<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 JUNE 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 practical date.
Common Stock, $.001 Par Value - 17,164,681 shares as of August 1, 2000.
<PAGE> 2
CERES GROUP, INC. AND SUBSIDIARIES
INDEX
PART I FINANCIAL INFORMATION Page
----
Item 1. Financial Statements - Unaudited 3
Condensed Consolidated Balance Sheets - June 30, 2000 and 3
December 31, 1999.
Condensed Consolidated Statements of Income - Three and six 4
months ended June 30, 2000 and 1999.
Condensed Consolidated Statements of Stockholders' Equity - Six 5
months ended June 30, 2000.
Condensed Consolidated Statements of Cash Flows - Six months 6
ended June 30, 2000 and 1999.
Notes to Condensed Consolidated Financial Statements. 7
Item 2. Management's Discussion and Analysis of Financial Condition and 14
Results of Operations
Item 3. Quantitative and Qualitative Disclosure of Market Risk 26
PART II OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds 26
Item 4. Submission of Matters to a Vote of Security Holders 26
Item 6. Exhibits and Reports on Form 8-K 28
Signatures 29
Exhibits 30
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>
JUNE 30, DECEMBER 31,
2000 1999
--------- ---------
<S> <C> <C>
ASSETS
Investments
Fixed maturities available for sale, at fair value $ 322,352 $ 300,986
Surplus notes 4,818 5,043
Policy and mortgage loans 3,764 3,923
--------- ---------
Total investments 330,934 309,952
Cash and cash equivalents (of which $7,827 and $4,763
is restricted, respectively) 32,974 42,921
Accrued investment income 5,735 5,234
Premiums receivable 6,696 4,905
Reinsurance receivable 254,828 263,289
Property held for sale -- 2,177
Property and equipment, net 15,094 15,091
Deferred federal income taxes -- 1,792
Deferred acquisition costs 40,550 26,650
Value of business acquired 17,318 16,731
Goodwill 22,339 22,857
Other assets 13,902 6,269
--------- ---------
Total assets $ 740,370 $ 717,868
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Policy liabilities and accrual
Future policy benefits, losses and claims $ 354,656 $ 357,149
Unearned premiums 34,058 32,045
Other policy claims and benefits payable 161,164 149,538
--------- ---------
549,878 538,732
Deferred reinsurance gain 17,736 20,932
Other policyholders' funds 23,605 22,365
Federal income taxes payable 1,163 1,449
Mortgage note payable 8,089 8,157
Long-term debt 38,000 40,000
Deferred federal income tax liability 2,811 --
Other liabilities 47,156 41,572
--------- ---------
Total liabilities 688,438 673,207
--------- ---------
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 13,781,381 in 2000 and 13,706,726 in 1999 14 14
Additional paid-in capital 60,797 60,290
Retained earnings 10,905 2,549
Accumulated other comprehensive loss (19,784) (18,192)
--------- ---------
Total stockholders' equity 51,932 44,661
--------- ---------
Total liabilities and stockholders' equity $ 740,370 $ 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
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
UNAUDITED
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------------ ------------------------
2000 1999 2000 1999
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
REVENUES
Premiums, net
Medical $ 92,652 $ 62,199 $ 173,489 $ 114,959
Senior and other 26,288 18,495 50,175 33,168
--------- --------- --------- ---------
Total premiums, net 118,940 80,694 223,664 148,127
Net investment income 5,963 6,590 11,986 11,368
Net realized gains (losses) 9 62 (64) 125
Fee and other income 8,078 4,809 14,496 9,701
Amortization of deferred reinsurance gain 1,799 1,400 3,197 2,668
--------- --------- --------- ---------
134,789 93,555 253,279 171,989
--------- --------- --------- ---------
BENEFITS, LOSSES AND EXPENSES
Benefits, claims, losses and settlement expenses
Medical 69,350 45,248 132,017 84,386
Senior and other 20,673 15,139 39,564 26,211
--------- --------- --------- ---------
Total benefits, claims, losses and settlement expenses 90,023 60,387 171,581 110,597
Selling, general and administrative expenses 43,445 32,350 80,925 59,629
Net amortization and change in deferral of acquisition
costs and value of business acquired (7,163) (5,048) (14,937) (8,287)
Amortization of goodwill 258 314 517 500
Interest expense and financing costs 1,171 914 2,337 1,491
--------- --------- --------- ---------
127,734 88,917 240,423 163,930
--------- --------- --------- ---------
Income before federal income taxes 7,055 4,638 12,856 8,059
Federal income tax expense 2,470 1,624 4,500 2,821
--------- --------- --------- ---------
NET INCOME $ 4,585 $ 3,014 $ 8,356 $ 5,238
========= ========= ========= =========
NET INCOME PER SHARE OF COMMON STOCK
Basic $ 0.33 $ 0.23 $ 0.61 $ 0.40
Diluted 0.32 0.19 0.58 0.34
