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 JUNE 30, 1998
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 0-25508
RTW, INC.
(Exact name of registrant as specified in its charter)
MINNESOTA 41-1440870
(State or other (I.R.S. Employer
jurisdiction of Identification No.)
incorporation or
organization)
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 / /
At July 31, 1998, 11,954,612 shares of Common Stock were outstanding.
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 20
Item 2. Changes in Securities 20
Item 3. Defaults Upon Senior Securities 20
Item 4. Submission of Matters to a Vote of Security Holders 20
Item 5. Other Information 20
Item 6. Exhibits and Reports on Form 8-K 20
Signatures 21
Exhibits 22
2
PART I - FINANCIAL INFORMATION
ITEM 1: CONSOLIDATED FINANCIAL STATEMENTS AND NOTES (UNAUDITED)
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE
----
CONSOLIDATED FINANCIAL STATEMENTS
Consolidated Balance Sheets 4
Consolidated Statements of Operations 5
Consolidated Statements of Cash Flows 6
Notes to Consolidated Financial Statements 7
3
RTW, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
JUNE 30, 1998 AND DECEMBER 31, 1997
(In thousands, except share data)
JUNE 30, DECEMBER 31,
1998 1997
----------- ------------
(Unaudited)
ASSETS
Investments available-for-sale, at fair value,
amortized cost of $126,754 and $110,880 $127,926 $112,294
Cash and cash equivalents 641 5,798
Accrued investment income 1,555 1,836
Premiums receivable, less allowance of $347 and $182 7,147 5,763
Reinsurance recoverables 5,156 5,374
Reinsurance receivables 498 743
Deferred policy acquisition costs 1,775 1,559
Furniture and equipment, net 4,873 4,927
Other assets 5,001 3,692
----------- ------------
Total assets $154,572 $141,986
----------- ------------
----------- ------------
LIABILITIES AND SHAREHOLDERS' EQUITY
Unpaid claim and claim settlement expenses $72,836 $ 61,069
Unearned premiums 16,336 13,580
Accrued expenses and other liabilities 2,319 4,105
Notes payable 4,918 4,875
----------- ------------
Total liabilities 96,409 83,629
Shareholders' equity:
Common Stock, no par value; authorized 25,000,000 shares; issued
and outstanding 11,954,612 shares at June 30, 1998 and
11,841,023 shares at December 31, 1997 29,538 28,976
Retained earnings 27,863 28,489
Unrealized gain on available-for-sale securities, net of tax 762 892
----------- ------------
Total shareholders' equity 58,163 58,357
----------- ------------
Total liabilities and shareholders' equity $154,572 $141,986
----------- ------------
----------- ------------
See notes to consolidated financial statements.
4
RTW, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
THREE AND SIX MONTH PERIODS ENDED JUNE 30, 1998 AND 1997
(Unaudited; in thousands, except share and per share data)
FOR THE THREE MONTHS FOR THE SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
----------------------- -------------------------
1998 1997 1998 1997
----------- ----------- ----------- -----------
Revenues:
Premiums earned $ 21,185 $ 19,652 $ 43,729 $ 38,855
Investment income 2,018 1,626 4,055 3,193
Net realized investment gains (losses) 716 (16) 719 (16)
----------- ----------- ----------- -----------
Total revenues 23,919 21,262 48,503 42,032
EXPENSES:
Claim and claim settlement expenses 17,938 12,886 37,211 25,866
Policy acquisition costs 3,310 2,992 6,590 5,606
General and administrative expenses 1,884 2,872 5,531 5,720
----------- ----------- ----------- -----------
Total expenses 23,132 18,750 49,332 37,192
----------- ----------- ----------- -----------
Income (loss) from operations 787 2,512 (829) 4,840
Interest expense 139 196 278 392
----------- ----------- ----------- -----------
Income (loss) before income taxes 648 2,316 (1,107) 4,448
Income tax expense (benefit) 157 850 (481) 1,642
----------- ----------- ----------- -----------
Net income (loss) $ 491 $ 1,466 $ (626) $ 2,806
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
Income (loss) per share:
Basic income (loss) per share $ 0.04 $ 0.12 $ (0.05) $ 0.24
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
Diluted income (loss) per share $ 0.04 $ 0.12 $ (0.05) $ 0.23
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
Weighted average shares outstanding:
Basic shares outstanding 11,940,000 11,837,000 11,912,000 11,824,000
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
Diluted shares outstanding 12,249,000 12,081,000 11,912,000 12,089,000
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
See notes to consolidated financial statements.
