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
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ___________ to __________
Commission file number 1-11733
AMERICAN STATES FINANCIAL CORPORATION
INDIANA NO. 35-1976549
State of Incorporation I.R.S. Employer Identification No.
500 NORTH MERIDIAN STREET
INDIANAPOLIS, INDIANA 46204-1275 (317) 262-6262
Address of principal executive offices Telephone Number
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes [x] No [ ]
Shares of common stock outstanding as of July 1, 1997: 60,050,515
DOCUMENTS INCORPORATED BY REFERENCE: Certain portions of the Registrant's
Form 8-K, dated June 6, 1997 are incorporated by reference in Part II of this
Form 10-Q.
The exhibit index to this report is located on page 23.
PART I - FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
AMERICAN STATES FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
June 30, December, 31
1997 1996
---------- ------------
(Dollars in Thousands)
ASSETS
Investments:
Securities available-for-sale at fair value:
Fixed maturity (amortized cost: 1997 - $3,618,363;
1996 - $3,579,807) $3,787,582 $3,763,880
Equity (cost: 1997 - $362,082; $1996 - $362,720) 460,560 435,137
Mortgage loans 21,871 32,293
Short-term investments 74,194 73,276
Other invested assets 39,450 37,986
---------- ----------
Total investments 4,383,657 4,342,572
Cash 19,338 13,610
Premium receivable 482,774 413,444
Deferred policy acquisition costs 212,250 202,233
Properties to be sold 23,218 30,633
Property and equipment 31,800 31,143
Accrued investment income 64,932 64,602
Current federal income taxes recoverable 4,968 ---
Deferred federal income taxes recoverable 121,066 128,742
Cost in excess of net assets of acquired subsidiaries 96,063 97,772
Ceded reinsurance on claims and claims expense reserves 175,149 179,445
Miscellaneous 36,658 36,887
---------- ----------
Total assets $5,651,873 $5,541,083
---------- ----------
---------- ----------
(continued on next page)
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
2
AMERICAN STATES FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (CONTINUED)
June 30, December, 31
1997 1996
---------- ------------
(Dollars in Thousands)
LIABILITIES AND SHAREHOLDERS' EQUITY
Policy liabilities and accruals:
Losses, loss adjustment expense and future policy benefits $2,854,688 $2,868,348
Unearned premiums 746,058 711,955
---------- ----------
Total policy liabilities and accruals 3,600,746 3,580,303
Commissions and other expenses 103,702 120,872
Current federal income taxes payable --- 5,303
Outstanding checks 64,128 69,901
Short-term debt due LNC 66,667 66,667
Notes payable 99,607 99,511
Debt due LNC 133,333 133,333
Other liabilities 166,731 129,154
---------- ----------
Total liabilities 4,234,914 4,205,044
Shareholders' equity:
Common stock, no par value: 195,000,000 shares authorized,
shares issued and outstanding: 1997 and 1996 - 60,050,515 304,500 304,493
Net unrealized gain on securities available-for-sale 171,494 163,647
Retained earnings 940,965 867,899
---------- ----------
Total shareholders' equity 1,416,959 1,336,039
---------- ----------
Total liabilities and shareholders' equity $5,651,873 $5,541,083
---------- ----------
---------- ----------
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
3
AMERICAN STATES FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
Three Months Ended Six Months Ended
June 30, June 30,
1997 1996 1997 1996
---------- ------------ ---------- -----------
(Dollars in Thousands, Except Per Share Data)
Revenue:
Premiums and other revenue $ 429,821 $ 424,483 $ 853,097 $ 848,477
Net investment income 66,525 66,156 133,003 134,489
Realized gain on investments 9,756 7,374 19,443 28,470
Gain on operating properties 4,208 --- 6,671 ---
---------- ----------- ---------- -----------
Total revenue 510,310 498,013 1,012,214 1,011,436
Benefits and expenses:
Benefits and settlement expenses 323,369 332,342 620,910 655,905
Commissions 71,657 72,510 140,762 144,382
Operating and administrative expenses 46,949 51,051 98,960 102,224
Taxes, licenses and fees 11,120 8,322 21,857 20,240
Interest on debt 5,227 1,835 10,392 1,835
---------- ----------- ---------- -----------
Total benefits and expenses 458,322 466,060 892,881 924,586
Income before federal income taxes 51,988 31,953 119,333 86,850
Federal income taxes (credit):
Current 4,842 (1,530) 17,617 14,401
Deferred 2,907 3,724 3,450 (4,223)
---------- ----------- ---------- -----------
Total federal income taxes 7,749 2,194 21,067 10,178
---------- ----------- ---------- -----------
