10-Q/A 1 d10qa.txt FORM 10-Q/A ================================================================================ SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q/A [x] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities and Exchange Act of 1934 For the quarterly period ended September 30, 2001 OR [ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities and Exchange Act of 1934 For the transition period from _______ to _______ Commission File Number 0-22922 AMERICAN COUNTRY HOLDINGS INC. ------------------------------------------------------------- (Exact Name of Registrant as specified in its charter) Delaware 06-0995978 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 222 North LaSalle Street, Chicago, Illinois 60601-1105 ------------------------------------------------------------- (Address of principal executive office) (Zip Code) Registrant's telephone number, including area code: (312) 456-2000 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. [x] Yes [ ] No The aggregate number of shares of the Registrant's Common Stock, $.01 par value, outstanding November 9, 2001 was 9,613,503. ================================================================================ AMERICAN COUNTRY HOLDINGS INC. PAGE INDEX PART I - FINANCIAL INFORMATION Item 1. Consolidated Financial Statements Consolidated Balance Sheets at September 30, 2001 (Unaudited) and December 31, 2000 ........................................... 3 Consolidated Statements of Income (Unaudited) for the Nine Months and Three Months Ended September 30, 2001 and 2000 ............................... 4 Consolidated Condensed Statements of Cash Flows (Unaudited) for the Nine Months Ended September 30, 2001 and 2000 ............................... 5 Consolidated Condensed Statements of Comprehensive Income (unaudited)for the Nine Months and Three Months Ended September 30, 2001 and 2000 ........................ 6 Notes to Consolidated Financial Statements (Unaudited) .......................................... 7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations ................... 16 PART II - OTHER INFORMATION Item 1. Effect of Terrorist Attacks on our Business.................. 24 Item 2. Legal Proceedings ........................................... 24 Item 3. Changes in Securities ....................................... 24 Item 4. Defaults upon Senior Securities ............................. 24 Item 5. Submission of Matters to a Vote of Security Holders ................................... 24 Item 6. Other Information ........................................... 24 Item 7. Exhibits and Reports on Form 8-K ............................ 24 Signature ................................................................. 25 2 AMERICAN COUNTRY HOLDINGS INC. CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE AMOUNTS) (Unaudited) September 30, December 31, 2001 2000 --------- --------- ASSETS Investments: Available-for-sale Fixed maturities - At fair value (amortized cost: 2001 - $122,864; 2000 - $125,346) .................... $ 127,100 $ 126,457 Equity securities - At fair value (cost: 2001 - $2,960; 2000 - $1,636) ..................... 2,993 1,640 Collateral loans (at amortized cost, which approximate fair value) .......... 1,554 2,005 --------- --------- Total investments ....................... 131,647 130,102 Cash and cash equivalents ............... 6,124 16,790 Premiums receivable (net of allowance: 2001 - $420; 2000 - $386) .............. 23,744 5,482 Reinsurance recoverable ................. 26,145 22,880 Deferred income taxes ................... 4,148 5,438 Deferred policy acquisition cost ........ 5,046 3,185 Accrued investment income ............... 1,584 1,808 Property and equipment .................. 1,049 633 Income Taxes recoverable ................ 6,286 2,018 Receivable for securities ............... 4,393 0 Other assets ............................ 2,484 1,382 --------- --------- Total assets ............................ $ 212,650 $ 189,718 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY Liabilities: Unpaid losses and loss adjustment expense ................... $ 136,876 $ 114,694 Unearned premiums ..................... 25,766 17,464 Note payable .......................... 10,750 10,750 Accrued expenses ...................... 5,931 3,070 Reinsurance payable ................... 1,572 0 Other liabilities ..................... 0 919 --------- --------- Total liabilities ....................... 180,894 146,897 --------- --------- Stockholders' equity: Common stock - $.01 par value: Authorized - 60,000,000 shares Issued and outstanding - shares: 2001 - 9,600,611; 2000 - 9,041,237 ................... 96 90 Preferred stock - $.10 par value: Authorized - 2,000,000 shares; issued and outstanding - shares: 2001 - 305,000; 2000 - 405,000 .... 31 41 Additional paid-in capital ............ 42,821 42,828 Accumulated other comprehensive income ............................... 3,583 902 Retained earnings ..................... (14,775) (1,040) --------- --------- Total stockholders equity ............... 31,756 42,821 --------- --------- Total liabilities and stockholders equity ................................. $ 212,650 $ 189,718 ========= ========= See Notes to the Consolidated Financial Statements. 3 AMERICAN COUNTRY HOLDINGS INC. CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)

See Notes to the Consolidated Financial Statements 4 AMERICAN COUNTRY HOLDINGS INC. CONSOLIDATED CONDENSED STATEMENT OF CASH FLOWS (UNAUDITED) Nine months ended September 30, 2001 2000 -------- -------- (in thousands) Net cash provided (used) by operating activities $(12,200) $ 2,998 -------- -------- INVESTING ACTIVITIES Fixed maturities - available-for-sale: Purchases .................................... (53,076) (77,264) Sales ........................................ 10,638 66,486 Maturities, calls, and prepayments ........... 45,723 8,709 Equity securities - available-for-sale: Purchases .................................... (1,677) (1,283) Sales ........................................ 380 -- Sale or maturity of other investments .......... 449 544 Property, equipment and other .................. (726) (125) -------- -------- Net cash provided (used) by investing activities .................................... 1,713 (2,933) -------- -------- FINANCING ACTIVITIES Payment on note payable ........................ -- (400) Payment of preferred dividend .................. (167) -- Proceeds (charges) from issuance of options, warrants or stock ... (12) 11 -------- -------- Net cash used by financing activities .......... (179) (389) -------- -------- Net decrease in cash ........................... (10,666) (324) Cash at beginning of period .................... 16,790 4,973 -------- -------- Cash at end of period .......................... $ 6,124 $ 4,649 ======== ======== See Notes to the Consolidated Financial Statements. 5 AMERICAN COUNTRY HOLDINGS INC. CONSOLIDATED CONDENSED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED) (IN THOUSANDS)

