10-Q/A 1 slp100c.txt -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION Washington, D.C. FORM 10-Q/A Amendment No. 1 QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the period ended: March 31, 2001 Commission file number: 0-2047 -------------- ------ CAPITOL TRANSAMERICA CORPORATION (CTC) ----------------------------------------------------------------------- (Exact name of registrant as specified in its charter) A Wisconsin Corporation 39-1052658 ----------------------- -------------------------------------- (State or other jurisdiction (I.R.S. Employer Identification Number) of incorporation or organization) 4610 University Avenue Madison, Wisconsin 53705-0900 - --------------------------------------- ---------------------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (608) 231-4450 -------------- Securities registered pursuant to Section 12 (g) of the Act: COMMON STOCK, $1.00 PAR VALUE -------------------------------------------------------------------------------- (Title of Class) 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 twelve 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 of each issuer's class of common stock, as of the latest practicable date: At March 31, 2001 Common Stock, $1.00 Par Value Issued: 11,560,789 Outstanding: 10,949,422 Explanatory Note ---------------- This Amendment No. 1 to the Quarterly Report for the three month period ended March 31, 2001 of Capitol Transamerica Corporation (the "Company") is being filed by the Company to amend and restate Part I of the Quarterly Report for the three month period ended March 31, 2001. In accordance with Rule 12b-15 promulgated under the Securities Exchange Act of 1934, as amended, the text of the amended items is amended and restated in its entirety as set forth in this Amendment No. 1. Securities and Exchange Commission ---------------------------------- Washington, D.C. ---------------- Form 10-Q --------- Part I ------ Financial Information Page - --------------------- ---- Consolidated Financial Statements 3 - 7 Notes to Consolidated Financial Statements 8 - 10 Management's Discussion and Analysis of Financial Condition and Results of Operations 11 - 16 Condensed Statutory Financial Statements of Insurance Subsidiaries 17 2

7 CAPITOL TRANSAMERICA CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MARCH 31, 2001 (1) Basis of Presentation ----------------------- The condensed financial statements included herein of Capitol Transamerica Corporation (the "Company"), other than the Consolidated Balance Sheet at December 31, 2000, and the Consolidated Statement of Shareholders' Investment and Comprehensive Income (Loss) and the Consolidated Statement of Cash Flows as of December 31, 2000, have been prepared by the Company without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to such rules and regulations. Although the Company believes the disclosures are adequate to make the information presented not misleading, it is suggested that these condensed financial statements be read in conjunction with the financial statements and the notes thereto included in the Company's 2000 annual report on Form 10-K. (2) Earnings Per Share -------------------- Basic earnings per share is computed by dividing net income by the weighted average number of shares of stock outstanding during the period. Diluted earnings per share is computed by dividing net income by the weighted average number of shares of common stock and common stock equivalents from options outstanding. The following table sets forth the computation of basic and diluted earnings per share (EPS):

