<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 QUARTERLY PERIOD ENDED SEPTEMBER 30, 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 practicable date.
Common Stock, $.001 Par Value - 17,249,294 shares as of October 31, 2000.
<PAGE> 2
CERES GROUP, INC. AND SUBSIDIARIES
INDEX
<TABLE>
<CAPTION>
PART I FINANCIAL INFORMATION Page
----
<S> <C>
Item 1. Financial Statements - Unaudited 3
Condensed Consolidated Balance Sheets - September 30, 2000 and
December 31, 1999. 3
Condensed Consolidated Statements of Income - Three and nine
months ended September 30, 2000 and 1999. 4
Condensed Consolidated Statements of Stockholders' Equity - Nine
months ended September 30, 2000. 5
Condensed Consolidated Statements of Cash Flows - Nine months
ended September 30, 2000 and 1999. 6
Notes to Condensed Consolidated Financial Statements. 7
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 15
Item 3. Quantitative and Qualitative Disclosure of Market Risk 26
PART II OTHER INFORMATION
Item 1. Legal Proceedings 26
Item 2. Changes in Securities and Use of Proceeds 28
Item 6. Exhibits and Reports on Form 8-K 28
Signatures 30
Exhibits 31
</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>
SEPTEMBER 30, DECEMBER 31,
2000 1999
------------- ------------
<S> <C> <C>
ASSETS
Investments
Fixed maturities available for sale, at fair value $ 384,771 $ 300,986
Surplus notes 4,867 5,043
Policy and mortgage loans 5,874 3,923
--------- ---------
Total investments 395,512 309,952
Cash and cash equivalents (of which $9,305 and $4,763 is restricted, respectively) 72,500 42,921
Accrued investment income 6,148 5,234
Premiums receivable 7,187 4,905
Reinsurance receivable 249,261 263,289
Property held for sale -- 2,177
Property and equipment, net 17,496 15,091
Deferred federal income taxes -- 1,792
Deferred acquisition costs 47,948 26,650
Value of business acquired 30,930 16,731
Goodwill 31,138 22,857
Federal income tax receivable 1,613 --
Other assets 6,900 6,269
--------- ---------
Total assets $ 866,633 $ 717,868
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Policy liabilities and accrual
Future policy benefits, losses and claims $ 410,091 $ 357,149
Unearned premiums 43,672 32,045
Other policy claims and benefits payable 178,695 149,538
--------- ---------
632,458 538,732
Deferred reinsurance gain 16,438 20,932
Other policyholders' funds 22,678 22,365
Federal income taxes payable -- 1,449
Mortgage note payable 8,054 8,157
Long-term debt 50,000 40,000
Deferred federal income tax liability 2,132 --
Other liabilities 47,662 41,572
--------- ---------
Total liabilities 779,422 673,207
--------- ---------
Stockholders' equity
Non-voting preferred stock, $.001 par value, 1,900,000 and 2,000,000 shares
authorized, respectively, none issued -- --
Convertible voting preferred stock, $.001 par value, at stated value, 100,000 and 0 shares
authorized, 75,000 and 0 shares issued and outstanding, respectively 7,500 --
Common stock, $.001 par value, 50,000,000 and 30,000,000 shares authorized,
17,202,379 and 13,706,726 shares issued and outstanding, respectively 17 14
Additional paid-in capital 79,781 60,290
Dividends distributable, convertible voting preferred stock 138 --
Retained earnings 14,739 2,549
Accumulated other comprehensive loss (14,964) (18,192)
--------- ---------
Total stockholders' equity 87,211 44,661
--------- ---------
Total liabilities and stockholders' equity $ 866,633 $ 717,868
========= =========
The accompanying notes are an integral part of these condensed consolidated financial statements.
</TABLE>
3
<PAGE> 4
CERES GROUP, INC AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
UNAUDITED
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------------- --------------------------
2000 1999 2000 1999
---------- --------- --------- ---------
<S> <C> <C> <C> <C>
REVENUES
Premiums, net
Medical $ 102,402 $ 66,115 $ 275,891 $ 181,074
Senior and other 38,438 21,455 88,613 54,623
--------- --------- --------- ---------
Total premiums, net 140,840 87,570 364,504 235,697
Net investment income 7,336 5,241 19,322 16,609
Net realized gains 99 155 35 280
Fee and other income 7,984 3,059 22,480 12,760
Amortization of deferred reinsurance gain 1,298 1,400 4,495 4,068
--------- --------- --------- ---------
157,557 97,425 410,836 269,414
--------- --------- --------- ---------
BENEFITS, LOSSES AND EXPENSES
Benefits, claims, losses and settlement expenses
Medical 74,506 42,567 206,523 126,953
Senior and other 29,512 17,541 69,076 43,752
--------- --------- --------- ---------
Total benefits, claims, losses and settlement expenses 104,018 60,108 275,599 170,705
Selling, general and administrative expenses 52,151 37,718 133,076 97,347
Net amortization and change in deferral of acquisition
costs and value of business acquired (6,633) (6,075) (21,570) (14,362)
Amortization of goodwill 265 295 782 795
Interest expense and financing costs 1,646 1,255 3,983 2,746
--------- --------- --------- ---------
151,447 93,301 391,870 257,231
--------- --------- --------- ---------
Income before federal income taxes 6,110 4,124 18,966 12,183
Federal income tax expense 2,138 1,443 6,638 4,264
--------- --------- --------- ---------
NET INCOME 3,972 2,681 12,328 7,919
Convertible voting preferred stock dividends (138) -- (138) --
--------- --------- --------- ---------
NET INCOME ATTRIBUTABLE TO COMMON STOCKHOLDERS $ 3,834 $ 2,681 $ 12,190 $ 7,919
========= ========= ========= =========
NET INCOME PER SHARE ATTRIBUTABLE TO COMMON STOCKHOLDERS
Basic $ 0.23 $ 0.20 $ 0.84 $ 0.60
Diluted 0.21 0.17 0.79 0.51
</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 NINE MONTHS ENDED SEPTEMBER 30, 2000
(DOLLARS IN THOUSANDS, EXCEPT SHARE AMOUNTS)
UNAUDITED
<TABLE>
<CAPTION>
<S> <C>
CONVERTIBLE VOTING PREFERRED STOCK
Balance at December 31, 1999 $ --
Issuance of shares 7,500
----------
Balance at September 30, 2000 $ 7,500
==========
COMMON STOCK
Balance at December 31, 1999 $ 14
Issuance of shares:
Private placement 3
----------
Balance at September 30, 2000 $ 17
==========
ADDITIONAL PAID-IN CAPITAL
Balance at December 31, 1999 $ 60,290
Issuance of shares:
Employee benefit plans 1,094
Private placement 18,397
----------
Balance at September 30, 2000 $ 79,781
==========
DIVIDENDS DISTRIBUTABLE, CONVERTIBLE VOTING PREFERRED STOCK
Balance at December 31, 1999 $ --
Dividends distributable 138
----------
Balance at September 30, 2000 $ 138
==========
RETAINED EARNINGS
Balance at December 31, 1999 $ 2,549
Net income 12,328
Dividends distributable, convertible voting preferred stock (138)
----------
Balance at September 30, 2000 $ 14,739
==========
ACCUMULATED OTHER COMPREHENSIVE LOSS
Balance at December 31, 1999 $ (18,192)
Other comprehensive loss, net:
Unrealized gain on securities, net of tax of $248 3,228
----------
Balance at September 30, 2000 $ (14,964)
==========
TOTAL STOCKHOLDERS' EQUITY $ 87,211
==========
NUMBER OF SHARES OF COMMON STOCK
Balance at December 31, 1999 13,706,726
Issuance of shares:
Employee benefit plans 162,319
Private placement 3,333,334
----------
