Our agencies are primarily located in leased locations pursuant to leases expiring at various times through February 2007. The aggregate annual rental for the facilities is approximately $799,000. Two of the locations are owned by us.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS - ------------------------------------------------------------------------------- OF OPERATIONS - -------------
We are a vertically integrated insurance holding company, which, through our subsidiaries, controls substantially all aspects of the insurance underwriting, distribution and claims process. We underwrite personal automobile insurance, general liability insurance, flood insurance, homeowners' insurance and mobile home property and casualty insurance in Florida and Georgia through our wholly owned subsidiaries, Federated National Insurance Company and American Vehicle Insurance Company. American Vehicle was approved in August 2003 to be a foreign insurer in the State of Georgia. During the year ended December 31, 2003, 67.2%, 23.4%, 2.4% and 7.0% 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. We also offer premium financing to our own and third-party insureds through our wholly owned subsidiary, Federated Premium Finance, Inc.
We market and distribute our own and third-party insurers' products and our other services primarily in Central and South Florida, through a network of 23 agencies owned by Federated Agency Group, Inc., a wholly owned subsidiary, 44 franchised agencies, and approximately 125 independent agents. Through our wholly owned subsidiary, FedUSA, Inc., we franchise agencies under the FedUSA name. As of December 31, 2003, franchises were granted for 44 FedUSA agencies, of which 38 were operating. We intend to focus our future expansion efforts for our agency network on franchised agencies.
Prepaid reinsurance premiums decreased $3.4 million or 30.5% to $7.8 million as of December 31, 2003 from $11.3 million as of December 31, 2002. Approximately $2.7 million of this decrease reflects the decrease in American Vehicle's ceded quota-share reinsurance from 70% of its premiums written to 40% effective November 1, 2002. Approximately $0.7 million of the decrease reflects the decrease in Federated National's ceded quota-share reinsurance from 40% of automobile premiums written in 2002 to 30% for automobile premiums written in the first quarter of 2003. Subsequent to the first quarter of 2003, Federated National increased its ceded quota-share reinsurance to 40% of automobile premiums written for the whole year. American Vehicle's reinsurance treaty did not change.
Deferred acquisition costs increased $1.7 million to $1.7 million as of December 31, 2003 from $7,721 as of December 31, 2002. At December 31, 2003, commission expense and commissions income, net were approximately $1.2 million and expenses connected with the writing of premiums such as salaries and premium taxes, net of policy fees totaled approximately $0.5 million. Deferred policy acquisition costs, net, increased primarily due to a $0.84 million increase of deferred commission expenses and a $0.82 million decrease in ceded unearned commissions income during the year ended December 31, 2003. The increase of deferred commission expenses primarily related to the increase in lines of insurance other than automobile, which are not subject to quota-share agreements. The decrease in ceded commissions income is due to a $3.4 million decline of ceded commissions.
Income tax recoverable increased by 100% to $1.1 million primarily due to payment patterns established by our estimations of taxable income.
Property plant and equipment, net of accumulated depreciation and amortization declined by $0.6 million to $4.2 million as of December 31, 2003 to $4.8 as of December 31, 2002. The decline is primarily attributable to the sale of one of our occupied properties.
Goodwill declined by approximately $49,000, or 2.8% to approximately $1,740,000 as of December 31, 2003 as compared to approximately $1,789,000 as of December 31, 2002 due to net conversions of our agencies to franchised operations. Goodwill otherwise remained unchanged during 2003 due to the adoption of SFAS 142, wherein our assessment of goodwill indicated no impairment.
Other assets increased by $0.5 million, or 29.5% to $2.3 million as of December 31, 2003 as compared to $1.8 million as of December 31, 2002. Major components of other assets are as follows:
Unearned premiums increased by $5.2 million or 17.9% to $34.1 million as of December 31, 2003 as compared to $28.9 million as of December 31, 2002. The increase was due to a $5.7 million increase in unearned homeowner's insurance premiums and $3.8 million in unearned premiums associated with the newly launched commercial liability program. Offsetting these increases was a $4.3 million decrease in automobile unearned premiums. These changes reflect our emphasis in 2003 on property and commercial general liability insurance products.
On July 31, 2003, we completed a private placement of our Notes, which were offered and sold to accredited investors as units consisting of one Note with a principal amount of $1,000 and one Warrant to purchase one half a share of our Common Stock. We sold an aggregate of $7.5 million of Notes in this placement, which resulted in proceeds to the Company (net of placement agent fees of $450,724 and offering expenses of $110,778) of $6,938,498. See footnote number 22, SUBORDINATED DEBT.
