<PAGE>
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2000
-------------------------------------
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
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Commission file number: 1-13654
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LIBERTY FINANCIAL COMPANIES, INC.
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(Exact name of registrant as specified in its charter)
Massachusetts 04-3260640
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
600 Atlantic Avenue, Boston, Massachusetts 02210-2214
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(Address of principal executive offices) (Zip Code)
(617) 722-6000
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(Registrant's telephone number, including area code)
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(Former name, former address and former fiscal year,
if changed since last report)
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. [ X ] Yes [ ] No
There were 48,475,421 shares of the registrant's Common Stock, $.01 par
value, and 213,242 shares of the registrant's Series A Convertible Preferred
Stock, $.01 par value, outstanding as of October 31, 2000.
Exhibit Index - Page 25 Page 1
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LIBERTY FINANCIAL COMPANIES, INC.
QUARTERLY REPORT ON FORM 10-Q FOR PERIOD ENDED SEPTEMBER 30, 2000
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PART I. FINANCIAL INFORMATION PAGE
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<S> <C> <C>
Item 1. Financial Statements
Consolidated Balance Sheets as of September 30, 2000 and
December 31, 1999 3
Consolidated Income Statements for the Three Months and Nine Months
Ended September 30, 2000 and 1999 4
Consolidated Statements of Cash Flows for the Nine Months Ended
September 30, 2000 and 1999 5
Consolidated Statement of Stockholders' Equity for the Nine Months
Ended September 30, 2000 6
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 12
Item 3. Quantitative and Qualitative Disclosures About Market Risk 23
PART II. OTHER INFORMATION
--------
Item 6. Exhibits and Reports on Form 8-K 23
Signatures 24
Exhibit Index 25
</TABLE>
2
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LIBERTY FINANCIAL COMPANIES, INC.
CONSOLIDATED BALANCE SHEETS
(IN MILLIONS)
<TABLE>
<CAPTION>
SEPTEMBER 30 DECEMBER 31
2000 1999
-------------- -------------
UNAUDITED
ASSETS
<S> <C> <C>
Assets:
Investments $12,170.3 $12,195.1
Cash and cash equivalents 2,039.8 1,232.6
Accrued investment income 150.2 162.0
Deferred policy acquisition costs 642.8 739.2
Deferred distribution costs 167.4 153.7
Intangible assets 548.8 282.0
Other assets 279.5 244.8
Separate account assets 3,907.2 3,363.1
-------------- -------------
$19,906.0 $18,372.5
============== =============
<CAPTION>
LIABILITIES AND STOCKHOLDERS' EQUITY
<S> <C> <C>
Liabilities:
Policyholder balances $12,117.0 $12,109.6
Notes payable 781.1 552.0
Payable for investments purchased and loaned 1,336.1 754.9
Other liabilities 479.5 453.1
Separate account liabilities 3,859.2 3,301.0
-------------- -------------
Total liabilities 18,572.9 17,170.6
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Series A redeemable convertible preferred stock, par
value $.01; authorized, issued and outstanding
213,242 shares in 2000 and 324,759 shares in 1999 10.7 16.0
-------------- -------------
Stockholders' Equity:
Common stock, par value $.01; authorized
100,000,000 shares, issued and outstanding
48,358,671 shares in 2000 and 47,462,995
shares in 1999 0.5 0.5
Additional paid-in capital 938.1 923.0
Retained earnings 500.5 425.2
Accumulated other comprehensive loss (112.1) (158.1)
Unearned compensation (4.6) (4.7)
-------------- -------------
Total stockholders' equity 1,322.4 1,185.9
-------------- -------------
$19,906.0 $18,372.5
============== =============
</TABLE>
See accompanying notes to consolidated financial statements.
3
<PAGE>
LIBERTY FINANCIAL COMPANIES, INC.
CONSOLIDATED INCOME STATEMENTS
(IN MILLIONS, EXCEPT PER SHARE DATA)
UNAUDITED
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30
--------- ---------------------------------
2000 1999 2000 1999
--------- ---------- ----------- ----------
<S> <C> <C> <C> <C>
Investment income, including distributions
from private equity limited partnerships
of $6.2 million and $8.7 million for
the three months and nine months ended
September 30, 2000,respectively $214.1 $197.9 $636.4 $601.2
Interest credited to policyholders (135.8) (131.3) (396.3) (395.5)
--------- ---------- ----------- ----------
INVESTMENT SPREAD 78.3 66.6 240.1 205.7
--------- ---------- ----------- ----------
NET REALIZED INVESTMENT LOSSES (20.8) (12.7) (37.6) (27.4)
--------- ---------- ----------- ----------
NET CHANGE IN UNREALIZED AND UNDISTRIBUTED
GAINS IN PRIVATE EQUITY LIMITED
PARTNERSHIPS 5.9 - 28.4 -
--------- ---------- ----------- ----------
Fee income:
Investment advisory and
administrative fees 71.2 68.2 214.4 202.6
Distribution and service fees 15.6 15.3 46.1 45.3
Transfer agency fees 12.3 13.1 37.2 38.8
Surrender charges and net commissions 10.1 9.6 30.1 27.0
Separate account fees 11.8 8.7 33.6 23.0
--------- ---------- ----------- ----------
TOTAL FEE INCOME 121.0 114.9 361.4 336.7
--------- ---------- ----------- ----------
Expenses:
Operating expenses (98.1) (89.1) (300.0) (268.3)
Restructuring charges (11.3) - (11.3) -
Amortization of deferred policy
acquisition costs (26.9) (22.8) (83.8) (69.5)
Amortization of deferred distribution
costs (10.9) (10.2) (31.5) (29.4)
Amortization of intangible assets (5.1) (5.0) (15.3) (15.1)
Interest expense, net (4.8) (4.6) (13.0) (15.6)
--------- ---------- ----------- ----------
TOTAL EXPENSES (157.1) (131.7) (454.9) (397.9)
--------- ---------- ----------- ----------
PRE-TAX INCOME 27.3 37.1 137.4 117.1
Income tax expense (5.2) (12.5) (46.9) (41.8)
--------- ---------- ----------- ----------
NET INCOME $22.1 $24.6 $90.5 $75.3
========= ========== =========== ==========
Net income per share - basic $0.46 $0.52 $1.89 $1.60
========= ========== =========== ==========
Net income per share - assuming dilution $0.45 $0.51 $1.86 $1.57
========= ========== =========== ==========
</TABLE>
See accompanying notes to consolidated financial statements.
4
<PAGE>
LIBERTY FINANCIAL COMPANIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN MILLIONS)
UNAUDITED
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30
-------------------------
2000 1999
----------- -----------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $90.5 $75.3
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization 59.1 56.8
Interest credited to policyholders 396.3 395.5
Net realized investment losses 37.6 27.4
Net change in unrealized and undistributed gains in private
equity limited partnerships (28.4) -
Net amortization on investments 58.5 61.6
Change in deferred policy acquisition costs (0.9) (13.4)
Net change in other assets and liabilities (81.1) (57.8)
----------- -----------
Net cash provided by operating activities 531.6 545.4
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Investments purchased available for sale (4,757.9) (4,032.8)
Investments sold available for sale 4,756.1 3,903.7
Investments matured available for sale 110.8 110.8
Change in policy loans, net (16.9) (10.9)
Change in mortgage loans, net 2.1 42.1
Acquisition, net of cash acquired (274.2) -
Other 44.4 (7.0)
----------- -----------
Net cash provided by (used in) investing activities (135.6) 5.9
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Withdrawals from policyholder accounts (1,545.7) (1,570.8)
Deposits to policyholder accounts 1,177.3 640.4
Securities lending 558.5 603.1
Change in notes payable 229.1 50.5
Exercise of stock options 2.2 5.0
Dividends paid (4.7) (4.7)
Redemption of preferred stock (5.5) -
----------- -----------
Net cash provided by (used in) financing activities 411.2 (276.5)
----------- -----------
Increase in cash and cash equivalents 807.2 274.8
Cash and cash equivalents at beginning of period 1,232.6 984.1
----------- -----------
Cash and cash equivalents at end of period $2,039.8 $ 1,258.9
=========== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
5
<PAGE>
LIBERTY FINANCIAL COMPANIES, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(IN MILLIONS)
UNAUDITED
<TABLE>
<CAPTION>
ACCUMULATED
ADDITIONAL OTHER TOTAL
COMMON PAID-IN RETAINED COMPREHENSIVE UNEARNED STOCKHOLDERS'
STOCK CAPITAL EARNINGS INCOME (LOSS) COMPENSATION EQUITY
---------- ---------- ------------- --------------- ------------- ----------------
<S> <C> <C> <C> <C> <C> <C>
BALANCE,
DECEMBER 31, 1999 $0.5 $923.0 $425.2 $(158.1) $(4.7) $1,185.9
Common stock issued for
acquisition 1.8 1.8
Effect of stock-based
compensation plans 3.0 0.1 3.1
Accretion to face value
of preferred stock (0.2) (0.2)
Common stock
dividends 10.3 (14.4) (4.1)
Preferred stock
dividends (0.6) (0.6)
Net income 90.5 90.5
Other comprehensive
income, net of tax 46.0 46.0
---------- ---------- ------------- --------------- ------------- ----------------
BALANCE,
SEPTEMBER 30, 2000 $0.5 $938.1 $500.5 $(112.1) $(4.6) $1,322.4
========== ========== ============= =============== ============= ================
</TABLE>
See accompanying notes to consolidated financial statements.
