- --------------------------------------------------------------------------------
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1999
Commission File Number 1-11422
PENNCORP FINANCIAL GROUP, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
Delaware 13-3543540
(STATE OR OTHER JURISDICTION
OF INCORPORATION OR ORGANIZATION) (I.R.S. EMPLOYER IDENTIFICATION NO.)
c/o Southwestern Financial
Services Corporation 75201
717 NORTH HARWOOD STREET (ZIP CODE)
Dallas, Texas
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
Registrant's telephone number, including area code: (214) 954-7111
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
Name of Each Exchange
Title of Each Class on Which Registered
------------------------------------- ---------------------------------------
Common Stock, $.01 par value New York Stock Exchange
------------------------------------- ---------------------------------------
$3.375 Convertible Preferred
Stock, $.01 par value New York Stock Exchange
------------------------------------- ---------------------------------------
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
None
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 period 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 [ ]
The number of Common Stock shares outstanding as of November 8, 1999, was
29,214,731.
- --------------------------------------------------------------------------------
1
<PAGE>
PENNCORP FINANCIAL GROUP, INC. AND SUBSIDIARIES
TABLE OF CONTENTS
PAGE
PART I -- FINANCIAL INFORMATION
Item 1. Financial Statements.................................................3
Consolidated Balance Sheets.........................................3
Consolidated Statements of Operations and Comprehensive Loss........4
Consolidated Statements of Cash Flows...............................5
Notes to Unaudited Consolidated Financial Statements................6
Review by Independent Certified Public Accountants.................16
Independent Auditors' Review Report................................17
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations.........................................18
Item 3. Quantitative and Qualitative Disclosures About Market Risk..........34
PART II -- OTHER INFORMATION
Item 1. Legal Proceedings...................................................35
Item 5. Other Information...................................................36
Item 6. Exhibits and Reports on Form 8-K....................................36
SIGNATURE
INDEX TO EXHIBITS
2
<PAGE>
PART I -- FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PENNCORP FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1999 1998
------------- -------------
(UNAUDITED)
<S> <C> <C>
ASSETS:
Investments:
Fixed maturities available for sale, at fair value............................. $ 2,433,210 $ 2,589,714
Equity securities available for sale, at fair value............................ 2,031 2,035
Mortgage loans on real estate, net............................................. 32,973 36,882
Policy loans................................................................... 199,316 207,490
Cash and short-term investments................................................ 115,507 92,727
OTHER INVESTMENTS.............................................................. 20,939 27,406
------------ ------------
Total investments ........................................................... 2,803,976 2,956,254
Accrued investment income......................................................... 38,696 37,291
Accounts and notes receivable..................................................... 13,232 14,319
Present value of insurance in force............................................... 186,255 170,729
Deferred policy acquisition costs................................................. 156,564 139,708
Costs in excess of net assets acquired............................................ 100,277 108,070
Income taxes, primarily deferred.................................................. 70,654 44,597
Other assets...................................................................... 74,514 91,252
ASSETS OF BUSINESSES HELD FOR SALE................................................ -- 2,421,804
------------ ------------
TOTAL ASSETS ................................................................ $ 3,444,168 $ 5,984,024
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY:
Liabilities:
Policy liabilities and accruals................................................... $ 2,771,219 $ 2,819,661
Notes payable..................................................................... 279,646 550,923
Accrued expenses and other liabilities............................................ 106,138 110,945
LIABILITIES OF BUSINESSES HELD FOR SALE........................................... -- 2,066,554
------------ ------------
TOTAL LIABILITIES............................................................ 3,157,003 5,548,083
------------ ------------
Shareholders' equity:
$3.375 Convertible Preferred Stock, $.01 par value, $50 redemption value;
authorized, issued and outstanding 2,300,000 at September 30, 1999 and
December 31, 1998.............................................................. 118,276 112,454
$3.50 Series II Convertible Preferred Stock, $.01 par value, $50 redemption value;
authorized, issued and outstanding 2,875,000 at September 30, 1999 and
December 31, 1998.............................................................. 149,220 141,673
Common stock, $.01 par value; authorized 100,000,000; issued and outstanding
30,143,416 at September 30, 1999 and 30,072,344 at December 31, 1998........... 303 301
Additional paid-in capital........................................................ 428,974 430,321
Accumulated other comprehensive income (loss), net of income taxes (benefits) (40,218) 19,995
Accumulated deficit............................................................... (337,293) (234,921)
Treasury shares (928,685 at September 30, 1999 and 1,105,369 at
December 31, 1998)............................................................. (30,829) (32,391)
NOTES RECEIVABLE AND OTHER ASSETS SECURED BY COMMON STOCK......................... (1,268) (1,491)
------------ ------------
TOTAL SHAREHOLDERS' EQUITY................................................... 287,165 435,941
------------ ------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY .................................. $ 3,444,168 $ 5,984,024
============ ============
</TABLE>
See accompanying Notes to Unaudited Consolidated Financial Statements.
3
<PAGE>
PENNCORP FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
1999 1998 1999 1998
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
REVENUES:
Premiums........................................ $ 38,108 $ 90,103 $ 185,878 $ 265,309
Interest sensitive policy product charges....... 31,841 33,502 100,539 96,103
Net investment income........................... 53,408 89,130 209,043 277,663
Other income.................................... 10,222 8,776 30,653 30,009
Net gains (losses) from the sale of investments. 870 4,171 (198) 13,059
Net gains (losses) from sales of subsidiaries
(including realized losses on foreign currency
of $24,978).................................. (21,643) -- 6,161 --
------------- ------------- ------------- -------------
TOTAL REVENUES.............................. 112,806 225,682 532,076 682,143
------------- ------------- ------------- -------------
BENEFITS AND EXPENSES:
Claims incurred................................. 45,706 81,734 189,623 240,733
Change in liability for future policy benefits
and other policy benefits..................... 28,695 52,639 116,985 185,309
Amortization of present value of insurance in
force and deferred policy acquisition costs... 15,263 27,546 56,358 78,485
Amortization of costs in excess of net assets
acquired and other intangibles................ 1,265 2,197 12,051 9,854
Underwriting and other administrative expenses.. 33,168 61,242 132,307 162,437
Interest and amortization of deferred debt
issuance costs................................ 7,713 10,672 33,057 30,945
Restructuring charge............................ -- 1,388 5,141 7,649
Impairment provision associated with Assets of
businesses held for sale...................... -- 145,000 58,486 285,485
------------- ------------- ------------- -------------
TOTAL BENEFITS AND EXPENSES................. 131,810 382,418 604,008 1,000,897
------------- ------------- ------------- -------------
Loss before income taxes (benefits) and
extraordinary charge............................. (19,004) (156,736) (71,932) (318,754)
Income taxes (benefits)....................... 9,094 3,900 17,037 (1,559)
------------- ------------- ------------- -------------
Loss before extraordinary charge................... (28,098) (160,636) (88,969) (317,195)
Extraordinary charge, net of income taxes..... -- -- -- (1,671)
------------- ------------- ------------- -------------
Net loss .......................................... (28,098) (160,636) (88,969) (318,866)
Preferred stock dividend requirements......... 4,456 4,456 13,369 13,816
------------- ------------- ------------- -------------
Net loss applicable to common stock................ $ (32,554) $ (165,092) $ (102,338) $ (332,682)
============= ============= ============= =============
PER SHARE INFORMATION:
Basic:
Loss before extraordinary charge applicable
to common stock............................... $ (1.11) $ (5.64) $ (3.49) $ (11.47)
Extraordinary charge, net of income taxes... -- -- -- (0.06)
------------- ------------- ------------- -------------
Net loss applicable to common stock............. $ (1.11) $ (5.64) $ (3.49) $ (11.53)
============= ============= ============= =============
Common shares used in computing basic loss per share 29,390 29,246 29,342 29,017
============= ============= ============= =============
Diluted:
Loss before extraordinary charge applicable
to common stock............................... $ (1.11) $ (5.64) $ (3.49) $ (11.47)
Extraordinary charge, net of income taxes... -- -- -- (0.06)
------------- ------------- ------------- -------------
NET LOSS APPLICABLE TO COMMON STOCK............. $ (1.11) $ (5.64) $ (3.49) $ (11.53)
============= ============= ============= =============
Common shares used in computing diluted loss
per share........................................ 29,390 29,246 29,342 29,017
============= ============= ============= =============
COMPREHENSIVE LOSS INFORMATION:
Net loss........................................ $ (28,098) $ (160,636) $ (88,969) $ (318,866)
Change in unrealized foreign currency translation
gains, net of income taxes.................... (1,691) (3,007) 1,713 (5,389)
Decrease in unrealized foreign currency
translation loss resulting from the sale
of subsidiaries............................... 24,978 -- 24,978 --
Change in unrealized holding gains (losses) arising
during the period on securities available for
sale, net of income taxes (benefits) of $(5,311),
$13,958, $(46,795) and $17,391................ (18,704) 32,127 (83,000) 43,906
Reclassification adjustments for gains included
in net loss................................... (1,145) (6,205) (2,056) (11,608)
Decrease in unrealized holding (gains) losses
resulting from the sale of subsidiaries, net of
income tax benefit of $1,198 and $1,865....... 2,224 -- (1,849) --
------------- ------------- ------------- -------------
Total comprehensive loss applicable
to common stock........................... $ (22,436) $ (137,721) $ (149,183) $ (291,957)
============= ============= ============= =============
</TABLE>
See accompanying Notes to Unaudited Consolidated Financial Statements.
4
<PAGE>
PENNCORP FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
1999 1998
------------- -------------
<S> <C> <C>
Cash flows from operating activities:
Loss before extraordinary charge............................................... $ (88,969) $ (317,195)
Adjustments to reconcile loss before extraordinary charge to net cash
provided (used) by operating activities:
Impairment provision associated with Assets of Businesses Held for Sale 58,486 285,485
Net gain from sales of subsidiaries........................................ (6,161) --
Capitalization of deferred policy acquisition costs........................ (62,275) (100,629)
Amortization of present value of insurance in force, deferred policy
acquisition costs, intangibles, depreciation and accretion, net.......... 63,253 82,740
Increase in policy liabilities, accruals and other policyholder funds...... 17,333 45,831
OTHER, NET................................................................. 41,043 6,144
------------- -------------
NET CASH PROVIDED BY OPERATING ACTIVITIES.............................. 22,710 2,376
------------- -------------
Cash flows from investing activities:
Cash received from sales of subsidiaries, net of cash and short-term
investments of $138,902 of subsidiaries sold................................. 138,718 --
Cash and short-term investments acquired in acquisition of businesses,
net of cash expended of $82,771 in 1998...................................... -- 91,492
Purchases of fixed maturity securities available for sale...................... (753,814) (699,347)
Purchases of equity securities available for sale.............................. -- (5,234)
Maturities of fixed maturity securities available for sale..................... 311,723 389,808
Sales of fixed maturity securities available for sale.......................... 561,808 502,502
Sales of equity securities..................................................... 20 25,351
Acquisitions and originations of mortgage loans................................ (1,082) (29,934)
Sales of mortgage loans........................................................ 8,229 4,927
Principal collected on mortgage loans.......................................... 33,132 45,496
OTHER, NET..................................................................... 12,069 10,011
------------- -------------
NET CASH PROVIDED BY INVESTING ACTIVITIES.................................. 310,803 335,072
------------- -------------
Cash flows from financing activities:
Additional borrowings.......................................................... -- 203,000
Reduction in notes payable..................................................... (271,277) (126,681)
Dividends on preferred and common stock........................................ -- (16,205)
Receipts from interest sensitive policies credited to policyholder
account balances............................................................. 137,454 284,291
RETURN OF POLICYHOLDER ACCOUNT BALANCES ON INTEREST SENSITIVE PRODUCTS......... (308,441) (557,467)
------------- -------------
NET CASH USED BY FINANCING ACTIVITIES...................................... (442,264) (213,062)
------------- -------------
Net increase (decrease) in cash............................................ (108,751) 124,386
Cash and short-term investments at beginning of period (including $131,531 of cash
and short-term investments classified as businesses held for sale in 1999)..... 224,258 109,013
------------- -------------
Cash and short-term investments at end of period (including $62,888 of cash and
short-term investmnets classified as assets of businesses held for sale in 1998) $ 115,507 $ 233,399
============= =============
Supplemental disclosures:
INCOME TAXES PAID (REFUNDED)................................................. $ (5,286) $ 7,279
============= =============
INTEREST PAID................................................................ $ 29,149 $ 26,118
============= =============
Non-cash financing activities:
REDEMPTION OF SERIES C PREFERRED STOCK....................................... $ -- $ 22,227
============= =============
ISSUANCE OF COMMON STOCK ASSOCIATED WITH THE ACQUISITION OF BUSINESSES $ -- $ 8,500
============= =============
ACCRUED AND UNPAID PREFERRED STOCK DIVIDENDS................................. $ 13,369 $ 4,456
============= =============
</TABLE>
See accompanying Notes to Unaudited Consolidated Financial Statements.
5
<PAGE>
PENNCORP FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
PennCorp Financial Group, Inc. ("PennCorp" or the "Company") is an insurance
holding company. Through its wholly-owned life insurance subsidiaries:
Pennsylvania Life Insurance Company ("PLIC") and its wholly-owned subsidiary,
PennCorp Life Insurance Company (collectively referred to as "Penn Life") (sold
July 30, 1999); Peninsular Life Insurance Company ("Peninsular") (sold July 30,
1999); Professional Insurance Company ("Professional") (sold March 31, 1999);
Pioneer Security Life Insurance Company ("Pioneer Security") and its
wholly-owned subsidiaries, American-Amicable Life Insurance Company of Texas and
Pioneer American Insurance Company (Pioneer Security and its subsidiaries
collectively referred to as "AA Life"); Southwestern Financial Corporation ("SW
Financial") and its wholly-owned subsidiaries, Southwestern Life Insurance
Company ("Southwestern Life"), Constitution Life Insurance Company
("Constitution") (sold July 30, 1999), Union Bankers Insurance Company ("Union
Bankers") (sold July 30, 1999), and Marquette National Life Insurance Company
("Marquette") (sold July 30, 1999); Security Life and Trust Insurance Company
("Security Life"); Occidental Life Insurance Company of North Carolina ("OLIC");
United Life & Annuity Insurance Company ("United Life") (sold April 30, 1999);
and Pacific Life and Accident Insurance Company ("PLAIC"), the Company offers a
broad range of accident and sickness, life, and accumulation insurance products
to individuals through independent general agents and payroll deduction
programs. Additionally, the Company owns KB Management, LLC ("KB Management"),
which provides management and advisory services to the Company; Marketing One,
Inc. ("Marketing One"), a third party marketing organization; KIVEX, Inc.
("KIVEX") (sold June 30, 1999), an internet service provider, UC Mortgage Corp.
("UC") (sold April 30, 1999) and Cyberlink Development, Inc. ("Cyberlink") (sold
April 30, 1999). As part of a subsidiary realignment, Southwestern Life became a
wholly-owned subsidiary of PLAIC as of July 30, 1999.
As a result of the Company's announcement of its decision to sell the Career
Sales Division (the Career Sales Division is comprised of the operations of Penn
Life, Peninsular, Union Bankers, Constitution and Marquette), KIVEX,
Professional, and the United Life Assets (the United Life Assets is comprised of
the operations of United Life, UC, Cyberlink and certain assets of Marketing
One), within a period not likely to exceed one year, the assets and liabilities
of the Career Sales Division, KIVEX, Professional and the United Life Assets
(collectively the "Businesses Held for Sale") were reported as "Assets of
Businesses Held for Sale" and "Liabilities of Businesses Held for Sale" as of
December 31, 1998 (see Note 3 of Notes to Unaudited Consolidated Financial
Statements). As of July 30, 1999, sales of all the Businesses Held for Sale had
been completed.
During the three month period ended June 30, 1999, the Company concluded that it
would retain, and shut down over time, certain remaining operations of Marketing
One.
The accompanying consolidated financial statements include the accounts of the
Company and its subsidiaries. All significant intercompany accounts and
transactions have been eliminated. All dollar amounts presented hereafter,
except share amounts, are stated in thousands.
The financial statements are prepared in accordance with generally accepted
accounting principles ("GAAP"). These principles are established primarily by
the Financial Accounting Standards Board ("FASB") and the American Institute of
Certified Public Accountants ("AICPA"). The preparation of financial statements
in conformity with GAAP requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities as well as revenues
and expenses. Accounts that the Company deems to be acutely sensitive to changes
in estimates include deferred policy acquisition costs, policy liabilities and
accruals, present value of insurance in force, costs in excess of net assets
acquired, the fair value of assets and liabilities classified as held for sale
and deferred taxes. In addition, the Company must determine the requirements for
disclosure of contingent assets and liabilities as of the date of the financial
statements based upon estimates. As additional information becomes available, or
actual amounts are determinable, the recorded estimates may be revised and
reflected in operating results. Although some variability is inherent in these
estimates, management believes the amounts provided are adequate. In all
instances, actual results could differ from estimates.
Certain prior period amounts have been reclassified to conform to current period
presentation.
The financial statements should be read in conjunction with the financial
statements included in the Company's Annual Report on Form 10-K for the year
ended December 31, 1998.
6
<PAGE>
PENNCORP FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. NEW ACCOUNTING PRONOUNCEMENTS NOT YET ADOPTED
In June 1998, the FASB issued Statement of Financial Accounting Standard
("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging
Activities." SFAS No. 133 defines derivative instruments and provides
comprehensive accounting and reporting standards for the recognition and
measurement of derivative and hedging activities (including certain instruments
embedded in other contracts). It requires derivatives to be recorded in the
Consolidated Balance Sheet at fair value and establishes criteria for hedges of
changes in the fair value of assets, liabilities or firm commitments, hedges of
variable cash flows of forecasted transactions, and hedges of foreign currency
exposures of net investments in foreign operations. Changes in the fair value of
derivatives not meeting specific hedge accounting criteria would be recognized
in the Consolidated Statement of Operations. SFAS No. 133 was originally
effective for all fiscal quarters of all fiscal years beginning after June 15,
1999. In June 1999, the FASB deferred the effective date until fiscal years
beginning after June 15, 2000. The Company is currently evaluating SFAS No.133
and has not determined its effect on the consolidated financial statements.
3. DISPOSITIONS AND OTHER EVENTS
On March 31, 1999, the Company consummated the sale of Professional to GE
Financial Assurance Holdings, Inc. The operating results of Professional are
included in the consolidated operating results through March 31, 1999. The
Company realized a gain from the sale of Professional totaling $1,054. Also, as
a result of the sale, unrealized gains on securities available for sale by
Professional decreased $488. The purchase and sale agreement included certain
settlement and consideration adjustment provisions which resulted in a reduction
of the consideration received by the Company of $1,237.
On April 30, 1999, the Company consummated the sale of the United Life Assets to
ING America Insurance Holdings, Inc. ("ING"). The operating results of the
United Life Assets are included in the consolidated operating results through
April 30, 1999. The Company realized a loss from the sale of the United Life
Assets totaling $3,922. Also, as a result of the sale, unrealized gains on
securities available for sale by United Life decreased $3,585. The purchase and
sale agreement includes certain settlement and consideration adjustment
provisions which are likely to occur prior to December 31, 1999.
On June 30, 1999, the Company consummated the sale of KIVEX to Allegiance
Telecom, Inc. ("Allegiance"). The Company recorded a gain of $30,881 on the
sale. The operating results of KIVEX are included in the consolidated operating
results through June 30, 1999.
On July 30, 1999, the Company consummated the sale of the Career Sales Division
to Universal American Financial Corp. ("Universal American"). The operating
results of the Career Sales Division are included in the consolidated operating
results through July 30, 1999. The Company realized a foreign currency
transaction loss on the sale of the Career Sales Division totaling $24,978
partially offset by a gain of $3,126 on the disposition of the Career Sales
Division resulting in a net loss on the disposition of $21,852 during the three
months ended September 30, 1999. Also, as a result of the sale, unrealized loss
on securities available for sale of the Career Sales Division decreased $2,224
and unrealized foreign currency translation losses decreased $24,978. The
purchase and sale agreement includes certain settlement and consideration
adjustment provisions, which are likely to occur prior to January 31, 2000 and
may result in a reduction of the consideration received by the Company.
As previously announced in July 1999, the New York Stock Exchange ("NYSE")
advised the Company that it has fallen below the exchange's continued listing
criteria for net tangible assets available to common stock (less than $12,000)
together with 3-year average net income (less than $600). Additionally, the NYSE
informed the Company that the NYSE's Board of Directors approved new continued
listing standards which require, among other things, (1) a minimum stockholders'
equity and market capitalization of $50,000, (2) a minimum average market
capitalization of $15,000, and (3) a minimum average stock price of not less
than one dollar per share.
On October 8, 1999, the Company was notified by the NYSE that together the
combined minimum average global market capitalization of the Company's common
stock and preferred stock meet the NYSE's $15,000 average market capitalization
criteria. The Company will continue to address the new NYSE continued listing
standards which require a 30-day minimum average stock price of greater than one
dollar, as a part of its plan to develop and effectuate recapitalization and
restructuring alternatives to strengthen and improve the Company's capital
structure. In order to comply with the new NYSE listing
7
<PAGE>
PENNCORP FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. DISPOSITIONS AND OTHER EVENTS (CONTINUED)
standards and maintain its listing on the NYSE, the Company has until February
18, 2000 to raise its common stock price above the required one dollar per share
level.
The Company has engaged Wasserstein, Perella & Co. ("Wasserstein Perella") to
review the Company's capital structure and develop recapitalization and
restructuring alternatives. The Company, with Wasserstein Perella, is currently
exploring with interested parties, a sale of the Company or certain of its
subsidiaries and, on a parallel track, a restructuring or recapitalization
transaction.
The Company's management and advisors are in the process of analyzing proposals
submitted by third parties for the sale of the Company or certain of its
subsidiaries and a recapitalization proposal submitted by certain preferred
stockholders. Once management has completed its analysis, the Company's Board of
Directors will meet to review the proposals and management's recommendations and
expects to make a determination shortly thereafter on a transaction or series of
transactions to be entered into by the Company. There can be no assurance: (i)
that the Company will be successful in developing and implementing one or more
of these transactions; (ii) as to the form the transactions will ultimately
take; or (iii) as to the timing to complete the process. Should the Company
enter into any such transaction, the terms of such transaction will be announced
upon execution of a definitive agreement.
4. NOTES PAYABLE
On March 31, April 30, May 14, June 25 and June 30, 1999, the Company entered
into amendments (the "amendments") to its existing bank credit facility (the
"Bank Credit Facility"). The amendments provide for additional covenants and
revise certain financial covenants to the Bank Credit Facility. In addition, the
amendments changed, among other things, the maturity date of the Bank Credit
Facility to May 2000, extensions of dates for cash sweeps, principal payments
and certain available commitments.
Significant additional covenants included in the March 31 and June 25, 1999
amendments require the Company to repay indebtedness at specified dates and
amounts throughout 1999. The timing and required debt reduction are as follows:
DATE AMOUNT
---- ------
Upon sale of Professional $ 40,000
Upon sale of United Life Assets 127,000
Upon sale of KIVEX 22,000
Upon sale of Career Sales Division 78,000
The required debt reduction of $40,000 was made on April 1, 1999, with proceeds
from the sale of Professional, and the required debt reduction of $127,000 was
made on April 30, 1999, with proceeds from the sale of the United Life Assets.
Additional debt reduction of $22,000 was made on June 30, 1999, upon the
completion of the sale of KIVEX. The Company repaid the final $78,000 of debt
reduction requirements on July 30, 1999, upon the completion of the sale of the
Career Sales Division. On September 23, 1999, the Company repaid an additional
$2,000 of indebtedness as a result of liquidity at the parent company above
amounts prescribed in the Bank Credit Facility, as amended. At September 30,
1999, the Company and its subsidiaries were in compliance with all applicable
covenants.
Management believes the Company will likely have sufficient financial
flexibility and projected liquidity sources to meet all cash requirements for
1999 and the first quarter of 2000. In May 2000, the Company's Bank Credit
Facility matures. The Company is currently reviewing and developing various sale
and recapitalization alternatives in order to repay or refinance such
indebtedness. With respect to current liquidity projections, there can be no
assurances actual liquidity sources will develop. In the event of a shortfall of
actual liquidity sources, and as a result of the necessity of the Company to
refinance the existing Bank Credit Facility, the Company will explore options to
generate any necessary liquidity, such as: (i) the sale of subsidiaries and (ii)
obtaining regulatory approval for extraordinary dividends from its insurance
subsidiaries (which is unlikely at the present time). If the Company is unable
to obtain sufficient liquidity to meet its projected cash requirements, such
failure could result in a default on one or more obligations and the holders
thereof would be entitled to exercise certain
8
<PAGE>
PENNCORP FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
4. NOTES PAYABLE (CONTINUED)
remedies, including the acceleration of the maturity of the entire indebtedness
and commencing legal proceedings to collect the indebtedness. In such event, the
Company will examine and consider the range of available alternatives to the
Company at that time.
5. SELECTED PRO FORMA FINANCIAL INFORMATION
The following selected pro forma financial information has been prepared to
illustrate the pro forma effects of the sales of the Career Sales Division,
KIVEX, Professional and the United Life Assets. The pro forma statement of
operations information for the three and nine month periods ended September 30,
1999 and 1998 gives effect to such sales as if they had occurred on January 1,
1998. The selected pro forma financial information has been prepared for
comparative purposes only and does not purport to be indicative of what would
have occurred had such sales been made as of January 1, 1998, or results which
may occur in the future.
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, 1999 SEPTEMBER 30, 1999
AS REPORTED PRO FORMA AS REPORTED PRO FORMA
----------- --------- ----------- ---------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C>
Total revenues................................ $ 112,806 $ 118,106 $ 532,076 $ 344,499
Net loss...................................... (28,098) (4,113) (88,969) (43,847)
Net loss applicable to common stock........... (32,554) (8,569) (102,338) (57,216)
PER SHARE INFORMATION:
Net loss applicable to common stock-basic... $ (1.11) $ (0.29) $ (3.49) $ (1.95)
Net loss applicable to common stock-diluted. (1.11) (0.29) (3.49) (1.95)
</TABLE>
<TABLE>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, 1998 SEPTEMBER 30, 1998
AS REPORTED PRO FORMA AS REPORTED PRO FORMA
----------- --------- ----------- ---------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C>
Total revenues................................ $ 225,682 $ 129,259 $ 682,143 $ 361,582
Loss before extraordinary charge.............. (160,636) (14,909) (317,195) (28,363)
Loss before extraordinary charge applicable
to common stock............................. (165,092) (19,365) (331,011) (42,179)
PER SHARE INFORMATION:
Loss before extraordinary charge applicable
to common stock-basic.................... $ (5.64) $ (0.66) $ (11.47) $ (1.45)
Loss before extraordinary charge applicable
to common stock-diluted................... (5.64) (0.66) (11.47) (1.45)
</TABLE>
6. RESTRUCTURING CHARGES
As a result of the tremendous growth of the Company and the diversification of
the underlying business units resulting from acquisitions over time, the Company
began a strategic business evaluation in the third quarter of 1996. The review
resulted in the Company establishing three divisional platforms, Career Sales
Division, Payroll Sales Division and Financial Services Division in 1997.
On January 2, 1998, and January 5, 1998, respectively, the Company acquired the
SW Financial Controlling Interest (the controlling interest in SW Financial
owned by Messrs. Steven W. Fickes, a former executive officer and director, and
David J. Stone, a former executive officer and director of the Company) and the
Fickes and Stone Knightsbridge Interests (the
9
<PAGE>
PENNCORP FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
6. RESTRUCTURING CHARGES (CONTINUED)
interests in KB Investment Fund I, LP, formerly known as Knightsbridge Capital
Fund I, LP; KB Management LLC and KB Consultants LLC, formerly known as
Knightsbridge Consultants LLC; owned by Messrs. Fickes and Stone). The
acquisition allowed the Company to complete its divisional restructuring which
began in 1997. As a result, the Company incurred restructuring costs aggregating
approximately $11,767 for the nine months ended September 30, 1998, directly and
indirectly associated with the divisional restructuring.
As a result of the sale of the United Life Assets along with other non-core
operations, the Company announced a restructuring plan in June 1999 to
significantly reduce its Dallas-based staff and vacate certain office space. The
Company incurred restructuring costs aggregating $5,307 for the nine months
ended September 30, 1999 associated with such restructuring.
The restructuring costs recognized the following for the nine months ended
September 30, 1999 and 1998:
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
1999 1998
------------- -------------
<S> <C> <C>
Severance and related benefits incurred due to staff reduction................. $ 3,185 $ 3,831
Estimated holding costs of vacated facilities.................................. 2,122 2,205
Write-off of certain fixed assets and other impaired assets.................... -- 862
ESTIMATED CONTRACT TERMINATION COSTS........................................... -- 4,869
------------- -------------
TOTAL RESTRUCTURING COSTS.................................................. $ 5,307 $ 11,767
============= =============
</TABLE>
During the nine months ended September 30, 1999, the Company re-evaluated the
restructuring costs and decreased the remaining accruals established in 1998 by
$166. During the three months ended September 30, 1998, the Company reevaluated
the restructuring costs established in 1998 and increased certain restructuring
accruals by $1,388, as a result of the final determination regarding contract
termination fees, certain impaired assets and severance. For the nine months
ended September 30, 1998, the net decrease in 1998 restructuring accruals was
$4,118. During the three and nine months ended September 30, 1999, the Company
paid severance totaling $829 and $1,459, respectively. During the three and nine
months ended September 30, 1998, the Company made severance payments totaling
$2,236 and $2,252, respectively. In addition, in the nine months ended September
30, 1998, the Company also paid contract termination fees of $3,531. As of
September 30, 1999, the Company had remaining accruals associated with
restructuring charges aggregating $8,196.
7. BUSINESS SEGMENT INFORMATION
Segment data as of September 30, 1999 and December 31, 1998, and for the three
and nine months ended September 30, 1999 and 1998, are as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
1999 1998 1999 1998
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
PREMIUMS AND POLICY PRODUCT CHARGES:
Financial Services Division................. $ 34,321 $ 38,638 $ 104,071 $ 105,935
Payroll Sales Division...................... 23,130 22,815 69,431 66,446
Businesses Held for Sale (United States).... 9,505 51,478 85,870 155,492
BUSINESSES HELD FOR SALE (CANADA)........... 2,993 10,674 27,045 33,539
------------- ------------- ------------- -------------
$ 69,949 $ 123,605 $ 286,417 $ 361,412
============= ============= ============= =============
OPERATING PROFIT (LOSS):
Financial Services Division................. $ 13,942 $ 5,673 $ 23,043 $ 19,324
Payroll Sales Division...................... 5,446 2,599 11,214 8,394
BUSINESSES HELD FOR SALE.................... (2,584) (1,806) 15,968 (10,654)
------------- ------------- ------------- -------------
$ 16,804 $ 6,466 $ 50,225 $ 17,064
============= ============= ============= =============
</TABLE>
10
<PAGE>
PENNCORP FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. BUSINESS SEGMENT INFORMATION (CONTINUED)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1999 1998
------------- -------------
<S> <C> <C>
TOTAL ASSETS:
Financial Services Division................................................ $ 2,625,916 $ 2,823,007
Payroll Sales Division..................................................... 707,791 648,400
Businesses Held for Sale (United States)................................... -- 2,294,945
BUSINESSES HELD FOR SALE (CANADA).......................................... -- 126,859
------------- -------------
$ 3,333,707 $ 5,893,211
============= =============
</TABLE>
Reconciliations of segment data to the Company's consolidated data are as
follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
1999 1998 1999 1998
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
TOTAL REVENUES:
Segments--premiums and policy
product charges........................... $ 69,949 $ 123,605 $ 286,417 $ 361,412
Net investment income....................... 53,408 89,130 209,043 277,663
Other income................................ 10,222 8,776 30,653 30,009
Net gains (losses) from sale of investments. 870 4,171 (198) 13,059
Net gains (losses) from sales of subsidiaries
(including realized losses on foreign
currency of $24,978)..................... (21,643) -- 6,161 --
------------- ------------- ------------- -------------
$ 112,806 $ 225,682 $ 532,076 $ 682,143
============= ============= ============= =============
LOSS BEFORE INCOME TAXES AND
EXTRAORDINARY CHARGE:
Segments.................................... $ 16,804 $ 6,466 $ 50,225 $ 17,064
Corporate expenses and eliminations......... (7,322) (10,313) (31,436) (24,798)
Impairment provision associated with
Assets of Businesses Held for Sale........ -- (145,000) (58,486) (285,485)
Interest and amortization of deferred
debt issuance costs....................... (7,713) (10,672) (33,057) (30,945)
Net gains (losses) on the sale of investments 870 4,171 (198) 13,059
Net gains (losses) from sales of subsidiaries
(including realized losses on foreign
currency of $24,978)..................... (21,643) -- 6,161 --
RESTRUCTURING COSTS......................... -- (1,388) (5,141) (7,649)
------------- ------------- ------------- -------------
$ (19,004) $ (156,736) $ (71,932) $ (318,754)
============= ============= ============= =============
</TABLE>
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1999 1998
------------- -------------
<S> <C> <C>
TOTAL ASSETS:
Segments................................................................... $ 3,333,707 $ 5,893,211
CORPORATE AND OTHER........................................................ 110,461 90,813
------------- -------------
$ 3,444,168 $ 5,984,024
============= =============
</TABLE>
8. COMMON STOCK
As part of a special bonus awarded to the Chairman of the Board of Directors,
the Company issued 188,235 shares of treasury stock. The result was to decrease
additional paid in capital and treasury shares by $1,447 and $1,562,
respectively.
In addition, the Company recorded compensation expense of $115.
11
<PAGE>
PENNCORP FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
9. ASSETS AND LIABILITIES OF BUSINESSES HELD FOR SALE
The Assets and Liabilities of Businesses Held for Sale at December 31, 1998,
were as follows:
<TABLE>
<S> <C>
Invested assets................................................. $ 1,974,280
Insurance assets................................................ 329,950
OTHER ASSETS.................................................... 117,574
-------------
TOTAL ASSETS.................................................. $ 2,421,804
=============
Insurance liabilities........................................... $ 1,853,163
OTHER LIABILITIES............................................... 213,391
-------------
TOTAL LIABILITIES............................................. $ 2,066,554
=============
</TABLE>
As of July 30, 1999, sales of all of the Businesses Held for Sale had been
completed. During the three months ended June 30, 1999, the Company concluded
that it would retain, and shut down over time, certain remaining operations of
Marketing One. The related financial statement accounts of Marketing One have
been reclassified out of Assets and Liabilities of Businesses Held for Sale.
10. COMMITMENTS AND CONTINGENCIES
During the third quarter of 1998, the first of ten class-action complaints were
filed in the United States District Court for the Southern District of New York
("District Court") against the Company and certain of its current or former
directors and officers.
During a pre-trial conference on November 9, 1998, all parties agreed to the
consolidation of all of the actions and the Court appointed lead plaintiffs on
behalf of shareholders and noteholders. The Court also approved the selection of
three law firms as co-lead counsel for shareholders and noteholders. A
consolidated and amended complaint was filed on January 22, 1999. A First
Consolidated Amended Class Action Complaint naming, as defendants, the Company,
David J. Stone, formerly a director and Chairman and Chief Executive Officer,
and Steven W. Fickes, formerly a director and President and Chief Financial
Officer was filed on March 15, 1999 (the "Complaint").
The Complaint alleges that defendants violated the Securities Exchange Act of
1934. Among other things, plaintiffs claim that defendants issued a series of
materially false and misleading statements and omitted material facts regarding
the Company's financial condition, including the value of certain of its assets,
and failed to timely disclose that it was under investigation by the Securities
and Exchange Commission (the "SEC").
Plaintiffs seek to recover damages in unspecified amounts on behalf of
themselves and all other purchasers of the Company's common stock and purchasers
of the Company's subordinated notes during the period of February 8, 1996,
through November 16, 1998.
During a conference on March 19, 1999, defendants sought and were granted
permission to file, and subsequently filed, a motion to dismiss the Complaint.
Although there are no assurances that the motion to dismiss will be granted,
management believes that there are meritorious defenses to the action that were
raised in connection with the motion, including whether the Complaint adequately
pleads scienter (i.e., intent to defraud) as required under the Private
Securities Litigation Reform Act of 1995.
The Company has notified its primary and excess carriers of directors and
officers liability insurance of the existence of the claims set forth in the
Complaint, and the total potential insurance available is $15,000 of primary and
$10,000 of excess coverage, respectively, for securities claims. The primary
insurance coverage requires the Company to bear 25% of: (i) all expenses and
(ii) any losses in excess of a $1,000 retention amount. The primary and excess
carriers have reserved their rights under the policies with respect to coverage
of the claims set forth in the Complaint. As explained below, the primary
insurer has agreed in principle to contribute to a settlement of the litigation.
12
<PAGE>
PENNCORP FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. COMMITMENTS AND CONTINGENCIES (CONTINUED)
Following settlement discussions with the Plaintiffs' counsel and
representatives of the primary insurance carrier and their counsel, the parties
to the Complaint have entered into a Memorandum of Understanding dated November
11, 1999 (the "Memo") containing the essential terms of a settlement.
The Memo states that $9,000 of cash plus interest accruing through the date of
consummation of the settlement, will be paid in full and final settlement of all
claims set forth in the Complaint (the "Settlement"). Of that sum, $1,500 plus
interest will be paid by the Company and $7,500 plus interest will be paid by
the Company's outside directors and officers liability insurance carrier. The
Settlement is conditioned upon, among other things, confirmatory discovery,
execution of a definitive settlement agreement and related documents, notice to
the Company's shareholders of the Settlement and final approval by the United
States District Court (with all time to appeal such approval having run or any
appeals having been resolved in favor of approval of the Settlement). During the
three months ended September 30, 1999, the Company established a $1,500
liability related to the settlement.
The Company expects that this litigation will not affect its ability to operate
through December 31, 1999. While it is not feasible to predict or determine the
final outcome of these proceedings or to estimate the amounts or potential range
of loss with respect to these matters, management believes that if the
Settlement is not consummated and there is an adverse outcome with respect to
such proceedings, it would have a material adverse impact on the Company and
affect its ability to operate as is currently intended.
On July 30, 1998, the SEC notified the Company that it had commenced a formal
investigation into possible violations of the federal securities laws including
matters relating to the Company's restatement of its financial statements for
the first six months of 1997, and for the years ended December 31, 1994, 1995
and 1996. The Company and its management are fully cooperating with the SEC in
its investigation.
The Company is a party to various other pending or threatened legal actions
arising in the ordinary course of business, some of which include allegations of
insufficient policy illustration and agent misrepresentations. Although the
outcome of such actions is not presently determinable, management does not
believe that such matters, individually or in the aggregate, would have a
material adverse effect on the Company's financial position or results of
operations if resolved against the Company.
In May 1998, the North Carolina Attorney General's Office (the "NCAG") initiated
an inquiry concerning certain life insurance products historically sold by
Security Life and representations allegedly made by Security Life's agents and
officers with respect to not charging insurance charges after the eighth policy
year for non-smoker insureds. The NCAG indicated that Security Life may be
estopped to change its current practice of not charging the cost of the
insurance for non-smoking policyholders because of certain representations made
by agents and officers of Security Life. Although Security Life has not charged
the cost of insurance charges for non-smoker policyholders who reached their
ninth policy year, this practice is not guaranteed under the life insurance
contracts. The contracts specifically allow Security Life the right to change
the cost of insurance rates in accordance with the parameters set forth in the
insurance contracts. Security Life has responded to the NCAG's inquiry by
denying that it is estopped from changing the cost of insurance rates based on
the alleged representations, and continuing to reserve its contractual rights to
charge the cost of insurance rates in accordance with the parameters set forth
in the insurance contracts. In June 1998, the NCAG informed Security Life that
it could not adjudicate this matter and left it mutually unresolved. In June
1999, the North Carolina Department of Insurance ("NCDOI") asked Security Life
about the status of its current practice of not charging cost of insurance
charges after the eighth contract year for non-smokers on these same insurance
products and requested to be informed if Security Life changes its current
practice. Security Life has responded to the NCDOI's inquiry by verifying that
no decision has been made to date to change such current practice and such
practice has not changed; and affirming that the NCDOI would be notified in the
event this current practice changes. The Company has initiated an exchange
program which enables policyholders of such life insurance products to terminate
their policies and, in exchange for the termination of the original policy and a
release, obtain either (i) the refund of all premiums paid and other
consideration or (ii) another Security Life product. As of September 30, 1999,
Security Life has established a regulatorily required contingency reserve
aggregating approximately $3,859 in its statutory financial statements
associated with the exchange program. On November 5, 1999, Security Life was
served with an Original Petition filed in state court in Dallas County, Texas,
asserting a class action concerning such policies. The petition alleges that
Security Life has
13
<PAGE>
PENNCORP FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. COMMITMENTS AND CONTINGENCIES (CONTINUED)
waived the right to charge cost of insurance charges after the eighth year on
such non-smoker policies and to increase cost of insurance charges on such
smoker policies. The petition alleges Security Life made these waivers through
its marketing pieces and signed statements by its officers. The petition also
alleges that not all of the facts were outlined in the Company's communication
to its policyholders outlining the exchange program and therefore alleges
Security Life's exchange program is deceptive. The petition asks for declaratory
judgment concerning the rights of the Plaintiffs, and the class of policyholders
of such policies and for attorney's fees. It, among other things, asks for an
injunction to prevent Security Life from charging cost of insurance charges for
such non-smoker policies or increasing cost of insurance charges on such smoker
policies after the eighth contract year. It also asks the Court to rule the
releases signed by such policyholders under the exchange program be declared
null and void and those policyholders who signed the releases be given the
option of reinstating the prior policies. The Company denies the allegations in
the petition and intends to vigorously defend this lawsuit. There can be no
assurances that the exchange program will be successful or that the Company will
resolve these matters on such life insurance products on a satisfactory basis,
or at all, or that any such resolution would not have a material adverse effect
on the Company's financial condition, results of operations or cash flows.
In connection with a potential leveraged buyout of the Career Sales Division
(which ultimately did not occur), the sales force of Penn Life agreed to a
reduction in the commission rates over the life of the policy contract on new
sales on and after January 1, 1998, in exchange for the opportunity to
participate in the equity in a newly-formed leveraged entity. Discussions had
also been held relating to equity incentive programs based on sales production
and persistency measures. Additionally, the Company held discussions with a
marketing organization, which it has contracted with for the development and
marketing of products focused on the senior marketplace, concerning the issuance
of equity in the newly-formed leveraged entity based on a percentage of profits
contributed by such marketing organization. In connection with the Company's
sale of the Career Sales Division and related assets to Universal American, the
sales force of Penn Life and the marketing organization received equity in
Universal American and participated in certain equity incentive programs of
Universal American. A portion of the proceeds received by the Company from
Universal American for the sale of the Career Sales Division were used to fund
the purchase of equity of Universal American by the sales force of Penn Life and
to make certain other payments to the sales force in exchange for a release of
claims relating to the potential leveraged buyout.
The life insurance subsidiaries of the Company are required to be members of
various state insurance guaranty associations in order to conduct business in
those states. These associations have the authority to assess member companies
in the event that an insurance company conducting business in that state is
unable to meet its policyholder obligations. Assessments from guaranty
associations, which have not been material, are recorded in accordance with
Statement of Position 97-3 issued by the AICPA, "Accounting by Insurance and
Other Enterprises for Insurance-Related Assessments." The Company periodically
evaluates the accruals for future assessments net of future premium tax
reductions at its life insurance subsidiaries. During the three month period
ended September 30, 1999, the Company reduced the accrual approximately $1,500.
In May 1998, the three senior executives of the Company entered into two year
employment agreements with the Company which have various annual bonus, deferred
payment and termination provisions. As of September 30, 1999, the Company had
accrued liabilities aggregating $1,350 for the annual 1999 bonus and $6,949 for
deferred compensation provisions, respectively associated with these employment
agreements. The deferred compensation provisions are payable upon the expiration
of the employment agreement, or sooner termination of the executive by the
Company without cause, or termination by the executive for "good reason" as
defined in the employment agreements.
Many computer and software programs were designed to accommodate only two digit
fields to represent a given year (e.g. "98" represents 1998). It is highly
likely that such systems will not be able to accurately process data containing
date information for the year 2000 and beyond. The Company is highly reliant
upon computer systems and software as are many of the businesses with which the
Company interacts. The Company's ability to service its policyholders and agents
is dependent upon accurate and timely transaction processing. Transaction
processing in turn is dependent upon the Company's highly complex interdependent
computer hardware, software, telecommunications and desktop applications. The
inability of the Company or any of its integral business partners to complete
year 2000 remediation efforts associated with these highly complex and
interdependent systems could lead to a significant business interruption. Such
an interruption could result in a decline in current and long-term profitability
and business franchise value.
14
<PAGE>
PENNCORP FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. COMMITMENTS AND CONTINGENCIES (CONTINUED)
Although the Company believes that its operating divisions, outside vendors and
most critical business partners will be sufficiently compliant and that the year
2000 issue should not cause a material disruption in the Company's business,
there can be no assurance that there will not be material disruptions to the
Company's business or an increase in the cost of the Company doing business.
Although the Company believes that the year 2000 issues should not cause a
material disruption in the Company's business, the Company has developed various
contingency plans associated with remediation tasks which the Company believes
are at a higher risk for potential failure.
The Company has provided certain assurances to each respective purchaser of the
Businesses Held for Sale with respect to each entity's ability to process
date-sensitive information for the year 2000 and beyond. Although the Company
believes that it will be able to meet the year 2000 representations and
warranties provided to the respective purchasers, there can be no assurances
that it will do so. Failure of the Company to meet such representations and
warranties could result in indemnification claims for breach of contract.
Each of the definitive purchase and sale agreements the Company has consummated
for Professional, the United Life Assets, KIVEX and the Career Sales Division,
contain indemnification provisions which survive the closing of each sales
transaction for varying periods of time. The indemnification provisions would be
invoked by the purchasers should the Company breach certain representation and
warranty provisions or upon the occurrence of specified events contained in the
purchase and sale agreements.
At September 30, 1999, the Company had outstanding commitments to invest up to
$12,500 in various limited partnership funds and other investments.
At September 30, 1999, the Company had a contingent obligation for mortgage
loans previously sold aggregating $4,884 as a result of the Company acting as a
servicing conduit.
15
<PAGE>
REVIEW BY INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
The September 30, 1999 and 1998, financial statements included in this filing
have been reviewed by KPMG LLP, independent certified public accountants, in
accordance with established professional standards and procedures for such a
review.
The report of KPMG LLP commenting upon their review is included on the following
page.
(REMAINDER OF PAGE INTENTIONALLY LEFT BLANK)
16
<PAGE>
INDEPENDENT AUDITORS' REVIEW REPORT
The Board of Directors and Shareholders of PennCorp Financial Group, Inc.
We have reviewed the accompanying consolidated balance sheet of PennCorp
Financial Group, Inc. and subsidiaries as of September 30, 1999, and the related
consolidated statements of operations and comprehensive loss for the three and
nine month periods ended September 30, 1999 and 1998, and consolidated
statements of cash flows for the nine month periods ended September 30, 1999 and
1998. These financial statements are the responsibility of the Company's
management.
We conducted our review in accordance with standards established by the American
Institute of Certified Public Accountants. A review of interim financial
information consists principally of applying analytical procedures to financial
data and making inquiries of persons responsible for financial and accounting
matters. It is substantially less in scope than an audit conducted in accordance
with generally accepted auditing standards, the objective of which is the
expression of an opinion regarding the financial statements taken as a whole.
Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that should
be made to the financial statements referred to above for them to be in
conformity with generally accepted accounting principles.
We have previously audited, in accordance with generally accepted auditing
standards, the consolidated balance sheet of PennCorp Financial Group, Inc. as
of December 31, 1998, and the related consolidated statements of operations and
comprehensive income (loss), shareholders' equity, and cash flows for the year
then ended (not presented herein); and in our report dated March 31, 1999, we
expressed an unqualified opinion on those consolidated financial statements. In
our opinion, the financial information set forth in the accompanying
consolidated condensed balance sheet as of December 31, 1998, is fairly
presented, in all material respects, in relation to the consolidated balance
sheet from which it has been derived.
/S/KPMG LLP
Dallas, Texas
November 9, 1999
17
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
This "Management's Discussion and Analysis of Financial Condition and Results of
Operations" should be read in conjunction with the comparable discussion filed
with the Company's annual filing with the Securities and Exchange Commission on
Form 10-K for the fiscal year ended December 31, 1998.
The following discussion should also be read in conjunction with the unaudited
consolidated financial statements and related notes of this Quarterly Report on
Form 10-Q.
CAUTIONARY STATEMENT
Cautionary Statement for purposes of the Safe Harbor Provisions of the Private
Securities Litigation Reform Act of 1995. All statements, trend analyses and
other information contained in this report relative to markets for PennCorp's
products and trends in PennCorp's operations or financial results, as well as
other statements including words such as "anticipate," "believe," "plan,"
"estimate," "expect," "intend," and other similar expressions, constitute
forward-looking statements under the Private Securities Litigation Reform Act of
1995. These forward-looking statements are subject to known and unknown risks,
uncertainties and other factors which may cause actual results to be materially
different from those contemplated by the forward-looking statements. Such
factors include, among other things: (1) PennCorp's ability to obtain final
approval of the settlement of the securityholders' class action lawsuit; (2)
general economic conditions and other factors, including prevailing interest
rate levels and stock market performance, which may affect the ability of
PennCorp to sell its products, the market value of PennCorp's investments and
the lapse rate and profitability of insurance products; (3) PennCorp's ability
to achieve anticipated levels of operational efficiencies and cost-saving
initiatives and to meet cash requirements based upon projected liquidity
sources; (4) customer response to new products, distribution channels and
marketing initiatives; (5) mortality, morbidity, and other factors which may
affect the profitability of PennCorp's insurance products; (6) changes in the
Federal income tax laws and regulations which may affect the relative tax
advantages of some of PennCorp's products; (7) increasing competition in the
sale of insurance and annuities; (8) regulatory changes or actions, including
those relating to regulation of insurance products and of insurance companies;
(9) ratings assigned to PennCorp's insurance subsidiaries by independent rating
organizations such as A.M. Best Company ("A.M. Best"); (10) PennCorp's ability
to successfully complete its year 2000 remediation efforts; (11) current and/or
unanticipated litigation; and (12) the effects of any sale, restructuring or
recapitalization of the Company. There can be no assurance that other factors
not currently anticipated by management will not also materially and adversely
affect the Company's results of operations.
GENERAL
The Company, through its three operating divisions, provides accumulation, life,
and fixed benefit accident and sickness insurance products throughout the United
States and Canada. The Company's products are sold through several distribution
channels, including exclusive agents, independent general agents, financial
institutions, and payroll deduction programs, and are targeted primarily to
lower and middle-income individuals in rural and suburban areas. These products
are primarily small premium accident and sickness insurance policies with
defined fixed benefit amounts, traditional whole life and universal life
insurance with low face amounts, and accumulation products such as single
premium deferred annuities.
The Company's financial condition and results of operations for the periods
covered by this and future "Management's Discussion and Analysis of Financial
Condition and Results of Operations" are or will be affected by several common
factors, each of which is discussed below.
DISPOSITIONS AND OTHER TRANSACTIONS. On July 30, 1999, The Company consummated
the sale of the Career Sales Division to Universal American. The net cash
proceeds after transaction costs and fulfillment of contract obligations were
$82.0 million. The Company used $78.0 million of the net proceeds to reduce the
principal under the Company's Bank Credit Facility. The Company realized a
foreign currency transaction loss of $25.0 million partially offset by a gain of
$3.1 million resulting in a net loss of $21.9 million during the three months
ended September 30, 1999. In addition, as a result of the sale unrealized gains
on securities available for sale and unrealized foreign currency translation
losses decreased by $2.2 million and $25.0 million, respectively. The purchase
and sale agreement includes certain settlement and consideration adjustment
provisions and may result in a reduction of the consideration received by the
Company.
On June 30, 1999, the Company completed the sale of KIVEX to Allegiance for
$34.5 million in cash. The net proceeds to the parent company from the sale were
$22.2 million after payment of costs and fees associated with the transaction
and after repayment of $10.2 million of intercompany borrowings to insurance
company affiliates of PennCorp. Of the net proceeds,
18
<PAGE>
$22.0 million was used to reduce principal and commitments under the Company's
Bank Credit Facility. The Company recorded a gain of $30.9 million from the
sale.
On April 30, 1999, the Company consummated the sale of the United Life Assets.
The purchase consideration totaled $154.1 million including a dividend of $2.1
million that was paid by United Life at closing. The cash consideration
ultimately was reduced as a result of the Company's obligation to purchase
certain mortgages and other assets as well as for transaction related costs at
closing. The Company received net cash proceeds of $136.5 million of which
$127.0 million was used to reduce principal and commitments under the Company's
Bank Credit Facility. The Company realized a loss from the sale of the United
Life Assets totaling $3.9 million. Also, as a result of the sale, unrealized
gains on securities held for sale by United Life decreased $3.6 million. The
amount of mortgages purchased is subject to adjustment for a period of 90 days
subsequent to closing pursuant to the terms of the purchase and sale agreement.
This review period has been extended by mutual agreement. The determination and
settlement of the final amount of mortgages included in the sale is expected to
occur prior to December 31, 1999. During the three months ended September 30,
1999, the Company sold substantially all of the mortgages originally held by
United Life but retained by the Company as part of the sale of the United Life
Assets. The Company may be obligated to repurchase certain of the mortgages
sold. The amount of mortgages the Company may be required to repurchase is not
expected to exceed approximately $1.6 million. At September 30, 1999, the
Company has established a $1.2 million liability related to these contingencies.
On March 31, 1999, the Company consummated the sale of Professional to GE
Financial Assurance Holdings, Inc. for cash proceeds of $47.5 million. The
Company realized net cash proceeds of $40.2 million. Of the net proceeds, $40.0
million was used to reduce principal and commitments under the Company's Bank
Credit Facility on April 1, 1999. The Company realized a gain from the sale of
Professional totaling $1.1 million. Also, as a result of the sale, unrealized
gains on securities held for sale by Professional decreased $488,000. The
purchase and sale agreement included certain settlement and consideration
adjustment provisions which resulted in a further reduction of consideration
received of approximately $1.2 million on September 15, 1999.
The Company has engaged Wasserstein Perella to review the Company's capital
structure and develop recapitalization and restructuring alternatives. The
Company, with Wasserstein Perella, is currently exploring with interested
parties, a sale of the Company or certain of its subsidiaries and, on a parallel
track, a restructuring or recapitalization transaction.
The Company's management and advisors are in the process of analyzing proposals
submitted by third parties for the sale of the Company or certain of its
subsidiaries and a recapitalization proposal submitted by certain preferred
stockholders. Once management has completed its analysis, the Company's Board of
Directors will meet to review the proposals and management's recommendations and
expects to make a determination shortly thereafter on a transaction or series of
transactions to be entered into by the Company. There can be no assurance: (i)
that the Company will be successful in developing and implementing one or more
of these transactions; (ii) as to the form the transactions will ultimately
take; or (iii) as to the timing to complete the process. Should the Company
enter into any such transaction, the terms of such transaction will be announced
upon execution of a definitive agreement.
As amended, the final maturity date of the Bank Credit Facility is May 2000.
Following the sale of the Career Sales Division and the realization of the net
proceeds therefrom to pay down the Bank Credit Facility and with an additional
repayment of $2.0 million made in September of 1999, the aggregate principal
amount of indebtedness remaining under the Bank Credit Facility as of September
30, 1999 was $165.0 million. In the event the Company does not consummate any of
the transactions described in the immediately preceding paragraph prior to the
maturity date of the Bank Credit Facility, the Company may seek to further amend
the Bank Credit Facility, to refinance the Bank Credit Facility, to sell
additional assets to fund the repayment of the Bank Credit Facility or to pursue
other alternatives. There can be no assurance that the Company will be
successful in implementing any one or more of such transactions or alternatives,
the form such transactions or alternatives may take, or the timing of such
transactions or alternatives. In the event the Company is unable to consummate
any of the foregoing transactions or alternatives and is otherwise unable to
obtain sufficient liquidity to repay the Bank Credit Facility on maturity, such
failure would result in a default under the Bank Credit Facility and the
indenture governing the Notes, entitling the holders thereof to exercise certain
remedies, including the acceleration of such indebtedness and the commencement
of legal actions to collect the indebtedness. In such event, the Company will
examine and consider any alternatives then available to the Company.
RESTRUCTURING AND OTHER COSTS. As a result of the tremendous growth of the
Company and the diversification of the underlying business units resulting from
acquisitions over time, the Company began a strategic business evaluation during
the third quarter of 1996. The review resulted in the Company establishing three
divisional platforms, Career Sales Division, Payroll Sales Division and
Financial Services Division in 1997.
19
<PAGE>
On January 2, 1998 and January 5, 1998, respectively, the Company acquired the
SW Financial Controlling Interest and the Fickes and Stone Knightsbridge
Interests. The acquisitions allowed the Company to complete its divisional
restructuring which began in 1997. As a result, the Company incurred
restructuring costs aggregating approximately $11.8 million for the nine months
ended September 30, 1998 directly and indirectly associated with divisional
restructuring.
As a result of the sale of the United Life Assets along with other non-core
operations, the Company announced a restructuring plan in June 1999 to
significantly reduce its Dallas-based staff and vacate certain office space. The
Company incurred restructuring costs aggregating $5.3 million for the nine
months ended September 30, 1999.
The restructuring costs recognized the following for the nine months ended
September 30, 1999 and 1998 (in thousands):
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
1999 1998
------------- -------------
<S> <C> <C>
Severance and related benefits incurred due to staff reduction................. $ 3,185 $ 3,831
Estimated holding costs of vacated facilities.................................. 2,122 2,205
Write-off of certain fixed assets and other impaired assets.................... -- 862
ESTIMATED CONTRACT TERMINATION COSTS........................................... -- 4,869
------------- -------------
TOTAL RESTRUCTURING COSTS.................................................. $ 5,307 $ 11,767
============= =============
</TABLE>
During the nine months ended September 30, 1999, the Company re-evaluated the
restructuring costs and decreased the remaining accruals established in 1998 by
$166,000. During the three months ended September 30, 1998, the Company
reevaluated the restructuring costs established in 1998 and increased certain
accruals by $1.4 million, as a result of the final determination regarding
contract termination fees, certain impaired assets and severance. For the nine
months ended September 30, 1998, the net decrease in 1998 restructuring accruals
was $4.1 million. During the three and nine months ended September 30, 1999, the
Company paid severance totaling $829,000 and $1.5 million, respectively. During
the three and nine months ended September 30, 1998, the Company made severance
payments totaling $2.2 million and $2.3 million, respectively. In addition, in
the nine months ended September 30, 1998, the Company also paid contract
termination fees of $3.5 million. As of September 30, 1999, the Company had
remaining accruals associated with restructuring charges aggregating $8.2
million.
YEAR 2000 ISSUES
Many computer and software programs were designed to accommodate only two digit
fields to represent a given year (e.g. "98" represents 1998). It is highly
likely that such systems will not be able to accurately process data containing
date information for the year 2000 and beyond. The Company is highly reliant
upon computer systems and software as are many of the businesses with which the
Company interacts. The Company's ability to service its policyholders and agents
is dependent upon accurate and timely transaction processing. Transaction
processing in turn is dependent upon the Company's highly complex interdependent
computer hardware, software, telecommunications and desktop applications. The
inability of the Company or any of its integral business partners to complete
year 2000 remediation efforts associated with these highly complex and
interdependent systems could lead to a significant business interruption. Such
an interruption could result in a decline in current and long-term profitability
and business franchise value.
The Company's overall year 2000 compliance initiatives, include the following
components: (i) assessment of all business critical systems (business critical
systems include computer and other systems), processes and external interfaces
and dependancies; (ii) remediation or upgrading of business critical systems;
(iii) testing of both modified and updated systems as well as integrated systems
testing; (iv) implementation of modified and updated systems; and (v)
contingency planning. As a part of the process, the Company has written letters
and corresponded with its outside vendors and critical business partners
concerning year 2000 compliance efforts and follows up periodically. Of those
parties that have responded, the Company's most significant third party vendors
and business partners have indicated that they have a plan for year 2000
compliance or believe that they are currently year 2000 compliant.
The Company has engaged outside vendors and focused certain employees' full time
efforts to help in the full array of its year 2000 initiative. This includes
systems assessment and monitoring advice, actual code remediation, communication
and
20
<PAGE>
consultation with critical business partners and additional data center and
testing resources. The Company originally projected to incur internal and
external costs associated with such expertise ranging from $10.6 million to
$14.5 million, which were anticipated to be incurred primarily during 1998 and
early 1999. Based upon revised projections, the Company anticipates incurring
internal and external costs of $7.4 million during 1999 for a total cost of
$22.7 million for year 2000 remediation. The Company estimates it has incurred
internal and external costs aggregating $900,000 and $6.7 million for the three
months ended September 30, 1999 and 1998, respectively. For the nine months
ended September 30, 1999 and 1998, the Company estimates it has incurred year
2000 costs totaling $6.6 million and $11.4 million, respectively.
Each of the operating divisions is primarily responsible for its remediation
efforts with corporate oversight provided as necessary. The Payroll Sales
Division has substantially completed the remediation of its largest
administrative platforms and anticipates successful remediation and testing of
the remaining sub-systems and system interfaces during the remainder of 1999.
The Company believes that the Payroll Sales Division is 99% complete with its
compliancy effort for critical business systems. The Company believes that the
Financial Services Division has contracted with sufficient resources to be able
to remediate its essential business systems. Currently, the Company believes
that the Financial Services Division is 99% complete with remediation efforts
associated with its critical business systems. The Company believes that both of
its divisions have substantially completed their remediation efforts, but each
division will continue to perform testing throughout the remainder of 1999.
Although the Company believes that its operating divisions, outside vendors and
most critical business partners will be sufficiently compliant and that the year
2000 issue should not cause a material disruption in the Company's business,
there can be no assurance that there will not be material disruptions to the
Company's business or an increase in the cost of the Company doing business.
Although the Company believes that the year 2000 issues should not cause a
material disruption in the Company's business, the Company has developed various
contingency plans associated with remediation tasks which the Company believes
are at a higher risk for potential failure.
The Company has provided certain assurances to each respective purchaser of the
Businesses Held for Sale with respect to each entity's ability to process
date-sensitive information for the year 2000 and beyond. Although the Company
believes that it will be able to meet the year 2000 representations and
warranties provided to the respective purchasers, there can be no assurances
that it will do so. Failure of the Company to meet such representations and
warranties could result in indemnification claims by the respective purchasers.
FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES
PARENT COMPANY
GENERAL. PennCorp ("parent company") is a legal entity, separate and distinct
from its subsidiaries and has no material business operations. The parent
company needs cash for: (i) principal and interest on debt; (ii) dividends on
preferred and common stock; (iii) holding company administrative expenses; (iv)
income taxes and (v) investments in subsidiaries. In September 1998, the Company
suspended payment of preferred and common stock dividends. The primary sources
of cash to meet these obligations include statutorily permitted payments from
life insurance subsidiaries, including: (i) surplus debenture interest and
principal payments, (ii) dividend payments; and (iii) tax sharing payments. The
parent company may also obtain cash through the sale of subsidiaries or other
assets.
21
<PAGE>
The following table shows the cash sources and uses of the parent company on a
projected basis for the remaining 1999 and on an actual basis for the nine
months ended September 30, 1999 and 1998:
<TABLE>
<CAPTION>
PROJECTED
PERIOD
OCTOBER 1, 1999 TO NINE MONTHS ENDED
DECEMBER 31, SEPTEMBER 30,
1999 1999 1998
------------- ------------- -------------
($ IN THOUSANDS)
<S> <C> <C> <C>
Cash sources:
Cash from subsidiaries................................... $ 5,648 $ 343,055 $ 56,694
Sales of directly owned subsidiaries..................... -- 5,989 --
Other investment income.................................. -- 695 2,683
Additional borrowings.................................... -- -- 203,000
Sales of/collection on assets currently held............. 2,604 9,438 23,504
OTHER, NET............................................... 191 12 624
------------- ------------- -------------
TOTAL SOURCES...................................... 8,443 359,189 286,505
------------- ------------- -------------
Cash uses:
Acquisition of businesses................................ -- -- 73,858
Interest paid on indebtedness............................ 9,113 29,149 26,118
Operating expenses, including restructuring charges...... 4,560 13,297 26,316
Reduction of notes payable............................... -- 269,000 126,015
Capital contributions to subsidiaries.................... -- 27,668 6,178
Costs to dispose of Businesses Held for Sale............. 3,000 14,991 --
Purchase of equity securities............................ -- -- 5,000
Dividends on preferred and common stock.................. -- -- 16,205
OTHER, NET............................................... 2,338 -- --
------------- ------------- -------------
TOTAL USES......................................... 19,011 354,105 279,690
------------- ------------- -------------
Increase (decrease) in cash and short-term investments..... (10,568) 5,084 6,815
CASH AND SHORT-TERM INVESTMENTS AT BEGINNING OF PERIOD..... 17,738 12,654 4,464
------------- ------------- -------------
CASH AND SHORT-TERM INVESTMENTS AT END OF PERIOD........... $ 7,170 $ 17,738 $ 11,279
============= ============= =============
</TABLE>
CASH SOURCES
CASH FROM SUBSIDIARIES. Cash generated by the Company's insurance subsidiaries
has been made available to PennCorp principally through periodic payments of
principal and interest on surplus debentures issued by PLAIC, Constitution (sold
July 30, 1999) and Pioneer Security (collectively, the "Surplus Note
Companies"). The surplus debentures issued by PLAIC and Constitution were repaid
in full in connection with the consummation of the sale of the Career Sales
Division. As part of a subsidiary realignment in conjunction with the Career
Sales Division divestiture, PLAIC issued a new surplus debenture to SW Financial
in the amount of $150.0 million. With respect to Constitution, Pioneer Security
and PLAIC (as a result of its surplus debenture issued as of July 30, 1999), the
surplus debenture payments have been made to non-insurance intermediate holding
companies and paid to the Company in the form of dividends and tax sharing
payments. The amounts outstanding under the surplus debentures totaled $258.3
million and $453.1 million as of September 30, 1999 and December 31, 1998,
respectively. The surplus debentures generally require (subject to availability
of statutory capital and surplus and in some instances, regulatory approval)
principal and interest payments to be made periodically in amounts sufficient to
allow PennCorp to meet its cash requirements.
The Surplus Note Companies rely upon dividends and tax sharing payments from
their respective insurance subsidiaries. Each of the insurance subsidiaries is
in turn subject to regulatory restrictions under the Texas Insurance Laws and
Regulations with respect to the maximum amount of dividends that can be paid to
the Surplus Note Companies within a twelve month period without prior regulatory
approval. Such dividend restrictions are generally the greater of 10% of
statutory capital and surplus or prior year's statutory earnings.
For the nine months ended September 30, 1999 and 1998, the Company received
surplus debenture interest and principal payments from PLAIC of $221.8 million
and $20.3 million, respectively, and received dividends and tax sharing payments
22
<PAGE>
of $121.2 million and $36.4 million, respectively from non-insurance
intermediate holding companies. Substantially all of the surplus debenture,
dividends and tax sharing payments made by PLAIC were the direct result of
proceeds received by PLAIC from the disposition of Businesses Held for Sale.
Approximately $80.0 million of dividends and tax sharing payments from
non-insurance intermediate holding companies in the nine months ended September
30, 1999 were the direct result of proceeds received from sales of Businesses
Held for Sale. The Surplus Note Companies received $7.0 million and $15.1
million from their respective subsidiaries in tax sharing payments during the
nine months ended September 30, 1999 and 1998, respectively. In addition, the
surplus note companies received $20.2 million and $19.5 million from their
respective subsidiaries in dividend payments during the nine months ended
September 30, 1999 and 1998, respectively.
SALES OF DIRECTLY OWNED SUBSIDIARIES. During the nine months ended September 30,
1999, the Company sold directly owned subsidiaries in connection with the
disposition of the Businesses Held for Sale and received proceeds of $6.0
million.
OTHER INVESTMENT INCOME. During the nine months ended September 30, 1999 and
1998, the Company received other investment income from short-term invested
assets held by the parent company.
ADDITIONAL BORROWINGS. During the nine months ended September 30, 1998, the
Company borrowed under its existing bank credit facilities primarily to fund
acquisitions or repay existing indebtedness. See "Cash Uses" below for the use
of proceeds from the additional borrowings.
SALE OF/COLLECTION ON ASSETS CURRENTLY HELD. During the nine months ended
September 30, 1999, the Company received mortgage loan principal payments and
distribution from a limited partnership totaling $1.4 million. In addition, the
Company sold certain mortgage loans held directly by the parent company for $8.0
million cash.
CASH USES
ACQUISITION OF BUSINESSES. During 1998, the Company acquired the SW Financial
Controlling Interest for $73.7 million in cash and the Fickes and Stone
Knightsbridge Interests for $10.6 million of which $200,000 of the consideration
was paid in cash. To fund such acquisitions the Company utilized borrowings
under its existing credit facility.
INTEREST PAID ON INDEBTEDNESS. During the nine months ended September 30, 1999
and 1998, the Company utilized varying amounts of leverage in its capital
structure. For the nine months ended September 30, 1999 and 1998, the average
indebtedness outstanding aggregated $414.1 million and $452.6 million,
respectively. The Company's weighted average costs of borrowings increased
significantly during 1999 as a result of the Company's increased leverage ratio
and projected weakness in future liquidity.
OPERATING EXPENSES, INCLUDING RESTRUCTURING CHARGES. During the nine months
ended September 30, 1999 and 1998, the Company directly and indirectly, through
charges from its subsidiaries, incurred significant operating and restructuring
charges. Total restructuring charges paid by the parent company during the nine
months ended September 30, 1999 and 1998 aggregated $944,000 and $305,000,
respectively. During the nine months ended September 30, 1998, the Company also
paid contract termination fees of $3.5 million. During the remainder of 1999,
the parent company anticipates funding an additional $200,000 of such charges.
During the nine months ended September 30, 1999, the parent company also
incurred legal, accounting and investment banking fees associated with asset
dispositions aggregating $2.3 million. Operating expenses for the nine months
ended September 30, 1999 and 1998 also include costs aggregating $1.5 million
and $233,000, respectively, associated with the pending class action
securityholder litigation and the SEC investigation. The Company anticipates
incurring additional expenses associated with such legal matters (although the
Company's Directors and Officers Liability Insurance carrier has begun to
reimburse the Company 75% of such expenses in excess of $1.0 million retention
amount in accordance with the terms of the directors and officers liability
coverage) and will additionally incur significant costs associated with its
capital restructuring efforts during the remainder of 1999.
REDUCTION IN NOTES PAYABLE. During the nine months ended September 30, 1999, the
Company made repayments under the Bank Credit Facility aggregating $267.0
million upon the consummation of sales of Professional, the United Life Assets,
KIVEX and the Career Sales Division. An additional $2.0 million was repaid
during September 1999 as a result of liquidity at the parent company level above
amounts prescribed in the Bank Credit Facility, as amended.
In conjunction with the Company's 1998 acquisition of the SW Financial
Controlling interest, the Company borrowed under its existing $450.0 million
revolving Bank Credit Facility to repay indebtedness of SW Financial aggregating
$115.0 million upon acquisition. In addition, during 1998 the Company used
existing liquidity to repay $11.0 million of indebtedness under the Company's
Bank Credit Facility.
23
<PAGE>
CAPITAL CONTRIBUTIONS TO SUBSIDIARIES. For the nine months ended September 30,
1999 and 1998, the Company made capital contributions to subsidiaries totaling
$27.7 million and $6.2 million, respectively. During the nine months ended
September 30, 1999, $3.3 million of the contribution was made to PLAIC to make a
subsequent capital contribution to PLIC and $1.1 million was made to a non-life
insurance subsidiary. Of the total capital contribution, $20.2 was contributed
to subsidiaries to meet certain target capital and surplus requirements as
required by the purchase and sale agreement for the Career Sales Division. The
Company utilized funds from proceeds from the sale of Businesses Held for Sale
to fund these contributions. During 1998, the contributions were primarily made
to non-life insurance subsidiaries for other corporate purposes.
COSTS TO DISPOSE OF BUSINESSES HELD FOR SALE. Utilizing funds received from
subsidiaries from the sales of Businesses Held for Sale, the Company paid $9.7
million to fund the purchase of the equity of the acquirer of Penn Life for the
sales force of Penn Life and to make certain other payments to the sales force
in exchange for a release of claims. The remaining $5.3 million of costs are
principally transaction costs which were paid from proceeds received on the sale
of Businesses Held for Sale.
PURCHASE OF EQUITY SECURITIES. In conjunction with the acquisition of the Fickes
and Stone Knightsbridge Interests, the Company acquired Fickes' and Stone's
interest in the ACO Brokerage Common Stock for $5.0 million during the nine
months ended September 30, 1998.
DIVIDENDS ON PREFERRED AND COMMON STOCK. During the nine months ended September
30, 1999 and 1998, the Company paid common and preferred stock dividends
aggregating $-- and $16.2 million, respectively. The absence of dividend
payments during 1999 was due to the Company's decision to halt common and
preferred stock dividend payments as a result of liquidity concerns and
restrictions contained in the amended Bank Credit Facility.
PROJECTED CASH SOURCES AND USES FOR THE REMAINING THREE MONTHS OF 1999
For the remainder of 1999, the Company anticipates receiving approximately $5.6
million in the form of dividends and tax sharing payments from the Surplus Note
Companies as a result of the ordinary dividend flow from the insurance
subsidiaries of the Surplus Notes Companies.
The Company acquired assets from United Life and Professional in connection with
the sale of such companies and anticipates it will be able to sell most of these
assets during the remainder of 1999 and realize cash proceeds of approximately
$2.6 million, though there can be no assurance that the Company will succeed in
doing so.
The purchase and sale agreement with respect to the sale of the Career Sales
Division includes certain settlement and consideration adjustment provisions
which may result in a reduction of the consideration received by the Company.
Based upon estimates provided by Universal American, the Company may be
obligated to provide approximately $3.0 million to Universal American for such
consideration adjustments. The Company is currently evaluating Universal
American's estimates. In addition, included in other disbursements is $1.5
million required to settle the Company's portion of the settlement of the
shareholder lawsuit (See Note 10 of Notes to Unaudited Consolidated Financial
Statements).
As a result of these anticipated actions, management believes the Company will
likely have sufficient financial flexibility and projected liquidity sources to
meet all cash requirements for 1999 and the first quarter of 2000. In May 2000,
the Company's Bank Credit Facility matures. The Company is currently working on
various sale and recapitalization alternatives in order to repay or refinance
such indebtedness. With respect to current liquidity projections, there can be
no assurances actual liquidity sources will develop as currently projected. In
the event of a shortfall of actual liquidity sources, and as a result of the
necessity of the Company to repay or refinance the existing Bank Credit
Facility, the Company will explore options to generate any necessary liquidity,
such as: (i) the sale of subsidiaries and (ii) obtain regulatory approval for
extraordinary dividends from its insurance subsidiaries (which approval is
unlikely at the present time). If the Company is unable to obtain sufficient
liquidity to meet its projected cash requirements, such failure could result in
a default on one or more obligations and the holders thereof would be entitled
to exercise certain remedies, including the acceleration of the maturity of the
entire indebtedness and commencing legal proceedings to collect the
indebtedness. In such event, the Company will examine and consider the range of
available alternatives to the Company at that time.
SUBSIDIARIES, PRINCIPALLY INSURANCE OPERATIONS
The insurance subsidiaries' principal sources of cash are premiums and
investment income. The insurance subsidiaries' primary uses of cash are policy
claims, commissions, operating expenses, income taxes and payments to the
Company for
24
<PAGE>
principal and interest due under surplus debentures, tax sharing payments and
dividends. Both sources and uses of cash are reasonably predictable.
CASH FLOW FROM OPERATING ACTIVITIES. Cash provided by operating activities,
excluding the parent company, were $41.1 million and $29.2 million for the nine
months ended September 30, 1999 and 1998, respectively. The increasing trend in
cash flow from operating activities principally resulted from decreasing costs
associated with: (i) year 2000 remediation at all of the insurance subsidiaries
and (ii) reduced costs as a result of strategic business evaluations and
associated restructuring of the Company.
CASH FLOW FROM INVESTING ACTIVITIES. The Company's investment portfolio is
managed with the objectives of maintaining high credited quality and liquidity,
maximizing current income within acceptable levels of risk, minimizing market
and credit risk, and matching the anticipated maturities of investments to the
Company's liabilities. The Company believes a conservative investment strategy
fits the nature of its insurance products which have little or no inflation risk
and limited build-up of cash accumulation values in earlier years.
The Company continuously evaluates its investment portfolio and the conditions
under which it might sell securities, including changes in interest rates,
changes in prepayment risk, liquidity needs, asset liability matching, tax
planning strategies and other economic factors. Those securities that the
Company believes would be subject to sale prior to the specified maturity date
are included in "securities available for sale," which amounted to $2,433.2
million and $2,589.7 million at September 30, 1999, and December 31, 1998,
respectively.
During the nine months ended September 30, 1999 and 1998, the Company's
subsidiaries sold $561.8 million and $527.9 million of fixed maturity and equity
securities, and purchased $753.8 million and $699.3 million of fixed maturity
and equity securities, respectively. Such sales and purchases were primarily
effected in order to reinvest cash from maturities of fixed maturity securities,
meet cash flow demands associated with policyholder surrenders that in the
aggregate exceeded policyholder deposits and to improve the quality of the
investment portfolio or avoid prepayment risks.
CASH FLOW FROM FINANCING ACTIVITIES. Cash used by financing activities,
excluding the parent company, were $465.5 million and $302.0 million for the
nine months ended September 30, 1999 and 1998, respectively. The majority of the
cash outflow is attributable to policyholder surrenders exceeding deposits by
$171.0 million and $273.2 million for the nine months ended September 30, 1999
and 1998, respectively. Cash outflows during the nine months ended September 30,
1999 also included dividends and surplus debenture principal payments
aggregating $319.9 million made to the parent company. Substantially all of
these payments were the direct result of proceeds received by PLAIC from the
disposition of Businesses Held for Sale.
RESULTS OF OPERATIONS
For the three and nine months ended September 30, 1999 and 1998, the Company has
prepared the following selected pro forma financial information for the
Company's remaining operating divisions, the Financial Services Division
(excluding the United Life Assets) and the Payroll Sales Division (excluding
Professional) and Businesses Held for Sale (Career Sales Division, Professional,
the United Life Assets and KIVEX). During the three months ended June 30, 1999,
the Company concluded that it would retain, and shut down over time, certain
remaining operations of Marketing One. Consequently, the results of operations
of Marketing One have been reclassified out of "Businesses Held for Sale" to
"Corporate" for all periods presented. The selected pro forma financial
information by operating division is defined as pre-tax income (loss) excluding
the impact of: (i) restructuring costs, (ii) gains or losses on the sale of
investments and (iii) the impact of the Company's decision to dispose of the
Businesses Held for Sale ((i), (ii) and (iii) collectively, "Operating Income
(Loss)").
The Company has prepared such information as it believes that: (i) the intended
disposition of the Businesses Held for Sale and (ii) the restructuring costs are
material enough to make historical comparative results not meaningful. In
addition, the Company believes that the selected pro forma financial information
will facilitate the subsequent discussion parallel with how management views and
evaluates the operations of the Company.
The following selected pro forma financial information has been prepared for
comparative purposes only and does not purport to be indicative of what would
have occurred had the transactions described above been made as of January 1,
1998, or the results which may occur in the future.
25
<PAGE>
SELECTED PRO FORMA FINANCIAL INFORMATION
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
1999 1998 1999 1998
------------- ------------- ------------- -------------
($ IN THOUSANDS)
<S> <C> <C> <C> <C>
Retained Business--Financial Services Division:
Operating income.............................. $ 13,942 $ 5,673 $ 23,043 $ 19,324
Net investment gains (losses)................. 1,035 1,884 (403) 4,785
RESTRUCTURING COSTS........................... -- (1,610) (5,313) (3,774)
------------- ------------- ------------- -------------
14,977 5,947 17,327 20,335
------------- ------------- ------------- -------------
Retained Business--Payroll Sales Division:
Operating income.............................. 5,446 2,599 11,214 8,394
NET INVESTMENT GAINS (LOSSES)................. 38 (3) (721) 336
------------- ------------- ------------- -------------
5,484 2,596 10,493 8,730
------------- ------------- ------------- -------------
Businesses Held for Sale:
Operating income (loss)....................... (2,584) (1,806) 15,968 (10,654)
Net investment gains (losses)................. (120) 2,290 889 7,940
Restructuring costs........................... -- 355 202 (2,696)
Net gains (losses) from sale of subsidiaries
(including realized losses on foreign
currency of $24,978)....................... (21,643) -- 6,161 --
IMPAIRMENT VALUATION.......................... -- (145,000) (58,486) (285,485)
------------- ------------- ------------- -------------
(24,347) (144,161) (35,266) (290,895)
------------- ------------- ------------- -------------
Corporate:
Interest and amortization of deferred
debt issuance cost.......................... (7,713) (10,672) (33,057) (30,945)
Corporate expenses, eliminations and other.... (7,322) (10,313) (31,436) (24,798)
Net investment gains (losses)................. (83) -- 37 (2)
RESTRUCTURING COSTS........................... -- (133) (30) (1,179)
------------- ------------- ------------- -------------
(15,118) (21,118) (64,486) (56,924)
------------- ------------- ------------- -------------
Loss before income taxes and
EXTRAORDINARY CHARGE.......................... $ (19,004) $ (156,736) $ (71,932) $ (318,754)
============= ============= ============= =============
</TABLE>
RETAINED BUSINESS--FINANCIAL SERVICES DIVISION
The Financial Services Division includes the operations of Southwestern Life and
Security Life. Southwestern Life and Security Life market life insurance and, to
a lesser extent annuity products, through independent general agents who sell
directly to individuals primarily in the southwestern and southeastern United
States.
SELECTED PRO FORMA FINANCIAL INFORMATION
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
1999 1998 1999 1998
------------- ------------- ------------- -------------
($ IN THOUSANDS)
<S> <C> <C> <C> <C>
Revenues:
Policy revenues............................... $ 34,321 $ 38,638 $ 104,071 $ 105,935
Net investment income......................... 40,287 43,179 122,349 135,599
OTHER INCOME.................................. 5,973 238 9,457 3,334
------------- ------------- ------------- -------------
80,581 82,055 235,877 244,868
------------- ------------- ------------- -------------
Benefits and expenses:
Total policyholder benefits................... 50,634 57,174 158,401 177,073
Insurance related expenses.................... 7,145 7,223 23,184 16,348
OTHER OPERATING EXPENSES...................... 8,860 11,985 31,249 32,123
------------- ------------- ------------- -------------
66,639 76,382 212,834 225,544
------------- ------------- ------------- -------------
PRE-TAX OPERATING INCOME.................... $ 13,942 $ 5,673 $ 23,043 $ 19,324
============= ============= ============= =============
</TABLE>
26
<PAGE>
POLICY REVENUES. Policy revenues include: (i) premiums received on traditional
life products and a small amount of traditional annuities (ii) mortality and
administrative fees earned on universal life insurance and annuities and (iii)
surrender charges on terminated universal life and annuity products. In
accordance with GAAP, premiums on universal life and annuity products are
accounted for as deposits to insurance liabilities.
Premiums, net of reinsurance, by major product line for the three and nine
months ended September 30, 1999 and 1998 are as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
1999 1998 1999 1998
------------- ------------- ------------- -------------
($ IN THOUSANDS)
<S> <C> <C> <C> <C>
Life premiums:
Universal life (first year)................... $ 2,224 $ 2,640 $ 7,251 $ 8,305
Universal life (renewal)...................... 21,371 37,315 53,740 86,999
Yearly renewable term reinsurance on
universal life.............................. (2,149) (2,024) (6,523) (5,414)
Traditional life (first year)................. 2,074 2,294 7,028 7,980
TRADITIONAL LIFE (RENEWAL).................... 9,013 13,315 24,669 32,122
------------- ------------- ------------- -------------
Life premiums, net of reinsurance........... 32,533 53,540 86,165 129,992
Annuity premiums................................ 1,993 4,104 6,651 12,662
Fixed benefit premiums:
Long-term care premiums net of reinsurance
(all first year)............................ 131 176 57 179
------------- ------------- ------------- -------------
Premiums, net of reinsurance.............. 34,657 57,820 92,873 142,833
Less premiums on universal life and
annuities which are recorded as additions
to insurance liabilities...................... (25,588) (44,059) (67,642) (107,966)
------------- ------------- ------------- -------------
Premiums on products with mortality or
morbidity risk.......................... 9,069 13,761 25,231 34,867
Fees and surrender charges on interest
sensitive products............................ 25,252 24,877 78,840 71,068
------------- ------------- ------------- -------------
POLICY REVENUES........................... $ 34,321 $ 38,638 $ 104,071 $ 105,935
============= ============= ============= =============
</TABLE>
Policy revenues decreased 11.2% and 1.8% during the three and nine months ended
September 30, 1999, respectively. Life premiums collected, net of reinsurance,
were $32.5 million and $86.2 million for the three and nine months ended
September 30, 1999 compared with $53.5 million and $130.0 million in the
comparable periods of 1998. First year universal life premiums decreased 15.8%
and 12.7% in the three and nine months ended September 30, 1999, respectively,
to $2.2 million and $7.3 million for the three and nine months ended September
30, 1999, respectively, and first year traditional life decreased 9.6% and 11.9%
to $2.1 million and $7.0 million for the three and nine months ended September
30, 1999, respectively. The decline is attributable to lower sales at Security
Life. New life sales at Security Life have declined significantly during 1998
and for the three and nine months ended September 30, 1999 reflecting the impact
of ratings downgrades and management changes in Security Life's marketing
management. The Company recently announced it was discontinuing new life sales
at Security Life in order to reduce costs and concentrate its marketing efforts
at Southwestern Life. Partially offsetting the decline in first year premiums
for Security Life was first year universal life premium at Southwestern Life
which increased 58.6% and 42.2% to $1.7 million and $5.4 million for the three
and nine months ended September 30, 1999, respectively compared with the
comparable periods of 1998. In addition, first year traditional life premiums at
Southwestern Life increased 29.2% to $1.6 million for the three months ended
September 30, 1999 and decreased 7.2% to $5.0 million for the nine months ended
September 30, 1999 compared with the comparable 1998 periods.
Universal life and traditional life renewal premiums declined $20.2 million and
$40.7 million or 40.0% and 34.2% for the three and nine months ended September
30, 1999 compared with the comparable 1998 periods. This reflects ratings
downgrades and the impact of certain management actions instituted by Security
Life. On January 1, 1999 Security Life instituted an exchange or refund program
for holders of certain types of interest sensitive insurance contracts. This
program resulted in a refund of premiums of $3.5 million and $21.6 million for
the three and nine months ended September 30, 1999, respectively, and will
likely result in additional refund of premiums for the remainder of 1999. See
"Total Policyholder Benefits," included herein and Note 10 of the Notes to
Unaudited Consolidated Financial Statements. Universal life and
27
<PAGE>
traditional life renewal premiums at Southwestern Life decreased by 3.2% and
2.1% to $19.2 million and $58.9 million for the three and nine months ended
September 30, 1999, respectively, compared with the comparable 1998 periods.
Annuity premiums of $2.0 million and $6.7 million for the three and nine months
ended September 30, 1999, respectively, were less than premiums of $4.1 million
and $12.7 million in the comparable periods of 1998. Annuity sales are likely to
continue to decline unless market conditions for fixed annuities become more
favorable and ratings improve.
Southwestern Life entered into an amendment to its currently existing
reinsurance on long-term care products increasing the cession amount to 80%
retroactively to 1998. The impact of such amendment was to reduce premium
consideration for long-term care by $527,000 and $1.8 million for the three and
nine months ended September 30, 1999, respectively.
NET INVESTMENT INCOME. Net investment income decreased 6.7% and 9.8% to $40.3
million and $122.3 million for the three and nine months ended September 30,
1999, respectively, due to a decrease in invested assets and reduced yields on
investments. Average invested assets declined approximately $162.0 million and
$198.5 million for the three and nine months ended September 30, 1999,
respectively, compared with the comparable periods in 1998. Most of this
decrease resulted from the need to liquidate invested assets to provide cash to
fund surrenders of annuities and universal life products, which totaled $59.4
million and $203.0 million for the three and nine months ended September 30,
1999, respectively. Most of these surrenders involved annuities which had
reached the end of their surrender fee period. A continued decline in the
invested asset base and related investment income is anticipated as surrenders
are expected to remain high over the next few years as more annuity contracts in
force reach the end of the surrender fee periods without the insurance companies
actively marketing other replacement business for these accumulation products.
The decrease in invested assets due to surrenders was partially offset by
premiums on new and existing life policies and investment income collected, less
commissions and operating expenses. Weighted average yields on invested assets
have decreased to 6.7% and 6.9% for the three and nine months ended September
30, 1999, respectively, compared to 6.9% and 7.0% for the three and nine months
ended September 30, 1998, respectively. During 1999, Southwestern Life and
Security Life have continued to liquidate mortgages, real estate and other
higher yielding but less liquid assets and have maintained higher than normal
balances in cash and short-term investments, which have moderately reduced
yields.
OTHER INCOME. Other income increased $5.7 million and $6.1 million to $6.0
million and $9.5 million for the three and nine months ended September 30, 1999,
respectively. Included in the three and nine months ended September 30, 1999 was
income of $5.7 million, which resulted from a gain and distribution of assets
from the sale of most of the operations and assets of a joint venture
investment. The remainder of the increase principally reflects changes in
consideration received on supplemental contracts. Supplemental contract revenue
is derived from annuity contracts which have reached the annuitization period.
Consideration from supplemental contracts recognized as other income is offset
by policyholder benefits, resulting in no net effect on the Company's results of
operations.
TOTAL POLICYHOLDER BENEFITS. The following table shows the components of total
policyholder benefits for the three and nine months ended September 30, 1999 and
1998:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
1999 1998 1999 1998
------------- ------------- ------------- -------------
($ IN THOUSANDS)
<S> <C> <C> <C> <C>
Death benefits.................................. $ 18,634 $ 21,159 $ 61,975 $ 66,950
Other insurance policy benefits and change
IN FUTURE POLICY BENEFITS..................... 32,000 36,015 96,426 110,123
------------- ------------- ------------- -------------
TOTAL POLICYHOLDER BENEFITS..................... $ 50,634 $ 57,174 $ 158,401 $ 177,073
============= ============= ============= =============
</TABLE>
Policyholder benefits decreased 11.4% and 10.5% to $50.6 million and $158.4
million for the three and nine months ended September 30, 1999, respectively,
compared with the comparable 1998 periods. Death benefits decreased $2.5 million
and $5.0 million or 11.9% and 7.4% for the three and nine months ended September
30, 1999, respectively, compared with the comparable 1998 periods. Death
benefits may vary significantly from period to period. Change in future policy
benefits and other benefits decreased 11.1% and 12.4% to $32.0 million and $96.4
million for the three and nine months ended September 30, 1999. As a result of
the exchange program at Security Life, reserves decreased $4.0 million and $11.4
million for the three and nine months ended September 30, 1999. The remainder of
the decrease for the nine month period ended September 30, 1999 compared to the
same period in 1998 is principally due to reduced other benefits and scheduled
annuity benefits reflecting lower in force amounts resulting from surrender
activity.
28
<PAGE>
The Company is continually evaluating actuarial assumptions associated with
interest sensitive life insurance contracts in which the determination of policy
reserves is highly sensitive to assumptions such as withdrawal rates, investment
earnings rates, mortality rates, and premium persistency. Currently reflected in
the Company's financial statements are policy reserves and account values
associated with such contracts, which aggregated approximately $518.6 million as
of September 30, 1999 and $525.4 million as of December 31, 1998. Current trends
associated with certain blocks of business appear to indicate the need to record
additional reserves or reduce intangible assets, which could have a material
impact on the Company's financial position and results of operations. Management
is also assessing the potential impact of future management actions, which might
mitigate the financial impact of these trends. Types of management actions would
likely include, but are not limited to, the redetermination of non-guaranteed
charges and/or benefits under the contracts, asset segmentation, and
reinsurance. The Company is pursuing a plan to continue charging certain expense
loads associated with certain interest sensitive life insurance contracts which
fully mitigates the impact of the need to record additional reserves on such
policies. There are risks associated with management action including potential
sales disruption and potential litigation. The Company is continuing to refine
its actuarial estimates and associated sensitivity testing of such
interdependencies on policy reserves associated with these contracts which could
result in changes in such estimates in the future.
In January 1999, Security Life initiated management action in the form of a new
exchange program for certain policyholders of Security Life. The program is
being offered to all policyholders who had certain policy forms in force as of
January 1, 1998. The program allows the policyholder the following options in
exchange for terminating his or her policy and executing a release: (i) refund
of 115% of all premiums paid for the policy prior to January 1, 1999 and 100% of
premiums paid thereafter; (ii) exchange the policy, without proof of
insurability, for the same face amount in a universal life policy, or a new term
universal life policy. The policyholder also has the choice of not accepting the
exchange program and keeping the current policy in force. There can be no
assurances that the exchange program will be successful or that the Company will
resolve these matters on such life insurance products on a satisfactory basis,
or at all, or that any such resolution would not have a material adverse effect
on the Company's financial condition, results of operations or cash flows. The
exchange program is not expected to have a material effect on the Company's
financial position or results of operations (see Note 10 of Notes to Unaudited
Consolidated Financial Statements).
INSURANCE RELATED EXPENSES. Insurance related expenses (including commissions,
amortization of deferred policy acquisition costs and amortization of present
value of insurance in force) decreased $78,000 and increased $6.8 million during
the three and nine months ended September 30, 1999, respectively, compared with
the comparable 1998 periods. Amortization of deferred policy acquisition costs
increased $3.4 million during the nine months ended September 30, 1999 compared
to the comparable 1998 period. The increase during the nine months ended
September 30, 1999, principally reflects the growing block of policies in force,
as a result of new business sales subsequent to the Company's acquisitions of
Security Life and Southwestern Life. The amortization of deferred policy
acquisition costs decreased $11,000 during the three months ended September 30,
1999 compared to the comparable 1998 period. As a result of unlocking
assumptions regarding future profitability of certain interest sensitive life
insurance products at Southwestern Life, amortization decreased approximately
$2.0 million which offset the general trend of increasing amortization.
Amortization of present value of insurance in force increased $2.7 million and
$8.0 million for the three and nine months ended September 30, 1999. The
increase for the three month period ended September 30, 1999 was principally
attributable to adjustments to VOBA amortization at Security Life. The increase
for the nine months ended September 30, 1999 compared to the comparable 1998
period was also effected by a favorable impact from unlocking certain
assumptions regarding the future profitability of certain interest sensitive
life insurance products for Southwestern Life, which occurred during the three
months ended March 31, 1998.
OTHER OPERATING EXPENSES. For the three and nine months ended September 30,
1999, other operating expenses (including general operating, overhead and policy
maintenance) decreased $3.1 million and $870,000 from the comparable periods in
1998. The decrease in the three months ended September 30, 1999 is attributable
to ongoing reductions in costs associated with the restructuring of the Dallas
operations, a reduction in non-deferrable expenses related to costs associated
with year 2000 remediation efforts and systems conversions for Security Life as
these projects were substantially completed in the three months ended September
30, 1999. The decrease for the nine months ended September 30, 1999 also
reflects a charge during 1998 for uncollectible agents' debit balances at
Security Life. The decrease was partially offset by increases in non-deferrable
expenses during the six months ended June 30, 1999 related to costs associated
with year 2000 remediation efforts and systems conversions for Security Life. In
addition, the liability held at Southwestern Life to reflect expected
assessments to life and health guaranty associations of states in which it is
licensed to do business was reduced by approximately $1.5 million as a result of
a re-evaluation of such estimates made in the three months ending September 30,
1999.
29
<PAGE>
RETAINED BUSINESS--PAYROLL SALES DIVISION
The Payroll Sales Division includes the operations of AA Life and OLIC. AA Life
markets and underwrites customized life insurance and accumulation products to
U.S. military personnel and federal employees through a general agency force.
OLIC provides individual fixed benefit and life products utilizing a network of
independent agents primarily in the southeastern United States through
employer-sponsored payroll deduction programs.
SELECTED PRO FORMA FINANCIAL INFORMATION
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
1999 1998 1999 1998
------------- ------------- ------------- -------------
($ IN THOUSANDS)
<S> <C> <C> <C> <C>
Revenues:
Policy revenues............................... $ 23,130 $ 22,815 $ 69,431 $ 66,446
Net investment income......................... 9,490 9,583 28,279 28,666
OTHER INCOME.................................. 549 (8) 1,452 250
------------- ------------- ------------- -------------
33,169 32,390 99,162 95,362
------------- ------------- ------------- -------------
Benefits and expenses:
Total policyholder benefits................... 13,322 16,166 46,642 48,093
Insurance related expenses.................... 9,996 8,991 27,560 25,686
OTHER OPERATING EXPENSES...................... 4,405 4,634 13,746 13,189
------------- ------------- ------------- -------------
27,723 29,791 87,948 86,968
------------- ------------- ------------- -------------
PRE-TAX OPERATING INCOME.................... $ 5,446 $ 2,599 $ 11,214 $ 8,394
============= ============= ============= =============
</TABLE>
POLICY REVENUES. Premiums received, net of reinsurance, by major product line
for the three and nine months ended September 30, 1999 and 1998 are as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
1999 1998 1999 1998
------------- ------------- ------------- -------------
($ IN THOUSANDS)
<S> <C> <C> <C> <C>
Life premiums:
Universal life (first year)................... $ 205 $ 158 $ 609 $ 636
Universal life (renewal)...................... 6,452 5,287 19,273 17,878
Traditional life (first year)................. 3,748 4,352 12,045 12,912
TRADITIONAL LIFE (RENEWAL).................... 9,327 7,412 28,751 21,784
------------- ------------- ------------- -------------
LIFE PREMIUMS, NET OF REINSURANCE........... 19,732 17,209 60,678 53,210
------------- ------------- ------------- -------------
ANNUITY PREMIUMS................................ 260 247 892 685
------------- ------------- ------------- -------------
Fixed benefit premiums:
Accident and health (first year).............. 726 815 1,946 2,049
ACCIDENT AND HEALTH (RENEWAL)................. 2,780 3,223 7,760 8,094
------------- ------------- ------------- -------------
FIXED BENEFIT PREMIUMS, NET OF REINSURANCE.. 3,506 4,038 9,706 10,143
------------- ------------- ------------- -------------
Premiums, net of reinsurance................ 23,498 21,494 71,276 64,038
Less premiums on universal life and
annuities which are recorded as additions
to insurance liabilities...................... (6,917) (5,692) (20,774) (19,199)
------------- ------------- ------------- -------------
Premiums on products with mortality or
morbidity risk............................ 16,581 15,802 50,502 44,839
Fees and surrender charges on interest
sensitive products............................ 6,549 7,013 18,929 21,607
------------- ------------- ------------- -------------
POLICY REVENUES............................. $ 23,130 $ 22,815 $ 69,431 $ 66,446
============= ============= ============= =============
</TABLE>
Total policy revenues increased modestly between the three and nine months ended
September 30, 1999 and the comparable 1998 periods. Policy revenues increased
$315,000 and $3.0 million or 1.4% and 4.5% during the three and nine months
ended
30
<PAGE>
September 30, 1999, respectively. Most of the increase was attributable to AA
Life's increasing new business sales during 1998 which resulted in higher
renewal premiums during the three and nine months ended September 30, 1999. AA
Life's first year sales for the three and nine month periods ended September 30,
1999 have lagged behind comparable 1998 levels as a result of (i) the high level
of readiness of U.S. military personnel, AA Life's principal market, throughout
the world and (ii) additional restrictions and scrutiny placed on sales
practices on U.S. military installations. The Company expects the decreased
level of new business production to continue in the foreseeable future.
NET INVESTMENT INCOME. Net investment income decreased 1.0% and 1.4% for the
three and nine months ended September 30, 1999 from the comparable 1998 periods
to $9.5 million and $28.3 million, respectively. The decrease in net investment
income was primarily the result of a decrease in average invested assets which
decreased $3.3 million (0.6%) and $6.6 million (1.3%) in the three and nine
months ended September 30, 1999, respectively, compared to the comparable 1998
periods.
OTHER INCOME. Other income was $549,000 and $1.5 million during the three and
nine months ended September 30, 1999, respectively, compared to a loss of $8,000
and income of $250,000 in the three and nine months ended September 30, 1998,
respectively. Supplemental contracts represent most of the other income in the
three and nine months ended September 30, 1999. These can fluctuate
significantly from period to period but have little impact on results of
operations as proceeds are offset by change in reserves.
TOTAL POLICYHOLDER BENEFITS. The following table shows the components of total
policyholder benefits for the three and nine months ended September 30, 1999 and
1998:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
1999 1998 1999 1998
------------- ------------- ------------- -------------
($ IN THOUSANDS)
<S> <C> <C> <C> <C>
Death benefits.................................. $ 5,202 $ 6,407 $ 16,874 $ 17,970
Fixed benefit claims incurred................... 1,886 1,756 6,323 5,883
Other insurance policy benefits and
CHANGE IN FUTURE POLICY BENEFITS.............. 6,234 8,003 23,445 24,240
------------- ------------- ------------- -------------
TOTAL POLICYHOLDER BENEFITS..................... $ 13,322 $ 16,166 $ 46,642 $ 48,093
============= ============= ============= =============
</TABLE>
Policyholder benefits decreased $2.8 million or 17.6% and $1.5 million or 3.0%
in the three and nine months ended September 30, 1999, compared with the
comparable 1998 periods. Death benefits decreased $1.2 million and $1.1 million
in the three and nine months ended September 30, 1999, compared with the
comparable 1998 periods. Death benefits may vary significantly from period to
period. Other insurance policy benefits and change in future policy benefits
decreased $1.8 million and $796,000 for the three and nine months ended
September 30, 1999 compared to comparable 1998 periods. Most of the decreases
reflect decreases in life and fixed benefit health reserves at OLIC as a result
of reduced claims activity and a reduced inventory of open claims.
INSURANCE RELATED EXPENSES. Insurance related expenses (including commissions,
amortization of deferred policy acquisition costs and amortization of present
value of insurance in force) increased $1.0 million and $1.9 million for the
three and nine months ended September 30, 1999, respectively, compared to the
comparable 1998 periods. Amortization of deferred policy acquisition costs at AA
Life increased $1.4 million and $3.5 million for the three and nine months ended
September 30, 1999, respectively, compared to the comparable 1998 periods
primarily reflecting the growing block of policies in force as a result of new
business sales subsequent to the Company's acquisition of AA Life. Amortization
of the present value of insurance in force decreased $843,000 and $1.3 million
for the three and nine months ended September 30, 1999, respectively, compared
with the comparable 1998 periods, primarily as a result of unlocking assumptions
regarding future profitability at OLIC during the three months ended December
31, 1998, which significantly reduced the amount of such assets, hence lowering
future amortization.
OLIC is currently implementing a plan to enhance the profitability associated
with certain of its interest sensitive life insurance and fixed benefit
products. If OLIC's plan is not implemented successfully the Company may be
required to reduce intangible assets, which could have a material impact on the
Company's financial position and results of operations. Profitability
enhancement measures include, but are not limited to, the redetermination of
non-guaranteed charges and/or benefits under the contracts. Such changes may
require the approval of the various state insurance departments, and there can
be no guarantee that OLIC will be granted the revised rates that it seeks. There
are risks associated with these
31
<PAGE>
management actions including potential sales disruption, excess lapse activity,
policyholder anti-selection and potential litigation. Management is also
assessing reinsurance alternatives to strengthen OLIC's capital position.
OTHER OPERATING EXPENSES. Other operating expenses (including general operating,
overhead and policy maintenance) decreased $229,000 in the three months ended
September 30, 1999 and increased $557,000 in the nine months ended September 30,
1999 compared to the comparable 1998 periods. The decrease in expenses is
principally attributable to reduced costs associated with the ongoing
integration of OLIC into the Waco operations. The increase for the nine months
ended September 30, 1999, is principally attributable to non-deferrable expenses
related to costs associated with year 2000 remediation efforts and systems
conversions.
BUSINESSES HELD FOR SALE
Businesses Held for Sale include the operations of the Career Sales Division
(sold July 30, 1999), KIVEX (sold June 30, 1999), Professional (sold March 31,
1999) and the United Life Assets (sold April 30, 1999). The Career Sales
Division, which includes the operations of Penn Life, markets and underwrites
fixed benefit accident and sickness products and, to a lesser extent, life
products through a sales force exclusive to the Company throughout the United
States and Canada. With the January 2, 1998, consummation of the acquisition of
the SW Financial Controlling Interest, the Company has integrated Union Bankers,
Marquette and Constitution with the Career Sales Division. KIVEX is an internet
service provider. Professional provides individual fixed benefit and life
products utilizing a network of independent agents primarily in the southeastern
United States through employer-sponsored payroll deduction programs. United Life
principally markets fixed and variable annuities through financial institutions
and independent general agents, primarily in the southern and western United
States.
SELECTED PRO FORMA FINANCIAL INFORMATION
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
1999 1998 1999 1998
------------- ------------- ------------- -------------
($ IN THOUSANDS)
<S> <C> <C> <C> <C>
Revenues:
Policy revenues............................... $ 12,498 $ 62,152 $ 112,915 $ 189,031
Net investment income......................... 2,877 34,533 54,568 107,584
OTHER INCOME.................................. 1,059 4,415 13,015 14,048
------------- ------------- ------------- -------------
16,434 101,100 180,498 310,663
------------- ------------- ------------- -------------
Benefits and expenses:
Total policyholder benefits................... 10,445 61,033 101,565 200,876
Insurance related expenses.................... 2,459 23,438 24,224 69,176
OTHER OPERATING EXPENSES...................... 6,114 18,435 38,741 51,265
------------- ------------- ------------- -------------
19,018 102,906 164,530 321,317
------------- ------------- ------------- -------------
PRE-TAX OPERATING INCOME (LOSS)............... $ (2,584) $ (1,806) $ 15,968 $ (10,654)
============= ============= ============= =============
</TABLE>
POLICY REVENUES. Policy revenues declined 79.9% and 40.3% or $49.7 million and
$76.1 million in the three and nine months ended September 30, 1999 compared to
the comparable 1998 periods. The decline is primarily attributable to the sale
of Professional, the United Life Assets and the Career Sales Division on March
31, 1999, April 30, 1999 and July 30, 1999, respectively. In addition, Union
Bankers discontinued sales of major medical health products and its life
insurance products and increased its utilization of reinsurance, each of which
had the impact of lowering policy revenues.
NET INVESTMENT INCOME. Net investment income decreased $31.7 million and $53.0
million during the three and nine months ended September 30, 1999 compared to
the comparable 1998 periods. The decrease is primarily attributable to the sales
of Professional, the United Life Assets and the Career Sales Division on March
31, 1999, April 30, 1999 and July 30, 1999, respectively.
OTHER INCOME. Other income decreased $3.4 million and $1.0 million in the three
and nine months ended September 30, 1999, respectively, compared to the
comparable 1998 periods. Most of the decrease is attributable to the sale of
KIVEX on June 30, 1999.
32
<PAGE>
TOTAL POLICYHOLDER BENEFITS. Policyholder benefits decreased $50.6 million and
$99.3 million in the three and nine months ended September 30, 1999 compared to
the comparable 1998 periods. The decrease is attributable to the sales of
Professional, the United Life Assets and the Career Sales Division on March 31,
1999, April 30, 1999 and July 30, 1999, respectively.
INSURANCE RELATED EXPENSES. Insurance related expenses (including commissions,
amortization of deferred policy acquisition costs and amortization of present
value of insurance in force) decreased $21.0 million and $45.0 million to $2.5
million and $24.2 million for the three and nine months ended September 30,
1999, respectively, compared to the comparable 1998 periods. Amortization of
present value of insurance in force decreased $4.0 million and $9.1 million in
the three and nine months ended September 30, 1999, respectively. Amortization
of deferred policy acquisition costs decreased $11.0 million and $19.7 million.
These decreases principally reflect the Company recording an impairment
provision associated with assets of Businesses Held for Sale in 1998 resulting
in the elimination of substantially all insurance assets subject to amortization
for the Career Sales Division. Most of the remainder of the decrease is
attributable to the sales of Professional and the United Life Assets on March
31, 1999 and April 30, 1999, respectively.
OTHER OPERATING EXPENSES. Other operating expenses (including general operating,
overhead and policy maintenance) decreased $12.3 million and $12.5 in the three
and nine months ended September 30, 1999, respectively, compared to the
comparable 1998 periods. The decrease is principally attributable to the sales
of Professional, United Life, KIVEX and the Career Sales Division on March 31,
1999, April 30, 1999, June 30, 1999 and July 30, 1999, respectively. The
decrease is partially offset by the increased operating expenses at KIVEX in the
six months ended June 30, 1999, reflecting costs associated with its expansion
into new cities.
GENERAL CORPORATE
INTEREST AND AMORTIZATION OF DEFERRED DEBT ISSUANCE COSTS. Interest and
amortization of deferred debt issuance costs decreased $3.0 million and
increased $2.1 million, respectively, in the three and nine months ended
September 30, 1999, respectively, compared to the comparable 1998 periods. The
decrease during the three months ended September 30, 1999 is principally a
result of principal repayments under the bank credit facility. The increase in
the nine months ended September 30, 1999 is the result of higher weighted
average borrowing costs, additional costs associated with credit facility fees
and costs incurred to amend the credit agreement. These are a direct result of
the Company's current financial position. In addition, during the three month
period ended March 31, 1999, the Company accelerated amortization of certain
deferred loan costs in the amount of $2.1 million in accordance with Emerging
Issues Task Force ("EITF") Issue No. 98-14, "Debtor's Accounting for Changes in
Line-of-Credit or Revolving-Debt-Arrangements," as a result of the amendment to
the Bank Credit Facility. EITF Issue No. 98-14 requires the unamortized deferred
loan costs be written off in proportion to the decrease in borrowing capacity of
the original arrangement. These increases were partially offset by a debt
reduction of $40.0 million of principal made on April 1, 1999 with proceeds from
the sale of Professional, a debt reduction of $127.0 million of principal made
on April 30, 1999 with proceeds from the sale of the United Life Assets, a debt
reduction of $22.0 million of principal made on June 30, 1999 with proceeds from
the sale of KIVEX, a debt reduction of $78.0 million of principal made on July
30, 1999 with proceeds from the sale of the Career Sales Division and a debt
reduction of $2.0 million on September 23, 1999.
CORPORATE EXPENSES, ELIMINATIONS AND OTHER. Corporate expenses, eliminations and
other costs were $7.3 million and $10.3 million for the three months ended
September 30, 1999 and 1998, respectively, and were $31.4 million and $24.8
million for the nine months ended September 30, 1999 and 1998, respectively. The
decrease for the three months ended September 30, 1999 was primarily the result
of the decision to close the Company's New York and Bethesda offices and
eliminate personnel located in such offices. In addition, the Company is in the
process of closing down Marketing One. Expenses at Marketing One decreased $1.4
million and $4.0 million for the three and nine months ended September 30, 1999
compared to comparable 1998 periods. The decrease was offset in the nine months
ended September 30, 1999 by several factors: (i) additional amortization of
costs in excess of net assets acquired of approximately $7.0 million for the
three months ended June 30, 1999 associated with KB Management. The write-off
reflects the Board of Directors' decision to terminate KB Investment Fund I, LP,
for which KB Management and KB Investment acts as administrator and general
partner, respectively; (ii) additional costs associated with efforts to develop
recapitalization and restructuring alternatives; (iii) additional consulting and
legal fees of $213,000 and $3.7 million for the three and nine months ended
September 30, 1999, respectively, associated with the negotiation and
implementation of, and compliance with, the amended Bank Credit Facility,
pending class action securityholder litigation and the SEC investigation; (iv)
additional deferred compensation of $2.5 million for the nine months ended
September 30, 1999, associated with the two year employment agreements of the
Company's three senior executives which were entered into in May 1998; and (v)
provisions of $2.3 million to settle shareholder and other litigation.
33
<PAGE>
INCOME TAXES (BENEFITS). For the three months ended September 30, 1999, the
Company recognized income tax expense of $9.1 million on loss before taxes of
$19.0 million. For the nine months ended September 30, 1999, income tax expense
was $17.0 million on loss before taxes of $71.9 million. The unusual effective
tax rates in 1999 and 1998 are substantially due to the non-deductibility of the
reduction in carrying value of the assets associated with Businesses Held for
Sale and a tax valuation allowance, primarily representing unrecoverable net
operating loss carryforwards at certain non-life companies.
In light of the continued changes in the ownership of shares of the Company's
common and preferred stock, management and its advisors are performing ongoing
evaluations of the possibility of a "change of control" as defined by the
Internal Revenue Code Section 382. Change of control provisions of Section 382
could limit the Company's ability to utilize certain tax benefits including net
operating loss carryforwards which could negatively impact the operating results
and cash flows of the Company and its subsidiaries in future periods.
NET INVESTMENT GAINS (LOSSES). The Company maintains an investment portfolio
that focuses on maximizing investment income, without exposure to unwarranted
interest rate and credit risk. The Company actively manages asset duration and
liquidity risks. As a result of this strategy, the Company routinely sells
positions in securities no longer meeting its criteria. Sales of securities
resulted in the Company realizing gains of $870,000 and $4.2 million, during the
three months ended September 30, 1999 and 1998, respectively. The Company
realized losses on sales of securities totaling $198,000 and gains totaling
$13.1 million during the nine months ended September 30, 1999 and 1998,
respectively. During the nine months ended September 30, 1999 and 1998, the
Company liquidated securities available for sale in order to meet cash flow
demands associated with policyholder surrenders that in the aggregate exceeded
policyholder deposits by $171.0 million and $273.2 million, respectively.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The Company analyzes and reviews the risks arising from market exposures of
financial instruments. Upward movement in market interest rates during the first
nine months of 1999 resulted in a significant decline in the unrealized
appreciation of the bond portfolio since the end of 1998. However, the Company's
assets and liabilities portfolio and its exposure to market risk has not changed
materially from its position at December 31, 1998. For disclosures about the
Company's market risk exposures of financial instruments for its Retained
Businesses, see the Company's Annual Report on Form 10-K for the year ended
December 31, 1998.
(REMAINDER OF PAGE INTENTIONALLY LEFT BLANK)
34
<PAGE>
PART II -- OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
During the third quarter of 1998, the first of ten class-action complaints were
filed in the United States District Court for the Southern District of New York
("District Court") against the Company and certain of its current or former
directors and officers.
During a pre-trial conference on November 9, 1998, all parties agreed to the
consolidation of all of the actions and the Court appointed lead plaintiffs on
behalf of shareholders and noteholders. The Court also approved the selection of
three law firms as co-lead counsel for shareholders and noteholders. A
consolidated and amended complaint was filed on January 22, 1999. A First
Consolidated Amended Class Action Complaint naming, as defendants, the Company,
David J. Stone, formerly a director and Chairman and Chief Executive Officer,
and Steven W. Fickes, formerly a director and President and Chief Financial
Officer was filed on March 15, 1999 (the "Complaint").
The Complaint alleges that defendants violated the Securities Exchange Act of
1934. Among other things, plaintiffs claim that defendants issued a series of
materially false and misleading statements and omitted material facts regarding
the Company's financial condition, including the value of certain of its assets,
and failed to timely disclose that it was under investigation by the Securities
and Exchange Commission (the "SEC").
Plaintiffs seek to recover damages in unspecified amounts on behalf of
themselves and all other purchasers of the Company's common stock and purchasers
of the Company's subordinated notes during the period of February 8, 1996,
through November 16, 1998.
During a conference on March 19, 1999, defendants sought and were granted
permission to file, and subsequently filed, a motion to dismiss the Complaint.
Although there are no assurances that the motion to dismiss will be granted,
management believes that there are meritorious defenses to the action that were
raised in connection with the motion, including whether the Complaint adequately
pleads scienter (i.e., intent to defraud) as required under the Private
Securities Litigation Reform Act of 1995.
The Company has notified its primary and excess carriers of directors and
officers liability insurance of the existence of the claims set forth in the
Complaint, and the total potential insurance available is $15,000 of primary and
$10,000 of excess coverage, respectively, for securities claims. The primary
insurance coverage requires the Company to bear 25% of: (i) all expenses and
(ii) any losses in excess of a $1,000 retention amount. The primary and excess
carriers have reserved their rights under the policies with respect to coverage
of the claims set forth in the Complaint. As explained below, the primary
insurer has agreed in principle to contribute to a settlement of the litigation.
Following settlement discussions with the Plaintiffs' counsel and
representatives of the primary insurance carrier and their counsel, the parties
to the Complaint have entered into a Memorandum of Understanding dated November
11, 1999 (the "Memo") containing the essential terms of a settlement.
The Memo states that $9,000 of cash plus interest accruing through the date of
consummation of the settlement, will be paid in full and final settlement of all
claims set forth in the Complaint (the "Settlement"). Of that sum, $1,500 plus
interest will be paid by the Company and $7,500 plus interest will be paid by
the Company's outside directors and officers liability insurance carrier. The
Settlement is conditioned upon, among other things, confirmatory discovery,
execution of a definitive settlement agreement and related documents, notice to
the Company's shareholders of the Settlement and final approval by the United
States District Court (with all time to appeal such approval having run or any
appeals having been resolved in favor of approval of the Settlement). During the
three months ended September 30, 1999, the Company established a $1,500
liability related to the settlement.
The Company expects that this litigation will not affect its ability to operate
through December 31, 1999. While it is not feasible to predict or determine the
final outcome of these proceedings or to estimate the amounts or potential range
of loss with respect to these matters, management believes that if the
Settlement is not consummated and there is an adverse outcome with respect to
such proceedings, it would have a material adverse impact on the Company and
affect its ability to operate as is currently intended.
On July 30, 1998, the SEC notified the Company that it had commenced a formal
investigation into possible violations of the federal securities laws including
matters relating to the Company's restatement of its financial statements for
the first six
35
<PAGE>
months of 1997, and for the years ended December 31, 1994, 1995 and 1996. The
Company and its management are fully cooperating with the SEC in its
investigation.
The Company is a party to various other pending or threatened legal actions
arising in the ordinary course of business, some of which include allegations of
insufficient policy illustration and agent misrepresentations. Although the
outcome of such actions is not presently determinable, management does not
believe that such matters, individually or in the aggregate, would have a
material adverse effect on the Company's financial position or results of
operations if resolved against the Company.
ITEM 5. OTHER INFORMATION
The disclosures contained in Notes 3 and 4 to the Unaudited Consolidated
Financial Statements of the Company contained in Item 1 of Part I of this Form
10-Q with respect to the sale of the Career Sales Division and the amendments to
the Bank Credit Facility are incorporated herein by reference. In addition, the
unaudited Selected Pro Forma Financial Information contained in Note 5 to the
Unaudited Consolidated Financial Statements of the Company contained in Item 1
of Part I of this Form 10-Q and the Selected Pro Forma Financial Information
contained in Item 2 of Part I of this Form 10-Q reflecting the disposition of
the Career Sales Division as well as the disposition of KIVEX, Professional and
the United Life Assets, are incorporated herein by reference.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(A) EXHIBITS
10.1 Pacific Life and Accident Insurance Company Surplus Debenture No. 7
dated as of July 30, 1999 for $150,000,000. (1)
10.2 Agreement dated September 9, 1999 between David C. Smith, Chairman of
the Board of the Company and PennCorp Financial Group, Inc. (1)
11.1 Computation of Loss per Share (1)
15.1 Independent Auditors' Report (2)
27 Financial Data Schedule (1)
(1) Filed herewith.
(2) Included in Item 1 of Part I of this Form 10-Q.
(B) REPORTS ON FORM 8-K
None.
36
<PAGE>
SIGNATURE
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.
PENNCORP FINANCIAL GROUP, INC.
BY:/S/JAMES P. MCDERMOTT
------------------------
James P. McDermott
Executive Vice President and Chief Financial Officer
(Authorized officer and principal accounting and
financial officer of the Registrant)
Date: November 9, 1999
37
<PAGE>
INDEX TO EXHIBITS
EXHIBIT NUMBERS
10.1 Pacific Life and Accident Insurance Company Surplus Debenture No. 7
dated as of July 30, 1999 for $150,000,000. (1)
10.2 Agreement dated September 9, 1999 between David C. Smith, Chairman of
the Board of the Company and PennCorp Financial Group, Inc. (1)
11.1 Computation of Loss per Share (1)
15.1 Independent Auditors' Report (2)
27 Financial Data Schedule (1)
(1) Filed herewith.
(2) Included in Item 1 of Part I of this Form 10-Q.
