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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS
PURSUANT TO SECTIONS 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
(Mark One)
[X]Annual Report under Section 13 or 15(d) of the Securities Act of 1934
For the fiscal year ended December 31, 2004
or
[_] Transition Report under Section 13 or 15(d) of the Securities Exchange
Act of 1934 For the transition period of _____________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 (I.R.S. 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)
Registrant's telephone number, including area code (954) 581-9993
Securities registered pursuant to Section 12(b) of the Exchange Act: None
Securities registered pursuant to Section 12(g) of the Exchange Act:
Common Stock, par value $0.01 per share
Redeemable Warrants expiring July 31, 2006
Redeemable Warrants expiring September 30, 2007
(Title of Class)
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, and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [_]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-X is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [_]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in the Exchange Act Rule 12b-2).
Yes [_] N [X]
The aggregate market value of the Issuer's common stock held by
non-affiliates (based on the last sale price of the common stock as reported by
the Nasdaq National Market) on June 30, 2004 was: $55,606,662.
As of June 30, 2004, there were 5,558,347 shares of the common stock
outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
21st Century Holding Company's definitive proxy statement for its 2005 annual
meeting of shareholders will be filed with the SEC not later than 120 days after
the end of the fiscal year covered by this report on Form 10-K pursuant to
General Instruction G (3) of the Form 10-K. Information from such definitive
proxy statement will be incorporated by reference into Part III, Items 10, 11,
12,13 and 14 hereof.
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21st Century Holding Company
PART I........................................................................5
ITEM 1. BUSINESS.............................................................5
GENERAL..................................................................5
RECENT DEVELOPMENTS......................................................6
BUSINESS STRATEGY........................................................8
INSURANCE OPERATIONS AND RELATED SERVICES................................9
General...............................................................9
Nonstandard Automobile................................................9
Standard Automobile..................................................10
Homeowners' and Mobile Homeowners'...................................10
Flood................................................................11
Commercial General Liability.........................................11
Future Products......................................................11
Assurance MGA........................................................11
Superior Adjusting...................................................11
Federated Premium Finance............................................11
Discontinued Operations..............................................13
Tax Preparation Services and Ancillary Services....................13
Franchise Operations...............................................13
MARKETING AND DISTRIBUTION..............................................13
REINSURANCE.............................................................14
LIABILITY FOR UNPAID LOSSES AND LAE.....................................16
COMPETITION.............................................................21
REGULATION..............................................................21
General..............................................................21
Insurance Holding Company Regulation.................................24
Finance Company Regulation...........................................24
Underwriting and Marketing Restrictions..............................24
Legislation..........................................................24
Industry Ratings Services............................................24
EMPLOYEES...............................................................24
SENIOR MANAGEMENT.......................................................25
GLOSSARY OF SELECTED TERMS..............................................25
ITEM 2. PROPERTIES..........................................................27
ITEM 3. LEGAL PROCEEDINGS...................................................27
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.................27
PART II......................................................................28
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS.............................................................28
(a) MARKET INFORMATION..............................................28
(b) HOLDERS ........................................................28
(c) DIVIDENDS.......................................................28
(d) SECURITIES AUTHORIZED FOR ISSUANCE UNDER EQUITY
COMPENSATION PLANS...........................................28
ITEM 6. SELECTED FINANCIAL DATA.............................................29
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS..............................31
OVERVIEW................................................................31
CRITICAL ACCOUNTING POLICIES............................................32
ACCOUNTING CHANGES......................................................32
ANALYSIS OF FINANCIAL CONDITION AS OF DECEMBER 31, 2004 AS
COMPARED TO DECEMBER 31, 2003.......................................33
Investments.....................................................33
Receivable for Investments Sold.................................33
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21st Century Holding Company
Finance Contracts...............................................33
Prepaid Reinsurance Premiums....................................33
Premiums Receivable.............................................34
Reinsurance Recoverable - net...................................34
Deferred Acquisition Costs - net................................34
Income Tax Recoverable..........................................34
Goodwill........................................................34
Other Assets....................................................34
Unpaid Losses and Loss Adjustment Expenses......................35
Unearned Premium................................................35
Bank Overdraft..................................................35
Deferred Income from sale of agency operations..................35
Subordinated Debt...............................................35
RESULTS OF OPERATIONS YEAR ENDED DECEMBER 31, 2004 COMPARED
TO YEAR ENDED DECEMBER 31, 2003.....................................36
Gross Premiums Written..........................................36
Gross Premiums Ceded............................................36
Increase (Decrease) in Prepaid Reinsurance Premiums.............36
Increase in Unearned Premiums...................................36
Managing General Agent Fees.....................................36
Net Investment Income...........................................36
Net Realized Investment Gains (Losses)..........................36
Losses and LAE..................................................36
Salaries and Wages..............................................37
Interest expense................................................38
Policy Acquisition Costs, Net of Amortization...................38
RESULTS OF OPERATIONS YEAR ENDED DECEMBER 31, 2003 COMPARED
TO YEAR ENDED DECEMBER 31, 2002......................................38
Gross Premiums Written..........................................38
Gross Premiums Ceded............................................39
Increase (Decrease) in Prepaid Reinsurance Premiums.............39
Increase in Unearned Premiums...................................39
Managing General Agent Fees.....................................39
Net Investment Income...........................................39
Net Realized Investment Gains (Losses)..........................39
Losses and LAE..................................................40
Salaries and Wages..............................................40
Policy Acquisition Costs, Net of Amortization...................40
LIQUIDITY AND CAPITAL RESOURCES......................................41
IMPACT OF INFLATION AND CHANGING PRICES..............................43
SELECTED QUARTERLY FINANCIAL DATA (Unaudited)........................44
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK.....46
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.....................48
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM..............49
CONSOLIDATED BALANCE SHEETS..........................................50
CONSOLIDATED STATEMENTS OF OPERATIONS................................51
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
AND COMPREHENSIVE INCOME (LOSS)...................................52
CONSOLIDATED STATEMENTS OF CASH FLOWS................................53
(1) ORGANIZATION AND BUSINESS......................................55
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND PRACTICES.......56
(a) CASH AND CASH EQUIVALENTS...................................56
(b) INVESTMENTS.................................................56
(c) PREMIUM REVENUE.............................................56
(d) DEFERRED ACQUISITION COSTS..................................56
(e) PREMIUM DEPOSITS............................................56
(f) UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES..................57
(g) COMMISSION INCOME...........................................57
(h) FINANCE REVENUE.............................................57
(i) CREDIT LOSSES...............................................57
(j) MANAGING GENERAL AGENT FEES.................................58
(k) POLICY FEES.................................................58
(l) REINSURANCE.................................................58
(m) INCOME TAXES................................................58
(n) CONTINGENT REINSURANCE COMMISSION...........................58
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21st Century Holding Company
(o) CONCENTRATION OF CREDIT RISK................................59
(p) ACCOUNTING CHANGES..........................................59
(q) USE OF ESTIMATES............................................59
(r) NATURE OF OPERATIONS........................................60
(s) FAIR VALUE..................................................60
(t) GOODWILL....................................................61
(u) STOCK OPTION PLANS..........................................61
(v) PROPERTY, PLANT AND EQUIPMENT...............................62
(w) RECLASSIFICATIONS...........................................62
(3) INVESTMENTS....................................................62
(a) FIXED MATURITIES AND EQUITY SECURITIES......................62
(b) MORTGAGE LOANS..............................................64
(4) FINANCE CONTRACTS RECEIVABLE...................................64
(5) PROPERTY, PLANT AND EQUIPMENT..................................65
(6) REINSURANCE....................................................65
(7) UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES.....................67
(8) REVOLVING CREDIT OUTSTANDING...................................68
(9) INCOME TAXES...................................................69
(10) REGULATORY REQUIREMENTS AND RESTRICTIONS......................71
(11) COMMITMENTS AND CONTINGENCIES.................................73
(12) LEASES........................................................74
(13) RELATED PARTY TRANSACTIONS....................................74
(14) NET INCOME (LOSS) PER SHARE...................................74
(15) SEGMENT INFORMATION...........................................75
(16) STOCK COMPENSATION PLANS......................................77
(17) EMPLOYEE BENEFIT PLAN.........................................79
(18) ACQUISITIONS..................................................79
(19) COMPREHENSIVE INCOME (LOSS)...................................79
(20) AUTHORIZATION OF PREFERRED STOCK..............................80
(21) 21ST CENTURY HOLDING COMPANY.................................80
(22) SUBORDINATED DEBT.............................................82
(23) SCHEDULE VI - SUPPLEMENTAL INFORMATION CONCERNING
PROPERTY CASUALTY INSURANCE OPERATIONS....................83
(24) DISCONTINUED OPERATIONS.......................................84
(25) SUBSEQUENT EVENTS.............................................84
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE..............................86
ITEM 9A. CONTROLS AND PROCEDURES.......................................86
(a) EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES................86
(b) CHANGES IN INTERNAL CONTROLS....................................86
ITEM 9B. OTHER INFORMATION.............................................86
PART III.....................................................................86
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.................86
ITEM 11. EXECUTIVE COMPENSATION.............................................86
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.....86
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.....................86
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES.............................87
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND
REPORTS ON FORM 8K..............................................87
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21st Century Holding Company
General information about 21st Century Holding Company can be found at
www.21stcenturyholding.com. We make our annual report on Form 10-K, quarterly
reports on Form 10-Q, current reports on Form 8-K and amendments to these
reports filed or furnished pursuant to Section 13 or 15(d) of the Securities and
Exchange Act of 1934 available free of charge on our web site, as soon as
reasonably practicable after they are electronically filed with the SEC.
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); catastrophe losses; weather conditions (including the
severity and frequency of storms, hurricanes, tornadoes and hail); pricing
competition and other initiatives by competitors; ability to obtain regulatory
approval for requested rate changes and the timing thereof; legislative and
regulatory developments, including with respect to state-sponsored catastrophe
loss funds; 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; the
availability and terms of reinsurance; insurance agents; claims experience;
ratings by industry services; changes in driving patterns and loss trends;
reliance on key personnel; acts of war and terrorist activities; court decisions
and trends in litigation; construction and property owners' repair costs; 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 generally accepted accounting principles, or 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.
PART I
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ITEM 1. BUSINESS
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GENERAL
21st Century Holding Company ("21st Century") is an insurance holding
company, which, through our subsidiaries and our contractual relationships with
our independent agents, controls substantially all aspects of the insurance
underwriting, distribution and claims process. We underwrite personal automobile
insurance, general liability insurance, homeowners' 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 Texas and expects to begin writing policies in that state in the
near future. American Vehicle is a fully admitted insurance carrier in Florida,
Louisiana and Texas and is admitted as a surplus lines carrier in Georgia and
Kentucky.
During the year ended December 31, 2004, 63.8%, 21.4%, 1.6% and 13.2% of
the policies we underwrote were for homeowners' property and casualty insurance,
personal automobile insurance, commercial general liability insurance, and
mobile home property and casualty insurance, 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 insurance, 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").
Our executive offices are located at 3661 West Oakland Park Boulevard,
Suite 300, Lauderdale Lakes, Florida and our telephone number is (954) 581-9993.
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21st Century Holding Company
RECENT DEVELOPMENTS
Impact of 2004 Hurricane Season
In August and September 2004, the State of Florida experienced four
hurricanes, Charley, Frances, Ivan and Jeanne. Since then, we have been
receiving and processing claims made under our homeowners' and mobile home
owners' policies, a process that is expected to be substantially completed
during the first half of 2005. One of our subsidiaries, Federated National,
incurred significant losses relative to its homeowners' insurance line of
business. As of December 31, 2004, approximately 8,500 policyholders had filed
hurricane-related claims totaling an estimated $105.4 million, of which we
currently estimate that our share of the costs associated with these hurricanes
will be approximately $43.5 million, net of our reinsurance recoveries and
amortized reinstatement premiums.
We have a reinsurance structure that is a combination of private
reinsurance and the Florida Hurricane Catastrophe Fund (FHCF). For each
catastrophic occurrence, the excess of loss treaty will insure us for $24
million with the company retaining the first $10 million of loss and loss
adjustment expense ("LAE") There are two layers involved with our excess of loss
reinsurance treaties, the $24 million is considered the 1st layer. The treaty
has a provision which, for an additional prorated premium will insure us for
another $24 million of loss and LAE for subsequent occurrences with the company
retaining the first $10 million in loss and LAE. As a result of the loss and LAE
incurred in connection with the Hurricanes Charles and Frances the company has
exhausted its recoveries of $48 million under the terms of this treaty.
The 2nd layer of our excess of loss treaty insures us for an additional
$34 million in excess of the $34 million 1st layer noted above with the same
reinstatement provision. The excess of loss treaties expire on June 30, 2005 and
the company is negotiating a new reinsurance treaty.
The FCAT treat provides protection for 90% of loss and LAE and attaches at
approximately $36.2 million. This treaty inures to the benefit of our excess of
loss treaty and expires on June 1, 2005. For a further discussion of our
reinsurance please see our section titled "REINSURANCE"
Since our initial preliminary provision for losses from these hurricanes
of $33 million, net of reinsurance recoveries, as of September 30, 2004, we
revised our provision for losses as described above. Because the storms occurred
during the third quarter of 2004, we were not able to complete physical
inspections of a sufficiently large percentage of claims, nor were complete
repair estimates available. During the fourth quarter of 2004, as physical
property inspections and repair estimates were completed, our initial estimates
of losses for these storms were increased to reflect increased estimates of
claim severity on our homeowners' policies in Florida. We do not currently
anticipate further material increases to our loss estimates from the 2004
hurricanes.
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). In connection with this review, we
requested that A.M. Best cease its ratings of these subsidiaries "NR-4 Not
rated, company's request". The withdrawal of our ratings could limit or prevent
us from writing or renewing desirable insurance policies, from obtaining
adequate reinsurance, or from borrowing on our line of credit, as described
below. Federated National and American Vehicle are currently rated "A"
("Unsurpassed," which is first of six ratings) by Demotech, Inc.
To retain our certificates of authority, Florida insurance laws and
regulations require that our insurance company subsidiaries, Federated National
and American Vehicle, maintain capital surplus equal to the greater of 10% of
its liabilities or $4.0 million, as defined in the Florida Insurance Code. As of
December 31, 2004, Federated National and American Vehicle were 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 December 31, 2004, Federated National
did not comply with the prescribed premium-to-capital surplus ratio, primarily
based on the incurred losses associated with the four 2004 hurricanes. As a
result of a $6.1 million capital contribution made during the first quarter of
2005 from 21st Century, Federated National's compliance with the prescribed
premium-to-capital surplus ratios has been restored. American Vehicle has
remained in compliance with the prescribed premium-to-capital surplus ratios.
Throughout the post-hurricane period, we have been and continue to be in
regular communications with the Florida Office of Insurance Regulation and have
complied with the office's verbal requests. We have relied on the office's
verbal representation that regulatory action will not be imposed at this time
because of Federated National's non-compliance with the prescribed
premium-to-capital surplus ratio.
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21st Century Holding Company
In the aftermath of the hurricanes in Florida, the Florida Office of
Insurance Regulation issued emergency orders that imposed a moratorium on
cancellations and non-renewals of various types of insurance coverages and that
require mediation to resolve disputes over personal property insurance claims.
For personal residential and commercial residential policies, the moratorium ran
through November 30, 2004. The orders also prohibit cancellations or
non-renewals based solely upon claims resulting from the hurricanes.
We believe that our company is sufficiently capitalized to operate our
business as it now exists and as we currently plan to expand it. Our existing
sources of funds include our revolving loan from Flatiron Funding Company LLC,
sales of our securities such as our September 2004 private placement described
below, possible sales of our investment securities, and our earnings from
operations and investments. Additional unexpected catastrophic events in our
market areas, such as the 2004 hurricanes, have resulted and will result in
greater claims losses than anticipated, which could require us to limit or halt
our growth while we redeploy our capital to pay these unanticipated claims
unless we are able to raise additional capital or increase our earnings in our
other divisions. 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 to $4.0 million over the next three years. Our
lender could determine to change our available credit based on a number of
factors, including the A.M. Best ratings of Federated National and American
Vehicle. Pursuant to our loan agreement, 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 loan agreement, policies
written by that subsidiary will no longer be eligible collateral, causing our
available credit to be reduced if we do not have other collateral qualifying as
eligible collateral. As of December 31, 2004, policies written by Federated
National were not considered by our lender to be eligible collateral. In March
2005, our lender agreed to permit policies written by Federated National to be
eligible collateral up to $165,000. We currently believe that our available
credit under this loan agreement will be sufficient based on our current
operations. If policies written by our insurance subsidiaries again do not
qualify as eligible collateral under our loan agreement and we are not able to
obtain working capital from our operations or other sources, then we would have
to restrict our growth and, possibly, our operations.
Although we believe that the occurrence of four hurricanes hitting Florida
within one year has not previously occurred for as long as records for weather
events have been kept, some weather analysts believe that a period of greater
hurricane activity has begun. To address this possibility, we are exploring
alternatives to reduce our exposure to these types of storms. Although these
measures may increase operating expenses, management believes that they will
assist us in protecting long-term profitability, although there can be no
assurances that will be the case.
Sale of Assets Related to Our Non-Standard Automobile Insurance Agency Business
On December 31, 2004, we, along with our wholly owned subsidiaries,
Federated Agency Group, Inc., Fed USA, Inc. and Assurance Managing General
Agents, Inc., sold certain assets related to our non-standard automobile
insurance agency business located in Florida to Fed USA Retail, Inc. and Fed USA
Franchising, Inc. As consideration for these assets, we received a cash payment
at closing of $7,000,000. In addition, we are entitled to receive an additional
payment of up to $2,500,000 calculated based on 10% of the "Gross Net Written
Premiums" (as defined in the asset purchase agreement) through our two insurance
company subsidiaries, Federated National and American Vehicle, or through any
insurance company affiliated with the buyers for gross net written premiums that
exceed $15,000,000 in the aggregate and that are less than $40,000,000 in the
aggregate with respect to agency business written by the buyers during the
12-month period following the closing. Fed USA Retail, Inc. and Fed USA
Franchising, Inc., which also assumed certain liabilities related to the assets
that were sold, are affiliates of Affirmative Insurance Holdings, Inc., an
insurance holding company based in Addison, Texas. Affirmative has agreed to
guarantee the buyers' obligations to make the post-closing payment described
above.
Sale of Express Tax
Effective January 1, 2005, we sold our 80% interest in Express Tax
Service, Inc. ("Express Tax"), along with its wholly owned subsidiary,
EXPRESSTAX Franchise Corporation. The purchasers were Robert J. Kluba, the
president of Express Tax and the holder of the 20% minority interest in Express
Tax, and Robert H. Taylor. In exchange for our shares, we received a net cash
payment of $311,351, which reflected a purchase price of $660,000 less $348,649.
in inter-company receivables we owed to Express Tax. In addition, we received a
payment of $1,200,000 in exchange for our agreement not to compete with the
current businesses of Express Tax for five years after the sale.
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21st Century Holding Company
Private Placement
On September 30, 2004, we completed a private placement of 6% Senior
Subordinated Notes due September 30, 2007. 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 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 due July 31, 2006 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 Financial Markets 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. The number of shares issuable upon exercise of the
warrants issued to the purchasers in our 2004 private placement 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.
Stock Split
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.
BUSINESS STRATEGY
Although our operations were dominated in the latter part of 2004 by the
claims made in connection with the four hurricanes, we expect that in 2005 we
will return to a focus on the key aspects of our business strategy. We will seek
continued growth of our business by capitalizing on the efficiencies of our
business model and by:
o expanding into additional states. Currently, we have obtained licenses to
underwrite and sell our insurance products in Alabama, Texas and
Louisiana;
o a shift in emphasis of our product mix to balance our nonstandard
automobile insurance products with our continued emphasis on homeowners'
and commercial general liability lines of insurance and by expanding our
product offerings to include other insurance products, subject to
regulatory approval;
o employing our business practices developed and used in Florida in our
expansion to other selected states;
o maintaining a commitment to provide high quality customer service to our
agents and insureds;
o encouraging agents to place a high volume of high quality business with us
by providing them with attractive commission structures tied to premium
levels and loss ratios;
o forming a strategic relationship with Affirmative, the parent company of
the purchasers of our non-standard agency assets located in Florida, which
is intended to enable us to market our insurance products through
Affirmative's retail distribution network and which, in turn, should
increase our revenues. For more information regarding this strategic
relationship, please see Note 24 to our Consolidated Financial Statements
included under Item 8 of this Report on Form 10-K; and
o additional strategies that may include possible acquisitions or further
dispositions of assets, and development of procedures to improve claims
history and mitigate losses from claims.
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21st Century Holding Company
There can be no assurances, however, that any of the foregoing strategies
will be developed or successfully implemented or, if implemented, that they will
positively affect our results of operations.
INSURANCE OPERATIONS AND RELATED SERVICES
General
We underwrite personal automobile, homeowners' and mobile home property
casualty insurance through Federated National and personal automobile property
and casualty insurance and commercial general liability insurance through
American Vehicle. Federated National and American Vehicle are both currently
licensed to conduct business in Florida as domestic admitted insurers. American
Vehicle is also licensed to conduct business in Texas and Louisiana as an
admitted foreign insurer and in Georgia and Kentucky as a non-admitted foreign
insurer. American Vehicle has been approved for admission into Alabama, subject
to our funding of a statutorily required deposit, which is in process.
The following tables set forth the amount and percentages of our gross
premiums written, premiums ceded to reinsurers and net premiums written by line
of business for the periods indicated.
Years Ended December 31
----------------------------------------------------------------------------
2004 2003 2002
---------------------- ---------------------- ---------------------
Premium Percent Premium Percent Premium Percent
--------- ------- --------- -------- ------- -------
(Dollars in Thousands)
Gross written premiums:
Automobile $ 24,239 24.1% $ 49,298 67.5% $ 52,586 83.4%
Homeowners 62,400 62.0% 16,804 23.0% 8,670 13.8%
Mobile Home 1,513 1.5% 1,739 2.4% 1,780 2.8%
Commercial General Liability 12,510 12.4% 5,151 7.1% -- 0.0%
--------- ------ --------- ------ --------- ------
Total gross written premiums $ 100,662 100.0% $ 72,992 100.0% $ 63,036 100.0%
========= ====== ========= ====== ========= ======
Ceded premiums:
Automobile $ (992) (6.4%) $ 22,091 100.0% $ 27,765 100.0%
Homeowners 14,932 96.4% -- 0.0% -- 0.0%
Mobile Home 1,546 10.0% -- 0.0% -- 0.0%
Commercial General Liability -- 0.0% -- 0.0% -- 0.0%
--------- ------ --------- ------ --------- ------
Total ceded premiums $ 15,486 100.0% $ 22,091 100.0% $ 27,765 100.0%
========= ====== ========= ====== ========= ======
Net written premiums
Automobile $ 25,231 29.6% $ 27,207 53.5% $ 24,821 70.4%
Homeowners 47,468 55.7% 16,804 33.0% 8,670 24.6%
Mobile Home (33) 0.0% 1,739 3.4% 1,780 5.0%
Commercial General Liability 12,510 14.7% 5,151 10.1% -- 0.0%
--------- ------ --------- ------ --------- ------
Total net written premiums $ 85,176 100.0% $ 50,901 100.0% $ 35,271 100.0%
========= ====== ========= ====== ========= ======
During the years ended December 31, 2004, 2003 and 2002, we marketed our
insurance products through a network of company-owned agencies, franchised
agencies, independent agents and general agents. Because we sold our
company-owned agencies and franchised agencies at the end of 2004, in 2005 and
thereafter we expect to continue to market our products through our existing
network of independent agents and general agents.
NONSTANDARD AUTOMOBILE
Nonstandard personal automobile insurance is principally provided to
insureds who are unable to obtain standard insurance coverage because of their
driving record, age, vehicle type or other factors, including market conditions.
Underwriting standards for preferred and standard coverage have become more
restrictive, thereby requiring more insureds to seek nonstandard coverage and
contributing to the increase in the size of the nonstandard automobile market.
Nonstandard automobile insurance, however, generally involves the potential for
increased loss exposure and higher claims experience. Loss exposure is mitigated
because premiums usually are written at higher rates than those written for
standard insurance coverage.
- 9 -
21st Century Holding Company
Both of our insurance subsidiaries currently underwrite nonstandard personal
automobile insurance only in Florida, where the minimum limits are $10,000 per
individual, $20,000 per accident for bodily injury, $10,000 per accident for
property damage and comprehensive, and $50,000 for collision. The average annual
premium on policies currently in force is approximately $1,057, as compared to
$751 for 2003, and represented approximately 97.25% of our written premiums for
automobile insurance as of the year ended December 31, 2004. Both Federated
National and American Vehicle underwrite this coverage on an annual and
semi-annual basis.
Due to the purchasing habits of nonstandard automobile insureds (for
example, nonstandard automobile insureds tend seek the least expensive insurance
required of the policyholder by statute that satisfies the requirements of state
laws to register a vehicle), policy renewal rates tend to be low compared to
standard policies. Our experience has been that a significant number of existing
nonstandard policyholders allow their policies to lapse and then reapply for
insurance as new policyholders. Our average policy renewal rate for our
nonstandard policies is 35% to 40% on policies that mature to full term. The
success of our nonstandard automobile insurance program, therefore, depends in
part on our ability to replace non-renewing insureds with new policyholders
through marketing efforts.
STANDARD AUTOMOBILE
Standard personal automobile insurance is principally provided to insureds
who present an average risk profile in terms of driving record, vehicle type and
other factors. Limits on standard personal automobile insurance are generally
significantly higher than those for nonstandard coverage, but typically provide
for deductibles and other restrictive terms. Federated National underwrites
standard personal automobile insurance policies providing coverage no higher
than $100,000 per individual, $300,000 per accident for bodily injury, $50,000
per accident for property damage and comprehensive and collision up to $50,000
per accident, with deductibles ranging from $200 to $1,000. The average premium
on the policies currently in force is approximately $1,402, as compared to
$1,472 for 2003, and represented approximately 2.75% of our written premiums for
automobile insurance as of the year ended December 31, 2004.
HOMEOWNERS' AND MOBILE HOMEOWNERS'
We underwrite homeowners' insurance principally in Central and Southern
Florida. Homeowners' insurance generally protects an owner of real and personal
property against covered causes of loss to that property. Limits on homeowners'
insurance are generally significantly higher than those for mobile homes, but
typically provide for deductibles and other restrictive terms. Our property
insurance products typically provide maximum coverage in the amount of $200,000,
with the average policy limit being approximately $250,000. The approximate
average premium on the policies currently in force is approximately $1,571, as
compared to $1,050 for 2003, and the typical deductible is $1,000 for
non-hurricane-related claims and generally 2% of the coverage amount for the
structure for hurricane-related claims.
We underwrite homeowners' insurance for mobile homes, principally in
Central and Northern Florida, where we believe that the risk of catastrophe loss
from hurricanes is in a typical year less than in other areas of the state.
Mobile homeowners' insurance generally involves the potential for above-average
loss exposure, as compared to homeowners' insurance. In the absence of major
catastrophe losses, however, loss exposure is limited because premiums usually
are at higher rates than those charged for non-mobile home-property and casualty
insurance. Additionally, our property lines for mobile homes typically provide
maximum coverage in the amount of $75,000, with the average policy limit being
approximately $31,000. In addition, we presently limit our mobile home coverage
to no more than 10% of our underwriting exposure. The average annual premium on
policies currently in force is approximately $315 and remains unchanged from
2003. The typical non-hurricane deductible is $500 and generally 2% of the
coverage amount for the structure for hurricane-related claims.
Federated National incurred significant losses relative to its homeowner's
and mobile homeowners' insurance lines of business as a result of the four
Florida hurricanes in 2004. Approximately 8,500 policyholders have filed
hurricane-related claims totaling an estimated $105.4 million, of which we
estimate that our share of the costs associated with these hurricanes will be
approximately $43.5 million, net of reinsurance recoveries and amortized
reinstatement premiums. For a further discussion of our reinsurance please see
our section titled "REINSURANCE"
Since our initial preliminary provision for losses from these hurricanes
of $33 million, net of reinsurance recoveries, as of September 30, 2004, we
revised our provision for losses as described above. Because the storms occurred
during the third quarter of 2004, we were not able to complete physical
inspections of a sufficiently large percentage of claims, nor were complete
repair estimates available. During the fourth quarter of 2004, as physical
property inspections and repair estimates were completed, our initial estimates
of losses for these storms were increased to reflect increased estimates of
claim severity on our homeowners' policies in Florida. We do not currently
anticipate further materials increases to our loss estimates from the 2004
hurricanes.
- 10 -
21st Century Holding Company
We continue to evaluate the premium rates that our property insurance
policyholders are charged and have implemented an average rate increase of 21.9%
for new and renewal policies in effect as of December 1, 2004 and December 15,
2004, respectively. These increases in premium rates are subject to approval by
the Florida Office of Insurance Regulation. There can be no assurances that our
requested rate increases will be approved.
FLOOD
We write flood insurance through the National Flood Insurance Program
("NFIP"). We write the policy for the NFIP, which assumes 100% of the flood risk
while we retain a commission for our service. The average flood policy premium
is $300 with limits up to $250,000.
COMMERCIAL GENERAL LIABILITY
We underwrite commercial general liability insurance for approximately 250
classes of artisan contracting trades (excluding home-builders and developers)
and for certain special events. The limits of liability range from $100,000 per
occurrence and $200,000 policy aggregate to $1 million per occurrence and $2
million policy aggregate. The average policy premium is approximately $520 with
deductibles of $250 to $500 per claim. We market the commercial general
liability insurance products through a limited number of general agencies
unaffiliated with the Company.
FUTURE PRODUCTS
We currently intend to expand our product offerings by underwriting
additional insurance products and programs, and marketing them through our
distribution network. Expansion of our product offerings will result in
increases in expenses due to additional costs incurred in actuarial rate
justifications, software and personnel. Offering additional insurance products
may also require regulatory approval, further increasing our costs.
ASSURANCE MGA
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 and American Vehicle, 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.
