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.
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.
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.
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.
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.
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.
Below is a summary of unrealized losses loss at December 31, 2004 and 2003 by category.
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.
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.
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.
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.
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.
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% ============ ===== ============ =====
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 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.
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 =========== ===========
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.
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.
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.
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.
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.
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 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.
Net realized gains (losses) on investments $ 2,231,334 $ (1,369,961) ============= =============
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.
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.
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.
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 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.
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.
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
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.
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.
(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.
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.
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.
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.
(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.
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.
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.
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.
Certain 2003 financial statement amounts have been reclassified to conform with the 2004 presentations.
The following table shows the realized gains (losses) for fixed and equity securities for the years ended December 31, 2004 and 2003:
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:
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) ----------- -----------
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
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.
Depreciation of property, plant, and equipment was $490,697, $437,356 and $376,516 during 2004, 2003 and 2002, respectively.
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 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.
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%
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.
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.
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.
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
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.
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.
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.
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.
A summary of the numerator and denominator of the basic and fully diluted (2003 only) net income (loss) per share is presented below:
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.
Information regarding components of operations for the years ended December 31, 2004, 2003 and 2002 follows:
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 ============= =============
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.
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.
Options outstanding as of December 31, 2004 are exercisable as follows:
Summary information about the Company's stock options outstanding at December 31, 2004:
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.
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 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.
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 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:
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.
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.
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.
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.