<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE PERIOD ENDED MARCH 31, 2000
--------------
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE TRANSITION PERIOD FROM ________ TO _________
Commission file number 0-8483
CERES GROUP, INC.
(Exact name of registrant as specified in its charter)
Delaware 34-1017531
-------- ----------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
17800 Royalton Road
Cleveland, Ohio 44136
---------------------
(Address of principal executive offices)
(Zip Code)
(440) 572-2400
--------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 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 ( )
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practical date.
Common Stock, $.001 Par Value - 13,781,381 shares as of May 1, 2000.
<PAGE> 2
CERES GROUP, INC. AND SUBSIDIARIES
INDEX
<TABLE>
<CAPTION>
PART I FINANCIAL INFORMATION Page
----
<S> <C> <C>
Item 1. Financial Statements - Unaudited 3
Condensed Consolidated Balance Sheets - March 31, 2000 and 3
December 31, 1999.
Condensed Consolidated Statements of Income - Three months ended 4
March 31, 2000 and 1999.
Condensed Consolidated Statements of Stockholders' Equity - Three 5
months ended March 31, 2000.
Condensed Consolidated Statements of Cash Flows - Three months 6
ended March 31, 2000 and 1999.
Notes to Condensed Consolidated Financial Statements. 7
Item 2. Management's Discussion and Analysis of Financial Condition and 13
Results of Operations
Item 3. Quantitative and Qualitative Disclosure of Market Risk 21
PART II OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 21
Signatures 22
Exhibits 23
</TABLE>
2
<PAGE> 3
PART I FINANCIAL INFORMATION
----------------------------
Item 1. Financial Statements - Unaudited
- -----------------------------------------
CERES GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS)
UNAUDITED
<TABLE>
<CAPTION>
March 31, December 31,
ASSETS 2000 1999
---------- ------------
<S> <C> <C>
Investments
Fixed maturities available for sale, at fair value $ 308,925 $ 300,986
Surplus notes 4,807 5,043
Policy and mortgage loans 3,933 3,923
--------- ---------
Total investments 317,665 309,952
Cash and cash equivalents (of which $6,897 and $4,763
is restricted, respectively) 27,274 42,921
Accrued investment income 4,966 5,234
Premiums receivable 5,179 4,905
Reinsurance receivable 270,731 263,289
Property held for sale 150 2,177
Property and equipment, net 15,215 15,091
Deferred federal income taxes 1,974 1,792
Deferred acquistion costs 33,679 26,650
Value of business acquired 17,067 16,731
Goodwill 22,598 22,857
Other assets 17,844 6,269
--------- ---------
Total assets $ 734,342 $ 717,868
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Policy liabilities and accrual
Future policy benefits, losses and claims $ 356,961 $ 357,149
Unearned premiums 32,914 32,045
Other policy claims and benefits payable 155,249 149,538
--------- ---------
545,124 538,732
Deferred reinsurance gain 19,534 20,932
Other policyholders' funds 26,321 22,365
Federal income taxes payable 4,087 1,449
Mortgage note payable 8,124 8,157
Long-term debt 39,000 40,000
Other liabilities 44,855 41,572
--------- ---------
Total liabilities 687,045 673,207
--------- ---------
Stockholders' equity
Non-voting preferred stock, $.001 par value, 2,000,000 shares
authorized, none issued - -
Common stock, $.001 par value, authorized 30,000,000 shares,
issued and outstanding 13,706,726 14 14
Additional paid-in capital 60,290 60,290
Retained earnings 6,320 2,549
Accumulated other comprehensive loss (19,327) (18,192)
--------- ---------
Total stockholders' equity 47,297 44,661
--------- ---------
Total liabilities and stockholders' equity $ 734,342 $ 717,868
========= =========
</TABLE>
The accompanying notes are an integral part of these condensed
consolidated financial statements.
3
<PAGE> 4
CERES GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
FOR THE THREE MONTHS ENDED MARCH 31, 2000 AND 1999
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
UNAUDITED
<TABLE>
<CAPTION>
2000 1999
----------- ----------
<S> <C> <C>
REVENUES
Premiums, net
Medical $ 80,837 $ 52,760
Specialty and other 23,887 14,673
--------- ---------
Total premiums, net 104,724 67,433
Net investment income 6,023 4,778
Net realized (losses) gains (73) 63
Fee and other income 6,418 4,892
Amortization of deferred reinsurance gain 1,398 1,268
--------- ---------
118,490 78,434
--------- ---------
BENEFITS, LOSSES AND EXPENSES
Benefits, claims, losses and settlement expenses
Medical 62,667 39,138
Specialty and other 18,891 11,072
--------- ---------
Total benefits, claims, losses and settlement expenses 81,558 50,210
Selling, general and administrative expenses 37,480 27,279
Net amortization and change in deferral of acquisition costs
and value of business acquired (7,774) (3,239)
Amortization of goodwill 259 186
Interest expense and financing costs 1,166 577
--------- ---------
112,689 75,013
--------- ---------
Income before federal income taxes 5,801 3,421
Federal income tax expense 2,030 1,197
--------- ---------
NET INCOME $ 3,771 $ 2,224
========= =========
EARNINGS PER SHARE OF COMMON STOCK
Basic $ 0.28 $ 0.17
Diluted 0.26 0.15
</TABLE>
The accompanying notes are an integral part of these condensed
consolidated financial statements.
