SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] Quarterly Report Pursuant To Section 13 Or 15(d) Of The
Securities Exchange Act Of 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1998
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 1-13154
AMERICAN MEDICAL SECURITY GROUP, INC.
(Exact name of Registrant as specified in its charter)
WISCONSIN 39-1431799
(State of Incorporation) (I.R.S. Employer Identification No.)
3100 AMS BOULEVARD, GREEN BAY, WISCONSIN 54313
(Address of principal executive offices) (Zip Code)
(920) 661-1500
(Registrant's telephone number, including area code)
United Wisconsin Services, Inc.
401 West Michigan Street, Milwaukee, Wisconsin 53203-2896
(Former name and former address)
Indicate by check mark whether registrant (1) has filed all documents and
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes __X__ No _____
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Common stock, no par value, outstanding as of October 31, 1998:
16,573,408 shares
AMERICAN MEDICAL SECURITY GROUP, INC.
INDEX
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed consolidated balance sheets--September 30, 1998
and December 31, 1997.......................................3
Condensed consolidated statements of income--Three months
ended September 30, 1998 and 1997; Nine months ended
September 30, 1998 and 1997.................................5
Condensed consolidated statements of cash flows--Nine months
ended September 30, 1998 and 1997...........................6
Notes to condensed consolidated financial statements--
September 30, 1998..........................................7
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations..................................12
Item 3. Quantitative and Qualitative Disclosures About Market Risk...17
PART II. OTHER INFORMATION
Item 1. Legal Proceedings............................................18
Item 2. Changes in Securities and Use of Proceeds....................18
Item 3. Defaults upon Senior Securities..............................18
Item 4. Submission of Matters to a Vote Security Holders.............18
Item 5. Other Information............................................18
Item 6. Exhibits and Reports on Form 8-K.............................18
Signatures.............................................................20
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
AMERICAN MEDICAL SECURITY GROUP, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
September 30, 1998 December 31, 1997
------------------------------------------
(000'S OMITTED)
ASSETS
Investments:
Securities available for sale, at fair value:
Fixed maturities $282,576 $266,976
Equity securities--common 15,014 -
Equity securities--preferred 2,469 787
Fixed maturity securities held to maturity, at amortized cost 3,532 3,804
-----------------------------------------
Total Investments 303,591 271,567
Cash and Cash Equivalents 8,532 45,291
Other Assets:
Property and equipment, net 35,913 37,169
Goodwill and other intangibles, net 131,069 137,796
Other assets 23,183 32,697
-----------------------------------------
Total Other Assets 190,165 207,662
Net Assets of Discontinued Operations - 123,616
-----------------------------------------
Total Assets $502,288 $648,136
=========================================
See notes to condensed consolidated financial statements
3
AMERICAN MEDICAL SECURITY GROUP, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
September 30, 1998 December 31, 1997
------------------------------------------
(000'S OMITTED)
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Medical and other benefits payable $108,630 $126,882
Advance premiums 18,004 19,986
Payables and accrued expenses 21,458 28,930
Notes payable 55,834 124,578
Other liabilities 22,610 21,383
------------------------------------------
Total Liabilities 226,536 321,759
Redeemable preferred stock - Series A adjustable rate nonconvertible,
$1,000 stated value, 25,000 shares authorized - -
Shareholders' Equity:
Preferred stock (no par value, 475,000 shares authorized) - -
Common stock (no par value, $1 stated value, 50,000,000 shares
authorized, 16,573,202 and 16,509,578 issued and outstanding
at September 30, 1998 and December 31, 1997, respectively) 16,573 16,510
Paid-in capital 188,650 186,768
Retained earnings 66,181 117,331
Unrealized gains on available for sale securities 4,348 5,768
------------------------------------------
Total Shareholders' Equity 275,752 326,377
------------------------------------------
Total Liabilities and Shareholders' Equity $502,288 $648,136
==========================================
See notes to condensed consolidated financial statements.
