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, 1999
-------------------------------------------------
[ ] 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
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(State or other jurisdiction (I.R.S. Employer
of incorporation) Identification No.)
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 42,060,417
- ---------------------------------------- -------------------------
(Class) (Outstanding on 05/03/99)
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INDEX
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Condensed consolidated balance sheets - March 31, 1999 and
December 31, 1998
Condensed consolidated statements of income - Three months
ended March 31, 1999 and 1998
Condensed consolidated statements of cash flows - Three months
ended March 31, 1999 and 1998
Notes to condensed consolidated financial statements -
March 31, 1999
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations
Item 3. Quantitative and Qualitative Disclosure of Market Risk
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
Item 2. Changes in Securities and Use of Proceeds
Item 3. Defaults upon Senior Securities
Item 4. Submission of Matters to a Vote of Security Holders
Item 5. Other Information
Item 6. Exhibits and Reports on Form 8-K
SIGNATURES
3
PART I. Financial Information
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(dollars in thousands, except share data)
(unaudited)
MARCH 31 DECEMBER 31
ASSETS 1999 1998
---- ----
Fixed maturities:
Held for investment, at amortized cost
(fair value $52,299 and $57,826, respectively) $ 50,580 $ 55,926
Available for sale, at fair value
(amortized cost $492,176 and $464,008, respectively) 506,960 481,844
Equity securities, at fair value (cost $33,800 and $29,233, respectively) 46,153 42,196
--------- ---------
Total investments 603,693 579,966
Cash and cash equivalents 50,824 32,605
Surplus note receivable -- 9,000
Deferred policy acquisition costs 27,419 24,799
Accrued investment income and other assets 18,618 19,542
Net prepaid pension expense 17,296 16,378
Reinsurance receivable 15,522 13,667
Prepaid reinsurance premiums 4,100 4,014
Property and equipment, net 10,058 7,927
Goodwill 2,722 1,880
--------- ---------
Total assets $ 750,252 $ 709,778
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Losses and loss expenses payable $ 239,925 $ 218,701
Unearned premiums 143,528 135,088
Current federal income taxes 3,234 2,608
Deferred federal income taxes 6,286 8,095
Due to affiliates 3,818 884
Other liabilities 4,429 3,578
--------- ---------
Total liabilities 401,220 368,954
--------- ---------
STOCKHOLDERS' EQUITY
Common stock, without par value. Authorized 100,000,000 shares;
42,076,442 and 42,039,892 shares issued, respectively, at stated value
of $2.50 per share 105,191 105,100
Less 18,525 and 13,212 treasury shares, respectively, at cost (231) (167)
Additional paid-in capital 41,572 41,539
Accumulated comprehensive income 17,869 20,276
Retained earnings 184,631 174,076
--------- ---------
Stockholders' equity 349,032 340,824
--------- ---------
Total liabilities and stockholders' equity $ 750,252 $ 709,778
========= =========
See accompanying notes to condensed consolidated financial statements.
4
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
For the Three Months Ended March 31, 1999 and 1998
(dollars in thousands, except per share amounts)
(unaudited)
1999 1998
---- ----
(Restated -
See Note 1)
Earned premiums (net of ceded earned premiums of
$3,635 and $3,496, respectively) $ 98,477 $ 88,142
Net investment income 8,451 8,011
Management services income 2,184 1,972
Net realized gains on investments 1,054 726
Other income 765 510
-------- --------
Total revenues 110,931 99,361
-------- --------
Losses and loss expenses (net of ceded losses and loss
expenses of $1,638 and $1,373, respectively) 66,492 55,991
Acquisition and operating expenses 28,210 26,207
Other expense 1,568 1,289
-------- --------
Total expenses 96,270 83,487
-------- --------
Income before federal income taxes 14,661 15,874
Federal income tax expense (benefit):
Current 3,388 4,546
Deferred 393 (203)
-------- --------
Total federal income taxes 3,781 4,343
-------- --------
Net income $ 10,880 $ 11,531
======== ========
Earnings per share:
- basic $ 0.25 $ 0.27
======== ========
- diluted $ 0.25 $ 0.27
======== ========
Dividends paid per common share $ 0.025 $ 0.023
======== ========
See accompanying notes to condensed consolidated financial statements.