4
<PAGE> 5
CERES GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE THREE MONTHS ENDED MARCH 31, 2000
(DOLLARS IN THOUSANDS)
UNAUDITED
<TABLE>
<CAPTION>
ACCUMULATED
COMMON STOCK ADDITIONAL OTHER TOTAL
----------------------- PAID-IN RETAINED COMPREHENSIVE STOCKHOLDERS'
SHARES AMOUNT CAPITAL EARNINGS LOSS EQUITY
------------ ---------- ------------ ---------- ------------- -------------
<S> <C> <C> <C> <C> <C> <C>
BALANCE, DECEMBER 31, 1999 13,706,726 $ 14 $ 60,290 $ 2,549 $ (18,192) $ 44,661
------------- -------------
Comprehensive income
Net income 3,771 - 3,771
Other comprehensive loss, net
Unrealized loss on securities,
net of tax of $0 (1,135) (1,135)
-------------
Comprehensive income 2,636
------------ ---------- ------------ ---------- ------------- -------------
BALANCE, MARCH 31, 2000 13,706,726 $ 14 $ 60,290 $ 6,320 $ (19,327) $ 47,297
============ ========== ============ ========== ============= =============
</TABLE>
The accompanying notes are an integral part of these
condensed consolidated financial statements.
5
<PAGE> 6
CERES GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDED MARCH 31, 2000 AND 1999
(DOLLARS IN THOUSANDS)
UNAUDITED
<TABLE>
<CAPTION>
2000 1999
----------- -----------
<S> <C> <C>
Operating activities
Net income $ 3,771 $ 2,224
Adjustments to reconcile net income to cash provided by (used in) operating activities:
Depreciation and amortization 611 151
Net realized losses (gains) 73 (63)
Deferred federal income tax benefit (39) (2,337)
Changes in assets and liabilities:
Reinsurance and premiums receivable (7,716) (238,624)
Value of business acquired (336) (405)
Goodwill 259 (5,221)
Federal income taxes payable/recoverable 2,638 4,771
Accrued investment income 268 517
Other assets (11,575) (1,236)
Future policy benefits, claims and funds payable 11,965 214,919
Unearned premium 869 14,981
Reinsurance payable 2,408 19,520
Other liabilities 875 12,906
Deferred policy acquisition costs (7,439) (3,648)
Deferred reinsurance gain (1,398) (1,268)
--------- ---------
Net cash (used in) provided by operating activities (4,766) 17,187
--------- ---------
INVESTING ACTIVITIES
Net (purchases) disposals of furniture and equipment (412) 337
Purchase of fixed maturities available-for-sale (12,514) (973)
Acquisition of Continental General Corporation, net of $24,712 cash acquired - (59,788)
Decrease in surplus notes 236 -
Increase in mortgage and policy loans, net (10) -
Proceeds from sales of fixed maturities available-for-sale 991 2,065
Proceeds from calls and maturities of fixed maturities available-for-sale 2,393 3,859
Proceeds from sale of property held for sale 1,954 -
--------- ---------
Net cash used in investing activities (7,362) (54,500)
--------- ---------
FINANCING ACTIVITIES
Increase in annuity account balances 4,204 2,998
Decrease in annuity account balances (6,690) (7,202)
Increase in note receivable - (100)
Principal payments on mortgage note payable (33) (30)
Increase in long-term debt borrowings 2,000 40,000
Principal payments on long-term debt (3,000) -
Proceeds from private placement - 15,027
--------- ---------
Net cash (used in) provided by financing activities (3,519) 50,693
--------- ---------
NET (DECREASE) INCREASE IN CASH (15,647) 13,380
Cash and cash equivalents at beginning of year 42,921 19,376
--------- ---------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 27,274 $ 32,756
========= =========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid during the quarter for interest $ 2,088 $ 459
Cash paid during the quarter for federal income taxes 1,000 900
</TABLE>
The accompanying notes are an integral part of these condensed
consolidated financial statements.
6
<PAGE> 7
CERES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - UNAUDITED
NOTE 1 - BASIS OF PRESENTATION
The condensed consolidated financial statements of Ceres Group, Inc. and
subsidiaries ("Ceres" or the "Company") included herein have been prepared by
Ceres without audit, pursuant to the rules and regulations of the Securities and
Exchange Commission and reflect all the adjustments that are, in the opinion of
management, necessary for a fair statement of the results for the interim
periods. All adjustments made were normal recurring accruals.
The condensed consolidated financial statements should be read in
conjunction with the consolidated financial statements and notes thereto
contained in Ceres' Annual Report on Form 10-K for the year ended December 31,
1999. The condensed consolidated financial statements for March 31, 2000 include
the accounts of Central Reserve Life Insurance Company ("Central"), Provident
American Life & Health Insurance Company ("Provident"), Continental General
Corporation ("Continental General") and its wholly-owned subsidiary Continental
General Insurance Company ("Continental") acquired on February 17, 1999 and
United Benefit Life Insurance Company ("United Benefit") under a reinsurance
arrangement effective August 1, 1998 and acquired on July 21, 1999. Operating
results for the interim periods are not necessarily indicative of results for an
entire year.
RECLASSIFICATIONS
Certain prior period amounts have been reclassified to conform to the
current year presentation.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents include cash and all liquid securities with
maturities of 90 days or less when purchased. At March 31, 2000 and December 31,
1999, the Company had approximately $6.9 million and $4.8 million, respectively,
in cash and cash equivalents that were not available due to restrictions on the
cash held for self-funded accident and health accounts. The Company is entitled
to investment income from these funds. A corresponding liability is included in
the accompanying consolidated financial statements.
