SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-KSB/A
(AMENDMENT NO. 2)
(MARK ONE)
( X ) ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES ACT OF
1934
(Fee Required)
For the fiscal year ended DECEMBER 31, 1998
or
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
(No Fee Required)
For the transition period of _____________to_______________
Commission file number 0-2500111
21ST CENTURY HOLDING COMPANY
(Exact name of small business issuer as specified in its Charter)
FL 65-0248866
------------------------------- -----------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No)
4161 N.W. 5TH STREET PLANTATION, FLORIDA 33317
-------------------------------------------------------------
(Address of Principal executive offices) (Zip Code
Registrant's telephone number, including area code (954) 581-9993
Securities registered pursuant to Section 12(b) of the Exchange Act: None
Securities registered pursuant to Section 12(g) of the Exchange Act:
COMMON STOCK, PAR VALUE $.01 PER SHARE
--------------------------------------
(Title of Class)
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the preceding 12 months (or for such
shorter periods that the registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days. YES x NO ___
Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B contained in this form, and no disclosure will be contained, to
the best of registrant's knowledge. In definitive proxy or information
statements incorporated by reference in Part III of this Form 100KSB or any
amendment to this Form 10-KSB. [ X ]
State issuer's revenues for its most recent fiscal year: $20,668,467
The aggregate market value of the Issuer's Common Stock, $.01 par value, held by
non-affiliates on March 29, 1999, based on the last sale price of the Common
Stock as reported by the Nasdaq National Market was: $7,709,873
As of March 29, 1999 there were 3,390,000 the issuer's Common Stock, $.01 par
value, outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
1
<PAGE>
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
The Company, through its subsidiaries, is engaged in the insurance
underwriting, distribution and claims business. Federated National, the
Company's insurance subsidiary, generates revenues from the collection and
investment of premiums. The Company's agency operations generate income from
policy fees, commissions, premium financing referral fees, auto tag agency fees
and the marketing of ancillary services. Federated Premium generates revenue
from premium financing provided to Company and third party insureds. Assurance
MGA, the Company's managing general agent, generates revenue through policy fee
income and other administrative fees from the marketing of third parties'
insurance products through the Company's distribution network.
The Company's business, results of operations and financial condition
are subject to fluctuations due to a variety of factors. Abnormally high
severity or frequency of claims in any period could have a material adverse
effect on the Company's business, results of operations and financial condition.
Also, if Federated National's estimated liabilities for unpaid losses and LAE is
less than actual losses and LAE, Federated National will be required to increase
reserves with a corresponding reduction in Federated National's net income in
the period in which the deficiency is identified. The Company operates in a
highly competitive market and faces competition from both national and regional
insurance companies, many of whom are larger and have greater financial and
other resources than the Company, have favorable A.M. Best ratings and offer
more diversified insurance coverage. The Company's competitors include other
companies which market their products through agents, as well as companies which
sell insurance directly to customers.
Large national writers may have certain competitive advantages over
agency writers, including increased name recognition, increased loyalty of their
customer base and reduced acquisition costs. The Company may also face
competition from new or temporary entrants in its niche markets. In some cases,
such entrants may, because of inexperience, desire for new business or other
reasons, price their insurance below that of the Company. Although the Company's
pricing is inevitably influenced to some degree by that of its competitors,
management of the Company believes that it is generally not in the Company's
best interest to compete solely on price, choosing instead to compete on the
basis of underwriting criteria, its distribution network and superior service to
its agents and insureds. The Company competes with respect to automobile
insurance in Florida with more than 100 companies which underwrite personal
automobile insurance.
RESULTS OF OPERATIONS
Year Ended December 31, 1998 Compared to Year Ended December 31, 1997
GROSS PREMIUMS WRITTEN. Gross premiums written increased 19.8% to $21.2
million in 1998 from $17.7 million in 1997. The increase was mainly due to an
increase in premium volume by our Company-owned agencies of approximately $3.3
million or 73.3% from the same period in 1997. The remaining increase was due to
an increase in the number of independent agents generating premiums for the
Company. Additionally, during 1998, gross premiums written for the mobile home
lines increased 512.2% from $343,000 in 1997 to $2.1 million in 1998
NET PREMIUMS WRITTEN. Net premiums written increased 12.3% to $14.6
million in 1998 from $13.0 million in 1997. The increase was mainly due to an
increase in premium volume by our Company-owned agencies of approximately $3.3
million or 73.37% from the same period in 1997, in addition to the increase in
mobile home premiums which increased 512.2% from $343,000 in 1997 to $2.1
million in 1998
NET PREMIUMS EARNED. Net premiums earned increased 28.4% to $14.0
million in 1998 from
24
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$10.9 million in 1997. This increase is mainly due to the increase in volume
experienced during 1998.
COMMISSION INCOME. Commission income decreased 16.7% to $2.0 million in
1998 from $2.4 million in 1997. Commission income consists of fees earned by the
Company-owned agencies placing business with third party insurers and third
party premium finance companies. The decrease is partially attributable to a
$300,000 decrease in commissions earned on business placed with third party
finance companies. During 1997, premium financing was placed almost exclusively
with third party companies for which commissions were received, as compared to
1998, where premium financing was placed substantially with Federated Premium
for which no commissions are paid.
FINANCE REVENUES. Finance revenues increased 718.2% to $1.8 million in
1998 from $220,000 in 1997. In order to terminate a premium finance lending
arrangement which was not favorable to the Company's overall growth strategy,
Federated Premium ceased all new premium financing with its customers in July
1996 and subsequently terminated the premium finance lending arrangement with
its lender in early 1997. In September 1997, a new premium finance lending
arrangement was established and the Company recommenced its premium financing
activities. In addition, during 1998 the Company began offering auto title loans
which generated $217,000in revenue for the year.
INVESTMENT INCOME. Investment income consists of net investment income
and net realized investment gains (losses). Investment income increased 40% to
$1.4 million in 1998 from $1.0 million in 1997. The Company experienced realized
gains of $442 in 1998 compared to realized losses of ($19) in 1997 and net
investment income of $984 in 1998 compared to $1.0 in 1997.
OTHER INCOME. Other income increased 16.7% to $1.4 million in 1998 from
$1.2 million in 1997, due to the expansion of the agency network and the
increase in the business they generate. Other income is comprised mainly of the
managing general agent's policy fee income on all new and renewal insurance
policies and revenue on auto tag products. Policy fee income increased 18.5% to
$972,000 in 1998 from $820,000 in 1997. In addition, auto tag income increased
39.4% to $386,000 in 1998 from $277,000 in 1997.
LOSSES AND LAE. The Company's Loss Ratio, as determined in accordance
with GAAP, for 1998 was 65.4% compared with 67.9% in 1997. The loss and LAE
increased 23.0% to $9.1 million in 1998 from $7.4 million in 1997 as compared to
net premium earned which increased by 28.4% to $14.0 million in 1998 from $10.9
million in 1997. The lower Loss Ratio in 1998 was primarily attributable to the
hiring of experienced key personnel, improvement on the claims evaluation
process and implementing a strategy to minimize legal expenses. In addition, the
Loss Ratio related to the mobile home product is below that of non-standard
automobile products. The increase in written premiums related to the program
further contributed to the reduction of the Loss Ratio during 1998. Non-standard
automobile insurance rates increased in 1998, further contributing to the
decrease in the Loss Ratio.
OPERATING AND UNDERWRITING EXPENSES. Operating and underwriting
expenses increased 30.3% to $4.3 million in 1998 from $3.3 million in 1997. This
increase is primarily due to the additional expenses incurred during 1998 as it
relates to the increase in premiums written. In addition, operating expenses
increased with the additional agencies, which were acquired during 1998.
Interest expense increased $268,000 from $54,000 in 1997 to $322,000 in 1998.
This is attributable to the new lending arrangement Federated Premium
established in September 1997 and the increase in the amount outstanding.
SALARIES AND WAGES. Salaries and wages increased 29.0% to $4.0 in 1998,
from $3.1 million in 1997. This increase is mainly due to the increase in
business in addition to the increase in Company-owned agencies that were
acquired during 1998.
AMORTIZATION OF DEFERRED POLICY ACQUISITION COSTS. Amortization of
deferred policy acquisition costs decreased 48.0% to $179,000 in 1998 from
$344,000 in 1997. Amortization of deferred acquisition costs consists of the
actual amortization of deferred policy acquisition costs less commission earned
on reinsurance ceded. The decrease in the amortization of deferred policy
acquisition costs is attributable to the increase in commissions from
reinsurance ceded and is also the result of the modification of the reinsurance
agreement in April 1997. Also, contributing to the decrease was a settlement
with the reinsurer
25
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on the ceding commissions for the 1995 and 1996 underwriting years, resulting in
additional ceding commissions of $223,000.
INCOME TAX EXPENSES. The Company's estimated effective income tax rate
was 34.7% for 1998 compared with 22.6% for 1997. This increase in the effective
tax rate is primarily the result of the January 1998 agency acquisitions by the
Company, which, prior to their acquisition, were S Corporations for Federal
income tax purposes.
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary sources of capital are revenues generated from
operations, the net proceeds of the IPO, investment income and borrowings under
the credit facility. Because the Company is a holding company, it is largely
dependent upon dividends from its subsidiaries for cash flow.
In November 1998, the Company generated net proceeds of approximately
$7.9 million from the IPO in which it sold 1,250,000 shares of Common Stock at a
price of $7.50 per share. The net proceeds of the IPO have been and are being
used for contributions to Federated National's capital, repayment of debt under
the Credit Facility, the financing of acquisitions and working capital and other
general corporate purposes.
