10-Q 1 a-century10q.txt QUARTERLY REPORT 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 JUNE 30, 2001, OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ________________ TO _________________. Commission file number 0-2500111 21st Century Holding Company ---------------------------- (Exact name of registrant as specified in its charter) FL 65-0248866 ------------------------------------------------------------------- (State or Other Jurisdiction of (IRS Employer Incorporation or Organization) Identification No.) 4161 N.W. 5th Street, Plantation, FL 33317 ------------------------------------------ (Address of principal executive offices) (Zip Code) 954-581-9993 ------------ (Registrant's telephone number, including area code) (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 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 [ ] Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Common Stock, $.01 par value - 3,160,701 shares outstanding as of August 10, 2001. 21ST CENTURY HOLDING COMPANY INDEX PART I: FINANCIAL INFORMATION PAGE ---- ITEM 1: Consolidated Balance Sheets as of June 30, 2001 (Unaudited) and December 31, 2000................................................. 3 Consolidated Statements of Operations for the three and six months ended June 30, 2001 (Unaudited) and 2000 (Unaudited).................................................. 4 Consolidated Cash Flow Statements for the six months ended June 30, 2001 (Unaudited) and 2000 (Unaudited).................................................. 5 Notes to Consolidated Financial Statements................................. 6 ITEM 2: Management's Discussion and Analysis of Financial Condition and Results of Operations...................... 9 PART II: OTHER INFORMATION Other Information.......................................................... 15 Signature.................................................................. 17 2 PART I ITEM I. FINANCIAL INFORMATION 21ST CENTURY HOLDING COMPANY CONSOLIDATED BALANCE SHEETS
JUNE 30, 2001 (UNAUDITED) DECEMBER 31, 2000 ------------ ----------------- ASSETS Investments Fixed maturities, available for sale at fair value $ 14,469,243 $ 15,691,147 Equity securities, available for sale at fair value 1,483,164 2,889,627 Trading securities, at fair value 1,140,750 -- Mortgage loans 575,910 385,024 ------------ ------------ Total investments 17,669,067 18,965,798 Cash and cash equivalents 7,436,030 2,627,041 Finance contracts, consumer loans and pay advances receivable, net of allowances for credit losses of $771,588 and $832,231, respectively 14,823,589 13,792,791 Prepaid reinsurance premiums 5,601,835 3,076,017 Premiums receivable, net of allowance of $100,000 and $325,000, respectively 1,286,398 246,787 Due from reinsurers, net 5,291,624 2,797,648 Deferred acquisition costs, net 775,829 1,192,260 Deferred income taxes 3,583,323 2,915,894 Property and equipment, net 5,263,723 5,381,780 Other assets 1,027,194 1,275,701 Goodwill 1,938,981 2,795,750 ------------ ------------ TOTAL ASSETS $ 64,697,593 $ 55,067,467 ============ ============ LIABILITIES AND SHAREHOLDERS' EQUITY Unpaid losses and loss adjustment expenses $ 12,548,056 $ 9,765,848 Unearned premiums 16,293,847 13,038,417 Revolving credit outstanding 9,357,683 8,091,034 Bank overdraft 4,781,445 3,212,962 Unearned commissions 3,191,056 2,505,690 Due to third party insurers 1,391,732 368,399 Accounts payable and accrued expenses 1,049,657 1,960,187 Premium deposits 640,839 382,058 Drafts payable to insurance companies 1,103,585 786,875 ------------ ------------ TOTAL LIABILITIES 50,357,900 40,111,470 ------------ ------------ Commitments and contingencies -- -- Shareholders' equity: Common stock of $.01 par value. Authorized 25,000,000 shares, issued 3,410,667 shares, and outstanding 3,161,101 and 3,330,367, respectively 34,107 34,107 Additional paid in capital 12,820,816 12,894,630 Accumulated other comprehensive income (386,348) (1,300,404) Retained earnings 2,517,287 3,642,066 Treasury stock, 249,566 and 80,300 shares, respectively, at cost (646,169) (314,402) ------------ ------------ TOTAL SHAREHOLDERS' EQUITY 14,339,693 14,955,997 ------------ ------------ TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 64,697,593 $ 55,067,467 ============ ============
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 3 21ST CENTURY HOLDING COMPANY CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30, 2001 2000 2001 2000 ------------ ------------ ------------ ------------ Revenues: Gross premiums written $ 11,594,744 $ 9,206,734 $ 19,199,059 $ 18,161,437 Gross premiums ceded (3,707,402) (911,271) (6,816,314) (664,087) ------------ ------------ ------------ ------------ Net premiums written 7,887,342 8,295,463 12,382,745 17,497,350 Increase (decrease) in unearned premiums, net of prepaid reinsurance premiums (2,695,973) (2,397,683) (2,507,652) (7,296,170) ------------ ------------ ------------ ------------ Net premiums earned 5,191,369 5,897,780 9,875,093 10,201,180 Commission income 600,744 478,907 1,488,782 1,733,091 Finance revenue 1,401,830 1,490,137 2,804,701 2,699,718 MGA fees 1,717,626 1,860,253 3,007,158 2,585,891 Net investment income 262,381 315,102 498,933 535,262 Net securities gains (losses) (1,809,009) (49,326) (1,883,042) 412,847 Other income 798,089 383,485 1,919,555 1,238,480 ------------ ------------ ------------ ------------ Total revenue 8,163,030 10,376,338 17,711,180 19,406,469 ------------ ------------ ------------ ------------ Expenses: Losses and loss adjustment expenses 5,257,370 4,377,200 8,588,615 7,375,276 Operating and underwriting expenses 2,695,672 2,622,701 5,443,344 4,950,792 Salaries and wages 2,020,679 2,209,364 4,500,163 4,487,343 Amortization of deferred acquisition costs 469,779 528,056 549,439 977,488 Amortization of goodwill 142,494 155,300 286,494 310,601 ------------ ------------ ------------ ------------ Total expenses 10,585,994 9,892,621 19,368,055 18,101,500 ------------ ------------ ------------ ------------ Income (loss) before provision (credit) for income tax expense (2,422,964) 483,717 (1,656,875) 1,304,969 Provision (credit) for income tax expense (933,293) 148,948 (665,950) 428,971 ------------ ------------ ------------ ------------ Net income (loss) $ (1,489,671) $ 334,769 $ (990,925) $ 875,998 ============ ============ ============ ============ Net income (loss) per share and net income (loss) per share-assuming dilution $ (0.47) $ 0.10 $ (0.31) $ 0.26 ============ ============ ============ ============ Weighted average number of common shares outstanding and weighted average number of common shares outstanding 3,163,801 3,405,667 3,233,563 3,395,445 (assuming dilution)