SUPERIOR ADJUSTING
Superior processes claims made by insureds from Federated National,
American Vehicle and third-party insurance companies. Our agents have no
authority to settle claims or otherwise exercise control over the claims
process. Furthermore, we believe that the employment of salaried claims
personnel, as opposed to independent adjusters, results in reduced ultimate loss
payments, lower loss adjustment expenses and improved customer service for most
of our insurance products. Where this is not the case, we retain independent
appraisers and adjusters. We also employ an in-house legal department to
cost-effectively manage claims-related litigation and to monitor our claims
handling practices for efficiency and regulatory compliance.
FEDERATED PREMIUM FINANCE
Federated Premium provides premium financing to Federated National's,
American Vehicle's and third-party's insureds. Premium financing has been
marketed through our distribution network of general agencies and a small number
of independent agents whose customer base and operational history meets our
strict criteria for creditworthiness and, prior to our sale at the end of 2004
of our company-owned and franchised agencies, also through those agencies.
Lending operations are supported by Federated Premium's own capital base and are
currently leveraged through our credit facility with FlatIron Funding Company
LLC, which is described in more detail below.
Premiums for property and casualty insurance are typically payable at the
time a policy is placed in force or renewed. Federated Premium's services allow
the insured to pay a portion of the premium when the policy is placed in force
and the balance in monthly installments over a specified term, generally between
six and eight months. As security, Federated Premium retains a contractual
right, if a premium installment is not paid when due, to cancel the insurance
policy and to receive the unearned premium from the insurer, or in the event of
insolvency of an insurer, from the Florida Guarantee Association, subject to a
$100 per policy deductible. In the event of cancellation, Federated Premium
applies the unearned premium towards the payment obligation of the insured.
- 11 -
21st Century Holding Company
At times, Federated Premium may advance funds for financed premiums to
independent insurance agencies that represent third-party insurers. A risk
exists if remittance is not made by the agency to the third-party insurer, as
advances made by Federated Premium may only be recoverable to the extent that
the agency's receipt of such advances is received by the third-party insurer. In
order to reduce this risk, we have in place strict criteria for the
creditworthiness of the agency's operational history and customer base.
Additionally, we closely monitor these agencies on an ongoing basis.
The following table sets forth the amount and percentages of premiums
financed for Federated National, American Vehicle and other insurers for the
periods indicated:
Years Ended December 31,
2004 2003 2002
==================== ==================== ====================
Premium Percent Premium Percent Premium Percent
(Dollars in Thousands)
Federated National $ 11,510 34.0% $ 19,227 49.9% $ 22,331 55.4%
American Vehicle 9,390 27.8% 15,519 40.3% 12,850 31.9%
Other insurers 12,925 38.2% 3,767 9.8% 5,124 12.7%
--------- --------- --------- --------- --------- ---------
Total $ 33,825 100.0% $ 38,513 100.0% $ 40,305 100.0%
========= ========= ========= ========= ========= =========
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 WPAC (Westchester Premium Acceptance Corporation)
(a wholly-owned subsidiary of FlatIron), which gives WPAC 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. Our lender could
determine to change our available credit based on a number of factors, including
the A.M. Best ratings of Federated National and American Vehicle. Pursuant to
our loan agreement, 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 loan agreement, policies written by that subsidiary
will no longer be eligible collateral, causing our available credit to be
reduced if we do not have other collateral qualifying as eligible collateral. As
of December 31, 2004, policies written by Federated National were not considered
by our lender to be eligible collateral. In March 2005, our lender agreed to
permit policies written by Federated National to be eligible collateral and
agreed to increase our total available credit by $0.5 million from $2.0 million
to $2.5 million. We currently believe that this higher available credit limit
will be sufficient based on our current operations. If policies written by our
insurance subsidiaries again do not qualify as eligible collateral under our
loan agreement and we are not able to obtain working capital from our operations
or other sources, then we would have to restrict our growth and, possibly, our
operations.
Direct billing is when the insurance company accepts from the insured, as
a receivable, a promise to pay the premium, as opposed to requiring payment of
the full amount of the policy, either directly from the insured or from a
premium finance company. We believe that the direct billing program does not
increase our risk because the insurance policy, which serves as collateral, is
managed by our computer system. Underwriting criteria are designed with down
payment requirements and monthly payments that create policyholder equity, also
called unearned premium, in the insurance policy. The equity in the policy is
collateral for the extension of credit to the insured. Through our monitoring
systems, we track delinquent payments and, in accordance with the terms of the
extension of credit, cancel the policy before the policyholder's equity is
extinguished. If any excess premium remains after cancellation of the policy and
deduction of applicable penalties, this excess is refunded to the policyholder.
Similarly, we believe that the premium financing that we offer to our own
insureds involves limited credit risk. By primarily financing policies
underwritten by our own insurance carriers, our credit risks are reduced because
we can more securely rely on the underwriting processes of our own insurance
carriers. Furthermore, the direct bill program enables us to closely manage our
risk while providing credit to our insureds.
- 12 -
21st Century Holding Company
The amount of WPAC'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 equals 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. The effective interest rate on this line of credit, based
on our average outstanding borrowings under the Revolving Agreement, was 5.71%,
4.83% and 6.23% for the years ended December 31, 2004, 2003 and 2002,
respectively.
Outstanding borrowings under the Revolving Agreement as of December 31,
2004 were approximately $2.1 million. Outstanding borrowings under the line of
credit agreement as previously in effect as of December 31, 2003 was
approximately $4.1. Outstanding borrowings in excess of the $2.0 million and
$4.0 million respective credit limits totaled $148,542 and $98,786 as of
December 31, 2004 and 2003, respectively. The excess amounts are permissible by
reason of a compensating cash balance of $156,095 and $200,430 for December 31
2004 and 2003, respectively, that was held for the benefit of WPAC and was
included in other assets. Interest expense on this revolving credit line for the
years ended December 31, 2004, 2003 and 2002 totaled approximately $178,000,
$203,000 and $342,000, respectively.
DISCONTINUED OPERATIONS
TAX PREPARATION SERVICES AND ANCILLARY SERVICES
During 2004, we also offered other services at our company-owned and
franchised agencies, including tax return preparation and electronic filing and
the issuance and renewal of license tags. On January 13, 2005, with an effective
date of January 1, 2005, we sold our 80% interest in Express Tax Service, Inc.
(along with its wholly owned subsidiary, EXPRESSTAX Franchise Corporation) to
Robert J. Kluba, the president of Express Tax and the holder of the 20% minority
interest in Express Tax, and Robert H. Taylor. In exchange for our shares, we
received a net cash payment of $311,351. which reflected a purchase price of
$660,000 less $348,649. in intercompany receivables we owed to Express Tax. In
addition, we received a payment of $1,200,000 in exchange for our agreement not
to compete with the current businesses of Express Tax for five years after the
sale. For further information about this transaction, please see Note 24 to our
Consolidated Financial Statements included under Item 8 of this Report on Form
10-K.
FRANCHISE OPERATIONS
On December 31, 2004, we sold most of the non-current assets related to
our franchise operations to Fed USA Retail, Inc. and Fed USA Franchising, Inc.
We retained ownership of the current assets and liabilities. For further
information about this transaction, please see "Recent Developments" above and
Note 24 to our Consolidated Financial Statements included under Item 8 of this
Report on Form 10-K.
At the time of sale, we had 42 operating franchises and six pending
franchises. The form of franchise agreement in effect during 2004 granted the
franchisee a license for the operation of an agency within an exclusive
territory for a 10-year period, with two additional 10-year options. We
collected from the franchisees a non-refundable initial franchise fee of
$14,950, royalty fees, advertising fees, and other fees. Our rights under these
franchise agreements were among the assets sold.
In addition, at the time of the sale of our interest in Express Tax, 231
EXPRESSTAX franchises had been granted. The form of EXPRESSTAX franchise
agreement in effect during 2004 granted the franchisee a non-exclusive license
to open and operate a center for a 10-year period, with two additional 10-year
options. As a result of the sale of our interest in Express Tax, we will no
longer be entering into such franchise agreements.
MARKETING AND DISTRIBUTION
During 2004, we marketed and distributed our own and third-party insurers'
products and 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, 42 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
homeowners' insurance and commercial general liability products. As described
above, on December 31, 2004, we sold most of the non-current assets and the
deferred policy acquisition liability related to our network of 24 company-owned
agencies and 48 franchised agencies located in Florida, including our franchise
operations. The company-owned agencies sold were located in Miami-Dade, Broward,
Palm Beach, Martin, Orange, Osceola, Volusia and Seminole counties in Florida.
The franchised agencies sold were located in Miami-Dade, Broward, Palm Beach,
Martin, St. Lucie, Orange, Lee and Collier counties in Florida. Our independent
agents are located primarily in South Florida.
As a result of this sale, we are focusing our marketing efforts on
continuing to continue to expand our distribution network and market our
products and services in other regions of Florida and other states by
establishing relationships with additional independent agents and general
agents. As this occurs, we will seek to replicate our distribution network in
those states. There can be no assurance, however, that we will be able to obtain
the required regulatory approvals to offer additional insurance products or
expand into states other than Florida, Georgia , Kentucky, Louisiana and Texas.
- 13 -
21st Century Holding Company
Our agents have the authority to sell and bind insurance coverage in
accordance with procedures established by Assurance MGA. Assurance MGA reviews
all coverage bound by the agents promptly and generally accepts all coverage
that falls within stated underwriting criteria. For automobile and commercial
general liability policies, Assurance MGA also has the right, within a period of
60 days from a policy's inception, to cancel any policy, upon 45 days' notice,
even if the risk falls within our underwriting criteria.
Except for the period as defined by the Florida Office of Insurance
Regulation, which following the four Florida hurricanes in the third quarter of
2004 issued an emergency order that imposed a moratorium on cancellations and
non-renewals of various types of insurance coverages, our homeowners' and mobile
home policies as underwritten by Assurance MGA provided for the right, within a
period of 90 days from a policy's inception, of Assurance MGA to cancel any
policy upon 25 days' notice or after 90 days from policy inception with 95 days'
notice, even if the risk falls within our underwriting criteria.
We believe that our integrated computer system, which allows for rapid
automated premium quotation and policy issuance by our agents, is a key element
in providing quality service to both our agents and insureds. For example, upon
entering a customer's basic personal information, the customer's driving record
is accessed and a premium rate is quoted. If the customer chooses to purchase
the insurance, the system can generate the policy on-site.
We believe that the management of our distribution system now centers on
our ability to capture and maintain relevant data by producing agent, none of
whom will be affiliated with us. We believe that information management of agent
production coupled with loss experience will enable us to maximize
profitability.
The following table sets forth the amount and percentages of insurance
premiums written through company-owned agencies, franchised agencies and
independent agents for the periods indicated:
Years Ended December 31,
------------------------
2004 2003 2002
==================== ==================== ====================
Premium Percent Premium Percent Premium Percent
(Dollars in Thousands)
Company-owned agencies $ 11,421 11.4% $ 22,320 30.6% $ 20,403 32.3%
Franchised agencies 7,999 7.9% 11,630 15.9% 11,761 18.7%
Independent agencies 81,242 80.7% 39,041 53.5% 30,872 49.0%
--------- --------- --------- --------- --------- ---------
Total $ 100,662 100.0% $ 72,991 100.0% $ 63,036 100.0%
========= ========= ========= ========= ========= =========
REINSURANCE
We follow industry practice of reinsuring a portion of our risks and
paying for that protection based upon premiums received on all policies subject
to such reinsurance. Reinsurance involves an insurance company transferring or
"ceding" all or a portion of its exposure on insurance underwritten by it to
another insurer, known as a "reinsurer." The reinsurer assumes a portion of the
exposure in return for a portion, or quota share, of the premium, and pays the
ceding company a commission based upon the amount of insurance ceded. The ceding
of insurance does not legally discharge the insurer from its primary liability
for the full amount of the policies. If the reinsurer fails to meet its
obligations under the reinsurance agreement, the ceding company is still
required to pay the loss.
Reinsurance is ceded under separate contracts or "treaties" for the
separate lines of business underwritten and terms of coverage. The Company
collectively ceded $15.5 million and $22.1 million in premiums written for the
years ended December 31, 2004 and 2003, respectively. During 2004, we primarily
reinsured Federated National's homeowners' insurance lines of business, while
during 2003 we primarily reinsured our American Vehicle's and Federated
National's automobile insurance lines of business. The Company's reinsurance for
homeowners' is with several participants, all of which are AM Best rated "A" or
better.
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' and
mobile homeowners' insurance lines of business. Approximately 8,500
policyholders have filed hurricane-related claims totaling an estimated $105.4
million, of which we estimate that our share of the costs associated with these
hurricanes will be approximately $43.5 million, net of reinsurance recoveries
and amortized reinstatement premiums.
- 14 -
21st Century Holding Company
For each catastrophic occurrence, the excess of loss treaty will insure us
for $24 million with the company retaining the first $10 million of loss and
LAE. The treaty has a provision which, for an additional prorated premium will
insure us for another $24 million of loss and LAE for subsequent occurrences
with the company retaining the first $10 million in loss and LAE. As a result of
the loss and LAE incurred in connection with the Hurricanes Charles and Frances
the company has exhausted its recoveries of $48 million under the terms of this
treaty.
The excess of loss treaty also insures us for an additional $34 million in
excess of the company's $10 million retention plus the next $24 million as
described above. Accordingly, loss and LAE incurred for Hurricanes Ivan, Jeanne
and any subsequent catastrophic events through June 30, 2005, up to $34 million
each, are the responsibility of the company, as illustrated in the accompanying
table.
(in millions)
Gross Reinsurance Net
Hurricane Losses Recoveries Losses
--------- --------- ---------- ---------
Charley (August 13) $ 44.2 $ 34.2 $ 10.0
Frances (September 3) 37.7 27.7 10.0
Ivan (September 14) 13.7 -- 13.7
Jeanne (September 25) 9.8 -- 9.8
--------- --------- ---------
Total Loss Estimate $ 105.4 $ 61.9 $ 43.5
========= ========= =========
Furthermore, as a result of the 2004 hurricanes, 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.
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.
We are selective in choosing a reinsurer and consider numerous factors,
the most important of which is the financial stability of the reinsurer, their
history of responding to claims and their overall reputation. In an effort to
minimize our exposure to the insolvency of a reinsurer, we evaluate the
acceptability and review the financial condition of the reinsurer at least
annually. Our current policy is to use only reinsurers that have an A.M. Best
rating of "A" (Excellent) or better.
The Company's reinsurance for automobile insurance was ceded with
Transatlantic Reinsurance Company ("Transatlantic"), an A+ rated reinsurance
company. During 2004, Federated National did not reinsure any of its automobile
insurance. In 2003 and 2002, Federated National ceded 40% of its automobile
premiums written and losses incurred to Transatlantic. Beginning in November
2001, and continuing through December 31, 2003, American Vehicle reinsured all
of its automobile insurance with Transatlantic at various levels. During 2004
American Vehicle did not reinsure any of its products.
The automobile quota-share reinsurance treaties for 2003 include loss
corridors with varying layers of coverage based on ultimate incurred loss ratio
results whereby the two insurance companies will retain 100% of the losses
between incurred loss ratios of 66% and 86% for policies with an effective date
of 2003. Despite the loss corridor, the reinsurer assumes significant insurance
risk under the reinsured portions of the underlying insurance contracts and it
is reasonably possible that the reinsurer may realize a significant loss from
the transaction. Our ultimate incurred loss ratios for these treaties are
estimated to be 69.2% and 72.5% for Federated National and American Vehicle,
respectively.
During 2002, Federated National entered into a 10% quota-share agreement
with our affiliate American Vehicle. The agreement ceded 10% of its premium and
losses on all policies with an effective date of 2002. For presentation
purposes, and in accordance with the principles of consolidation, the agreement
between the two affiliated insurance companies has been eliminated.
- 15 -
21st Century Holding Company
LIABILITY FOR UNPAID LOSSES AND LAE
We are directly liable for loss and loss adjustment expense ("LAE")
payments under the terms of the insurance policies that we write. In many cases
there may be a time lag between the occurrence and reporting of an insured loss
and our payment of that loss. As required by insurance regulations and
accounting rules, we reflect the liability for the ultimate payment of all
incurred losses and LAE by establishing a liability for those unpaid losses and
LAE for both reported and unreported claims, which represent estimates of future
amounts needed to pay claims and related expenses.
When a claim, other than personal automobile, involving a probable loss is
reported, we establish a liability for the estimated amount of our ultimate loss
and LAE payments. The estimate of the amount of the ultimate loss is based upon
such factors as the type of loss, jurisdiction of the occurrence, knowledge of
the circumstances surrounding the claim, severity of injury or damage, potential
for ultimate exposure, estimate of liability on the part of the insured, past
experience with similar claims and the applicable policy provisions.
All newly reported claims received with respect to personal automobile
policies are set up with an initial average liability. The average liability for
these claims is determined no less than annually by dividing the number of
reported claims into the total amount paid during the same period. If a claim is
open more than 45 days, that open case liability is evaluated and the liability
is adjusted upward or downward according to the facts and circumstances of that
particular claim.
In addition, management provides for a liability on an aggregate basis to
provide for losses incurred but not reported ("IBNR"). We utilize independent
actuaries to help establish liability for unpaid losses and LAE. We do not
discount the liability for unpaid losses and LAE for financial statement
purposes.
The estimates of the liability for unpaid losses and LAE are subject to
the effect of trends in claims severity and frequency and are continually
reviewed. As part of this process, we review historical data and consider
various factors, including known and anticipated legal developments, changes in
social attitudes, inflation and economic conditions. As experience develops and
other data become available, these estimates are revised, as required, resulting
in increases or decreases to the existing liability for unpaid losses and LAE.
Adjustments are reflected in results of operations in the period in which they
are made and the liabilities may deviate substantially from prior estimates.
Among our classes of insurance, the automobile and homeowners' liability claims
historically tend to have longer time lapses between the occurrence of the
event, the reporting of the claim and the final settlement, than do automobile
physical damage and homeowners' property claims. Liability claims often involve
parties filing suit and therefore may result in litigation. By comparison,
property damage claims tend to be reported in a relatively shorter period of
time and settled in a shorter time frame with less occurrence of litigation. We
do not experience changes in payment patterns due to portfolio loss transfers or
structured settlements.
There can be no assurance that our liability for unpaid losses and LAE
will be adequate to cover actual losses. If our liability for unpaid losses and
LAE proves to be inadequate, we will be required to increase the liability with
a corresponding reduction in our net income in the period in which the
deficiency is identified. Future loss experience substantially in excess of
established liability for unpaid losses and LAE could have a material adverse
effect on our business, results of operations and financial condition.
The following table sets forth a reconciliation of beginning and ending
liability for unpaid losses and LAE as shown in our consolidated financial
statements for the periods indicated.
- 16 -
21st Century Holding Company
For the years ending December 31,
---------------------------------
2004 2003 2002
---- ---- ----
(Dollars in Thousands)
Balance at January 1: $ 24,570 $ 16,984 $ 11,005
Less reinsurance recoverables (9,761) (7,848) (4,798)
--------- --------- ---------
Net balance at January 1 $ 14,809 $ 9,136 $ 6,207
========= ========= =========
Incurred related to:
Current year $ 76,423 $ 26,275 $ 15,896
Prior years (1,430) 1,234 91
--------- --------- ---------
Total incurred $ 74,993 $ 27,509 $ 15,987
========= ========= =========
Paid related to:
Current year $ 42,304 $ 14,205 $ 8,148
Prior years 10,342 7,631 4,910
--------- --------- ---------
Total paid $ 52,646 $ 21,836 $ 13,058
========= ========= =========
Net balance at year-end $ 37,156 $ 14,809 $ 9,136
Plus reinsurance recoverables 9,415 9,761 7,848
--------- --------- ---------
Balance at year-end $ 46,571 $ 24,570 $ 16,984
========= ========= =========
As shown above, and as a result of our review of liability for losses and
LAE, which includes a re-evaluation of the adequacy of reserve levels for prior
year's claims, we decreased the liability for loss and LAE for claims occurring
in prior years by $1,431,000 for the year ended December 31, 2004 and we
increased the liability for loss and LAE for claims occurring in prior years by
$1,234,000 and $91,000 for the years ended December 31, 2003 and 2002,
respectively. There can be no assurance concerning future adjustments of
reserves, positive or negative, for claims through December 31, 2004.
Based upon discussions with our independent actuarial consultants and
their statements of opinion on losses and LAE, we believe that the liability for
unpaid losses and LAE is currently adequate to cover all claims and related
expenses which may arise from incidents reported and IBNR.
The following table presents total unpaid loss and LAE, net, and total
reinsurance recoverables due (to) or from our automobile reinsures as shown in
our consolidated financial statements for the periods indicated.
As of December 31,
------------------
2004 2003
---- ----
Transatlantic Reinsurance Company (A+ A.M. Best Rated):
Unearned premiums $ 2,559 $ 7,823,374
Reinsurance recoverable on paid losses and loss adjustment expenses 1,661,751 2,457,228
Unpaid losses and loss adjustment expenses 2,507,403 9,761,353
------------ ------------
$ 4,171,713 $ 20,041,955
============ ============
Amounts due from reinsurers consisted of amounts related to:
Unpaid losses and loss adjustment expenses $ 2,507,403 $ 9,761,353
Reinsurance recoverable on paid losses and loss adjustment expenses 1,661,751 2,457,228
Reinsurance receivable (payable) 11,301 (1,339,162)
------------ ------------
$ 4,180,455 $ 10,879,419
============ ============
In addition to our reinsurance recoverable from our automobile reinsurers,
we also have reinsurance recoveries due from our catastrophic reinsurance
companies relating to the four hurricanes that occurred in August and September
of 2004. The following table presents total unpaid loss and LAE, net, and total
reinsurance recoverables due from our catastrophic reinsurers as shown in our
consolidated financial statements.
- 17 -
21st Century Holding Company
As of December 31,
------------------
2004 2003
---- ----
Catastrophe Excess of Loss (Various participants)
and Florida Hurricane Catastrophe Fund:
Reinsurance recoverable on paid losses and loss adjustment
expenses $ 18,191,799 $ --
Unpaid losses and loss adjustment expenses 6,907,390
------------
$ 25,099,189 $ --
============ ============
Amounts due from reinsurers consisted of amounts related to:
Unpaid losses and loss adjustment expenses $ 6,907,390 $ --
Reinsurance recoverable on paid losses and loss adjustment
expenses 18,191,799 --
Reinsurance receivable (payable) (3,371,458)
------------
$ 21,727,731 $ --
============ ============
- 18 -
21st Century Holding Company
The following table presents the liability for unpaid losses and LAE for
the years ended December 31, 1995 through 2004. The top line of the table shows
the estimated net liabilities for unpaid losses and LAE at the balance sheet
date for each of the periods indicated. These figures represent the estimated
amount of unpaid losses and LAE for claims arising in all prior years that were
unpaid at the balance sheet date, including losses that had been incurred but
not yet reported. The portion of the table labeled "Cumulative paid as of" shows
the net cumulative payments for losses and LAE made in succeeding years for
losses incurred prior to the balance sheet date. The lower portion of the table
shows the re-estimated amount of the previously recorded liability based on
experience as of the end of each succeeding year.
Years Ended December 31,
2004 2003 2002 2001 2000 1999 1998 1997 1996 1995
---- ---- ---- ---- ---- ---- ---- ---- ---- ----
Dollars in Thousands
Balance Sheet Liability $37,156 $14,809 $9,136 $6,207 $6,976 $4,428 $5,366 $4,635 $4,532 $3,688
Cumulative paid as of:
One year later 9,969 7,622 5,275 8,228 4,289 3,460 2,694 2,850 3,250
Two years later 9,401 7,222 9,568 5,799 4,499 3,533 3,539 3,898
Three years later 7,711 10,101 6,328 5,111 3,972 3,882 4,164
Four years later 10,352 6,408 5,387 4,241 4,107 4,300
Five years later 6,542 5,227 4,325 4,223 4,404
Six years later 5,216 4,121 4,262 4,493
Seven years later 4,035 3,985 4,423
Eight years later 3,746 3,786
Nine years later 3,800
2004 2003 2002 2001 2000 1999 1998 1997 1996 1995
---- ---- ---- ---- ---- ---- ---- ---- ---- ----
Re-estimated net liability as of:
End of year $ 37,156 $ 14,809 $ 9,136 $ 6,207 $ 6,976 $ 4,428 $ 5,366 $ 4,635 $ 4,532 $ 3,688
One year later 14,256 10,897 6,954 9,445 5,872 4,676 4,360 4,332 4,728
Two years later 10,625 7,842 10,200 6,284 5,157 4,063 4,255 4,867
Three years later 8,069 10,425 6,605 5,352 4,314 4,102 4,872
Four years later 10,616 6,561 5,515 4,386 4,304 4,748
Five years later 6,664 5,384 4,395 4,321 4,899
Six years later 5,396 4,277 4,321 4,808
Seven years later 4,284 4,189 4,792
Eight years later 4,191 4,796
Nine years later 4,796
Cumulative redundancy
(deficiency) $ 553 $ (1,489) $ (1,862) $ (3,640) $ (2,236) $ (30) $ 351 $ 341 $ (1,108)
Cumulative redundancy
- -deficiency as a % of
reserves originally
established 3.7% -16.3% -30.0% -52.2% -50.5% -0.6% 7.6% 7.5% -30.0%
The cumulative redundancy or deficiency represents the aggregate change in
the estimates over all prior years. A deficiency indicates that the latest
estimate of the liability for losses and LAE is higher than the liability that
was originally estimated and a redundancy indicates that such estimate is lower.
It should be emphasized that the table presents a run-off of balance sheet
liability for the periods indicated rather than accident or policy loss
development for those periods. Therefore, each amount in the table includes the
cumulative effects of changes in liability for all prior periods. Conditions and
trends that have affected liabilities in the past may not necessarily occur in
the future.
The table below sets forth the differences between loss and LAE reserves
as disclosed for GAAP basis compared to Statutory Accounting Principles ("SAP")
basis of presentation for the years ended 2004 and 2003.
- 19 -
21st Century Holding Company
Years Ended December 31,
------------------------
2004 2003
------- -------
GAAP basis Loss and LAE reserves $46,571 $24,570
Less unpaid Losses and LAE ceded 9,415 9,761
------- -------
Balance Sheet Liability 37,156 14,809
Add Insurance Apportionment Plan 234 505
------- -------
SAP basis Loss and LAE reserves $37,390 $15,314
======= =======
The table below sets forth the differences between loss and LAE incurred
as disclosed for GAAP basis compared to SAP basis presentation for the years
ended 2004, 2003 and 2002.
Years Ended December 31,
------------------------
2004 2003 2002
-------- -------- --------
(Dollars in Thousands)
GAAP basis Loss and LAE incurred $ 74,993 $ 27,509 $ 15,987
Intercompany adjusting and other expenses 5,597 3,579 2,484
Insurance apportionment plan 185 1,940 700
-------- -------- --------
SAP basis Loss and LAE incurred $ 80,775 $ 33,028 $ 19,171
======== ======== ========
Underwriting results of insurance companies are frequently measured by
their Combined Ratios. However, investment income, federal income taxes and
other non-underwriting income or expense are not reflected in the Combined
Ratio. The profitability of property and casualty insurance companies depends on
income from underwriting, investment and service operations. Underwriting
results are considered profitable when the Combined Ratio is under 100% and
unprofitable when the Combined Ratio is over 100%.
The following table sets forth Loss Ratios, Expense Ratios and Combined
Ratios for the periods indicated for the insurance business of Federated
National and American Vehicle for 2004, 2003 and 2002. The ratios, inclusive of
unallocated loss adjustment expenses ("ULAE"), are shown in the table below, and
are computed based upon SAP.
Years Ended December 31,
------------------------
2004 2003 2002
------ ------ ------
Loss Ratio 117.7% 67.4% 59.6%
Expense Ratio 23.1% 25.7% 24.7%
------ ------ ------
Combined Ratio 140.8% 93.1% 84.3%
====== ====== ======
The 47.8% increase in the SAP loss ratio from 2004 to 2003 in part
reflects our experience relating to the four hurricanes that occurred in August
and September of 2004, net of improved non-catastrophic loss ratio experience as
the following table reflects.
Calendar year 2004
------------------
Non-
Catastrophic Catastrophic
experience experience Total
---------- ---------- -----
Net Written Premiums (a) $ 83,660 $ 3,000 $ 86,660
Net Earned Premiums (b) $ 67,293 $ 1,308 $ 68,601
Net Incurred Losses & LAE (c) $ 39,791 $ 40,984 $ 80,775
Net Underwriting Expense (d) $ 18,743 $ 1,286 $ 20,029
Loss Ratio (c/b) 59.1% 3132.4% 117.7%
Expense Ratio (d/a) 22.4% 42.9% 23.1%
--------- --------- ---------
Combined Ratio 81.5% 3175.3% 140.8%
========= ========= =========
Main factors for the improved, non-catastrophic ratios between 2004 and
2003 include, but are not limited to, the termination of unprofitable agency
relations, increased scrutiny over fraudulently asserted claims, streamlined
paperless claims processing system, new claims management supervision, in house
legal counsel, as well as overall stricter underwriting guidelines.
- 20 -
21st Century Holding Company
An increase in severity primarily associated with the personal injury
protection line of automobile insurance can be attributed to the $1.2 million
adverse development incurred in 2003 relative to accidents that occurred prior
to 2003. Main factors for the 2003 loss ratio include unanticipated severity
associated with adjusting personal injury protection claims which were mitigated
by favorable loss experience associated with the property and commercial general
liability lines of insurance. Additionally, during 2003, both of the insurance
companies revised their respective automobile rates and the available
deductibles limits.
COMPETITION
We operate in highly competitive markets 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 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. With respect to automobile
insurance in Florida, we compete 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.
REGULATION
GENERAL
We are subject to the laws and regulations in Florida, Georgia, Kentucky,
Louisiana and Texas, and will be subject to the laws and regulations of any
other states in which we seek to conduct business in the future. The regulations
cover all aspects of our business and are generally designed to protect the
interests of insurance policyholders, as opposed to the interests of
shareholders. Such regulations relate to authorized lines of business, capital
and surplus requirements, allowable rates and forms (particularly for the
nonstandard auto segment), investment parameters, underwriting limitations,
transactions with affiliates, dividend limitations, changes in control, market
conduct, maximum amount allowable for premium financing service charges and a
variety of other financial and non-financial components of our business. Our
failure to comply with certain provisions of applicable insurance laws and
regulations could have a material adverse effect on our business, results of
operations or financial condition. In addition, any changes in such laws and
regulations, including the adoption of consumer initiatives regarding rates
charged for automobile or other insurance coverage, could materially adversely
affect our operations or our ability to expand. We are, however, unaware of any
consumer initiatives which could have a material adverse effect on our business,
results of operations or financial condition.