5
RTW, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
SIX MONTHS ENDED JUNE 30, 1998 AND 1997
(Unaudited, in thousands)
FOR THE SIX MONTHS
ENDED JUNE 30,
--------------------
1998 1997
-------- --------
CASH FLOWS FROM OPERATING ACTIVITIES:
Reconciliation of net income (loss) to net cash provided by operating
activities:
Net income (loss) $ (626) $ 2,806
Adjustments to reconcile net income (loss) to net cash provided by
operating activities:
Depreciation and amortization 626 496
Deferred income taxes (1,069) (680)
Net realized investment (gains) losses (719) 16
Changes in assets and liabilities:
Amounts due from reinsurers 463 225
Unpaid claim and claim settlement expenses 11,767 5,806
Unearned premiums, net of premiums receivable 1,372 201
Other, net (1,830) 919
-------- --------
Net cash provided by operating activities 9,984 9,789
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from maturities of available-for-sale securities 1,000 --
Proceeds from sales of available-for-sale securities 35,655 14,464
Purchases of available-for-sale securities (51,829) (23,247)
Purchases of furniture and equipment (529) (1,217)
-------- --------
Net cash used in investing activities (15,703) (10,000)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from stock options exercised 333 1
Issuance of Common Stock to ESOP -- 115
Issuance of Common Stock under ESPP 199 154
Proceeds from sales of Common Stock 30 --
-------- --------
Net cash provided by financing activities 562 270
-------- --------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (5,157) 59
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 5,798 10,410
-------- --------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 641 $ 10,469
-------- --------
-------- --------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest $ 234 $ 339
-------- --------
-------- --------
Income taxes $ 320 $ 1,861
-------- --------
-------- --------
See notes to consolidated financial statements.
6
RTW, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THREE AND SIX MONTH PERIODS ENDED JUNE 30, 1998 AND 1997
(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 RTW, Inc. 1997 Annual Report to
Shareholders filed with the Securities and Exchange Commission 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, 1997, has been prepared by us without audit by independent
certified public accountants. We derived the consolidated balance sheet at
December 31, 1997 from the audited consolidated financial statements for the
year ended December 31, 1997, but this report 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 our opinion, 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 1997 Annual Report.
NOTE B - RECENTLY ISSUED ACCOUNTING STANDARDS
Effective January 1, 1998, we adopted Statement of Financial Accounting
Standards No. 130 (SFAS 130), Reporting Comprehensive Income, and Statement of
Financial Accounting Standards No. 131 (SFAS 131), Disclosures About Segments of
an Enterprise and Related Information. SFAS 130 requires that all items
recognized under accounting standards as components of comprehensive income be
reported in a financial statement that is displayed with the same prominence as
other financial statements. The Statement also requires that an entity classify
items of other comprehensive income by their nature in a financial statement.
Items contained in other comprehensive income for us include unrealized gains
and losses on investments classified as available-for-sale. Our total
comprehensive income (loss) includes unrealized gains (losses) on all
investments at June 30, 1998 due to reclassifying held-to-maturity securities to
available-for-sale in December 1997 compared to including only unrealized gains
(losses) on available-for-sale securities at June 30, 1997. Total comprehensive
income (loss) was as follows (000's):
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------------------- --------------------
1997 1998 1998 1997
--------- --------- --------- ---------
Net income (loss) $ 491 $ 1,466 $ (626) $ 2,806
Other comprehensive income (loss) (346) 367 (130) 25
--------- --------- --------- ---------
Total comprehensive income (loss) $ 145 $ 1,833 $ (756) $ 2,831
--------- --------- --------- ---------
--------- --------- --------- ---------
SFAS 131 requires certain disclosures about segments of an enterprise and has no
impact on our Consolidated Financial Statements.
7
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
THE COMPANY - RTW, Inc. (RTW) and its wholly owned insurance subsidiary,
American Compensation Insurance Company (ACIC), provide disability management
services to employers. Collectively, 'we,' 'our' and 'us' will refer to these
entities in this 'Management's Discussion and Analysis of Financial Condition
and Results of Operations.'
We developed a proprietary management system, the RTW SOLUTION-Registered
Trademark-, designed to lower employers' workers' compensation costs and return
injured employees to work as soon as possible. We combine our management system
with insurance products underwritten by our insurance subsidiary to offer
services to customers. We currently provide workers' compensation management
services solely to employers insured through our insurance subsidiary or through
fronted insurance arrangements. We currently operate in Minnesota, Colorado,
Missouri, Illinois, Kansas, Michigan, Indiana, Massachusetts, Connecticut,
Wisconsin, Rhode Island and New Hampshire.
The following analysis of the consolidated results of operations and
financial condition of RTW and ACIC, should be read in conjunction with our
consolidated financial statements and notes thereto at June 30, 1998 and
December 31, 1997 and the three and six month periods ended June 30, 1998 and
1997.
