As of December 31, 2003, Federated National owned and partially occupied a three-story building with approximately 39,250 square feet of office space in Lauderdale Lakes, Florida. During the fourth quarter of 2003 Federated National sold its two-story, 13,960 square foot office building in Plantation, Florida to unrelated investors for a gain on its investment of approximately $108,000. Executive headquarters, underwriting and the mailroom departments remain located there under a one-year lease arrangement with the new owners. Our operations, including claims, accounting and premium finance, were relocated to the Lauderdale Lakes property. Approximately 59.1% of the Lauderdale Lakes building is occupied by our operations and 40.9% is leased to third parties or is vacant.
We believe that these facilities are adequate for our current needs.
We offer electronic tax filing services through Express Tax Service, Inc., an 80%-owned subsidiary, as well as franchise opportunities for these services. As of December 31, 2003, there were 231 franchises granted in 18 states. Revenue is generated through franchise sales, collection of royalties on tax preparation fees, incentives from business partners as well as fees from the preparation of income tax returns and income tax refund anticipation loans. In addition, Express Tax offers tax preparation services through more than 500 licensees nationwide.
We operate in a highly competitive market and face competition from both national and regional insurance companies, many of whom are larger and have greater financial and other resources, have better A.M. Best ratings and offer more diversified insurance coverage. Our competitors include other companies which market their products through agents, as well as companies which sell insurance directly to their customers. Large national writers may have certain competitive advantages over agency writers, including increased name recognition, increased loyalty of their customer base and reduced policy acquisition costs. We may also face competition from new or temporary entrants in our niche markets. In some cases, such entrants may, because of inexperience, desire for new business or other reasons, price their insurance below ours. Although our pricing is inevitably influenced to some degree by that of our competitors, we believe that it is generally not in our best interest to compete solely on price. We instead tend to compete on the basis of underwriting criteria, our distribution network and superior service to our agents and insureds. We compete with respect to automobile insurance in Florida with more than 100 companies, which underwrite personal automobile insurance. Comparable companies which compete with us in the personal automobile insurance market include U.S. Security Insurance Company, United Automobile Insurance Company, Direct General Insurance Company and Security National Insurance Company, as well as major insurers such as Progressive Casualty Insurance Company. Comparable companies which compete with us in the homeowners' market include Florida Family Insurance Company, Florida Select Insurance Company, Atlantic Preferred Insurance Company and Vanguard Insurance Company. Comparable companies which compete with us in the general liability insurance market include Century Surety Insurance Company, Atlantic Casualty Insurance Company, Colony Insurance Company and Burlington/First Financial Insurance Companies. Competition could have a material adverse effect on our business, results of operations and financial condition.
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 the Company's 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.
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 "Notes"), which were offered and sold to accredited investors as units consisting of one Note with a principal amount of $1,000 and warrants (the "Warrants") to purchase shares of the Company's Common Stock. 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.
ANALYSIS OF FINANCIAL CONDITION AS OF DECEMBER 31, 2003 AS COMPARED TO DECEMBER 31, 2002
Investments increased $21.9 million or 86% to $47.3 million as of December 31, 2003 from $25.4 million as of December 31, 2002 primarily as a result an increase in written insurance premiums and positive underwriting experience. An investment impairment of $2.0 million was charged to operations in 2002 for WorldCom bonds held by the Company and reflecting WorldCom's bankruptcy. These bonds were marked to market from $2.5 million to $0.5 million based on our estimate of the ultimate realizable value of the bonds. As of December 31, 2003 we have one-half remaining of our $0.5 million investment in WorldCom, the balance of which was liquidated during 2003 with a realized gain of $0.2 million.
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 2003 or 2002.
Below is a summary of unrecognized impairment loss at December 31, 2003 and 2002 by category.
