(1) Pro forma net income (loss) per share (unaudited) for 1995 and 1994 has been calculated based on the 4,039,780 shares of Cumberland Common Stock that were outstanding after the Distribution. The 1998, 1997 and
premium increased by $2,340,624 or 37.5%. Earned premium growth increased by 32.5% to $7,534,000 for 1998 as compared to $5,684,000 for 1997. The increase in earned premiums resulted from CCS s continued growth in the direct surety bond market.
Direct . . . $ 9,451,746 $ 6,797,136 39.1% Assumed . . . 1,478,109 1,189,689 24.2%
Total . . . . $ 8,574,885 $ 6,234,261 37.5% ============== ==============
Total . . . . $ 7,533,684 $ 2,648,074 35.1% ============== ==============
During the year ended December 31, 1998 the net amortization of deferred policy acquisitions costs increased to $2,252,195 from $1,778,808 for the year ended December 31, 1997. The increase is attributed to the increase in earned premiums.
Interest expense is interest paid to the Surety Group and Surety Associates on notes due to agencies the Company purchased in 1995.
Year Ended December 31, 1997 Compared to Year Ended December 31, ----------------------------------------------------------------- -- The following table sets forth, for the periods indicated, (i) summary financial data (in thousands), and (ii) the percentage change in the dollar amount for such items from period to period.
Net reinsurance premiums earned through the Pooling Agreements were $1,166,025 and $2,693,418 for 1997 and 1996, respectively, representing a decrease of $1,527,393, or 57 percent.
Total . . . . $ 6,234,261$ 4,368,046 43% ============== ==============
During the year ended December 31, 1997, operating expenses increased to $3,903,476 from $3,255,805 in 1996. The increase is due to expenses incurred in the continuing research and development of Cumberland's Bond Program and additional personnel employed to direct market its insurance products.
At December 31, 1998, the Company s $16,545,051 of total assets calculated based on generally accepted accounting principles were distributed primarily as follows: 50 percent in cash and investments (including accrued investment income), 30 percent in receivables and reinsurance recoverables, 18 percent in intangibles and deferred policy acquisition costs and 2 percent in other assets.
Net cash (used in) provided by operating activities was $(193,734), $1,925,903 and $(16,958) for the years ended December 31, 1998, 1997 and 1996, respectively. In 1998, the decrease in cash provided by operating activities is primarily attributed to an increase in receivables of $1,047,974 and income taxes recoverable of $120,000. In 1997, the cash provided by operating activities was primarily attributable to the increase in ceded reinsurance payable and pooling liabilities and accruals. In 1996, the cash used in operating activities was primarily attributable to payments of claims and reinsurance, which was offset in part by a decrease in accounts receivable.
Net cash (used in) provided by investing activities was $1,718,716, $(120,560) and $253,876 for the years ended December 31, 1998, 1997 and 1996, respectively. Investing activities consist of purchases and sales of investments and advances to and from KC.
The Company has developed an in-house surety administrative system BondPro . BondPro is an agency surety bond administration system that issues bonds, tracks underwriting, and accounting and reporting from its database. Bond-Pro is a Windows based program and is year 2000 compliant. The Company is aware of the issues that many computer systems will face as the millennium (year 2000) approaches. The Company, however, believes that its own internal software and hardware is year 2000 compliant. The Company believes that any year 2000 problems encountered by procurement agencies, and other customers and vendors are not likely to have a material adverse effect on the Company s operations.
Excluding any possible catastrophic events such as the loss of utilities or banking, financial or communications services, the potential risks known to the Company at this time are primarily limited to delays, disruptions or losses resulting from information bottlenecks and the lack of computer processing power. In order to mitigate the risk to the greatest extent possible, the Company will be prepared to track mission-critical information manually. Such information includes tracking premium income, and receivables and recording payments received from agencies. The Company believes its current workforce and the employment pool available in the area is sufficiently skilled to accommodate such a demand. The Company will continue to evaluate its contingency planning activities as more information becomes available. At this time, the total cost of the risks is not anticipated to have a material adverse effect on the business, financial condition or results of operations of the Company.
