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 PERIOD ENDED SEPTEMBER 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 .
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COMMISSION FILE NUMBER 0-25508
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RTW, INC.
(Exact name of registrant as specified in its charter)
MINNESOTA 41-1440870
- ----------------------------------------------- ----------------------------
(State or other jurisdiction of incorporation (I.R.S. Employer
or organization) Identification No.)
8500 NORMANDALE LAKE BOULEVARD, SUITE 1400
BLOOMINGTON, MN 55437
(Address of principal executive offices and zip code)
(612)-893-0403
(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 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
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At October 31, 1997, 11,841,023 shares of Common Stock were outstanding.
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TABLE OF CONTENTS
PART I - FINANCIAL INFORMATION PAGE
Item 1. Consolidated Financial Statements and Notes (Unaudited) 3
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 8
PART II - OTHER INFORMATION
Item 1. Legal Proceedings 15
Item 2. Changes in Securities 15
Item 3. Defaults Upon Senior Securities 15
Item 4. Submission of Matters to a Vote of Security Holders 15
Item 5. Other Information 15
Item 6. Exhibits and Reports on Form 8-K 15
Signatures 16
Exhibits 17
2
ITEM 1: FINANCIAL STATEMENTS
INDEX TO FINANCIAL STATEMENTS
PAGE
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FINANCIAL STATEMENTS
Consolidated Balance Sheets - September 30, 1997 and December 31, 1996 4
Consolidated Statements of Income - Three and nine month periods ended
September 30, 1997 and 1996 5
Consolidated Statements of Cash Flows - Nine months ended September 30,
1997 and 1996 6
Notes to Consolidated Financial Statements 7
3
RTW, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, 1997 AND DECEMBER 31, 1996
(In thousands, except share data)
SEPTEMBER 30, DECEMBER 31,
1997 1996
------------- ------------
ASSETS (Unaudited)
Investments:
Held-to-maturity, at amortized cost, fair value of $54,533 and $54,396 $ 53,851 $ 53,977
Available-for-sale, at fair value, amortized cost of $49,466 and $35,854 50,175 35,872
------------ ------------
Total investments 104,026 89,849
Cash and cash equivalents 10,613 10,410
Accrued investment income 1,276 1,724
Premiums receivable, less allowance of $130 and $105 6,268 4,476
Reinsurance receivable 5,406 6,183
Reinsurance premiums receivable, net 3,153 2,555
Deferred policy acquisition costs 1,722 1,624
Furniture and equipment, net 4,483 3,423
Other assets 4,244 3,487
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$ 141,191 $ 123,731
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LIABILITIES AND SHAREHOLDERS' EQUITY
Unpaid claim and claim settlement expenses $ 57,681 $ 49,256
Unearned premiums 15,809 13,308
Accrued expenses and other liabilities 4,237 3,117
Notes payable 6,840 6,739
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Total liabilities 84,567 72,420
Shareholders' equity:
Common Stock, no par value; authorized 25,000,000 shares; issued
and outstanding 11,841,023 shares at September 30, 1997 and
11,807,576 shares at December 31, 1996 28,976 28,610
Retained earnings 27,201 22,690
Unrealized appreciation on securities available-for-sale 447 11
------------ ------------
Total shareholders' equity 56,624 51,311
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$ 141,191 $ 123,731
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See accompanying notes to consolidated financial statements.
4
RTW, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
THREE AND NINE MONTH PERIODS ENDED SEPTEMBER 30, 1997 AND 1996
(Unaudited; in thousands, except per share data)
FOR THE THREE MONTHS FOR THE NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
------------------------ ------------------------
1997 1996 1997 1996
--------- --------- --------- ---------
REVENUES:
Premiums earned $ 20,423 $ 16,914 $ 59,278 $ 46,022
Investment income 1,906 1,465 5,083 4,131
--------- --------- --------- ---------
Total revenues 22,329 18,379 64,361 50,153
EXPENSES:
Claim and claim settlement expenses 14,250 10,025 40,116 26,386
Policy acquisition costs 2,876 2,132 8,482 5,429
General and administrative expenses 2,329 1,815 8,049 5,767
--------- --------- --------- ---------
Total expenses 19,455 13,972 56,647 37,582
--------- --------- --------- ---------
Income from operations 2,874 4,407 7,714 12,571
Interest expense 196 273 588 821
--------- --------- --------- ---------
Income before income taxes 2,678 4,134 7,126 11,750
Provision for income taxes 973 1,552 2,615 4,404
--------- --------- --------- ---------
Net income $ 1,705 $ 2,582 $ 4,511 $ 7,346
--------- --------- --------- ---------
--------- --------- --------- ---------
Net income per common and
common share equivalent $ 0.14 $ 0.21 $ 0.37 $ 0.60
--------- --------- --------- ---------
--------- --------- --------- ---------
See accompanying notes to consolidated financial statements.