Balance at September 30, 2000 17,202,379
==========
NUMBER OF SHARES OF CONVERTIBLE VOTING PREFERRED STOCK
Balance at December 31, 1999 --
Issuance of shares 75,000
----------
Balance at September 30, 2000 75,000
==========
</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 NINE MONTHS ENDED SEPTEMBER 30, 2000 AND 1999
(DOLLARS IN THOUSANDS)
UNAUDITED
<TABLE>
<CAPTION>
2000 1999
--------- ---------
<S> <C> <C>
OPERATING ACTIVITIES
Net income $ 12,328 $ 7,919
Adjustments to reconcile net income to cash provided by (used in) operating activities:
Depreciation and amortization 2,053 2,192
Net realized gains (35) (225)
Deferred federal income taxes 8,273 2,733
Changes in assets and liabilities:
Reinsurance and premiums receivable 15,215 (238,287)
Value of business acquired (1,516) (1,676)
Goodwill 1,943 (5,228)
Federal income taxes payable/recoverable (3,062) 5,795
Accrued investment income 998 (90)
Other assets 941 (4,602)
Future policy benefits, claims and funds payable 14,679 236,252
Unearned premium 10,451 17,929
Reinsurance payable 1,506 1,310
Other liabilities 2,351 (290)
Deferred policy acquisition costs (20,054) (13,686)
Deferred reinsurance gain (4,495) (4,068)
--------- ---------
Net cash provided by operating activities 41,576 5,978
--------- ---------
INVESTING ACTIVITIES
Net purchases of furniture and equipment (1,376) (834)
Purchase of fixed maturities available-for-sale (40,846) (8,299)
Acquisition of Continental General Corporation, net of $24,712 cash acquired -- (59,788)
Acquisition of Pyramid Life Insurance Company, net of $7,159 cash acquired (37,339) --
Decrease in mortgage and policy loans, net 321 --
Foreclosure on assets of United Benefit Life Insurance Company, net of $1,251 cash overdrafts -- (7,211)
Proceeds from sales of fixed maturities available-for-sale 11,527 13,938
Proceeds from calls and maturities of fixed maturities available-for sale 27,462 10,331
Proceeds from sales, calls and fixed maturities of held-to-maturity -- 3,923
Proceeds from sale of property held for sale 2,115 --
Other -- 71
--------- ---------
Net cash used in investing activities (38,136) (47,869)
--------- ---------
FINANCING ACTIVITIES
Increase in annuity account balances 12,408 12,961
Decrease in annuity account balances (23,160) (25,337)
Decrease in note receivable -- 7,368
Principal payments on mortgage note payable (103) (94)
Increase in long-term debt borrowings 15,000 40,000
Principal payments on long-term debt (5,000) --
Proceeds from issuance of common stock 1,094 1,132
Proceeds from private placement of common stock, net of acquisition costs 18,400 15,117
Proceeds from private placement of preferred stock 7,500 --
--------- ---------
Net cash provided by financing activities 26,139 51,147
--------- ---------
NET INCREASE IN CASH 29,579 9,256
Cash and cash equivalents at beginning of year 42,921 19,376
--------- ---------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 72,500 $ 28,632
========= =========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid during the period for interest $ 4,031 $ 2,432
Cash paid during the period for federal income taxes 1,000 2,078
</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
A. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements of
Ceres Group, Inc. and subsidiaries ("Ceres," "we," "our" or the "Company")
included herein have been prepared by Ceres in accordance with generally
accepted accounting principles for interim financial information and 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 September 30, 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, United Benefit Life Insurance Company ("United Benefit") under a
reinsurance arrangement effective August 1, 1998 and acquired on July 21, 1999,
and Pyramid Life Insurance Company ("Pyramid") acquired on July 26, 2000.
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 September 30, 2000 and December
31, 1999, the Company had approximately $9.3 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 condensed 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 PRONOUNCEMENTS
In September 2000, the Financial Accounting Standards Board ("FASB") issued
Financial Accounting Standard ("FAS") No. 140, Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities which replaces
FAS No. 125, Accounting for Transfers
7
<PAGE> 8
and Servicing of Financial Assets and Extinguishments of Liabilities. This
standard revises the methods for accounting for securitizations and other
transfers of financial assets and collateral as outlined in FAS No. 125, and
requires certain additional disclosures. For transfers and servicing of
financial assets and extinguishments of liabilities, this standard will be
effective for the Company's June 30, 2001 financial statements. However, for
disclosures regarding securitizations and collateral, as well as the accounting
for recognition and reclassification of collateral, this standard will be
effective for the Company's December 31, 2000 financial statements. The Company
is currently evaluating the impact of the adoption of this standard; however, it
does not expect the adoption of this standard to have a material effect on its
financial position or results of operations.
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 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 standard will not have a significant effect on its
financial position or results of operations.
B. 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. A loss of $0.1 million was
recognized on the sale of the property in the first quarter of 2000. In the
second quarter, the Company sold the remaining vacant land parcel located next
to United Benefit's home office for $177,000 resulting in a gain on sale of
$12,000.
C. DEBT
SEPTEMBER 30, DECEMBER 31,
2000 1999
------------------ -----------------
(dollars in thousands)
Mortgage note payable $ 8,054 $ 8,157
=========== =========
Bank credit facility $ 35,000 $ 40,000
Revolver 15,000 --
----------- ---------
$ 50,000 $ 40,000
=========== =========
8
<PAGE> 9
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 consisted of $40.0 million bank credit
facility and a $10.0 million line of credit, referred to as the revolver.
Quarterly principal payments are due through February 2005. On July 25, 2000,
the Company, along with The Chase Manhattan Bank and associated banks, amended
its Credit Agreement to increase the revolver from $10.0 million to $15.0
million. The amendment included provisions to allow for the Pyramid acquisition
along with certain revisions in the financial covenants to be maintained by the
Company.
Interest rates under the Credit Agreement at September 30, 2000 ranged from
10.1% to 10.3%. See "Liquidity and Capital Resources" for further information on
our Credit Agreement.
D. REINSURANCE
The Company has entered into several quota-share reinsurance treaties with
Hannover Life Reassurance Company of America (formerly Reassurance Company of
Hannover) 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 nine 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.