The following table provides a reconciliation of the beginning and ending liability balances, net of reinsurance recoverable, for 1998, 1997 and 1996 to the gross amounts reported in Cumberland s balance sheets:
Losses and LAE payments for claims, net of reinsurance, occurring during: The current year . . . . 557,997 553,629 422,544 Prior years . . . . . . 1,802,428 440,479 1,705,721 ----------- ----------- ---------- 2,360,425 994,108 2,128,265 ----------- ----------- ----------
Liability for losses and LAE, gross of reinsurance recoverables on unpaid $ 3,220,457 $ 2,550,300 $ 1,991,796 losses, at end of year . . =========== =========== ==========
Liability for losses and LAE, as reported in the accompanying GAAP basis financial statements . . . . . . . . . . . . . . $ 3,220,457 ==============
The following table represents the development of the liability for unpaid liabilities, net of reinsurance, for 1991 through 1998 (in thousands).
Year ended December 31 ---------------------------------- 1998 1997 1996 ----------- ----------- ---------- Operating activities: Net (loss) income . . . . . . $ (321,409) $ 170,520 $ (582,744) Adjustments to reconcile net (loss) income to net cash (used in) provided by operating activities: Amortization/accretion of investment premiums and discounts . . . . . . . 391 (2,788) (6,052) Policy acquisition costs amortized . . . . . . . 2,252,194 1,778,808 1,532,355 Policy acquisition costs deferred . . . . . . . . (2,686,004) (1,956,364) (1,732,272) Depreciation and amortization . . . . . . 225,108 370,553 378,447 Net realized loss(gain) on sales of investments 437,566 (201,863) (117,824) Provision for bad debts - 113,120 - Accrued interest on term notes, net . . . . . . . - - 404,337 (Increase) decrease in: Accrued investment income . . . . . . 27,473 6,831 (2,421) Reinsurance recoverable (289,616) (425,900) 709,464 Trade receivables . . . (502,510) (852,285) (139,675) Income tax recoverable (120,000) - - Other assets . . . . . . 11,434 57,079 (232,148) Increase (decrease) in: Policy liabilities and accruals . . . . . . 1,790,820 1,325,672 319,801 Ceded reinsurance payable . . . . . . . (1,344,906) 1,690,766 165,504 Accounts payable and other liabilities . . 325,725 (148,246) (713,730) ----------- ----------- ---------- Net cash (used in) provided by operating activities . . (193,734) 1,925,903 (16,958)
To the extent recoverable from future policy revenues, the costs of acquiring new surety business, principally commissions, are deferred and amortized in a manner which charges each year s operations in direct proportion to the premium revenue recognized.
Intangible assets are stated at cost and principally represent purchased customer accounts and the excess of costs over the fair value of identifiable net assets acquired ( Goodwill ). Purchased customer accounts, noncompete agreements, and purchased contract agreements are being amortized on a straight-line basis over the related estimated lives and contract periods, which range from 3 to 15 years. Goodwill is being amortized on a straight-line basis over 15 years. Purchased customer accounts are records and files obtained from acquired businesses that contain information on insurance policies and the related insured parties that is essential to policy renewals.
The liability for loss and loss adjustment expenses including incurred but not reported losses is based on the estimated ultimate cost of settling the claim using traditional paid and incurred loss development methods. These estimates are subject to the effects of trends in loss severity and frequency. Although considerable variability is inherent in such estimates, management believes that the reserves for loss and loss adjustment expenses are adequate. The estimates are continually reviewed and adjusted as necessary as experience develops or new information becomes known. Such adjustments are included in current operations. A liability for all costs expected to be incurred in connection with the settlement of unpaid loss and loss adjustment expenses is accrued when the related liability for unpaid losses is accrued. Loss adjustment expenses include costs associated directly with specific claims paid or in the process of settlement, such as legal and adjusters fees. Loss adjustment expenses also include other costs that cannot be associated with specific claims but are related to losses paid or in the process of settlement, such as internal costs of the claims function.