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STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Three Months Ended March 31, 1999 and 1998
(in thousands)
(unaudited)
1999 1998
---- ----
(Restated -
See Note 1)
Cash flows from operating activities:
Net income $ 10,880 $ 11,531
Adjustments to reconcile net earnings to net cash provided by operating
activities:
Depreciation and amortization, net 704 573
Net realized gains on investments (1,054) (726)
Changes in operating assets and liabilities:
Deferred policy acquisition costs (642) (255)
Accrued investment income and other assets 1,084 (941)
Net prepaid pension expense (481) (491)
Other liabilities and due to/from affiliate, net 3,166 (1,861)
Reinsurance receivable and prepaid reinsurance premiums 612 (536)
Losses and loss expenses payable (1,551) 1,924
Unearned premiums (2,488) (176)
Federal income taxes 1,561 2,085
-------- --------
11,791 11,127
Cash provided from the change in the reinsurance pool
participation percentage 11,419 19,708
-------- --------
Net cash provided by operating activities 23,210 30,835
-------- --------
Cash flows from investing activities:
Purchase of fixed maturities - available for sale (73,990) (72,678)
Purchase of equity securities (7,495) (1,512)
Maturities, calls and principal reductions of fixed maturities -
held to maturity 5,283 2,898
Maturities, calls and principal reductions of fixed maturities -
available for sale 8,771 8,636
Sale of fixed maturities - available for sale 48,943 26,325
Sale of equity securities 3,973 1,294
Net cash acquired on acquisition of Farmers Casualty
Insurance Company and subsidiary 11,568 --
Net additions of property and equipment (1,780) (77)
-------- --------
Net cash used in investing activities (4,727) (35,114)
-------- --------
Cash flows from financing activities:
Net proceeds from sale of common stock 60 126
Payment of dividends (324) (287)
-------- --------
Net cash used in financing activities (264) (161)
-------- --------
Net increase (decrease) in cash and cash equivalents 18,219 (4,440)
Cash and cash equivalents at beginning of period 32,605 30,931
-------- --------
Cash and cash equivalents at end of period $ 50,824 $ 26,491
======== ========
Supplemental disclosures:
Federal income taxes paid $ 2,200 $ 2,200
======== ========
See accompanying notes to condensed consolidated financial statements.
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STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
March 31, 1999
(unaudited)
1. BASIS OF PRESENTATION
The accompanying condensed consolidated financial statements for the interim
periods included herein have been prepared by State Auto Financial Corporation
(the "Company" or "State Auto Financial") 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.
The balance sheet at December 31, 1998 has been derived from the audited
financial statements at that date but does not include all of the information
and footnotes required by generally accepted accounting principles for complete
financial statements.
These financial statements should be read in conjunction with the financial
statements and notes thereto for the year ended December 31, 1998 included in
the Company's 1998 Form 10-K filed with the Securities and Exchange Commission.
In July 1998 the Company acquired the outstanding shares of Milbank Insurance
Company ("Milbank") from State Automobile Mutual Insurance Company ("Mutual"),
an affiliated company. The transaction was effected through an exchange with
Mutual of approximately 5.1 million Company common shares for all of the issued
and outstanding capital stock of Milbank. Since the transaction was a
combination of entities under common control it has been accounted for similar
to a pooling-of-interest. The March 31, 1998 financial information has been
restated to include the financial position and operations of Milbank.
Effective January 1, 1999, the Company purchased Farmers Casualty Insurance
Company ("Farmers Casualty"), an Iowa domiciled standard property casualty
insurer, for approximately $9.0 million. In addition, Farmers Casualty owns 100%
of the outstanding shares of Mid-Plains Insurance Company ("Mid-Plains"); an
Iowa domiciled property casualty insurer, which principally writes nonstandard
auto insurance. This transaction has been accounted for using the purchase
method of accounting. In conjunction with the acquisition, liabilities assumed
were as follows (in thousands):
Fair value of assets acquired $28,040
Cash paid for the common stock (9,000)
-------
Liabilities assumed $19,040
=======
Also on January 1, 1999, the pooling arrangement was amended to include all of
the property and casualty business of Farmers Casualty. With the inclusion of
Farmers Casualty in the pool, the pooling participation percentages were amended
to allocate 37% to State Auto Property & Casualty ("State Auto P&C"), a wholly
owned subsidiary of the Company, 49% to Mutual, 10% to Milbank, 1% to Midwest
Security Insurance Company, a wholly owned subsidiary of Mutual, and 3% to
Farmers Casualty. State Auto P&C, Milbank and Farmers Casualty received
approximately $11.4 million to cover their increased share of pool liabilities.