Net Unrealized Gains (Losses) Years Ended December 31, ------------------------ 2003 2002 ---- ---- Fixed maturities: U.S. government obligations $(793,613) $ 425 Obligations of states and political subdivisions (4,840) 33,610 --------- --------- (798,453) 34,035 --------- ---------
Corporate securities: Communications 209,226 (332,383) Financial 14,694 62,101 Other 45,475 28,703 --------- --------- 269,395 (241,579) --------- --------- Equity securities: Preferred stocks 400 (316) Common stocks 3,154 (23,843) --------- --------- 3,554 (24,159) --------- ---------
The December 31, 2002 balance was composed of commission expense offset by ceded commissions income of approximately $(423,000) and other expenses connected with the writing of premiums such as salaries, payroll taxes and premium taxes, and offset by policy fees of approximately $431,000. The decrease in ceded unearned commissions in 2003 as compared to 2002 relates to the decline in reliance on quota-share reinsurance associated with the insurance company's automobile premiums as detailed in the discussion of Prepaid Reinsurance Premiums noted above.
December 31, ------------ 2003 2002 ---- ---- Accrued interest income $ 680,017 $ 364,335 Notes receivable 460,145 405,992 Unamortized loan costs 430,803 -- Compensating cash balances 200,430 352,433 Other 568,262 684,364 ---------- ---------- Total $2,339,656 $1,807,123 ========== ==========
Income taxes payable decreased by 100% as compared to 2002 primarily due to payment patterns established by our estimations of taxable income.
RESULTS OF OPERATIONS YEAR ENDED DECEMBER 31, 2003 COMPARED TO YEAR ENDED DECEMBER 31, 2002
Twelve months ended Decemder 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% =========== ===== =========== =====
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.
Net investment income increased by $0.3 million or 29.5% to $1.6 million for the year ending 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 ending December 31, 2002 to 3.4% for the year ended December 31, 2003.
For the year ending December 31, -------------------------------- 2003 2002 ---- ---- Realized gains: Fixed securities $ 1,590,935 $ 774,931 Equity securities 1,230,118 123,232 ----------- ----------- Total realized gains 2,821,053 898,163 ----------- ----------- 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 $ 2,231,332 $ 1,369,961 =========== ===========
Loss and loss adjustment expenses increased by $11.5 million, or 72.1%, to $27.5 million for the year ending December 31, 2003, as compared to $16.0 million as of December 31, 2002. The increase is predominately 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%
Amortization of deferred policy acquisition costs increased by $1.2 million, or 58.6%, to a credit of $0.9 million for the year ending December 31, 2003, as compared to a credit of $2.1 million as of December 31, 2002. Amortization of deferred policy acquisition costs consists of the actual policy acquisition costs, including commissions, payroll and premium taxes, less commissions earned on reinsurance ceded and policy fees earned. During the twelve months ending 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 the amortization of deferred policy acquisition costs in the 2003 period as compared to the 2002 period is attributable to the increase in ceded commissions earned during the twelve months ending December 31, 2003 totaling $1.0 million, netted against amortized costs of $2.2 million during the same twelve month period.
Gross premiums ceded increased from $12.8 million for the year ended December 31, 2001, to $25.3 million for the year ended December 31, 2002. The increase of $12.5 million is primarily due to the acquisition of American Vehicle and its 70% quota-share reinsurance treaty, which we entered into in order to maintain the ratio of premiums written to surplus mandated by the State of Florida.
Prepaid reinsurance premiums increased by $5.0 to $5.7 million for the year ended December 31, 2002 as compared to $0.7 million as of December 31, 2001. The increase is primarily due to the addition of a full year of operations for American Vehicle as compared to two months of operations in 2001.
In August 2001, we recorded an extraordinary gain of $1.2 million, which represents the excess of the fair value of the net assets purchased over the purchase price, when we acquired American Vehicle.