Many states have also enacted laws which restrict an insurer's
underwriting discretion, such as the ability to terminate policies, terminate
agents or reject insurance coverage applications, and many state regulators have
the power to reduce, or to disallow increases in, premium rates. These laws may
adversely affect the ability of an insurer to earn a profit on its underwriting
operations.
Most states have insurance laws requiring that rate schedules and other
information be filed with the state's insurance regulatory authority, either
directly or through a rating organization with which the insurer is affiliated.
The regulatory authority may disapprove a rate filing if it finds that the rates
are inadequate, excessive or unfairly discriminatory. Rates, which are not
necessarily uniform for all insurers, vary by class of business, hazard covered,
and size of risk. Certain states have recently adopted laws or are considering
proposed legislation which, among other things, limit the ability of insurance
companies to effect rate increases or to cancel, reduce or non-renew insurance
coverage with respect to existing policies, particularly personal automobile
insurance.
- 21 -
21st Century Holding Company
The Company's experience in Florida to date, however, has been that although
legislative proposals of this type have been considered from time to time, none
have yet been adopted. Nevertheless, the Florida legislature may adopt laws of
this type in the future, which could adversely affect the Company's business.
Most states require licensure or regulatory approval prior to the
marketing of new insurance products. Typically, licensure review is
comprehensive and includes a review of a company's business plan, solvency,
reinsurance, character of officers and directors, rates, forms and other
financial and non-financial aspects of a company. The regulatory authorities may
not allow entry into a new market by not granting a license or by withholding
approval.
All insurance companies must file quarterly and annual statements with
certain regulatory agencies and are subject to regular and special examinations
by those agencies. The last regulatory examination of Federated National covered
the three-year period ended on December 31, 2001. The last regulatory
examination of American Vehicle covered the three-year period ended on December
31, 2002. No material deficiencies were found during either of the regulatory
examinations. In some instances, various states routinely require deposits of
assets for the protection of policyholders either in those states or for all
policyholders. As of December 31, 2004, Federated National and American Vehicle
held investment securities with a fair value of approximately $1,024,000, each
as deposits with the State of Florida. Additionally, as of December 31, 2004,
American Vehicle has a $100,000 deposit with the State of Louisiana and is in
the process of funding a $400,000 deposit in connection with its approval in
Alabama.
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 Office of Insurance
Regulation 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 Office of Insurance Regulation
(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 Office
of Insurance Regulation 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 Office of Insurance Regulation or (ii) 30 days after the Florida Office
of Insurance Regulation has received notice of such dividend or distribution and
has not disapproved it within such time.
Under these laws, based on their respective 2004 surplus and income,
Federated National and American Vehicle would not be permitted to pay dividends
in 2004. No dividends were paid by Federated National or American Vehicle in
2003, 2002 or 2001, and none are anticipated in 2005. Although we believe that
amounts required to meet our financial and operating obligations will be
available from sources other than dividends from insurance subsidiaries, there
can be no assurance in this regard. Further, there can be no assurance that, if
requested, the Florida Office of Insurance Regulation will allow any dividends
in excess of the amount available, to be paid by Federated National and American
Vehicle to us 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, which also may be constrained by
business and regulatory considerations, such as the impact of dividends on
capital surplus, which could affect an insurer's competitive position, the
amount of premiums that can be written and the ability to pay future dividends.
Further, state insurance laws and regulations require that the statutory capital
surplus of an insurance company following any dividend or distribution by it be
reasonable in relation to its outstanding liabilities and adequate for its
financial needs.
While the non-insurance company subsidiaries are not subject directly to
the dividend and other distribution limitations, insurance holding company
regulations govern the amount that any affiliate within the holding company
system may charge any of the insurance companies for service (e.g., management
fees and commissions). In order to enhance the regulation of insurer solvency,
the National Association of Insurance Commissioners ("NAIC") established
risk-based capital requirements for insurance companies that are designed to
assess capital adequacy and to raise the level of protection that statutory
surplus provides for policy holders. These requirements measure three major
areas of risk facing property and casualty insurers: (i) underwriting risks,
which encompass the risk of adverse loss developments and inadequate pricing;
(ii) declines in asset values arising from credit risk; and
- 22 -
21st Century Holding Company
(iii) other business risks from investments. Insurers having less statutory
surplus than required will be subject to varying degrees of regulatory action,
depending on the level of capital inadequacy. Based upon the 2004 statutory
financial statements for American Vehicle, statutory surplus exceeded all
regulatory action levels established by the NAIC. Based upon the 2004 statutory
financial statements for Federated National, statutory surplus did not exceed
regulatory action levels established by the NAIC. Federated National's results
required us to submit a plan containing corrective actions. Federated has
submitted its plan for corrective action and is currently in discussions with
the Florida Office of Insurance Regulation regarding the merits of the action
plan points. The regulatory action level permits the insurance regulators to
perform an examination or other analysis and issue a corrective order. Federated
National is scheduled to have its statutorily required triennial examination
during 2005 for the three years ended December 31, 2004 to be performed by the
Florida Office of Insurance Regulation. We may be subject of additional targeted
examinations or analysis. These examinations or analysis may result in one or
more corrective orders being issued by the Florida Office of Insurance
Regulation.
The Florida Office of Insurance Regulation, which follows these
requirements, could require Federated National or American Vehicle to cease
operations in the event they fail to maintain the required statutory capital.
Based on Risk Based Capital requirements, the extent of regulatory
intervention and action increases as the ratio of an insurer's statutory surplus
to its Authorized Control Level ("ACL"), as calculated under the NAIC's
requirements, decreases. The first action level, the Company Action Level,
requires an insurer to submit a plan of corrective actions to the insurance
regulators if statutory surplus falls below 200.0% of the ACL amount. The second
action level, the Regulatory Action Level, requires an insurer to submit a plan
containing corrective actions and permits the insurance regulators to perform an
examination or other analysis and issue a corrective order if statutory surplus
falls below 150.0% of the ACL amount. The Authorized Control Level, the third
action level, allows the regulators to rehabilitate or liquidate an insurer in
addition to the aforementioned actions if statutory surplus falls below the ACL
amount. The fourth action level is the Mandatory Control Level, which requires
the regulators to rehabilitate or liquidate the insurer if statutory surplus
falls below 70.0% of the ACL amount. Federated National's ratio of statutory
surplus to its ACL was 125.5%, 434.2% and 274.2% at December 31, 2004, 2003 and
2002, respectively. American Vehicle's ratio of statutory surplus to its ACL was
545.1%, 585.2% and 401.6% at December 31, 2004, 2003 and 2002, respectively.
The NAIC has also developed Insurance Regulatory Information Systems
("IRIS") ratios to assist state insurance regulators in identifying companies
which may be developing performance or solvency problems, as signaled by
significant changes in the companies' operations. Such changes may not
necessarily result from any problems with an insurance company, but may merely
indicate changes in certain ratios outside the ranges defined as normal by the
NAIC. When an insurance company has four or more ratios falling outside "usual
ranges," state regulators may investigate to determine the reasons for the
variance and whether corrective action is warranted.
As of December 31, 2004, Federated National was outside NAIC's usual
ranges with respect to its IRIS tests on seven out of twelve ratios. With the
exception of two of these test results, all of test results can be attributed to
the significant degradation of policyholders' surplus stemming from the losses
incurred in its homeowners' line of business as a result of the four Florida
hurricanes in 2004. The change in net writings and two-year reserve development
to policyholders' surplus resulted from test ratio results that do not employ
current year policyholders' surplus, and were unusual due to the increase in
written premiums from 2004 compared to 2003 and the increased estimates of the
costs to settle private passenger automobile liability claims in relation to
Federated National's surplus level as of December 31, 2002.
As of December 31, 2003, Federated National was outside NAIC's usual
ranges with respect to its IRIS tests on five out of twelve ratios. The first
ratio relates to a larger than expected change in net writings, the second ratio
relates to higher surplus growth that stemmed from 21st Century's capital
contributions totaling $3.9 million during the year and the third ratio relates
to an investment yield that was less than expected. The fourth and fifth ratios
involved the one and two year reserve development to policyholder surplus ratios
that were in excess of the "usual ranges" and relate to modest, but adverse,
development which incurred in 2003 relating to 2002 and 2001 loss reserves.
As of December 31, 2004, American Vehicle was outside NAIC's usual ranges
for three out of twelve ratios. The first ratio relates to a larger than
anticipated change in net writings, the second ratio relates to higher surplus
growth that stemmed from the Parent company's capital contributions totaling
$4.3 million during the year and the third ratio relates to an investment yield
that was slightly less than expected.
As of December 31, 2003, American Vehicle was outside NAIC's usual ranges
for three out of twelve ratios. The first ratio relates to a larger than
anticipated change in net writings, the second ratio relates to higher surplus
growth that stemmed from the Parent company's capital contributions totaling
$5.9 million during the year and the third ratio relates to an investment yield
that was slightly less than expected.
- 23 -
21st Century Holding Company
We do not currently believe that the Florida Office of Insurance
Regulation will take any significant action with respect to Federated National
or American Vehicle regarding the IRIS ratios, although there can be no
assurance that will be the case.
INSURANCE HOLDING COMPANY REGULATION
We are subject to laws governing insurance holding companies in Florida
where Federated National and American Vehicle are domiciled. These laws, among
other things, (i) require us to file periodic information with the Florida
Office of Insurance Regulation, including information concerning our capital
structure, ownership, financial condition and general business operations, (ii)
regulate certain transactions between us and our affiliates, including the
amount of dividends and other distributions and the terms of surplus notes and
(iii) restrict the ability of any one person to acquire certain levels of our
voting securities without prior regulatory approval. Any purchaser of 5% or more
of the outstanding shares of our Common Stock will be presumed to have acquired
control of Federated National and American Vehicle unless the Florida Office of
Insurance Regulation, upon application, determines otherwise.
FINANCE COMPANY REGULATION
Our financing program is also subject to certain laws governing the
operation of premium finance companies. These laws pertain to such matters as
books and records that must be kept, forms, licensing, fees and charges. For
example, in Florida, the maximum late payment fee Federated Premium may charge
is the greater of $10 per month or 5% of the amount of the overdue payment.
UNDERWRITING AND MARKETING RESTRICTIONS
During the past several years, various regulatory and legislative bodies
have adopted or proposed new laws or regulations to address the cyclical nature
of the insurance industry, catastrophic events and insurance capacity and
pricing. These regulations include (i) the creation of "market assistance plans"
under which insurers are induced to provide certain coverages, (ii) restrictions
on the ability of insurers to rescind or otherwise cancel certain policies in
mid-term, (iii) advance notice requirements or limitations imposed for certain
policy non-renewals and (iv) limitations upon or decreases in rates permitted to
be charged.
LEGISLATION
From time to time, new regulations and legislation are proposed to limit
damage awards, to control plaintiffs' counsel fees, to bring the industry under
regulation by the Federal government, to control premiums, policy terminations
and other policy terms and to impose new taxes and assessments. It is not
possible to predict whether, in what form or in what jurisdictions, any of these
proposals might be adopted, or the effect, if any, on us.
INDUSTRY RATINGS SERVICES
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). In connection with this review, we
requested that A.M. Best cease its ratings of these subsidiaries "NR-4 - Not
rated, company's request". The withdrawal of our ratings could limit or prevent
us from writing or renewing desirable insurance policies, obtaining adequate
reinsurance or borrowing on our line of credit. Federated National and American
Vehicle are currently rated "A" ("Unsurpassed," which is first of six ratings)
by Demotech, Inc. A.M. Best's and Demotech's ratings are based upon factors of
concern to agents, reinsurers and policyholders and are not primarily directed
toward the protection of investors.
EMPLOYEES
As of December 31, 2004, and subsequent to the sale of our discontinued
operations (see "Recent Developments" and "Discontinued Operations" above and
Note 24 to our Consolidated Financial Statements included under Item 8 of this
Report on Form 10-K) we had approximately 135 employees, including four
executive officers. We are not a party to any collective bargaining agreement
and we have not experienced work stoppages or strikes as a result of labor
disputes. We consider relations with our employees to be satisfactory.
- 24 -
21st Century Holding Company
SENIOR MANAGEMENT
Set forth below is certain information concerning our executive officers
who are not also directors:
James Gordon Jennings, III was appointed Chief Financial Officer of 21st
Century in August 2002. Mr. Jennings became our Controller in May 2000 and for
approximately 10 years prior thereto was employed by American Vehicle, where he
was formally involved with all aspects of property and casualty insurance. Mr.
Jennings', formerly a certified public accountant, also holds a Certificate in
General Insurance and an Associate in Insurance Services as designated by the
Insurance Institute of America.
Kent M. Linder assumed the position of Chief Operating Officer of 21st
Century in September 2003 and was designated an executive officer by our Board
of Directors in March 2005. Prior to this position, Mr. Linder served 21st
Century as Director of Franchise Development and previous to that as the
President of Federated Agency Group, Inc. Prior to joining our management team,
Mr. Linder owned and operated a group of 18 insurance agencies in the Orlando,
Florida area. Mr. Linder acquired his management experience while spending 12
years with United Parcel Service, in which he served in various management
positions. Mr. Linder holds a bachelor's degree from the University of South
Florida in Finance and is a licensed 220 property and casualty agent and 215
life agent.
GLOSSARY OF SELECTED TERMS
CEDE To transfer to an insurer or reinsurer all or part of the
insurance written by an insurance entity.
CEDING COMMISSION A payment by a reinsurer to the ceding company, generally on
a proportional basis, to compensate the ceding company for
its policy acquisition costs.
COMBINED RATIO The total of the Loss Ratio plus the Expense Ratio on either
SAP or GAAP basis.
EXPENSE RATIO Under SAP, the ratio of underwriting expenses to net written
premiums. Using GAAP basis, the ratio of underwriting
expenses to net premiums earned.
GENERALLY ACCEPTED
ACCOUNTING
PRINCIPLES
("GAAP") Accounting practices and principles, as defined principally
by the American Institute of Certified Public Accountants,
the Financial Accounting Standards Board. GAAP is the method
of accounting typically used by the Company for reporting to
persons or entities other than insurance regulatory
authorities.
GROSS PREMIUMS
WRITTEN The total of premiums received or to be received for
insurance written by an insurer during a specific period of
time without any reduction for reinsurance ceded.
HARD
MARKET The portion of the market cycle of the property and casualty
insurance industry characterized by constricted industry
capital and underwriting capacity, increasing premium rates
and, typically, enhanced underwriting performance.
INCURRED BUT
NOT REPORTED
LOSSES ("IBNR") The estimated liability of an insurer, at a given point in
time, with respect to losses that have been incurred but not
yet reported to the insurer, and for potential future
developments on reported claims.
INSURANCE
REGULATORY
INFORMATION
SYSTEM ("IRIS") A system of ratio analysis developed by the NAIC primarily
intended to assist the state insurance Department of
Financial Services in executing their statutory mandates to
oversee the financial condition of insurance companies.
LOSS ADJUSTMENT
EXPENSE ("LAE") The expense of investigating and settling claims, including
legal fees, outside adjustment expenses and other general
expenses of administering the claims adjustment process.
LOSS RATIO Under both SAP and GAAP, net losses and LAE incurred,
divided by net premiums earned, expressed as a percentage.
- 25 -
21st Century Holding Company
LOSS RESERVES The estimated liability of an insurer, at a given point in
time, with respect to unpaid incurred losses, including
losses, which are IBNR and related LAE.
LOSSES
INCURRED The total of all policy losses sustained by an insurance
company during a period, whether paid or unpaid. Incurred
losses include a provision for claims that have occurred but
have not yet been reported to the insurer.
NATIONAL
ASSOCIATION OF
INSURANCE
COMMISSIONERS
("NAIC") A voluntary organization of state insurance officials that
promulgates model laws regulating the insurance industry,
values securities owned by insurers, develops and modifies
insurer financial reporting, statements and insurer
performance criteria and performs other services with
respect to the insurance industry.
NET PREMIUMS
EARNED The amount of net premiums written allocable to the expired
period of an insurance policy or policies.
NET PREMIUMS
WRITTEN The gross premiums written during a specific period of time,
less the portion of such premiums ceded to (reinsured by)
other insurers.
NONSTANDARD Risks that generally have been found unacceptable by
standard lines insurers for various underwriting reasons.
REINSURANCE A procedure whereby a primary insurer transfers (or "cedes")
a portion of its risk to a reinsurer in consideration of a
payment of premiums by the primary insurer to the reinsurer
for their assumption of such portion of the risk.
Reinsurance can be affected by a treaty or individual risk
basis. Reinsurance does not legally discharge the primary
insurer from its liabilities with respect to its obligations
to the insured.
REINSURERS Insurers (known as the reinsurer or assuming company) who
agree to indemnify another insurer (known as the reinsured
or ceding company) against all or part of a loss that the
latter may incur under a policy or policies it has issued.
RISK-BASED CAPITAL
REQUIREMENTS
("RBC") Capital requirements for property and casualty insurance
companies adopted by the NAIC to assess minimum capital
requirements and to raise the level of protection that
statutory surplus provides for policy holder obligations.
SOFT MARKET The portion of the market cycle of the property and casualty
insurance industry characterized by heightened premium rate
competition among insurers, increased underwriting capacity
and, typically, depressed underwriting performance.
STANDARD
AUTOMOBILE
INSURANCE Personal automobile insurance written for those individuals
presenting an average risk profile in terms of loss history,
driving record, type of vehicle driven and other factors.
STATUTORY
ACCOUNTING
PRACTICES ("SAP") Those accounting principles and practices which provide the
framework for the preparation of financial statements, and
the recording of transactions, in accordance with the rules
and procedures adopted by regulatory authorities, generally
emphasizing solvency consideration rather than a going
concern concept of accounting. The principal differences
between SAP and GAAP are as follows: (a) under SAP, certain
assets (non-admitted assets) are eliminated from the balance
sheet; (b) under SAP, policy acquisition costs are expensed
upon policy inception, while under GAAP they are deferred
and amortized over the term of the policies; and (c) under
SAP, certain reserves are recognized which are not
recognized under GAAP.
- 26 -
21st Century Holding Company
UNDERWRITING The process whereby an underwriter reviews applications
submitted for insurance coverage and determines whether it
will provide all or part of the coverage being requested,
and the price of such premiums. Underwriting also includes
an ongoing review of existing policies and their pricing.
UNDERWRITING
EXPENSE The aggregate of policy acquisition costs, including that
portion of general and administrative expenses attributable
to underwriting operations.
UNEARNED PREMIUMS The portion of premiums written representing unexpired
policy terms as of a certain date.
ITEM 2. PROPERTIES
As of December 31, 2004, Federated National owned and partially occupied a
three-story building with approximately 39,250 square feet of office space in
Lauderdale Lakes, Florida. During 2004, our executive offices and our
underwriting and mailroom departments relocated to the Lauderdale Lakes
property, joining our other operations, including claims, accounting and premium
finance, which had relocated in 2003 to that building. Approximately 55% of the
Lauderdale Lakes building is occupied by our operations and 45% is leased to
third parties or is vacant.
Effective March 1, 2005, Federated National sold its interest in the
Lauderdale Lakes property to 21st Century at the property's net book value of
approximately $2.9 million.
We believe that this building is adequate for our current needs.
ITEM 3. 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.
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 agreed to settle the case for
$525,000. The Court has issued a Preliminary Order approving the settlement and
the full amount was funded in February 2005. Notices have been sent to class
members and the Court has set the Final Settlement Hearing for July 26, 2005. We
anticipate our active involvement with this matter to be concluded.
We had reserved and charged against forth quarter 2003 earnings $600,000
for the potential settlement and associated costs.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
- 27 -
21st Century Holding Company
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
(A) MARKET INFORMATION
Our common stock has been listed for trading on the Nasdaq National Market
under the symbol "TCHC" since November 5, 1998. For the calendar quarters
indicated, the table below sets forth the high and low closing prices per share
of the common stock based on published financial resources.
Quarter Ended High Low
- ------------- ---- ---
March 31, 2004 $25.00 $19.00
June 30, 2004 $23.19 $18.58
September 30, 2004 $24.84 $9.04
December 31, 2004 $14.68 $9.91
March 31, 2003 $9.33 $6.00
June 30, 2003 $11.17 $6.97
September 30, 2003 $12.50 $9.27
December 31, 2003 $15.73 $9.33
(B) HOLDERS
As of March 29, 2005, there were approximately 36 holders of record of our
common stock. We believe that the number of beneficial owners of our common
stock is in excess of 3,000.
(C) DIVIDENDS
During 2003, we paid quarterly dividends of $0.05, $0.06, $0.07 and $0.08
per share for the first, second, third and fourth quarters, respectively. During
2004, we paid quarterly dividends of $0.08 per share for each quarter. Although
we continued the $0.08 per share dividend for the first quarter of 2005, payment
of dividends in the future will depend on our earnings and financial position
and such other factors, as our Board of Directors deems relevant. Moreover, our
ability to continue to pay dividends may be restricted by regulatory limits on
the amount of dividends that Federated National and American Vehicle are
permitted to pay to the parent company. All of the foregoing per-share amounts
reflect our three-for-two stock split in September 2004.
(D) SECURITIES AUTHORIZED FOR ISSUANCE UNDER EQUITY COMPENSATION PLANS
The following table summarizes our equity compensation plans as of
December 31, 2004. We do not currently have any equity compensation plans not
approved by security holders.
EQUITY COMPENSATION PLAN INFORMATION
- ------------------------------------------------------------------------------------------------------
NUMBER OF SECURITIES
REMAINING AVAILABLE FOR
FUTURE ISSUANCE UNDER
NUMBER OF SECURITIES TO WEIGHTED-AVERAGE EQUITY COMPENSATION
BE ISSUED UPON EXERCISE EXERCISE PRICE OF PLANS (EXCLUDING
OF OUTSTANDING OPTIONS, OUTSTANDING OPTIONS, SECURITIES REFLECTED IN
WARRANTS AND RIGHTS WARRANTS AND RIGHTS COLUMN (A))
PLAN CATEGORY (A) (B) (C)
- ------------------------------------------------------------------------------------------------------
Equity compensation plans
approved by security
holders* 1,119,575 $9.954 1,527,864
- ------------------------------------------------------------------------------------------------------
* Includes options from the 1998 Stock Option Plan, 2001 Franchise
Program Stock Option Plan and the 2002 Stock Option Plan.
- 28 -
21st Century Holding Company
For additional information concerning our capitalization please see Note
16 to our Consolidated Financial Statements included under Item 8 of this Report
on Form 10-K.
ITEM 6. SELECTED FINANCIAL DATA
As of or for the year ended December 31,
----------------------------------------
2004 2003 2002 2001 2000
---- ---- ---- ---- ----
BALANCE SHEET DATA
Total assets 163,601,372 106,695,593 75,318,011 56,228,577 55,412,969
Investments 84,382,173 47,290,420 25,377,796 17,507,422 18,965,798
Finance contracts, consumer loans and pay
advances receivable, net 8,289,356 9,891,642 7,217,873 10,813,881 13,792,791
Total liabilities 138,624,637 74,649,217 57,220,348 42,019,446 40,456,972
Unpaid losses and loss adjustment expenses 46,570,679 24,570,198 16,983,756 11,005,337 9,765,848
Unearned premiums 50,152,711 34,122,663 28,934,486 14,951,228 13,038,417
Revolving credit outstanding 2,148,542 4,098,786 4,312,420 6,676,817 8,091,034
Total shareholders' equity $ 24,976,735 $ 32,046,376 $ 18,097,664 $ 14,209,131 14,955,997
Book value per share $ 4.15 $ 5.89 $ 4.03 $ 3.13 $ 2.99
- 29 -
21st Century Holding Company
As of or for the year ended December 31,
----------------------------------------
2004 2003 2002 2001 2000
---- ---- ---- ---- ----
OPERATIONS DATA:
Revenue:
Gross premiums written $ 100,662,025 $ 72,991,434 $ 63,036,468 $ 34,271,338 $ 32,073,768
Gross premiums ceded (15,485,917) (22,090,644) (27,765,267) (12,789,404) (7,625,095)
------------- ------------- ------------- ------------- -------------
Net premiums written 85,176,108 50,900,790 35,271,201 21,481,934 24,448,673
Increase (decrease) in prepaid
reinsurance premiums (2,904,716) (3,427,818) 5,691,283 686,438 874,000
(Increase) decrease in unearned premiums (16,030,048) (5,188,177) (14,047,919) (1,912,811) (5,001,334)
------------- ------------- ------------- ------------- -------------
Net change in prepaid reinsurance
premiums and unearned premiums (18,934,764) (8,615,995) (8,356,636) (1,226,373) (4,127,334)
------------- ------------- ------------- ------------- -------------
Net premiums earned 66,241,344 42,284,795 26,914,565 20,255,561 20,321,339
Commission income -- -- -- -- --
Finance revenue 3,667,837 4,327,675 4,452,626 5,267,523 5,709,848
Managing general agent fees 2,039,783 2,328,681 1,970,226 5,871,388 5,410,500
Net investment income 3,171,620 1,624,216 1,253,765 1,066,641 1,225,413
Net realized investment gains (losses) 688,676 2,231,333 (1,369,961) (2,911,658) (109,256)
Other income 762,164 791,718 769,915 1,378,631 786,145
------------- ------------- ------------- ------------- -------------
Total revenue 76,571,424 53,588,418 33,991,136 30,928,086 33,343,989
------------- ------------- ------------- ------------- -------------
Expenses:
Loss and loss adjustment expenses 74,992,781 27,508,979 15,987,125 16,154,902 14,990,118
Operating and underwriting expenses 8,139,812 7,249,440 6,367,633 9,358,031 9,231,053
Salaries and wages 6,134,168 5,425,538 4,562,115 4,673,772 5,142,391
Interest expense 1,087,494 606,910 353,225 587,654 662,809
Amortization of deferred acquisition
costs, net 8,422,808 (854,279) (2,064,314) 1,467,238 1,673,754
Amortization of goodwill -- -- -- 540,010 606,653
------------- ------------- ------------- ------------- -------------
Total expenses 98,777,063 39,936,588 25,205,784 32,781,607 32,306,778
------------- ------------- ------------- ------------- -------------
Income (loss) from continuing operations
before provision (benefit for income
tax expense) (22,205,639) 13,651,830 8,785,252 (1,853,521) 1,037,211
Provision (benefit) for income tax expense (8,600,911) 4,357,961 3,685,572 (630,553) (462,396)
------------- ------------- ------------- ------------- -------------
Net income (loss) from continuing
operation before extraordinary gain (13,604,728) 9,293,869 5,099,781 (1,222,968) 1,499,607
Extraordinary gain -- -- -- 1,185,895 --
------------- ------------- ------------- ------------- -------------
Net income (loss) from continuing
operations and extraordinary gain (13,604,728) 9,293,869 5,099,781 (37,073) 1,499,607
------------- ------------- ------------- ------------- -------------
Discontinued operations:
Income (loss) on discontinued operations (900,473) (1,364,605) (912,303) (955,017) (2,022,481)
Gain on sale or disposal 5,384,050 -- -- -- --
------------- ------------- ------------- ------------- -------------
Income on discontinued operations before tax
provision (benefit) 4,483,577 (1,364,605) (912,303) (955,017) (2,022,481)
Provision (benefit) for income tax expense 1,736,624 (435,611) (382,723) -- --
------------- ------------- ------------- ------------- -------------
Income (loss) on discontinued
operations 2,746,953 (928,994) (529,580) (955,017) (2,022,481)
------------- ------------- ------------- ------------- -------------
Net income (loss) $ (10,857,775) $ 8,364,875 $ 4,570,201 $ (992,090) $ (522,874)
============= ============= ============= ============= =============
Basic net income (loss) per share from
continuing operations $ (2.34) $ 1.96 $ 1.13 $ (0.26) $ 0.30
============= ============= ============= ============= =============
Extraordinary gain -- -- -- 0.25 --
============= ============= ============= ============= =============
Basic net income (loss) per share
from discontinued operations $ 0.47 $ (0.20) $ (0.12) $ (0.20) $ (0.40)
============= ============= ============= ============= =============
Basic net income (loss) per share $ (1.86) $ 1.76 $ 1.01 $ (0.21) $ (0.10)
Fully diluted net income (loss) per share
from continuing operations $ (2.34) $ 1.85 $ 1.13 $ (0.26) $ 0.30
============= ============= ============= ============= =============
Fully diluted extraordinary gain $ -- $ -- $ -- $ 0.25 $ --
============= ============= ============= ============= =============
Fully diluted net income (loss) per share from
discontinued operations $ 0.47 $ (0.18) $ (0.12) $ (0.20) $ (0.40)
============= ============= ============= ============= =============
Fully diluted net income (loss) per share $ (1.86) $ 1.67 $ 1.01 $ (0.21) $ (0.10)
============= ============= ============= ============= =============
Cash dividends declared per share $ 0.32 $ 0.25 $ 0.10 $ 0.05 $ 0.01
============= ============= ============= ============= =============
- 30 -
21st Century Holding Company
Management's Discussion and Analysis of Financial Condition and
Results of Operations
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
We are an insurance holding company, which, through our subsidiaries and
our contractual relationships with our independent agents, control substantially
all aspects of the insurance underwriting, distribution and claims process. We
underwrite personal automobile insurance, general liability insurance,
homeowners' insurance and mobile home property and casualty insurance in Florida
and Georgia through our wholly owned subsidiaries, Federated National and
American Vehicle. We internally process claims made by our own and third party
insureds through our wholly owned claims adjusting company, Superior Adjusting,
Inc. We also offer premium financing to our own and third-party insureds through
our wholly owned subsidiary, Federated Premium Finance, 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 and American Vehicle, 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 our distribution network.
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 LAE are less than actual losses and LAE, we
will be required to increase reserves with a corresponding reduction in our net
income in the period in which the deficiency is identified.