Gross premiums ceded decreased $5.8 million or 22.9% to $19.5 million for the year ended December 31, 2003, from $25.3 million for the year ended December 31, 2002. The decrease is primarily due to the decline in our ceded quota-share reinsurance associated with our automobile insurance.
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 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.
Losses and loss adjustment expenses, the Company's most significant expense, represent actual payments made and changes in estimated future payments to be made to or on behalf of its policyholders, including expenses required to settle claims and losses. Management revises its estimates based on the results of its analysis of estimated future payments to be made. This process assumes that past experience, adjusted for the effects of current developments and anticipated trends, is an appropriate basis for predicting future events. The Company attributes the overall increase in the loss ratio primarily to its liability lines of insurance associated with automobile claims and the related estimates of the costs necessary to settle the claims. The estimated cost to close all claim files, for accidents that occurred in years other than the accidents that occurred in the current year ending December 31, 2003 and net of reinsurance recoveries, has increased by a total of $1.2 million over the ultimate estimates made as of December 31, 2002, primarily due to a decrease of claim frequency and claim severity and periodic estimates made by management of the ultimate costs required to settle all claims, both reported and not yet reported.
Salaries and wages increased $1.2 million, or 14.3%, to $9.2 million for the year ending December 31, 2003, as compared to $8.0 million for the year ending December 31, 2002. Management believes that the increase in salaries and wages is consistent with retaining quality management and increased premium production.
RESULTS OF OPERATIONS YEAR ENDED DECEMBER 31, 2002 COMPARED TO YEAR ENDED DECEMBER 31, 2001
Gross premiums written increased $28.8 million, or 84%, to $63.0 million for the year ended December 31, 2002 as compared to $34.2 million in 2001. The increase is due to the addition of American Vehicle's operations composing $19.9 million of the increase and $8.9 in increased written premiums by Federated National, which were the result of increased premium volume due to additional capacity created by increased surplus.
The change to unearned premiums increased by $12.1 million to $14.0 million as of December 31, 2002 as compared to $1.9 million as of December 31, 2001. Again, the predominate reason for the increase was due to the addition of a full year of operations for American Vehicle as compared to two months of operations in 2001.
Managing general agent fees are charged at a rate of $25.00 per policy, which is the maximum currently permitted under Florida law. These fees declined $3.9 million to $2.0 million for the year ended 2002. The decline is a result of Assurance MGA's completion of underwriting insurance for an unaffiliated insurance company.
The Company experienced net losses of $1.4 million for the year ended December 31, 2002 as compared to $2.9 million for the same period in 2001. Once thought to be only a function of the equity market, segments of the highly rated bond market proved to be unsound in 2002. During 2002, we incurred an "other than temporary" decline in value of $2.0 million in our investment in WorldCom, Inc. bonds.
Our loss ratio, combining the results of both insurance companies, as determined in accordance with GAAP, for the year ended December 31, 2002 was 54.4% compared with 79.8% for 2001. Losses and loss adjustment expenses incurred decreased $168,000 to $16.0 million for 2002 from $16.2 million for 2001. Losses and loss adjustment expenses, our most significant expenses, represent actual payments made and changes in estimated future payments to be made to or on behalf of policyholders, including expenses required to settle claims and losses.
Our deferred policy acquisition costs declined by $3.1 million to a credit balance of $2.1 million as compared to a charge against income of $1.0 million in 2001. The increase is associated with the shift in business underwritten by Assurance MGA away from an unaffiliated insurance company to American Vehicle.
(1) Represents the private placement in July 2003 of our Notes, which were offered and sold to accredited investors as units consisting of one Note with a principal amount of $1,000 and one Warrant to purchase one half a share of our Common Stock. We sold an aggregate of $7.5 million of Notes in this placement, which resulted in proceeds to the Company (net of placement agent fees of $450,724 and offering expenses of $110,778) of $6,938,498. The $7.5 million principle amount was reduced by the first quarterly installment payment of $625,000 due November 1, 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, in 2002, we implemented a direct bill program for policies underwritten by our carriers. These changes markedly decreased credit risks and made our reliance on the higher credit commitment previously offered by FlatIron unnecessary.