See Notes to the Consolidated Financial Statements 6 AMERICAN COUNTRY HOLDINGS INC. PART I FINANCIAL INFORMATION (See Financial Statements and Exhibits Attached) Notes to the Consolidated Financial Statements (Unaudited) A. NATURE OF OPERATIONS American Country Holdings Inc. (the "Company") is an insurance holding company which operates through its direct subsidiaries American Country Insurance Company ("American Country"), American Country Financial Services Corp. ("Financial Services"), American Country Professional Services Corp. ("Professional Services") and American Country Underwriting Agency Inc. American Country is an Illinois domestic property and casualty insurance company that specializes in the underwriting and marketing of commercial property and casualty insurance for a focused book of business. American Country concentrates on types of insurance in which it has expertise: transportation and hospitality lines. Financial Services operates principally as a premium finance company. Professional Services operates principally as a third party claims administrator. American Country Underwriting Agency Inc. will operate as an underwriting manager for other insurance companies. B. ACCOUNTING PRINCIPLES The accompanying financial statements have been prepared in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X and, accordingly, do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. The accompanying financial statements should be read in conjunction with the consolidated financial statements of the Company included in the Company's Annual Report on Form 10-K filed on March 30, 2001. The interim financial data as of September 30, 2001 and for the nine months ended and three months ended September 30, 2001 and September 30, 2000 is unaudited. However, in the opinion of management, the interim data includes all adjustments, consisting of normal recurring accruals, necessary for a fair statement of the Company's results for the interim periods. The operating results for the interim periods are not necessarily indicative of the results to be expected for the full year. All significant intercompany amounts have been eliminated. Certain amounts 7 applicable to prior periods have been reclassified to conform to presentation followed in 2001. Earnings per share information is presented on the basis of weighted average shares outstanding for the period, restated for a one-for-four reverse stock split effective at the close of business on May 8, 2000. Basic earnings per share is computed based on the weighted-average number of common shares outstanding, excluding any dilutive effect of options and warrants. Net income available to common shareholders is equal to net income less preferred stock dividends. Dilutive earnings per share is computed based on the weighted-average number of common shares outstanding, plus the dilutive effect of convertible preferred stock, options and warrants. The dilutive effect of convertible preferred stock, options and warrants is calculated under the treasury stock method using the average market price for the period. Because the Company is in a net loss position for all periods presented, common share equivalents are anti-dilutive, and therefore not included in the computation. Earnings per share is calculated as follows (in thousands except per share data):

In the first quarter of 2001, the Company adopted the Financial Accounting Standards Board (FASB) Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities and Statement of Financial Accounting Standards No. 138, Accounting for Certain Derivative Instruments and Certain Hedging Activities (collectively referred to as SFAS 8 133). The Company had no derivatives as of January 1, 2001. Initial adoption of SFAS 133 did not have a significant impact on the equity of the Company; however, adoption of SFAS 133 resulted in a pre-tax decrease to nine month 2001 earnings of $781,000. This amount related to the Company's convertible investments, which were purchased in the first quarter of 2001 to diversify the portfolio. Because the Company already carried its investments at fair value through other comprehensive income, there was an equal and offsetting adjustment of $781,000, to stockholders' equity (accumulated other comprehensive income). See Note C. for a complete discussion of the Company's adoption of these accounting pronouncements. On January 1, 2001, American Country adopted the Codification of Statutory Accounting Principles (Codification) for preparing its statutory-basis financial statements. Codification, which is intended to standardize regulatory accounting and reporting to state insurance departments, was effective January 1, 2001. However, statutory accounting principles will continue to be established by individual state laws and permitted practices. The states in which American Country conducts business required adoption of Codification (with certain modifications) for the preparation of statutory-basis financial statements effective January 1, 2001. American Country's adoption of Codification, as modified, resulted in an increase in statutory capital and surplus as of January 1, 2001 of approximately $2.9 million, which primarily relates to deferred tax assets, partially offset by insurance-related assessments and pension-related liabilities. This change had no impact on net earned premiums or net income. 9 C. DERIVATIVE FINANCIAL INSTRUMENTS As discussed in Note B, effective in 2001, the Company accounts for derivatives and hedging in accordance with SFAS 133. A derivative is typically defined as an instrument whose value is "derived" from an underlying instrument, index or rate, has a notional amount, and can be net settled. Derivatives include, but are not limited to, the following types of investments: interest rate swaps, interest rate caps and floors, put and call options, warrants, swaptions, futures, forwards and commitments to purchase securities and combinations of the foregoing. Derivatives embedded within non-derivative instruments (such as call options embedded in convertible bonds) must be split from the host instrument and accounted for under SFAS 133 when the embedded derivative is not clearly and closely related to the host instrument. In addition, non-investment instruments, including certain types of insurance contracts that have historically not been considered derivatives can be derivatives or contain embedded derivatives under SFAS 133. SFAS 133 requires that all derivatives be recorded in the balance sheet at fair value. If certain conditions are met, a derivative may be specifically designated as a hedge of exposures to changes in fair value, cash flows or foreign currency exchange