9
<PAGE> 10
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 NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------------------- ---------------------------------
2000 1999 2000 1999
-------------- ---------------- --------------- ---------------
(dollars in thousands)
<S> <C> <C> <C> <C>
Premiums
Direct $ 201,127 $ 153,481 $ 546,812 $ 391,472
Assumed 2,728 12,350 14,374 71,043
Ceded (63,015) (78,261) (196,682) (226,818)
------------ ------------- ------------- --------------
Net premiums $ 140,840 $ 87,570 $ 364,504 $ 235,697
============ ============= ============= ==============
Benefits, claims, losses, and
settlement expenses $ 152,465 $ 208,042 $ 429,333 $ 427,921
Reinsurance recoveries (48,447) (147,934) (153,734) (257,216)
------------ ------------- ------------- --------------
$ 104,018 $ 60,108 $ 275,599 $ 170,705
============ ============= ============= ==============
Selling, general, and administrative
expenses
Commissions $ 33,195 $ 22,041 $ 94,846 $ 62,479
Other operating expenses 34,177 25,667 87,424 66,359
Reinsurance expenses 1,016 10,958 3,242 32,359
Reinsurance allowances (16,237) (20,948) (52,436) (63,850)
------------ ------------- ------------- --------------
$ 52,151 $ 37,718 $ 133,076 $ 97,347
============ ============= ============= ==============
</TABLE>
<TABLE>
<CAPTION>
E. COMPREHENSIVE INCOME (LOSS)
Comprehensive income (loss) is as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------------- ---------------------------
2000 1999 2000 1999
---------- ----------- ----------- -----------
(dollars in thousands)
<S> <C> <C> <C> <C>
Net income $ 3,972 $ 2,681 $ 12,328 $ 7,919
Other comprehensive loss, net
Unrealized gain (loss) on securities,
net of tax of $248 4,820 (4,353) 3,228 (16,001)
Reclassification adjustment for
gains included in net income -- 100 -- 182
---------- ----------- ----------- -----------
Comprehensive income (loss) $ 8,792 $ (1,572) $ 15,556 $ (7,900)
========== =========== =========== ===========
</TABLE>
10
<PAGE> 11
F. 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 NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------------------- ----------------------------------
2000 1999 2000 1999
----------------- ------------------ --------------- -----------------
(dollars in thousands, except per share amounts)
<S> <C> <C> <C> <C>
BASIC
Average common stock
outstanding 16,301,049 13,642,706 14,595,057 13,196,072
============== ============== =============== ===============
Net income attributable to common
stockholders $ 3,834 $ 2,681 $ 12,190 $ 7,919
============== ============== =============== ===============
Net income per share attributable
to common stockholders $ 0.23 $ 0.20 $ 0.84 $ 0.60
============== ============== =============== ===============
DILUTED
Average common stock
outstanding 16,301,049 13,642,706 14,595,057 13,196,072
Convertible voting preferred stock 888,845 -- 298,444 --
Warrants/stock options -
treasury stock method 801,972 1,767,845 683,736 2,171,280
-------------- -------------- --------------- ---------------
Weighted average shares
of common stock 17,991,866 15,410,551 15,577,237 15,367,352
============== ============== =============== ===============
Net income $ 3,972 $ 2,681 $ 12,328 $ 7,919
============== ============== =============== ===============
Net income per share attributable
to common stockholders $ 0.21 $ 0.17 $ 0.79 $ 0.51
============== ============== =============== ===============
</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.
G. 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. See "Part II Other
Information, Item 1. Legal Proceedings" for further information.
11
<PAGE> 12
H. ACQUISITION
THE PYRAMID LIFE INSURANCE COMPANY ACQUISITION
On July 26, 2000, the Company, through Continental, completed the purchase
of The Pyramid Life Insurance Company ("Pyramid") from United Insurance Company
of America ("United"), a subsidiary of Unitrin, Inc. of Chicago, Illinois.
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 insurance products. At June 30, 2000 (prior to
payment of the $25.0 million pre-closing dividend), Pyramid had assets of $140.9
million and total revenues of $37.0 million. Pyramid markets senior insurance
products through approximately 2,500 independent agents in 40 states.
The $67.5 million purchase price was financed as follows:
- $20.0 million from the sale of 3,333,334 newly-issued shares
of our common stock at $6.00 per share, in a private placement
offering;
- $7.5 million from the sale to United of 75,000 newly-issued
shares of our convertible voting preferred stock, which shares
are (1) convertible into our common stock, (2) receive
cumulative dividends of 10% per annum and (3) prohibit the
payment of dividends on shares of our common stock unless all
previous dividends on the convertible voting preferred stock
have been paid;
- $25.0 million from a special pre-closing dividend paid by
Pyramid to United in connection with the acquisition; and
- $15.0 million from a combination of funds from Continental and
financing provided by The Chase Manhattan Bank and associated
banks.
Under purchase accounting, the total purchase cost for the acquisition has
been allocated to the assets and liabilities of Pyramid based on their fair
values. Allocations are subject to valuations as of the date of the acquisition
based on appraisals and other studies which are not yet fully completed.
Accordingly, the final allocations may be different from the amounts reflected
herein. Although the final allocations may differ, the unaudited pro forma
financial statements reflect management's best estimates based on currently
available information as of the date of this filing.
12
<PAGE> 13
The following unaudited pro forma information presents the consolidated
results of operations of the Company assuming the acquisition of Pyramid was
completed on January 1, 1999 and 2000:
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
---------------------------------------------
2000 1999
-------------------- --------------------
<S> <C> <C>
Revenues $ 452,834 $ 320,130
Income before federal income taxes 23,249 17,557
Federal income tax expense 8,235 6,263
Net income 15,014 11,294
Net income attributable to common stockholders 14,452 10,731
Net income per share attributable to common
stockholders
Basic 0.85 0.65
Diluted 0.75 0.56
</TABLE>
The pro forma results of operations are not indicative of the actual
results of operations that would have occurred had the acquisition been made on
the dates indicated, or the results that may be obtained in the future.
I. OPERATING SEGMENTS
In conjunction with the Company's continued growth and refinement of a
defined organization structure, the Company expanded its operating segments to
the following three distinct operating segments based upon product types:
medical, senior and other (formerly specialty and other), and corporate and
other. Products included in the medical segment include comprehensive major
medical plans. Significant products in the senior and other include Medicare
Supplement, long-term care, dental, life insurance, and annuities. The corporate
and other segment encompasses all other activities of the Company, including
interest income and expense of the parent company.