5
RTW, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996
(Unaudited, in thousands)
FOR THE NINE MONTHS
ENDED SEPTEMBER 30,
-----------------------------
1997 1996
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CASH FLOWS FROM OPERATING ACTIVITIES:
Reconciliation of net income to net cash provided by operating activities:
Net income $ 4,511 $ 7,346
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization 780 554
Deferred income taxes (532) (564)
Changes in assets and liabilities:
Amounts due from reinsurers 179 1,698
Unpaid claim and claim settlement expenses 8,425 8,040
Unearned premiums, net of premiums receivable 709 2,733
Other, net 1,222 (1,119)
--------- ---------
Net cash provided by operating activities 15,294 18,688
CASH FLOWS FROM INVESTING ACTIVITIES:
Maturities of held-to-maturity securities - 3,000
Purchases of available-for-sale securities (41,639) (19,845)
Sales of available-for-sale securities 28,017 -
Purchases of furniture and equipment (1,739) (1,371)
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Net cash used in investing activities (15,361) (18,216)
CASH FLOWS FROM FINANCING ACTIVITIES:
Stock options and warrants exercised 1 129
Issuance of Common Stock under ESPP 154 129
Issuance of Common Stock to ESOP 115 236
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Net cash provided by financing activities 270 494
--------- ---------
NET INCREASE IN CASH AND CASH EQUIVALENTS 203 966
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 10,410 12,962
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CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 10,613 $ 13,928
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SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest $ 501 $ 692
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Income taxes $ 2,636 $ 4,758
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See accompanying notes to consolidated financial statements.
6
RTW, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THREE AND NINE MONTH PERIODS ENDED SEPTEMBER 30, 1997 AND 1996
(Unaudited)
NOTE A - BASIS OF PRESENTATION
The accompanying consolidated financial statements have been prepared in
conformity with generally accepted accounting principles and such principles
were applied on a basis consistent with the 1996 Annual Report filed with the
Securities and Exchange Commission ("SEC") except that the consolidated
financial statements were prepared in conformity with the instructions to Form
10-Q for interim financial information and, accordingly, do not include all of
the information and notes required by generally accepted accounting principles
for complete financial statements. The consolidated financial information
included herein, other than the consolidated balance sheet at December 31, 1996,
has been prepared by management without audit by independent certified public
accountants. The consolidated balance sheet at December 31, 1996 has been
derived from the audited consolidated financial statements for the year ended
December 31, 1996, but does not include all the disclosures contained therein.
The information furnished includes all adjustments and accruals, consisting only
of normal, recurring accrual adjustments, which are, in the opinion of
management, necessary for a fair statement of results for the interim period.
The results of operations for any interim period are not necessarily indicative
of results for the full year. The unaudited interim consolidated financial
statements should be read in conjunction with the consolidated financial
statements and notes thereto contained in the RTW, Inc. Annual Report to
Shareholders for the year ended December 31, 1996.
NOTE B - SHAREHOLDERS' EQUITY
STOCK SPLIT - On April 25, 1996, the Company's Board of Directors approved a
3-for-2 stock split in the form of a 50 percent stock dividend, distributed on
May 17, 1996, to shareholders of record on the close of business on May 6, 1996.
All share and per share information has been restated to reflect the stock
split.
