SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 1999
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)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (920) 661-3075
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes __X__ No _____
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 July 31, 1999: 16,653,359 shares
AMERICAN MEDICAL SECURITY GROUP, INC.
INDEX
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets--June 30, 1999 and
December 31, 1998.............................................3
Condensed Consolidated Statements of Income--
Three months ended June 30, 1999 and 1998;
Six months ended June 30, 1999 and 1998.......................5
Condensed Consolidated Statements of Cash Flows--
Six months ended June 30, 1999 and 1998.......................6
Notes to Condensed Consolidated Financial Statements--
June 30, 1999.................................................7
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations....................................11
Item 3. Quantitative and Qualitative Disclosures About Market Risk.....16
PART II. OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders............17
Item 5. Other Information..............................................18
Item 6. Exhibits and Reports on Form 8-K...............................18
Signatures........................................................19
Exhibit Index...................................................EX-1
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
AMERICAN MEDICAL SECURITY GROUP, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
June 30, December 31,
1999 1998
-----------------------------------
(000'S OMITTED)
ASSETS
Investments:
Securities available for sale, at fair value:
Fixed maturities $ 303,100 $ 293,096
Equity securities-preferred 2,198 2,457
Fixed maturity securities held to maturity, at amortized cost 3,795 3,361
----------------------------------
Total Investments 309,093 298,914
Cash and Cash Equivalents (1,951) 10,648
Other Assets:
Property and equipment, net 34,470 35,356
Goodwill and other intangibles, net 114,035 116,093
Other assets 43,913 37,711
----------------------------------
Total Other Assets 192,418 189,160
----------------------------------
Total Assets $ 499,560 $ 498,722
==================================
See Notes to Condensed Consolidated Financial Statements
3
AMERICAN MEDICAL SECURITY GROUP, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
June 30, December 31,
1999 1998
-----------------------------------
(000'S OMITTED)
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Medical and other benefits payable $ 119,364 $ 113,133
Advance premiums 19,300 18,157
Payables and accrued expenses 25,749 23,439
Notes payable 53,463 55,064
Other liabilities 24,007 22,478
----------------------------------
Total Liabilities 241,883 232,271
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, 16,653,303 and 16,653,179 issued and outstanding
at June 30, 1999 and December 31, 1998, respectively) 16,653 16,653
Paid-in capital 187,950 188,981
Retained earnings 59,037 59,572
Accumulated other comprehensive income (loss), net of taxes of $3,211,000
and $642,000 at June 30, 1999 and December 31, 1998, respectively (5,963) 1,245
--------------- ---------------
Total Shareholders' Equity 257,677 266,451
--------------- ---------------
Total Liabilities and Shareholders' Equity $ 499,560 $ 498,722
==================================
See Notes to Condensed Consolidated Financial Statements
4
AMERICAN MEDICAL SECURITY GROUP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
--------------------------------- ---------------------------------
1999 1998 1999 1998
--------------------------------- ---------------------------------
(000'S OMITTED, EXCEPT PER SHARE DATA)
Revenues:
Insurance premiums $ 264,198 $ 226,956 $ 527,090 $ 461,915
Net investment income 4,700 5,723 9,675 11,804
Other revenue 5,498 4,675 11,684 9,475
--------------------------------- ---------------------------------
Total Revenues 274,396 237,354 548,449 483,194
Expenses:
Medical and other benefits 210,758 174,325 409,165 353,610
Selling, general and administrative 67,109 57,693 135,790 116,735
Interest expense 872 2,336 1,766 4,707