</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 SIX MONTHS ENDED JUNE 30, 2000
(DOLLARS IN THOUSANDS)
UNAUDITED
<TABLE>
<S> <C>
COMMON STOCK
Balance at December 31, 1999 and June 30, 2000 $ 14
============
ADDITIONAL PAID-IN CAPITAL
Balance at December 31, 1999 $ 60,290
Issuance of common shares:
Employee benefit plans 507
------------
Balance at June 30, 2000 $ 60,797
============
RETAINED EARNINGS
Balance at December 31, 1999 $ 2,549
Net income 8,356
------------
Balance at June 30, 2000 $ 10,905
============
ACCUMULATED OTHER COMPREHENSIVE LOSS
Balance at December 31, 1999 $ (18,192)
Other comprehensive loss, net:
Unrealized loss on securities, net of tax of $0 (1,592)
------------
Balance at June 30, 2000 $ (19,784)
============
TOTAL STOCKHOLDERS' EQUITY $ 51,932
============
NUMBER OF SHARES OF COMMON STOCK
Balance at December 31, 1999 13,706,726
Issuance of common shares:
Employee benefit plans 74,655
------------
Balance at June 30, 2000 13,781,381
============
</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 SIX MONTHS ENDED JUNE 30, 2000 AND 1999
(DOLLARS IN THOUSANDS)
UNAUDITED
<TABLE>
<CAPTION>
2000 1999
--------- ---------
<S> <C> <C>
OPERATING ACTIVITIES
Net income $ 8,356 $ 5,238
Adjustments to reconcile net income to cash provided by (used in)
operating activities:
Depreciation and amortization 1,285 1,280
Net realized losses (gains) 64 (125)
Deferred federal income taxes 4,760 1,608
Changes in assets and liabilities:
Reinsurance and premiums receivable 6,670 (279,738)
Value of business acquired (587) (1,117)
Goodwill 518 (5,854)
Federal income taxes payable/recoverable (286) 3,386
Accrued investment income (501) (517)
Other assets (7,633) (1,502)
Future policy benefits, claims and funds payable 15,440 216,024
Unearned premium 2,013 17,814
Reinsurance payable 2,234 47,460
Other liabilities 3,350 15,079
Deferred policy acquisition costs (14,349) (8,171)
Deferred reinsurance gain (3,196) (2,668)
--------- ---------
Net cash provided by operating activities 18,138 8,197
--------- ---------
INVESTING ACTIVITIES
Net purchases of furniture and equipment (645) (44)
Purchase of fixed maturities available-for-sale (31,098) (3,472)
Acquisition of Continental General Corporation, net of $24,712 cash acquired -- (59,788)
Decrease in mortgage and policy loans, net 159 --
Proceeds from sales of fixed maturities available-for-sale 991 13,609
Proceeds from calls and maturities of fixed maturities available-for sale 7,021 4,618
Proceeds from sales, calls and fixed maturities of held-to-maturity -- 3,923
Proceeds from sale of property held for sale 2,115 --
Other -- 105
--------- ---------
Net cash used in investing activities (21,457) (41,049)
--------- ---------
FINANCING ACTIVITIES
Increase in annuity account balances 8,256 7,889
Decrease in annuity account balances (13,323) (7,246)
Increase in note receivable -- (299)
Principal payments on mortgage note payable (68) (62)
Increase in long-term debt borrowings 2,000 40,000
Principal payments on long-term debt (4,000) --
Proceeds from issuance of common shares 507 15,117
--------- ---------
Net cash (used in) provided by financing activities (6,628) 55,399
--------- ---------
NET (DECREASE) INCREASE IN CASH (9,947) 22,547
Cash and cash equivalents at beginning of year 42,921 19,376
--------- ---------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 32,974 $ 41,923
========= =========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid during the period for interest $ 3,260 $ 1,332
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 June 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 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 June 30, 2000 and December 31,
1999, the Company had approximately $7.8 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 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
7
<PAGE> 8
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
Statement will not have a significant effect on its results of operations or
financial position.
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
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
2000 1999
------- -------
(dollars in thousands)
<S> <C> <C>
Mortgage note payable $ 8,089 $ 8,157
======= =======
Bank credit facility $36,000 $40,000
Revolver 2,000 --
------- -------
$38,000 $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 and May 17, 2000, Ceres made principal payments of $3.0
million and $1.0 million, respectively on the bank credit facility. Quarterly
principal payments are due thereafter through February 2005. Interest on the
outstanding balance will be determined based on Ceres' selection each quarter of
either 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%. At June 30, 2000, the
interest rate for the bank credit facility was 10.2%.