4
AMERICAN MEDICAL SECURITY GROUP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------------ ------------------------------------
1998 1997 1998 1997
------------------------------------ ------------------------------------
(000 OMITTED, EXCEPT PER SHARE DATA)
Revenues:
Insurance premiums $224,160 $222,414 $686,075 $716,329
Net investment income 6,167 6,044 17,971 16,582
Other revenue 7,082 5,710 16,557 20,088
------------------------------------ ------------------------------------
Total Revenues 237,409 234,168 720,603 752,999
Expenses:
Medical and other benefits 168,513 168,931 522,123 546,993
Selling, general and administrative 61,832 57,495 178,567 187,806
Interest expense 2,033 2,348 6,739 6,975
Amortization of goodwill and intangibles 2,186 2,003 6,621 6,027
------------------------------------ ------------------------------------
Total Expenses 234,564 230,777 714,050 747,801
------------------------------------ ------------------------------------
Income From Continuing Operations,
Before Income Taxes 2,845 3,391 6,553 5,198
Income Tax Expense 1,208 1,042 2,973 2,209
------------------------------------ ------------------------------------
Income From Continuing Operations (see Note B) 1,637 2,349 3,580 2,989
Income From Discontinued Operations,
Less Applicable Income Taxes 4,289 4,062 10,003 12,355
------------------------------------ ------------------------------------
Net Income $5,926 $6,411 $13,583 $15,344
==================================== ====================================
Earnings Per Common Share - Basic
Income from continuing operations (see Note B) $0.10 $0.14 $0.22 $0.18
Income from discontinued operations 0.26 0.25 0.60 0.75
------------------------------------ ------------------------------------
Net Income Per Common Share $0.36 $0.39 $0.82 $0.93
==================================== ====================================
Earnings Per Common Share - Diluted
Income from continuing operations (see Note B) $0.10 $0.14 $0.21 $0.18
Income from discontinued operations 0.26 0.24 0.60 0.74
------------------------------------ ------------------------------------
Net Income Per Common Share $0.36 $0.38 $0.81 $0.92
==================================== ====================================
See notes to condensed consolidated financial statements
5
AMERICAN MEDICAL SECURITY GROUP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Nine Months Ended September 30,
-----------------------------------------
1998 1997
-----------------------------------------
(000'S OMITTED)
Operating Activities:
Income from continuing operations $3,580 $2,989
Adjustments to reconcile income from continuing operations to
net cash used in operating activities:
Depreciation and amortization 11,619 13,333
Realized investment gains (2,368) (591)
Deferred income tax benefit (1,260) (2,255)
Changes in operating accounts:
Other assets 9,677 9,354
Medical and other benefits payable (19,414) (44,625)
Advance premiums (2,157) (6,314)
Payables and accrued expenses (8,110) (1,201)
Other liabilities 2,452 (12,891)
-----------------------------------------
Net Cash Used in Operating Activities (5,981) (42,201)
Investing Activities:
Acquisition of subsidiaries (net of cash and cash equivalents
acquired of $2,773,000) 2,623 -
Purchases of available for sale securities (252,382) (205,611)
Proceeds from sale of available for sale securities 224,376 222,829
Purchases of held to maturity securities - (1,630)
Proceeds from maturity of held to maturity securities 400 -
Purchases of property and equipment (2,630) (1,524)
Proceeds from sale of property and equipment 235 1,807
-----------------------------------------
Net Cash (Used in) Provided by Investing Activities (27,378) 15,871
Financing Activities:
Cash dividends paid (5,956) (5,915)
Issuance of common stock 1,941 2,211
Repayment of notes payable (46,174) (900)
Proceeds on notes payable borrowings 45,158 -
-----------------------------------------
Net Cash Used in Financing Activities (5,031) (4,604)
Net Cash Provided by Discontinued Operations 1,631 9,809
-----------------------------------------
Cash and Cash Equivalents:
Net decrease (36,759) (21,125)
Balance at beginning of year 45,291 31,999
-----------------------------------------
Balance at End of Period $8,532 $10,874
=========================================
See notes to condensed consolidated financial statements.
6
AMERICAN MEDICAL SECURITY GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
September 30, 1998
NOTE A. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have
been prepared in accordance with generally accepted accounting principles for
interim financial information and with the instructions to Form 10-Q and Article
10 of Regulation S-X. Accordingly, they do not include all of the information
and footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
of only normal recurring adjustments) considered necessary for a fair
presentation have been included. Operating results for the three and nine month
periods ended September 30, 1998 are not necessarily indicative of the results
that may be expected for the year ended December 31, 1998. These condensed
consolidated financial statements should be read in conjunction with the
consolidated financial statements and footnotes thereto included in the United
Wisconsin Services, Inc. (UWS) annual report on Form 10-K for the year ended
December 31, 1997.
NOTE B. DISCONTINUED OPERATIONS
On May 27, 1998, the Board of Directors of UWS approved a plan to spin off
its managed care companies and specialty management business to its
shareholders. In connection with the spin-off, UWS changed its name to American
Medical Security Group, Inc. (AMSG or the Company). On September 25, 1998, the
distribution date, shareholders of AMSG received one share of common stock of a
newly formed company, Newco/UWS, Inc. (Newco), for every share of AMSG owned as
of September 11, 1998, the record date. The net assets of Newco consisted of
assets and liabilities of the managed care and specialty management business
along with $70.0 million in debt. Newco was renamed United Wisconsin Services,
Inc. AMSG has obtained a private ruling from the Internal Revenue Service that
the spin-off is tax free to AMSG, Newco and to AMSG shareholders. The operations
of Newco, along with direct costs associated with the spin-off of $4.9 million,
have been reflected in discontinued operations. All prior periods of the
condensed consolidated financial statements of AMSG have been restated to
reflect Newco operations as discontinued operations. Interest expense on the
$70.0 million in debt assumed by Newco is reflected in continuing operations
through September 11, 1998.