Amortization of goodwill and intangibles 1,010 2,195 2,058 4,435
--------------------------------- ---------------------------------
Total Expenses 279,749 236,549 548,779 479,487
--------------------------------- ---------------------------------
Income (Loss) From Continuing Operations,
Before Income Taxes (5,353) 805 (330) 3,707
Income Tax Expense (Benefit) (1,823) 413 205 1,764
--------------------------------- ---------------------------------
Income (Loss) From Continuing Operations (3,530) 392 (535) 1,943
Income From Discontinued Operations,
Less Applicable Income Taxes - 874 - 5,714
--------------- --------------- --------------- ---------------
Net Income (Loss) $ (3,530) $ 1,266 $ (535) $ 7,657
================================= =================================
Earnings (Loss) Per Common Share - Basic
Income (loss) from continuing operations $ (0.21) $ 0.03 $ (0.03) $ 0.12
Income from discontinued operations - 0.05 - 0.34
--------------- --------------- --------------- ---------------
Net Income (Loss) Per Common Share $ (0.21) $ 0.08 $ (0.03) $ 0.46
================================= =================================
Earnings (Loss) Per Common Share - Diluted
Income (loss) from continuing operations $ (0.21) $ 0.03 $ (0.03) $ 0.12
Income from discontinued operations - 0.05 - 0.34
--------------- --------------- --------------- ---------------
Net Income (Loss) Per Common Share $ (0.21) $ 0.08 $ (0.03) $ 0.46
================================= =================================
See Notes to Condensed Consolidated Financial Statements
5
AMERICAN MEDICAL SECURITY GROUP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Six Months Ended
June 30,
----------------------------------
1999 1998
----------------------------------
(000'S OMITTED)
OPERATING ACTIVITIES:
Income (loss) from continuing operations $ (535) $ 1,943
Adjustments to reconcile income (loss) from continuing
operations to net cash provided by (used in) operating activities:
Depreciation and amortization 5,299 7,740
Net realized investment (gains) losses 282 (1,465)
Deferred income tax (benefit) expense (320) 185
Changes in operating accounts:
Other assets (6,202) 589
Medical and other benefits payable 6,231 (20,521)
Advance premiums 1,143 354
Payables and accrued expenses 2,310 (9,167)
Other liabilities 4,697 9,884
----------------------------------
Net Cash Provided by (Used in) Operating Activities 12,905 (10,458)
INVESTING ACTIVITIES:
Acquisition of subsidiaries (net of cash and cash equivalents
acquired of $2,773,000) - 2,623
Purchases of available for sale securities (183,689) (176,093)
Proceeds from sale of available for sale securities 143,046 140,948
Proceeds from maturity of available for sale securities 18,496 8,700
Purchases of held to maturity securities (200) -
Purchases of property and equipment (1,589) (2,070)
Proceeds from sale of property and equipment 31 54
----------------------------------
Net Cash Used in Investing Activities (23,905) (25,838)
FINANCING ACTIVITIES:
Cash dividends paid - (3,967)
Issuance of common stock 2 1,718
Borrowings under line of credit agreement 5,000 -
Repayment on line of credit agreement (5,000) -
Repayment of notes payable (1,601) (837)
----------------------------------
Net Cash Used in Financing Activities (1,599) (3,086)
Net Cash Provided by Discontinued Operations - 1,169
----------------------------------
Cash and Cash Equivalents:
Net decrease (12,599) (38,213)
Balance at beginning of year 10,648 45,291
----------------------------------
Balance at End of Period $ (1,951) $ 7,078
==================================
See Notes to Condensed Consolidated Financial Statements
6
AMERICAN MEDICAL SECURITY GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
June 30, 1999
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 six month
periods ended June 30, 1999 are not necessarily indicative of the results that
may be expected for the year ended December 31, 1999. These condensed
consolidated financial statements should be read in conjunction with the
consolidated financial statements and footnotes thereto included in the American
Medical Security Group, Inc. ("AMSG" or the "Company") annual report on Form
10-K for the year ended December 31, 1998.
