(16,946,258) $ 1,990,831 $(10,347,473) $ 6,413,166
============ ============ ============ ============
Basic net income (loss) per share ($2.86) $0.42 ($1.79) $1.39
====== ===== ====== =====
Weighted average number of common shares
outstanding 5,925,952 4,738,130 5,786,803 4,612,370
========= ========= ========= =========
Fully diluted net income (loss) per share ($2.86) $0.38 ($1.79) $1.32
====== ===== ====== =====
Weighted average number of common shares
outstanding (assuming dilution) 6,279,826 5,277,875 6,248,663 4,874,178
========= ========= ========= =========
Dividends declared per share $0.08 $0.07 $0.16 $0.17
===== ===== ===== =====
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
4
21ST CENTURY HOLDING COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
Nine months ended September 30,
2004 2003
------------- -------------
Cash flow from operating activities:
Net income (loss) $ (10,347,473) $ 6,413,166
Adjustments to reconcile net income to net cash
(used in) provided by operating activities:
Amortization of investment premium, net 134,507 219,654
Depreciation and amortization of property plant and
equipment, net 355,217 317,347
Deferred income tax expense (1,351,182) 174,168
Net realized investment gains 80,959 (1,562,618)
Common Stock issued for interest on Notes 281,250 --
Provision for credit losses, net 707,051 470,114
Provision for uncollectible premiums receivable (66,824) 34,627
Recognition of deferred income from sale of
franchises (131,647) --
Changes in operating assets and liabilities:
Premiums receivable 1,551,468 597,723
Prepaid reinsurance premiums 5,334,921 2,550,620
Due from reinsurers, net (23,463,843) (2,778,999)
Income taxes recoverable (6,377,438) --
Policy acquisition costs, net of amortization (5,275,089) (1,354,297)
Goodwill -- (220,362)
Finance contracts receivable 1,349,872 (1,891,914)
Other assets 517,935 (701,574)
Unpaid losses and loss adjustment expenses 52,083,422 7,057,548
Unearned premiums 14,342,263 4,921,972
Premium deposits 1,903,918 154,371
Funds held under reinsurance treaties 9,108,429 --
Income taxes payable -- (1,471,182)
Accounts payable and accrued expenses 80,750 (32,043)
------------- -------------
Net cash provided by operating activities 40,818,466 12,898,321
------------- -------------
Cash flow (used in) provided by investing activities:
Proceeds from sale of investment securities available
for sale 45,474,173 129,333,747
Purchases of investment securities available for sale (88,685,210) (151,221,985)
Receivable for investments sold 1,993,689 --
Collection of mortgage loans 137,571 6,247
Purchases of property and equipment (146,012) (576,307)
Proceeds from sale of assets -- 1,599,000
------------- -------------
Net cash used in investing activities (41,225,789) (20,859,298)
------------- -------------
Cash flow (used in) provided by financing activities:
Subordinated debt 12,500,000 7,500,000
Exercised stock options 2,722,562 2,271,621
Dividends paid (1,417,784) (807,670)
Purchases of treasury stock (2,197) (26,667)
Revolving credit outstanding (2,817,265) (1,473,338)
------------- -------------
Net cash provided by financing activities 10,985,316 7,463,946
------------- -------------
Net (decrease) increase in cash and cash equivalents 10,577,993 (497,031)
Cash and cash equivalents at beginning of period 6,770,169 4,478,383
------------- -------------
Cash and cash equivalents at end of period $ 17,348,162 $ 3,981,352
============= =============
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest $ 160,148 $ 156,012
============= =============
Income taxes $ 2,095,000 $ 4,715,000
============= =============
Non-cash investing and finance activities:
Accrued dividends payable $ 438,720 $ 314,718
============= =============
Retirement of subordinated debt by
Common Stock issuance $ 1,875,000 $ --
============= =============
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 GAAP for a complete financial statement presentation, and should be
read in conjunction with the audited consolidated financial statements and notes
thereto included in our annual report on Form 10-K for the year ended December
31, 2003. The December 31, 2003 year-end balance sheet data was derived from
audited financial statements but does not include all disclosures required by
GAAP. 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
for the three-month and nine-month periods are not necessarily indicative of the
results of operations that may be achieved in the future.
The accompanying consolidated financial statements include the accounts of
the Company and its subsidiaries. All material intercompany accounts and
transactions have been eliminated in accordance with GAAP.
We are a vertically integrated insurance holding company that, through its
subsidiaries, controls substantially all aspects of the insurance underwriting,
distribution and claims process. We underwrite personal automobile insurance,
general liability insurance, flood insurance and homeowners' and mobile home
property and casualty insurance in Florida, Louisiana and Georgia through wholly
owned subsidiaries, Federated National and American Vehicle. American Vehicle
has recently been authorized to write commercial general liability policies in
Kentucky and expects to begin writing policies in that state in the near future.
American Vehicle is a fully admitted insurance carrier in Florida and Louisiana
and is admitted as a surplus lines carrier in Georgia and Kentucky.
During the nine months ended September 30, 2004, 21.4%, 63.8%, 1.6% and
13.2% of the policies we underwrote were for personal automobile insurance,
homeowners' property and casualty insurance, mobile home property and casualty
insurance, and commercial general liability, respectively. During the year ended
December 31, 2003, 67.5%, 23.0%, 2.4% and 7.1% of the policies we underwrote
were for personal automobile insurance, homeowners' property and casualty
insurance, mobile home property and casualty insurance and commercial general
liability, respectively. We internally process claims made by our own and third
party insureds through our wholly owned claims adjusting company, Superior
Adjusting, Inc. ("Superior"). We also offer premium financing to our own and
third-party insureds through our wholly owned subsidiary, Federated Premium
Finance, Inc. ("Federated Premium").
We market and distribute our own and third-party insurers' products and
our other services primarily in Central and South Florida, through a network of
24 agencies owned by Federated Agency Group, Inc. ("Federated Agency Group"), a
wholly owned subsidiary, 45 franchised agencies, approximately 1500 independent
agents and a select number of general agents. Our independent agents and general
agents are primarily responsible for the distribution of our homeowner insurance
and commercial general liability products. Through our wholly owned subsidiary,
FedUSA, Inc. ("FedUSA"), we franchise agencies under the FedUSA name. As of
September 30, 2004, franchises were granted for 48 FedUSA agencies, of which 42
were operating and 6 are pending.
Assurance Managing General Agents, Inc., a wholly owned subsidiary, acts
as Federated National's and American Vehicle's exclusive managing general agent.
Assurance MGA currently provides all underwriting policy administration,
marketing, accounting and financial services to Federated National, American
Vehicle and our agencies, and participates in the negotiation of reinsurance
contracts. Assurance MGA generates revenue through policy fee income and other
administrative fees from the marketing of companies' products through the
Company's distribution network. Assurance MGA plans to establish relationships
with additional carriers and add additional insurance products in the future.
We offer electronic tax filing services through Express Tax Service, Inc.
("Express Tax"), an 80%-owned subsidiary, as well as franchise opportunities for
these services through EXPRESSTAX Franchise Corporation. As of September 30,
2004, there were 252 franchises granted in 19 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 income tax refund anticipation loans. In addition, Express Tax
offers tax preparation services through approximately 300 licensees nationwide.
6
21st Century Holding Company
Notes to Consolidated Financial Statements
(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 us 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
our financial statements include estimates associated with our evaluation of the
determination of liability for unpaid losses and loss adjustment expenses. In
addition, significant estimates form the basis for our reserves with respect to
finance contracts, premiums receivable, deferred income taxes, deferred policy
acquisition costs and loss contingencies and the recoverability of goodwill.
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. We periodically re-evaluate these
significant factors and make adjustments where facts and circumstances dictate.
(B) IMPACT OF NEW ACCOUNTING PRONOUNCEMENTS
In January 2003, the Financial Accounting Standards Board ("FASB") issued
Interpretation No. 46, Consolidation of Variable Interest Entities ("FIN 46"),
which requires the consolidation of certain entities considered to be variable
interest entities ("VIEs"). An entity is considered to be a VIE when it has
equity investors who lack the characteristics of having a controlling financial
interest, or its capital is insufficient to permit it to finance its activities
without additional subordinated financial support. Consolidation of a VIE by an
investor is required when it is determined that the investor will absorb a
majority of the VIE's expected losses if they occur, receive a majority of the
entity's expected residual returns if they occur, or both. The adoption of
Interpretation No. 46 did not have any impact on our Consolidated Financial
Statements.
In May 2003, the FASB issued Statement of Financial Accounting Standard
Number 150, "Accounting for Certain Financial Instruments with Characteristics
of both Liabilities and Equity." This Statement establishes standards for how an
issuer classifies and measures certain financial instruments with
characteristics of both liabilities and equity and it requires that an issuer
classify a financial instrument that is within its scope as a liability because
the financial instrument embodies an obligation of the issuer. This Statement is
effective for financial instruments entered into or modified after May 31, 2003,
and otherwise is effective in the first interim period beginning after June 15,
2003. On July 31, 2003 , we completed a private placement of our 6% Senior
Subordinated Notes (the "July 2003 Notes"), and on September 30, 2004 , we
completed another private placement of our 6% Senior Subordinated Notes (the
"September 2004 Notes"), both of which were offered and sold to accredited
investors as units consisting of one Note with a principal amount of $1,000 and
warrants (the "Warrants") to purchase shares of our Common Stock. These Notes
fall within the definition of financial instruments as described in Financial
Accounting Standard Number 150 are presented as a liability in conformity with
Statement of Financial Accounting Standard Number 150. As such, the adoption of
this Statement did not have any impact on our Consolidated Financial Statements.
(C) STOCK OPTIONS
We continue to account for stock-based compensation using the intrinsic
value method prescribed by APB 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 our stock compensation
plans been determined based upon fair values at the grant dates for awards under
the plan in accordance with SFAS No. 123, our net income and net income per
share would have been reduced to the pro forma amounts indicated below.