8
<PAGE> 9
The $10.0 million revolver portion of the Credit Agreement bears interest
at the same rate choices available for the bank credit facility. At June 30,
2000, the interest rate was 10.2%. 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 June 30, 2000, the amount available for
additional borrowings under the revolver was $8.0 million. See Note I.
"Subsequent Events" for further information.
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 six 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 SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------------ ------------------------
2000 1999 2000 1999
--------- --------- --------- ---------
(dollars in thousands)
<S> <C> <C> <C> <C>
Premiums
Direct $ 175,728 $ 125,244 $ 345,685 $ 237,991
Assumed 8,870 28,130 11,646 58,693
Ceded (65,658) (72,680) (133,667) (148,557)
--------- --------- --------- ---------
Net premiums $ 118,940 $ 80,694 $ 223,664 $ 148,127
========= ========= ========= =========
Benefits, claims, losses, and
settlement expenses $ 142,027 $ 134,843 $ 276,868 $ 219,879
Reinsurance recoveries (52,004) (74,456) (105,287) (109,282)
--------- --------- --------- ---------
$ 90,023 $ 60,387 $ 171,581 $ 110,597
========= ========= ========= =========
Selling, general, and administrative
expenses
Commissions $ 31,966 $ 23,797 $ 61,651 $ 40,438
Other operating expenses 26,744 23,274 53,247 40,692
Reinsurance expenses 866 11,139 2,226 21,401
Reinsurance allowances (16,131) (25,860) (36,199) (42,902)
--------- --------- --------- ---------
$ 43,445 $ 32,350 $ 80,925 $ 59,629
========= ========= ========= =========
</TABLE>
9
<PAGE> 10
E. COMPREHENSIVE INCOME (LOSS)
Comprehensive income (loss) is as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------------------- --------------------
2000 1999 2000 1999
------- ------- ------- -------
(dollars in thousands)
<S> <C> <C> <C> <C>
Net income $ 4,585 $ 3,014 $ 8,356 $ 5,238
Other comprehensive loss, net
Unrealized loss on securities,
net of tax of $0 (457) (7,199) (1,592) (11,648)
Reclassification adjustment for
gains included in net income -- 40 -- 82
------- ------- ------- -------
Comprehensive income (loss) $ 4,128 $(4,145) $ 6,764 $(6,328)
======= ======= ======= =======
</TABLE>
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 SIX MONTHS ENDED
JUNE 30, JUNE 30,
2000 1999 2000 1999
----------- ----------- ----------- -----------
(dollars in thousands, except per share amounts)
<S> <C> <C> <C> <C>
BASIC
Average common stock
outstanding 13,758,027 13,506,997 13,732,688 13,168,178
=========== =========== =========== ===========
Net income $ 4,585 $ 3,014 $ 8,356 $ 5,238
=========== =========== =========== ===========
Net income per share of
common stock $ 0.33 $ 0.23 $ 0.61 $ 0.40
=========== =========== =========== ===========
DILUTED
Average common stock
outstanding 13,758,027 13,506,997 13,732,688 13,168,178
Warrants/stock options -
treasury stock method 503,216 2,278,778 676,988 2,266,154
----------- ----------- ----------- -----------
Weighted average shares
of common stock 14,261,243 15,785,775 14,409,676 15,434,332
=========== =========== =========== ===========
Net income $ 4,585 $ 3,014 $ 8,356 $ 5,238
=========== =========== =========== ===========
Net income per share of
common stock $ 0.32 $ 0.19 $ 0.58 $ 0.34
=========== =========== =========== ===========
</TABLE>
10
<PAGE> 11
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.