The most significant events affecting our results of operations and
financial condition in 2004 were the four hurricanes that struck the State of
Florida in the third quarter. Since then, we have been receiving and processing
claims made under our homeowners' and mobile home owners' policies, a process
that is expected to be substantially completed during the first half of 2005.
Federated National incurred significant losses relative to its homeowners'
insurance line of business. As of December 31, 2004, approximately 8,500
policyholders had filed hurricane-related claims totaling an estimated $105.4
million, of which we currently estimate that our share of the costs associated
with these hurricanes will be approximately $43.5 million, net of our
reinsurance recoveries and amortized reinstatement premiums. For a further
discussion of our reinsurance please see our section titled "REINSURANCE"
Since our initial preliminary provision for losses from these hurricanes
of $33 million, net of reinsurance recoveries, as of September 30, 2004, we
revised our provision for losses as described above. Because the storms occurred
during the third quarter of 2004, we were not able to complete physical
inspections of a sufficiently large percentage of claims, nor were complete
repair estimates available. During the fourth quarter of 2004, as physical
property inspections and repair estimates were completed, our initial estimates
of losses for these storms were increased to reflect increased estimates of
claim severity on our homeowners' policies in Florida. We do not currently
anticipate further materials increases to our loss estimates from the 2004
hurricanes.
We have operated in a competitive market and face competition from both
national and regional insurance companies, although the number of competitors in
the homeowners' line of business has been somewhat reduced because of the
effects of the 2004 hurricanes. Many of our competitors are larger and have
greater financial and other resources, have better industry 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. Competition could have a material adverse effect on our business,
results of operations and financial condition.
- 31 -
21st Century Holding Company
Management's Discussion and Analysis of Financial Condition and
Results of Operations
CRITICAL ACCOUNTING POLICIES
Our accounting policies are more fully described in Note 2 of Notes to
Consolidated Financial Statements. As disclosed therein, the preparation of
financial statements in conformity with GAAP requires management to make
estimates and assumptions about future events that affect the amounts reported
in the financial statements and accompanying notes. Future events and their
effects cannot be determined with absolute certainty. Therefore, the
determination of estimates requires the exercise of judgment. Actual results
inevitably will differ from those estimates, and such differences may be
material to the financial statements.
The most significant accounting estimates inherent in the preparation of
our financial statements include estimates associated with management's
evaluation of the determination of liability for unpaid losses and loss
adjustment expense, the recoverability of goodwill and amortization of deferred
policy acquisition costs. In addition, significant estimates form the bases for
our reserves with respect to finance contracts, premiums receivable and deferred
income taxes. 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,
current and expected economic conditions, and in the case of unpaid losses and
loss adjustment expense, an actuarial valuation. Management constantly
reevaluates these significant factors and makes adjustments where facts and
circumstances dictate. See Note 2 of the Notes to Consolidated Financial
Statements.
ACCOUNTING CHANGES
In December 2004, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 123, Share-Based Payments (revised 2004) ("SFAS No. 123R"). This
statement eliminates the option to apply the intrinsic value measurement
provisions of APB No. 25 to stock compensation awards issued to employees.
Rather, SFAS No. 123R requires companies to measure the cost of employee
services received in exchange for an award of equity instruments based on the
grant date fair value of the award. That cost will be recognized over the period
during which an employee is required to provide services in exchange for the
award - the requisite service period (usually the vesting period). SFAS No. 123R
will also require companies to measure the cost of employee services received in
exchange for employee stock purchase plan awards. SFAS No. 123R will be
effective for 21st Century's fiscal quarter beginning July 1, 2005. We have not
yet determined the effect on us of the adoption of SFAS No. 123R.
In January 2003, the 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. In July 2003 and September 2004, we completed private placements of our 6%
Senior Subordinated Notes. These notes fall within the definition of financial
instruments as described in Financial Accounting Standard Number 150 and were
originally 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.
- 32 -
21st Century Holding Company
Management's Discussion and Analysis of Financial Condition and
Results of Operations
ANALYSIS OF FINANCIAL CONDITION AS OF DECEMBER 31, 2004 AS COMPARED TO
DECEMBER 31, 2003
INVESTMENTS.
Investments increased $37.1 million or 78.4% to $84.4 million as of
December 31, 2004 from $47.3 million as of December 31, 2003 primarily as a
result an increase in written insurance premiums.
As a result of the adverse market conditions which 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. We did not hold any non-traded investment
securities during 2004 or 2003.
Below is a summary of unrealized losses loss at December 31, 2004 and 2003
by category.
Net Unrealized Gains (Losses)
Years Ended December 31,
------------------------
2004 2003
---- ----
Fixed maturities:
U.S. government obligations $(582,310) $(793,613)
Obligations of states and political
subdivisions (4,501) (4,840)
--------- ---------
(586,811) (798,453)
--------- ---------
Corporate securities:
Communications 23,299 209,226
Financial (11,220) 14,694
Other 64,377 45,475
--------- ---------
76,456 269,395
--------- ---------
Equity securities:
Preferred stocks -- 400
Common stocks (312,410) 3,154
--------- ---------
(312,410) 3,554
--------- ---------
Total fixed, corporate and equity securities $(822,765) $(525,504)
========= =========
RECEIVABLE FOR INVESTMENTS SOLD.
Receivable for investments in 2003 were realized in 2004. The receivable
is a result of investment trading activity that occurred in late December 2003
and did not settle until early January 2004.
FINANCE CONTRACTS.
Finance contracts receivable decreased $1.6 million or 16.2% from $8.3
million as of December 31, 2004 as compared to $9.9 million as of December 31,
2003. The decrease of the finance contracts receivable is primarily the result
of our requested credit reduction.
PREPAID REINSURANCE PREMIUMS.
Prepaid reinsurance premiums decrease was $2.9 million, net or 34.5% to
$5.5 million as of December 31, 2004 from $8.4 million as of December 31, 2003.
The decrease in Federated National's and American Vehicle's ceded quota-share
reinsurance totaled $4.0 million and $3.8 million, respectively. This decrease
was mitigated by an increase in ceded unearned premiums relative to Federated
National's homeowners' and mobile homeowners' insurance products.
- 33 -
21st Century Holding Company
Management's Discussion and Analysis of Financial Condition and
Results of Operations
PREMIUMS RECEIVABLE.
Premiums receivable decreased $1.3 million, or 17.8% to $6.0 million as of
December 31, 2004, from $7.3 million as of December 31, 2003. The decline can be
attributed to the decline in automobile written premiums and the diversification
of our product lines. The predominate user of the finance products is the
automobile customer. There is less of a tendency to finance homeowner premiums
due to policyholder mortgage escrow arrangements and only a modest need to
finance commercial general liability insurance.
REINSURANCE RECOVERABLE - NET.
Reinsurance recoverable increased $14.4 million or 130.6% to $25.5 million
as of December 31, 2004 from $11.1 million as of December 31, 2003. This
increase is the result of the increase in loss and loss adjustment expenses
incurred relative to the four hurricanes that affected Florida in August and
September 2004 and, to a lesser extent, the timing of settlements with our
reinsurers. All amounts are considered current and are primarily associated with
the catastrophic weather events.
DEFERRED ACQUISITION COSTS - NET.
Deferred acquisition costs increased $5.3 million to $7.0 million as of
December 31, 2004 from $1.7 million as of December 31, 2003. At December 31,
2004, commission expense net of commissions income was approximately $6.1
million and expenses connected with the writing of premiums such as salaries and
premium taxes, net of policy fees totaled approximately $0.9 million. Deferred
policy acquisition costs, net, increased primarily due to a $2.5 million
increase of deferred commission expenses and a $2.3 million decrease in ceded
unearned commissions income during the year ended December 31, 2004. The
increase of deferred commission expenses continues to be 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
$7.8 million decline of ceded commissions.
At December 31, 2003, commission expense net of commissions income was
approximately $1.2 million and expenses connected with the writing of premiums
such as salaries and premium taxes, net of policy fees totaled approximately
$0.5 million. Deferred policy acquisition costs, net, increased primarily due to
a $0.84 million increase of deferred commission expenses and a $0.82 million
decrease in ceded unearned commissions income during the year ended December 31,
2003. The increase of 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
$3.4 million decline of ceded commissions.
INCOME TAX RECOVERABLE.
Income tax recoverable increased by 887.5% to $7.9 as of December 31, 2004
as compared to $0.8 million as of December 31, 2003 and is primarily due to the
effects of the current year net operating loss. Income tax provisions allows us
to carry back our current year net operating loss two years and receive a tax
refund for taxes paid in profitable years. The tax benefit is recognized as a
receivable for the refundable amount. Further, the tax benefit reduces the
current year's tax expense based on the tax rates in effect in the carryback
period.
GOODWILL.
Goodwill declined by approximately $1.6 million, or 91.2% to approximately
$154,000 as of December 31, 2004 as compared to approximately $1,740,000 as of
December 31, 2003 due to the sale of our captive and franchised agencies on
December 31, 2004. Goodwill otherwise remained unchanged during 2004 due to the
adoption of SFAS 142, wherein our assessment of goodwill indicated no impairment
of the remaining goodwill associated with Express Tax. Please see "Recent
Developments" and "Discontinued Operations" above and Note 24 to our
Consolidated Financial Statements included under Item 8 of this Report on Form
10-K for a description of our January 1, 2005 sale of our interest in Express
Tax.
OTHER ASSETS.
Other assets increased by $2.5 million, or 108.7% to $4.8 million as of
December 31, 2004 as compared to $2.3 million as of December 31, 2003. The
largest contribution to the increase in other assets is associated with our
receivable due in connection with our sale in December 2004 of our assets
related to our non-standard automobile insurance agency business in Florida
(please see "Recent Developments" and "Discontinued Operations" above and Note
24 to our Consolidated Financial Statements included under Item 8 of this Report
on Form 10-K for a description of this transaction). Major components of other
assets are as follows:
- 34 -
21st Century Holding Company
Management's Discussion and Analysis of Financial Condition and
Results of Operations
December 31,
------------
2004 2003
---- ----
Accrued interest income $ 605,484 $ 680,017
Notes receivable 64,320 460,145
Unamortized loan costs 837,665 430,803
Compensating cash balances 156,070 200,430
Due from sale of discontinued operations (see
note 24) 2,587,343 --
Other 572,060 568,261
---------- ----------
Total $4,822,942 $2,339,656
========== ==========
UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES.
Unpaid losses and loss adjustment expenses increased $22.0 million or
89.5% to $46.6 million as of December 31, 2004 as compared to $24.6 million as
of December 31, 2003. The increase is most notably associated with the four
hurricanes that occurred in August and September of 2004.
Federated National's reserves increased by $23.0 million in 2004 as
compared to 2003 and American Vehicle's reserves decreased by $1.4 million in
2004 as compared to 2003. Factors, other than the four hurricanes that struck
Florida in August and September 2004, 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 "Losses and LAE."
UNEARNED PREMIUM.
Unearned premiums increased by $16.0 million or 47.0% to $50.1 million as
of December 31, 2004 as compared to $34.1 million as of December 31, 2003. The
increase was due to a $18.9 million increase in unearned homeowner's insurance
premiums and $2.7 million in unearned premiums associated with the commercial
liability program. Offsetting these increases was a $5.5 million decrease in
automobile unearned premiums. These changes reflect our continued emphasis in
2004 on property and commercial general liability insurance products.
BANK OVERDRAFT.
Bank overdraft increased $14.3 million to $14.8 million for the year ended
December 31, 2004 as compared to $0.6 million for the year ended December 31,
2003. The significant increase primarily relates to hurricane-related loss and
LAE checks issued but not yet paid by the bank.
DEFERRED INCOME FROM SALE OF AGENCY OPERATIONS.
Deferred income from sale of agency operations was $2.5 million as of
December 31, 2004 as compared to zero as of December 31, 2003. This reflects the
contractual provisions associated with the December 31, 2004 sale of our
non-standard automobile insurance agency business in Florida that provide for a
post-closing payment of up to $2.5 million provided that certain performance
criteria are met. The company believes it will meet these criteria during 2005.
For further information about this transaction, please see "Recent Developments"
above and Note 24 to our Consolidated Financial Statements included under Item 8
of this Report on Form 10-K.
SUBORDINATED DEBT.
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 subordinated notes and warrants sold in our July 2003 private placement
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. By comparison, the
subordinated notes that we sold in 2003 (the "July 2003 Notes") resulted in net
proceeds to us of $6,938,498. Please see Note 22 to our Consolidated Financial
Statements included under Item 8 of this Report on Form 10-K, for further
discussion.
- 35 -
21st Century Holding Company
Management's Discussion and Analysis of Financial Condition and
Results of Operations
RESULTS OF OPERATIONS YEAR ENDED DECEMBER 31, 2004 COMPARED TO YEAR ENDED
DECEMBER 31, 2003
GROSS PREMIUMS WRITTEN.
Gross premiums written increased $27.7 million, or 37.9%, to $100.7
million for the year ended December 31, 2004, as compared to $73.0 million for
the comparable period in 2003. The following table denotes gross premiums
written by major product line.
Year eneded December 31,
------------------------
2004 2003
---- ----
Automobile $ 24,239,001 24.1% $ 49,297,915 67.5%
Homeowners' 62,400,283 62.0% 16,804,497 23.0%
Commercial liability 12,509,942 12.4% 5,149,944 7.1%
Mobile home owners' 1,512,799 1.5% 1,739,078 2.4%
------------ ----- ------------ -----
Gross written premiums $100,662,025 100.0% $ 72,991,434 100.0%
============ ===== ============ =====
This table reflects the success of our efforts to expand our line of
insurance products to include products other than automobile insurance.
GROSS PREMIUMS CEDED.
Gross premiums ceded decreased $6.6 million or 29.9% to $15.5 million for
the year ended December 31, 2004, from $22.1 million for the year ended December
31, 2003. The decrease due to decline in our ceded quota-share reinsurance
associated with our automobile insurance totaled $20.5 million and was offset by
a $13.9 million increase in ceded premiums associated with our property lines of
business.
INCREASE (DECREASE) IN PREPAID REINSURANCE PREMIUMS.
Prepaid reinsurance premiums decreased $0.5 million or 15.3%, to ($2.9)
million as of December 31, 2004, from ($3.4) million for the year ended December
31, 2003. The decrease is due primarily to our decreased reliance on quota-share
reinsurance on its automobile insurance products.
INCREASE IN UNEARNED PREMIUMS.
The increase in unearned premiums rose by $10.8 million, or 209.0% to
($16.0) million as of December 31, 2004, as compared to ($5.2) million as of
December 31, 2003. The unearned premium liability increase of $16.0 million
during 2004 is net of homeowner and commercial liability unearned premiums
increases of $18.9 million and $2.7 million, respectively, and is offset by
automobile unearned premiums decreases of $5.5 million. These changes reflect
our continued emphasis in 2004 on property and commercial general liability
insurance products.
MANAGING GENERAL AGENT FEES.
Managing General Agent Fees decreased modestly by $0.2 million or 11.0% to
$2.1 million as compared to $2.3 million as of December 31, 2003. The decrease
reflects an overall decrease in the production of insurance policies mitigated
by policies with higher rates and volume of one-year term policies.
NET INVESTMENT INCOME.
Net investment income increased by $1.6 million or 95.3% to $3.2 million
for the year ended December 31, 2004, as compared to $1.6 million for the year
ended December 31, 2003. The increase in investment income is a result of the
additional amounts of invested assets. Our overall investment yield increased by
..35%, from 4.47% for the year ended December 31, 2003 to 4.82% for the year
ended December 31, 2004.
NET REALIZED INVESTMENT GAINS (LOSSES).
Net realized investment gains decreased by $1.5 million, or 69.1%, to $0.7
million for the year ended December 31, 2004 as compared $2.2 million for the
year ended December 31, 2003. The table below reflects the gains and losses by
investment category.
36
21st Century Holding Company
Management's Discussion and Analysis of Financial Condition and
Results of Operations
For the year ending December 31,
--------------------------------
2004 2003
---- ----
Realized gains:
Fixed securities $ 62,513 $ 1,590,937
Equity securities 894,883 1,230,118
----------- -----------
Total realized gains 957,396 2,821,055
----------- -----------
Realized losses:
Fixed securities (42,911) (508,299)
Equity securities (225,809) (81,422)
----------- -----------
Total realized losses (268,720) (589,721)
----------- -----------
Net realized gains (losses) on
investments $ 688,676 $ 2,231,334
=========== ===========
LOSSES AND LAE.
Loss and loss adjustment expenses increased by $47.5 million, or 172.6%,
to $75.0 million for the year ended December 31, 2004, as compared to $27.5
million as of December 31, 2003. The increase is due to the impact of the 2004
hurricane season wherein August and September of 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. The Company's loss ratio, as determined
in accordance with GAAP, for the year ended December 31, 2004 was 113.21%
compared with 61.30% for the same period in 2003. The table below reflects the
loss ratios by product line.
For the year ending December 31,
--------------------------------
2004 2003
---- ----
Automobile 73.24% 79.51%
Home owners 166.54% 21.30%
Commercial liability 18.74% 18.50%
Mobile home owners 238.79% 28.74%
All Product Lines 113.21% 61.30%
Approximately 8,500 policyholders have filed hurricane-related claims
totaling an estimated $105.4 million, of which we estimate that our share of the
costs associated with these hurricanes will be approximately $39.1 million and
$4.4 million for homeowners' and mobile homeowners', respectively, net of
reinsurance recoveries and amortized reinstatement premiums. As of September 30,
2004 approximately 7,500 policyholders had filed hurricane-related claims
totaling an estimated $62.0 million, of which we estimated that our share of the
costs associated with these hurricanes will be approximately $33.0 million, net
of reinsurance recoveries and amortized reinstatement premiums.
For each catastrophic occurrence, the excess of loss treaty will insure us
for $24 million with the company retaining the first $10 million of loss and
LAE. The treaty has a provision which, for an additional prorated premium will
insure us for another $24 million of loss and LAE for subsequent occurrences
with the company retaining the first $10 million in loss and LAE. As a result of
the loss and LAE incurred in connection with the Hurricanes Charles and Frances
the company has exhausted its recoveries of $48 million under the terms of this
treaty.
The excess of loss treaty also insures us for an additional $34 million in
excess of the company's $10 million retention plus the next $24 million as
described above. Accordingly, loss and LAE incurred for Hurricanes Ivan, Jeanne
and any subsequent catastrophic events through June 30, 2005, up to $34 million
each, are the responsibility of the company, as illustrated in the accompanying
table.
37
21st Century Holding Company
Management's Discussion and Analysis of Financial Condition and
Results of Operations
(in millions)
Gross Reinsurance Net
Hurricane Losses Recoveries Losses
--------- ------ ---------- ------
Charley (August 13) $ 44.2 $ 34.2 $ 10.0
Frances (September 3) 37.7 27.7 10.0
Ivan (September 14) 13.7 -- 13.7
Jeanne (September 25) 9.8 -- 9.8
------------- ------------- -------------
Total Loss Estimate $ 105.4 $ 61.9 $ 43.5
============= ============= =============
Furthermore, as a result of the 2004 hurricanes, 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.
The All Products Lines loss ratio of 113.21% as of December 31, 2004 would
have been 47.42% without the impact of the four hurricanes in August and
September of 2004. The four hurricanes in August and September of 2004 increased
our homeowners' and mobile homeowners' loss ratio for the year ended December
31, 2004 by approximately 129.14 percentage points and 205.67 percentage points,
respectively.
Losses and loss adjustment expenses, the Company's most significant
expense, represent actual payments made and changes in estimated future payments
to be made to or on behalf of its policyholders, including expenses required to
settle claims and losses. 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.
The Company attributes the overall increase in the loss ratio to be
clearly related to the four hurricanes in August and September of 2004. If we
were to segregate the affects of the four hurricanes in August and September of
2004 we estimate that our All Products Lines loss ratio would have been
approximately 47.42% as of December 31, 2004 as compared to 61.30% as of
December 31, 2003 and attribute that decrease to the increasingly significant
operational contributions made by our lines of business other than automobile.
SALARIES AND WAGES.
Salaries and wages increased $0.7 million, or 13.0%, to $6.1 million for
the year ended December 31, 2004, as compared to $5.4 million for the year ended
December 31, 2003. Management believes that the increase in salaries and wages
is consistent with retaining quality management and increased premium
production.
INTEREST EXPENSE.
Interest expense increased by $0.5 million, or 79.2%, to $1.1 million for
the year ended December 31, 2004, as compared to $0.6 million as of December 31,
2003. The increase in interest expense is attributable to our July 2003 and
September 2004 Notes. For further discussion relative to the Notes see footnote
22 titled Subordinated Debt.
POLICY ACQUISITION COSTS, NET OF AMORTIZATION.
Policy acquisition costs, net of amortization, increased by $9.3 million,
charging earnings by $8.4 million for the year ended December 31, 2004, as
compared to a credit of $0.9 million as of December 31, 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.
During the year ended December 31, 2004, the difference between the ceded
commissions earned of $1.5 million and amortized costs of $9.9 million resulted
in a charge to earnings of $8.4 million. The $9.3 million increase in policy
acquisition costs, net of amortization, in the 2004 period as compared to the
2003 period is attributable to the decrease in ceded commissions earned during
the year ended December 31, 2004 totaling $5.2 million, netted against amortized
costs of $4.1 million during the same period.
RESULTS OF OPERATIONS YEAR ENDED DECEMBER 31, 2003 COMPARED TO YEAR ENDED
DECEMBER 31, 2002
GROSS PREMIUMS WRITTEN.
Gross premiums written increased $10.0 million, or 15.8%, to $73.0 million
for the year ended December 31, 2003, as compared to $63.0 million for the
comparable period in 2002. The following table denotes gross premiums written by
major product line.
38
21st Century Holding Company
Management's Discussion and Analysis of Financial Condition and
Results of Operations
Year eneded December 31,
------------------------
2003 2002
---- ----
Automobile $49,297,915 67.5% $52,586,436 83.4%
Homeowners' 16,804,497 23.0% 8,669,642 13.8%
Commercial liability 5,149,944 7.1% -- 0.0%
Mobile home owners' 1,739,078 2.4% 1,780,390 2.8%
----------- ----- ----------- -----
Gross written premiums $72,991,434 100.0% $63,036,468 100.0%
=========== ===== =========== =====
This table reflects the success of our efforts to expand our line of
insurance products to include products other than automobile insurance.
GROSS PREMIUMS CEDED.
Gross premiums ceded decreased $5.7 million or 25.8% to $22.1 million for
the year ended December 31, 2003, from $25.3 million for the year ended December
31, 2002. The decrease is primarily due to the decline in our ceded quota-share
reinsurance associated with our automobile insurance.
INCREASE (DECREASE) IN PREPAID REINSURANCE PREMIUMS.
Prepaid reinsurance premiums decreased $9.1 million or 160.2%, to ($3.4)
million as of December 31, 2003, from $5.7 million for the year ended December
31, 2002. The decrease is due primarily to American Vehicle's decreased reliance
on quota-share reinsurance on its automobile insurance products.
INCREASE IN UNEARNED PREMIUMS.
The increase in unearned premiums declined by $8.8 million, or 63.1% to
($5.2) million as of December 31, 2003, as compared to ($14.0) million as of
December 31, 2002. The unearned premium liability increase of $5.2 million
during 2003 is net of homeowner and commercial liability unearned premiums
increases of $5.7 million and $3.8 million, respectively, and is offset by
automobile unearned premiums decreases of $4.3 million. These changes reflect
our emphasis in 2003 on property and commercial general liability insurance
products.
MANAGING GENERAL AGENT FEES.
Managing General Agent Fees increased modestly from $2.0 million for the
year ended 2002 to $2.3 million for the year ended December 31, 2003. The
increase reflects an overall increase in the production of insurance policies.
NET INVESTMENT INCOME.
Net investment income increased by $0.3 million or 29.5% to $1.6 million
for the year ended December 31, 2003, as compared to $1.3 million for the year
ended December 31, 2002. The increase in investment income is a result of the
additional amounts of invested assets. Although the Company's net investment
income has increased during 2003 compared to 2002, our overall investment yield
declined by 1.5%, from 4.9% for the year ended December 31, 2002 to 3.4% for the
year ended December 31, 2003.
NET REALIZED INVESTMENT GAINS (LOSSES).
Net realized investment gains increased by $3.6 million to $2.2 million
for the year ended December 31, 2003 as compared to a loss of $1.4 million for
the year ended December 31, 2002. The table below reflects the gains and losses
by investment category.
39
21st Century Holding Company
Management's Discussion and Analysis of Financial Condition and
Results of Operations
For the year ending December 31,
--------------------------------
2003 2002
---- ----
Realized gains:
Fixed securities $ 1,590,937 $ 774,931
Equity securities 1,230,118 123,232
------------- -------------
Total realized gains 2,821,055 898,163
------------- -------------
Realized losses:
Fixed securities (508,299) (2,164,790)
Equity securities (81,422) (103,334)
------------- -------------
Total realized losses (589,721) (2,268,124)
------------- -------------
Net realized gains (losses) on
investments $ 2,231,334 $ (1,369,961)
============= =============
LOSSES AND LAE.
Loss and loss adjustment expenses increased by $11.5 million, or 72.1%, to
$27.5 million for the year ended December 31, 2003, as compared to $16.0 million
as of December 31, 2002. The increase is predominantly due to the increase in
net premiums earned. The Company's loss ratio, as determined in accordance with
GAAP, for the year ended December 31, 2003 was 60.8% compared with 54.4% for the
same period in 2002. The table below reflects the loss ratios by product line.
For the year ending December 31,
--------------------------------
2003 2002
---- ----
Automobile 79.51% 70.55%
Home owners 21.30% 21.64%
Commercial liability 18.50% 0.00%
Mobile home owners 28.74% 33.37%
All Product Lines 61.30% 54.39%
Losses and loss adjustment expenses, the Company's most significant
expense, represent actual payments made and changes in estimated future payments
to be made to or on behalf of its policyholders, including expenses required to
settle claims and losses. 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. The
Company attributes the overall increase in the loss ratio primarily to its
liability lines of insurance associated with automobile claims and the related
estimates of the costs necessary to settle the claims. The estimated cost to
close all claim files, for accidents that occurred in years other than the
accidents that occurred in the current year ended December 31, 2003 and net of
reinsurance recoveries, has increased by a total of $1.2 million over the
ultimate estimates made as of December 31, 2002, primarily due to a decrease of
claim frequency and claim severity and periodic estimates made by management of
the ultimate costs required to settle all claims, both reported and not yet
reported.
SALARIES AND WAGES.
Salaries and wages increased $0.8 million, or 18.9%, to $5.4 million for
the year ended December 31, 2003, as compared to $4.6 million for the year ended
December 31, 2002. Management believes that the increase in salaries and wages
is consistent with retaining quality management and increased premium
production.
POLICY ACQUISITION COSTS, NET OF AMORTIZATION.
Policy acquisition costs, net of amortization, increased by $1.2 million,
or 58.6%, to a credit of $0.9 million for the year ended December 31, 2003, as
compared to a credit of $2.1 million as of December 31, 2002. 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.
During the year ended December 31, 2003, the difference between the ceded
commissions earned of $6.7 million and amortized costs of $5.8 million resulted
in a credit to earnings of $0.9 million. The $1.2 million increase in policy
acquisition costs, net of amortization, in the 2003 period as compared to the
2002 period is attributable to the increase in ceded commissions earned during
the year ended December 31, 2003 totaling $1.0 million, netted against amortized
costs of $2.2 million during the same period.
40
21st Century Holding Company
Management's Discussion and Analysis of Financial Condition and
Results of Operations
LIQUIDITY AND CAPITAL RESOURCES
Our primary sources of capital in 2004 were revenues generated from
operations, including our investment portfolios, issuance of debt securities,
sale of certain assets related to our non-standard automobile agency insurance
business in Florida, and borrowings under our Revolving Loan Agreement (the
"Revolving Agreement"), as described below. Because we are a holding company, we
are largely dependent upon fees from our subsidiaries for cash flow.
For the years ended December 31, 2004 and 2003, operations generated net
operating cash flow of $18.6 million and $12.3 million, respectively. During the
year ended December 31, 2004, gross cash flow from operations generated
approximately $62.3 million, due to an increase in unpaid loss and loss
adjustment expenses totaling $22.0 million, increased unearned premiums
liability totaling $16.0 million, increased prepaid reinsurance premiums
totaling $2.9 million and increased bank overdrafts totaling $14.1 million, all
in conjunction with a net loss of $10.9 million.
Operations for the year ended December 31, 2004 used $32.9 million of
gross cash flow primarily for a $14.4 million increase to reinsurance
recoverable, net and a $7.1 million increase income taxes recoverable, and $5.2
million gain on sale of agency operations. Additionally, $5.2 million was used
to pay agent commissions where the underlying policy term is unexpired as of
December 31, 2004.
Net operating cash flow is currently expected to be positive in both the
short-term and the reasonably foreseeable future.
For the year ended December 31, 2003, operations generated a cash flow of
$12.3 million as compared to $14.5 million in 2002. Cash flow provided by
financing activities was $12.2 million in 2003, as we generated $6.9 million
through exercised stock options and $7.5 million through the sale of our July
2003 Notes.
In addition, our investment portfolio is highly liquid as it consists
almost entirely of readily marketable securities. Cash flow used in net
investing activities was $30.9 million for the year ended December 31, 2004, as
we invested the cash flow from operating and financing activities. While in a
period in which written premiums are increasing, it is reasonably expected that
cash from premiums will be used for investing activities. In the future, we
expect a continued cash flow deficit from investing activities, as we invest
cash from operations.
Net cash generated from financing activities was $11.7 million for the
year ended December 31, 2004. The source of cash from financing activities is
primarily reflected by the receipt of $12.5 million from the issuance of
additional 6% Senior Subordinated Notes and proceeds from exercised stock
options totaling $3.0 million, offset by $1.9 million paid in dividends and $2.0
million used to reduce revolving credit outstanding.
The 2003 Warrants issued 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 July 2003 Warrants had zero
value at the date of issuance.
On September 30, 2004, we completed a private placement of 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.
41
21st Century Holding Company
Management's Discussion and Analysis of Financial Condition and
Results of Operations
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. 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
September 2004 Warrants had zero value at the date of issuance. 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.