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STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements - continued
March 31, 1999
(unaudited)
2. COMPREHENSIVE INCOME
The components of comprehensive income, net of related tax, are as follows:
Three months ended
March 31
--------
1999 1998
---- ----
(in thousands)
Net income $ 10,880 $ 11,531
Unrealized holding gains (losses), net of tax (2,407) 985
-------- --------
Comprehensive income $ 8,473 $ 12,516
======== ========
The components of accumulated other comprehensive income, net of related tax,
included in stockholders' equity at March 31, 1999 and December 31, 1998 include
only unrealized holding gains, net of tax.
3. EARNINGS PER COMMON SHARE
The following table sets forth the computation of basic and diluted earnings per
common share:
Three months ended
March 31
--------
1999 1998
---- ----
(in thousands, except per share amounts)
Numerator:
Net income for basic and diluted
Earnings per share $10,880 $11,531
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Denominator:
Weighted average shares for
Basic earnings per share 42,054 41,828
Effect of dilutive stock options 796 1,059
Adjusted weighted average shares
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For diluted earnings per share 42,850 42,887
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Basic earnings per share $ 0.25 $ 0.27
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Diluted earnings per share $ 0.25 $ 0.27
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STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements - continued
March 31, 1999
(unaudited)
4. SEGMENT INFORMATION
Three months ended
March 31
--------
1999 1998
---- ----
(in thousands)
Revenues from external customers:
Standard insurance $ 99,701 $ 90,680
Nonstandard insurance 8,392 6,505
Investment management services 865 812
All other 874 618
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Total revenues from external customers $ 109,832 $ 98,615
========= =========
Intersegment revenues:
Standard insurance $ 93 $ 65
Nonstandard insurance (30) (22)
Investment management services 646 568
All other 340 242
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Total intersegment revenues $ 1,049 $ 853
========= =========
Segment profit (loss):
Standard insurance $ 12,263 $ 13,965
Nonstandard insurance (218) 41
Investment management services 1,310 1,210
All other 547 231
--------- ---------
Total segment profit 13,902 15,447
Reconciling items:
Corporate expenses (254) (296)
Net realized gains 1,054 726
Miscellaneous adjustments (41) (3)
--------- ---------
Total consolidated income before taxes $ 14,661 $ 15,874
========= =========
Segment assets:
Standard insurance $ 677,531 $ 620,501
Nonstandard insurance 47,350 38,132
Investment management services 7,277 4,890
All other 874 13,890
--------- ---------
Total segment assets $ 733,032 $ 677,413
========= =========
The standard insurance segment's assets increased about $36.0 million at March
31, 1999 from the amount reported at December 31, 1998 because the acquisition
of Farmers Casualty and the concurrent change in the pooling arrangement, as
discussed above in Note 1. The nonstandard insurance segment's assets increased
about $9.0 million from the amount reported at December 31, 1998, because
Mid-Plains, which is a wholly owned subsidiary of Farmers Casualty, is a part of
the nonstandard insurance segment.
5. RECLASSIFICATIONS
Certain items in the 1998 condensed consolidated financial statements have been
reclassified to conform with the 1999 presentation.
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STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
Results of Operations
Earnings before federal income taxes decreased $1.2 million to $14.7 million for
the quarter ended March 31, 1999 from the same 1998 period. An increase in the
level of catastrophe losses of approximately $3.0 million from the same 1998
period contributed to the decrease in earnings.
First quarter 1999 was also impacted by the acquisition of Farmers Casualty
Insurance Company ("Farmers Casualty") and an amendment to the Company's pooling
Arrangement. On January 1, 1999, the Company acquired Farmers Casualty and its
subsidiary Mid-Plains Insurance Company ("Mid-Plains"), both Iowa domiciled
insurers. Farmers Casualty is a standard property and casualty insurer while
Mid-Plains writes principally nonstandard auto insurance. This transaction was
accounted for under the purchase method of accounting. During 1998, the
Company's standard insurance subsidiaries, State Auto Property & Casualty
Insurance Company ("State Auto P&C") and Milbank Insurance Company ("Milbank")
participated in a pooling arrangement with State Automobile Mutual Insurance
Company ("Mutual"), a majority shareholder of the Company and Midwest Security
Insurance Company ("Midwest Security"), a wholly owned subsidiary of Mutual.