6
<PAGE>
LIBERTY FINANCIAL COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2000
UNAUDITED
1. GENERAL
The accompanying unaudited consolidated financial statements include
all adjustments, consisting of normal recurring accruals, that management
considers necessary for a fair presentation of the Company's financial
position and results of operations as of and for the interim periods
presented. Certain footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted pursuant to the rules and
regulations of the Securities and Exchange Commission. Therefore, these
consolidated financial statements should be read in conjunction with the
audited consolidated financial statements contained in the Company's Form
10-K for the year ended December 31, 1999. The results of operations for the
three months and nine months ended September 30, 2000 are not necessarily
indicative of the results to be expected for the full year.
The Company has restated its first and second quarter results of
operations and related financial statements to reflect the after-tax net
change in unrealized and undistributed gains in private equity limited
partnerships as described in Note 6.
2. SEGMENT INFORMATION
The Company is an asset accumulation and management company with two
reportable segments: retirement-oriented insurance (principally annuities)
and asset management. The annuity insurance business is conducted at Keyport
Life Insurance Company ("Keyport"). Keyport generates investment spread
income from the investment portfolio which supports policyholder balances
associated with its fixed and indexed annuity business and its closed block
of single premium whole life insurance. The annuity insurance business also
derives fee income from the administration of fixed, indexed and variable
annuity contracts. The asset management business is conducted at Liberty
Funds Group, an investment advisor (through its subsidiary Colonial
Management Associates), distributor and transfer agent to mutual funds,
Stein Roe & Farnham Incorporated, a diversified investment advisor, Newport
Pacific Management, Inc., an investment advisor to mutual funds and
institutional accounts specializing in Asian equity markets, Crabbe Huson
Group, Inc., an investment advisor to mutual funds and institutional
accounts, Progress Investment Management Company, an investment advisor to
institutional accounts, Liberty Asset Management Company, an investment
advisor to mutual funds, and Liberty Wanger Asset Management, an investment
advisor to mutual funds and institutional accounts. The asset management
business derives fee income from investment products and services.
7
<PAGE>
The Company's reportable segments offer different products and are each
managed separately. Information by reportable segment is shown below (in
millions):
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30
--------------------------------------
2000 1999 2000 1999
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Statement of Operations Data
REVENUES (EXCLUDING NET REALIZED INVESTMENT
LOSSES AND NET CHANGE IN UNREALIZED AND
UNDISTRIBUTED GAINS IN PRIVATE EQUITY LIMITED
PARTNERSHIPS):
Annuity:
Unaffiliated $236.8 $215.5 $700.6 $648.6
Intersegment (4.1) (3.5) (12.2) (10.3)
------ ------ ------ ------
Total annuity 232.7 212.0 688.4 638.3
------ ------ ------ ------
Asset management:
Unaffiliated 98.3 97.3 297.2 289.3
Intersegment 4.1 3.5 12.2 10.3
------ ------ ------ ------
Total asset management 102.4 100.8 309.4 299.6
------ ------ ------ ------
Total revenues (excluding net realized
investment losses and net change in unrealized
and undistributed gains in private equity
limited partnerships) $335.1 $312.8 $997.8 $937.9
====== ====== ====== ======
INCOME BEFORE INCOME TAXES:
Annuity:
Income before amortization of intangible
assets $ 52.0 $43.0 $152.7 $127.9
Amortization of intangible assets (0.3) (0.3) (0.9) (0.9)
------ ------ ------ ------
Subtotal annuity 51.7 42.7 151.8 127.0
------ ------ ------ ------
Asset management:
Income before amortization of intangible
assets 10.3 22.7 44.2 65.9
Amortization of intangible assets (4.8) (4.6) (14.4) (14.0)
------ ------ ------ ------
Subtotal asset management 5.5 18.1 29.8 51.9
------ ------ ------ ------
Other:
Loss before amortization of intangible assets (15.0) (10.9) (35.0) (34.2)
Amortization of intangible assets - (0.1) - (0.2)
------ ------ ------ ------
Subtotal other (15.0) (11.0) (35.0) (34.4)
------ ------ ------ ------
Income before net realized investment losses,
net change inunrealized and undistributed
gains in private equity limited partnerships,
and income taxes 42.2 49.8 146.6 144.5
Net realized investment losses (20.8) (12.7) (37.6) (27.4)
Net change in unrealized and undistributed
gains in private equity limited partnerships 5.9 - 28.4 -
------ ------ ------ ------
Total income before income taxes $27.3 $ 37.1 $137.4 $117.1
====== ====== ====== ======
</TABLE>
8
<PAGE>
3. INVESTMENTS
Investments were comprised of the following (in millions):
<TABLE>
<CAPTION>
SEPTEMBER 30 DECEMBER 31
2000 1999
------------- --------------
<S> <C> <C>
Fixed maturities $10,565.9 $10,516.1
Equity securities 65.8 37.9
Policy loans 616.4 599.5
Other invested assets 922.2 1,041.6
------------- --------------
Total $12,170.3 $12,195.1
============= ==============
</TABLE>
The Company's general investment policy is to hold fixed maturity
securities for long-term investment and, accordingly, the Company does not
have a trading portfolio. To provide for maximum portfolio flexibility and
appropriate tax planning, the Company classifies its entire portfolio of
fixed maturity securities as "available for sale" and accordingly carries
such investments at fair value.