rates. The accounting for changes in the fair value of a derivative depends on the intended use of the derivative and the nature of any hedge designation thereon. Options embedded in convertible debt and equity securities do not qualify for hedge accounting. Embedded derivatives are classified as fixed maturities or equity securities in the Consolidated Balance Sheets, consistent with the host instruments. The change in the market value of the embedded derivatives resulted in a pre-tax loss of approximately $781,000 for the nine months ended September 30, 2001, and has been recorded as a realized investment loss in the consolidated statement of income. D. CAPITAL STOCK On May 8, 2000, the Company effected a one-for-four reverse stock split. No fractional shares were issued as a result of the reverse stock split. The number of common shares issued and outstanding have been restated for all periods presented. Preferred dividends of $167,250 were declared and paid by the Company on the Series A Preferred Stock during the nine-month period ended September 30, 2001. The Company has two classes of warrants, Common Warrants and Class A Common Warrants. At September 30, 10 2001, the Company had 2,019,424 Common Warrants outstanding. The warrants allow the warrant holder to purchase .5475 shares of Common Stock at a price of $7.32 through August 31, 2002. At September 30, 2001, the Company had 814,286 Class A Common Warrants outstanding. The warrants allow the warrant holder to purchase 1 (one) share of Common Stock at a price of $1.925 through December 29, 2005. At September 30, 2001, the Company had 305,000 shares of Series A Convertible Preferred Stock outstanding. Each share of Series A Convertible Preferred Stock has a stated value of $10 and an initial conversion price of $1.75 per share. Shares of the Series A Convertible Preferred Stock accrue dividends on a quarterly basis at an annual rate of 6% of the per share value. Dividends are cumulative and accrue, whether or not declared by the Board of Directors, but are payable only when and if declared by the Board. The holders of the Series A Convertible Preferred Stock are entitled to vote together as a class with the Common Stock. Based on the stated value and conversion price, the preferred stockholders are entitled to 1,742,855 votes. Common shares outstanding on September 30, 2001 were 9,600,611. E. STOCK OPTION PLAN The Company has established a Stock Option Plan (the "Plan"), as amended, under which options to purchase shares up to a total amount equal to five percent (5%) of the shares issued and outstanding on the January 1st last preceding the grant date. Stock options granted under this Plan, which may be either incentive stock options or nonqualified stock options for federal income tax purposes, expire up to ten years after date of grant and become exercisable over a three year period. Employees who have left the Company have 90 days to exercise their options. On June 7, 2001, the Company granted additional options to purchase 214,325 shares of common stock for $2.18 per share to certain of its directors, officers and employees. These options vest at 33 1/3% per year and are fully exercisable two years from the date of grant. These options expire five years from the date of grant. At September 30, 2001, the Company had 1,425,054 options outstanding with exercise prices ranging from $2.18 per share to $13.00 per share. The Company has elected to follow Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25") and related interpretations in accounting for its employee stock options rather than the alternative fair value accounting provided for under Financial Accounting Standards Board ("FASB") Statement No. 123, "Accounting for Stock-Based Compensation." Under APB 25, because the exercise price of the Company's employee stock options is greater than the market price of the underlying stock on the date of grant, no compensation expense is recognized. 11 F. EMPLOYEE STOCK PURCHASE PLAN The Company has established an Employee Stock Purchase Plan (the "Stock Purchase Plan"), under which active employees working more than 20 hours per week may contribute, on an after-tax basis, between 2%-15% of their eligible compensation to the Stock Purchase Plan. The purchase price for each share of common stock purchased under the Stock Purchase Plan is the lesser of (1) the offering price, which is defined as 85% of the fair market value of the common stock on the first day of each purchase period or (2) 85% of the fair market value of the common stock on the last day of each purchase period, each adjusted to the nearest cent. Fair market value of a share is defined as the average closing price of the common stock on the 20 business days preceding the purchase date. G. REINSURANCE The components of the net reinsurance recoverable balances in the accompanying balance sheets were as follows: September 30, December 31, 2001 2000 --------------------------- (In thousands) Ceded paid losses recoverable ............ $ 3,859 $ 1,530 Ceded unpaid losses and loss adjustment expenses ("LAE") ............. 19,474 16,318 Ceded unearned premiums .................. 2,812 5,032 ------- ------- Total .................................... $26,145 $22,880 ======= ======= The components of the reinsurance ceded relating to the accompanying statements of income were as follows: Nine months ended September 30, 2001 2000 ------------------------------ (In thousands) Ceded premiums earned ................ $16,512 $ 6,540 Ceded incurred losses ................ 23,210 4,331 Ceded incurred LAE ................... 1,826 520 Three months ended September 30, 2001 2000 ------------------------------- (In thousands) Ceded premiums earned .................. $4,661 $2,221 Ceded incurred losses .................. 6,882 2,216 Ceded incurred LAE ..................... 1,816 115 12 The effect of reinsurance on premiums written and earned for the periods ended September 30, 2001, and 2000 was as follows:

H. BUSINESS SEGMENTS The Company through American Country is engaged primarily as a property and casualty insurance carrier, providing commercial lines coverage including commercial auto, commercial multiple peril and workers' compensation to three key niche markets: transportation, hospitality and contractors. In addition, the Company through its other subsidiaries provides premium and other financing services through secured loans to certain larger customers. All revenues are derived from markets in the United States. Segment revenues for the nine months ended September 30, were (in thousands): 2001 2000 ------- ------- SEGMENT REVENUES Transportation ................................. $42,924 $43,432 Hospitality .................................... 5,308 7,078 Other Commercial ............................... 9,066 12,067 Personal Lines ................................. 0 11 Other .......................................... 97 854 ------- ------- Total Segment Revenues ................ 57,395 63,442 ------- ------- Other reconciling items: Investment and other income not attributable to segments ....................... 184 529 ------- ------- Total revenues ................................. $57,579 $63,971 ======= ======= 13 Segment operating profit (loss) for the nine months ended September 30, were (in thousands): 2001 2000 -------- -------- SEGMENT OPERATING PROFIT (LOSS) Transportation ................................... $ (1,873) $ 6,120 Hospitality ...................................... (2,474) (1,230) Other Commercial ................................. (13,362) (5,406) Personal Lines ................................... 31 (233) Other ............................................ 97 854 -------- -------- Total segment operating profit (loss) ........ (17,581) 465 -------- -------- Other reconciling items: Investment and other income not attributable to segments ........................ 184 529 General corporate expenses ....................... 0 (646) Other expenses, net .............................. 0 0 -------- -------- Total adjustments ................................ 184 (117) -------- -------- Total operating profit (loss) ................ $(17,397) $ 348 ======== ======== Segment revenues for the three months ended September 30, were (in thousands): 2001 2000 -------- -------- SEGMENT REVENUES Transportation ................................... $ 14,436 $ 15,068 Hospitality ...................................... 1,950 2,255 Other Commercial ................................. 2,785 3,607 Personal Lines ................................... 0 5 Other ............................................ (507) 194 -------- -------- Total Segment Revenues ....................... 18,664 21,129 Other reconciling items: Investment and other income not attributable to segments ........................ (186) 125 -------- -------- Total revenues ................................... $ 18,478 $ 21,254 ======== ======== 14 Segment operating profit (loss) for the three months ended September 30, were (in thousands): 2001 2000 -------- -------- SEGMENT OPERATING PROFIT (LOSS) Transportation ................................... $ (5,743) $ 1,098 Hospitality ...................................... (2,071) (476) Other Commercial ................................. (8,556) (1,734) Personal Lines ................................... (106) (79) Other ............................................ (421) 194 -------- -------- Total Segment operating profit (loss) .......... (16,897) (997) Other reconciling items: Investment and other income not attributable to segments ........................ (186) 125 General corporate expenses ....................... 445 (271) Other expenses, net .............................. 0 94 -------- -------- Total adjustments ................................ 259 (52) -------- -------- Total operating profit (loss) ........... $(16,638) $ (1,049) ======== ======== I. SUBSEQUENT EVENTS On May 20, 1999, Frontier Insurance Group, Inc. (which owned approximately 25% of the outstanding shares of the Company) filed a purported shareholder derivative action in Delaware Chancery Court against the Company's directors and the Company itself as a nominal defendant. On November 2, 2001, a Stipulation of Dismissal was entered and accepted by the Delaware Chancery Court. The Stipulation dismissed the action without prejudice. On November 7, 2001, the amount available under the Company's revolving credit facility was reduced to $2.25 million and the due date was extended to January 1, 2002. On November 7, 2001, the Company made a $500,000 payment on the revolving credit agreement to reduce the outstanding balance to $2.25 million. J. Debt and Line of Credit Agreements This footnote is submitted for the first time in the Form 10-Q/A for the period ended September 30, 2001. We were in discussions with our lender, The Northern Trust, regarding our indebtedness both prior and subsequent to our initial filing of this Form 10-Q on November 14, 2001. We have amended our filing to better describe the risks and uncertainties related to our liquidity situation. On October 5, 1999, the Company entered into a loan agreement with Northern Trust wherein the Company's existing $15.0 million line of credit was converted to an $8.0 million four-year term loan and a $7.0 million 364 day revolving credit facility. Under the $8.0 million term loan, as amended, the principal repayments are scheduled as follows: $1 million due on 04/30/02 $2 million due on 04/30/03 $2 million due on 04/30/04 $2 million due on 04/30/05 $1 million due on 04/30/06 The interest rate on the term loan, as amended, is based upon LIBOR + 1.25% through April 30, 2004, and LIBOR + 1.50% for the remainder of the term. In February 2001, the $7.0 million revolving credit facility was reduced to $5 million. Of the $5 million available, $2.75 million was outstanding at September 30, 2001. The revolving credit facility had a termination date of November 7, 2001, with a commitment fee of .25% per annum on the unused portion, and an interest rate of LIBOR + 1.25%. The loan agreement contains various covenants and conditions for prepayment, the most restrictive covenants being the ratio of debt to capitalization and the minimum shareholders equity requirement. At September 30, 2001, the Company was in violation of the minimum shareholders equity covenant requirement of $38.5 million. On November 7, 2001, the bank waived this covenant for the period from September 30, 2001 through January 1, 2002. The Company was in compliance with all other financial covenants. On November 7, 2001, the amount available under the revolving credit facility was reduced to $2.25 million and the due date was extended to January 1, 2002. On November 7, 2001, the Company made a $500,000 payment on the revolving credit agreement to reduce the outstanding balance to $2.25 million. Under the terms of the amended agreement, the bank has the right to terminate the revolving credit facility and demand full and immediate repayment on January 1, 2002. If the Company is unable to cure the existing covenant violation by the end of the waiver period on January 1, 2002, The bank may also declare the term note in default at the expiration of the waiver period and demand full and immediate repayment on January 1, 2002. If such repayments are required, the Company may not have sufficient cash on hand to repay the bank loan. The bank has not expressed a current intent to require immediate repayment of either the term loan or the revolving credit facility and has indicated revised terms will be presented to the Company on or before December 24, 2001. Although the bank and the Company are having negotiations to amend the loan agreements, there