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 March 31, 1998
-------------------------------------------------
( ) 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
of incorporation) Identification No.)
518 East Broad Street, Columbus, Ohio 43215-3976
- --------------------------------------------------------------------------------
(Address of principal executive offices) (zip code)
(614) 464-5000
- --------------------------------------------------------------------------------
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 18,350,632
- -------------------------------- ------------------------
(CLASS) (OUTSTANDING ON 4/30/98)
2
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(dollars in thousands, except share data)
(unaudited)
March 31 December 31
ASSETS 1998 1997
---- ----
Fixed maturities:
Held for investment, at amortized cost
(fair value $78,635 and $81,571, respectively) $ 76,336 $ 79,300
Available for sale, at fair value
(amortized cost $344,714 and $307,589, respectively) 355,875 320,299
Equity securities, at fair value (cost $4,286) 5,251 4,580
-------- --------
Total investments 437,462 404,179
Cash and cash equivalents 19,185 23,918
Deferred policy acquisition costs 19,075 17,689
Accrued investment income and other assets 17,241 16,327
Net prepaid pension expense 13,298 12,133
Reinsurance recoverable 12,284 9,871
Prepaid reinsurance premiums 4,031 3,627
Due from affiliates 3,742 2,179
Property and equipment, net 3,277 3,228
-------- --------
Total assets $529,595 $493,151
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Losses and loss expenses payable $178,803 $162,446
Unearned premiums 107,222 99,445
Current federal income taxes 3,813 15
Deferred federal income taxes 2,585 3,049
Other liabilities 2,689 2,717
-------- --------
Total liabilities 295,112 267,672
-------- --------
STOCKHOLDERS' EQUITY
Common stock, without par value. Authorized 30,000,000
shares; 18,350,632 and 18,341,899 shares issued and outstanding,
respectively, at stated value of $5 per share 91,753 91,709
Additional paid-in capital 2,976 2,894
Accumulated comprehensive income 8,232 8,830
Retained earnings 131,522 122,046
-------- --------
Stockholders' equity 234,483 225,479
-------- --------
Total liabilities and stockholders' equity $529,595 $493,151
======== ========
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 March 31, 1998 and 1997
(dollars in thousands, except per share amounts)
(unaudited)
1998 1997
---- ----
Earned premiums (net of ceded earned premiums of
$4,031 and $2,747, respectively) $70,933 $62,251
Net investment income 6,528 6,236
Management services income 2,331 2,207
Net realized gains on investments 290 238
------- -------
Total revenues 80,082 70,932
------- -------
Losses and loss expenses (net of ceded losses and loss
expenses of $2,997 and $1,034, respectively) 45,132 41,940
Acquisition and operating expenses 20,821 18,175
Other expense, net 652 472
------- -------
Total expenses 66,605 60,587
------- -------
Earnings before federal income taxes 13,477 10,345
Federal income tax expense:
Current 3,856 2,487
Deferred (142) 327
------- -------
Total federal income taxes 3,714 2,814
------- -------
Net earnings $ 9,763 $ 7,531
======= =======
Net earnings per share:
- basic $ 0.53 $ 0.42
======= =======
- diluted $ 0.52 $ 0.41
======= =======
Dividends paid per common share $ 0.045 $ 0.040
======= =======
See accompanying notes to condensed consolidated financial statements.
4
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Three Months Ended March 31, 1998 and 1997
(in thousands)
(unaudited)
1998 1997
---- ----
Cash flows from operating activities:
Net earnings $ 9,763 $ 7,531
Adjustments to reconcile net earnings to net cash
provided by operating activities:
Depreciation and amortization, net 216 198
Net realized gains on investments (290) (238)
Changes in operating assets and liabilities:
Deferred policy acquisition costs (277) (871)
Accrued investment income and other assets (914) (1,529)
Net prepaid pension expense (424) (317)
Other liabilities and due to/from affiliate, net (1,590) (786)
Reinsurance recoverable and prepaid reinsurance premiums (717) 552
Losses and loss expenses payable 1,988 570
Unearned premiums 137 981
Federal income taxes 3,656 804
-------- --------
11,548 6,895
Cash provided from the change in the reinsurance pool
participation percentage 18,059 --
-------- --------
Net cash provided by operating activities 29,607 6,895
-------- --------
Cash flows from investing activities:
Purchase of fixed maturities - available for sale (58,630) (22,765)
Maturities, calls and principal reductions of fixed maturities -
held to maturity 2,899 1,640
Maturities, calls and principal reductions of fixed maturities -
available for sale 8,123 1,645
Sale of fixed maturities - available for sale 13,506 13,994
Net additions of property and equipment (77) --
-------- --------
Net cash used in investing activities (34,179) (5,486)
-------- --------
Cash flows from financing activities:
Net proceeds from sale of common stock 126 182
Payment of dividends (287) (246)
-------- --------
Net cash used in financing activities (161) (64)
-------- --------
Net increase (decrease) in cash and cash equivalents (4,733) 1,345
Cash and cash equivalents at beginning of period 23,918 12,868
-------- --------
Cash and cash equivalents at end of period $ 19,185 $ 14,213
======== ========
Supplemental disclosures:
Federal income taxes paid -- $ 1,950
======== ========
See accompanying notes to condensed consolidated financial statements.