7
21st Century Holding Company
Notes to Consolidated Financial Statements
For the three months For the nine months
ending September 30, ending September 30,
--------------------------- ---------------------------
2004 2003 2004 2003
------------ ---------- ------------ ----------
Net Income (loss) as
reported $(16,946,258) $1,990,831 $(10,347,473) $6,413,166
Compensation, net of
tax effect 6,171,950 865,096 6,714,508 1,125,656
------------ ---------- ------------ ----------
Pro forma net income $(23,118,208) $1,125,735 $(17,061,981) $5,287,510
============ ========== ============ ==========
Net income per share
As reported - Basic $ (2.86) $ 0.42 $ (1.79) $ 1.39
As reported - Diluted $ (2.86) $ 0.38 $ (1.79) $ 1.32
Pro forma - Basic $ (3.90) $ 0.24 $ (2.95) $ 1.15
Pro forma - Diluted $ (3.90) $ 0.21 $ (2.95) $ 1.09
Additional stock option awards are anticipated in future years.
The weighted average fair value of options granted during the nine months
ended September 30, 2004, estimated on the date of grant using the Black-Scholes
option-pricing model, was $18.02. The weighted average fair value of options
granted during 2004 and 2003, estimated on the date of grant using the
Black-Scholes option-pricing model, was $6.67 to $10.74 in 2004 and $4.21 to
$8.01 in 2003. The fair value of options granted is estimated on the date of
grant using the following assumptions:
September 30, 2004 December 31, 2003
------------------ -----------------
Dividend yield 2.24% to 3.19% 1.96% to 2.10%
Expected volatility 99.65% to 103.20% 105.91% to 108.73%
Risk-free interest rate 2.13% to 3.60% 2.30% to 3.94%
Expected life (in years) 3.00 to 3.60 3.00 to 6.36
(D) EARNINGS PER SHARE
Basic earnings per share is computed by dividing net income by the
weighted average number of common shares outstanding during each period
presented. Diluted earnings per share is computed by dividing net income by the
weighted average number of shares 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.
On September 7, 2004, we completed a three-for-two stock split in the form
of a stock dividend, whereby shareholders received three shares of common stock
for every two shares of our common stock held on the record date. Just prior to
the three-for-two stock split, we had approximately 3,957,000 shares
outstanding, and following the stock split, we had approximately 5,936,000
shares outstanding, including fractional shares that were paid in common stock.
All earnings per share data included in the consolidated financial statements
and notes thereto has been restated after giving retroactive effect for the
September 7, 2004 three-for-two stock split.
(E) RECLASSIFICATIONS
Certain amounts in 2003 financial statements have been reclassified to
conform to the 2004 presentation.
(3) REVOLVING CREDIT OUTSTANDING
Federated Premium's operations are funded by a revolving loan agreement
("Revolving Agreement") with FlatIron Funding Company LLC ("FlatIron"). The
Revolving Agreement is structured as a sale of contracts receivable under a sale
and assignment agreement with FPF, Inc. ("FPF", a wholly-owned subsidiary of
FlatIron), which gives FPF 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.
During September 2004, we negotiated a new revolving loan agreement with
FPF in which the maximum credit commitment available to us was reduced at our
request to $2.0 million with built-in options to incrementally increase the
maximum credit commitment up $4.0 million over the next three years. We believe
that this available
8
21st Century Holding Company
Notes to Consolidated Financial Statements
credit is sufficient based on our current operations. Our lender, however, could
decide to reduce our available credit based on a number of factors, including
the A.M. Best ratings of Federated National and American Vehicle. If the A.M.
Best rating of Federated National falls below a "C", or if the financial
condition of American Vehicle, as determined by our lender (in its sole and
absolute discretion) suffers a material adverse change, then under the terms of
our revolving loan agreement, policies written by that subsidiary will no longer
be eligible collateral, causing our available credit to be reduced. If that
occurs and we are not able to obtain working capital from other sources, then we
would have to restrict our growth and, possibly, our operations.
The amount of FPF's advance is subject to availability under a borrowing
base calculation, with maximum advances outstanding not to exceed the 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 lower to total contracts receivable. As of
September 30, 2004, our rate was 4.75% as compared to our rate as of September
30, 2003 of 5.75%.
The Revolving Agreement contains various operating and financial
covenants, with which we were in compliance at September 30, 2004 and December
31, 2003. Outstanding borrowings under the Revolving Agreement as of September
30, 2004 and December 31, 2003 were $1.3 million and $4.1 million, respectively.
Outstanding borrowings in excess of the $4.0 million commitment totaled $98,786
as of December 31, 2003. The excess amount, permissible by reason of a
compensating cash balance of $200,430 for December 31, 2003, was held for the
benefit of FPF and is included in other assets. Interest expense on this
revolving credit line for the nine months ended September 30, 2004 and 2003
totaled approximately $150,000 and $156,000, respectively. For the nine months
ended September 30, 2004 and 2003 the effective interest rate on this line of
credit, based on our average outstanding borrowings under the Revolving
Agreement, was 6.97% and 5.90%, respectively.
(4) COMMITMENTS AND CONTINGENCIES
We are 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 our
consolidated financial position, results of operations, or liquidity.
In June 2000, a lawsuit was filed against us, our directors and our
executive officers seeking compensatory damages in an undisclosed amount on the
basis of allegations that our amended registration statement dated November 4,
1998 was inaccurate and misleading concerning the manner in which we 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. The lawsuit was filed in the United States District Court for the
Southern District of New York. The plaintiff class purportedly includes
purchasers of our Common Stock between November 5, 1998 and August 13, 1999. The
Court granted the plaintiffs class status.
Specifically, the plaintiffs allege that we 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. We believe, however, that the lawsuit is
without merit and we have vigorously defended the action, because we reasonably
relied upon outside subject matter experts to make these determinations at the
time. We have also since accounted for ceded commission on a pro rata basis and
have done so since these matters were brought to our attention in 1998.
Nevertheless, we have also continued to actively participate in settlement
negotiations with the plaintiffs and have tentatively agreed to settle the case.
The parties are currently negotiating the final terms of a Memorandum of
Understanding, which will have to be executed by the parties and then approved
by the court. We have reserved and charged against fourth quarter 2003 earnings
$600,000 for the potential settlement and associated costs.
As a direct premium writer in the State of Florida, we are required to
participate in certain insurer solvency pools under Florida Statutes section
631.57(3)(a). Participation in these pools is based on our written premium by
line of business to total premiums written statewide by all insurers.
Participation may result in assessments against us.
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
9
21st Century Holding Company
Notes to Consolidated Financial Statements
participating insurers. In the event of an underwriting deficit incurred by the
JUA Plan and the deficit 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 premiums of each such member
written during the preceding calendar year bear to the aggregate net direct
premiums written in this state by all members of the JUA Plan.
On September 28, 2004, Federated National and American Vehicle were
assessed by the JUA Plan $362,121 and $120,009, respectively. These assessments
were charged against current operations. Future assessments against either
insurance company are not reasonably predicable in terms of frequency or
amounts.
(5) COMPREHENSIVE INCOME
For the three and nine months ended September 30, 2004 and 2003,
comprehensive income consisted of the following:
Three months ended September 30, Nine months ended September 30,
2004 2003 2004 2003
------------ ------------ ------------ ------------
Net income $(16,946,258) $ 1,990,831 $(10,347,473) $ 6,413,166
Change in net unrealized gains on
investments available for sale 1,772,140 82,369 (169,579) 241,830
------------ ------------ ------------ ------------
Comprehensive income, before tax (15,174,118) 2,073,200 (10,517,052) 6,654,996
Income tax benefit (expense) related
to items of other comprehensive income (661,633) (32,537) 69,036 (95,524)
------------ ------------ ------------ ------------
Comprehensive income $(15,835,751) $ 2,040,663 $(10,448,016) $ 6,559,472
============ ============ ============ ============
(6) SEGMENT INFORMATION
We 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, homeowner's and mobile homeowner's
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 our
insureds and is marketed through our 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. We evaluate our
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 preparation.
10
21st Century Holding Company
Notes to Consolidated Financial Statements
Information regarding components of operations for the three and nine
months ended September 30, 2004 and 2003 follows:
Three months ended September 30, Nine months ended September 30,
2004 2003 2004 2003
------------ ------------ ------------ ------------
Total revenue
Insurance segments $ 29,131,025 $ 16,991,819 $ 66,547,303 $ 46,705,850
Financing segment 594,540 598,290 2,118,732 1,878,531
All other segments 915,812 349,660 4,122,925 3,840,782
------------ ------------ ------------ ------------
Total operating segments 30,641,377 17,939,769 72,788,960 52,425,163
Intercompany eliminations (2,208,240) (2,918,348) (6,210,254) (7,596,953)
------------ ------------ ------------ ------------
Total revenues $ 28,433,137 $ 15,021,421 $ 66,578,706 $ 44,828,210
============ ============ ============ ============
Earnings before income taxes
Insurance segments $(26,594,817) $ 2,990,072 $(17,374,061) 8,173,155
Financing segment 213,266 243,538 800,027 514,387
All other segments (97,832) (160,955) 487,141 1,140,978
------------ ------------ ------------ ------------
Total earnings before income taxes $(26,479,383) $ 3,072,655 $(16,086,893) 9,828,520
============ ============ ============ ============
Information regarding total assets as of September 30, 2004 and December 31,
2003 follows:
September 30, 2004 December 31, 2003
------------------ -----------------
Total assets
Insurance segments $ 171,031,140 $ 93,301,125
Financing segment 7,979,364 10,105,548
All other segments 18,719,496 3,602,606
------------- -------------
Total operating segments 197,730,000 107,009,279
Intercompany eliminations (13,067,923) (313,686)
------------- -------------
Total assets $ 184,662,077 $ 106,695,593
============= =============
(7) REINSURANCE AGREEMENTS
We are not subscribing to quota-share reinsurance for automobile insurance
policies issued with an effective date beyond December 31, 2003. The quota-share
reinsurance treaties for 2003 automobile insurance policies include loss
corridors with varying layers of coverage based on ultimate incurred loss ratio
results whereby Federated National and American Vehicle will retain 100% of the
losses between incurred loss ratios of 66% and 86%. Despite the loss corridors,
substantially all of the insurance risk relating to the reinsured portions of
the underlying insurance agreements has been assumed by the reinsurer, wherein
the reinsurer's exposure to loss is essentially the same as ours.