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 4 21ST CENTURY HOLDING COMPANY CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
SIX MONTHS ENDED JUNE 30, 2001 2000 ------------ ------------ Cash flow from operating activities: Net income (loss) $ (990,925) $ 875,998 Adjustments to reconcile net income to net cash flow used in operating activities: Accretion of investment discounts (13,201) (6,323) Depreciation and amortization 198,380 111,555 Amortization of goodwill 286,494 310,601 Deferred income tax benefit (expense) 574,165 (500,697) Net securities (gains) losses (1,883,042) (412,847) Amortization of deferred acquisition costs, net 549,439 977,488 Provision for credit losses 969,453 707,209 Provision for uncollectible premiums receivable 6,479 125,000 Net loss on sale of agencies 13,198 -- Changes in operating assets and liabilities: Premiums receivable (1,046,090) (119,311) Prepaid reinsurance premiums (2,525,818) 886,539 Due from reinsurers (2,493,976) 80,539 Deferred acquisition costs, net (133,008) (1,651,312) Other assets 820,782 14,482 Unpaid loss and loss adjustment expenses 2,782,208 2,201,586 Unearned premiums 3,255,430 7,853,943 Unearned commissions 685,366 293,568 Accounts payable and accrued expenses (755,430) 933,610 Due to third party insurers 1,023,333 3,979,444 Premium deposits 258,781 19,343 Drafts payable to insurance companies 316,710 2,677,532 ------------ ------------ Net cash flow provided by operating activities 3,871,736 19,357,947 ------------ ------------ Cash flow from investing activities: Proceeds from sale of securities 47,730,367 21,792,982 Purchases of securities (46,647,053) (31,332,778) Finance contracts, consumer loans and pay advances receivable (2,000,251) (5,390,545) Collection of mortgage loans 7,192 2,144 Purchases of property and equipment (137,005) (823,899) Origination of mortgage loans (198,078) (160,000) ------------ ------------ Net cash flow used in investing activities (1,244,828) (15,912,096) ------------ ------------ Cash flows from financing activities Increase in bank overdraft 1,568,483 1,369,976 Repayment of notes payable -- (312,823) Dividends paid (133,854) -- Purchases of treasury stock (519,197) (67,465) Increase in revolving credit outstanding 1,266,649 1,179,846 Net cash flow provided by financing activities 2,182,081 2,169,534 ------------ ------------ Net increase in cash & cash equivalents 4,808,989 5,615,385 Cash & cash equivalents at beginning of year 2,627,041 923,175 ------------ ------------ Cash & cash equivalents at end of period $ 7,436,030 $ 6,538,560 ============ ============ Supplemental disclosure of cash flow information: Cash paid during the year for: Interest $ 326,197 $ 290,015 ============ ============ Income taxes $ -- $ 500,000 ============ ============ Non-cash investing and financing activities Dividends accrued $ 63,222 $ -- ============ ============ Stock received for sale of agency $ 41,484 $ -- ============ ============ Stock issued for employees' bonus $ 155,100 $ 100,000 ============ ============ Stock issued for settlement of note payable $ -- $ 104,950 ============ ============ Notes receivable for sale of agencies, net of unrealized gains $ 572,275 $ -- ============ ============
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 5 21ST CENTURY HOLDING COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (1) ORGANIZATION AND BUSINESS The accompanying unaudited consolidated financial statements of 21st Century Holding Company (the "Company") have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions for Form 10-Q and Rule 10-01 of Regulation S-X. These financial statements do not include all information and notes required by generally accepted accounting principles for complete financial statements, and should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Company's annual report on Form 10-KSB for the year ended December 31, 2000. The December 31, 2000 year end balance sheet data was derived from audited financial statements but does not include all disclosures required by generally accepted accounting principles. The financial information furnished reflects all adjustments, consisting only of normal recurring accruals, which are, in the opinion of management, necessary for a fair presentation of the financial position, results of operations and cash flows for the periods presented. The results of operations are not necessarily indicative of results of operations, which may be achieved in the future. The Company is a vertically integrated insurance holding company, which, through its subsidiaries, controls substantially all aspects of the insurance underwriting, distribution and claims process. The Company underwrites nonstandard and standard personal automobile insurance and homeowners and mobile home property and casualty insurance in the State of Florida through its subsidiary, Federated National Insurance Company ("Federated National"). The Company has underwriting authority for third-party insurance companies, which it represents through a wholly owned managing general agent, Assurance Managing General Agents, Inc. ("Assurance MGA"). The Company internally processes claims made by Federated National's and third-party insureds through a wholly-owned claims adjusting company, Superior Adjusting, Inc. ("Superior"). The Company also offers premium financing to its own and third-party insureds through its wholly owned subsidiary, Federated Premium Finance, Inc. ("Federated Premium"), and pay advances through Fed First Corp. ("Fed First"). The Company, through its wholly owned subsidiary, FedUSA, Inc. ("FedUSA"), franchises agencies under the FedUSA name. The Company markets and distributes Federated National's and third-party insurers' products and its other services primarily in Central and South Florida, through a network of 20 agencies owned by its subsidiary, Federated Agency Group, 19 FedUSA