SUMMARY OPERATING RESULTS - The following table provides an overview of our key
operating results (000's):
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------------------- --------------------
1997 1998 1998 1997
--------- --------- --------- ---------
Total revenues $ 23,919 $ 21,262 48,503 42,032
Net income (loss) 491 1,466 (626) 2,806
1998 1997
--------- ---------
Premiums in force at June 30 $ 80,500 $ 72,700
Our premiums in force grew 10.7% to $80.5 million at June 30, 1998 from
$72.7 million at June 30, 1997 due primarily to $16.7 million in growth in our
newer markets including Missouri, Illinois, Michigan and Massachusetts and
$700,000 growth in Colorado offset by a $9.6 million decrease in premiums in
force in Minnesota.
Revenues for the second quarter of 1998 include $716,000 in net realized
investment gains compared to $16,000 in net realized investment losses in the
second quarter of 1997. Additionally, total revenues for the six months ended
June 30, 1998 include a $2.2 million refund received from the Minnesota Workers'
Compensation Reinsurance Association (WCRA) recorded in the first quarter of
1998. The $7.8 million growth in premiums in force, combined with gains
recognized in the second quarter of 1998, the refund received from the WCRA and
increased earnings on our investment portfolio, resulted in an increase in
revenues of 12.5% to $23.9 million for the second quarter of 1998 from $21.3
million for the second quarter of 1997 and an increase of 15.4% to $48.5
millionfor the six month period ended June 30, 1998 from $42.0 million for the
six month period ended June 30, 1997.
We recognized net income of $491,000 in the second quarter of 1998 compared
to net income of $1.5 million in the second quarter of 1997 and a $626,000 loss
for the six months ended June 30, 1998 compared to net income of $2.8 million
for the six month period ended June 30, 1997 due primarily to the following
factors:
- The Minnesota Insurance Guarantee Association, an organization formed
to fund Minnesota claims for insolvent insurance companies, did not
assess its members in 1998 for workers' compensation claim liabilities
arising from current or prior insolvencies. As a result, we reversed
the $1.1 million pre-tax accrual recorded in 1997 and recognized a
corresponding reduction in general and administrative expenses during
second quarter of 1998.
- Our average cost per claim continued to increase for accident year
1998 compared to accident year 1997 due to medical inflation and an
increase in the severity of claims reported. In connection with this
increase, we continued to build loss reserves in the second quarter.
The six month results include a $3.0
8
million increase in reserves for unpaid claim and claim settlement
expenses recorded in the first quarter of 1998 to reflect adverse
development of prior period claims. We also increased our accrual
for the Minnesota Special Compensation Fund (SCF) by approximately
$400,000 in the second quarter of 1998. The SCF assesses us to
cover the costs of second injuries which are substantially greater,
because of a preexisting physical impairment, than what would have
resulted from the second injury alone. Combined with pricing
pressure, our loss ratio has increased;
- Pricing pressure continues to affect premiums in force and decrease
profit margins in all markets. The pricing pressure is the result of
(i) increased competition in our markets and (ii) continued price
declines due to legislative benefit changes in 1997 and prior years;
- Operating costs, including personnel costs and other operating
expenses allocated to claim and claim settlement expenses, policy
acquisition costs and general and administrative expenses, have
increased when compared to the first six months of 1997 due to (i)
increased premiums in force, (ii) increased fixed costs resulting from
opening the Michigan office in late 1996 and the Massachusetts office
in the second quarter of 1997, (iii) higher compensation for existing
employees, and (iv) increased fees for professional services. Actions
to reduce personnel costs were initiated in the first quarter of 1998
to bring these expenses more in line with revenues. These actions
resulted in reducing second quarter 1998 personnel costs and operating
expenses by 14.0% from the first quarter of 1998. Other expenses
continue to be managed aggressively and reduced where appropriate; and
- Decreased effective income tax rates resulting from the decrease in
income and the purchase of tax-exempt municipal securities which
generated tax-exempt income in the second quarter of 1998.
While we expect to continue to operate in a difficult pricing
environment for the remainder of 1998, we are working to improve
profitability in all of our offices by continuing to aggressively manage
expenses, refining our sales and distribution channels and improving our
underwriting.
TOTAL REVENUES: Our total revenues include premiums earned and investment
income.
PREMIUMS EARNED - Premiums on workers' compensation insurance policies
are our largest source of revenue. Premiums earned are the gross
premiums earned by us on in force workers' compensation policies, net
of the effects of ceded premiums under reinsurance agreements.
Reinsurance agreements allow us to share certain risks with other
insurance companies. The primary purpose of ceded reinsurance is to
protect us from potential losses in excess of the level we are willing
to accept. Our primary ceded reinsurance is excess of loss coverage
that limits our per incident exposure. We expect the companies to
which we have ceded reinsurance to honor their obligations. In the
event that these companies are unable to honor their obligations to
us, we will be required to pay these obligations ourselves. We are not
aware of any developments with respect to any of our reinsurers that
would prevent them from honoring any of their obligations to us.
INVESTMENT INCOME - Our investment income includes earnings on our
investment portfolio.
TOTAL EXPENSES: Our expenses include claim and claim settlement expenses,
policy acquisition costs, general and administrative expenses, interest expense
and income taxes.
