KMG America Corporation (the �Company� or �KMG America�) (NYSE:
KMA) today reported financial results for the first quarter ended
March 31, 2007. The financial results reflect two special charges:
the establishment of a valuation allowance against its non-life
deferred tax asset of $6.5 million, or $0.29 per diluted share, and
a pretax charge for increased claims and reserves on stop loss
business of $6 million, or $0.17 per diluted share. Taking these
two special charges into account, the Company reported a Q1 2007
net loss of $9.4 million, or $0.42 per diluted share, compared to
net income of $1.2 million, or $0.06 per diluted share for the
first quarter of 2006. Excluding the valuation allowance and stop
loss charges, actions intended to enhance the Company�s financial
position, operating income for the first quarter of 2007 would have
been $1.0 million, or $0.05 per diluted share. Reflecting these
special charges as well as the Company�s Q1 operating performance,
KMG America reported a book value at March 31, 2007 of $8.26 per
share. KEEFE, BRUYETTE & WOODS (KBW) RETAINED TO PURSUE
STRATEGIC ALTERNATIVES KMG America�s Chief Executive Officer,
Kenneth Kuk, commented, �The late March revision of our ratings
outlook from �stable� to �negative� has forced us to consider a
range of alternatives that afford the best chance to maintain our
A.M. Best A- rating. We believe several actions including
establishing incremental reserves in the first quarter are initial
steps to facilitate our efforts to achieve that objective. Further,
we believe there are several options available to us that will
satisfy rating agency concerns. We had retained KBW to help us
explore a variety of strategic alternatives, including the possible
sale or merger of the Company with a more highly rated firm. The
KBW-led process is underway, and discussions are ongoing with
several interested parties. Of course, there are no guarantees that
this process will result in a transaction.� FIRST QUARTER
DEVELOPMENTS After a comprehensive review of its stop loss book of
business, the Company recognized a $6 million charge for increased
claims and reserves that reflects recent experience on stop loss
cases. The Company began writing annually renewable stop loss in
mid-2005, and initially relied on pricing assumptions, a common
industry practice relative to new books of stop loss business, to
establish expected loss ratios due to lack of credible actual
claims experience. In contrast, companies with mature books of stop
loss typically establish claim reserves as a function of experience
studies derived from the historical performance of its business.
Because actual claims on stop loss cases typically are not fully
reported until after the end of the policy period, it is a common
practice to increase or decrease claims reserves once the actual
claims experience becomes known. After a few years, these
adjustments tend to be offsetting. As experience has emerged, the
Company has recognized additional claims and reserves reflecting
the recent adverse claims experience. The Company also decided to
increase claims assumptions on business prospectively, reflecting a
more conservative estimate of future claims on this business. As a
result of these actions, the Company believes the likelihood of
additional claim reserve increases in the future is greatly
reduced. In order to address the current imbalance toward stop loss
in its overall new sales mix, the Company has restructured the
sales incentive compensation plan for its sales organization with
increased incentives for sales of core group life/disability and
voluntary benefit products. Additionally, the Company is limiting
new sales of stop loss by means of more conservative pricing and a
requirement that sales of stop loss be packaged with other
products. The Company also established a $6.5 million valuation
allowance as a non-cash charge to offset the portion of the
deferred tax asset relating to the holding company. Due to the
unique way life insurance company earnings are taxed at the federal
level, the Company will not be able to deduct holding company
expenses on its life insurance federal tax return for a number of
years. The Company determined it would be prudent to establish the
valuation allowance at this time to afford greater flexibility in
implementing a variety of actions this year, including those
intended to address the issues raised by AM Best. The discussion of
operating earnings that follows has been segregated into earnings
attributed to the Kanawha legacy business and the earnings of the
new large case activity. The Company believes that segregating the
earnings results of the new large case activity provides a more
meaningful comparison of the underlying strength in the earnings
produced by Kanawha�s legacy business. This earnings derivation is
