1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
(Mark One)
[x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ________ TO ________
COMMISSION FILE NUMBER 0-25984
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SUPERIOR NATIONAL INSURANCE GROUP, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 95-4610936
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
26601 AGOURA ROAD
CALABASAS, CA 91302
(Address of principal executive offices)
(818) 880-1600
(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 [ ]
Number of shares of Common Stock, without par value, outstanding as of
close of business on May 12, 1997: 5,837,144 shares.
2
SUPERIOR NATIONAL INSURANCE GROUP, INC.
INDEX TO FORM 10-Q
PAGE
----
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements............................................................................3
Condensed consolidated balance sheets as of
March 31, 1997 (unaudited) and December 31, 1996.......................................3
Condensed consolidated statements of income for the three months ended
March 31, 1997 (unaudited) and March 31, 1996 (unaudited)..............................4
Condensed consolidated statement of changes in shareholders' equity
for the three months ended March 31, 1997 (unaudited)..................................5
Condensed consolidated statements of cash flows for the three months ended
March 31, 1997 (unaudited) and March 31, 1996 (unaudited)..............................6
Notes to condensed consolidated financial statements (unaudited)................................7
Item 2. Management's Discussion and Analysis of Consolidated Financial Condition and
Results of Operations...........................................................................9
PART II. OTHER INFORMATION
Item 2. Changes in Securities..........................................................................14
Item 5. Other Information..............................................................................14
Item 6. Exhibits and Reports on Form 8-K...............................................................16
SIGNATURE........................................................................................................18
EXHIBIT INDEX....................................................................................................19
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PART I FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
SUPERIOR NATIONAL INSURANCE GROUP, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except per share data)
March 31, December 31,
ASSETS 1997 1996
------------ ------------
(Unaudited) (*)
Investments:
Bonds and notes:
Available-for-sale, at market
(cost: 1997, $55,171; 1996, $46,549) $ 54,755 $ 46,330
Equity securities, at market
Common stock (cost: 1997, $1,344; 1996, $1,199) 1,177 1,173
Cash and Invested cash (Restricted cash: 1997, $208; 1996, $297) 83,600 100,487
Restricted investment 1,380 1,450
------------ ------------
TOTAL INVESTMENTS 140,912 149,440
Reinsurance receivable 25,974 25,274
Premiums receivables (less allowance for doubtful
accounts: $300, 1997 and 1996) 13,768 14,641
Deferred policy acquisition costs 4,248 3,042
Deferred income taxes 9,202 9,520
Receivable from reinsurer 91,639 93,266
Other Assets 12,241 11,386
------------ ------------
TOTAL ASSETS $ 297,984 $ 306,569
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Claims and claim adjustment expenses $ 106,758 $ 115,529
Unearned premiums 10,446 9,702
Long-term debt 96,947 98,961
Accounts payable and other liabilities 13,851 13,615
------------ ------------
TOTAL LIABILITIES 228,002 237,807
PREFERRED SECURITIES ISSUED BY AFFILIATE;
authorized 1,100,000 shares; issued and outstanding
1,013,753 shares in 1997 and 1996 24,258 23,571
Shareholders' Equity:
Common stock, no par value; authorized
25,000,000 shares; issued and outstanding
3,446,492 shares in 1997 and 1996 16,022 16,022
Unrealized gain (loss) on investments, net of taxes (385) (162)
Paid in capital - warrants 2,206 2,206
Retained earnings 27,881 27,125
------------ ------------
TOTAL SHAREHOLDERS' EQUITY 45,724 45,191
------------ ------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 297,984 $ 306,569
============ ============
* Derived from audited financial statements
See Notes to Condensed Consolidated Financial Statements.
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SUPERIOR NATIONAL INSURANCE GROUP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share amounts)
(Unaudited)
Three Months Ended
March 31,
----------------------
1997 1996
-------- --------
REVENUES:
Premiums written, net of reinsurance ceded $ 20,003 $ 18,643
Net change in unearned premiums (1,025) 254
-------- --------
Net premiums earned 18,978 18,897
Net investment income 2,086 2,191
-------- --------
TOTAL REVENUES 21,064 21,088
EXPENSES:
Claims and claim adjustment expenses,
net of reinsurance recoveries 10,271 10,275
Commissions, net of
reinsurance commissions 2,201 2,475
Policyholder dividends - 299
Interest expense 1,727 2,528
General and administrative expenses
Underwriting 4,803 3,725
Other 181 130
-------- --------
TOTAL EXPENSES 19,183 19,432
-------- --------
INCOME BEFORE INCOME TAXES AND PREFERRED
SECURITIES DIVIDENDS AND ACCRETION 1,881 1,656
Income tax expense 671 573
-------- --------
INCOME BEFORE PREFERRED SECURITIES
DIVIDENDS AND ACCRETION 1,210 1,083
Preferred securities dividends and
accretion, net of income taxes (454) (405)
-------- --------
NET INCOME $ 756 678
======== ========
EARNINGS PER COMMON AND DILUTIVE
COMMON EQUIVALENT SHARES:
INCOME BEFORE PREFERRED SECURITIES
DIVIDENDS AND ACCRETION $ 0.23 $ 0.32
Preferred securities dividends and accretion (0.08) (0.12)
-------- --------
NET INCOME $ 0.15 $ 0.20
======== ========
See notes to condensed Consolidated Financial Statements.