NOTE B. DISCONTINUED OPERATIONS
On May 27, 1998, the Board of Directors of the Company, then known as
United Wisconsin Services, Inc. ("UWS"), approved a plan to spin off its managed
care companies and specialty management business to its shareholders (the
"Spin-off"). 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/UWS"), for every share of AMSG owned as of
September 11, 1998, the record date. The net assets of Newco/UWS consisted of
assets and liabilities of the managed care and specialty business along with
$70.0 million in debt that was assumed by Newco/UWS in conjunction with the
Spin-off. Newco/UWS was renamed United Wisconsin Services, Inc. AMSG has
obtained a private ruling from the Internal Revenue Service to the effect that
the Spin-off qualifies as tax free to AMSG, Newco/UWS and to AMSG shareholders.
The operations of Newco/UWS are reflected in discontinued operations through
September 25, 1998. All prior periods of the Company's financial statements have
been restated to reflect Newco/UWS operations as discontinued operations.
Interest expense on the $70.0 million in debt assumed by Newco/UWS is reflected
in continuing operations through September 11, 1998.
7
NOTE C. EARNINGS 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 Six Months Ended
June 30, June 30,
----------------------------- -----------------------------
1999 1998 1999 1998
----------------------------- -----------------------------
Weighted average common shares
outstanding - Basic 16,653,282 16,546,176 16,653,254 16,531,108
Effect of dilutive stock options - 175,925 - 173,671
----------------------------- -----------------------------
Weighted average common shares
outstanding - Diluted 16,653,282 16,722,101 16,653,254 16,704,779
============================= =============================
The effect of dilutive securities is excluded from the diluted earnings per
common share computation for the three and six months ended June 30, 1999
because employee stock options are antidilutive during such periods. Certain
options to purchase shares were not included in the computation of diluted
earnings per common share because the options' exercise prices were greater than
the average market price of the outstanding common shares for the three and six
month periods ended June 30, 1998.
NOTE D. COMPREHENSIVE INCOME
Comprehensive income (loss) for the Company is defined as net income (loss)
plus or minus unrealized gains or losses, net of income tax effects, on certain
investments in debt and equity securities. Comprehensive income (loss) totaled
$(7.2) million and $(1.5) million for the three months ended June 30, 1999 and
1998, respectively, and $(7.7) million and $5.1 million for the six months ended
June 30, 1999 and 1998, respectively.
NOTE E. SEGMENT INFORMATION
The Company has two reportable segments: 1) health insurance products and
2) life insurance products. The Company's health insurance products consist of
the following coverages related to small group preferred provider organization
products: fully insured medical, self funded medical, dental and short-term
disability. Life products consist primarily of group term-life insurance.
Operations not directly related to the business segments (i.e., corporate
investment income, interest expense on corporate debt, amortization of goodwill
and intangibles, unallocated overhead expenses and health maintenance
organization ("HMO") operations) are included in "All Other". The segments are
reported separately because they differ in the nature of the products offered
and in profit margins.
The Company 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 the Company's consolidated financial statements.
Intercompany transactions have been eliminated prior to reporting reportable
segment information.