SHAREHOLDER PREFERRED STOCK PURCHASE RIGHTS IN THE EVENT OF A CHANGE OF CONTROL
- - In April 1997, the Company adopted a shareholder rights plan and declared a
dividend of one right for each outstanding share of common stock to shareholders
of record at the close of business on June 30, 1997. The rights become
exercisable only after any person or group (the "Acquiring Person") becomes the
beneficial owner of 15% or more of the voting power of the Company. Certain
shares held by the Company's Chairman, President and Chief Executive Officer and
his wife are excluded from the computation for determining whether a person is
an Acquiring Person. Each right entitles its registered holder to purchase from
the Company one one-hundredth share of a new Series A Junior Participating
Preferred Stock, no par value, at a price of $85 per one one-hundredth share,
subject to adjustment. If any Acquiring Person acquires beneficial ownership of
15% or more of the voting power of the Company, each right will entitle its
holder (other than such Acquiring Person) to purchase, at the then current
purchase price of the right, that number of shares of the Company's common stock
having a market value of two times the purchase price of the right, subject to
certain possible adjustments. In addition, if the Company is acquired in a
merger or other business combination transaction, each right will entitle its
holder to purchase, at the then current purchase price of the right, that number
of common shares of the acquiring company having a market value of two times the
purchase price of the right. Following the acquisition of a beneficial
ownership of 15% or more of the Company's outstanding common stock by any
Acquiring Person and prior to an acquisition by any Acquiring Person of 50% or
more of the Company's outstanding common stock, the Board of Directors may
exchange the outstanding rights (other than rights owned by such Acquiring
Person), in whole or in part, at an exchange ratio of one share of common stock,
or one one-hundredth share of Preferred Stock (or equivalent securities) per
right, subject to adjustment. The Company may redeem the rights, in whole, at
$.001 per right, at any time prior to an acquisition by any Acquiring Person of
15% or more of the Company's outstanding common stock and prior to the
expiration of the rights. The rights expire on April 17, 2007, unless extended
or earlier redeemed by the Company.
7
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW
The following analysis of the consolidated results of operations and financial
condition of RTW, Inc. (the "Company") and its wholly-owned subsidiary, American
Compensation Insurance Company ("ACIC"), should be read in conjunction with the
Company's consolidated financial statements and notes thereto at September 30,
1997 and December 31, 1996 and the three and nine month periods ended September
30, 1997 and 1996.
The Company's revenues consist of premiums earned and investment income.
Premiums earned during a period are the gross premiums earned by the Company on
workers' compensation policies less premiums ceded to reinsurers (as adjusted by
refunds or return of premiums from those reinsurers). Investment income
represents income on the Company's investment portfolio, including realized
gains and losses.
The Company's expenses are comprised of claim and claim settlement expenses,
policy acquisition costs, general and administrative expenses, interest expense
and income taxes.
RESULTS OF OPERATIONS
The following tables summarize the components of revenues for the three and nine
month periods ended September 30, 1997 and 1996 and premiums in force at
September 30, 1997 and 1996:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------- -------------------
1997 1996 1997 1996
------ ------ ------ ------
(In thousands) (In thousands)
Gross premiums earned $ 20,279 $ 17,161 $ 59,401 $ 46,443
Premiums ceded 144 (247) (123) (421)
-------- -------- -------- --------
Premiums earned 20,423 16,914 59,278 46,022
Investment income 1,906 1,465 5,083 4,131
-------- -------- -------- --------
Total revenues $ 22,329 $ 18,379 $ 64,361 $ 50,153
-------- -------- -------- --------
-------- -------- -------- --------
1997 1996
--------- ---------
(In thousands)
Premiums in force at September 30:
Minnesota $ 45,700 $ 52,900
Colorado 13,000 10,600
Missouri 11,300 3,000
Michigan 3,100 -
Illinois 1,300 -
Massachusetts 900 -
Wisconsin 200 -
--------- ----------
Total in force at September 30: $ 75,500 $ 66,500
--------- ----------
--------- ----------
PREMIUMS EARNED. Gross premiums earned increased 18.2% to $20.3 million in
the third quarter of 1997 from $17.2 million in the third quarter of 1996 and
27.9% to $59.4 million for the nine months ended September 30, 1997 from $46.4
million for the nine months ended September 30, 1996. The increase in gross
premiums earned resulted from an increase in the amount of premiums in force,
due primarily to increased an number of policies in force resulting from the
Company's continued growth in its existing markets and expansion into new
markets.
8
The following factors have resulted in premium reductions on renewal accounts
and comparatively lower premiums on new accounts.
- Legislative action has reduced estimated loss costs in recent years,
ultimately reducing premiums charged for workers' compensation insurance.