We continue to participate in the Florida Hurricane Catastrophe Fund
("FCAT") and we subscribe to an excess of loss reinsurance policy to protect our
interest in the insurable risks associated with our homeowner and mobile home
owner insurance products. Maximum coverage afforded from the combined policies
of our FCAT and excess of loss policies in effect for varying dates from June 1,
2004 to June 30, 2005 total approximately $200.0 million where we will retain
the first $10 million of insurable losses on each event. Our amount of
reinsurance coverage was determined by subjecting our homeowner and mobile
homeowner exposures to statistical forecasting models that are designed to
quantify a catastrophic event in terms of the frequency of a storm occurring
once in every "n" years. Our reinsurance coverage contemplated a catastrophic
event occurring once every 100 years. As a result of the hurricanes experienced
in Florida in August and September 2004, we incurred a net reinstatement
insurance premium of $3.0 million that is amortized through operations from the
reinstatement date of August 13, 2004 to June 30, 2005.
11
21st Century Holding Company
Notes to Consolidated Financial Statements
(8) STOCK COMPENSATION PLANS
In 1998, we issued warrants to two employees to purchase a total of 62,500
shares of our common stock at $9.00 per share. The warrants vested immediately
and are exercisable until 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 nine months ended September 30, 2004, all
of the 7,800 remaining warrants were exercised.
We 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 our success by
providing employees the opportunity to acquire common stock. Options outstanding
under this plan have been granted at prices that 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, we are
authorized to grant options to purchase up to 900,000 common shares, and, as of
September 30, 2004 and December 31, 2003, we had outstanding exercisable options
to purchase 239,158 and 408,530 shares, respectively.
In 2001, we implemented a franchisee stock option plan that provides for
the granting of stock options to individuals purchasing Company-owned agencies
that are then converted to franchised agencies. The purpose of the plan is to
advance our interests 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, we
are authorized to grant options to purchase up to 1,033,500 common shares, and
as of September 30, 2004 and December 31, 2003, we had outstanding exercisable
options to purchase 15,000 and 39,960 shares, respectively.
In 2002, we implemented the 2002 Option Plan. The purpose of this plan is
to advance our interests 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 our success is largely dependent, by
authorizing the grant of options to purchase Common Stock to persons who are
eligible to participate thereunder, thereby encouraging stock ownership 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, we are authorized to
grant options to purchase up to 1,800,000 common shares, and, as of September
30, 2004 and December 31, 2003, we had outstanding exercisable options to
purchase 906,900 and 938,100 shares, respectively.
12
21st Century Holding Company
Notes to Consolidated Financial Statements
Activity in the Company's stock option plans for the period from January
1, 2002 to September 30, 2004 is summarized below:
--------------------------------- --------------------------- ---------------------------
1998 Plan 2001 Franchisee Plan 2002 Plan
--------------------------------- --------------------------- ---------------------------
Weighted Average Weighted Average Weighted Average
Option Exercise Number of Option Exercise Number of Option Exercise
Number of Shares Price Shares Price Shares Price
---------------- ---------------- --------- ---------------- --------- ----------------
Outstanding at December 31, 2001 618,858 $6.67 125,745 $6.67 --
Granted 342,398 $6.67 1,174,500 $ 8.91
Exercised (1,500) --
Cancelled (158,249) $6.67 (8,512) $6.67 (84,000) $ 9.02
-------- ----- ------- ----- ---------
Outstanding at December 31, 2002 801,507 $6.67 117,233 $6.67 1,090,500 $ 8.90
Granted -- $6.67 15,000 $9.17 152,250 $10.51
Exercised (375,371) $6.67 (92,273 $6.67 (216,900) $ 8.57
Cancelled (17,606) $6.67 -- (87,750) $ 9.37
-------- ----- ------- ----- ---------
Outstanding at December 31, 2003 408,530 $6.67 39,960) $7.61 938,100 $ 9.20
Granted -- -- 168,750 $18.02
Exercised (155,872) $6.67 (24,960) $6.67 (130,800) $ 9.16
Cancelled (13,500) $6.67 -- (69,150 $10.59
-------- ----- ------- ----- ---------
Outstanding at September 30, 2004 239,158 $6.67 15,000 $9.17 906,900 $10.74
======== ===== ======= ===== =========
Options outstanding as of September 30, 2004 are exercisable as follows:
--------------------------------- --------------------------- ---------------------------
1998 Plan 2001 Franchisee Plan 2002 Plan
--------------------------------- --------------------------- ---------------------------
Weighted Average Weighted Average Weighted Average
Option Exercise Number of Option Exercise Number of Option
Options Exercisable at: Number of Shares Price Shares Price Shares Exercise Price
---------------- ---------------- --------- ---------------- --------- -----------------
September 30, 2004 143,907 $6.67 15,000 $6.67 411,126 $8.90
December 31, 2004 -- $6.67 -- $6.67 18,300 $8.90
December 31, 2005 47,625 $6.67 -- $6.67 136,608 $8.90
December 31, 2006 47,626 $6.67 -- $6.67 136,608 $8.90
December 31, 2007 -- $ -- -- $6.67 136,608 $8.90
December 31, 2008 -- $ -- -- $6.67 67,650 $8.90
Thereafter -- $ -- -- $6.67 $8.90
------- ------ -------
Total options exercisible 239,158 15,000 906,900
======= ====== =======
We continue to account for stock-based compensation using the intrinsic
value method prescribed by APB 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, our net income and net
income per share would have been reduced to the pro forma amounts indicated
below.
For the three months ending For the nine months ending
September 30, September 30,
------------ ------------ ------------ ------------
2004 2003 2004 2003
------------ ------------ ------------ ------------
Net Income (loss) as
reported $(16,946,258) $ 1,990,831 $(10,347,473) $ 6,413,166
Compensation, net of
tax effect 6,171,950 865,096 6,714,508 1,125,656
------------ ------------ ------------ ------------
Pro forma net income $(23,118,208) $ 1,125,735 $(17,061,981) $ 5,287,510
============ ============ ============ ============
Net income per share
As reported - Basic $ (2.86) $ 0.42 $ (1.79) $ 1.39
As reported - Diluted $ (2.86) $ 0.38 $ (1.79) $ 1.32
Pro forma - Basic $ (3.90) $ 0.24 $ (2.95) $ 1.15
Pro forma - Diluted $ (3.90) $ 0.21 $ (2.95) $ 1.09
13
21st Century Holding Company
Notes to Consolidated Financial Statements
Additional stock option awards are anticipated in future years.
The weighted average fair value of options granted during the nine months
ended September 30, 2004, estimated on the date of grant using the Black-Scholes
option-pricing model, was $18.02. The weighted average fair value of options
granted during 2004 and 2003, estimated on the date of grant using the
Black-Scholes option-pricing model, was $6.67 to $10.74 in 2004 and $4.21 to
$8.01 in 2003. The fair value of options granted is estimated on the date of
grant using the following assumptions:
September 30, 2004 December 31, 2003
------------------ -----------------
Dividend yield 2.24% to 3.19% 1.96% to 2.10%
Expected volatility 99.65% to 103.20% 105.91% to 108.73%
Risk-free interest rate 2.13% to 3.60% 2.30% to 3.94%
Expected life (in years) 3.00 to 3.60 3.00 to 6.36
Summary information about the Company's stock options outstanding at September
30, 2004:
Weighted Average Weighted
Range of Outstanding at Contractual Average Exercisable at
Exercise Price September 30, 2004 Periods in Years Exercise Price September 30, 2004
-------------- ------------------ ---------------- -------------- ------------------
1998 Plan $6.67 239,158 2.29 $ 6.67 143,907
2001 Franchise Plan $6.67 to $9.17 15,000 2.86 $ 9.17 15,000
2002 Plan $8.33 - $20.00 906,900 3.32 $10.74 411,126
(9) SUBORDINATED DEBT
On July 31, 2003, we completed a private placement of our 6% Senior
Subordinated Notes (the " July 2003 Notes"), which were offered and sold to
accredited investors as units consisting of one Note with a principal amount of
$1,000 and warrants (the "Warrant") to purchase shares of our Common Stock. We
sold an aggregate of $7.5 million of Notes in this placement, which resulted in
proceeds to us (net of placement agent fees of $450,724 and offering expenses of
$110,778) of $6,938,498.
The July 2003 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 July 2003 Notes may be
made in cash or, at our option, in shares of our 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.
We issued Warrants to purchase shares of our Common Stock to the
purchasers of the July 2003 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 our Common Stock. The total number of shares
issuable upon exercise of Warrants issued to the purchasers of the July, 2003
Notes and to J. Giordano were determined after the expiration of 60 consecutive
trading days following July 31, 2003, which was the date of closing of the
offering and totaled 408,050. The number of shares issued upon exercise of the
Warrants issued to purchasers equaled $7.5 million divided by the exercise price
of the Warrants and totaled 392,356 shares. The number of shares issuable upon
exercise of the Warrants issued to J. Giordano equaled $300,000 divided by the
exercise price of the Warrants and totaled 15,694 shares. The exercise price of
the Warrants equals 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. As computed, the exercise price of the Warrants equaled
$19.1153. 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. GAAP requires that detachable warrants be
valued separately from
14
21st Century Holding Company
Notes to Consolidated Financial Statements
debt and included in paid-in capital. Based on the terms of the unit purchase
agreement with the investors in the private placement, management believes that
the Warrants had zero value at the date of issuance of the July, 2003 Notes.
On September 30, 2004, we completed a private placement of 6% Senior
Subordinated Notes due September 30, 2007 (the "September 2004 Notes"). These
notes were offered and sold to accredited investors as units consisting of one
note with a principal amount of $1,000 and warrants to purchase shares of our
common stock, the terms of which are similar to our notes and warrants sold in
July 2003, except as described below. We sold an aggregate of $12.5 million of
units in this placement, which resulted in proceeds (net of placement agent fees
of $700,000 and offering expenses of $32,500) to us of $11,767,500.