7
The following pro forma information presents the consolidated results of
AMSG's continuing operations assuming the debt was assumed by Newco as of
January 1, 1997:
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------------- ---------------------------
1998 1997 1998 1997
--------------------------- ---------------------------
(000'S OMITTED, EXCEPT PER SHARE DATA)
Total Revenues $237,409 $234,168 $720,603 $752,999
Total Expenses 233,588 229,531 710,642 744,149
--------------------------- ---------------------------
Income From Continuing Operations,
Before Income Taxes 3,821 4,637 9,961 8,850
Income Tax Expense 1,549 1,478 4,165 3,487
--------------------------- ---------------------------
Income From Continuing Operations $2,272 $3,159 $5,796 $5,363
=========================== ===========================
Earnings Per Common Share:
Basic $0.14 $0.19 $0.35 $0.33
Diluted $0.14 $0.19 $0.35 $0.32
NOTE C. NET INCOME PER SHARE
Basic earnings per common share are computed by dividing net income by the
weighted average number of common shares outstanding. Diluted earnings per
common share are computed by dividing net income by the weighted average number
of common shares outstanding, adjusted for the effect of dilutive employee stock
options.
The following table provides a reconciliation of the number of weighted
average basic and diluted shares outstanding:
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------------- --------------------------
1998 1997 1998 1997
--------------------------- --------------------------
Weighted average common shares
outstanding 16,571,502 16,448,225 16,544,517 16,403,129
Potentially dilutive stock options 48,816 229,424 126,173 187,397
--------------------------- --------------------------
Weighted average common and potentially
dilutive shares outstanding 16,620,318 16,677,649 16,670,690 16,590,526
=========================== ==========================
Other options to purchase shares were not included in the computation of
earnings per diluted common share because the options' exercise prices were
greater than the average market price of the outstanding common shares for the
period.
NOTE D. ADOPTION OF NEW GENERALLY ACCEPTED ACCOUNTING PRINCIPLES
Effective January 1, 1998, the Company adopted Statement of Financial
Accounting Standards No. 130, "Reporting Comprehensive Income" (SFAS 130),
issued by the FASB in June 1997. Comprehensive income is defined therein as all
changes in equity during the period except those resulting from shareholder
equity contributions and distributions. Comprehensive income from continuing
operations totaled $4.1 million and $1.8 million for the three months ended
September 30, 1998 and 1997, respectively, and $5.4 million and $2.1 million
8
for the nine months ended September 30, 1998 and 1997. Comprehensive income
from discontinued operations totaled $3.0 million and $5.1 million for the three
months ended September 30, 1998 and 1997, respectively, and $6.8 million and
$13.6 million for the nine months ended September 30, 1998 and 1997.
NOTE E. SEGMENTS OF THE BUSINESS
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 131, "Disclosures About Segments of an
Enterprise and Related Information" (SFAS 131). SFAS 131 establishes standards
for the reporting of operating segment information in both annual financial
reports and interim financial reports issued to shareholders. Operating segments
are components of an entity for which separate financial information is
available and is evaluated regularly by the entity's chief operating management.
SFAS 131 is effective for fiscal years beginning after December 15, 1997 and is
not required to be adopted in interim financial reports during the first year of
adoption.
AMSG has two reportable segments: 1) health insurance products and 2) life
insurance products. AMSG's health insurance products consist of the following
coverages related to small group preferred provider organization (PPO) products:
fully insured medical, self funded medical, dental and short-term disability.
Life products consist primarily of group term-life insurance. The reportable
segments are managed separately because they differ in the nature of the
products offered and in profit margins.
AMSG evaluates segment performance based on profit or loss from operations
before income taxes, not including gains and losses on the Company's investment
portfolio. The accounting policies of the reportable segments are the same as
those used to report AMSG's consolidated financial statements. Intercompany
transactions have been eliminated prior to reporting reportable segment
information.
