SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
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|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2002
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
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Commission file number 1-16725
PRINCIPAL FINANCIAL GROUP, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
Delaware 42-1520346
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
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711 High Street, Des Moines, Iowa 50392
(Address of principal executive offices)
(515) 247-5111
(Registrant's telephone number, including area code)
------------------
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days. Yes |X| No |_|
The total number of shares of the registrant's Common Stock, $0.01 par value,
outstanding as of November 4, 2002, was 336,892,211.
1
PRINCIPAL FINANCIAL GROUP, INC.
TABLE OF CONTENTS
PAGE
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Statements of Financial Position at September 30, 2002
(Unaudited) and December 31, 2001.................................... 3
Unaudited Consolidated Statements of Operations for the three months
and nine months ended September 30, 2002 and 2001.................... 4
Unaudited Consolidated Statements of Stockholders' Equity for the nine
months ended September 30, 2002 and 2001............................. 5
Unaudited Consolidated Statements of Cash Flows for the nine months
ended September 30, 2002 and 2001.................................... 6
Notes to Unaudited Consolidated Financial Statements - September 30,
2002................................................................. 8
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations............................................ 26
Item 3. Quantitative and Qualitative Disclosures about Market Risk....... 80
Item 4. Controls and Procedures.......................................... 85
PART II - OTHER INFORMATION
Item 1. Legal Proceedings................................................ 86
Item 6. Exhibits and Reports on Form 8-K................................. 87
Signature and Certifications............................................. 88
2
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PRINCIPAL FINANCIAL GROUP, INC.
CONSOLIDATED STATEMENTS OF FINANCIAL POSITION
SEPTEMBER 30, DECEMBER 31,
2002 2001
------------- ---------------
(Unaudited) (Note 1)
(IN MILLIONS,
EXCEPT PER SHARE DATA)
ASSETS
Fixed maturities, available-for-sale........... $33,057.2 $30,012.3
Fixed maturities, trading...................... 92.7 17.8
Equity securities, available-for-sale.......... 379.5 837.2
Mortgage loans................................. 11,283.6 11,065.7
Real estate.................................... 1,168.9 1,181.8
Policy loans................................... 822.9 831.9
Other investments.............................. 1,111.4 832.3
------------- ---------------
Total investments........................... 47,916.2 44,779.0
Cash and cash equivalents...................... 631.5 561.2
Accrued investment income...................... 585.1 594.1
Premiums due and other receivables............. 786.6 489.0
Deferred policy acquisition costs.............. 1,399.0 1,372.5
Property and equipment......................... 484.2 494.2
Goodwill....................................... 126.0 104.0
Other intangibles.............................. 55.8 61.5
Mortgage loan servicing rights................. 1,505.0 1,779.2
Separate account assets........................ 30,872.5 34,376.0
Assets of discontinued operations.............. 2,535.2 2,974.3
Other assets................................... 1,373.6 765.5
------------- ---------------
Total assets........................... $88,270.7 $88,350.5
============= ===============
LIABILITIES
Contractholder funds........................... $26,470.5 $24,684.4
Future policy benefits and claims.............. 14,484.3 14,034.6
Other policyholder funds....................... 608.9 589.1
Short-term debt................................ 474.3 511.6
Long-term debt................................. 1,303.7 1,378.4
Income taxes currently payable................. 326.6 35.1
Deferred income taxes.......................... 899.9 853.6
Separate account liabilities................... 30,872.5 34,376.0
Liabilities of discontinued operations......... 1,632.4 1,773.3
Other liabilities.............................. 4,563.6 3,294.1
------------- ---------------
Total liabilities........................... 81,636.7 81,530.2
STOCKHOLDERS' EQUITY
Common stock, par value $.01 per share -
2,500 million shares authorized, 376.5
million and 375.8 million shares issued,
343.2 million and 360.1 million shares
outstanding, respectively................... 3.8 3.8
Additional paid-in capital..................... 7,099.0 7,072.5
Retained-earnings deficit...................... (102.2) (29.1)
Accumulated other comprehensive income......... 507.9 147.5
Treasury stock, at cost (33.3 million and 15.7
million shares, respectively)............... (874.5) (374.4)
------------- ---------------
Total stockholders' equity.................. 6,634.0 6,820.3
------------- ---------------
Total liabilities and stockholders' equity.. $88,270.7 $88,350.5
============= ===============
SEE ACCOMPANYING NOTES.
3
PRINCIPAL FINANCIAL GROUP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
FOR THE THREE MONTHS ENDED FOR THE NINE MONTHS
SEPTEMBER 30, ENDED SEPTEMBER 30,
-------------------------------- -------------------------------
2002 2001 2002 2001
--------------- ---------------- ---------------- --------------
(IN MILLIONS, EXCEPT PER SHARE DATA)
REVENUES
Premiums and other considerations.............. $ 888.7 $1,255.0 $ 2,941.0 $ 3,210.3
Fees and other revenues........................ 516.6 403.7 1,386.7 1,141.5
Net investment income.......................... 821.2 826.4 2,455.5 2,506.1
Net realized/unrealized capital losses......... (230.6) (80.1) (224.0) (257.0)
--------------- ---------------- ---------------- --------------
Total revenues........................... 1,995.9 2,405.0 6,559.2 6,600.9
EXPENSES
Benefits, claims and settlement
expenses.................................. 1,231.6 1,597.3 3,942.7 4,236.5
Dividends to policyholders..................... 79.1 79.1 241.0 241.2
Operating expenses............................. 640.2 574.2 1,832.2 1,673.3
--------------- ---------------- ---------------- --------------
Total expenses............................ 1,950.9 2,250.6 6,015.9 6,151.0
--------------- ---------------- ---------------- --------------
Income from continuing operations before income
taxes..................................... 45.0 154.4 543.3 449.9
Income taxes................................... 2.4 34.5 140.6 90.8
--------------- ---------------- ---------------- --------------
Income from continuing operations.............. 42.6 119.9 402.7 359.1
Loss from discontinued operations, net of
related income taxes...................... (201.0) (4.1) (194.9) (8.2)
--------------- ---------------- ---------------- --------------
Income (loss) before cumulative effect of
accounting changes........................ (158.4) 115.8 207.8 350.9
Cumulative effect of accounting changes,
net of related income taxes............... - - (280.9) (10.7)
--------------- ---------------- ---------------- --------------
Net income (loss).............................. $ (158.4) $ 115.8 $ (73.1) $ 340.2
=============== ================ ================ ==============
FOR THE THREE MONTHS FOR THE NINE MONTHS ENDED
ENDED SEPTEMBER 30, 2002 SEPTEMBER 30, 2002
----------------------------- --------------------------------
EARNINGS PER COMMON SHARE
Basic earnings per common share:
Income from continuing operations.............. $ 0.12 $ 1.13
Loss from discontinued operations, net
of related income taxes...................... (0.58) (0.54)
----------------------------- --------------------------------
Income (loss) before cumulative effect (0.46) 0.59
of accounting change.........................
Cumulative effect of accounting change,
net of related income taxes.................. - (0.80)
----------------------------- --------------------------------
Net loss....................................... $(0.46) $(0.21)
============================= ================================
Diluted earnings per common share:
Income from continuing operations.............. $ 0.12 $ 1.13
Loss from discontinued operations, net
of related income taxes...................... (0.57) (0.55)
----------------------------- --------------------------------
Income (loss) before cumulative effect (0.45) 0.58
of accounting change.........................
Cumulative effect of accounting change,
net of related income taxes.................. - (0.79)
----------------------------- --------------------------------
Net loss....................................... $(0.45) $(0.21)
============================= ================================
SEE ACCOMPANYING NOTES.
4
PRINCIPAL FINANCIAL GROUP, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(UNAUDITED)
ACCUMULATED
ADDITIONAL RETAINED OTHER TOTAL
COMMON PAID-IN EARNINGS COMPREHENSIVE TREASURY STOCKHOLDERS' OUTSTANDING
STOCK CAPITAL (DEFICIT) INCOME STOCK EQUITY SHARES
----------- ----------- ----------- ---------------- --------- ------------- --------------
(IN MILLIONS) (IN THOUSANDS)
BALANCES AT JANUARY 1, 2001..... $ - $ - $6,312.5 $(60.0) $ - $6,252.5 -
Comprehensive income:
Net income.................... - - 340.2 - - 340.2 -
Net unrealized gains.......... - - - 541.3 - 541.3 -
Provision for
deferred income taxes....... - - - (195.6) - (195.6) -
Foreign currency translation
adjustment.................. - - - (105.2) - (105.2) -
Cumulative effect of
accounting change, net of
related income taxes........ - - - (14.2) - (14.2) -
-------------
Comprehensive income............ 566.5
----------- ----------- ----------- ---------------- --------- ------------- --------------
BALANCES AT SEPTEMBER 30, 2001.. $ - $ - $6,652.7 $166.3 $ - $6,819.0 -
=========== =========== =========== ================ ========= ============= ==============
BALANCES AT JANUARY 1, 2002..... $3.8 $7,072.5 $ (29.1) $147.5 $(374.4) $6,820.3 360,142.2
Stock issued.................... - 17.8 - - - 17.8 710.8
Stock-based compensation:
Stock incentive plan.......... - 4.0 - - - 4.0 -
Directors stock plan.......... - 0.1 - - - 0.1 -
Stock purchase plan........... - 3.3 - - - 3.3 -
Treasury stock acquired
and reissued, net............. - 1.3 - - (500.1) (498.8) (17,624.8)
Comprehensive income:
Net loss...................... - - (73.1) - - (73.1) -
Net unrealized gains.......... - - - 411.2 - 411.2 -
Provision for deferred
income taxes................ - - - (146.5) - (146.5) -
Foreign currency translation
adjustment.................. - - - 95.7 - 95.7 -
-------------
Comprehensive income............ 287.3
----------- ----------- ----------- ---------------- --------- ------------- --------------
BALANCES AT SEPTEMBER 30, 2002.. $3.8 $7,099.0 $ (102.2) $507.9 $(874.5) $6,634.0 343,228.2
=========== =========== =========== ================ ========= ============= ==============
SEE ACCOMPANYING NOTES.