described later in �Notes on Financial Presentation�. The
discussion below focuses primarily on first quarter 2007 results
compared to the fourth quarter 2006 results. KANAWHA LEGACY RESULTS
Operating income attributed to the Kanawha legacy business for the
first quarter of 2007 was $2.7 million, or $0.12 per diluted share,
compared to $5.7 million, or $0.26 per diluted share, reported in
the fourth quarter of 2006. The difference in results is due in
part to particularly strong earnings results reported in the fourth
quarter of 2006, stemming from very favorable results in the
Company�s long term care book of business and the impact of
favorable persistency on the amortization of deferred acquisition
costs (DAC)/value of business acquired (VOBA). Also contributing to
the decline in earnings this quarter were adverse claims experience
in the legacy Worksite and Acquired segments, and increased
amortization of DAC/VOBA reflecting the impact of increased policy
lapses. Earned premiums reported in the Kanawha legacy business for
the first quarter of 2007 were $24.1 million, down slightly
compared to the $24.4 million reported in the fourth quarter of
2006, due primarily to a decline of $0.9 million in the Acquired
segment resulting from increased experience refunds in certain
reinsurance treaties. The decline was partially offset by increased
premiums in the Senior segment of $0.6 million. The benefit ratio
reported for the Kanawha legacy business for the first quarter of
2007 increased to 83.8% compared to 72.0% reported in the fourth
quarter of 2006. The legacy Worksite business experienced a benefit
ratio of 76.0% compared to 68.9% reported in the fourth quarter of
2006 due primarily to increased claims in the disability and
medical product lines. The Senior segment experienced a first
quarter 2007 benefit ratio of 71.9% compared to a very favorable
58.9% reported in the fourth quarter of 2006. The first quarter
results compares favorably to the average benefit ratio reported
for the first three quarters of 2006 of 75.0%. The benefit ratios
reported in the Acquired segment are impacted by refunds which
reduce both premiums and policyholder benefits equally. Excluding
the impact of these refunds, the first quarter 2007 benefit ratio
was 190.9% compared to 156.6% in the fourth quarter, reflecting
adverse claims experience in certain acquired blocks. The unusually
high benefit ratios reported in the Acquired segment reflect the
fact that much of this business is paid up relative to current and
future premium, as well as the impact of increased experience
rating refunds on one acquired block that reduced premiums and
claims by the same amount. Amortization of DAC/VOBA increased to
$1.5 million in the first quarter of 2007, compared to ($0.2)
million in the fourth quarter of 2006 due primarily to the impact
of increased lapses in the first quarter after very good
persistency reported in the fourth quarter of 2006. Also
contributing to the increase was a one-time reduction of $0.5
million to VOBA amortization in the fourth quarter of 2006 related
to the refinement of the persistency adjustment on long-term care
policies. NEW LARGE CASE ACTIVITY RESULTS Principally reflecting
the $6 million pretax charge for increased claims and reserves in
the stop loss business and a $6.5 million valuation allowance on a
portion of the deferred tax asset discussed earlier, operating
losses attributed to the new large case activity increased to $12.1
million, or $0.54 per diluted share, compared to a loss of $3.4
million, or $0.15 per diluted share, reported in the fourth quarter
of 2006. Premium revenue (net of reinsurance) for the first quarter
of 2007 was $15.8 million compared to $8.8 million reported in the
fourth quarter of 2006 due to increased sales results in the first
quarter of 2007. First quarter 2007 sales results (as measured by
new annualized issued premiums) attributed to the new large case
activity were $31.6 million, compared to $8.4 million reported in
the fourth quarter of 2006 and $15.9 million reported in the first
quarter of 2006. The primary driver of this increase was new stop
loss premiums. Sales results for core group products are typically
skewed heavily to the first quarter while sales of voluntary
benefit products tend to be more concentrated in the fourth
quarter. Sales of core group life and disability were $3.4 million
in the first quarter of 2007 compared to $1.3 million reported in
the first quarter of 2006. The benefit ratio reported for the new
large case activity in the first quarter of 2007 increased to
109.6% compared to the 94.6% reported in the fourth quarter of
2006. The benefit ratios for both periods were adversely impacted
by the increased claims and reserves for stop loss business.