Direct insurance and assumed reinsurance premiums earned are recognized on a pro-rata basis over the period of risk. Commission income is recognized at the effective date of the bonds issued. Other income consisting primarily of consulting fees are recognized when the negotiated services are provided.
The Company files a consolidated tax return that includes all of its subsidiaries. See Note 7.
Earnings (loss) per share is based on the weighted average number of shares outstanding, adjusted for the dilutive effect of stock options. Since the effect of including the entire 168,486 outstanding stock options in the denominator of the calculation for the year ended December 31, 1998 had no effect on the result of the calculation, and the effect of stock options for the years ended December 31, 1997, and 1996 would be antidilutive, earnings per share is the same on both a basic and diluted basis for 1998, 1997 and 1996.
Effective January 1, 1998, the Company adopted the Financial Accounting Standards Board s Statement of Financial Accounting Standards No. 131, Disclosures about Segments of an Enterprise and Related Information (Statement 131). Statement 131 superseded FASB Statement No. 14, Financial Reporting for Segments of a Business Enterprise. Statement 131 establishes standards for the way that public business enterprises report information about operating segments in annual financial statements and requires that those enterprises report selected information about operating segments in interim financial reports. The Company's only material operating segment is the underwriting of surety insurance products. In accordance with Statement 131 the Company has not reported financial information on separate segments. Statement 131 also establishes standards for related disclosures about products and services, geographic areas, and major customers. The adoption of Statement 131 did not affect results of operations or financial position.
In June 1998, the Financial Accounting Standards Board issued Statement No. 133, Accounting for Derivative Instruments and Hedging Activities, which is required to be adopted in years beginning after June 15, 1999. Because of the Company s minimal use of derivatives, management does not anticipate that the adoption of the new Statement will have a significant effect on earnings or the financial position of the Company.
Certain amounts in the 1997 financial statements have been reclassified to conform to the 1998 financial statement presentation. These reclassifications had no effect on net loss or stockholders equity previously reported.
CTI and its subsidiaries have entered into transactions with KC and companies affiliated through common ownership. CCS writes surety bonds for KC and its affiliates. Revenues attributable to surety bonds with KC and its affiliates were $14,907, $1,738 and $2,873 for the years ended December 31, 1998, 1997 and 1996, respectively. Qualex performs consulting services for KC and affiliates. Other income from affiliates consist primarily of consulting services provided to KC.
Affiliate accounts receivable represents funds advanced and joint expenses that have not yet been reimbursed from KC and its affiliates. These receivables are paid periodically and no interest is charged on the outstanding balances which are payable on demand. Also included in affiliate accounts receivable at December 31, 1997 is a $135,000 note receivable from the Company s Chairman of the Board of Directors. During 1998, KC reimbursed SSI for certain project premiums that had been guaranteed by the Chairman. As a result, the note receivable was paid in full and a commission of $83,952 was recognized by CCS.
CUMBERLAND TECHNOLOGIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 3. Investments ----------- The Company s investments in available-for-sale securities and held-to-maturity securities are summarized as follows:
At December 31, 1998 and 1997, the Company had $3.4 million and $5.3 million, respectively, in restricted investments (fixed maturity securities and short-term investments). Restricted investments primarily represent funds held as collateral in connection with reinsurance trust agreements and funds held as
Net investment income for the Company is comprised of the following:
Year ended December 31 ---------------------------------- 1998 1997 1996 ----------- ---------- ---------- Fixed maturity and equity securities . . . . . . . . $ 246,618 $ 344,459 $ 388,700 Mortgage loans on real estate 6,711 4,105 4,613 Short-term investments, including cash and cash equivalents . . . . . . . . 135,926 70,857 50,684 ----------- ----------- ---------- 389,255 419,421 443,997 Less investment expenses . . (12,037) (1,1371) (40,078) ----------- ----------- ---------- Net investment income . . . . $ 377,218 $ 408,050 $ 403,919
Realized gain (loss) on available-for-sale securities: Fixed maturities - gains . 15,589 - - Equity securities - gains 226,613 201,863 117,824 Equity securities - losses (679,767) - - ----------- ----------- ---------- Net realized investment gains $ (437,565)$ 201,863 $ 117,824 (losses) . . . . . . . . . .