13
<PAGE> 14
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 NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------- -------------------------
2000 1999 2000 1999
---------- ---------- ---------- ----------
(dollars in thousands)
<S> <C> <C> <C> <C>
MEDICAL
Revenues
Premiums, net $ 102,402 $ 66,115 $ 275,891 $ 181,074
Net investment income and net realized gains 2,733 1,602 6,623 5,428
Fee and other income 8,716 2,805 25,239 15,068
---------- ---------- ---------- ----------
113,851 70,522 307,753 201,570
---------- ---------- ---------- ----------
Expenses
Benefits, claims, losses and settlement expenses 74,506 42,567 206,523 126,953
Other operating expenses 32,687 26,069 85,251 67,856
---------- ---------- ---------- ----------
107,193 68,636 291,774 194,809
---------- ---------- ---------- ----------
Segment profit before federal income taxes $ 6,658 $ 1,886 $ 15,979 $ 6,761
========== ========== ========== ==========
SENIOR AND OTHER
Revenues
Premiums, net $ 38,438 $ 21,455 $ 88,613 $ 54,623
Net investment income and net realized gains 4,364 3,745 12,234 11,258
Fee and other income 566 1,017 1,736 1,017
---------- ---------- ---------- ----------
43,368 26,217 102,583 66,898
---------- ---------- ---------- ----------
Expenses
Benefits, claims, losses and settlement expenses 29,512 17,541 69,076 43,752
Other operating expenses 10,579 4,199 24,514 12,989
---------- ---------- ---------- ----------
40,091 21,740 93,590 56,741
---------- ---------- ---------- ----------
Segment profit before federal income taxes $ 3,277 $ 4,477 $ 8,993 $ 10,157
========== ========== ========== ==========
CORPORATE
Revenues
Net investment income $ 338 $ 49 $ 500 $ 203
Fee and other income -- 637 -- 743
---------- ---------- ---------- ----------
338 686 500 946
---------- ---------- ---------- ----------
Expenses
Interest expense and financing costs 1,646 1,255 3,983 2,746
Other operating expenses 2,517 1,670 2,523 2,935
---------- ---------- ---------- ----------
4,163 2,925 6,506 5,681
---------- ---------- ---------- ----------
Segment profit (loss) before federal income taxes $ (3,825) $ (2,239) $ (6,006) $ (4,735)
========== ========== ========== ==========
INCOME BEFORE FEDERAL INCOME TAXES $ 6,110 $ 4,124 $ 18,966 $ 12,183
========== ========== ========== ==========
</TABLE>
The Company does not separately allocate investment or other identifiable
assets by industry segment, nor are income tax (benefits) expenses allocated by
industry segment.
14
<PAGE> 15
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 services and specialty products and services to approximately 600,000
insureds. We actively distribute our products on a national basis through
approximately 50,000 independent licensed agents and career agents and through
various e-commerce platforms, including our subsidiary, QQLink.com. Traditional
and e-commerce products are marketed to individuals, small businesses and the
senior market. Through the implementation of our sales and financial business
plan and acquisition strategy, we focus on increasing fee based revenue and
reducing medical costs and underwriting risks.
The financial information for the quarter and nine months ended September
30, 1999 includes the operations of Continental since February 1, 1999, United
Benefit (through reinsurance until July 20, 1999 and thereafter as an acquired
entity) and Provident for the entire period. The financial information for the
quarter and nine months ended September 30, 2000 includes the operations of
Continental, Provident and United Benefit for the entire period and Pyramid
since July 26, 2000.
RECENT EVENTS
THE PYRAMID LIFE INSURANCE COMPANY ACQUISITION
On July 26, 2000, we completed the purchase of The Pyramid Life Insurance
Company from United Insurance Company of America, a subsidiary of Unitrin, Inc.
of Chicago, Illinois. For additional information regarding the acquisition of
Pyramid, see Note H. "Acquisition" to the Notes to the Condensed Consolidated
Financial Statements.
CREDIT AGREEMENT AMENDMENT
In conjunction with the Pyramid acquisition, on July 25, 2000, we, along
with The Chase Manhattan Bank and associated banks, amended our Credit Agreement
to increase the revolver from $10.0 million to $15.0 million. For additional
information regarding the amendment to our Credit Agreement, see "Liquidity and
Capital Resources."
15
<PAGE> 16
RESULTS OF OPERATIONS
QUARTER ENDED SEPTEMBER 30, 2000 COMPARED TO QUARTER ENDED SEPTEMBER 30, 1999
1. NET PREMIUMS
<TABLE>
<CAPTION>
THREE MONTHS THREE MONTHS INCREASE FROM
ENDED % OF ENDED % OF PREVIOUS YEAR
SEPTEMBER 30, CONSOLIDATED SEPTEMBER 30, CONSOLIDATED --------------------
2000 REVENUES 1999 REVENUES DOLLARS %
------------- ------------ ------------- ------------ ------- ------
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Premiums, net
Medical $ 102,402 65.0% $ 66,115 67.9% $ 36,287 54.9%
Senior and other 38,438 24.4% 21,455 22.0% 16,983 79.2%
---------- ----------- --------- -------- ---------
Total $ 140,840 89.4% $ 87,570 89.9% $ 53,270 60.8%
========== =========== ========= ======== =========
</TABLE>
For the quarter ended September 30, 2000, total net premiums were $140.8
million, an increase of 60.8%, from $87.6 million for the same quarter in 1999.
Medical premiums for the quarter ended September 30, 2000 were $102.4
million compared to $66.1 million for the quarter ended September 30, 1999, an
increase of 54.9%. The increase in medical premiums was the result of premium
rate increases and $1.3 million attributable to Pyramid.
Senior and other premiums, which primarily include Medicare Supplement,
long-term care, dental, life insurance and annuities, were $38.4 million for the
quarter ended September 30, 2000 compared to $21.5 million for the quarter ended
September 30, 1999, an increase of 79.2%. The increase in senior and other
premiums was primarily the result of $10.4 million attributable to Pyramid,
increased Medicare Supplement sales and premium rate increases.
2. OTHER REVENUES
<TABLE>
<CAPTION>
INCREASE /
THREE MONTHS THREE MONTHS (DECREASE) FROM
ENDED % OF ENDED % OF PREVIOUS YEAR
SEPTEMBER 30, CONSOLIDATED SEPTEMBER 30, CONSOLIDATED --------------------
2000 REVENUES 1999 REVENUES DOLLARS %
------------- ------------ ------------- ------------ ------- ------
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Net investment
income $7,336 4.7% $5,241 5.4% $2,095 40.0%
Fee and other
income 7,984 5.1% 3,059 3.1% 4,925 161.0%
Amortization of
deferred
reinsurance gain 1,298 0.8% 1,400 1.4% (102) (7.3)%
</TABLE>
Net investment income increased to $7.3 million for the third quarter of
2000 from $5.2 million for the third quarter of 1999, an increase of 40.0%, due
primarily to an increased investment base from the addition of Pyramid.
Fee and other income increased to $8.0 million for the quarter ended
September 30, 2000 compared to $3.1 million for the same quarter of 1999, an
increase of 161.0%. This increase was
16
<PAGE> 17
attributable to additional fees charged for new services, as well as fees
received on a larger volume of business in force.