8
A reconciliation of segment income (loss) before income taxes to
consolidated income (loss) from continuing operations before income taxes is as
follows:
Three Months Ended Six Months Ended
June 30, June 30,
------------------------------- ------------------------------
1999 1998 1999 1998
--------------- --------------- -------------- ---------------
(000'S OMITTED)
Health $ (7,426) $ 421 $ (3,945) $ 28
Life 2,700 3,061 4,576 5,487
All other (627) (2,677) (961) (1,808)
--------------- --------------- -------------- ---------------
$ (5,353) $ 805 $ (330) $ 3,707
=============== =============== ============== ===============
Operating results and statistics for each of the Company's segments are as
follows:
Three Months Ended Six Months Ended
June 30, June 30,
--------------------------- ---------------------------
1999 1998 1999 1998
------------- ------------- ------------- -------------
(000'S OMITTED, EXCEPT FINANCIAL STATISTICS)
HEALTH SEGMENT
OPERATING RESULTS
Revenues:
Insurance premiums $ 246,752 $ 215,649 $ 493,404 $ 438,521
Net investment income 2,297 2,151 4,565 4,288
Other revenue 4,696 3,400 9,908 6,907
------------- ------------- ------------- -------------
Total Revenues 253,745 221,200 507,877 449,716
Expenses:
Medical and other benefits 199,474 167,887 386,894 342,032
Selling, general and administrative 61,697 52,892 124,928 107,656
------------- ------------- ------------- -------------
Total Expenses 261,171 220,779 511,822 449,688
------------- ------------- ------------- -------------
Income (Loss) Before Income Taxes $ (7,426) $ 421 $ (3,945) $ 28
============= ============= ============= =============
FINANCIAL STATISTICS
Loss ratio 80.8% 77.9% 78.4% 78.0%
Expense ratio 23.1% 22.9% 23.3% 23.0%
------------- ------------- ------------- -------------
Combined ratio 103.9% 100.8% 101.7% 101.0%
============= ============= ============= =============
Membership at End of Period:
Medical:
Fully insured 615,729 518,584
Self funded 49,964 58,936
------------- -------------
Total medical* 665,693 577,520
Dental 350,806 411,364
*Total medical membership of the Company includes HMO membership of 29,182 and
16,404 at June 30, 1999 and 1998, respectively. HMO operations are not included
in health segment operating results.
9
Three Months Ended Six Months Ended
June 30, June 30,
--------------------------- ---------------------------
1999 1998 1999 1998
------------- ------------- ------------- -------------
(000'S OMITTED, EXCEPT FINANCIAL STATISTICS)
LIFE SEGMENT
OPERATING RESULTS
Revenues:
Insurance premiums $ 6,450 $ 6,082 $ 13,110 $ 12,552
Net investment income 48 59 99 114
Other revenue 66 38 138 78
------------- ------------- ------------- -------------
Total Revenues 6,564 6,179 13,347 12,744
Expenses:
Medical and other benefits 2,078 1,250 4,851 3,385
Selling, general and administrative 1,786 1,868 3,920 3,872
------------- ------------- ------------- -------------
Total Expenses 3,864 3,118 8,771 7,257
------------- ------------- ------------- -------------
Income Before Income Taxes $ 2,700 $ 3,061 $ 4,576 $ 5,487
============= ============= ============= =============
FINANCIAL STATISTICS
Loss ratio 32.2% 20.6% 37.0% 27.0%
Expense ratio 26.7% 30.1% 28.8% 30.2%
------------- ------------- ------------- -------------
Combined ratio 58.9% 50.7% 65.8% 57.2%
============= ============= ============= =============
Membership at end of period 309,173 228,832
NOTE F. RECLASSIFICATIONS
Certain reclassifications have been made to the consolidated financial
statements for 1998 to conform with the 1999 presentation.
10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW
American Medical Security Group, Inc. ("AMSG" or the "Company"), formerly
known as United Wisconsin Services, Inc., together with its subsidiary companies
is a provider of health and life insurance products for individuals and employer
groups. The Company's principal product offering is small group health
insurance. It also sells individual and large group health insurance and group
life, dental, prescription drug, disability and accidental death insurance. The
Company's products are actively marketed in 33 states and the District of
Columbia through independent agents. The Company's products generally provide
discounts to insureds that utilize preferred provider organizations. The average
group size is six lives.
HISTORY
Prior to and for most of the year 1998, the business of the Company, then
known as "United Wisconsin Services, Inc.", consisted of two main components:
the small group business and the managed care and specialty business. On
September 11, 1998, the Company contributed all of its subsidiaries comprising
the managed care and specialty business to a newly created subsidiary named
"Newco/UWS, Inc.", a Wisconsin corporation ("Newco/UWS"). On September 25, 1998,
the Company spun off the managed care and specialty business through a
distribution of 100% of the issued and outstanding shares of common stock of
Newco/UWS to the Company's shareholders of record as of September 11, 1998. The
Company thereupon adopted its current name of "American Medical Security Group,
Inc." and Newco/UWS changed its name to "United Wisconsin Services, Inc." The
net assets of Newco/UWS consisted of assets and liabilities of the managed care
and specialty management business along with $70.0 million in debt that was
assumed by Newco/UWS in conjunction with the distribution. The operations of
Newco/UWS are reflected in discontinued operations through September 25, 1998.