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SUPERIOR NATIONAL INSURANCE GROUP, INC.
CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
(Amounts in thousands)
(Unaudited)
Net Unrealized
Unrealized Gain (Loss) Total
Gain (Loss) on Available- Paid in Share-
Common on Equity for-sale Capital- Retained holders'
Stock Securities Investments Warrants Earnings Equity
--------------------------------------------------------------------------------
Balance at December 31, 1996 $16,022 $(17) $(145) $2,206 $27,125 $45,191
Net income - - - - 756 756
Change in unrealized gain
(loss) on investments, net
of taxes - (93) (130) - - (223)
Common stock issued - - - - - -
--------------------------------------------------------------------------------
Balance at March 31, 1997 $16,022 $(110) $(275) $2,206 $27,881 $45,724
================================================================================
See Notes to Condensed Consolidated Financial Statements.
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SUPERIOR NATIONAL INSURANCE GROUP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in thousands)
(Unaudited)
Three Months Ended March 31,
----------------------------
1997 1996
--------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 756 $ 678
--------- ---------
Adjustments to reconcile net income to net cash provided by (used in) operating
activities:
Amortization of bonds and preferred stock (161) (295)
(Gain) on sale of investments (9) -
(Gain) on sale of funds withheld investments - (2,463)
Preferred securities dividends and accretion 687 613
(Increase) decrease in reinsurance receivables (700) 7,083
Decrease in premiums receivables 72 854
(Increase) in deferred policy acquisition costs (1,206) (722)
Decrease in income taxes 433 360
(Decrease) in claims and claim adjustment
expense reserves (8,771) (11,109)
Increase (decrease) in unearned premium reserves 744 (354)
Increase in policyholder dividends payable - 198
Increase in other liabilities, net of other assets 182 1,437
--------- ---------
Total adjustments (8,729) (4,398)
--------- ---------
Net cash (used in) operating activities (7,973) (3,720)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Retirement of long-term debt (2,014) (300)
Proceeds from repurchase transaction - 3,640
--------- ---------
Net cash (used in) provided by financing activities (2,014) 3,340
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of bonds and notes:
Investments available-for-sale (21,297) (16,300)
Investment funds withheld from reinsurers - (59,143)
Purchase of equity security (145) -
Decrease in receivable from reinsurer 1,627 -
Sales of bonds and notes: Investments available-for-sale 9,919 4,680
Maturities of bonds and notes: Investments available-for-sale 2,683 437
Sales and maturities of bonds and notes held to maturity:
Funds withheld from reinsurers - 76,996
Net decrease in invested cash 243 7,501
--------- ---------
Net cash (used in) provided by investing activities (6,970) 14,171
--------- ---------
Net (decrease) increase in cash (16,957) 13,791
Cash and Invested cash at beginning of period 101,937 2,952
--------- ---------
Cash and Invested cash at end of period $ 84,980 $ 16,743
========= =========
Supplemental disclosure of cash flow information:
Cash paid during the year for income taxes $ 4 $ 4
========= =========
Cash paid during the year for interest $ 141 $ 168
========= =========
See Notes to Condensed Consolidated Financial Statements.
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SUPERIOR NATIONAL INSURANCE GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTHS ENDED MARCH 31, 1997
(UNAUDITED)
NOTE A. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
A.1 BASIS OF PRESENTATION
Superior National Insurance Group, Inc. ("SNIG") is a holding company
that, through its wholly-owned subsidiary, Superior National Insurance Company
("SNIC"), is engaged in writings workers' compensation insurance principally in
the State of California, and until September 30, 1993, was engaged in writing
commercial property and casualty insurance. The "Company" refers to SNIG and its
subsidiaries.
The accompanying unaudited condensed consolidated financial statements
of the Company have been prepared in accordance with generally accepted
accounting principles for interim financial information and with the
instructions to Form 10-Q and Article 10 of regulation S-X. Accordingly, they do
not include all of the information and footnotes required by generally accepted
accounting principles for complete financial statements. In the opinion of
management, all adjustments, including normally occurring accruals, considered
necessary for a fair presentation have been included. Certain reclassifications
of prior year amounts have been made to conform with the 1997 presentation.
Operating results for the three months ended March 31, 1997 are not necessarily
indicative of the results to be expected for the year ended December 31, 1997.