Estimated loss costs will continue to decrease into 1998 but the
comparative impact on premiums charged for workers' compensation insurance
from levels charged in 1997 is unknown at this time.
- The Company continues, as anticipated, to experience reduced pricing on
renewal policies due to its success in lowering customers' loss experience
which reduces customer experience modifiers and, in some cases, increases
competition for the customers' business.
- From October 1995 through September 1996, the Company attempted to write
more customers with credit experience modifiers and experienced increased
competition in this customer base (including traditional insurance
companies competing in greater numbers for accounts). The Company
repositioned its marketing efforts in the fourth quarter of 1996 to refocus
on its traditional debit experience modifier customer base. The Company
will continue to be affected by these credit experience modifier premiums
through the fourth quarter of 1997.
The impact of legislative changes in estimated loss costs, decreasing customer
loss experience and increased competition in credit modifier customers may
continue to result in lower premiums generated on new and renewal policies
through the remainder of 1997 and into fiscal year 1998.
Premiums ceded reflect "excess of loss" reinsurance policies purchased by the
Company. The following tables summarize the components of premiums ceded for
the three and nine month periods ended September 30, 1997 and 1996:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------ -----------------
1997 1996 1997 1996
-------- -------- -------- -------
(In thousands) (In thousands)
Premiums ceded:
Minnesota Workers' Compensation
Reinsurance Association (the "WCRA") $ - $ 90 $ - $ 287
Refund from the WCRA on prior years'
excess of loss ceded premiums (358) - (358) -
Benefit recognized for over-estimated
excess of loss premiums at December 31,
1995 - - - (251)
Non-Minnesota excess of loss policies 214 157 481 385
------ ------ ------ ------
Total premiums ceded cost (benefit) $ (144) $ 247 $ 123 $ 421
------ ------ ------ ------
------ ------ ------ ------
Premiums ceded decreased to a benefit of $144,000 in the third quarter of 1997
from a cost of $247,000 in the third quarter of 1996 and decreased to a cost of
$123,000 for the nine months ended September 30, 1997 from a cost of $421,000
for the nine months ended September 30, 1996. The decrease in premiums ceded to
reinsurers resulted from the recognition of a return premium of $358,000 in the
third quarter of 1997 from the WCRA. Premiums ceded for the nine months ended
September 30, 1997 decreased from 1996 levels (after adjusting for the $358,000
benefit recognized in the third quarter of 1997 and the $251,000 benefit
recognized in the second quarter of 1996) due to (i) reduced rates charged on
Minnesota premiums for excess of loss reinsurance by the WCRA in 1997 from rates
charged in 1996, and (ii) reduced rates negotiated for excess of loss
reinsurance in non-Minnesota locations beginning January 1, 1997 from rates on
similar policies in 1996. Minnesota's retention level for 1997 is $1.1 million
while Colorado, Missouri, Michigan, Illinois, Massachusetts and Wisconsin
retention levels are $500,000 in 1997.
Premiums earned increased 20.7% to $20.4 million in the third quarter of 1997
from $16.9 million in the third quarter of 1996 and increased 28.8% to $59.3
million for the nine months ended September 30, 1997 from $46.0 million for the
nine months ended September 30, 1996 as a result of these changes.
The Company expects continued growth in gross premiums earned for the remainder
of 1997 as it continues to expand in Colorado, Missouri, Michigan and
Massachusetts. Premiums ceded as a percentage of premiums earned will be
consistent with the third quarter results after adjusting for the $358,000
return premium received.
9
During the third quarter of 1997, the WCRA notified its members of its rate
structure for 1998 mandatory excess of loss coverage. The excess of loss rate
for the "super retention" limit, a retention of $1.1 million, increased to 1.7%
for 1998 from 0.0% in 1997. The Company has elected to decrease its 1998
retention level from $1.1 million to $280,000 which will cost the Company 6.8%
cost of Minnesota gross premiums earned. The Company expects that this cost
increase will be offset substantially by decreases in expected Minnesota claim
and claim settlement expenses. Although the lower retention level will result
in premiums ceded becoming a higher percentage of the gross premiums earned, the
Company believes it will eliminate the adverse effect that any claims in excess
of $280,000 would have on the Company and result in lower claim and claim
settlement expense.