Interest expense on the $70.0 million in debt assumed by Newco/UWS is reflected
in continuing operations through September 11, 1998. After the Spin-off, the
business of the Company consisted solely of the Company's small group insurance
business. The continuing operations of the Company reflect the historical small
group insurance portion of the Company's business.
RESULTS OF CONTINUING OPERATIONS
RESERVE STRENGTHENING CHARGE
During the second quarter of 1999, the Company recorded an after-tax charge
to earnings of $5.8 million or $0.35 per share to strengthen its medical claims
reserves. The reserve strengthening is the result of an adverse medical loss
ratio trend identified by management in the second quarter. The adverse medical
loss ratio trend relates primarily to three principle areas of its health
segment: 1) continued adverse trends in its one and two life business,
particularly in Florida where the corrective action plan initiated late in 1998
has developed more slowly than expected; 2) adverse trends on certain older
blocks of business; and 3) increased utilization claim cost trends particularly
in pharmacy benefits.
In response, management has developed and implemented a series of strategic
action plans directed at improving the profitability of these identified
under-performing segments. Specifically, in Florida, the Company's actions
include a redesigned product line, the conversion of older benefit plans to new
plans with higher deductibles, and widespread repricing.
11
Other plans designed to improve the Company's health loss ratio include
raising its average rate increases on renewals during the last half of this
year, accelerated repricing in certain targeted business segments, introduction
of redesigned products, and the conversion of older group health plans into new
benefit designs. In August 1999, the Company is also introducing a two-tier
copay plan to help reverse the unfavorable pharmacy cost trend. While management
is confident in the success of these actions, the financial impact of these
actions will not be significant during the remainder of 1999. However, it is
anticipated that the financial impact will be significant early in the year
2000. Management anticipates that the Company's financial performance for the
second half of 1999 will be break even to a small profit. In addition,
management anticipates that earnings per share for the year 2000 will be $0.70
or greater. These performance and earnings forecasts are subject to certain
risks, uncertainties and assumptions. Factors that could cause actual results to
differ materially include, but are not limited to, claim cost trends,
utilization persistency, new sales, regulatory approvals of rate increases and
other factors discussed in "Forward Looking Statements" below.
INSURANCE PREMIUMS
Insurance premiums for the three months ended June 30, 1999 increased 16.4%
to $264.2 million from $227.0 million for the same period in 1998. Insurance
premiums for the six months ended June 30, 1999 increased 14.1% to $527.1
million from $461.9 million for the same period in 1998. The premium increase
reflects both internal growth and growth from business acquired from other
insurance carriers. The Company acquired the majority of the fully insured group
health business of Continental Assurance Company ("CNA") effective January 1,
1999. The results for the three and six months ended June 30, 1999 included
$23.7 and $52.3 million, respectively, of premium related to the CNA acquired
business.
Average fully insured medical premium per member per month during the six
month period ended June 30, 1999 increased 2.4% to $126 compared to $123 during
the same period in 1998. Medical membership at June 30, 1999 increased 15.3% to
665,693 from 577,520 at June 30, 1998, primarily due to new sales growth and the
addition of the CNA business.
NET INVESTMENT INCOME
Net investment income includes investment income and realized gains and
losses on investments. Net investment income for the three months ended June 30,
1999 declined 17.9% to $4.7 million from $5.7 million for the three months ended
June 30, 1998. The decline is due to lower average annual investments yields and
a decrease in realized gains of $0.8 million. Net investment income for the six
months ended June 30, 1999 decreased 18.0% to $9.7 million from $11.8 million
for the same period one year ago. Average annual investment yields, excluding
realized gains and losses were 6.4% and 6.5% for the three months and six months
ended June 30, 1999, respectively, compared to 7.1% and 7.4% for the same
respective periods in the prior year. Investment gains and losses are realized
in the normal investment process in response to market opportunities. Average
invested assets at cost for the three months ended June 30, 1999 were $309.8
million compared to $290.0 million for the three months ended June 30, 1998.
