1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
Form 10-Q
(X) Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934.
For the quarterly period ended June 30, 1997
-------------------------------------------------
( ) Transition report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934.
For the Transition period from ______________________ to _______________________
State Auto Financial Corporation
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Ohio 31-1324304
- ------------------------------ ------------------------------------
(State or other jurisdiction (I.R.S. Employer Identification No.)
of incorporation)
518 East Broad Street, Columbus, Ohio 43215-3976
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(Address of principal executive offices) (zip code)
(614) 464-5000
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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 such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
(X) Yes ( ) No
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date:
Common shares, without par value 18,205,569
- -------------------------------- -------------------------
(Class) (Outstanding on 08/01/97)
2
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
June 30 December 31
1997 1996
----------------- -----------------
ASSETS (UNAUDITED) (NOTE 1)
Fixed maturities:
Held for investment, at amortized cost
(fair value $87,873,663 and $91,058,485, respectively) $86,832,015 $90,251,124
Available for sale, at fair value
(amortized cost $301,659,268 and $286,790,650, respectively) 308,506,291 294,056,432
------------------ ------------------
Total investments 395,338,306 384,307,556
Cash and cash equivalents 10,325,932 12,867,968
Deferred policy acquisition costs 16,975,599 15,711,347
Accrued investment income and other assets 16,327,276 13,845,107
Net prepaid pension expense 11,256,308 10,622,708
Reinsurance recoverable 10,525,061 9,691,202
Prepaid reinsurance premiums 3,722,635 3,379,741
Due from affiliates 3,662,817 -
Deferred federal income taxes - 153,984
Property and equipment, net 2,503,558 2,540,526
----------------- -----------------
Total assets $470,637,492 $453,120,139
================== ==================
LIABILITIES AND STOCKHOLDERS' EQUITY
Losses and loss expenses payable $167,079,432 $165,874,707
Unearned premiums 98,085,882 93,883,927
Current federal income taxes 805,383 2,076,374
Deferred federal income taxes 149,919 -
Due to affiliates - 2,903,548
Other liabilities 2,514,763 1,920,655
------------------ ------------------
Total liabilities 268,635,379 266,659,211
------------------ ------------------
STOCKHOLDERS' EQUITY
Common stock, without par value. Authorized 30,000,000
shares; 18,205,569 and 18,135,526 shares issued and outstanding,
respectively, at stated value of $5 per share 91,027,845 90,677,630
Additional paid-in capital 1,797,912 1,456,083
Net unrealized holding gains 4,872,717 5,179,126
Retained earnings 104,303,639 89,148,089
------------------ ------------------
Stockholders' equity 202,002,113 186,460,928
================== ==================
Total liabilities and stockholders' equity $470,637,492 $453,120,139
================== ==================
See accompanying notes to condensed consolidated financial statements.
3
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS
For the Three Months Ended June 30, 1997 and 1996
1997 1996
---------------- ----------------
(unaudited) (unaudited)
Earned premiums (net of ceded earned premiums of
$3,076,432 and $2,769,194, respectively) $63,765,837 $59,861,465
Net investment income 6,265,865 5,925,574
Management services income 2,265,658 2,000,020
Net realized gains on investments 83,001 587,854
----------------- -----------------
Total revenues 72,380,361 68,374,913
----------------- -----------------
Losses and loss expenses (net of ceded losses and loss
expenses of $2,413,371 and $1,198,968, respectively) 41,656,535 44,326,383
Acquisition and operating expenses 19,027,040 16,582,300
Other expense, net 419,236 799,109
----------------- -----------------
Total expenses 61,102,811 61,707,792
----------------- -----------------
Earnings before federal income taxes 11,277,550 6,667,121
Federal income tax expense:
Current 3,016,714 1,704,645
Deferred 142,409 112,410
----------------- -----------------
Total federal income taxes 3,159,123 1,817,055
----------------- -----------------
Net earnings $8,118,427 $4,850,066
================= =================
Weighted average common shares outstanding 18,174,120 18,057,291
================= =================
Net earnings per common share $0.44 $0.27
================= =================
Dividends paid per common share $0.040 $0.037
================= =================
See accompanying notes to condensed consolidated financial statements.