The amortization of deferred reinsurance gain of $1.3 million for the
quarter ended September 30, 2000 represents the recognition of the ceding
commission allowances received under our reinsurance agreements. The unamortized
amount of $16.4 million at September 30, 2000 is accounted for as a deferred
reinsurance gain on the consolidated condensed balance sheet.
3. BENEFITS, CLAIMS, LOSSES AND SETTLEMENT EXPENSES
<TABLE>
<CAPTION>
THREE MONTHS THREE MONTHS INCREASE FROM
ENDED ENDED PREVIOUS YEAR
SEPTEMBER 30, LOSS SEPTEMBER 30, LOSS -----------------------
2000 RATIO 1999 RATIO DOLLARS %
------------- ------ --------------- ----- ----------- -----
<S> <C> <C> <C> <C> <C> <C>
Benefits, claims, losses and
settlement expenses
Medical $ 74,506 72.8% $ 42,567 64.4% $ 31,939 75.0%
Senior and other 29,512 76.8% 17,541 81.8% 11,971 68.2%
----------- ----------- -----------
Total $ 104,018 73.9% $ 60,108 68.6% $ 43,910 73.1%
=========== =========== ===========
</TABLE>
Total benefits, claims and settlement expenses increased to $104.0 million
for the quarter ended September 30, 2000 compared to $60.1 million for the same
quarter in 1999, an increase of 73.1%.
Medical benefits, claims, losses and settlement expenses were $74.5 million
for the quarter ended September 30, 2000 compared to $42.6 million for the same
quarter in 1999, an increase of 75.0%. The increase is a result of higher
benefit utilization in the third quarter of 2000 versus the same quarter of 1999
on a larger volume of business in force, increased medical costs, the resolution
of certain outstanding claims, and $0.8 million attributable to Pyramid. The
medical loss ratio was 72.8% for the quarter ended September 30, 2000 compared
to 64.4% for the same quarter of 1999. The increase is attributable to higher
benefit utilization.
Senior and other benefits, claims, losses and settlement expenses were
$29.5 million for the quarter ended September 30, 2000 compared to $17.5 million
for the same quarter of 1999, an increase of 68.2%. The increase is a result of
$7.5 million attributable to Pyramid and claims and benefits paid on a larger
volume of business in force. The senior and other loss ratio decreased to 76.8%
for the third quarter of 2000 compared to 81.8% for the third quarter of 1999,
primarily attributable to the acquisition of Pyramid.
17
<PAGE> 18
4. OTHER EXPENSES AND NET INCOME
<TABLE>
<CAPTION>
INCREASE /
THREE MONTHS THREE MONTHS (DECREASE) FROM
ENDED % OF ENDED % OF PREVIOUS YEAR
SEPTEMBER 30, CONSOLIDATED SEPTEMBER 30, CONSOLIDATED -------------------
2000 REVENUES 1999 REVENUES DOLLARS %
-------------- ------------ ------------- ------------ ------- -------
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Selling, general and
administrative expenses $ 52,151 33.1 % $ 37,718 38.7% $14,433 38.3 %
Net amortization and change
in deferral of acquisition
costs and value of
business acquired (6,633) (4.2)% (6,075) (6.2)% (558) (9.2)%
Interest expenses and
financing costs 1,646 1.0 % 1,255 1.3 % 391 31.2 %
Federal income tax expense 2,138 1.4 % 1,443 1.5 % 695 48.2 %
Net income 3,972 2.5 % 2,681 2.8 % 1,291 48.2 %
</TABLE>
Selling, general and administrative expenses increased to $52.2 million in
the third quarter of 2000 compared to $37.7 million in the third quarter of
1999, an increase of 38.3%. The increase in selling, general and administrative
expenses represents a $11.1 million increase in commissions and a $8.5 million
increase in other operating expenses attributable to our increased business
base. Pyramid accounted for $3.7 million of the $14.4 million increase. The
increase in selling, general and administrative expenses was partially offset by
a $5.2 million net increase in reinsurance allowances and charges. As a
percentage of revenues, selling, general and administrative expenses decreased
to 33.1% in the third quarter of 2000 compared to 38.7% in the third quarter of
1999.
The net amortization and change in deferral of acquisition costs and value
of business acquired resulted in a net deferral of $6.6 million for the third
quarter of 2000 compared to a net deferral of $6.1 million for the third quarter
of 1999. Pyramid accounted for $0.9 million of the net deferral. The remaining
increase in the deferral is a result of capitalized acquisition expenses on new
business. The increase was offset by a reduction in the net deferral of $0.8
million for additional amortization of previously capitalized expenses for
certain states in which there were higher than anticipated claim loss ratios.
Interest expense and financing costs increased to $1.6 million in the third
quarter of 2000 compared to $1.3 million in the third quarter of 1999 as a
result of a higher outstanding balance and increased interest rates under the
Credit Agreement.
A provision for federal income taxes of $2.1 million, or 35.0% of income
before federal taxes of $6.1 million, was established for the third quarter of
2000. A similar effective rate was used for 1999.
As a result of the foregoing, net income for the third quarter of 2000 was
$3.9 million, or $0.23 basic and $0.21 diluted earnings per share of common
stock, compared to net income of $2.7 million, or $0.20 basic and $0.17 diluted
earnings per share of common stock, for the third quarter of 1999.
18
<PAGE> 19
NINE MONTHS ENDED SEPTEMBER 30, 2000 COMPARED TO NINE MONTHS ENDED
SEPTEMBER 30, 1999
1. NET PREMIUMS
<TABLE>
<CAPTION>
NINE MONTHS NINE MONTHS INCREASE FROM
ENDED % OF ENDED % OF PREVIOUS YEAR
SEPTEMBER 30, CONSOLIDATED SEPTEMBER 30, CONSOLIDATED ------------------------
2000 REVENUES 1999 REVENUES DOLLARS %
------------- ------------ ------------- ------------ --------- -----
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Premiums, net
Medical $ 275,891 67.1% $ 181,074 67.2% $ 94,817 52.4%
Senior and other 88,613 21.6% 54,623 20.3% 33,990 62.2%
------------- ----- ----------- ----- ---------
Total $ 364,504 88.7% $ 235,697 87.5% $ 128,807 54.6%
============= ===== =========== ===== =========
</TABLE>
For the nine months ended September 30, 2000, total net premiums were
$364.5 million, an increase of 54.6%, from $235.7 million for the same period in
1999.
Medical premiums for the nine months ended September 30, 2000 were $275.9
million compared to $181.1 million for the nine months ended September 30, 1999,
an increase of 52.4%. The increase in medical premiums was the result of
increased new sales, premium rate increases, the inclusion of Continental's
results for nine months in 2000 compared to eight months in 1999, additional
reinsurance assumed, and $1.3 million attributable to Pyramid.