The carrying amounts and fair values of the Company's financial instruments at December 31, 1998 are as follows:
December 31, 1998 ---------------------------- Carrying Amount Fair Value ---------------------------- Assets: Cash and cash equivalents, including short-term investments . . . . . . . . $ 4,626,344 $ 4,626,344 Investments . . . . . . . . . 3,563,280 3,554,591 Accounts receivable . . . . . 2,737,636 2,737,636 Reinsurance receivable . . . 2,306,372 2,306,372
Liabilities: Long-term debt . . . . . . $ 2,330,588 $ 2,330,588 Policy loss reserves . . . 3,220,457 3,220,457 Ceded reinsurance payable 1,114,267 1,114,267
Investments: Fair values for fixed maturity securities are based on quoted market prices, where available, and are recognized in the balance sheet for available-for-sale securities. The fair values for equity securities are based on quoted market prices and are recognized in the balance sheet.
1998 1997 -------------- -------------- Purchased customer accounts $ 1,084,041 $ 1,084,041 Noncompete agreements . . . . - 234,000 Goodwill . . . . . . . . . . 926,661 926,661 2,010,702 2,244,702 -------------- -------------- Less accumulated amortization 555,177 (564,069) -------------- -------------- $ 1,455,525 $ 1,680,633 ============== ==============
1998 1997 1996 ----------- ----------- ---------- Federal statutory tax rate . . . . . . . . . . (34.0)% 34.0% (34.0)% State income taxes, net of federal income tax benefit . . . . . . . . (3.0) 3.9 (3.7)% Income exempt from taxation and dividend exclusions . . . . . . . (9.7) (7.2) (10.1) Differences between income statement and tax return . . . . . . . . . (7.0) 69.3 - Utilization of NOL carryforwards . . . . . 38.2 (110.1) 44.4 Nondeductible expenses . 15.5 10.1 3.4 ----------- ----------- ---------- Effective tax rate . . . - - - =========== =========== ==========
In connection with the acquisition of certain agencies during 1995, the Company entered into two notes payable with the agencies previous owners. One note is due March 1, 2002 and bears interest at 8% through February 28, 2001 and 10% thereafter. Principal payments of $125,000 are due annually beginning March 1, 2000. The other is due June 30, 2010 and bears interest 9%. Principal payments of $40,000 were due annually for three years beginning January 5, 1996. Payments of $11,104 including principal and interest are payable monthly beginning April 1, 1997.
Interest paid in 1998, 1997 and 1996 for term notes due nonaffiliates was $118,239, 124,298 and $121,271, respectively.
On April 1, 1996, CTI adopted a defined contribution 401(k) plan covering substantially all employees. Under the plan, the Company makes contributions equal to one percent of the participant's compensation, not to exceed six percent of the participant's annual compensation. The Company's contributions to the plan totaled $11,701, $9,367 and $7,288 in 1998, 1997 and 1996, respectively.
CTI has 400,000 shares of its common stock reserved for issuance for the exercise of options to be granted under CTI s 1991 stock option plan (the Plan ). Options granted under the Plan, in general, expire no later than ten years from the date of grant.
Effective, March 18, 1998, the Company granted options to purchase 12,000 shares to certain individuals at CCS at a price of $2.25 per share. As of December 31, 1998, 2,400 of the options were exercisable.