Federated Premium's operations are funded by the 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
WPAC (a wholly-owned subsidiary of FlatIron), which gives WPAC 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.
The Revolving Agreement, which was amended and revised in September 2001,
allowed for a maximum credit commitment of $7.0 million plus an initial
additional amount of $700,000 for the transition from September 30, 2001 when
the previous agreement expired. The line declined by $100,000 each month
beginning November 1, 2001. In September 2002 the line was amended and revised
allowing for a maximum credit commitment of $4.0 million.
The amount of WPAC'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 December 31, 2004, our interest rate was 7.00% as
compared to our interest rate as of December 31, 2003 of 5.75%
The Revolving Agreement contains various operating and financial
covenants, with which we were in compliance at December 31, 2004 and December
31, 2003. Outstanding borrowings under the Revolving Agreement as of December
31, 2004 and December 31, 2003 were $2.1 million and $4.1 million, respectively.
Outstanding borrowings in excess of the $2.0 million commitment totaled $148,542
as of December 31, 2004. The excess amount, permissible by reason of a
compensating cash balance of $156,070 for December 31, 2004, was held for the
benefit of WPAC and is included in other assets. 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 years
ended December 31, 2004, 2003 and 2002 totaled approximately $178,000, $203,000
and $342,000, respectively.
The annual interest rate on advances under the Revolving Agreement is the
prime rate plus additional interest varying from 1.25% to 3.25% based on the
prior month's ratio of contracts receivable related to insurance companies with
an A. M. Best rating of B or worse to total contracts receivable. The effective
interest rate on this line of credit, based on our average outstanding
borrowings under the Revolving Agreement, was 5.71%, 4.83% and 6.23% for the
years ended December 31, 2004, 2003 and 2002, respectively.
In September 2002, FlatIron reduced the maximum credit commitment under
the Revolving Agreement due to the A.M. Best ratings of third party insurance
carriers with which we were financing policies at the time. Simultaneously,
however, we ceased financing policies underwritten by third party insurance
carriers altogether and began financing only those policies underwritten by our
insurance carriers (in 2003 we began again to finance policies from a small
number of independent agents whose customer base and operational history meet
our strict criteria for credit worthiness). Additionally, in 2002, we
implemented a direct bill program for policies underwritten by our carriers.
These changes markedly decreased credit risks and made our reliance on the
higher credit commitment previously offered by FlatIron unnecessary.
42
21st Century Holding Company
Management's Discussion and Analysis of Financial Condition and
Results of Operations
As an alternative to premium finance we offer direct billing where the
insurance company accepts from the insured, as a receivable, a promise to pay
the premium, as opposed to requiring the full amount of the policy, either
directly from the insured or from a premium finance company. The advantage of
direct billing a policyholder by the insurance company is that we are not
reliant on our credit facility, but remain able to charge and collect interest
from the policyholder.
We believe that our current capital resources, including the net proceeds
from the sale of our agency operations, the Express Tax sale and the issuance of
our Notes described above, together with cash flow from operations, will be
sufficient to meet currently anticipated working capital requirements. There can
be no assurances, however, that such will be the case.
At December 31, 2004 and 2003, we did not have any relationships with
unconsolidated entities or financial partnerships, such as entities often
referred to as "structured finance" or "special purpose" entities, which were
established for the purpose of facilitating off-balance-sheet arrangements or
other contractually narrow or limited purposes. As such, management believes
that we currently are not exposed to any financing, liquidity, market or credit
risks that could arise if we had engaged in transactions of that type requiring
disclosure herein.
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. Our primary assets and liabilities are monetary in nature. As a
result, interest rates have a more significant impact on 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 LAE.
Insurance premiums are established before we know the amount of loss and
LAE 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 increasing
levels of inflation could cause increases in the dollar amount of incurred loss
and LAE and thereby materially adversely affect future liability requirements.
43
21st Century Holding Company
Management's Discussion and Analysis of Financial Condition and
Results of Operations
SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
Year Ended December 31, 2004
--------------------------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
------------ ------------ ------------ ------------
Continuing Operations:
Revenue:
Net premiums earned $ 13,007,676 $ 16,929,178 $ 25,290,962 $ 11,013,528
Other revenue 2,463,357 2,436,982 2,355,004 3,074,737
------------ ------------ ------------ ------------
Total revenue 15,471,033 19,366,160 27,645,966 14,088,265
------------ ------------ ------------ ------------
Expenses:
Losses and loss adjustment expenses 6,474,833 7,618,159 42,292,556 18,607,233
Other expenses 4,818,353 5,899,996 11,292,297 1,773,636
------------ ------------ ------------ ------------
Total expenses 11,293,186 13,518,155 53,584,853 20,380,869
------------ ------------ ------------ ------------
Income (loss) from continuing operations before provision
(benefit) for income tax expense 4,177,847 5,848,005 (25,938,887) (6,292,604)
Provision (benefit for income tax expense 1,546,817 2,110,216 (9,338,535) (4,328,814)
------------ ------------ ------------ ------------
Net income (loss) from continuing operations 2,631,030 3,737,789 (16,600,352) (1,963,790)
Discontinued Operations:
Revenue:
Other revenue 2,101,268 1,207,108 787,171 855,156
------------ ------------ ------------ ------------
Total revenue 2,101,268 1,207,108 787,171 855,156
------------ ------------ ------------ ------------
Expenses:
Other expenses 1,636,046 1,305,692 1,327,667 1,581,771
Total expenses 1,636,046 1,305,692 1,327,667 1,581,771
Gain on sale of discontinued operations -- -- -- 5,384,050
------------ ------------ ------------ ------------
Income (loss) from discontinued operations before provision
(benefit) for income tax expense 465,222 (98,584) (540,496) 4,657,435
Provision (benefit) for income tax expense 172,245 (35,573) (194,590) 3,203,947
------------ ------------ ------------ ------------
Net income (loss) from discontinued operations 292,977 (63,011) (345,906) 1,453,488
Income (loss) before provision for income tax expense 4,643,069 5,749,421 (26,479,383) (1,635,169)
Provision for income tax expense 1,719,062 2,074,643 (9,533,125) (1,124,867)
------------ ------------ ------------ ------------
Net income (loss) $ 2,924,007 $ 3,674,778 $(16,946,258) $ (510,302)
============ ============ ============ ============
Basic net income (loss) per share from continuing operations $ 0.47 $ 0.65 $ (2.80) $ (0.32)
============ ============ ============ ============
Basic net income (loss) per share from discontinued operations $ 0.05 $ (0.01) $ (0.06) $ 0.24
============ ============ ============ ============
Basic net income (loss) per share $ 0.52 $ 0.63 $ (2.86) $ (0.08)
============ ============ ============ ============
Fully diluted net income (loss) per share from continuing
operations $ 0.43 $ 0.61 $ (2.80) $ (0.32)
============ ============ ============ ============
Fully diluted net income (loss) per share from discontinued
operations $ 0.05 $ (0.01) $ (0.06) $ 0.24
============ ============ ============ ============
Fully diluted net income (loss) per share $ 0.48 $ 0.60 $ (2.86) $ (0.08)
============ ============ ============ ============
44
21st Century Holding Company
Management's Discussion and Analysis of Financial Condition and
Results of Operations
Year Ended December 31, 2003
--------------------------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
------------ ------------ ------------ ------------
Continuing Operations:
Revenue:
Net premiums earned $ 10,456,944 $ 10,949,001 $ 11,850,497 $ 11,620,788
Other revenue 2,632,346 3,361,987 2,479,655 2,829,634
------------ ------------ ------------ ------------
Total revenue 13,089,290 14,310,988 14,330,152 14,450,422
------------ ------------ ------------ ------------
Expenses:
Losses and loss adjustment expenses 6,787,709 7,493,747 6,322,281 6,905,242
Other expenses 3,025,855 2,958,918 4,322,351 4,712,920
------------ ------------ ------------ ------------
Total expenses 9,813,564 10,452,665 10,644,632 11,618,162
------------ ------------ ------------ ------------
Income from continuing operations before provision for income
tax expense 3,275,726 3,858,323 3,685,520 2,832,260
Provision for income tax expense 1,179,257 1,268,215 1,297,602 584,024
------------ ------------ ------------ ------------
Net income (loss) from continuing operations 2,096,469 2,590,108 2,387,918 2,248,236
Discontinued Operations:
Revenue:
Other revenue 1,772,720 633,791 691,269 837,668
------------ ------------ ------------ ------------
Total revenue 1,772,720 633,791 691,269 837,668
Expenses:
Other expenses 1,441,577 1,343,118 1,304,134 1,211,222
------------ ------------ ------------ ------------
Total expenses 1,441,577 1,343,118 1,304,134 1,211,222
Income (loss) from discontinued operations before provision
(benefit) for income tax expense 331,143 (709,327) (612,865) (373,554)
Provision (benefit) for income tax expense 119,211 (233,153) (215,778) (77,028)
------------ ------------ ------------ ------------
Net income (loss) from discontinued operations 211,932 (476,174) (397,087) (296,526)
Income before provision for income tax expense 3,606,869 3,148,996 3,072,655 2,458,706
Provision for income tax expense 1,298,468 1,035,062 1,081,824 506,996
------------ ------------ ------------ ------------
Net income $ 2,308,401 $ 2,113,934 $ 1,990,831 $ 1,951,710
============ ============ ============ ============
Basic net income (loss) per share from continuing operations $ 0.47 $ 0.56 $ 0.50 $ 0.44
============ ============ ============ ============
Basic net income (loss) per share from discontinued operations $ 0.04 $ (0.10) $ (0.08) $ (0.06)
============ ============ ============ ============
Basic net income (loss) per share $ 0.51 $ 0.46 $ 0.42 $ 0.38
============ ============ ============ ============
Fully diluted net income (loss) per share from continuing
operations $ 0.46 $ 0.54 $ 0.45 $ 0.40
============ ============ ============ ============
Fully diluted net income (loss) per share from discontinued
operations $ 0.04 $ (0.10) $ (0.08) $ (0.05)
============ ============ ============ ============
Fully diluted net income (loss) per share $ 0.50 $ 0.44 $ 0.38 $ 0.35
============ ============ ============ ============
45
21st Century Holding Company
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Our investment objective is to maximize total rate of return after Federal
income taxes while maintaining liquidity and minimizing risk. Our current
investment policy limits investment in non-investment grade fixed maturity
securities (including high-yield bonds), and limits total investments in
preferred stock, common stock and mortgage notes receivable. We also comply with
applicable laws and regulations, which further restrict the type, quality and
concentration of investments. In general, these laws and regulations permit
investments, within specified limits and subject to certain qualifications, in
Federal, state and municipal obligations, corporate bonds, preferred and common
equity securities and real estate mortgages.
Our investment policy is established by the Board of Directors or the
Investment Committee and is reviewed on a regular basis. Pursuant to this
investment policy, as of December 31, 2004, approximately 82.6% of investments
were in fixed income securities and short-term investments, which are considered
to be available for sale, based upon our intent at the time of purchase. Fixed
maturities are considered available for sale and are marked to market. We may in
the future also consider fixed maturities to be held to maturity and carried at
amortized cost. We do not use any material swaps, options, futures or forward
contracts to hedge or enhance our investment portfolio.
The investment portfolio is managed by the Investment Committee consisting
of our President, independent directors and our affiliated director in
accordance with guidelines established by the Florida Office of Insurance
Regulation.
The table below sets forth investment results for the periods indicated.
Years Ended December 31,
-----------------------------------
2004 2003 2002
------- ------- -------
(Dollars in Thousands)
Interest on fixed maturities $ 2,437 $ 1,463 $ 1,190
Dividends on equity securities 165 109 18
Interest on short-term securities 23 27 59
Other 555 118 17
------- ------- -------
Total investment income 3,180 1,717 1,284
Investment expense (8) (93) (30)
------- ------- -------
Net investment income $ 3,172 $ 1,624 $ 1,254
======= ======= =======
Net realized gain (loss) $ 689 $ 2,231 $(1,370)
======= ======= =======
The following table summarizes, by type, our investments as of December
31, 2004 and 2003.
December 31, 2004 December 31, 2003
----------------- -----------------
Carrying Percent Carrying Percent
Amount of Total Amount of Total
------- ------ ------- ------
(Dollars in (Dollars in
Thousands) Thousands)
Fixed maturities, at market:
U.S. government agencies and authorities $54,114 64.13% $25,544 54.02%
Obligations of states and political subdivisions 9,502 11.26% 7,634 16.14%
Corporate securities 5,971 7.08% 10,311 21.80%
------- ------ ------- ------
Total fixed maturities 69,587 82.47% 43,489 91.96%
Equity securities, at market 14,795 17.53% 3,663 7.75%
Mortgage notes receivable -- 0.00% 138 0.29%
------- ------ ------- ------
Total investments $84,382 100.00% $47,290 100.00%
======= ====== ======= ======
46
21st Century Holding Company
Fixed maturities are carried on the balance sheet at market. At December 31,
2004 and 2003, fixed maturities had the following quality ratings (by Moody's
Investors Service, Inc. ("Moody's") and for securities not assigned a rating by
Moody's, by Standard and Poor's Corporation)
December 31, 2004 December 31, 2003
----------------- -----------------
Carrying Percent Carrying Percent
Amount of Total Amount of Total
------- ------ ------- ------
(Dollars in (Dollars in
Thousands) Thousands)
AAA $62,487 89.80% $31,485 72.40%
AA 425 0.61% 226 0.52%
A 2,532 3.64% 7,135 16.41%
BBB 3,840 5.52% 3,925 9.03%
BB++ 303 0.43% 300 0.69%
Not rated -- 0.00% 419 0.95%
------- ------ ------- ------
$69,587 100.00% $43,490 100.00%
======= ====== ======= ======
The following table summarizes, by maturity, the fixed maturities as of
December 31, 2004 and 2003.
December 31, 2004 December 31, 2003
----------------- -----------------
Carrying Percent Carrying Percent
Amount of Total Amount of Total
------- ------ ------- ------
(Dollars in (Dollars in
Thousands) Thousands)
Matures In:
One year or less $ 390 0.56% $ 4,038 9.29%
One year to five years 6,892 9.90% 6,078 13.97%
Five years to 10 years 50,263 72.24% 22,373 51.44%
More than 10 years 12,042 17.30% 11,001 25.30%
------- ------ ------- ------
Total fixed maturities $69,587 100.00% $43,490 100.00%
======= ====== ======= ======
At December 31, 2004, the weighted average maturity of the fixed
maturities portfolio was approximately 9 years.
The following table provides information about the financial instruments
as of December 31, 2004 that are sensitive to changes in interest rates. The
table presents principal cash flows and the related weighted average interest
rate by expected maturity date:
2005 2006 2007 2008 2009
--------- ------- ------- --------- ---------
(Dollars in Thousands)
Principal amount by expected maturity:
U.S. government agencies and authorities $ 2,000 $ -- $ -- $ -- $ 2,000
Obligations of states and political subdivisions -- 350 950 1,180 1,345
Corporate securities 907 500 -- 2,200 250
Collateralized mortgage obligations -- -- -- -- --
Equity securities, at market -- -- -- -- --
Mortgage notes receivable -- -- -- -- --
--------- ------- ------- --------- ---------
All investments $ 2,907 $ 850 $ 950 $ 3,380 $ 3,595
========= ======= ======= ========= =========
Weighted average interest rate by expected maturity:
U.S. government agencies and authorities 4.00% 0.00% 0.00% 0.00% 4.12%
Obligations of states and political subdivisions 0.00% 5.75% 4.17% 4.74% 4.40%
Corporate securities 7.25% 4.00% 0.00% 6.08% 7.51%
Collateralized mortgage obligations 0.00% 0.00% 0.00% 0.00% 0.00%
Equity securities, at market 0.00% 0.00% 0.00% 0.00% 0.00%
Mortgage notes receivable 0.00% 0.00% 0.00% 0.00% 0.00%
All investments 5.01% 4.72% 4.17% 5.61% 4.46%
Carrying
Thereafter Total Amount
---------- ---------- -------
(Dollars in Thousands)
Principal amount by expected maturity:
U.S. government agencies and authorities $ 49,200 $ 53,200 $54,114
Obligations of states and political subdivisions 5,375 9,200 9,502
Corporate securities 2,000 5,857 5,971
Collateralized mortgage obligations -- -- --
Equity securities, at market -- -- 14,795
Mortgage notes receivable -- -- --
---------- ---------- -------
All investments $ 56,575 $ 68,257 $84,382
========== ========== =======
Weighted average interest rate by expected maturity:
U.S. government agencies and authorities 4.75% 4.70%
Obligations of states and political subdivisions 4.13% 4.31%
Corporate securities 3.38% 5.22%
Collateralized mortgage obligations 0.00% 0.00%
Equity securities, at market 0.00% 0.00%
Mortgage notes receivable 0.00% 0.00%
All investments 4.65% 4.69%
47
21st Century Holding Company
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE
Independent Auditors' Reports................................ 49
Consolidated Balance Sheets
as of December 31, 2004 and 2003........................... 50
Consolidated Statements of Operations
For the years ended December 31, 2004, 2003 and 2002....... 51
Consolidated Statements of Changes in Shareholders' Equity
and Comprehensive Income (Loss) For the years ended
December 31, 2004, 2003 and 2002........................... 52
Consolidated Statements of Cash Flows
For the years ended December 31, 2004, 2003 and 2002....... 53
Notes to Consolidated Financial Statements................... 55
48
21st Century Holding Company
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
21st Century Holding Company
We have audited the accompanying consolidated balance sheets of 21st Century
Holding Company and Subsidiaries (the "Company"), a Florida corporation, as of
December 31, 2004 and 2003, and the related consolidated statements of
operations, changes in stockholders' equity, and cash flows for each of the
years in the three-year period ended December 31, 2004. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. Our audit included consideration of internal control over financial
reporting as a basis for designing audit procedures that are appropriate in the
circumstances but not for the purpose of expressing an opinion on the
effectiveness of the Company's internal control over financial reporting.
Accordingly, we express no such opinion. An audit also includes assessing the
accounting principles used and significant estimates made by management, as well
as evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of 21st Century Holding Company
and Subsidiaries at December 31, 2004 and 2003 and the results of their
operations and their cash flows for each of the years in the three-year period
ended December 31, 2004 in conformity with U.S. generally accepted accounting
principles.
De Meo, Young, McGrath, CPA
Boca Raton, Florida
March 31, 2005
49
21st Century Holding Company and Subsidiaries
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2004 AND 2003
December 31, 2004 December 31, 2003
----------------- -----------------
ASSETS
Investments
Fixed maturities, available for
sale, at fair value $ 69,587,030 $ 43,489,598
Equity securities 14,795,143 3,663,251
Mortgage loans -- 137,571
------------- -------------
Total investments 84,382,173 47,290,420
------------- -------------
Cash and cash equivalents 6,127,706 6,770,169
Receivable for investments sold -- 2,118,595
Finance contracts, net of allowance for credit
losses of $475,788 in 2004 and $562,558 in 2003 8,289,356 9,891,642
Prepaid reinsurance premiums 5,510,379 8,415,095
Premiums receivable, net of allowance
for credit losses of $541,851 and
$123,000, respectively 6,024,913 7,328,256
Reinsurance recoverable, net 25,488,956 11,053,747
Deferred policy acquisition costs 6,957,168 1,739,685
Income taxes recoverable 7,915,424 824,787
Deferred income taxes 3,656,076 3,030,183
Property, plant and equipment, net 4,272,733 4,153,643
Goodwill, net 153,546 1,739,715
Other assets 4,822,942 2,339,656
------------- -------------
Total assets $ 163,601,372 $ 106,695,593
============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY
Unpaid losses and loss adjustment expenses $ 46,570,679 $ 24,570,198
Unearned premiums 50,152,711 34,122,663
Premiums deposits 1,871,683 621,777
Revolving credit outstanding 2,148,542 4,098,786
Bank overdraft 14,832,698 567,553
Subordinated debt 16,875,000 6,875,000
Deferred income from sale of agency operations 2,500,000 --
Accounts payable and accrued expenses 3,673,324 3,793,240
------------- -------------
Total liabilities 138,624,637 74,649,217
------------- -------------
Commitments and contingencies
Shareholders' equity:
Common stock, $0.01 par value
Authorized 37,500,000 shares;
issued 6,744,791 and 6,133,386
shares, respectively;
Outstanding 6,048,842 and
5,437,587, respectively 67,448 61,333
Additional paid-in capital 26,310,147 20,434,473
Accumulated other comprehensive income (deficit) (504,972) (324,881)
Retained earnings 883,757 13,643,225
Treasury stock, 696,849 shares and
695,799 shares, at cost,
respectively (1,779,645) (1,767,774)
------------- -------------
Total shareholders' equity 24,976,735 32,046,376
------------- -------------
Total liabilities and shareholders' equity $ 163,601,372 $ 106,695,593
============= =============
See accompanying notes to consolidated financial statements.
50
21st Century Holding Company and Subsidiaries
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
2004 2003 2002
------------- ------------- -------------
Revenue:
Gross premiums written $ 100,662,025 $ 72,991,434 $ 63,036,468
Gross premiums ceded (15,485,917) (22,090,644) (27,765,267)
------------- ------------- -------------
Net premiums written 85,176,108 50,900,790 35,271,201
------------- ------------- -------------
Increase (decrease) in prepaid reinsurance premiums (2,904,716) (3,427,818) 5,691,283
Decrease (increase) in unearned premiums (16,030,048) (5,188,177) (14,047,919)
------------- ------------- -------------
Net change in prepaid reinsurance
premiums and unearned premiums (18,934,764) (8,615,995) (8,356,636)
Net premiums earned 66,241,344 42,284,795 26,914,565
Finance revenue 3,667,837 4,327,675 4,452,626
Managing general agent fees 2,039,783 2,328,681 1,970,226
Net investment income 3,171,620 1,624,216 1,253,765
Net realized investment gains 688,676 2,231,333 (1,369,961)
Other income 762,164 791,718 769,915
------------- ------------- -------------
Total revenue 76,571,424 53,588,418 33,991,136
------------- ------------- -------------
Expenses:
Loss and loss adjustment expenses 74,992,781 27,508,979 15,987,125
Operating and underwriting expenses 8,139,812 7,249,440 6,367,632
Salaries and wages 6,134,168 5,425,538 4,562,115
Interest expense 1,087,494 606,910 353,225
Policy acquisition costs, net of amortization 8,422,808 (854,279) (2,064,314)
------------- ------------- -------------
Total expenses 98,777,063 39,936,588 25,205,783
Income (loss) from continuing operations
before provision (benefit) for income
tax expense (22,205,639) 13,651,830 8,785,353
Provision (benefit) for income tax expense (8,600,911) 4,357,960 3,685,572
------------- ------------- -------------
Net income (loss) from continuing operations (13,604,728) 9,293,870 5,099,781
Discontinued operations:
Income (loss) from discontinued
operations (including gain on
disposal of $5,384,050 for 2004) 4,483,577 (1,364,605) (912,303)
Provision (benefit) for income tax expense 1,736,624 (435,611) (382,723)
------------- ------------- -------------
Income (loss) on discontinued operations 2,746,953 (928,994) (529,580)
------------- ------------- -------------
Net income (loss) $ (10,857,775) $ 8,364,876 $ 4,570,201
============= ============= =============
Basic net income (loss) per share from continuing operations $ (2.34) $ 1.96 $ 1.13
============= ============= =============
Basic net income (loss) per share from discontinued operations $ 0.47 $ (0.20) $ (0.12)
============= ============= =============
Basic net income (loss) per share $ (1.86) $ 1.76 $ 1.01
============= ============= =============
Fully diluted net income (loss) per share from continuing operations $ (2.34) $ 1.85 $ 1.13
============= ============= =============
Fully diluted net income (loss) per share from discontinued operations $ 0.47 $ (0.18) $ (0.12)
============= ============= =============
Fully diluted net income (loss) per share $ (1.86) $ 1.67 $ 1.01
============= ============= =============
Weighted average number of common shares outstanding 5,847,102 4,756,972 4,508,439
========= ========= =========
Weighted average number of common shares outstanding (assuming dilution) 5,847,102 5,022,938 4,508,439
========= ========= =========
Dividends declared per share $ 0.32 $ 0.25 $ 0.10
============= ============= =============
See accompanying notes to consolidated financial statements.
51
21st Century Holding Company and Subsidiaries
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
AND COMPREHENSIVE INCOME (LOSS)
YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
Accumulated
Additional Other
Comprehensive Common Paid-in Comprehensive Retained
Income Stock Capital Deficit Earnings
------------- -------- ------------- ----------- -------------
Balance as of December 31, 2001 $ 51,161 $ 12,816,092 ($ 218,137) $ 2,400,301
Net Income $ 4,570,201 4,570,201
Cash Dividends (449,475)
Acqusition of common shares
Stock options exercised 15 22,392
Net unrealized change in investments, (8,954)
net of tax effect of $4,613 (8,954)
-------------
Comprehensive income $ 4,561,247
=============
-------- ------------- ----------- -------------
Balance as of December 31, 2002 $ 51,176 $ 12,838,484 $ (227,091) $ 6,521,027
-------- ------------- ----------- -------------
Net Income $ 8,364,876 8,364,876
Cash Dividends (1,242,678)
Acqusition of common shares
Stock options exercised 9,539 6,859,107
Stock issued in lieu of cash payment for 618 736,882
principal and interest associated with our
notes
Net unrealized change in investments, (97,790)
net of tax effect of $196,012 (97,790)
-------------
Comprehensive income $ 8,267,086
=============
-------- ------------- ----------- -------------
Balance as of December 31, 2003 $ 61,333 $ 20,434,473 $ (324,881) $ 13,643,225
-------- ------------- ----------- -------------
Net Loss ($ 10,857,775) (10,857,775)
Cash Dividends (1,879,585)
Acqusition of common shares
Stock options exercised 3,729 2,774,716
Warrants exercised 117 224,869
Stock issued in lieu of cash payment for 2,269 2,853,981
principal and interest associated with our
notes
Net unrealized change in investments,
net of tax effect of $304,667 (180,091) (180,091)
-------------
Comprehensive loss ($ 11,037,866)
=============
-------- ------------- ----------- -------------
Balance as of December 31, 2004 $ 67,448 $ 26,288,039 $ (504,972) $ 905,865
======== ============= =========== =============
Total
Treasury Shareholder'
Stock Equity
------------- -------------
Balance as of December 31, 2001 ($ 840,286) $ 14,209,131
Net Income 4,570,201
Cash Dividends (449,475)
Acqusition of common shares (253,446) (253,446)
Stock options exercised 7,800 30,207
Net unrealized change in investments, (8,954)
net of tax effect of $4,613
Comprehensive income --
------------- -------------
Balance as of December 31, 2002 $ (1,085,932) $ 18,097,664
------------- -------------
Net Loss 8,364,876
Cash Dividends (1,242,678)
Acqusition of common shares (681,842) (681,842)
Stock options exercised 6,868,646
Stock issued in lieu of cash payment for 737,500
principal and interest associated with our
notes
Net unrealized change in investments, (97,790)
net of tax effect of $196,012
Comprehensive income --
------------- -------------
Balance as of December 31, 2003 $ (1,767,774) $ 32,046,376
------------- -------------
Net Loss (10,857,775)
Cash Dividends (1,879,585)
Acqusition of common shares (11,871) (11,871)
Stock options exercised 2,778,445
Warrants exercised 224,986
Stock issued in lieu of cash payment for 2,856,250
principal and interest associated with our
notes
Net unrealized change in investments,
net of tax effect of $304,667 (180,091)
Comprehensive income --
------------- -------------
Balance as of December 31 2004 $ (1,779,645) $ 24,976,735
============= =============
See accompanying notes to consolidated financial statements.
52
21st Century Holding Company and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
For the year ended December 31,
2004 2003 2002
------------- ------------- -------------
Cash flow from operating activities:
Net income (loss) $ (10,857,775) $ 8,364,876 $ 4,570,201
Adjustments to reconcile net income (loss) to net cash provided by
operating activities:
Amortization of investment premium, net (190,777) 290,987 84,360
Depreciation and amortization of property plant and equipment, net 490,048 437,356 376,516
Deferred income tax expense (625,893) (338,874) (1,107,092)
Net realized investment gains (loss) 743,772 (2,042,607) 1,369,961
Common Stock issued for interest on Notes 356,250 112,500 --
Provision for credit losses, net 646,166 819,868 1,036,092
Provision for uncollectible premiums receivable 311,073 45,424 33,663
Gain on sale of agency operations (5,299,274) -- --
Other -- -- 30,207
Changes in operating assets and liabilities:
Premiums receivable 992,270 999,424 (6,845,853)
Prepaid reinsurance premiums 2,904,716 3,427,819 (5,691,284)
Due from reinsurers, net (14,435,209) (3,788,496) (803,643)
Income taxes recoverable (7,090,637) --
Policy acquisition costs, net of amortization (5,217,483) (1,731,964) 4,231
Goodwill -- (242,746) --
Finance contracts receivable 956,120 (3,493,637) 2,559,916
Other assets 44,597 (532,533) 640,212
Unpaid losses and loss adjustment expenses 22,000,481 7,586,442 5,978,419
Unearned premiums 16,030,048 5,188,177 13,983,258
Premium deposits 1,249,906 (33,936) (478,264)
Income taxes payable -- (1,676,020) 1,907,042
Bank overdraft 14,832,698 (277,394) (2,677,565)
Accounts payable and accrued expenses (736,699) (19,765) (475,019)
------------- ------------- -------------
Net cash provided by operating activities 18,577,796 12,270,114 14,495,358
------------- ------------- -------------
Cash flow (used in) provided by investing activities:
Proceeds from sale of investment securities available for sale 81,245,978 167,978,275 41,293,545
Purchases of investment securities available for sale (119,153,291) (188,055,815) (51,088,365)
Receivable for investments sold 2,118,595 (2,118,595) --
Collection of mortgage loans 137,571 7,472 451,314
Purchases of property and equipment (719,332) (1,289,108) (308,936)
Proceeds from sale of agency operations 5,488,489 -- --
Proceeds from sale of assets -- 1,621,384 199,687
------------- ------------- -------------
Net cash used in investing activities (30,881,990) (21,856,387) (9,452,755)
------------- ------------- -------------
Cash flow (used in) provided by financing activities:
Subordinated debt 12,500,000 7,500,000
Exercised stock options 2,778,444 6,868,646 --
Exercised warrants 224,987 -- --
Dividends paid (1,879,585) (1,242,678) (449,475)
Purchases of treasury stock (11,871) (681,842) (253,446)
Revolving credit outstanding (1,950,244) (213,634) (2,364,397)
------------- ------------- -------------
Net cash provided by financing activities 11,661,731 12,230,492 (3,067,318)
------------- ------------- -------------
Net (decrease) increase in cash and cash equivalents (642,463) 2,644,219 1,975,285
Cash and cash equivalents at beginning of period 6,770,169 4,125,950 2,150,665
------------- ------------- -------------
Cash and cash equivalents at end of period $ 6,127,706 $ 6,770,169 $ 4,125,950
============= ============= =============
See accompanying notes to consolidated financial statements.