Federated Premium is party to the credit facility (the "Credit
Facility"), which is used to fund its operations. Each advance is subject to
availability under a borrowing base calculation based upon a percentage of
eligible accounts receivable, with maximum advances outstanding not to exceed
the maximum credit commitment which is currently $5.0 million, increased from
$4.0 million pursuant to a modification effective January 25, 1999. The
outstanding balance of the Credit Facility as of December 31, 1998 was $2.1
million. The annual interest rate on borrowings under the Credit Facility is
currently the prime rate plus .75%,decreased from the prime rate plus 1.75% due
to the January 1999 modification. The Credit Facility contains various operating
and financial covenants and is collateralized by a first lien and assignment of
all of Federated Premium's finance contracts receivable. Federated Premium was
in compliance with all covenants under the Credit Facility as of December 31,
1998. The Credit Facility expires on September 30, 2000.
For the year ended December 31, 1998, operations generated operating
cash flow deficiency of $2.5 million which was primarily attributable to the
increased volume of premium financing and auto title loans. Operating cash flow
is expected to be positive in both the short-term and reasonably foreseeable
future. In addition, the Company's investment portfolio is highly liquid as it
consists almost entirely of readily marketable securities.
In October 1996, Federated National purchased land in Plantation,
Florida to construct a headquarters building. In August 1998, the building was
completed and the Company consolidated its executive offices and administrative
operations in the building, which consists of approximately 14,000 square feet.
The cost of the project was approximately $1.4 million.
To retain its certificate of authority, the Florida insurance laws and
regulations require that Federated National maintain capital surplus equal to
the greater of 10.0% of its liabilities or the 1998 statutory minimum capital
and surplus requirement of $2.25 million as defined in the Florida Insurance
Code. The Company is also required to adhere to prescribed premium-to-capital
surplus ratios. The Company is in compliance with these requirements.
The maximum amount of dividends, which can be paid by Florida insurance
companies without prior approval of the Florida Commissioner, is subject to
restrictions relating to statutory surplus. The maximum dividend that may be
paid in 1999, by the Company without prior approval, is limited to the lesser of
statutory net income from operations of the preceding calendar year or 10.0% of
statutory unassigned capital surplus as of the preceding December 31. No
dividends were paid during 1998.
26
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The Company is party to the Consent Order which limits the amount of
premiums it can underwrite in 1998 and 1999.
The Company is required to comply with the NAIC's risk-based capital
requirements. 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. As of December 31, 1998, based on calculations using the appropriate
NAIC formula, the Company's total adjusted capital is in excess of ratios, which
would require any form of regulatory action. GAAP differs in some respects from
reporting practices prescribed or permitted by the Florida Department of
Insurance. Federated National's statutory capital surplus was approximately $4.1
million as of December 31, 1997 and $7.3 million as of December 31, 1998.
Statutory net income was $591,000 for the year ended December 31, 1997 and $1.4
million for 1998.
IMPACT OF INFLATION AND CHANGING PRICES
The consolidated and combined financial statements and related data
presented herein have been prepared in accordance with GAAP which requires the
measurement of financial position and operating results in terms of historical
dollars without considering changes in the relative purchasing power of money
over time due to inflation. The primary assets and liabilities of the Company
are monetary in nature. As a result, interest rates have a more significant
impact on the Company's performance than the effects of the general levels of
inflation. Interest rates do not necessarily move in the same direction or with
the same magnitude as the cost of paying losses and LAE.
Insurance premiums are established before the Company knows the amount
of loss and LAE and the extent to which inflation may affect such expenses.
Consequently, the Company attempts to anticipate the future impact of inflation
when establishing rate levels. While the Company attempts to charge adequate
rates, the Company may be limited in raising its premium levels for competitive
and regulatory reasons. Inflation also affects the market value of the Company's
investment portfolio and the investment rate of return. Any future economic
changes which result in prolonged and increasing levels of inflation could cause
increases in the dollar amount of incurred loss and LAE and thereby materially
adversely affect future liability requirements.
YEAR 2000 MATTERS
In 1996, the Company began converting its computer systems to be year
2000 compliant. The Company has evaluated its internal systems, both hardware
and software, facilities, and interactions with business partners in relation to
year 2000 issues. As of December 31, 1998, the Company believes that it had
completed its efforts to bring the systems in compliance. The total cost
incurred during the year ended December 31, 1998 to modify these existing
systems, which include both internal and external costs of programming, coding
and testing, was not material. The Company continually evaluates computer
hardware and software upgrades and, therefore, many of the costs to replace
existing items with year 2000 compliant upgrades are not likely to be
incremental costs to the Company. During 1999, the Company will continue to
contact its business partners (including agents, banks, motor vehicle
departments and rating agencies) to determine the status of their compliance and
to assess the impact of noncompliance on the Company. The Company believes that
it is taking the necessary measures to mitigate issues that may arise relating
to the year 2000. To the extent that any additional issues arise, the Company
will evaluate the impact on its business, results of operations and financial
condition and, if material, make the necessary disclosures and take appropriate
remedial action.
27
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FORWARD-LOOKING STATEMENTS
Except for the historical information contained herein, this "Item 6
Management's Discussion and Analysis of Financial Condition and Results of
Operations", contains forward-looking statements that
involve a number or risks and uncertainties, including the risks described
elsewhere in this Report and detailed from time to time in the Company's filings
with the Commission.
ITEM 7. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See pages F-1 through F-30 appearing at the end of this Report.
28
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 12 the Securities Exchange Act
of 1934, as amended, the Registrant has duly caused this report or amendment to
be signed on its behalf by the undersigned, thereto duly authorized.
21st HOLDING COMPANY
By: /s/ EDWARD J. LAWSON
----------------------------------------
Edward J. Lawson, Chairman of the Board,
President and Chief Executive Officer
Dated: May 5, 1999
38
<PAGE>
21ST CENTURY HOLDING COMPANY
INDEX TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS
PAGE
----
Independent Auditor's Report........................................... F-2
Consolidated and Combined Balance Sheets
as of December 31, 1998 and December 31, 1997........................ F-3
Consolidated and Combined Statements of Income
For the years ended December 31, 1998 and 1997....................... F-4
Consolidated and Combined Statements of Changes in
Shareholders' Equity and Comprehensive Income
For the years ended December 31, 1998 and 1997....................... F-5
Consolidated and Combined Statements of Cash Flows
For the years ended December 31, 1998 and 1997....................... F-6
Notes to Consolidated and Combined Financial Statements................ F-7
F-1
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors
21st Century Holding Company:
We have audited the accompanying consolidated and combined balance sheets of
21st Century Holding Company (the "Company") as of December 31, 1998 and 1997,
and the related consolidated and combined statements of income, changes in
shareholders' equity and comprehensive income, and cash flows for the years
ended December 31, 1998 and 1997. These consolidated and combined financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated and combined
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. 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. 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 consolidated and combined financial statements referred to
above present fairly, in all material respects, the financial position of 21st
Century Holding Company as of December 31, 1998 and 1997, and the results of
their operations and their cash flows for the years ended December 31, 1998 and
1997, in conformity with generally accepted accounting principles.
KPMG LLP
Miami, Florida
March 30, 1999
F-2
<PAGE>
<TABLE>
<CAPTION>
21ST CENTURY HOLDING COMPANY
CONSOLIDATED AND COMBINED BALANCE SHEETS
DECEMBER 31, 1998 AND DECEMBER 31, 1997
DECEMBER 31,
1998 1997
------------ ------------
<S> <C> <C>
ASSETS
Available for sale at fair value:
Investments
Fixed maturities ....................................................... $ 14,605,582 13,267,284
Equity securities ...................................................... 2,936,520 2,208,594
Mortgage loan ............................................................ 163,164 283,712
------------ ------------
Total investments .................................................. 17,705,266 15,759,590
------------ ------------
Cash and cash equivalents ................................................ 2,250,061 1,684,450
Finance contracts receivable and auto title loans receivable,
net of allowance for credit losses of $195,883 and $36,980,
respectively ........................................................... 7,093,593 2,226,777
Prepaid reinsurance premiums ............................................. 2,648,098 2,217,664
Due from reinsurers ...................................................... 1,926,736 1,024,512
Deferred acquisition costs ............................................... 89,524 160,934
Deferred income taxes .................................................... 1,085,255 713,819
Property, Plant and Equipment net ........................................ 1,763,254 385,730
Other assets ............................................................. 866,335 535,410
Goodwill ................................................................. 2,748,281 476,006
------------ ------------
Total assets ....................................................... $ 38,176,403 $ 25,184,892
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Unpaid losses and loss adjustment expenses ............................... $ 7,603,460 6,726,462
Unearned premiums ........................................................ 8,534,320 7,499,742
Premium deposits ......................................................... 492,422 1,341,556
Revolving credit outstanding ............................................. 2,062,948 1,593,752
Bank overdraft ........................................................... 1,199,941 730,289
Unearned commissions ..................................................... 586,592 645,594
Accounts payable and accrued expenses .................................... 1,932,950 1,040,809
Notes payable ............................................................ 500,000 552,625
Drafts payable to insurance companies .................................... 295,947 269,160
Due to shareholders ...................................................... 0 57,250
------------ ------------
Total liabilities .................................................. 23,208,580 20,457,239
------------ ------------
Shareholders' equity:
Common stock of $0.01 par value. Authorized 25,000,000 shares,
issued and outstanding 3,350,000 and 1,042,121 shares,
respectively ......................................................... 33,500 10,421
Common stock of $1 par value. Authorized, issued and
outstanding 840 shares ............................................... -- 840
Additional paid-in capital ............................................. 12,460,287 4,304,758
Accumulated other comprehensive income ................................. (257,227) 124,677
Retained earnings ...................................................... 2,731,263 286,957
------------ ------------
Total shareholders' equity ......................................... 14,967,823 4,727,653
Commitments and contingencies
Total liabilities and shareholders' equity ......................... $ 38,176,403 25,184,892
============ ============
</TABLE>
See accompanying notes to consolidated and combined financial statements.