A reconciliation of segment income before income taxes to consolidated
income from continuing operations before income taxes is as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------- ------------------------------
1998 1997 1998 1997
------------------------------- ------------------------------
(000'S OMITTED)
Health $1,391 $2,437 $1,419 $2,976
Life 1,872 2,586 7,359 8,695
All other (418) (1,632) (2,225) (6,473)
------------------------------- ------------------------------
$2,845 $3,391 $6,553 $5,198
=============================== ==============================
9
Operating results and statistics for each of the Company's segments are as
follows:
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------------- ---------------------------
1998 1997 1998 1997
--------------------------- ---------------------------
(000'S OMITTED, EXCEPT FINANCIAL STATISTICS)
HEALTH SEGMENT
OPERATING RESULTS
Revenues:
Insurance premiums $212,159 $214,489 $650,680 $686,505
Net investment income 2,162 2,385 6,450 8,503
Other revenue 5,663 5,325 12,570 17,633
--------------------------- ---------------------------
Total Revenues 219,984 222,199 669,700 712,641
Expenses:
Medical and other benefits 160,906 165,654 502,938 533,786
General and administrative 34,187 31,710 95,795 102,912
Commission 23,500 22,398 69,548 72,967
--------------------------- ---------------------------
Total Expenses 218,593 219,762 668,281 709,665
--------------------------- ---------------------------
Income Before Income Taxes $1,391 $2,437 $1,419 $2,976
============= ============= ============= =============
FINANCIAL STATISTICS
Loss Ratio 75.8% 77.2% 77.3% 77.8%
Expense Ratio:
General and administrative 13.4% 12.3% 12.8% 12.5%
Commission 11.1% 10.4% 10.7% 10.6%
--------------------------- ---------------------------
Total Expense Ratio 24.5% 22.7% 23.5% 23.1%
--------------------------- ---------------------------
Combined Ratio 100.3% 99.9% 100.8% 100.9%
=========================== ===========================
Premiums per Member per Month:
Fully insured medical $123 $120 $123 $118
Self funded . 48 45 45 43
Dental 17 13 16 13
Short-term disability 17 15 18 13
Benefits Cost per Member per Month:
Fully insured medical $95 $94 $95 $93
Self funded 31 24 29 27
Dental 12 11 13 11
Short-term disability 11 8 11 7
Membership at End of Period:
AMS medical 460,062 478,000
AMS self funded 49,092 112,214
Pan Am medical 55,324 -
Pan Am self funded 41,812 -
HMO 18,166 -
---------------------------
Total medical 624,456 590,214
Dental 385,706 477,322
10
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------------- ---------------------------
1998 1997 1998 1997
--------------------------- ---------------------------
(000'S OMITTED, EXCEPT FINANCIAL STATISTICS)
LIFE SEGMENT
OPERATING RESULTS
Revenues:
Insurance premiums $6,328 $6,758 $18,880 $22,811
Net investment income 54 57 168 230
Other revenue 107 59 185 191
--------------------------- ---------------------------
Total Revenues 6,489 6,874 19,233 23,232
Expenses:
Medical and other benefits 2,597 2,239 5,982 7,561
General and administrative 962 863 2,620 2,883
Commission 1,058 1,186 3,272 4,093
--------------------------- ---------------------------
Total Expenses 4,617 4,288 11,874 14,537
--------------------------- ---------------------------
Income Before Income Taxes $1,872 $2,586 $7,359 $8,695
=========================== ===========================
FINANCIAL STATISTICS
Loss ratio 41.0% 33.1% 31.7% 33.1%
Expense ratio:
General and administrative 13.5% 11.9% 12.9% 11.8%
Commission 16.7% 17.5% 17.3% 17.9%
--------------------------- ---------------------------
Total expense ratio 30.2% 29.4% 30.2% 29.7%
--------------------------- ---------------------------
Combined ratio 71.2% 62.5% 61.9% 62.8%
=========================== ===========================
Membership at end of period 261,625 266,514
NOTE F. RECLASSIFICATIONS
Certain reclassifications have been made to the consolidated financial
statements for 1997 to conform with the 1998 presentation.
11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
AMERICAN MEDICAL SECURITY GROUP, INC.
OVERVIEW
American Medical Security Group, Inc. formerly known as United Wisconsin
Services, Inc. (AMSG or the Company), is a provider of medical and specialty
health and life insurance products and administrative services for small groups.
The Company offers a wide variety of health care insurance products including
medical, dental, prescription drug, disability and life insurance products. The
Company's products are actively marketed in 33 states and the District of
Columbia.
On May 27, 1998, the Board of Directors of UWS approved a formal plan to
spin off its managed care companies and specialty managed business to its
shareholders. In connection with the spin-off, UWS changed its name to American
Medical Security Group, Inc. On September 25, 1998, the distribution date,
shareholders of AMSG received one share of common stock of a newly formed
company, Newco/UWS, Inc. (Newco), for every share of ASMG owned as of September
11, 1998, the record date. AMSG has received a private letter ruling from the
Internal Revenue Service that the distribution is tax-free to AMSG, Newco and
AMSG shareholders.
As a result of the spin-off, the revenues and expenses, assets and
liabilities, and cash flows of the managed care and specialty segments have been
classified as discontinued operations in the interim consolidated financial
statements. Accordingly, the discussions of continuing operations that follow
reflect the operations of the AMSG small group managed care and life products.
SUMMARY OF CONTINUING OPERATING RESULTS
INSURANCE PREMIUMS
Insurance premiums for the three months ended September 30, 1998 increased
0.8% to $224.2 million from $222.4 million for the same period in 1997. The
premium increase reflects an increase in the Company's health maintenance
organization (HMO) premiums offset by slight declines in the health and life
insurance premiums. Average fully insured medical premium per member per month
during the three month period ending September 30, 1998 increased 2.5% to $123
compared to $120 during the same period in 1997.
