10-Q 1 century21-10q.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 MARCH 31, 2002 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 - 3,015,501 shares outstanding as of May 13, 2002. 21ST CENTURY HOLDING COMPANY INDEX PART I: FINANCIAL INFORMATION PAGE ---- ITEM 1: Consolidated Balance Sheets as of March 31, 2002 (Unaudited) and December 31, 2001 (Audited)....................................... 3 Consolidated Statements of Operations for the three months ended March 31, 2002 (Unaudited) and 2001 (Unaudited).................................................. 4 Consolidated Cash Flow Statements for the three months ended March 31, 2002 (Unaudited) and 2001 (Unaudited).................................................. 5 Notes to Consolidated Financial Statements................................. 6 ITEM 2: Management's Discussion and Analysis of Financial Condition and Results of Operations...................... 10 ITEM 3 Quantitative and Qualitative Disclosures About Market Risk................. 13 PART II: OTHER INFORMATION Other Information.......................................................... 14 Signatures................................................................. 15 2 PART I ITEM I. FINANCIAL INFORMATION 21ST CENTURY HOLDING COMPANY CONSOLIDATED BALANCE SHEETS
MARCH 31, 2002 DECEMBER 31, 2001 -------------- ----------------- (UNAUDITED) ASSETS Investments Fixed maturities, available for sale at fair value $ 19,328,564 $ 16,713,321 Equity securities, at fair value 193,250 192,500 Mortgage loans 150,011 601,601 ------------ ------------ Total investments 19,671,825 17,507,422 Cash and cash equivalents 549,056 775,699 Finance contracts and pay advances receivable, net of allowances for credit losses of $823,550 and $723,756, respectively 12,140,321 10,813,881 Prepaid reinsurance premiums 7,954,932 5,559,909 Premiums receivable, net of allowance of $178,000 and $235,000, respectively 3,475,835 1,560,914 Reinsurance recoverable, net 5,730,383 7,053,329 Deferred acquisition costs, net (697,918) 11,952 Deferred income taxes 2,401,876 2,252,176 Property, plant and equipment, net 4,945,681 5,086,884 Other assets 1,303,027 2,442,092 Goodwill 1,789,353 1,789,353 ------------ ------------ TOTAL ASSETS $ 59,264,371 $ 54,853,611 ============ ============ LIABILITIES AND SHAREHOLDERS' EQUITY Unpaid losses and loss adjustment expenses $ 11,926,809 $ 11,005,337 Unearned premiums 19,093,312 14,951,228 Revolving credit outstanding 6,165,671 6,676,817 Bank overdraft 810,170 2,147,546 Unearned commissions 1,663,476 2,098,808 Accounts payable and accrued expenses 2,306,734 2,030,015 Premium deposits 1,468,029 1,133,977 Drafts payable to insurance companies 1,237,555 600,752 ------------ ------------ TOTAL LIABILITIES 44,671,756 40,644,480 ------------ ------------ Commitments and contingencies -- -- Shareholders' equity: Common stock of $.01 par value. Authorized 25,000,000 shares, issued 3,410,667 shares, and outstanding 3,027,901 and 3,030,001 shares, respectively 34,107 34,107 Additional paid in capital 12,838,198 12,833,146 Accumulated other comprehensive income (762,063) (218,137) Retained earnings 3,331,403 2,400,301 Treasury stock, 382,766 and 380,666 shares, respectively, at cost (849,030) (840,286) ------------ ------------ TOTAL SHAREHOLDERS' EQUITY 14,592,615 14,209,131 ------------ ------------ TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 59,264,371 $ 54,853,611 ============ ============
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 3 21ST CENTURY HOLDING COMPANY CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
THREE MONTHS ENDED MARCH 31, 2002 2001 ---- ---- Revenues: Gross premiums written $ 13,074,985 $ 7,604,315 Gross premiums ceded (5,893,430) (3,108,912) ------------ ------------ Net premiums written 7,181,555 4,495,403 Increase (decrease) in unearned premiums, net of prepaid reinsurance premiums (1,747,061) 188,321 ------------ ------------ Net premiums earned 5,434,494 4,683,724 Commission income 428,346 888,038 Finance revenue 1,061,431 1,402,871 MGA fees 959,000 1,289,532 Net investment income 334,622 236,552 Net realized investment gains (losses) 53,781 (74,033) Other income 1,235,326 1,121,466 ------------ ------------ Total revenue 9,507,000 9,548,150 ------------ ------------ Expenses: Losses and loss adjustment expenses 3,184,631 3,331,245 Operating and underwriting expenses 2,845,525 2,747,672 Salaries and wages 2,002,890 2,479,484 Amortization of deferred acquisition costs (70,282) 79,660 Amortization of goodwill -- 144,000 ------------ ------------ Total expenses 7,962,764 8,782,061 ------------ ------------ Income before provision for income tax expense 1,544,236 766,089 Provision for income tax expense 552,866 267,343 ------------ ------------ Net income $ 991,370 $ 498,746 ============ ============ Net income per share and net income per share- assuming dilution $ 0.33 $ 0.15 ============ ============ Weighted average number of common shares outstanding and Weighted average number of common shares outstanding (assuming dilution) 3,028,926 3,303,324