The following summarizes future cash outflows related to our contractual obligations required to be disclosed herein at December 31, 2003 (in thousands):
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 FPF, Inc. (a wholly-owned subsidiary of FlatIron), which gives FPF Inc. the right to sell or assign these contracts receivable. Federated Premium, which services these contracts, has recorded transactions under the Revolving Agreement as secured borrowings. The Revolving Agreement, which was amended and revised in September 2001, allowed for a maximum credit commitment of $7.0 million plus an initial additional amount of $700,000 for the transition from September 30, 2001 when the previous agreement expired. The line declined by $100,000 each month beginning November 1, 2001. In September 2002 the line was amended and revised allowing for a maximum credit commitment of $4.0 million.
The amount of FPF's advance is subject to availability under a borrowing base calculation, with maximum advances outstanding not to exceed the maximum credit commitment. The annual interest rate on advances under the Revolving
Agreement is the prime rate plus additional interest varying from 1.25% to 3.25% based on the prior month's ratio of contracts receivable related to insurance companies with an A. M. Best rating of B or worse to total contracts receivable. The effective interest rate on this line of credit, based on our average outstanding borrowings under the Revolving Agreement, was 5.63%, 6.23% and 7.84% for the years ended December 31, 2003, 2002 and 2001, respectively. The Revolving Agreement contains various operating and financial covenants, with which the Company was in compliance at December 31, 2003 and 2002. The Revolving Agreement, as amended, expires September 30, 2004 and we intend to negotiate a similar agreement to replace the expiring agreement. Outstanding borrowings under the Revolving Agreement as of December 31, 2003 and 2002 were approximately $4.1 million and $4.3 million, respectively. Outstanding borrowings in excess of the $4.0 million commitment totaled $98,786 and $312,420, respectively for December 31, 2003 and 2002. The excess amounts are permissible by reason of a compensating cash balance of $200,430 and $352,433, respectively for December 31, 2003 and 2002 and are held for the benefit of FPF, Inc. and are included in other assets. Interest expense on this revolving credit line for the years ended December 31, 2003, 2002 and 2001 totaled approximately $203,000, $342,000 and $592,000, respectively.
The Notes pay interest at the annual rate of 6%, are subordinated to senior debt, and mature on July 31, 2006. Quarterly payments of principal and interest due on the Notes may be made in cash or, at our option, in shares of our Common Stock. If paid in shares of Common Stock, the number of shares to be issued shall be determined by dividing the payment due by 95% of the weighted-average volume price for the Common Stock on Nasdaq as reported by Bloomberg Financial Markets ("Bloomberg") for the 20 consecutive trading days preceding the payment date.
Operations for the twelve month period ending December 31, 2003 used $15.0 million of gross cash flow primarily for net realized investment gains of $2.0 million, a $3.8 million increase to reinsurance recoverable, net, a $3.5 million increase of finance contract receivable, $1.7 million used to reduce income taxes payable and $0.3 million used to decrease accounts payable and accrued expenses. Additionally, $1.7 million was used to pay agent commissions and other costs, where-in the underlying policy term is un-expired as of December 31, 2003.
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, 2002, operations generated a cash flow of $15.0 million as compared to a cash flow deficit of $946,000 in 2001. The investment portfolio, which is highly liquid as it consists almost entirely of readily marketable securities, is available to offset any cash flow deficits from operations. The 2002 cash flow deficit from investing activities was $6.9 million and was used to purchase investment securities. In 2001 we used $2.5 million to offset deficits in operating and financing cash flows. Cash flow used by financing activities was $5.7 million in 2002, as we reduced the revolving credit outstanding and purchased shares of our Common Stock in the open market. Future financing activities may use cash, if we believe our stock is undervalued and decide to continue to purchase shares in the open market. The Board of Directors has authorized the purchase in the open market of approximately $1.0 million of additional shares. During 2003, we acquired 42,400 shares for a total cost of $681,842. During 2002, we acquired 40,800 shares for a total cost of $253,446.
We believe that our current capital resources, including the net proceeds from the sale 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.