can be no assurances that the bank will not require such repayment. The Company believes that other financing alternatives would be available in the event that the Company and the bank cannot reach an agreement. However, there is no assurance that acceptable alternatives can be found. Although the Company's consolidated assets would be sufficient to repay the bank, a significant portion of the Company's consolidated assets represent assets of the Company's insurance subsidiaries that can only be transferred to the Company in the form of dividends, loans or advances in compliance with the Illinois Insurance Code. The code permits dividends, loans and advances to be paid only out of earned surplus, and limits the annual amount payable without prior approval of the Department to the greater of 10% of policyholders' surplus or the amount of the prior year's statutory net income. For American Country Insurance Company, the Company's principal subsidiary, policyholders' surplus was $27.4 million at September 30, 2001 and the statutory net loss was $14.2 million for the nine months then ended. As such, it is likely the Company would be prohibited from transferring sufficient funds from its subsidiaries to repay the bank if the bank were to request immediate repayment on January 1, 2002. 15 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations The following discussion and analysis should be read in conjunction with the consolidated financial statements and notes thereto included elsewhere in this Report. Overview American Country Holdings Inc. (the "Company") is an insurance holding company which operates through its direct subsidiaries American Country Insurance Company ("American Country"), American Country Financial Services Corp. ("Financial Services"), American Country Professional Services Corp. ("Professional Services") and American Country Underwriting Agency Inc. American Country is an Illinois domestic property and casualty insurance company that specializes in the underwriting and marketing of commercial property and casualty insurance for a focused book of business. American Country concentrates on types of insurance in which it has expertise: transportation and hospitality lines. Financial Services operates principally as a premium finance company. Professional Services operates principally as a third party claims administrator. American Country Underwriting Agency Inc. will operate as an underwriting manager for other insurance companies. Three Months Ended September 30, 2001 compared to Three months Ended September 30, 2000 Overall premium revenues decreased 13.8% in the third quarter of 2001 to $17.0 million from $19.8 million in the comparable period in 2000, due to various reinsurance agreements entered into in the fourth quarter of 2000, as well as re-underwriting and non-renewal of certain lines of business. The following table sets forth the net premiums earned by the principal lines of insurance underwritten by American Country for the periods indicated and the dollar amount and percentage of change therein from period to period: 16 Net Premiums Earned Three Months Ended Increase (Decrease) September 30, 2001 from 2000 ------------------ -------------------- 2001 2000 Amount Percent -------- ------- -------- -------- (in thousands) Transportation lines .... $ 12,949 $13,289 $(340) (2.5)% Hospitality Lines ....... 1,653 2,293 (640) (27.9) Commercial lines ........ 2,355 4,191 (1,836) (43.8) Personal lines .......... 0 5 (5) (100.0) -------- ------- -------- -------- Totals $ 16,957 $19,778 $(2,721) (13.8)% ======== ======= ======== ======== Premium revenues for transportation lines, which consist of taxicab and limousine liability and physical damage programs, decreased in the third quarter of 2001 by 2.5% to $12.9 million, as compared to $13.3 million in 2000. This is due to a quota share agreement entered into on October 1, 2000. Under this agreement, as amended, American Country cedes 10% of the earned premium from the transportation lines. Premium revenues for hospitality lines decreased 27.9% to approximately $1.65 million, as compared to $2.3 million for 2000. This decrease is attributable to non-renewal of the unprofitable non-Illinois business. Premium revenues for commercial lines decreased 43.8% to $2.35 million in the third quarter of 2001, as a result of strict re-underwriting of these lines prior to April 1, 2000, and also to management's decision to non-renew this book of business effective March 31, 2001. Net investment income decreased 13.1%, to $1.9 million in the third quarter of 2001, as compared to $2.1 million in the comparable period in 2000. Realized losses amounted to $380,000 in the third quarter of 2001, compared to losses of $79,000 in the comparable period in 2000. Other income increased $626,000 in the third quarter of 2001. This is due to reclassification of a ceding commission received on American Country's reinsurance program in 2000. Losses and loss adjustment expenses (LAE) increased 65.5% or $12.1 million in the third quarter of 2001, to $30.5 million in the third quarter of 2001, from $18.4 million in the third quarter of 2000, resulting in a loss ratio of 180.1% in the third quarter of 2001 compared to 93.3% in the comparable period in 2000. This includes reserve strengthening for prior accident years of approximately $15.0 million in the third quarter. This reserve strengthening was based on a management review of two actuarial studies conducted by American Country's actuary and a third-party consulting actuary. 17 These studies indicate that the losses for several lines of business are developing at ratios much higher than originally projected. The bulk of the reserve increases were in the 1999 and 2000 accident years. Losses and LAE for transportation lines increased $6.0 million in the third quarter of 2001, or 59.5% over the comparable period in 2000. The loss ratio for this line increased to 124.5% as compared to 76.0% for the same period in 2000. This increase in the loss ratio was primarily due to adverse development on the non-Illinois book in prior years. Due to lack of historical data, the prior actuarial projections were based on American Country's Illinois book, which has historically been very profitable. Now that more data recently became available for the non-Illinois book, the projected loss ratios have increased substantially. This is primarily due to increased frequency of claims in states other than Illinois. Losses and LAE for hospitality increased $1.1 million, or 44.6% over the comparable period in 2000. The loss ratio for hospitality lines increased to 216.5% compared to 107.9% in the same period in 2000. This is the result of both reduced earned premium in 2001 and adverse development in the non-Illinois book from prior years that was recognized in the current period. The adverse