OTHER REVENUE
Other revenue increased to $5.5 million for the three months ended June 30,
1999 from $4.7 million for the same period in 1998. The increase is primarily
due to an increase in fee revenue associated with the Pan American Life
Insurance Company business acquired July 1998 and CNA business acquired January
1999. Other revenue for the six month period increased to $11.7 million in 1999
from $9.5 million in 1998. Management expects that other revenue will decline
slightly during the remainder of 1999 as the acquired blocks of business run
off.
12
LOSS RATIO
The health segment loss ratio for the three months ended June 30, 1999 was
80.8% compared with 77.9% for the three months ended June 30, 1998. The
unfavorable health loss ratio for the quarter reflects the reserve strengthening
in the second quarter as discussed above. The health segment loss ratio for the
six months ended June 30, 1999 was 78.4% compared with 78.0% for the six months
ended June 30, 1998. As discussed previously, management is aggressively
pursuing strategic action plans designed to improve the Company's health loss
ratio. Management anticipates the health loss ratio will be approximately 78.5%
to 79.0% for the last half of 1999. However, the Company's actual health loss
ratio for the remainder of 1999 is dependent upon future events including claim
cost trends, utilization persistency, new sales, regulatory approvals of rate
increases and other factors. Consequently, there can be no assurance that the
Company's action plans will have the desired effect on the health loss ratio in
future periods.
The life segment loss ratio for the three months ended June 30, 1999 was
32.2% compared to 20.6% for the three months ended June 30, 1998. The life
segment loss ratio for the six months ended June 30, 1999 was 37.0% compared
with 27.0% for the six months ended June 30, 1998. The results in the life
segment for the second quarter of 1999 are consistent with historical trends and
management's expectations on an on-going basis. The fluctuation from the second
quarter of 1998 is due to unusually low claims utilization during that period.
Management expects the life segment loss ratio to remain relatively stable
during the remainder of 1999.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSE RATIO
The selling, general and administrative ("SGA") expense ratio for health
segment products for the three months ended June 30, 1999 was 23.1% compared
with 22.9% for the three months ended June 30, 1998. For the six months ended
June 30, 1999 and 1998, the SGA expense ratio for health segment products was
23.3% and 23.0%, respectively. The slight increase in the SGA expense ratio is
the result of higher commissions on new policy sales offset by a lower
administrative expense ratio caused by a leveraging of the Company's operations
over increased revenues.
OTHER EXPENSES
Interest expense decreased to $0.9 million for the three months ended June
30, 1999 from $1.1 million for the same period in the prior year. For the six
months ended June 30, 1999, interest expense decreased to $1.8 million from $2.3
million for the six months ended June 30, 1998. The decrease in interest expense
for the quarter and six month period reflects the assumption of $70.0 million in
debt by Newco/UWS on September 11, 1998, as part of the Spin-off transaction, as
described in Note B of the Notes to Condensed Consolidated Financial Statements.
Amortization of goodwill and other intangibles totaled $1.0 million for the
second quarter of 1999, compared with $2.2 million of amortization expense for
the second quarter of 1998. On a year to date basis, amortization of goodwill
and intangibles decreased to $2.1 million from $4.4 million for the six months
ended June 30, 1998. The decline in amortization is principally due to the
write-off of the Company's distribution system intangible asset at December 31,
1998, as described in the Company's annual report on Form 10-K for the year
ended December 31, 1998. Management believes that no other material impairment
of goodwill and other intangible assets exists at June 30, 1999.