INVESTMENTS
The Company's insurance subsidiaries had certificates of deposit and fixed
maturity securities on deposit with various state insurance departments to
satisfy regulatory requirements.
NEW ACCOUNTING PRONOUNCEMENT
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards ("SFAS") No. 133, Accounting for Derivative
Instruments and Hedging Activities as amended by SFAS No. 137, Accounting for
Derivative Instruments and Hedging Activities - Deferral of the Effective Date
of FASB Statement No. 133, which is required to be adopted for all fiscal
quarters of all fiscal years beginning after June 15, 2000. The Company expects
to adopt the new statement effective January 1, 2001. This Statement will
require the Company to recognize all derivatives on the balance sheet at fair
value. Derivatives that are not hedges must be adjusted to fair value through
income. If a derivative is a hedge, depending on the nature of the hedge,
changes in the fair value of the derivative will either be offset against the
change in fair value of the hedged asset, liability, or firm commitment through
earnings, or recognized in other
7
<PAGE> 8
comprehensive income until the hedged item is recognized in earnings. The
ineffective portion of a derivative's change in fair value will be immediately
recognized in earnings. The Company anticipates that the adoption of this
Statement will not have a significant effect on its results of operations or
financial position.
NOTE 2 - PROPERTY HELD FOR SALE
During the fourth quarter of 1999, management committed to a plan to
consolidate the operations of United Benefit into the Company's other
administrative facilities and to sell United Benefit's home office property. At
December 31, 1999, the Company recorded the property at its estimated fair
value less the estimated incremental direct costs to transact a sale. On March
31, 2000, the property was sold for $3.7 million. Net sales proceeds after
settlement of the mortgage, commissions and closing costs were $2.0 million. A
loss of $0.1 million was recognized on the sale of the property in the first
quarter of 2000. The Company continues to hold a vacant land parcel located
next to United Benefit's home office with an estimated fair value of $150,000.
Management has plans to sell this vacant land parcel.
NOTE 3 - DEBT
<TABLE>
<CAPTION>
March 31, December 31,
2000 1999
---------- -----------
(dollars in thousands)
<S> <C> <C>
Mortgage note payable $ 8,124 $ 8,157
======== ========
Bank credit facility $ 37,000 $ 40,000
Revolver 2,000 -
-------- --------
$ 39,000 $ 40,000
======== ========
</TABLE>
The mortgage note on the Company's Cleveland headquarters bears interest at
9 1/2% per annum. Principal payments are due monthly with the final payment of
$8.0 million due on January 1, 2001.
The Company entered into a $50.0 million Senior Secured Credit Agreement
("Credit Agreement") with a syndicate of major commercial banks in the first
quarter of 1999. The Credit Agreement consists of a $40.0 million bank credit
facility and a $10.0 million line of credit, referred to as the revolver. On
February 17, 2000, Ceres made its first principal payment of $3.0 million on the
bank credit facility. Quarterly principal payments are due thereafter through
February 2005. Interest on the outstanding balance will be determined based on
whether Ceres selects a "Base Rate Loan", the higher of either 1/2 of 1% in
excess of a federal funds rate or U.S. prime rate plus 2 1/2% or a "Eurodollar
Loan", London Interbank Offered Rate, referred to as LIBOR plus 3 1/2%. The
interest rate is selected by the Company each quarter. At March 31, 2000, the
interest rate for the bank credit facility was 9.63%.
The $10.0 million revolver portion of the Credit Agreement bears interest
at the same rate choices available for the bank credit facility. At March 31,
2000, the interest rate was 11.25%. Additionally, under this Credit Agreement,
the Company is charged a commitment fee of 3/4 of 1% per annum on the average
daily unutilized line of credit. At March 31, 2000, the amount available for
additional borrowings under the revolver was $8.0 million.
8
<PAGE> 9
NOTE 4 - REINSURANCE
The Company has entered into several quota-share reinsurance treaties with
Hannover Life Reassurance Company of America on various blocks of business of
its subsidiaries. Under the provisions of the treaties, the Company cedes
between 50% and 100% of the premiums for these policies and in return receives
reimbursement, for the same percentage, of the claims. In addition, the Company
receives a commission and expense allowance. In another reinsurance arrangement,
the Company also assumes certain policies, in which it paid certain commission
and expense allowances, which are classified as reinsurance expenses below. For
the first three months of 2000 the premiums and benefits, claims, losses, and
settlement expenses of United Benefit were classified on a direct basis rather
than on the assumed basis of 1999 due to the foreclosure and subsequent
ownership of United Benefit. The following table summarizes the net impact of
reinsurance arrangements on premiums and benefits, claims, losses and settlement
expenses, commissions, and other operating expenses:
<TABLE>
<CAPTION>
Three Months Ended
March 31,
---------------------------
2000 1999
--------- ---------
(dollars in thousands)
<S> <C> <C>
Premiums
Direct $ 169,957 $ 112,747
Assumed 2,776 30,563
Ceded (68,009) (75,877)
--------- ---------
Net premiums $ 104,724 $ 67,433
========= =========
Benefits, claims, losses, and
settlement expenses $ 134,841 $ 85,036
Reinsurance recoveries (53,283) (34,826)
--------- ---------
$ 81,558 $ 50,210
========= =========
Selling, general, and administrative
expenses
Commissions $ 29,685 $ 16,641
Other operating expenses 26,503 17,418
Reinsurance expenses 1,360 10,262
Reinsurance allowances (20,068) (17,042)
--------- ---------
$ 37,480 $ 27,279
========= =========
</TABLE>
The Company has reclassified certain direct and ceded premiums in
accordance with 2000 treatment.