INVESTMENT INCOME. Investment income increased to $1.9 million in the third
quarter of 1997 from $1.5 million in the third quarter of 1996 and increased to
$5.1 million for the nine months ended September 30, 1997 from $4.1 million for
the nine months ended September 30, 1996 due to increased funds available for
investment and increased yields on funds invested. Funds invested increased to
$104.0 million at September 30, 1997 from $84.8 million at September 30, 1996
due to net cash provided by operating activities since September 30, 1996. The
investment yield increased to 6.3% for the quarter ended September 30, 1997 from
6.2% for the quarter ended September 30, 1996. Historically, the Company
invested only in U.S. Treasury and Agency Securities. In the first quarter of
1997, the Company expanded its investment strategy to include other fixed income
securities such as mortgage-backed, asset-backed and corporate debt securities
which meet certain criteria. The Company entered into an agreement with an
investment manager during April 1997 to provide expertise in this investment
diversification. The investment yield realized in the future will be affected
by yields attained on new investments and yield changes on maturing investments
and available-for sale investments sold as the portfolio is repositioned. The
Company expects that the investment yield for the remainder of 1997 will be
consistent with the yield attained during the first nine months of 1997.
CLAIM AND CLAIM SETTLEMENT EXPENSES. Claim and claim settlement expenses
increased 42.1% to $14.3 million in the third quarter of 1997 from $10.0 million
in the third quarter of 1996 and 52.0% to $40.1 million for the nine month ended
September 30, 1997 from $26.4 million for the nine months ended September 30,
1996. As a percentage of premiums earned, claim and claim settlement expenses
increased to 69.8% for the third quarter of 1997 from 59.3% for the third
quarter of 1996 and increased to 67.7% for the nine months ended September 30,
1997 from 57.3% for the nine months ended September 30, 1996. The net increase
is due to the following:
- Premiums earned increased in the third quarter of 1997 from the third
quarter of 1996 resulting in a corresponding increase claim and claim
settlement expenses.
- Average claim cost continued to decrease slightly in the third quarter
of 1997 from the third quarter of 1996 due to efficiencies within the
Company and legislative changes in benefits to claimants. The
legislative changes have reduced estimated loss costs, ultimately
reducing premiums charged for workers' compensation insurance.
However, average claim costs have not decreased as significantly as
premiums charged resulting in increased claim and claim settlement
expenses as a percentage of premiums earned.
- In the third quarter of 1997, the Company reduced its estimate of
pre-1997 unpaid claim and claim settlement expenses, which resulted in
an $850,000 reduction in third quarter 1997 claim and claim settlement
expenses. Combined with the first quarter reduction of $675,000 and
the second quarter reduction of $850,000, the cumulative reduction
totaled approximately $2.4 million for the nine months ended September
30, 1997. Comparatively, the Company recorded a third quarter
reduction of $608,000 in 1996 and approximately $1.7 million for the
nine months ended September 30, 1996.
The Company believes that, in the current environment (reduced premiums due to
legislative changes in estimated costs of losses, increased competition in
credit modifier customers written from October 1995 through September 1996,
decreasing customer loss experience and decreasing average claim costs), it may
continue to experience upward pressure on claim and claim settlement expenses as
a percentage of premiums earned.
10
POLICY ACQUISITION COSTS. The following table summarizes policy acquisition
costs for the three and nine month periods ended September 30, 1997 and 1996:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------ -----------------
1997 1996 1997 1996
------- ------- ------- -------
(In thousands) (In thousands)
Commission expense $ 1,585 $ 1,333 $ 4,714 $ 3,275
Premium tax expense 412 349 1,217 958
Other policy acquisition costs 879 592 2,551 1,613
------- ------- ------- -------
Direct policy acquisition costs 2,876 2,274 8,482 5,846
Ceding commissions
Favorable claims experience
adjustments for 1992 to 1994 - (142) - (417)
------- ------- ------- -------
Policy acquisition costs $ 2,876 $ 2,132 $ 8,482 $ 5,429
------- ------- ------- -------
------- ------- ------- -------
Policy acquisition costs increased to $2.9 million in the third quarter of 1997
from $2.3 million in the third quarter of 1996 and increased to $8.5 million for
the nine months ended September 30, 1997 from $5.8 million for the nine months
ended September 30, 1996 for the following reasons:
- Commission expense decreased to 7.8% of gross premiums earned in the
third quarter of 1997 from 7.9% in the third quarter of 1996 and
increased to 8.0% of gross premiums earned for the nine months ended
September 30, 1997 from 7.1% for the nine months ended September 30,
1996. The Company initiated marketing programs in the first quarters
of 1997 and 1996, including volume-based incentive programs and higher
commissions for new business, that increased commission rates to
agents resulting in increased average commissions and commission
expense. Additionally, as the Company entered new markets, it
introduced higher commission rates to attract business from
established agents. The Company expects commission rates to remain
consistent with results attained in the third quarter of 1997.