The September 2004 Notes pay interest at the annual rate of 6%, mature on
September 30, 2007, and rank pari passu in terms of payment and priority to the
6% Senior Subordinated Notes dated July 31, 2003 in the original principal
amount of $7,500,000 that we sold in 2003. Quarterly payments of principal and
interest due on these notes, like the notes we sold in 2003, may be made in cash
or, at our option, in shares of our 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.
We also issued warrants to purchase shares of our common stock to the
purchasers of the notes and to the placement agent in the offering, J. Giordano
Securities Group. Each warrant entitles the holder to purchase one share of our
common stock at an exercise price of $12.75 per share and will be exercisable
until September 30, 2007. By comparison, the warrants we sold in 2003 are each
exercisable for one-half share of common stock at an exercise price of $12.74
per whole share. The number of shares issuable upon exercise of the warrants
issued to purchasers equaled $12.5 million divided by the exercise price of the
warrants, and totaled 980,392. The number of shares issuable upon exercise of
the warrants issued to J. Giordano equaled $500,000 divided by the exercise
price of the warrants, and totaled 39,216. 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.
For the July 2003 Notes, quarterly principal and interest payments,
totaling approximately $0.7 million per payment, are due on January 31, April
30, July 31, and October 31 with the last installment due on July 31, 2006. The
scheduled loan payments for the July 2003 Notes for the next three years are as
follows:
For the period
--------------
Three months ending December 31, 2004 $ 625,000
Year ending December 31, 2005 2,500,000
Year ending December 31, 2006 1,875,000
----------
Total $5,000,000
==========
On or about January 31, 2004, April 30, 2004, July 31, 2004 and October
31, 2004, we paid, pursuant to the terms of the July 2003 Notes, the quarterly
payments of principal and interest due in shares of our Common Stock and in
accordance with the contractual computations issued 54,014; 53,729; 49,965 and
69,200 shares of Common Stock, respectively.
For the September 2004 Notes, quarterly principal and interest payments,
totaling approximately $1.2 million per payment, are due, beginning next year,
on January 31, April 30, July 31, and October 31 with the last installment due
on September 30, 2007. The scheduled loan payments for the September 2004 Notes
for the next three years are as follows:
For the period
--------------
Year ending December 31, 2005 $ 4,166,668
Year ending December 31, 2006 4,166,668
Year ending December 31, 2007 4,166,664
-----------
$12,500,000
===========
15
21st Century Holding Company
Management's Discussion and Analysis of
Financial Condition and Results of Operations
ITEM 2:
Forward-Looking Statements
Statements in this report or in documents that are incorporated by
reference 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 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 us, including the terms
of any settlements; risks related to the nature and the type of our business;
dependence on investment income and the composition of our investment portfolio;
the adequacy of our liability for loss and loss adjustment expense; 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; court decisions
and trends in litigation and health care and auto repair costs; and other
matters described from time to time by us in this report, and our other filings
with the SEC.
You are cautioned not to place reliance on these forward-looking
statements, which are valid only as of the date they were made. We undertake 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 GAAP prescribes 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
We are a vertically integrated insurance holding company, which, through
our subsidiaries, control substantially all aspects of the insurance
underwriting, distribution and claims process. We underwrite personal automobile
insurance, general liability insurance, flood insurance, homeowners' insurance
and mobile home property and casualty insurance in Florida, Georgia and
Louisiana through our wholly owned subsidiaries, Federated National Insurance
Company ("Federated National") and American Vehicle Insurance Company ("American
Vehicle"). American Vehicle has recently been authorized to write commercial
general liability policies in Kentucky and expects to begin writing policies in
that state in the near future. American Vehicle is a fully admitted insurance
carrier in Florida and Louisiana and is admitted as a surplus lines carrier in
Georgia and Kentucky.
During the nine months ended September 30, 2004, 21.4%, 63.8%, 1.6% and
13.2% of the policies we underwrote were for personal automobile insurance,
homeowners' property and casualty insurance, mobile home property and casualty
insurance, and commercial general liability, respectively. During the year ended
December 31, 2003, 67.5%, 23.0%, 2.4% and 7.1% of the policies we underwrote
were for personal automobile insurance, homeowners' property and casualty
insurance, mobile home property and casualty insurance, and commercial general
liability, respectively. We internally process claims made by our own and third
party insureds through our wholly owned claims adjusting company, Superior
Adjusting, Inc.("Superior"). We also offer premium financing to our own and
third-party insureds through our wholly owned subsidiary, Federated Premium
Finance, Inc. ("Federated Premium").
We market and distribute our own and third-party insurers' products and
our other services primarily in Central and South Florida, through a network of
24 agencies owned by Federated Agency Group, Inc. ("Federated Agency Group"), a
wholly owned subsidiary, 45 franchised agencies, approximately 1,500 independent
agents and a select number of general agents. Our independent agents and general
agents are primarily responsible for the distribution of our homeowner insurance
and commercial general liability products. Through our wholly owned subsidiary,
FedUSA, Inc. ("FedUSA"), we franchise agencies under the FedUSA name. As of
September 30, 2004, franchises were granted to 48 FedUSA agencies, of which 42
were operating and 6 are pending.
16
21st Century Holding Company
Management's Discussion and Analysis of
Financial Condition and Results of Operations
Assurance Managing General Agents, Inc. ("Assurance MGA"), a wholly owned
subsidiary, acts as Federated National's and American Vehicle's exclusive
managing general agent. Assurance MGA currently provides all underwriting policy
administration, marketing, accounting and financial services to Federated
National, American Vehicle and our agencies, and participates in the negotiation
of reinsurance contracts. Assurance MGA generates revenue through policy fee
income and other administrative fees from the marketing of companies' products
through the Company's distribution network. Assurance MGA plans to establish
relationships with additional carriers and add additional insurance products in
the future.
We offer electronic tax filing services through Express Tax Service, Inc.
("Express Tax"), an 80%-owned subsidiary, as well as franchise opportunities for
these services. As of September 30, 2004, there were 252 franchises granted in
19 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 income tax refund anticipation loans.
In addition, Express Tax offers tax preparation services through approximately
300 licensees nationwide.
Our business, results of operations and financial condition are subject to
fluctuations due to a variety of factors. Abnormally high severity or frequency
of claims in any period could have a material adverse effect on our business,
results of operations and financial condition. Also, if our estimated
liabilities for unpaid losses and loss adjustment expenses are less than actual
losses and loss adjustment expenses, we will be required to increase reserves
with a corresponding reduction in our net income in the period in which the
deficiency is identified.
We operate in a highly competitive market and face competition from both
national and regional insurance companies, many of whom are larger and have
greater financial and other resources, have better A.M. Best ratings and offer
more diversified insurance coverage. Our competitors include other companies
which market their products through agents, as well as companies which sell
insurance directly to their customers. Large national writers may have certain
competitive advantages over agency writers, including increased name
recognition, increased loyalty of their customer base and reduced policy
acquisition costs. We may also face competition from new or temporary entrants
in our niche markets. In some cases, such entrants may, because of inexperience,
desire for new business or other reasons, price their insurance below ours.
Although our pricing is inevitably influenced to some degree by that of our
competitors, we believe that it is generally not in our best interest to compete
solely on price. We instead tend to compete on the basis of underwriting
criteria, our distribution network and superior service to our agents and
insureds. We compete with respect to automobile insurance in Florida with more
than 100 companies, which underwrite personal automobile insurance. Comparable
companies which compete with us in the personal automobile insurance market
include U.S. Security Insurance Company, United Automobile Insurance Company,
Direct General Insurance Company and Security National Insurance Company, as
well as major insurers such as Progressive Casualty Insurance Company.
Comparable companies which compete with us in the homeowners' market include
Florida Family Insurance Company, Florida Select Insurance Company, Atlantic
Preferred Insurance Company and Vanguard Insurance Company. Comparable companies
which compete with us in the general liability insurance market include Century
Surety Insurance Company, Atlantic Casualty Insurance Company, Colony Insurance
Company and Burlington/First Financial Insurance Companies. Competition could
have a material adverse effect on our business, results of operations and
financial condition.
Our executive offices are located at 3661 West Oakland Park Boulevard,
Suite 300, Lauderdale Lakes, Florida 33313 and our telephone number is (954)
581-9993.
Recent Events
In August and September 2004, the State of Florida experienced four
hurricanes, Charley, Frances, Ivan and Jeanne. One of our subsidiaries,
Federated National, incurred significant losses relative to its homeowners'
insurance line of business. Approximately 7,500 policyholders have filed
hurricane-related claims totaling an estimated $62.0 million, of which we
estimate that our share of the costs associated with these hurricanes will be
approximately $33.0 million, net of our reinsurance recoveries.
On June 14, 2004 we announced a 3-for-2 stock split. The stock split was
in the form of a stock dividend and was distributed on or about September 7,
2004, to shareholders of record at the close of business on August 23, 2004.
Shareholders received three shares of common stock for every two shares of our
stock held on the record date. Just prior to the three-for-two stock split, we
had approximately 3,957,000 shares outstanding, and following the stock split,
we had approximately 5,936,000 shares outstanding, including fractional shares
that were paid in common stock. All earnings per share data included in the
consolidated financial statements and notes
17
21st Century Holding Company
Management's Discussion and Analysis of
Financial Condition and Results of Operations
thereto have been restated after giving retroactive effect for the September 7,
2004 three-for-two stock split.
In August 2004, A.M. Best Company notified us that Federated National and
American Vehicle were being placed under review with negative implications. A.M.
Best in 2003 had assigned Federated National a B rating ("Fair," which is the
seventh of 14 rating categories) and American Vehicle a B+ rating ("Very Good,"
which is the sixth of 14 rating categories). Federated National and American
Vehicle are currently rated "A" ("Unsurpassed," which is first of six ratings)
by Demotech, Inc. We will most likely not maintain our A. M. Best ratings due to
the recent hurricanes. A downgrade or withdrawal of our ratings could limit or
prevent us from writing or renewing desirable insurance policies or from
obtaining adequate reinsurance and may limit our expansion plans.
