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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON D.C. 20549
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FORM 10-Q
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE PERIOD ENDED SEPTEMBER 30, 1997
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER 1-14094
MEADOWBROOK INSURANCE GROUP, INC.
(Exact name of registrant as specified in its charter)
MICHIGAN 38-2626206
(State of Incorporation) (IRS Employer Identification No.)
26600 TELEGRAPH ROAD, SOUTHFIELD, MICHIGAN 48034
(Address, zip code of principal executive offices)
(248) 358-1100
(Registrant's telephone number, including area code)
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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 aggregate number of shares of the Registrant's Common Stock, $.01 par
value, outstanding on November 11, 1997 was 8,658,187. Total number of
Pages: 18
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TABLE OF CONTENTS
PAGE
PART I - FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS
Condensed Consolidated Statements of Income 3-4
Condensed Consolidated Balance Sheet 5
Condensed Consolidated Statement of Cash Flows 6
Notes to Consolidated Financial Statements and
Management Representation 7
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS 8-13
PART II - OTHER INFORMATION
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K 14-17
SIGNATURES 18
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PART I - FINANCIAL INFORMATION
ITEM 1
FINANCIAL STATEMENTS
MEADOWBROOK INSURANCE GROUP, INC.
CONDENSED CONSOLIDATED STATEMENT OF INCOME
FOR THE NINE MONTHS ENDED SEPTEMBER 30,
(UNAUDITED)
1997 1996
------------ ------------
Revenues:
Net premium earned $ 48,904,304 $ 63,797,509
Net commissions and fees 18,211,486 11,931,839
Net investment income 6,034,370 5,940,090
Miscellaneous income 6,506 26,971
------------ ------------
Total Revenues 73,156,666 81,696,409
Expenses:
Loss and loss adjustment expenses 54,204,463 47,561,403
Reinsurance recoveries (26,672,414) (16,368,801)
------------ ------------
Net loss and loss adjustment expenses 27,532,049 31,192,602
Other operating expenses 12,876,875 24,548,519
Salaries and employee benefits 19,814,568 18,045,985
Interest on notes payable 366,281 --
------------ ------------
Total Expenses 60,589,773 73,787,106
Income before income taxes 12,566,893 7,909,303
Federal income taxes:
Current 1,505,312 734,096
Deferred 1,415,187 796,124
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Total income taxes 2,920,499 1,530,220
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Net income $ 9,646,394 $ 6,379,083
============ ============
Primary and fully diluted earnings per share $ 1.05 $ 0.70
Weighted average number of common shares and
common share equivalents outstanding 9,159,468 9,176,342
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MEADOWBROOK INSURANCE GROUP, INC.
CONDENSED CONSOLIDATED STATEMENT OF INCOME
FOR THE QUARTER ENDED SEPTEMBER 30,
(UNAUDITED)
1997 1996
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Revenues:
Net premium earned $ 17,150,037 $ 22,428,764
Net commissions and fees 7,165,417 3,290,997
Net investment income 2,056,549 1,945,561
Miscellaneous income 7,284 61,036
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Total Revenues 26,379,287 27,726,358
Expenses:
Loss and loss adjustment expenses 19,092,358 16,239,474
Reinsurance recoveries (10,692,945) (4,502,105)
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Net loss and loss adjustment expenses 8,399,413 11,737,369
Other operating expenses 6,467,081 9,392,259
Salaries and employee benefits 7,216,872 6,292,564
Interest on notes payable 258,256 --
------------ ------------
Total Expenses 22,341,622 27,422,192
Income before income taxes 4,037,665 304,166
Federal income taxes:
Current 529,585 (330,710)
Deferred 330,051 141,686
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Total income taxes 859,636 (189,024)
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Net income $ 3,178,029 $ 493,190
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Primary and fully diluted earnings per share $ 0.35 $ 0.05
Weighted average number of common shares and
common share equivalents outstanding 9,156,848 9,183,681
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MEADOWBROOK INSURANCE GROUP, INC.
