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 September 30, 1997
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( ) 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
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(Exact name of registrant as specified in its charter)
Ohio 31-1324304
- --------------------------------- ----------------------------------
(State or other (I.R.S. Employer Identification No.)
jurisdiction 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 18,279,064
- -------------------------------- -------------------------
(CLASS) (OUTSTANDING ON 11/07/97)
2
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
September 30 December 31
1997 1996
------------ ------------
ASSETS (unaudited) (Note 1)
Fixed maturities:
Held for investment, at amortized cost
(fair value $83,144,713 and $91,058,485, respectively) $ 81,256,317 $ 90,251,124
Available for sale, at fair value
(amortized cost $295,593,329 and $286,790,650, respectively) 306,153,446 294,056,432
Equity securities, at fair value (cost $3,857,955 and $-0-, respectively) 3,997,120 -
------------ ------------
Total investments 391,406,883 384,307,556
Cash and cash equivalents 27,083,072 12,867,968
Deferred policy acquisition costs 17,174,943 15,711,347
Accrued investment income and other assets 16,091,658 13,845,107
Net prepaid pension expense 11,573,108 10,622,708
Reinsurance recoverable 9,535,749 9,691,202
Prepaid reinsurance premiums 3,677,196 3,379,741
Due from affiliates 1,134,082 -
Deferred federal income taxes - 153,984
Property and equipment, net 3,232,598 2,540,526
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Total assets $480,909,289 $453,120,139
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Losses and loss expenses payable $164,306,759 $165,874,707
Unearned premiums 99,645,090 93,883,927
Current federal income taxes 704,968 2,076,374
Deferred federal income taxes 1,653,648 -
Due to affiliates - 2,903,548
Other liabilities 2,345,433 1,920,655
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Total liabilities 268,655,898 266,659,211
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STOCKHOLDERS' EQUITY
Common stock, without par value. Authorized 30,000,000
shares; 18,218,044 and 18,135,526 shares issued and outstanding,
respectively, at stated value of $5 per share 91,090,220 90,677,630
Additional paid-in capital 1,772,779 1,456,083
Net unrealized holding gains 7,357,924 5,179,126
Retained earnings 112,032,468 89,148,089
------------ ------------
Stockholders' equity 212,253,391 186,460,928
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Total liabilities and stockholders' equity $480,909,289 $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 September 30, 1997 and 1996
1997 1996
----------- -----------
(unaudited) (unaudited)
Earned premiums (net of ceded earned premiums of
$2,986,003 and $2,885,414, respectively) $63,917,515 $60,239,698
Net investment income 6,172,031 5,999,047
Management services income 2,241,150 1,997,413
Net realized gains on investments 100,074 255,031
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Total revenues 72,430,770 68,491,189
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Losses and loss expenses (net of ceded losses and loss
expenses of $1,281,896 and $1,365,509, respectively) 41,669,544 46,506,377
Acquisition and operating expenses 18,997,180 16,926,697
Other expense, net 480,654 528,080
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Total expenses 61,147,378 63,961,154
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Earnings before federal income taxes 11,283,392 4,530,035
Federal income tax expense:
Current 3,109,486 753,934
Deferred 165,163 116,113
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Total federal income taxes 3,274,649 870,047
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Net earnings $ 8,008,743 $ 3,659,988
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Weighted average common shares outstanding 18,211,539 18,086,725
=========== ===========
Net earnings per common share $ 0.44 $ 0.20
=========== ===========
Dividends paid per common share $ 0.045 $ 0.040
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See accompanying notes to condensed consolidated financial statements.
4
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS
For the Nine Months Ended September 30, 1997 and 1996
1997 1996
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(unaudited) (unaudited)
Earned premiums (net of ceded earned premiums of
$8,809,828 and $8,366,487, respectively) $189,934,023 $179,035,250
Net investment income 18,673,420 17,866,113
Management services income 6,713,861 6,004,448
Net realized gains on investments 421,457 1,292,268
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Total revenues 215,742,761 204,198,079
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Losses and loss expenses (net of ceded losses and loss
expenses of $4,729,755 and $3,602,614, respectively) 125,266,395 133,475,120
Acquisition and operating expenses 56,199,101 49,853,520
Other expense, net 1,371,078 1,991,341
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Total expenses 182,836,574 185,319,981
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Earnings before federal income taxes 32,906,187 18,878,098
Federal income tax expense:
Current 8,613,495 4,639,650
Deferred 634,104 121,186
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Total federal income taxes 9,247,599 4,760,836
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Net earnings $ 23,658,588 $ 14,117,262
============ ============
Weighted average common shares outstanding 18,177,142 18,058,226
============ ============
Net earnings per common share $ 1.30 $ 0.78
============ ============
Dividends paid per common share $ 0.125 $ 0.113
============ ============
See accompanying notes to condensed consolidated financial statements.