Net income $ 44,239 $ 29,759 $ 98,266 $ 76,672
---------- ----------- ---------- -----------
---------- ----------- ---------- -----------
Net income per share $ .74 $ .55 $ 1.64 $ 1.48
---------- ----------- ---------- -----------
---------- ----------- ---------- -----------
Weighted average shares outstanding 60,050,515 53,644,692 60,050,515 51,832,414
---------- ----------- ---------- -----------
---------- ----------- ---------- -----------
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
4
AMERICAN STATES FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Six Months Ended
June 30,
1997 1996
---------- -----------
(Dollars in Thousands)
Common stock:
Balance at beginning of period $ 304,493 $ 387,547
Public offering of common stock --- 215,482
Common stock issued for employee benefit plans 7 1,161
Assumption and issuance of debt in exchange with LNC --- (299,398)
---------- -----------
Balance at end of period 304,500 304,792
Net unrealized gain (loss) on securities available-for-sale:
Balance at beginning of period 163,647 211,767
Change during the period 7,847 (97,793)
---------- -----------
Balance at end of period 171,494 113,974
Retained earnings:
Balance at beginning of period 867,899 1,069,393
Dividend of assets to LNC prior to public offering --- (299,866)
Dividends declared and paid on Common Stock ($.42 per share) (25,200) (46,134)
Net income 98,266 76,672
---------- -----------
Balance at end of period 940,965 800,065
---------- -----------
Total shareholders' equity $1,416,959 $ 1,218,831
---------- -----------
---------- -----------
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
5
AMERICAN STATES FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Six Months Ended
June 30,
1997 1996
--------- ---------
(Dollars in Thousands)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 98,266 $ 76,672
Adjustments to reconcile net income to cash provided by
(used in) operating activities:
Deferred policy acquisition costs (9,149) (4,270)
Premiums and fees in course of collection (69,330) (37,052)
Accrual of discount on investments (9,445) (9,617)
Amortization of premium on investments 2,034 2,767
Accrued investment income (331) (1,800)
Policy liabilities and accruals 4,183 76,793
Federal income taxes (6,821) (25,110)
Provisions for depreciation 3,761 3,850
Gain on sale of investments (19,443) (28,470)
Gain on operating properties (6,671) ---
Ceded reinsurance on claims and claims expense reserves 4,296 (36,914)
Other (11,359) (21,514)
--------- ---------
Net adjustments (118,275) (81,337)
--------- ---------
Net cash used in operating activities (20,009) (4,665)
CASH FLOWS FROM INVESTING ACTIVITIES
Securities available-for-sale:
Purchase of investments (335,737) (753,087)
Sales of investments 280,360 583,064
Maturities and redemptions 45,070 38,401
Purchase of mortgage loans and other investments (3,836) (7,011)
Sale or maturity of mortgage loans and other investments 11,684 3,945
Net increase in short-term investments (918) (59,495)
Net sale (purchase) of property and equipment 9,669 (4,472)
Other 28,379 16,518
--------- ---------
Net cash provided by (used in) investing activities 34,671 (182,137)
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from issuance of common stock 7 215,482
Universal life investment contract deposits 25,334 24,837
Universal life investment contract withdrawals (9,075) (6,605)
Dividends paid (25,200) (46,134)
--------- ---------
Net cash provided by (used in) financing activities (8,934) 187,580
Net increase (decrease) in cash 5,728 778
Cash at beginning of period 13,610 12,708
--------- ---------
Cash at end of period $ 19,338 $ 13,486
--------- ---------
--------- ---------
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
6
AMERICAN STATES FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following notes should be read in conjunction with the notes to
consolidated financial statements included in the American States Financial
Corporation Form 10-K dated February 26, 1997. Unless the context otherwise
indicates; (1) the "Company" refers to American States Financial
Corporation and its wholly-owned, consolidated subsidiaries; (ii) "ASI"
refers to American States Insurance Company, the Company's sole direct
wholly-owned subsidiary, and its consolidated subsidiaries; and (iii) the
"Subsidiaries" refer to the direct and indirect subsidiaries of the Company,
which include ASI and its subsidiaries. Operating results for the six months
ended June 30, 1997 are not necessarily indicative of the results that may be
expected for the full year ending December 31, 1997.