For further information, refer to the consolidated financial statements and
footnotes thereto included in SNIG's annual report on Form 10-K for the year
ended December 31, 1996.
A.2 EARNINGS PER SHARE ("EPS")
Earnings per common and dilutive common equivalent shares for the three
months ended March 31, 1997 and 1996 are based on the average number of common
shares outstanding during each period and assuming conversion of all stock
options and warrants which are common stock equivalents. Common share
equivalents included in the computation represent shares issuable upon assumed
exercise of stock options and warrants which would have a dilutive effect. If
the calculation of income per share including all common stock equivalents is
antidilutive, such common stock equivalents are excluded from the EPS amounts.
The number of shares used in the EPS calculations are 5,465,459 shares for the
three months ended March 31, 1997; and 3,430,373 shares for the three months
ended March 31, 1996. The increase in shares was due to the application of the
"modified treasury stock method" of computing earnings per share, which
increases dilution as the price of the Company's shares increases.
In February 1997, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standard presentation No. 128, and "Earnings
per Share" ("SFAS 128"), which establishes the computation, presentation, and
disclosure requirements for earnings per share. SFAS 128 is effective for fiscal
periods ending after December 15, 1997. The effects of SFAS 128 on the Company's
earnings per share calculation is not expected to be materially different than
that historically presented.
A.3 CLAIMS AND CLAIM ADJUSTMENT EXPENSE RESERVES
The liability for unpaid claims and claim adjustment expenses is based
on an evaluation of reported losses and on estimates of incurred but unreported
losses. The reserve liabilities are determined using adjusters' individual case
estimates and statistical projections, which can be affected by many external
factors that are difficult to predict, including changes in the economy, trends
in medical treatments and litigation, changes in regulatory environment, medical
services, and employment rights. The liability is reported net of estimated
salvage and subrogation recoverable. Adjustments to the liability resulting from
subsequent developments or revisions to the estimate are reflected in results of
operations in the period which such adjustment become known. While there can be
no assurance that reserves at any given date are adequate to meet SNIG's
obligations, the amounts reported on the balance sheet are management's best
estimate of that amount.
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A.4 ACQUISITION OF PACIFIC RIM
On April 11, 1997, the Company acquired Pac Rim Holding Corporation
("Pac Rim") for total consideration of approximately $42 million in cash, which
consideration resulted in payment of approximately $20 million ($2.105 per
share) to Pac Rim's common stockholders; $20 million to Pac Rim's debenture
holders; and the remainder to Pac Rim's warrant and option holders. SNIG
financed the acquisition with a combination of common stock and bank debt. A
group of investors including Insurance Partners, L.P., TJS Partners, L.P., and
SNIG management purchased approximately $18 million of newly issued SNIG common
stock. The remaining portion of the purchase price was funded by a $44 million
term loan provided by a bank syndicate led by The Chase Manhattan Bank
("Chase"). Approximately $6.6 million of the loan proceeds was used to repay
SNIG's outstanding long-term debt. Additionally, approximately $10 million of
the loan proceeds was contributed to the capital of Pacific Rim Assurance
Company.
A.5 FINANCING AGREEMENT
On September 17, 1996, the Company consummated a three-part financing
transaction, involving Centre Reinsurance Limited ("Centre Re") and The Chase
Manhattan Bank ("Chase"). Chase extended a $93.1 million term loan (net of
transaction costs) to the Company in exchange for future reinsurance recoveries
due from Centre Re to SNIC. The proceeds from the financing were used by the
Company to purchase reinsurance receivables due to SNIC from Centre Re, and SNIC
utilized a portion of the proceeds to extinguish a $71 million liability for
reinsurance premiums due to Centre Re. The transaction was approved by the
California Department of Insurance.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
References to "SNIG" and "the Company" in this quarterly report do not include
the newly acquired subsidiary Pacific Rim Assurance Company, and the results of
Pacific Rim are not reported or discussed herewith, as the acquisition closed
after the end of the first quarter.
FINANCIAL CONDITION:
Total assets decreased $8.6 million to $297,984 for the quarter ended March 31,
1997. The decrease was due primarily to a decline of $8.5 million in cash and
invested assets.
The decrease in cash and invested assets was offset by an $8.5 million decrease
in claims and claim adjustment expenses.
RESULTS OF OPERATIONS:
The following selected financial data and analysis provide an
assessment of SNIG's financial results for the three months ended March 31, 1997
as compared to the three months ended March 31, 1996. Certain prior period
amounts have been reclassified to conform to the current period presentation.
Selected financial data as reported for the three months ended March 31, 1997
and 1996 are presented below.