F-3
<PAGE>
21ST CENTURY HOLDING COMPANY
CONSOLIDATED AND COMBINED STATEMENTS OF INCOME
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
DECEMBER 31,
1998 1997
------------ ------------
Revenue:
Gross premiums written ................... $ 21,195,144 $ 17,675,375
Gross premiums ceded ..................... (6,628,270) (4,659,378)
------------ ------------
Net premiums written ................. 14,566,874 13,015,997
Decrease in unearned premiums, net
of prepaid reinsurance premiums .......... (604,143) (2,091,718)
------------ ------------
Net premiums earned .................. 13,962,731 10,924,279
Commission income ......................... 2,036,637 2,357,579
Finance revenue ........................... 1,825,268 220,434
Net investment income ..................... 983,592 1,047,348
Net realized investment gains (losses) .... 441,810 (19,395)
Other income .............................. 1,418,429 1,218,895
------------ ------------
Total revenue ........................ 20,668,467 15,749,140
------------ ------------
Expenses:
Losses and loss adjustment expenses ...... 9,133,332 7,414,151
Operating and underwriting expenses ...... 4,291,613 3,300,713
Salaries and wages ....................... 4,042,226 3,148,558
Amortization of deferred acquisition
costs ................................ 179,057 343,716
Amortization of goodwill ................. 239,619 38,102
------------ ------------
Total expenses ....................... 17,885,847 14,245,240
------------ ------------
Income before provision for income
tax expense ....................... 2,782,620 1,503,900
Provision for income tax expense .......... 965,000 339,369
------------ ------------
Net income ........................... $ 1,817,620 $ 1,164,531
============ ============
Net income per share ................. $ 0.79 $ 0.55
============ ============
Net income per share--
assuming dilution ................. $ 0.79 $ 0.55
============ ============
Pro forma information: (Unaudited)
Historical income before provisions for
income tax expense ..................... -- 1,503,900
Pro forma income tax expense ............. -- 524,043
Pro forma net income ..................... -- 979,857
Pro forma net income per share (basic) ... -- 0.46
Pro forma net income per share (diluted) . -- 0.46
Weighted average shares outstanding
(basic) ................................ -- 2,100,000
Weighted average shares outstanding
(diluted) .............................. -- 2,100,000
See accompanying notes to the consolidated and combined financial statements.
F-4
<PAGE>
<TABLE>
<CAPTION>
21ST CENTURY HOLDING COMPANY
CONSOLIDATED AND COMBINED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
AND COMPREHENSIVE INCOME
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
ACCUMULATED
ADDITIONAL OTHER
COMPREHENSIVE COMMON PAID-IN COMPREHENSIVE RETAINED
DESCRIPTION INCOME STOCK CAPITAL INCOME (LOSS) EARNINGS
- ----------- ------------- ---------- ---------- -------------- --------
<S> <C> <C> <C> <C> <C>
Balance as of December 31, 1996........... 26,930 4,598,595 (20,721) (795,089)
Capital contributions.................... -- 222,500 -- --
Acquisition and consolidation of
affiliates previously combined......... (15,669) (359,399) -- 375,068
Distributions to affiliated
corporations' shareholders............. -- -- -- (457,553)
Distributions to shareholders............ -- (156,938) -- --
Net income............................... 1,164,531 -- -- -- 1,164,531
Net appreciation on investments,
net of reclassification adjustment
net of tax of......................... 145,398 -- -- 145,398 --
---------
Comprehensive Income..................... 1,309,929
========= ------- ----------- --------- ----------
Balance as of December 31, 1997........... 11,261 4,304,758 124,677 286,957
Acquisition and consolidation of
affiliates previously combined......... 9,739 358,687 -- 626,686
Distributions to shareholders............ -- (100,000) -- --
Net income............................... 1,817,620 -- -- -- 1,817,620
Net depreciation on investments,
net of tax of (381,904) (381,904)
---------
Comprehensive Income 1,435,716
=========
Net Proceeds from relating to IPO......... 12,500 7,896,842
------- ----------- --------- ----------
Balance as of December 31, 1998.......... $33,500 $12,460,287 $(257,227) $2,731,263
======= =========== ========= ==========
<CAPTION>
TOTAL
STOCKHOLDERS'
DESCRIPTION EQUITY
- ----------- -------------
<S> <C>
Balance as of December 31, 1996........... 3,809,715
Capital contributions.................... 222,500
Acquisition and consolidation of
affiliates previously combined......... --
Distributions to affiliated
corporations' shareholders............. (457,553)
Distributions to shareholders............ (156,938)
Net income............................... 1,164,531
Net appreciation on investments,
net of reclassification adjustment
net of tax of......................... 145,398
Comprehensive Income.....................
-----------
Balance as of December 31, 1997........... 4,727,653
Acquisition and consolidation of
affiliates previously combined......... 995,112
Distributions to shareholders............ (100,000)
Net income............................... 1,817,620
Net depreciation on investments,
net of tax of (381,904)
Comprehensive Income
Net Proceeds from relating to IPO......... 7,909,342
-----------
Balance as of December 31, 1998.......... $14,967,823
===========
</TABLE>
See accompanying notes to consolidated and combined financial statements.
F-5
<PAGE>
<TABLE>
<CAPTION>
21ST CENTURY HOLDING COMPANY
CONSOLIDATED AND COMBINED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
1998 1997
------------ ------------
<S> <C> <C>
Cash flow from operating activities:
Net income ........................................................................ $ 1,817,620 $ 1,164,531
Adjustments to reconcile net income to net cash flow used in
operating activities:
Amortization of investment premiums ............................................. 6,759 1,175
Depreciation and amortization ................................................... 54,089 50,935
Amortization of goodwill ........................................................ 239,619 38,102
Deferred income tax expense ..................................................... (143,226) 105,291
Loss (gain) on sale of investment securities .................................... (441,810) 19,395
Gain on sale of property and equipment .......................................... -- (11,433)
Provision for credit losses ..................................................... 158,903 38,362
Changes in operating assets and liabilities:
Finance contracts receivables and auto title loans receivable .................. (5,025,719) (1,674,974)
Prepaid reinsurance premiums ................................................... (430,434) 707,320
Due from reinsurers ............................................................ (902,224) (484,134)
Deferred acquisition costs ..................................................... 71,410 (338,322)
Other assets ................................................................... (330,925) (319,626)
Unpaid losses and loss adjustment expenses ..................................... 876,998 492,502
Unearned premiums .............................................................. 1,034,578 1,255,201
Premium deposits ............................................................... (849,134) 398,826
Revolving credit outstanding ................................................... 469,196 1,593,752
Unearned commissions ........................................................... (59,001) 37,700
Accounts payable and accrued expenses .......................................... 892,141 770,880
Drafts payable to insurance companies .......................................... 26,787 269,160
------------ ------------
Net cash flow (used in) provided by operating activities ...................... (2,534,373) 4,114,643
------------ ------------
Cash flow from investing activities:
Proceeds from sale of investment securities available for sale .................... 39,841,097 21,088,211
Purchases of investment securities available for sale ............................. (42,087,422) (24,469,367)
Loans from Shareholders ........................................................... 31,000 --
Cost of mortgage loan ............................................................. -- (200,000)
Sale of mortgage loan ............................................................. 120,548 89,421
Acquisition of affiliates previously combined ..................................... -- (80,175)
Purchases of property and equipment ............................................... (1,431,608) (102,073)
Proceeds from sales of property and equipment ..................................... -- 314,874
Acquisitions of Agencies .......................................................... (1,100,000) --
------------ ------------
Net cash flow used in investing activities .................................... (4,626,385) (3,359,109)
------------ ------------
Cash flow from financing activities:
Bank overdraft .................................................................... 469,652 211,477
Capital contribution .............................................................. 0 222,500
Distributions to shareholders ..................................................... (100,000) (457,553)
Net proceeds from IPO ............................................................. 7,909,342 --
Borrowings from bank .............................................................. -- 431,000
Repayment of indebtedness ......................................................... (552,625) (710,146)
------------ ------------
Net cash flow (used in) provided by financing activities ...................... 7,726,369 (302,722)
------------ ------------
Net increase in cash and cash equivalents ..................................... 565,611 452,812
Cash and cash equivalents at beginning of year ...................................... 1,684,450 1,231,638
------------ ------------
Cash and cash equivalents at end of year ............................................ $ 2,250,061 $ 1,684,450
============ ============
Supplemental disclosure of cash flow information:
Cash paid during the year for:
Interest ......................................................................... $ 322,313 $ 21,758
============ ============
Income taxes ..................................................................... $ 226,047 $ 26,211
============ ============
Cash received during the year from:
Income taxes ..................................................................... $ -- $ 61,000
============ ============
<FN>
See note 2(a) regarding non-cash financing and investing activities
</FN>
</TABLE>
See accompanying notes to consolidated financial statements
F-6
<PAGE>
21ST CENTURY HOLDING COMPANY
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
(1) ORGANIZATION AND BUSINESS
The accompanying consolidated and combined financial statements include
the accounts of 21st Century Holding Company and its wholly owned subsidiaries
and those entities which are under common control through common ownership
(collectively referred to as the "Company"). All significant intercompany
balances and transactions have been eliminated in consolidation.