38
<PAGE>
EXHIBIT 11.1
PENNCORP FINANCIAL GROUP, INC. AND SUBSIDIARIES
COMPUTATION OF LOSS PER SHARE
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
1999 1998 1999 1998
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Basic net loss applicable to common stock:
Loss before extraordinary charge
applicable to common stock.................... $ (32,554) $ (165,092) $ (102,338) $ (331,011)
Redemption Premium on Series C
PREFERRED STOCK............................. -- -- -- (1,913)
------------- ------------- ------------- -------------
(32,554) (165,092) (102,338) (332,924)
EXTRAORDINARY CHARGE............................ -- -- -- (1,671)
------------- ------------- ------------- -------------
$ (32,554) $ (165,092) $ (102,338) $ (334,595)
============= ============= ============= =============
Diluted net loss applicable to common stock:
Loss before extraordinary charge
applicable to common stock.................... $ (32,554) $ (165,092) $ (102,338) $ (331,011)
Redemption Premium on Series C
preferred stock............................. -- -- -- (1,913)
------------- ------------- ------------- -------------
(32,554) (165,092) (102,338) (332,924)
EXTRAORDINARY CHARGE............................ -- -- -- (1,671)
------------- ------------- ------------- -------------
$ (32,554) $ (165,092) $ (102,338) $ (334,595)
============= ============= ============= =============
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
1999 1998 1999 1998
------------- ------------- ------------- -------------
Basic:
Shares outstanding beginning of period.......... 30,072 28,860 30,072 28,860
Incremental shares applicable to Stock
Warrants/Stock Options and Restricted Stock... 73 357 66 357
Acquisition of Fickes and Stone
Knightsbridge Interests....................... 173 347 173 347
Redemption of Series C Preferred Stock.......... -- 692 -- 463
TREASURY SHARES................................. (928) (1,010) (969) (1,010)
------------- ------------- ------------- -------------
29,390 29,246 29,342 29,017
============= ============= ============= =============
Diluted:
Shares outstanding beginning of period.......... 30,072 28,860 30,072 28,860
Incremental shares applicable to Stock
Warrants/Stock Options and Restricted Stock... 73 357 66 357
Acquisition of Fickes and Stone
Knightsbridge Interests....................... 173 347 173 347
Redemption of Series C Preferred Stock.......... -- 692 -- 463
TREASURY SHARES................................. (928) (1,010) (969) (1,010)
------------- ------------- ------------- -------------
29,390 29,246 29,342 29,017
============= ============= ============= =============
</TABLE>
39
PACIFIC LIFE AND ACCIDENT INSURANCE COMPANY
SURPLUS DEBENTURE No. 7
$ 150,000,000.00 July 30, 1999
FOR VALUE RECEIVED, Pacific Life and Accident Insurance Company, a Texas life
insurance corporation ("Pacific"), subject to the terms, conditions,
restrictions, and limitations contained herein, promises to pay to the order of
Southwestern Financial Corporation, a Delaware Corporation ("Southwestern"), or
to any subsequent holder hereof (the "Holder"), the principal sum of One Hundred
Fifty Million Dollars ($150,000,000.00) together with interest on the unpaid
balance thereof at a rate (the "Rate") equal to ten percent (10%) per annum.
Interest on this Surplus Debenture will be payable each quarter on the day in
which Pacific's financial statements are finalized for the prior quarter (each,
a "Payment Date") and continuing until the principal amount of this Surplus
Debenture is paid full. Both principal and interest on this Surplus Debenture
will be due and payable in the following manner at the offices of Holder
1. On or before each Payment Date, Pacific will calculate the Surplus of
Pacific (as hereinafter defined) as of the most recent date practicable,
but in no event poor to the end of the immediately preceding calendar
quarter (each such date being hereinafter referred to as a "Calculation
Date").
2. On each Payment Date, Pacific will pay the Holder the amount of accrued but
unpaid interest on the unpaid principal balance of this Surplus Debenture
to the extent the Surplus of Pacific exceeds $1.2 million as of the
Calculation Date immediately prior to such Interest Payment Date.
3. If, as of any Calculation Date, the Surplus of Pacific does not exceed $1.2
million by an amount sufficient to pay all accrued but unpaid interest on
this Surplus Debenture, the remaining accrued but unpaid interest shall be
payable on the next Payment Date to the extent the Surplus of Pacific
exceeds $1.2 million as of the Calculation Date immediately prior to such
next Payment Date.
4. Pacific will pay principal payments to the Holder on a quarterly basis on
the Payment Date in accordance with the principal amortization schedule
attached hereto as Exhibit A, to the extent the Surplus of Pacific exceeds
$1.2 million as of the most recent Calculation Date.
5. If on a Payment Date, the Surplus of Pacific does not exceed $1.2 million
by an amount sufficient to pay the Holder the principal amount due,
together with all accrued but unpaid interest on this Surplus Debenture,
the remaining unpaid portion of such principal amount and such interest
<PAGE>
shall be payable thereafter at such time or from time to time as the Surplus of
Pacific exceeds $1.2 million.
For purposes of this Surplus Debenture, the term "Surplus of Pacific" shall mean
the remainder obtained after subtracting the carrying value of insurance
subsidiaries of Pacific from the sum of:
(a) "common capital stock" of Pacific;
(b) "gross paid-in and contributed surplus" of Pacific;
(c) "unassigned surplus" of Pacific;
(d) "special surplus" of Pacific;
(e) any amounts required to be carried as liabilities with respect to
outstanding surplus debentures issued by Pacific; and
(f) surplus evidenced by surplus debentures of Pacific which is included in
clauses a-e of this paragraph 6.
The items listed in clauses a-f of this paragraph 6 will be calculated in
accordance with the accounting practices required or permitted by the Texas
Department of Insurance ("Texas Department") for inclusion in the Annual
Statement of Pacific filed with the Texas Department as of December 31, of each
year.
7. The obligation of Pacific to pay this Surplus Debenture will not otherwise
be or constitute a liability of Pacific or a claim against any of its
assets except in the event of the liquidation of Pacific, and in no event
will this Surplus Debenture be considered or treated as a current or fixed
liability or obligation of Pacific under the Texas insurance laws and the
regulations thereunder except to the extent that a payment of principal or
interest becomes due and payable hereunder or to the extent otherwise
required by Texas law.
8. In event of the liquidation of Pacific, this Surplus Debenture will become
immediately due and payable and will be superior to and in preference of
the rights and claims of the shareholders of Pacific; provided, however,
that to the extent required by applicable law, all obligations, rights and
claims hereunder are expressly subordinated to the claims of (a)
policyholders, insureds, and beneficiaries under insurance contracts
policies issued by Pacific and (b) any supervisor, conservator or receiver
of Pacific appointed by the Commissioner of Insurance of the State of
Texas.
2
<PAGE>
9. All payments made hereunder will be credited first to accrued but unpaid
interest, if any, and the balance of such payment will be credited to the
principal amount hereof.
10. As a condition to the consolidation or merger of Pacific into another
corporation or the sale of all or substantially all of Pacific's assets to
any other corporation, the corporation into which Pacific is consolidated,
merged or to which the assets of Pacific are transferred shall
unconditionally assume the liability of Pacific hereunder.
11. By acceptance and as a part of the consideration for the issuance hereof,
the Holder expressly acknowledges that it has been informed and has
knowledge that this Surplus Debenture has not been registered under the
Securities Act of 1933, as amended, or the securities laws of any state and
that Pacific has issued this Surplus Debenture for investment purposes and
not with a view toward a public distribution hereof and that this Surplus
Debenture may not be sold or otherwise transferred in absence of an
effective registration statement with respect hereto or an exemption from
registration under the Securities Act of 1933, as amended, or any other
applicable securities laws.
12. If this Surplus Debenture is collected through judicial proceedings,
Pacific agrees, subject to conditions and restrictions contained herein, to
pay all reasonable legal fees and disbursements incurred by the Holder in
connection with such collection.
13. This Surplus Debenture may be prepaid in whole or in part at any time or
from time to time without premium or penalty to the extent that the Surplus
of Pacific exceeds $1.2 million on the most recent Calculation Date before
the date of any proposed prepayment.
14. This Surplus Debenture will be governed by and construed in accordance with
the laws of the State of Texas.
15. It being the intention of the parties hereto to conform strictly to the
applicable usury laws of the State of Texas, all agreements between Pacific
and Southwestern and any other Holder whether now or hereafter arising and
whether written or oral, are here expressly limited so that in no event,
whether by reason of acceleration of the maturity of any amount owed
hereunder or otherwise, shall the amount paid or agreed to be paid to
Southwestern or any other Holder for the use, forbearance or retention of
money hereunder or otherwise exceed the maximum amount permissible under
applicable law (the "Maximum Lawful Amount"). If fulfillment of any
provision hereof, at the time performance of such provision shall be due,
shall cause the amount of interest applicable to this
3
<PAGE>
Surplus Debenture to exceed the Maximum Lawful Amount, then, ipso facto,
the obligation to be fulfilled shall be reduced to the extent necessary to
cause the amount of interest applicable to this Surplus Debenture not to
exceed the Maximum Lawful Amount; and if the Holder of this Surplus
Debenture shall ever receive anything of value deemed interest under
applicable law that would cause the interest applicable to this Surplus
Debenture to exceed the Maximum Lawful Rate, an amount equal to the portion
of such interest in excess of the Maximum Lawful Rate shall be applied to
the reduction of the principal amount owing hereunder and not to the
payment of interest, or if such excessive interest exceeds the unpaid
principal amount hereof, such excess shall be promptly refunded to Pacific
by the Holder hereof. All sums paid or agreed to be paid to the Holder of
this Surplus Debenture for the use, forbearance or retention of the
indebtedness of Pacific shall, to the extent permitted by applicable law,
be amortized, prorated, allocated and spread throughout the full term of
such indebtedness until payment in full so that interest on account of such
indebtedness is uniform throughout the full term thereof. The provisions of
this paragraph shall control agreements between Pacific and the holder of
this Surplus Debenture.
16. Southwestern may assign its rights hereunder to any person or entity
without the consent of Pacific. This Surplus Debenture will inure to the
benefit of Pacific and its successors and assignees. Notwithstanding the
above, this Surplus Debenture is registered as to both principal and any
stated interest with Pacific and transfer of the Surplus Debenture may be
effected only by surrender of the old instrument and either the reissuance
by Pacific of a new instrument to the new Holder or the issuance Pacific of
a new instrument to the new Holder. No transfer of any ownership interest
in this Surplus Debenture shall be made unless such transfer is permitted
under Texas insurance law and Pacific and Southwestern shall comply with
all regulatory and legal limitations and requirements in connection with
any transfer of this Surplus Debenture.
17. The occurrence of any one or more of the following events shall constitute
an Event of Default (herein so called) hereunder:
(a) The Company shall fail to make any payment of interest on this Surplus
Debenture when due and payable or declared due and payable, and such
failure shall have remained unremedied for a period of 5 days.
(b) The Company shall fail to make any payment of principal of this
Surplus Debenture when due and payable or declared due and payable.
(c) The Company shall (i) be the subject of a petition seeking relief
under any state liquidation, rehabilitation, conservation, or
supervision law or other similar state or federal laws, or any
delinquency proceeding or to
4
<PAGE>
the appointment of or taking possession by a custodian, receiver,
liquidator, assignee, trustee or similar official of any substantial
part of its properties, (ii) fail generally to pay is debts as such
debts become due, or (iii) take any corporate action in furtherance of
any action.
If, at any time, any Event of Default has occurred and is continuing, the
Holder hereof may, without further action, declare the entire principal
amount under this Surplus Debenture to be due and payable, and such
principal amount, together with all accrued but unpaid interest hereon,
shall be paid to the Holder hereof by the Company to the extent the Surplus
of the Company exceeds $1.2 million on the date of such declaration by the
Holder hereof or at any time thereafter.
18. To the extent required by Texas law, Pacific will notify the Texas
Department of the payment of principal and interest under this Surplus
Debenture. Pacific will take all actions reasonably necessary to maintain
the enforceability of this Surplus Debenture.
IN WITNESS WHEREOF, Pacific has caused this Surplus Debenture to be duly
executed as of July 30, 1999.
PACIFIC LIFE AND ACCIDENT INSURANCE COMPANY
By: /s/Scott D. Silverman
-------------------------
Name: Scott D. Silverman
Title: Senior Vice President
September 9, 1999
David C. Smith
14 Lyric Arbor Circle
The Woodlands, Texas 77381
Dear David:
This letter confirms PennCorp Financial Group, Inc.'s (the "Company") March
4, 1999 award to you of 188,235 shares of the Company's Common Stock ("Common
Stock") on the following terms and conditions.
1. In connection with your services to the Company as Chairman of the Board
of Directors (the "Board"), the Compensation Committee (the "Committee") has
agreed to provide you with a bonus award of $100,000 payable in 188,235 shares
of Common Stock ("Bonus Stock Award").
2. In determining the number of shares of common stock to be awarded to you
for purposes of the Bonus Stock Award, the Committee used the closing price of
the Common Stock as of March 3, 1999, the day prior to the day the Bonus Stock
Award was approved by the Company's Board of Directors, discounted by a factor
of 15%. The fair market value of each share of Common Stock was discounted
because the stock remains subject to the restrictions placed on its
transferability and sale pursuant to Rule 144 of the Securities and Exchange Act
of 1934, as amended (the "Securities Act"). The Common Stock is considered to be
a restricted security as defined under Rule 144 since it is being acquired from
the issuer in a transaction not involving any public offering. In general, a
minimum of one year must elapse between the date of the acquisition of the
securities and any resale of such securities in reliance on Rule 144. For this
reason, the Committee discounted the fair market value of each share of common
stock to compensate you for the effect Rule 144 might have on your ability to
transfer the Common Stock, in general, or on the value of the Common Stock, in
particular. In determining the applicable marketability discount, the Company
obtained advice from Salomon Smith Barney Inc.
3. The Bonus Stock Award is being issued to you with the understanding
that, in the event you are prevented from selling or exchanging your shares of
Common Stock into any Change of Control (as defined below) or restructuring
transaction in which the Company may be involved for the same consideration, if
any, that other holders of Common Stock will receive, upon your written request
to the Chairman of the Committee, such request to be made on the closing date of
the Change of Control or restructuring transaction, the Company will pay you a
lump sum cash payment equal to the value of the shares of Common Stock, valued
on the date immediately preceding the date of the request, less the
marketability discount, within five (5) business days of said written request.
For purposes of this letter, Change of Control means: (1) any "person" (as
such term is used in Section 13(d) of the Securities Exchange Act of 1934, as
amended (the "Exchange Act")) who becomes the "beneficial owner" (as determined
pursuant to Rule 13d-3 under the Exchange Act), directly or indirectly, of
securities of the Company representing twenty-five percent (25%) or more of the
combined voting power of the Company's then outstanding securities; or (2)
during any period of two (2) consecutive years (not including any period prior
to the execution of this letter), individuals who at the beginning of such
period constitute the members of the Company's Board of Directors (the "Board")
and any new director, whose election to the Board or nomination for election to
the Board by the Company's stockholders was approved by a vote of at least
two-thirds (2/3) of the directors then still in office who either were directors
at the beginning of the period or whose election or nomination for election was
previously so approved, cease for any reason to constitute a majority of the
Board; or (3) the Company shall merge with or consolidate into any other
corporation, other than a merger or consolidation which would result in the
holders of the voting securities of the Company outstanding immediately prior
thereto holding immediately thereafter securities representing more than sixty
percent (60%) of the combined voting power of the voting securities of the
Company or such surviving entity outstanding immediately after such merger or
consolidation; or (4) the stockholders of the Company approve a plan of complete
liquidation of the Company or an agreement for the sale or disposition by the
Company of all or substantially all of the Company's assets or such a plan is
commenced.
4. The terms and conditions of the Common Stock granted to you as a Bonus
Stock Award under the terms of this letter are also governed by any and all
other applicable provisions of the Securities Act and other federal, state and
local laws relating to the issuance, transfer and sale of securities.
5. The Bonus Stock Award herein is being issued to you as additional
compensation for the services you provided to the Board and the Company during
1998.
6. The Bonus Stock Award is also being paid to you in addition to any and
all other fees, expenses, stock options or awards, phantom stock awards and
warrants you are entitled to as a Non-Employee Director of the Company.
7. This letter sets forth the entire agreement and understanding between
you, the Board, the Committee and the Company with respect to this Bonus Stock
Award. Additionally, nothing contained in this letter shall be construed as
indicating any additional entitlement to Bonus Stock Awards relating to your
services for any year other than 1998.
If you are in agreement with the terms and conditions contained in this
letter, please sign and return the original to Scott D. Silverman, General
Counsel.
Very truly yours,
By:/s/Keith A. Maib
-------------------
Keith A. Maib
President & Chief Executive
Officer
/s/David C. Smith
- -----------------
David C. Smith
September 9, 1999
<TABLE> <S> <C>
<ARTICLE> 7
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-END> SEP-30-1999
<DEBT-HELD-FOR-SALE> 2,433,210
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 2,031
<MORTGAGE> 32,973
<REAL-ESTATE> 7,433
<TOTAL-INVEST> 2,803,976
<CASH> 115,507
<RECOVER-REINSURE> 0
<DEFERRED-ACQUISITION> 156,564
<TOTAL-ASSETS> 3,444,168
<POLICY-LOSSES> 2,651,407
<UNEARNED-PREMIUMS> 1,884
<POLICY-OTHER> 46,113
<POLICY-HOLDER-FUNDS> 71,815
<NOTES-PAYABLE> 279,646
0
267,496
<COMMON> 303
<OTHER-SE> 26,066
<TOTAL-LIABILITY-AND-EQUITY> 3,444,168
286,417
<INVESTMENT-INCOME> 209,043
<INVESTMENT-GAINS> (198)
<OTHER-INCOME> 30,653
<BENEFITS> 306,608
<UNDERWRITING-AMORTIZATION> 38,113
<UNDERWRITING-OTHER> 155,693
<INCOME-PRETAX> (71,932)
<INCOME-TAX> 17,037
<INCOME-CONTINUING> (88,969)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (102,338)
<EPS-BASIC> (3.49)
<EPS-DILUTED> (3.49)
<RESERVE-OPEN> 0
<PROVISION-CURRENT> 0
<PROVISION-PRIOR> 0
<PAYMENTS-CURRENT> 0
<PAYMENTS-PRIOR> 0
<RESERVE-CLOSE> 0
<CUMULATIVE-DEFICIENCY> 0
</TABLE>