Under these laws, Federated National would have been permitted to pay dividends of approximately $441,000 to 21st Century in 2004, and American Vehicle would be permitted to pay approximately $116,000 in dividends to 21st Century in 2004. No dividends were paid by Federated National or American Vehicle in 2003, 2002, or 2001 and none are anticipated in 2004. Although we believe that amounts required to meet 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
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of 21st Century Holding Company and Subsidiaries as of December 31, 2003 and 2002, and the results of their operations and their cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America.
We have audited the accompanying consolidated statements of operations, changes in shareholders' equity and comprehensive income and cash flows of 21st Century Holding Company and Subsidiaries ("the Company" and a Florida corporation) for the year ended December 31, 2001. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audit.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the results of their operations and their cash flows of 21st Century Holding Company and Subsidiaries for the year ended December 31, 2001, , in conformity with accounting principles generally accepted in the United States of America.
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY AND COMPREHENSIVE INCOME (LOSS) YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
We consider all short-term highly liquid investments with original maturities of three months or less to be cash equivalents.
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.
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.
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 $859,000, $550,000 and $544,000, net of reinsurance, at December 31, 2003, 2002 and 2001, respectively.
We do not discount unpaid losses and loss adjustment expenses for financial statement purposes.
Provisions for credit losses are provided for 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.
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.
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 underwriting costs are included as a component of deferred acquisition costs.
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, 2003, all reinsurance recoverables are considered collectible.
In May 2003, the Financial Accounting Standards Board 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 "Notes"), which were offered and sold to accredited investors as units consisting of one note with a principal amount of $1,000 and warrants (the "warrant") to purchase one half a share of the Company's Common Stock. 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.
Similar to other property and casualty insurers, our liability for unpaid losses and loss adjustment expenses, 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.
(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. Although we have not experienced significant claims due to a weather event, the occurrence of a catastrophe in an area where we have a concentration of policy holders could substantially harm us by causing claims to exceed our reinsurance coverage.
The carrying amounts for the following financial instrument categories approximate their fair values at December 31, 2003 and 2002 because of their short-term nature: cash and cash equivalents, premiums receivable, finance contracts, consumer loans and pay advance receivables, due from reinsurers, drafts payable to insurance companies, revolving credit outstanding, bank overdrafts, and accounts payable and accrued expenses.
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. Periodic reviews of the recoverability of goodwill were performed by assessing undiscounted cash flows of future operations.
Year Ended December 31, ----------------------- 2003 2002 2001 ------------- ------------- -----------
Reported net income (loss) $ 8,364,876 $ 4,570,201 $ (992,090) Add back goodwill amortization -- -- 540,010 ------------- ------------- ----------- Adjusted net income (loss) $ 8,364,876 $ 4,570,201 $ (452,080) ============= ============= ===========
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 16 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.
Net income (loss) per share As reported - Basic $ 2.64 $ 1.52 $ (0.31) As reported - Diluted $ 2.50 $ 1.52 $ (0.31) Pro forma - Basic $ 1.13 $ 0.94 $ (0.37) Pro forma - Diluted $ 1.07 $ 0.94 $ (0.37)
Certain 2002 financial statement amounts have been reclassified to conform with the 2003 presentations.
A summary of the amortized cost, estimated fair value, gross unrealized gains and losses of fixed maturities and equity securities at December 31, 2003 and 2002 is as follows:
Political subdivision bonds with an amortized cost of approximately $502,000 and a fair market value of approximately $506,000 were on deposit with the Florida Department of Financial Services as of December 31, 2003, as required by law.
Years Ended December 31, ------------------------ 2003 2002 2001 ----------- ----------- -----------
Fixed maturities $ 1,462,919 $ 1,189,683 $ 484,913 Equity maturities 108,983 18,009 13,301 Cash and cash equivalents 26,676 59,182 559,017 Other 118,057 17,328 38,390 ----------- ----------- -----------
Total investment income 1,716,635 1,284,202 1,095,621 Less investment expenses (92,419) (30,437) (28,980) ----------- ----------- -----------
Net investment income $ 1,624,216 $ 1,253,765 $ 1,066,641 =========== =========== ===========
A portion of these amounts represents outstanding balances from related party transactions. Refer to Note 13 for details.