5
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
March 31, 1998
(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,
1997 included in the Company's 1997 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, 1998.
2. NET EARNINGS PER COMMON SHARE
The following table sets forth the compilation of basic and diluted net earnings
per common share:
Three months ended
March 31
1998 1997
---- ----
(in thousands, except per share amounts)
Numerator:
Net earnings for basic and diluted earnings
per common share $ 9,763 $ 7,531
-------------------------
Denominator:
Weighted average shares for basic net
earnings per common share 18,346 18,145
Effect of dilutive stock options 529 406
Adjusted weighted average shares for
diluted net earnings per common share 18,875 18,551
-------------------------
Basic net earnings per common share $ 0.53 $ 0.42
-------------------------
Diluted net earnings per common share $ 0.52 $ 0.41
-------------------------
3. COMPREHENSIVE INCOME
As of January 1, 1998, the Company adopted SFAS No. 130, "Reporting
Comprehensive Income." SFAS No. 130 establishes new rules for the reporting and
display of comprehensive income and its components; however, the adoption of
SFAS No. 130 had no impact on the Company's net earnings or shareholders'
equity. SFAS No. 130 requires unrealized gains or losses on the Company's
available-for-sale securities, which prior to adoption were reported separately
in shareholders' equity, to be included in other comprehensive income. Prior
year financial statements have been reclassified to conform to the requirements
of SFAS No. 130.
The components of comprehensive income, net of related tax, for the three-month
periods ended March 31, 1998 and 1997 are as follows:
1998 1997
---- ----
(in thousands)
Net earnings $9,763 $7,531
Unrealized holding losses, net of tax (598) (3,124)
-----------------
Comprehensive income $9,165 $4,407
=================
6
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements - continued
March 31, 1998
(unaudited)
3. COMPREHENSIVE INCOME - continued
The components of accumulated other comprehensive income, net of related tax,
included in stockholders' equity at March 31, 1998 and December 31, 1997 include
only unrealized holding gains (losses), net of tax.
4. NEW ACCOUNTING STANDARDS
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, but is not required to be applied to interim
period financial statements in the year of adoption. SFAS No. 131 changes the
way public companies report segment information in annual financial statements
and also requires those companies to report selected segment information in
interim financial reports to shareholders. The Company has not yet determined
the reporting changes required by SFAS No. 131 to 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 $3.1 million to $13.5 million for
the quarter ended March 31, 1998 from the same 1997 period. This increase in
earnings is a result of an improvement in the Company's losses and loss expenses
from the same 1997 period. Also impacting the quarterly operations was an
amendment to the pooling arrangement by the Company's principal insurance
subsidiary, State Auto Property & Casualty Insurance Company (State Auto P&C).
From 1995 through 1997, State Auto P&C participated in a pooling arrangement
with State Automobile Mutual Insurance Company (Mutual), a majority shareholder
of the Company, and Milbank Insurance Company (Milbank), a wholly-owned
subsidiary of Mutual, whereby State Auto P&C assumed 35% of the pooled business,
Mutual 55% and Milbank 10%. Effective January 1, 1998, the pooling arrangement
was amended to include the insurance operations of Midwest Security Insurance
Company (Midwest), a wholly-owned subsidiary of Mutual. Concurrent with the
addition of Midwest to the pool, the pooling participation percentages were
amended to allocate 37% to State Auto P&C, 52% to Mutual, 10% to Milbank and 1%
to Midwest. In connection with the January 1, 1998 pooling changes, State Auto
P&C received approximately $18.1 million to cover its increased share of the
pooled liabilities.
Earned premiums, during the quarter ended March 31, 1998, increased $8.7 million
to $70.9 million from the same 1997 period. Of the $8.7 million increase, $7.3
million was due to an increase in earned premiums of State Auto P&C, of which
$5.3 million was due to the impact of the change in the pooling arrangement with
the remaining portion of the increase attributable to State Auto P&C's share of
the increase in the earned premiums of the pooled companies. The remaining $1.4
million of the $8.7 million increase was due to the earned premium growth of
State Auto National Insurance Company (National), the Company's non-standard
insurance company.