The Company is a vertically integrated insurance holding company,
which, through its subsidiaries, controls substantially all aspects of the
insurance underwriting, distribution and claims process. The Company's Federated
National Insurance Company ("Federated National") subsidiary underwrites
nonstandard and standard personal automobile insurance and mobile home property
and casualty insurance in the State of Florida. Through a wholly-owned managing
general agent, Assurance Managing General Agents, Inc. ("Assurance MGA"), the
Company has underwriting and claims authority for third-party insurance
companies. The Company also offers premium financing, auto title loans and other
ancillary services to its customers.
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND PRACTICES
(A) BASIS OF ACCOUNTING
In January 1997, the Company acquired all of the issued and outstanding
capital stock of Assurance MGA, Federated Premium Finance, Inc. and Superior
Adjusting, Inc., the Company's claims processing subsidiary, for cash
consideration. Principal shareholders of the Company were also principal
shareholders of Assurance MGA, Federated Premium Finance, Inc. and Superior
Adjusting, Inc. The Company has accounted for the acquisitions at historical
cost in a manner similar to that in pooling of interests accounting due to the
entities being under the common control of the owners of 21st Century Holding
Company. The cash paid to individuals of the control group for their shares in
these entities was recorded as a distribution in the statement of changes in
shareholders' equity. In addition, the Company purchased the assets of two
independent agencies for cash consideration of $540,000. These transactions were
accounted for by the purchase method of accounting, generating goodwill
amounting to approximately $533,000.
In January 1998, the Company acquired all of the issued and outstanding
capital stock of eight affiliated corporations, principally the Company's
insurance agencies, in exchange for the issuance of shares of common stock. The
financial statements of these entities have been presented in the combined
statements of the Company based on the common control of ownership interest. The
minority interest relative to the ownership of the affiliated corporations,
whose results are combined prior to their acquisition on January 1, 1998, was
accounted for as a component of equity of the Company. This treatment was
applied because the minority interest was in a deficit position due to
distributions to shareholders in excess of basis and deemed uncollectible from
the unaffiliated shareholders. The acquisition of the minority interest in the
affiliated corporations was accounted for by the purchase method. The aggregate
acquisition price was allocated to the portion of the net identifiable assets
pertaining to the minority interest based on their fair value. The allocation of
the acquisition price to the minority interest's net identifiable assets had an
excess of fair value over the new adjusted book basis creating goodwill of
approximately $1,035,000 and eliminated the minority interest deficit of
approximately $113,000. The acquisition of the net retained deficit of the
affiliated corporations which are presented on a combined basis and the
elimination of their common stock resulted in the net credit to the equity of
the Company of approximately $995,000. The issuance of $100,000 to individuals
of the control group for their shares in these entities, was recorded as a
distribution in the statement of changes in shareholders' equity.
F-7
<PAGE>
21ST CENTURY HOLDING COMPANY
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS--(CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND PRACTICES--(CONTINUED)
In November 1998, the company consummated an initial public offering
(the "IPO") of 1,250,000 shares of its Common Stock at a price of $7.50 per
share. Proceeds from the IPO, which were approximately $7.9 million net of
underwriting costs and expenses of the offering, have been and are being used
for contributions to Federated National's capital, repayment of debt under the
Company's credit facility (the "Credit Facility"), the financing of
acquisitions, working capital and other general corporate purposes.
In December 1998, the Company consummated an asset acquisition of 18
agencies in exchange for $1.1 million in cash and a $500,000 note payable. The
aggregate acquisition price was allocated to the net identifiable assets based
on their fair value. The allocation of acquisition price to net identifiable
assets had an excess of fair value over the new adjusted book basis creating
goodwill of approximately $1.4 million.
Amounts included herein and referring to 1997 have been restated from
those previously filed in conjuction with the Company's initial public offering
filed on Form SB-2. Amounts restated have been identified in the Company's Form
10-QSB for the quarter ended September 30, 1998.
(B) CASH AND CASH EQUIVALENTS
The Company considers all short-term highly liquid investments with
original maturities of three months or less to be cash equivalents.
(C) INVESTMENTS AVAILABLE FOR SALE
All of the Company's investment securities have been classified as
available-for-sale because all of the Company's securities are available to be
sold in response to the Company's liquidity needs, changes in market interest
rates and asset-liability management strategies, among other reasons.
Investments available-for-sale on the balance sheet are stated at fair value.
Unrealized gains and losses are excluded from earnings and reported as a
separate component of 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. For the
years ending December 31, 1998 and 1997, the realized losses for declines in
fair value deemed to be other than temporary were $51,570 and $0, respectively
and is reported as a component of net realized investment gains (losses).
Premiums and discounts are amortized or accreted, respectively, over
the life of the related fixed maturity security as an adjustment to yield using
a method that approximates yield to maturity. Dividends and interest income are
recognized when earned. Realized gains and losses are included in earnings and
are derived using the specific-identification method for determining the cost of
securities sold.
(D) PREMIUM REVENUE
Premium revenue on property and casualty insurance is earned on a pro
rata basis over the life of the policies. Unearned premiums represent the
portion of the premium related to the unexpired policy terms.
F-8
<PAGE>
21ST CENTURY HOLDING COMPANY
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS--(CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND PRACTICES--(CONTINUED)
(E) DEFERRED ACQUISITION COSTS
Deferred acquisition costs represent commissions paid to the Company's
agents at the time of policy issuance (to the extent they are recoverable from
future premium income) net of ceding premium commission earned from reinsurers
and are amortized over the life of the related policy in relation to the amount
of premiums earned. The method followed in computing deferred acquisition costs
limits the amount of such deferred costs to their estimated realizable value,
which gives effect to the premium to be earned, related investment income,
unpaid losses and loss adjustment expenses and certain other costs expected to
be incurred as the premium is earned. There is no indication that these costs
will not be fully recoverable in the near term.
An analysis of deferred acquisition costs follows:
DECEMBER 31
1998 1997
--------- ---------
Balance, beginning of period .. $ 160,934 $(177,389)
Acquisition costs deferred .... 107,647 682,039
Amortized to expense during
the period ............... (179,057) (343,716)
--------- ---------
Balance, end of period .... $ 89,524 $ 160,934
========= =========
(F) PREMIUM DEPOSITS
Premium deposits represent premiums received on policies not yet
written. The Company takes approximately 35 working days to write the policy
from the date the cash and policy application are received.
(G) UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES
Unpaid losses and loss adjustment expenses are provided for through the
establishment of liabilities in amounts estimated to cover incurred losses and
loss adjustment expenses. Such liabilities are determined based upon the
Company's assessment of claims pending and the development of prior years' loss
liability. These amounts include liabilities based upon individual case
estimates for reported losses and loss adjustment expenses and estimates of such
amounts that are incurred but not reported ("IBNR"). Changes in the estimated
liability are charged or credited to operations as the estimates are revised.
Unpaid losses and loss adjustment expenses are reported net of estimates for
salvage and subrogation recoveries which totaled $329,172 and $341,118, net of
reinsurance, at December 31, 1998 and 1997, respectively.
The estimates of unpaid losses and loss adjustment expenses are subject
to the effect of trends in claims severity and frequency and are continually
reviewed. As part of the process, the Company reviews historical data and
considers various factors, including known and anticipated legal developments,
changes in social attitudes, inflation and economic conditions. As experience
develops and other data becomes available, these estimates are revised, as
required, resulting in increases or decreases to the existing unpaid losses and
loss adjustment expenses. Adjustments are reflected in results of operations in
the period in which they are made and the liabilities may deviate substantially
from prior estimates.
F-9
<PAGE>
21ST CENTURY HOLDING COMPANY
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS--(CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND PRACTICES--(CONTINUED)
There can be no assurance that the Company's unpaid losses and loss
adjustment expenses will be adequate to cover actual losses. If the Company's
unpaid losses and loss adjustment expenses prove to be inadequate, the Company
will be required to increase the liability with a corresponding reduction in the
Company's net income in the period in which the deficiency is identified. Future
loss experience substantially in excess of the established unpaid losses and
loss adjustment expenses could have a material adverse effect on the Company's
business, results of operations and financial condition.
The Company does not discount unpaid losses and loss adjustment
expenses for financial statement purposes.
(H) COMMISSION INCOME
Commission income consists of fees earned by the Company-owned agencies
placing business with third party insurers and third party premium finance
companies. Commission income is earned on a pro rata basis over the life of the
policies. Unearned commissions represent the portion of the commissions related
to unexpired policy terms.
(I) FINANCE REVENUE
Interest and service income, resulting from the financing of insurance
premiums and auto title loans, is recognized using a method that approximates
the effective interest method. Late charges are recognized as income when
chargeable.
(J) CREDIT LOSSES
Provisions for credit losses are charged to operations in amounts
sufficient to maintain the allowance for credit losses at a level considered
adequate to cover anticipated losses in the existing finance contracts
receivables and auto title loans receivable.
(K) POLICY FEES
Policy fees represent a $25 non-refundable application fee for
insurance coverage, which is intended to reimburse the Company for the incurred
cost. The fees are recognized as income when charged and are included in other
income.
(L) REINSURANCE
The Company recognizes the income and expense on reinsurance contracts
principally on a pro-rata basis over the life of the policies covered under the
reinsurance agreements. The Company is reinsured under separate reinsurance
agreements for the different lines of business underwritten. Reinsurance
contracts do not relieve the Company from its obligations to policyholders. The
Company continually monitors its reinsurers to minimize its exposure to
significant losses from reinsurer insolvencies. The Company only cedes risks to
reinsurers whom the Company believes to be financially sound. The Company's
reinsurance is primarily ceded to Transatlantic Re, an A++ rated reinsurance
company, on a quota share basis. At December 31, 1998, all reinsurance
recoverables are considered collectible.