The effective tax rate was 34.1% for the three months ended June 30, 1999
compared with 51.3% for the three months ended June 30, 1998. The effective tax
rate for the six months ended June 30, 1999 was (62.1%) compared with 47.6% for
the six months ended June 30, 1998. The effective tax rate is impacted primarily
by level amortization of non-deductible goodwill in relation to varying pre-tax
income.
13
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.
The Company's cash flow from operations was positive at $12.9 million for
the six months ended June 30, 1999. This compares to negative cash flow from
operations of $10.5 million for the six months ended June 30, 1998. The positive
results are due to growth in membership and lower debt costs as a result of the
assumption of $70.0 million in debt by Newco/UWS 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 June 30, 1999, $306.9 or 99.3% of the Company's investment
portfolio was invested in bonds. At December 31, 1998, $296.5 or 99.2% of the
Company's investment portfolio was invested in bonds. The bond portfolio had an
average quality rating of Aa3 at June 30, 1999, and A1 at December 31, 1998, as
measured by Moody's Investor Service. The majority of the bond portfolio was
classified as available for sale. 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.
The Company's insurance subsidiaries operate in states that require certain
levels of regulatory capital and surplus and may restrict dividends to their
parent companies. The National Association of Insurance Commissioners has
adopted risk-based capital ("RBC") standards for health and life insurers
designed to evaluate the adequacy of statutory capital and surplus in relation
to various business risks faced by such insurers. The RBC formula is used by
state insurance regulators as an early warning tool to identify insurance
companies that potentially are inadequately capitalized. At December 31, 1998,
the Company's principal insurance company subsidiaries had an RBC ratio that was
substantially above the levels which would require regulatory action.
The Company has a five year revolving line of credit with a maximum
commitment of $70.0 million, and a $10.0 million sublimit for swingline loans.
The outstanding line of credit balance at June 30, 1999 was $45.2 million, which
is included in notes payable.
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.
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").
14
In-house Applications represent the primary operating software of the
Company and include premium billing and cash posting, claims adjudication and
commission payment processing applications. The project to make all in-house
Applications Year 2000 compliant was completed in 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 was completed in early March 1999.
Customized Applications software products include electronic data
interchange applications, publishing systems, fax capabilities, accounting
packages and other special application software as well as utility software
packages that serve as links between different packages. Each of these software
packages is currently being upgraded or replaced. It is anticipated that all
Customized Applications will be compliant prior to the end of 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 systems and other numerous products as well as third party
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 93%
complete, is on schedule and is planned for completion in September 1999.
YEAR 2000 PLAN PERCENT COMPLETE COMPLETION DATE
In-house Applications 100% March 1999
Customized Applications 91% September 1999
Third Party Products 93% September 1999
The cost of the Year 2000 project is being funded through operating cash
flows and is not expected to be material to the Company's financial position.
For the six months ended June 30, 1999, the Company has incurred costs of $2.8
million ($0.3 million in the second quarter of 1999) relating to the Year 2000
project. For the remainder of 1999, the Company anticipates an additional cost
of $0.3 million which will be expensed as incurred. The company has made capital
expenditures of $4.4 million for the six months ended June 30, 1999, and expects
to make an additional $0.5 million in capital expenditures to complete the
project.
During the second quarter of 1999, the Company has completed 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 efforts necessary to achieve Year 2000 compliance on a
timely basis. While the Company currently believes that the timely completion of
its Year 2000 project will limit exposure so that the Year 2000 issue will not
pose material operational problems, the Company cannot control third party
systems. Contingency plans have been developed and documented for dealing with
the worst case scenarios with the highest chance of occurring.