On July 31, 2003, we completed a private placement of our Notes, which were offered and sold to accredited investors as units consisting of one Note with a principal amount of $1,000 and one Warrant to purchase one half a share of our Common Stock. We sold an aggregate of $7.5 million of Notes in this placement, which resulted in proceeds to the Company (net of placement agent fees of $450,724 and offering expenses of $110,778) of $6,938,498. On or about October 31, 2003, we exercised our option to make a quarterly payment in shares of our Common Stock and issued a total of 41,195 shares of Common Stock to the purchasers of the Notes.
We issued Warrants to purchase shares of the Company's Common Stock to the purchasers of the Notes and to the placement agent in the offering, J. Giordano Securities Group ("J. Giordano"). Each Warrant entitles the holder to purchase one-half of one share of the Company's Common Stock. The total number of shares issuable upon exercise of Warrants 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 July 31, 2004.
For the twelve months ended December 31, 2003 and 2002, operations generated net operating cash flow of $12.3 million and $17.2 million, respectively. During the year ended December 31, 2003 gross cash flow from operations generated approximately $18.9 million, mostly by an increase in unpaid loss and loss adjustment expenses totaling $7.6 million, increased unearned premiums liability totaling $5.2 million, increased prepaid reinsurance premiums totaling $3.4 million and a $1.0 million decrease in premiums receivable, all in conjunction with net income of $8.4 million.
Net cash generated from financing activities was $12.2 million for the twelve months ended December 31, 2003. The source of cash from financing activities is primarily reflected by the receipt of $7.5 million from the issuance of the Notes and proceeds from exercised stock options totaling $6.9 million, offset by $1.2 million paid in dividends, $0.7 million used to retire outstanding shares of stock and $0.2 million used to reduce the revolving credit outstanding.
assurance that, if requested, the Florida Department of Financial Services will allow any dividends in excess of the amount available, to be paid by Federated National or American Vehicle in the future. The maximum dividends permitted by state law are not necessarily indicative of an insurer's actual ability to pay dividends or other distributions to a parent company, which also may be constrained by business and regulatory considerations, such as the impact of dividends on capital surplus, which could affect an insurer's competitive position, the amount of premiums that can be written and the ability to pay future dividends. Further, state insurance laws and regulations require that the statutory capital surplus of an insurance company, following any dividend or distribution by it, be reasonable in relation to its outstanding liabilities and adequate for its financial needs.
Insurance companies are required to comply with the risk-based capital requirements of the NAIC. The NAIC's risk-based capital requirements are a method of measuring the amount of capital appropriate for an insurance company to support its overall business operations in light of its size and risk profile. NAIC's risk-based capital standards are used by regulators to determine appropriate regulatory actions relating to insurers who show signs of weak or deteriorating condition. Based on calculations using the appropriate NAIC formula and the respective insurance company data for the year ending December 31, 2003, both insurance companies' total adjusted capital was in excess of ratios that would require regulatory action. GAAP differs in some respects from statutory reporting practices prescribed or permitted by the Florida Department of Financial Services. Federated National's and American Vehicle's statutory capital surplus levels as of December 31, 2003 were approximately $16.7 million and $10.7 million, respectively, and their statutory net income for the twelve months ended December 31, 2003 was $2.9 million and $0.8 million, respectively.
At December 31, 2003 and 2002, we did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as "structured finance" or "special purpose" entities, which were established for the purpose of facilitating off-balance-sheet arrangements or other contractually narrow or limited purposes. As such, management believes that we currently are not exposed to any financing, liquidity, market or credit risks that could arise if we had engaged in transactions of that type requiring disclosure herein.
We have audited the accompanying consolidated balance sheets of 21st Century Holding Company and Subsidiaries ("the Company" and a Florida Corporation) as of December 31, 2003, and 2002 and the related consolidated statements of operations, changes in shareholders' equity and comprehensive income (loss) and cash flows for the years then ended. 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 audits.
CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
The accompanying consolidated financial statements include the accounts of 21st Century Holding Company and its subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.
We are a vertically integrated insurance holding company, which, through our subsidiaries, controls substantially all aspects of the insurance underwriting, distribution and claims process. We underwrite personal automobile insurance, general liability insurance, flood insurance, homeowners' insurance and mobile home property and casualty insurance in Florida and Georgia through our wholly owned subsidiaries, Federated National Insurance Company and American Vehicle Insurance Company. American Vehicle was approved in August 2003 to be a foreign insurer in the State of Georgia. During the year ended December 31, 2003, 67.2%, 23.4%, 2.4% and 7.0% 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. We also offer premium financing to our own and third-party insureds through our wholly owned subsidiary, Federated Premium Finance, Inc.