Three Months Ended March 31,
----------------------------
(Dollars in thousands) 1997 1996
- ---------------------- -------- --------
Gross premiums written $ 22,780 $ 21,293
Net premiums written $ 20,003 $ 18,643
Net premiums earned $ 18,978 $ 18,897
Less: Claims and claim adjustment expenses, net of
reinsurance recoveries (10,271) (10,275)
Underwriting expenses (7,004) (6,200)
Policyholder dividends - (299)
-------- --------
Underwriting profit $ 1,703 $ 2,123
======== ========
Net investment income $ 2,086 $ 2,191
Interest expense $ 1,727 $ 2,528
Underwriting ratios (GAAP Basis):
- ---------------------------------
Net claims and claim adjustment expense ratio 54.1% 54.4%
Underwriting expense ratio 36.9% 32.8%
Policyholder dividends ratio - 1.6%
-------- --------
Combined ratio 91.0% 88.8%
======== ========
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
Gross premiums written increased $1.5 million or 7% in the first
quarter of 1997 as compared to the same period in 1996. The increase in premiums
written is attributable to SNIC's strategy to underwrite smaller risks. The
Company's strategy is to continue to focus on profitable operating margins first
and market share second. At the end of the first quarter of 1997, production
measured in policy counts was 26% higher than it was in the first quarter of
1996, and the estimated annual premium associated with those policies decreased
7%. The Company is continuing to make strenuous efforts to increase production,
subject to the constraints of sound underwriting standards, and to reduce the
Company's fixed and semi-fixed expense ratios commensurate with premium levels.
The Company believes the acquisition of Pac Rim Holding Corporation ("PRIM")
will enhance its ability to pursue this strategy.
Net premiums written increased $1.4 million or 7% in the first quarter
of 1997 as compared to the first quarter of 1996. The increase in net premiums
written is reflective of the increase in gross premiums written as discussed
above.
Net premiums earned increased $0.08 million or less than 1% in the
first quarter of 1997 as compared to the first quarter of 1996. The increase in
net premiums earned reflects the increase in net premiums written described
above.
Claims and claim adjustment expense, net of reinsurance recoveries
decreased less than 1% in the first quarter of 1997 as compared to the same
period in 1996. The net claims and claim adjustment expense ratio decreased
slightly to 54.1% in the first quarter of 1997 from 54.4% in the same period in
1996.
Underwriting expenses, excluding policyholder dividends, increased $0.8
million or 13.5% in the first quarter of 1997 as compared to the same period in
1996. The underwriting expense ratio deteriorated 12.5% to 36.9% for the first
quarter of 1997 from 32.8% for the corresponding period in 1996. The increase is
primarily due to higher general and administrative expenses for the first
quarter of 1997 which increased $1.1 million or 29% as compared to the same
period in 1996. The increase in general and administrative expenses including
marketing costs are associated with the Company's increased efforts to increase
its market share of smaller risks.
Policyholder dividends, prior to open rating, served both as an
economic incentive to employers for safe operations and as a means of price
differentiation. As a result of consumers' preference for the lowest net price
at the policy's inception under open rating, dividends are no longer a
significant factor in the marketing of workers' compensation insurance in
California. As a result, SNIC's management determined at year-end 1996 that it
was prudent to suspend the further issuance of policyholder dividends.
Therefore; no policyholder dividend expense was incurred during the first
quarter of 1997 as compared to $0.3 million for the same period in 1996.
Underwriting profit from continuing operations decreased $0.4 million
to $1.7 million in the first quarter of 1997 from $2.1 million in the same
period in 1996. The decrease of $.4 million in the first quarter of 1997 was due
primarily to increased general and administrative expenses. The 29% or $1.1
million increase in general and administrative expenses reflects the Company's
recent increases in marketing and underwriting efforts associated with the
strategic changes in the Company's focus on smaller risks.
Net investment income decreased $0.1 million or 5% in the first quarter
of 1997 compared to the same period in 1996. The decrease in net investment
income is due to a decrease in the average investable assets of $25.6 million in
1997 as compared to 1996.
Interest expense for the first quarter of 1997 was $1.7 million as
compared to $2.5 million for the same period in 1996. The decrease of $0.8
million was a result of lower interest expense due to declining long-term debt
balances and a declining bank term loan as a result of principal paydown.