4
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS
For the Six Months Ended June 30, 1997 and 1996
1997 1996
----------------- ----------------
(unaudited) (unaudited)
Earned premiums (net of ceded earned premiums of
$5,823,825 and $5,481,073, respectively) $126,016,508 $118,795,552
Net investment income 12,501,389 11,867,066
Management services income 4,472,711 4,007,035
Net realized gains on investments 321,383 1,037,237
----------------- -----------------
Total revenues 143,311,991 135,706,890
----------------- -----------------
Losses and loss expenses (net of ceded losses and loss
expenses of $5,429,185 and $4,745,928, respectively) 83,596,851 86,968,743
Acquisition and operating expenses 37,201,921 32,926,823
Other expense, net 890,424 1,463,261
----------------- -----------------
Total expenses 121,689,196 121,358,827
----------------- -----------------
Earnings before federal income taxes 21,622,795 14,348,063
Federal income tax expense:
Current 5,504,009 3,885,716
Deferred 468,941 5,073
----------------- -----------------
Total federal income taxes 5,972,950 3,890,789
----------------- -----------------
Net earnings $15,649,845 $10,457,274
================= =================
Weighted average common shares outstanding 18,159,659 18,043,820
================= =================
Net earnings per common share $0.86 $0.58
================= =================
Dividends paid per common share $0.080 $0.073
================= =================
See accompanying notes to condensed consolidated financial statements.
5
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Six Months Ended June 30, 1997 and 1996
1997 1996
----------------- ----------------
(unaudited) (unaudited)
Cash flows from operating activities:
Net earnings $15,649,845 $10,457,274
----------------- -----------------
Adjustments to reconcile net earnings to net cash provided by operating
activities:
Depreciation and amortization, net 385,298 376,142
Change in deferred policy acquisition costs (1,264,252) (583,191)
Change in accrued investment income and other assets (2,482,169) (306,384)
Change in net prepaid pension expense (633,600) (551,200)
Change in other liabilities and due to/from affiliate, net (5,972,165) 4,029,865
Change in reinsurance recoverable and prepaid reinsurance premiums (1,176,753) 112,967
Change in losses and loss expenses payable 1,204,725 (3,092,909)
Change in unearned premiums 4,201,955 2,235,910
Change in federal income taxes (802,050) (368,318)
Net realized gains on investments (321,383) (1,056,640)
----------------- -----------------
Net cash provided by operating activities 8,789,451 11,253,516
----------------- -----------------
Cash flows from investing activities:
Purchase of fixed maturities - held to maturity - (6,058,920)
Purchase of fixed maturities - available for sale (49,041,991) (60,866,146)
Maturities, calls and principal reductions of fixed maturities -
held to maturity 3,338,120 7,109,710
Maturities, calls and principal reductions of fixed maturities -
available for sale 8,068,113 2,020,000
Sale of fixed maturities - available for sale 26,120,250 57,256,234
Net additions of property and equipment (13,728) (101,663)
----------------- -----------------
Net cash used in investing activities (11,529,236) (640,785)
----------------- -----------------
Cash flows from financing activities:
Net proceeds from sale of common stock 692,044 683,206
Payment of dividends (494,295) (444,424)
----------------- -----------------
Net cash provided by financing activities 197,749 238,782
----------------- -----------------
Net increase (decrease) in cash and cash equivalents (2,542,036) 10,851,513
Cash and cash equivalents at beginning of period 12,867,968 11,227,375
----------------- -----------------
Cash and cash equivalents at end of period $10,325,932 $22,078,888
================= =================
Supplemental disclosures:
Federal income taxes paid $6,775,000 $4,259,106
================= =================
See accompanying notes to condensed consolidated financial statements.