(3) Comprehensive Income (Loss) ----------------------------- Comprehensive income (loss) is defined as net income plus or minus other comprehensive income (loss), which for the Company, under existing accounting standards, includes unrealized gains and losses, net of income tax effects, on certain investments in debt and equity securities. Comprehensive income (loss) is reported by the Company in the Consolidated Statements of Shareholders' Investment and Comprehensive Income (Loss). (4) Income Taxes ------------- Deferred income taxes reflect the net tax effect of temporary differences between the carrying amounts of assets and liabilities for financial statement purposes and the corresponding amounts used for income tax reporting. (5) Common Stock Options ---------------------- There were 2,022 options exercised during the three months ended March 31, 2001 compared to 19,196 options exercised during the three months ended March 31, 2000. For further information regarding stock options, refer to Note 6 of the Notes to the Consolidated Financial Statements included in the Company's 2000 annual report. 8 (6) Dividends --------- 2001 ---- On February 27, 2001, a cash dividend of $.08 per share was declared to shareholders of record March 9, 2001 and paid March 23, 2001 in the amount of $878,211. 2000 ---- On November 21, 2000, a cash dividend of $.07 per share was declared to shareholders of record December 8, 2000 and paid December 20, 2000 in the amount of $773,304. On September 5, 2000, a cash dividend of $.07 per share was declared to shareholders of record September 15, 2000 and paid September 26, 2000 in the amount of $773,993. On May 30, 2000, a cash dividend of $.07 per share was declared to shareholders of record June 16, 2000 and paid June 28, 2000 in the amount of $775,865. On February 18, 2000, a cash dividend of $.07 per share was declared to shareholders of record March 10, 2000 and paid March 23, 2000 in the amount of $788,776. (7) Investments ----------- The Company's fixed maturities and equity securities are classified as available-for-sale and, accordingly, are carried at fair value, with unrealized gains (losses) reported as a separate component of the shareholders' investment, net of taxes. The cost of fixed maturities is adjusted for the amortization of premiums and accretion of discounts to maturity. Fixed maturities and equity securities deemed to have declines in value that are other than temporary are written down through the statement of income to carrying values equal to their estimated fair values. Investment real estate is carried at cost, net of accumulated depreciation of $1,722,517, $1,595,693 and $1,274,060 at March 31, 2001, December 31, 2000 and March 31, 2000, respectively. Real estate is depreciated over the useful life of the asset. The cost of investments sold is determined under the specific identification method. (8) Contingent Liabilities ----------------------- The Company is a defendant in certain lawsuits involving complaints which demand damages and recoveries for claims and losses allegedly related to risks insured by the Company. Management's opinion is that such lawsuits are a result of the ordinary course of business in the insurance industry. The reserve for losses includes management's estimates of the probable ultimate cost of settling all losses involving lawsuits. 9 (9) Industry Segment Disclosures ------------------------------ The Company has three business segments, which are segregated based on the types of products and services provided. The segments are (1) property and casualty, (2) fidelity and surety, and (3) reinsurance assumed operations. These segments constitute 100% of the operations of the Company. Data for each segment as required for interim reporting follows in the table below. In analyzing this information, keep the following discussion in mind. The reconciliation items to get to the consolidated GAAP basis come from two sources: investment income on capital and surplus and intercompany eliminations (management fees for intercompany services provided and dividend income on stock held by affiliates). Specifically, revenues are adjusted for investment income from capital and surplus, and intercompany eliminations for management fees from intercompany service agreements and intercompany dividends. Pre-tax profit is adjusted for the net effect of the amounts in revenues along with intercompany eliminations for management fees from expense items (loss adjustment and underwriting expenses).

10 MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION & RESULTS OF OPERATIONS OVERVIEW -------- Capitol Transamerica Corporation (the "Company") is an insurance holding company, which operates in 37 states and writes, through its subsidiaries, both property-casualty and fidelity-surety insurance. The property-casualty segment accounts for approximately 77% of the business written while the fidelity-surety segment accounts for approximately 23% of the business. The underwriting cycles of the property-casualty insurance industry have been characterized by peak periods of adequate rates, underwriting profits and lower combined ratios, with the down side of the cycles being characterized by inadequate rates, underwriting losses and higher combined ratios. The adequacy of premium rates is affected primarily by the severity and frequency of claims, which, in turn, are affected by natural disasters, regulatory measures and court decisions, which continue to uphold the "deep pocket" theory in awarding against insurance companies. Unfortunately for the insurance industry, the trend of increasing price competition has continued as has the number of significant natural disasters. This combination has resulted in a considerable reduction in underwriting profitability for the industry as a whole. Adequate premium rates continue to be a concern for the Company and the property-casualty insurance industry as a whole. Management feels strongly that rate regulators have been slow to adjust rates in response to increased claim costs from the factors noted above. This, when combined with increased competition in the Company's niche market, has presented an unprecedented challenge to management. The Company has responded to this challenge with increased marketing efforts as well as the addition of innovative programs and alliances that should position the Company for continued expansion and profitability. OPERATING RESULTS ------------------ Total revenues decreased by approximately $442,738, or approximately 2%, for the three months ended March 31, 2001 compared to the same period in 2000 due primarily to realized investment losses. Underwriting income decreased by approximately $3.1 million for the three months ended March 31, 2001 compared to the same period in 2000 due primarily to increased loss and loss adjustment expenses. Net income decreased to $1.9 million for the three months ended March 31, 2001 compared to $5.7 million for the same period in 2000. A more detailed analysis of the Company's results of operations follows. Premiums written are earned and recognized as revenues after a reduction for reinsurance ceded and after establishing a provision for the pro rata unearned portion of the premiums written. The following table illustrates the premiums for the three months ended March 31, 2001 compared to the three months ended March 31, 2000 and the twelve months ended December 31, 2000.