- Premium tax expense remained at 2.0% of gross premiums earned in the
third quarters of 1997 and 1996 and 2.1% for the nine month periods
ending September 30, 1997 and 1996. The Company expects premium tax
expense as a percent of gross premiums earned to remain consistent
with the results attained during the nine month period ended September
30, 1997 for the remainder of 1997 and into 1998.
- Other policy acquisition costs increased to 4.3% of gross premiums
earned in the third quarter of 1997 from 3.5% in the third quarter of
1996 and increased to 4.3% of gross premiums earned for the nine
months ended September 30, 1997 from 3.5% for the nine months ended
September 30, 1996 due to increased personnel costs necessary for the
growth in premiums in force and increased focus on marketing programs
as the Company expands into new states and continues to grow in it's
more established markets.
- The Company recognized no accident year 1994, 1993 or 1992 favorable
reserve development in the third quarter of 1997 or for the nine
months ended September 30, 1997, resulting in the recognition of no
ceding commissions compared to a benefit of $142,000 recognized in the
third quarter of 1996 and a benefit of $417,000 recognized for the
nine months ended September 30, 1996. Future ceding commission
changes will be affected by the continued development of the reserves
with respect to accident years 1994, 1993 and 1992.
The Company believes that continued application of its claims
management technology to 1992 through 1994 open claims could provide
future favorable ceding commission adjustments. Any such adjustments
are expected to decrease significantly from the levels attained in
1996 due to the reduced number of open claims remaining for those
years.
GENERAL AND ADMINISTRATIVE EXPENSES. The Company's general and administrative
expenses increased to $2.3 million in the third quarter of 1997 from $1.8
million in the third quarter of 1996 and increased to $8.0 million for the nine
months ended September 30, 1997 from $5.8 million for the nine months ended
September 30, 1996. This increase reflects:
11
- additional personnel costs for new employees
- higher compensation for existing employees
- expenses incurred for growth in Minnesota, Colorado and Missouri
- expenses incurred for expansion into Michigan, Illinois and
Massachusetts, and Wisconsin
- increased fees for professional services incurred in connection with
increased levels of operations
- the Company recognized a reduction in general and administrative
expenses of $842,000 in the third quarter of 1997 resulting from the
reversal of an accrual established in 1996 for the Minnesota Insurance
Guarantee Association.
The Company anticipates that general and administrative expenses will continue
to increase as it continues to expand into new states and grows in its existing
states for the remainder of 1997 and into fiscal year 1998.
INTEREST EXPENSE. Interest expense decreased to $196,000 in the third quarter
of 1997 from $273,000 in the third quarter of 1996 and decreased to $588,000 for
the nine months ended September 30, 1997 from $821,000 for the nine months ended
September 30, 1996 due to principal payments on the Series 1991A, Series 1991B
and Senior Notes totaling approximately $2.4 million in December 1996. Notes
payable decreased to $6.8 million at September 30, 1997 from $9.0 million at
September 30, 1996 as a result of the payments. Interest expense is expected to
remain consistent with the results attained during the nine months ended
September 30, 1997 for the fourth quarter of 1997 and is expected to decrease in
1998 due to principal payments totaling $2.0 million to be made in December
1997.