CCS assumes reinsurance through a program whereby its subsidiary, SSI, has contracted through a joint partnering agreement with St. Paul Fire and Marine Group, f/k/a United States Fidelity and Guaranty Company ( St. Paul ) to pursue small to medium size contract and commercial surety business in states in which CCS is not licensed. CCS participates in the St. Paul agreement underwriting risk through a retrocessional treaty with St. Paul s reinsurer, Transatlantic Reinsurance Company.
Effective October 1, 1996, CCS entered into a quota share agreement with First Indemnity of America Insurance Company whereby all of the premiums written through a shared underwriting office are subject to this treaty. Cumberland assumes 50% of the premiums written by FIA and cedes 50% of the premiums written by CCS.
CCS assumed reinsurance primarily from a pooling agreement which expired in April, 1997 for which CCS assumed 10 percent of the risk with a maximum exposure to CCS of $125,000 per bond. CCS is still receiving residual revenues from a pooling agreement for which CCS assumed 25 percent and 20 percent of the risk with a maximum exposure to CCS of $125,000 and $600,000 per bond, respectively.
The Company cedes to Transatlantic Reinsurance Company on an excess of loss treaty 95% of the risk insured with a maximum exposure to the Company of $235,000 per principal. Transatlantic Reinsurance Company is rated A+ by A.M. Best. For its liability line of registered investment advisor insurance, the Company has reduced its exposure on any one risk, with a purchase of a quota share agreement with Dorinco Reinsurance (Dorinco Treaty) which is rated A (Excellent) by A.M. Best. Under the Dorinco Treaty, CCS cedes 50% of its liability on all registered investment advisor policies, which have an aggregate net liability limit of $500,000 per endorsement. The Company continues to have exposure to risk for reinsurance ceded in the event that the reinsurer is unable to meet its obligation under the reinsurance agreement in force. Reinsurance does not relieve an insurer of its liability to policyholders, however, the reinsurer is obligated to the insurer for the portion assumed by such reinsurer.
1998 1997 1996 ----------- ----------- ---------- Direct . . . . . . . . . $ 1,743,448 $ 1,048,450 $ 127,232 Assumed . . . . . . . . 1,343,334 741,351 1,587,890 Ceded . . . . . . . . . (438,708) 2316 (44,482) ----------- ----------- ---------- Net losses and loss adjustment expenses . $ 2,648,074 $ 1,792,117 $ 1,670,640 =========== =========== ==========
The Company reported reinsurance recoverables on paid losses of $408,708 and $448,553 at 1998 and 1997, respectively.
Year Ended December 31 1998 1997 1996 ----------- ----------- ---------- Statutory capital and surplus $ 4,843,478 $ 5,044,527 $5,034,662 Net income (loss) . . . . . . 74,157 $ 959,304 $ (293,204)
CCS is domiciled in Florida and prepares its statutory-basis financial statements in accordance with accounting practices prescribed or permitted by the Florida Insurance Department. Prescribed statutory accounting practices include state laws, regulations, and general administrative rules, as well as a variety of publications of the National Association of Insurance Commissioners ( NAIC ). Permitted statutory accounting practices encompass all accounting practices that are not prescribed; such practices may differ from state to state, may differ from company to company within a state, and may change in the future. The NAIC currently is in the process of codifying statutory accounting practices, the result of which is expected to constitute the only source of prescribed statutory accounting practices. Accordingly, that project, which was completed in 1998, will likely change, to some extent, prescribed statutory accounting practices, and may result in changes to the accounting practices that insurance enterprises use to prepare their statutory financial statements.
The Company adopted the provisions of the SFAS No. 130, Reporting Comprehensive Income, in 1998. Comprehensive income is defined as any change in equity from transactions and other events originating from nonowner sources. For the Company comprehensive income is composed of reported net income and changes in the unrealized appreciation of available for sale investment portfolio. SFAS No. 130 requires the Company to report all components of comprehensive income. The following summaries present the components of our comprehensive income, other than net income, for the last two years.