CONDENSED CONSOLIDATED BALANCE SHEET
(UNAUDITED)
SEPTEMBER 30, DECEMBER 31,
ASSETS 1997 1996
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Investments:
Debt securities held to maturity, at amortized cost (Note 1)
(fair value of $122,485,366 in 1996) $ -- $ 120,116,668
Debt securities available for sale, at fair value
(amortized cost of $130,376,911 and $16,025,804) 133,454,940 15,955,481
Equity securities available for sale, at fair value
(cost of $4,850,695 and $1,562,999) 5,311,752 1,420,949
Cash and cash equivalents 20,691,831 19,002,241
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Total investments and cash and cash equivalents 159,458,523 156,495,339
Premiums and agent balances receivable 32,882,399 25,907,407
Reinsurance recoverable on:
Paid losses 8,630,589 6,672,133
Unpaid losses 32,512,204 26,615,052
Deferred policy acquisition costs 5,057,356 4,264,795
Prepaid reinsurance premiums 23,834,622 20,271,068
Intangible assets 8,472,299 5,414,073
Other assets 24,787,203 19,395,474
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Total assets $295,635,195 $ 265,035,341
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LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES:
Reserve for losses and loss adjustment expenses $ 95,997,947 $ 92,390,227
Unearned premiums 50,564,211 44,090,675
Notes payable, bank 14,349,507 --
Other liabilities 22,832,349 28,353,605
Commitments and contingencies -- --
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Total liabilities 183,744,014 164,834,507
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SHAREHOLDERS' EQUITY:
Common stock, $.01 stated value; authorized 20,000,000 shares;
8,659,397 and 8,649,346 shares issued and outstanding 86,594 86,493
Additional paid-in capital 72,896,284 72,873,396
Retained earnings 36,572,507 27,381,111
Unrealized appreciation (depreciation) on available for sale
securities, net of deferred federal income taxes 2,335,796 (140,166)
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Total shareholders' equity 111,891,181 100,200,834
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Total liabilities and shareholders' equity $295,635,195 $ 265,035,341
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MEADOWBROOK INSURANCE GROUP, INC.
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30,
(UNAUDITED)
1997 1996
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Net cash (used in) provided by operating activities $(11,833,453) $ 6,910,004
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Cash flows from investing activities:
Purchase of debt securities held to maturity -- (26,506,680)
Purchase of debt securities available for sale (12,297,046) (2,834,919)
Purchase of equity securities available for sale (3,832,224) --
Proceeds from maturity of debt securities held to maturity 4,611,894 7,172,691
Proceeds from sale of debt securities held to maturity 1,690,955 --
Proceeds from sale of debt securities available for sale 12,201,662 --
Proceeds from sale of equity securities available for sale 460,691 69,918
Proceeds from the sale of fixed assets 389,157 1,000
Capital expenditures (1,937,852) (2,072,434)
Purchase of subsidiaries, net of cash of acquired (1,497,929) --
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Net cash used in investing activities (210,692) (24,170,424)
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Cash flows from financing activities:
Additional expenses from initial public offering -- (51,193)
Proceeds from bank loan 14,349,507 --
Dividends paid on common stock (483,341) (344,800)
Retirement of common stock (222,041) --
Issuance of common stock 89,610 --
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Net cash provided by (used in) financing activities 13,733,735 (395,993)
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Increase (decrease) in cash and cash equivalents 1,689,590 (17,656,413)
Cash and cash equivalents, beginning of period 19,002,241 41,906,577
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Cash and cash equivalents, end of period $ 20,691,831 $ 24,250,164
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1
In the third quarter of 1997, the Company sold securities that had been
classified as held to maturity for the purpose of generating taxable realized
gains to utilize the tax loss carryforwards which expire in 1997 and for other
short-term operating needs. The specific securities sold and the related
amortized cost and realized gains are as follow:
SECURITY AMORTIZED COST REALIZED GAIN
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Municipal Bond, Chicago, IL $ 192,400 $ 16,006
Municipal Bond, Santa Ana, CA 116,295 16,366
Municipal Bond, Wayne County, MI 279,977 25,729
Municipal Bond, Northeastern PA Hospital 201,173 18,355
Municipal Bond, San Diego County, CA COP 178,170 21,174
Municipal Bond, Indiana St Education 180,640 21,560
Municipal Bond, Massachusetts Muni 187,857 15,725
Municipal Bond, Northeastern PA Hospital 200,000 19,528
The sale of the above held to maturity securities were for reasons other than
those permitted by Statement of Financial Accounting Standards No. 115.