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 4 21ST CENTURY HOLDING COMPANY CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
THREE MONTHS ENDED MARCH 31, 2002 2001 ---- ---- Cash flow from operating activities: Net income $ 991,370 $ 498,746 Adjustments to reconcile net income to net cash flow used in operating activities: Amortization (accretion) of investment premiums (discounts) (15,029) (1,809) Depreciation and amortization 95,895 83,775 Amortization of goodwill -- 144,000 Deferred income tax expense (149,700) (218,136) Net realized investment (gains) losses (53,781) 74,033 Amortization of deferred acquisition costs, net (70,282) 79,660 Provision for credit losses 474,361 277,233 Provision for uncollectible premiums 96,679 125,134 Gain on sale of agency -- (16,075) Stock option expense 5,052 -- Changes in operating assets and liabilities: Premiums receivable (2,011,600) 127,220 Prepaid reinsurance premiums (2,395,023) (2,018,796) Due from reinsurers 1,322,946 (345,082) Deferred acquisition costs, net 780,152 499,850 Other assets 1,139,065 523,376 Unpaid loss and loss adjustment expenses 921,472 552,702 Unearned premiums 4,142,084 (99,487) Unearned commissions (435,332) 203,215 Accounts payable and accrued expenses 277,319 (192,580) Due to third party insurers -- 2,250,018 Premium deposits 334,052 513,881 Drafts payable to insurance companies 636,803 9,418 ------------ ------------ Net cash flow provided by operating activities 6,086,503 3,070,296 ------------ ------------ Cash flow from investing activities: Proceeds from sale of investment securities available for sale 1,767,061 11,051,126 Purchases of investment securities available for sale (4,920,801) (7,919,353) Finance contracts receivables, consumer loans and pay advances receivable (1,800,801) (430,723) Collection of mortgage loans 451,590 3,559 Purchases of property and equipment (91,748) (70,703) Proceeds from sale of property and equipment 199,687 -- Mortgage loans -- (106,809) ------------ ------------ Net cash flow provided by (used in) investing activities (4,395,012) 2,527,097 ------------ ------------ Cash flows from financing activities Decrease in bank overdraft (1,337,377) (473,348) Dividends paid (60,868) (65,794) Purchases of treasury stock (8,744) (489,278) Increase (decrease) in revolving credit outstanding (511,145) 251,950 ------------ ------------ Net cash flow used in financing activities (1,918,134) (776,470) ------------ ------------ Net increase (decrease) in cash & cash equivalents (226,643) 4,820,923 Cash & cash equivalents at beginning of year 775,699 1,192,487 ------------ ------------ Cash & cash equivalents at end of period $ 549,056 $ 6,013,410 ============ ============ Supplemental disclosure of cash flow information: Cash paid during the period for: Interest $ 101,172 $ 168,091 ============ ============ Income taxes $ 258 $ -- ============ ============ Non-cash investing and financing activities Dividends accrued $ 60,268 $ 65,727 ============ ============ Stock received for sale of agency $ -- $ 41,484 ============ ============ Stock issued for employees' bonus $ -- $ 155,100 ============ ============
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-K for the year ended December 31, 2001. The December 31, 2001 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 wholly-owned subsidiaries, Federated National Insurance Company ("Federated National") and American Vehicle Insurance Company ("American Vehicle"). 