franchised agencies, and approximately 400 active independent agents. (2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND PRACTICES (A) ACCOUNTING PRONOUNCEMENTS NOT YET ADOPTED In July 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (SFAS) No. 141, Business Combinations and SFAS No. 142 Goodwill and Intangible Assets, which become effective for fiscal years beginning after December 15, 2001. The key elements of these statements are (1) the elimination of the pooling-of-interest method for business combinations, (2) the elimination of amortization of goodwill for both new and previous acquisitions, (3) intangible assets must be recognized separately from goodwill, (4) the impairment of goodwill must be tested annually at a reporting unit level, and (5) pro forma disclosures for all past periods presented to reflect the amount of amortization which would have been reversed had the standard been applied retroactively. Upon adoption of this standard, the Company will cease to amortize goodwill and the remaining unamortized balance will be periodically tested for impairment. (B) ACCOUNTING FOR DERIVATIVES AND HEDGING ACTIVITY On January 1, 2001, the Company adopted SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," which requires all derivatives to be recognized at fair value as either assets or liabilities on the balance sheet. Any gain or loss resulting from changes in such fair value are recognized in earnings, to the extent the derivatives are not effective as hedges. Adoption of this statement did not have a material impact on the Company's results of operations or financial position. (C) CODIFICATION OF STATUTORY ACCOUNTING PRINCIPLES Effective January 1, 2001, the Company adopted the Codification of Statutory Accounting Principles guidance (the "Codification") issued by the National Association of Insurance Commissioners ("NAIC"). The Codification provides guidance for areas where statutory accounting has been silent and changes current accounting in some areas. The adoption of the Codification did not have a material effect on the Company's results of operations or financial position. 6 21ST CENTURY HOLDING COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND PRACTICES (CONTINUED) (D) Earnings per share Basic earnings per share ("Basic EPS") is computed by dividing net income by the weighted average number of common shares outstanding during each period presented. Diluted earnings per share ("Diluted EPS") is computed by dividing net income by the weighted average number of common stock and common stock equivalents during the period presented; outstanding warrants and stock options are considered common stock equivalents and are included in the calculation using the treasury stock method. Diluted EPS excluded the impact of warrants and stock options as such amounts are anti-dilutive. (E) RECLASSIFICATIONS Certain amounts in 2000 financial statements have been reclassified to conform with 2001 presentation. (3) REVOLVING CREDIT OUTSTANDING The Company, through its wholly owned subsidiary, Federated Premium is a party to a revolving loan agreement ("Revolving Agreement") with Flatiron Funding Company LLC ("Flatiron"). The Revolving Agreement is structured as a sale of contracts receivable under a sale and assignment agreement with FPF, Inc. (a wholly-owned subsidiary of Flatiron), which gives FPF Inc. the right to sell or assign these contracts receivable. Federated Premium, which services these contracts, has recorded transactions under the Revolving Agreement as secured borrowings. The Revolving Agreement allows for a maximum credit commitment of $9.8 million, including $800,000 of overline availability for collateral not delivered. The amount of an advance is subject to availability under a borrowing base calculation, with maximum advances outstanding not to exceed the maximum credit commitment. The annual interest rate on advances under the Revolving Agreement is the prime rate plus additional interest varying from .75% to prime only based on the prior month's average outstanding balance. Interest on the overline availability is at the default rate of 17.5%. The Revolving Agreement contains various operating and financial covenants, with which the Company was in compliance at June 30, 2001. The Revolving Agreement expires September 30, 2001 and the Company believes it will be renewed or alternative financing will be obtained. (4) COMMITMENTS AND CONTINGENCIES The Company is involved in various claims and legal actions arising in the ordinary course of business. In the opinion of management, the ultimate disposition of these matters will not have a material adverse effect on the Company's consolidated financial position, results of operations, or liquidity. In June 2000, a lawsuit was filed against the Company and its directors and executive officers seeking compensatory damages on the basis of allegations that the Company's amended registration statement dated November 4, 1998 was inaccurate and misleading concerning the manner in which the Company recognized ceded insurance commission income, in violation of Sections 11 and 15 of the Securities Act of 1933 and Sections 10(b) and 20(a) of the Securities Exchange Act of 1934. The lawsuit was filed in the United States District Court for the Southern District of New York and seeks class action status. The plaintiff class purportedly includes purchasers of the Company's common stock between November 5, 1998 and August 13, 1999. The Company believes that the lawsuit is without merit and intends to vigorously defend such action. On November 1, 2000, the Company filed a motion to dismiss this lawsuit. On August 6, 2001, the district court granted the Company's motion to dismiss, in part, and allowed the plaintiffs 30 days to file an amended complaint. In June 2001, a lawsuit was filed against Federated National by Virtual Insurance Processing Systems, a software vendor, alleging that Federated National breached a software vending contract and misappropriated trade secrets. The case is pending in the Circuit Court of the 17th Judicial Circuit in and for Broward County, Florida and seeks both money damages and injunctive relief. The Company believes that the lawsuit is without merit and intends to vigorously defend such action. 7 21ST CENTURY HOLDING COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (5) COMPREHENSIVE INCOME (DEFICIT) For the three and six months ended June 30, 2001 and 2000, comprehensive income consisted of the following:
Three months ended June 30, Six months ended June 30, 2001 2000 2001 2000 ----------- ----------- ----------- ----------- Net income $(1,489,671) $ 334,769 $ (990,925) $ 875,998 Change in net unrealized losses on investments held for sale, net of income taxes 1,379,491 (512,475) 914,056 (513,606) ----------- ----------- ----------- ----------- Comprehensive income (loss) $ (110,180) $ (177,706) $ (76,869) $ 362,392 =========== =========== =========== ===========
(6) SEGMENT INFORMATION The Company and its subsidiaries operate principally in two business segments consisting of insurance and financing. The insurance segment consists of underwriting through Federated National, managing general agent operations through Assurance MGA, claims processing through Superior, marketing and distribution through Federated Agency Group and franchise operations through FedUSA. The insurance segment sells primarily nonstandard personal automobile insurance and includes substantially all aspects of the insurance, distribution and claims process. The financing segment consists of premium financing through Federated Premium Finance, consumer loans through RPA Financial Corporation, and pay advances through FedFirst. The financing segment provides premium financing to both Federated National's insureds and to third-party insureds, consumer loans and pay advances, and is marketed through the Company's distribution network of Company-owned agencies (Federated Agency Group) and independent agents. The accounting policies of the segments are the same as those described in the summary of significant accounting policies and practices. The Company evaluates its business segments based on GAAP pretax operating earnings. Corporate overhead expenses are not allocated to business segments. Transactions between reportable segments are accounted for at fair value. Operating segments that are not individually reportable are included in the "All Other" category, which includes the operations of 21st Century Holding Company and income tax return preparation. Information regarding components of operations for the three months and six months ended June 30, 2001 and 2000 follows:
Three months ended June 30, Six months ended June 30, 2001 2000 2001 2000 ------------ ------------ ------------ ------------ Total Revenue Insurance Segment $ 8,298,527 $ 8,446,047 $ 16,847,187 $ 15,524,294 Financing Segment 1,389,037 1,460,137 2,769,787 2,669,718 All Other 1,712,262 1,157,242 2,598,811 2,940,240 ------------ ------------ ------------ ------------ Total Operating Segments 11,399,826 11,063,426 22,215,785 21,134,252 Intercompany Eliminations (3,236,796) (687,088) (4,504,605) (1,727,783) ------------ ------------ ------------ ------------ Total Revenues $ 8,163,030 $ 10,376,338 $ 17,711,180 $ 19,406,469 ============ ============ ============ ============ Earnings Before Income Taxes Insurance Segment $ (3,177,072) $ 1,035,658 $ (3,446,859) $ 1,890,442 Financing Segment 458,629 412,392 739,513 769,562 All Other 295,479 (964,333) 1,050,471 (1,355,035) ------------ ------------ ------------ ------------ Total Earnings before Income Taxes $ (2,422,964) $ 483,717 $ (1,656,875) $ 1,304,969 ============ ============ ============ ============
Information regarding total assets as of June 30, 2001 and December 31, 2000 follows:
2001 2000 ------------ ------------ Total Assets Insurance Segment $ 44,656,176 $ 35,503,710 Finance Segment 15,609,854 14,570,175 All Other 5,728,778 7,072,230 ------------ ------------ Total Operating Segments 65,994,808 57,146,115 Intercompany Eliminations (1,297,215) (2,078,648) ------------ ------------ Total Assets $ 64,697,593 $ 55,067,467 ============ ============
8 21ST CENTURY HOLDING COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (7) PENDING ACQUISITION In March 2001, the Company agreed to purchase all of the outstanding stock and all of the outstanding surplus notes of American Vehicle Insurance Company ("American Vehicle") for $500,000 in cash. In addition, the Company has agreed to pay two executives of American Vehicle a finders' fee of $400,000 over a period of three years. The purchase is subject to approval by the Florida Department of Insurance, and the Company anticipates that as part of that approval, the Company will have to contribute approximately $1,000,000 to American Vehicle to bring its statutory surplus to $2.75 million. The acquisition will be accounted for under the purchase method of accounting and is expected to create negative goodwill. 9 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION 21st Century Holding Company (the "Company") cautions readers that certain important factors may affect the Company's actual results and could cause such results to differ materially from any forward-looking statements which may be deemed to have been made in this report or which are otherwise made by or on behalf of the Company. For this purpose, any statements contained in this report that are not statements of historical fact may be deemed to be forward-looking statements. Without limiting the generality of the foregoing, words such as "may", "will", "expect", "believe", "anticipate", "intend", "could", "would", "estimate", or "continue" or the negative other variations thereof or comparable terminology are intended to identify forward-looking statements. Factors which may affect the Company's results include, but are not limited to, risks related to the nature of the Company's business; dependence on investment income; the adequacy of its liability for loss and loss adjustment expense ("LAE"); regulation; insurance agents; claims experience; limited experience in the insurance industry; competition; ratings by industry services; catastrophe losses; reliance on key personnel and other risks discussed elsewhere in this Report and in the Company's other filings with the Securities and Exchange Commission. OVERVIEW The Company is a vertically integrated insurance holding company, which, through its subsidiaries, controls substantially all aspects of the insurance underwriting, distribution