9
<PAGE> 10
NOTE 5 - COMPUTATION OF NET INCOME PER SHARE OF COMMON STOCK
The following table sets forth the computation of basic and diluted net
income per share of common stock:
<TABLE>
<CAPTION>
Three Months Ended
March 31,
------------------------------
2000 1999
------------ -----------
(dollars in thousands)
<S> <C> <C>
Basic
Average common stock
outstanding 13,706,726 12,829,359
=========== ===========
Net income $ 3,771 $ 2,224
=========== ===========
Net income per share of
common stock $ 0.28 $ 0.17
=========== ===========
Diluted
Average common stock
outstanding 13,706,726 12,829,359
Warrants/stock options -
treasury stock method 840,264 2,349,954
----------- -----------
Weighted average shares
of common stock 14,546,990 15,179,313
=========== ===========
Net income $ 3,771 $ 2,224
=========== ===========
Net income per share of
common stock $ 0.26 $ 0.15
=========== ===========
</TABLE>
In computing diluted earnings per share, only potential shares of common
stock that are dilutive, those that reduce earnings per share, are included. The
exercise of options and warrants is not assumed if the result would be
antidilutive, such as when a loss from continuing operations is reported.
NOTE 6 - CONTINGENCIES
The Company is involved in litigation and may become involved in additional
litigation arising in the ordinary course of business. In the opinion of
management, the effects, if any, on such litigation are not expected to be
material to the Company's consolidated financial condition.
NOTE 7 - OPERATING SEGMENTS
In conjunction with the Company's continued growth and refinement of
defined organization structure, the Company expanded its operating segments to
the following three distinct operating segments based upon product types:
medical, specialty and other, and corporate and other. Products included in the
medical segment include comprehensive major medical plans. Significant products
in the specialty and other segment include Medicare supplement, long-term care,
dental, life insurance, and annuities.
10
<PAGE> 11
The corporate and other segment encompasses all other activities of the
Company, including interest income and expense of the parent company. Revenues
from each segment are primarily generated from premiums charged to policyholders
and interest earned on cash and investments, and are summarized in the following
table:
<TABLE>
<CAPTION>
Three Months Ended
March 31,
-----------------------------
2000 1999
------------ ------------
MEDICAL (dollars in thousands)
<S> <C> <C>
Revenues
Premiums, net $ 80,837 $ 52,760
Net investment income and net realized (losses) gains 1,868 1,817
Fee and other income 7,446 5,899
-------- --------
90,151 60,476
-------- --------
Expenses
Benefits, claims, losses and settlement expenses 62,667 39,138
Other operating expenses 23,169 19,592
-------- --------
85,836 58,730
-------- --------
Segment profit before federal income taxes $ 4,315 $ 1,746
======== ========
SPECIALTY AND OTHER
Revenues
Premiums, net $ 23,887 $ 14,673
Net investment income and net realized (losses) gains 4,016 2,917
Fee and other income 370 137
-------- --------
28,273 17,727
-------- --------
Expenses
Benefits, claims, losses and settlement expenses 18,891 11,072
Other operating expenses 5,990 3,996
-------- --------
24,881 15,068
-------- --------
Segment profit before federal income taxes $ 3,392 $ 2,659
======== ========
CORPORATE
Revenues
Net investment income $ 66 $ 107
Fee and other income - 124
-------- --------
66 231
-------- --------
Expenses
Interest expense and financing costs 1,166 577
Other operating expenses 806 638
-------- --------
1,972 1,215
-------- --------
Segment loss before federal income taxes $ (1,906) $ (984)
======== ========
INCOME BEFORE FEDERAL INCOME TAXES $ 5,801 $ 3,421
======== ========
</TABLE>
11
<PAGE> 12
The Company does not separately allocate investment or other identifiable
assets by industry segment, nor are income tax (benefits) expenses allocated by
industry segment. The Company also expanded the detail of its disclosures in
1999, which included certain reclassifications.
NOTE 8 - SUBSEQUENT EVENT
On October 7, 1999, the Company announced the signing of a definitive
agreement to purchase The Pyramid Life Insurance Company ("Pyramid") from United
Insurance Company of America, a subsidiary of Unitrin, Inc. of Chicago,
Illinois. The parties also reached an agreement in principle for the Company's
subsidiaries to sell specialty medical insurance products through the agent
distribution systems of selected Unitrin insurance subsidiaries. Pyramid, based
in Mission, Kansas, provides health and life insurance primarily for the senior
market, including Medicare supplement, long-term care, home health care, and
senior life products. At December 31, 1999, Pyramid had assets of $138.9 million
and revenues for the year ended 1999 of $70.8 million. Pyramid markets senior
insurance products through approximately 2,500 independent agents in 40 states.
The acquisition, subject to regulatory approvals and other customary terms
and conditions, is expected to be completed in June, 2000. At completion,
Pyramid will be a wholly-owned subsidiary. The $67.5 million purchase price is
expected to be financed as follows:
- - up to $15.0 million from financing provided by The Chase Manhattan Bank
and associated banks;
- - $25.0 million from special dividends to be paid by Pyramid in
conjunction with the purchase;
- - $7.5 million from the sale of our convertible preferred stock to the
seller; and
- - $20.0 million from the proceeds of a private placement offering of our
common stock at $6.00 per share.