H. 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, 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.
11
<PAGE> 12
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 SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------------ ------------------------
2000 1999 2000 1999
--------- --------- --------- ---------
(dollars in thousands)
<S> <C> <C> <C> <C>
MEDICAL
Revenues
Premiums, net $ 92,652 $ 62,199 $ 173,489 $ 114,959
Net investment income and net realized gains 2,022 2,009 3,890 3,826
Fee and other income 9,077 6,364 16,523 12,263
--------- --------- --------- ---------
103,751 70,572 193,902 131,048
--------- --------- --------- ---------
Expenses
Benefits, claims, losses and settlement expenses 69,350 45,248 132,017 84,386
Other operating expenses 29,395 22,195 52,564 41,787
--------- --------- --------- ---------
98,745 67,443 184,581 126,173
--------- --------- --------- ---------
Segment profit before federal income taxes $ 5,006 $ 3,129 $ 9,321 $ 4,875
========= ========= ========= =========
SENIOR AND OTHER
Revenues
Premiums, net $ 26,288 $ 18,495 $ 50,175 $ 33,168
Net investment income and net realized gains 3,854 4,596 7,870 7,513
Fee and other income 800 (137) 1,170 --
--------- --------- --------- ---------
30,942 22,954 59,215 40,681
--------- --------- --------- ---------
Expenses
Benefits, claims, losses and settlement expenses 20,673 15,139 39,564 26,211
Other operating expenses 7,945 4,794 13,935 8,790
--------- --------- --------- ---------
28,618 19,933 53,499 35,001
--------- --------- --------- ---------
Segment profit before federal income taxes $ 2,324 $ 3,021 $ 5,716 $ 5,680
========= ========= ========= =========
CORPORATE
Revenues
Net investment income $ 96 $ 47 $ 162 $ 154
Fee and other income -- (18) -- 106
--------- --------- --------- ---------
96 29 162 260
--------- --------- --------- ---------
Expenses
Interest expense and financing costs 1,171 914 2,337 1,491
Other operating expenses (800) 627 6 1,265
--------- --------- --------- ---------
371 1,541 2,343 2,756
--------- --------- --------- ---------
Segment profit (loss) before federal income taxes $ (275) $ (1,512) $ (2,181) $ (2,496)
========= ========= ========= =========
INCOME BEFORE FEDERAL INCOME TAXES $ 7,055 $ 4,638 $ 12,856 $ 8,059
========= ========= ========= =========
</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.
12
<PAGE> 13
I. SUBSEQUENT EVENTS
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.
Pyramid is a wholly-owned subsidiary. The $67.5 million purchase price was
financed as follows:
- $20.0 million from the sale of 3,333,334 newly-issued shares of Ceres
common stock, par value $0.001 per share, 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
Ceres convertible voting preferred stock, par value $0.001 per share,
which shares are convertible into common stock of Ceres;
- $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.
CREDIT AGREEMENT AMENDMENT
In conjunction with the acquisition of Pyramid, 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 as follows:
- the 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;
- minimum consolidated net worth 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.
13
<PAGE> 14
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
50,000 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.
The financial information for the six months ended June 30, 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
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 I. "Subsequent Events" 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 its Credit Agreement
to increase the revolver from $10.0 million to $15.0 million. For additional
information regarding the Credit Agreement Amendment, see Note I. "Subsequent
Events" to the Notes to the Condensed Consolidated Financial Statements.
14
<PAGE> 15
RESULTS OF OPERATIONS
QUARTER ENDED JUNE 30, 2000 COMPARED TO QUARTER ENDED JUNE 30, 1999
1. NET PREMIUMS
<TABLE>
<CAPTION>
INCREASE FROM
THREE MONTHS % OF THREE MONTHS % OF PREVIOUS YEAR
ENDED CONSOLIDATED ENDED CONSOLIDATED -----------------------
JUNE 30, 2000 REVENUES JUNE 30, 1999 REVENUES DOLLARS %
------------- -------- ------------- -------- ------- --------
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Premiums, net
Medical $ 92,652 68.7% $ 62,199 66.5% $ 30,453 49.0%
Senior and other 26,288 19.5% 18,495 19.8% 7,793 42.1%
-------- ------ -------- ------ --------
Total $118,940 88.2% $ 80,694 86.3% $ 38,246 47.4%
======== ====== ======== ====== ========
</TABLE>
For the quarter ended June 30, 2000, total net premiums were $118.9
million, an increase of 47.4%, from $80.7 million for the same quarter in 1999.
Medical premiums for the quarter ended June 30, 2000 were $92.7 million
compared to $62.2 million for the quarter ended June 30, 1999, an increase of
49.0%. The increase in medical premiums was the result of increased new sales,
premium rate increases, and additional reinsurance assumed.
Senior and other premiums, which primarily include Medicare supplement,
long-term care, dental, life insurance and annuities, were $26.3 million for the
quarter ended June 30, 2000 compared to $18.5 million for the quarter ended June
30, 1999, an increase of 42.1%. The increase in senior and other premiums was
primarily the result of increased new sales and premium rate increases.
2. OTHER REVENUES
<TABLE>
<CAPTION>
INCREASE/
(DECREASE) FROM
THREE MONTHS % OF THREE MONTHS % OF PREVIOUS YEAR
ENDED CONSOLIDATED ENDED CONSOLIDATED -----------------------
JUNE 30, 2000 REVENUES JUNE 30, 1999 REVENUES DOLLARS %
------------- -------- ------------- -------- ------- --------
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Net investment income $ 5,963 4.4% $ 6,590 7.0% $ (627) (9.5)%
Fee and other income 8,078 6.0% 4,809 5.1% 3,269 68.0%
Amortization of deferred
reinsurance gain 1,799 1.3% 1,400 1.5% 399 28.5%
</TABLE>
Net investment income decreased to $6.0 million for the second quarter of
2000 from $6.6 million for the second quarter of 1999, due primarily to interest
received in 1999 on a note related to the reinsurance transaction with United
Benefit, which was extinguished upon the acquisition of United Benefit through
foreclosure in July, 1999.