4. NET INCOME PER SHARE
The following table sets forth the computation of net income per
share-basic and net income per share-assuming dilution:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30
---------------------- -----------------------
2000 1999 2000 1999
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Numerator (in millions)
Net income $ 22.1 $ 24.6 $ 90.5 $ 75.3
Less: preferred stock dividends (0.2) (0.2) (0.6) (0.7)
---------- ---------- ---------- ----------
Numerator for net income per share - basic -
income available to common stockholders 21.9 24.4 89.9 74.6
Plus: income impact of assumed conversions
Preferred stock dividends 0.2 0.2 0.6 0.7
---------- ---------- ---------- ----------
Numerator for net income per share -
assuming dilution - income available to
common stockholders after assumed
conversions $ 22.1 $ 24.6 $ 90.5 $ 75.3
Denominator
Denominator for net income per share -
basic - weighted-average shares 47,927,182 46,867,054 47,680,808 46,599,909
Effect of dilutive securities:
Employee stock options 588,352 727,461 407,683 686,173
Convertible preferred stock 339,547 514,370 440,543 514,368
Common stock issuable as contingent purchase
price - 55,486 - 35,222
---------- ---------- ---------- ----------
Dilutive potential common shares 927,899 1,297,317 848,226 1,235,763
---------- ---------- ---------- ----------
Denominator for net income per share -
assuming dilution 48,855,081 48,164,371 48,529,034 47,835,672
========== ========== ========== ==========
Net income per share - basic $ 0.46 $ 0.52 $ 1.89 $ 1.60
========== ========== ========== ==========
Net income per share - assuming dilution $ 0.45 $ 0.51 $ 1.86 $ 1.57
========== ========== ========== ==========
</TABLE>
9
<PAGE>
5. COMPREHENSIVE INCOME
Comprehensive income (loss) was comprised of the following (in
millions):
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30
----------------------- -------------------
2000 1999 2000 1999
----------- ----------- -------- -------
<S> <C> <C> <C> <C>
Net income $ 22.1 $ 24.6 $ 90.5 $ 75.3
Other comprehensive income (loss), net of taxes:
Net unrealized income (losses) on
securities 84.3 (30.0) 46.0 (76.5)
------ ------ ------ -----
Comprehensive income (loss) $106.4 $ (5.4) $136.5 $ (1.2)
====== ====== ====== ======
</TABLE>
6. NET CHANGE IN UNREALIZED AND UNDISTRIBUTED GAINS IN PRIVATE EQUITY
LIMITED PARTNERSHIPS
The net change in unrealized and undistributed gains in private equity
limited partnerships is accounted for on the equity method and represents
primarily increases in the fair value of the underlying investments of the
private equity limited partnerships for which the Company has ownership
interests in excess of 3%. This change in unrealized and undistributed gains
is recorded net of the related amortization of deferred policy acquisition
costs of $11.0 million and $52.6 million for the three months and nine
months ended September 30, 2000, respectively, and net of amounts realized,
which are recognized in investment income, of $6.2 million and $8.7 million
for the three months and nine months ended September 30, 2000, respectively.
The financial information for these investments is obtained directly from
the private equity limited partnerships on a periodic basis. The
corresponding amounts in 1999 were insignificant.
The Company has restated its first and second quarter results of
operations and related financial statements to reflect the after-tax net
change in unrealized and undistributed gains in private equity limited
partnerships. The net increase in net income and net income per share
resulting from such changes was $9.7 million and $0.20 per share,
respectively, for the quarter ended March 31, 2000 and $4.9 million and
$0.10 per share, respectively, for the quarter ended June 30, 2000. The
corresponding amounts in 1999 were insignificant.
7. RECENT ACCOUNTING PRONOUNCEMENT
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 133 "Accounting for
Derivative Instruments and Hedging Activities." In June 1999, the FASB
issued SFAS No. 137 "Accounting for Derivative Instruments and Hedging
Activities - Deferral of the Effective Date of FASB Statement No. 133." This
statement amended SFAS No. 133 to defer its effective date one year to
fiscal years beginning after June 15, 2000. In June 2000, the FASB issued
SFAS No. 138, "Accounting for Certain Derivative Instruments and Certain
Hedging Activities" - an amendment of SFAS No. 133. This statement makes
certain changes in the hedging provisions of SFAS No. 133 and is effective
concurrent with SFAS No. 133 (collectively hereafter referred to as the
"Statement"). The Statement will require the Company to recognize all
derivatives on the balance sheet at fair value. Derivatives that are not
hedges must be adjusted to fair value through income. If the derivative is a
hedge, depending on the nature of the hedge, changes in the fair value of
derivatives will either be offset by the change in fair value of the hedged
assets, liabilities, or firm commitments through earnings or recognized in
other comprehensive income until the hedged item is recognized in earnings.
The ineffective portion of a derivative's change in fair value will be
immediately recognized in earnings. Upon adoption, the Company will be
required to record a cumulative effect adjustment to reflect this accounting
change.
The Company is in the process of completing its analysis and evaluation
of the requirements and impact of this Statement. Changes in the S&P 500
Index, interest rates, and the interpretation of the Statement by various
interested accounting groups will effect the amount of the accounting
change. The Company believes, based upon current market conditions and
accounting literature, that the cumulative effect, reported after tax and
net of related
10
<PAGE>
effects on deferred policy acquisition costs, upon adoption at January 1,
2001 will decrease net income and stockholders' equity in a range from $30.0
million to $70.0 million. The adoption of the Statement may increase
volatility in reported income due to the requirements of defining an
effective hedging relationship under the Statement as opposed to certain
hedges the Company believes are effective economic hedges. The Company
believes that it will continue to utilize its current risk management
philosophy, which includes the use of derivative instruments.
8. ACQUISITION
On September 29, 2000, the Company completed the acquisition of Wanger
Asset Management, L.P. ("Wanger"), a registered investment advisor. Total
assets under management of Wanger as of September 30, 2000 were
approximately $9.4 billion. The purchase price for this transaction was
approximately $277.4 million in cash, including the costs of acquisition. In
addition, the Company has agreed to make additional payments over the next
five years of up to $178.0 million in cash, with $170.0 million contingent
upon the attainment of certain earnings objectives. This transaction was
accounted for as a purchase and resulted in the recording of $133.0 million
of intangible assets which will be amortized over 13 years and $146.5
million of goodwill which will be amortized over 25 years. The Company
funded the acquisition of Wanger with cash and investments and $200.0
million of debt issued to Liberty Mutual Insurance Company. Such debt
consists of a $180.0 million 12-year note with interest payable
semi-annually at 8.85% and a $20.0 million 20-year note with interest
payable semi-annually at 9.35%. Such notes are immediately due upon a change
in control of the Company.
9. RESTRUCTURING CHARGES
In the third quarter of 2000, the Company recorded pre-tax restructuring
charges of $11.3 million, consisting of severance and other expenses. The
restructuring charges related to two initiatives, streamlining the Company's
mutual fund product offerings and centralizing corporate functions. The
first initiative follows an in-depth analysis of the Company's mutual fund
and variable annuity products and considers the Wanger acquisition, which
brings additional scale and products to the Company's mutual fund product
offerings. As a result of this analysis, the Company plans to merge a number
of its smaller mutual funds into larger ones. The fund consolidation was
filed with the Securities and Exchange Commission on October 5, 2000 and is
subject to shareholder approval. The second initiative involves centralizing
the finance, human resources, legal and compliance, and communications
functional areas. Previously, these functions were managed independently in
each operating company. The functional centralization process began in
August of this year and the Company anticipates that it will be fully
implemented by the end of 2001. The Company currently expects that there
will be additional pre-tax charges of $8.7 million in the fourth quarter of
2000 and $5.0 million in 2001.
10. SUBSEQUENT EVENTS
On November 1, 2000, the Company announced an agreement to sell the
Private Capital Management ("PCM") division of Stein Roe & Farnham
Incorporated to a new entity which will be jointly owned by the current PCM
management team and an outside investor group. Under the terms of the sales
agreement, the Company is to receive proceeds of $40.0 million, which
includes $10.0 million in cash and a $30.0 million 12% note due over five
years. Closing of this transaction, which is subject to certain conditions,
is expected to occur at year-end. It is estimated that this transaction will
result in an after-tax gain of approximately $13.8 million.
On November 1, 2000, the Company announced that it has retained the
investment banking firm of Credit Suisse First Boston Corporation to review
its strategic alternatives, including a possible sale of the Company.
11
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RESULTS OF OPERATIONS
NET INCOME was $22.1 million or $0.45 per share for the quarter ended
September 30, 2000 compared to $24.6 million or $0.51 per share for the quarter
ended September 30, 1999. This decrease resulted largely from restructuring
charges, higher operating expenses, net realized investment losses and
amortization expense. Partially offsetting these items were higher investment
spread, lower income tax expense, higher fee income and net change in unrealized
and undistributed gains in private equity limited partnerships. For the first
nine months of 2000, net income was $90.5 million or $1.86 per share compared to
$75.3 million or $1.57 per share for the first nine months of 1999. This
increase resulted largely from higher investment spread, net change in
unrealized and undistributed gains in private equity limited partnerships, fee
income and lower interest expense, net. Partially offsetting these items were
higher operating expenses, amortization expense, restructuring charges, net
realized investment losses and income tax expense.