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary sources of cash are premiums and investment income while
its cash requirements consist primarily of payments for claim and claim
settlement expenses, policy acquisition costs, general and administrative
expenses, income taxes, capital expenditures, and principal repayment and debt
service on its outstanding Senior Notes. The Company generates positive net
cash from operations due, in part, to the timing differences between the receipt
of premiums and the payment of claim and claim settlement expenses. Cash is
invested pending future payments for such expenses. The Company's investment
portfolio currently consists of U.S. Treasury and Agency Securities, mortgage
backed securities, corporate debt securities and asset-backed securities. The
Company revised its investment policy during the first quarter of 1997 to
include fixed income securities, including corporate debt securities,
obligations of the U.S. Government and its agencies, tax exempt securities of
municipal and state governments, Government Agency mortgage-backed securities
and other asset-backed securities, with credit ratings that meet or exceed a BBB
rating from Standard & Poor's or a Baa rating from Moody's Investors Services,
Inc. Cash and cash equivalents consist primarily of U.S. Treasury or Agency
Securities acquired under repurchase agreements with original maturities of 90
days or less, with the remaining balances in cash and a money market fund that
invests in short-term government securities.
Cash provided by operating activities for the nine months ended September 30,
1997 was $15.3 million primarily as a result of the Company's net income of $4.5
million, an increase of $8.4 million in unpaid claim and claim settlement
expenses which are non-cash accruals for future claims, and an increase of
$709,000 in unearned premiums, net of premiums receivable. Net cash used in
investing activities was $15.4 million due to $14.6 million in purchases of
available-for-sale securities and $1.7 million in purchases of furniture and
equipment offset by $28.0 million in proceeds from sales of available-for-sale
securities. Net cash provided by financing activities was $270,000 primarily the
result of issuance of Common Stock to the Company's Employee Stock Option
("ESOP") and Employee Stock Purchase ("ESPP") plans.
The Company's investments increased to $104.0 million at September 30, 1997 from
$89.8 million at December 31, 1996 due to net purchases of available-for-sale
investments, changes in market values of the available-for-sale investments, and
net of amortization of premiums on the held-to-maturity investments. Of the
Company's investments at September 30, 1997, $53.9 million were classified as
held-to-maturity and valued at amortized cost, while $50.1 million were
classified as available-for-sale and valued at fair value.
Historically, changes in market interest rates have caused fluctuations in the
fair value of securities. Beginning July 1995, the Company invested solely in
available-for-sale securities. As a result of the increased holdings in
12
securities classified as available-for-sale, and thus carried at fair value, the
Company expects increased volatility in shareholders' equity as market interest
rates and other factors change. Adjustments in the fair value of
available-for-sale securities are recorded directly to shareholders' equity and
do not affect the Company's Consolidated Statements of Income.
The Company's need for additional capital is primarily the result of regulations
which require certain ratios of capital to premiums written. In the future, the
Company expects that its need for additional capital will be primarily related
to the growth of ACIC and the need to maintain appropriate capital to premium
ratios as defined by state regulatory bodies. As an alternative to raising
additional capital, the Company believes it could secure quota-share or other
reinsurance which would have the effect of reducing the ratio of premiums to
capital and could be used to satisfy state regulatory requirements.
State insurance regulations limit distributions, including dividends, from ACIC
to the Company. The maximum amount of dividends that can be paid by ACIC to the
Company in any year is equal to the lesser of: (i) 10% of ACIC's statutory
surplus as of the end of the previous fiscal year, and (ii) the statutory net
gain from operations (not including realized capital gains) of ACIC in its most
recent fiscal year. Based on this limitation, the maximum dividend that ACIC
could pay to the Company in 1997, without regulatory approval, is approximately
$4.0 million. ACIC may be subject to more restrictive limitations on dividends
as it enters additional states. ACIC has never paid a dividend to the Company
and, for the foreseeable future, the Company intends to retain capital in ACIC
to enable the Company and ACIC to expand their operations.
The Company believes that cash flow generated by its operations and its cash and
investment balances will be sufficient to fund continuing operations, debt
service on its outstanding Senior Notes including principal repayments of $2.0
million due in December 1997, and capital expenditures for the next 12 months.
NAIC RISK-BASED CAPITAL STANDARDS
The National Association of Insurance Commissioners ("NAIC") has risk-based
capital standards to determine the capital requirements of a property and
casualty insurance carrier based upon the risks inherent in its operations.