Consolidated Statements of Comprehensive Income Twelve Months Ended December 31 1998 1997 ----------- ----------- Net income (loss) . . . . . . $ (321,409)$ 170,520 Other comprehensive income, net of tax:
Unrealized (depreciation) appreciation of available for sale securities arising during period . . (830,088) 161,425 ----------- ----------- Less: reclassification adjustment for (losses) gains included in net $ (504,958) $ 126,000 income ---------------- ----------------
Accounts payable to affiliates . . . 1,442,165 1,213,207 Accounts payable . 4,701 3,488 ------------- -------------
Common stock . . . 5,763 5,763 Other stockholders' 5,343,467 6,003,506 equity . . . . . ------------- -------------
Condensed Statements of Operations 1998 1997 1996 ---------------------- ------------- ------------- -------------
Federal and state income tax benefits . . . . . - - - Equity in net income (loss) of subsidiaries . . . (386,559) 105,168 (439,401) ------------- ------------- -------------
Net income (loss) . . $ (321,409)$ 170,520 $ (582,744) ============= ============= =============
The Company operates through its wholly-owned subsidiaries and all operating activities have been funded by its subsidiaries.
Organization - Cumberland Technologies, Inc. ( CTI or Cumberland ), a Florida corporation, was formed on November 18, 1991, to be a holding company and a wholly-owned subsidiary of Kimmins Corp. ( KC ). Effective October 1, 1992, KC contributed all of the outstanding common stock of two of its wholly-owned subsidiaries, Cumberland Casualty & Surety Company ( CCS ) and Surety Specialists, Inc. ( SSI ) to CTI. KC then distributed to its stockholders CTI's common stock on the basis of one share of common stock of CTI for each five shares of KC common stock and Class B common stock owned (the Distribution ). CTI conducts its business through its subsidiaries, CCS, SSI, Surety Group, Inc. ( SG ), Surety Associates ( SA ), and Qualex Consulting Group, Inc. ( Qualex ) (collectively together with Cumberland, the Company. ) CCS, a Florida corporation formed in May 1988, provides performance and payment bonds for contractors and miscellaneous surety bonds to federal and local government agencies. The surety services provided include direct surety and, to a lesser extent, reinsurance. SSI, a Florida corporation formed in August 1988, is a general lines agency which operates as an independent agent. SG, a Georgia corporation, and Associates Acquisition Corp. d/b/a Surety Associates, a South Carolina corporation, purchased by Cumberland in February and July 1995, respectively, are general lines insurance agencies which operate as independent agencies. Qualex, a Florida corporation formed in November 1995, provides claim and contracting consulting services.
For the years ended December 31, 1998 and 1997, CTI charged its subsidiaries excluding CCS, a management fee.
In 1988, CCS issued a surplus debenture to KC in exchange for $3,000,000 which bears interest at 10 percent per annum. In 1992, the debenture due to KC from CCS was assigned to CTI. Interest and principal payments are subject to approval by the Florida Department of Insurance. On April 1, 1997, CTI forgave $375,000 of its $3,000,000 surplus debenture due to CCS. As a result, CCS increased paid-in-capital by $375,000. As of December 31, 1998, no payments could be made under the terms of the debenture.
Allowance for doubtful accounts . . . . $ -0- $113,120 $ -0- $ -0- $ 113,120 ========== ========== ========== ========== ==========
Allowance for doubtful accounts $ 113,120 -0- $ -0- $ 113,120 $ -0- ========== ========== ========== ========== ==========
Deferred income tax valuation allowance . . . . $298,135 $ -0- $168,664 $ -0- $ 466,799 ========== ========== ========== ========== ========== /TABLE
Totals . . . . . . . . . . . 5,447,996 5,449,518 4,026,655 =========== =========== ==========
Net income (loss) . . . . . . (321,409)$ 170,520 $ (582,744) =========== =========== ==========
Earnings (loss) per share amount . . . . . . . . . . $ (.06)$ .03 $ (.14) =========== =========== ==========
As of December 31, 1998, the subsidiaries of Cumberland Technologies, Inc. were as follows: