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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 March 31, 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 (I.R.S. employer identification no.)
incorporation or organization)
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 May 11, 1999, was
29,026,496.
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<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 Income (Loss)...........................4
Consolidated Statements of Cash Flows........................5
Notes to Unaudited Consolidated Financial Statements.........6
Review by Independent Certified Public Accountants..........15
Independent Auditors' Review Report.........................16
Item 2. Management's Discussion And Analysis of Financial Condition
and Results of Operations............................17
Item 3. Quantitative and Qualitative Disclosures About Market Risk...31
PART II -- OTHER INFORMATION
Item 1. Legal Proceedings............................................32
Item 6. Exhibits and Reports on Form 8-K.............................32
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>
March 31, December 31,
1999 1998
------------- ------------
(Unaudited)
<S> <C> <C>
ASSETS:
Investments:
Fixed maturities available for sale, at fair value............................. $ 2,518,510 $ 2,589,714
Equity securities available for sale, at fair value............................ 2,026 2,035
Mortgage loans on real estate.................................................. 35,026 36,882
Policy loans................................................................... 205,409 207,490
Cash and short-term investments................................................ 122,521 92,727
Other investments.............................................................. 27,348 27,406
------------ ------------
Total investments ........................................................... 2,910,840 2,956,254
Accrued investment income......................................................... 36,420 37,291
Accounts and notes receivable..................................................... 12,332 14,319
Present value of insurance in force............................................... 176,288 170,729
Deferred policy acquisition costs................................................. 144,867 139,708
Costs in excess of net assets acquired............................................ 106,486 108,070
Income taxes, primarily deferred.................................................. 56,575 44,597
Other assets...................................................................... 149,847 138,629
Assets of Businesses Held for Sale................................................ 2,259,376 2,421,804
------------ ------------
Total assets ................................................................ $ 5,853,031 $ 6,031,401
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY:
Liabilities:
Policy liabilities and accruals................................................... $ 2,837,126 $ 2,867,038
Notes payable..................................................................... 510,887 550,923
Obligations in course of settlement............................................... 40,000 --
Accrued expenses and other liabilities............................................ 115,378 110,945
Liabilities of Businesses Held for Sale........................................... 1,983,486 2,066,554
------------ ------------
Total liabilities............................................................ 5,486,877 5,595,460
------------ ------------
Shareholders' equity:
$3.375 Convertible Preferred Stock, $.01 par value, $50 redemption value;
authorized, issued and outstanding 2,300,000 at March 31, 1999 and
December 31, 1998.............................................................. 114,394 112,454
$3.50 Series II Convertible Preferred Stock, $.01 par value, $50 redemption value;
authorized, issued and outstanding 2,875,000 at March 31, 1999 and
December 31, 1998.............................................................. 144,189 141,673
Common stock, $.01 par value; authorized 100,000,000; issued and outstanding
30,143,416 at March 31, 1999 and 30,072,344 at December 31, 1998............... 303 301
Additional paid-in capital........................................................ 430,421 430,321
Accumulated other comprehensive income (loss), net of income taxes (benefits)..... (8,200) 19,995
Retained earnings (deficit)....................................................... (281,069) (234,921)
Treasury shares (1,116,920 at March 31, 1999 and 1,105,369 at December 31, 1998).. (32,391) (32,391)
Notes receivable and other assets secured by common stock......................... (1,493) (1,491)
------------ ------------
Total shareholders' equity................................................... 366,154 435,941
------------ ------------
Total liabilities and shareholders' equity .................................. $ 5,853,031 $ 6,031,401
============ ============
</TABLE>
See accompanying Notes to Unaudited Consolidated Financial Statements
3
<PAGE>
PENNCORP FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
(In thousands, except per share amounts)
(Unaudited)
<TABLE>
<CAPTION>
Three Month Periods Ended
March 31,
1999 1998
------------- -------------
<S> <C> <C>
REVENUES:
Premiums, principally accident and sickness.................................... $ 81,392 $ 89,425
Interest sensitive policy product charges...................................... 32,480 34,167
Net investment income.......................................................... 86,107 96,215
Other income................................................................... 10,945 11,321
Net gains from the sale of investments......................................... 2,179 1,523
Net gain from sale of subsidiary............................................... 996 --
------------- -------------
Total revenues............................................................... 214,099 232,651
------------- -------------
BENEFITS AND EXPENSES:
Claims incurred................................................................ 72,916 82,034
Change in liability for future policy benefits and other policy benefits....... 55,711 56,061
Amortization of present value of insurance in force and deferred policy
acquisition costs............................................................ 22,369 23,973
Amortization of costs in excess of net assets acquired and other intangibles... 2,028 3,742
Underwriting and other administrative expenses................................. 53,718 43,261
Interest and amortization of deferred debt issuance costs...................... 14,120 9,917
Restructuring charge........................................................... 5 8,017
Impairment provision associated with Assets of Businesses Held for Sale........ 30,287 --
------------- -------------
Total benefits and expenses.................................................. 251,154 227,005
------------- -------------
Income (loss) before income taxes and extraordinary charge........................ (37,055) 5,646
Income taxes................................................................. 4,600 2,757
------------- -------------
Income (loss) before extraordinary charge......................................... (41,655) 2,889
Extraordinary charge......................................................... -- (1,671)
------------- -------------
Net income (loss)................................................................. (41,655) 1,218
Preferred stock dividend requirements........................................ 4,456 4,904
------------- -------------
Net loss applicable to common stock............................................... $ (46,111) $ (3,686)
============= =============
PER SHARE INFORMATION:
Basic:
Loss before extraordinary charge applicable to common stock.................... $ (1.58) $ (0.14)
Extraordinary charge, net of income taxes.................................... -- (0.06)
------------- -------------
Net loss applicable to common stock............................................ $ (1.58) $ (0.20)
============= =============
Common shares used in computing basic loss per share.............................. 29,184 28,572
============= =============
Diluted:
Loss before extraordinary charge applicable to common stock.................... $ (1.58) $ (0.14)
Extraordinary charge, net of income taxes.................................... -- (0.06)
------------- -------------
Net loss applicable to common stock............................................ $ (1.58) $ (0.20)
============= =============
Common shares used in computing diluted loss per share............................ 29,184 28,572
============= =============
COMPREHENSIVE INCOME (LOSS) INFORMATION:
Net income (loss).............................................................. $ (41,655) $ 1,218
Change in unrealized foreign currency translation gains, net of income taxes... 1,070 1,869
Change in unrealized holding gains (losses) arising during the period
on securities available for sale, net of income taxes (benefits) of
$(15,230) and $123........................................................... (26,617) 1,673
Reclassification adjustments for gains included in net income (loss)........... (1,835) (1,445)
Decrease in unrealized gains resulting from the sale of subsidiary,
net of income tax of $438.................................................... (813) --
------------- -------------
Total comprehensive income (loss) applicable to common stock............... $ (69,850) $ 3,315
============= =============
</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>
Three Month Periods Ended
March 31,
1999 1998
------------- -------------
<S> <C> <C>
Cash flows from operating activities:
Income (loss) before extraordinary charge...................................... $ (41,655) $ 2,889
Adjustments to reconcile income before extraordinary charge to net cash
provided (used) by operating activities:
Impairment provision associated with Assets of Businesses Held for Sale.... 30,287 --
Net gain from sale of subsidiary........................................... (996) --
Capitalization of deferred policy acquisition costs........................ (26,864) (34,399)
Amortization of present value of insurance in force, deferred policy
acquisition costs, intangibles, depreciation and accretion, net.......... 23,042 26,010
Increase in policy liabilities, accruals and other policyholder funds...... 1,032 3,514
Other, net................................................................. 3,149 16,169
------------- -------------
Net cash provided (used) by operating activities....................... (12,005) 14,183
------------- -------------
Cash flows from investing activities:
Cash received from sale of subsidiary, net of cash and short-term
investments of $6,482 of subsidiary sold..................................... 33,740 --
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...................... (435,218) (276,426)
Purchases of equity securities available for sale.............................. -- (16,063)
Maturities of fixed maturity securities available for sale..................... 119,117 23,462
Sales of fixed maturity securities available for sale.......................... 341,378 241,252
Sales of equity securities..................................................... 10 271
Acquisitions and originations of mortgage loans................................ (844) (10,849)
Sales of mortgage loans........................................................ 195 2,928
Principal collected on mortgage loans.......................................... 13,021 13,826
Other, net..................................................................... 2,415 4,438
------------- -------------
Net cash provided by investing activities.................................. 73,814 74,331
------------- -------------
Cash flows from financing activities:
Additional borrowings.......................................................... -- 200,000
Reduction in notes payable..................................................... (36) (126,164)
Dividends on preferred and common stock........................................ -- (6,354)
Receipts from interest sensitive polices credited to policyholder
account balances............................................................. 57,774 62,748
Return of policyholder account balances on interest sensitive products......... (145,075) (144,170)
------------- -------------
Net cash used by financing activities...................................... (87,377) (13,940)
------------- -------------
Net increase (decrease) in cash............................................ (25,528) 74,574
Cash and short-term investments at beginning of period............................ 224,260 109,013
------------- -------------
Cash and short-term investments at end of period (including $76,211 and
$72,493 of cash and short-term investments classified as Assets of Businesses
Held for Sale in 1999 and 1998)................................................ $ 198,732 $ 183,587
============= =============
Supplemental disclosures:
Income taxes paid (refunded)................................................. $ (211) $ 2,228
============= =============
Interest paid................................................................ $ 7,330 $ 5,793
============= =============
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................................. $ 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");
Peninsular Life Insurance Company ("Peninsular"); Professional Insurance Company
("Professional"); 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"), Union Bankers Insurance Company ("Union Bankers"), and
Marquette National Life Insurance Company ("Marquette"); Security Life and Trust
Insurance Company ("Security Life"); Occidental Life Insurance Company of North
Carolina ("OLIC"); United Life & Annuity Insurance Company ("United Life"); 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 a sales force that is contractually exclusive to certain
of the Company's subsidiaries and through general agents. 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"), an internet service
provider, UC Mortgage Corp.("UC") and Cyberlink Development, Inc. ("Cyberlink").
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, United Life, UC, Cyberlink and Marketing One within a period not
likely to exceed one year, the assets and liabilities of the Career Sales
Division, KIVEX, Professional, United Life, UC, Cyberlink and Marketing One
(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. The Assets of Businesses Held for Sale and Liabilities of
Businesses Held for Sale as of March 31, 1999 excluded the accounts of
Professional as a result of the consummation of the sale of Professional on
March 31, 1999 (see Note 3 of Notes to Unaudited Consolidated Financial
Statements).
The Retained Businesses includes the Payroll Sales Division (the Payroll Sales
Division is comprised of AA Life and OLIC) and the Financial Services Division
(the Financial Services Division is comprised of Southwestern Life and Security
Life).
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.
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.
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
6
<PAGE>
PENNCORP FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. NEW ACCOUNTING PRONOUNCEMENTS NOT YET ADOPTED (Continued)
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 is
effective for all fiscal quarters of all years beginning after June 15, 1999.
The Company is currently evaluating SFAS No.133 and has not determined its
effect on the consolidated financial statements.
3. DISPOSITIONS AND OTHER TRANSACTIONS
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 $996. This was
partially offset by a decrease in unrealized gains of $813 resulting from the
sale of Professional. The purchase and sale agreement includes certain
settlement and consideration adjustment provisions which occur prior to August
23, 1999 which will likely result in a reduction of the consideration received
by the Company of approximately $1,000.
On February 21, 1999, the Company signed a definitive agreement to sell United
Life and its wholly-owned subsidiary, United Variable Services, Inc., to ING
America Insurance Holdings, Inc. ("ING"). The sale of United Life to ING also
includes the sale of UC, Cyberlink and certain assets of Marketing One ("United
Life Assets"). The sale was consummated on April 30, 1999 (see Note 10 of Notes
to Unaudited Consolidated Financial Statements).
On December 31, 1998, the Company entered into a definitive agreement to sell
the Career Sales Division and related assets to Universal American Financial
Corp. ("Universal American"). The purchase price of $175,000 is subject to
adjustment based on the capital and surplus of the Career Sales Division at the
closing date. The purchase price consists of $136,000 in cash and $39,000
initial principal amount, subject to adjustment, of subordinated notes of
Universal American. The subordinated notes will bear interest at a rate of 8.0%
per annum and will mature ten years from date of issuance. The accreted value of
the notes will be subject to offset in the event of adverse development (or
subject to increase in the event of positive development) in the disability
income reserves of PLIC and may be offset for other indemnification claims under
the purchase and sale agreement. In addition, the Company is required under the
terms of the purchase and sale agreement to deliver the Career Sales Division
and related assets with certain minimum levels of statutory capital and surplus,
pay certain ongoing costs and other expenses.
The Company has recently held a series of discussions with representatives of
Universal American regarding certain closing conditions outlined in the purchase
and sale agreement, specifically, the condition relating to reserves. These
discussions were prompted by the preliminary findings of a third party actuarial
review performed on the Career Sales Division's Penn Life subsidiaries. Such
findings relate primarily to an approximately $16,200 deficiency in Penn Life's
statutory reserves associated with its disability income block of business.
Universal American has indicated that such findings are not acceptable under the
current contractual arrangements. The Company and Universal American are working
towards a definitive solution for restructuring the December 31, 1998 definitive
agreement to consider the impact of the preliminary actuarial findings, as well
as other components of the existing definitive agreement. Such modifications to
the existing purchase and sale agreement would require approval by a majority of
the banks comprising the participating institutions of the amended Bank Credit
Facility ("Bank Group"). There can be no assurance that the Company and
Universal American will come to a definitive agreement with respect to modified
terms to the existing purchase and sale agreement or, should the Company and
Universal American reach an agreement, that the Company will receive the
required Bank Group approval or that the acquisition will be consummated.
As a result of the preliminary actuarial findings and their likely impact on the
fair value of Career Sales Division, the Company has recorded an additional
impairment provision aggregating $30,287 during the period ended March 31, 1999.
The Company will continue to evaluate fair value of the Career Sales Division in
light of the ongoing negotiations.
7
<PAGE>
PENNCORP FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. DISPOSITIONS AND OTHER TRANSACTIONS (Continued)
In the third quarter 1998, the Company made the decision to sell KIVEX. The
Company has engaged the investment banking firm of ING Barings Furman Selz. As
of May 14, 1999, the Company has received expressions of interest from potential
purchasers, but has not entered into a definitive agreement to sell KIVEX.
4. NOTES PAYABLE
On March 31, 1999, the Company entered into an amendment (the "amendment") to
its existing bank credit facility (the "Bank Credit Facility"). The amendment
provides for additional covenants and revises certain financial covenants to the
Bank Credit Facility. In addition, the amendment changes the maturity date of
the Bank Credit Facility to May 2000. Significant additional covenants include
the requirement for the Company to repay indebtedness at specified dates and
amounts throughout 1999, based upon anticipated dates and cash proceeds to be
received from the consummation of the Career Sales Division, Professional and
the United Life Asset sales. The timing and required debt reduction are as
follows:
Date Amount
---- ------
April 30, 1999 $ 40,000
May 31, 1999 127,000
June 30, 1999 70,000
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.
The Company's ability to meet the remaining debt reduction covenants of the Bank
Credit Facility is dependent on being able to consummate the sale of the Career
Sales Division to generate sufficient cash flows.
Though the Company has the obligation to consummate the sales of the Businesses
Held for Sale and to prepay the loans to certain covenanted levels, the Company
may not have the requisite ability to effectuate the sale as a result of the
restrictive covenants contained in the amended Bank Credit Facility. The
accessibility of the cash proceeds of the Businesses Held for Sale is the
subject of regulatory approval. While certain regulatory filings with respect to
the sale of the Businesses Held for Sale have been made, not all filings have
been so made and the final structure by which such proceeds will be upstreamed
to the Company has not yet been finalized. The amended Bank Credit Facility
provides that the Company and its subsidiaries are limited from entering into
certain mergers, consolidations, amalgamations, liquidations, winding up or
dissolutions, incurring certain indebtedness and liabilities, making
dispositions, prepaying certain indebtedness, declaring dividends, or issuing,
redeeming, purchasing, retiring, exchanging or converting capital securities, in
each case with very limited or scheduled exceptions. While the Company believes
it has scheduled or otherwise provided for a majority of the possible
combinations it will take to effectively upstream the cash proceeds of the sales
of the Businesses Held for Sale, it is not possible to foresee all combinations.
Accordingly, the mechanism to upstream to the Company the necessary cash to pay
the covenanted prepayment under the amended Bank Credit Facility may be subject
to the approval of the majority banks which, if not given, would result in an
event of default under the amended Bank Credit Facility. Should the sale
transactions not close within specified time periods, the Company may face
difficulty in meeting its existing and estimated cash obligations and would be
in default of certain covenants under the amended Bank Credit Facility.
The net proceeds available to the Company from the asset sales may vary
significantly from current estimates as a result of (i) minimum levels of
statutory capital and surplus required to be delivered at closing for certain
insurance subsidiaries, (ii) amounts to be held in escrow, (iii) valuation of
certain consideration to be received by the Company, (iv) the timing of the
closing and (v) various indemnification obligations included in each purchase
and sale agreement. Specifically, the purchase and sale agreement for the Career
Sales Division requires the purchaser to be satisfied with disability claims
reserve liabilities and other active life reserves. The Company has received
preliminary reports from an actuarial consulting firm engaged to provide
analysis to the purchaser regarding such reserves. The Company is aware of
potential deficiencies in the statutory determination of certain statutory
reserves that will likely impact the total consideration the Company is to
receive. The Company and Universal American have engaged in discussions and are
working toward the resolution of the statutory reserve issues (see Note 3 of
Notes to Unaudited Consolidated Financial Statements).
8
<PAGE>
PENNCORP FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
4. NOTES PAYABLE (Continued)
The Bank Credit Agreement provides certain relief from the June 30, 1999 $70,000
required debt reduction should the Company be unable to consummate the sale of
the Career Sales Division to Universal American. Should the Universal American
transaction terminate on or before June 30, 1999, the Company shall, on or
before September 30, 1999, enter into one or more definitive agreements to sell
the Career Sales Division or other assets pursuant to which the majority of the
Bank Group has determined that the Company will receive net cash proceeds of not
less than $70,000 that the Bank Group has determined will be available to the
Company to be applied to the outstanding senior bank debt no later than December
31, 1999.
The amendment requires the Company to work with the Bank Group on aggregating
cash at the parent company level, provide information on asset sale
transactions, obtain the Bank Group's consent to the potential sale of KIVEX and
meet certain cash flow payment requirements from the Company's insurance
subsidiaries on specified dates. In addition, the amendment eliminates the
Company's ability to pay dividends on its common and preferred stock and
severely limits the ability of the Company to effectuate the sale of capital
securities or to borrow funds available under the amended Bank Credit Facility.
With respect to borrowings, the Company may only borrow funds, up to $7,000, for
the payment of interest under the amended Bank Credit Facility and the unsecured
9 1/4 senior subordinated notes subject to certain restrictions. Upon
consummation of the Career Sales Division divestiture, the commitment will be
reduced to $5,000. Finally, the amendment modifies pricing spreads, fees and
other costs associated with the Bank Credit Facility.
5. PRO FORMA FINANCIAL INFORMATION
The following unaudited selected pro forma financial information has been
prepared to illustrate the pro forma effects of the sales of the Career Sales
Division, KIVEX, Professional, United Life, UC, Cyberlink and Marketing One. The
pro forma statement of operations for the three month periods ended March 31,
1999 and 1998 give effect to such sales as if they had occurred on January 1,
1998. The unaudited 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>
(In thousands, except per share amounts)
As Reported Pro forma
For the three month period ended March 31, 1999 1999
------------------------------------------------------------------------ ------------- -------------
<S> <C> <C>
Total revenues.......................................................... $ 214,099 $ 112,086
Net loss................................................................ (41,655) (17,032)
Net loss applicable to common stock..................................... (46,111) (21,488)
Per share information:
Net loss applicable to common stock-basic............................. $ (1.58) $ (0.74)
Net loss applicable to common stock-diluted........................... (1.58) (0.74)
As Reported Pro forma
For the three month period ended March 31, 1998 1998
------------------------------------------------------------------------ ------------- -------------
Total revenues.......................................................... $ 232,651 $ 120,200
Income (loss) before extraordinary charge............................... 2,889 (2,730)
Loss before extraordinary charge applicable to common stock............. (2,015) (7,634)
Per share information:
Loss before extraordinary charge applicable to common stock-basic..... $ (0.14) $ (0.27)
Loss before extraordinary charge applicable to common stock-diluted... (0.14) (0.27)
</TABLE>
6. RESTRUCTURING CHARGES
As a result of the tremendous growth of the Company and the diversification of
the underlying business units resulting from acquisition over time, the Company
began a strategic business evaluation in the third quarter of 1996. The review
resulted
9
<PAGE>
PENNCORP FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
6. RESTRUCTURING CHARGES (Continued)
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 Southwestern
Financial Corporation ("SW Financial") owned by Messrs. Steven W. Fickes, a
former executive officer and director, and David J. Stone, a director and former
executive officer of the Company) and the Fickes and Stone Knightsbridge
Interest (the 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 three month period
ended March 31, 1998, directly and indirectly associated with the divisional
restructuring.
The restructuring costs recognized the following for the three month period
ended March 31, 1998:
<TABLE>
<S> <C>
Severance and related benefits incurred due to staff reduction.... $ 3,831
Estimated holding costs of vacated facilities..................... 2,205
Write-off of certain fixed assets and other impaired assets....... 862
Estimated contract termination costs.............................. 4,869
-----------
Total restructuring costs.................................... $ 11,767
===========
</TABLE>
During the three month period ended March 31, 1999, the Company re-evaluated the
restructuring costs and increased the remaining accruals by $5. During the three
month period ended March 31, 1998, the Company re-evaluated the restructuring
costs and reduced the remaining accruals by $3,750 as a result of the final
determination of certain obligations. As of March 31, 1999, the Company had
remaining accruals associated with restructuring charges aggregating $4,475.
7. BUSINESS SEGMENT INFORMATION
Segment data as of March 31, 1999 and December 31, 1998 and for the three month
periods ended March 31, 1999 and 1998 are as follows:
<TABLE>
<CAPTION>
Three Month Periods Ended
March 31,
1999 1998
------------- -------------
<S> <C> <C>
Premiums and policy product charges:
Financial Services Division.............................................. $ 33,786 $ 37,093
Payroll Sales Division................................................... 23,283 22,003
Businesses Held for Sale (United States)................................. 45,879 52,976
Businesses Held for Sale (Canada)........................................ 10,924 11,520
------------- -------------
$ 113,872 $ 123,592
============= =============
Operating profit:
Financial Services Division.............................................. $ 3,528 $ 11,375
Payroll Sales Division................................................... 1,899 4,928
Businesses Held for Sale................................................. 7,723 9,040
------------- -------------
$ 13,150 $ 25,343
============= =============
March 31, December 31,
1999 1998
------------- -------------
Total assets:
Financial Services Division.............................................. $ 2,772,102 $ 2,823,007
Payroll Sales Division................................................... 731,327 695,777
Businesses Held for Sale (United States)................................. 2,115,640 2,294,945
Businesses Held for Sale (Canada)........................................ 143,736 126,859
------------- -------------
$ 5,762,805 $ 5,940,588
============= =============
</TABLE>
10
<PAGE>
PENNCORP FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. BUSINESS SEGMENT INFORMATION (Continued)
Reconciliations of segment data to the Company's consolidated data are as
follows:
<TABLE>
<CAPTION>
Three Month Periods Ended
March 31,
1999 1998
------------- -------------
<S> <C> <C>
Total revenues:
Segments--premiums and policy product charges............................. $ 113,872 $ 123,592
Net investment income.................................................... 86,107 96,215
Other income............................................................. 10,945 11,321
Net gain from sale of investments........................................ 2,179 1,523
Net gain from sale of subsidiary......................................... 996 --
------------- -------------
$ 214,099 $ 232,651
============= =============
Income (loss) before income taxes and extraordinary charge:
Segments................................................................. $ 13,150 $ 25,343
Corporate expenses and eliminations...................................... (8,968) (3,286)
Impairment provision associated with Assets of Businesses Held for Sale.. (30,287) --
Interest and amortization of deferred debt issuance costs................ (14,120) (9,917)
Net gains on the sale of investments..................................... 2,179 1,523
Net gain from sale of subsidiary......................................... 996 --
Restructuring costs...................................................... (5) (8,017)
------------- -------------
$ (37,055) $ 5,646
============= =============
March 31, December 31,
1999 1998
------------- -------------
Total assets:
Segments................................................................. $ 5,762,805 $ 5,940,588
Corporate and other...................................................... 90,226 90,813
------------- -------------
$ 5,853,031 $ 6,031,401
============= =============
</TABLE>
8. ASSETS AND LIABILITIES OF BUSINESSES HELD FOR SALE
The Assets and Liabilities of Businesses Held for Sale at March 31, 1999 and
December 31, 1998 were as follows:
<TABLE>
<CAPTION>
1999 1998
------------- -------------
<S> <C> <C>
Invested assets.......................................................... $ 1,846,503 $ 1,974,280
Insurance assets......................................................... 302,983 329,950
Other assets............................................................. 109,890 117,574
------------- -------------
Total assets........................................................... $ 2,259,376 $ 2,421,804
============= =============
Insurance liabilities.................................................... $ 1,774,354 $ 1,853,163
Other Liabilities........................................................ 209,132 213,391
------------- -------------
Total liabilities...................................................... $ 1,983,486 $ 2,066,554
============= =============
</TABLE>
9. 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
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
11
<PAGE>
PENNCORP FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
9. COMMITMENTS AND CONTINGENCIES (Continued)
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, a director
and formerly 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 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 will be 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 all expenses and 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.
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 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 has 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 changing 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 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 recently 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 change 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. No further
communications from the NCAG have been received to date. The Company has
initiated
12
<PAGE>
PENNCORP FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
9. COMMITMENTS AND CONTINGENCIES (Continued)
an exchange program which enables policyholders of such life insurance products
to terminate their policies and obtain either (i) the refund of all premiums
paid and other consideration or (ii) another Security Life product. As of March
31, 1999, Security Life has established a regulatorily required contingency
reserve aggregating approximately $9,000 in its statutory financial statements
associated with the exchange program. 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,
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 have also been held relating to equity incentive
programs based on sales production and persistency measures. Additionally, the
Company has 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 definitive agreement to sell the
Career Sales Division and related assets to Universal American, the sales force
of Penn Life and the marketing organization will receive equity in Universal
American and will participate in certain equity incentive programs of Universal
American. A portion of the proceeds to be received by the Company from Universal
American for the sale of the Career Sales Division will be used to fund the
equity of Universal American to be issued to the sales force of Penn Life and to
make certain other payments to the sales force in exchange for a release
relating to the potential leveraged buyout. If the Company does not consummate
its transaction with Universal American, then it will pursue alternatives with
the Penn Life sales force in light of the modifications to commissions
associated with new business production after January 1, 1998 and with the
marketing organization in light of the marketing contract.
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."
In May 1998, the three senior executives of the Company entered into two year
employment agreements with the Company which have various annual bonus and
termination provisions. As of March 31, 1999, the Company had accrued
compensation expense of approximately $450 and $4,343 for the annual 1999 bonus
and termination provisions, respectively associated with these employment
agreements. Termination provisions are payable upon the expiration of the
employment agreement, termination by the Company without cause, or termination
by the officer 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.
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
13
<PAGE>
PENNCORP FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
9. COMMITMENTS AND CONTINGENCIES (Continued)
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.
Failure of the Company to meet such representations and warranties could result
in a decision by the purchaser not to consummate the transaction and/or
indemnification claims for breach of contract.
Each of the definitive purchase and sale agreements the Company has entered into
for the disposition of Professional, the United Life Assets and the Career Sales
Division, contain indemnification provisions which survive the consummation 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 under any of the purchase and sale
agreements.
The Company has outstanding commitments to invest up to $15,223 in various
limited partnership funds and other investments.
The Company has a contingent obligation for mortgage loans previously sold
aggregating $5,650 as a result of the Company acting as a servicing conduit.
10. SUBSEQUENT EVENTS
On April 30, 1999, the Company consummated the sale of the United Life Assets to
ING. The aggregate purchase price totaled $154,052 including a dividend of
$2,052 that was paid by United Life at closing. The purchase and sale agreement
includes certain settlement and consideration adjustment provisions which are
likely to occur prior to July 29, 1999.
14
<PAGE>
REVIEW BY INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
The March 31, 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)
15
<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 March 31, 1999, and the related
consolidated statements of operations and comprehensive income (loss) for the
three month periods ended March 31, 1999 and 1998, and consolidated statements
of cash flows for the three month periods ended March 31, 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
May 13, 1999
16
<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) 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 policies; (2)
PennCorp's ability to achieve anticipated levels of operational efficiencies and
cost-saving initiatives and to meet cash requirements based upon projected
liquidity sources; (3) customer response to new products, distribution channels
and marketing initiatives; (4) mortality, morbidity, and other factors which may
affect the profitability of PennCorp's insurance products; (5) changes in the
Federal income tax laws and regulations which may affect the relative tax
advantages of some of PennCorp's products; (6) increasing competition in the
sale of insurance and annuities; (7) regulatory changes or actions, including
those relating to regulation of insurance products and of insurance companies;
(8) ratings assigned to PennCorp's insurance subsidiaries by independent rating
organizations such as A.M. Best Company ("A.M. Best"), which the Company
believes are particularly important to the sale of annuity and other
accumulation products; (9) PennCorp's ability to successfully complete its year
2000 remediation efforts, (10) the successful completion of the sale of, and the
ultimate realizable value of Businesses Held for Sale and (11) current and/or
unanticipated litigation. 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
institution, 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 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 repay bank indebtedness
on April 1, 1999. The purchase and sale agreement includes certain settlement
and consideration adjustment provisions which occur prior to August 23, 1999,
which will likely result in a further reduction of consideration received of
approximately $1.0 million.
On December 31, 1998, the Company entered into a definitive agreement to sell
the Career Sales Division and related assets to Universal American Financial
Corp. ("Universal American"). The purchase price of $175.0 million is subject to
adjustment based on the capital and surplus of the Career Sales Division at the
closing date. The purchase price consists of $136.0 million in cash and $39.0
million initial principal amount, subject to adjustment, of subordinated notes
of Universal American. The subordinated notes will bear interest at a rate of
8.0% per annum and will mature ten years from date of issuance. The accreted
value of the notes will be subject to offset in the event of adverse development
(or subject to increase in the event of positive development) in the disability
income reserves of PLIC and may be offset for other indemnification claims under
17
<PAGE>
the purchase and sale agreement. In addition, the Company is required under the
terms of the purchase and sale agreement to deliver the Career Sales Division
and related assets with certain minimum levels of statutory capital and surplus,
pay certain ongoing costs and other expenses.
The Company has recently held a series of discussions with representatives of
Universal American regarding certain closing conditions outlined in the purchase
and sale agreement, specifically, the condition relating to reserves. These
discussions were prompted by the preliminary findings of a third party actuarial
review performed on the Career Sales Division's Penn Life subsidiaries. Such
findings relate primarily to an approximately $16.2 million deficiency in Penn
Life's statutory reserves associated with its disability income block of
business. Universal American has indicated that such findings are not acceptable
under the current contractual arrangements. The Company and Universal American
are working towards a definitive solution for restructuring the December 31,
1998 definitive agreement to consider the impact of the preliminary actuarial
findings, as well as other components of the existing definitive agreement. Such
modifications to the existing purchase and sale agreement would require approval
by a majority of the banks comprising the current bank credit facility lenders.
There can be no assurance that the Company and Universal American will come to a
definitive agreement with respect to modified terms to the existing purchase and
sale agreement or should the Company and Universal American reach an agreement
that the Company will receive the required bank group approval or that the
acquisition will be consummated.
As a result of the preliminary actuarial findings and their likely impact on the
fair value of Career Sales Division, the Company has recorded an additional
impairment provision aggregating $30.3 million during the period ended March 31,
1999. The Company will continue to evaluate fair value of the Career Sales
Division in light of the ongoing negotiations.
On February 21, 1999, the Company signed a definitive agreement to sell the
United Life Assets. The sale was consummated on April 30, 1999. The purchase
price 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 repay
bank indebtedness. The amount of mortgages purchased is subject to change for a
period of 90 days subsequent to closing pursuant to terms of the purchase and
sale agreement. The purchase and sale agreement includes certain settlement and
consideration adjustment provisions which are likely to occur prior to July 29,
1999.
In the third quarter of 1998, the Company made the decision to dispose of KIVEX,
an internet service provider. The Company has engaged the investment banking
firm of ING Barings Furman Selz. As of May 14, 1999, the Company has received
expressions of interest from potential purchasers, but has not entered into a
definitive agreement to sell KIVEX.
During the fourth quarter of 1998, the Company made the decision to sell
Marketing One, excluding those assets included with the sale of United Life
Assets. Should the Company be unable to dispose of Marketing One over a short
period of time, the Company would consider other options including the
termination of existing operations.
The Company has engaged Wasserstein, Perella & Co. ("Wasserstein Perella") to
review the Company's capital structure and develop recapitalization and
restructuring alternatives. Wasserstein Perella is presently evaluating the
Company's business plan alternatives and capital structure and will advise and
assist it with developing strategies, tactics and timetables to effectuate
financing, refinancing, sale, recapitalization or restructuring transactions, as
appropriate. These transactions may take the form of: (i) a restructuring or
recapitalization of the Company's equity (including preferred or preference
shares), debt securities or other indebtedness or obligations, including an
exchange transaction or otherwise; (ii) a sale of the Company or any subsidiary;
and (iii) a sale or placement of the Company's equity or debt securities or
obligations with one or more lenders or investors or any loan or financing, or
rights offering. There can be no assurance: (i) the Company will be successful
in developing and implementing one or more of these transactions; (ii) the form
the transactions will ultimately take; or (iii) the timing to complete the
process.
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.
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 three month
period ended March 31, 1998 directly and indirectly associated with divisional
restructuring.
18
<PAGE>
The restructuring costs recognized the following for the three month period
ended March 31, 1998 (in millions):
<TABLE>
<S> <C>
Severance and related benefits incurred due to staff reduction. $ 3.8
Estimated holding costs of vacated facilities.................. 2.2
Write-off of certain fixed assets and other impaired assets.... .9
Estimated contract termination costs........................... 4.9
-------------
Total restructuring costs................................. $ 11.8
=============
</TABLE>
During the three month period ended March 31, 1999, the Company re-evaluated the
restructuring costs and increased the remaining accruals by $5,000. During the
three month period ended March 31, 1998, the Company re-evaluated the
restructuring costs and reduced the remaining accruals by $3.8 million as a
result of the final determination of certain obligations. As of March 31, 1999,
the Company had remaining accruals associated with restructuring charges
aggregating $4.5 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 includes 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 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 during the fourth quarter of 1998,
the Company anticipates incurring internal and external costs of $5.6 million
during 1999. The Company estimates it has incurred internal and external costs
aggregating $3.7 million and $2.3 million for the three month periods ended
March 31, 1999 and 1998, respectively.
Each of the operating divisions is primarily responsible for its remediation
efforts with corporate oversight provided as necessary. The Company believes
that the Career Sales Division has substantially completed its year 2000
assessment and remediation efforts, which will be subject to ongoing tests for
the remainder of 1999. In addition, the Career Sales Division has committed to a
strategy of utilizing third party administrative experts, who have indicated
year 2000 compliance, to handle the processing of certain components of its
health insurance business, thus eliminating the need for the upgrade or
modification of certain existing health administration systems. 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 98.0% complete with its
compliancy effort for critical business systems. The efforts of the Company's
Financial Services Division are highly dependent on the utilization of outside
resources. 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 99.0% complete with remediation efforts associated with its critical
business systems. The Company believes that all of its divisions will have
completed their remediation efforts by June 1999, but each division will
continue to perform testing throughout 1999.
19
<PAGE>
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.
Failure of the Company to meet such representations and warranties could result
in a decision by the purchaser not to consummate the transaction and/or
indemnification claims for breach of contract.
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.
The following table shows the cash sources and uses of the parent company on a
projected basis for 1999 and on an actual basis for the three month periods
ended March 31, 1999 and 1998:
<TABLE>
<CAPTION>
Projected
Period
April 1, 1999 to Three Month Periods Ended
December 31, March 31,
1999 1999 1998
------------- ------------- -------------
($ in thousands)
<S> <C> <C> <C>
Cash sources:
Cash from subsidiaries................................. $ 266,242 $ 18,311 $ 20,384
Other investment income................................ -- 124 969
Additional borrowings.................................. -- -- 200,000
Sales of assets currently held......................... 11,000 -- --
Other, net............................................. -- 12 537
------------- ------------- -------------
Total sources.................................... 277,242 18,447 221,890
------------- ------------- -------------
Cash uses:
Acquisition of businesses.............................. -- -- 73,858
Interest paid on debt.................................. 30,444 7,330 5,793
Operating expenses, including restructuring charges.... 14,504 4,930 4,257
Reduction of notes payable............................. 197,000 -- 126,015
Reduction of obligation in course of settlement........ 40,000 -- --
Capital contributions to subsidiaries.................. 1,100 3,303 1,000
Purchase of equity securities.......................... -- -- 5,000
Dividends on preferred and common stock................ -- -- 6,354
------------- ------------- -------------
Total uses....................................... 283,048 15,563 222,277
------------- ------------- -------------
Increase (decrease) in cash and short-term investments... (5,806) 2,884 (387)
Cash and short-term investments at beginning of period... 15,538 12,654 4,464
------------- ------------- -------------
Cash and short-term investments at end of period......... $ 9,732 $ 15,538 $ 4,077
============= ============= =============
</TABLE>
20
<PAGE>
Cash Sources
Cash from Subsidiaries. Cash generated by the Company's insurance subsidiaries
is made available to PennCorp principally through periodic payments of principal
and interest on surplus debentures issued by PLAIC, Constitution and Pioneer
Security (collectively, the "Surplus Note Companies"). With respect to
Constitution and Pioneer Security, the surplus debenture payments are 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 $444.8 million and $453.1 million as of March 31, 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 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 statutory
earnings.
For the three month periods ended March 31, 1999 and 1998, the Company received
surplus debenture interest and principal payments from PLAIC of $456,000 and
$5.2 million, respectively, and received dividends and tax sharing payments of
$17.8 million and $15.2 million, respectively. The Surplus Note Companies
refunded taxes of $378,000 to their respective subsidiaries and received $5.0
million in tax sharing payments from their respective insurance subsidiaries
during the three month periods ended March 31, 1999 and 1998, respectively.
Other Investment Income. During the three month periods ended March 31, 1999 and
1998, the Company received other investment income from short-term invested
assets held by the parent company.
Additional Borrowings. During the three month period ended March 31, 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.
Cash Uses
Acquisition of Businesses. During 1998, the Company acquired the Controlling
Interest in SW Financial 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 borrowing under
its existing credit facility.
Interest Paid on Indebtedness. During the three month periods ended March 31,
1999 and 1998, the Company utilized varying amounts of leverage in its capital
structure. For the three month periods ended March 31, 1999 and 1998, the
average indebtedness outstanding aggregated $548.6 million and $451.1 million,
respectively. The Company's weighted average costs of borrowings increased
significantly during 1998 as a result of the Company's increased leverage ratio
and projected weakness in future liquidity. The Company anticipates higher
interest costs to continue for the year ended 1999.
Operating Expenses Including Restructuring Charges. During the three month
periods ended March 31, 1999 and 1998, the parent 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 three month periods ended March 31, 1999 and 1998
aggregated $1.6 million and $--, respectively. During the remainder of 1999, the
parent company anticipates to fund an additional $2.1 million of such charges.
During the three month period ended March 31, 1999, the parent company also
incurred legal, accounting and investment banking fees associated with asset
dispositions aggregating $594,000. Operating expenses also include costs
aggregating $733,000 associated with the pending class action securityholder
litigation and the SEC's investigation into the Company's historical accounting
practices. The Company anticipates incurring additional amounts of such costs
during the remainder of 1999.
Reduction in Notes Payable. 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 (the "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.
Capital Contributions to Subsidiaries. For the three month periods ended March
31, 1999 and 1998, the Company made capital contributions to subsidiaries
totaling $3.3 million and $1.0 million, respectively. During 1999, the
contribution was made to
21
<PAGE>
PLAIC to make a capital contribution to PLIC. During 1998 the contribution was
primarily made to a non-life insurance subsidiary for other corporate purposes.
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.
Dividends of Preferred and Common Stock. During the three month periods ended
March 31, 1999 and 1998, the Company paid common and preferred stock dividends
aggregating $-- and $6.4 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 Nine Months of 1999
For the remainder of 1999, the Company anticipates receiving approximately $12.5
million in the form of principal and interest payments or dividends and tax
sharing payments from the Surplus Note Companies as a result of the ordinary
dividend flow from the Surplus Notes Companies' insurance subsidiaries. In
April, the Company received payments of $40.2 million and $136.5 million from
proceeds from the sales of Professional and the United Life Assets. In addition,
the Company currently anticipates receiving principal payments of at least $70.0
million under the surplus debentures as a result of the sale of the Career Sales
Division by the Surplus Note Companies. Consummation of the Career Sales
Division sale transaction is subject to regulatory approvals and other material
closing conditions. There can be no assurances that the Career Sales Division
sale will be consummated or that the cash proceeds will be in the amount
anticipated by the Company, (see Notes 3 and 4 of Notes to Unaudited
Consolidated Financial Statements). During April of 1999, the Company utilized
$40.0 million of proceeds from the sale of Professional to reduce the obligation
in course of settlement and $127.0 million of proceeds from the sale of the
United Life Assets to repay indebtedness of the parent company.
The Company's ability to receive surplus note principal and interest payments
above $12.5 million is contingent upon the Company's ability to consummate the
sale of the Career Sales Division, which is the only remaining sales transaction
of the Businesses Held for Sale currently under contract. The Company has
currently realized net cash proceeds after required debt reduction under the
Company's Bank Credit Facility of $9.9 million from the sales of Professional
and the United Life Assets. The Company acquired assets from United Life and
Professional with a carrying value of $9.3 million. The Company anticipates it
will be able to sell most of these assets during 1999 and realize cash proceeds
of approximately $11.0 million, though there can be no assurance that the
Company will succeed in doing so. Such liquidity is necessary for the Company to
fund interest payments under the Bank Credit Facility and the notes and to fund
operating expenses of the Company. Though the Company has the obligation to
consummate the sales of the Businesses Held for Sale and to prepay the loans to
certain covenanted levels, the Company may not have the requisite ability to
effectuate the sale as a result of the restrictive covenants contained in the
amended Bank Credit Facility. The accessibility of the cash proceeds of the
Career Sales Division is the subject of regulatory approval. While certain
regulatory filings with respect to the sale of the Career Sales Division have
been made, not all filings have been so made and the final structure by which
such proceeds will be upstreamed to the Company have not yet been finalized. The
amended Bank Credit Facility provides that the Company and its subsidiaries are
limited from entering into certain mergers, consolidations, amalgamations,
liquidations, winding up or dissolutions, incurring certain indebtedness and
liabilities, making dispositions, prepaying certain indebtedness, declaring
dividends, or issuing, redeeming, purchasing, retiring, exchanging or converting
capital securities, in each case with very limited or scheduled exceptions.
While the Company believes it has scheduled or otherwise provided for a great
majority of the possible combinations it will take to effectively upstream the
cash proceeds of the sales of the Career Sales Division, it is not possible to
foresee all combinations. Accordingly, the mechanism to upstream to the Company
the necessary cash to pay the covenanted prepayment under the amended Bank
Credit Facility may be subject to the approval of the majority banks which, if
not given, would result in an event of default under the amended Bank Credit
Facility. Should the sale transactions not close within specified time periods,
the Company may face difficulty in meeting its existing and estimated cash
obligations and would be in default of certain covenants under the amended Bank
Credit Facility.
The net proceeds available to the Company from the asset sales may vary
significantly from current estimates as a result of (i) minimum levels of
statutory capital and surplus required to be delivered at closing for certain
insurance subsidiaries, (ii) amounts to be held in escrow, (iii) valuation of
certain consideration to be received by the Company, (iv) the timing of the
closing and (v) various indemnification obligations included in each purchase
and sale agreement. Specifically, the purchase and sale agreement for the Career
Sales Division requires the purchaser to be reasonably satisfied with disability
claims reserve liabilities and other active life reserves. The Company has
received preliminary reports from an actuarial consulting firm engaged to
provide analysis to the purchaser regarding such reserves. The Company is aware
of potential deficiencies in the statutory determination of certain statutory
reserves that will likely impact the total consideration the Company is to
22
<PAGE>
receive. The Company and the purchaser have engaged in discussions to resolve
the reserve issues (see Note 3 of Notes to Unaudited Consolidated Financial
Statements). In addition, the purchase and sale agreement for the United Life
Assets required the Company to purchase certain residential mortgage loans,
should the loans not meet specified criteria under the purchase and sale
agreement. At closing, on April 30, 1999, the Company acquired approximately
$11.7 million of principal amount of such loans. The amount of mortgages
purchased is subject to adjustment for a period of 90 days subsequent to closing
subject to terms of the purchase and sale agreement.
The Bank Credit Agreement provides certain relief from the June 30, 1999 $70.0
million required debt reduction should the Company be unable to consummate the
sale of the Career Sales Division to Universal American. Should the Universal
American transaction terminate on or before June 30, 1999, the Company shall, on
or before September 30, 1999, enter into one or more definitive agreements to
sell the Career Sales Division or other assets pursuant to which the majority of
the Bank Group has determined that the Company will receive net cash proceeds of
not less than $70.0 million that the Bank Group has determined will be available
to the Company to be applied to the outstanding senior bank debt no later than
December 31, 1999.
In addition to the above proceeds, there exists $7.0 million of unused
commitments under the Company's existing credit facility that are available only
for the purpose of payments of interests, should the Company not have sufficient
liquidity from other sources. Upon consummation of the Career Sales Division
divestiture the commitment will be reduced to $5.0 million.
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. However, there can be no assurances actual
liquidity sources will develop as currently projected. In the event of a
shortfall of actual liquidity sources, the Company will explore options to
generate any necessary liquidity such as: (i) the sale of non-strategic
subsidiaries and (ii) obtain 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 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 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 (used) by operating
activities, excluding the parent company, were $(337,000) and $17.1 million for
the three month periods ended March 31, 1999 and 1998, respectively. The
decreasing trend in cash flow from operating activities principally resulted
from increasing costs associated with: (i) year 2000 remediation at all of the
insurance subsidiaries, (ii) the strategic business evaluations and associated
restructuring of the Company and (iii) the accelerating expansion and transition
of KIVEX from a regional to a national internet service provider.
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 $2,518.5
million and $2,589.7 million at March 31, 1999 and December 31, 1998,
respectively.
During the three month periods ended March 31, 1999 and 1998, the Company's
subsidiaries sold $341.4 and $241.5 million of fixed maturity and equity
securities, and purchased $435.2 million and $287.5 million of fixed maturity
and equity securities, respectively. Such sales and purchases were primarily
effected in order to reinvest cash from maturities of fixed
23
<PAGE>
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 $101.9 million and $95.2 million for the
three month periods ended March 31, 1999 and 1998, respectively. The majority of
the cash outflow is attributable to policyholder surrenders exceeding deposits
by $87.3 million and $81.4 million for the three month periods ended March 31,
1999 and 1998, respectively.
RESULTS OF OPERATIONS
For the three month periods ended March 31, 1999 and 1998, the Company has
prepared the following unaudited selected pro forma financial information for
the Company's remaining operating divisions, the Financial Services Division
(excluding the United Life Assets) and the Payroll Sales Division (excluding
Professional) and Businesses Held for Sale (Career Sales Division, Professional,
the United Life Assets, KIVEX and Marketing One). The pro forma financial
information by operating division is defined as pre-tax income (loss) excluding
the impact of: (i) restructuring costs, (ii) gains or losses on the sale of
investments and (iii) the impact of the Company's decision to dispose of the
Businesses Held for Sale ((i), (ii) and (iii) collectively, "Operating Income
(Loss)").
The Company has prepared such information as it believes that: (i) the intended
disposition of the Businesses Held for Sale and (ii) the restructuring costs are
material enough to make historical comparative results not meaningful. In
addition, the Company believes that the pro forma financial information will
facilitate the subsequent discussion parallel with how management views and
evaluates the operations of the Company.
The following unaudited selected pro forma financial information has been
prepared for comparative purposes only and does not purport to be indicative of
what would have occurred had the transactions described above been made as of
January 1, 1998, or the results which may occur in the future.
<TABLE>
<CAPTION>
SELECTED PRO FORMA FINANCIAL INFORMATION
Three Month Periods Ended
March 31,
1999 1998
------------- -------------
($ in thousands)
<S> <C> <C>
Financial Services Division:
Operating income........................................................... $ 3,528 $ 11,375
Net investment gains....................................................... 1,122 230
Restructuring costs........................................................ (38) (2,164)
------------- -------------
4,612 9,441
------------- -------------
Payroll Sales Division:
Operating income........................................................... 1,899 4,928
Net investment gains (losses).............................................. (13) 24
------------- -------------
1,886 4,952
------------- -------------
Businesses Held for Sale:
Operating income........................................................... 7,723 9,040
Net investment gains....................................................... 1,071 1,270
Restructuring costs........................................................ 33 (3,074)
Net gain from sale of subsidiary........................................... 996 --
Impairment valuation....................................................... (30,287) --
------------- -------------
(20,464) 7,236
------------- -------------
Corporate:
Interest and amortization of deferred debt interest cost................... (14,120) (9,917)
Corporate expenses, eliminations and other................................. (8,968) (3,286)
Net investment gains....................................................... (1) (1)
Restructuring costs........................................................ -- (2,779)
------------- -------------
(23,089) (15,983)
Income (loss) before income taxes and extraordinary charge................... $ (37,055) $ 5,646
============= =============
</TABLE>
24
<PAGE>
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.
<TABLE>
<CAPTION>
SELECTED PRO FORMA FINANCIAL INFORMATION
Three Month Periods Ended
March 31,
1999 1998
------------- -------------
($ in thousands)
<S> <C> <C>
Revenues:
Policy revenues............................................................ $ 33,786 $ 37,093
Net investment income...................................................... 42,856 48,083
Other income............................................................... 1,323 1,414
------------- -------------
77,965 86,590
------------- -------------
Benefits and expenses:
Total policyholder benefits................................................ 55,369 63,136
Insurance related expenses................................................. 9,497 3,913
Other operating expenses................................................... 9,570 8,166
------------- -------------
74,437 75,215
------------- -------------
Pre-tax operating income................................................. $ 3,528 $ 11,375
============= =============
</TABLE>
Policy Revenues. Policy revenues include: (i) premiums received on traditional
life products (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 month periods
ended March 31, 1999 and 1998 are as follows:
<TABLE>
<CAPTION>
Three Month Periods Ended
March 31,
1999 1998
------------- -------------
($ in thousands)
<S> <C> <C>
Life premiums:
Universal life (first year)................................................ $ 7,089 $ 9,421
Universal life (renewal)................................................... 17,858 27,201
Traditional life (first year).............................................. 2,510 3,009
Traditional life (renewal)................................................. 6,454 6,240
------------- -------------
Life premiums, net of reinsurance........................................ 33,911 45,871
------------- -------------
Annuity premiums:
Traditional fixed (first year)............................................. 2,325 3,494
Traditional fixed (renewal)................................................ 1,998 555
------------- -------------
Annuity premiums, net of reinsurance..................................... 4,323 4,049
------------- -------------
Fixed benefit premiums:
Long-term care premiums (all first year)................................... 405 --
------------- -------------
Premiums, net of reinsurance................................................. 38,639 49,920
Less premiums on universal life and annuities which are recorded as
additions to insurance liabilities and other premium adjustments........... (29,270) (40,671)
------------- -------------
Premiums on products with mortality or morbidity risk........................ 9,369 9,249
Fees and surrender charges on interest sensitive products.................... 24,417 27,844
------------- -------------
Policy revenues.............................................................. $ 33,786 $ 37,093
============= =============
</TABLE>
25
<PAGE>
Policy revenues decreased 8.9% during the three month period ended March 31,
1999. Life premiums collected, net of reinsurance, were $33.9 million for the
three month period ended March 31, 1999 compared with $45.9 million in 1998.
First year universal life premiums decreased 24.8% in 1999 to $7.1 million and
first year traditional life decreased 16.6% to $2.5 million. The Company expects
the A.M. Best downgrades, which occurred during the third quarter of 1998 to
continue to negatively impact 1999 new business production levels relative to
1998. New life sales were strong at Security Life for the three month period
ended March 31, 1998 but had declined significantly throughout the remainder of
1998 and for the three month period ended March 31, 1999 reflecting the impact
of ratings downgrades and management changes in Security Life's marketing
management. Life renewal premiums declined 27.3% for the three month period
ended March 31, 1999 compared with the comparable 1998 period. 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 $5.6 million for the three
month period ended March 31, 1999 and will likely result in additional refund of
premiums for the remainder of 1999. See "Policyholder Benefits," included
herein. Annuity premiums of $4.3 million for the three month period ended March
31, 1999 were consistent with premiums of $4.0 million in the comparable period
of 1998. Annuity sales are likely to decline unless market conditions for fixed
annuities become more favorable and ratings of Southwestern Life and Security
Life improve.
Net Investment Income. Net investment income decreased 10.9% to $42.9 million
for the three month period ended March 31, 1999 due to a decrease in invested
assets and reduced yields on investments. Average invested assets declined
approximately $214.0 million for the three month period ended March 31, 1999
compared with the comparable period 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 $75.4 million for the three
month period ended March 31, 1999 and $313.1 million for all of 1998. Most of
these surrenders involved annuities which had reached the end of their surrender
fee period. A continued decline in the invested asset base and related
investment income is anticipated as surrenders are expected to remain high over
the next few years as more annuities in force reach the end of the surrender fee
periods. The decrease in invested assets due to surrenders was partially offset
by premiums on new and existing life policies and investment income collected,
less commissions and operating expenses. Weighted average yields on invested
assets have decreased to 7.0% for the three month period ended March 31, 1999
compared to 7.2% for the comparable 1998 period. The decline principally
reflects lower new money rates available to the Company to invest as a result of
extensive maturities and calls of higher yielding investments.
Other Income. Other income for the three month period ended March 31, 1999 was
nearly unchanged compared to the comparable 1998 period. Nearly all of the
modest difference between the periods reflect changes in consideration received
on supplemental contracts. Supplemental contract revenue is derived from annuity
contracts which have reached the annuitization period. Consideration from
supplemental contracts recognized as other income is offset by policyholder
benefits, resulting in no net effect on the Company's results of operations.
Total Policyholder Benefits. The following table shows the components of total
policyholder benefits for the three month periods ended March 31, 1999 and 1998:
<TABLE>
<CAPTION>
Three Month Periods Ended
March 31,
1999 1998
------------- -------------
($ in thousands)
<S> <C> <C>
Death benefits............................................................... $ 20,162 $ 23,551
Other insurance policy benefits and change in future policy benefits......... 35,207 39,585
------------- -------------
Total policyholder benefits.................................................. $ 55,369 $ 63,136
============= =============
</TABLE>
During 1999, policyholder benefits decreased 12.3% to $55.4 million for the
three month period ended March 31, 1999 compared with the comparable 1998
period. Death benefits decreased $3.4 million or 14.4% compared with the
comparable 1998 period. Death benefits may vary significantly from period to
period. Change in future policy benefits and other benefits decreased 11.1% to
$35.2 million for the three month period ended March 31, 1999 principally due to
reduced scheduled annuity benefits reflecting lower in force amounts resulting
from surrender activity.
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 $532.9 million as
of March 31, 1999 and
26
<PAGE>
$525.4 million as of December 31, 1998. If developing trends were to continue,
the Company would be required 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. 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. The exchange program
is not expected to have a material effect on the Company's financial position or
results of operations (see Note 9 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) increased to $9.5 million during the three month
period ended March 31, 1999 compared with $3.9 million in the comparable 1998
period. Amortization of deferred policy acquisition costs increased $1.6 million
during the three month period ended Mach 31, 1999 compared to the comparable
1998 period. These increases principally reflect 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. Amortization of present
value of future profits increased $3.9 million to $4.4 million for the three
month period ended March 31, 1999. During the three month period ended March 31,
1998, Southwestern Life benefited from a favorable impact of unlocking certain
assumptions regarding the future profitability of certain interest sensitive
life insurance products.
Other Operating Expenses. For the three month period ended March 31, 1999, other
operating expenses (including general operating, overhead and policy
maintenance) increased $1.4 million from the comparable period in 1998. The 1999
increase is principally attributable to additional non-deferrable expenses
related to costs associated with year 2000 remediation efforts and systems
conversions for Security Life.
RETAINED BUSINESS--PAYROLL SALES DIVISION
The Payroll Sales Division includes the operations of AA Life and OLIC. AA Life
markets and underwrites customized life insurance and accumulation products to
U.S. military personnel and federal employees through a general agency force.
OLIC provides individual fixed benefit and life products utilizing a network of
independent agents primarily in the southeastern United States through
employer-sponsored payroll deduction programs.
<TABLE>
<CAPTION>
SELECTED PRO FORMA FINANCIAL INFORMATION
Three Month Periods Ended
March 31,
1999 1998
------------- -------------
($ in thousands)
<S> <C> <C>
Revenues:
Policy revenues............................................................ $ 23,283 $ 22,003
Net investment income...................................................... 9,558 9,800
Other income (loss)........................................................ 491 (26)
------------- -------------
33,332 31,777
------------- -------------
Benefits and expenses:
Total policyholder benefits................................................ 17,785 15,168
Insurance related expenses................................................. 8,888 7,835
Other operating expenses................................................... 4,760 3,846
------------- -------------
31,433 26,849
------------- -------------
Pre-tax operating income................................................. $ 1,899 $ 4,928
============= =============
</TABLE>
27
<PAGE>
Policy Revenues. Premiums received, net of reinsurance, by major product line
for the three month periods ended March 31, 1999 and 1998 are as follows:
<TABLE>
<CAPTION>
Three Month Periods Ended
March 31,
1999 1998
------------- -------------
($ in thousands)
<S> <C> <C>
Life premiums:
Universal life (first year)................................................ $ 228 $ 245
Universal life (renewal)................................................... 6,221 6,445
Traditional life (first year).............................................. 4,259 4,228
Traditional life (renewal)................................................. 9,725 7,426
------------- -------------
Life premiums, net of reinsurance.......................................... 20,433 18,344
------------- -------------
Annuity premiums:
Traditional fixed (first year)............................................. 222 13
Traditional fixed (renewal).................................................. 180 203
------------- -------------
Annuity premiums, net of reinsurance....................................... 402 216
------------- -------------
Fixed benefit premiums:
Accident and Health (first year)........................................... 631 616
Accident and Health (renewal).............................................. 2,492 2,435
------------- -------------
Fixed benefit premiums, net of reinsurance............................... 3,123 3,051
------------- -------------
Premiums, net of reinsurance................................................. 23,958 21,611
Less premiums on universal life and annuities which are recorded as
additions to insurance liabilities and other premium adjustments........... (6,851) (6,906)
------------- -------------
Premiums on products with mortality or morbidity risk........................ 17,107 14,705
Fees and surrender charges on interest sensitive products.................... 6,176 7,298
------------- -------------
Policy revenues.............................................................. $ 23,283 $ 22,003
============= =============
</TABLE>
Total policy revenues increased modestly between the three month period ended
March 31, 1999 and the comparable 1998 period. Policy revenues increased $1.3
million or 5.8%. 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 month period ended March 31, 1999.
Net Investment Income. Net investment income decreased 2.5% for the three month
period ended March 31, 1999 from the comparable 1998 period to $9.6 million. The
decrease in net investment income was primarily the result of a decrease in
weighted average yields on invested assets which decreased to 7.0% in the three
month period ended March 31, 1999 compared to 7.2% in the comparable 1998
period. The decrease in yields is primarily attributed to lower reinvestment
rates.
Other Income. Other income was $491,000 during the three month period ended
March 31, 1999 compared to a loss of $26,000 in the comparable 1998 period.
Supplemental contracts represent most of the other income in the three month
period ended March 31, 1999. These can fluctuate significantly from period to
period but have little impact on results of operations as proceeds are offset by
change in reserves.
Total Policyholder Benefits. The following table shows the components of total
policyholder benefits for the three month periods ended March 31, 1999 and 1998:
<TABLE>
<CAPTION>
Three Month Periods Ended
March 31,
1999 1998
------------- -------------
($ in thousands)
<S> <C> <C>
Death benefits............................................................... $ 6,635 $ 6,245
Fixed benefit claims incurred................................................ 2,503 2,025
Other insurance policy benefits and change in future policy benefits......... 8,647 6,898
------------- -------------
Total policyholder benefits.................................................. $ 17,785 $ 15,168
============= =============
</TABLE>
28
<PAGE>
Policyholder benefits totaled $17.8 million in the three month period ended
March 31, 1999, which was a 17.3% or $2.6 million increase compared with the
three month period of 1998. Most of the increase is attributable to OLIC which
experienced increases in future policy benefits and claim reserves associated
with accident and health products.
Insurance Related Expenses. Insurance related expenses (including commissions,
amortization of deferred policy acquisition costs and amortization of present
value of insurance in force) increased $1.1 million for the three month period
ended March 31, 1999 compared to the comparable 1998 period. Amortization of
deferred policy acquisition costs at AA Life increased $1.1 million for the
three month period ended March 31, 1999 compared to the comparable 1998 period
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.
Other Operating Expenses. Other operating expenses (including general operating,
overhead and policy maintenance) increased $900,000 in the three month period
ended March 31, 1999 compared to the comparable 1998 period. The increase is
principally attributable to non-deferrable expenses related to costs associated
with year 2000 remediation efforts and systems conversions.
BUSINESSES HELD FOR SALE
Businesses Held for Sale include the operations of the Career Sales Division,
KIVEX, Professional, the United Life Assets and Marketing One. The Career Sales
Division, which includes the operations of Penn Life, markets and underwrites
fixed benefit accident and sickness products and, to a lesser extent, life
products through a sales force exclusive to the Company throughout the United
States and Canada. With the January 2, 1998, consummation of the acquisition of
the SW Financial Controlling Interest, the Company has integrated Union Bankers,
Marquette and Constitution with the Career Sales Division. KIVEX is an internet
service provider. Professional provides individual fixed benefit and life
products utilizing a network of independent agents primarily in the southeastern
United States through employer-sponsored payroll deduction programs. United Life
principally markets fixed and variable annuities through financial institutions
and independent general agents, primarily in the southern and western United
States.
<TABLE>
<CAPTION>
SELECTED PRO FORMA FINANCIAL INFORMATION
Three Month Periods Ended
March 31,
1999 1998
------------- -------------
($ in thousands)
<S> <C> <C>
Revenues:
Policy revenues............................................................ $ 56,803 $ 64,496
Net investment income...................................................... 34,134 37,272
Other income............................................................... 9,008 9,412
------------- -------------
99,945 111,180
------------- -------------
Benefits and expenses:
Total policyholder benefits................................................ 55,473 59,791
Insurance related expenses................................................. 12,843 21,925
Other operating expenses................................................... 23,906 20,424
------------- -------------
92,222 102,140
------------- -------------
Pre-tax operating income (loss)............................................ $ 7,723 $ 9,040
============= =============
</TABLE>
Policy Revenues. Policy revenues declined 11.9% or $7.7 million to $56.8 million
in the three month period of 1999 compared to the comparable 1998 period. The
decline is primarily attributable to Union Bankers which discontinued sales of
major medical health products and its life insurance products and increased its
utilization of reinsurance.
Net Investment Income. Net investment income decreased $3.1 million or 8.4 %
during the three month period ended March 31, 1999 compared to the comparable
1998 period. The decrease is primarily attributable to United Life, where net
investment income decreased $2.5 million in the three month period ended March
31, 1999 compared to the comparable 1998 period. United Life has experienced
high surrenders of fixed annuities in the three month period ended March 31,
1999 and during all of 1998 reflecting low reinvestment rates available for
annuities as they reached the end of their surrender fee period. Surrenders at
United Life totaled $54.3 million during the three month period ended March 31,
1999 and $63.5 million in three month period ended March 31, 1998. Such
surrenders resulted in a liquidation of invested assets which caused the
declines in investment income. Most of the remainder of the decline was
attributable to Union Bankers as a result of fewer sales and increased
utilization of reinsurance.
29
<PAGE>
Other Income. Other income decreased $400,000 or 4.3% to $9.0 million in the
three month period ended March 31, 1999 compared to the comparable 1998 period.
The decrease in other income in the three month period ended March 31, 1999
compared to the three month period ended March 31, 1998 is attributable to a
decline in the amortization of Union Bankers' deferred gain associated with a
third party Medicare reinsurance contract. The decrease in amortization is
attributable to a decline in the underlying premium in force subject to the
reinsurance arrangement, over time, which results in lower amortization of the
gain. Also contributing to the decline in other income is reduced revenues for
Marketing One resulting from the cancellation of a number of marketing
relationships. These decreases are partially offset by increased fee income for
United Life and a $1.1 million increase in revenues for KIVEX to $1.8 million.
Total Policyholder Benefits. Policyholder benefits decreased $4.3 million or
7.2% in the three month period ended March 31, 1999 compared to the comparable
1998 period. Union Bankers experienced a decrease in policyholder benefits of
$4.7 million, reflecting less business in force as a result of the decision to
cease sales of major medical and life business, the cession of the remaining 20%
of the Medicare business and the runoff of existing business.
Insurance Related Expenses. Insurance related expenses (including commissions,
amortization of deferred policy acquisition costs and amortization of present
value of insurance in force) decreased $9.1 million to $12.8 million for the
three month period ended March 31, 1999 compared to the comparable 1998 period.
Amortization of present value of insurance in force decreased $5.1 million and
amortization of deferred policy acquisition costs decreased $3.3 million
principally as a result of 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.
Non-deferrable commissions decreased $700,000. Most of the decrease is
attributable to the new sales compensation structure at Penn Life.
Other Operating Expenses. Other operating expenses (including general operating,
overhead and policy maintenance) increased $3.5 million or 17.0% in the three
month period ended March 31, 1999 compared to the comparable 1998 period.
KIVEX's operating expenses increased $4.5 million reflecting costs associated
with its expansion into new cities. Offsetting the increases in operating
expenses is reduced amortization of costs in excess of net assets acquired
associated with the Assets of the Businesses Held for Sale.
GENERAL CORPORATE
Interest and Amortization of Deferred Debt Issuance Costs. Interest and
amortization of deferred debt issuance costs increased $4.2 million for the
three month period ended March 31, 1999 compared to the comparable 1998 period.
This is the result of higher weighted average borrowing costs and 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.
Corporate Expenses. Corporate expenses, eliminations and other costs were $9.0
million and $3.3 million for the three month periods ended March 31, 1999 and
1998, respectively. The increase is primarily attributable to two factors: (i)
consulting and legal fees of $3.2 million associated with the disposal of the
Businesses Held for Sale as well as the negotiation and implementation of, and
compliance with, the amended Bank Credit Facility, pending class action
securityholder litigation and the SEC's investigation into the Company's
historical accounting practices, and (ii) additional deferred compensation of
$1.8 million associated with the two year employment agreements of the Company's
three senior executives which were entered into in May 1998.
Income Taxes. For the three month period ended March 31, 1999, the Company
recognized income tax expense of $4.6 million on loss before taxes of $37.1
million. The effective tax rate for the three month period ended March 31, 1998
was 48.8%. The significant change in the effective tax rate between 1999 and
1998 is substantially due to the non-deductibility of the reduction in carrying
value of the assets associated with Businesses Held for Sale and an increase in
the 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 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
30
<PAGE>
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. 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 $2.2 million and $1.5 million, during the three
months ended March 31, 1999 and 1998, respectively. During the three month
periods ended March 31, 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
$87.3 million and $81.4 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. During the three month period ended March 31, 1999, there
have been no material changes to such risks. 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.
31
<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
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 Chairman and Chief Executive Officer, and Steven W.
Fickes, formerly 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 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 will be 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 $15.0 million of
primary and $10.0 million of excess coverage, respectively, for securities
claims. The primary insurance coverage requires the Company to bear 25% of all
expenses and any losses in excess of a $1.0 million 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.
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 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 has 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.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
11.1 Computation of Earnings per Share
15.1 Independent Auditors' Report
27 Financial Data Schedule
32
<PAGE>
(b) Reports on Form 8-K
A report on Form 8-K dated December 31, 1998 was filed with the
Securities and Exchange Commission ("SEC") on January 11, 1999,
reporting the execution by the Company of a purchase agreement with
Universal American Financial Corp. to sell the Company's Career Sales
Division (the "PennUnion Purchase Agreement"). Also reported on the
Form 8-K was the execution of a stock purchase agreement by the Company
with GE Financial Assurance Holdings, Inc. dated as of December 31,
1998 to sell all of the outstanding stock of Professional Insurance
Company ("Professional"). In addition, the Form 8-K also reported the
amendment of the Company's existing bank credit agreement (the "Credit
Agreement") to permit the transaction contemplated by the PennUnion
Purchase Agreement.
A report on Form 8-K dated March 5, 1999 was filed with the SEC on
March 11, 1999, reporting the execution of a purchase agreement on
February 21, 1999 by the Company with ING America Insurance Holdings,
Inc. to sell the Company's subsidiaries: United Life and Annuity
Insurance Company, UC Mortgage Corp., Cyberlink Development Inc. and
certain related assets (the "United Life Purchase Agreement"). The Form
8-K also reported the consent to the transactions contemplated by the
United Life Purchase Agreement by the parties to the Credit Agreement.
A report on Form 8-K dated March 31, 1999 was filed with the SEC on
April 5, 1999, reporting the consummation of the sale of Professional
and the use of the net proceeds from the sale to pay down the
outstanding balance under the Credit Agreement. The Form 8-K also
reported the further amendment to the Credit Agreement effective as of
March 31, 1999.
33
<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: May 17, 1999
34
<PAGE>
INDEX TO EXHIBITS
Exhibit Numbers
11.1 Computation of Earnings per Share
15.1 Independent Auditors' Report
27 Financial Data Schedule
35
<PAGE>
EXHIBIT 11.1
PENNCORP FINANCIAL GROUP, INC. AND SUBSIDIARIES
COMPUTATION OF EARNINGS (LOSS) PER SHARE
(In thousands)
(Unaudited)
<TABLE>
<CAPTION>
Three Month Periods Ended
March 31,
1999 1998
------------- -------------
<S> <C> <C>
Basic net income (loss) applicable to common stock:
Loss before extraordinary charge applicable to common stock................ $ (46,111) $ (2,015)
Redemption Premium on Series C
Preferred Stock.......................................................... -- (1,913)
------------- -------------
(46,111) (3,928)
Extraordinary charge....................................................... -- (1,671)
------------- -------------
$ (46,111) $ (5,599)
============= =============
Diluted net income (loss) applicable to common stock:
Loss before extraordinary charge applicable to common stock................ $ (46,111) $ (2,015)
Redemption Premium on Series C
Preferred Stock.......................................................... -- (1,913)
------------- -------------
(46,111) (3,928)
Extraordinary charge....................................................... -- (1,671)
------------- -------------
$ (46,111) $ (5,599)
============= =============
Three Month Periods Ended
March 31,
1999 1998
------------- -------------
Basic:
Shares outstanding beginning of period..................................... 30,072 28,860
Incremental shares applicable to Stock Warrants/Stock Options.............. 50 375
Acquisition of Fickes and Stone Knightsbridge Interests.................... 173 347
Treasury shares............................................................ (1,111) (1,010)
------------- -------------
29,184 28,572
============= =============
Diluted:
Shares outstanding beginning of period..................................... 30,072 28,860
Incremental shares applicable to Stock Warrants/Stock Options.............. 50 375
Acquisition of Fickes and Stone Knightsbridge Interests.................... 173 347
Treasury shares............................................................ (1,111) (1,010)
------------- -------------
29,184 28,572
============= =============
</TABLE>
36
<TABLE> <S> <C>
<ARTICLE> 7
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-END> MAR-31-1999
<DEBT-HELD-FOR-SALE> 2,518,510
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 2,026
<MORTGAGE> 35,026
<REAL-ESTATE> 8,794
<TOTAL-INVEST> 2,910,840
<CASH> 122,521
<RECOVER-REINSURE> 0
<DEFERRED-ACQUISITION> 144,867
<TOTAL-ASSETS> 5,853,031
<POLICY-LOSSES> 2,675,951
<UNEARNED-PREMIUMS> 44,321
<POLICY-OTHER> 45,829
<POLICY-HOLDER-FUNDS> 71,025
<NOTES-PAYABLE> 510,887
0
258,583
<COMMON> 303
<OTHER-SE> 107,268
<TOTAL-LIABILITY-AND-EQUITY> 5,853,031
113,872
<INVESTMENT-INCOME> 86,107
<INVESTMENT-GAINS> 2,179
<OTHER-INCOME> 10,945
<BENEFITS> 128,627
<UNDERWRITING-AMORTIZATION> 15,543
<UNDERWRITING-OTHER> 92,864
<INCOME-PRETAX> (37,055)
<INCOME-TAX> 4,600
<INCOME-CONTINUING> (41,655)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (46,111)
<EPS-PRIMARY> (1.58)
<EPS-DILUTED> (1.58)
<RESERVE-OPEN> 0
<PROVISION-CURRENT> 0
<PROVISION-PRIOR> 0
<PAYMENTS-CURRENT> 0
<PAYMENTS-PRIOR> 0
<RESERVE-CLOSE> 0
<CUMULATIVE-DEFICIENCY> 0
</TABLE>