5
PRINCIPAL FINANCIAL GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
FOR THE NINE MONTHS ENDED
SEPTEMBER 30,
---------------------------------
2002 2001
----------------- ---------------
(IN MILLIONS)
OPERATING ACTIVITIES
Net income (loss)............................ $ (73.1) $ 340.2
Adjustments to reconcile net income (loss)
to net cash provided by operating activities:
Loss from discontinued operations, net of
related income taxes..................... 194.9 8.2
Cumulative effect of accounting changes,
net of related income taxes.............. 280.9 10.7
Amortization of deferred policy
acquisition costs........................ 109.6 130.8
Additions to deferred policy acquisition
costs.................................... (233.5) (191.4)
Accrued investment income.................. 9.1 (57.4)
Premiums due and other receivables......... (45.1) (71.5)
Contractholder and policyholder liabilities
and dividends............................ 1,545.5 1,703.3
Current and deferred income taxes.......... 310.4 62.2
Net realized/unrealized capital losses..... 224.0 257.0
Depreciation and amortization expense...... 74.5 69.7
Amortization of mortgage servicing rights.. 223.9 138.7
Stock-based compensation................... 7.4 -
Mortgage servicing rights valuation
adjustments.............................. 800.5 146.7
Other...................................... 366.6 324.0
----------------- ----------------
Net adjustments.............................. 3,868.7 2,531.0
----------------- ----------------
Net cash provided by operating activities.... 3,795.6 2,871.2
INVESTING ACTIVITIES
Available-for-sale securities:
Purchases................................ (11,882.9) (10,818.6)
Sales.................................... 6,081.3 4,157.3
Maturities............................... 3,109.1 3,457.2
Net cash flows from trading securities....... (69.1) -
Mortgage loans acquired or originated........ (33,052.9) (27,931.2)
Mortgage loans sold or repaid................ 32,703.2 28,011.9
Purchase of mortgage servicing rights........ (695.6) (651.0)
Proceeds from sale of mortgage servicing
rights..................................... 11.3 29.6
Real estate acquired......................... (143.3) (228.9)
Real estate sold............................. 198.2 535.9
Net change in property and equipment......... (41.8) (58.6)
Net proceeds (disbursements) from sales of
subsidiaries............................... 1.4 (7.9)
Purchases of interest in subsidiaries, net
of cash acquired........................... (48.0) (4.2)
Net change in other investments.............. 258.7 (222.8)
----------------- ----------------
Net cash used in investing activities........ $ (3,570.4) $ (3,731.3)
6
PRINCIPAL FINANCIAL GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
(UNAUDITED)
FOR THE NINE MONTHS ENDED
SEPTEMBER 30,
----------------------------------
2002 2001
----------------- ----------------
(IN MILLIONS)
FINANCING ACTIVITIES
Issuance of common stock..................... $ 17.8 $ -
Acquisition and reissuance of treasury stock,
net........................................ (498.8) -
Issuance of long-term debt................... 11.0 157.0
Principal repayments of long-term debt....... (85.7) (110.0)
Proceeds of short-term borrowings............ 6,350.1 6,391.1
Repayment of short-term borrowings........... (6,387.4) (6,136.8)
Investment contract deposits................. 5,510.2 4,192.8
Investment contract withdrawals.............. (5,072.1) (4,307.2)
----------------- ----------------
Net cash provided by (used in) financing
activities................................. (154.9) 186.9
----------------- ----------------
Net increase (decrease) in cash and
cash equivalents........................... 70.3 (673.2)
Cash and cash equivalents at beginning of
period..................................... 561.2 791.0
----------------- ----------------
Cash and cash equivalents at end of period... $ 631.5 $ 117.8
================= ================
SEE ACCOMPANYING NOTES.
7
PRINCIPAL FINANCIAL GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2002
(UNAUDITED)
1. NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements of Principal
Financial Group, Inc. and its majority-owned subsidiaries ("the Company") have
been prepared in conformity with accounting principles generally accepted in the
U.S. ("U.S. GAAP") for interim financial statements and with the instructions to
Form 10-Q and Article 10 of Regulation S-X. In the opinion of management, all
adjustments (consisting of normal recurring accruals) considered necessary for a
fair presentation have been included. Operating results for the three months and
nine months ended September 30, 2002, are not necessarily indicative of the
results that may be expected for the year ended December 31, 2002. These interim
unaudited consolidated financial statements should be read in conjunction with
the Company's annual audited financial statements as of December 31, 2001,
included in the Company's Form 10-K for the year ended December 31, 2001, filed
with the United States Securities and Exchange Commission. The accompanying
consolidated statement of financial position at December 31, 2001, has been
derived from the audited consolidated statement of financial position but does
not include all of the information and footnotes required by U.S. GAAP for
complete financial statements.
Reclassifications have been made to the December 31, 2001 and September 30,
2001, financial statements to conform to the September 30, 2002, presentation.
SEPARATE ACCOUNTS
At September 30, 2002, the Separate Accounts included a separate account valued
at $942.5 million which primarily included shares of the Company's stock that
were allocated and issued to eligible participants of qualified employee benefit
plans administered by the Company as part of the policy credits issued under the
Company's demutualization. These shares are included in both basic and diluted
earnings per share calculations. The separate account shares are recorded at
fair value and are reported as separate account assets and separate account
liabilities in the consolidated statement of financial position. Activity of the
separate account shares is reflected in both the separate account assets and
separate account liabilities and does not impact the Company's results of
operations.
ACCOUNTING CHANGES
The Financial Accounting Standards Board (the "FASB") Statement of Financial
Accounting Standards ("SFAS") No. 123, ACCOUNTING FOR STOCK-BASED COMPENSATION
("SFAS 123"), encourages but does not require companies to record compensation
cost for stock-based employee compensation plans based on the fair value of
options granted. The Company has elected to adopt the fair value based method of
accounting prescribed in SFAS 123, retroactive to January 1, 2002, for its
employee stock-based compensation plans for all stock-based awards granted
subsequent to January 1, 2002. Prior to January 1, 2002, the Company elected to
account for its stock-based compensation plans under the provisions of
Accounting Principles Board ("APB") Opinion No. 25, ACCOUNTING FOR STOCK ISSUED
TO EMPLOYEES ("APB 25"), and accordingly, the majority of employee stock-based
compensation costs were excluded from compensation expense. For information
regarding the adoption of the fair value method defined in SFAS 123, refer to
Note 10.
In June 2002, the FASB issued SFAS No. 146, ACCOUNTING FOR COSTS ASSOCIATED WITH
EXIT OR DISPOSAL ACTIVITIES ("SFAS 146"), which is effective for exit or
disposal activities initiated after December 31, 2002. SFAS 146 addresses
financial accounting and reporting for costs incurred in connection with exit or
disposal activities and nullifies Emerging Issues Task Force ("EITF") Issue No.
94-3, LIABILITY RECOGNITION FOR CERTAIN EMPLOYEE TERMINATION BENEFITS AND OTHER
COSTS TO EXIT AN ACTIVITY (INCLUDING CERTAIN COSTS INCURRED IN A RESTRUCTURING)
("EITF 94-3"). Under SFAS 146, a liability related to an exit or disposal
activity is not recognized until such liability has actually been incurred
rather than at the date of an entity's commitment to an exit plan, which was the
standard for liability recognition under EITF 94-3. The Company has early
adopted SFAS 146, which did not have a material effect on its consolidated
financial statements.
8
PRINCIPAL FINANCIAL GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2002
(UNAUDITED)
1. NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
In June 2001, the FASB issued SFAS No. 141, BUSINESS COMBINATIONS ("SFAS 141"),
and SFAS No. 142, GOODWILL AND OTHER INTANGIBLE Assets ("SFAS 142"). SFAS 141
requires that the purchase method of accounting be used for all business
combinations initiated after June 30, 2001, and requires separate recognition of
intangible assets apart from goodwill, if such intangible assets meet certain
criteria. SFAS 142, effective January 1, 2002, prohibits the amortization of
goodwill and intangible assets with indefinite useful lives. Intangible assets
with finite lives will continue to be amortized over their estimated useful
lives. Additionally, SFAS 142 requires that goodwill and indefinite-lived
intangible assets be reviewed for impairment at least annually, which the
Company plans to do in the fourth quarter each year.
The initial adoption of SFAS 142 required the Company to perform a two-step
fair-value based goodwill impairment test. The first step of the test compared
the estimated fair value of the reporting unit to its carrying value, including
goodwill. If the carrying value exceeded fair value, a second step was
performed, which compared the implied fair value of the applicable reporting
unit's goodwill with the carrying amount of that goodwill, to measure the
goodwill impairment, if any. Additionally, the Company was required to perform
an impairment test on its indefinite-lived intangible assets, which consisted of
a comparison of the fair value of an intangible asset with its carrying amount.
The Company's measurements of fair value were based on evaluations of future
discounted cash flows, product level analysis, market performance assumptions
and cash flow assumptions. These evaluations utilized the best information
available in the circumstances, including reasonable and supportable assumptions
and projections. The discounted cash flow evaluations considered earnings
scenarios and the likelihood of possible outcomes. Collectively, these
evaluations were management's best estimate of projected future cash flows.
As a result of performing the two-step impairment test, the Company recorded
goodwill impairments of $196.5 million, $20.9 million and $4.6 million, net of
income taxes, related to its BT Financial Group ("BT"), Principal International
and Life and Health Insurance operations, respectively. Additionally, as a
result of performing the indefinite-lived intangible asset impairment test, the
Company recognized an after-tax impairment of $58.9 million to its brand name
and management rights intangible asset related to BT.