Senior and other premiums, which primarily includes Medicare Supplement,
long-term care, dental, life insurance and annuities, were $88.6 million for the
nine months ended September 30, 2000 compared to $54.6 million for the nine
months ended September 30, 1999, an increase of 62.2%. The increase in senior
and other premiums was primarily the result of the inclusion of Continental's
senior premiums for nine months in 2000 versus eight months in 1999, $10.4
million attributable to Pyramid, increased Medicare Supplement sales, and
premium rate increases.
2. OTHER REVENUES
<TABLE>
<CAPTION>
NINE MONTHS NINE MONTHS INCREASE FROM
ENDED % OF ENDED % OF PREVIOUS YEAR
SEPTEMBER 30, CONSOLIDATED SEPTEMBER 30, CONSOLIDATED ----------------------
2000 REVENUES 1999 REVENUES DOLLARS %
------------- ------------ ------------- ------------ --------- -----
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Net investment income $ 19,322 4.7% $ 16,609 6.2% $ 2,713 16.3%
Fees and other income 22,480 5.5% 12,760 4.7% 9,720 76.2%
Amortization of deferred
reinsurance gain 4,495 1.1% 4,068 1.5% 427 10.5%
</TABLE>
Net investment income increased to $19.3 million for the first nine months
of 2000 from $16.6 million for the first nine months of 1999, an increase of
16.3%. The increase in net investment income is primarily a result of including
nine months of Continental's activity in 2000 compared to eight months in 1999,
and an increased investment base from the addition of Pyramid.
19
<PAGE> 20
Fee and other income increased to $22.5 million for the nine months ended
September 30, 2000 compared to $12.8 million for the same period of 1999, an
increase of 76.2%. This increase was attributable to additional fees charged for
new services, as well as fees received on a larger volume of business in force.
The amortization of deferred reinsurance gain of $4.5 million for the nine
months ended September 30, 2000 represents the recognition of the ceding
commission allowances received under our reinsurance agreements. The unamortized
amount of $16.4 million at September 30, 2000 is accounted for as a deferred
reinsurance gain on the consolidated condensed balance sheet.
3. BENEFITS, CLAIMS, LOSSES AND SETTLEMENT EXPENSES
<TABLE>
<CAPTION>
NINE MONTHS NINE MONTHS INCREASE FROM
ENDED ENDED PREVIOUS YEAR
SEPTEMBER 30, LOSS SEPTEMBER 30, LOSS -------------------
2000 RATIO 1999 RATIO DOLLARS %
------------- ----- ------------- ----- ---------- -----
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Benefits, claims, losses and
settlement expenses
Medical $ 206,523 74.9% $ 126,953 70.1% $ 79,570 62.7%
Senior and other 69,076 78.0% 43,752 80.1% 25,324 57.9%
---------- ------------ -----------
Total $ 275,599 75.6% $ 170,705 72.4% $ 104,894 61.4%
========== ============ ==========
</TABLE>
Total benefits, claims and settlement expenses increased to $275.6 million
for the nine months ended September 30, 2000 compared to $170.7 million for the
same period in 1999, an increase of 61.4%.
Medical benefits, claims, losses and settlement expenses were $206.5
million for the nine months ended September 30, 2000 compared to $127.0 million
for the same period in 1999, an increase of 62.7%. The increase is a result of
higher benefit utilization in the first nine months of 2000 versus the same
period of 1999 on a larger volume of business in force, increased medical costs,
the resolution of certain outstanding claims, and $0.8 million attributable to
Pyramid. The medical loss ratio was 74.9% for the nine months ended September
30, 2000 compared to 70.1% for the same period of 1999. The increase is
attributable to higher benefit utilization.
Senior and other benefits, claims, losses and settlement expenses were
$69.1 million for the nine months ended September 30, 2000 compared to $43.8
million for the same period of 1999, an increase of 57.9%. The increase is a
result of the inclusion of nine months of senior benefits of Continental in 2000
versus eight months in 1999, $7.5 million attributable to Pyramid, and claims
and benefits paid on a larger volume of business in force. The senior and other
loss ratio decreased to 78.0% for the first nine months of 2000 compared to
80.1% for the first nine months of 1999, primarily attributable to lower loss
ratios for the long-term care business at Continental, as well as the
acquisition of Pyramid.
20
<PAGE> 21
4. OTHER EXPENSES AND NET INCOME
<TABLE>
<CAPTION>
NINE MONTHS NINE MONTHS INCREASE /
ENDED % OF ENDED % OF (DECREASE) FROM
SEPTEMBER 30, CONSOLIDATED SEPTEMBER 30, CONSOLIDATED PREVIOUS YEAR
2000 REVENUES 1999 REVENUES DOLLARS %
------------- ------------ ------------- ------------ ------- ------
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Selling, general and
administrative expenses $ 133,076 32.4% $ 97,347 36.1% $35,729 36.7%
Net amortization and change
in deferral of acquisition
costs and value of business
acquired (21,570) (5.3)% (14,362) (5.3)% (7,208) (50.2)%
Interest expenses and
financing costs 3,983 1.0% 2,746 1.0% 1,237 45.0%
Federal income tax expense 6,638 1.6% 4,264 1.6% 2,374 55.7%
Net income 12,328 3.0% 7,919 2.9% 4,409 55.7%
</TABLE>
Selling, general and administrative expenses increased to $133.1 million
for the first nine months of 2000 compared to $97.3 million for the first nine
months of 1999, an increase of 36.7%. The increase in selling, general and
administrative expenses represents a $32.4 million increase in commissions, and
a $21.0 million increase in other operating expenses attributable to our
increased business base, which includes Continental for nine months in 2000
versus eight months in 1999. Pyramid accounted for $3.7 million of the $35.7
million increase. The increase in selling, general and administrative expenses
was partially offset by a $17.7 million net increase in reinsurance allowances
and charges. As a percentage of revenues, selling, general and administrative
expenses decreased to 32.4% in the first nine months of 2000 compared to 36.1%
in the first nine months of 1999.
The net amortization and change in deferral of acquisition costs and value
of business acquired resulted in a net deferral of $21.6 million for the first
nine months of 2000 compared to a net deferral of $14.4 million for the first
nine months of 1999. The increase in the deferral is a result of capitalized
acquisition expenses on new business, including Continental's new business for
nine months in 2000 versus eight months in 1999, and $0.9 million attributable
to Pyramid. The increase was offset by a reduction in the net deferral of $0.8
million for additional amortization of previously capitalized expenses for
certain states in which there were higher than anticipated claims loss ratios.
Interest expense and financing costs increased to $4.0 million in the first
nine months of 2000 compared to $2.7 million in the first nine months of 1999 as
a result of interest expense incurred under our Credit Agreement for nine months
in 2000 compared to interest expense for the nine months in 1999 which did not
begin to accrue until February 17, 1999, the closing date of the purchase of
Continental, and a higher outstanding balance. Interest rates charged under the
Credit Agreement for the first nine months of 2000 were also higher than those
charged for the same period in 1999.
A provision for federal income taxes of $6.6 million, or 35% of income
before federal taxes of $19.0 million, was established for the first nine months
of 2000. A similar effective rate was used for 1999.