We market and distribute our own and third-party insurers' products and our other services primarily in Central and South Florida, through a network of 23 agencies owned by Federated Agency Group, Inc., a wholly owned subsidiary, 44 franchised agencies, approximately 125 independent agents and a select number of general agents. Through our wholly owned subsidiary, FedUSA, Inc., we franchise agencies under the FedUSA name. As of December 31, 2003, franchises were granted for 44 FedUSA agencies, of which 38 were operating and 6 are pending. We intend to focus our future expansion efforts for our agency network on franchised agencies.
Assurance Managing General Agents, Inc., a wholly owned subsidiary, acts as Federated National's and American Vehicle's exclusive managing general agent. Assurance MGA currently provides all underwriting policy administration, marketing, accounting and financial services to Federated National, American Vehicle and our agencies, and participates in the negotiation of reinsurance contracts. Assurance MGA generates revenue through policy fee income and other administrative fees from the marketing of companies' products through the Company's distribution network. Although Assurance MGA recently replaced business from an unaffiliated insurance company with business from American Vehicle, and ceased acting as a third-party administrator for this company, Assurance MGA plans to establish relationships with additional carriers and add additional insurance products in the future.
We offer electronic tax filing services through Express Tax Service, Inc., an 80%-owned subsidiary, as well as franchise opportunities for these services through EXPRESSTAX. 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.
Our investment securities have been classified as available-for-sale because all of the securities are available to be sold in response to our liquidity needs, changes in market interest rates and asset-liability management strategies, among other reasons. Investments available-for-sale are stated at fair value on the balance sheet. Unrealized gains and losses are excluded from earnings and are reported as a component of other comprehensive income within shareholders' equity, net of related deferred income taxes.
A decline in the fair value of an available-for-sale security below cost that is deemed other than temporary results in a charge to income, resulting in the establishment of a new cost basis for the security. Premiums and discounts are amortized or accreted, respectively, over the life of the related fixed maturity security as an adjustment to yield using a method that
Premium revenue on property and casualty insurance is earned on a pro rata basis over the life of the policies. Unearned premiums represent the portion of the premium related to the unexpired policy term.
Deferred acquisition costs represent primarily commissions paid to outside agents at the time of policy issuance (to the extent they are recoverable from future premium income) net of ceded premium commission earned from reinsurers, salaries and premium taxes net of policy fees, and are amortized over the life of the related policy in relation to the amount of premiums earned. The method followed in computing deferred acquisition costs limits the amount of such deferred costs to their estimated realizable value, which gives effect to the premium to be earned, related investment income, unpaid losses and loss adjustment expenses and certain other costs expected to be incurred as the premium is earned. There is no indication that these costs will not be fully recoverable in the near term.
Years Ended December 31, ---------------------------------------- 2003 2002 2001 ----------- ----------- ----------- Balance, beginning of year $ 7,721 $ 11,952 $ 1,192,260 Acquisition costs deferred 885,406 (2,068,545) 286,930 Amortization expense during year 854,279 2,064,314 (1,467,238) ----------- ----------- ----------- Balance, end of year $ 1,747,406 $ 7,721 $ 11,952 =========== =========== ===========
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 have not experienced significant losses related to consumer loans or pay advances receivable. 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 January 2003, the Financial Accounting Standards Board ("FASB") issued Interpretation No. 46, Consolidation of Variable Interest Entities ("FIN 46"), which requires the consolidation of certain entities considered to be variable interest entities ("VIEs"). An entity is considered to be a VIE when it has equity investors who lack the characteristics of having a controlling financial interest, or its capitalis 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 adoptionof Interpretation No. 46 did not have any impact on our Consolidated Financial Statements.
The preparation of the consolidated financial statements in conformity with general accepted accounting principles 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 and Georgia, we are more exposed to this risk than some of our more geographically balanced competitors.
The fair value of mortgage loans is estimated using the present value of future cash flows based on the market rate for similar types of loans. Carrying value approximates market value as rates used are commensurate with market rate.