PRE-TAX INCOME was $27.3 million for the quarter ended September 30, 2000
compared to $37.1 million for the quarter ended September 30, 1999. This
decrease resulted largely from restructuring charges, higher operating expenses,
net realized investment losses and amortization expense. Partially offsetting
these items were higher investment spread, fee income and net change in
unrealized and undistributed gains in private equity limited partnerships. For
the first nine months of 2000, pre-tax income was $137.4 million compared to
$117.1 million for the first nine months of 1999. This increase resulted largely
from higher investment spread, net change in unrealized and undistributed gains
in private equity limited partnerships, fee income and lower interest expense,
net. Partially offsetting these items were higher operating expenses,
amortization expense, restructuring charges and net realized investment losses.
INVESTMENT SPREAD is the amount by which investment income earned on the
Company's investments exceeds interest credited on policyholder balances.
Investment spread was $78.3 million for the quarter ended September 30, 2000
compared to $66.6 million for the quarter ended September 30, 1999. The amount
by which the average yield on investments exceeds the average interest credited
rate on policyholder balances is the investment spread percentage. The
investment spread percentage for the quarter ended September 30, 2000 was 2.20%
compared to 1.90% for the quarter ended September 30, 1999. For the first nine
months of 2000, investment spread was $240.1 million compared to $205.7 million
for the first nine months of 1999. The investment spread percentage was 2.28%
for the first nine months of 2000 compared to 1.93% for the first nine months of
1999. These increases in investment spread percentage resulted primarily from
increased yields on average invested assets, largely relating to distributed
realized gains in private equity limited partnerships, including those accounted
for under the cost method.
Investment income was $214.1 million for the quarter ended September 30,
2000 compared to $197.9 million for the quarter ended September 30, 1999. The
increase of $16.2 million in 2000 compared to 1999 includes a $15.9 million
increase as a result of a higher average investment yield and a $0.3 million
increase resulting from a slightly higher level of average invested assets. The
2000 investment income was net of $19.7 million of S&P 500 Index call option
amortization expense related to the Company's equity-indexed annuities compared
to $19.8 million in 1999. The average investment yield was 6.69% for the quarter
ended September 30, 2000 compared to 6.20% for the quarter ended September 30,
1999. For the first nine months of 2000, investment income was $636.4 million
compared to $601.2 million for the first nine months of 1999. The increase of
$35.2 million in 2000 compared to 1999 includes a $45.5 million increase as a
result of a higher average investment yield, partially offset by an $10.3
million decrease resulting from a lower level of average invested assets. The
2000 investment income was net of $64.3 million of S&P 500 Index call option
amortization expense related to the Company's equity-indexed annuities compared
to $58.6 million in 1999. The average investment yield was 6.67% for the first
nine months of 2000 compared to 6.20% for the first nine months of 1999.
Interest credited to policyholders totaled $135.8 million for the quarter
ended September 30, 2000 compared to $131.3 million for the quarter ended
September 30, 1999. The increase of $4.5 million in 2000 compared to 1999
12
<PAGE>
primarily relates to a $5.8 million increase as a result of a higher average
interest credited rate, partially offset by a $1.3 million decrease as a result
of a lower level of average policyholder balances. Policyholder balances
averaged $12.1 billion (including $9.8 billion of fixed products, consisting of
fixed annuities and a closed block of single premium whole life insurance, and
$2.3 billion of equity-indexed annuities) for the quarter ended September 30,
2000 compared to $12.2 billion (including $10.0 billion of fixed products and
$2.2 billion of equity-indexed annuities) for the quarter ended September 30,
1999. The average interest credited rate was 4.49% (5.30% on fixed products and
0.85% on equity-indexed annuities) for the quarter ended September 30, 2000
compared to 4.30% (5.00% on fixed products and 0.85% on equity-indexed
annuities) for the quarter ended September 30, 1999. Keyport's equity-indexed
annuities credit interest to the policyholder at a "participation rate" equal to
a portion (ranging for existing policies from 25% to 100%) of the change in
value of the S&P 500 Index. Keyport's equity-indexed annuities also provide a
full guarantee of principal if held to term, plus interest at 0.85% annually.
For each of the periods presented, the interest credited to equity-indexed
policyholders related to the participation rate was offset by investment income
recognized on the S&P 500 Index call options resulting in a 0.85% net credited
rate. For the first nine months of 2000, interest credited to policyholders
totaled $396.3 million compared to $395.5 million for the first nine months of
1999. The increase of $0.8 million in 2000 compared to 1999 primarily relates to
a $10.7 million increase as a result of a higher average interest credited rate,
partially offset by a $9.9 million decrease resulting from a lower level of
average policyholder balances. Policyholder balances averaged $12.1 billion
(including $9.7 billion of fixed products and $2.4 billion of equity-indexed
annuities) for the first nine months of 2000 compared to $12.3 billion
(including $10.2 billion of fixed products and $2.1 billion of equity-indexed
annuities) for the first nine months of 1999. The average interest credited rate
was 4.39% (5.18% on fixed products and 0.85% on equity-indexed annuities) for
the first nine months of 2000 compared to 4.27% (5.00% on fixed products and
0.85% on equity-indexed annuities) for the first nine months of 1999.
Average investments in the Company's general account (computed without
giving effect to Statement of Financial Accounting Standards No. 115), including
a portion of the Company's cash and cash equivalents, were $12.8 billion for the
quarters ended September 30, 2000 and 1999. For the first nine months of 2000,
such average investments were $12.7 billion compared to $12.9 billion for the
first nine months of 1999. This decrease was primarily due to net redemptions
and transfers to separate accounts, partially offset by the reinvestment of
portfolio earnings for the twelve months ended September 30, 2000.
NET REALIZED INVESTMENT LOSSES were $20.8 million for the quarter ended
September 30, 2000 compared to $12.7 million for the quarter ended September 30,
1999. For the first nine months of 2000, net realized investment losses were
$37.6 million compared to $27.4 million for the first nine months of 1999. The
net realized investment losses in 2000 included losses of $8.7 million for the
nine months for certain fixed maturity investments where the decline in value
was determined to be other than temporary.
NET CHANGE IN UNREALIZED AND UNDISTRIBUTED GAINS IN PRIVATE EQUITY LIMITED
PARTNERSHIPS is accounted for on the equity method and represents primarily
increases in the fair value of the underlying investments of the private equity
limited partnerships for which the Company has ownership interests in excess of
3%. This change in unrealized and undistributed gains is recorded net of the
related amortization of deferred policy acquisition costs of $11.0 million and
$52.6 million for the three months and nine months ended September 30, 2000,
respectively, and net of amounts realized, which are recognized in investment
income, of $6.2 million and $8.7 million for the three months and nine months
ended September 30, 2000, respectively. The financial information for these
investments is obtained directly from the private equity limited partnerships on
a periodic basis. The increase for the three months and nine months ended
September 30, 2000 was due primarily to the increase in the valuation of the
underlying investments of certain private equity limited partnerships. The
corresponding amounts in 1999 were insignificant. There can be no assurance that
any unrealized and undistributed gains will ultimately be realized or that the
Company will not incur losses in the future on such investments.
The Company has restated its first and second quarter results of operations
and related financial statements to reflect the after-tax net change in
unrealized and undistributed gains in private equity limited partnerships. The
net increase in net income and net income per share was $9.7 million and $0.20
per share, respectively, for the quarter ended March 31, 2000 and $4.9 million
and $0.10 per share, respectively, for the quarter ended June 30, 2000. The
corresponding amounts in 1999 were insignificant.
13
<PAGE>
INVESTMENT ADVISORY AND ADMINISTRATIVE FEES are based on the market value of
assets managed for mutual funds, private capital management and institutional
investors. Investment advisory and administrative fees were $71.2 million for
the quarter ended September 30, 2000 compared to $68.2 million for the quarter
ended September 30, 1999. For the first nine months of 2000, investment advisory
and administrative fees were $214.4 million compared to $202.6 million for the
first nine months of 1999. These increases during 2000 compared to 1999
primarily reflect a higher level of average fee-based assets under management.