Accordingly, the Company has reclassified the remaining held to maturity
securities (with an amortized cost of $114.1 million and fair value of $115.8
million) to the available for sale category.
MANAGEMENT REPRESENTATION
In the opinion of management, the consolidated financial statements reflect all
adjustments of a normal recurring nature necessary for a fair presentation of
the interim periods. Preparation of financial statements under generally
accepted accounting principles ("GAAP") requires management to make estimates.
Actual results could differ from those estimates. Interim results are not
necessarily indicative of results expected for the entire year. These financial
statements should be read in conjunction with the Company's 1996 Annual Report
to Shareholders, as filed on Form 10-K to the Securities and Exchange
Commission.
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PART I - FINANCIAL INFORMATION
ITEM 2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FOR THE PERIODS ENDED SEPTEMBER 30, 1997 AND 1996
RESULTS OF OPERATIONS
ACQUISITION
On July 1st, 1997, the Company acquired for $9.4 million cash all of the
outstanding stock of Crest Financial Corporation (Crest), a California-based
holding company with subsidiaries operating in the insurance industry. This
transaction was accounted for as a purchase and the operating results of Crest
were consolidated into the Company's financial statements beginning this
quarter. $3.1 million of goodwill was recorded as part of this transaction,
which is being amortized over a 20 year period on a straight-line basis.
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996
Net income for the nine months ended September 30, 1997 was $9.6 million, an
increase of $3.3 million, or 51.2%, from $6.4 million for same period in 1996.
This increase was the result of a combination of the following items. Net earned
premiums declined $14.9 million and losses and LAE decreased $3.7 million over
the prior year, primarily due to the reinsurance of the surety business to
Connecticut Surety, which began on December 1, 1996. Commission and fee revenue
increased $6.3 million, which is mainly the result of additional fee revenue
generated from both the Association Self Insurance Services, Inc. (ASI)
acquisition in November of 1996 and the Crest acquisition. Salaries and employee
benefits were up $1.8 million from the prior year due to the additional
employees from ASI and Crest. Other operating expenses were down $11.7 million
from the same period in 1996 as a result of ceding commissions recorded in
connection with the reinsurance of the surety operation, in addition to
management's efforts to control costs.
REVENUE
Revenue for the nine month period ended September 30, 1997 was $73.2 million,
a decrease of $8.5 million, or 10.5%, from 1996's revenue of $81.7 million.
Nine Months Ended September 30,
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1997 1996
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(In Thousands)
Risk management fees & commissions $18,212 $11,932
Net earned premiums 48,904 63,798
Net investment income 6,034 5,940
Miscellaneous income 7 26
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$73,157 $81,696
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Risk Management Fees and Commissions
The Company's risk management fee and commission income generated from its
managed program operations and retail agency consist of the following:
Nine Months Ended September 30,
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1997 1996
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(In Thousands)
Commissions $ 6,213 $ 3,987
Management fees 5,069 4,167
Claims fees 5,614 2,097
Loss control fees 905 1,038
Reinsurance placement 404 625
Miscellaneous fees & charges 7 18
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$18,212 $11,932
Net fee and commission income increased by $6.3 million, or 52.6%, to $18.2
million for the nine month period ended September 30, 1997, from $11.9 million
for the same period in 1996. Claims fees increased $3.5 million to $5.6 million
in 1997, from $2.1 million in 1996, which explains over half of the growth in
risk management fees and commissions. This was mainly the result of $2.9 million
of additional fee revenue generated from the ASI acquisition. Commissions were
up $2.2 million to $6.2 million in 1997, from $4.0 million in 1996, $1.8 million
of which is attributable to Crest. Management fees increased $902,000; $259,000
of which was additional revenue from Crest and the remainder was due to
additional revenues from one new program and growth in two existing programs.