1. ORGANIZATION AND BASIS OF PRESENTATION
On February 5, 1996, the Company was incorporated in the State of
Indiana to serve as the holding company for ASI. The formation of the Company
was done in contemplation of an initial public offering. On April 22, 1996,
ASI declared, and on May 15, 1996, it distributed to its parent, Lincoln
National Corporation ("LNC"), a dividend of $300 million, consisting
primarily of tax-exempt securities ("Dividended Assets"). On May 16, 1996, LNC
transferred all of the outstanding shares of ASI to the Company in exchange
for 50,000,000 shares of the Company's common stock. Concurrently with the
transfer of the ASI stock, the Company assumed $100 million of LNC debt
("Assumed Debt") and issued a $200 million note to LNC (the "Term Note").
On May 29, 1996, the Company issued 10,000,000 shares of common stock at
$23 per share to the public (the "Offering"). The net proceeds from the
Offering (after deduction of underwriting discounts and offering expenses)
were $215.2 million. The Company contributed $140.5 million of such net
proceeds to ASI to enable it to invest in taxable securities for its
investment portfolio to partially replace the Dividended Assets. The
remainder of the net proceeds were retained by the Company for general
corporate purposes. As a result of the Offering, LNC's ownership was reduced
to approximately 83%.
The 50,000,000 shares held by LNC are "restricted shares" as defined by
Rule 144 of the Securities Act of 1993, as amended (the "Securities Act").
Such shares may not be resold in the absence of registration under the
Securities Act or exemptions from such registration, including, among others,
the exemption provided by Rule 144 under the Securities Act. As an affiliate
of the Company, LNC is subject to certain volume restrictions on the sale of
shares of the Company's common stock.
The Company's common stock is publicly traded on the New York Stock
Exchange under the symbol "ASX".
The transfer of ASI stock to the Company by LNC in exchange for Company
common stock and the Assumed Debt and Term Note have been accounted for
similar to a pooling of interests in the consolidated financial statements of
the Company, in that the assets, liabilities, shareholders' equity and the
results of operation of the Company and its subsidiaries have been combined
at historical carrying values.
The consolidated financial statements as of and for the six months ended
June 30, 1997 and 1996, are unaudited. In the opinion of management, these
financial statements include all adjustments, consisting only of normal
recurring items, which are necessary to present fairly the Company's
financial position and results of operations on a basis consistent with that
of prior audited consolidated financial statements. The balance sheet at
December 31, 1996, 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. Significant intercompany balances and transactions have been
eliminated. Certain amounts from prior periods were reclassified to conform to
the 1997 presentation. Net income and shareholders' equity have not been
affected by these reclassifications.
7
AMERICAN STATES FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
1. ORGANIZATION AND BASIS OF PRESENTATION (Continued)
The Company underwrites property and casualty insurance, concentrating
on providing commercial insurance to small to medium-sized businesses and
preferred personal lines coverages to individuals. As a complement to its
property and casualty operations, the Company also markets life insurance.
The Company writes business throughout the United States with the greatest
volume in the Midwest and Pacific Northwest.
2. CHANGE IN ACCOUNTING PRINCIPLE
In February 1997, the Financial Accounting Standards Board ("FASB")
issued Statement of Financial Accounting Standards No. 128 ("FAS 128"),
EARNINGS PER SHARE which the Company will adopt in the fourth quarter of
1997. Earlier adoption is not permitted. In accordance with FAS 128, the
Company will present "basic" and "diluted" earnings per share on the face of
the income statement regardless of the difference between the two
calculations. When calculating the diluted earnings per share, the treasury
stock method will be applied using the average market price for the period
rather than the higher of the average market price or the ending market
price. Using the terms of FAS 128, the basic and diluted earnings per share
for the first six months of 1997 would be $1.64. The basic and diluted
earnings per share for the first six months of 1996 would be $1.48.
In June of 1997, the FASB issued Statement 130, "Reporting Comprehensive
Income". Statement 130 is effective for fiscal years beginning after December
15, 1997 and ASFC will adopt it in the first quarter of 1998. Adoption will
have no effect on net income but will require the reporting of "comprehensive
income," which will include net income and certain items currently reported
in stockholders' equity.
The FASB issued Statement 131, "Disclosures about Segments of an
Enterprise and Related Information" in June of 1997. FAS 131 changes the way
companies report information about business segments in annual financial
statements and requires the reporting of selected segment information in
their interim reports. FAS 131 is effective for financial statements for
periods beginning after December 15, 1997 except that providing interim
information in the initial year (1998) may be deferred until 1999. ASFC plans
on providing the required segment information in its 1998 annual report and
in its interim reports beginning in 1999. FAS 131 has no effect on net income.
3. FEDERAL INCOME TAXES
A consolidated federal income tax return is filed by LNC and includes
the Company. Pursuant to an agreement with LNC, the Company provides for
income taxes on the basis of a separate return calculation. The taxes
computed are remitted to or collected from LNC.
The effective tax rate on pre-tax income is lower than the prevailing
corporate federal income tax rate primarily due to tax-exempt interest on
municipal securities.
8
AMERICAN STATES FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
4. NOTES PAYABLE AND DEBT DUE LNC
The Assumed Debt is governed by an agreement between the Company and LNC
(the "Assumption Agreement") which provides for the payment by the Company of
the currently outstanding 7 1/8% notes due July 15, 1999, originally issued
to the public by LNC on July 15, 1992. LNC will continue to be the primary
obligor of this public debt; however, pursuant to the Assumption Agreement,
the Company is obligated to make a $100 million principal payment on July 15,
1999 to repay the holders of the public debt. The Assumption Agreement also
provides that interest at 7 1/8% is payable semi-annually by the Company.
The Term Note will pay interest quarterly at a rate of 50 basis points
over the rate on three year Treasury Notes through and including November 14,
1997, 50 basis points over the rate on two year Treasury Notes from November
15, 1997 through and including November 14, 1998 and 50 basis points over the
rate on one-year Treasury Bills from November 15, 1998 through the maturity
date. The current rate on the Term Note is 6.7%. The Term Note is payable in
three equal principal payments due on August 15, 1997, 1998 and 1999.
Pursuant to the provisions on the Term Note, the Company will have the right
to prepay the Term Note at any time. The Term Note also contains covenants
that will, among other things, (i) require the Company to maintain certain
levels of adjusted consolidated net worth (as defined in the Term Note), and
(ii) restrict the ability of the Company to incur indebtedness in excess of
50% of its adjusted consolidated net worth and to enter into a major
corporate transaction unless the Company is the survivor and would not be in
default.
However, as disclosed in Note 6 to the Notes to Consolidated Financial
Statements, LNC will be paid the outstanding balance and accrued but unpaid
interest thereon of the Assumed Debt and Term Note pursuant to terms of the
pending Agreement and Plan of Merger by and among ASFC, SAFECO Corporation
and ASFC Acquisition Co. if and when the sale is consummated.
On May 29, 1996, the Company entered into a revolving credit agreement
in which the Company may borrow and repay amounts up to a maximum of $200
million (the "Line of Credit"). Borrowings using the Line of Credit will bear
interest generally at variable rates tied to LIBOR, an adjusted certificate
of deposit rate or other short-term indices. No debt was outstanding using
the Line of Credit at June 30, 1997.