Average fee-based assets under management were $53.3 billion for the quarter
ended September 30, 2000 compared to $48.6 billion for the quarter ended
September 30, 1999. For the first nine months of 2000, average fee-based assets
under management were $52.3 billion compared to $48.0 billion for the first nine
months of 1999. These increases during 2000 compared to 1999 resulted from net
sales and market appreciation for the twelve months ended September 30, 2000.
Investment advisory and administrative fees were 0.53% and 0.56% of average
fee-based assets under management for the quarters ended September 30, 2000 and
1999, respectively. For the first nine months of 2000 and 1999, such percentages
were 0.55% and 0.56%, respectively.
The amount of fee-based assets under management is affected by product sales
and redemptions and changes in the market values of such assets under
management. Fee-based assets under management and changes in such assets are set
forth in the tables below (in billions).
FEE-BASED ASSETS UNDER MANAGEMENT
<TABLE>
<CAPTION>
AS OF SEPTEMBER 30
-------------------------
2000 1999
---------- -----------
<S> <C> <C>
Mutual Funds:
Intermediary-distributed $17.9 $17.5
Direct-marketed 14.3 6.1
Closed-end 2.8 2.5
Variable annuity 2.9 1.8
---------- -----------
37.9 27.9
Private Capital Management 9.6 8.2
Institutional 15.5 11.9
---------- -----------
Total Fee-Based Assets Under Management* $63.0 $48.0
========== ===========
</TABLE>
--------------
* As of September 30, 2000 and 1999, Keyport's insurance assets of $14.4
billion and $13.4 billion, respectively, bring total assets under management
to $77.4 billion and $61.4 billion, respectively.
14
<PAGE>
CHANGES IN FEE-BASED ASSETS UNDER MANAGEMENT
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30
---------------------- ----------------------
2000 1999 2000 1999
----------- ---------- ----------- ----------
<S> <C> <C> <C> <C>
Fee-based assets under management - beginning $52.5 $49.1 $51.4 $47.9
Sales and reinvestments:
Mutual funds 1.6 1.8 4.8 5.5
Private Capital Management 0.4 0.5 1.3 1.1
Institutional 0.7 0.9 2.9 2.4
----------- ---------- ----------- ----------
2.7 3.2 9.0 9.0
----------- ---------- ----------- ----------
Redemptions and withdrawals:
Mutual funds (1.5) (1.8) (5.3) (5.7)
Private Capital Management (0.1) (0.4) (0.6) (0.7)
Institutional (0.2) (0.3) (1.2) (1.9)
----------- ---------- ----------- ----------
(1.8) (2.5) (7.1) (8.3)
----------- ---------- ----------- ----------
Asset acquisition 9.4 - 9.4 -
Market appreciation (depreciation) 0.2 (1.8) 0.3 (0.6)
----------- ---------- ----------- ----------
Fee-based assets under management - ending $63.0 $48.0 $63.0 $48.0
=========== ========== =========== ==========
</TABLE>
DISTRIBUTION AND SERVICE FEES are based on the market value of the Company's
intermediary-distributed mutual funds. Distribution fees of 0.75% are generally
earned on the average assets attributable to such funds sold with 12b-1
distribution fees and contingent deferred sales charges and service fees of
0.25% (net of amounts passed on to selling brokers) are generally earned on the
total of such average mutual fund assets. These fees totaled $15.6 million for
the quarter ended September 30, 2000 compared to $15.3 million for the quarter
ended September 30, 1999. For the first nine months of 2000, distribution and
service fees were $46.1 million compared to $45.3 million for the first nine
months of 1999. As a percentage of intermediary-distributed average mutual fund
assets, distribution and service fees were approximately 0.36% for the quarter
ended September 30, 2000 compared to 0.35% for the quarter ended September 30,
1999. For the first nine months of 2000 and 1999, such percentage was 0.35%.
TRANSFER AGENCY FEES are based on the market value of assets managed and
the volume of transactions in the Company's intermediary-distributed,
direct-marketed and variable annuity mutual funds. Such fees were $12.3 million
on average assets of $26.6 billion for the quarter ended September 30, 2000 and
$13.1 million on average assets of $26.0 billion for the quarter ended September
30, 1999. For the first nine months of 2000, transfer agency fees were $37.2
million on average assets of $26.5 billion and $38.8 million on average assets
of $26.1 billion for the first nine months of 1999. As a percentage of total
average assets under management, transfer agency fees were approximately 0.19%
for the quarter ended September 30, 2000 compared to 0.20% for the quarter ended
September 30, 1999. For the first nine months of 2000 and 1999, such percentages
were 0.19% and 0.20%, respectively.
SURRENDER CHARGES AND NET COMMISSIONS are revenues earned on: a) the early
withdrawal of annuity policyholder balances and redemptions of the
intermediary-distributed mutual funds which were sold with 12b-1 distribution
fees and contingent deferred sales charges; b) the distribution of the Company's
intermediary-distributed mutual funds (net of the substantial portion of such
commissions that is passed on to the selling brokers); and c) the sales of
non-proprietary products in the Company's bank marketing businesses (net of
commissions that are paid to the Company's client banks and brokers). Total
surrender charges and net commissions were $10.1 million for the quarter ended
September 30, 2000 compared to $9.6 million for the quarter ended September 30,
1999. For the first nine months of 2000, total surrender charges and net
commissions were $30.1 million compared to $27.0 million for the first nine
months of 1999.
Surrender charges on fixed and variable annuity withdrawals generally are
assessed at declining rates applied to policyholder withdrawals during the first
five to seven years of the contract; contingent deferred sales charges on mutual
fund redemptions are assessed at declining rates on amounts redeemed generally
during the first nine years. Such charges totaled $8.0 million for the quarter
ended September 30, 2000 and $6.5 million for the quarter ended
15
<PAGE>
September 30, 1999. For the first nine months of 2000, surrender charges were
$22.7 million compared to $18.0 million for the first nine months of 1999. Total
annuity withdrawals represented 15.0% and 15.2% of the total average annuity
policyholder and separate account balances for the quarters ended September 30,
2000 and 1999, respectively. For the first nine months of 2000 and 1999, the
corresponding percentages were 15.6% and 14.4%, respectively. Net commissions
were $2.1 million for the quarter ended September 30, 2000 and $3.1 million for
the quarter ended September 30, 1999. For the first nine months of 2000, net
commissions were $7.4 million compared to $9.0 million for the first nine months
of 1999.
SEPARATE ACCOUNT FEES are primarily mortality and expense charges earned on
variable annuity and variable life policyholder balances. In addition, for
certain separate institutional accounts, the difference between investment
income and interest credited on these institutional accounts is included in
separate account fees. These fees, which are primarily based on the market
values of the assets in separate accounts supporting the contracts, were $11.8
million for the quarter ended September 30, 2000 compared to $8.7 million for
the quarter ended September 30, 1999. For the first nine months of 2000,
separate account fees were $33.6 million compared to $23.0 million for the first
nine months of 1999. The increase in separate account fees was due to the
increase in separate account assets in 2000. Such fees represented 1.23% and
1.31% of average variable annuity, variable life and institutional separate
account balances for the quarters ended September 30, 2000 and 1999,
respectively. For the first nine months of 2000 and 1999, such percentages were
1.25% and 1.29%, respectively.
OPERATING EXPENSES primarily represent compensation, marketing, and other
general and administrative expenses. These expenses were $98.1 million for the
quarter ended September 30, 2000 compared to $89.1 million for the quarter ended
September 30, 1999. For the first nine months of 2000, operating expenses were
$300.0 million compared to $268.3 million for the first nine months of 1999.
These increases during 2000 compared to 1999 were primarily related to the
expansion of investment management capabilities, mutual fund product lines,
distribution and electronic commerce activities. Operating expenses expressed as
a percent of average total assets under management were 0.58% for the quarters
ended September 30, 2000 and 1999. For the first nine months of 2000 and 1999,
such percentages were 0.60% and 0.59%, respectively.