Insurance Premiums
The Company's gross premium written increased by $11.9 million, or 14.0%, to
$96.9 million for the nine months ended September 30, 1997, from $85.0 million
for the same period in 1996. This was mainly due to growth in existing programs,
new programs, and retrospectively-rated adjustments, offset partially by
discontinued programs. Existing business grew by $14.1 million, or 25.3%, and
new business generated $8.3 million in additional premium. The growth in
existing business was the result of two programs initiated in 1996 growing by a
total of $7.9 million, $2.9 million in additional premium from assumed business,
$1.4 million in growth from one program expanding into other states, and $2.3
million in additional revenue from one program's growth in its inland marine
line of business. The new business was primarily generated from twelve new
accounts and partially from the $954,000 in additional premium related to
Crest's insurance subsidiary, Williamsburg. In addition, approximately $1.7
million of retrospectively-rated adjustments resulted in increased premiums.
Partially offsetting the above items was the decrease in premium from
discontinued programs. During 1996 the Company decided to decrease its writings
in historically unprofitable programs which accounted for a $11.8 million
decline in gross written premiums this year, $5.0 million of which was from
surety and $6.8 million from other discontinued programs. Also, premium assumed
from workers' compensation involuntary pools, in which the Company's insurance
subsidiaries participate, decreased $523,000 from the prior year.
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Net premium written decreased by $11.1 million, or 17.9%, to $50.7 million for
the nine months ended September 30, 1997, from $61.7 million for the same period
in 1996. On a pro forma basis, as if the reinsurance of the surety business had
occurred at the beginning of 1996, net written premiums increased $6.7 million,
or 15.3%. New business generated $2.7 million in additional premium ($954,000 of
this was from Crest), existing business grew by $4.2 million, and
retrospectively-rated programs increased by $1.8 million. These increases were
partially offset by the $1.5 million decrease in non-surety discontinued
programs and a $495,000 decline in workers' compensation involuntary pools.
Net premium earned decreased by $14.9 million, or 23.3%, to $48.9 million for
the nine month period ended September 30, 1997, from $63.8 million for the same
period in 1996. On a pro forma basis, net earned premiums increased by $1.8
million, or 3.9%, from 1996. This increase in earned premiums corresponds to the
growth in new business of $2.0 million ($1.1 million from Crest) and existing
programs of $1.9 million. As explained above, the growth in premiums was
partially offset by decreases from non-surety discontinued programs of $1.6
million and workers' compensation involuntary pools of $571,000.
Net Investment Income
Net investment income was relatively flat at $6.0 million for nine months, from
$5.9 million for the same period in 1996. This was a result of the decrease in
cash and invested assets (net of the $11.4 million in cash held by the newly
acquired Crest) as a result of cash outflows due to the Connecticut Surety
reinsurance transaction, the acquisitions of ASI and Crest, and the run-off of
the surety book of business and other discontinued programs. The pre-tax
weighted average yield on invested assets was 5.3% for 1997 and 5.1% for 1996.
The Company's investment philosophy is one of maximizing after-tax earnings
through significant investments in tax-exempt bonds. Accordingly, the weighted
average yield on invested assets on an after-tax basis was 4.8%, which is a
slight increase from 4.6% for the same period in the prior year.
EXPENSES
Total expenses decreased $13.2 million, or 17.9%, to $60.6 million at
September 30, 1997, from $73.8 million for the same period in 1996.