21
<PAGE> 22
As a result of the foregoing, net income for the first nine months of 2000
was $12.3 million, or $0.84 basic and $0.79 diluted earnings per share of common
stock, compared to net income of $7.9 million, or $0.60 basic and $0.51 diluted
earnings per share of common stock, for the first nine months 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 $395.5 million, or 45.6% of the total assets, were in investments
at September 30, 2000. Fixed maturities are our primary investment and were
$384.8 million, or 97.3% of total investments, at September 30, 2000. Other
investments consist of surplus notes, policy loans and mortgage loans. We were
carrying all of our fixed maturities at estimated fair value (available for
sale) at September 30, 2000. We hold less than 1% high-yield type securities,
with nearly 100% of our bonds being investment grade quality.
In addition to the fixed maturities, we also had $72.5 million in cash and
cash equivalents, and a $15.0 million line of credit with a syndicate of major
commercial banks at September 30, 2000. At September 30, 2000, there was no
amount available for additional borrowings under the line of credit.
The total reinsurance receivable was $249.3 million at September 30, 2000.
Of this amount, $227.3 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 20.7% to $866.6 million at September 30, 2000 from $717.9
million at December 31, 1999. The increase was primarily due to the $130.5
million in assets at Pyramid and new business.
The total policy liabilities and accruals (reserves) were 81.1% of the
total liabilities at September 30, 2000, compared to 80.0% at December 31, 1999.
To provide funds for the acquisition of Continental in February 1999, 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, quarterly
principal payments are due through February 2005, as defined in the Credit
Agreement. Interest on the outstanding balance will be determined based on
Ceres' selection each quarter of either 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 an 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.
At September 30, 2000, the interest rate was 10.3%. The Credit
22
<PAGE> 23
Agreement was amended on July 25, 2000 to increase the revolver from $10.0
million to $15.0 million in connection with the acquisition of Pyramid. The
$15.0 million revolver bears interest at the same rate choices as the $40.0
million loan. At September 30, 2000, the interest rate was 10.1% on the
outstanding balance of $15.0 million. 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, as amended, 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 leverage ratio (consolidated debt to consolidated total
capital) of 0.40 to 1.00 through December 31, 2000, 0.35 to 1.00
thereafter through December 31, 2001, and 0.30 to 1.00
thereafter;
- 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;
- a risk-based capital ratio for any regulated insurance company
subsidiary of the Company of not less than 125.0%;
- consolidated net worth, as defined in the Credit Agreement, as
amended, of $80.0 million through December 31, 2000, $110.0
million thereafter through December 31, 2001, $160.0 million
thereafter through December 31, 2002, and $200.0 million
thereafter; and
- a fixed charge coverage ratio (borrower cash flow to the sum of
consolidated interest expense and scheduled repayments) of not
less than 1.05 to 1.00 for the period of June 30, 2000 through
June 30, 2001, 1.10 to 1.00 thereafter through June 30, 2002,
1.20 to 1.00 thereafter through June 30, 2003, and 1.30 to 1.00
thereafter.
In addition, we pledged the common stock of Continental General, Central,
Provident, Pyramid and other subsidiaries as security for the Credit Agreement.
At September 30, 2000, we were in compliance with the covenants contained in the
Credit Agreement.
On July 26, 2000, we sold 75,000 shares of our convertible voting preferred
stock at $100.00 per share to finance, in part, the acquisition of Pyramid. The
convertible voting preferred stock (1) is convertible into our common stock,
(2) receives dividends of 10% per annum, and (3) prohibits the payment of
dividends on our shares of common stock unless all previous dividends on the
convertible voting preferred stock have been paid.
The mortgage note on our 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. We are in the process of evaluating our options
with respect to the extension, refinancing, renewal or payoff of this mortgage
note. Management believes that it will be successful in any such extension,
refinancing or payoff.
We believe that cash flow from operating activities will be sufficient to
meet our currently anticipated operating and capital expenditure requirements
over the next 12 months. 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.
FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS
We have three segments: medical, which includes comprehensive major medical
plans, senior and other, which includes Medicare Supplement, long-term care,
dental, life insurance and annuities, and corporate and other, which includes
primarily interest income and operating and interest expense. See Note I.
"Operating Segments" to the Notes to the Condensed Consolidated Financial
Statements for further information.
23
<PAGE> 24
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 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 interest 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
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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 cost 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 operations of Pyramid
into those of Ceres, including the failure to achieve cost
savings;
- 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 or adverse changes in
persistency or profitability of insurance contracts that would
accelerate the amortization of our deferred acquisition costs;
- 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;
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- 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.
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 Items 1, 2 and 6 are either
inapplicable to Ceres, would not require a response, or have been previously
reported.
ITEM 1. LEGAL PROCEEDINGS
----------------------------
We are defendants in a lawsuit filed on August 14, 2000, Insurance
Advisors of America, Inc., Transcend Group, Inc., and Jimmy K. Walker vs. Ceres
Group, Inc., Ceres Financial Services, Inc., Peter W. Nauert, Central Reserve
Life Insurance Company, Hannover Life Reassurance Company of America (f/k/a
Reassurance Company of Hannover), Provident American Life and Health Insurance
Company and Health Plan Services, Inc., United Benefit Life Insurance Company
and Billy B. Hill, Jr., case no. 17-184-65-00, in State District Court of
Tarrant County, Texas. The lawsuit involves a number of agreements between
Insurance Advisors of America, Ceres, Ceres Financial and United Benefit in
which, among other things, we reinsured United Benefit's policies, Insurance
Advisors entered into a non-compete agreement which prohibited them from selling
insurance products not provided by us, and Insurance Advisors signed a $10
million promissory note payable to us. Pursuant to such agreements, we acquired
through foreclosure the stock of United Benefit. Plaintiffs allege,
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among other things, fraud, breach of contract and negligence relating to unfair
competition and failure to allow them to cross-sell insurance products. Damages
sought are in excess of $50 million. As discussed below, Hannover has now been
dismissed from this action. Additionally, plaintiffs voluntarily dismissed our
general counsel, Billy B. Hill, Jr., from the lawsuit.
On October 25, 2000, we filed a counterclaim in Tarrant County, Texas,
asserting that the plaintiffs failed to make payments under the various lending
agreements entered into by Transcend, breach of fiduciary duties,
misrepresentation of financial condition, breach of contract and certain other
claims. Damages sought are in excess of $25 million.
On September 5, 2000, we initiated a lawsuit, Ceres Group, Inc.,
Central Reserve Life Insurance Company, Provident America Life and Health
Insurance Company, and United Benefit Life Insurance Company vs. Insurance
Advisors of America, Inc., Robert H. Merrill, Private Business Management, Inc.,
Transcend Group, Inc. and Jimmy K. Walker, in the Court of Common Pleas of
Cuyahoga County, Ohio, relating to the foreclosure on the United Benefit stock
and Transcend's failure to make payments under the promissory note. On September
15, 2000, the Court of Common Pleas entered a temporary restraining order in our
favor, which order was superceded by an agreed order dated October 2, 2000.