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, American Vehicle and third-party insurance companies 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"). In the first quarter of 2002, the Company decided to discontinue offering pay advances through its wholly-owned subsidiary, FedFirst Corp. ("FedFirst"), due to declining profits in this line of business. The Company markets and distributes Federated National's, American Vehicle's and third-party insurers' products and its other services primarily in South Florida, through a network of 23 agencies, owned by the Company's wholly-owned subsidiary Federated Agency Group, Inc. ("Federated Agency Group"), 21 franchised agencies and approximately 125 active independent agents. The Company, through its wholly-owned subsidiary, FedUSA, Inc. ("FedUSA"), franchises agencies under the FedUSA name. In December 2000, the Company sold its first franchised agency, which began operations on January 1, 2001. The Company intends to focus its future expansion efforts on franchised agencies. The Company offers income tax preparation software and service through its 80%-owned subsidiary Express Tax Service Company ("Express Tax"). (2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND PRACTICES (A) CRITICAL ACCOUNTING POLICIES The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions about future events that affect the amounts reported in the financial statements and accompanying notes. Future events and their effects cannot be determined with absolute certainty. Therefore, the determination of estimates requires the exercise of judgment. Actual results inevitably will differ from those estimates, and such differences may be material to the financial statements. The most significant accounting estimates inherent in the preparation of the Company's financial statements include estimates associated with management's evaluation of the determination of liability for unpaid losses and loss adjustment expense and the recoverability of goodwill. In addition, significant estimates form the bases for the Company's reserves with respect to finance contracts, consumer loans, pay advances receivable, premiums receivable, deferred income taxes and loss contingencies. Various assumptions and other factors underlie the determination of these significant estimates. The process of determining significant estimates is fact specific and takes into account factors such as historical experience, as well as current and expected economic conditions. Management constantly re-evaluates these significant factors and makes adjustments where facts and circumstances dictate. 6 21ST CENTURY HOLDING COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND PRACTICES (CONTINUED) (B) IMPACT OF NEW ACCOUNTING PRONOUNCEMENTS In June 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets" ("SFAS No. 142"). This statement addresses how goodwill should be accounted for after it has initially been recognized in the financial statements. The provisions of SFAS No. 142 no longer allow the amortization of goodwill but require that impairment be tested at least annually. The Company adopted SFAS No. 142 effective January 1, 2002. The initial application of SFAS No. 142 did not result in the need to recognize any impairment losses for goodwill resulting from the transitional impairment test. The elimination of goodwill amortization increased pretax net income for the three months ended March 31, 2002 by approximately $126,000, or $.03 per share. (C) 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 for the periods presented in this Report, however, excluded the impact of warrants and stock options as such amounts are anti-dilutive. (D) RECLASSIFICATIONS Certain amounts in 2001 financial statements have been reclassified to conform with 2002 presentation. (3) REVOLVING CREDIT OUTSTANDING The Company, through its 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, which was amended and revised in September 2001, allows for a maximum credit commitment of $7.0 million plus an initial additional amount of $700,000 for the transition from September 30, 2001 when the previous agreement expired. This initial additional amount declines by $100,000 each month beginning November 1, 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 1.25% to 2.75% based on the prior month's ratio of contracts receivable related to insurance companies with an A. M. Best rating of B or worse to total contracts receivable. The Revolving Agreement contains various operating and financial covenants, with which the Company was in compliance at March 31, 2002. The Revolving Agreement, as amended, expires September 30, 2004. (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 is vigorously defending such action. The Company is currently awaiting the Court's ruling on its Motion to Dismiss the plaintiff's First Amended Complaint. 