Insurance premiums for the nine months ending September 30, 1998 decreased
4.2% to $686.1 million from $716.3 million for the same period in 1997. The
decline in premium is the result of a decline in average membership of 10.1%
during the nine month period in 1998 compared to 1997. Membership has declined
at a faster rate than the decline in premium as a result of a significant
reduction in self funded members, which has a lower premium per member than
other business. Average fully insured medical premium per month during the nine
month period ending September 30, 1998 increased 4.2% to $123 from $118 during
the same period in 1997.
Medical membership at September 30, 1998 increased 5.8% from June 1998. The
increase is the result of a revitalized sales effort along with a favorable
environment for health care benefit companies offering PPOs (preferred provider
organizations). Medical membership at September 30, 1998 also reflects two
acquired blocks of business (one in October 1997 and one in July 1998) from Pan
American Life Insurance Company (Pan Am)
12
and HMO membership which is the result of acquiring controlling interest in the
Florida HMO effective January 1, 1998. The following table reflects the growth
in medical membership during 1998:
September 30, June 30, September 30,
1998 1998 1997
-------------------------- ------------------------- -------------------------
AMS medical 460,062 455,644 478,000
AMS self funded 49,092 58,936 112,214
Pan Am medical 55,324 46,536 -
Pan Am self funded 41,812 - -
HMO 18,166 16,404 -
-------------------------- ------------------------- -------------------------
624,456 577,520 590,214
========================== ========================= =========================
NET INVESTMENT INCOME
Net investment income includes investment income and realized gains
(losses) on investments. Net investment income for the three months ended
September 30, 1998 increased 2.0% to $6.2 million from $6.0 million for the
three months ended September 30, 1997. Net investment income for the nine months
ended September 30, 1998 increased 8.4% to $18.0 million from $16.6 million for
the same period one year ago. Average annual investment yields, excluding
realized gains and losses, were 6.9% for the three months ended September 30,
1998 and 1997 respectively. Average annual investment yields, excluding realized
gains and losses were 6.8% for the nine months ended September 30, 1998 compared
to 7.2% for the same period in the prior year. Investment gains and losses are
realized in the normal investment process in response to market opportunities.
Average invested assets for the three months ended September 30, 1998 increased
3.3% to $307.3 million from $297.4 million for the three months ended September
30, 1997.
OTHER REVENUE
Other revenue increased to $7.1 million for the three months ended
September 30, 1998 from $5.7 million for the same period on 1997. The increase
is primarily due to fee revenues associated with the Pan Am business acquired in
July 1998 offset by lower self funded fee revenue on smaller self funded
membership. Other revenue for the nine month period decreased to $16.6 million
in 1998 from $20.1 million in 1997. The decrease is primarily due to lower self
funded fee revenue in 1998 offset by additional fees related to Pan Am beginning
in the third quarter 1998.
LOSS RATIO
The health loss ratio for the three months ended September 30, 1998 was
75.8% compared with 77.2% for the three months ended September 30, 1997. The
health loss ratio for the nine months ended September 30, 1998 was 77.3%
compared with 77.8% for the nine months ended September 30, 1997. The improved
loss ratio for the quarter and nine month period reflects management's efforts
to remove unprofitable business and add profitable new business. Also, the 1998
health loss ratio reflects an improved dental loss ratio which is the result of
the cancellation of the stand-alone dental business effective June 1, 1998.
The life loss ratio for the three months ended September 30, 1998 was 41.0%
compared to 33.1% for the three months ended September 30, 1997. The life loss
ratio for the nine months ended September 30, 1998 was 31.7% compared to 33.1%
for the nine months ended September 30, 1997. The higher loss ratio for the
three months ended September 30, 1998 reflects a reserve strengthening in the
third quarter offsetting favorable second quarter results. The nine month loss
ratio is comparable to 1997 and is consistent with ongoing expectations.
13
SELLING, GENERAL AND ADMINISTRATIVE EXPENSE RATIO
The selling, general and administrative (SGA) expense ratio for health
products for the three months ended September 30, 1998 was 24.5% compared with
22.7% for the three months ended September 30, 1997. For the nine months ended
the SGA ratio for health products was 23.5% and 23.1% for 1998 and 1997,
respectively. The increased health expense ratio for the third quarter and the
nine month period in 1998 reflects higher commission costs related to growth in
new business and an investment in the Company's distribution network. Also
contributing to the increase were expenses related to the Year 2000 initiative,
and a one-time investment in re-engineering administrative work flow processes.
The SGA expense ratio for life products for the third quarter of 1998 was
30.2% compared with 29.4% for the same period in the prior year. The SGA expense
ratio for life products for the nine months ended September 30, 1998 was 30.2%
compared to the nine months ended September 30, 1997 of 29.7%.
The Company's distribution system consists of a network of sales managers
located in offices throughout the United States. The Company's sales managers
support approximately 38,000 independent agents. The Company has made continued
investments in its distribution channel during 1997 and 1998 to reorganize sales
managers, sales offices and products. Management is currently studying its agent
distribution system and expects to complete its analysis during the fourth
quarter of 1998. Depending on the results of this study, the Company's
distribution system intangible asset with a carrying value of $13.9 million at
September 30, 1998, may be considered impaired.