12
<PAGE> 13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
- --------------------------------------------------------------------------------
OF OPERATIONS
- -------------
This discussion should be read in conjunction with our condensed
consolidated financial statements, notes and tables included elsewhere in this
report. Management's discussion and analysis may contain forward-looking
statements that are provided to assist in the understanding of anticipated
future financial performance. However, such performance involves risks and
uncertainties which may cause actual results to differ materially from those
expressed in the forward-looking statements. See "Forward-Looking Statements."
OVERVIEW
We provide a broad spectrum of health and life insurance, medical cost
management and specialty products and services to more than 525,000 insureds. We
actively distribute our products on a national basis through approximately
60,000 independent licensed agents and through various e-commerce platforms to
individuals, small businesses and the senior market. For our subsidiaries and
the blocks of business we acquire, we focus on reducing medical costs and
underwriting risks and increasing fee-based revenue.
Since January 1, 1998, we
- began executing a new business plan designed to expand our distribution
systems, lower medical claim costs, reduce underwriting risks,
consolidate administrative functions, increase fee-based revenue and
acquire complementary businesses;
- underwent a change in control;
- completed a private placement of our common stock in July, 1998 in
which we issued and sold 7,300,000 shares of common stock at $5.50 per
share and warrants to purchase an additional 3,650,000 shares of common
stock at $5.50 per share for gross proceeds of approximately
$40.2 million;
- entered into an agreement with United Benefit as of August 1, 1998 to
reinsure 100% of the major medical policies of United Benefit Life,
covering approximately 100,000 members with estimated annual premiums
of $100.0 million at that time;
- acquired Provident from Provident American Corporation on
December 31, 1998 for $5.5 million in cash;
- acquired Continental General and Continental from The Western and
Southern Life Insurance Company of Cincinnati, Ohio, on
February 17, 1999 for $84.5 million in cash;
- completed a private placement of common stock in February, 1999 to
provide funds for the Continental General acquisition, in which
2,000,000 shares of common stock were issued and sold at $7.50 per
share;
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<PAGE> 14
- entered into a $50.0 million Senior Secured Credit Agreement, which
consists of a $40.0 million bank credit facility and a $10.0 million
line of credit to finance the Continental General acquisition; and
- acquired United Benefit in July, 1999 through foreclosure.
Year-to-year financial results must be viewed in light of the change in
control, reinsurance, acquisitions and changes to our equity and debt. The
financial information for the three months ended March 31, 1999 includes the
operations of Continental General since February 1, 1999 and for Provident
and United Benefit (through reinsurance) for the entire period.
RECENT EVENTS
On October 7, 1999, we announced a definitive agreement to purchase The
Pyramid Life Insurance Company from United Insurance Company of America, a
subsidiary of Unitrin, Inc. of Chicago, Illinois. For additional information
regarding the proposed acquisition of Pyramid, see Note 8 to the Condensed
Consolidated Financial Statements.
We have not yet completed the private equity offerings or the amendment to
our existing line of credit that are necessary to finance the Pyramid
acquisition and we cannot guarantee that the acquisition of Pyramid will be
completed.
RESULTS OF OPERATIONS
QUARTER ENDED MARCH 31, 2000 COMPARED TO QUARTER ENDED MARCH 31, 1999
For the quarter ended March 31, 2000, total net premiums were $104.7
million, an increase of 55.3%, from $67.4 million for the same quarter in 1999.
Medical premiums for the quarter ended March 31, 2000 were $80.8 million
compared to $52.8 million for the quarter ended March 31, 1999, an increase of
53.0%. The increase in medical premiums was the result of increased new sales,
premium rate increases, and the inclusion of Continental's results for three
months in 2000 compared to two months in 1999.
Specialty and other premiums, which primarily includes Medicare supplement,
long-term care, dental, life insurance and annuities, were $23.9 million for the
quarter ended March 31, 2000 compared to $14.7 million for the quarter ended
March 31, 1999, an increase of 62.6%. The increase in specialty and other
premiums was primarily the result of the inclusion of Continental's specialty
premium for three months in 2000 versus two months in 1999, which increased $8.5
million.
Net investment income increased to $6.0 million for the first quarter of
2000 from $4.8 million for the first quarter of 1999, an increase of 25.0%. The
increase in net investment income is primarily a result of including three
months of Continental's activity in 2000 compared to two months in 1999, which
increased $1.4 million.
Fee and other income increased to $6.4 million for the quarter ended March
31, 2000 compared to $4.9 million for the same quarter of 1999, an increase of
30.6%. This increase was
14
<PAGE> 15
attributable to fees received on increased sales volume, as well as additional
fees charged for new services.
The amortization of deferred reinsurance gain of $1.4 million for the
quarter ended March 31, 2000 represents the recognition of the ceding commission
allowances received under the Company's reinsurance agreements. The unamortized
amount of $19.5 million for the quarter ended March 31, 2000 is accounted for as
a deferred reinsurance gain on the consolidated condensed balance sheet.
Total benefits, claims and settlement expenses increased to $81.6 million
for the quarter ended March 31, 2000 compared to $50.2 million for the same
quarter in 1999, an increase of 62.5%. The increase was a direct result of the
increased volume of business in force, including three months of Continental
activity in 2000 versus two months in 1999.