7 21ST CENTURY HOLDING COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (4) COMMITMENTS AND CONTINGENCIES (CONTINUED) Prior to its acquisition, American Vehicle was involved in litigation with a former officer and director of American Vehicle. The litigation was adjudicated and American Vehicle, among others, was found liable and paid the final judgment. There remains one outstanding issue, which is the assessment of attorney's fees and costs. A petition has been filed seeking costs of $136,000 and appellate attorney's fees in excess of $2 million. If American Vehicle is found liable for such fees and costs, they are indemnified by American Vehicle's previous owners, in accordance with the purchase agreement. Furthermore, the $500,000 purchase price paid to the former owners remains in escrow pending settlement of the fees and costs. Consequently, no liability for these fees and costs has been recorded. (5) COMPREHENSIVE INCOME For the three months ended March 31, 2002 and 2000, comprehensive income consisted of the following: 2002 2001 ---- ---- Net income $ 991,370 $ 498,746 Change in net unrealized losses on investments held for sale, net of income taxes (543,926) (465,435) --------- --------- Comprehensive income $ 447,444 $ 33,311 ========= ========= (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, and marketing and distribution through Federated Agency Group. The insurance segment sells personal automobile and homeowner insurance and includes substantially all aspects of the insurance, distribution and claims process. The financing segment consists of premium financing through Federated and pay advances through FedFirst. The financing segment provides premium financing to both Federated National's insureds and to third-party insureds, and pay advances, and is marketed through the Company's distribution network of Company-owned agencies and franchised 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 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, franchise operations and income tax return preparation. Information regarding components of operations for the three-month period ending March 31, 2002 and 2001 follows:
2002 2001 ---- ----- TOTAL REVENUE Insurance Segment $ 8,187,365 $ 8,566,104 Financing Segment 1,000,764 1,380,750 All Other 1,213,452 869,105 ------------ ------------ Total Operating Segments 10,401,581 10,815,959 Intercompany Eliminations (894,581) (1,267,809) ------------ ------------ Total Revenues $ 9,507,000 $ 9,548,150 ============ ============ EARNINGS BEFORE INCOME TAXES Insurance Segment $ 401,414 $ (289,545) Financing Segment 159,234 280,884 All Other 983,588 774,750 ------------ ------------ Total Earnings before Income Taxes $ 1,544,236 $ 766,089 ============ ============
8 21ST CENTURY HOLDING COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (6) SEGMENT INFORMATION (CONTINUED) Information regarding total assets as of March 31, 2002 and December 31,2001 follows: 2002 2001 ---- ---- TOTAL ASSETS Insurance Segment $45,317,627 $40,503,331 Finance Segment 10,717,061 10,697,865 All Other 3,227,164 3,630,319 ----------- ----------- Total Operating Segments 59,261,852 54,831,515 Intercompany Eliminations 2,520 22,096 ----------- ----------- Total Assets $59,264,372 $54,853,611 =========== =========== (7) ACQUISITION In August 2001, the Company purchased all of the outstanding stock and all of the outstanding surplus notes of American Vehicle for $500,000 in cash. In addition, the Company agreed to pay two executives of American Vehicle a finders' fee of $400,000 over a period of three years. American Vehicle was organized and incorporated as a multi-line property and casualty insurance company and primarily writes nonstandard private passenger automobile liability and physical damage coverage. The Consolidated Balance Sheets as of March 31, 2002 and December 31, 2001 include the balance sheets of American Vehicle. The Consolidated Statements of Operations and the Consolidated Statement of Cash Flow for the three months ended March 31, 2002 include American Vehicle. Unaudited pro forma results of operations for the three months ended March 31, 2001 giving effect to the acquisition as of January 1, 2001 is as follows: Revenue $9,532,936 Income before extraordinary gain 914,932 Extraordinary gain 1,185,895 Net income 2,100,827 Earnings (loss) per share and earnings (loss) per share assuming dilution Net income (loss) before extraordinary gain $ 0.28 Extraordinary gain 0.36 Net income (loss) 0.64 The above pro forma information is not necessarily indicative of the results of operations that would have occurred had the acquisition taken place as of January 1, 2001, or of results that may occur in the future. 