Fee and other income increased to $8.1 million for the quarter ended June
30, 2000 compared to $4.8 million for the same quarter of 1999, an increase of
68.0%. This increase was
15
<PAGE> 16
attributable to fees received on increased sales volume, as well as additional
fees charged for new services.
The amortization of deferred reinsurance gain of $1.8 million for the
quarter ended June 30, 2000 represents the recognition of the ceding commission
allowances received under the Company's reinsurance agreements. The unamortized
amount of $17.7 million at June 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>
INCREASE FROM
THREE MONTHS THREE MONTHS PREVIOUS YEAR
ENDED LOSS ENDED LOSS ------------------------
JUNE 30, 2000 RATIO JUNE 30, 1999 RATIO DOLLARS %
------------- ----- ------------- ----- ------- ---------
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Benefits, claims, losses and
settlement expenses
Medical $69,350 74.8% $45,248 72.7% $24,102 53.3%
Senior and other 20,673 78.6% 15,139 81.9% 5,534 36.6%
------- ------- ------
Total $90,023 75.7% $60,387 74.8% $29,636 49.1%
======= ======= ======
</TABLE>
Total benefits, claims and settlement expenses increased to $90.0 million
for the quarter ended June 30, 2000 compared to $60.4 million for the same
quarter in 1999, an increase of 49.1%. The increase was a direct result of the
increased volume of business in force.
Medical benefits, claims, losses and settlement expenses were $69.4 million
for the quarter ended June 30, 2000 compared to $45.2 million for the same
quarter in 1999, an increase of 53.3%. The medical loss ratio was 74.8% for the
quarter ended June 30, 2000 compared to 72.7% for the same quarter of 1999. The
increases are a result of higher benefit utilization in the second quarter of
2000 versus the same quarter of 1999, on a larger volume of business in force.
Senior and other benefits, claims, losses and settlement expenses were
$20.7 million for the quarter ended June 30, 2000 compared to $15.1 million for
the same quarter of 1999, an increase of 36.6%. The increase is a direct result
of claims and benefits paid on a larger volume of business in force. The senior
and other loss ratio decreased to 78.6% in the second quarter of 2000 compared
to 81.9% in the second quarter of 1999.
16
<PAGE> 17
4. OTHER EXPENSES AND NET INCOME
<TABLE>
<CAPTION>
INCREASE/
(DECREASE) FROM
THREE MONTHS % OF THREE MONTHS % OF PREVIOUS YEAR
ENDED CONSOLIDATED ENDED CONSOLIDATED -----------------------
JUNE 30, 2000 REVENUES JUNE 30, 1999 REVENUES DOLLARS %
---------------- -------------- -------------- ------------ ------------ ----------
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Selling, general and
administrative expenses $ 43,445 32.2% $ 32,350 34.6% $ 11,095 34.3%
Net amortization and change
in deferral of acquisition
costs and value of business
acquired (7,163) (5.3)% (5,048) (5.4)% (2,115) (41.9)%
Amortization of goodwill 258 0.2% 314 0.3% (56) (17.8)%
Interest expenses and
financing costs 1,171 0.9% 914 1.0% 257 28.1%
Federal income tax expense 2,470 1.8% 1,624 1.7% 846 52.1%
Net income 4,585 3.4% 3,014 3.2% 1,571 52.1%
</TABLE>
Selling, general and administrative expenses increased to $43.4 million in
the second quarter of 2000 compared to $32.4 million in the second quarter of
1999, an increase of $11.1 million or 34.3%. The increase in selling, general
and administrative expenses represents a $8.2 million increase in commissions
and a $3.4 million increase in other operating expenses attributable to our
increased business base including the establishment of a bad debt allowance of
$0.6 million in the second quarter of 2000 on a note receivable related to
United Benefit. The increase in selling, general and administrative expenses was
partially offset by a $0.5 million net increase in reinsurance allowances and
charges. As a percentage of revenues, selling, general and administrative
expenses decreased to 32.2% in the second quarter of 2000 compared to 34.6% in
the second quarter of 1999.
The net amortization and change in deferral of acquisition costs and value
of business acquired resulted in a net deferral of $7.2 million for the second
quarter of 2000 compared to a net deferral of $5.0 million for the second
quarter of 1999. The increase in the deferral is a result of capitalized
acquisition expenses on increased new business.
Amortization of goodwill of $0.2 million primarily relates to the February
1999 acquisition of Continental. The goodwill asset of $22.3 million as of June
30, 2000 is being amortized over periods of 25 years or less.