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
A summary of net investment income for the three months ended March 31,
1997 and 1996 are as follows:
Three months ended March 31,
----------------------------
(Dollars in thousands) 1997 1996
-------- --------
Interest on bonds and notes $ 858 $ 2,232
Interest on invested cash 1,346 81
-------- --------
Total investment income 2,204 2,313
Capital gains 9 -
Investment expense 127 122
-------- --------
Net investment income $ 2,086 $ 2,191
======== ========
The distribution of SNIG's consolidated investment portfolio is as
follows (in thousands):
March 31, 1997 December 31, 1996
-------------------- ----------------------
Amortized Market Amortized Market
Cost Value Cost Value
------- ------- ------- -------
Available for Sale:
U.S. Government
Agencies & Authorities $22,503 $22,179 $22,596 $22,484
Collateralized Mortgage Obligations 20,791 20,479 12,989 12,855
Corporate Instruments 10,777 10,979 9,864 9,867
State & Political Subdivisions 1,100 1,118 1,100 1,124
------- ------- ------- -------
Total Available for Sale $55,171 $54,755 $46,549 $46,330
======= ======= ======= =======
March 31, 1997 December 31, 1996
------------------------------- ------------------------------
Market Market
Equity Securities Cost Value Cost Value
- ----------------- ----------- ----------- ----------- -----------
Corporate $ 1,344 $ 1,177 $ 1,199 $ 1,173
----------- ----------- ----------- -----------
Total $ 1,344 $ 1,177 $ 1,199 $ 1,173
=========== =========== =========== ===========
The Company's management monitors the matching of assets and
liabilities and attempts to maintain its investment duration at the mid-point of
the length of its net claim and claim adjustment expenses payout pattern.
Investment duration is the weighted average measurement of the current maturity
of a fixed income security, in terms of time, of the present value of the future
payments to be received from that security. However, in selecting assets to
purchase for its investment portfolio, the Company considers each security's
modified duration and the effect of that security's modified duration on the
portfolio's overall modified duration. Modified duration is a measurement that
estimates the percentage change in market value of an investment for a small
change in interest rates. The modified duration of fixed maturities at March 31,
1997 was 2.31 years compared to 2.77 years at December 31, 1996. At March 31,
1997, 98% of the carrying values of investments in the fixed maturities
portfolio were rated as investment grade by the Securities Valuation Office of
the National Association of Insurance Commissioners.
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
DISCONTINUED OPERATIONS:
Discontinued operations claims counts and losses remained consistent
with management's expectations during the first quarter of 1997. The Company has
significant exposure to construction defect liabilities on casualty insurance
policies underwritten from 1986 to 1991. Management continues to closely monitor
its potential exposure to construction defect claims. Management believes its
current reserves are adequate to cover this increase in claims activity
depending on the length of time the recent reporting trends continue. There can
be no assurance, therefore, that further upward development of ultimate loss
costs associated with construction defect claims will not occur. The Company
will continue to closely monitor the adequacy of its loss reserves in the
discontinued operations.
LIQUIDITY AND CAPITAL RESOURCES:
Liquidity is a measure of an entity's ability to secure sufficient cash
to meet its contractual obligations and operating needs. The Company's cash
inflows are generated from cash collected for policies sold, investment income
on the existing portfolio and sales and maturities of investments. The Company's
cash outflows consist primarily of payments for policyholders' claims and
operating expenses. For its insurance operations, SNIC must have available cash
and liquid assets to meet its obligations to policyholders and claimants in
accordance with contractual obligations in addition to meeting its ordinary
operating costs. It is management's opinion that its present cash resources,
with the addition of $44 million in additional bank debt and $18 million in
equity raised in April 1997, in connection with the PRIM acquisition, are
sufficient to meet the needs of the Company.
During the first three months of 1997, the Company used $8.0 million of
cash in its operations versus $3.7 million during the same period in 1996. The
$4.3 million increase in funds used in operating activities in 1997 was
primarily the result of the Company's debt agreement dated September 17, 1996.
The debt agreement had the effect of returning all of the Centre Re reinsurance
recoverables in a lump sum to the Company. Therefore, the Company had no
recoveries in the first quarter of 1997 related to the Centre Re treaties, where
as during the first quarter 1996 the Company recovered $5.7 million. The
Company's continued negative cashflow is the result of the Company's historical
in-force premium base being significantly higher than its current level. The
Company anticipates to continue to experience negative cashflow until the claims
related to the historically higher premium base have been paid out. SNIG
believes that it has adequate short-term investments and readily marketable
investment grade securities to cover both claim payments and expenses. As of
March 31, 1997, the Company had total cash, cash equivalents and investments of
$140.9 million.
The Company used $0.4 million in cash from financing activities for the
three months ended March 31, 1997 and generated $3.3 million for the
corresponding period in 1996. The cash used by financing activities in the three
months of 1997 was for the paydown of the outstanding term loan.