11 In 1998 and 1999, the Company established new underwriting standards. With new underwriting standards in place, the Company began to increase the gross premiums written in late 1999 and throughout 2000. For the three months ended March 31, 2001 compared to the same period in 2000, the Company reduced its gross written premiums in the fidelity-surety bond market by approximately 11% due almost entirely to decreases in volume. The Company increased its gross written premiums in the property-casualty market by approximately 24%, of which approximately 10% of the increase in gross written premiums was due to rate increases with the remainder coming from volume increases. For the three months ended March 31, 2001 compared to the same period in 2000, the Company increased its gross written premiums across all lines by approximately 17.0%, of which approximately 8% is attributable to rate increases with the remainder being due to volume increases. For the three months ended March 31, 2001, the fidelity-surety loss and loss adjustment expense ratio was 63.7% of net earned premium compared to 13.5% of net earned premiums for the same period in 2000. This increase is due to two factors. First, the ratio for the three months ended March 31, 2000 is low compared to the Company's history of approximately 55% of net premiums earned, and, second, claims from one specific bonded contractor accounted for approximately 33% of the fidelity-surety losses and loss adjustment expenses for the three months ended March 31, 2001. To prevent additional losses, the Company has stopped writing new bonds with this contractor as well as canceling the agents responsible for the production of this and other unprofitable business. Had the fidelity-surety losses discussed above not occurred, the Company's fidelity-surety loss and loss adjustment expense ratio would have been 55% and its overall loss and loss adjustment expense ratio would have been 53%. Operating expenses remained relatively constant for the three months ended March 31, 2001 compared to the same period in 2000 climbing slightly from a ratio of 38.0% to 38.4%. The deferred acquisition costs reduced the operating expenses 1.4% of net premiums earned for the three months ended March 31, 2001 compared to a reduction of 2.0% of net earned premiums for the three months ended March 31, 2000. This reduction is due primarily to two factors. First, the increase in deferred acquisition costs, which is a reduction of operating expenses, is $111,138 less for the three months ended March 31, 2001 compared to the same period last year. Second, the net earned premiums grew by over $2 million compared to the same period in 2000. The Company regularly reviews its calculation of deferred acquisition costs to ensure that the portion of underwriting expenses that should be deferred appropriately matches the premiums that have yet to be earned. As a result of this analysis, the Company determined that the amount of resources, such as salaries and rent, allocable to the premiums yet to be earned needed to be adjusted downward because the amount of resources used to produce this business compared to the prior year is less when taken in conjunction with the resources used for the remainder of the Company's operations. This downward adjustment, when coupled with the higher premiums, caused the lower ratio applicable to the deferred acquisition costs described above. The Company's operating results from underwriting operations can be measured by the combined loss, loss adjustment expense and operating expense ratios determined in accordance with generally accepted accounting principles ("GAAP"). Under GAAP, the loss, loss adjustment expenses and operating expenses are all stated as a ratio of net premiums earned. The combined ratio is useful because it shows the operating profitability of the Company excluding income from investment-related activities. In other words, it reflects the profitability of the insurance operations. A combined ratio greater than 100% means the Company's insurance operations are operating at a loss, which the Company believes is typical on average for the insurance industry in recent years. This, however, does not mean the Company is losing money, because investment income and realized investment gains are also included in the determination of net income. Conversely, if the Company's combined ratio is less than 100%, the insurance operations are operating at a gain. The combined ratio should not be considered in isolation from or as a substitute for net income, cash flows from operating activities or other combined income or cash flow data prepared in accordance with GAAP or as a measure of overall profitability or liquidity. The following table depicts the Company's combined ratios for the three months ended March 31, 2001 compared with the same period in 2000 and the year ended December 31, 2000 broken down into its loss and operating expense components on a GAAP basis. 12

Investment income has been increasing due to the Company concentrating on investing in the fixed maturities market, most notably in tax-exempt municipal bonds. The relationship of the increase in investment in fixed maturities and net investment income is illustrated in the table below:

The Company sells investments, and, thus, realizes investment gains, when it is advantageous to the Company within the marketplace. The investment gains realized, or market value of the investments sold compared to the Company's cost of those investments, fluctuates with both the market conditions when the investment is sold and the Company's management of its portfolio. Additionally, under FASB Statement 115, the Company absorbed $2.0 million in realized losses for the three months ended March 31, 2001 for "other-than-temporary" market value adjustments for certain securities held in its portfolio. No such adjustments were made during the same period during 2000. Management continues to monitor its investment portfolio for other securities that could potentially fall into this category in the future. Had the FASB 115 losses not occurred, the Company's realized gains would have amounted to $0.2 million for the three months ended March 31, 2001 compared to $1.0 million for the same period in 2000 and $11.8 million for the full year of 2000. The Company's income tax expense has decreased from $2.6 million for the three months ended March 31, 2000 to $0.6 million for the same period in 2001 for two reasons. First, income from underwriting operations has decreased, and, second, the Company's increased investment in municipal bonds has decreased the amount of taxable income. 13 REINSURANCE ----------- The Company follows the customary practice of reinsuring with other companies, i.e., ceding a portion of its exposure on the policies it has written. This program of reinsurance permits the Company greater diversification of business and the ability to write larger policies while limiting the extent of its maximum net loss. It provides protection for the Company against unusually severe occurrences in which a number of claims could produce a large aggregate loss. Management continually monitors the Company's reinsurance program to obtain protection that should be adequate to ensure the availability of funds for losses while maintaining future growth. NET INVESTMENT INCOME AND REALIZED GAINS - --------------------------------------------- The Company's fixed maturities and equity securities are classified as available-for-sale and are carried at fair value. The unrealized gains and losses, net of tax, are reported as "Accumulated Other Comprehensive Income (Loss)" in the equity portion of the balance sheet. Interest and Dividend Income: Interest on fixed maturities is recorded as income when earned and is adjusted for any amortization of purchase premium or accretion of discount. Dividends on equity securities are recorded as income on ex-dividend dates.