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 wholly-owned subsidiaries, Federated National and American Vehicle. 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, American Vehicle and third-party insurance companies 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. In the first quarter of 2002, the Company decided to discontinue offering pay advances through its wholly-owned subsidiary, FedFirst, due to declining profits in this line of business. The Company markets and distributes Federated National's, American Vehicle's and third-party insurers' products and its other services primarily in South Florida, through a network of 23 agencies owned by the Company's wholly-owned subsidiary Federated Agency Group, Inc. ("Federated Agency Group"), 21 franchised agencies and approximately 125 active independent agents. The Company, through its wholly-owned subsidiary, FedUSA, franchises agencies under the FedUSA name. In December 2000, the Company sold its first franchised agency, which began operations on January 1, 2001. The Company intends to focus its future expansion efforts on franchised agencies. The Company offers income tax preparation software and services through its 80% owned subsidiary Express Tax. 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 the Company's estimated liabilities for unpaid losses and LAE is less than actual losses and LAE, the Company will be required to increase reserves with a corresponding reduction in the Company'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, which market their products through agents, as well as companies, which 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. 10 ANALYSIS OF FINANCIAL CONDITION AS OF MARCH 31, 2002 AS COMPARED TO DECEMBER 31, 2001 INVESTMENTS. Investments increased $2.6 million, or 15.7%, to $19.3 million as of March 31, 2002 as compared to $16.7 million as of December 31, 2001. This increase in investments is the result of an increase in premiums written discussed below. FINANCE CONTRACTS AND PAY ADVANCES RECEIVABLE. Finance contracts and pay advances receivable increased $1.3 million, or 12.3%, to $12.1 million as of March 31, 2002 from $10.8 as of December 31, 2001. This increase is also the result of the increase in premiums written discussed below. PREPAID REINSURANCE PREMIUMS. Prepaid reinsurance premiums increased $2.5 million, or 43.1%, to $8.0 million as of March 31, 2002 from $5.6 million as of December 31, 2001 This increase is also the result of the increase in premiums written, partially offset by a decrease in Federated National's quota-share reinsurance on automobile insurance from 50% of premiums written in 2001 to 40% for premiums written in 2002. American Vehicle reinsures 80% of its premiums written. PREMIUMS RECEIVABLE. Premiums receivable increased $1.9 million, or 122.7%, from $1.6 million as of December 31, 2001 to $3.5 million as of March 31, 2002. This increase is the result of the increase in premiums written plus added emphasis on payment plan automobile insurance policies. REINSURANCE RECOVERABLE. Reinsurance recoverable decreased $1.3 million to $5.7 million as of March 31, 2002 from $7.0 million as of December 31, 2001. This decrease is the result of the decrease of Federated National's reinsurance discussed above coupled with lower losses and loss adjustment expenses as the Company is experiencing an improvement its loss ratio discussed below. DEFERRED ACQUISITION COSTS, NET. Deferred acquisition costs decreased from $11,000 as of December 31, 2001 to a credit of $698,000 as of March 31, 2002. Included in the December 31, 2001 balance were deferred commissions of $1.7 million offset by unearned ceded commissions of $1.7 million. As of March 31, 2002, deferred commissions were $1.6 million offset by unearned ceded commissions of $2.3 million. Deferred commissions declined despite the increase in premiums written because of increases in commissions paid to captive agents which are eliminated in consolidation. The increase in unearned ceded commissions is related to American Vehicle, which is 80% reinsured. UNEARNED PREMIUMS. Unearned premiums increased $4.1 million, or 27.7 %, to $19.1 million as of March 31, 2002 from $15.0 million as of December 31, 2001. This increase is the result