5
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Nine Months Ended September 30, 1997 and 1996
1997 1996
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(unaudited) (unaudited)
Cash flows from operating activities:
Net earnings $ 23,658,588 $ 14,117,262
Adjustments to reconcile net earnings to net cash provided by operating
activities:
Depreciation and amortization, net 686,695 565,676
Change in deferred policy acquisition costs (1,463,596) (649,046)
Change in accrued investment income and other assets (2,246,551) (216,578)
Change in net prepaid pension expense (950,400) (858,622)
Change in other liabilities and due to/from affiliate, net (3,613,560) 1,340,653
Change in reinsurance recoverable and prepaid reinsurance premiums (142,002) 39,058
Change in losses and loss expenses payable (1,567,948) (2,108,674)
Change in unearned premiums 5,761,163 3,547,237
Change in federal income taxes (737,302) (556,943)
Net realized gains on investments (421,457) (1,311,672)
------------ -------------
Net cash provided by operating activities 18,963,630 13,908,351
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Cash flows from investing activities:
Purchase of fixed maturities - held to maturity - (9,073,770)
Purchase of fixed maturities - available for sale (71,649,161) (100,746,601)
Purchase of equity securities (4,049,596)
Maturities, calls and principal reductions of fixed maturities -
held to maturity 8,772,903 8,612,448
Maturities, calls and principal reductions of fixed maturities -
available for sale 12,072,291 2,024,908
Sale of fixed maturities - available for sale 50,725,640 88,011,016
Sale of equity securities 202,378
Net additions of property and equipment (778,160) (101,663)
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Net cash used in investing activities (4,703,705) (11,273,662)
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Cash flows from financing activities:
Net proceeds from sale of common stock 729,286 680,655
Payment of dividends (774,107) (687,893)
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Net cash used in financing activities (44,821) (7,238)
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Net increase in cash and cash equivalents 14,215,104 2,627,451
Cash and cash equivalents at beginning of period 12,867,968 11,227,375
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Cash and cash equivalents at end of period $ 27,083,072 $ 13,854,826
============ =============
Supplemental disclosures:
Federal income taxes paid $ 9,985,000 $ 5,317,779
============ =============
See accompanying notes to condensed consolidated financial statements.
6
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
September 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. NEW 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
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Earnings before federal income taxes increased $6.8 million to $11.3 million and
$14.0 million to $32.9 million for the three months and nine months ended
September 30, 1997, respectively, from the same 1996 periods. These increases
are due to a combination of revenue growth and improvement in losses and loss
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 94.9% for the quarter ended
September 30, 1997 from 105.3% for the same period in 1996 and for the nine
months ended September 30, 1997, decreased to 95.5% from 102.4% for the same
period in 1996.
Earned premiums increased $3.7 million (6.1%) to $63.9 million for the quarter
ended September 30, 1997 and $10.9 million (6.1%) to $189.9 million for the nine
months ended September 30, 1997 from the same 1996 periods. The Company's
principal insurance subsidiary, State Auto P&C, increased its earned premium
approximately 2.9% from the same three month and nine month periods,
respectively, in 1996. During the three months and nine months ended September
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
8.8% 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 premiums approximately 57.9% and
60.2% from the same three month and nine 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 September
30, 1997, State Auto National's net written premiums increased 42.6% which were
down from the increases reflected in the first two quarters of 1997. This
decrease between subsequent periods is the likely 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 began operations during the third quarter 1997 in
three new states: Alabama, Illinois and Missouri.
Net investment income increased $0.2 million to $6.2 million for the three
months ended September 30, 1997 and $0.8 million to $18.7 million for the nine
months ended September 30, 1997, from the same 1996 periods. An increase in
invested assets over the same 1996 periods contributed to these increases. Total
invested assets at September 30, 1997 were $391.4 million compared to $371.7
million at September 30, 1996. The investment yield, based on the available for
sale portfolio valued at fair value, decreased to 6.0% and 6.1% for the three
months and nine months ended September 30, 1997, respectively, from 6.3% and
6.2% for the same 1996 comparable periods, respectively. During the third
quarter 1997, the Company allocated approximately $4.0 million to investment in
equity securities.
Management services income increased $0.2 million to $2.2 million for the three
months ended September 30, 1997 and $0.7 million to $6.7 million for the nine
months ended September 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 65.2%
for the three months ended September 30, 1997 from 77.2% for the same 1996
period and for the nine months ended September 30, 1997, decreased to 66.0% from
74.6% for the same 1996 period. The decrease in these ratios is due to a
reduction in the level of catastrophe losses experienced by the Company as
compared to the same periods in 1996 and continuing improvement in the Company's
core underwriting operations.
Acquisition and operating expenses, as a percentage of earned premiums,
increased to 29.7% for the three months ended September 30, 1997 from 28.1% for
the same 1996 period and for the nine months ended September 30, 1997, increased
to 29.6% from 27.8% for the same 1996 period. The increase 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. A Bonus has been paid in each of the 1997
quarterly periods.
Other expenses remained consistent for the three months ended September 30, 1997
from the same period in 1996. For the nine months ended September 30, 1997 other
expenses decreased $0.6 million to $1.4 million from the same 1996 period
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 $2.4 million to $3.3 million for the three months
ended September 30, 1997 and $4.5 million to $9.2 million for the nine months
ended September 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. The tax benefit from
tax exempt securities for the three month and nine month periods for 1997
remained comparable to the same periods in 1996.
Liquidity and Capital Resources
- -------------------------------
Net cash provided by operating activities increased to $18.9 million for the
nine months ended September 30, 1997 from $13.9 million for the same 1996
period. Net cash used in investing activities decreased to $4.7 million from
$11.3 million for the same 1996 period. Net cash used in financing activities
remained comparable to the 1996 period. As of September 30, 1997, funds
consisting of cash and cash equivalents for general operations were $27.1
million compared to $13.9 million at September 30, 1996. No long-term fixed
maturities were required to be sold to meet obligations 1997.
The Board declared a quarterly cash dividend of $0.045 per common share payable
on September 30, 1997, to shareholders of record on September 12, 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.
9
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 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.
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
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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 - None
Item 5. Other Information - None
INDEX TO EXHIBITS
Item 6. a. Exhibits
Exhibit No. Description of Exhibits
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10(GG) Amended and Restated Credit Included herein
Agreement dated August 16, 1996 amended
and restated as of July 18, 1997 between
SAF Funding Corporation and the
Chase Manhattan Bank
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: NOVEMBER 12, 1997 /s/ Steven J. Johnston
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Steven J. Johnston
Treasurer and Chief Financial Officer
(Duly Authorized Officer and
Principal Financial Officer)