These impairments, recognized January 1, 2002, as a cumulative effect of a
change in accounting principle, were reported in the Company's operating
segments as follows (in millions):
INTERNATIONAL ASSET LIFE
MANAGEMENT AND AND HEALTH
ACCUMULATION INSURANCE CONSOLIDATED
----------------------- ---------------- -------------------
Goodwill......................................... $ 321.2 $4.6 $ 325.8
Indefinite-lived intangibles..................... 89.8 - 89.8
Income tax impact................................ (134.7) - (134.7)
----------------------- ---------------- -------------------
Total impairment, net of income taxes .......... $ 276.3 $4.6 $ 280.9
======================= ================ ===================
9
PRINCIPAL FINANCIAL GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2002
(UNAUDITED)
1. NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Net income and earnings per share (basic and diluted) for the three months and
nine months ended September 30, 2002 and 2001, adjusted for the effects of SFAS
142 related to non-amortization of goodwill and indefinite-lived intangibles,
are as follows (in millions, except per share data):
FOR THE THREE MONTHS ENDED FOR THE NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------------- ------------------------------------
2002 2001(1) 2002 2001(1)
-------------- -------------- ----------------- ----------------
Reported net income (loss) ............ $ (158.4) $ 115.8 $(73.1) $ 340.2
Adjustment for amortization expense:
Goodwill (2)......................... - 2.6 - 7.7
Amortization included in
discontinued operations (see
Note 3) ........................... - 8.7 - 30.2
-------------- -------------- ----------------- ----------------
Total amortization expense ............ - 11.3 - 37.9
Tax impacts of amortization expense ... - (3.1) - (10.4)
-------------- -------------- ----------------- ----------------
Adjusted net income (loss)............. $ (158.4) $ 124.0 $(73.1) $ 367.7
============== ============== ================= ================
Basic earnings per share:
Reported net income (loss) ............ $ (0.46) $ 0.32 $ (0.21) $ 0.94
Adjustment for amortization expense:
Goodwill............................. - 0.01 - 0.02
Amortization included in
discontinued operations............ - 0.02 - 0.09
-------------- -------------- ----------------- ----------------
Total amortization expense ............ - 0.03 - 0.11
Tax impacts of amortization expense ... - (0.01) - (0.03)
-------------- -------------- ----------------- ----------------
Adjusted net income (loss)............. $ (0.46) $ 0.34 $ (0.21) $ 1.02
============== ============== ================= ================
Diluted earnings per share:
Reported net income (loss)............. $ (0.45) $ 0.32 $ (0.21) $ 0.94
Adjustment for amortization expense:
Goodwill............................. - 0.01 - 0.02
Amortization included in
discontinued operations............ - 0.02 - 0.09
------------- -------------- ----------------- ----------------
Total amortization expense ............ - 0.03 - 0.11
Tax impacts of amortization expense ... - (0.01) - (0.03)
------------- -------------- ----------------- ----------------
Adjusted net income (loss)............. $ (0.45) $ 0.34 $ (0.21) $ 1.02
============= ============== ================= ================
- ------
(1) For purposes of the Company's unaudited basic and diluted pro-forma earnings
per share calculations, the weighted average number of shares outstanding during
the three months and nine months ended September 30, 2001, was assumed to be
360.8 million shares. These shares represent 260.8 million shares issued to
policyholders entitled to receive compensation in the demutualization and 100.0
million shares sold to investors in the initial public offering ("IPO"),
effective October 26, 2001.
(2) Includes amortization expenses related to equity investment subsidiaries of
the Company.
10
PRINCIPAL FINANCIAL GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2002
(UNAUDITED)
1. NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
In August 2001, the FASB issued SFAS No. 144, ACCOUNTING FOR THE IMPAIRMENT OR
DISPOSAL OF LONG-LIVED ASSETS ("SFAS 144"). This Statement supersedes SFAS No.
121, ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS AND FOR LONG-LIVED
ASSETS TO BE DISPOSED OF, and amends APB Opinion No. 30, REPORTING THE RESULTS
OF OPERATIONS - REPORTING THE EFFECTS OF DISPOSAL OF A SEGMENT OF A BUSINESS,
AND EXTRAORDINARY, UNUSUAL AND INFREQUENTLY OCCURRING EVENTS AND TRANSACTIONS
("APB 30"), establishing a single accounting model for the disposal of
long-lived assets. SFAS 144 generally retains the basic provisions of existing
guidance, but broadens the presentation of any discontinued operations to
include a component of an entity (rather than a segment of a business as defined
in APB 30). The Company adopted SFAS 144 on January 1, 2002, which did not have
a significant impact on the Company's consolidated financial statements as of
the adoption date. On August 25, 2002, the Company entered into an agreement to
sell substantially all of BT (see Note 3). The sale of BT is accounted for under
the provisions of SFAS 144 and consistent with such guidance, the BT results and
loss on sale are reported as a discontinued operation at September 30, 2002.
SFAS 144 also eliminated the temporary control exception when determining the
consolidation of affiliated entities. This change impacted the reporting of the
Company's investment in company sponsored mutual funds whereby the Company now
reports the change in value of its investment as a part of net income rather
than as an unrealized gain or loss on equity securities available-for-sale. The
change in value is reported in the net realized/unrealized capital losses line
on the consolidated statement of operations.
On January 1, 2001, the Company adopted SFAS No. 133, ACCOUNTING FOR DERIVATIVE
INSTRUMENTS AND HEDGING ACTIVITIES ("SFAS 133"), as amended by SFAS No. 138,
ACCOUNTING FOR CERTAIN DERIVATIVE INSTRUMENTS AND CERTAIN HEDGING ACTIVITIES -
AN AMENDMENT OF FASB STATEMENT NO. 133. As amended, SFAS 133 requires, among
other things, that all derivatives be recognized in the consolidated statement
of financial position as either assets or liabilities that are measured at fair
value. SFAS 133 also established special accounting for qualifying hedges, which
allows for matching the timing of gain or loss recognition on the hedging
instrument with the recognition of the corresponding changes in value of the
hedged item. Changes in the fair value of a derivative qualifying as a hedge are
recognized in earnings or directly in stockholders' equity depending on the
instrument's intended use. For derivatives that are not designated as hedges or
that do not meet the hedge accounting criteria in SFAS 133, changes in fair
value are required to be recognized in earnings in the period of change.
At January 1, 2001, the Company's consolidated financial statements were
adjusted to record a cumulative effect of adopting SFAS 133, as follows (in
millions):
ACCUMULATED OTHER
NET LOSS COMPREHENSIVE LOSS
-------------- ---------------------
Adjustment to fair value of
derivative contracts (1)..... $(16.4) $(15.8)
Income tax impact.............. 5.7 1.6
-------------- ---------------------
Total ......................... $(10.7) $(14.2)
============== =====================
- ------------------
(1) Amount presented is net of adjustment to hedged item.
11
PRINCIPAL FINANCIAL GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2002
(UNAUDITED)
2. GOODWILL AND OTHER INTANGIBLE ASSETS
Amortized intangible assets are as follows (in millions):
AS OF SEPTEMBER 30, 2002 AS OF DECEMBER 31, 2001
--------------------------------------- ---------------------------------------
GROSS NET GROSS NET
CARRYING ACCUMULATED CARRYING CARRYING ACCUMULATED CARRYING
AMOUNT AMORTIZATION AMOUNT AMOUNT AMORTIZATION AMOUNT
---------- ---------------- ----------- ----------- ------------------ --------
Value of insurance in
force acquired............ $50.4 $6.0 $44.4 $54.4 $7.2 $47.2
Other ...................... 1.6 0.4 1.2 2.1 0.2 1.9
---------- ---------------- ----------- ----------- ------------------ --------
Total amortized
intangibles .............. $52.0 $6.4 $45.6 $56.5 $7.4 $49.1
========== ================ =========== =========== ================== ========
Unamortized intangible assets are as follows (in millions):
AS OF SEPTEMBER 30, AS OF DECEMBER 31,
2002 2001
------------------------ ------------------------
NET CARRYING NET CARRYING
AMOUNT AMOUNT
------------------------ ------------------------
Other indefinite-lived
intangible assets........ $10.2 $12.4
======================== ========================
The amortization expense for the definite-lived intangible assets were $0.8
million and $1.8 million for the three months and nine months ended September
30, 2002, respectively, and $0.5 million and $1.6 million for the three months
and nine months ended September 30, 2001, respectively. At December 31, 2001,
the estimated amortization expense for the next five years is as follows (in
millions):
Estimated
Amortization Expense
----------------------
2002................ $1.7
2003................ 1.8
2004................ 1.7
2005................ 1.6
2006................ 1.6
12
PRINCIPAL FINANCIAL GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2002
(UNAUDITED)
2. GOODWILL AND OTHER INTANGIBLE ASSETS (CONTINUED)
The changes in the carrying amount of goodwill reported in the Company's
operating segments for the nine months ended September 30, 2002, are as follows
(in millions):
U.S. ASSET
MANAGEMENT INTERNATIONAL LIFE AND
AND ASSET MANAGEMENT HEALTH MORTGAGE
ACCUMULATION AND ACCUMULATION INSURANCE BANKING CONSOLIDATED
--------------- ------------------ -------------- -------------- ----------------
Balance at January 1, 2002..... $12.5 $33.7 $49.4 $8.4 $ 104.0
Goodwill from acquisitions..... - 33.3 - - 33.3
Goodwill disposed of
during the period............ - - (0.7) - (0.7)
Cumulative effect of
accounting change (1)........ - - (4.6) - (4.6)
Foreign currency translation... - (6.0) - - (6.0)
--------------- ------------------ -------------- -------------- ----------------
Balance at September 30, 2002.. $12.5 $61.0 $44.1 $8.4 $ 126.0
=============== ================== ============== ============== ================
- ------
(1) Excludes goodwill impairments of $300.3 million related to BT (see Note 3)
and $20.9 million related to an equity investment subsidiary of Principal
International.