and claims process. The Company underwrites nonstandard and standard personal automobile insurance and homeowners and mobile home property and casualty insurance in the State of Florida through its subsidiary, Federated National. The Company has underwriting authority for third-party insurance companies, which it represents through a wholly owned managing general agent, Assurance MGA. The Company internally processes claims made by Federated National's and third-party insureds through a wholly-owned claims adjusting company, Superior. The Company also offers premium financing to its own and third-party insureds through its wholly owned subsidiary, Federated Premium, and pay advances through Fed First. The Company, through its wholly owned subsidiary, FedUSA, franchises agencies under the FedUSA name. The Company markets and distributes Federated National's and third-party insurers' products and its other services primarily in South Florida, through a network of 20 agencies owned by its subsidiary, Federated Agency Group, 19 FedUSA franchised agencies, and approximately 400 active independent agents. The Company's business, results of operations and financial condition are subject to fluctuations due to a variety of factors. Abnormally high severity or frequency of claims in any period could have a material adverse effect on the Company's business, results of operations and financial condition. Also, if Federated National's estimated liabilities for unpaid losses and LAE is less than actual losses and LAE, Federated National will be required to increase reserves with a corresponding reduction in Federated National's net income in the period in which the deficiency is identified. The Company operates in a highly competitive market and faces competition from both national and regional insurance companies, many of whom are larger and have greater financial and other resources than the Company, have favorable ratings from A. M. Best, a leading rating agency for the insurance industry, and offer more diversified insurance coverage. The Company's competitors include other companies that market their products through agents, as well as companies that sell insurance directly to customers. Large national writers may have certain competitive advantages over agency writers, including increased name recognition, increased loyalty of their customer base and reduced acquisition costs. The Company may also face competition from new or temporary entrants in its niche markets. In some cases, such entrants may, because of inexperience, desire for new business or other reasons, price their insurance below that of the Company. Although, the Company's pricing is inevitably influenced to some degree by that of its competitors, the Company's management believes that it is generally not in the Company's best interest to compete solely on price, choosing instead to compete on the basis of underwriting criteria, its distribution network and superior service to its agents and insureds. The Company competes with respect to automobile insurance in Florida with more than 100 companies which underwrite personal automobile insurance. During the six months ended June 30, 2001, the Company sold, in eleven separate transactions, 13 agencies. The aggregate consideration received by the Company was approximately $1.1 million in notes receivable and 13,828 shares of 21st Century common stock. In accounting for these sales, the Company has recorded a deferred gain of $567,000, which represents the difference in consideration received and the net book value of the assets sold (primarily fixed assets and goodwill). No gain or interest income on the notes will be recognized until the book value is recovered. 10 ANALYSIS OF FINANCIAL CONDITION AS OF JUNE 30, 2001 AS COMPARED TO DECEMBER 31, 2000 Investments. Investments decreased $2.5 million to $16.5million as of June 30, 2001 as compared to $19.0 million as of December 31, 2000. This decrease in investments is primarily because the Company invested $1.1 million in trading securities and an additional $3.5 million in cash equivalents as of June 30, 2001. Cash and Cash Equivalents. Cash and cash equivalents were $7.4 million as of June 30, 2001, as compared to $2.6 million as of December 31, 2000. This increase of $4.8 million is due primarily to an additional investment in a short-term money market account of $3.5 million as of June 30, 2001. Trading Securities. Beginning April 1, 2001, the Company began classifying certain equity security purchases as trading securities. As of June 30, 2001, the Company had $1.1 million of trading securities as compared to none at December 31, 2000. Finance Contracts, Consumer Loans and Pay Advances Receivable. Finance contracts, consumer loans and pay advances receivable increased $1.0 million from $13.8 million as of December 31, 2000 to $14.8 million as of June 30,2001 primarily because, in 2001, the Company began requiring agencies to place financing with the Company on all policies underwritten by the Company. Prepaid Reinsurance Premiums. Prepaid reinsurance premiums increased $2.5 million to $5.6 million as of June 30, 2001 from $3.1 million as of December 31, 2000 because the Company increased its quota-share reinsurance on automobile insurance from 30% of premiums to 50%, effective January 1, 2001. Premiums Receivable. Premiums receivable were $1.3 million as of June 30, 2001, an increase of $1.0 million as compared to $247,000 outstanding as of December 31, 2000. This increase is the result of added emphasis placed on direct bill premium financing by Federated National. Due from Reinsurers. Due from reinsurers increased $2.5 million to $5.3 million as of June 30, 2001 from $2.8 million as of December 31, 2000. This increase is the result of the increase of reinsurance discussed above. Deferred Acquisition Costs, net. Deferred acquisition costs decreased from $1.2 million as of December 31, 2000 to $776,000 as of June 30, 2001. Included in the December 31, 2000 balance were deferred commissions of $2.1 million offset by unearned ceded commissions of $877,000. As of June 30, 2000, deferred commissions were $2.5 million offset by unearned ceded commissions of $1.7 million. The increase in unearned ceded commissions is related to the increase in