Interest expense and financing costs increased to $1.2 million in the
second quarter of 2000 compared to $0.9 million in the second quarter of 1999 as
a result of the increased interest rates under the Credit Agreement.
A provision for federal income taxes of $2.5 million, or 35.0%, of income
before federal taxes of $7.1 million, was established for the second quarter of
2000.
17
<PAGE> 18
As a result of the foregoing, net income for the second quarter of 2000 was
$4.6 million, or $0.33 basic and $0.32 diluted earnings per share of common
stock, compared to net income of $3.0 million, or $0.23 basic and $0.19 diluted
earnings per share of common stock, for the second quarter of 1999.
SIX MONTHS ENDED JUNE 30, 2000 COMPARED TO JUNE 30, 1999
1. NET PREMIUMS
<TABLE>
<CAPTION>
INCREASE FROM
SIX MONTHS % OF SIX MONTHS % OF PREVIOUS YEAR
ENDED CONSOLIDATED ENDED CONSOLIDATED ------------------------
JUNE 30, 2000 REVENUES JUNE 30, 1999 REVENUES DOLLARS %
------------- ------------ ------------ ------------ ---------- --------
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Premiums, net
Medical $173,489 68.5% $114,959 66.8% $ 58,530 50.9%
Senior and other 50,175 19.8% 33,168 19.3% 17,007 51.3%
-------- ---- -------- ---- --------
Total $223,664 88.3% $148,127 86.1% $ 75,537 51.0%
======== ==== ======== ==== ========
</TABLE>
For the six months ended June 30, 2000 total net premiums were $223.7
million, an increase of 51.0%, from $148.1 million for the same period in 1999.
Medical premiums for the six months ended June 30, 2000 were $173.5 million
compared to $115.0 million for the six months ended June 30, 1999, an increase
of 50.9%. The increase in medical premiums was the result of increased new
sales, premium rate increases, the inclusion of Continental's results for six
months in 2000 compared to five months in 1999, and additional reinsurance
assumed.
Senior and other premiums, which primarily includes Medicare supplement,
long-term care, dental, life insurance and annuities, were $50.2 million for the
six months ended June 30, 2000 compared to $33.2 million for the six months
ended June 30, 1999, an increase of 51.3%. The increase in senior and other
premiums was primarily the result of the inclusion of Continental's senior
premium for six months in 2000 versus five months in 1999, in addition to
increased new sales and premium rate increases.
2. OTHER REVENUES
<TABLE>
<CAPTION>
INCREASE FROM
SIX MONTHS % OF SIX MONTHS % OF PREVIOUS YEAR
ENDED CONSOLIDATED ENDED CONSOLIDATED ------------------------
JUNE 30, 2000 REVENUES JUNE 30, 1999 REVENUES DOLLARS %
------------- ------------ ------------ ------------ ---------- --------
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Net investment income $11,986 4.7% $11,368 6.6% $ 618 5.4%
Fee and other income 14,496 5.7% 9,701 5.6% 4,795 49.4%
Amortization of deferred
reinsurance gain 3,197 1.3% 2,668 1.6% 529 19.8%
</TABLE>
18
<PAGE> 19
Net investment income increased to $12.0 million for the first six months
of 2000 from $11.4 million for the first six months of 1999, an increase of
5.4%. The increase in net investment income is primarily a result of including
six months of Continental's activity in 2000 compared to five months in 1999,
which increased $0.9 million.
Fee and other income increased to $14.5 million for the six months ended
June 30, 2000 compared to $9.7 million for the same period of 1999, an increase
of 49.4%. This increase was attributable to fees received on increased sales
volume, as well as additional fees charged for new services.
The amortization of deferred reinsurance gain of $3.2 million for the six
months ended June 30, 2000 represents the recognition of the ceding commission
allowances received under the Company's reinsurance agreements. The unamortized
amount of $17.7 million at June 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>
INCREASE FROM
SIX MONTHS SIX MONTHS PREVIOUS YEAR
ENDED ENDED ------------------------
JUNE 30, 2000 LOSS RATIO JUNE 30, 1999 LOSS RATIO DOLLARS %
------------- ------------ ------------ ------------ ---------- --------
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Benefits, claims, losses and
settlement expenses
Medical $132,017 76.1% $ 84,386 73.4% $ 47,631 56.4%
Senior and other 39,564 78.9% 26,211 79.0% 13,353 50.9%
-------- -------- --------
Total $171,581 76.7% $110,597 74.7% $ 60,984 55.1%
======== ======== ========
</TABLE>
Total benefits, claims and settlement expenses increased to $171.6 million
for the six months ended June 30, 2000 compared to $110.6 million for the same
period in 1999, an increase of 55.1%. The increase was a direct result of the
increased volume of business in force, including six months of Continental's
activity in 2000 versus five months in 1999.