CLAIM AND CLAIM SETTLEMENT EXPENSES - Claim expenses refer to amounts
that we paid or expect to pay to claimants for events that have
occurred. The costs of investigating, resolving and processing these
claims are referred to as claim settlement expenses. We record these
expenses, net of amounts recoverable under reinsurance contracts, to
claim and claim settlement expenses in the Consolidated Statements of
Operations.
POLICY ACQUISITION COSTS - Policy acquisition costs are costs directly
related to writing an insurance policy and consist of commissions, state
premium taxes, underwriting personnel costs and expenses, sales and
marketing costs and other underwriting expenses, offset by ceding
commissions received from our reinsurers. Ceding commissions are amounts
that reinsurers pay to us for placing reinsurance with them. Ceding
commissions represent adjustments based on actual claim and claim
settlement expenses related to premiums ceded in prior years. Under
reinsurance agreements, our ceding commission is adjusted to the extent
that actual claim and claim settlement expenses vary from levels
specified in the agreement.
9
GENERAL AND ADMINISTRATIVE EXPENSES - Our general and administrative
expenses include personnel costs, office rent, certain state
administrative assessments based on premiums and other costs and
expenses not specific to claim and claim settlement expenses or policy
acquisition costs.
INTEREST EXPENSE - We incur interest charges on our Senior Notes. The
Senior Notes mature in series during the years 1995 through 1999.
INCOME TAXES - We incur federal income taxes on our combined service
organization (RTW) operations and insurance (ACIC) operations. We incur
state income taxes on the results of our service organization's
operations and incur premium taxes in lieu of state income taxes for
substantially all of our insurance operations. In certain instances, we
may incur state income taxes on our insurance operations. Additionally,
certain provisions of the Internal Revenue Code adversely affect our
taxable income by accelerating recognition of revenues, deferring
recognition of expenses ultimately accelerating the payment of income
taxes. Adjustments to book income generating current tax liabilities
include limitations on the deductibility of unpaid claim and claim
settlement expenses, limitations on the deductibility of unearned
premium reserves and limitations on deductions for bad debt reserves.
In the following pages, we take a look at the results for the three and six
month periods ended June 30, 1998 and 1997 in these areas and also explain key
balance sheet accounts in greater detail.
RESULTS OF OPERATIONS
The following tables summarize the components of revenues and premiums in force
(000's):
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------------------- --------------------
1997 1998 1998 1997
--------- --------- --------- ---------
Gross premiums earned $ 22,241 $ 19,814 $ 43,574 $ 39,122
Premiums (ceded) recovered (1,056) (162) 155 (267)
--------- --------- --------- ---------
Premiums earned 21,185 19,652 43,729 38,855
Investment income 2,018 1,626 4,055 3,193
Net realized investment gains (losses):
Gains 720 32 723 32
Losses (4) (48) (4) (48)
--------- --------- --------- ---------
Total revenues $ 23,919 $ 21,262 $ 48,503 $ 42,032
--------- --------- --------- ---------
--------- --------- --------- ---------
1998 1997
--------- ---------
Premiums in force at quarter-end:
Minnesota $ 38,000 $ 47,600
Colorado 13,400 12,700
Missouri 14,300 9,200
Michigan 7,600 2,100
Massachusetts 4,700 600
Illinois 1,400 500
Kansas 500 --
Wisconsin 300 --
Connecticut, Rhode Island and New Hampshire 300 --
--------- ---------
Total premiums in force June 30: $ 80,500 $ 72,700
--------- ---------
--------- ---------
GROSS PREMIUMS EARNED: The premium we charge a policyholder is a function of
its payroll, industry and prior workers' compensation claims experience. In
underwriting a policy, we receive policyholder payroll estimates for the ensuing
year. We record premiums written on an installment basis matching billing to the
policyholder and earn premiums on a daily basis over the life of each insurance
policy based on the payroll estimate. We record the excess of premiums billed
over premiums earned for each policy as unearned premiums on our balance sheet.
When a policy expires, we audit employer payrolls for the policy period and
adjust the estimated payroll to its actual value. The result is a "final audit"
adjustment recorded to premiums earned when the adjustment becomes known.
10
Our gross premiums earned increased 12.2% to $22.2 million for the second
quarter of 1998 from $19.8 million for the second quarter of 1997 and increased
11.4% to $43.6 million for the six months ended June 30, 1998 from $39.1 million
for the six months ended June 30, 1997. These increases resulted, in part, from
the 10.7% increase in premiums in force to $80.5 million at June 30, 1998, from
$72.7 million at June 30, 1997. Included in this 10.7% increase is a $9.6
million decrease in Minnesota premiums in force. Additionally, gross premiums
earned included $1.9 million of final audit premiums recognized in the second
quarter of 1998 and $3.4 million recognized for the six months ended June 30,
1998 compared to $1.4 million recognized in the second quarter of 1997 and $3.0
million recognized for the six months ended June 30, 1997. Final audit premiums
recognized during the period include billed final audit premiums plus (or minus)
the change in estimate for audit premiums on unexpired and expired unaudited
policies.