The net unrealized loss of $1.5 million for the first three months of 2001 consists of a $0.7 million unrealized gain on fixed maturities and a $2.2 million unrealized loss on the Company's equity portfolio. Management has begun to increase its tax-free bond holdings and de-emphasize the equity portfolio, but is optimistic that the recent downturn in the value of its equity investments is temporary and that the current market conditions will provide an even greater opportunity to invest and build shareholder value over the long term. For the three months ended March 31, 2001, net investment income increased from $2.3 million to $2.5 million, or 8.6%, over the same period last year. The Company holds a large percentage of equity investments, which results in a comparatively lower rate of return on invested assets than other property-casualty insurance companies. Please see the Operating Results section for a discussion of the losses absorbed in 2001 for "other-than-temporary" investment losses under FASB Statement 115. INCOME TAXES ------------- Income tax expense is based on income reported for financial statement purposes and tax laws and rates in effect for the years presented. Deferred federal income taxes arise from timing differences between the recognition of income determined for financial reporting purposes and income tax purposes. Such timing differences are related principally to the deferral of policy acquisition costs, the recognition of unearned premiums and the discounting of claims reserves for tax purposes. Deferred taxes are also provided on unrealized gains and losses. Also of note is that the Company's effective income tax rate tends to be lower than most companies because of the high concentration of investment income related to tax-free municipal bonds. 14 LOSS RESERVES -------------- Reserves for losses and loss adjustment expenses reflect the Company's best estimate of the liability for the ultimate cost of reported claims and incurred but not reported (IBNR) claims at the end of each period. The estimates are based on past claim experience and consider current claim trends as well as social and economic conditions. The Company's reserves for losses and loss adjustment expenses were $74.1 million at March 31, 2001, compared to $75.7 million at March 31, 2000. These reserves remain relatively constant due to the Company having a high level of loss and loss adjustment expense payments during the first quarter compared to the first quarter of last year, $15.9 million compared to $9.0 million. Management continues to closely monitor the loss and loss adjustment expense reserves to assure adequate recognition of the ultimate liability for claims and claims expenses. Management recognizes that this is especially important in light of today's climate whereby the Company has had increased premium volume and larger than expected contract bond payments in the Florida and Texas markets. LIQUIDITY AND CAPITAL RESOURCES ---------------------------------- Liquidity refers to the Company's ability to meet obligations as they become due. The obligations and cash outflows of the Company include claim settlements, acquisition and administrative expenses, investment purchases and dividends to shareholders. In addition to satisfying obligations and cash outflows through premium collections, there are cash inflows obtained from interest and dividend income, and maturities and sales of investments. Because cash inflows from premiums are received in advance of the cash outflows required to settle claims, the Company accumulates funds, which it invests pending liquidity requirements. Therefore, investments represent the majority (82.7%, 82.0% and 83.8% at March 31, 2001, December 31, 2000 and March 31, 2000, respectively) of the Company's assets. Cash outflows can be unpredictable for two reasons: first, a large portion of liabilities representing loss reserves have uncertainty regarding settlement dates; and second, there is a potential for losses occurring either individually or in the aggregate. As a result, the Company maintains adequate short-term investment programs necessary to ensure the availability of funds. The investment programs are structured so that a forced sale liquidation of fixed maturities should not be necessary during the ordinary course of business. The Company has no material capital expenditure requirements. SEGMENT INFORMATION ------------------- The Company has three business segments, which are segregated based on the types of products and services provided. These segments are (1) property and casualty, (2) fidelity and surety and (3) reinsurance assumed operations. These segments constitute 100% of the operations of the Company. The Company maintains and monitors its segment information on a statutory basis. Financial data by segment, including a reconciliation to consolidated GAAP basis is in footnote 9 to the Financial Statements for the three month periods ended March 31, 2001 and 2000 and the year ended December 31, 2000. The property and casualty segment provides specialty commercial coverages for beauty and barber shops, bowling alleys, contractors/manufacturers, day care centers, restaurants, detective/guard agencies, golf courses and taverns. This segment also provides nurses professional, deer hunters and sportsmen's accident, and special event coverages. The fidelity and surety segment offers a full range of surety and fidelity bonds, including contractor's payment and performance bonds, license/permit bonds, fiduciary and judicial bonds, as well as commercial fidelity bonds. The reinsurance assumed segment consists of active reinsurance assumed and discontinued reinsurance assumed. The Company's discontinued reinsurance assumed business involved providing reinsurance coverage by assuming a portion of the risks underwritten by other insurance companies and risk pools, including asbestos and environmental risks. Although the Company withdrew from this reinsurance business in 1976, liability remains for losses on policies written during the period in which it participated as a reinsurer. The Operating Results section discussed the premium growth as well as the loss and loss adjustment expenses for the fidelity-surety and property-casualty lines of business. The reinsurance assumed business had a net underwriting loss of $25,000. Discontinued reinsurance assumed had an underwriting loss of $60,000 for the three months ended March 31, 2001, compared to underwriting income of $871,000 for the same period in 2000. For the three months ended March 31, 2001, the Company decreased IBNR reserves by $1 million after consultation with the independent actuary retained by the Company to assess the adequacy of these reserves. Had the Company not decreased these reserves, the Company would have had an underwriting loss of $129,000, which is consistent with the amounts reported for the comparable period in 2000. In addition to the discontinued reinsurance assumed, the Company is involved in active reinsurance assumed business, which has a minimal effect on the overall underwriting operations of the Company, contributing underwriting income of $34,000 and $7,000 for the three months ended March 31, 2001 and March 31, 2000, respectively. Commissions and other underwriting expenses are allocated to the lines of business based on premium volume and weighted average salaries by full-time equivalent employees. Investment income is allocated by line of business and capital and surplus based on a complex formula that incorporates premium volume, reserves and surplus to allocate among the different lines of business as well as to capital and surplus. Income taxes are allocated to the lines of business based on the effective tax rates for the different items affecting income -investment income (dividends, interest and capital gains) and underwriting income. 15 STATUTORY UNDERWRITING RESULTS ------------------------------ The financial statements of the insurance subsidiaries have been prepared in accordance with accounting principles prescribed or permitted by insurance regulatory authorities (statutory basis), which differ in certain respects from accounting principles generally accepted in the United States. The Company's underwriting results can be measured by the combined loss and expense ratios on a statutory basis. Losses and loss adjustment expenses are stated as a ratio of net premiums earned, while underwriting expenses are stated as a ratio of net premiums written. See the Operating Results section for a discussion on the significance of the combined ratios. The following table depicts the Company's two subsidiary insurance companies' combined ratios on a statutory basis.

The Company's combined ratios on a statutory basis continue to compare very favorably with the industry average on a statutory basis, as indicated below.

SAFE HARBOR STATEMENT ----------------------- Some of the statements in this report, as well as statements by the Company in periodic press releases and oral statements made by the Company's officials to analysts and shareholders in the course of presentations about the Company, constitute "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements involve known and unknown risks, estimates subject to change circumstances, uncertainties and other factors that may cause the actual results, performance or achievements of the Company to be materially different from any future results, performance or achievements expressed or implied by the forward-looking statements. 16

17 SIGNATURES ---------- Pursuant to the requirements of Section 13 or 15(d) of amendment to the Securities and Exchange Act of 1934, the Company has duly caused this amendment to report to be signed on its behalf by the undersigned thereunto duly authorized on the 7th day of December, 2001. CAPITOL TRANSAMERICA CORPORATION By: /s/ George A. Fait --------------------------------------------- George A. Fait Chairman of the Board and President By: /s/ Paul J. Breitnauer --------------------------------------------- Paul J. Breitnauer Vice President and Treasurer 18

CAPITOL TRANSAMERICA CORP 10-Q/A