RESTRUCTURING CHARGES in the third quarter of 2000 of $11.3 million consist
of severance and other expenses. The restructuring charges related to two
initiatives, streamlining the Company's mutual fund product offerings and
centralizing corporate functions. The first initiative follows an in-depth
analysis of the Company's mutual fund and variable annuity products and
considers the Wanger acquisition, which brings additional scale and products to
the Company's mutual fund product offerings. As a result of this analysis, the
Company plans to merge a number of its smaller mutual funds into larger ones.
The fund consolidation was filed with the Securities and Exchange Commission on
October 5, 2000 and is subject to shareholder approval. The second initiative
involves centralizing the finance, human resources, legal and compliance, and
communications functional areas. Previously, these functions were managed
independently in each operating company. The functional centralization process
began in August of this year and the Company anticipates that it will be fully
implemented by the end of 2001. The Company currently expects that there will be
additional pre-tax charges of $8.7 million in the fourth quarter of 2000 and
$5.0 million in 2001.
AMORTIZATION OF DEFERRED POLICY ACQUISITION COSTS relates to the costs of
acquiring new business, which vary with, and are primarily related to, the
production of new annuity business. Such costs include commissions, costs of
policy issuance and underwriting and selling expenses. Amortization was $26.9
million for the quarter ended September 30, 2000 compared to $22.8 million for
the quarter ended September 30, 1999. For the first nine months of 2000,
amortization of deferred policy acquisition costs was $83.8 million compared to
$69.5 million for the first nine months of 1999. The increase during 2000
compared to 1999 was due to the increased profit realized on the in-force
business. Amortization expense represented 29.9% and 30.3% of investment spread
and separate account fees for the quarters ended September 30, 2000 and 1999,
respectively. For the first nine months of 2000 and 1999, the corresponding
percentages were 30.6% and 30.4%, respectively.
AMORTIZATION OF DEFERRED DISTRIBUTION COSTS relates to the distribution of
mutual fund shares sold with 12b-1 distribution fees and contingent deferred
sales charges. Amortization was $10.9 million for the quarter ended September
30, 2000 compared to $10.2 million for the quarter ended September 30, 1999. For
the first nine months of
16
<PAGE>
2000, amortization of deferred distribution costs was $31.5 million compared to
$29.4 million for the first nine months of 1999.
AMORTIZATION OF INTANGIBLE ASSETS relates to goodwill and certain
identifiable intangible assets arising from business combinations accounted for
as purchases. Amortization was $5.1 million for the quarter ended September 30,
2000 compared to $5.0 million for the quarter ended September 30, 1999. For the
first nine months of 2000, amortization of intangible assets was $15.3 million
compared to $15.1 million for the first nine months of 1999. The Company has
experienced higher than anticipated redemptions of assets under management at an
acquired company, which at September 30, 2000 had goodwill and other intangible
assets of $80.8 million. Although the Company has determined that there is no
impairment of goodwill and other intangible assets at this time, if the higher
level of redemptions were to continue and sales were not to increase, the
Company's estimate of related future cash flows may change, resulting in the
need to record an impairment loss.
INTEREST EXPENSE, NET was $4.8 million for the quarter ended September 30,
2000 compared to $4.6 million for the quarter ended September 30, 1999. For the
first nine months of 2000, interest expense, net was $13.0 million compared to
$15.6 million for the first nine months of 1999. Interest expense primarily
consists of interest on notes payable and interest on the Liberty Funds Group
revolving credit facility which is utilized to finance deferred sales
commissions paid in connection with the distribution of mutual fund shares sold
with 12b-1 distribution fees and contingent deferred sales charges. Interest
expense was net of interest income of $5.7 million and $4.3 million for the
quarters ended September 30, 2000 and 1999, respectively. For the first nine
months of 2000 and 1999, interest expense was net of interest income of $17.4
million and $11.2 million, respectively.
INCOME TAX EXPENSE was $5.2 million or 19.0% of pre-tax income for the
quarter ended September 30, 2000 compared to $12.5 million, or 33.7% of pre-tax
income for the quarter ended September 30, 1999. The decrease in the effective
tax rate for the third quarter of 2000 primarily reflects a reduction to the
valuation allowance established for unrealized capital losses in the "available
for sale" investment portfolio. For the first nine months of 2000, income tax
expense was $46.9 million or 34.1% of pre-tax income compared to $41.8 million
or 35.7% of pre-tax income for the first nine months of 1999.
FINANCIAL CONDITION
STOCKHOLDERS' EQUITY was $1.32 billion as of September 30, 2000 compared to
$1.19 billion as of December 31, 1999. Net income for the first nine months of
2000 was $90.5 million and cash dividends on the Company's preferred and common
stock totaled $4.7 million. Common stock totaling $2.2 million was issued in
connection with the exercise of stock options. A decrease in accumulated other
comprehensive loss, which consists of net unrealized investment losses, net of
adjustments to deferred policy acquisition costs and income taxes, during the
period increased stockholders' equity by $46.0 million.
BOOK VALUE PER SHARE amounted to $27.35 at September 30, 2000 compared to
$24.99 at December 31, 1999. Excluding net unrealized losses on investments,
book value per share amounted to $29.66 at September 30, 2000 and $28.32 at
December 31, 1999. As of September 30, 2000, there were 48.4 million common
shares outstanding compared to 47.5 million shares as of December 31, 1999.
INVESTMENTS not including cash and cash equivalents, totaled $12.2 billion
at September 30, 2000 and December 31, 1999.
The Company manages the majority of its invested assets internally. The
Company's general investment policy is to hold fixed maturity securities for
long-term investment and, accordingly, the Company does not have a trading
portfolio. To provide for maximum portfolio flexibility and appropriate tax
planning, the Company classifies its entire portfolio of fixed maturity
securities as "available for sale" and accordingly carries such investments at
fair value. The Company's total investments at September 30, 2000 and December
31, 1999 reflected net unrealized losses of $199.6 million and $318.6 million,
respectively.
17
<PAGE>
Approximately $11.8 billion, or 80.1%, of the Company's general account and
certain separate account investments at September 30, 2000, were rated by
Standard & Poor's Corporation, Moody's Investors Service or under comparable
statutory rating guidelines established by the National Association of Insurance
Commissioners ("NAIC"). At September 30, 2000, the carrying value of investments
in below investment grade securities represented $1.2 billion or 8.5% of general
account investments, including cash and cash equivalents in the Company's
annuity operations, and certain separate account investments. Below investment
grade securities generally provide higher yields and involve greater risks than
investment grade securities because their issuers typically are more highly
leveraged and more vulnerable to adverse economic conditions than investment
grade issuers. In addition, the trading market for these securities may be more
limited than for investment grade securities.
The Company routinely reviews its portfolio of investment securities. The
Company identifies monthly any investments that require additional monitoring,
and carefully reviews the carrying value of such investments at least quarterly
to determine whether specific investments should be placed on a nonaccrual basis
and to determine declines in value that may be other than temporary. In making
these reviews, the Company principally considers the adequacy of collateral (if
any), compliance with contractual covenants, the borrower's recent financial
performance, news reports, and other externally generated information concerning
the borrower's affairs. In the case of publicly traded fixed maturity
securities, management also considers market value quotations if available. As
of September 30, 2000 and December 31, 1999, the carrying value of fixed
maturity securities that were non-income producing was $26.2 million and $22.6
million, respectively.