6
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
June 30, 1997
(unaudited)
1. BASIS OF PRESENTATION
The financial statements for the interim periods included herein have been
prepared by the Company without audit; however, such information reflects all
adjustments (consisting of normal recurring adjustments) which are, in the
opinion of management, necessary for a fair presentation of the financial
position, results of operations and cash flows for the interim periods. Certain
information and footnote disclosures normally included in financial statements
prepared in accordance with generally accepted accounting principles have been
condensed or omitted. These financial statements should be read in conjunction
with the financial statements and notes thereto for the year ended December 31,
1996 included in the Company's 1996 Form 10-K filed with the Securities and
Exchange Commission.
The results of operations for the interim periods presented are not necessarily
indicative of the operating results that may be expected for the full fiscal
year ending December 31, 1997.
2. NET EARNINGS PER COMMON SHARE
Net earnings per common share is computed on the basis of the weighted average
number of common shares outstanding during each of the respective periods
presented. Additional shares arising from the assumed exercise of employee and
director stock options were not included in the computations as the dilutive
effect was not material.
In February 1997, the FASB issued SFAS No. 128, "Earnings per Share," which is
required to be adopted on December 31, 1997. At that time, the Company will be
required to change the method currently used to compute earnings per share and
to restate all prior periods. Under the new requirements for calculating primary
earnings per share, the dilutive effect of stock options will be excluded, and
is not expected to be material to the Company. The Company has not yet
determined what the impact of Statement 128 will be on the calculation of fully
diluted earnings per share, but it is not expected to be material.
3. NET ACCOUNTING STANDARDS
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income,"
which is effective for fiscal years beginning after December 15, 1997. Statement
130 establishes standards for the reporting and display of comprehensive income
and its components in a full set of general purpose financial statements. Also
in June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information," which is effective for fiscal years
beginning after December 15, 1997. Statement 131 changes the way public
companies report segment information in annual financial statements and also
requires those companies to report selected segment information interim
financial reports to shareholders. The Company has not yet determined the
reporting changes required by Statements 130 and 131 to comprehensive income and
segment information.
7
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
Results of Operations
- ---------------------
Earnings before federal income taxes increased $4.6 million to $11.3 million and
$7.3 million to $21.6 million for the three months and six months ended June 30,
1997, respectively, from the same 1996 periods. These increases are due to a
combination of revenue growth and improvement in total expenses of the Company
from the same 1996 periods. The GAAP combined ratio, i.e., losses and loss
expenses plus acquisition and operating expenses, as a percentage of earned
premiums, decreased to 95.1% for the quarter ended June 30, 1997 from 101.7% for
the same period in 1996 and for the six months ended June 30, 1997, decreased to
95.8% from 100.9% for the same period in 1996.
Earned premiums increased $3.9 million (6.5%) to $63.8 million for the quarter
ended June 30, 1997 and $7.2 million (6.1%) to $126.0 million for the six months
ended June 30, 1997 from the same 1996 periods. The Company's principal
insurance subsidiary, State Auto P&C, increased its earned premium approximately
3.2% and 3.0% from the same three month and six month periods, respectively, in
1996. Approximately 1.3 percentage points of the three month and six month
period increase is due to the catastrophe reinsurance agreement, effective July
1, 1996, between State Auto P&C and its insurance affiliates whereby State Auto
P&C became the catastrophe reinsurer for the State Auto Insurance Companies
(State Auto P&C, State Automobile Mutual, Milbank and State Auto National) for
$100.0 million excess of $120.0 million, pursuant to a catastrophe assumption
reinsurance agreement. During the three months and six months ended June 30,
1997, the pooled companies' (State Auto P&C, State Automobile Mutual and
Milbank) experienced minimal growth in direct written premiums on its personal
lines of business, while commercial lines reflected an increase of approximately
7.5% and 9.0%, respectively, from the same 1996 periods. Commercial lines growth
decreased from levels experienced by the Company in 1996. Part of this decrease
is due to a reduction in NCCI loss costs in the workers compensation line of
business that began approximately a year ago. State Auto National, the Company's
non-standard automobile subsidiary, increased its earned premium approximately
63.9% and 61.5% from the same three month and six month periods, respectively,
in 1996. Contributing to these increases was State Auto National's entry into
three new states of operation in late 1996. During the three month period ended
June 30, 1997, State Auto National's net written premiums increased 47.5% which
was down from the first quarter 1997 increase of 92.7%. This decrease between
subsequent periods is the result of rate increases State Auto National
implemented in the first quarter of 1997 in two of its operating states as well
as a more aggressive underwriting posture with several larger agencies. State
Auto National remains on track for entry into two to three states during 1997.