3. DISCONTINUED OPERATIONS
On August 25, 2002, the Company announced it had entered into an agreement to
sell substantially all of BT to Westpac Banking Corporation ("Westpac") for
estimated proceeds of A$900.0 million Australian dollars ("A$") (approximately
U.S. $500.0 million), and future contingent proceeds in 2004 of up to A$150.0
million (approximately U.S. $80.0 million). The contingent proceeds will be
based on Westpac's future success in growing retail funds under management.
Excluding the contingent proceeds, the Company estimates after-tax proceeds of
approximately U.S. $870.0 million. This amount includes cash proceeds, tax
benefits, and a gain from unwinding the hedged asset associated with debt used
to acquire BT in 1999. The Company closed the sale of BT on October 31, 2002 and
has accrued for an estimated after-tax loss on disposal of $206.6 million as of
September 30, 2002. Future adjustments to the estimated loss are expected to be
recorded through the first half of 2003, as the proceeds from the sale are
finalized.
BT is accounted for as a discontinued operation and therefore, the results of
operations (excluding corporate overhead) and cash flows have been removed from
the Company's results of continuing operations for all periods presented.
Corporate overhead allocated to BT does not qualify for discontinued operations
treatment under SFAS 144, and therefore is still included in the Company's
results of continuing operations. Assets and liabilities related to BT have been
reclassified to assets of discontinued operations and liabilities of
discontinued operations on the Company's consolidated statements of financial
position for all periods presented. Additionally, the results of operations
(excluding corporate overhead) for BT are reported as non-recurring items for
the International Asset Management and Accumulation segment in the Segment
Information note (Note 9).
13
PRINCIPAL FINANCIAL GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2002
(UNAUDITED)
3. DISCONTINUED OPERATIONS (CONTINUED)
Selected financial information for the discontinued operations is as follows:
AS OF SEPTEMBER 30, AS OF DECEMBER 31,
2002 2001
-------------------------- -------------------------
(IN MILLIONS)
ASSETS
Goodwill and other intangibles .................... $ 419.6 $ 993.0
Separate account assets ........................... 1,539.9 1,488.8
Other assets ...................................... 575.7 492.5
-------------------------- -------------------------
Total assets of discontinued operations ......... $ 2,535.2 $ 2,974.3
========================== =========================
LIABILITIES
Separate account liabilities....................... 1,539.9 1,488.8
Other liabilities ................................. 92.5 284.5
-------------------------- -------------------------
Total liabilities of discontinued operations ... $ 1,632.4 $ 1,773.3
========================== =========================
FOR THE THREE MONTHS ENDED FOR THE NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------------------- -----------------------------------
2002 2001 2002 2001
-------------- --------------- -------------- -----------------
(IN MILLIONS)
Total revenues ........................ $ 39.2 $50.5 $ 128.1 $173.0
============== =============== ============== =================
Loss from continuing operations,
net of related income taxes
(corporate overhead)................ $ (0.8) $(1.0) $ (2.3) $ (2.7)
Loss from discontinued operations:
Income (loss) before income taxes... 3.9 (5.8) 16.3 (10.1)
Income taxes (benefits)............. (1.7) (1.7) 4.6 (1.9)
-------------- --------------- -------------- -----------------
Income (loss) from discontinued 5.6 (4.1) 11.7 (8.2)
operations .......................
Loss on disposal, net of related
income taxes...................... (206.6) - (206.6) -
-------------- --------------- -------------- -----------------
Loss from discontinued operations, (201.0) (4.1) (194.9) (8.2)
net of related income taxes.........
Cumulative effect of accounting change,
net of related income taxes......... - - (255.4) -
-------------- --------------- -------------- -----------------
Net loss............................... $(201.8) $(5.1) $ (452.6) $(10.9)
============== =============== ============== =================
14
PRINCIPAL FINANCIAL GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2002
(UNAUDITED)
4. ACQUISITIONS AND OTHER DIVESTITURES
On May 31, 2002, the Company purchased a 100% ownership of Zurich AFORE S.A. de
C.V. ("Zurich AFORE") in Mexico from Zurich Financial Services for $49.0 million
in cash. The operations of Zurich AFORE have been integrated into Principal
International, Inc., as a part of the Company's International Asset Management
and Accumulation segment.
On February 1, 2002, the Company sold its remaining stake of 15.1 million shares
in Coventry Health Care, Inc. ("Coventry") common stock and a warrant,
exercisable for 3.1 million shares of Coventry common stock. Total proceeds from
the completion of this transaction were $325.4 million and the Company
recognized a net realized capital gain of $183.0 million.
5. CLOSED BLOCK
In connection with its 1998 mutual insurance holding company formation,
Principal Life Insurance Company ("Principal Life") formed and began operating a
closed block ("Closed Block") for the benefit of individual participating
dividend-paying policies in force on that date. As of September 30, 2002,
cumulative actual earnings have been less than cumulative expected earnings.
However, cumulative net unrealized gains were greater than expected resulting in
the recognition of a policyholder dividend obligation of $16.1 million as of
September 30, 2002.
Closed Block liabilities and assets designated to the Closed Block are as
follows:
AS OF SEPTEMBER 30, AS OF DECEMBER 31,
2002 2001
--------------------- ----------------------
(IN MILLIONS)
CLOSED BLOCK LIABILITIES
Future policy benefits and
claims......................... $5,295.2 $5,248.7
Other policyholder funds......... 30.4 20.3
Policyholder dividends payable... 381.0 376.6
Policyholder dividend obligation. 16.1 -
Other liabilities................ 37.7 11.8
--------------------- ----------------------
Total Closed Block
liabilities.................... 5,760.4 5,657.4
ASSETS DESIGNATED TO THE CLOSED BLOCK
Fixed maturities,
available-for-sale............. 2,643.7 2,466.3
Equity securities,
available-for-sale............. 23.4 23.4
Mortgage loans................... 859.3 880.0
Policy loans..................... 779.2 792.5
Other investments................ 6.9 6.9
--------------------- ----------------------
Total investments.............. 4,312.5 4,169.1
Cash and cash equivalents
(deficit)...................... 36.0 (8.0)
Accrued investment income........ 73.9 77.2
Deferred tax asset............... 70.6 80.8
Premiums due and other
receivables.................... 29.7 33.3
--------------------- ----------------------
Total assets designated
to the Closed Block.......... 4,522.7 4,352.4
--------------------- ----------------------
Excess of Closed Block liabilities
over assets designated to the
Closed Block................... 1,237.7 1,305.0
Amounts included in other
comprehensive income........... 72.6 43.6
--------------------- ----------------------
Maximum future earnings to be
recognized from Closed Block
assets and liabilities......... $1,310.3 $1,348.6
===================== ======================
15
PRINCIPAL FINANCIAL GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2002
(UNAUDITED)
5. CLOSED BLOCK (CONTINUED)
Closed Block revenues and expenses were as follows:
FOR THE THREE MONTHS ENDED FOR THE NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------------------- -----------------------------------
2002 2001 2002 2001
-------------- --------------- -------------- -----------------
(IN MILLIONS)
REVENUES
Premiums and other considerations..... $ 171.0 $177.2 $ 530.8 $ 553.3
Net investment income................. 77.3 78.1 233.5 229.9
Net realized/unrealized
capital losses ..................... (5.3) (1.2) (27.3) (3.0)
-------------- --------------- -------------- -----------------
Total revenues...................... 243.0 254.1 737.0 780.2
EXPENSES
Benefits, claims, and
settlement expenses................. 141.3 146.1 432.6 451.2
Dividends to policyholders............ 76.4 77.6 231.6 235.8
Operating expenses.................... 2.7 2.7 8.9 8.9
-------------- --------------- -------------- -----------------
Total expenses...................... 220.4 226.4 673.1 695.9
-------------- --------------- -------------- -----------------
Closed Block revenue, net of Closed
Block expenses, before income taxes. 22.6 27.7 63.9 84.3
Income taxes.......................... 7.5 8.8 20.8 27.3
-------------- --------------- -------------- -----------------
Closed Block revenue, net of Closed
Block expenses and income taxes..... 15.1 18.9 43.1 57.0
Funding adjustment charges............ (0.9) (3.3) (4.8) (6.6)
-------------- --------------- -------------- -----------------
Closed Block revenue, net of Closed
Block expenses, income taxes
and funding adjustment charges...... $ 14.2 $ 15.6 $ 38.3 $ 50.4
============== =============== ============== =================
The change in maximum future earnings of the Closed Block was as follows:
AS OF OR FOR THE NINE MONTHS
ENDED SEPTEMBER 30,
-------------------------------
2002 2001
-------------- ----------------
(IN MILLIONS)
Beginning of year........................... $ 1,348.6 $1,408.8
End of period............................... 1,310.3 1,358.4
-------------- ----------------
Change in maximum future earnings........... $ (38.3) $ (50.4)
============== ================
Principal Life charges the Closed Block with federal income taxes, payroll
taxes, state and local premium taxes and other state or local taxes, licenses
and fees as provided in the plan of reorganization.
16
PRINCIPAL FINANCIAL GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2002
(UNAUDITED)
6. FEDERAL INCOME TAXES
The effective income tax rate on net income for the three months and nine months
ended September 30, 2002 and 2001, is lower than the prevailing corporate
federal income tax rate primarily due to income tax deductions allowed for
corporate dividends received, partially offset by additional state income taxes.