DERIVATIVES
As a component of its investment strategy and to reduce its exposure to
interest rate risk, the Company utilizes interest rate and total return swap
agreements to match assets more closely to liabilities. Interest rate swap
agreements are agreements to exchange with a counterparty interest rate payments
of differing character (e.g., fixed-rate payments exchanged for variable-rate
payments) based on an underlying principal balance (notional principal) to hedge
against interest rate changes. The Company currently utilizes interest rate swap
agreements to reduce asset duration and to better match interest earned on
longer-term fixed-rate assets with interest credited to policyholders. A total
return swap agreement is an agreement to exchange payments based upon an
underlying notional balance and changes in variable rate and total return
indices. The Company utilizes total return swap agreements to hedge its
obligations related to certain separate account liabilities. The Company had 60
and 67 outstanding swap agreements with an aggregate notional principal amount
of $3.2 billion and $3.4 billion as of September 30, 2000 and December 31, 1999,
respectively.
With respect to the Company's equity-indexed annuities and certain separate
account liabilities, the Company buys call options, futures and certain total
return swap agreements on the S&P 500 Index to hedge its obligations to provide
returns based upon this index. The Company had call options with a carrying
value of $443.6 million and $701.1 million as of September 30, 2000 and December
31, 1999, respectively. The Company had total return swap agreements with a
carrying value of $29.9 million and $37.8 million as of September 30, 2000 and
December 31, 1999, respectively.
There are risks associated with some of the techniques the Company uses to
match its assets and liabilities. The primary risk associated with swap, cap and
call option agreements is counterparty non-performance. The Company believes
that the counterparties to its swap, cap and call option agreements are
financially responsible and that the counterparty risk associated with these
transactions is minimal. Futures contracts trade on organized exchanges and
therefore have minimal credit risk. In addition, swap and cap agreements have
interest rate risk and call options, futures and certain total return swap
agreements have stock market risk. These swap and cap agreements hedge
fixed-rate assets and the Company expects that any interest rate movements that
adversely affect the market value of swap and cap agreements would be offset by
changes in the market values of such fixed rate assets. However, there can be no
assurance that these hedges will be effective in offsetting the potential
adverse effects of changes in interest rates. Similarly, the call options,
futures and certain total return swap agreements hedge the Company's obligations
to provide returns on equity-indexed annuities and certain separate liabilities
based upon the S&P 500 Index, and the Company believes that any stock market
movements that adversely affect the market value of S&P 500 Index call options,
futures
18
<PAGE>
and certain total return swap agreements would be substantially offset by a
reduction in policyholder and certain separate account liabilities. However,
there can be no assurance that these hedges will be effective in offsetting the
potentially adverse effects of changes in S&P 500 Index levels. The Company's
profitability could be adversely affected if the value of its swap and cap
agreements increase less than (or decrease more than) the change in the market
value of its fixed rate assets and/or if the value of its S&P 500 Index call
options, futures and certain total return swap agreements increase less than (or
decrease more than) the value of the guarantees made to equity-indexed and
certain separate account policyholders.
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 133 "Accounting for
Derivative Instruments and Hedging Activities." In June 1999, the FASB issued
SFAS No. 137 "Accounting for Derivative Instruments and Hedging Activities -
Deferral of the Effective Date of FASB Statement No. 133." This statement
amended SFAS No. 133 to defer its effective date one year to fiscal years
beginning after June 15, 2000. In June 2000, the FASB issued SFAS No. 138,
"Accounting for Certain Derivative Instruments and Certain Hedging Activities" -
an amendment of SFAS No. 133. This statement makes certain changes in the
hedging provisions of SFAS No. 133 and is effective concurrent with SFAS No. 133
(collectively hereafter referred to as the "Statement"). The Statement will
require the Company to recognize all derivatives on the balance sheet at fair
value. Derivatives that are not hedges must be adjusted to fair value through
income. If the derivative is a hedge, depending on the nature of the hedge,
changes in the fair value of derivatives will either be offset by the change in
fair value of the hedged assets, liabilities, or firm commitments through
earnings or recognized in other comprehensive income until the hedged item is
recognized in earnings. The ineffective portion of a derivative's change in fair
value will be immediately recognized in earnings. Upon adoption, the Company
will be required to record a cumulative effect adjustment to reflect this
accounting change.
The Company is in the process of completing its analysis and evaluation of
the requirements and impact of this Statement. Changes in the S&P 500 Index,
interest rates, and the interpretation of the Statement by various interested
accounting groups will effect the amount of the accounting change. The Company
believes, based upon current market conditions and accounting literature, that
the cumulative effect, reported after tax and net of related effects of deferred
policy acquisition costs, upon adoption at January 1, 2001 will decrease net
income and stockholders' equity in a range from $30.0 million to $70.0 million.
The adoption of the Statement may increase volatility in reported income due to
the requirements of defining an effective hedging relationship under the
Statement as opposed to certain hedges the Company believes are effective
economic hedges. The Company believes that it will continue to utilize its
current risk management philosophy, which includes the use of derivative
instruments.
ACQUISITION
On September 29, 2000, the Company completed the acquisition of Wanger Asset
Management, L.P. ("Wanger"), a registered investment advisor. Total assets under
management of Wanger as of September 30, 2000 were approximately $9.4 billion.
The purchase price for this transaction was approximately $277.4 million in
cash, including the costs of acquisition. In addition, the Company has agreed to
make additional payments over the next five years of up to $178.0 million in
cash, with $170.0 million contingent upon the attainment of certain earnings
objectives. This transaction was accounted for as a purchase and resulted in the
recording of $133.0 million of intangible assets which will be amortized over 13
years and $146.5 million of goodwill which will be amortized over 25 years. The
Company funded the acquisition of Wanger with cash and investments and $200.0
million of debt issued to Liberty Mutual Insurance Company. Such debt consists
of a $180.0 million 12-year note with interest payable semi-annually at 8.85%
and a $20.0 million 20-year note with interest payable semi-annually at 9.35%.
LIQUIDITY
The Company is a holding company whose liquidity needs include the
following: (i) operating expenses; (ii) debt service; (iii) dividends on
preferred stock and common stock; (iv) acquisitions; and (v) working capital
where needed by its operating subsidiaries. The Company's principal sources of
cash are dividends from its operating subsidiaries, and, in the case of funding
for acquisitions and certain long-term capital needs of its subsidiaries,
long-term borrowings and offerings of preferred and common stock.
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The Company has a $150.0 million revolving credit facility (the "Facility"),
established in April 1999 which is utilized to finance sales commissions paid in
connection with the distribution of mutual fund shares sold with 12b-1
distribution fees and contingent deferred sales charges. This five year Facility
is secured by such 12b-1 distribution fees and contingent deferred sales
charges. Interest accrues on the outstanding borrowings under the Facility at a
rate determined by sales of highly rated commercial paper backed in part by the
security interest in such fees and charges. At September 30, 2000, the interest
paid on borrowings under the Facility was at the rate of 6.63% per annum.
Current Rhode Island insurance law applicable to Keyport permits the payment
of dividends or distributions, which, together with dividends and distributions
paid during the preceding 12 months, do not exceed the lesser of (i) 10% of
Keyport's statutory surplus as of the preceding December 31 or (ii) Keyport's
statutory net gain from operations for the preceding fiscal year. Any proposed
dividend in excess of this amount is called an "extraordinary dividend" and may
not be paid until it is approved by the Commissioner of Insurance of the State
of Rhode Island. As of September 30, 2000, the amount of dividends that Keyport
could pay without such approval was $47.8 million. Future regulatory changes and
credit agreements may create additional limitations on the ability of the
Company's subsidiaries to pay dividends.
Based upon the historical cash flow of the Company, the Company's current
financial condition and the Company's expectation that there will not be a
material adverse change in the results of operations of the Company and its
subsidiaries during the next twelve months, the Company believes that cash flow
provided by operating activities over this period will provide sufficient
liquidity for the Company to meet its working capital, capital investment and
other operational cash needs, its debt service obligations, its obligations to
pay dividends on the preferred stock and its intentions to pay dividends on the
common stock. As was the case with the Wanger acquisition, the Company may
require external sources of liquidity in order to finance material acquisitions
where the purchase price is not paid in equity.