F-10
<PAGE>
21ST CENTURY HOLDING COMPANY
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS--(CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND PRACTICES--(CONTINUED)
(M) INCOME TAXES
Income taxes are accounted for under the asset and liability method.
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases, and operating loss and tax-credit carryforwards. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to taxable
income in the years in which those temporary differences are expected to be
recovered or settled. The effect on deferred tax assets and liabilities of a
change in tax rates is recognized in income in the period that includes the
enactment date.
Pro forma income taxes presented for 1997 represents the total of
historical income taxes that would have been reported had the respective
entities filed income tax returns as a taxable C corporation for each of the
periods presented.
(N) CONTINGENT REINSURANCE COMMISSION
The Company's reinsurance contracts provide ceding commissions for
premiums written which are subject to adjustment. The amount of ceding
commissions is determined by the loss experience for the reinsurance agreement
term. The reinsurer provides commissions on a sliding scale with maximum and
minimum achievable levels. The reinsurer provides the Company with the
provisional commissions. The Company has recognized the commissions based on the
current loss experience for the policy year premiums. This results in
establishing a contingent liability, included in due from reinsurers, for the
excess of provisional commissions retained compared to amounts recognized, which
is subject to variation until the ultimate loss experience is determinable.
(O) CONCENTRATION OF CREDIT RISK
Financial instruments, which potentially expose the Company to
concentrations of credit risk consist primarily of premiums receivable, amounts
due from reinsurers on unpaid losses and auto title loans. The Company has not
experienced significant losses related to premiums receivable from individual
policyholders or groups of policyholders in a particular industry or geographic
area. The Company has not experienced significant losses related to auto title
loans. Management believes no credit risk beyond the amounts provided for
collection losses is inherent in the Company's premiums receivable or auto title
loans. In order to reduce credit risk for amounts due from reinsurers, the
Company seeks to do business with financially sound reinsurance companies and
regularly reviews the financial strength of all reinsurers used.
(P) DUE FROM FLORIDA JOINT UNDERWRITING ASSOCIATION (THE "ASSOCIATION")
PARTICIPATION
The amount recorded as a component of other assets represents the
Company's proportionate share of the net assets of the Association. The
Company's proportionate share of premiums, losses, loss expenses, and other
related items is recorded and presented in their respective accounts in the
accompanying consolidated and combined financial statements.
F-11
<PAGE>
21ST CENTURY HOLDING COMPANY
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS--(CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND PRACTICES--(CONTINUED)
(Q) ACCOUNTING CHANGES
On January 1, 1998, the Company adopted FAS No. 130, "Reporting
Comprehensive Income." Comprehensive income presents a measure of all changes in
shareholders' equity except for changes resulting from transactions with
shareholders in their capacity as shareholders. The Company's total
comprehensive income presently consists of net unrealized holding gains (losses)
on investments available for sale. The Statement also requires the separate
presentation of the accumulated balance of comprehensive income other than net
earnings in the consolidated and combined balance sheets.
Effective December 31, 1998, the Company adopted FAS No. 131,
"Disclosures About Segments of an Enterprise and Related Information." This
statement establishes standards for reporting information about a company's
operating segments and related disclosures about its products, services,
geographic areas of operations and major customers. Adoption of this statement
did not impact the Company's results of operations or financial position.
(R) ACCOUNTING PRONOUNCEMENTS NOT YET ADOPTED
In June 1998, the Financial Accounting Standards Board issued FAS No.
133, "Accounting for Derivative Instruments and Hedging Activities," which
requires all derivatives to be recognized at fair value as either assets or
liabilities on the balance sheet. Any gain or loss resulting from changes in
such fair value is required to be recognized in earnings, to the extent the
derivatives are not effective as hedges. This statement is effective for fiscal
years beginning after June 15, 1999, and is effective for interim periods in the
initial year of adoption.
In December 1997, the Accounting Standards Executive Committee issued
Statement of Position 97-3, "Accounting by Insurance and Other Enterprises for
Insurance Related Assessments," which requires entities to recognize liabilities
for insurance related assessments when such assessments are probable and the
amount of the assessment can be reasonably estimated. The Statement of Position
is effective for fiscal years beginning after December 15, 1998.
Adoption of these statements is not expected to have a material impact
on the Company's results of operations or financial position.
(S) USE OF ESTIMATES
The preparation of the consolidated and combined financial statements
in conformity with GAAP requires management to make estimates and assumptions
that affect the reported financial statement balances as well as the disclosure
of contingent assets and liabilities. Actual results could differ materially
from those estimates used.
Similar to other property and casualty insurers, the Company's
liability for unpaid losses and loss adjustment expenses, although supported by
actuarial projections and other data is ultimately based on management's
reasoned expectations of future events. Although considerable variability is
inherent in these estimates, management believes that this liability is
adequate. Estimates are reviewed regularly and adjusted as necessary. Such
adjustments are reflected in current operations. In addition, the realization of
the Company's deferred income tax assets is dependent on generating sufficient
future taxable income. It is reasonably possible that the expectations
associated with these accounts could change in the near term and that the effect
of such changes could be material to the consolidated and combined financial
statements.
F-12
<PAGE>
21ST CENTURY HOLDING COMPANY
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS--(CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND PRACTICES-(CONTINUED)
(T) NATURE OF OPERATION
The following is a description of the most significant risks facing the
Company and how it mitigates those risks:
(I) LEGAL/REGULATORY RISKS--the risk that changes in the regulatory
environment in which 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. The Company
attempts to mitigate this risk by monitoring proposed regulatory
legislation and by assessing the impact of new laws. As the Company
writes business only in the state of Florida, it is more exposed to
this risk than some of its more geographically balanced competitors.
(II) CREDIT RISK--the risk that issuers of securities owned by the
Company will default or that other parties, including reinsurers to
whom business is ceded, which owe the Company money, will not pay. The
Company attempts to minimize this risk by adhering to a conservative
investment strategy and by maintaining sound reinsurance agreements
with a number of reinsurers, and by providing for any amounts deemed
uncollectible.
(III) INTEREST RATE RISK--the risk that interest rates will change and
cause a decrease in the value of an insurer's investments. To the
extent that liabilities come due more quickly than assets mature, an
insurer might have to sell assets prior to maturity and potentially
recognize a gain or a loss. The Company attempts to mitigate this risk
by attempting to match the maturity schedule of its assets with the
expected payouts of its liabilities.
(U) FAIR VALUE
The fair value of the Company's investments are estimated based on bid
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, 1998. Changes in interest rates subsequent
to December 31, 1998 may affect the fair value of the Company's investments.
Refer to Note 3(a) for details.
The carrying amounts for the following financial instrument categories
approximate their fair values at December 31, 1998 and December 31, 1997 because
of their short-term nature: cash and cash equivalents, finance contracts
receivable, and auto title loans receivable, due from reinsurers, prepaid
reinsurance premiums, unearned premiums, finance contracts payable and notes
payable.
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.
F-13
<PAGE>
21ST CENTURY HOLDING COMPANY
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS--(CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND PRACTICES--(CONTINUED)
(V) GOODWILL
Goodwill, representing the excess of cost over the fair value of assets
acquired and the cost of a purchased book of business, is amortized on a
straight-line basis over seven years. The carrying value of goodwill is
periodically reviewed by the Company based on the expected future undiscounted
operating cash flows of the related item. Based upon its most recent analysis,
the Company believes that no material impairment of goodwill exists at December
31, 1998.
(W) PRO FORMA NET INCOME
Pro forma net income represents the results of operations for the year
ended December 31, 1997, adjusted to reflect a provision for income tax on
historical income before income taxes which gives effect to the change in the
affiliated corporations' income tax status to C corporations.
(X) STOCK OPTION PLAN
The Company accounts for stock-based compensation using the intrinsic
value method prescribed in Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees". Compensation cost for stock options,
if any, is measured as the excess of the quoted market price of the Company's
stock at the date of grant over the amount an employee must pay to acquire the
stock.
Statement of Financial Accounting Standards ("SFAS") No. 123,
"Accounting for Stock-Based Compensation, established accounting and disclosure
requirements using a fair-value-based method of accounting for stock-based
employee compensation plans.
(Y) PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment are stated at cost less accumulated
depreciation. Depreciation on property, plant and equipment is calculated on a
straight line method over the following estimated useful lives: building and
improvements - 30 years and furniture and fixtures 7 years.
(Z) RECLASSIFICATION
Certain 1997 financial statement amounts have been reclassified to
conform with 1998 presentation.