7. COMPREHENSIVE INCOME
Comprehensive income is as follows:
FOR THE THREE FOR THE NINE
MONTHS ENDED MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------- -------------------------
2002 2001 2002 2001
----------- ---------- ----------- ----------
(IN MILLIONS)
COMPREHENSIVE INCOME:
Net income (loss).................................... $ (158.4) $ 115.8 $(73.1) $ 340.2
Net change in unrealized gains and losses on fixed
maturities, available-for-sale.................... 557.0 550.4 603.9 731.8
Net change in unrealized gains and losses on equity
securities, available-for-sale, including seed
money in separate accounts........................ 35.0 (109.6) 39.4 (34.9)
Adjustments for assumed changes in amortization
patterns:
Deferred policy acquisition costs................. (56.9) (73.0) (82.0) (99.8)
Unearned revenue reserves......................... 4.3 5.6 4.9 6.2
Net change in unrealized gains and losses on
derivative instruments............................ (124.9) (50.7) (138.9) (53.2)
Adjustments to unrealized gains for policyholder
dividend obligation............................... (16.1) (8.8) (16.1) (8.8)
Provision for deferred income taxes.................. (143.4) (110.0) (146.5) (195.6)
Change in net foreign currency translation
adjustment........................................ 89.9 (29.1) 95.7 (105.2)
Cumulative effect of accounting change, net of
related income taxes.............................. - - - (14.2)
----------- ---------- ---------- ----------
Comprehensive income................................. $ 186.5 $ 290.6 $287.3 $ 566.5
=========== ========== ========== ==========
8. COMMITMENTS AND CONTINGENCIES
LITIGATION
The Company is a plaintiff or defendant in actions arising out of its
operations. The Company is, from time to time, also involved in various
governmental and administrative proceedings. While the outcome of any pending or
future litigation cannot be predicted, management does not believe that any
pending litigation will have a material adverse effect on the Company's
business, financial condition or results of operations. However, no assurances
can be given that such litigation would not materially and adversely affect the
Company's business, financial condition or results of operations.
Other companies in the life insurance industry have historically been subject to
substantial litigation resulting from claims disputes and other matters. Most
recently, such companies have faced extensive claims, including class-action
lawsuits, alleging improper life insurance sales practices. Negotiated
settlements of such class-action lawsuits have had a material adverse effect on
the business, financial condition and results of operations of certain of these
companies. Principal Life is currently a defendant in two class-action lawsuits,
which allege improper sales practices.
17
PRINCIPAL FINANCIAL GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2002
(UNAUDITED)
8. COMMITMENTS AND CONTINGENCIES (CONTINUED)
In 2000, the Company reached an agreement to settle these two class-action
lawsuits alleging improper sales practices. In April 2001, the proposed
settlement of the class-action lawsuits received court approval. In agreeing to
the settlement, the Company specifically denied any wrongdoing. The Company has
accrued a loss reserve for its best estimate based on information available, and
believes this reserve is sufficient to cover the Company's obligation under the
settlement. A number of persons and entities who were eligible to be class
members have excluded themselves from the class (or "opted out"), as the law
permits them to do. The Company has been notified that some of those who opted
out from the class will file lawsuits and make claims similar to those addressed
by the settlement. Some of these lawsuits are presently on file. The Company has
accrued a loss reserve for its best estimate of its potential exposure to the
suits and claims. As uncertainties continue to exist in resolving this matter,
it is reasonably possible that all the actual costs of the suits and claims
could exceed the Company's estimate. The range of any such costs cannot be
presently estimated; however, the Company believes the additional costs will not
have a material impact on its business, financial condition or results of
operations.
9. SEGMENT INFORMATION
The Company provides financial products and services through the following
segments: U.S. Asset Management and Accumulation, International Asset Management
and Accumulation, Life and Health Insurance and Mortgage Banking. In addition,
there is a Corporate and Other segment. The segments are managed and reported
separately because they provide different products and services, have different
strategies or have different markets and distribution channels.
The U.S. Asset Management and Accumulation segment provides retirement and
related financial products and services primarily to businesses, their employees
and other individuals and provides asset management services to the Company's
asset accumulation business, the life and health insurance operations and
third-party clients.
The International Asset Management and Accumulation segment provides asset
management products and services to retail clients in Australia and
institutional clients throughout the world and provides life insurance and
retirement and related financial products and services primarily to businesses,
their employees and other individuals principally in Australia, Chile, Brazil,
New Zealand, Mexico, India, Japan, Argentina and Hong Kong. On August 25, 2002,
the Company signed an agreement to sell substantially all of BT (an asset
management company operating in Australia and New Zealand), described further in
Note 3. As a result, the results of operations (excluding corporate overhead)
for BT are reported as non-recurring items for all periods presented.
The Life and Health insurance segment provides individual life and disability
insurance to the owners and employees of businesses and other individuals in the
U.S. and provides group life and health insurance to businesses in the U.S.
The Mortgage Banking segment originates and services residential mortgage loan
products for customers primarily in the U.S.
The Corporate and Other segment manages the assets representing capital that has
not been allocated to any other segment. Financial results of the Corporate and
Other segment primarily reflect financing activities for the Company, income on
capital not allocated to other segments, intersegment eliminations and
non-recurring or other income or expenses not allocated to the segments based on
review of the nature of such items.
The Corporate and Other segment includes an equity ownership interest in
Coventry. The ownership interest was sold on February 1, 2002, described further
in Note 4. The Corporate and Other segment's equity in earnings of Coventry,
which was included in net investment income, was $2.1 million for the nine
months ended September 30, 2002, and $5.2 million and $15.1 million for the
three months and nine months ended September 30, 2001, respectively.
18
PRINCIPAL FINANCIAL GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2002
(UNAUDITED)
9. SEGMENT INFORMATION (CONTINUED)
The Company evaluates segment performance on segment operating earnings, which
is determined by adjusting U.S. GAAP net income for net realized/unrealized
capital gains and losses, as adjusted, and non-recurring items which management
believes are not indicative of overall operating trends. Net realized/unrealized
capital gains and losses, as adjusted, are net of income taxes, related changes
in the amortization pattern of deferred policy acquisition costs, recognition of
front-end fee revenues for sales charges on pension products and services, net
realized capital gains credited to customers and certain market value
adjustments to fee revenues. Segment operating revenues exclude net
realized/unrealized capital gains and their impact on recognition of front-end
fee revenues. While these items may be significant components in understanding
and assessing the consolidated financial performance, management believes the
presentation of segment operating earnings enhances the understanding of the
Company's results of operations by highlighting earnings attributable to the
normal, recurring operations of the business. However, segment operating
earnings are not a substitute for net income determined in accordance with U.S.
GAAP.
For the three months ended September 30, 2002, non-recurring items of $214.0
million, net of income taxes, included the negative effects of: (1) a loss from
the discontinued operations of BT ($201.0 million); and (2) an increase to a
loss contingency reserve established for sales practice litigation ($13.0
million).
For the three months ended September 30, 2001, non-recurring items of $8.2
million, net of income taxes, included the negative effects of: (1) expenses
related to the demutualization ($4.1 million); and (2) a loss from the
discontinued operations of BT ($4.1 million).
For the nine months ended September 30, 2002, non-recurring items of $490.8
million, net of income taxes, included the negative effects of: (1) a cumulative
effect of accounting change related to the implementation of SFAS 142 ($280.9
million); (2) a loss from the discontinued operations of BT ($194.9 million);
(3) an increase to a loss contingency reserve established for sales practice
litigation ($13.0 million); and (4) expenses related to the demutualization
($2.0 million).
For the nine months ended September 30, 2001, non-recurring items of $43.7
million, net of income taxes, included the negative effects of: (1) expenses
related to the demutualization ($18.9 million); (2) a cumulative effect of
change in accounting principle related to the implementation of SFAS 133 ($10.7
million); (3) a loss from the discontinued operations of BT ($8.2 million); and
(4) an increase to a loss contingency reserve established for sales practices
litigation ($5.9 million).
The accounting policies of the segments are similar to those of the Company,
with the exception of capital allocation. The Company allocates capital to its
segments based upon an internal capital model that allows management to more
effectively manage the Company's capital.