Goodwill is stated separately on the balance sheet and totaled $ 1,739,715 and $1,789,353 at December 31, 2003 and 2002, respectively, net of $1,726,530 and $1,725,622 of accumulated amortization as of December 31, 2003 and 2002, respectively. Goodwill relates to our insurance segment. The impairment computation for 2003 and 2002 indicated there was no impairment of goodwill. Impairment testing was performed during the fourth quarter of 2003, pursuant to the requirements of SFAS 142. Based upon this valuation analysis, goodwill does not appear to be impaired. Impairment testing will continue to be performed on no less than an annual basis, or when there is reason to suspect the value of these assets has diminished or is impaired.
Below is a calculation of the pro forma effects of eliminating the amortization of goodwill for each of the years in the three-year period ended December 31, 2003.
Basic earnings per share: Reported net income $ 2.64 $ 1.52 (0.31) Goodwill amortization $ -- $ -- $ 0.14 ------------- ------------- ----------- Adjusted net income $ 2.64 $ 1.52 $ (0.17) ============= ============= ===========
December 31, ------------ Net income (loss) 2003 2002 2001 ------------- ------------- ------------- As reported $ 8,364,876 $ 4,570,201 $ (992,090) Compensation, net of tax effect $ 4,783,080 $ 1,750,528 $ 189,765 ------------- ------------- ------------- Pro forma net income (loss) $ 3,581,796 $ 2,819,673 $ (1,181,855) ============= ============= =============
Property, plant and equipment are stated at cost less accumulated depreciation. Depreciation on property, plant and equipment is calculated on a straight-line basis over the following estimated useful lives: building and improvements - 30 years and furniture and fixtures 7 years. We capitalize betterments and any other expenditure in excess of $500 if the asset is expected to have a useful life greater than one year. The carrying value of property, plant and equipment is periodically reviewed based on the expected future undiscounted operating cash flows of the related item. Based upon our most recent analysis, we believe that no impairment of property, plant and equipment exists at December 31, 2003.
The following table shows the realized gains (losses) for fixed and equity securities for the years ended December 31, 2003 and 2002:
Proceeds from sales of fixed maturities and equity securities for the years ending December 31, 2003, 2002 and 2001 were approximately $168 million, $41 million and $62 million, respectively.
Years Ended December 31, ------------------------ 2003 2002 2001 --------- --------- ---------
Mortgage receivable beginning of year $ 145,043 $ 601,601 $ 385,024 New mortgages -- -- 450,000 Principal payments received (7,472) (456,558) (233,423) --------- --------- --------- Mortgage receivable end of year $ 137,571 $ 145,043 $ 601,601 ========= ========= =========
Below is a summary of the components of the finance contracts, consumer loans and pay advances receivable balance:
As of December 31, 2003, we have approximately $1.4 million, or 12.7%, of the gross premium finance receivables (before the allowances for credit losses and unearned premium finance charges) that comprises policies from an unrelated insurer. This unrelated insurance company currently is rated "B-" (Fair) by A.M. Best.
Years Ended December 31, 2003 2002 ----------- ----------- Land $ 632,144 $ 787,144 Building and improvements 2,823,400 3,775,208 Furniture and fixtures 2,385,083 1,729,033 ----------- ----------- Property, plant and equipment, gross 5,840,627 6,291,385 Accumulated depreciation (1,686,984) (1,471,768) ----------- ----------- Property, plant and equipment, net $ 4,153,643 $ 4,819,617 =========== ===========
We received approximately $6.7 million, $6.8 million and $3.8 million in commissions on premiums ceded during the years ended December 31, 2003, 2002 and 2001, respectively. Had all of our reinsurance agreements been canceled at December 31, 2003, we would have returned a total of approximately $2.5 million in reinsurance commissions to our reinsurers; in turn, our reinsurers would have returned approximately $7.8 million in unearned premiums to us.
At December 31, 2003 and 2002, the Company had an unsecured aggregate recoverable for paid and unpaid losses and loss adjustment expenses and unearned premiums with the following reinsurers:
Based upon consultations with our independent actuarial consultants and their statement of opinion on losses and loss adjustment expenses, we believe that the liability for unpaid losses and loss adjustment expenses is adequate to cover all claims and related expenses which may arise from incidents reported.