F-14
<PAGE>
21ST CENTURY HOLDING COMPANY
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS--(CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
(3) INVESTMENTS
(A) FIXED MATURITIES AND EQUITY SECURITIES
A summary of the amortized cost, estimated fair value, gross unrealized
gains and gross unrealized losses of fixed maturities and equity securities at
December 31, 1998 and December 31, 1997 is as follows:
<TABLE>
<CAPTION>
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED ESTIMATED
COST GAINS LOSSES FAIR VALUE
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
DECEMBER 31, 1998
Fixed Maturities:
U.S. treasury securities and obligations
of U.S. government corporations
and agencies ..................................... $ 0 $ 0 $ 0 $ 0
Mortgage-backed securities .......................... 379,494 -- 6,969 372,525
Obligations of states and political
subdivisions ..................................... 10,926,135 111,983 62,118 10,976,000
Corporate securities ................................ 3,264,047 48,163 55,153 3,257,057
----------- ----------- ----------- -----------
$14,569,676 $ 160,146 $ 124,240 $14,605,582
=========== =========== =========== ===========
Equity Securities:
Preferred stocks .................................... $ 1,507,041 $ 44,595 $ 11,590 $ 1,540,046
Common stocks ....................................... 1,882,943 15,142 501,611 1,396,474
----------- ----------- ----------- -----------
$ 3,389,984 $ 59,737 $ 513,201 $ 2,936,520
=========== =========== =========== ===========
</TABLE>
F-15
<PAGE>
21ST CENTURY HOLDING COMPANY
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS--(CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
3) INVESTMENTS (CONTINUED)
(A) FIXED MATURITIES AND EQUITY SECURITIES
<TABLE>
<CAPTION>
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED ESTIMATED
COST GAINS LOSSES FAIR VALUE
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
DECEMBER 31, 1997
Fixed Maturities:
U.S. treasury securities and obligations
of U.S. government corporations
and agencies .................................... $ 7,291,936 $ 105,335 $ 3,135 $ 7,394,136
Mortgage-backed securities ......................... 519,439 -- 3,473 515,966
Obligations of states and political
subdivisions .................................... 4,422,736 109,601 -- 4,532,337
Corporate securities ............................... 804,420 21,029 604 824,845
----------- ----------- ----------- -----------
$13,038,531 $ 235,965 $ 7,212 $13,267,284
=========== =========== =========== ===========
Equity Securities:
Preferred stocks ................................... $ 1,089,268 $ 10,613 $ 2,749 $ 1,097,132
Common stocks ...................................... 1,159,826 3,706 52,070 1,111,462
----------- ----------- ----------- -----------
$ 2,249,094 $ 14,319 $ 54,819 $ 2,208,594
=========== =========== =========== ===========
</TABLE>
A summary of fixed maturities available for sale at December 31, 1998
and December 31, 1997 are shown below by contractual or expected maturity
periods. Expected maturities may differ from contractual maturities because
borrowers may have the right to call or prepay obligations with or without call
or prepayment penalties.
<TABLE>
<CAPTION>
DECEMBER 31, 1998 DECEMBER 31, 1997
AMORTIZED ESTIMATED AMORTIZED ESTIMATED
COST FAIR VALUE COST FAIR VALUE
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Due in one year or less ............................... $ 0 $ 0 $ 275,850 $ 275,358
Due after one year through
five years ........................................... 400,403 423,402 2,200,570 2,229,280
Due after five years through ten
years ................................................ 4,688,377 4,693,108 5,491,936 5,592,622
Due after ten years ................................... 9,480,896 9,489,072 5,070,175 5,170,024
----------- ----------- ----------- -----------
$14,569,676 $14,605,582 $13,038,531 $13,267,284
=========== =========== =========== ===========
</TABLE>
A summary of the sources of net investment income follows:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
1998 1997
----------- -----------
<S> <C> <C>
Fixed maturities ............................. $ 878,319 $ 816,904
Equity securities ............................ 94,144 146,942
Cash and cash equivalents .................... 2,886 38,463
Other ........................................ 23,659 63,726
----------- -----------
Total investment income ................... 999,008 1,066,035
Less investment expenses ..................... (15,416) (18,687)
----------- -----------
Net investment income ..................... $ 983,592 $ 1,047,348
=========== ===========
</TABLE>
F-16
<PAGE>
21ST CENTURY HOLDING COMPANY
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS--(CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
(3) INVESTMENTS--(CONTINUED)
Proceeds from sales of fixed maturities and equity securities for the
years ending December 31, 1998 and 1997 were $39,841,097 and $21,088,211,
respectively.
A summary of realized gains (losses) and increases (decreases) in net unrealized
gains (losses) follows:
YEARS ENDED DECEMBER 31,
1998 1997
--------- ---------
Net realized gains (losses):
Fixed maturities ...................... $ 222,645 $ 18,891
Equity securities ..................... 219,165 (33,798)
Other ................................. -- --
Cash and cash equivalents ............. -- (4,488)
--------- ---------
Total .............................. $ 441,810 $ (19,395)
========= =========
Change in net unrealized gains (losses):
Fixed maturities ...................... $(192,847) $ 203,504
Equity securities ..................... (412,964) 16,144
--------- ---------
Total .............................. $(605,811) $ 219,648
========= =========
(B) MORTGAGE LOANS
The amount represents outstanding balances from related party
transactions. Refer to note 14 for details.
(4) PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment at December 31, 1998 and 1997 consist of
the following:
1998 1997
----------- -----------
Land .............................. 155,000 155,000
Building and Improvements ......... 1,218,143 68,885
Furniture and Fixtures ............ 663,488 381,133
----------- -----------
2,036,631 605,018
Accumulated Depreciation .......... (273,377) (219,288)
----------- -----------
$ 1,763,254 $ 385,730
=========== ===========
Total depreciation on property, plant, and equipment was $54,089 and
$50,028 during 1998 and 1997 respectively.
(5) REINSURANCE
The Company reinsures (cedes) a portion of its written premiums on a
quota-share basis to nonaffiliated insurance companies in order to limit its
loss exposure. The Company also maintains coverages to limit losses from large
exposures, which the Company believes are adequate for its current volume. To
the extent that reinsuring companies are unable to meet their obligations
assumed under the reinsurance agreements, the Company remains primarily liable
to its policyholders.
F-17
<PAGE>
21ST CENTURY HOLDING COMPANY
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS--(CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
(5) REINSURANCE--(CONTINUED)
The impact of reinsurance on the financial statements is as follows:
YEARS ENDED DECEMBER 31,
1998 1997
------------ ------------
Premiums written:
Direct ................................... $ 21,195,144 $ 17,675,375
Ceded .................................... (6,628,270) (4,659,378)
------------ ------------
$ 14,566,874 $ 13,015,997
Premiums earned:
Direct ................................... $ 20,160,566 $ 16,420,172
Ceded .................................... (6,197,835) (5,495,893)
------------ ------------
$ 13,962,731 $ 10,924,279
Losses and loss adjustment expenses incurred:
Direct ................................... $ 12,885,795 $ 11,241,218
Ceded .................................... (3,752,463) (3,827,067)
------------ ------------
$ 9,133,332 $ 7,414,151
============ ============
AS OF DECEMBER 31,
1998 1997
----------- -----------
Unpaid losses and loss adjustment expenses:
Direct ................................. $ 7,603,460 $ 6,726,462
Ceded .................................. (2,237,688) (2,090,998)
----------- -----------
$ 5,365,772 $ 4,635,464
=========== ===========
Unearned premiums:
Direct ................................. $ 8,534,320 $ 7,499,742
Ceded .................................. (2,648,098) (2,217,664)
----------- -----------
$ 5.886,222 $ 5,282,078
=========== ===========
The Company received approximately $2.0 million and $1.4 million in
commissions on premiums ceded during the years ended December 31, 1998 and
December 31, 1997. Had all of the Company's reinsurance agreements been canceled
at December 31, 1998, the Company would have returned a total of approximately
$356,000 in contingent reinsurance commissions to its reinsurers; in turn, its
reinsurers would have returned approximately $2.6 million in unearned premiums
to the Company.
F-18
<PAGE>
21ST CENTURY HOLDING COMPANY
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS--(CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
(5) REINSURANCE--(CONTINUED)
At December 31, 1998 and December 31, 1997, the Company had an
unsecured aggregate recoverable for losses paid, unpaid losses and loss
adjustment expenses including IBNR and unearned premiums with the following
companies:
<TABLE>
<CAPTION>
DECEMBER 31,
1998 1997
----------- -----------
<S> <C> <C>
Transatlantic Reinsurance Company (A++A.M. Best Rated):
Unearned premiums ....................................... $ 2,218,734 $ 2,119,819
Reinsurance recoverable on loss payments ................ 1,495,035 717,569
Unpaid losses and loss adjustment liability ............. 2,173,174 2,090,998
----------- -----------
5,886,943 4,928,386
Other:
Unearned premium ........................................ 429,364 97,845
----------- -----------
$ 6,316,307 $ 5,026,231
=========== ===========
Amounts due from reinsurers consisted of amounts related to:
Unpaid losses and loss adjustment expense ............... $ 2,237,688 $ 2,090,998
Paid losses and loss adjustment expense ................. 1,514,262 717,569
Reinsurance payable ..................................... (1,469,273) (1,114,520)
Contingent ceded commissions payable..................... (355,941) (669,535)
----------- -----------
$ 1,926,736 $ 1,024,512
=========== ===========
</TABLE>
(6) UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES
The liability for unpaid losses and loss adjustment expenses is
determined on an individual-case basis for all incidents reported. The liability
also includes amounts for unallocated expenses, anticipated future claim
development and IBNR.
F-19
<PAGE>
21ST CENTURY HOLDING COMPANY
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS-(CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
(6) UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES--(CONTINUED)
Activity in the liability for unpaid losses and loss adjustment expenses is
summarized as follows:
DECEMBER 31,
1998 1997
----------- -----------
Balance at January 1 ......................... $ 6,726,462 $ 6,233,962
Less reinsurance recoverables ............... (2,090,998) (1,701,685)
----------- -----------
Net balance at January 1 .................. $ 4,635,464 $ 4,532,277
=========== ===========
Incurred related to:
Current year ................................ $ 9,403,866 $ 7,612,167
Prior years ................................. (270,534) (198,016)
----------- -----------
Total incurred ............................ $ 9,133,332 $ 7,414,151
=========== ===========
Paid related to:
Current year ................................ $ 5,700,515 $ 4,458,527
Prior years ................................. 2,702,509 2,852,437
----------- -----------
Total paid ................................ $ 8,403,024 $ 7,310,964
=========== ===========
Net balance at year end ...................... $ 5,365,772 $ 4,635,464
Plus reinsurance recoverables ............... 2,237,688 2,090,998
----------- -----------
Balance at year end ....................... $ 7,603,460 $ 6,726,462
=========== ===========
Based upon consultations with the Company's independent actuarial
consultants and their statement of opinion on losses and loss adjustment
expenses, the Company believes 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.