Analysis of Financial Condition
As of September 30, 2004 as Compared to December 31, 2003
Investments.
Investments increased $42.4 million, or 89.6%, to $89.7 million as of
September 30, 2004, as compared to $47.3 million as of December 31, 2003,
primarily as a result of our investment of the proceeds from an increase in
written insurance premiums.
As a result of the adverse market conditions that occurred in 2002,
management more carefully monitors its concentrations, industries and asset
allocations. There were no other instances of large concentrations of investment
securities requiring write-downs.
Financial Accounting Standards ("FAS") number 115 addresses accounting and
reporting for (a) investments in equity securities that have readily
determinable fair values and (b) all investments in debt securities. FAS 115
requires that these securities be classified in three categories and given
specific accounting treatment as follows:
Classification Accounting Treatment
-------------- --------------------
Held-to-maturity Amortized cost
Debt securities with the intent and
ability to hold to maturity
Trading securities Fair value, with unrealized holding
Debt and equity securities bought and gains and losses included in operations
held primarily for sale in the near
term
Available-for-sale Fair value, with unrealized holding
Debt and equity securities not gains and losses excluded from earnings and reported as a
classified as held-to-maturity or separate component of shareholders' equity,
trading securities namely "Other Comprehensive Income"
18
21st Century Holding Company
Management's Discussion and Analysis of
Financial Condition and Results of Operations
In accordance with the above we have classified all of our investment
portfolio as available-for-sale during the nine months ending September 30, 2004
and the year ended December 31, 2003.
Below is a summary of unrealized gains and (losses) at September 30, 2004
and December 31, 2003 by category.
Unrealized Gains and (Losses)
----------------------------------------
September 30, 2004 December 31, 2003
------------------ -----------------
Fixed maturities:
U.S. government obligations $(452,464) $(793,613)
Obligations of states and political subdivisions (6,300) (4,840)
--------- ---------
(458,764) (798,453)
--------- ---------
Corporate securities:
Communications 16,632 209,226
Financial 5,300 14,694
Other 79,103 45,475
--------- ---------
101,035 269,395
--------- ---------
Equity securities:
Preferred stocks (500) 400
Common stocks (359,249) 3,154
--------- ---------
(359,749) 3,554
--------- ---------
Total unrealized gains and (losses) $(717,478) $(525,504)
========= =========
For further detail, see the section titled ITEM 3. QUANTITATIVE AND
QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Receivable for Investments Sold.
The receivable for investments sold decreased $2.0 million, or 94.1%, to
$0.1 million as of September 30, 2004, as compared to $2.1 million as of
December 31, 2003. The decrease is a result of investment trading activity that
occurred in late December 2003 and did not settle until early January 2004.
Prepaid Reinsurance Premiums.
Prepaid reinsurance premiums decreased $5.3 million, or 63.4%, to $3.1
million as of September 30, 2004, as compared to $8.4 million as of December 31,
2003. The decline reflects a $7.4 decrease in our insurance subsidiaries'
reliance on automobile quota-share reinsurance. During 2003 we ceded 40% of our
automobile premiums to our reinsurer, and for the first nine months of 2004, the
company has not ceded any automobile premiums. The decrease in prepaid
reinsurance premiums was mitigated by an increase of $2.1 in prepaid
catastrophic reinsurance premiums during the same nine-month period ending
September 30, 2004.
Reinsurance Recoverable, Net.
Reinsurance recoverable, net increased $23.5 million, or 212.3%, to $34.5
million as of September 30, 2004, as compared to $11.0 million as of December
31, 2003. The increase in reinsurance recoverable, net consists of $28.6 million
due to our claims associated with the hurricanes experienced in August and
September of 2004 mitigated by a decrease in reinsurance recoverable, net of
$5.1 million.
19
21st Century Holding Company
Management's Discussion and Analysis of
Financial Condition and Results of Operations
Deferred Policy Acquisition Costs.
Deferred policy acquisition costs increased $5.3 million, or 303.2%, to
$7.0 million as of September 30, 2004, as compared to $1.7 million as of
December 31, 2003. For the nine months ended September 30, 2004, commission
expense and commission income, net, were approximately $6.2 million and expenses
connected with the writing of premiums such as salaries and premium taxes, net
of policy fees, totaled approximately $0.8 million. Deferred policy acquisition
costs increased primarily due to a $2.7 million increase in deferred commission
expenses and a $2.2 million decrease in ceded unearned commissions income during
the nine months ended September 30, 2004. The increase in deferred commission
expenses primarily related to the increase in lines of insurance other than
automobile, which are not subject to quota-share agreements. The decrease in
ceded commissions income is due to a $7.4 million decline in ceded commissions
and is due to the intentional absence of a quota-share agreement in place for
premiums written in 2004. Deferred policy acquisition costs was formerly titled
Deferred acquisition costs.
Income Taxes Recoverable
Income taxes recoverable increased $6.4 million, or 775.1%, to $7.2
million as of September 30, 2004, as compared to $0.8 million as of December 31,
2003. The increase in Income taxes recoverable consists of the recoupment of
estimated 2004 income tax payments paid in 2004 and Federal net operating loss
carry-back provisions.
Unpaid Losses and Loss Adjustment Expenses.
Unpaid losses and loss adjustment expenses increased $52.1 million, or
212.0%, to $76.7 million as of September 30, 2004, as compared to $24.6 million
as of December 31, 2003. The widely publicized hurricanes during August and
September of 2004 significantly affected our homeowner line of insurance
products. Approximately 7,500 policyholders have filed hurricane related claims
totaling an estimated $62.0 million of which we estimate that our share of the
costs associated with these hurricanes will be approximately $33.0 million. Our
Automobile and Commercial General Liability insurance products were not
materially affected by the hurricanes. As of September 30, 2004, approximately
$9.1 million has been received by us to settle hurricane losses and is reflected
on our consolidated balance sheet at September 30, 2004 as Funds held under
reinsurance treaties. The remainder of our expected incurred losses associated
with the four hurricanes is recorded as part of our Unpaid Losses and Loss
Adjustment Expenses. The following schedule reflects the activity in the
liability for unpaid losses and loss adjustment expenses for the nine months
ending September 30, 2004 and December 31, 2003.
December 31,
September 30, 2004 2003
------------------ ------------
Balance at January 1: $ 24,570,198 $ 16,983,756
Less reinsurance recoverables (9,761,354) (7,847,421)
------------ ------------
Net balance at January 1 $ 14,808,844 $ 9,136,335
============ ============
Incurred related to:
Current year $ 57,845,208 $ 26,274,932
Prior years (103,995) 1,234,047
------------ ------------
Total incurred $ 57,741,213 $ 27,508,979
============ ============
Paid related to:
Current year $ 17,796,300 $ 14,205,212
Prior years 9,145,184 7,631,258
------------ ------------
Total paid $ 26,941,484 $ 21,836,470
============ ============
Net balance at year-end $ 45,608,573 $ 14,808,844
Plus reinsurance recoverables 31,045,047 9,761,354
------------ ------------
Balance at year-end $ 76,653,620 $ 24,570,198
============ ============
20
21st Century Holding Company
Management's Discussion and Analysis of
Financial Condition and Results of Operations
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). Periodic estimates
by management of the ultimate costs required to settle all claim files are based
on the Company's analysis of historical data and estimations of the impact of
numerous factors such as (i) per claim information; (ii) company and industry
historical loss experience; (iii) legislative enactments, judicial decisions,
legal developments in the awarding of damages, and changes in political
attitudes; and (iv) trends in general economic conditions, including the effects
of inflation. Management revises its estimates based on the results of its
analysis. This process assumes that past experience, adjusted for the effects of
current developments and anticipated trends, is an appropriate basis for
estimating the ultimate settlement of all claims. There is no precise method for
subsequently evaluating the impact of any specific factor on the adequacy of the
reserves, because the eventual redundancy or deficiency is affected by multiple
factors. For further discussion, see "Loss and Loss Adjustment Expenses" below.
Unearned Premiums.
Unearned premiums increased by $14.4 million or, 42.0%, to $48.5 million
as of September 30, 2004, as compared to $34.1 million as of December 31, 2003.
The increase was due to a $20.4 million increase in unearned homeowner's
insurance premiums and $2.6 million in unearned premiums associated with the
commercial liability program. Offsetting these increases was a $8.7 million
decrease in automobile unearned premiums. These changes reflect our emphasis on
property and commercial general liability insurance products. During the quarter
ending June 30, 2004, our plans to assume homeowner policies from the insurer
created by the State of Florida, Citizens Property Insurance Corporation
("Citizens"), came to fruition. Of the $20.4 million increase in our homeowner's
insurance unearned premiums as of September 30, 2004, 30.5 %, or $6.2 million
relates to our assumption of homeowner insurance policies from Citizens.
Funds Held Under Reinsurance Treaties
Funds held under reinsurance treaties increased by $9.1 million, or 100%
as of September 30, 2004. The increase reflects funds advanced to us under our
reinsurance treaties by our reinsurers to pay hurricane related claims. Our
obligation, pursuant to the reinsurance contracts, is to pay the first $10.0
million for each event before we are permitted to use the funds held under our
reinsurance treaties.
Results of Operations
Three Months Ended September 30, 2004 as Compared to Three
Months Ended September 30, 2003
Gross Premiums Written.
Gross premiums written increased $1.9 million, or 8.6%, to $24.3 million
for the three months ended September 30, 2004, as compared to $22.4 million for
the comparable period in 2003. The following table denotes gross premiums
written by major product line.
Three months ended September 30,
---------------------------------------------
2004 2003
----------- -----------
Automobile $ 4,045,750 16.6% $13,960,744 62.4%
Homeowners' 16,564,249 68.2% 5,356,294 23.9%
Commercial liability 3,389,016 13.9% 2,664,980 11.9%
Mobile home owners' 302,785 1.3% 387,211 1.8%
----------- ----- ----------- -----
Gross written premiums $24,301,800 100.0% $22,369,229 100.0%
=========== ===== =========== =====
As noted above, our efforts to expand our lines of insurance products
to emphasize products other than automobile insurance are coming to fruition.