Each of the Company's business segments has its own liquidity needs and
financial resources. In the Company's annuity insurance operations, liquidity
needs and financial resources pertain to the management of the general account
assets and policyholder balances. In the Company's asset management business,
liquidity needs and financial resources pertain to the investment management and
distribution of mutual funds, private capital management and institutional
accounts. The Company expects that, based upon their historical cash flow and
current prospects, these operating subsidiaries will be able to meet their
liquidity needs from internal sources and, in the case of Liberty Funds Group,
from its credit facility used to finance sales of mutual fund shares sold with
12b-1 distribution fees and contingent deferred sales charges.
Keyport uses cash for the payment of annuity and life insurance benefits,
operating expenses and policy acquisition costs, and the purchase of
investments. Keyport generates cash from annuity premiums and deposits, net
investment income, and from the sales and maturities of fixed investments.
Annuity premiums, maturing investments and net investment income have
historically been sufficient to meet Keyport's cash requirements. Keyport
monitors cash and cash equivalents in an effort to maintain sufficient liquidity
and has strategies in place to maintain sufficient liquidity in changing
interest rate environments. Consistent with the nature of its obligations,
Keyport has invested a substantial amount of its general account assets in
readily marketable securities. As of September 30, 2000, $11.7 billion, or
81.6%, of Keyport's general account and certain separate account investments are
considered readily marketable.
To the extent that unanticipated surrenders cause Keyport to sell for
liquidity purposes a material amount of securities prior to their maturity, such
surrenders could have a material adverse effect on the Company. Although no
assurances can be given, Keyport believes that liquidity to fund anticipated
withdrawals would be available through incoming cash flow and the sale of
short-term or floating-rate investments, thereby precluding the sale of fixed
maturity investments in a potentially unfavorable market. In addition, the
Company's fixed-rate products incorporate surrender charges to encourage
persistency and to make the cost of its policyholder balances more predictable.
Approximately 88% of the Company's fixed annuity policyholder balances were
subject to surrender charges or restrictions as of September 30, 2000.
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EFFECTS OF INFLATION
Inflation has not had a material effect on the Company's consolidated
results of operations to date. The Company manages its investment portfolio in
part to reduce its exposure to interest rate fluctuations. In general, the
market value of the Company's fixed maturity portfolio increases or decreases in
inverse relationship with fluctuations in interest rates, and the Company's net
investment income increases or decreases in direct relationship with interest
rate changes. For example, if interest rates decline, the Company's fixed
maturity investments generally will increase in market value, while net
investment income will decrease as fixed maturity investments mature or are sold
and the proceeds are reinvested at reduced rates. Inflation may result in
increased operating expenses that may not be readily recoverable in the prices
of the services charged by the Company.
SUBSEQUENT EVENTS
On November 1, 2000, the Company announced an agreement to sell the Private
Capital Management ("PCM") division of Stein Roe & Farnham Incorporated to a new
entity which will be jointly owned by the current PCM management team and an
outside investor group. Under the terms of the sales agreement, the Company is
to receive proceeds of $40.0 million, which includes $10.0 million in cash and a
$30.0 million 12% note due over five years. Closing of this transaction, which
is subject to certain conditions, is expected to occur at year-end. It is
estimated that this transaction will result in an after-tax gain of
approximately $13.8 million.
On November 1, 2000, the Company announced that it has retained the
investment banking firm of Credit Suisse First Boston Corporation to review its
strategic alternatives, including a possible sale of the Company.
FORWARD-LOOKING STATEMENTS
The Company desires to take advantage of the "safe harbor" provisions of the
Private Securities Litigation Reform Act of 1995 (the "Reform Act"). Investors
are cautioned that all statements not based on historical fact, trend analyses
and other information contained in this report or in any of the Company's
filings under Section 13 or 15 (d) of the Securities Exchange Act of 1934 (the
"Exchange Act"), relative to the Company's plans, markets for the Company's
products and trends in the Company'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 Reform Act. These forward-looking
statements are made based on current expectations and assumptions and are
subject to known and unknown risks, uncertainties and other factors, many of
which are beyond the Company's control, that may cause actual results to be
materially different from those expressed or implied by the forward-looking
statements. Such factors include, among other things: (1) general economic
conditions and market factors, such as prevailing interest rate levels, stock
market performance and fluctuations in the market for retirement-oriented
savings products and investment management products, which may adversely affect
the ability of the Company to sell its products and services and the market
value of the Company's investments and assets under management and, therefore,
the portion of its revenues that are based on a percentage of assets under
management; (2) the Company's ability to manage effectively its investment
spread (i.e. the amount by which investment income exceeds interest credited to
annuity and life insurance policyholders) as a result of changes in interest
rates and crediting rates to policyholders, market conditions and other factors
(the Company's results of operations and financial condition are significantly
dependent on the Company's ability to manage effectively its investment spread);
(3) that the net change in unrealized and undistributed gains in private equity
limited partnerships will not be realized or that future losses on such
investment will not occur; (4) levels of surrenders, withdrawals and net
redemptions of the Company's retirement-oriented insurance products and
investment management products; (5) relationships with investment management
clients, including levels of assets under management; (6) the ability of the
Company to manage effectively certain risks with respect to its investment
portfolio, including risks relating to holding below investment grade securities
and the ability to dispose of illiquid and/or restricted securities at desired
times and prices, and the ability to manage and hedge against interest rate
changes through asset/liability management techniques; (7) competition in the
sale of the Company's products and services, including the Company's ability to
establish and maintain relationships with distributors of its products; (8)
changes in financial ratings of Keyport or those of its competitors; (9) the
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<PAGE>
Company's ability to attract and retain key employees, including senior
officers, portfolio managers and sales executives; (10) the impact of and
compliance by the Company with existing and future regulation, including
restrictions on the ability of certain subsidiaries to pay dividends and any
obligations of the Company under any guaranty fund assessment laws; (11) changes
in applicable tax laws which may affect the relative tax advantages and
attractiveness of some of the Company's products; (12) the result of any
litigation or legal proceedings involving the Company; (13) changes in generally
accepted accounting principles and the impact of accounting principles and
pronouncements on the Company's financial condition and results of operations;
(14) changes in the Company's senior debt ratings; (15) changes in operating
expense levels; (16) acquisition risks, including risks that the acquisition and
integration of Wanger Asset Management, L.P. will not be as successful as
anticipated; (17) risks that the proposed sale of PCM will not be consummated;
(18) risks that the Company's restructuring efforts and its exploration of
strategic alternatives will not be successful or result in a transaction; and
(19) the other risk factors or uncertainties contained from time to time in any
document incorporated by reference in this report or otherwise filed by the
Company under the Exchange Act. Given these uncertainties, prospective investors
are cautioned not to place undue reliance on such forward-looking statements and
no assurances can be given that the estimates and expectations reflected in such
statements will be achieved.
22
<PAGE>
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
There have been no material changes during the first nine months of 2000 in
the Company's market risks or in the methods which the Company uses to manage
such risks, which are described in the Company's Form 10-K for the year ended
December 31, 1999.
PART II
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
<TABLE>
<S> <C>
10.1 Loan Agreement dated as of September 28, 2000 between Liberty
Financial Companies, Inc. and Liberty Mutual Insurance Company,
as Agent ("Wanger Loan Agreement")
10.2 Form of Promissory Note issued pursuant to the Wanger Loan
Agreement
12 Statement re Computation of Ratios
27 Financial Data Schedule
</TABLE>
(b) REPORTS ON FORM 8-K
There were no reports on Form 8-K filed during the quarter ended September
30, 2000.
23
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
LIBERTY FINANCIAL COMPANIES, INC.
/s/ J. Andy Hilbert
-------------------------------------------
J. Andy Hilbert
(Duly Authorized Officer and
Chief Financial Officer)
Date: November 14, 2000
24
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION PAGE
----------- ----------- ----
<S> <C> <C>
10.1 Loan Agreement dated as of September 28, 2000 between Liberty
Financial Companies, Inc. and Liberty Mutual Insurance Company,
as Agent ("Wanger Loan Agreement")
10.2 Form of Promissory Note issued pursuant to the Wanger Loan
Agreement
12 Statement re Computation of Ratios
27 Financial Data Schedule
</TABLE>
25