Underlying these increases in gross premiums earned is another trend. The
premium rate that we charge policyholders per payroll dollar has declined for
several years. This is the result, in part, of the following:
- Many state legislatures where we provide coverage have reduced
benefits that injured employees are paid, resulting in lower loss
costs of workers' compensation insurance and decreased
corresponding premiums to the policyholder;
- As the loss cost structure of workers' compensation has declined,
more insurance companies have entered or re-entered the workers'
compensation insurance market, resulting in increased competition;
and
- We continue to experience reduced pricing on renewal policies due,
in part, to our success in lowering our policyholders' loss
experience which then improves their claims history, lowering the
premium that they have to pay for insurance. The improvement that
we do for our customers also has the effect of making them more
desirable to our competition, thus increasing price competition on
these accounts.
PREMIUMS CEDED: We pay reinsurers, under excess of loss reinsurance policies,
to limit our per incident exposure and record this cost as a reduction of gross
premiums earned. We are required to purchase excess of loss coverage for
Minnesota policies from the Minnesota Workers' Compensation Reinsurance
Association (WCRA). Our selected retention level in Minnesota is $280,000 for
1998 and was approximately $1.1 million in 1997. In other states, we have chosen
to limit our per incident exposure to $500,000 and purchased this coverage from
various reinsurers.
The following table summarizes the components of premiums ceded (000's):
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
--------------------- ----------------------
1997 1998 1998 1997
--------- --------- --------- ---------
Premiums (ceded to) recovered from:
WCRA $ (782) $ -- $ (1,568) $ --
Non-Minnesota excess of loss policies (274) (162) (524) (267)
Refund from the WCRA on prior years' activity -- -- 2,247 --
--------- --------- --------- ---------
Premiums (ceded) recovered $ (1,056) $ (162) $ 155 $ (267)
--------- --------- --------- ---------
--------- --------- --------- ---------
Premiums ceded to reinsurers was a cost of $1.1 million for the second
quarter of 1998 compared to a cost of $162,000 for the second quarter of 1997.
This increased cost resulted from (i) reducing our selected Minnesota excess of
loss reinsurance coverage levels to $280,000 in 1998 from $1.1 million in 1997;
(ii) increased excess of loss premium rates in Minnesota in 1998 from 1997, and
(iii) increased excess of loss cost resulting from increased premiums earned in
non-Minnesota states. Premiums ceded to reinsurers was a benefit of $155,000
for the six months ended June 30, 1998 versus a cost of $267,000 for the six
months ended June 30, 1997. The decrease in premiums ceded for the six months
ended June 30, 1998 compared to the same period for 1997 resulted from
recognizing a $2.2 million refund received from the WCRA in the first quarter of
1998 as a reduction of premiums ceded. This refund was offset by increased
excess of loss cost in Minnesota in 1998 from 1997 (as discussed in (i) and (ii)
above) and increased excess of loss cost resulting from increased premiums
earned in non-Minnesota states for the six months ended June 30, 1998.
PREMIUMS EARNED OUTLOOK: The outlook for gross premiums earned and premiums
ceded for the remainder of 1998 includes the following factors:
11
- We expect continued growth in premiums in force in our
non-Minnesota markets and stabilizing in force premium in Minnesota
which will lead to growth in gross premiums earned for the
remainder of the year;
- We expect continued downward pressure on the amount we charge for
our products and services; and
- After adjusting for the effect of the $2.2 million refund received
from the WCRA, we expect that premiums ceded for the remainder of
1998 will remain consistent with the results attained for the six
months ended June 30, 1998. Premiums ceded may decrease slightly in
future quarters of 1998 as a percent of gross premiums earned as
the non-Minnesota markets, where we pay smaller premiums, continue
to grow relative to Minnesota. Premiums ceded (after adjusting for
the WCRA refund) will continue to run much higher in 1998 when
compared to 1997 due to the 6.8% policy premium we are paying for
increased excess of loss coverage in Minnesota compared to the
premium-free rate received in 1997.
INVESTMENT INCOME AND NET REALIZED INVESTMENT GAINS (LOSSES): We currently
invest entirely in taxable and tax-exempt fixed maturity investments and
classify our investments as available-for-sale. We intend to hold our available-
for-sale investments to maturity, but may sell before maturity in response to
changes in interest rates, changes in prepayment risk and changes in funding
sources or terms, or to address liquidity needs. Our primary investment
objective is to maintain a diversified, high-quality, fixed-investment portfolio
structured to maximize our after-tax investment income without taking
inappropriate credit risk. For further discussion of investments, see the
"Investments" section of this Management's Discussion and Analysis.