Medical benefits, claims, losses and settlement expenses were $132.0
million for the six months ended June 30, 2000 compared to $84.4 million for the
same period in 1999, an increase of 56.4%. The medical loss ratio was 76.1% for
the six months ended June 30, 2000 compared to 73.4% for the same period of
1999. The increases are a result of higher benefit utilization in the first six
months of 2000 versus the same period of 1999, on a larger volume of business in
force.
Senior and other benefits, claims, losses and settlement expenses were
$39.6 million for the six months ended June 30, 2000 compared to $26.2 million
for the same period of 1999, an increase of 50.9%. The increase is a direct
result of the inclusion of six months of senior benefits of Continental in 2000
versus five months in 1999, in addition to claims and benefits paid on a larger
volume of business in force. The senior and other loss ratio was 78.9% in the
first six months of 2000 compared to 79.0% in the first six months of 1999.
19
<PAGE> 20
4. OTHER EXPENSES AND NET INCOME
<TABLE>
<CAPTION>
INCREASE/(DECREASE)
SIX MONTHS % OF SIX MONTHS % OF FROM PREVIOUS YEAR
ENDED CONSOLIDATED ENDED CONSOLIDATED -------------------------
JUNE 30, 2000 REVENUES JUNE 30, 1999 REVENUES DOLLARS %
------------- ------------ ------------ ------------ ---------- --------
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Selling, general and
administrative expenses $ 80,925 32.0% $ 59,629 34.7% $ 21,296 35.7%
Net amortization and change
in deferral of acquisition
costs and value of business
acquired (14,937) (5.9)% (8,287) (4.8)% (6,650) (80.2)%
Amortization of goodwill 517 0.2% 500 0.3% 17 3.4%
Interest expenses and
financing costs 2,337 0.9% 1,491 0.9% 846 56.7%
Federal income tax expense 4,500 1.8% 2,821 1.6% 1,679 59.5%
Net income 8,356 3.3% 5,238 3.0% 3,118 59.5%
</TABLE>
Selling, general and administrative expenses increased to $80.9 million for
the first six months of 2000 compared to $59.6 million for the first six months
of 1999, an increase of $21.3 million or 35.7%. The increase in selling, general
and administrative expenses represents a $21.2 million increase in commissions,
a $12.6 million increase in other operating expenses attributable to our
increased business base, which includes Continental for six months in 2000
versus five months in 1999, and the establishment of a bad debt allowance of
$0.6 million in the second quarter of 2000 on a note receivable related to
United Benefit. The increase in selling, general and administrative expenses was
partially offset by a $12.5 million net increase in reinsurance allowances and
charges. As a percentage of revenues, selling, general and administrative
expenses decreased to 32.0% in the first six months of 2000 compared to 34.7% in
the first six months of 1999.
The net amortization and change in deferral of acquisition costs and value
of business acquired resulted in a net deferral of $14.9 million for the first
six months of 2000 compared to a net deferral of $8.3 million for the first six
months of 1999. The increase in the deferral is a result of capitalized
acquisition expenses on increased new business, including Continental's new
business for six months in 2000 versus five 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 were higher than anticipated claims loss ratios.
Amortization of goodwill of $0.5 million primarily relates to the February
1999 acquisition of Continental. The goodwill asset of $22.3 million as of June
30, 2000 is being amortized over periods of 25 years or less.
Interest expense and financing costs increased to $2.3 million in the first
six months of 2000 compared to $1.5 million in the first six months of 1999 as a
result of interest expense incurred under the Credit Agreement for six months
in 2000 compared to interest expense which did not begin to accrue until
February 17, 1999, the closing date of the purchase of Continental. Interest
rates charged under the Credit Agreement for the first six months of 2000 were
also higher than those charged for the same period in 1999.
20
<PAGE> 21
A provision for federal income taxes of $4.5 million, or 35%, of income
before federal taxes of $12.9 million was established for the first six months
of 2000.
As a result of the foregoing, net income for the first six months of 2000
was $8.4 million, or $0.61 basic and $0.58 diluted earnings per share of common
stock, compared to a net income of $5.2 million, or $0.40 basic and $0.34
diluted earnings per share of common stock, for the first six 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 $330.9 million, or 44.7% of the total assets, were in investments
at June 30, 2000. Fixed maturities are our primary investment and were $322.4
million, or 97.4% of total investments, at June 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 June 30,
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 $33.0 million in cash and
cash equivalents, and a $10.0 million line of credit with a major bank at June
30, 2000. There was $8.0 million available under the line of credit at June 30,
2000.
The total reinsurance receivable was $254.8 million at June 30, 2000. Of
this amount, $233.4 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 3.1% to $740.4 million at June 30, 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 $7.5 million in agency
receivables.