Medical benefits, claims, losses and settlement expenses were $62.7 million
for the quarter ended March 31, 2000 compared to $39.1 million for the same
quarter in 1999, an increase of 60.4%. The medical loss ratio was 77.5% for the
quarter ended March 31, 2000 compared to 74.2% for the same quarter of 1999.
The increases are a result of higher utilization and processed claims in the
first quarter of 2000 versus the same quarter of 1999, on a larger volume of
business in force.
Specialty and other benefits, claims, losses and settlement expenses were
$18.9 million for the quarter ended March 31, 2000 compared to $11.1 million for
the same quarter of 1999, an increase of 70.3%. The entire increase is a direct
result of the inclusion of three months of specialty benefits of Continental in
the first three months of 2000 versus two months of 1999. The increase in the
specialty benefit ratio to 79.1% in the first quarter of 2000 compared to 75.5%
in the first quarter of 1999 was also a result of the inclusion of Continental
for three months in 2000 versus two months in 1999.
Selling, general and administrative expenses increased to $37.5 million in
the first quarter of 2000 compared to $27.3 million in the first quarter of
1999, an increase of $10.2 million or 37.4%. The increase in selling, general
and administrative expenses represents a $13.0 million increase in commissions
and a $9.1 million increase in other operating expenses attributable to our
increased business base and inclusion of Continental for three months in 2000
versus two months in 1999, offset by a $11.9 million net increase in reinsurance
allowances. As a percentage of revenues, selling, general and administrative
expenses decreased to 31.6% in the first quarter of 2000 compared to 34.8% in
the first quarter of 1999.
The net amortization and change in deferral of acquisition costs and value
of business acquired resulted in a net deferral of $7.8 million for the first
quarter of 2000 compared to a net deferral of $3.2 million for the first
quarter of 1999. The increase in the deferral is a result of capitalized
acquisition expenses on increased new business, including Continental's new
business for three months in 2000 versus two months in 1999. The increase was
offset by a reduction in the net deferral of $1.2 million for additional
amortization of previously capitalized expenses for certain states in which
there are higher than anticipated claim loss ratios.
Amortization of goodwill of $0.3 million primarily relates to the February
1999 acquisition of Continental. The goodwill asset of $22.6 million as of March
31, 2000 is being amortized over periods of 25 years or less.
Interest expense and financing costs increased to $1.2 million in the first
quarter of 2000 compared to $0.6 million in the first quarter of 1999 as a
result of the interest expense under the
15
<PAGE> 16
credit facility which began to accrue on February 17, 1999, the closing date of
the purchase of Continental.
A provision for federal income taxes of $2.0 million, or 35.0%, of income
before federal taxes of $5.8 million, was established for the first quarter of
2000.
As a result of the foregoing, net income for the first quarter of 2000 was
$3.8 million, or $0.28 basic and $0.26 diluted earnings per share of common
stock, compared to a net income of $2.2 million, or $0.17 basic and $0.15
diluted earnings per share of common stock, for the first quarter of 1999.
LIQUIDITY AND CAPITAL RESOURCES
Liquidity is our ability to generate adequate amounts of cash to meet our
financial commitments. The major needs for cash are to enable our insurance
subsidiaries to pay claims and expenses as they come due. The primary sources of
cash are premiums, investment income, fee income and reimbursements from
reinsurers. Payments consist of current claim payments to insureds, managed care
expenses, operating expenses such as salaries, employee benefits, commissions,
taxes and interest on debts.
Assets of $317.7 million, or 43.3% of the total assets, are in investments
at March 31, 2000. Fixed maturities are our primary investment and were $308.9
million, or 97.2% of total investments, at March 31, 2000. Other investments
consist of surplus notes, policy loans and mortgage loans. We are carrying all
of our fixed maturities at estimated fair value (available for sale) at March
31, 2000. We hold few high-yield type securities, with nearly 100% of our bonds
being investment grade quality.
In addition to the fixed maturities, we also had $27.3 million in cash and
cash equivalents, and a $10.0 million line of credit with a major bank at March
31, 2000. There was $8.0 million available under the line of credit at March 31,
2000.
The total reinsurance receivable was $270.7 million at March 31, 2000. Of
this amount, $246.2 million represents reserves held by our reinsurers under our
various reinsurance treaties in place. Almost all of these reserves are held by
Hannover, supported by investment grade securities.
Assets increased 2.3% to $734.3 million at March 31, 2000 from $717.9
million at December 31, 1999. The increase was primarily due to the increase in
new business, including an increase in other assets of $8.1 million in agency
receivables.
The total policy liabilities and accruals (reserves) were 79.3% of the
total liabilities at March 31, 2000, compared to 80.0% at December 31, 1999.
Continental accounted for 75.1% of the reserves at March 31, 2000.
To provide funds for the acquisition of Continental, we incurred debt of
$40.0 million under a credit agreement. Under the terms of the credit agreement,
dated as of February 17, 1999, among Ceres' various lending institutions and The
Chase Manhattan Bank, as Administrative Agent, the first principal payment of
$3.0 million was paid February 17, 2000. Quarterly payments are due thereafter
starting with $1.0 million through February 17, 2001; $1.5 million thereafter
through February 17, 2002; and $2.25 million thereafter to February 17, 2005.