reinsurance discussed above. Unpaid Losses and Loss Adjustment Expenses. Unpaid loss and loss adjustment expenses increased $2.7 million, from $9.8 million at December 31, 2000 to $12.5 million as of June 30, 2001. This increase is primarily due to an increase in losses the Company has recorded recently. Revolving Credit Outstanding. The amount borrowed under the Revolving Agreement increased $1.3 million to $9.4 million outstanding as of June 30, 2001 from $8.1 million as of December 31, 2000. This increase is related to the increase in finance contracts receivable discussed above. Bank Overdraft. Bank overdraft is the result of the cash management techniques employed by the Company. The overdraft was $4.7 million as of June 30, 2001, a $1.5 million increase from $3.2 million as of December 31, 2000. This increase is primarily related to the timing of the issuance of refund and claim checks. Due to Third Party Insurers. Due to third party insurers increased from $368,000 as of December 31, 2000 to $1.4 million as of June 30, 2001. This increase is primarily related to the amount of third party insurance underwritten by Assurance MGA in June compared to December. Typically, the number of policies underwritten in December is low compared to other months. Accounts Payable and Accrued Expenses. Accounts payable and accrued expenses declined $910,000 from $2.0 million as of December 31, 2000 to $1.1 million as of June 30, 2000 due primarily to payment of year-end accruals in 2001. Premium Deposits. Premium deposits increased $259,000 to $641,000 as of June 30, 2001 from $382,000 as of December 31, 2000. This increase is related to the timing of the issuance of policy refund checks as well as the amount of policies in process of being underwritten. 11 RESULTS OF OPERATIONS THREE MONTHS ENDED JUNE 30, 2001 COMPARED TO THREE MONTHS ENDED JUNE 30, 2000 Gross Premiums Written. Gross premiums written increased $2.4 million, or 25.9% to $11.6 million for the three months ended June 30, 2001 as compared to $9.2 million for the comparable period in 2000. $825,000 of the increase was attributable to automobile insurance and $1.6 million was attributable to homeowners insurance. In the year 2000, the Company expanded its homeowner line from only mobile homes to single-family homes as well. Gross Premiums Ceded. Gross premiums ceded increased from $911,000 for the three months ended June 30, 2000, to $3.7 million for the three months ended June 30, 2001. In 2000, the Company had 15% automobile quota-share reinsurance as compared to 50% automobile quota-share reinsurance in the first quarter of 2001. MGA Fees. MGA fees decreased $142,000 to $1.7 million for the three-month period ended June 30, 2001 from approximately $1.9 million for the same period in 2000. The decrease is because in 2001, the Company ceased underwriting for one nonaffiliated insurance Company. Net Securities Gains (Losses). The Company experienced net losses of $1.8 million for the three-month period ended June 30, 2001 compared to $49,000 for the same period in 2000. Realized gains or losses are primarily a function of the equity markets, and therefore it is not possible to predict whether the Company will record gains or losses in the future. Other Income. Other income increased $415,000 to $798,000 for the three-month period ended June 30, 2001 from $383,000 for the same period in 2000. This increase is primarily attributable to an increase in adjusting fees due to the addition in 2000 of two nonaffiliated insurance companies as claim adjusting customers. Losses and LAE. The Company's loss ratio, as determined in accordance with GAAP, for the three-month period ended June 30, 2001 was 101% compared with 74% for the same period in 2000. Losses and LAE incurred increased $880,000 to $5.3 million for the three-month period ended June 30, 2001 from $4.4 million for the same period in 2000. Losses and LAE, the Company's most significant expense, represent actual payments made and changes in estimated future payments to be made to or on behalf of its policyholders, including expenses required to settle claims and losses. In the second quarter of 2001, the Company experienced a significant increase in lawsuits relating to automobile claims. Management believes this increase in lawsuits is in anticipation of the effective date of recent legislation passed by the Florida legislature. This legislation, which becomes effective October 1, 2001, includes the establishment of a pre-suit notice requirement for no fault claims, fee schedules for certain medical procedures, the licensing of health care clinics, and toughened criminal sanctions for fraud. RESULTS OF OPERATIONS SIX MONTHS ENDED JUNE 30, 2001 COMPARED TO SIX MONTHS ENDED JUNE 30, 2000 Gross Premiums Written. Gross premiums written increased $1.0 million, or 5.7% to $19.2 million for the six months ended June 30, 2001 as compared to $18.2 million for the comparable period in 2000. Homeowners insurance, which was expanded in 2000 as discussed above, increased $1.8 million and automobile insurance decreased $771,000 due to three rate increases since January 1, 2000. Gross Premiums Ceded. Gross premiums ceded increased from $664,000 for the six months ended June 30, 2000, to $6.8 million for the six months ended June 30, 2001. In the second quarter of 2000, the Company had 15% automobile quota-share reinsurance as compared to 50% automobile quota-share reinsurance in the second quarter of 2001. Increase (Decrease) in Unearned Premiums, net of Prepaid Reinsurance Premiums. The decrease in unearned premiums, net of prepaid reinsurance premiums, was $2.5 million for the six months ended June 30, 2001 compared to $7.3 million for the six months ended June 30, 2000. This decrease is due primarily to the change in quota-share reinsurance discussed above. Commission Income. Commission income decreased $244,000 to $1.5 million for the six-month period ended June 30, 2001 from $1.7 million for the same period in 2000. Commission income consists of fees earned by Company-owned agencies placing business with third party insurers. This decrease is due to agencies writing more Company business and less third party business. MGA Fees. MGA fees increased $421,000 to $3.0 million for the six-month period ended June 30, 2001 from $2.6 million for the same period in 2000. The increase is because the Company began underwriting for its largest non-affiliated insurance client in the first half of 2000. 