OTHER EXPENSES
Interest expense decreased to $2.0 million for the three months ended
September 30, 1998 from $2.3 million for the same period in the prior year. For
the nine months ended September 30, 1998, interest expense decreased to $6.7
million from $7.0 million for the nine months ended September 30, 1997. The
decrease in interest expense for the quarter and nine month periods reflects the
assumption of $70.0 million in debt by Newco on September 11, 1998 as described
in Note B to the condensed consolidated financial statements.
Amortization of goodwill and other intangibles totaled $2.2 million for the
third quarter of 1998, compared with $2.0 million of amortization expense for
the third quarter of 1997. On a year to date basis, amortization of goodwill and
intangibles increased to $6.6 million from $6.0 million for the nine months
ended September 30, 1997. The increase in amortization expense in 1998 is
primarily due to recorded intangibles related to the Pan American small group
business acquired in October 1997.
The effective tax rate was 42.5% for the three months ended September 30,
1998 compared with 30.7% for the three months ended September 30, 1997. The
effective tax rate for the nine months ended September 30, 1998 was 45.4%
compared with 42.5% for the nine months ended September 30, 1997. The effective
tax rate is impacted significantly by the amortization of non-deductible
goodwill in relation to pretax income. In addition, in 1997 the Company fully
utilized certain state net operating loss carryforwards and, as a result, has
incurred higher state income tax expense in 1998.
INCOME FROM CONTINUING OPERATIONS
Income from continuing operations for the three months ended September 30,
1998 decreased 30.3% to $1.6 million or $.10 per share from $2.3 million or $.14
per share for the three months ended September 30, 1997. The decline in income
from continuing operations for the quarter is the result of an increased life
loss ratio and a higher SGA expense ratio offset by an improved health loss
ratio. Income from continuing operations for the nine months ended September 30,
1998 increased 19.8% to $3.6 million or $.22 per share from $3.0 million or $.18
per share for the nine months ended September 30, 1997. The increase in income
from continuing operations for the nine month period is due to an improved loss
ratio partially offset by higher expenses. Income from continuing operations,
excluding debt service costs assumed by Newco on the $70.0 million debt, was
$2.3
14
million or $.14 per share and $5.8 million or $.35 per share for the three
and nine months ended September 30, 1998, respectively.
LIQUIDITY AND CAPITAL RESOURCES
The Company's sources of cash flow consist primarily of insurance premiums,
administrative fee revenue and investment income. The primary uses of cash
include medical and other benefits and operating expense payments. Positive cash
flows are invested pending future payments of medical and other benefits and
other operating expenses. The Company's investment policies are designed to
maximize yield, preserve principal and provide liquidity to meet anticipated
payment obligations.
Cash flow from operations for the three months ended September 30, 1998 was
$4.4 million. The Company generated negative cash flows from operations of $6.0
million for the nine months ended September 30, 1998. Negative cash flows from
operations is principally the result of the decline in medical and other
benefits payable of $19.4 million for 1998. The decline in medical and other
benefits payable results primarily from a reduction in inventory claims pending
adjudication and the decline in overall membership. The Company believes cash
flow from operations will continue to improve due to a leveling of the claims
inventory, growth in membership and lower debt service costs as a result of the
assumption of $70.0 million in debt by Newco in September 1998.
The Company's investment portfolio from continuing operations consists
primarily of investment grade bonds and has limited exposure to equity
securities. At September 30, 1998, $286.1 million or 94.2% of the Company's
total investment portfolio was invested in bonds. At December 31, 1997, $270.8
million or 99.7% of the Company's total investment portfolio was invested in
bonds. The bond portfolio had an average quality rating of Aa3 at both September
30, 1998 and December 31, 1997 as measured by Moody's Investor Service, and the
majority of the bond portfolio was classified as available for sale. The market
value of the total investment portfolio from continuing operations, which
includes stocks and bonds, exceeded amortized cost by $2.8 million and $3.9
million at September 30, 1998 and December 31, 1997, respectively. The Company
has no investment in mortgage loans, non-publicly traded securities (except for
principal only strips of U.S. Government securities), real estate held for
investment or financial derivatives.
From time to time, the Company makes capital contributions to its
subsidiaries to assist them in maintaining appropriate levels of capital and
surplus for regulatory and rating purposes. Insurance subsidiaries are required
to maintain certain levels of statutory capital and surplus. As of the balance
sheet date presented, statutory capital and surplus for each of these insurance
subsidiaries exceeded required levels.
On July 31, 1998, in anticipation of the spin-off transactions, the Company
refinanced its subordinated notes outstanding in the amount of $44.9 million.