Early in 1995, SNIC entered into a reverse repurchase facility with a
national securities brokerage firm ("broker") that allows SNIC to engage in up
to $5 million in reverse repurchase transactions secured either by U.S. Treasury
instruments or U.S. Agency debt. This arrangement provides SNIC with additional
short-term liquidity. Under the facility, SNIC contacts the broker and indicates
the size of the reverse repurchase transaction desired, and the nature of the
security SNIC proposes to "sell" to the broker. Based upon the characteristics
of the security, the broker indicates at what price it will purchase the
security and what rate they will sell the security back to SNIC in 30 days. SNIC
then transfers the security to the broker in exchange for the agreed-upon
proceeds. SNIC repurchases the security from the broker at a later date at a
previously agreed-upon price. SNIC may roll over any reverse repurchase
transaction, and the transaction is repriced at the time of roll over. This type
of financing allows SNIC a great deal of flexibility to manage short-term
investments, avoiding the unnecessary realization of losses to satisfy
short-term cash needs. Further, this method of financing is relatively
inexpensive as compared to bank debt. Reverse repurchase transactions are viewed
as short-term financing both by the DOI and current accounting literature. As of
March 31, 1997, SNIC had no obligation outstanding under this facility.
Historically, for long-term financing, the Company required borrowings in order
to meet its obligations.
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
Because SNIG depends on dividends from its insurance subsidiary for its
net cash flow requirements, absent other sources of cash flow, SNIG cannot pay
dividends materially in excess of the amount of dividends that could be paid by
SNIC to SNIG. Insurance companies are also subject to restrictions affecting the
amount of shareholder dividends and advances that may be paid within any one
year without the prior approval of the DOI. The California Insurance Code
provides that amounts may be paid as dividends on an annual noncumulative basis
(generally based on the greater of (1) net income for the preceding year or (2)
10% of statutory surplus as regards policyholders as of the preceding December
31) without prior notice to, or approval by, the DOI. No ordinary dividends were
paid during the three months ended March 31, 1997.
SNIC is a party to various leases principally associated with the
Company's home and branch office space. Such leases contain provisions for
scheduled lease charges and escalations in base rent over the lease term. The
Company's minimum commitment with respect to these leases in 1997 is
approximately $1.9 million. These leases expire from 1997 to 2001.
The Company does not foresee any expenditures other than those arising
in the normal course of business and the PRIM acquisition.
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PART II. OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES
The Company hereby incorporates by reference the text of Item 5 to
its Current Report on Form 8-K, filed with the Securities and Exchange
Commission on April 24, 1997, as a partial response to this item.
From January 1, 1997 until March 18, 1997, the effective date of the
Company's Registration Statement on Form S-8 relating to its (i) 1986
Non-Statutory Stock Option and 1986 Non-Statutory Stock Purchase Plan and (ii)
1995 Stock Incentive Plan (the "1995 Plan"), the Company awarded to certain
employees under the 1995 Plan, options to purchase an aggregate of 28,600 shares
of Common Stock, vesting in equal annual increments of 20% from the date of
grant of such options and having exercise prices ranging from $11.38 to $12.38
per share. In issuing such options, the Company relied upon the exemption from
registration provided by Section 4(2) of the Securities Act of 1933, as amended
(the "Securities Act").
In order to help finance the Company's acquisition of PRIM, discussed
below under "Item 5. Other Information," the Company issued and sold on April
11, 1997 to Insurance Partners, L.P., Insurance Partners Offshore (Bermuda),
L.P., TJS Partners, L.P. and certain members of the Company's management, in a
private transaction, 2,390,438 shares of Common Stock at $7.53 per share for an
aggregate purchase price of approximately $18 million. In issuing and selling
such shares of Common Stock, the Company relied upon the exemption from
registration provided by Section 4(2) of the Securities Act.
ITEM 5. OTHER INFORMATION
On April 11, 1997, the Company completed its acquisition of PRIM. The
total purchase price for PRIM's outstanding common stock, stock options,
debentures and warrants was approximately $42 million. In addition, at closing,
the Company repaid $6.6 million in long-term debt and contributed $10 million to
the capital of Pacific Rim Assurance Company, the wholly-owned operating
subsidiary of PRIM, now renamed "Superior Pacific Casualty Company." Financing
for the acquisition is discussed below,
The Company believes that the integration of PRIM with SNIC will
beneficially impact earnings in 1998 and beyond, as it provides an opportunity
to realize immediate strategic and financial benefits. The consolidation should
provide significant economies of scale that neither company could achieve
independently.
The closing of the acquisition was originally anticipated to occur in
late 1996, but was delayed because PRIM's claim and claim adjustment expense
reserves for accident years 1995 and prior were scrutinized by the DOI, and then
eventually strengthened by $12 million effective December 31, 1996. The PRIM
reserve adjustment was booked, and the purchase price renegotiated, in February
1997. The parties were able to close the transaction promptly after receipt of
shareholder and regulatory approval. However, the delay in closing the
acquisition has had the effect of delaying the realization of anticipated cost
savings and, as is typical in such transactions, probably caused some weakening
of PRIM's business base as time passed. Realization of management's belief and
projections will depend on a number of factors, including management's
successful execution of its business plan for integrating the operations of the
two companies, the insurance market's reception to the combined companies, and
other factors beyond SNIG's control.