Expenses for the first quarter of 2007 were $4.9 million compared
to $5.3 million reported in the fourth quarter of 2006, a decrease
of $0.4 million due primarily to reduced litigation expenses.
STATISTICAL SUPPLEMENT AVAILABLE ON COMPANY WEBSITE The statistical
supplement can be accessed on the Company�s website of
www.kmgamerica.com via the �Investor Relations� tab, �Financial
Reports� tab, and found under the �Quarterly & Other Reports�
section. A derivation of �normalized� earnings (a non-GAAP measure)
is provided in the statistical supplement for the current and prior
quarters to identify and adjust for certain timing differences and
unusual or temporary items and to help analysts and investors focus
on recurring earnings trends. While this reporting basis requires
management�s subjective judgment, the details are identified and
described in detail so the investors and analysts can form their
own opinions. WEBCAST The Company will host an investor and analyst
webcast today, Monday, May 7, 2007, at 10:00 a.m. Eastern. The
webcast and replay will be available via the following links:
www.kmgamerica.com, analyst/investor tab � for all investors;
www.streetevents.com � for institutional investors;
www.earnings.com � for retail investors. The replay will be
available starting approximately two hours after the original
webcast. The replay will be available through Monday, May 21, 2007.
ABOUT KMG AMERICA CORPORATION KMG America is a holding company that
was formed to acquire the Southeastern regional insurance company,
Kanawha Insurance Company, and to operate and grow Kanawha's
insurance and other related businesses nationwide. KMG America
offers a broad mix of individual and group insurance products and
stop-loss coverage along with third-party administration services
to employers and to working Americans. For more information visit:
www.kmgamerica.com. NOTES ON FINANCIAL PRESENTATION Non-GAAP
Financial Measures: Operating Income - To supplement the financial
statements presented on a GAAP basis, the Company reported
operating income, which is a non-GAAP measure. Operating income is
defined as net income excluding realized investment gains/losses
(except for realized investment gains/losses that are directly
offset by executive deferred compensation expense), net of income
taxes. Management believes this non-GAAP measure provides
investors, potential investors, securities analysts and others with
useful additional information to evaluate the performance of the
business, because it excludes items that management believes are
not indicative of the operating results of the business. In
addition, this non-GAAP measure is used by management to evaluate
the operating performance of the Company. The presentation of this
additional information is not meant to be considered in isolation
or as a substitute for net income determined in accordance with
GAAP. A reconciliation of the non-GAAP financial measures contained
in this release to the most comparable GAAP measures appears in the
attached tables. Presentation of Earnings Results: The Company has
separated the financial performance of KMG America into two primary
components: �Kanawha legacy activity� and �new large case
activity�. This is done to highlight the strength of, and trends
in, the Kanawha business activity that existed prior to the
acquisition (Kanawha legacy activity), and segregate these results
from the financial performance related to transforming KMG America
into a new public company with a new national marketing focus (new
large case activity). The financial results in the �new large case
activity� include all public company costs, the cost of the new
management team, and all incremental sales and underwriting costs
and product revenues associated with sales generated by the new
national sales organization. FORWARD LOOKING INFORMATION This press