53
21st Century Holding Company and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
For the year ended December 31,
2004 2003 2002
----------- ----------- -----------
(Continued)
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest $ 188,118 $ 393,729 $ 354,572
Income taxes $ 733,748 $ 4,784,502 $ 1,565,069
Non-cash investing and finance activities:
Accrued dividends payable $ 442,183 $ 422,890 $ 179,947
Retirement of subordinated debt by Common Stock issuance $ 3,125,000 $ 625,000 $ --
Stock issued to employees $ -- $ -- $ 7,800
Notes reveivable, net of deferred gains, received for sale of agencies $ 187,402 $ 187,790 $ (35,523)
See accompanying notes to consolidated financial statements
54
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2004, 2003, 2002
(1) ORGANIZATION AND BUSINESS
The accompanying consolidated financial statements include the accounts of
21st Century Holding Company and its subsidiaries. All significant intercompany
balances and transactions have been eliminated in consolidation.
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.
We are an insurance holding company, which, through our subsidiaries and
our contractual relationships with our independent agents, control substantially
all aspects of the insurance underwriting, distribution and claims process. We
underwrite personal automobile insurance, general liability 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, Louisiana and Texas and is admitted as a
surplus lines carrier in Georgia and Kentucky.
During the year ended December 31, 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").
During 2004, we marketed and distributed 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, 42 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 December 31, 2004, franchises were granted for 48 FedUSA
agencies, of which 42 were operating and 6 were pending.
On December 31, 2004, we sold most of the non-current assets and the
deferred policy acquisition liability related to our network of 24 Company-owned
agencies, 48 franchised agencies located in Florida including our franchise
operations to Fed USA Retail, Inc. and Fed USA Franchising, Inc. We retained
ownership of the current assets and liabilities. For further discussion of this
transaction see footnote 24, Discontinued Operations.
The Company-owned agencies were located in Miami-Dade, Broward, Palm
Beach, Martin, Orange, Osceola, Volusia and Seminole Counties, Florida. The
franchised agencies are located in Miami-Dade, Broward, Palm Beach, Martin, St.
Lucie, Orange, Lee and Collier Counties, Florida. The independent agents are
located throughout Florida.
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 also offered other services at our Company-owned and franchised
agencies, including tax return preparation and electronic filing and the
issuance and renewal of license tags. In August 1999, we acquired an 80%
interest in Express Tax Service, Inc ("Express Tax"). Express Tax licenses tax
return preparation software to business locations throughout the United States
and also earns fees on all electronically filed returns. Express Tax licenses
its software to the Company's agencies. On January 13, 2005, with an effective
date of January 1, 2005, we sold our 80% interest in Express Tax Service, Inc.
55
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2004, 2003, 2002
(along with its wholly owned subsidiary, EXPRESSTAX Franchise Corporation) to
Robert J. Kluba, the president of Express Tax and the holder of the 20% minority
interest in Express Tax, and Robert H. Taylor. In exchange for our shares, we
received a net cash payment of $311,351, which reflected a purchase price of
$660,000 less $348,649. in intercompany receivables we owed to Express Tax. In
addition, we received a payment of $1,200,000 in exchange for our agreement not
to compete with the current businesses of Express Tax for five years after the
sale. For further discussion see our Subsequent Events section.
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND PRACTICES
(A) CASH AND CASH EQUIVALENTS
We consider all short-term highly liquid investments with original
maturities of three months or less to be cash equivalents.
(B) INVESTMENTS
Our investment securities have been classified as available-for-sale
because all of the securities are available to be sold in response to our
liquidity needs, changes in market interest rates and asset-liability management
strategies, among other reasons. Investments available-for-sale are stated at
fair value on the balance sheet. Unrealized gains and losses are excluded from
earnings and are reported as a component of other comprehensive income within
shareholders' equity, net of related deferred income taxes.
A decline in the fair value of an available-for-sale security below
cost that is deemed other than temporary results in a charge to income,
resulting in the establishment of a new cost basis for the security. Premiums
and discounts are amortized or accreted, respectively, over the life of the
related fixed maturity security as an adjustment to yield using a method that
approximates the effective interest method. Dividends and interest income are
recognized when earned. Realized gains and losses are included in earnings and
are derived using the specific-identification method for determining the cost of
securities sold.
(C) PREMIUM REVENUE
Premium revenue on property and casualty insurance is earned on a
pro rata basis over the life of the policies. Unearned premiums represent the
portion of the premium related to the unexpired policy term.
(D) DEFERRED ACQUISITION COSTS
Deferred acquisition costs represent primarily commissions paid to
outside agents at the time of policy issuance (to the extent they are
recoverable from future premium income) net of ceded premium commission earned
from reinsurers, salaries and premium taxes net of policy fees, and are
amortized over the life of the related policy in relation to the amount of
premiums earned. The method followed in computing deferred acquisition costs
limits the amount of such deferred costs to their estimated realizable value,
which gives effect to the premium to be earned, related investment income,
unpaid losses and loss adjustment expenses and certain other costs expected to
be incurred as the premium is earned. There is no indication that these costs
will not be fully recoverable in the near term.
An analysis of deferred acquisition costs follows:
Year Ended December 31,
-----------------------
2004 2003 2002
------------ ------------ ------------
Balance, beginning of year $ 1,739,685 $ 7,721 $ 11,952
Acquisition costs deferred 13,640,291 877,685 (2,068,545)
Amortization expense during year (8,422,808) 854,279 2,064,314
------------ ------------ ------------
Balance, end of year $ 6,957,168 $ 1,739,685 $ 7,721
============ ============ ============
(E) PREMIUM DEPOSITS
56
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2004, 2003, 2002
Premium deposits represent premiums received on policies not yet
written. We take approximately 30 working days to issue the policy from the date
the cash and policy application are received.
(F) UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES
Unpaid losses and loss adjustment expenses are determined by
establishing liabilities in amounts estimated to cover incurred losses and loss
adjustment expenses. Such liabilities are determined based upon our assessment
of claims pending and the development of prior years' loss liability. These
amounts include liabilities based upon individual case estimates for reported
losses and loss adjustment expenses and estimates of such amounts that are
incurred but not reported. Changes in the estimated liability are charged or
credited to operations as the estimates are revised. Unpaid losses and loss
adjustment expenses are reported net of estimates for salvage and subrogation
recoveries, which totaled approximately $889,000, $859,000 and $550,000, net of
reinsurance, at December 31, 2004, 2003 and 2002, respectively.
The estimates of unpaid losses and loss adjustment expenses are
subject to the effect of trends in claims severity and frequency and are
continually reviewed. As part of the process, we review historical data and
consider various factors, including known and anticipated legal developments,
changes in social attitudes, inflation and economic conditions. As experience
develops and other data becomes available, these estimates are revised, as
required, resulting in increases or decreases to the existing unpaid losses and
loss adjustment expenses. Adjustments are reflected in results of operations in
the period in which they are made and the liabilities may deviate substantially
from prior estimates.
There can be no assurance that our unpaid losses and loss adjustment
expenses will be adequate to cover actual losses. If our unpaid losses and loss
adjustment expenses prove to be inadequate, we will be required to increase the
liability with a corresponding reduction in our net income in the period in
which the deficiency is identified. Future loss experience substantially in
excess of the established unpaid losses and loss adjustment expenses could have
a material adverse effect on our business, results of operations and financial
condition.
We do not discount unpaid losses and loss adjustment expenses for
financial statement purposes.
(G) COMMISSION INCOME
Commission income consists of fees earned by the Company-owned
agencies placing business with third party insurers and third party premium
finance companies. Commission income is earned on a pro rata basis over the life
of the policies. Unearned commissions represent the portion of the commissions
related to unexpired policy terms. During 2002 Assurance MGA completed its
program for underwriting insurance for an unaffiliated insurance company.
(H) FINANCE REVENUE
Interest and service income, resulting from the financing of
insurance premiums, is recognized using a method that approximates the effective
interest method. Late charges are recognized as income when chargeable.
(I) CREDIT LOSSES
Provisions for credit losses are provided in amounts sufficient to
maintain the allowance for credit losses at a level considered adequate to cover
anticipated losses. Generally, accounts that are over 90 days old are written
off to the allowance for credit losses. We have been increasing our reliance on
the direct billing our policyholders for their insurance premiums. Direct
billing is when the insurance company accepts from the insured, as a receivable,
a promise to pay the premium, as opposed to requiring payment of the full amount
of the policy, either directly from the insured or from a premium finance
company. We believe that the direct billing program does not increase our risk
because the insurance policy, which serves as collateral, is managed by our
computer system. Underwriting criteria are designed with down payment
requirements and monthly payments that create policyholder equity, also called
unearned premium, in the insurance policy. The equity in the policy is
collateral for the extension of credit to the insured. The increase in the
allowance for credit losses can be primarily attributed to homeowner and mobile
homeowner policyholders and a cancellation moratorium in effect for non-payment
of insurance premiums.
The activity in the allowance for credit losses for premiums
receivable was as follows:
57
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2004, 2003, 2002
Year Ended December 31,
-----------------------
2004 2003 2002
--------- --------- ---------
Allowance for credit losses at beginning of year $ 123,000 $ 201,000 $ 235,000
Additions charged to bad debt expense 462,365 11,259 34,710
Write-downs charged against the allowance (43,514) (89,259) (68,710)
--------- --------- ---------
Allowance for credit losses at end of year $ 541,851 $ 123,000 $ 201,000
========= ========= =========
See Note 4 for the activity in the allowance for credit losses for
finance contracts.
(J) MANAGING GENERAL AGENT FEES
If substantially all the costs associated with the MGA contracts
which do not involve affiliated insurers are incurred during the underwriting
process, then the MGA fees and the related acquisition costs are recognized at
the time the policy is underwritten, net of estimated cancellations. If the MGA
contract requires significant involvement subsequent to the completion of the
underwriting process, then the MGA fees and related acquisition costs are not
deferred and recognized over the life of the policy.
(K) POLICY FEES
Policy fees represent a $25 non-refundable application fee for
insurance coverage, which are intended to reimburse us for the costs incurred to
underwrite the policy. The fees and related costs are recognized when the policy
is underwritten. These fees are netted against underwriting costs and are
included as a component of deferred acquisition costs.
(L) REINSURANCE
We recognize the income and expense on reinsurance contracts
principally on a pro-rata basis over the life of the policies covered under the
reinsurance agreements. We are reinsured under separate reinsurance agreements
for the different lines of business underwritten. Reinsurance contracts do not
relieve us from our obligations to policyholders. We continually monitor our
reinsurers to minimize our exposure to significant losses from reinsurer
insolvencies. We only cede risks to reinsurers whom we believe to be financially
sound. At December 31, 2004, all reinsurance recoverables are considered
collectible.
(M) INCOME TAXES
Income taxes are accounted for under the asset and liability method.
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases, and operating loss and tax-credit carryforwards. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to taxable
income in the years in which those temporary differences are expected to be
recovered or settled. The effect on deferred tax assets and liabilities of a
change in tax rates is recognized in income in the period that includes the
enactment date.
(N) CONTINGENT REINSURANCE COMMISSION
Our reinsurance contracts provide ceding commissions for premiums
written which are subject to adjustment. The amount of ceding commissions is
determined by the loss experience for the reinsurance agreement term. The
reinsurer provides commissions on a sliding scale with maximum and minimum
achievable levels. The reinsurer provides us with the provisional commissions.
We have recognized the commissions based on the current loss experience for the
policy year premiums. This results in establishing a liability for the excess of
provisional commissions retained compared to amounts recognized, which is
subject to variation until the ultimate loss experience is determinable. There
were no contingent ceding commissions recognized for the year ended December 31,
2003 due to the provisions contained in the reinsurance contract allowing for a
flat rate commission schedule. For the year ended December 31, 2002 there was
$369,000 of contingent ceding commissions recognized.
58
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2004, 2003, 2002
(O) CONCENTRATION OF CREDIT RISK
Financial instruments, which potentially expose us to concentrations
of credit risk, consist primarily of investments, premiums receivable, amounts
due from reinsurers on paid and unpaid losses, finance contracts, consumer loans
and pay advances receivable. We have not experienced significant losses related
to premiums receivable from individual policyholders or groups of policyholders
in a particular industry or geographic area. We believe no credit risk beyond
the amounts provided for collection losses is inherent in our premiums
receivable or finance contracts, consumer loans and pay advances receivable. In
order to reduce credit risk for amounts due from reinsurers, we seek to do
business with financially sound reinsurance companies and regularly review the
financial strength of all reinsurers used.
(P) ACCOUNTING CHANGES
In December 2004, the Financial Accounting Standards Board ("FASB")
issued SFAS No. 123, Share-Based Payments (revised 2004) ("SFAS No. 123R"). This
statement eliminates the option to apply the intrinsic value measurement
provisions of APB No. 25 to stock compensation awards issued to employees.
Rather, SFAS No. 123R requires companies to measure the cost of employee
services received in exchange for an award of equity instruments based on the
grant date fair value of the award. That cost will be recognized over the period
during which an employee is required to provide services in exchange for the
award - the requisite service period (usually the vesting period). SFAS No. 123R
will also require companies to measure the cost of employee services received in
exchange for employee stock purchase plan awards. SFAS No. 123R will be
effective for 21st Century's fiscal quarter beginning July 1, 2005. We have not
yet determined the effect on us of the adoption of SFAS No. 123R.
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 which 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.
(Q) USE OF ESTIMATES
The preparation of the consolidated financial statements in
conformity with GAAP requires management to make estimates and assumptions that
affect the reported financial statement balances as well as the disclosure of
contingent assets and liabilities. Actual results could differ materially from
those estimates used.
Similar to other property and casualty insurers, our liability for
unpaid losses and LAE, although supported by actuarial projections and other
data, is ultimately based on management's reasoned expectations of future
events. Although considerable variability is inherent in these estimates, we
believe that this liability is adequate. Estimates are reviewed regularly and
adjusted as necessary. Such adjustments are reflected in current operations. In
addition, the realization of our deferred income tax assets is dependent on
generating sufficient future taxable income. It is reasonably possible that the
expectations associated with these accounts could change in the near term and
that the effect of such changes could be material to the Consolidated Financial
Statements.
59
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2004, 2003, 2002
(R) NATURE OF OPERATIONS
The following is a description of the most significant risks facing
us and how we mitigate those risks:
(I) LEGAL/REGULATORY RISKS--the risk that changes in the
regulatory environment in which an insurer operates will
create additional expenses not anticipated by the insurer in
pricing its products. That is, regulatory initiatives designed
to reduce insurer profits, restrict underwriting practices and
risk classifications, mandate rate reductions and refunds, and
new legal theories or insurance company insolvencies through
guaranty fund assessments may create costs for the insurer
beyond those recorded in the financial statements. We attempt
to mitigate this risk by monitoring proposed regulatory
legislation and by assessing the impact of new laws. As we
write business only in the states of Florida, Louisiana,
Texas, Alabama and Georgia, we are more exposed to this risk
than some of our more geographically balanced competitors.
As a result of the hurricanes striking Florida in August and
September 2004, we are not in compliance with certain
regulatory requirements. To retain our certificates of
authority, Florida insurance laws and regulations require that
our insurance company subsidiaries, Federated National and
American Vehicle, maintain capital surplus equal to the
greater of 10% of its liabilities or the 2004 statutory
minimum capital and surplus requirement of $4.00 million as
defined in the Florida Insurance Code. As of December 31,
2004, Federated National was not in compliance with its
requirement to maintain minimum capital surplus primarily
based on the incurred losses associated with the four
hurricanes that occurred in August and September 2004. Under
the provisions afforded Federated National according to
Statement of Statutory Accounting Principles No 72 titled
"Surplus and Quasi-reorganizations," compliance with this
provision was restored by way of a surplus infusion from 21st
Century. 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 December 31, 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. Under the provisions
afforded Federated National according to Statement of
Statutory Accounting Principles No. 72, compliance with this
provision was also restored. American Vehicle remains in
compliance with statutory premium-to-capital surplus ratios.
(II) CREDIT RISK--the risk that issuers of securities owned by us
will default or that other parties, including reinsurers to
whom business is ceded, which owe us money, will not pay. We
attempt to minimize this risk by adhering to a conservative
investment strategy, maintaining reinsurance agreements with
financially sound reinsurers, and by providing for any amounts
deemed uncollectible.
(III) INTEREST RATE RISK--the risk that interest rates will change
and cause a decrease in the value of an insurer's investments.
To the extent that liabilities come due more quickly than
assets mature, an insurer might have to sell assets prior to
maturity and potentially recognize a gain or a loss.
(IV) CATASTOPHIC EVENT RISK--the risk associated with writing
insurance policies covering automobile owners, home owners,
and business owners for losses that result from catastrophes,
including hurricanes, tropical storms, tornadoes or other
weather related events. We mitigate our risk of catastrophic
events through the use of reinsurance, forecast modeling
techniques and the monitoring of concentrations of risk, all
designed to protect the statutory surplus of the insurance
companies.
(S) FAIR VALUE
The fair value of our investments is estimated based on prices
published by financial services or quotations received from securities dealers
and is reflective of the interest rate environment that existed as of the close
of business on December 31, 2004 and 2003. Changes in interest rates subsequent
to December 31, 2004 may affect the fair value of our investments. Refer to Note
3(a) for details.
The carrying amounts for the following financial instrument
categories approximate their fair values at December 31, 2004 and 2003 because
of their short-term nature: cash and cash equivalents, premiums receivable,
finance contracts, due from reinsurers, drafts payable to insurance companies,
revolving credit outstanding, bank overdraft, accounts payable, accrued expenses
and subordinated debt.
60
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2004, 2003, 2002
(T) GOODWILL
In July 2001, the FASB issued SFAS 141 "Business Combinations,"
effective for all business combinations initiated after June 30, 2001, and SFAS
142 "Accounting for Goodwill and Other Intangible Assets," effective for fiscal
years beginning after December 15, 2001. SFAS 141 requires the purchase method
of accounting be used for all business combinations. Goodwill and
indefinite-lived intangible assets will remain on the balance sheet and not be
amortized. Intangible assets with a definite life will continue to be amortized
over their estimated useful lives. SFAS 142 establishes a new method of testing
goodwill for impairment. On an annual basis, and when there is reason to suspect
that their values may have been diminished or impaired, these assets must be
tested for impairment. The amount of goodwill determined to be impaired will be
expensed to current operations. Prior to the adoption of SFAS 141 and 142,
goodwill was amortized on a straight-line basis for financial statement purposes
over periods ranging from 10 to 20 years. Effective December 31, 2004 we sold
our interest in the assets associated with approximately $1,586,000 of goodwill.
The remaining goodwill as of Decemeber 31, 2004 was sold on January 1, 2005.
According to these transactions it was determined that goodwill was not impaired
as of December 31, 2004. There was no amortization of goodwill recorded in 2004
and 2003.
Goodwill is stated separately on the balance sheet and totaled $
153,546 and $1,739,715 at December 31, 2004 and 2003, respectively, net of
$61,419 and $1,726,530 of accumulated amortization as of December 31, 2004 and
2003, respectively. Our remaining goodwill relates to our Express Tax Service
and EXPRESSTAX franchise subsidiaries which are included in our other segment.
The impairment computation for 2004 and 2003 indicated there was no impairment
of goodwill as of December 31, 2004 and 2003. Based upon this valuation
analysis, goodwill does not appear to be impaired as of December 31, 2004 and
2003.
(U) STOCK OPTION PLANS
We account for stock-based compensation using the intrinsic value
method prescribed in Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees". Compensation cost for stock options, if any, is
measured as the excess of the quoted market price of our stock at the date of
grant over the amount an employee must pay to acquire the stock.
The FASB Statement of Financial Accounting Standards No. 123,
"Accounting for Stock-Based Compensation" (FAS 123) establishes financial
accounting and reporting standards for stock-based compensation plans. As
permitted by FAS 123, we use the accounting method prescribed by Accounting
Principles Board Opinion No. 25 "Accounting for Stock Issued to Employees" (APB
25) to account for our stock-based compensation plans. Companies using APB 25
are required to make pro forma footnote disclosures of net income and earnings
per share as if the fair value method of accounting, as defined in FAS 123, had
been applied. See Note 2(e) "Accounting Changes" and Note 16 "Stock Compensation
Plans" for more information.
As of December 31, 2002 we adopted the FASB Statement of Financial
Accounting Standards No. 148, "Accounting for Stock-Based Compensation -
Transition and Disclosure" (FAS 148). FAS 148 amends FAS 123 to provide
alternative methods of transition to FAS 123's fair value method of accounting
for stock-based compensation. FAS 148 also amends the disclosure provisions of
FAS 123 to require disclosure in the Summary of Significant Accounting Policies
footnote the effects of an entity's accounting policy with respect to
stock-based employee compensation on reported net income and earnings per share.
We continue to account for stock-based compensation using the
intrinsic value method prescribed by Accounting Principles Board Opinion No. 25,
under which no compensation cost for stock options is recognized for stock
option awards granted to employees at or above fair market value. Had
compensation expense for our stock compensation plan been determined based upon
fair values at the grant dates for awards under the plan in accordance with SFAS
No. 123, our net income (loss) and net income (loss) per share would have been
reduced (increased) to the pro forma amounts indicated below. Additional stock
option awards are anticipated in future years.
61
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2004, 2003, 2002
For the year ended December 31,
--------------------------------
2004 2003 2002
-------------- ------------- -------------
Net Income (loss) as reported $ (10,857,776) $ 8,364,876 $ 4,570,201
Compensation, net of tax effect 7,277,028 4,783,080 1,750,528
-------------- ------------- -------------
Pro forma net income (loss) $ (18,134,804) $ 3,581,796 $ 2,819,673
============== ============= =============
Net income (loss) per share
As reported - Basic $ (1.86) $ 1.76 $ 1.01
As reported - Diluted $ (1.86) $ 1.67 $ 1.01
Pro forma - Basic $ (3.10) $ 0.75 $ 0.63
Pro forma - Diluted $ (3.10) $ 0.71 $ 0.63
(V) PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment are stated at cost less accumulated
depreciation. Depreciation on property, plant and equipment is calculated on a
straight-line basis over the following estimated useful lives: building and
improvements - 30 years and furniture and fixtures - 7 years. We capitalize
betterments and any other expenditure in excess of $500 if the asset is expected
to have a useful life greater than one year. The carrying value of property,
plant and equipment is periodically reviewed based on the expected future
undiscounted operating cash flows of the related item. Based upon our most
recent analysis, we believe that no impairment of property, plant and equipment
exists at December 31, 2004.
(W) RECLASSIFICATIONS
Certain 2003 financial statement amounts have been reclassified to
conform with the 2004 presentations.
(3) INVESTMENTS
(A) FIXED MATURITIES AND EQUITY SECURITIES
The following table shows the realized gains (losses) for fixed and
equity securities for the years ended December 31, 2004 and 2003:
Year Ended December 31,
Gains (Losses) Fair Value Gains (Losses) Fair Value
2004 at Sale 2003 at Sale
------------ ------------ ------------ ------------
Fixed income securities $ 62,513 $ 6,418,287 $ 1,590,936 $102,966,845
Equity securities 894,883 16,751,595 1,230,118 38,847,014
------------ ------------ ------------ ------------
Total realized gains 957,396 23,169,882 2,821,054 141,813,859
------------ ------------ ------------ ------------
Fixed income securities (42,911) 38,133,986 (508,299) 17,213,554
Equity securities (225,809) 16,997,269 (81,422) 7,555,755
------------ ------------ ------------ ------------
Total realized losses (268,720) 55,131,255 (589,721) 24,769,309
------------ ------------ ------------ ------------
Net realized gains on
investments $ 688,676 $ 78,301,137 $ 2,231,333 $166,583,168
============ ============ ============ ============
62
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2004, 2003, 2002
A summary of the amortized cost, estimated fair value, gross unrealized
gains and losses of fixed maturities and equity securities at December 31, 2004
and 2003 is as follows:
Gross Gross
Amortized Unrealized Unrealized Estimated
Cost Gains Losses Fair Value
----------- ----------- ----------- -----------
December 31, 2004
Fixed Maturities:
U.S. government obligations $54,695,914 $ 154,809 $ 737,119 $54,113,604
Obligations of states and
political subdivisions 9,506,161 63,179 67,681 9,501,659
Corporate securities 5,895,310 101,684 25,227 5,971,767
----------- ----------- ----------- -----------
$70,097,385 $ 319,672 $ 830,027 $69,587,030
=========== =========== =========== ===========
Equity securities - preferred stocks $ 2,000,000 $ -- $ -- $ 2,000,000
common stocks 13,107,553 147,287 459,697 12,795,143
----------- ----------- ----------- -----------
$15,107,553 $ 147,287 $ 459,697 $14,795,143
=========== =========== =========== ===========
December 31, 2003
Fixed Maturities:
U.S. government obligations $26,337,724 $ 63,038 $ 856,651 $25,544,111
Obligations of states and
political subdivisions 7,639,293 60,501 65,342 7,634,452
Corporate securities 10,041,640 298,631 29,236 10,311,035
----------- ----------- ----------- -----------
$44,018,657 $ 422,170 $ 951,229 $43,489,598
=========== =========== =========== ===========
Equity securities - preferred stocks $ 250,000 $ 400 $ -- $ 250,400
common stocks 3,409,697 5,000 1,846 3,412,851
----------- ----------- ----------- -----------
$ 3,659,697 $ 5,400 $ 1,846 $ 3,663,251
=========== =========== =========== ===========
Below is a summary of fixed maturities at December 31, 2004 and 2003 by
contractual or expected maturity periods. Expected maturities may differ from
contractual maturities because borrowers may have the right to call or prepay
obligations with or without call or prepayment penalties.
December 31, 2004 December 31, 2003
----------------- -----------------
Amortized Estimated Amortized Estimated
Cost Fair Value Cost Fair Value
----------- ----------- ----------- -----------
Due in one year or less $ 386,076 $ 389,648 $ 3,823,434 $ 4,039,356
Due after one year through
five years 6,876,095 6,892,451 5,975,696 6,077,534
Due after five years through
ten
years 50,509,441 50,263,305 22,835,339 22,372,081
Due after ten years 12,325,772 12,041,626 11,384,188 11,000,627
----------- ----------- ----------- -----------
$70,097,384 $69,587,030 $44,018,657 $43,489,598
=========== =========== =========== ===========
63
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2004, 2003, 2002
United States Treasury Notes with a book value of $1,000,000, each,
and maturing in 2012 were on deposit with the Florida Office of Insurance
Regulation as of December 31, 2004, as required by law for both Federated
National and American Vehicle.
A summary of the sources of net investment income follows:
Years Ended December 31,
------------------------
2004 2003
----------- -----------
Fixed maturities $ 2,436,845 $ 1,462,919
Equity securities 691,192 108,983
Cash and cash equivalents 49,178 26,676
Other 3,065 118,057
----------- -----------
Total investment income 3,180,280 1,716,635
Less investment expenses (8,660) (92,419)
----------- -----------
Net investment income $ 3,171,620 $ 1,624,216
=========== ===========
Proceeds from sales of fixed maturities and equity securities for
the years ended December 31, 2004, 2003 and 2002 were approximately
$81.2 million, $168.0 million and $41.3 million, respectively.
A summary of realized investment gains (losses) and (increases) in
net unrealized losses follows:
Years Ended December 31,
------------------------
2004 2003
----------- -----------
Net realized gains
(losses):
Fixed maturities $ 19,602 $ 1,082,637
Equity securities 669,074 1,148,696
----------- -----------
Total $ 688,676 $ 2,231,333
=========== ===========
*Includes a $2,000,000 impairment loss
Net unrealized losses:
Fixed maturities $ 18,701 $ (321,514)
Equity securities (315,964) 27,712
----------- -----------
Total $ (297,263) $ (293,802)
=========== ===========
(B) MORTGAGE LOANS
Years Ended December 31,
------------------------
2004 2003
--------- ---------
Mortgage receivable beginning of year $ 137,571 $ 145,043
New mortgages -- --
Principal payments received (137,571) (7,472)
--------- ---------
Mortgage receivable end of year $ -- $ 137,571
========= =========
A portion of these amounts represents outstanding balances from
related party transactions. Refer to Note 13 for details.
(4) FINANCE CONTRACTS RECEIVABLE
Below is a summary of the components of the finance contracts receivable
balance:
64
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2004, 2003, 2002
Years Ended December 31,
2004 2003
------------ ------------
Finance contracts receivable $ 9,218,631 $ 10,990,446
Less:
Unearned income (453,487) (536,246)
Allowance for credit losses (475,788) (562,558)
------------ ------------
Finance contracts, net of allowance for credit losses $ 8,289,356 $ 9,891,642
============ ============
The activity in the allowance for credit losses was as follows:
Years Ended December 31,
------------------------
2004 2003
--------- ---------
Allowance for credit losses at beginning of year $ 562,558 $ 404,356
Additions charged to bad debt expense 559,396 819,868
Write-offs charged against the allowance (646,166) (661,666)
--------- ---------
Allowance for credit losses at end of year $ 475,788 $ 562,558
========= =========
As of December 31, 2004, approximately $2.6 million, or 28.8%, of the
gross premium finance receivables (before the allowances for credit losses and
unearned premium finance charges) that represent policies from an unrelated
insurer. This unrelated insurance company currently is rated "B-" (Fair) by A.M.
Best.
As security, Federated Premium retains a contractual right, if a premium
installment is not paid when due, to cancel the insurance policy and to receive
the unearned premium from the insurer.