Net investment income increased $0.3 million to $6.5 million from the same 1997
period. Contributing to this increase, was the transfer to State Auto P&C of
approximately $18.1 million in conjunction with the change in the pooling
arrangement and a general increase in investable assets over the same 1997
period. Total cost of investable assets at March 31, 1998 was $444.5 million
compared to $396.8 million at March 31, 1997. The investment yield, based on
fixed and equity securities at cost, decreased to 6.0% from 6.4% for the same
1997 period. Contributing to the decrease in the investment yield has been the
gradual shift in the composition of the fixed maturity portfolio from taxables
to tax-exempt securities. At March 31, 1998, approximately 64% of the fixed
maturity portfolio was comprised of tax-exempt securities whereas at March 31,
1997, tax exempts comprised 53% of the portfolio.
Management services income increased slightly from the same 1997 period and
realized gains on investments were comparable to the same period in 1997.
Losses and loss expenses, as a percentage of earned premiums, decreased to 63.6%
for the quarter ended March 31, 1998 from 67.4% for the same 1997 period. The
decrease in this ratio is due to a reduction in the level of catastrophe losses
experienced by the Company as compared to the same period in 1997 and continuing
improvement in the Company's core underwriting operations. Nearly all lines of
business reflected improvements in their statutory loss ratios compared to the
same period in 1997.
Acquisition and operating expenses, as a percentage of earned premiums,
increased slightly to 29.4% from 29.2% in 1997.
8
Federal income taxes increased $0.9 million to $3.7 million from the same 1997
period. The effective tax rate increased slightly to 27.6% for the three months
ending March 31,1998 from 27.2% for the 1997 period. See discussion above
regarding the shift from taxables to tax exempts within the fixed maturity
portfolio.
Liquidity and Capital Resources
- -------------------------------
Net cash provided by operating activities increased to $29.6 million for the
three months ended March 31, 1998 from $6.9 million for the same 1997 period.
This increase is due primarily to the transfer of $18.1 million to State Auto
P&C in connection with the amended pooling arrangement, as discussed above.
Additionally, the Company has experienced an increase in its cash flow from
operations due to improvements in its underlying book of business. Net cash used
in investing activities increased to $34.2 million for the three months ended
March 31, 1998 from $5.5 million for the same 1997 period. This increase is due
to the investing of the cash associated with the transfer of the $18.1 million
as well as cash generated from insurance operations. Net cash used in financing
activities for the three months ended March 31, 1998 remained comparable to the
same period in 1997. As of March 31, 1998, funds consisting of cash and cash
equivalents available for general operations were $19.2 million compared to
$14.2 million at March 31, 1997. No long-term fixed maturities were required to
be sold to meet obligations during the first three months of 1998.
Damage from spring storms that spawned tornadoes and hail in several of the
Company's operating states will impact the Company's second quarter results.
Management currently estimates losses from these spring storms to the Company to
be approximately $6.0 million.
On March 6, 1998, the Board of Directors of State Auto Financial adopted a
resolution authorizing the officers of State Auto Financial to take such steps
as are necessary to effect the exercise of State Auto Financial's option to
acquire Milbank from Mutual. State Auto Financial's acquisition of Milbank is
subject to procedural matters contemplated by an agreement entered into by
Mutual and State Auto Financial in 1993 being completed and regulatory approval
in Ohio and South Dakota. The proposed effective date of transfer is third
quarter 1998. Additionally, the Board declared a two-for-one stock split to be
distributed July 8, 1998, to shareholders of record on June 18, 1998. The split
is contingent upon shareholder approval of a proposal to increase the number of
authorized common shares, without par value, from 30 million to 100 million at
the Company's annual meeting of shareholders on May 28, 1998. Accordingly, the
impact of this stock split is not reflected in these financial statements.
With respect to the Year 2000 Issue, see the discussion regarding this subject
in the Company's December 31, 1997 Management's Discussion and Analysis of
Financial Condition and Results of Operations, included in the December 31, 1997
Form 10-K. There have been no material changes in the information reported
regarding the Year 2000 in the 1997 Form 10-K.
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. Such statements
include, without limitation, those pertaining to the spring storms impacting the
Company's losses, and the Year 2000 discussion. 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, economic conditions, technological
difficulties and advancements, availability of labor and materials in storm hit
areas, late reported claims and previously undisclosed damage.
9
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
----------- -----------------------
10(II) Amended and Restated Reinsurance Included herein
Pooling Agreement between State
Automobile Mutual Insurance Company,
State Auto Property and Casualty
Insurance Company, Milbank Insurance
Company and Midwest Security
Insurance Company effective January
1, 1998.
24(D) Power of Attorney - John R. Lowther Included herein
27 Financial data schedules Included herein
b. Reports on Form 8-K - None
10
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: MAY 05, 1998 /s/ Steven J. Johnston
------------ --------------------------------------
Steven J. Johnston
Treasurer and Chief Financial Officer
(Duly Authorized Officer and
Principal Financial Officer)