Net investment income increased $0.3 million to $6.3 million for the three
months ended June 30, 1997 and $0.6 million to $12.5 million for the six months
ended June 30, 1997, from the same 1996 periods. An increase in invested assets
over the same 1996 periods contributed to these increases. Total amortized cost
of invested assets at June 30, 1997 was $388.5 million compared to $356.5
million at June 30, 1996. The investment yield, based on the available for sale
portfolio valued at fair value, remained comparable for the three month and six
month periods ending June 30, 1997 to 1996 levels at approximately 6.23%.
Management services income increased $0.3 million to $2.3 million for the three
months ended June 30, 1997 and $0.5 million to $4.5 million for the six months
ended June 30, 1997, from the same 1996 periods. These increases are due to an
increase in fees generated from both investment and insurance management
services as well as new fee income received for these services in 1997 from
Midwest Security Insurance Company, an affiliate acquired by State Automobile
Mutual in early 1997.
8
Losses and loss expenses, as a percentage of earned premiums, decreased to 65.3%
for the three months ended June 30, 1997 from 74.0% for the same 1996 period and
for the six months ended June 30, 1997, decreased to 66.3% from 73.2% for the
same 1996 period. The decrease in these ratios are due to a reduction in the
level of catastrophe losses experienced by the Company as compared to the same
periods in 1996. Additionally, nearly all lines of business recorded an
improvement in their statutory loss ratio over the same periods in 1996
indicating strong performance in core underwriting operations.
Acquisition and operating expenses, as a percentage of earned premiums,
increased to 29.8% for the three months ended June 30, 1997 from 27.7% for the
same 1996 period and for the six months ended June 30, 1997, increased to 29.5%
from 27.7% for the same 1996 period. The increases in these percentages are
primarily due to the amortization of software expenses and the Quality
Performance Bonus ("the Bonus"). Beginning with the first quarter of 1997, the
Companies began amortizing costs associated with the development of its claims
and billing processing system that began a little over two years ago. The
amortization period of these costs will be approximately three years.
Additionally, there was an increase over the same periods in 1996 of the Bonus
earned by nearly all permanent employees. Performance is measured quarterly and
the Bonus is earned if the State Auto Insurance Companies' quarterly direct
statutory combined ratio is better than predetermined targets set at the
beginning of each fiscal year.
Decrease in other expenses of $0.4 million to $0.4 million for the three months
ended June 30, 1997 and $0.6 million to $0.9 million for the six months ended
June 30, 1997, from the same 1996 periods is primarily due to the State Auto
Insurance Companies changing the catastrophe portion of its reinsurance treaty
beginning July 1, 1996, that prior to this period was accounted for as deposit
reinsurance. Expenses associated with the catastrophe portion of the treaty
accounted for as deposit reinsurance were included in other expense.
Federal income taxes increased $1.3 million to $3.2 million for the three months
ended June 30, 1997 and $2.1 million to $6.0 million for the six months ended
June 30, 1997 from the same periods in 1996. These increases are due to the
increase in taxable income as a result of the improvement in insurance
operations in 1997 compared to the same periods in 1996.
Liquidity and Capital Resources
- -------------------------------
Net cash provided by operating activities decreased to $8.8 million for the six
months ended June 30, 1997 from $11.3 million for the same 1996 period. Net cash
used in investing activities increased to $11.5 million from $0.6 million for
the same 1996 period. Net cash provided by financing activities remained
comparable to the 1996 period. As of June 30, 1997, funds consisting of cash and
cash equivalents for general operations were $10.3 million compared to $22.1
million at June 30, 1996. No long-term fixed maturities were required to be sold
to meet obligations during the first half of 1997.