Interest on the outstanding
16
<PAGE> 17
balance will be determined based on whether we select a "Base Rate Loan" or a
"Eurodollar Loan". Under the Base Rate Loan, the interest rate will be 2.5% per
annum plus the higher of (a) the rate which is 1/2 of 1% in excess of a federal
funds rate and (b) Chase's prime rate as in effect from time to time. Under the
Eurodollar Loan, the interest rate will be 3.5% per annum plus a Eurodollar
rate, which is the arithmetic average of the offered quotation to first-class
banks in the interbank Eurodollar market by Chase, adjusted for certain reserve
requirements. The interest rate is selected by the Company each quarter. At
March 31, 2000, the interest rate was 9.63%. The credit agreement also provides
for a $10.0 million line of credit which bears interest at the same rate choices
as the $40.0 million loan. At March 31, 2000, the interest rate was 11.25% on
the outstanding balance of $2.0 million. The revolver borrowings were placed at
base rate for short-term flexibility. A commitment fee of 3/4 of 1% per annum on
the average daily unutilized line of credit is charged to Ceres under the credit
agreement.
The credit agreement contains financial and other covenants that, among
other matters:
- prohibit the payment of cash dividends on our shares of common stock,
except upon compliance with certain conditions;
- restrict the creation of liens and sales of assets; and
- require that we at a minimum maintain (a) a leverage ratio
(consolidated debt to consolidated total capital) of 0.45 to 1.00
through December 31, 2000, 0.40 to 1.00 thereafter through December 31,
2001, 0.35 to 1.00 thereafter, (b) an interest coverage ratio
(consolidated earnings before interest, income taxes, depreciation,
and amortization to consolidated interest expense) of 2.5 to 1
through December 31, 2000, and 3.0 to 1 thereafter, (c) a risk-based
capital ratio for any regulated insurance company subsidiary of the
Company of not less than 125.0%, and (d) consolidated net worth of
$40.0 million through December 31, 2000, $50.0 million thereafter
through December 31, 2001, $60.0 million thereafter through December
31, 2002, and $70.0 million thereafter.
In addition, we pledged the common stock of Continental General, Central,
Provident and other insignificant subsidiaries as security for the credit
agreement. At March 31, 2000, we were in compliance with the covenants contained
in the credit agreement.
We believe that cash flow from operating activities will be sufficient to meet
our currently anticipated operating and capital expenditure requirements. We are
seeking to raise $27.5 million in a private offering of common and preferred
stock to finance the acquisition of Pyramid and will also expand our line of
credit from $10.0 million to $15.0 million. We have not yet completed the
private equity offerings or the amendment to our existing line of credit. If we
are unable to do so, we may not be able to complete the acquisition of Pyramid.
If additional funds are required for long-term growth, we believe that these
funds could be obtained through equity or debt offerings as market conditions
permit or dictate. We may not be able to obtain any additional financing on
terms that are favorable to us.
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<PAGE> 18
FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS
We have three segments: medical, which includes comprehensive major medical
plans, specialty and other which includes Medicare supplement, long-term care,
dental, life insurance and annuities, and corporate and other which consists of
primarily interest income and operating and interest expense.
The medical segment had net revenues of $90.2 million in the first quarter
of 2000 compared to $60.5 million in 1999. The major reason for the increase was
increased premium rate increases, increased new sales and collection fees.
Total benefits, claims, losses and settlement expenses for the medical
segment were $62.7 million in the first quarter of 2000 compared to $39.1
million in the first quarter of 1999. The increase was primarily a result of
increased claims utilization on a larger amount of in force business.
The specialty and other segment had revenues of $28.3 million for the first
quarter in 2000 compared to $17.7 million in the first quarter of 1999. The
increase was primarily attributable to the Continental business acquired in
February, 1999. Benefits, claims, losses, and settlement expenses for the
specialty and other segment were $18.9 million in the first quarter of 2000
compared to $11.1 million for 1999. Again, the increase was primarily
attributable to Continental.
Total corporate and other revenues were $66,000 for the first quarter of
2000 compared to $231,000 for 1999. The decrease was primarily due to
discontinuance of the printing operations at Continental.
MARKET RISK AND MANAGEMENT POLICIES
The following is a description of certain risks facing life and accident
and health insurers and how we mitigate those risks:
Legal/Regulatory Risk is the risk that changes in the legal or regulatory
environment in which an insurer operates will create additional expenses not
anticipated by the insurer in pricing its products. That is, regulatory
initiatives designed to reduce insurer profits or otherwise affecting the
industry in which the insurer operates, new legal theories or insurance company
insolvencies through guaranty fund assessments, may create costs for the insurer
beyond those recorded in the financial statements. We attempt to mitigate this
risk by offering a wide range of products and by operating in many states, thus
reducing our exposure to any single product of non-Federal jurisdiction, and
also by employing underwriting practices which identify and minimize the adverse
impact of this risk.
Inadequate Pricing Risk is the risk that the premium charged for insurance
and insurance related products is insufficient to cover the costs associated
with the distribution of such products which include: benefits, claims and
losses, settlement expenses, acquisition expenses and other corporate expenses.
We utilize a variety of actuarial and/or qualitative methods to set such pricing
levels.
Credit Risk is the risk that issuers of securities owned by us will default
or that other parties, including reinsurers that have obligations to us, will
not pay or perform. We attempt to minimize this
18
<PAGE> 19
risk by adhering to a conservative investment strategy and by maintaining sound
reinsurance and credit and collection policies.