Under Florida law, a domestic insurer may not pay any dividend or distribute cash or other property to its shareholders except out of that part of its available and accumulated capital surplus funds which is derived from realized net operating profits on its business and net realized capital gains. A Florida domestic insurer may not make dividend payments or distributions to shareholders without prior approval of the Florida Department of Financial Services if the dividend or distribution would exceed the larger of (i) the lesser of (a) 10 percent of capital surplus (b) net income, not including realized capital gains, plus a two-year carryforward, (ii) 10 percent of capital surplus with dividends payable constrained to unassigned funds minus 25 percent of unrealized capital gains of (iii) the lesser of (a) 10 percent of capital surplus or (b) net investment income plus a three-year carryfoward with dividends payable constrained to unassigned funds minus 25 percent of unrealized capital gains. Alternatively, a Florida domestic insurer may pay a dividend or distribution without the prior written approval of the Florida Department of Financial Services (i) if the dividend is equal to or less than the greater of (a) 10 percent of the insurer's capital surplus as regards policyholders derived from realized net operating profits on its business and net realized capital gains or (b) the insurer's entire net operating profits and realized net capital gains derived during the immediately preceding calendar year, (ii) the insurer will have policyholder capital surplus equal to or exceeding 115 percent of the minimum required statutory capital surplus after the dividend or distribution, (iii) the insurer files a notice of the dividend or distribution with the Florida Department of Financial Services at least ten business days prior to the dividend payment or distribution and (iv) the notice includes a certification by an officer of the insurer attesting that, after the payment of the dividend or distribution, the insurer will have at least 115 percent of required statutory capital surplus as to policyholders. Except as provided above, a Florida domiciled insurer may only pay a dividend or make a distribution (i) subject to prior approval by the Florida Department of Financial Services or (ii) 30 days after the Florida Department of Financial Services has received notice of such dividend or distribution and has not disapproved it within such time. No dividends were declared or paid in 2003, 2002 or 2001.
We are required to comply with NAIC RBC requirements. RBC is a method of measuring the amount of capital appropriate for an insurance company to support its overall business operations in light of its size and risk profile. NAIC's RBC standards are used by regulators to determine appropriate regulatory actions relating to insurers who show signs of weak or deteriorating condition. As of December 31, 2003, based on calculations using the appropriate NAIC formula, both Federated National's and American Vehicle's total adjusted capital are in excess of ratios, which would require any form of regulatory action.
We do not currently believe that the Florida Department of Financial Services will take any significant action with respect to Federated National or American Vehicle regarding the IRIS ratios, though there can be no assurance that will be the case.
In June 2000, a lawsuit was filed against us, our directors and our executive officers seeking compensatory damages in an undisclosed amount on the basis of allegations that our amended registration statement dated November 4, 1998 was inaccurate and misleading concerning the manner in which we recognized ceded insurance commission income, in violation of Sections 11 and 15 of the Securities Act of 1933 and Sections 10(b) and 20(a) of the Securities Exchange Act of 1934. The lawsuit was filed in the United States District Court for the Southern District of New York. The plaintiff class purportedly includes purchasers of our common stock between November 5, 1998 and August 13, 1999. The Court recently granted the plaintiffs class status.
Specifically, the plaintiffs allege that we recognized ceded commission income on a written basis, rather than amortized on a pro rata basis. The plaintiffs allege that this was contrary to the Statement of Financial Accounting Concepts Nos. 1, 2 and 5. We believe, however, that the lawsuit is without merit and we have vigorously defended the action, because we reasonably relied upon outside subject matter experts to make these determinations at the time. We have also since accounted for ceded commission on a pro rata basis and have done so since these matters were brought to our attention in 1998. Nevertheless, we have also continued to actively participate in settlement negotiations with the plaintiffs and have tentatively agreed to settle the case. The parties are currently negotiating the final terms of a Memorandum of Understanding, which will have to be executed by the parties and then approved by the court. We have reserved and charged against current year earnings $600,000 for the potential settlement and associated costs.
Prior to its acquisition in 2001, American Vehicle was involved in litigation with a former officer and director. The litigation was adjudicated and American Vehicle, among others, was found liable and paid the final judgment. A petition was filed seeking costs of $136,000 and appellate attorneys fees in excess of $2.0 million. American Vehicle's previous owners have agreed to indemnify us against any such fees and costs and, the $500,000 purchase price for American Vehicle is held in escrow pending settlement of the fees and costs issued. On February 26, 2003, the 11th Judicial Circuit in Miami, Florida entered an amended final judgment awarding the plaintiffs $1,140,387 in attorney fees and costs. Both parties are appealing this judgment. Management anticipates that there will be no costs associated with the settlement of this case, consequently, no liability for fees and costs have been accrued.