The Board declared a quarterly cash dividend of $0.04 per common share payable
on June 30, 1997, to shareholders of record on June 10, 1997.
The State Auto Insurance Companies, like most owners and users of computer
software, are required to modify significant portions of its software so it will
function properly in the year 2000. The Companies have dedicated resources in
its efforts to address Year 2000 compliance.
New Accounting Standards
- ------------------------
In February 1997, the FASB issued SFAS No. 128, "Earnings per Share," which is
required to be adopted on December 31, 1997. At that time, the Company will be
required to change the method currently used to compute earnings per share and
to restate all prior periods. Under the new requirements for calculating primary
earnings per share, the dilutive effect of stock options will be excluded, and
is not expected to be
9
material to the Company. The Company has not yet determined what the impact of
Statement 128 will be on the calculation of fully diluted earnings per share,
but it is not expected to be material.
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income,"
which is effective for fiscal years beginning after December 15, 1997. Statement
130 establishes standards for the reporting and display of comprehensive income
and its components in a full set of general purpose financial statements. Also
in June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information," which is effective for fiscal years
beginning after December 15, 1997. Statement 131 changes the way public
companies report segment information in annual financial statements and also
requires those companies to report selected segment information interim
financial reports to shareholders. The Company has not yet determined the
reporting changes required by Statements 130 and 131 to comprehensive income and
segment information.
Safe Harbor Statement Under the Private Securities Litigation Reform Act of 1995
- --------------------------------------------------------------------------------
Statements contained herein expressing the beliefs of management and the other
statements which are not historical facts contained in this report are forward
looking statements that involve risks and uncertainties. These risks and
uncertainties include but are not limited to: legislative, judicial, and
regulatory changes, the impact of competitive products and pricing, product
development, geographic spread of risk, weather and weather-related events,
other types of catastrophic events, fluctuations of securities markets, and
technological difficulties and advancements.
10
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
PART II. OTHER INFORMATION
Item 1. Legal Proceedings - None
Item 2. Changes in Securities - None
Item 3. Defaults Upon Senior Securities - None
Item 4. Submission of Matters to a Vote of Securities Holders
The annual meeting of shareholders of State Auto Financial Corporation
was held on Thursday, May 29, 1997. The total shares represented at the meeting
were 16,756,412. This constituted 92% of the Company's 18,151,775 shares
outstanding. At the meeting, the shareholders voted on one resolution which was
the election of Urlin G. Harris, Jr., David L. Bickelhaupt, and George R. Manser
as Class III Directors, each to hold office until the 2000 annual meeting of
shareholders and until a successor is elected and qualified, each director
nominee received the votes indicated:
NUMBER OF VOTES
---------------
FOR WITHHELD
--- --------
Urlin G. Harris, Jr. 16,697,666 58,746
David L. Bickelhaupt 16,694,186 62,226
George R. Manser 16,699,027 57,385
On the basis of this vote, Urlin G. Harris, Jr., David L. Bickelhaupt,
and George R. Manser were elected as Class III Directors to serve until the 2000
annual meeting and until a successor is elected and qualified.
Item 5. Other Information - None
INDEX TO EXHIBITS
Item 6. a. Exhibits
Exhibit No. Description of Exhibits
----------- -----------------------
24(c) Powers of Attorney - William J. Included herein
Lhota, Urlin G. Harris, Jr., Robert
J. Murchake, Paul W. Huesman,
George R. Manser, David L.
Bickelhaupt, and David J. D'Antoni
27 Financial data schedules
b. Reports on Form 8-K - None
11
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 hereunto duly authorized.
STATE AUTO FINANCIAL CORPORATION
Date: AUGUST 11, 1997 /s/ Steven J. Johnston
--------------- ----------------------------------
Steven J. Johnston
Treasurer and Chief Financial Officer
(Duly Authorized Officer and
Principal Financial Officer)