Such standards require the computation of a risk-based capital amount which is
then compared to a carrier's actual total adjusted capital. The computation
involves applying factors to various financial data to address four primary
risks: asset risk, insurance underwriting risk, credit risk and off-balance
sheet risk. These standards provide for regulatory intervention when the
percentage of total adjusted capital to authorized control level risk-based
capital is below certain levels. Based upon the risk-based capital standards,
the Company's insurance subsidiary's percent of total adjusted capital is in
excess of authorized control level risk-based capital.
REGULATION
The Company's insurance subsidiary is subject to substantial regulation by the
governmental agencies in the states in which it is licensed, and will be subject
to such regulation in any state in which it provides workers' compensation
products and services in the future. State regulatory agencies have broad
administrative power with respect to all aspects of the business of the Company
and its insurance subsidiary, including premium rates, benefit levels, policy
forms, dividend payments, capital adequacy and the amount and type of
investments. These regulations are primarily intended to protect covered
employees and policyholders rather than the insurance company. Both the
legislation covering insurance companies and the regulations adopted by state
agencies are subject to change. The Company's insurance subsidiary is currently
licensed to do business in Minnesota, Colorado, Missouri, Michigan,
Massachusetts, Pennsylvania, Illinois, Kansas, Iowa, Connecticut and South
Dakota.
The NAIC is in the process of codifying statutory accounting principles. The
ultimate completion date is expected in 1999 and impact of this project on
current statutory policies and practices is unknown.
13
RECENTLY ISSUED ACCOUNTING STANDARDS
In February 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards ("SFAS") No. 128, "Earnings per Share," which is
effective for the Company for periods ending after December 15, 1997. SFAS No.
128 revises standards for computing and presenting earnings per share (EPS),
replaces the presentation of primary EPS with a presentation of basic EPS,
requires dual presentation of basic and diluted EPS on the face of the income
statement and requires a reconciliation of the numerator and denominator of the
basic EPS computation to the numerator and denominator of the diluted EPS
computation. SFAS No. 128 supersedes Opinion No. 15 and AICPA Accounting
Interpretations 1-102 of Opinion No. 15. The Company will continue to apply APB
Opinion No. 15 to compute EPS through the effective date. The income per share
amounts as computed under SFAS No. 128 for the third quarter of 1997 are not
materially different from those computed under APB Opinion No. 15.
FORWARD LOOKING STATEMENTS
Information included in this Form 10-Q which can be identified by the use of
forward-looking terminology such as "may," "will," "expect," "anticipate,"
"estimate," or "continue" or the negative thereof or other variations thereon or
comparable terminology constitutes forward-looking information. The following
important factors, among others, in some cases have affected and in the future
could affect the Company's actual results and could cause the Company's actual
financial performance to differ materially from that expressed in any
forward-looking statement: (i) the Company's ability to expand into new states
and attract customers in those states, (ii) the Company's ability to manage both
its existing claims and its new claims in an effective manner, (iii) the
Company's ability to further penetrate the market in its existing states, (iv)
the Company's ability to retain its existing customers at favorable premium
rates when their policies renew, (v) competition from traditional workers'
compensation insurance carriers, (vi) the Company's ability to successfully
introduce new products and services, and (vii) changes in workers' compensation
regulation by states, including changes in mandated benefits or insurance
company regulation.
14
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 SECURITY HOLDERS
Not applicable
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) LISTING OF EXHIBITS
Exhibit 11 - STATEMENT REGARDING COMPUTATION OF NET INCOME
PER COMMON AND COMMON SHARE EQUIVALENT
Exhibit 27 - FINANCIAL STATEMENT SCHEDULE
(b) LISTING OF REPORTS ON FORM 8-K
None
15
SIGNATURES
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, thereunto duly authorized.
RTW, INC.
Dated: November 5, 1997 By /s/ David C. Prosser
---------------------------------------------
David C. Prosser
Chairman, President, Chief Executive Officer
and Director
(Principal Executive Officer)
Dated: November 5, 1997 By /s/ Alfred L. LaTendresse
---------------------------------------------
Alfred L. LaTendresse
Secretary, Treasurer and Chief Financial
Officer
(Principal Financial and Accounting Officer)
16
EXHIBIT INDEX
Exhibit
Number Description Page
- --------- --------------------------------------------------------- -------
11 Statement Regarding Computation of Net Income Per Common
and Common Share Equivalent 18
27 Financial Statement Schedule 19
17