(5) PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consist of the following:
Years Ended December 31,
------------------------
2004 2003
----------- -----------
Land $ 625,000 $ 632,144
Building and improvements 3,114,300 2,823,400
Furniture and fixtures 2,562,971 2,385,083
----------- -----------
Property, plant and equipment, gross 6,302,271 5,840,627
Accumulated depreciation (2,029,538) (1,686,984)
----------- -----------
Property, plant and equipment, net $ 4,272,733 $ 4,153,643
=========== ===========
Depreciation of property, plant, and equipment was $490,697, $437,356 and
$376,516 during 2004, 2003 and 2002, respectively.
(6) REINSURANCE
We reinsure (cede) a portion of written premiums on a quota-share basis
to nonaffiliated insurance companies in order to limit our loss exposure. We
also maintain coverages to limit losses from large exposures, which we believe
are adequate for current volume. To the extent that reinsuring companies are
unable to meet their obligations assumed under the reinsurance agreements, we
remain primarily liable to our policyholders.
The impact of reinsurance on the financial statements is as follows:
65
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2004, 2003, 2002
Years Ended December 31,
------------------------
2004 2003 2002
------------- ------------- -------------
Premium written:
Direct $ 100,662,025 $ 72,991,434 $ 63,036,468
Ceded (15,485,917) (22,090,644) (25,286,828)
------------- ------------- -------------
$ 85,176,108 $ 50,900,790 $ 37,749,640
============= ============= =============
Premiums earned:
Direct $ 84,631,511 $ 67,803,257 $ 48,988,774
Ceded (18,390,167) (25,518,462) (19,595,770)
------------- ------------- -------------
$ 66,241,344 $ 42,284,795 $ 29,393,004
============= ============= =============
Losses and loss adjustment expenses incurred:
Direct $ 138,605,465 $ 46,035,627 $ 29,776,770
Ceded (63,612,684) (18,526,648) (13,789,645)
------------- ------------- -------------
$ 74,992,781 $ 27,508,979 $ 15,987,125
============= ============= =============
As of December 31,
------------------
2004 2003
------------ ------------
Unpaid losses and loss adjustment expenses, net:
Direct $ 46,570,679 $ 24,570,198
Ceded (9,414,794) (9,761,353)
------------ ------------
$ 37,155,885 $ 14,808,845
============ ============
Unearned premiums:
Direct $ 50,152,711 $ 34,122,663
Ceded (5,510,379) (7,823,374)
------------ ------------
$ 44,642,332 $ 26,299,289
============ ============
We earned approximately $1.5 million, $6.7 million and $6.8 million in
commissions on premiums ceded during the years ended December 31, 2004, 2003 and
2002, respectively. Had all of our reinsurance agreements been cancelled at
December 31, 2004 we would have returned no reinsurance commissions to our
reinsurers and in turn, our reinsurers would have nothing to return to us from
unearned premiums. Had all of our reinsurance agreements been canceled at
December 31, 2003, we would have returned a total of approximately $2.5 million
in reinsurance commissions to our reinsurers; in turn, our reinsurers would have
returned approximately $7.8 million in unearned premiums to us.
66
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2004, 2003, 2002
At December 31, 2004 and 2003, the Company had an unsecured aggregate
recoverable for paid and unpaid losses and loss adjustment expenses and unearned
premiums with the following reinsurers:
As of December 31,
------------------
2004 2003
------------ ------------
Transatlantic Reinsurance Company (A+ A.M. Best Rated):
Unearned premiums $ 2,559 $ 7,823,374
Reinsurance recoverable on paid losses and loss adjustment
expenses 1,661,751 2,457,228
Unpaid losses and loss adjustment expenses 2,507,403 9,761,353
------------ ------------
$ 4,171,713 $ 20,041,955
Amounts due from reinsurers consisted of amounts related to:
Unpaid losses and loss adjustment expenses $ 2,507,403 $ 9,761,353
Reinsurance recoverable on paid losses and loss adjustment
expenses 1,661,751 2,457,228
Reinsurance receivable
(payable) 11,301 (1,339,162)
------------ ------------
$ 4,180,455 $ 10,879,419
(7) UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES ("LAE")
The liability for unpaid losses and loss adjustment expenses is determined
on an individual-case basis for all incidents reported. The liability also
includes amounts for unallocated expenses, anticipated future claim development
and IBNR.
Activity in the liability for unpaid losses and loss adjustment expenses
is summarized as follows:
For the years ended December 31,
---------------------------------
2004 2003 2002
------------ ------------ ------------
Balance at January 1: $ 24,570,198 $ 16,983,756 $ 11,005,337
Less reinsurance recoverables (9,761,354) (7,847,421) (4,798,556)
------------ ------------ ------------
Net balance at January 1 $ 14,808,844 $ 9,136,335 $ 6,206,781
============ ============ ============
Incurred related to:
Current year $ 76,423,059 $ 26,274,932 $ 15,896,251
Prior years (1,430,278) 1,234,047 90,874
------------ ------------ ------------
Total incurred $ 74,992,781 $ 27,508,979 $ 15,987,125
============ ============ ============
Paid related to:
Current year $ 42,304,178 $ 14,205,212 $ 8,149,079
Prior years 10,341,563 7,631,258 4,908,492
------------ ------------ ------------
Total paid $ 52,645,741 $ 21,836,470 $ 13,057,571
============ ============ ============
Net balance at year-end $ 37,155,884 $ 14,808,844 $ 9,136,335
Plus reinsurance recoverables 9,414,795 9,761,354 7,847,421
------------ ------------ ------------
Balance at year-end $ 46,570,679 $ 24,570,198 $ 16,983,756
============ ============ ============
Based upon consultations with our independent actuarial consultants and
their statement of opinion on losses and loss adjustment expenses, we believe
that the liability for unpaid losses and loss adjustment expenses is adequate to
cover all claims and related expenses which may arise from incidents reported.
67
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2004, 2003, 2002
As a result of our review of our liability for losses and LAE, which
includes a re-evaluation of the adequacy of reserve levels for prior year's
claims, we decreased the liability for loss and LAE for claims occurring in
prior years by $1,430,278 for the year ended December 31, 2004 and increased the
liability for loss and LAE for claims occurring in prior years by $1,234,047 and
$90,874 for the year ended December 31, 2003 and 2002, respectively. The
adjustments in the liability were primarily attributable to loss development
with respect to our personal automobile insurance program. There can be no
assurance concerning future adjustments of reserves, positive or negative, for
claims through December 31, 2004.
(8) 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 WPAC, a wholly-owned subsidiary of FlatIron, which
gives WPAC 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 to $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. As of December 31,
2004, under the terms of our agreement with FlatIron, only American Vehicle
policies are eligible for collateral and beginning in March 2005, our Lender
agreed to permit policies written by Federated National to be eligible for
collateral up to $165,000.
The amount of WPAC'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 December 31, 2004, our interest rate was 7.00% as
compared to our interest rate as of December 31, 2003 of 5.75%
The Revolving Agreement contains various operating and financial
covenants, with which we were in compliance at December 31, 2004 and December
31, 2003. Outstanding borrowings under the Revolving Agreement as of December
31, 2004 and December 31, 2003 were $2.1 million and $4.1 million, respectively.
Outstanding borrowings in excess of the $2.0 million commitment totaled $148,542
as of December 31, 2004. The excess amount, permissible by reason of a
compensating cash balance of $156,070 for December 31, 2004, was held for the
benefit of FPF and is included in other assets. 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 years ended
December 31, 2004, 2003 and 2002 totaled approximately $178,000, $203,000 and
$342,000, respectively.
The annual interest rate on advances under the Revolving Agreement is the
prime rate plus additional interest varying from 1.25% to 3.25% based on the
prior month's ratio of contracts receivable related to insurance companies with
an A. M. Best rating of B or worse to total contracts receivable. The effective
interest rate on this line of credit, based on our average outstanding
borrowings under the Revolving Agreement, was 5.71%, 4.83% and 6.23% for the
years ended December 31, 2004, 2003 and 2002, respectively.
In September 2002, Flatiron reduced the maximum credit commitment under
the Revolving Agreement due to the A.M. Best ratings of third party insurance
carriers with which we were financing policies at the time. Simultaneously,
however, we ceased financing policies underwritten by third party insurance
carriers altogether and began financing only those policies underwritten by our
insurance carriers (in 2003 we began again to finance policies from a small
number of independent agents whose customer base and operational history meet
our strict criteria for credit worthiness). Additionally, we implemented a
direct billing program for policies underwritten by our carriers. These changes
markedly decreased credit risks and made our reliance on the higher credit
commitment previously offered by FlatIron unnecessary.
Direct billing is where the insurance company accepts from the insured, as
a receivable, a promise to pay the premium, as opposed to requiring the full
amount of the policy, either directly from the insured or from a premium finance
company. The amount of WPAC's advance is subject to availability under a
borrowing base calculation, with maximum advances outstanding not to exceed the
maximum credit commitment.
68
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2004, 2003, 2002
(9) INCOME TAXES
A summary of the provision for income tax expense (benefit) is as follows:
Year Ended December 31,
-----------------------
2004 2003 2002
----------- ----------- -----------
Federal:
Current $(6,656,755) $ 3,404,982 $ 3,323,281
Deferred 778,573 (39,283) (453,708)
----------- ----------- -----------
Provision (benefit) for Federal income tax expense (5,878,182) 3,365,699 2,869,573
----------- ----------- -----------
State:
Current -- 563,375 510,941
Deferred (986,105) (6,725) (77,665)
----------- ----------- -----------
Provision (benefit) for state income tax expense (986,105) 556,650 433,276
----------- ----------- -----------
Provision (benefit) for income tax expense $(6,864,287) $ 3,922,349 $ 3,302,849
=========== =========== ===========
The actual income tax expense (benefit) differs from the "expected" income
tax expense (benefit) (computed by applying the combined applicable effective
federal and state tax rates to income (loss) before provision for income tax
expense (benefit)) as follows:
Year Ended December 31,
-----------------------
2004 2003 2002
----------- ----------- -----------
Computed expected tax (benefit), at federal rate $(6,025,502) $ 4,177,657 $ 2,437,254
State tax, net of federal deduction benefit (650,829) 556,650 443,276
Tax-exempt interest (124,125) (122,275) (95,564)
Amortization of goodwill -- 53,536 54,641
Dividend received deduction (135,847) (42,612) (5,205)
Capital loss carryforward -- (371,847) --
Disposition of financially impaired bond -- (340,000) --
Valuation allowance for capital loss carry forward -- -- 256,083
Interest expense not requiring cash 176,375 -- --
Other, net (104,359) 11,240 212,364
----------- ----------- -----------
Income tax expense (benefit), as reported $(6,864,287) $ 3,922,349 $ 3,302,849
=========== =========== ===========
69
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2004, 2003, 2002
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components of
our net deferred tax asset are as follows:
Year Ended December 31,
-----------------------
2004 2003
----------- -----------
Deferred tax assets:
Unpaid losses and loss adjustment expenses $ 1,369,078 $ 501,190
Unearned premiums 3,340,012 1,979,284
Unrealized loss on investment securities 304,667 196,012
Allowance for credit losses 367,232 257,975
Unearned commissions 183,486 189,222
Accrued class action settlement 225,780 225,780
Deferred commissions 56,445 75,260
Goodwill 52,130 131,063
Unearned adjusting income 9,462 20,456
Capital loss carryforward - Impairment loss 376,300 376,300
----------- -----------
Total deferred tax assets 6,284,592 3,952,542
----------- -----------
Deferred tax liabilities:
Prepaid Florida Hurricane Catastrophic Fund -- (222,664)
Deferred acquisition costs, net (2,624,702) (661,262)
Depreciation (3,814) (38,433)
----------- -----------
Total deferred tax liabilities (2,628,516) (922,359)
----------- -----------
Net deferred tax asset $ 3,656,076 $ 3,030,183
=========== ===========
In assessing the net realizable value of deferred tax assets, management
considers whether it is more likely than not that some portion or all of the
deferred tax assets will not be realized. The ultimate realization of deferred
tax assets is dependent upon the generation of future taxable income during the
periods in which those temporary differences become deductible. Management
considers the scheduled reversal of deferred tax liabilities, projected future
taxable income and tax planning strategies in making this assessment. At
December 31, 2004 and 2003, based upon the level of historical taxable income
and projections for future taxable income over the periods in which the deferred
tax assets are deductible, management believes it is more likely than not that
the Company will realize the benefits of these deductible differences.
70
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2004, 2003, 2002
(10) REGULATORY REQUIREMENTS AND RESTRICTIONS
To retain our certificate of authority, the Florida Insurance Code (the
"Code") requires Federated National and American Vehicle to maintain capital and
surplus equal to the greater of 10 percent of their liabilities or a statutory
minimum capital and surplus as defined in the Code. In 2004, 2003 and 2002,
Federated National and American Vehicle were required to have capital surplus of
$4.0 million, $3.60 million and $3.25 million, each, respectively. At December
31, 2004, 2003 and 2002, Federated National's statutory capital surplus was $7.6
million, $16.7 million and $9.2 million, respectively. At December 31, 2004,
2003 and 2002, American Vehicle had statutory capital surplus of $17.1 million,
$10.7 million and $4.0 million, respectively. Further, the companies were also
required to adhere to a prescribed net premium-to-surplus ratio.
As of December 31, 2004, Federated National was not in compliance with its
requirement to maintain minimum capital surplus primarily based on the incurred
losses associated with the four hurricanes that occurred in August and September
2004. Under the provisions afforded Federated National according to Statement of
Statutory Accounting Principles No 72 titled "Surplus and
Quasi-reorganizations," compliance with this provision was restored. 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 December 31, 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. Under the provisions afforded Federated National
according to Statement of Statutory Accounting Principles No 72, compliance with
this provision was also restored. American Vehicle remains in compliance with
statutory premium-to-capital surplus ratios.
As of December 31, 2004, to meet regulatory requirements, we had bonds
with a carrying value of approximately $2,049,000 pledged to the Insurance
Commissioner of the State of Florida.
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 Office of Insurance
Regulation if the dividend or distribution would exceed the larger of (i) the
lesser of (a) 10 percent of capital surplus (b) net income, not including
realized capital gains, plus a two-year carryforward, (ii) 10 percent of capital
surplus with dividends payable constrained to unassigned funds minus 25 percent
of unrealized capital gains or (iii) the lesser of (a) 10 percent of capital
surplus or (b) net investment income plus a three-year carryforward with
dividends payable constrained to unassigned funds minus 25 percent of unrealized
capital gains. Alternatively, a Florida domestic insurer may pay a dividend or
distribution without the prior written approval of the Florida Office of
Insurance Regulation (i) if the dividend is equal to or less than the greater of
(a) 10 percent 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 immediate preceding calendar year, (ii) the insurer
will have policyholder capital surplus equal to or exceeding 115 percent 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 Office of Insurance Regulation 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 percent 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 Office of Insurance Regulation or (ii) 30 days
after the Florida Office of Insurance Regulation has received notice of such
dividend or distribution and has not disapproved it within such time. No
dividends were declared or paid in 2004, 2003 or 2002. Under these laws, neither
Federated National nor American Vehicle would be permitted to pay dividends to
21st Century in 2004.
In order to enhance the regulation of insurer solvency, the NAIC
established risk-based capital requirements for insurance companies that are
designed to assess capital adequacy and to raise the level of protection that
statutory surplus provides for policy holders. These requirements measure three
major areas of risk facing property and casualty insurers: (i) underwriting
risks, which encompass the risk of adverse loss developments and inadequate
pricing; (ii) declines in asset values arising from credit risk; and (iii) other
business risks from investments. Insurers having less statutory surplus than
required will be subject to varying degrees of regulatory action, depending on
the level of capital inadequacy. Based upon the 2004 statutory financial
statements for American Vehicle, statutory surplus exceeded all regulatory
action levels established by the NAIC. Based upon the 2004 statutory financial
statements for Federated National, statutory surplus did not exceed regulatory
action levels established by the NAIC. Federated National's results required us
to submit a plan containing corrective actions. Federated has submitted its plan
71
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2004, 2003, 2002
for corrective action and is currently in discussions with the Florida Office of
Insurance Regulation regarding the merits of the action plan points. The
regulatory action level permits the insurance regulators to perform an
examination or other analysis and issue a corrective order. Federated National
is scheduled to have its statutorily required triennial examination during 2005
for the three years ended December 31, 2004 to be performed by the Florida
Office of Insurance Regulation. We may be subject of additional targeted
examinations or analysis. These examinations or analysis may result in one or
more corrective orders being issued by the Florida Office of Insurance
Regulation.
The Florida Office of Insurance Regulation, which follows these
requirements, could require Federated National or American Vehicle to cease
operations in the event they fail to maintain the required statutory capital.
Based on Risk Based Capital requirements, the extent of regulatory
intervention and action increases as the ratio of an insurer's statutory surplus
to its Authorized Control Level ("ACL"), as calculated under the NAIC's
requirements, decreases. The first action level, the Company Action Level,
requires an insurer to submit a plan of corrective actions to the insurance
regulators if statutory surplus falls below 200.0% of the ACL amount. The second
action level, the Regulatory Action Level, requires an insurer to submit a plan
containing corrective actions and permits the insurance regulators to perform an
examination or other analysis and issue a corrective order if statutory surplus
falls below 150.0% of the ACL amount. The Authorized Control Level, the third
action level, allows the regulators to rehabilitate or liquidate an insurer in
addition to the aforementioned actions if statutory surplus falls below the ACL
amount. The fourth action level is the Mandatory Control Level, which requires
the regulators to rehabilitate or liquidate the insurer if statutory surplus
falls below 70.0% of the ACL amount. Federated National's ratio of statutory
surplus to its ACL was 125.5%, 434.2% and 274.2% at December 31, 2004, 2003 and
2002, respectively. American Vehicle's ratio of statutory surplus to its ACL was
545.1%, 585.2% and 401.6% at December 31, 2004, 2003 and 2002, respectively.
The NAIC has also developed Insurance Regulatory Information Systems
("IRIS") ratios to assist state insurance Department of Financial Services in
identifying companies which may be developing performance or solvency problems,
as signaled by significant changes in the companies' operations. Such changes
may not necessarily result from any problems with an insurance company, but may
merely indicate changes in certain ratios outside the ranges defined as normal
by the NAIC. When an insurance company has four or more ratios falling outside
"usual ranges," state regulators may investigate to determine the reasons for
the variance and whether corrective action is warranted.
As of December 31, 2004, Federated National was outside NAIC's usual
ranges with respect to its IRIS tests on seven out of twelve ratios. With the
exception of two of these test results, all of test results can be attributed to
the significant degradation of Policyholders' Surplus stemming from the losses
incurred relative to its homeowner s' line of business as a result of the four
hurricanes that affected Florida in August and September of 2004. Change in Net
Writings and Two-Year Reserve Development to Policyholders' Surplus was the
results of test ratios that do not employ Policyholders' Surplus.
As of December 31, 2003, Federated National was outside NAIC's usual
ranges with respect to its IRIS tests on five out of twelve ratios. The first
ratio relates to a larger than expected change in net writings, the second ratio
relates to higher surplus growth that stemmed from the Parent company's capital
contributions totaling $3.9 million during the year and the third ratio relates
to an investment yield that was less than expected. The fourth and fifth ratios
involved the one and two year reserve development to policyholder surplus ratios
that were in excess of the "usual ranges" and relate to modest, but adverse,
development which incurred in 2003 relating to 2002 and 2001 loss reserves.
As of December 31, 2004, American Vehicle was outside NAIC's usual ranges
for three out of twelve ratios. The first ratio relates to a larger than
anticipated change in net writings, the second ratio relates to higher surplus
growth that stemmed from the Parent company's capital contributions totaling
$4.3 million during the year and the third ratio relates to an investment yield
that was slightly less than expected.
As of December 31, 2003, American Vehicle was outside NAIC's usual ranges
for three out of twelve ratios. The first ratio relates to a larger than
anticipated change in net writings, the second ratio relates to higher surplus
growth that stemmed from the Parent company's capital contributions totaling
$5.9 million during the year and the third ratio relates to an investment yield
that was slightly less than expected.
We do not currently believe that the Florida Office of Insurance
Regulation will take any significant action with respect to Federated National
or American Vehicle regarding the IRIS ratios, though there can be no assurance
that will be the case.
72
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2004, 2003, 2002
The table below reflect the range and test results for both Federated
National and American Vehicle for the years ended December 31 2004 and 2003,
respectively.
Unusual Values
Equal to or Federated National American Vehicle
Over Under 2004 2003 2004 2003
---- ----- ---- ---- ---- ----
Gross Premiums to Ploicyholders' Surplus 900 -- 997.0 * 294.6 154.1 261.7
Net Premium to Policyholders' Surplus 300 -- 786.7 * 229.5 157.0 182.2
Change in Net Writtings 33 -33 56.2 * 35.2 * 37.3 * 58.7 *
Surplus Aid to Policyholders' Surplus 15 -- 0.03 6.8 0 9.7
Two-year Overall Operating Ratio 100 -- 130.1 * 83.3 83.3 86.7
Investment Yield 10.0 4.5 5.1 2.7 * 3.3 * 3.5 *
Change in Policyholders' Surplus 50 -10 -31.9 * 72.0 * 64.3 * 165.3 *
Liabilities to Liquid Assets 105 -- 183.3 * 71.9 63.1 71.2
Gross Agents' Balance to Policyholders' Surplus 40 -- 0 6.9 9.8 11.9
One-Year Reserve Development to Policyholders' Surplus 20 -- 6.4 22.5 * 5.8 17.1
Two-Year Reserve Development to Policyholders' Surplus 20 -- 22.4 * 28.1 * 11.5 0.9
Estimated Current Reserve Deficiency to Policyholdes' Surplus 25 -- -200.4 13.6 7.9 19.1
* indicates an unusual value
GAAP differs in some respects from reporting practices prescribed or
permitted by the Florida Office of Insurance Regulation. Federated National's
statutory capital and surplus was $7.6 million and $16.7 million as of December
31, 2004 and 2003, respectively. Federated National's statutory net income
(loss) was ($25.4) million, $2.9 million and ($2.1) million for the years ended
December 31, 2004, 2003 and 2002, respectively. Federated National's statutory
non-admitted assets were approximately $8.9 million and $504,000 as of December
31, 2004 and 2003, respectively.
American Vehicle's statutory capital and surplus was $17.1 million and
$10.7 million as of December 31, 2004 and 2003, respectively. American Vehicle's
statutory net income was approximately $2,032,000, $848,000 and $135,000 for the
years ended December 31, 2004, 2003 and 2002 respectively. American Vehicle's
statutory non-admitted assets were approximately $167,000 and $161,000 as of
December 31, 2004 and 2003, respectively.
(11) COMMITMENTS AND CONTINGENCIES
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 included
purchasers of our common stock between November 5, 1998 and August 13, 1999. The
Court granted the plaintiffs class status. Specifically, the plaintiffs alleged
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 agreed to
settle the case. The parties have negotiated the final terms of a Memorandum of
Understanding, which was executed by the parties and then approved by the court
in late February 2005. We have reserved and charged against forth quarter 2003
earnings $600,000 for the potential settlement and associated costs. During
2004, and through the date of the auditor's report, no adjustment to the
original reserve has been deemed necessary.
We are involved in other 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.
73
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2004, 2003, 2002
As a direct premium writer in the State of Florida, we are required to
participate in certain insurer solvency pools under Florida Statutes
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. We were assessed $258,000
for the year ended December 31, 2002. There was no assessment made for the years
ended December 31, 2004 or 2003.
Federated National and American Vehicle are also required to participate
in an insurance apportionment plan under Florida Statutes 627.351 referred to as
a Joint Underwriting Association Plan ("JUA Plan"). The "JUA Plan" shall provide
for the equitable apportionment of any profits realized, or losses and expenses
incurred, among participating insurers. In the event of an underwriting deficit
incurred by the "JUA Plan" and the deficit is not recovered through the
policyholders in the "JUA Plan", such deficit shall be recovered from the
companies participating in the "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
joint underwriting "JUA Plan".
During the year ended December 31, 2004 Federated National and American
Vehicle were assessed $362,121 and $120,009, respectively. These charges are
contained in Operating and Underwriting Expenses in the Statement of Operations.
Future assessments by this association are undeterminable at this time.
See Note 25, "Subsequent Events," for a discussion on the possibility of
an assessment imposed by Florida's state run insurer of last resort, Citizens
Property Insurance Corporation.
(12) LEASES
Effective December 31, 2004 we sold our interest in our agency operations
which relieved us from our lease obligations. Until then we leased office space
under various lease agreements with expiration dates through September 2007.
Rental expense associated with operating leases was charged to expense in the
period incurred. Rental expenses for 2004, 2003 and 2002 were approximately
$840,000, $733,000 and $756,000, respectively, and are included in operating and
underwriting expenses in the accompanying consolidated statements of operations.
At December 31, 2004, there are no minimum aggregate rental commitments.
(13) RELATED PARTY TRANSACTIONS
One of our directors is a partner at a law firm that handles the Company's
claims litigation. Fees paid to this law firm amounted to approximately
$327,000, $219,000 and $266,000 for the years ended December 31, 2004, 2003 and
2002, respectively.
In September 2002, one of our directors, who is also on the Investment
Committee, began to oversee an investment account for the Company. The oversight
arrangement was subsequently terminated in March of 2003. Fees paid to this
director in 2003 and 2002 totaled $7,500 and $1,250, respectively.
(14) NET INCOME (LOSS) PER SHARE
Net income (loss) per share is computed by dividing net income (loss) by
the weighted average number of shares of common stock and common stock
equivalents outstanding during the periods presented. Options granted in
accordance with the stock option plan were anti-dilutive for the years ended
December 31, 2004 and 2002 and were not taken into account in the computation.
At December 31, 2003 and 2002, warrants issued to two employees to
purchase 7,800, and 62,500 shares, respectively, of common stock at $9 per share
were outstanding. During 2003, 54,700 warrants were exercised.
At December 31, 2002, warrants sold as part of an underwriting agreement
at a price of $0.0001 per warrant, entitling the holder to purchase 125,000
shares of common stock at $10.86 per share, were outstanding. During 2003, all
of the 125,000 shares were exercised. All of these potential common shares were
excluded from the computation of net income per share for 2002 because their
inclusion would have an anti-dilutive effect.
74
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2004, 2003, 2002
A summary of the numerator and denominator of the basic and fully diluted
(2003 only) net income (loss) per share is presented below:
Income (Loss) Shares Outstanding Per-share
(Numerator) (Denominator) Amount
------------ --------- ------
For the year ended December 31, 2004:
Basic net income (loss) per share $(10,857,775) 5,847,102 $(1.86)
============ ========= ======
Fully diluted income (loss) per share $(10,857,775) 5,847,102 $(1.86)
============ ========= ======
For the year ended December 31, 2003:
Basic net income per share $ 8,364,876 4,756,972 $1.76
============ ========= ======
Fully diluted income per share $ 8,364,876 5,022,938 $1.67
============ ========= ======
For the year ended December 31, 2002:
Basic net income per share $ 4,570,201 4,508,439 $1.01
============ ========= ======
Fully diluted income per share $ 4,570,201 4,508,439 $1.01
============ ========= ======
(15) 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 Adjusting and marketing and
distribution through independent agents. The insurance segment sells primarily
standard and nonstandard personal automobile insurance, homeowners' insurance,
mobile home property and casualty insurance, and general liability insurance.
This segment includes substantially all aspects of the insurance, distribution
and claims process. The financing segment consists of premium financing through
Federated Premium Finance. The financing segment provides premium financing to
our insureds and third party carrier insureds, and is marketed through our
distribution network.
The accounting policies of the segments are the same as those described in
the summary of significant accounting policies and practices. We evaluate
business segments based on GAAP pretax operating earnings. Corporate overhead
expenses are not allocated to business segments. Transactions between reportable
segments are accounted for at fair value.
Operating segments that are not individually reportable are included in
the "All Other" category, which includes the operations of the parent holding
company.
75
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2004, 2003, 2002
Information regarding components of operations for the years ended
December 31, 2004, 2003 and 2002 follows:
Years Ended December 31,
------------------------
2004 2003 2002
------------ ------------ ------------
Total Revenues
Insurance Segment:
Earned premium $ 66,241,344 $ 42,284,795 $ 26,914,565
Investment income 4,160,658 5,815,074 1,253,215
Adjusting income 5,771,141 4,172,084 2,886,838
MGA fee income 2,039,783 2,328,681 1,970,226
Commision income 2,240,386 3,532,108 670,918
Other income 434,819 (625,157) 93,719
------------ ------------ ------------
Total insurance revenue 80,888,131 57,507,585 33,789,481
------------ ------------ ------------
Financing Segment:
Premium finance income 2,748,149 2,622,745 3,657,942
Pay day advances -- -- 56,584
------------ ------------ ------------
Total financing revenue 2,748,149 2,622,745 3,714,526
------------ ------------ ------------
All other segment revenue 2,918,690 3,224,734 1,445,606
------------ ------------ ------------
Total operating revenue 86,554,970 63,355,064 38,949,613
Intercompany eliminations (9,983,546) (9,766,646) (4,958,477)
------------ ------------ ------------
Total revenues $ 76,571,424 $ 53,588,418 $ 33,991,136
============ ============ ============
Earnings (loss) before income taxes:
Insurance segment $(24,436,582) $ 13,241,545 $ 7,563,465
Financing segment 1,059,107 622,740 1,421,302
All other segments 1,171,835 (212,455) (199,414)
------------ ------------ ------------
Total earnings (loss) before income taxes $(22,205,639) $ 13,651,830 $ 8,785,353
============ ============ ============
Information regarding total assets as of December 31, 2004 and 2003
follows:
Years Ended December 31,
------------------------
2004 2003
------------- -------------
Assets by segment
Insurance segment $ 134,894,764 $ 93,301,125
Financing segment 8,536,786 10,105,548
All other segments 15,460,463 3,602,606
------------- -------------
Total assets by segment 158,892,013 107,009,279
Intercompany eliminations 4,709,359 (313,686)
------------- -------------
Total assets by segment $ 163,601,372 $ 106,695,593
============= =============
76
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2004, 2003, 2002
Supplemental segment information as of and for the year ended December 31,
2004, 2003 and 2002 follows:
Years Ended December 31,
------------------------
2004 2003 2002
------------ ------------ ------------
Insurance segment
Deferred policy acquisition costs - $ 6,957,168 $ 1,739,685 $ 7,721
Reserves for unpaid loss and LAE $ 46,570,679 $ 24,570,198 $ 16,983,756
Unearned premiums $ 50,152,711 $ 34,122,663 $ 28,934,486
Earned premiums $ 66,241,344 $ 44,877,230 $ 29,393,004
Net investment income (loss)
Insurance segment $ 4,139,178 $ 1,624,216 $ 1,253,765
All other segments 21,480 -- --
------------ ------------ ------------
Total net investment income (loss) $ 4,160,658 $ 1,624,216 $ 1,253,765
============ ============ ============
Claims and adjustment expenses incurred related to
current years - Insurance segment $ 76,423,059 $ 26,274,932 $ 15,896,251
============ ============ ============
Claims and adjustment expenses incurred related to
prior years - Insurance segment $ (1,430,278) $ 1,234,047 $ 90,874
============ ============ ============
Amortization of deferred acquisition costs -
Insurance segment
Insurance segment $ 10,525,334 $ 2,436,813 $ 776,171
Financing segment 137,861 212,285 (237,851)
Eliminations (2,240,386) (3,503,376) (2,602,634)
------------ ------------ ------------
Total amortization of deferred acquisition costs: $ 8,422,808 $ (854,278) $ (2,064,314)
============ ============ ============
Paid claims and claim adjustment expense - Insurance
segment $ 52,645,741 $ 21,836,470 $ 13,057,571
============ ============ ============
Net premiums written - Insurance segment $ 85,176,108 $ 50,900,790 $ 35,271,201
============ ============ ============
(16) STOCK COMPENSATION PLANS
In December 1998, we issued warrants to two employees to purchase 62,500
shares of common stock of the Company at $9 per share. 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 2004, all
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 includes 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, which are either equal to or above
the market value of the stock on the date of grant, vest over a four-year
period, and expire ten years after the grant date. Under this plan, we are
authorized to grant options to purchase up to 900,000 common shares, and, as of
December 31, 2004, we had outstanding exercisable options to purchase 198,275
shares.