Nine Months Ended September 30,
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1997 1996
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(In Thousands)
Net losses and loss adjustment expenses incurred $27,532 $31,193
Salaries & employee benefits 19,815 18,046
Other operating expenses 12,877 24,548
Interest on notes payable 366 --
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$60,590 $73,787
Net losses and Loss Adjustment Expenses (LAE) Incurred
Net losses and LAE incurred decreased by $3.7 million, or 11.7%, to $27.5
million for the nine month period ended September 30, 1997, from $31.2 million
for the same period in 1996. The
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loss and LAE ratio for 1997 was 60.5% as compared to 52.0% for 1996. On a pro
forma basis, as if the Connecticut Surety reinsurance ceding arrangement on the
surety business had occurred at the beginning of 1996, the loss and LAE ratio
would have been 55.9% in 1996. Analyzing the results on a pro forma basis, the
4.6 point, or $3.2 million, increase was primarily from the run-off of claims on
the surety bond book of business.
Salaries and Employee Benefits
Salaries and employee benefits increased by $1.8 million, or 9.8%, to $19.8
million for the nine months ended September 30, 1997, compared to $18.0 million
for the same period in 1996. Salaries and employee benefits for 1997 include
nine months of expenses for the 57 employees of ASI (purchased in November 1996)
and three months of expenses for the 87 employees recently acquired from Crest.
This increase is offset partially by the reduction in surety department salaries
due to the Connecticut Surety arrangement. The average salaries and wages per
person remained relatively consistent for the first nine months of 1997 compared
to the same period in 1996.
Other Operating Expenses
Other operating expenses decreased by $11.7 million, or 47.5%, to $12.9 million
for the nine month period ended September 30, 1997, from $24.5 million for the
same period in 1996. On a pro forma basis, as if the reinsurance of the surety
business had occurred at the beginning of 1996, expenses decreased $3.4 million,
or 20.8%. Analyzing expenses utilizing GAAP insurance ratios, the expense ratio
decreased 17.0 points on an actual basis and 8.0 points on a comparable pro
forma basis. The $3.4 million, or 8.0 point, decrease is mainly the result of
the earning of $2.9 million of previously deferred income from the Connecticut
Surety arrangement, which was to cover expenses related to the run-off of the
surety bond business. Underwriting expenses were reduced by this $2.9 million
ceding commission, while incurred losses increased by the same amount. The
remaining $475,000 of the decrease is the net result of management's cost
cutting efforts and the close monitoring thereof, reduced partially by the
additional expenses from ASI and Crest.
Interest Expense
Interest expense of $366,000 was recorded for the nine months ended September
30, 1997, related to draws on the Company's line of credit. There was no
interest expense recorded for the nine months ended September 30, 1996, as there
was no debt outstanding during 1996.
Federal Income Taxes
The provision for income taxes was $2.9 million for the nine month period ended
September 30, 1997, and $1.5 million for the same period in 1996, representing
effective tax rates of 23.2% and 19.3%, respectively. These tax rates were
significantly lower than the 34% corporate rate due to the Company's heavily
tax-exempt investment portfolio. The increase in the Company's effective tax
rate was due to the growth in pre-tax underwriting income during 1997.
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FOR THE THREE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996
Net income for the quarter ended September 30, 1997, was $3.2 million, an
increase of $2.7 million, from $493,000 for the same period in 1996. Revenue
decreased by $1.3 million, expenses decreased by $5.1 million, and taxes
increased by $1.0 million. The increase in net income was primarily due to the
reinsurance of the surety book of business, which sustained losses in the third
quarter 1996. In addition, increased profits were realized from core business
operations, supplemented by favorable results from the ASI and Crest
acquisitions.
REVENUE
Revenue decreased by $1.3 million, or 4.9%, to $26.4 million for the quarter,
compared to $27.7 million for the same period in 1996. Net investment income was
relatively unchanged, while earned premium decreased by $5.3 million, or 23.5%,
and net fees and commissions increased by $3.9 million, or 117.7%. On a pro
forma basis, as if the reinsurance of the surety business had occurred at the
beginning of 1996, net earned premium increased by $824,000. As explained
previously in the nine months ended section, this growth was the result of
existing programs increasing by $1.7 and new business by $1.4 million ($1.1
million of this was from Crest). These premium increases were partially offset
by the decline in workers' compensation involuntary pools of $1.4 million,
retrospectively-rated programs of $194,000 and non-surety discontinued programs
of $677,000. The increase in net fee and commission income is mainly the result
of additional fee revenue generated from the ASI and Crest acquisitions.