Investment income increased 24.1% to $2.0 million in the second quarter of
1998 from $1.6 million in the second quarter of 1997 and increased 27.0% to $4.1
million for the six months ended June 30, 1998 from $3.2 million for the six
months ended June 30, 1997. Investment income increased for these periods due
to increased funds available for investment. Funds available for investment
increased to $127.9 million at June 30, 1998, from $98.5 million at June 30,
1997, due to increased net cash provided by operating activities, resulting
primarily from (i) the difference in timing between the receipt of premiums and
the payment of claim and claim settlement expenses and (ii) net cash provided by
investment income. Pre-tax investment yields increased to 6.4% for the six
months ended June 30, 1998 from 6.2% for the six months ended June 30, 1997 due
to portfolio diversification which began in the second quarter of 1997 and the
purchase of tax-exempt municipal securities during the second quarter of 1998.
The investment yields realized in future periods will be affected by yields
attained on new investments and will decrease, on a pre-tax basis, due to the
purchase of tax-exempt municipal securities.
Net realized investment gains increased to $716,000 in the second
quarter of 1998 compared to net realized losses of $16,000 in the second
quarter of 1997 and increased to a net realized gains of $719,000 for the six
months ended June 30, 1998 versus net realized investment losses of $16,000
for the six months ended June 30, 1997. The increase in net realized
investment gains in the second quarter of 1998 is the result of repositioning
U.S. government securities previously classified as held-to-maturity and
transferred to available-for-sale in December 1997, to higher after-tax
yielding securities, including tax-exempt municipal securities and corporate
securities.
INVESTMENT INCOME AND NET REALIZED INVESTMENT GAINS (LOSSES) OUTLOOK: In
December 1997, we reclassified our entire held-to-maturity portfolio,
invested in U.S. government securities to available-for-sale investments. We
reclassified these securities to enable us to more actively manage our
investment yield and overall portfolio risk. The held-to-maturity portfolio
had a net unrealized gain of approximately $900,000 at December 31, 1997,
while the total portfolio net unrealized gain at June 30, 1998, was $1.2
million. Barring significant changes in interest rates or operational cash
flows, we expect that the yield from our investment portfolio for the
remainder of 1998 will be affected by the following:
- Our investment portfolio will increase as funds become available
for investment from net cash provided by current year operating and
investing activities;
- Our recognition of realized gains and losses will depend on the
repositioning of the portfolio that occurs for the remainder of the
year as we continue to diversify the previously classified held-to-
maturity securities from U.S. government securities to other
taxable and tax-exempt fixed maturity securities; and
- We further diversified our investment portfolio in the second
quarter of 1998 by purchasing $48.1 million (fair value) fixed
maturity tax- exempt securities to increase after-tax yields. Fixed
maturity, tax- exempt securities will reduce investment income
recognized and decrease pre-tax investment yields but are expected
to contribute more to after-tax net income as a result of the
favorable treatment tax- exempt municipal income receives for
federal tax purposes.
12
CLAIM AND CLAIM SETTLEMENT EXPENSES: Claim and claim settlement expenses are
our largest expense and result in our largest liability. We establish
reserves that reflect our estimates of the total claim and claim settlement
expenses we will ultimately have to pay under our workers' compensation
insurance policies. These include claims that have been reported but not
settled and claims that have been incurred but not yet reported to us. For
further discussion of reserve determination, see the "Unpaid Claim and Claim
Settlement Expenses" section of this Management's Discussion and Analysis.
Claim and claim settlement expenses increased to $17.9 million in the
second quarter of 1998 from $12.9 million in the second quarter of 1997 and
increased to $37.2 million for the six months ended June 30, 1998 from $25.9
million for the six months ended June 30, 1997. As a percent of gross
premiums earned, claim and claim settlement expenses increased to 80.7% for
the second quarter of 1998 from 65.0% for the second quarter of 1997 and
increased to 85.4% for the six months ended June 30, 1998 from 66.1% for the
six months ended June 30, 1997. These changes are due to the following:
- We recorded reserve estimate changes in the second quarter and
six month results of 1998 and 1997 as follows:
- We increased our accrual for the Minnesota Special
Compensation Fund in the second quarter of 1998 by
approximately $400,000 for periods prior to March 31,
1998 resulting from an increased rate of assessment
declared during the second quarter of 1998.
- We increased our estimate of the pre-1998 liability for
unpaid claim and claim settlement expenses by $3.0
million in the first quarter of 1998 as a result of
unfavorable claims experience for those periods.
- We reduced our estimate of the pre-1997 liability for
unpaid claim and claim settlement expenses by $850,000
in the second quarter of 1997 as a result of favorable
claims experience for those periods and when combined
with the reduction of $675,000 recorded in the first
quarter of 1997, totaled $1.5 million for the six
months ended June 30, 1997.