Financing
The acquisition of PRIM was financed in part by the Company's issuance
and sale of Common Stock for an aggregate purchase price of approximately $18
million, as discussed above under "Item 2. Changes in Securities."
In addition, the Company obtained a $44 million term loan from a
syndicate of banks led by the Chase Manhattan Bank ("Chase"), pursuant to a
Credit Agreement dated as of April 11, 1997 ("Credit Agreement"), by and among
the Company, Superior Pacific Insurance Group, Inc. (formerly SNTL Acquisition
Corp.), as Borrower, the banks and Chase, as administrative agent. The term loan
is payable in full on April 11, 2003. The Company will repay the principal in
eleven equal annual installments of $3.65 million and a final installment of
$3.85 million on the due date. In addition, certain transactions, such as asset
sales and changes in control of the Company, trigger mandatory prepayment
obligations. The Company may make prepayments without penalty at any time.
Interest on
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the term loan is generally payable quarterly, unless the Company elects an
interest rate based on the 1-month LIBOR rate, in which case interest is payable
monthly. The rate is a floating rate selected by the Company. At the Company's
option, it may pay a rate of 200 basis points in excess of the 1, 3 or 6 month
LIBOR rate, or 100 basis points in excess of Chase's prime lending rate.
Beginning January 1, 1998, the spread over LIBOR or prime, as the case may be,
will be dependent on the Company's fixed charge coverage ratio. If that ratio is
less than 1.75:1, the spread will increase to 225 or 125 basis points, as the
case may be, but if the ratio increases then the spread will be reduced.
In addition to the covenant regarding fixed charge coverage, the
Company agreed to other financial covenants in the Credit Agreement, a leverage
ratio, a minimum statutory surplus, minimum risk based capital and a limit on
operating leverage (premiums written as compared to statutory surplus), which is
not to exceed 2.50:1. Furthermore, one covenant requires that the Company
maintain a "B+" A.M. Best Rating for SNIC, and "B" Rating for Superior Pacific
Casualty Company should it be rated on a stand alone basis. The Company believes
that its operating results in the future will remain at a level sufficient to
meet the financial covenants and maintain a "B+" Rating, but such positive
results cannot be assured. The banks may, in the event of default, upon giving
notice to the Company accelerate the obligations due under the Credit Agreement.
The Credit Agreement also contains customary limitations on the
Company's operations, including limits on indebtedness and capital expenditures,
limits on asset sales, and restrictions on investments. For the most part,
additional equity issued by the Company must be used to repay the term loan. In
addition, the Company has agreed that it will not pay dividends to holders of
SNIG Common Stock.
The Credit Agreement is secured by a pledge of all of the assets of
SNIG, Superior Pacific Insurance Group (the "Borrower") (an intermediate holding
company), and the Borrower's unregulated subsidiaries. Among the assets pledged
are the Stock held by Borrower in the regulated insurance companies -- SNIC,
Superior Pacific Casualty Company, and Superior (Bermuda) Ltd., of which only
SNIC is active in writing new and renewal business.
As a result of incurring the indebtedness under the term loan, the
Company was required to secure waivers under the 1996 loan agreement with Chase
and the documents governing the 1994 issuance of preferred stock by a subsidiary
of the Company, Superior National Capital, L.P., to CRS III Limited, an
affiliate of Centre Reinsurance Limited. The Company agreed to extend the
expiration date of the warrant issued to Centreline Reinsurance Limited in the
1994 transaction from June 2001 to April 30, 2002.
On April 11, 1997, the company reincorporated in Delaware, and in
reincorporating adopted restrictions on transfers of Common Stock to 4.90% or
more shareholders of the Company.
The Company announced on April 16, 1997, that William L. Gentz,
President and Chief Executive Officer of the Company, had suffered a mild heart
attack and underwent surgery. The Company expects Mr. Gentz to make a full
recovery and return to work in late May or June 1997.
The Company announced that to better reflect the combined strength of
Superior National Insurance Company and Superior Pacific Casualty Company
(formerly Pacific Rim Assurance Company) it will conduct business under the name
"Superior Pacific," although the parent company will continue to be known as
"Superior National Insurance Group" and trade on the Nasdaq Stock Market under
the symbol "SNTL."
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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
EXHIBIT
NUMBER DESCRIPTION
- ------ -----------
2.1 Amended and Restated Agreement and Plan of Merger dated as of February
17, 1997 among the Company, SNTL Acquisition Corp., and PRIM*****
3.1 Certificate of Incorporation of the Company, as currently in effect ++
3.2 Bylaws of the Company, to date ++
10.1 Credit Agreement between the Company and The Chase Manhattan Bank
("Chase") dated as of November 12, 1996, (the "1996 Credit Agreement"),
and all material exhibits thereto +
10.2 Amendment No. 1 to 1996 Credit Agreement dated as of April 11, 1997
10.3 Assumption Acknowledgment under the 1996 Credit Agreement dated as of
April 11, 1997 among the Company, as a California corporation
("SNIG-California"), the Company and Chase
10.4 Stock Purchase Agreement dated as of September 17, 1996, as amended and
restated effective as of February 17, 1997, among the Company,
Insurance Partners, L.P., Insurance Partners Offshore (Bermuda), L.P.,
TJS Partners, L.P., and certain members of the Company's
management*****
10.5 Registration Rights Agreement dated as of April 11, 1997 among the
Company, Insurance Partners, L.P. and Insurance Partners Offshore
(Bermuda), L.P.