12 RESULTS OF OPERATIONS SIX MONTHS ENDED JUNE 30, 2001 COMPARED TO SIX MONTHS ENDED JUNE 30, 2000 (CONTINUED) Net Securities Gains (Losses). The Company experienced net losses of $1.9 million for the six-month period ended June 30, 2001 compared to net gains of $413,000 for the same period in 2000. Realized gains or losses are primarily a function of the equity markets and therefore it is not possible to predict whether the Company will record gains or losses in the future. Other Income. Other income increased $681,000 to $1.9 million for the six-month period ended June 30, 2001 from $1.2 million for the same period in 2000. This increase is primarily attributable to an increase in adjusting fees due to the addition in 2000 of two nonaffiliated insurance companies as claims adjusting customers. Losses and LAE. The Company's loss ratio, as determined in accordance with GAAP, for the six-month period ended June 30, 2001 was 87% compared with 72% for the same period in 2000. Losses and LAE incurred increased $1.2 million to $8.6 million for the six-month period ended June 30, 2001 from $7.4 million for the same period in 2000. Losses and LAE, the Company's most significant expense, represent actual payments made and changes in estimated future payments to be made to or on behalf of its policyholders, including expenses required to settle claims and losses. In the second quarter of 2001, the Company experienced a significant increase in lawsuits relating to automobile claims. Management believes this increase in lawsuits is in anticipation of the effective date of recent legislation passed by the Florida legislature. This legislation, which becomes effective October 1, 2001, includes the establishment of a pre-suit notice requirement for no fault claims, fee schedules for certain medical procedures, the licensing of health care clinics, and toughened criminal sanctions for fraud. Operating and Underwriting Expenses. Operating and underwriting expenses increased $493,000 to $5.4 million for the six-month period ended June 30, 2001 from $4.9 million for the same period in 2000. This increase is related primarily to underwriting costs for third party insurers. Amortization of Deferred Policy Acquisition Costs. Amortization of deferred policy acquisition costs decreased to $549,000 for the six-month period ended June 30, 2001 from $977,000 for the same period in 2000. Amortization of deferred policy acquisition costs consists of the actual amortization of deferred policy acquisition costs less commissions earned on reinsurance ceded. The decrease is due to an increase in commissions earned on reinsurance ceded, as the Company increased its automobile quota-share reinsurance from 15% in the first half of 2000 to 50% in the first half of 2001. LIQUIDITY AND CAPITAL RESOURCES The Company's primary sources of capital are revenues generated from operations, investment income and borrowings under the Revolving Agreement. Because the Company is a holding company, it is largely dependent upon dividends and fees from its subsidiaries for cash flow. Federated Premium is a party to the Revolving Agreement, which is used to fund its operations. The Revolving Agreement allows for a maximum credit commitment of $9.8 million, including $800,000 of overline availability for collateral not delivered and expires September 30, 2001. The amount of an advance is subject to availability under a borrowing base calculation, with maximum advances outstanding not to exceed the maximum credit commitment. The annual interest rate on advances under the Revolving Agreement is the prime rate plus additional interest varying from .75% to prime only based on the prior month's average outstanding balance. Interest on the overline availability is at the default rate of 17.5%. Outstanding borrowings under the Revolving Agreement as of June 30, 2001 and December 31, 2000 were approximately $9.4 million and $8.1 million, respectively. The Revolving Agreement contains various operating and financial covenants, with which the Company was in compliance at June 30, 2001. The Company believes that the Revolving Agreement will be renewed upon maturity or alternative financing will be obtained. However, there can be no assurances that the Revolving Agreement will be renewed or that the Company will be able to refinance the Revolving Agreement at reasonable terms. For the six months ended June 30, 2001, operations generated operating cash flow of $3.9 million. Operating cash flow is expected to be negative in the short-term as the Company raised prices on automobile insurance effective July 1, 2001, which has slowed the volume of premiums written. In the long-term, the price increase should generate cash when related automobile insurance expenditures slow. The short-term short fall in cash flow is expected to be funded by the Company's trading and investment portfolios, which is highly liquid as it consists almost entirely of readily marketable securities. Cash flow used in investing activities was $1.2 million for the six months ended June 30, 2001 due primarily to the purchase of securities. Cash flow from financing activities was $2.2 million for the six months ended June 30, 2001, which was derived primarily from increases in the Revolving Agreement and the bank overdraft. The Company believes that its current capital resources will be sufficient to meet its anticipated working capital requirements through at least 2001. There can be no assurances, however, that such will be the case. 13 LIQUIDITY AND CAPITAL RESOURCES (CONTINUED) To retain its certificate of authority, the Florida insurance laws and regulations require that Federated National maintain capital surplus equal to the greater of 10% of its liabilities or the 2000 statutory minimum capital and surplus requirement of $2.75 million as defined in the Florida Insurance Code. Federated National is also required to adhere to prescribed premium-to-capital surplus ratios. Federated National is required to comply with the risk-based capital requirements of the NAIC. The NAIC's risk-based capital requirements are a