5. CONTINGENCIES
On February 14, 1996, three of the Company's property and casualty
insurance subsidiaries were among 23 underwriters of real property insurance
named defendants in a case alleging that their underwriting, sales and
marketing practices violated a number of civil rights laws (including,
without limitation, the Fair Housing Act). It was also alleged that the
defendants' actions constituted a civil conspiracy. Brought in the United
States District Court for the Western District of Missouri, the plaintiffs
sought to represent themselves and a putative class of similarly situated
persons in the State of Missouri. This action sought injunctive relief,
unspecified compensatory damages, punitive damages and attorney's fees. In
response to motions filed by the defendants, the court dismissed the
conspiracy count by Order dated October 2, 1996 but required that the
defendants answer the remaining counts. On June 19, 1997 the court denied
class certification and dismissed the case for lack of standing. On July 17,
1997 the same plaintiffs filed a separate action against the same three
property and casualty subsidiaries of the Company.
9
AMERICAN STATES FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
5. CONTINGENCIES (Continued)
The plaintiffs in this new case have asked that it be certified as a
class action and make substantially the same allegations and seek
substantially the same remedies as were sought in the original case. In
addition, the plaintiffs filed a notice of appeal in the original case on
July 18, 1997. Management believes, based upon current information, that the
Company's underwriting, sales and marketing practices have complied in all
material respects with the applicable requirements of both state and federal
law. The Company intends to defend these actions vigorously.
On August 29, 1996, the first of two actions were brought in Missouri
state courts alleging that underinsured motorist insurance coverage sold in
that state by three of the Company's property and casualty insurance
subsidiaries constitutes "phantom coverage" when sold at limits equal to the
State's financial responsibility requirements. In both actions, the
plaintiffs sought to represent themselves and a putative class of similarly
situated persons in the State of Missouri. Both actions sought compensatory
and punitive damages based upon a number of legal theories, including,
without limitation, breach of fiduciary duty, negligence, breach of contract,
unjust enrichment and misrepresentation. A motion to consolidate the two
cases has been entered. Discovery has begun. Management does not believe,
based upon current information, that the allegations have merit and it
therefore intends to defend the consolidated action vigorously.
6. RECENT DEVELOPMENTS
On June 6, 1997, ASFC entered into an Agreement and Plan of Merger dated
as of the same date (the "Merger Agreement"), by and among ASFC, SAFECO
Corporation ("Buyer") and ASFC Acquisition Co., a wholly owned subsidiary of
Buyer ("Buyer Sub"). The Merger Agreement provides for, among other things,
the merger of Buyer Sub with and into ASFC (the "Merger"), with ASFC
surviving the Merger as a wholly owned subsidiary of Buyer. Pursuant to the
Merger Agreement and upon consummation of the Merger each outstanding share
of Common Stock of ASFC ("ASFC Common Stock") will be converted into the
right to receive $47 in cash without interest thereon. Consummation of the
Merger is subject to certain conditions, including, among others, (a) the
approval by certain state insurance regulators of the Merger and (b)
compliance with applicable provisions of the Hart-Scott-Rodino Antitrust
Improvements Act of 1976, as amended (the "HSR Act"). Early termination of
the HSR Act waiting period was received on July 15, 1997.
In connection with the Merger Agreement, LNC and Buyer entered into a
Voting, Support and Indemnification Agreement dated June 6, 1997 (the "Voting
Agreement"), certain sections of which were agreed to and acknowledged by
ASFC. Pursuant to the Voting Agreement, LNC agreed, among other things, (a)
to vote all ASFC Common Stock held by it or any of its subsidiaries in favor
of the Merger, the Merger Agreement and the transactions contemplated
thereby, (b) to grant Buyer an irrevocable proxy in all ASFC Common Stock
held by it or any of its subsidiaries for purposes of a vote at a meeting of
the holders of ASFC Common Stock held to consider the Merger and (c) to
allocate between LNC and Buyer certain tax and employee benefits liabilities;
and Buyer agreed, among other things, to pay to LNC (a) $100 million plus an
amount equal to the accrued but unpaid interest on the outstanding 7 1/8%
notes due July 15, 1999, originally issued to the public by LNC on July 15,
1992, in consideration of the termination of the agreement relating to the
Assumed Debt, and (b) the outstanding principle balance of, plus accrued but
unpaid interest on, the Term Note, in consideration of the surrender of the
Term Note by LNC to ASFC for cancellation.
10