Furthermore, our assumption of policies from Citizens during the three months
ended September 30, 2004 totaled 10.4% or $2.5 million of the $24.3 million of
gross written premiums.
21
21st Century Holding Company
Management's Discussion and Analysis of
Financial Condition and Results of Operations
Gross Premiums Ceded.
Gross premiums ceded decreased $5.7 million to $0.1 million for the three
months ended September 30, 2004, as compared to a charge to operations of $5.6
million for the three months ended September 30, 2003. The decrease is due to
the decline in our ceded quota-share reinsurance associated with our automobile
insurance. For the quarter ended September 30, 2004, we did not cede any
automobile insurance premiums, as compared to a 40% cession for the same period
last year.
Increase (Decrease) in Prepaid Reinsurance Premiums.
The change in the increase (decrease) in prepaid reinsurance premiums was
$3.2 million, or $0.8 million for the three months ended September 30, 2004,
compared to ($2.5) million for the three months ended September 30, 2003. The
increase is due to the intentional absence of a quota-share agreement in place
for premiums written in 2004 totaling $1.2 million and an increase in our
catastrophic insurance premiums totaling $2.1 million.
Decrease (Increase) in Unearned Premiums.
Unearned premiums decreased by $2.6 million to ($0.2) million as of
September 30, 2004, as compared to a charge to operations of $2.4 million as of
September 30, 2003. The decrease was due to a $2.4 million increase in unearned
homeowners' insurance premiums and $0.6 million in unearned premiums associated
with the commercial liability insurance program. Offsetting these increases was
a $3.0 million decrease in automobile unearned premiums.
Net Investment Income.
Net investment income increased by $0.3 million, or 63.5%, to $0.8 million
for the three months ended September 30, 2004, as compared to $0.5 million for
the same three month period ended September 30, 2003. The increase in investment
income is a result of the additional amounts of invested assets. Also affecting
our net investment income were our declining yields of 3.99% for the three
months ended September 30, 2004 as compared to 4.83% for the three months ended
September 30, 2003.
Net Realized Investment Gains.
Net realized investment gains increased by $.05 million, or 139.8% to
$0.08 million for the three months ended September 30, 2004, as compared to $.03
million for the three months ended September 30, 2003. The table below depicts
the gains by investment category.
22
21st Century Holding Company
Management's Discussion and Analysis of
Financial Condition and Results of Operations
Net Realized Gains (Losses)
Three Months Ended September 30,
--------------------------------
2004 2003
--------- ---------
Fixed maturities:
U.S. government obligations $ (32,116) $(209,334)
Obligations of states and political subdivisions (10,450) --
--------- ---------
(42,566) (209,334)
--------- ---------
Corporate securities:
Communications -- 79,248
Financial -- (693)
Other -- (78,557)
--------- ---------
-- (2)
--------- ---------
Equity securities:
Preferred stocks (56) --
Common stocks 123,581 243,101
--------- ---------
123,525 243,101
--------- ---------
Total net realized gains (losses) $ 80,959 $ 33,765
========= =========
Loss and Loss Adjustment Expenses.
Loss and loss adjustment expenses increased by $36.0 million, or 568.9%,
to $42.3 million for the three months ended September 30, 2004, as compared to
$6.3 million as of September 30, 2003. The widely publicized hurricane season
significantly affected our homeowners' line of insurance products. Approximately
7,500 policyholders have filed hurricane related claims totaling an estimated
$62.0 million of which we estimate that our share of the costs associated with
these hurricanes will be approximately $33.0 million. Our automobile and
commercial general liability insurance products were not materially affected by
the hurricanes. Our loss ratio, as determined in accordance with GAAP, for the
three-month period ended September 30, 2004 was 167.22% compared with 53.35% for
the same period in 2003. The table below reflects the loss ratios by product
line.
Three months ending September 30,
---------------------------------
2004 2003
---- ----
Automobile 114.52% 65.88%
Home owners 196.22% 25.36%
Commercial liability 9.86% 50.32%
Mobile home owners 777.05% 24.44%
All product lines 167.22% 53.35%
Losses and loss adjustment expense, our most significant expense,
represent actual payments made and changes in estimated future payments to be
made to or on behalf of our policyholders, including expenses required to settle
claims and losses. Management revises its estimates based on the results of its
analysis of estimated future payments to be made. This process assumes that past
experience, adjusted for the effects of current developments and anticipated
trends, is an appropriate basis for predicting future events.
Operating and Underwriting Expenses.
Operating and underwriting expenses rose by $4.5 million, or 150.6%, to
$7.4 million for the three months ended September 30, 2004, as compared to $3.0
million for the three months ended September 30, 2003. The increase is primarily
associated with our cost of obtaining various types of insurance products, as
well as an assessment pursuant to our participation in an insurance
apportionment plan.
23
21st Century Holding Company
Management's Discussion and Analysis of
Financial Condition and Results of Operations
Policy Acquisition Costs, Net of Amortization.
Policy acquisition costs, net of amortization, increased by $2.4 million,
charging earnings $2.5 million for the three months ended September 30, 2004, as
compared to a charge to earnings of $0.12 million as of September 30, 2003.
Policy acquisition costs, net of amortization consists of the actual policy
acquisition costs, including commissions, payroll and premium taxes, less
commissions earned on reinsurance ceded and policy fees earned attributable to
premiums earned during the period.
During the three months ended September 30, 2004, the difference between
the ceded commissions earned of $0.4 million and amortized costs of $2.9 million
resulted in a charge to earnings of $2.5 million. The $2.4 million increase in
the amortization of deferred policy acquisition costs in the 2004 period as
compared to the 2003 period is attributable to the decrease in ceded commissions
earned totaling $1.1 million, and increased amortized costs of $1.3 million
during the three month period ended September 30, 2004. Policy acquisition
costs, net of amortization was formerly titled Amortization of deferred
acquisition costs, net.
Provision (Benefit) for Income Tax Expense.
There was an income tax benefit for the three months ended September 30,
2004, compared with a provision for income taxes for the same three-month period
last year. The income tax benefit is a result of the losses incurred during the
third quarter of 2004. The benefit reflects our ability to carry-back our
Federal income taxes and carry-forward our Florida income taxes.
Results of Operations
Nine Months Ended September 30, 2004 as Compared to Nine Months Ended September
30, 2003
Gross Premiums Written.
Gross premiums written increased $17.4 million, or 30.7%, to $73.9 million
for the nine months ended September 30, 2004, as compared to $56.6 million for
the comparable period in 2003. The following table denotes gross premiums
written by major product line.
Nine months ended September 30,
------------------------------------------------
2004 2003
----------- ----------
Automobile $15,824,076 21.4% $39,915,374 70.6%
Homeowners' 47,131,793 63.8% 12,614,755 22.3%
Commercial liability 9,762,931 13.2% 2,664,980 4.7%
Mobile home owners' 1,210,771 1.6% 1,364,694 2.4%
----------- ----- ----------- -----
Gross written premiums $73,929,571 100.0% $56,559,803 100.0%
=========== ===== =========== =====
As noted above, our efforts to expand our lines of insurance products to
emphasize products other than automobile insurance are coming to fruition.
Furthermore, our assumption of policies from Citizens during the nine months
ended September 30, 2004 totaled 18.4% or $13.6 million of the $73.9 million of
gross written premiums as of September 30, 2004.
Gross Premiums Ceded.
Gross premiums ceded decreased $16.8 million to $1.0 million for the nine
months ended September 30, 2004, as compared to a charge to operations of $15.8
million for the nine months ended September 30, 2003. The decrease is due to the
decline in our ceded quota-share reinsurance associated with our automobile
insurance. For the quarter ended September 30, 2004, we did not cede any
automobile insurance premiums, as compared to a 40% cession for the same period
last year.
Increase (Decrease) in Prepaid Reinsurance Premiums.
The change in the increase (decrease) in prepaid reinsurance premiums was
a decrease of $2.8 million, or ($5.3) million for the nine months ended
September 30, 2004, compared to ($2.5) million for the nine months ended
September 30, 2003. The increase is due to the intentional absence of a
quota-share agreement in place for
24
21st Century Holding Company
Management's Discussion and Analysis of
Financial Condition and Results of Operations
premiums written in 2004 totaling $1.2 million and an increase in our
catastrophic insurance premiums totaling $2.1 million.
Decrease (Increase) in Unearned Premiums.
Unearned premiums increased by $9.4 million to ($14.3) million as of
September 30, 2004, as compared to ($4.9) million as of September 30, 2003. The
increase was due to a $15.5 million increase in unearned homeowners' insurance
premiums and $0.3 million in unearned premiums associated with the commercial
liability insurance program. Offsetting these increases was a $6.3 million
decrease in automobile unearned premiums.
Net Investment Income.
Net investment income increased by $0.9 million, or 74.2%, to $2.1 million
for the nine months ended September 30, 2004, as compared to $1.2 million for
the same nine month period ended September 30, 2003. The increase in investment
income is a result of the additional amounts of invested assets. Also affecting
our net investment income are the declining yields of 0.51% for the nine months
ended September 30, 2004 as compared to 5.23% for the nine months ended
September 30, 2003.
Net Realized Investment Gains.
Net realized investment gains decreased by $1.2 million, or 82.0% to $0.3
million for the nine months ended September 30, 2004, as compared to $1.5
million for the nine months ended September 30, 2003. The table below depicts
the gains by investment category.
Net Realized Gains
Nine Months Ended September 30,
-------------------------------
2004 2003
---------- ----------
Fixed maturities:
U.S. government obligations $ 30,397 $ 291,427
Obligations of states and political
subdivisions (10,566) 345,177
---------- ----------
19,831 636,604
---------- ----------
Corporate securities:
Communications -- 118,107
Financial (219) 88,683
Other -- 57,453
---------- ----------
(219) 264,243
---------- ----------
Equity securities:
Preferred stocks (56) 23,555
Common stocks 241,830 529,063
---------- ----------
241,774 552,618
---------- ----------
Total net realized gains $ 261,386 $1,453,465
========== ==========
Loss and Loss Adjustment Expenses.