Depreciation of property, plant, and equipment was $437,356, $376,516 and $396,047 during 2003, 2002 and 2001, respectively.
Activity in the liability for unpaid losses and loss adjustment expenses is summarized as follows:
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 increased the liability for loss and LAE for claims occurring in prior years by $1,234,047, $90,874 and $2,568,476 for the year ended December 31, 2003, 2002 and 2001, 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, 2003.
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 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.
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 FPF's advance is subject to availability under a borrowing base calculation, with maximum advances outstanding not to exceed the maximum credit commitment. The annual interest rate on advances under the Revolving Agreement is the prime rate plus additional interest varying from 1.25% to 3.25% based on the prior month's ratio of contracts receivable related to insurance companies with an A. M. Best rating of B or worse to total contracts receivable. The effective interest rate on this line of credit, based on our average outstanding borrowings under the Revolving Agreement, was 5.63%, 6.23% and 7.84% for the years ended December 31, 2003, 2002 and 2001, respectively. The Revolving Agreement contains various operating and financial covenants, with which the Company was in compliance at December 31, 2003 and 2002. The Revolving Agreement, as amended, expires September 30, 2004 and we intend to negotiate a similar agreement to replace the expiring agreement. Outstanding borrowings under the Revolving Agreement as of December 31, 2003 and 2002 were approximately $4.1 million and $4.3 million, respectively. Outstanding borrowings in excess of the $4.0 million commitment totaled $98,786 and $312,420, respectively for December 31, 2003 and 2002. The excess amounts are permissible by reason of a compensating cash balance of $200,430 and $352,433, respectively for December 31, 2003 and 2002 and are held for the benefit of FPF, Inc. and are included in other assets. Interest expense on this revolving credit line for the years ended December 31, 2003, 2002 and 2001 totaled approximately $203,000, $342,000 and $592,000, respectively.
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, 2003 and 2002, 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.
As of December 31, 2003, to meet regulatory requirements, we had bonds with a carrying value of approximately $1,983,000 pledged to the Insurance Commissioner of the State of Florida.
Under these laws, Federated National would be permitted to pay dividends of approximately $441,000 to 21st Century in 2004, and American Vehicle would be permitted to pay $116,000 in dividends in 2004. Dividends in excess of this amount require approval by the Florida Department of Financial Services. There can be no assurance that, if requested, the Florida Department of Financial Services will allow any dividends in excess of this amount to be paid by Federated National or American Vehicle.
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 expected 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.
Generally accepted accounting principles differ in some respects from reporting practices prescribed or permitted by the Florida Department of Financial Services. Federated National's statutory capital and surplus was $16.7 million and $9.2 million as of December 31, 2003 and 2002, respectively. Federated National's statutory net income was $2.9 and $2.2 million for the years ended December 31, 2003 and 2002, respectively. Federated National incurred a statutory net loss of $2.1 million for the year ended December 31, 2001. Federated National's statutory non-admitted assets were approximately $504,000 and $45,000 as of December 31, 2003 and 2002, respectively. American Vehicle's statutory capital and surplus was $10.7 million and $4.0 million as of December 31, 2003 and 2002, respectively. American Vehicle's statutory net income was approximately $848,000, $135,000 and $64,000 for the years ended December 31, 2003, 2002 and 2001 respectively. American Vehicle's statutory non-admitted assets were approximately $161,000 and $16,000 as of December 31, 2003 and 2002, respectively.
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".
No assessments have been incurred by either insurance company through the date of issuance of this report.