After adjusting for these estimate changes, claim and claim
settlement expenses increased to 78.9% for the second quarter of
1998 from 69.3% for the second quarter of 1997 and increased to
77.6% for the six months ended June 30, 1998 from 70.0% for the six
months ended June 30, 1997 as a percent of gross premiums earned;
- Reduced premiums due to legislative changes in estimated loss
costs, increased competition and improving customer loss
experience, have resulted in an increase in claim and claim
settlement expenses as a percentage of gross premiums earned;
- Average claim cost increased in accident year 1998 as compared
to accident year 1997 due to increasing medical and indemnity
costs resulting from inflationary changes and increased
severity; and
- Gross premiums earned increased to $22.2 million in the second
quarter of 1998 from $19.8 million in the second quarter of
1997 and increased to $43.6 million for the six months ended
June 30, 1998 from $39.1 million for the six months ended June
30, 1997 resulting in increased claim and claim settlement
expenses as we provided coverage for more employers.
CLAIM AND CLAIM SETTLEMENT EXPENSE OUTLOOK: We expect that claim and claim
settlement expenses will be affected by the following factors:
- Average claim costs will be affected by (i) increases
in medical and indemnity costs resulting from
inflationary changes, (ii) severity experienced in
future periods in our policy holder base, (iii) changes
resulting from increases in operating efficiency and
effectiveness realized through enhancements to our
internal processes and procedures, including changes to
our proprietary computer systems, and (iv) legislative
changes in estimated loss costs;
- Continued pricing pressure due to legislative changes
in estimated loss costs, increased competition and
improving customer loss experience may result in
reduced premiums, ultimately increasing claim and claim
settlement expense as a percent of gross premium
earned; and
- Continued application of our claims management
technology and methods to all open claims at June 30,
1998, may benefit future periods. The ultimate effect
cannot be quantified at this time.
The ultimate result of the above factors, combined with the change in
premium rates, on claim and claim settlement expenses as a percent of gross
premiums earned for the remainder of 1998 is unknown at this time.
POLICY ACQUISITION COSTS. The following table summarizes policy acquisition
costs (000's):
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------ ----------------
1997 1998 1998 1997
------------------ ----------------
Commission expense $1,724 $1,599 $3,415 $3,129
Premium tax expense 448 405 904 805
Other policy acquisition costs 1,138 988 2,271 1,672
-------- ------- ------- ------
Direct policy acquisition costs $3,310 $2,992 $6,590 $5,606
-------- ------- ------- ------
-------- ------- ------- ------
Policy acquisition costs increased to $3.3 million in the second quarter of
1998 from $3.0 million in the second quarter of 1997 and increased to $6.6
million for the six months ended June 30, 1998 from $5.6 million for the six
months ended June 30, 1997. As a percent of gross premiums earned, policy
acquisition costs decreased slightly to 14.9% for the second quarter of 1998
from 15.1% for the second quarter of 1997 and increased to 15.1% for the six
months ended June 30, 1998 from 14.3% for the six months ended June 30, 1997.
These changes reflect the following:
- Commission expense was 7.8% of gross premiums earned in
the second quarter of 1998 compared to 8.1% in the
second quarter of 1997 and was 7.8% of gross earned
premiums for the six months ended June 30, 1998 versus
8.0% for the six months ended June 30, 1997.
Historically, as we entered new markets, we introduced
higher commission rates to attract business from
established agents. These rates have continued into
current policy periods and will have a greater affect
on the commission expense percent as the non-Minnesota
states continue to grow relative to Minnesota. In all
of our markets, we believe the commission rates we pay
are marketplace competitive;
- Premium tax expense remained consistent at 2.0% of
gross premiums earned for the second quarters of 1998
and 1997 and was stable at 2.1% of gross premiums
earned for the six months ended June 30, 1998 and 1997.
Premium tax expense for the six month period is running
slightly higher than our historical rate of 2.0% due to
accrual adjustments in the first quarter of 1998 and
higher premium tax rates paid for premiums earned in
Colorado. The rates in Colorado decreased from 2.15% in
1997 to 2.10% in 1998; and
- Other policy acquisition costs increased to 5.1% of
gross premiums earned in the second quarter of 1998
from 5.0% in the second quarter of 1997 and increased
to 5.2% of gross premiums earned for the six months
ended June 30, 1998 from 4.3% for the six months ended
June 30, 1997, due to increased focus on marketing
programs as we expanded into Michigan and Massachusetts
and continued to grow in our more established markets
and increased personnel costs necessary for the growth
in premiums in force.