(7) NOTES PAYABLE
The following is a summary of outstanding debt at December 31, 1998 and December
31, 1997:
<TABLE>
<CAPTION>
DECEMBER 31,
1998 1997
-------- --------
<S> <C> <C>
Notes payable:
Line of credit, expiration date December 30, 1998, interest only at
1.25% over bank's variable base rate is due monthly (bank's
base rate at December 31, 1997 was 10%). Line is collateralized
by all assets of 21st Century Holding Company .................... $ 0 $400,000
Bank loan, principal and interest due February 1998, interest at
18.00%. Note is collateralized by finance contracts receivables of
Federated Premium Finance, Inc. .................................. 0 152,625
-------- --------
Unsecured note payable in the amount of $500,000 at 6% interest
Due on January 1, 2000 ........................................... 500,000 0
-------- --------
$500,000 $552,625
======== ========
</TABLE>
F-20
<PAGE>
21ST CENTURY HOLDING COMPANY
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS--(CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
(8) REVOLVING CREDIT OUTSTANDING
On September 24, 1997, the Company, through Federated Premium Finance,
Inc. entered into a revolving loan agreement ("Revolving Agreement") with
Flatiron Funding Company LLC. Under the Revolving Agreement, the Company can
borrow up to the maximum credit commitment of $4.0 million. The amount of an
advance is subject to availability under a borrowing base calculation, with
maximum advances outstanding not to exceed the maximum credit commitment. The
annual interest rate on advances under the Revolving Agreement loan is the prime
rate plus 1.75 percent, which amounted to 9.5% at December 31, 1998. The
Revolving Agreement contains various operating and financial covenants and is
collateralized by a first lien and assignment of all of the Company's assigned
finance contracts receivables. The Revolving Agreement expires on September 30,
2000. Outstanding borrowings under the Revolving Agreement as of December 31,
1998 and 1997 were $2,062,948 and $1,593,752, respectively, and interest expense
for the years ended December 31, 1998 and 1997 totaled $287,175 and $12,702,
respectively. At December 31, 1998 and 1997, the Company was in compliance with
all covenants under the Revolving Agreement. In January 1999, the maximum credit
commitment was increased to $5.0 million and the annual interest rate was
changed to the prime rate plus .75 percent.
(9) INCOME TAXES
A summary of the provision (benefit) for income tax expense for the
years ended December 31, 1998 and 1997 is as follows:
DECEMBER 31,
------------
1998 1997
--------- ---------
Federal:
Current ......................... $ 929,938 $ 195,623
Deferred ........................ (129,410) 99,604
--------- ---------
800,528 295,227
--------- ---------
State:
Current ......................... 178,288 38,454
Deferred ........................ (13,816) 5,688
--------- ---------
164,472 44,142
--------- ---------
$ 965,000 $ 339,369
========= =========
F-21
<PAGE>
21ST CENTURY HOLDING COMPANY
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS--(CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
(9) INCOME TAXES--(CONTINUED)
The actual income tax expense differs from the "expected" income tax
expense for the years ended December 31, 1998 and 1997 (computed by applying
U.S. federal tax rate of 34 percent to income before provision for income tax
expense) as follows:
DECEMBER 31,
1998 1997
--------- ---------
Computed "expected" tax expense,
at federal rate .............................. $ 946,091 $ 512,111
Effect of S corporation income ................ -- (184,674)
State tax expense ............................. 100,796 32,260
Tax-free interest ............................. (122,583) (40,000)
Goodwill ...................................... 90,169 10,035
Other, net .................................... (49,473) 9,637
--------- ---------
Income tax expense, as reported ............... $ 965,000 $ 339,369
========= =========
Deferred income taxes reflect the net tax effects of temporary
differences between the carrying amounts of assets and liabilities for financial
reporting purposes and the amounts used for income tax purposes. Significant
components of the Company's net deferred tax assets and liabilities as of
December 31, 1998 and 1997 are as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
1998 1997
---------- ----------
<S> <C> <C>
Deferred tax assets:
Unpaid losses and loss adjustment expenses ........... $ 222,105 $ 191,876
Unearned premiums .................................... 442,997 397,529
Unrealized loss on investments available for sale .... 157,127 --
Allowance for credit losses .......................... 67,734 15,052
Unearned Commissions ................................. 220,735 242,937
Other ................................................ 17,473 --
---------- ----------
Total gross deferred tax assets .................... 1,128,171 847,394
Less valuation allowance ........................... -- --
---------- ----------
Net deferred tax assets ............................ $1,128,171 $ 875,947
---------- ----------
Deferred tax liabilities:
Unrealized gain on investments available for sale .... -- 71,083
Deferred acquisition costs ........................... 33,688 60,834
Depreciation ......................................... 9,228 --
Other................................................. -- 1,658
---------- ----------
Total gross deferred tax liabilities ............... 42,916 133,575
---------- ----------
Net deferred tax asset ............................. $1,085,255 $ 713,819
========== ==========
</TABLE>
In assessing the realizability 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, 1998 and
1997, 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.
F-22
<PAGE>
21ST CENTURY HOLDING COMPANY
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS--(CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
(10) REGULATORY REQUIREMENTS AND RESTRICTIONS
To retain its certificate of authority, the Florida Insurance Code (the
"Code") requires that Federated National maintain capital and surplus equal to
the greater of 10 percent of its liabilities or the 1998 statutory minimum
capital and surplus requirement of $2,250,000 as defined in the Code. The
Company is also required to adhere to prescribed premium-to-surplus ratios. The
Company is in compliance with these requirements as of December 31, 1998. As of
December 31, 1998, to meet regulatory requirements, the Company had a
certificate of deposit in the amount of $250,000 pledged to the Insurance
Commissioner of the State of Florida (the "Commissioner").
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 Insurance 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 Insurance (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 department 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
Insurance of (ii) 30 days after the Florida Department of Insurance has received
notice of such dividend or distribution and has not disapproved it within such
time. No dividends were declared or paid in 1998.
Under these laws, Federated National is not permitted to pay dividends
to the Company in 1999 without prior regulatory approval. Although the Company
believes that amounts required for it to meet its financial and operating
obligations will be available, there can be no assurance in this regard.
Further, there can be no assurance that, if requested, that the Florida
Department of Insurance will allow any dividends to be paid by Federated
National.
The Company is required to comply with NAIC risk-based capital ("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, 1998, based on calculations using
the appropriate NAIC formula, The Company's total adjusted capital is in excess
of ratios, which would require any form of regulatory action.
F-23
<PAGE>
21ST CENTURY HOLDING COMPANY
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS-(CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
(10) REGULATORY REQUIREMENTS AND RESTRICTIONS-(CONTINUED)
Pursuant to a consent order issued in conjunction with the Company's
authorization to underwrite mobile home insurance (the "Consent Order"), the
Company's growth is subject to regulatory limits on the amount of premiums it
can underwrite. In 1998, Federated National may only underwrite $21 million in
direct written premiums and $14 million in total net written premiums. In 1999,
Federated National is limited to $24 million and $15 million, respectively.
Federated National also is required to maintain a minimum capital surplus to
support its underwriting program. In 1998 and 1999, Federated National is
required to have capital surplus of $4.7 million and $5.9 million, respectively.
The premium limits and capital surplus requirements impact Federated National's
potential growth. Federated National's ability to exceed these limitations will
be subject to the prior approval of the Florida Department of Insurance. . At
December 31, 1998, Federated National's capital surplus was $7.3 million. . The
Florida Department of Insurance has indicated in writing its willingness to
modify the Consent Order and increase Federated National's underwriting
authority. The Company is currently negotiating with the Department of
Insurance. However, there can be no assurance that the Company will obtain the
approval of the Florida Department of Insurance to exceed the underwriting
limitations or that it will not be subject to other regulatory limits on the
amount of premiums it can underwrite.
Generally accepted accounting principles differ in some respects from
reporting practices prescribed or permitted by the Department of Insurance of
the State of Florida. Federated National's statutory capital and surplus was
$7,281,326 and $4,112,265 as of December 31, 1998 and 1997, respectively. The
Company's statutory net income was $1,390,110 and $591,090 for the year ended
December 31, 1998 and 1997, respectively.
(11) COMMITMENTS AND CONTINGENCIES
The Company is involved in various claims and legal actions arising in
the ordinary course of business. In the opinion of management, the ultimate
disposition of these matters will not have a material adverse effect on the
Company's consolidated financial position, results of operations, or liquidity.
The Company, as a direct premium writer in the state of Florida, is required to
participate in certain risk pools. Participation in these pools is based on the
Company's written premium by line of business to total premiums written
statewide by all insurers. Participation may impact the Company's financial
position or results of operations.
F-24
<PAGE>
21ST CENTURY HOLDING COMPANY
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS-(CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
(12) LEASES
The Company leases office space under various lease agreements with
expirations dates through September 2016. Rental expense associated with
operating leases is charged to expense in the year incurred. Rental expenses for
1998 and 1997 was approximately $539,356 and $392,486, respectively.