Loss and loss adjustment expenses increased by $35.7 million, or 173.7%,
to $56.4 million for the nine months ended September 30, 2004, as compared to
$20.6 million as of September 30, 2003. The widely publicized hurricane season
significantly affected our homeowners' line of insurance products. Approximately
7,500 policyholders have filed hurricane-related claims totaling an estimated
$62.0 million of which we estimate that our share of the costs associated with
these hurricanes will be approximately $33.0 million. Our automobile and
commercial general liability insurance products were not materially affected by
the hurricanes. Our loss ratio, as determined in accordance with GAAP, for the
nine month period ended September 30, 2004 was 106.11% compared with 61.95% for
the same period in 2003. The table below reflects the loss ratios by product
line.
25
21st Century Holding Company
Management's Discussion and Analysis of
Financial Condition and Results of Operations
Nine months ending September 30,
--------------------------------
2004 2003
---- ----
Automobile 90.87% 77.84%
Home owners 121.89% 18.94%
Commercial liability 17.70% 24.44%
Mobile home owners 281.41% 35.06%
All product lines 106.11% 61.95%
Losses and loss adjustment expense, our most significant expense,
represents actual payments made and changes in estimated future payments to be
made to or on behalf of our policyholders, including expenses required to settle
claims and losses. Management revises its estimates based on the results of its
analysis of estimated future payments to be made. This process assumes that past
experience, adjusted for the effects of current developments and anticipated
trends, is an appropriate basis for predicting future events. We attribute the
"all lines" decrease in the loss ratio primarily to the increasingly significant
operational contributions made by our lines of insurance other than automobile.
Operating and Underwriting Expenses.
Operating and underwriting expenses rose by $5.6 million, or 67.3%, to
$13.9 million for the nine months ended September 30, 2004, as compared to $8.3
million for the nine months ended September 30, 2003. The increase is primarily
associated with our cost of obtaining various types of insurance products, as
well as an assessment pursuant to our participation in a insurance apportionment
plan.
Policy Acquisition Costs, Net of Amortization.
Policy acquisition costs, net of amortization, increased by $5.6 million,
charging earnings by $4.6 million for the nine months ended September 30, 2004,
as compared to a credit of $0.9 million as of September 30, 2003. Policy
acquisition costs, net of amortization consists of the actual policy acquisition
costs, including commissions, payroll and premium taxes, less commissions earned
on reinsurance ceded and policy fees earned attributable to premiums earned
during the period.
During the nine months ended September 30, 2004, the difference between
the ceded commissions earned of $1.9 million and amortized costs of $6.5 million
resulted in a charge to earnings of $4.6 million. The $3.7 million increase in
the amortization of deferred policy acquisition costs in the 2004 period as
compared to the 2003 period is attributable to the decrease in ceded commissions
earned totaling $7.2 million, and increased amortized costs of $10.9 million
during the nine month period ended September 30, 2004. Policy acquisition costs,
net of amortization was formerly titled Amortization of deferred acquisition
costs, net.
Provision (Benefit) for Income Tax Expense.
There was an income tax benefit for the nine months ended September 30,
2004, compared with a provision for income taxes for the same nine-month period
last year. The income tax benefit is a result of the losses incurred during the
third quarter of 2004. The benefit reflects our ability to carry-back our
Federal income taxes and carry-forward our Florida income taxes.
Liquidity and Capital Resources
Our primary sources of capital during the nine months ended September 30,
2004 are revenues generated from operations, issuance of debt securities,
investment income and borrowings under the Revolving Agreement, described below.
Because we are a holding company, we are largely dependent upon fees from our
subsidiaries for cash flow.
Federated Premium's operations are funded by a revolving loan agreement
("Revolving Agreement") with FlatIron Funding Company LLC ("FlatIron"). The
Revolving Agreement is structured as a sale of contracts receivable under a sale
and assignment agreement with FPF, Inc., a wholly-owned subsidiary of FlatIron
("FPF"), which gives FPF 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.
During September 2004, we negotiated a new revolving loan agreement in
which the maximum credit commitment available to us was reduced at our request
to $2.0 million with built-in options to incrementally increase the maximum
credit commitment up $4.0 million over the next three years. We believe that
this available credit is sufficient based on our current operations. Our lender,
however, could decide to reduce our available credit based on a number of
factors, including the A.M. Best ratings of Federated National and American
Vehicle. If the A.M. Best rating of Federated National falls below a "C," or if
the financial condition of American Vehicle, as determined by our lender in its
sole discretion suffers a material adverse change, then under the terms of the
Revolving Agreement, policies written by that subsidiary will no longer be
eligible collateral, causing our available credit to be reduced. If that occurs
and we are not able to obtain working capital from other sources, then we would
have to restrict our growth and, possibly, our operations.
26
The amount of FPF's advances are 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 lower to total contracts receivable.
As of September 30, 2004, our interest rate was 4.75% as compared to our
interest rate as of September 30, 2003 of 5.75%.
The Revolving Agreement contains various operating and financial
covenants, with which we were in compliance at September 30, 2004 and December
31, 2003. Outstanding borrowings under the Revolving Agreement as of September
30, 2004 and December 31, 2003 were $1.3 million and $4.1 million, respectively.
Outstanding borrowings in excess of the $4.0 million commitment totaled $98,786
as of December 31, 2003. The excess amount, permissible by reason of a
compensating cash balance of $200,430 for December 31, 2003, was held for the
benefit of FPF and is included in other assets. Interest expense on the
Revolving Agreement for the nine months ended September 30, 2004 and 2003
totaled approximately $150,000 and $156,000, respectively. For the nine months
ended September 30, 2004 and 2003 the effective interest rate on this line of
credit, based on our average outstanding borrowings under the Revolving
Agreement, was 6.97% and 5.90%, respectively.
On July 31, 2003, we completed a private placement of our 6% Senior
Subordinated Notes (the "July 2003 Notes"), which were offered and sold to
accredited investors as units consisting of one July 2003 Note with a principal
amount of $1,000 and warrants (the "2003 Warrants") to purchase shares of our
Common Stock. We sold an aggregate of $7.5 million of July 2003 Notes in this
placement, which resulted in proceeds to us (net of placement agent fees of
$450,724 and offering expenses of $110,778) of $6,938,498.
The July 2003 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 July 2003 Notes may be
made in cash or, at our option, in shares of our 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.
27
21st Century Holding Company
Management's Discussion and Analysis of
Financial Condition and Results of Operations
The 2003 Warrants issued in this placement to the purchasers of the July
2003 Notes and to the placement agent in the offering, J. Giordano Securities
Group ("J. Giordano"), each entitle the holder to purchase 3/4 of one share of
our Common Stock at an exercise price of $12.7435 per whole share (as adjusted
for the Company's three-for-two stock split) until July 31, 2006. The total
number of shares issuable upon exercise of 2003 Warrants issued to the
purchasers of the July 2003 Notes and to J. Giordano totaled 408,050. GAAP
requires that detachable warrants be valued separately from debt and included in
paid-in capital. Based on the terms of the purchase agreement with the investors
in the private placement, management believes that the 2003 Warrants had zero
value at the date of issuance.
On September 30, 2004, we completed a private placement of 6% Senior
Subordinated Notes due September 30, 2007 (the "September 2004 Notes"). These
notes were offered and sold to accredited investors as units consisting of one
September 2004 Note with a principal amount of $1,000 and warrants to purchase
shares of our Common Stock (the "2004 Warrants"), the terms of which are similar
to our July 2003 Notes and 2003 Warrants, except as described below. We sold an
aggregate of $12.5 million of units in this placement, which resulted in
proceeds (net of placement agent fees of $700,000 and offering expenses of
$32,500) to us of $11,767,500.
The September 2004 Notes pay interest at the annual rate of 6%, mature on
September 30, 2007, and rank pari passu in terms of payment and priority to the
July 2003 Notes. Quarterly payments of principal and interest due on the
September 2004 Notes, like the July 2003 Notes, may be made in cash or, at our
option, in shares of our 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 2004 Warrants issued to the purchasers of the September 2004 Notes and
to the placement agent in the offering, J. Giordano, each entitle the holder to
purchase one share of our Common Stock at an exercise price of $12.75 per share
and will be exercisable until September 30, 2007. The number of shares issuable
upon exercise of the 2004 Warrants issued to purchasers equaled $12.5 million
divided by the exercise price of the warrants, and totaled 980,392. The number
of shares issuable upon exercise of the 2004 Warrants issued to J. Giordano
equaled $500,000 divided by the exercise price of the warrants, and totaled
39,216. The terms of the 2004 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.
On or about October 31, 2003, January 31, 2004, April 30, 2004, July 31,
2004 and October 31, 2004, we paid, pursuant to the terms of the July 2003
Notes, the quarterly payments of principal and interest due in shares of our
Common Stock and in accordance with the contractual computations issued 61,792,
54,014, 53,729, 49,965 and 69,200 shares of Common Stock, respectively.
28
21st Century Holding Company
Management's Discussion and Analysis of
Financial Condition and Results of Operations
For the September 2004 Notes, quarterly principal and interest payments,
totaling approximately $1.2 million per payment, are due beginning next year on
January 31, April 30, July 31, and October 31, with the last installment due on
September 30, 2007.
For the nine months ended September 30, 2004, operations generated net
operating cash flow of $40.8 million as compared to $12.9 million for the nine
months ended September 30, 2003. Gross cash flow provided by operations
generated approximately $87.2 million, mostly by an increase of unpaid losses
and loss adjustment expenses totaling $52.1 million. Other cash was provided by
a $14.3 million increase in unearned premiums and $9.1 million received and
reflected as funds held under reinsurance treaties. Additional cash was provided
by operating activities from prepaid reinsurance premiums totaling $5.3 million
and premium deposits totaling $1.9 million, in conjunction with premiums
receivable of $1.6 million and financed contracts receivable of $1.3 million.