of the increase in premiums written. BANK OVERDRAFT. Bank overdraft is the result of the cash management techniques employed by the Company. The overdraft was $810,000 as of March 31, 2002, a $1.3 million decrease from $2.1 million as of December 31, 2001. This decrease is primarily related to the timing of the issuance of refund and claim checks and receipt of reinsurance money. DRAFTS PAYABLE TO INSURANCE COMPANIES. Drafts payable to insurance companies increased $637,000 to $1.2 million as of March 31, 2002 from $601,000 as of December 31, 2001. This increase is related to the timing of the receipt of premium finance contracts as compared to the receipt of the related draft from the bank. RESULTS OF OPERATIONS THREE MONTHS ENDED MARCH 31, 2002 COMPARED TO THREE MONTHS ENDED MARCH 31, 2001 GROSS PREMIUMS WRITTEN. Gross premiums written increased $5.4 million, or 71.9%, to $13.1 million for the three months ended March 31, 2002 as compared to $7.6 million for the comparable period in 2001. $3.9 million of this increase is attributable to American Vehicle which was acquired in August 2001. Federated National's automobile premiums written increased $779,000 and its homeowner premiums written increased $818,000. GROSS PREMIUMS CEDED. Gross premiums ceded increased $1.5 million to $5.6 million for the three months ended March 31, 2001, from $3.1 million for the three months ended March 31,2001. This increase is primarily due to American Vehicle, which cedes 80% of its premium. Federated National decreased its quota-share reinsurance on automobile insurance from 50% of premiums written in 2001 to 40% for premiums written in 2002. 11 RESULTS OF OPERATIONS - THREE MONTHS ENDED MARCH 31, 2001 COMPARED TO THREE MONTHS ENDED MARCH 31, 2000 (CONTINUED) INCREASE (DECREASE) IN UNEARNED PREMIUMS, NET OF PREPAID REINSURANCE PREMIUMS. The increase (decrease) in unearned premiums, net of prepaid reinsurance premiums was a positive $188,000 for the three months ended March 31, 2001 compared to a negative $1.7 million for the three months ended March 31, 2001. In the first quarter of 2002, premiums written were increasing and, consequently, the change in unearned premiums was increasing. In the first quarter of 2001, premiums written were relatively unchanged, consequently the change in unearned premiums was small. COMMISSION INCOME. Commission income decreased $460,000 to $428,000 for the three-month period ended March 31, 2002 from $888,000 for the same period in 2001. Commission income consists of fees earned by Company-owned agencies placing business with third party insurers. This decrease reflects the Company's sale or closure of 15 agencies in 2001. FINANCE REVENUE. Finance revenue decreased $341,000 to $1.1 million for the three-month period ended March 31, 2002 as compared to $1.4 million for the same period in 2001 due to lower receivable balances during the 2002 period as compared to 2001. MGA FEES. MGA fees declined $331,000 to $959,000 for the three-month period ended March 31, 2002 from $1.3 million for the same period in 2001. The decrease is because the Company ceased underwriting for a non-affiliated insurance client in the fourth quarter of 2001. NET REALIZED INVESTMENT GAINS. The Company experienced net realized gains of $54,000 for the three-month period ended March 31, 2001 compared to realized losses of $74,000 for the same period in 2001. Realized gains or losses are primarily a function of the bond and equity markets. There can be no assurance that the Company will record gains in the future. LOSSES AND LAE. The Company's loss ratio, as determined in accordance with GAAP, for the three-month period ended March 31, 2002 was 58.6% compared with 71.1% for the same period in 2001. Losses and LAE incurred decreased $147,000 to $3.2 million for the three-month period ended March 31, 2002 from $3.3 million for the same period in 2001. 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. The Company attributes the decrease in the loss ratio to a number of factors including premium increases in July 2001, management changes to its claims adjusting subsidiary in June 2001, a decrease in premiums written in Miami-Dade County, Florida and a new law in Florida that 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. SALARIES AND WAGES. Salaries and wages decreased $477,000 to $2.0 million for the three-month period ended March 31, 2002 from $2.5 million for the same period in 2001. This increase is related primarily to the reduction in the number of Company-owned agencies from 38 to 23 through sale and closures. AMORTIZATION OF DEFERRED POLICY ACQUISITION COSTS. Amortization of deferred policy acquisition costs decreased from $80,000 for the three-month period ended March 31, 2001 to a credit $70,000 for the same period in 2002. 