We lease office space under various lease agreements with expiration dates through September 2007. Rental expense associated with operating leases is charged to expense in the period incurred. Rental expenses for 2003, 2002 and 2001 were approximately $733,000, $756,000 and $797,000, respectively, and are included in operating and underwriting expenses in the accompanying consolidated statements of operations.
At December 31, 2003, the minimum aggregate rental commitments are as follows:
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.
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 Federated Agency Group, franchised agencies and 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.
Information regarding components of operations for the years ended December 31, 2003, 2002 and 2001 follows:
Information regarding total assets as of December 31, 2003 and 2002 follows:
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 659,000 common shares, and, as of December 31, 2003, we had outstanding exercisable options to purchase 26,640 shares.
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 1,200,000 common shares, and, as of December 31, 2003, we had outstanding exercisable options to purchase 625,400 shares.
Options outstanding as of December 31, 2002 are exercisable as follows:
Summary information about the Company's stock options outstanding at December 31, 2003:
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, 2003, 2002 and 2001, we did not contribute to the plan. Our contributions, if any, are vested incrementally over five years.
American Vehicle was organized and incorporated as a multi-line property and casualty insurance company and primarily wrote nonstandard private passenger automobile liability and physical damage coverage. Pursuant to a January 8, 1998, consent order entered into with the Florida Department of Financial Services, American Vehicle ceased writing new or renewal business and pursuant to an additional consent order, the Company had been placed in Administrative Supervision effective March 2, 2001. Pursuant to a third consent order as of August 30, 2001, the two previous consent orders were vacated and the Florida Department of Financial Services approved this acquisition. Also, pursuant to the third consent
order, American Vehicle is not allowed to pay dividends for three years without the Florida Department of Financial Services approval and all contracts with affiliates must also be approved by the Florida Department of Financial Services.
The Consolidated Statements of Operations for the year ended December 31, 2001 and the Consolidated Statement of Cash Flow for the year ended December 31, 2001 include American Vehicle from the acquisition date (August 30, 2001) through December 31, 2001.
Unaudited pro forma results of operations giving effect to the acquisition as of the beginning of each year presented are as follows:
---- Revenue $35,545,435 Income before extraordinary gain (2,270,396) Extraordinary gain 1,185,895 Net income (1,084,501)
Reclassification adjustments related to the investment securities included in comprehensive income (loss) for the years ended December 31, 2003, 2002 and 2001 are as follows:
21ST CENTURY HOLDING COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 2003, 2002, 2001
issued to the purchasers of the Notes and to J. Giordano was determined after the expiration of 60 consecutive trading days following July 31, 2003, which was the date of closing, and totaled 408,050. The number of shares issuable upon exercise of the warrants issued to purchasers equaled $7.5 million divided by the exercise price of the warrants, and totaled 392,356. The number of shares issuable upon exercise of the warrants issued to J. Giordano equaled $300,000 divided by the exercise price of the warrants, and totaled 15,694. The exercise price of the warrants equaled 115% of the weighted-average volume price of the Common Stock on Nasdaq as reported by Bloomberg, for the 60 consecutive trading days following July 31, 2003, with a maximum of $25.00 per share and a minimum of $15.00 per share. As computed, the exercise price of the warrants is $19.1153. The terms of the warrants provide for adjustment of the exercise price and the number of shares issuable thereunder upon the occurrence of certain events typical for private offerings of this type. The warrants will be exercisable until July 31, 2006. We have the option to redeem the warrants beginning on July 31, 2004. On or about October 31, 2003, we exercised our option to make a quarterly payment in shares of the Company's Common Stock and issued a total of 41,195 shares of common stock to the purchasers of the Notes.
The first payments totaling approximately $0.7 million 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 year ending 2004 2,500,000 2005 2,500,000 2006 1,875,000 ----------- Total $ 6,875,000 ===========
Subsequent to December 31, 2003 and the date of presentation the Company received notice from the Louisiana Department of Insurance that American Vehicle has been admitted and licensed to underwrite homeowner and commercial general liability lines of insurance.