release contains forward-looking statements that are made pursuant
to the safe harbor provisions of the Private Securities Litigation
Reform Act of 1995. The accuracy of such statements is subject to a
number of risks, uncertainties and assumptions that may cause the
Company�s actual results to differ materially from those expressed
in the forward-looking statements including, but not limited to:
implementation of its business strategy; hiring and retaining key
employees; predicting and managing claims and other costs;
fluctuations in its investment portfolio; financial strength
ratings of its insurance subsidiary; government regulations,
policies and investigations affecting the insurance industry;
competitive insurance products and pricing; reinsurance costs;
fluctuations in demand for insurance products; possible
recessionary trends in the U.S. economy; and other risks that are
detailed from time to time in reports filed by the Company with the
Securities and Exchange Commission. The Company assumes no
obligation to publicly update or revise any forward-looking
statements. KMG America Corporation Consolidated Statements of
Income (unaudited) (in thousands, except share data and
percentages) � � Quarter Ended � 3/31/2007� � 12/31/2006� �
3/31/2006� Operating income (1): Insurance premiums, net of
reinsurance $ 39,916� $ 33,261� $ 29,811� Net investment income
7,876� 7,668� 7,206� Commission and fee income 4,168� 4,151� 4,219�
Gain on extinguishment of debt -� 1,021� -� Other income � 1,059� �
1,267� � 986� Total revenues 53,019� 47,368� 42,222� � Policyholder
benefits 37,543� 25,929� 23,354� Insurance commissions, net of
deferrals 4,152� 3,574� 2,981� Expenses, taxes, fees and
depreciation, net of deferrals 13,607� 14,085� 12,852� Amortization
of DAC and VOBA (2) � 2,081� � 91� � 1,178� Total benefits and
expenses 57,383� 43,679� 40,365� � Operating income (loss) before
income taxes (4,364) 3,689� 1,857� (Provision) for income taxes �
(5,002) � (1,303) � (630) Operating income (loss) � (9,366) �
2,386� � 1,227� � Operating income (loss) per share - diluted $
(0.42) $ 0.11� $ 0.06� � Items excluded from operating income:
Realized investment gains (losses) (53) 1,115� 211� Deferred
compensation expense adjustment (3) (58) (264) (197) Cumulative
effect of accounting changes � -� � -� � -� Total items excluded
from operating income, before tax (111) 851� 14� Income taxes, not
applicable to operating income � 39� � (298) � (5) Total items
excluded from operating income, after tax � (72) � 553� � 9� Net
income (loss) $ (9,438) $ 2,939� $ 1,236� � Net income (loss) per
share - diluted $ (0.42) $ 0.13� $ 0.06� � Weighted-average shares
outstanding - diluted: 22,258� 22,213� 22,138� � Operating income
split: Kanawha legacy $ 2,714� $ 5,747� $ 3,583� New large case
activity � (12,080) � (3,361) � (2,356) Total company $ (9,366) $
2,386� $ 1,227� � Operating income per share - diluted Kanawha
legacy $ 0.12� $ 0.26� $ 0.16� New large case activity $ (0.54) $
(0.15) $ (0.10) Total company $ (0.42) $ 0.11� $ 0.06� � Annualized
operating return on average equity: Kanawha legacy activity (4)
5.8% 12.6% 8.4% Total company -19.3% 4.8% 2.5% � (1) Operating
income is a non-GAAP measure, and is defined as net income
excluding realized gains (losses), except for realized gains
(losses) that are directly offset by executive deferred
compensation expense, net of income taxes. (2) DAC: deferred
acquisition costs; VOBA: value of business acquired. (3) Offsetting
expense for realized gains (losses) related to executive deferred
compensation trading activity. (4) Equity attributed to Kanawha
legacy consists of the initial allocation of IPO proceeds of $155
million increased by retained earnings from the Kanawha legacy
business. KMG America Corporation and Subsidiary Consolidated
Balance Sheets (in thousands, except share data) � � � March 31,