15
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 that 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",
"expect", "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, (1) the
Company's ability to successfully implement the action plans to improve loss
ratios; (2) the effects of either federal or state health care reform or other
legislation; (3) rising health care costs, including the Company's ability to
predict such costs and adequately price its products; (4) changes in membership
utilization and risk; (5) government regulations, including changes in
insurance, health care and other regulatory conditions; (6) delays in regulatory
approvals, and regulatory action resulting from market conduct activity and
general administrative compliance with state and federal laws; (7) general
business conditions, including competitive practices and demand for the
Company's products; (8) development of and changes in claims reserves; (9)
rating agency policies and practices; (10) general economic conditions,
including changes in interest rates and the effect of such changes on the
Company's investment portfolio; (11) the Company's ability to integrate
acquisitions; (12) unforeseen costs or consequences of Year 2000 issues; (13)
the retention of key management and technical employees, and (14) 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 DISCLOSURE ABOUT MARKET RISK
The Company's market risk has not substantially changed from the year ended
December 31, 1998.
16
PART II. OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Annual Meeting of shareholders of the Company was held on May 27, 1999
for the purpose of (1) electing three directors for terms expiring at the 2002
Annual Meeting of Shareholders, (2) amending the Company's Equity Incentive Plan
(the "Equity Incentive Plan") to allow non-employee directors to participate in
the Equity Incentive Plan and to make other amendments to the Equity Incentive
Plan, and (3) approving the Company's Executive Annual Incentive Plan.
All three of the Company's nominees were elected, the amendment of the
Equity Incentive Plan was approved, and the Executive Annual Incentive Plan was
approved. The voting results for the proposals were as follows:
ELECTION OF DIRECTORS FOR TERMS EXPIRING IN 2002:
Roger H. Ballou: W. Francis Brennan:
For 15,646,802 shares For 15,649,815 shares
Withheld 806,547 shares Withheld 803,534 shares
Abstained 0 Abstained 0
Broker Non-Votes 0 Broker Non-Votes 0
J. Gus Swoboda:
For 15,649,425 shares
Withheld 803,924 shares
Abstained 0
Broker Non-Votes 0
AMENDMENT OF EQUITY INCENTIVE PLAN:
For 12,878,509 shares
Against 3,567,765 shares
Abstained 7,075 shares
Broker Non-Votes 0 shares
APPROVAL OF EXECUTIVE ANNUAL INCENTIVE PLAN:
For 16,162,427 shares
Against 276,568 shares
Abstained 14,354 shares
Broker Non-Votes 0 shares
Further information concerning these matters, including the names of the
directors whose terms continued after the meeting, is contained in the Company's
Proxy Statement dated April 14, 1999 with respect to the 1999 Annual Meeting of
Shareholders.
17
ITEM 5. OTHER INFORMATION
On August 3, 1999, the Company announced that its Board of Directors has
authorized the Company to repurchase up to $10 million of the Company's
outstanding common stock. The plan to repurchase its common stock will allow the
Company to buy back its shares, from time to time, in open market or privately
negotiated transactions, subject to price and market conditions. Any purchases
will be made in a manner to comply with the provisions of Rule 10b-18 under the
Securities Exchange Act of 1934. In determining when and whether to purchase
shares, management will also consider, among other factors, market price, the
number of shares actively traded in the market, indications of seller interest,
the number of shares held by large shareholders, and the effect of purchases on
shareholder value. Because of the unpredictability of these factors, no
assurance can be given as to how many shares may be repurchased.
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 May 24, 1999 was filed by the Company to
report (under Item 5) the announcement by the Company of its plans to take a
charge in the second quarter of 1999 to strengthen its medical claims reserves.
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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: August 12, 1999
-----------------
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)
19
AMERICAN MEDICAL SECURITY GROUP, INC.
(COMMISSION FILE NO. 1-13154)
EXHIBIT INDEX
TO
FORM 10-Q QUARTERLY REPORT
for quarter ended June 30, 1999
INCORPORATED HEREIN FILED
EXHIBIT NO. DESCRIPTION BY REFERENCE TO HEREWITH
3.2 Bylaws of the Company as amended and X
restated May 27, 1999
27.1 Financial Data Schedule X
27.2 Restated Financial Data Schedule X
(six months ended June 30, 1998)
EX-1