Uses of cash during the nine months ended September 30, 2004 included $23.5
million due from reinsurance, net; $7.2 million due from income taxes deferred
and recoverable; $5.3 million for policy acquisition costs, net of amortization;
in conjunction with net losses of $10.3 million. For the nine months ended
September 30, 2003, operations generated net operating cash flow of $15.0
million as compared to $12.0 million for the same nine months ending September
30, 2003. Gross cash flow from operations generated approximately $25.2 million,
mostly by an increase in unpaid loss and loss adjustment expenses totaling $7.0
million, increased unearned premiums liability totaling $4.9 million, increased
prepaid reinsurance premiums totaling $2.6 million and exercised stock options
totaling $2.3 million, in conjunction with net income of $6.4 million. We do not
expect our operations to generate positive cash flow in the fourth quarter as
the Company settles its claims relating the four hurricanes that occurred in
August and September of 2004. We currently expect positive operating cash flow
to resume during 2005.
Our investment portfolio is highly liquid as it consists almost entirely
of readily marketable securities. Cash flow used in net investing activities was
$41.2 million and $20.9 million for the nine months ended September 30, 2004 and
September 30, 2003, respectively. We anticipate that cash flow will be provided
by investing activities during the fourth quarter of 2004, because the Company
expects to liquidate certain of its investments to settle claims relating the
four hurricanes that occurred in August and September 2004. We currently expect
cash flow used in investing activities to resume during 2005.
Net cash provided by financing activities was $11.0 million for the nine
months ended September 30, 2004, primarily reflecting the sale of the September
2004 Notes. Other cash sources include $2.7 million from the exercise of stock
options. Cash used in financing activities include $2.8 million for revolving
credit outstanding and $1.4 million used to pay dividends. Net cash generated
from financing activities was $4.8 million for the nine months ended September
30, 2003. This primarily reflected the receipt of $6.9 million from the issuance
of the July 2003 Notes, offset by $0.8 million paid in dividends and $1.5
million paid to reduce the revolving credit outstanding. The Company believes
that its current capital resources, including the net proceeds from the sale of
its July 2003 and September 2004 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 our certificates 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 2003
statutory minimum capital and surplus requirement of $3.60 million as defined in
the Florida Insurance Code. As of September 30, 2004, Federated National was not
in compliance with its requirement to maintain capital surplus equal to the
greater of 10% of its liabilities by approximately $0.3 million. Based on
Federated National's payment patterns associated with the settlement of its
claims, compliance with the 10% provision has been fully restored by the filing
of this Report and the Company does not currently anticipate any regulatory
action relative to this matter. American Vehicle remains in compliance with
statutory minimum capital and surplus requirement.
The insurance companies are also required to adhere to prescribed
premium-to-capital surplus ratios. As of September 30, 2004, Federated National
did not comply with the prescribed premium-to-capital surplus ratio, primarily
based on the incurred losses associated with the four hurricanes that occurred
in August and September 2004. Pursuant to verbal representations made to us by
senior officials from the Florida Office of Insurance Regulation ("OIR") of the
Florida Department of Financial Services, strict adherence to the prescribed
premium-to-capital surplus ratio requirement may not be immediately imposed. The
Company is in regular communications with the OIR and has complied with their
verbal requests and has relied on their verbal representation that immediate
regulatory action will not be imposed relative to its non-compliance with the
prescribed premium-to-capital surplus ratio. American Vehicle is in compliance
with the prescribed premium-to-capital surplus ratios.
29
21st Century Holding Company
Management's Discussion and Analysis of
Financial Condition and Results of Operations
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.
No dividends were paid by Federated National or American Vehicle during
the nine months ending September 30, 2004 or the year ending December 31, 2003,
and none are anticipated to be paid in 2005. Although we believe that amounts
required to meet our financial and operating obligations will be available from
sources other than dividends from our 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 in
the future. 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. The ability to pay dividends 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.
Insurance companies are required to comply with the risk-based capital
requirements of the National Association of Insurance Commissioners ("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. Based on
calculations using the appropriate NAIC formula and the respective insurance
company data for the year ended December 31, 2003, both of the insurance
companies total adjusted capital were in excess of ratios that would require
regulatory action. GAAP differs in some respects from statutory 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 September 30, 2004 were approximately $8.0 million and $15.0
million, respectively, and their statutory net income (loss) for the nine months
ended September 30, 2004 was ($16.6) million and $0.2 million, respectively.
Federated National entered into an agreement with the insurer created by
the State of Florida, Citizens, to assume the unexpired portion of specifically
chosen homeowner insurance policies on varying dates during May, June and July
2004. As part of the assumption agreement, certain provisions provide for a
"take out" bonus to be paid to Federated National based upon the successful
retention of the assumed policies for the next three years, subject to certain
qualifications. Citizens has agreed to fund an escrow account in the name of
both Citizens and Federated National in accordance with the contract provisions;
however, Federated National is prevented from recognizing the take-out bonus
until it has fulfilled its policyholder retention responsibilities, which is
expected to be some time subsequent to May 2007. As of September 30, 2004, the
escrow account has been funded for $2.9 million and, in accordance with GAAP, is
not included in either our consolidated balance sheet or our consolidated
statements of operations.
30
21st Century Holding Company
Management's Discussion and Analysis of
Financial Condition and Results of Operations
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 our
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
inflationary effect on the cost of paying losses and loss adjustment expenses.
Insurance premiums are established before we know the amount of loss and
loss adjustment expense and the extent to which inflation may affect such
expenses. Consequently, we attempt to anticipate the future impact of inflation
when establishing rate levels. While we attempt to charge adequate premiums, we
may be limited in raising premium levels for competitive and regulatory reasons.
Inflation also affects the market value of our investment portfolio and the
investment rate of return. Any future economic changes which result in prolonged
and increased levels of inflation could cause increases in the dollar amount of
incurred loss and loss adjustment expenses and thereby materially adversely
affect future liability requirements.
31
21st Century Holding Company
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 our Annual Report on Form 10-K as of December
31, 2003. No material changes have occurred in market risk since this
information was disclosed except as discussed below.
Our 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. A summary of the investment portfolio as of September 30, 2004
follows:
Unrealized
Gain
Amortized Cost Fair Value (Loss)
-------------- ---------- ------
Fixed maturities:
U.S. government obligations $54,729,524 60.55% $54,277,060 60.52 $ (452,464)
Obligations of states and
political subdivisions 21,623,036 23.92% 21,616,736 24.11% (6,300)
----------- ----- ----------- ----- -----------
76,352,560 84.47% 75,893,796 84.63% (458,764)
----------- ----- ----------- ----- -----------
Corporate securities:
Communications 1,190,007 1.31% 1,197,663 1.34% 7,656
Financial 1,800,000 1.99% 1,805,300 2.01% 5,300
Other 3,711,787 4.11% 3,799,866 4.24% 88,079
----------- ----- ----------- ----- -----------
6,701,794 7.41% 6,802,829 7.59% 101,035
----------- ----- ----------- ----- -----------
Equity securities:
Preferred stocks 50,000 0.06% 49,500 0.05% (500)
Common stocks 7,290,153 8.06% 6,930,904 7.73% (359,249)
----------- ----- ----------- ----- -----------
7,340,153 8.12% 6,980,404 7.78% (359,749)
----------- ----- ----------- ----- -----------
Total fixed, corporate and equity securities $90,394,507 100.00% $89,677,029 100.00 $ (717,478)
=========== ====== =========== ====== ===========
As of September 30, 2004, there was one obligation of a state subdivision
that represented approximately 7% of the amortized cost of the entire investment
portfolio.
Item 4. Controls And Procedures
Evaluation of Disclosure Controls and Procedures
An evaluation of the effectiveness of the design and operation of our
disclosure controls and procedures within 90 days of this report was carried out
by us under the supervision and with the participation of our management,
including the Chief Executive Officer and Chief Financial Officer. Based on that
evaluation, the Chief Executive Officer and Chief Financial Officer concluded
that our 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 us 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 our internal
controls, there were no significant changes in our 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.
32
21st Century Holding Company
Other Information
PART II: OTHER INFORMATION
Item 1.
Legal Proceedings
We are 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 our
consolidated financial position, results of operations, or liquidity.
In June 2000, a lawsuit was filed against us, our directors and our
executive officers seeking compensatory damages in an undisclosed amount on the
basis of allegations that our amended registration statement dated November 4,
1998 was inaccurate and misleading concerning the manner in which we 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. The lawsuit was filed in the United States District Court for the
Southern District of New York. The plaintiff class purportedly includes
purchasers of our common stock between November 5, 1998 and August 13, 1999. The
Court granted the plaintiffs class status.
Specifically, the plaintiffs allege that we 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. We believe, however, that the lawsuit is
without merit and we have vigorously defended the action, because we reasonably
relied upon outside subject matter experts to make these determinations at the
time. We have also since accounted for ceded commissions on a pro rata basis and
have done so since these matters were brought to our attention in 1998.
Nevertheless, we have also continued to actively participate in settlement
negotiations with the plaintiffs and have tentatively agreed to settle the case.
The parties are currently negotiating the final terms of a Memorandum of
Understanding, which will have to be executed by the parties and then approved
by the court. We have reserved and charged against fourth quarter 2003 earnings
$600,000 for the potential settlement and associated costs.
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
On July 31, 2004 and October 31, 2004 we issued an aggregate of 49,965 and
69,200 shares, respectively, of our common stock to holders of our Notes in
payment of the quarterly interest and principal payments due pursuant to the
terms of the Notes. These shares were issued without registration under the
Securities Act of 1933 (the "Act") by reason of the exemption from registration
pursuant to Section 4(2) of the Act and Regulation D thereunder.
On September 30, 2004, we completed a private placement of our September
2004 Notes and 2004 Warrants (see "Liquidity and Capital Resources" under Item
2, Management's Discussion and Analysis of Financial Conditions and Results of
Operations, above). These securities were issued without registration under the
Act by reason of the exemption from registration pursuant to Section 4(2) of the
Act and Regulation D thereunder.
Item 3.
Defaults Upon Senior Securities
None.
Item 4.
Submission of Matters to a Vote of Security Holders
None.
33
21st Century Holding Company
Other Information
Item 5
Other Information
None.
Item 6
Exhibits
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.
34
21st Century Holding Company
Other Information
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,
Treasurer and Chief Financial Officer
Date: November 15, 2004
35