State Auto P&C assumed 37% of the pooled business, Milbank 10%, Mutual 52% and
Midwest Security 1%. Effective January 1, 1999, the Company amended its pooling
arrangement to include all of the property and casualty insurance business of
Farmers Casualty. With the inclusion of Farmers Casualty in the pool, the
pooling participation percentages were amended to allocate 37% to State Auto
P&C, 49% to Mutual, 10% to Milbank, 1% to Midwest Security and 3% to Farmers
Casualty (collectively, these companies are referred to as the "Pooled
Companies"). In connection with the January 1, 1999 pooling changes, the Company
received approximately $11.4 million to cover its increased share of the pooled
liabilities.
Consolidated earned premiums during the quarter ended March 31, 1999, increased
$10.3 million (11.7%) to $98.5 million from the same 1998 period. The 11.7%
increase was derived principally from three sources. The impact of the change in
allocation percentages of the Company's pooling arrangement, as well as the
addition of Farmers Casualty to the pool increased consolidated earned premiums
8.7%. The growth in the standard insurance segment (State Auto P&C, Milbank and
Farmers Casualty), excluding the impact of the changes in the pooling
arrangement, increased consolidated earned premiums 1.0%. The impact of the
addition of Mid-Plains to the nonstandard insurance segment increased
consolidated earned premium 2.0%. During the first quarter of 1999, the
nonstandard insurance segment experienced no growth in earned premiums,
excluding the addition of Mid-Plains.
During the first quarter 1999 the Company continued to experience minimal growth
in its standard insurance segment. While commercial lines pricing remained
competitive, the Company did experience an increase in new business during the
quarter. Competition for private passenger auto continues to be very intense,
particularly among the direct response companies. This adversely affected the
Pooled Companies ability to generate new private passenger business because
management continued to stress responsible pricing and diligent underwriting.
The nonstandard insurance segment experienced a decrease in its net written
premiums. This was the continuing result of significant auto physical damage
rate increases and a more restrictive underwriting posture the Company
implemented in this segment throughout most of its operating states during 1998.
While these actions have resulted in a decrease in the rate of growth over the
last several reporting periods, this segment's statutory loss experience has
improved over comparative prior periods.
Net investment income increased $0.4 million (5.5%) to $8.5 million from the
same 1998 period. Contributing to this increase was the transfer to the Company
of approximately $11.4 million in conjunction with the change in the pooling
arrangement, the addition of Farmers Casualty and Mid-Plains to the Company's
operations and a general increase in investable assets over the previous 1998
period. Total cost of investable assets at March 31, 1999 was $627.4 million
compared to $566.1 million at March 31, 1998. The investment yield, based on
fixed and equity securities at cost, decreased to 5.4% from 5.7% for the same
1998 period.
10
Losses and loss expenses, as a percentage of earned premiums, increased to 67.5%
for the quarter ended March 31, 1999 from 63.5% for the same 1998 period. As
previously noted, the increase in losses and loss expenses was due primarily to
a higher level of catastrophe losses experienced by the Company compared to the
same 1998 period. In January 1999 the Company experienced an increase in
reported winter weather related claims as well as tornadoes, high wind and hail
losses in Arkansas and Tennessee. The impact of the first quarter 1999 total
estimated catastrophe losses amounted to 7.6 GAAP loss ratio points whereas
first quarter 1998 catastrophe losses totaled 4.5 GAAP loss ratio points.
Acquisition and operating expenses, as a percentage of earned premiums (the
"expense ratio"), decreased to 28.6% for the quarter ended March 31, 1999 from
29.7% for the same 1998 period. The decrease in the expense ratio can be
attributed to a reduced amount of Quality Performance Bonus (the Bonus) earned
by employees in the current quarter compared to that earned during the same time
period in 1998.
The effective Federal tax rate was 25.8% and 27.4% for the three months ending
March 31, 1999 and 1998 respectively. The lower rate in 1999 was due to a
decrease in the underwriting profit caused by the increased level of catastrophe
losses as well as a higher percentage of the Company's fixed maturity portfolio
being invested in tax exempt securities as compared to the same period in 1998.