At December 31, 1998, the minimum aggregate rental commitments are as follows:
FISCAL YEAR LEASES
---------------------------------
1999 $743,872
2000 709,861
2001 582,463
2002 426,566
2003 311,540
Thereafter 757,416
----------
Total $3,531,718
(13) SEGMENT INFORMATION
The Company and its subsidiaries operate principally in two business
segments consisting of insurance and financing. The insurance segment consist of
underwriting through Federated National, managing general agent through
Assurance MGA, claims processing through Superior Adjusting and marketing and
distribution through Federated Agency Group. The insurance segment sells
primarily nonstandard personal automobile insurance and includes substantially
all aspects of the insurance, distribution and claims process. The financing
segment consists of premium financing through Federated Premium Finance and auto
title loans through Florida State Discount Auto Title Loans. The financing
segment provides premium financing to both Federated National's insureds and to
third-party insureds and short-term auto title loans and is marketed through the
Company's distribution network of Company-owned agencies (Federated Agency
Group) and independent agents.
The accounting policies of the segments are the same as those described
in the summary of significant accounting policies. The Company evaluates its
business segments based on GAAP pretax operating earnings. Corporate overhead
expenses are not allocated to business segments.
Operating segments that are not individually reportable are included in
the "All Other" category, which includes the operations of 21st Century (holding
company).
F-25
<PAGE>
21ST CENTURY HOLDING COMPANY
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS-(CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
(13) SEGMENT INFORMATION (CONTINUED)
Information regarding components of operations for the years ended December 31
follows:
1998 1997
------------ ------------
TOTAL REVENUES
Insurance Segment
Earned Premiums 13,962,731 10,924,279
Investment Income 1,451,464 1,027,953
Adjusting Income 909,019 773,959
MGA Fee Income 971,794 819,576
Commission Income 3,122,492 3,111,092
Miscellaneous Income 426,990 329,953
------------ ------------
Total Insurance Revenue 20,844,499 16,986,812
============ ============
Financing Segment:
Premium Finance Income 1,608,145 220,434
Title Loan Interest 217,122 0
Investment Income 9,450 0
Miscellaneous Income 13,525 29,433
------------ ------------
Total Financing Revenues 1,848,242 249,867
============ ============
All Other
Total All Other 535,118 63,057
============ ============
Total Operating Segments 23,227,859 17,299,736
Intercompany Eliminations (2,559,392) (1,550,596)
------------ ------------
Total Revenues $ 20,668,467 $ 15,749,140
============ ============
EARNINGS BEFORE INCOME TAXES
Insurance Segment 2,663,740 1,512,838
Financing Segment 619,461 (14,023)
All Other (497,724) 5,085
------------ ------------
Total Operating Segments 2,803,477 1,503,900
Intercompany Eliminations (20,857) 0
------------ ------------
Total Earnings before Income Taxes $ 2,782,620 $ 1,503,900
============ ============
TOTAL ASSETS
Insurance Segment $ 28,706,376 $ 22,288,678
Finance Segment 7,076,524 2,279,388
All Others 4,523,632 987,799
------------ ------------
Total Operating Segments 40,306,532 25,555,865
Intercompany Eliminations (2,130,129) (370,973)
------------ ------------
TOTAL ASSETS $ 38,176,403 $ 25,184,892
============ ============
F-26
<PAGE>
21ST CENTURY HOLDING COMPANY
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS-(CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
(14) RELATED PARTY TRANSACTIONS
In October 1997, the Company sold an office property to a group of
officers and shareholders. The sale price of the property was $255,000, which
generated a profit of approximately $13,000. In connection with the sale, the
Company provided seller-financing in an amount of $200,000. The note bears
interest at 8.00 percent per annum with monthly payments of principal and
interest. The note matures on October 31, 2002. The outstanding principal
balance of the note at December 31, 1998 and December 31, 1997 was $163,164 and
$197,278, respectively.
The Company also leases a second insurance agency location from
principal shareholders at a rental of $3,500 per month pursuant to a lease
expiring in May 2001.
Prior to the Company's consolidation of its executive offices and
administrative operations, the Company leased two locations at a rental of
$9,150 per month from principle shareholders.
The Company believes these arrangements are on terms at least as
favorable as those the Company could secure from a nonaffiliated third party.
One of the Company's directors is a partner at Conroy, Simberg, Ganon a
law firm which handles the Company's claims litigation.
One December 1998, the Company executed a one-year, 7% interest, note
receivable with one of its employees in the amount of $25,000. Principal and
interest is due on January 2000.
(15) STOCK COMPENSATION PLANS
The Company initiated a stock option plan in November 1998 that
provides for the granting of stock options to officer, key employees and
consultants. The objectives of the plan includes attracting and retaining the
best personnel, providing for additional performance incentives, and promoting
the success of the Company by providing employees the opportunity to acquire
common stock. The Company is authorized to grant options up to 350,000 common
shares under the Plan of which 310,800 have been granted. Options outstanding
under the 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.
The status of the Company's stock option plans is summarized below as
of December 31, 1998:
WEIGHTED AVERAGE
NUMBER OF SHARES OPTION EXERCISE PRICE
---------------- ---------------------
Outstanding at December 31, 1997 0
Granted 310,800 $ 10
Exercised 0
Canceled 0
------- -------
Outstanding at December 31, 1998 310,800 $ 10
======= =======
F-27
<PAGE>
21ST CENTURY HOLDING COMPANY
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS-(CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
(15) STOCK COMPENSATION PLANS (CONTINUED)
WEIGHTED AVERAGE
Options exercisable at: NUMBER OF SHARES OPTION EXERCISE PRICE
---------------- ---------------------
December 31, 1999 77,700 $10
December 31, 2000 77,700 $10
December 31, 2001 77,700 $10
December 31, 2002 77,700 $10
------ ---
310,800 $10
The Company continues to account for stock-based compensation using the
intrinsic value method prescribed by Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees," under which no compensation cost for
stock options is recognized for stock option awards granted at or above fair
market value. Had compensation expense for the Company's stock compensation plan
been determined based upon fair values at the grant dates for awards under those
plans in accordance with SFAS No. 123, "Accounting for Stock-Based
Compensation," the Company's net earnings and earnings per share would have been
reduced to the pro forma amounts indicated below. Additional stock option awards
are anticipated in future years.
1998
----
Net earnings
As reported $ 1,817,620
Pro forma $ 1,805,443
Earnings per share
As reported $ 0.79
Pro forma $ 0.78
The weighted average fair value of options granted during 1998
estimated on the date of grant using the Black-Scholes option-pricing model was
$1.61. The fair value of 1998 options granted is estimated on the date of grant
using the following assumptions: dividends yield of 0% expected volatility of
50%, risk-free interest rate of 4.4% and an expected life of 10 years.
Summary information about the Company's stock options outstanding at
December 31, 1998:
<TABLE>
<CAPTION>
WEIGHTED
OUTSTANDING AVERAGE WEIGHTED EXERCISABLE WEIGHTED
RANGE OF AT 12/31/98 CONTRACTUAL AVERAGE AT 12/31/98 AVERAGE
EXERCISE PRICE (IN THOUSANDS) PERIODS IN YEARS EXERCISE PRICE (IN THOUSANDS) EXERCISE PRICE
- -------------- -------------- ---------------- -------------- -------------- --------------
<S> <C> <C> <C> <C> <C>
$10 310,000 9.9 $10 0 $0
</TABLE>
F-28
<PAGE>
21ST CENTURY HOLDING COMPANY
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS-(CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
(16) NET INCOME PER SHARE
Net income per share is computed by dividing net income 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
Company's stock option plan are anti dilutive.
A reconciliation of the numerators and denominators of the "income per
share" and "income per share-assuming dilution" computations for income before
cumulative effect of change in accounting method' are presented below:
INCOME SHARE PER-SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
----------- ------------- ---------
For the year ended December 31, 1998:
Income per share $1,817,620 2,308,333 $ 0.79
---------- ---------- ------
Income per share - basic and
assuming dilution $1,817,620 2,308,333 $ 0.79
========== ========== ======
For the year ended December 31, 1997:
Income per share $1,164,531 2,100,000 $ 0.55
---------- ---------- ------
Income per share - basic and
assuming dilution $1,164,531 2,100,000 $ 0.55
========== ========== ======
The weighted average shares outstanding gives effect to a 1.8-for-one,
1.2-for-one and 926.33-for-one stock splits effected in November 1996, January
1997 and September 1998, respectively; and gives effect to the consolidation of
the Company effected in January 1997 and January 1998 and February 1998. The
Company's Common Stock par value of $.01 per share remained unchanged. All
historical share and per share amounts have been restated to retroactively
reflect the stock splits.
(17) COMPREHENSIVE INCOME
Reclassification adjustments related to the investment securities
included in comprehensive income for the years ended December 31, 1998 and 1997
are as follows:
1998 1997
-------- --------
Unrealized holdings gains (170,510) 200,286
(losses) arising during the year
Reclassification adjustment for
gains/losses included in
net income (441,810) 19,395
-------- --------
(605,811) 219,684
Tax effect 223,907 (74,286)
-------- --------
Net (depreciation) appreciation on investment
securities (381,904) 145,398
======== ========
F-29
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21ST CENTURY HOLDING COMPANY
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS-(CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
(18) SUBSEQUENT EVENTS (UNAUDITED)
In January 1999, the Company consummated an asset acquisition of two agencies in
exchange for $125,000 cash and 40,000 shares of the Company's stock.
In January 1999, the Company purchased two office properties from officers,
which have been utilized for agencies' operations. One of the properties had
previously been sold to the officers at the same sales price, resulting in no
gain or loss to the officer. Consideration for both acquisitions was cash of
$442,000 and satisfaction of mortgage loan receivable of $163,000.
F-30