development was caused by an increase in severity of liability claims made under the commercial multiple-peril restaurant policies. Commercial lines experienced a $4.9 million, or 85.5% increase in losses and LAE that resulted in a loss ratio of 456.0% in the third quarter of 2001 as compared to 138.2% in the comparable period in 2000. The increase in losses was due to continuing adverse development in prior years as well as higher than expected losses for the current accident year. The increase in the loss ratio is due to both reduced earned premium in 2001 and adverse development from prior years that was recognized in the current period. With respect to workers compensation lines, the adverse development is attributable to several factors, including inadequate pricing, increasing medical costs, higher wage bases, and increased lengths of disability. Losses for liability claims have also developed unfavorably. This is the result of an increase in the severity of claims, partially the result of increasing levels of court awards. Amortization of deferred policy acquisition costs increased approximately $1.45 million in the third quarter of 2001 due to the run-off of higher commission business, as a result of the decreased writings for commercial and hospitality business. Administrative and general expenses decreased $728,000 or 80.9% in the third quarter of 2001, due to decreased marketing and underwriting expenses incurred as a result of slowing the geographic expansion. Interest expense decreased $83,000 or 40.1% in the third quarter of 2001. This is due to the changes in the debt structure noted under the caption "Liquidity and Capital Resources" as well as interest rate reductions. 18 Nine months ended September 30, 2001 compared to nine months ended September 30, 2000 Overall premium revenues decreased 11.7% in the nine months ended September 30, 2001 to $51.0 million from $57.8 million in the comparable period in 2000, due to the re-underwriting and non-renewal of the commercial and non-Illinois hospitality lines. Beginning in April, 2000, these lines were subject to a quota share agreement, which further reduced the net earned premium. The following table sets forth the net premiums earned by the principal lines of insurance underwritten by American Country for the periods indicated and the dollar amount and percentage of change therein from period to period: Net Premiums Earned Nine months ended Increase (Decrease) September 30, 2001 from 2000 ----------------- ------------------- 2001 2000 Amount Percent ---- ---- ------ ------- (in thousands) Transportation lines ... $38,681 $37,406 $ 1,276 3.4% Hospitality lines ...... 4,635 6,735 (2,100) (31.2) Commercial lines ....... 7,725 13,676 (5,591) (43.5) Personal lines ......... 0 11 (11) (100.0) ----- ---- -------- ----- Totals ............ $51,040 $57,828 $ (6,788) (11.7)% ======= ====== ========= ----- Premium revenues for transportation lines, which consist of taxicab and limousine liability and physical damage programs, expanded in the nine months ended September 30, 2001 by 3.4% to $38.7 million from $37.4 million, over the comparable period in 2000. This increase is primarily due to increased writings in the Chicago taxi market, as well as rate increases in other geographical areas, particularly in the state of New York, offset by a quota share agreement entered into on October 1, 2000. Under this agreement, as amended, American Country cedes 10% of the earned premium from the transportation lines. Premium revenues for hospitality lines decreased 31.2% to approximately $4.6 million as compared to $6.7 million for 2000. This decrease is due to a quota share agreement entered into on April 1, 2000. Under the agreement, 30% of the hospitality premiums 19 written from April 1, 2000 through June 30, 2000, and 50% of hospitality premiums written from July 1, 2000 through March 31, 2001 were ceded to a reinsurer. Premium revenues for commercial lines experienced a decrease of 43.5% to $7.7 million in the nine months ended September 30, 2001, as compared to $13.7 million for the same period in 2000, the result of both management's decision to non-renew this business effective March 31, 2001 and a quota share agreement entered into on April 1, 2000. Under the agreement, 30% of the commercial premiums written from April 1, 2000 through June 30, 2000, and 50% of commercial premiums written from July 1, 2000 through March 31, 2001 were ceded to a reinsurer. This agreement expired on March 31, 2001. The personal lines have been completely run-off, with no premium earned on this line in 2001. Net investment income increased $259,000 or approximately 4.2%, to $6.5 million in the nine months ended September 30, 2001, as compared to $6.2 million in the same period in 2000. Realized losses amounted to $70,000 in the nine months ended September 30, 2001 compared to a loss of $318,000 in the same period in 2000. This is the result of increases in the market value of fixed income securities, as well as improved yields on the investment portfolio. Other income decreased $113,000 in the nine months ended September 30, 2001 as compared to the nine months ended September 30, 2000. This is due to reclassification of a ceding commission received on the Company's reinsurance program in 2001. Losses and loss adjustment expenses (LAE) increased 23.5% or $12.1 million in the nine months ended September 30, 2001, to $64.1 million from $51.9 million in the comparable period in 2001, resulting in a loss ratio of 125.6% in the nine months ended September 30, 2001 compared to 89.8% in the comparable period in 2000. This reserve strengthening was based on a management review of two actuarial studies conducted by American Country's actuary and a third-party consulting actuary. These studies indicate that the loss ratios for several lines of business are developing at ratios much higher than originally projected. The bulk of the reserve increases were in the 1999 and 2000 accident years. 