Liquidity and Capital Resources
In 1999, net cash provided by operating activities decreased to $23.2 million
($30.8 million in 1998). On January 1, 1998 the Company amended its pooling
Arrangement to include the insurance operations of Midwest Security as well as
change its allocation percentages. In connection with the January 1, 1998
pooling change, the Company received approximately $19.7 million to cover its
increased share of the pooled liabilities whereas for the January 1, 1999
pooling change the Company received $11.4 million.
Net cash used in investing activities decreased to $4.7 million ($35.1 million
in 1998). Contributing to this decrease was an increase in cash flows provided
by sale of fixed maturities, which were $48.9 million in 1999, and $26.3 million
in 1998. During the first quarter of 1999 the Company repositioned its
investment portfolio by selling certain lower yielding fixed maturities and
reinvesting in slightly higher yielding ones. Also impacting this decrease was
$11.6 million in net cash acquired by the Company on the acquisition of Farmers
Casualty and its subsidiary Mid-Plains.
Net cash used in financing activities for the three months ended March 31, 1999
remained comparable to the same period in 1998. As of March 31, 1999, funds
consisting of cash and cash equivalents were $50.8 million versus $26.5 million
at March 31, 1998. At March 31, 1999, a portion of the $50.8 million balance had
been allocated for securities investment in the second quarter of 1999 (not all
of the $11.4 million in cash transferred on the pooling change was invested
during the first quarter of 1999), while $5.8 million had been allocated to an
escrow account for the initial capitalization of State Auto Insurance Company,
with the balance allocated to fund general operations.
During the second quarter of 1999 the United States experienced significant
storm related losses which included several devastating tornadoes in Ohio,
Oklahoma, Kansas and Tennessee. Damage from these spring storms in several of
the Company's operating states will impact the Company's second quarter results,
but as of this writing the Company had not yet made an assessment of the
estimated losses resulting from this weather related activity.
On May 7, 1999, State Auto Financial's Board of Directors approved a plan to
repurchase up to 4.0 million shares of its common stock until December 31, 2000.
Currently, Mutual owns approximately 70% of State Auto Financial's outstanding
shares and the public owns the other 30%. State Auto Financial anticipates
repurchasing the shares in the same proportion.
11
Market Risk
With respect to Market Risk, see the discussion regarding this subject in the
Company's December 31, 1998 Management's Discussion and Analysis of Financial
Condition and Results of Operations, included in the December 31, 1998 Form
10-K. There have been no material changes from the information reported
regarding Market Risk in the 1998 Form 10-K.
Year 2000
With respect to the Year 2000, see the discussion regarding this subject in the
Company's December 31, 1998 Management's Discussion and Analysis of Financial
Condition and Results of Operations, included in the December 31, 1998 Form
10-K. There have been no material changes from the information reported
regarding the Year 2000 in the 1998 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 weather related
catastrophes impacting the Company's losses, product offerings, National's
premium receivable collections effort, the Year 2000 discussion, the statements
relating to the new insurer to be created, State Auto Insurance Company, the
legislative and regulatory environment and sales forecasts. These risks and
uncertainties include, but are not limited to, legislative changes, judicial and
regulatory decisions, 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, previously undisclosed
damage, utilities and financial institution disruptions, shortages of
programmers, and regulatory or governmental systems breakdowns.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE OF MARKET RISK
The information called for by this item is provided under the caption "Market
Risk" under Item 2 - Management's Discussion and Analysis of Financial Condition
and Results of Operations.
12
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
If a stockholder who plans to present a matter at the 2000 Annual
Meeting of Stockholders fails to provide notice of the matter to the Secretary
of the Company by March 13, 2000, it is the intention of the Company that,
pursuant to CFR Section 240.14 a-4(c)(1), the persons authorized under
management proxies will have discretionary authority to vote and act according
to their best judgment on said matter.
INDEX TO EXHIBITS
Item 6. a. Exhibits
Exhibit No. Description of Exhibits
----------- -----------------------
27 Financial data schedules
b. Reports on Form 8-K - None
13
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 14, 1999 /s/ STEVEN J. JOHNSTON
------------ -------------------------------------
Steven J. Johnston
Treasurer and Chief Financial Officer
(Duly Authorized Officer and
Principal Financial Officer)