19
PRINCIPAL FINANCIAL GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2002
(UNAUDITED)
9. SEGMENT INFORMATION (CONTINUED)
The following tables summarize selected financial information on a continuing
basis by segment as of or for the three months ended September 30, 2002 and
2001, and reconciles segment totals to those reported in the consolidated
financial statements (in millions):
INTERNATIONAL
U.S. ASSET ASSET
MANAGEMENT MANAGEMENT LIFE AND
AND AND HEALTH MORTGAGE CORPORPATE AND
ACCUMULATION ACCUMULATION INSURANCE BANKING OTHER CONSOLIDATED
-------------- --------------- ------------- ------------- --------------- --------------
2002
Revenues:
Operating revenues........ $ 865.9 $ 82.8 $ 987.7 $312.9 $ (15.8) $ 2,233.5
Net realized/unrealized
capital gains (losses).. (83.1) 0.5 (16.0) - (132.0) (230.6)
Plus recognition of
front-end fee revenues.. 2.0 - - - - 2.0
Less capital gains
distributed as market
value adjustment........ (9.0) - - - - (9.0)
-------------- --------------- ------------- ------------- --------------- --------------
Revenues.................... $ 775.8 $ 83.3 $ 971.7 $312.9 $ (147.8) $ 1,995.9
============== =============== ============= ============= =============== ==============
Net income:
Operating earnings (loss). $ 84.9 $ 5.0 $ 55.7 $ 62.5 $ (5.6) $ 202.5
Net realized/unrealized
capital gains (losses),
as adjusted............. (55.0) 3.0 (10.1) - (84.8) (146.9)
Non-recurring items....... - (201.0) - - (13.0) (214.0)
-------------- --------------- ------------- ------------- --------------- --------------
Net income (loss)........... $ 29.9 $ (193.0) $ 45.6 $ 62.5 $ (103.4) $ (158.4)
============== =============== ============= ============= =============== ==============
Other segment data:
Revenues from external
customers............... $ 763.1 $ 82.9 $ 972.8 $303.0 $ (125.9) $ 1,995.9
Intersegment revenues..... 12.7 0.4 (1.1) 9.9 (21.9) -
Interest expense.......... 0.7 0.2 0.1 - 20.0 21.0
Income tax expense
(benefit)............... (11.2) 0.7 23.9 52.5 (63.5) 2.4
Amortization of
intangibles............. 0.1 0.7 - - - 0.8
20
PRINCIPAL FINANCIAL GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2002
(UNAUDITED)
9. SEGMENT INFORMATION (CONTINUED)
INTERNATIONAL
U.S. ASSET ASSET
MANAGEMENT MANAGEMENT LIFE AND
AND AND HEALTH MORTGAGE CORPORPATE AND
ACCUMULATION ACCUMULATION INSURANCE BANKING OTHER CONSOLIDATED
-------------- --------------- ------------- ------------- --------------- --------------
2001
Revenues:
Operating revenues........ $1,065.4 $ 224.2 $ 970.3 $207.7 $ 16.7 $2,484.3
Net realized/unrealized
capital losses.......... (47.2) (5.2) (7.6) - (20.1) (80.1)
Plus recognition of
front-end fee revenues.. 0.8 - - - - 0.8
-------------- --------------- -------------- ------------- -------------- --------------
Revenues.................... $1,019.0 $ 219.0 $ 962.7 $207.7 $ (3.4) $2,405.0
============== =============== ============== ============= ============== ==============
Net income:
Operating earnings (loss) $ 82.5 $ 1.7 $ 60.7 $ 26.5 $ (2.6) $ 168.8
Net realized/unrealized
capital gains (losses),
as adjusted............. (28.6) 1.3 (4.3) - (13.2) (44.8)
Non-recurring items....... - (4.1) - - (4.1) (8.2)
-------------- --------------- -------------- ------------- -------------- --------------
Net income (loss)........... $ 53.9 $ (1.1) $ 56.4 $ 26.5 $(19.9) $ 115.8
============== =============== ============== ============= ============== ==============
Other segment data:
Revenues from external
customers............... $1,007.1 $ 218.5 $ 963.5 $207.7 $ 8.2 $2,405.0
Intersegment revenues..... 11.9 0.5 (0.8) - (11.6) -
Interest expense.......... 0.7 0.1 (1.6) - 18.6 17.8
Income tax expense
(benefit)............... (2.6) (9.2) 28.1 20.4 (2.2) 34.5
Amortization of goodwill
and other intangibles... 0.3 0.9 1.1 0.1 - 2.4
21
PRINCIPAL FINANCIAL GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2002
(UNAUDITED)
9. SEGMENT INFORMATION (CONTINUED)
The following tables summarize selected financial information on a continuing
basis by segment as of or for the nine months ended September 30, 2002 and 2001,
and reconciles segment totals to those reported in the consolidated financial
statements (in millions):
INTERNATIONAL
U.S. ASSET ASSET
MANAGEMENT MANAGEMENT LIFE AND
AND AND HEALTH MORTGAGE CORPORATE AND
ACCUMULATION ACCUMULATION INSURANCE BANKING OTHER CONSOLIDATED
-------------- --------------- -------------- ------------- -------------- --------------
2002
Revenues:
Operating revenues........ $ 2,863.7 $ 252.3 $ 2,950.7 $731.3 $ 1.4 $ 6,799.4
Net realized/unrealized
capital gains (losses).. (246.0) 37.1 (66.4) - 51.3 (224.0)
Plus recognition of
front-end fee revenues.. 6.0 - - - - 6.0
Less capital gains
distributed as market
value adjustment........ (22.2) - - - - (22.2)
-------------- --------------- -------------- ------------- --------------- -------------
Revenues.................... $ 2,601.5 $ 289.4 $ 2,884.3 $731.3 $ 52.7 $ 6,559.2
============== =============== ============== ============= =============== =============
Net income:
Operating earnings (loss). $ 287.2 $ 10.1 $ 171.7 $113.8 $ (11.3) $ 571.5
Net realized/unrealized
capital gains (losses),
as adjusted............. (160.2) 14.0 (41.4) - 33.8 (153.8)
Non-recurring items....... - (471.2) (4.6) - (15.0) (490.8)
-------------- --------------- -------------- ------------- --------------- -------------
Net income (loss)........... $ 127.0 $ (447.1) $ 125.7 $113.8 $ 7.5 $ (73.1)
============== =============== ============== ============= =============== =============
Other segment data:
Revenues from external
customers............... $ 2,560.8 $ 288.2 $ 2,888.5 $721.4 $ 100.3 $ 6,559.2
Intersegment revenues..... 40.7 1.2 (4.2) 9.9 (47.6) -
Interest expense.......... 2.8 0.5 0.3 - 63.2 66.8
Income tax expense
(benefit)............... (12.4) 6.8 68.2 82.9 (4.9) 140.6
Amortization of
intangibles............. 0.1 1.6 0.1 - - 1.8
22
PRINCIPAL FINANCIAL GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2002
(UNAUDITED)
9. SEGMENT INFORMATION (CONTINUED)
INTERNATIONAL
U.S. ASSET ASSET
MANAGEMENT MANAGEMENT LIFE AND
AND AND HEALTH MORTGAGE CORPORATE AND
ACCUMULATION ACCUMULATION INSURANCE BANKING OTHER CONSOLIDATED
-------------- --------------- -------------- ------------- -------------- --------------
2001
Revenues:
Operating revenues........ $2,923.6 $ 409.1 $ 2,948.5 $500.8 $ 74.6 $ 6,856.6
Net realized/unrealized
capital losses.......... (112.6) (43.9) (16.7) - (83.8) (257.0)
Plus recognition of
front-end fee revenues.. 1.3 - - - - 1.3
--------------- ---------------- ------------- ------------- -------------- --------------
Revenues.................... $2,812.3 $ 365.2 $ 2,931.8 $500.8 $ (9.2) $ 6,600.9
=============== ================ ============= ============= ============== ==============
Net income:
Operating earnings........ $ 259.4 $ 1.1 $ 151.6 $ 95.3 $ 29.5 $ 536.9
Net realized/unrealized
capital losses,
as adjusted............. (69.4) (19.9) (9.0) - (54.7) (153.0)
Non-recurring items....... (10.8) (8.2) 0.1 - (24.8) (43.7)
--------------- ---------------- ------------- ------------- -------------- --------------
Net income (loss)........... $ 179.2 $ (27.0) $ 142.7 $ 95.3 $(50.0) $ 340.2
=============== ================ ============= ============= ============== ==============
Other segment data:
Revenues from external
customers............... $2,774.2 $364.1 $ 2,934.3 $500.8 $ 27.5 $ 6,600.9
Intersegment revenues..... 38.1 1.1 (2.5) - (36.7) -
Interest expense.......... 2.8 0.1 0.6 - 54.7 58.2
Income tax expense
(benefit)............... 14.2 (28.8) 71.6 57.4 (23.6) 90.8
Amortization of goodwill
and other intangibles... 0.7 2.9 3.0 0.6 - 7.2
Summarized assets by segment are as follows:
AS OF SEPTEMBER 30, AS OF DECEMBER 31,
2002 2001
---------------------- -------------------
(IN MILLIONS)
ASSETS
U.S. Asset Management and
Accumulation............... $68,556.7 $68,543.8
International Asset
Management and
Accumulation............... 4,528.1 4,956.9
Life and Health Insurance.... 11,152.0 10,776.2
Mortgage Banking ............ 3,220.3 2,718.8
Corporate and Other.......... 813.6 1,354.8
---------------------- -------------------
Total Consolidated Assets.. $88,270.7 $88,350.5
====================== ===================
23
PRINCIPAL FINANCIAL GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2002
(UNAUDITED)
10. STOCK COMPENSATION PLANS
Effective July 1, 2002, the Company adopted the fair value method for
stock-based compensation as defined in SFAS 123 in accounting for the Company's
Stock Incentive Plan, Board of Directors' Stock Plan and Employee Stock Purchase
Plan. SFAS 123, which indicates that the fair value method is the preferable
method of accounting, requires that the fair value method for stock-based
compensation be applied as of the beginning of the fiscal year in which it is
adopted for all stock-based awards granted subsequent to such date. The
financial statements for the first two quarters of 2002 were not restated for
this change since its effects were not materially different from amounts
reported for both financial position and results of operations. Such effects for
the first two quarters of 2002 were charged against income for the three and
nine months ended September 30, 2002 and were not material to such results of
operations. The Company expects its stock-based compensation expense to increase
in future years due to the cumulative impact of anticipated future grants. Prior
to January 1, 2002, the Company applied the intrinsic value method (as permitted
under SFAS 123) defined in APB 25 and related Interpretations, which excluded
employee options and stock purchases from compensation expense. Compensation
expense was recognized for stock option awards issued to career agents using the
fair value method as prescribed in FASB Interpretation No. 44, ACCOUNTING FOR
CERTAIN TRANSACTIONS INVOLVING STOCK COMPENSATION - AN INTERPRETATION OF APB
OPINION NO. 25.
11. STOCKHOLDERS' EQUITY
COMMON STOCK
During the nine months ended September 30, 2002, the Company repurchased 17.9
million shares of its outstanding common stock on the open market at an
aggregate cost of $506.4 million relating to two authorized stock repurchase
programs. The Company purchased 15.9 million shares at an aggregate cost of
$450.0 million completing a stock repurchase program authorized in February
2002. The Company purchased 2.0 million shares at an aggregate cost of $56.4
million under an additional stock repurchase program authorized on August 29,
2002, for which the Company's board of directors approved repurchases of up to
$300.0 million.