20 Losses and LAE for Transportation lines increased $9.8 million or 37.0% in the nine months ended September 30, 2001, over the comparable period in 2000, due to adverse development in American Country's non-Illinois business, offset by improved loss ratios on American Country's Illinois business. The loss ratio for this line in the nine months ended September 30, 2001 was 94.0% compared to 70.9% in the comparable period in 2000. Due to lack of historical data, the prior actuarial projections were based on American Country's Illinois book, which has historically been very profitable. Now that more data recently became available for the non-Illinois book, the projected loss ratios have increased substantially. This is primarily due to increased frequency of claims in states other than Illinois. The loss ratio for hospitality lines increased to 146.0% compared to 104.8% in the same period in 2000, which is primarily the result of reduced premium earned and increased losses on the non-Illinois book. The loss ratio was further increased due to the quota-share agreement, which does not provide for the ceding of loss adjustment expense. The adverse development was caused by an increase in severity of liability claims made under the commercial multiple-peril restaurant policies. Commercial lines experienced a significant increase in losses and LAE, from $18.1 million in 2000 to $21.0 million in 2001, which cause a substantial increase in the loss ratio in the nine months ended September 30, 2001. The increase was most significant in workers compensation, but also rose substantially for the commercial multiple peril products. The loss ratio was 272.2% in the nine months ended September 30, 2001, compared to 132.3% in the comparable period in 2000. This increase is primarily attributable to continuing adverse development on prior years, particularly 1999 and 2000. With respect to workers compensation lines, the adverse development is attributable to several factors, including inadequate pricing, increasing medical costs, higher wage bases, and increased lengths of disability. Losses for liability claims have also developed unfavorably. This is the result of an increase in the severity of claims, partially the result of increasing levels of court awards. The loss ratio was further increased due to the quota-share agreement, which does not provide for the ceding of loss adjustment expense. Amortization of deferred policy acquisition costs decreased $135,000 in the nine months ended September 30, 2001. This is due to the ceding commission received under the various reinsurance agreements, which resulted in lower commission expense. Administrative and general expenses decreased $701,000, or approximately 25.7% in the nine months ended September 30, 2001. Liquidity and Capital Resources The Company is a holding company, receiving cash principally through fees and dividends from its subsidiaries and borrowings. American Country, the principal subsidiary of the Company, is the only subsidiary of the Company subject to restrictions and regulatory approval on fees and dividends. The ability of insurance and reinsurance companies to underwrite insurance and reinsurance is based on maintaining liquidity and capital resources sufficient to pay claims and expenses as they become due. The 21 primary sources of liquidity for the Company's insurance subsidiary are funds generated from insurance premiums, investment income, commission and fee income, capital contributions from the Company and proceeds from sales and maturities of portfolio investments. The principal expenditures are for payment of losses and LAE, operating expenses and commissions. On October 5, 1999, the Company entered into a loan agreement with Northern Trust wherein the Company's existing $15.0 million line of credit was converted to an $8.0 million four-year term loan and a $7.0 million 364 day revolving credit facility. Under the $8.0 million term loan, as amended, the principal repayments are scheduled as follows: $1 million due on 04/30/02 $2 million due on 04/30/03 $2 million due on 04/30/04 $2 million due on 04/30/05 $1 million due on 04/30/06 The interest rate on the term loan, as amended, is based upon LIBOR + 1.25% through April 30, 2004, and LIBOR + 1.50% for the remainder of the term. In February 2001, the $7.0 million revolving credit facility was reduced to $5 million. Of the $5 million available, $2.75 million was outstanding at September 30, 2001. The revolving credit facility had a termination date of November 7, 2001, with a commitment fee of .25% per annum on the unused portion, and an interest rate of LIBOR + 1.25%. The loan agreement contains various covenants and conditions for prepayment, the most restrictive covenants being the ratio of debt to capitalization and the minimum shareholders equity requirement. At September 30, 2001, the Company was in violation of the minimum shareholders equity covenant requirement of $38.5 million. On November 7, 2001, the bank waived this covenant for the period of September 30, 2001 through January 1, 2002. The Company was in compliance with all other financial covenants. On November 7, 2001, the amount available under the revolving credit facility was reduced to $2.25 million and the due date was extended to January 1, 2002. On November 7, 2001, the Company made a $500,000 payment on the revolving credit agreement to reduce the outstanding balance to $2.25 million. Under the terms of the amended agreement, the bank has the right to terminate the revolving credit facility and demand full and immediate repayment on January 1, 2002. If the Company is unable to cure the existing covenant violation by the expiration of the waiver period on January 1, 2002, The bank may also declare the term note in default at the expiration of the waiver period and demand full and immediate repayment on January 1, 2002. If such repayments are required, the Company may not have sufficient cash on hand to repay the bank loan. The bank has not expressed a current intent to require immediate repayment, of either the term loan or the revolving credit facility and has indicated revised terms will be presented to the Company on or before December 24, 2001. Although the bank and the Company are having negotiations to amend the loan agreements, there can be no assurances that the bank will not require such repayment. The Company believes that other financing alternatives would be available in the event that the Company and the bank cannot reach an agreement. However, there is no assurance that acceptable alternatives can be found. Although the Company's consolidated assets would be sufficient to repay the bank, a significant portion of the Company's consolidated assets represent assets of the Company's insurance subsidiaries that can only be transferred to the Company in the form of dividends, loans or advances in compliance with the Illinois Insurance Code. The code permits dividends, loans and advances to be paid only out of earned surplus, and limits the annual amount payable without prior approval of the Department to the greater of 10% of policyholders' surplus or the amount of the prior year's statutory net income. For American Country Insurance Company, the Company's principal subsidiary, policyholders' surplus was $27.4 million at September 30, 2001 and the statutory net loss was $14.2 million for the nine months then ended. As such, it is likely the Company would be prohibited from transferring sufficient funds from its subsidiaries to repay the bank if the bank were to request immediate repayment on January 1, 2002. At September 30, 2001, the Company's total assets of $212.7 million was comprised of the following: Cash and investments, 64.8%; premiums receivable, 11.2%; reinsurance recoverables, 12.3%; deferred expenses (policy acquisition costs and deferred taxes) 4.3%; fixed assets, 0.5%; accrued investment income, .7%; income taxes recoverable, 3.0% and other assets, 3.2%. The Company's subsidiaries seek to maintain liquid operating positions and follow investment guidelines and state regulations for investments that are intended to provide for an acceptable return on investment while preserving capital, maintaining sufficient liquidity to meet its obligations and, as to the Company's insurance subsidiary, maintaining a sufficient margin of capital and surplus to ensure its unimpaired ability to write insurance and assume reinsurance. 