The subordinated notes, including accrued interest, were replaced with
borrowings of $45.2 million on a bank line of credit with a maximum indebtedness
of $70.0 million. The line of credit contains certain covenants which, among
other matters, require the Company to maintain a minimum tangible net worth and
restrict the Company's ability to incur additional debt, pay future cash
dividends and transfer assets.
In addition to internally generated funds and periodic borrowings on its
bank line of credit, the Company believes that additional financing to
facilitate long-term growth could be obtained through equity offerings, debt
offerings, or bank borrowings, as market conditions may permit or dictate.
The Company does not expect to pay any cash dividends in the foreseeable
future and intends to employ its earnings in the continued development of its
business. The future dividend policy will depend on the Company's earnings,
capital requirements, financial condition and other factors considered relevant
by the Board of Directors.
15
YEAR 2000
The Year 2000 issue is the result of computer programs being written using
two digits rather than four to define the applicable year. Computer equipment
and software devices with embedded technology that are time-sensitive may
recognize a date using "00" as the Year 1900 rather than the Year 2000. This
could result in a system failure or miscalculations causing disruptions of
operations, including, among other things, a temporary inability to process
transactions or engage in similar normal business activities.
The Company has divided the Year 2000 issues facing the organization into
three major sections: 1) software applications developed in-house (In-house
Applications); 2) software applications acquired from a third party that have
been customized by the Company (Customized Applications); and 3) software
applications acquired from a third party that have not been customized by the
Company and those products and services provided to the Company by third parties
(Third Party Products).
In-house Applications represent the primary operating software of the
Company and includes premium, claims and commission processing applications.
In-house Applications are expected to be Year 2000 compliant by November 1998.
The deletion of temporary bridges and workfiles used to facilitate communication
between compliant and non-compliant computer codes during the course of the
implementation will be completed in March of 1999.
All Customized Applications software include electronic data interchange,
publishing systems, fax capabilities, accounting packages and other special
application software as well as ancillary software packages that serve as links
among the various software packages. Each of these software packages are
currently being upgraded or replaced. It is anticipated that all Customized
Applications will be compliant during the third quarter of 1999.
With respect to Third Party Products, the Company has reviewed its business
processes that may have Year 2000 concerns performed by, with, or through
external business associates. This includes computer hardware, telephone
systems, security system and other numerous products as well as third party
software applications that have not been customized by the Company. The Company
has evaluated various third parties that provide products or services, such as
printing companies, power and utility companies and other vendors. Where
appropriate, agreements with third party vendors have been amended and Year 2000
compliance certifications have been obtained. Significant business partners and
vendors will be required to provide the Company with Year 2000 certified
products or services. Such products and services are being tested by the Company
to validate the compliance certification. This portion of the plan is 65%
complete, is on schedule, and is planned for completion during the second
quarter of 1999.
YEAR 2000 PLAN PERCENT COMPLETE COMPLETION DATE
In-house Applications 72% March 1999
Customized Applications 42% September 1999
Third Party Products 65% June 1999
The total cost associated with required modifications to become Year 2000
compliant is not expected to be material to the Company's financial position.
The estimated total cost of the Year 2000 project is approximately $6.2 million,
of which $3.1 million are costs from outside consultants and $3.1 million are
costs related to modifying and/or replacing existing systems. The total amount
expended on the project through September 30, 1998, was $2.6 million. Costs
associated with the Year 2000 plan will be funded from operating cash flows.
The Company is developing a comprehensive analysis of the operational
problems and costs (including loss of revenues) that could result from the
unlikely failure by the Company and certain third parties to complete
16
efforts
necessary to achieve Year 2000 compliance on a timely basis. The majority of the
contingency plans have been developed and documented for dealing with the worst
case scenarios with the highest chance of occurring. The Company currently plans
to complete such analysis and contingency planning during the second quarter of
1999.
The costs of the project and the date on which the Company plans to
complete the necessary Year 2000 modifications are based on management's best
estimates, which were derived using numerous assumptions of future events
including the continued availability of certain resources, third party
remediation plans and other factors. There can be no guarantee that these
timelines or estimates will be achieved. Actual results could differ materially
from those planned. Specific factors that might cause such material differences
to occur include, but are not limited to, the availability and cost of personnel
trained in this area; the ability to locate and correct all relevant computer
codes; and the ability of the Company's significant suppliers, customers and
others with which it conducts business, including federal, state and local
governmental agencies, to identify and resolve their own Year 2000 issues and
similar uncertainties. Due to these uncertainties, the Company may face certain
claims, the impact of which is not currently estimable. No assurance can be
given that the cost of defending and resolving such claims, if any, will not
significantly affect the Company's results of operations. Although the Company
has some agreements with third party vendors and suppliers that contain
indemnification provisions that protect the Company under certain circumstances
relating to Year 2000 issues, there can be no assurances that such
indemnification provisions will cover all of the Company's liabilities and costs
related to Year 2000 claims by third parties.