method of measuring the amount of capital appropriate for an insurance company to support its overall business operations in light of its size and risk profile. NAIC's risk-based capital standards are used by regulators to determine appropriate regulatory actions relating to insurers that show signs of weak or deteriorating condition. As of June 30, 2001, based on calculations using the appropriate NAIC formula, Federated National's total adjusted capital is in excess of ratios that would require regulatory action. GAAP differs in some respects from reporting practices prescribed or permitted by the Florida Department of Insurance. Federated National's statutory capital surplus was approximately $5.5 million as of June 30, 2001. Statutory net loss was $401,000 for the six months ended June 30, 2001. The maximum amount of dividends that can be paid by Florida insurance companies without prior approval of the Florida Commissioner, is subject to restrictions relating to statutory surplus. The maximum dividend that may be paid in 2001, by Federated National without prior approval, is limited to the lesser of statutory net income from operations of the preceding calendar year or 10% of statutory unassigned capital surplus as of the preceding December 31. Federated National paid no dividends during 2001 or 2000. IMPACT OF INFLATION AND CHANGING PRICES The consolidated financial statements and related data presented herein have been prepared in accordance with GAAP which requires the measurement of financial position and operating results in terms of historical dollars without considering changes in the relative purchasing power of money over time due to inflation. The primary assets and liabilities of the Company are monetary in nature. As a result, interest rates have a more significant impact on the Company's performance than the effects of the general levels of inflation. Interest rates do not necessarily move in the same direction or with the same magnitude as the cost of paying losses and LAE. Insurance premiums are established before the Company knows the amount of loss and LAE and the extent to which inflation may affect such expenses. Consequently, the Company attempts to anticipate the future impact of inflation when establishing rate levels. While the Company attempts to charge adequate rates, the Company may be limited in raising its premium levels for competitive and regulatory reasons. Inflation also affects the market value of the Company's investment portfolio and the investment rate of return. Any future economic changes which result in prolonged and increasing levels of inflation could cause increases in the dollar amount of incurred loss and LAE and thereby materially adversely affect future liability requirements. 14 PART II. OTHER INFORMATION ITEM 1 LEGAL PROCEEDINGS In June 2000, a lawsuit was filed against the Company and its directors and executive officers seeking compensatory damages on the basis of allegations that the Company's amended registration statement dated November 4, 1998 was inaccurate and misleading concerning the manner in which the Company recognized ceded insurance commission income, in violation of Sections 11 and 15 of the Securities Act of 1933 and Sections 10(b) and 20(a) of the Securities Exchange Act of 1934. The lawsuit was filed in the United States District Court for the Southern District of New York and seeks class action status. The plaintiff class purportedly includes purchasers of the Company's common stock between November 5, 1998 and August 13, 1999. The Company believes that the lawsuit is without merit and intends to vigorously defend such action. On November 1, 2000, the Company filed a motion to dismiss this lawsuit. On August 6, 2001, the district court granted the Company's motion to dismiss, in part, and allowed the plaintiffs 30 days to file an amended complaint. In June 2001, a lawsuit was filed against Federated National by Virtual Insurance Processing Systems, a software vendor, alleging that Federated National breached a software vending contract and misappropriated trade secrets. The case is pending in the Circuit Court of the 17th Judicial Circuit in and for Broward County, Florida and seeks both money damages and injunctive relief. The Company believes that the lawsuit is without merit and intends to vigorously defend such action. ITEM 2 CHANGES IN SECURITIES None. ITEM 3 DEFAULTS UPON SENIOR SECURITIES None. ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS On June 5, 2001, the Company held its Annual Meeting of Shareholders (the "Meeting"). At the Meeting, the following matters were voted upon: (i) Election of Directors The following table sets forth the name of each nominee and the voting with respect to each nominee for director who will hold office until the annual meeting of shareholders to be held in 2004: Withhold -------- Name For Authority ---- --- --------- Edward J. Lawson 2,844,740 9,600 Michele V. Lawson 2,844,635 9,705 (ii) Adoption of the Franchise Stock Option Plan Adoption of a Franchise Stock Option Plan in which 659,000 shares of the Company's common stock, $.01 par value per share, would be issuable to specified individuals purchasing company owned agencies, which are then to be converted to franchised agencies. With respect to the foregoing matter, 1,639,665 shares were voted in favor, 80,500 shares were voted against and 1,100 shares abstained. There were no broker non-votes. 15 ITEM 5 OTHER INFORMATION None. ITEM 6 EXHIBITS AND REPORTS ON FORM 8-K On May 8, 2001, the Company filed a Report on Form 8-K to reflect changes to the beneficial ownership of the common stock, par value, $0.01 to reflect recent sales by certain former 10% beneficial stockholders. These sales effectively increased the number of shares in the "public float" and thereby increased the "market value of public float" as defined by the Nasdaq National Market. In order for the Company to maintain its listing on the Nasdaq National Market, the Company is required to maintain a "market value of public float" of $5.0 million or more. 16 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 hereunto duly authorized. 21ST CENTURY HOLDING COMPANY DATE: August 10, 2001 By: /s/ Samuel A. Milne ----------------------- Title: Chief Financial Officer 17