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 because American Vehicle, which was acquired in August 2001, reinsures 80% of its premiums written. 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, which was amended and revised in September 2001, allows for a maximum credit commitment of $7.0 million. 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 1.25% to 2.75% based on the prior month's ratio of contracts receivable related to insurance companies with an A. M. Best rating of B or worse to total contracts receivable. The Revolving Agreement, as amended, expires September 30, 2004. Outstanding borrowings under the Revolving Agreement as of March 31, 2002 and December 31, 2001 were approximately $6.2 million and $6.7 million, respectively. The Revolving Agreement contains various operating and financial covenants, with which the Company was in compliance at March 31, 2002. 12 LIQUIDITY AND CAPITAL RESOURCES (CONTINUED) For the three months ended March 31, 2002, operations generated operating cash flow of $6.1 million, which was primarily attributable to the increase in premiums written. Operating cash flow is currently expected to be positive in both the short-term and the reasonably foreseeable future. In addition, the Company's investment portfolio is highly liquid as it consists almost entirely of readily marketable securities. Cash flow used in investing activities was $4.4 million for the quarter ended March 31, 2002 as the Company invested the cash flow from operating activities. In the future, the Company expects a continued cash flow deficit from investing activities as the Company invests cash from operations. Cash deficit from financing activities was $2.0 million for the quarter ended March 31, 2002, as the Company reduced its bank overdraft and the amount outstanding under its Revolving Agreement. The Company believes that its current capital resources, together with cash flow from its operations, will be sufficient to meet its currently anticipated working capital requirements. There can be no assurances, however, that such will be the case. To retain its certificate of authority, Florida insurance laws and regulations require that Federated National and American Vehicle maintain capital surplus equal to the greater of 10% of its liabilities or the 2002 statutory minimum capital and surplus requirement of $3.0 million as defined in the Florida Insurance Code. The insurance companies are also required to adhere to prescribed premium-to-capital surplus ratios. The maximum amount of dividends that can be paid by Florida insurance companies without prior approval of the Florida Department of Insurance, is subject to restrictions relating to statutory surplus. The maximum dividend that may be paid in 2002 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. American Vehicle may not pay dividends in 2002. No dividends were paid by either company during 2002 or 2001. Insurance companies are 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 who show signs of weak or deteriorating condition. As of March 31, 2002, based on calculations using the appropriate NAIC formula, the Company'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 and American Vehicle's statutory capital surplus levels as of March 31, 2002 were approximately $6.1 million and $3.1 million, respectively, and their statutory net income for the quarter ended March 31, 2002 was $399,000 and $79,000, respectively. 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. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. Information related to quantitative and qualitative disclosures about market risk was included under Item 7a, "Quantitative and Qualitative Disclosures about Market Risk" in the Company's Annual Report on Form 10-K as of December 31, 2001. No material changes have occurred in market risk since this information was disclosed. 13 PART II. OTHER INFORMATION ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. ITEM 5 EXHIBITS AND REPORTS ON FORM 8-K None 14 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: May 14, 2002 By: /s/ Samuel A. Milne ----------------------- Title: Chief Financial Officer 15