FORWARD LOOKING STATEMENTS
Statements contained in this report which are not historical facts are
forward-looking statements subject to inherent risks and uncertainties that may
cause actual results or events to differ materially from those contemplated by
such forward-looking statements. The terms "anticipate", "believe", "estimate",
"expert", "objective", "plan", "project" and similar expressions are intended to
identify forward-looking statements. In addition to the assumptions and other
factors referred to specifically in connection with such statements, factors
that may cause actual results or events to differ materially from those
contemplated by such forward looking statements, include, among others, product
and policy demand and market responses, the effect of economic conditions, the
impact of competitive products, policies and pricing, product and policy
development, development of claims reserves, rising health care costs, changes
in regulatory conditions, rating agency policies and practices, investment
portfolio developments and changes in market conditions, the actual closing of
contemplated transactions and agreements and other factors that may be referred
to in the Company's reports filed with the Securities and Exchange Commission
from time to time.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable to the Company at this time.
17
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None
ITEM 2. CHANGES IN SECURITIES
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
At a special meeting of shareholders of the Company held on July 24, 1998,
shareholders approved (i) the amendment of the Company's Restated and Amended
Articles of Incorporation to change the name of the Company from United
Wisconsin Services, Inc. to American Medical Security Group, Inc., and (ii) the
amendment of the Company's 1995 Director Stock Option Plan to increase the
number of shares that may be granted to individual participants. The voting
results for the proposals were as follows:
Amendment of Restated and Amended Articles of Incorporation:
For 15,721,901 Shares
Against 6,906 Shares
Abstained 10,041 Shares
Broker Non-votes 26,083 Shares
Amendment of 1995 Director Stock Option Plan:
For 13,717,286 Shares
Against 2,036,395 Shares
Abstained 11,250 Shares
Broker Non-votes 0 Shares
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
See the Exhibit Index following the Signature page of this report, which is
incorporated herein by reference.
(b) REPORTS ON FORM 8-K
A Form 8-K Current Report dated September 25, 1998, was filed by the
Company on September 30, 1998, to report (under Item 2) the distribution of
shares of common stock of Newco to shareholders of the Company (the
Distribution) and to include (under Item 7) unaudited pro forma consolidated
financial statements of the Company reflecting the Distribution. The Form 8-K
also included a description of the business of the Company, the Company's
business strategy and the Company's dividend policy, in each instance, following
the
18
Distribution. In addition, the Form 8-K identifie the executive officers
and directors of the Company following the Distribution.
19
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
DATE: November 12, 1998
AMERICAN MEDICAL SECURITY GROUP, INC.
/s/ Gary D. Guengerich
---------------------------------------------------------
Gary D. Guengerich
Executive Vice President and Chief Financial Officer
(Principal Financial Officer and Chief Accounting Officer
and duly authorized to sign on behalf of the Registrant)
20
AMERICAN MEDICAL SECURITY GROUP, INC.
("AMSG")
(COMMISSION FILE NO. 1-13154)
EXHIBIT INDEX
TO
FORM 10-Q QUARTERLY REPORT
for quarter ended September 30, 1998
INCORPORATED HEREIN FILED
EXHIBIT NO. DESCRIPTION BY REFERENCE TO HEREWITH
2.1 Distribution and Indemnity Agreement Exhibit 2.1 to Newco/UWS, Inc.'s
between United Wisconsin Services, Registration Statement on Form 10,
Inc. and Newco/UWS, Inc., dated as as amended (the "Registration
of September 11, 1998 Statement") (File No. 1-14177)
2.2 Employee Benefits Agreement, dated Exhibit 10.1 to the Registration
as of September 11, 1998, by and Statement
between United Wisconsin Services,
Inc. and Newco/UWS, Inc.
2.3 Tax Allocation Agreement, entered Exhibit 10.2 to the Registration
into as of September 11, 1998, by Statement
and between United Wisconsin
Services, Inc. and Newco/UWS, Inc.
3.1 Restated and Amended Articles of Exhibit 3.1 to AMSG's Current
Incorporation of American Medical Report on Form 8-K dated September
Security Group, Inc. (f/k/a United 25, 1998
Wisconsin Services, Inc.), as (the "9/25/98 8-K")
amended through September 28, 1998
3.2 Bylaws of American Medical Security Exhibit 3.2 to the 9/25/98 8-K
Group, Inc. (f/k/a United Wisconsin
Services, Inc.), as amended and
restated through September 25, 1998
4 Amended and Restated Credit X
Agreement dated as of October 15,
1998 among AMSG, United Wisconsin
Life Insurance Company and the First
National Bank of Chicago and other
Lenders
10.1 Equity Incentive Plan as amended and X
restated September 25, 1998
10.2 1995 Director Stock Option Plan as X
amended and restated September 25,
1998.
10.3 Deferred Compensation Plan for X
Directors as amended and restated
September 25, 1998
10.4 Change of Control Severance Benefit X
Plan
27.1 Financial Data Schedule X
27.2 Restated Financial Data Schedule X
(nine months ended 9/30/97)