In February 2002, the Company reissued treasury stock held in the rabbi trust,
which generated proceeds of $8.0 million, with a cost of $6.7 million.
12. EARNINGS PER SHARE
After the Company's IPO, effective October 26, 2001, SFAS No. 128, EARNINGS PER
SHARE, was adopted, which requires disclosure of basic and diluted earnings per
share.
24
PRINCIPAL FINANCIAL GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2002
(UNAUDITED)
12. EARNINGS PER SHARE (CONTINUED)
Reconciliations of weighted-average shares outstanding and income from
continuing operations for basic and diluted earnings per share for the three
months and nine months ended September 30, 2002, are presented below (in
millions, except per share data):
FOR THE THREE MONTHS ENDED FOR THE NINE MONTHS ENDED
SEPTEMBER 30, 2002 SEPTEMBER 30, 2002
---------------------------------------- ----------------------------------------
INCOME WEIGHTED INCOME WEIGHTED
AVERAGE PER SHARE AVERAGE PER SHARE
SHARES AMOUNT SHARES AMOUNT
----------- ------------- ------------- ------------ -------------- ------------
Basic earnings per share:
Income from continuing
operations................ $42.6 347.2 $0.12 $402.7 354.8 $1.13
Dilutive effects:
Long-term performance plan - 0.6 - - 0.1 -
Stock options............. - 0.4 - - 0.4 -
Restricted stock units(1). - - - - - -
----------- ------------- ------------- ------------ -------------- ------------
Diluted earnings per share..... $42.6 348.2 $0.12 $402.7 355.3 $1.13
=========== ============= ============= ============ ============== ============
- -----------------
(1) The dilutive effect of the restricted stock units did not meet specified
reporting thresholds.
The calculation of diluted earnings per share for the three months and nine
months ended September 30, 2002, excludes the incremental effect related to
certain outstanding stock-based compensation grants due to their anti-dilutive
effect.
13. SUBSEQUENT EVENT
On October 25, 2002, the Company's Board of Directors declared an annual
dividend of approximately $84.6 million, equal to $0.25 per share, payable on
December 9, 2002, to shareholders of record as of November 8, 2002.
25
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following analysis discusses our financial condition as of September 30,
2002, compared with December 31, 2001, and our consolidated results of
operations for the three months and nine months ended September 30, 2002 and
2001, prepared in conformity with accounting principles generally accepted in
the U.S. ("U.S. GAAP"). The discussion and analysis includes, where appropriate,
factors that may affect our future financial performance. The discussion should
be read in conjunction with our Form 10-K, for the year ended December 31, 2001,
filed with the United States Securities and Exchange Commission, the unaudited
consolidated financial statements and the related notes to the financial
statements and the other financial information included elsewhere in this Form
10-Q.
FORWARD-LOOKING INFORMATION
Our narrative analysis below contains forward-looking statements intended to
enhance the reader's ability to assess our future financial performance.
Forward-looking statements include, but are not limited to, statements that
represent our beliefs concerning future operations, strategies, financial
results or other developments, and contain words and phrases such as
"anticipate," "believe," "plan," "estimate," "expect," "intend," and similar
expressions. Forward-looking statements are made based upon management's current
expectations and beliefs concerning future developments and their potential
effects. Such forward-looking statements are not guarantees of future
performance.
Actual results may differ materially from those included in the forward-looking
statements as a result of risks and uncertainties including, but not limited to
the following: (1) a decline or increased volatility in the securities markets
could result in investors withdrawing from the markets or decreasing their rates
of investment, either of which could reduce our net income, revenues and assets
under management; (2) our investment portfolio is subject to several risks which
may diminish the value of our invested assets and affect our sales,
profitability and the investment returns credited to our customers; (3)
competition from companies that may have greater financial resources, broader
arrays of products, higher ratings and stronger financial performance may impair
our ability to retain existing customers, attract new customers and maintain our
profitability; (4) a downgrade in Principal Life Insurance Company's ("Principal
Life") financial strength ratings may increase policy surrenders and
withdrawals, reduce new sales and terminate relationships with distributors and
cause some of our existing liabilities to be subject to acceleration, additional
collateral support, changes in terms, or creation of additional financial
obligations; (5) our efforts to reduce the impact of interest rate changes on
our profitability and surplus may not be effective; (6) if we are unable to
attract and retain sales representatives and develop new distribution sources,
sales of our products and services may be reduced; (7) our international
businesses face political, legal, operational and other risks that could reduce
our profitability in those businesses; (8) our reserves established for future
policy benefits and claims may prove inadequate, requiring us to increase
liabilities; (9) our ability to pay stockholder dividends and meet our
obligations may be constrained by the limitations on dividends Iowa insurance
laws impose on Principal Life; (10) we may need to fund deficiencies in our
closed block ("Closed Block") assets which benefit only the holders of Closed
Block policies; (11) changes in regulations or accounting standards may reduce
our profitability; (12) litigation and regulatory investigations may harm our
financial strength and reduce our profitability; (13) fluctuations in foreign
currency exchange rates could reduce our profitability; (14) a challenge to the
Insurance Commissioner of the State of Iowa's approval of the plan of conversion
could put the terms of our demutualization in question and reduce the market
price of our common stock; (15) applicable laws and our stockholder rights plan,
certificate of incorporation and by-laws may discourage takeovers and business
combinations that our stockholders might consider in their best interests; and
(16) a downgrade in our debt ratings may adversely affect our ability to secure
funds and cause some of our existing liabilities to be subject to acceleration,
additional collateral support, changes in terms, or creation of additional
financial obligations.
OVERVIEW
We are a leading provider of retirement savings, investment and insurance
products and services. We have four operating segments:
o U.S. Asset Management and Accumulation, which consists of our asset
accumulation operations providing retirement savings and related investment
products and services, and our asset management operations which are
conducted through Principal Global Investors, formerly known as Principal
Capital Management. We provide a comprehensive portfolio of asset
accumulation products and services to businesses and individuals in the
U.S., with a concentration on small and medium-sized businesses, which we
define as businesses with fewer than 1,000 employees. We offer to
businesses products and services for defined contribution pension plans,
26
including 401(k) and 403(b) plans, defined benefit pension plans and
non-qualified executive benefit plans. We also offer annuities, mutual
funds and bank products and services to the employees of our business
customers and other individuals.
o International Asset Management and Accumulation, which consists of BT
Financial Group, our Australian-based asset manager, and Principal
International, which offers retirement products and services, annuities,
mutual funds and life insurance through subsidiaries in Argentina, Chile,
Mexico and Hong Kong and joint ventures in Brazil, Japan and India. We have
entered into an agreement to sell substantially all of BT Financial Group,
effective October 31, 2002. See "Transactions Affecting Comparability of
Results of Operations."
o Life and Health Insurance, which provides individual life and disability
insurance as well as group life and health insurance throughout the U.S.
Our individual insurance products include interest-sensitive life,
traditional life and disability insurance. Our group insurance products
include life, disability, medical, dental and vision insurance, and
administrative services.
o Mortgage Banking, which engages in originating, purchasing, selling and
servicing residential mortgage loans in the U.S.
We also have a Corporate and Other segment, which consists of the assets and
activities that have not been allocated to any other segment.
RECENT EVENTS AND TRENDS
STOCKHOLDER DIVIDENDS
On October 25, 2002, the Company's Board of Directors declared an annual
dividend of approximately $84.6 million, equal to $0.25 per share, payable on
December 9, 2002, to shareholders of record as of November 8, 2002.
RATINGS
On September 25, 2002, the rating agency Moody's Investors Service lowered
Principal Life's financial strength rating to Aa3 from Aa2. Our new rating, Aa3,
is the fourth highest rating of Moody's 21 rating levels and is defined as
"Excellent." Moody's also downgraded the commercial paper rating of Principal
Financial Services, Inc., to Prime-2 from Prime-1 and senior debt rating to A3
from A2. We do not expect these rating changes to have any adverse impact on our
business.
DECLINES IN THE U.S. AND AUSTRALIAN EQUITY MARKETS
Declines in the equity markets in the U.S. and Australia during the nine months
ended September 30, 2002 have reduced equity securities, a component of our
assets under management. Our assets under management at September 30, 2002 were
$117.4 billion, compared to $120.2 billion at December 31, 2001. Continued
declines could further reduce the amount of asset-based fee revenue in our U.S.
Asset Management and Accumulation segment. In addition to market declines,
during the nine months ended September 30, 2002, BT Financial Group has
experienced net cash outflows from assets under management.
DECLINES IN THE VALUES OF OUR U.S. FIXED MATURITY INVESTMENTS
During the nine months ended September 30, 2002, our investments in fixed
maturity securities were negatively impacted by credit problems of certain
investments. Accordingly, we recognized other than temporary impairments of
$242.0 million, before taxes. The largest impairment related to our holdings in
WorldCom Inc. for which we recognized an other than temporary impairment of
$46.4 million before taxes, and an additional $18.0 million, before taxes,
related to the sales of WorldCom, Inc., investments. The credit market continues
to be volatile, and we expect additional capital losses in the fourth quarter of
2002.
INTEREST RATE DECLINES
During the nine months ended September 30, 2002, interest rates have remained
relatively low. Low interest rates impact our Mortgage Banking segment by
reducing the value of our mortgage loan servicing rights but can lead to higher
mortgage loan production. Interest rate declines also have a negative impact on
the investment yields of our fixed income securities.
27
TRANSACTIONS AFFECTING COMPARABILITY OF RESULTS OF OPERATIONS
ACQUISITIONS
We acquired the following businesses, among others, during 2002 and 2001:
ZURICH AFORE S.A. DE C.V. On May 31, 2002, we purchased a 100% ownership of
Zurich AFORE S.A. de C.V. ("Zurich AFORE") in Mexico from Zurich Financial
Services for $49.0 million in cash. The operations of Zurich AFORE have been
integrated into Principal International, Inc., as a part of our International
Asset Management and Accumulation segment.