10.6 Letter Agreement dated November 25, 1996 among the Company and the
shareholders and holders of warrants party thereto, relating to such
warrants and certain registration rights
10.7 Credit Agreement dated as of April 11, 1997 (the "1997 Credit
Agreement") among the Company, SNTL Acquisition Corp., various lending
institutions, and Chase
10.8 Pledge Agreement under the 1997 Credit Agreement dated as of April 11,
1997 among the Pledgors therein and Chase
10.9 Assumption Acknowledgment under the 1997 Credit Agreement dated as of
April 11, 1997 among SNTL Acquisition Corp., Superior Pacific Insurance
Group, Inc. and Chase
10.10 SNIG Assumption Acknowledgment under the 1997 Credit Agreement dated as
of April 11, 1997 among SNIG-California, the Company, and Chase
27 Financial Data Schedule
***** Previously filed as an exhibit to SNIG's statement on Schedule 13D
filed for Pac Rim Holding Corporation, as filed with the SEC on
February 27, 1997.
+ Previously filed as an exhibit to SNIG's Annual Report on Form 10-K for
the fiscal year ended December 31, 1996, as filed with the SEC on March
10, 1997.
++ Previously filed as an exhibit to SNIG's Current Report on Form 8-K, as
filed with the SEC on April 24, 1997.
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(b) Reports on Form 8-K:
The Company did not file any reports on Form 8-K during the
three months ended March 31, 1997.
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Dated: May 14, 1997 SUPERIOR NATIONAL INSURANCE GROUP, INC.
By /s/ J. Chris Seaman
-------------------------------------
Name: J. Chris Seaman
Title: Executive Vice President and
Chief Financial Officer
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EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION
- ------ -----------
2.1 Amended and Restated Agreement and Plan of Merger dated as of February
17, 1997 among the Company, SNTL Acquisition Corp., and PRIM*****
3.1 Certificate of Incorporation of the Company, as currently in effect ++
3.2 Bylaws of the Company, to date ++
10.1 Credit Agreement between the Company and The Chase Manhattan Bank
("Chase") dated as of November 12, 1996, (the "1996 Credit Agreement"),
and all material exhibits thereto +
10.2 Amendment No. 1 to 1996 Credit Agreement dated as of April 11, 1997
10.3 Assumption Acknowledgment under the 1996 Credit Agreement dated as of
April 11, 1997 among the Company, as a California corporation
("SNIG-California"), the Company and Chase
10.4 Stock Purchase Agreement dated as of September 17, 1996, as amended and
restated effective as of February 17, 1997, among the Company,
Insurance Partners, L.P., Insurance Partners Offshore (Bermuda), L.P.,
TJS Partners, L.P., and certain members of the Company's
management*****
10.5 Registration Rights Agreement dated as of April 11, 1997 among the
Company, Insurance Partners, L.P. and Insurance Partners Offshore
(Bermuda), L.P.
10.6 Letter Agreement dated November 25, 1996 among the Company and the
shareholders and holders of warrants party thereto, relating to such
warrants and certain registration rights
10.7 Credit Agreement dated as of April 11, 1997 (the "1997 Credit
Agreement") among the Company, SNTL Acquisition Corp., various lending
institutions, and Chase
10.8 Pledge Agreement under the 1997 Credit Agreement dated as of April 11,
1997 among the Pledgors therein and Chase
10.9 Assumption Acknowledgment under the 1997 Credit Agreement dated as of
April 11, 1997 among SNTL Acquisition Corp., Superior Pacific Insurance
Group, Inc. and Chase
10.10 SNIG Assumption Acknowledgment under the 1997 Credit Agreement dated as
of April 11, 1997 among SNIG-California, the Company, and Chase
27 Financial Data Schedule
***** Previously filed as an exhibit to SNIG's statement on Schedule 13D
filed for Pac Rim Holding Corporation, as filed with the SEC on
February 27, 1997.
+ Previously filed as an exhibit to SNIG's Annual Report on Form 10-K for
the fiscal year ended December 31, 1996, as filed with the SEC on March
10, 1997.
++ Previously filed as an exhibit to SNIG's Current Report on Form 8-K, as
filed with the SEC on April 24, 1997.
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