22 The following table provides a profile of the Company's fixed maturities investment portfolio by rating at September 30, 2001: Fair Percent S&P/Moody's Ratings(1) Value of Total -------- ---------- AAA/Aaa (including US Treasuries of $4,376) ... $58,784 46.3% AA/Aa .................... 15,444 12.2% A/A ...................... 32,427 25.6% BBB/Baa .................. 14,742 11.5% All other ................ 5,703 4.4% -------- ---------- Total .................... $127,100 100.0% ======== ========== (1) Ratings are assigned primarily by Standard & Poor's Corporation, with remaining ratings as assigned by Moody's Investors Service, Inc. Cash flow used by operations for the quarter ended September 30, 2001 was $12.2 million, as compared to cash provided of $3.0 million for the same period in 2000. The decrease in cash flow provided for the quarter ended September 30, 2001, as compared to the same period in 2000 is attributable to decreased premium writings as compared to the comparable period in 2000, as well as increased claim payments in 2001. Forward-Looking Statements The Company cautions readers regarding certain forward-looking statements contained in the foregoing and elsewhere and in any other statements made by, or on behalf of, the Company, whether or not in future filings with the Securities and Exchange Commission. Forward-looking statements are statements not based on historical facts. In particular, statements using verbs such as "expect," "intend," "plan," "anticipate," "believe" or similar words generally involve forward- looking statements. Forward-looking statements also include but may not be limited to, statements relating to future plans, targets and objectives, financial results, cyclical industry conditions, government and regulatory policies, the uncertainties of the reserving process and the competitive environment in which the Company operates. Forward-looking statements are based upon estimates and assumptions that are subject to significant business, economic and competitive uncertainties, many of which are beyond the Company's control and subject to change. These uncertainties can affect actual results and could cause actual results to differ materially from those expressed in any forward-looking statements. Whether or not actual results differ materially from forward-looking statements may depend on numerous foreseeable and unforeseeable events or developments, some of which may be national in scope, such as consequences attributable to the events that took place in New York City and Washington, D.C. on September 11, 2001, including further attacks, retaliation and the threat of future attacks or retaliation, general economic conditions and interest rates. Some of these events or developments may be related to the insurance 23 industry generally, such as pricing competition, regulatory developments and industry consolidation. Others may relate to the Company specifically, such as credit, volatility and other risks associated with the Company's investment portfolio, and other factors. Investors are also directed to consider other risks and uncertainties discussed in documents filed by the Company with the SEC, including Exhibit 99 to the Annual Report to the Securities and Exchange Commission on Form 10-K for the year ended December 31, 2000. The Company disclaims any obligation to update forward-looking information. PART II OTHER INFORMATION Item 1. Effect of Terrorist Acts on our Business The terrorist acts of September 11, 2001, the military response, the actual and perceived threat of further terrorist acts and future possible military and political actions have created an atmosphere of economic uncertainty in the United States and our results may be impacted by the adverse macroeconomic effect of those events, especially if the conditions persist. As a result of the attacks on September 11, we did not suffer the loss of any employees or assets. However, because both the transportation and hospitality lines are heavily dependent upon travel and tourism, our customers have faced slowdowns in their businesses, which may have a material effect on our business. While we have taken all prudent precautions against foreseeable threats, recent events have proven that the object of terrorist activities is inherently uncertain. Any terrorist occurrence may have a material adverse effect on our financial position, cash flow or profit from operations in any reporting period. Item 2. Legal Proceedings There are no pending material legal proceedings to which the Company or its subsidiaries is a party or of which any of the properties of the Company or its subsidiaries is subject, except as noted below. The Company is subject to claims arising in the ordinary course of its business. Most of these proceedings involve claims under insurance policies issued by American Country. These lawsuits are considered by American Country in estimating the reserves for losses and loss adjustment expenses. In the opinion of management, the ultimate resolution of such litigation will not have a material effect on the financial condition of the Company. On May 20, 1999, Frontier Insurance Group, Inc. (which owned approximately 25% of the outstanding shares of the Company) filed a purported shareholder derivative action in Delaware Chancery Court against the Company's directors and the Company itself as a nominal defendant. On November 2, 2001, a Stipulation of Dismissal was entered and accepted by the Delaware Chancery Court. The Stipulation dismissed the action without prejudice. Item 3. Changes in Securities None. Item 4. Defaults upon Senior Securities None. Item 5. Submission of Matters to Vote of Security Holders None. Item 6. Other Information None. Item 7. Exhibits and Reports on Form 8-K a. Exhibits: None. b. Reports on Form 8-K: None. 24 SIGNATURE Pursuant to the requirements of the Securities and Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Date: December 7, 2001 AMERICAN COUNTRY HOLDINGS INC. (Registrant) By: /s/ Karla M. Violetto -------------------------- Vice President and Chief Financial Officer 25

AMERICAN COUNTRY HOLDINGS INC 10-Q/A