2007 December 31, 2006 (Unaudited) Assets: Cash and cash
equivalents $ 45,730� $ 21,744� Investments � 575,635� � 558,336�
Total cash and investments 621,365� 580,080� Accrued investment
income 6,740� 6,503� DAC 31,813� 28,454� VOBA 69,671� 70,766� Other
assets (1) � 139,995� � 145,911� Total assets $ 869,584� $ 831,714�
� Liabilities and shareholders' equity: Total policy and contract
liabilities $ 584,424� $ 572,364� Deferred income taxes 13,707�
14,735� Other liabilities (2) � 87,975� � 52,563� Total liabilities
686,106� 639,662� Total shareholders' equity � 183,478� � 192,052�
Total liabilities and shareholders' equity $ 869,584� $ 831,714� �
Book value per share: Basic $ 8.26� $ 8.65� Diluted $ 8.26� $ 8.61�
� Book value per share: (excl FAS 115) (3) Basic $ 8.56� $ 8.96�
Diluted $ 8.56� $ 8.93� � Ending shares outstanding: Basic 22,214�
22,212� Diluted (4) 22,214� 22,299� � � (1) Other assets include
reinsurance balances recoverable, real estate and equipment,
federal income tax recoverable and other assets. (2) Other
liabilities include accounts payable and accrued expenses, $14.1
million of outstanding bank debt, and $36.1 million of subordinated
debt securities. (3) The book values are recalculated excluding
$6.6 million of unrealized capital losses, net of taxes, on March
31, 2007. Unrealized capital losses were $7.1 million, net of
taxes, on December 31, 2006. (4) Diluted shares were calculated
using the treasury stock method. KMG America Corporation
Statistical and Operating Data at or for the Periods Indicated -
Unaudited (in thousands, except percentages) � Quarter Ended
3/31/2007� 12/31/2006� 3/31/2006� SALES RESULTS (issued and paid
for annualized premiums): � Worksite insurance segment - Kanawha
legacy: Life $ 834� $ 1,088� $ 402� Cancer 466� 487� 486�
Disability income 528� 790� 633� Other A&H � 362� � 1,113� �
210� Total worksite - Kanawha Legacy 2,190� 3,478� 1,731� �
Worksite insurance segment - New large case activity: Core Group
Products: Life $ 1,726� $ 58� $ 1,151� Stop loss 27,099� 4,626�
12,776� Disability income 1,353� 3� 149� Other A&H -� -� -�
Voluntary Benefit Products: Life 338� 2,026� 122� Cancer 59� 260�
41� Disability income 821� 899� 1,278� Other A&H � 237� � 516�
� 336� Total worksite - New large case activity 31,633� 8,388�
15,853� � Other Kanawha legacy sales: Long term care � 43� � 45� �
303� � Total sales $ 33,866� $ 11,911� $ 17,887� � OTHER KMG
AMERICA KEY FINANCIAL INDICATORS: � Effective tax rate -110.9%
35.3% 33.9% � Benefit ratio - total company (1): 94.1% 78.0% 78.3%
Kanawha legacy only 83.8% 72.0% 80.2% New large case activity only
109.6% 94.6% 67.7% � Expense ratio - total company (2): 45.0% 47.4%
50.0% Kanawha legacy only 45.1% 38.0% 40.4% New large case activity
only 44.8% 78.0% 112.2% � Average portfolio yield (3) 5.16% 5.20%
4.95% � Average invested assets $ 560,301� $ 551,464� $ 519,669�
Average cash/equivalents & short terms (3) � 50,356� � 37,946�
� 62,679� Total average cash and invested assets $ 610,657� $
589,410� $ 582,348� � Earned premiums and fees - total company: $
44,084� $ 37,412� $ 34,030� Kanawha legacy only 28,235� 28,599�
29,495� New large case activity only 15,849� 8,813� 4,535� � (1)
Benefit ratio is defined as total policyholder benefits divided by
total net premiums. (2) Expense ratio is defined as commissions,
expenses and amortization of DAC/VOBA (on operating income basis)
divided by earned premiums plus commissions/fees. (3) Average
portfolio yield is defined as net investment income divided by
average invested assets, excluding the impact of FAS115 unrealized
gains (losses) plus average cash and equivalents. Average
cash/equivalents and short term assets include the portion of
initial public offering proceeds that are invested short (less than
2 year maturities).
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