As a direct premium writer in the State of Florida, we are required to participate in certain insurer solvency pools under Florida Statutes 631.57(3)(a). Participation in these pools is based on our written premium by line of business to total premiums written statewide by all insurers. Participation may result in assessments against us. We were assessed $258,000 and $203,000, for the years ended December 31, 2002 and 2001, respectively. There was no assessment made for the year ended December 31, 2003. We are entitled to recover all of these assessments as permitted by the State of Florida through
policy surcharges. During 2002, we recovered $180,000 of the 2001 assessment and during 2003 we recovered the balance of the 2001 assessment and $142,000 of the 2002 assessment. Of the 2002 assessment, $16,000 will not be passed through as policy surcharges and $99,000 remains to be collected through policy surcharges as of December 31, 2003.
Fiscal Year Leases ----------- ------ 2004 $ 303,366 2005 157,871 2006 81,695 2007 49,146 Thereafter -- ---------- Total $ 592,078 ==========
One of our directors is a partner at a law firm that handles the Company's claims litigation. Fees paid to this law firm amounted to approximately $219,000, $266,000 and $530,000 for the years ended December 31, 2003, 2002 and 2001, respectively.
Net income (loss) per share is computed by dividing net income (loss) by the weighted average number of shares of common stock and common stock equivalents outstanding during the periods presented. Options granted in accordance with the stock option plan were anti-dilutive for the years ended December 31, 2002 and 2001 and were not taken into account in the computation.
At December 31, 2003, 2002 and 2001, warrants issued to two employees to purchase 7,800, 62,500 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 and 2001, 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, 100% of the 125,000 shares were exercised. All of these potential common shares were excluded from the computation of net income (loss) per share for 2002 and 2001 because their inclusion would have an anti-dilutive effect.
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 warrants vested immediately and are exercisable between December 1999 and December 2004, at which time if they have not been exercised, they will be canceled. The estimated fair value of these warrants at the date issued was approximately $226,000 using a Black-Scholes option pricing model and assumptions similar to those used for valuing the Company's stock options as described below. During 2003, 54,700 of these warrants were exercised and 7,800 remain to be 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 600,000 common shares, and, as of December 31, 2003, we had outstanding exercisable options to purchase 272,353 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
Activity in our stock option plans for the period from January 1, 2001 to December 31, 2003 is summarized below:
We continue to account for stock-based compensation using the intrinsic value method prescribed by Accounting Principles Board Opinion No. 25, under which no compensation cost for stock options is recognized for stock option awards granted to employees at or above fair market value. Had compensation expense for our stock compensation plan been determined based upon fair values at the grant dates for awards under the plan in accordance with SFAS No. 123, our net income (loss) and net income (loss) per share would have been reduced (increased) to the pro forma amounts indicated below. Additional stock option awards are anticipated in future years.
In August 2001, we purchased all of the outstanding stock and all of the outstanding surplus notes of American Vehicle for $500,000 in cash. In addition, we agreed to pay two executives of American Vehicle a finders' fee of $400,000 over a period of three years. Income and expenses of American Vehicle beginning September 1, 2001 are included in our Consolidated Statements of Operations. The fair value of the net assets (which consisted primarily of marketable securities) of American Vehicle at the date of acquisition was approximately $2.1 million. In accordance with SFAS No. 141, Business Combinations, the excess of the fair value of the net assets purchased over the purchase price has been reported as an extraordinary gain in the accompanying Consolidated Statements of Operations.
Our Amended and Restated Articles of Incorporation authorize the issuance of one million shares of preferred stock with designations, rights and preferences determined from time to time by our board of directors. Accordingly, our board of directors is empowered, without shareholder approval, to issue preferred stock with dividends, liquidation, conversion, voting or other rights that could adversely affect the voting power or other rights of the holders of common stock. We have not issued preferred shares as of December 31, 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 one warrant (the "warrant") to purchase one half a share of our Common Stock. We sold an aggregate of $7.5 million of Notes in this placement, which resulted in proceeds to the Company (net of placement agent fees of $450,724 and offering expenses of $110,778) of $6,938,498.
We issued warrants to purchase shares of the Company's Common Stock to the purchasers of the Notes and to the placement agent in the offering, J. Giordano Securities Group ("J. Giordano"). Each warrant entitles the holder to purchase one-half of one share of the Company's Common Stock. The total number of shares issuable upon exercise of warrants