SPECTRUM ASSET MANAGEMENT. On October 1, 2001, Spectrum Asset Management
("Spectrum") became an affiliate of Principal Global Investors. The acquisition
was accounted for using the purchase method and the results of operations of the
acquired business have been included in our financial statements from the date
of acquisition. We included revenues of $1.6 million and $3.5 million for the
three months and nine months ended September 30, 2002, respectively, in our
consolidated results of operations.
DISPOSITIONS
We entered into disposition agreements or disposed of the following businesses,
among others, during 2002 and 2001:
BT FINANCIAL GROUP. On August 25, 2002, we announced we had entered into an
agreement to sell substantially all of BT Financial Group to Westpac Banking
Corporation ("Westpac") for estimated proceeds of A$900.0 million Australian
dollars ("A$") (approximately U.S. $500.0 million), and future contingent
proceeds in 2004 of up to A$150.0 million (approximately U.S. $80.0 million).
The contingent proceeds will be based on Westpac's future success in growing
retail funds under management. Excluding the contingent proceeds, we estimate
after-tax proceeds of approximately U.S. $870.0 million. This amount includes
cash proceeds, tax benefits, and gain from unwinding the hedged asset associated
with debt used to acquire BT Financial Group in 1999. We closed the sale of BT
Financial Group on October 31, 2002, and have accrued for an estimated after-tax
loss on disposal of $206.6 million as of September 30, 2002. This loss is
recorded in the loss from discontinued operations in the consolidated statement
of operations. Future adjustments to the estimated loss are expected to be
recorded through the first half of 2003, as the proceeds from the sale are
finalized.
BT Financial Group is accounted for as a discontinued operation and therefore,
the results of operations (excluding corporate overhead) and cash flows have
been removed from our results of continuing operations for all periods
presented. Corporate overhead allocated to BT Financial Group does not qualify
for discontinued operations treatment under SFAS 144, ACCOUNTING FOR THE
IMPAIRMENT OR DISPOSAL OF LONG-LIVED ASSETS, and therefore is still included in
the our results of continuing operations. Assets and liabilities related to BT
Financial Group have been reclassified to assets of discontinued operations and
liabilities of discontinued operations on our consolidated statements of
financial position for all periods presented. Additionally, the results of
operations (excluding corporate overhead) for BT Financial Group are reported as
non-recurring items in our International Asset Management and Accumulation
segment. Selected financial information for the discontinued operations is as
follows:
28
AS OF OR FOR THE THREE MONTHS AS OF OR FOR THE NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
--------------------------------- -----------------------------------
2002 2001 2002 2001
-------------- --------------- -------------- -----------------
(IN MILLIONS, EXCEPT AS INDICATED)
Total assets under management ($ in
billions)................................ $ 15.6 $20.4 $ 15.6 $ 20.4
============== =============== ============== =================
Total revenues ............................ $ 39.2 $50.5 $ 128.1 $ 173.0
============== =============== ============== =================
Loss from continuing operations
(corporate overhead) ................... $ (0.8) $(1.0) $ (2.3) $ (2.7)
Loss from discontinued operations:
Income (loss) before income taxes....... 3.9 (5.8) 16.3 (10.1)
Income taxes (benefits)................. (1.7) (1.7) 4.6 (1.9)
-------------- --------------- -------------- -----------------
Income (loss) from discontinued
operations ........................... 5.6 (4.1) 11.7 (8.2)
Loss on disposal, net of related
income taxes.......................... (206.6) - (206.6) -
-------------- --------------- -------------- -----------------
Loss from discontinued operations,
net of related income taxes............. (201.0) (4.1) (194.9) (8.2)
Cumulative effect of accounting change,
net of related income taxes............. - - (255.4) -
-------------- --------------- -------------- -----------------
Net loss................................... $(201.8) $(5.1) $ (452.6) $ (10.9)
============== =============== ============== =================
COVENTRY HEALTH CARE. On February 1, 2002, we sold our remaining stake of 15.1
million shares of Coventry Health Care, Inc. ("Coventry") common stock and a
warrant, exercisable for 3.1 million shares of Coventry common stock. We
received proceeds of $325.4 million, resulting in a net realized capital gain of
$183.0 million, or $114.5 million net of income taxes.
We reported our investment in Coventry in our Corporate and Other segment and
accounted for it using the equity method prior to its sale. Our share of
Coventry's net income was $2.1 million for the nine months ended September 30,
2002, and $5.2 million and $15.1 million for the three months and nine months
ended September 30, 2001, respectively.
PT ASURANSI JIWA PRINCIPAL INDONESIA. On September 25, 2001, we disposed of all
the stock of PT Asuransi Jiwa Principal Indonesia, our subsidiary in Indonesia.
We currently have no business operations in Indonesia. We received nominal
proceeds, which resulted in a pre-tax realized capital loss of $6.7 million. We
included nominal revenues, net income and net loss from our operations in
Indonesia in our consolidated results of operations for the three months and
nine months ended September 30, 2001.
PRINCIPAL INTERNATIONAL ESPANA, S.A. DE SEGUROS DE VIDA. On February 15, 2001,
we disposed of all of the stock of Principal International Espana, S.A. de
Seguros de Vida, our subsidiary in Spain, for nominal proceeds, resulting in a
realized capital loss of $38.4 million, or $21.0 million net of income taxes,
ceasing our business operations in Spain.
We did not include revenues or net income from our operations in Spain in our
consolidated results of operations for the three months and nine months ended
September 30, 2002 and 2001.
OTHER TRANSACTIONS
KEYCORP. On June 12, 2002, we announced we had entered into an agreement with
KeyCorp (through affiliates Victory Capital Management and KeyBank National
Association) to offer transition of servicing of KeyCorp's 1,400 employer
defined contribution clients with up to $8.0 billion in assets under management.
29
KeyCorp transitioned out of the bundled defined contribution business and will
recommend our servicing to its full-service defined contribution clients
nationwide.
REINSURANCE TRANSACTIONS. Effective January 1, 2002, we entered into a
reinsurance agreement to reinsure group medical insurance contracts, which
should result in reduced volatility of our group medical insurance earnings. The
reinsurance agreement resulted in $11.4 million and $33.9 million of ceded
premiums for the three months and nine months ended September 30, 2002,
respectively. In addition, the reinsurance agreement resulted in $11.0 million
and $29.5 million of ceded claims for the three months and nine months ended
September 30, 2002, respectively.
FLUCTUATIONS IN FOREIGN CURRENCY TO U.S. DOLLAR EXCHANGE RATES
Fluctuations in foreign currency to U.S. dollar exchange rates for countries in
which we have operations can affect reported financial results. In years when
foreign currencies weaken against the U.S. dollar, translating foreign
currencies into U.S. dollars results in fewer U.S. dollars to be reported. When
foreign currencies strengthen, translating foreign currencies into U.S. dollars
results in more U.S. dollars to be reported.
In January 2002, the Argentine government ended its tie of the Argentine peso to
the U.S. dollar, creating a dual currency system with an official fixed exchange
rate of 1.4 pesos to 1.0 U.S. dollar for import and export transactions and
free-floating exchange rate for other transactions, subsequently floating the
Argentine peso in February. The devaluation did not materially impact our
consolidated results of operations.
Foreign currency exchange rate fluctuations create variances in our financial
statement line items but have not had a material impact on our consolidated
operating earnings and net income. Our consolidated operating earnings were
negatively impacted $1.2 million for the three months ended September 30, 2002,
and were negatively impacted $0.8 million for the three months ended September
30, 2001, as a result of fluctuations in foreign currency to U.S. dollar
exchange rates. Our consolidated operating earnings were negatively impacted
$1.9 million for the nine months ended September 30, 2002, and were negatively
impacted $1.1 million for the nine months ended September 30, 2001,
respectively, as a result of fluctuations in foreign currency to U.S. dollar
exchange rates. For a discussion of our approaches to foreign currency exchange
rate risk, see Item 3, "Quantitative and Qualitative Disclosures about Market
Risk."
CHANGES TO OUR CRITICAL ACCOUNTING POLICIES
Changes in the business environment and applicable authoritative accounting
guidance require us to closely monitor our accounting policies. During the nine
months ended September 30, 2002, we adopted newly issued guidance from the
Financial Accounting Standards Board ("FASB") and changed our critical
accounting policy for business combinations.
ACCOUNTING FOR BUSINESS COMBINATIONS, GOODWILL AND OTHER INTANGIBLE ASSETS
In June 2001, the FASB issued Statement of Financial Accounting Standards
("SFAS") No. 141, BUSINESS COMBINATIONS ("SFAS 141"), and SFAS No. 142, GOODWILL
AND OTHER INTANGIBLE ASSETS ("SFAS 142"). SFAS 141 requires that the purchase
method of accounting be used for all business combinations initiated after June
30, 2001, and requires separate recognition of intangible assets apart from
goodwill, if such intangible assets meet certain criteria. SFAS 142, effective
January 1, 2002, prohibits the amortization of goodwill and intangible assets
with indefinite useful lives. Intangible assets with finite lives will continue
to be amortized over their estimated useful lives. Additionally, SFAS 142
requires that goodwill and indefinite-lived intangible assets be reviewed for
impairment at least annually, which we plan to do in the fourth quarter each
year.
The initial adoption of SFAS 142 required us to perform a two-step fair-value
based goodwill impairment test. The first step of the test compared the
estimated fair value of the reporting unit to its carrying value, including
goodwill. If the carrying value exceeded fair value, a second step was
performed, which compared the implied fair value of the applicable reporting
unit's goodwill with the carrying amount of