The total policy liabilities and accruals (reserves) were 79.9% of the
total liabilities at June 30, 2000, compared to 80.0% at December 31, 1999.
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, made principal payments of $3.0
million and $1.0 million on February 17, 2000 and May 17, 2000, respectively.
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 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
21
<PAGE> 22
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 June 30, 2000, the
interest rate was 10.2%. 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 June 30, 2000, the interest rate was 10.2% on the outstanding
balance of $2.0 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 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 June 30, 2000, we were in compliance with the covenants contained
in the Credit Agreement.
The covenants were modified due to the Credit Agreement Amendment on July
25, 2000. For additional information regarding the Credit Agreement Amendment,
see Note I. "Subsequent Events" to the Notes to the Condensed Consolidated
Financial Statements.
We believe that cash flow from operating activities will be sufficient to
meet our currently anticipated operating and capital expenditure requirements.
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.
22
<PAGE> 23
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 consists of
primarily interest income and operating and interest expense.
The medical segment had revenues of $193.9 million in the first six
months of 2000 compared to $131.0 million in 1999. The major reason for the
increase was increased new sales, premium rates, additional reinsurance
assumed, increased fees, and the inclusion of Continental's results for six
months in 2000 compared to five months for the same period in 1999.
Total benefits, claims, losses and settlement expenses for the medical
segment were $132.0 million in the first six months of 2000 compared to $84.4
million in the first six months of 1999. The increase was primarily a result of
increased benefit utilization on a larger amount of in force business.
The senior and other segment had revenues of $59.2 million for the
first six months in 2000 compared to $40.7 million in the first six months of
1999. The increase was primarily attributable to the Continental business
acquired in February, 1999 and a larger volume of business in force.
Benefits, claims, losses, and settlement expenses for the senior and
other segment were $39.6 million in the first six months of 2000 compared to
$26.2 million for 1999. The increase is a direct result of the inclusion of six
months of senior benefits at Continental in 2000 versus five months in 1999 in
addition to claims and benefits paid on a larger volume of business in force.
Total corporate and other revenues were $162,000 for the first six months
of 2000 compared to $260,000 for 1999. The decrease was primarily due to the
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.
23
<PAGE> 24
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
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.
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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;
- 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.
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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 2, 4 and 6 are either inapplicable to
Ceres, would not require a response, or have been previously reported.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
-------------------------------------------------
On May 1, 2000, pursuant to the stock award provision of Peter W.
Nauert's, our Chairman of the Board, President and Chief Executive Officer,
employment agreement, as amended, we issued 26,722 shares of common stock to Mr.
Nauert in connection with his January 1, 2000 stock award and 32,421 shares of
common stock to Mr. Nauert in connection with his April 1, 2000 stock award.
These issuances 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.
On May 1, 2000, we issued 6,571 shares of common stock to Billy B. Hill,
Jr., our General Counsel, pursuant to his retainer agreement. These issuances
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.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
-----------------------------------------------------------
a) The Annual Meeting of Stockholders was held on June 27, 2000.
b) Proxies were solicited for election of directors by Ceres' management
pursuant to Regulation 14A under the Securities Exchange Act of 1934. No
solicitation in opposition to management's nominees as listed in the proxy
statement was made. All of management's nominees were elected to hold
office until the next annual election of directors and until their
successors are elected and qualified pursuant to the vote of the
stockholders.
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c) The matters voted upon were the following:
1. With respect to the election of nine directors to serve until the
next annual election of directors and until their successors are
elected and qualified:
Name For
---- ---
Andrew A. Boemi 13,124,524
Michael A. Cavataio 13,123,895
Bradley E. Cooper 13,102,824
Susan S. Fleming 13,123,327
Rodney L. Hale 13,125,024
Peter W. Nauert 12,974,030
William J. Ruh 13,123,824
Robert A. Spass 13,101,624
Mark H. Tabak 13,123,824
2. With respect to a proposal to approve an amendment to Ceres'
Certificate of Incorporation to increase the number of authorized
shares of common stock:
For 12,960,024
Against 189,324
Withheld 24,106
3. With respect to a proposal to approve an amendment to Ceres' 1998
Key Employee Share Incentive Plan to increase the total number of
shares of common stock available for issuance under the plan:
For 11,575,149
Against 321,727
Withheld 36,656
4. With respect to a proposal to approve Ceres' 2000 Employee Stock
Purchase Plan:
For 11,723,254
Against 174,017
Withheld 36,261
5. With respect to a proposal to approve and ratify Ernst & Young, LLP
as Ceres' independent accountants for the fiscal year ending
December 31, 2000:
For 13,150,826
Against 11,036
Withheld 11,593
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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 quarter
ended June 30, 2000.
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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: August 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
--------
(27) Financial Data Schedule
30