In 2001, we implemented a franchisee stock option plan that provides for
the granting of stock options to individuals purchasing Company owned agencies
which are then converted to franchised agencies. The purpose of the plan is to
advance 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,
which 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 988,500 common shares, and, as
of December 31, 2004, we had outstanding exercisable options to purchase 15,000
shares.
77
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2004, 2003, 2002
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 hereunder, 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 which 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 December 31,
2004, we had outstanding exercisable options to purchase 906,300 shares.
Activity in our stock option plans for the period from January 1, 2002 to
December 31, 2004 is summarized below:
-------------------------------- ----------------------------- --------------------------------
1998 PLAN 2001 FRANCHISEE PLAN 2002 PLAN
-------------------------------- ----------------------------- --------------------------------
Weighted Weighted Weighted
Average Average Average
Option Option Option
Number of Exercise Number of Exercise Number of Exercise
Shares Price Shares Price Shares Price
--------------- -------------- ----------- -------------- ----------- ------------------
Outstanding at January 1, 2002 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 -- -- 178,750 $18.02
Exercised (193,755) $ 6.67 (24,960) $ 6.67 (136,300) $ 9.16
Cancelled (16,500) $ 6.67 -- (74,250) $10.59
--------- --------- ---------
Outstanding at December 31, 2004 198,275 $ 6.67 15,000 $ 9.17 906,300 $10.74
========= ========= =========
Options outstanding as of December 31, 2004 are exercisable as follows:
---------------------------------- ---------------------------- ---------------------------------
1998 PLAN 2001 FRANCHISEE PLAN 2002 PLAN
---------------------------------- ---------------------------- ---------------------------------
Weighted Weighted Weighted Average
Number of Average Option Number Average Option Number of Option Exercise
Shares Exercise Price of Shares Exercise Price Shares Price
Options Exercisable at: -------------- ---------------- ---------- -------------- ----------- ------------------
December 31, 2004 141,275 $6.67 15,000 $ 6.67 491,126 $8.90
December 31, 2005 28,500 $6.67 -- $ 6.67 160,874 $8.90
December 31, 2006 28,500 $6.67 -- $ 6.67 89,150 $8.90
December 31, 2007 $6.67 -- $ 6.67 89,150 $8.90
December 31, 2008 -- $ -- -- $ 6.67 44,300 $8.90
Thereafter -- $ -- -- $ 6.67 31,700 $8.90
------- ------ -------
Total options
exercisible 198,275 15,000 906,300
======= ====== =======
We continue to account for stock-based compensation using the intrinsic
value method prescribed by Accounting Principles Board Opinion No. 25, under
which no compensation cost for stock options is recognized for stock option
awards granted to employees at or above fair market value. Had compensation
expense for our stock compensation plan been determined based upon fair values
at the grant dates for awards under the plan in accordance with SFAS No. 123,
our net income (loss) and net income (loss) per share would have been reduced
(increased) to the pro forma amounts indicated below. Additional stock option
awards are anticipated in future years.
78
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2004, 2003, 2002
For the year ending December 31,
--------------------------------
2004 2003 2002
-------------- -------------- --------------
Net Income (loss) as reported . $ (10,857,776) $ 8,364,876 $ 4,570,201
Compensation, net of tax effect 7,277,028 4,783,080 1,750,528
-------------- -------------- --------------
Pro forma net income (loss) ... $ (18,134,804) $ 3,581,796 $ 2,819,673
============== ============== ==============
Net income (loss) per share
As reported - Basic ........... $ (1.86) $ 1.76 $ 1.01
As reported - Diluted ......... $ (1.86) $ 1.67 $ 1.01
Pro forma - Basic ............. $ (3.10) $ 0.75 $ 0.63
Pro forma - Diluted ........... $ (3.10) $ 0.71 $ 0.63
The weighted average fair value of options granted during 2004, 2003 and
2002 estimated on the date of grant using the Black-Scholes option-pricing model
was $6.13 to $18.26; $4.21 to $8.31 and $1.45 to $5.37, respectively. The fair
value of options granted is estimated on the date of grant using the following
assumptions:
December 31, 2004 December 31, 2003 December 31, 2002
----------------- ----------------- -----------------
Dividend yield 2.24% to 3.19% 1.96% to 2.10% .073% to 3.50%
Expected volatility 96.76% to 103.20% 105.91% to 108.73% 120.22%
Risk-free interest rate 2.13% to 3.25% 2.30% to 3.94% 4.49% to 5.82%
Expected life (in years) 3.00 to 3.60 3.00 to 6.36 4.83 to 7.02
Summary information about the Company's stock options outstanding at
December 31, 2004:
Weighted Average Weighted
Range of Outstanding at Contractual Average Exercisable at
Exercise Price December 31, 2004 Periods in Years Exercise Price December 31, 2004
-------------- ----------------- ---------------- ----- -----------------
1998 Plan $6.67 198,275 1.99 $6.67 141,275
2001 Franchise Plan $6.67 to $9.17 15,000 3.21 $9.17 15,000
2002 Plan $8.33 - $20.00 906,300 2.60 $10.74 491,126
(17) EMPLOYEE BENEFIT PLAN
We have established a profit sharing plan under Section 401(k) of the
Internal Revenue Code. This plan allows eligible employees to contribute up to
15 percent of their compensation on a pre-tax basis, not to exceed statutory
limits. For the years ended December 31, 2004, 2003 and 2002, we did not
contribute to the plan. Our contributions, if any, are vested incrementally over
five years.
(18) ACQUISITIONS
We made no acquisitions during 2004.
(19) COMPREHENSIVE INCOME (LOSS)
Reclassification adjustments related to the investment securities included
in comprehensive income (loss) for the years ended December 31, 2004, 2003 and
2002 are as follows:
79
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2004, 2003, 2002
December 31,
------------
2004 2003 2002
--------- --------- ---------
Unrealized holdings net gains (losses) arising during the year $(809,639) $(520,893) $(103,764)
Reclassification adjustment for (gains) losses included in net
income 520,893 227,091 90,197
--------- --------- ---------
(288,746) (293,802) (13,567)
Tax effect 108,655 196,012 4,613
--------- --------- ---------
Net depreciation on investment securities $(180,091) $ (97,790) $ (8,954)
========= ========= =========
(20) AUTHORIZATION OF PREFERRED STOCK
Our Amended and Restated Articles of Incorporation authorize the
issuance of one million shares of preferred stock with designations, rights and
preferences determined from time to time by our board of directors. Accordingly,
our board of directors is empowered, without shareholder approval, to issue
preferred stock with dividends, liquidation, conversion, voting or other rights
that could adversely affect the voting power or other rights of the holders of
common stock. We have not issued preferred shares as of December 31, 2004.
(21) 21ST CENTURY HOLDING COMPANY
The following summarizes the major categories of 21st Century Holding
Company's (parent company only) financial statements:
ASSETS 2004 2003
------------ ------------
Cash and cash equivalents $ 5,641,910 $ 547,760
Investments and advances to subsidiaries 40,753,944 28,893,129
Deferred income taxes 7,917,385 824,171
Income taxes recoverable (8,674,526) 765,634
Property, plant and equipment, net 637,641 699,919
Loan costs, net of amortization 837,665 430,803
Other assets 6,123,042 258,280
------------ ------------
Total assets $ 53,237,061 $ 32,419,696
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Subordinated debt $ 16,875,000 $ 6,875,000
Dividends payable 442,183 422,890
Other liabilities 7,118,905 909,171
------------ ------------
Total liabilities 24,436,088 8,207,061
------------ ------------
Shareholders' equity:
Common stock 67,448 40,889
Additional paid-in capital 26,310,147 21,181,048
Accumulated other comprehensive deficit 309,280 (525,506)
Retained earnings 3,893,743 5,283,978
Treasury stock (1,779,645) (1,767,774)
------------ ------------
Total shareholders' equity 28,800,973 24,212,635
------------ ------------
Total liabilities and shareholders' equity $ 53,237,061 $ 32,419,696
============ ============
80
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2004, 2003, 2002
Condensed Statements of Operations
2004 2003 2002
------------ ------------ ------------
Revenue:
Management fees from subsidiaries $ 1,992,000 $ 1,993,500 $ 1,885,000
Equity in income (loss) of subsidiaries (16,433,198) 12,871,893 5,605,148
Net investment income (loss) 21,480 308 --
Other income 95,520 336,194 95,283
------------ ------------ ------------
Total revenue (14,324,198) 15,201,895 7,585,431
------------ ------------ ------------
Expenses:
Advertising 519,245 315,125 140,287
Salaries and wages 716,229 519,456 457,856
Legal fees 232,971 855,573 50,304
Interest expense and amortization of loan
costs 909,162 403,952 8,853
Other expenses 1,020,257 836,921 674,654
------------ ------------ ------------
Total expenses 3,397,864 2,931,027 1,331,954
------------ ------------ ------------
Income (loss) before provision for income tax
expense and extraordinary gain (17,722,062) 12,270,867 6,253,477
Benefit (expense) for income tax 6,864,287 (3,905,992) (1,683,276)
------------ ------------ ------------
Net income (loss) $(10,857,775) $ 8,364,875 $ 4,570,201
============ ============ ============
Condensed Statements of Cash Flow
2004 2003 2002
------------ ------------ ------------
Cash flow from operating activities:
Net income (loss) $(10,857,775) $ 8,364,876 $ 4,570,201
Adjustments to reconcile net income (loss) to net cash provided
by operating activities:
Equity in income (loss) of subsidiaries 32,632,932 (3,096,893) (2,505,148)
Depreciation and amortization of property plant and
equipment 94,257 138,151 126,295
Common Stock issued for interest on Notes 356,250 112,500 --
Deferred income tax expense (7,093,214) (24,094) (497,655)
Income tax recoverable 9,440,160 (765,634) --
Dividends payable 19,293 (242,943) (119,079)
Changes in operating assets and liabilities:
Other assets (5,864,762) 154,012 66,220
Other Liabilities 6,209,732 497,197 (11,388)
------------ ------------ ------------
Net cash provided by operating activities 24,936,873 5,137,172 1,629,446
------------ ------------ ------------
Cash flow from investing activities:
Purchases of property and equipment 31,979 (17,604) (13,322)
Increased capital of subsidiaries (16,199,733) (9,775,000) (3,100,000)
------------ ------------ ------------
Net cash provided by (used in) investing activities (16,167,754) (9,792,604) (3,113,322)
------------ ------------ ------------
Cash flow from financing activities:
Dividends paid (1,882,399) (999,106) (449,475)
Subordinated debt 12,500,000 7,500,000 --
Stock options exercised 2,856,250 6,868,646 --
Purchases of treasury stock (11,871) (681,842) (245,646)
Advances from (to) subsidiaries (20,135,929) (7,506,855) 2,197,493
------------ ------------ ------------
Net cash provided by (used in) financing activities (6,673,949) 5,180,843 1,502,372
------------ ------------ ------------
Net increase in cash and cash equivalents 2,095,170 525,411 18,496
Cash and cash equivalents at beginning of year 547,760 22,349 3,853
------------ ------------ ------------
Cash and cash equivalents at end of year $ 2,642,930 $ 547,760 $ 22,349
============ ============ ============
81
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2004, 2003, 2002
(22) 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 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.
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 $12.74 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 July 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. 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
September 2004 Warrants had zero value at the date of issuance.
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.
As indicated on the table below, 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
common stock as follows:
82
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2004, 2003, 2002
Quarterly payment due date 2004 2003
- -------------------------- ------- -------
January 31, 54,014 --
April 30, 53,729 --
July 31, 49,965 --
October 31, 69,200 61,792
------- -------
Total common stock issued 226,908 61,792
======= =======
For the July 2003 Notes, the first quarterly principal and interest
payments totaling approximately $0.7 million per payment were due on October 31,
2003 and quarterly thereafter for three years with the last installment due on
July 31, 2006. The scheduled loan payments for the next three years are as
follows:
For the period
- --------------
Year ending December 31, 2005 $2,500,000
Year ending December 31, 2006 1,875,000
----------
Total $4,375,000
==========
For the September 2004 Notes, the first quarterly principal and interest
payments, totaling approximately $1.2 million per payment, is due beginning next
year on January 31, then quarterly thereafter for three years with the last
installment due on September 30, 2007. The scheduled loan payments 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
===========
(23) SCHEDULE VI - SUPPLEMENTAL INFORMATION CONCERNING PROPERTY-CASUALTY
INSURANCE OPERATIONS
83
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2004, 2003, 2002
Amortization
Loss and loss Loss and loss of deferred Paid losses
adjustment adjustment policy and loss
expenses expenses acquisition adjustment Net premiums
CURRENT YEAR PRIOR YEAR expenses expenses written
--------------- ------------- ----------- ------------ -----------
2004 $ 76,423,059 $ (1,430,278) $ 8,422,808 $ 52,645,741 $85,176,108
=============== ============= =========== ============ ===========
2003 $ 26,274,932 $ 1,234,047 $ (854,279) $ 21,836,470 $50,900,790
=============== ============= =========== ============ ===========
2002 $ 15,896,251 $ 90,874 $(2,064,314) $ 13,057,571 $35,271,201
=============== ============= =========== ============ ===========
Deferred Discount, if
policy Reserves for losses any, deducted Net
Affiliation acquisition and loss adjustment from previous Unearned Net premiums investment
with registrant costs expenses column premiums earned income
--------------- ---------------------- --------------- ---------------- --------------- ---------------
Consolidated
Property and
Casualty
Subsidiaries
2004 $6,957,168 $46,570,679 $ -- $50,152,711 $66,241,344 $3,171,620
========== =========== ==== =========== =========== ==========
2003 $1,739,685 $24,570,198 $ -- $34,122,663 $42,284,795 $1,624,216
========== =========== ==== =========== =========== ==========
2002 $7,721 $16,983,756 $ -- $28,934,486 $26,914,565 $1,253,765
====== =========== ==== =========== =========== ==========
(24) DISCONTINUED OPERATIONS
On December 22, 2004 we announced our intention to sell our interest in
Express Tax Service, Inc. and EXPRESSTAX Franchise Corporation for approximately
$2 million cash. This transaction closed with an effective date of January 1,
2005. The book value of Express Tax Service, Inc. and EXPRESSTAX Franchise
Corporation on January 1, 2005 was approximately $0.6 million.
Additionally, on the same day, the Company also announced a definitive
agreement to sell the assets of its subsidiaries, Federated Agency Group, Inc.
and Fed USA, Inc., to affiliates of Affirmative Insurance Holdings, Inc.
("Affirmative")(Nasdaq: AFFM) for approximately $9.5 million. The sale of assets
to Affirmative closed on December 31, 2004, at which time the Company received
$7 million cash, with up to an additional $2.5 million due in the first quarter
of 2006, subject to certain performance criteria are met. The company believes
it will meet these criteria during 2005. Assets and liabilities, including
goodwill, that were sold totaled approximately $2.1 million on December 31,
2004.
The company has recognized a $2.5 million receivable relating to this
transaction and it is reflected in Other Assets. Concurrently, the company has
also recognized a $2.5 million deferred gain relating to the same transaction
and it is reflected as a liability titled Deferred income on discontinued
operations.
(25) SUBSEQUENT EVENTS
Subsequent to December 31, 2004 and the date of presentation the Company
received notice from the Alabama Department of Insurance that American Vehicle
has been admitted and licensed to underwrite personal automobile and commercial
general liability lines of insurance.
On or about January 31, 2005 the Company issued 159,407 shares of common
stock in payment of the principal and interest due on the July 2003 and
September 2004 Notes for the three months ended January 31, 2005.
84
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2004, 2003, 2002
On February 18, 2005, Florida's Citizens Property Insurance Corporation,
the state-run insurer of last resort, announced that it will likely need to
impose an assessment on all property insurers in Florida pursuant to their
deficit resulting from the claims from 2004's four hurricanes. The assessment,
if imposed, would be based on our homeowner premiums written to total homeowner
premiums written statewide by all insurers. The assessment would then be passed
on to all property policyholders. An estimate of our assessment, if an
assessment is made, is undeterminable at this time.
21st Century Holding Company (the "Company") completed the transaction
contemplated by the Stock Purchase and Redemption Agreement (the "Agreement")
dated January 3, 2005 with Express Tax Service, Inc. ("ETS"), Robert J. Kluba
("Kluba") and Robert H. Taylor ("Taylor"); together with Kluba, the "Buyers").
The Company was the beneficial and record owner of 80% of the issued and
outstanding stock of ETS, which in turn owned 100% of the issued and outstanding
stock of EXPRESSTAX Franchise Corporation ("ETFC"). Kluba was the President and
a director of ETS and ETFC, and the owner of the remaining 20% of the issued and
outstanding stock of ETS. The sale of the assets closed on January 13, 2005 with
an effective date of January 1, 2005. For more information, see Note 24,
"Discontinued Operations."
The Company received at closing a cash payment of $311,351, which
reflected the purchase price of $660,000 for all of the Company's common stock
in ETS, less $348,649 representing intercompany receivables owed to ETS by the
Company. The Company also received a payment of $1,200,000 in exchange for the
Company's agreement not to compete with the current business of ETS and ETFC for
five years following the closing.
In connection with the transaction, the Company has extended the
expiration dates for the 75,000 outstanding stock options previously granted to
Kluba and the 30,000 outstanding stock options previously granted to Kluba's
wife, such that 80% of such stock options shall expire, if not exercised, on the
first anniversary date of the closing and the remaining 20% of such stock
options shall expire on the second anniversary date of the closing; none of
these options shall be exercisable for the six-month period following the
closing.
Effective March 1, 2005, Federated National sold its interest in the
Lauderdale Lakes property used by the company as its headquarters to 21st
Century at the property's net book value of approximately $2.9 million.
As a result of a $6.1 million capital contribution made during the first
quarter of 2005 from 21st Century, Federated National's compliance with the
precribed premium to capital surplus ratio has been restored.
85
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
ITEM 9A. CONTROLS AND PROCEDURES
(A) 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 the Company under the supervision and with the participation of the Company's
management, including the Chief Executive Officer and Chief Financial Officer.
Based on that evaluation, the Chief Executive Officer and Chief Financial
Officer concluded that 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 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. A 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.
(B) 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.
ITEM 9B. OTHER INFORMATION
None
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information contained under the caption "Election of Directors" to
appear in our definitive proxy statement relating to the Annual Meeting of
Shareholders, which definitive proxy statement will be filed with the Securities
and Exchange Commission not later than 120 days after the end of our fiscal year
covered by this report on Form 10-K (herein referred to as the "Annual Meeting
Proxy Statement") is incorporated herein by reference.
Information regarding executive officers is included in Part I of this
Form 10-K as permitted by General Instruction G (3).
ITEM 11. EXECUTIVE COMPENSATION
The information contained under the caption "Executive Compensation" to
appear in the Annual Meeting Proxy Statement is incorporated herein by
reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information contained under the caption "Beneficial Security
Ownership" to appear in the Annual Meeting Proxy Statement is incorporated
herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information contained under the caption "Certain Transactions" to
appear in the Annual Meeting Proxy Statement is incorporated herein by
reference.
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21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
The information contained under the caption "Principal Accounting Fees and
Services" to appear in the Annual Meeting Proxy Statement is incorporated by
reference.
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8K
(A) THE FOLLOWING DOCUMENTS ARE FILED AS PART OF THIS REPORT:
(1) Financial Statements
The following consolidated financial statements of the Company
and the reports of independent auditors thereon are filed with
this report:
Independent Auditors' Report (De Meo, Young, McGrath).
Consolidated Balance Sheets as of December 31, 2004 and 2003.
Consolidated Statements of Operations for the years ended
December 31, 2004, 2003 and 2002.
Consolidated Statements of Shareholders' Equity and
Comprehensive Income (Loss) for the years ended December 31,
2004, 2003 and 2002.
Consolidated Statements of Cash Flows for the years ended
December 31, 2004, 2003 and 2002.
Notes to Consolidated Financial Statements for the years ended
December 31, 2004, 2003 and 2002.
(2) Financial Statement Schedules.
Schedule VI, Supplemental information concerning
property-casualty insurance operations, is included herein
under Item 8, Financial Statements and Supplementary Data.
(3) Exhibits
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21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
EXHIBIT DESCRIPTION
3.1 Amended and Restated Articles of Incorporation (1)
3.2 Form of Registrant's Amended and Restated Bylaws (1)
4.1 Specimen of Common Stock Certificate (1)
4.2 Revised Representative's Warrant Agreement including form of
Representative's Warrant (2)
4.3 Amendment dated October 1, 2003 to Warrant Agreement (3)
4.4 Form of 6% Senior Subordinated Note due July 31, 2006 (4)
4.5 Form of Redeemable Warrant dated July 31, 2003 (4)
4.6 Unit Purchase Agreement dated July 31, 2003 between the Company and the
Purchasers of the 6% Senior Subordinated Notes (5)
4.7 Amendment to Unit Purchase Agreement and Registration Rights Agreement
dated October 15, 2003 between the Company and the Purchasers of the 6%
Senior Subordinated Notes (6)
4.8 Form of 6% Senior Subordinated Note due September 30, 2007 (15)
4.9 Form of Redeemable Warrant dated September 30, 2004 (15)
4.10 Unit Purchase Agreement dated September 30, 2004 between the Company and
the Purchasers of the 6% Senior Subordinated Notes due September 30, 2007
(15)
10.1 Stock Option Plan, as amended (7)*
10.2 Employment Agreement between the Registrant and Edward J. Lawson (1)*
10.3 Employment Agreement between the Registrant and Michele V. Lawson (1)*
10.4 Form of Indemnification Agreement between the Registrant and its directors
and executive officers (1)*
10.5 Revolving Credit and Term Loan Agreement between Westchester Premium
Acceptance Corporation and WPAC, as amended (1)
10.6 Third Modification Agreement to Revolving Credit and Term Loan Agreement
between FlatIron Funding Company, LLC and WPAC (9)
10.7 Fourth Modification Agreement to Revolving Credit and Term Loan Agreement
between Federated Premium Finance, Inc., FlatIron Funding Company, LLC,
FlatIron Funding Company and FlatIron Credit Company, Inc. (10)
10.8 Sale and Assignment Agreement between Federated Premium Finance, Inc. and
WPAC (9)
10.9 Premium Receivable Servicing Agreement between Federated Premium Finance,
Inc. and FPF, Inc. (10)
10.10 First Modification Agreement between Federated Premium Finance, Inc. and
WPAC (11)
10.11 General Agency Agreement dated August 1, 1998 between Federated National
Insurance Company and Assurance Managing General Agents, Inc. (12)
10.12 Managing General Agency Agreement dated September 4, 2001 between American
Vehicle Insurance Company and Assurance Managing General Agents, Inc. (12)
10.13 Commercial and Private Passenger Automobile Quota Share Treaty dated
December 31, 2003 between Federated National Insurance Company and
TransAtlantic Reinsurance Company (13)
10.14 Private Passenger Automobile Quota Share Treaty dated January 1, 2003
between American Vehicle Insurance Company and TransAtlantic Reinsurance
Company (13)
10.15 Addendum No. 1 dated September 1, 2003 to Private Passenger Automobile
Quota Share Treaty between American Vehicle Insurance Company and
TransAtlantic Reinsurance Company (9)
10.16 Employment Agreement dated November 1, 2003 between Registrant and Richard
A. Widdicombe (13)*
10.17 Assumption Agreement dated as of May 3, 2004 between Federated National
Insurance Company and Citizens Property Insurance Corporation (14)
10.18 Escrow Agreement dated as of May 3, 2004 among Citizens Property Insurance
Corporation, Federated National Insurance Company and Wells Fargo, N.A.
(14)
10.19 Employment Agreement dated as of June 8, 2004 between James Gordon
Jennings III and 21st Century Holding Company (14)
10.20 Second Modification Agreement, dated as of September 28, 2004, between
Federated Premium Finance, Inc. and Westchester Premium Acceptance
Corporation (16)
10.21 First Modification Agreement, dated as of December 7, 2004 between 21st
Century Holding Company and Edward J. Lawson (17)
10.22 Contract for sale and purchase of real property between Federated National
Insurance Company and 21st Century Holding Company **
10.23 Form of 2001 Franchise Program Stock Option Agreement * **
10.24 Form of 2002 Stock Option Plan Option Agreement * **
88
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
21.1 Subsidiaries of the Registrant (10)
23.1 Consent of De Meo, Young, McGrath, Independent Certified Public
Accountants **
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 **
* Management Compensation Plan or Arrangement
** Filed herewith
(1) Previously filed as an exhibit of the same number to the Registrant's
Registration Statement on Form SB-2 (File No. 333-63623) and incorporated
herein by reference.
(2) Previously filed as an exhibit of the same number of the 1998 Annual
Report on Form 10-KSB and incorporated herein by reference.
(3) Previously filed as an exhibit of the same number to the Registrant's
Registration Statement on Form S-3 (File No. 333-105221) and incorporated
herein by reference.
(4) Previously filed as Exhibits 4.1 and 4.2, respectively, to the Quarterly
Report on Form 10-Q for the quarter ended June 30, 2003 and incorporated
herein by reference.
(5) Previously filed as Exhibit 4.5 to the Registrant's Registration Statement
on Form S-3 (File No 333-109313) and incorporated herein by reference.
(6) Previously filed exhibit of the same number to the Registrant's
Registration Statement on Form S-3 (File No. 333-108739) and incorporated
herein by reference.
(7) Previously filed as an exhibit to the Company's 2000 Annual Meeting Proxy
Statement and incorporated herein by reference.
(8) Previously filed as an exhibit of the same number of the 1999 Annual
Report on Form 10-KSB and incorporated herein by reference.
(9) Previously filed as an exhibit of the same number of the 2000 Annual
Report on Form 10-KSB and incorporated herein by reference.
(10) Previously filed as an exhibit of the same number of the 2001 Annual
Report on Form 10-K and incorporated herein by reference.
(11) Previously filed as an exhibit of the same number of the 2002 Annual
Report on Form 10-K and incorporated herein by reference.
(12) Previously filed as an exhibit of the same number of Amendment No. 1 to
the 2002 Annual Report on Form 10K and incorporated herein by reference.
(13) Previously filed as an exhibit of the same number of the 2003 Annual
Report on Form 10-K and incorporated herein by reference.
(14) Previously filed as Exhibits 10.1, 10.2 and 10.3, respectively, to the
Quarterly Report on Form 10-Q for the quarter ended June 30, 2004 and
incorporated herein by reference.
(15) Previously filed as exhibits of the same number to the Registrant's
Registration Statement on Form S-3 (File No. 333-120157) and incorporated
herein by reference.
(16) Previously filed as Exhibit 10.1 to the Current Report on Form 8-K dated
September 28, 2004 and incorporated herein by reference.
(17) Previously filed as Exhibit 10.1 to the Current Report on Form 8-K dated
December 7, 2004 and incorporated herein by reference.
89
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereto duly authorized.
21ST CENTURY HOLDING COMPANY
By: /s/ Richard A. Widdicombe
Richard A. Widdicombe, Chief Executive Officer
/s/ James G. Jennings III
James G. Jennings III, Chief Financial Officer
Dated: March 30, 2005
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed by the following persons on behalf of the registrant and
in the capacities and on the date indicated.
SIGNATURE TITLE DATE
/s/ Richard A. Widdicombe Chief Executive Officer March 30, 2005
- -------------------------- (Principal Executive Officer)
Richard A. Widdicombe
Chairman of the Board and March 30, 2005
- -------------------------- President
Edward J. Lawson
/s/ James G. Jennings III Chief Financial Officer (Principal March 30, 2005
- -------------------------- Financial and Accounting Officer)
James G. Jennings III
Director March 30, 2005
- --------------------------
Carl Dorf
/s/ Bruce Simberg Director March 30, 2005
- --------------------------
Bruce Simberg
/s/ Charles B. Hart, Jr. Director March 30, 2005
- --------------------------
Charles B. Hart, Jr.
/s/ Richard W. Wilcox, Jr. Director March 30, 2005
- --------------------------
Richard W. Wilcox, Jr.
/s/ Peter Prygelski Director March 30, 2005
- --------------------------
Peter Prygelski
90