In addition, a lawsuit was also filed by Hannover, Hannover Life
Reassurance Company of America vs. Transcend Group, Inc., Insurance Advisors of
America, Inc. and Jimmy K. Walker, Sr., case number C10 00-644-8, in Circuit
Court of the Ninth Judicial Circuit in and for Orange County, Florida. The
complaint alleges Transcend breached an agreement in connection with a revolving
credit facility originally provided to Transcend by Ceres Financial which in
turn assigned its position to Hannover. This action was dismissed pursuant to an
agreement reached by the parties in the Texas action and Hannover was dismissed
with prejudice from the Texas action.
Presently, we cannot predict the ultimate outcome nor the financial
impact, if any, of the lawsuit filed against us. Although we cannot rule out the
possibility that the outcome of this litigation may have a material adverse
impact on us, we denied liability to plaintiffs and we intend to vigorously
contest this matter, as well as pursue the claims we hold against Transcend and
its affiliates both in the litigation we initiated in Ohio and in our
counterclaim in the Texas action. Further, we are not aware of any actions taken
by any of our employees or representatives which justify the allegations made by
plaintiffs in the Texas litigation and we believe these allegations to be
groundless.
In addition to the above litigation, we have recently been sued in
certain actions pertaining to the insureds of United Benefit arising from claims
payment issues. While we do not believe that United Benefit has harmed any of
the plaintiffs in these lawsuits and we believe our claims reserves are
adequate, we cannot predict their outcome at this time. To the extent we are
found liable with respect to any of these cases, we may have a right to
indemnity from our third party administrator.
Other than ordinary routine litigation incidental to the business and
the above matters, neither Ceres nor any of our subsidiaries is party to any
material pending legal proceeding nor is any of their property the subject
thereof.
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ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
----------------------------------------------------
On July 25, 2000, we sold 3,333,334 shares of our common stock at $6.00
per share in a private placement offering, and, on July 26, 2000, we sold 75,000
shares of our convertible voting preferred stock at $100.00 per share to United
Insurance Company of America in a private placement offering. The $27.5 million
proceeds from these sales were used for the purchase of Pyramid from United
Insurance, a subsidiary of Unitrin, Inc. The sales were exempt from registration
in accordance with Section 4(2) of the Securities Act of 1933, as amended, and
exemptions available under applicable state securities laws.
The private placement offerings in connection with the acquisition of
Pyramid resulted in adjustments to the number of warrant shares and exercise
price of the Common Share Purchase Warrants, dated July 1, 1998 (the
"Warrants"), pursuant to the Warrants' anti-dilution provisions. The Warrants
were originally exercisable into 3,650,000 shares of our common stock at $5.50
per share. The adjustments resulted in an additional 57,743 Warrant shares and
an adjusted exercise price of $5.41. While we believe that the issuances should
not be deemed to constitute a "sale," as that term is defined in the Securities
Act of 1933, as amended, the issuances of the additional Warrant shares would
also be exempt from registration in accordance with Section 4(2) of the
Securities Act of 1933, as amended, and exemptions available under applicable
state securities laws.
On July 1, 2000, we issued 33,988 shares of our common stock to Peter
W. Nauert, our Chairman of the Board, President and Chief Executive Officer,
pursuant to the stock award provision of his employment agreement, as amended.
This issuance was exempt from registration in accordance with Section 4(2) of
the Securities Act of 1933, as amended, and exemptions available under
applicable state securities laws.
Also on July 1, 2000, we issued 3,776 shares of our common stock to
Billy B. Hill, Jr., our General Counsel, pursuant to his retainer agreement.
This issuance was exempt from registration in accordance with Section 4(2) of
the Securities Act of 1933, as amended, and exemptions available under
applicable state securities laws.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
-------------------------------------------
(a) Exhibits.
(10) Third Amendment to Credit Agreement, dated as of September 22,
2000, among Ceres Group, Inc., the lending institutions party
to the Credit Agreement referred to therein and The Chase
Manhattan Bank, as Administrative Agent
(27) Financial Data Schedule
(b) Reports on Form 8-K.
Current report on Form 8-K dated July 25, 2000 announcing our
acquisition of Pyramid Life Insurance Company, filed August 9, 2000.
Attached as exhibits were:
2.1 Purchase Agreement, dated October 7, 1999, by and between
United Insurance Company of America and Ceres Group, Inc.
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2.2 Amendment to Purchase Agreement by and between United
Insurance Company of America and Ceres Group, Inc., dated as
of April 17, 2000
2.3 Amendment No. 2 to Purchase Agreement by and between United
Insurance Company of America and Ceres Group, Inc., dated as
of July 5, 2000
3.1 Certificate of Amendment of the Certificate of Incorporation
of Ceres Group, Inc. dated July 25, 2000
4.1 Amended and Restated Registration Rights Agreement dated as of
July 25, 2000 between Ceres Group, Inc. (as
successor-in-interest to Central Reserve Life Corporation) and
the persons and entities set forth on the signature pages
thereof
4.2 Amended and Restated Voting Agreement dated as of July 25,
2000 by and among Ceres Group, Inc. (as successor-in-interest
to Central Reserve Life Corporation) and the security holders
listed on the signature pages thereof
4.3 Form of Stockholders Agreement by and among Ceres Group, Inc.
(as successor-in-interest to Central Reserve Life Corporation)
and the security holders listed on the signature pages thereof
(Incorporated by reference to Exhibit D to Ceres' Proxy
Statement on Schedule 14A as filed with the Securities and
Exchange Commission on May 26, 1998 (Reg. No. 000-08483))
4.4 United Registration Rights Agreement dated as of July 26, 2000
between Ceres Group, Inc. and United Insurance Company of
America
10.1 Credit Agreement, dated as of February 17, 1999, among Ceres
Group, Inc., the lending institutions listed from time to time
on Annex I thereto and The Chase Manhattan Bank, as
Administrative Agent (Incorporated by reference to Exhibit
10.1 to Ceres' Form 8-K as filed with the Securities and
Exchange Commission on March 4, 1999 (Reg. No. 000-08483))
10.2 First Amendment to the Credit Agreement, dated as of May 3,
1999, among Ceres Group, Inc., the lending institutions party
to the Credit Agreement and The Chase Manhattan Bank, as
Administrative Agent
10.3 Second Amendment to Credit Agreement, dated as of July 25,
2000, among Ceres Group, Inc., the lending institutions party
to the Credit Agreement and The Chase Manhattan Bank, as
Administrative Agent
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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: November 14, 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)
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EXHIBITS
10.1 Third Amendment to Credit Agreement, dated as of September 22,
2000, among Ceres Group, Inc., the lending institutions party
to the Credit Agreement referred to therein and The Chase
Manhattan Bank, as Administrative Agent.
27 Financial Data Schedule