EXPENSES
Expenses decreased by $5.1 million, or 18.5%, to $22.3 million for the quarter,
compared to $27.4 million for the same period in 1996. Other operating expenses
decreased by $2.9 million, or 31.1%, net losses and LAE incurred decreased by
$3.3 million, or 28.4%, and salaries and employee benefits increased by
$924,000, or 14.7%. These fluctuations are the result of the following items: On
a pro forma basis, excluding surety, other operating expenses increased by
$462,000. This is the net result of $1.5 million and $376,000 in increased
expenses from the additions of Crest and ASI, respectively, and decreases
resulting from management's cost cutting efforts. On a pro forma basis, net
losses and LAE incurred have increased by $1.5 million, primarily from the
run-off of claims on the surety book of business and partially due to the
addition of Crest. Salaries and employee benefits were higher, due to the
additional employees from ASI and Crest, offset partially by the reduction in
surety department salaries due to the Connecticut Surety arrangement.
FEDERAL INCOME TAXES
The provision for income taxes was $860,000 for the quarter, compared to a
benefit of $189,000 for the same period in 1996, representing effective tax
rates of 21.3% and (62.1%), respectively. These tax rates were significantly
lower than the 34% corporate rate due to the Company's heavily tax-exempt
investment portfolio. The increase in the Company's effective tax rate over the
prior year was due to the significantly better underwriting results in 1997.
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LIQUIDITY AND CAPITAL RESOURCES
The principal sources of funds for the Company are insurance premiums,
investment income, proceeds from the maturity and sale of invested assets, risk
management fees and agency commissions. Funds are primarily used for the payment
of claims, commissions, salaries and employee benefits, and other operating
expenses. In addition, the Company has a high volume of intercompany
transactions due to the insurance operations paying management fees to the risk
management operations. Such fees are subject to regulatory approval by state
insurance departments and are eliminated in consolidation.
Cash flows from operations for the nine month period ended September 30, 1997,
was a negative $11.8 million, as compared to a positive $6.9 million for the
same period in 1996. The negative cash flow for 1997 is the result of the
Connecticut Surety transaction, combined with the run-off of surety and other
discontinued programs. The Company expects cash flows from operations to be
positive for the fourth quarter of 1997. At September 30, 1997, the Company held
$20.7 million in cash and cash equivalents.
The Company has one unsecured line of credit totaling $15.0 million, of which
$14.3 million was outstanding at September 30, 1997. The line expires on January
1, 2000. The Company drew on this line of credit to meet cash flow needs,
primarily to consummate the acquisitions of both Crest and ASI and to settle
claims on surety and other discontinued programs. The Company had no debt
outstanding during 1996.
In the third quarter of 1997, the Company sold securities that had been
classified as held to maturity for the purpose of generating taxable realized
gains to utilize the tax loss carryforwards which expire in 1997 and for other
short-term operating needs. The Company has reclassified the remaining held to
maturity securities to the available for sale category. (See Note 1)
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PART II - OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8K
(A) The following documents are filed as part of this Report:
Exhibit
No. Description
- ------- -----------
11 Statement re computation of per share earnings
27 Financial Data Schedule
(B) Reports on Form 8-K
No reports on Form 8-K were filed by the Registrant during the quarter ended
September 30, 1997.
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SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934, the
Registrant has duly caused this Report to be signed on its behalf by the
undersigned, thereunto duly authorized.
MEADOWBROOK INSURANCE GROUP, INC.
By:/s/ Daniel G. Gibson
-----------------------
Chief Financial Officer
Dated: November 12, 1997
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EXHIBIT INDEX
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Exhibit No. Description
- ----------- -----------
11 Statement re computation of per share earnings
27 Financial Data Schedule