Interest Rate Risk is the risk that interests rates will change and cause a
decrease in the value of an insurer's investments. This change in rates may
cause certain interest-sensitive products to become uncompetitive or may cause
disintermediation if we attempt to mitigate this risk by charging fees for
non-conformance with certain policy provisions and/or by attempting to match the
maturity schedule of its assets with the expected payouts of its liabilities. To
the extent that liabilities come due more quickly than assets mature, an insurer
would have to sell assets prior to maturity and recognize a gain or loss.
We also have long-term debt that bears interest at variable rates;
therefore our results of operations would be affected by interest rate changes.
We do not expect a significant rate change in the near future that would have a
material effect on our near-term results of operations.
IMPACT OF INFLATION
Inflation rates impact our financial condition and operating results in
several areas. Changes in inflation rates impact the market value of the
investment portfolio and yields on new investments.
Inflation has had an impact on claim costs and overall operating costs and
although it has been lower in the last few years, hospital and medical costs
have still increased at a higher rate than general inflation, especially
prescription drug costs. New, more-expensive and wider use of pharmaceuticals is
inflating healthcare costs. The Health Insurance Association of America
reported, in an Issue Brief dated March 2000, that prescription drug costs are
increasing more than 16% a year. While to a certain extent these increased costs
are offset by interest rates (investment income), the rate of income from
investments has not increased proportionately. We will continue to establish
premium rates in accordance with trends in hospital and medical costs along with
concentrating on various costs containment programs. However, there can be no
assurance that these efforts by us will fully offset the impact of inflation or
that premiums will equal or exceed increasing healthcare costs.
FORWARD-LOOKING STATEMENTS
This report contains both historical and forward-looking statements.
Forward-looking statements are statements other than historical information or
statements of current condition. The forward-looking statements relate to the
plans and objectives for future operations. In addition to statements, which are
forward-looking by reason of context, the words "believe," "expect,"
"anticipate," "intend," "designed," "goal," "objective," "optimistic," "will"
and other similar expressions identify forward-looking statements. In light of
the risks and uncertainties inherent in all future projections, the inclusion of
the forward-looking statements should not be regarded as a representation by
Ceres or any other person that our objectives or plans will be achieved.
Many factors could cause our actual results to differ materially and
adversely from those in the forward-looking statements, including the following:
- the failure to successfully integrate the businesses of Continental,
Provident and United Benefit into Ceres, including the failure to
achieve cost savings;
19
<PAGE> 20
- the failure to complete the acquisition of Pyramid or if the
acquisition is completed, the failure to successfully integrate the
operations of Pyramid into those of Ceres; including the failure to
achieve cost savings;
- any further shortfall in the assets or reserves of United Benefit,
or the commissions due to Insurance Advisors, which were foreclosed
upon on July 21, 1999;
- rising healthcare costs, especially the rising costs of prescription
drug costs that are rising faster than other medical costs;
- business conditions and competition in the healthcare industry;
- developments in healthcare reform and other regulatory issues;
- changes in laws and regulations affecting our business;
- adverse changes in interest rates;
- unforeseen losses with respect to loss and settlement expense reserves
for unreported and reported claims;
- our ability to develop, distribute, and administer competitive products
and services in a timely cost-effective manner;
- our visibility in the marketplace and our financial and claims paying
ratings;
- the costs of defending litigation and the risk of unanticipated
material adverse outcomes in such litigation;
- the performance of others on whom we rely for reinsurance, particularly
Hannover upon whom we rely for most of our reinsurance;
- the risk that issuers of securities owned by Ceres will default or that
other parties will not pay or perform;
- changes in accounting and reporting practices;
- the effect of any future acquisitions;
- our ability to fully collect all agent advances;
- the failure to comply with financial and other covenants in our loan
agreements; and
- our ability to obtain additional debt or equity financing on terms
favorable to us to facilitate long-term growth.
20
<PAGE> 21
The foregoing review of important factors should not be construed as
exhaustive and should be read in conjunction with other cautionary statements
that are included in this report, including the risks detailed under "Market
Risk and Management Policies." We undertake no obligation to update
forward-looking statements to reflect events or circumstances after the date
hereof or to reflect the occurrence of unanticipated events.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE OF MARKET RISK
- ---------------------------------------------------------------
The information called for by this item is provided under the caption "Market
Risk and Management Policies" under Item 2 - Management's Discussion and
Analysis of Financial Condition and Results of Operations.
PART II OTHER INFORMATION
-------------------------
All items of Part II other than Item 6 are either inapplicable to Ceres,
would not require a response, or have been previously reported.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
- -----------------------------------------
a) Exhibits.
(27) Financial Data Schedule
b) Reports on Form 8-K.
The Company did not file any reports on Form 8-K during the three
months ended March 31, 2000.
21
<PAGE> 22
SIGNATURES
----------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
CERES GROUP, INC.
Date: May 15, 2000 By: /s/ Charles E. Miller, Jr.
----------------- --------------------------------------
Charles E. Miller, Jr.
Executive Vice President and Chief
Financial Officer (Principal Financial
Officer and Chief Accounting Officer)
22
<PAGE> 23
EXHIBITS
--------
(27) Financial Data Schedule
23
<TABLE> <S> <C>
<ARTICLE> 7
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED FINANCIAL STATEMENTS OF CERES GROUP, INC. AND SUBSIDIARIES FOR THE
THREE MONTHS ENDED MARCH 31, 2000 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE
TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
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<NAME> CERES GROUP, INC.
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<FISCAL-YEAR-END> DEC-31-2000
<PERIOD-START> JAN-01-2000
<PERIOD-END> MAR-31-2000
<DEBT-HELD-FOR-SALE> 308,925
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