POLICY ACQUISITION COST OUTLOOK: We expect that policy acquisition costs as a
percent of gross premiums earned will stabilize or remain relatively constant as
a percent of gross premiums earned during the remainder of 1998 due to the
following:
- We expect commission expense as a percent of gross premiums
earned to increase slightly during the remainder of 1998 as the
non-Minnesota states continue to grow in size relative to
Minnesota;
- We expect premium tax expense as a percent of gross
premiums earned to remain consistent with the first six
months of 1998; and
- We expect that other policy acquisition costs will
decrease as a percent of gross premiums earned as we
increase premiums in force and generate additional
revenues to cover the relatively fixed policy
acquisition costs. We also expect that these costs will
decrease as a result of increases in operating
efficiency and effectiveness during the remainder of
1998 realized through enhancements to our internal
processes and procedures, including changes to our
proprietary computer systems.
GENERAL AND ADMINISTRATIVE EXPENSES: Our general and administrative expenses
for the second quarter of 1998 and six months ended June 30, 1998 include a $1.1
million benefit resulting from the reversal of a 1997 accrual for assessments by
the Minnesota Insurance Guarantee Association (MIGA), an organization formed to
fund Minnesota claims for insolvent insurance companies. MIGA did not assess its
members in 1998 for workers' compensation
14
claim liabilities arising from current or prior insolvencies resulting in the
accrual reversal. After adjusting for the accrual reversal, our general and
administrative expenses increased to $3.0 million in the second quarter of
1998 from $2.9 million in the second quarter of 1997 and increased to $6.6
million for the six months ended June 30, 1998 from $5.7 million for the six
months ended June 30, 1997. As a percent of gross premiums earned, adjusted
general and administrative expenses decreased to 13.3% for the second quarter
of 1998 from 14.5% for the second quarter of 1997 and increased to 15.2% for
the six months ended June 30, 1998 from 14.6% for the six months ended June
30, 1997. These changes reflect:
- expenses incurred for expansion in Michigan and
Massachusetts, not initially offset by revenues from
premiums in force in those states;
- additional personnel costs for new employees resulting
from the growth in in force premium;
- higher compensation for existing employees; and
- Actions to reduce personnel costs were initiated in the
first quarter of 1998 to bring operating expenses more
in line with revenues. These actions resulted in
reducing second quarter 1998 personnel costs and
operating expenses by 14.0% from the first quarter of
1998. Other expenses continue to be managed
aggressively and reduced where appropriate.
GENERAL AND ADMINISTRATIVE EXPENSES OUTLOOK: We expect that general and
administrative expenses will be affected by the following:
- We will continue to aggressively manage general and
administrative expenses, specifically legal and
consulting expenses to decrease relative costs during
the remainder of 1998;
- We have no plans to open new state offices in 1998 and
expect that growth in premiums in force in Michigan and
Massachusetts will result in additional revenues to
cover the fixed costs in those states;
- We expect to increase operational efficiency during
1998 through enhancements to our internal processes and
procedures, including changes to our internal
proprietary computer systems; and
- We have limited our salary increases.
INTEREST EXPENSE: We are paying interest at rates ranging from 9.25% to 9.50%
during 1998 and paid interest at rates ranging from 9.00% to 9.50% during 1997
on the outstanding balance on our Senior Notes.
Interest expense decreased to $139,000 in the second quarter of 1998 from
$196,000 in the second quarter of 1997 and decreased to $278,000 for the six
months ended June 30, 1998 from $392,000 for the six months ended June 30,
1997 due to principal payments on the Senior Notes in December 1997.
INTEREST EXPENSE OUTLOOK: Interest expense for the remainder of 1998 is
expected to be consistent with the results attained for the six months ended
June 30, 1998. Total interest expense on the Senior Notes is expected to
decrease to $546,000 in 1998 from $777,000 in 1997 as a result of principal
payments of $2.0 million made in December 1997.
INCOME TAXES: Income tax expense was $157,000 for the second quarter of 1998
compared to income tax expense of $850,000 for the second quarter of 1997 and
was a benefit of $481,000 for the six months ended June 30, 1998 compared to
income tax expense of $1.6 million for the six months ended June 30, 1997. As
a percent of income (loss) before income taxes, the income tax expense
(benefit) was 24.2% for second quarter of 1998 versus 36.7% for the second
quarter of 1997 and was 43.5% of the cumulative loss for the six months ended
June 30, 1998 compared to 36.9% of net income for the six months ended June
30, 1997. The income tax expense (benefit) percent in 1998 has been effected
by (i) decreased taxable net income from the service organization (RTW) which
is subject to both federal and state income taxes, (ii) decreases in the
profitability of ACIC, and (iii) the introduction of tax-exempt municipal
income in the second quarter of 1998.
INCOME TAX OUTLOOK: Income tax expense (benefit) will vary based on (i) the
operational income recognized by us for the remainder of 1998, and will (ii)
decrease as a percent of income (loss) before taxes relative to the statutory
effective rate as we purchase additional tax-exempt municipal fixed
investments for our investment portfolio. The ultimate change is unknown at
this time.
15
INVESTMENTS
Our portfolio included taxable and tax-exempt fixed maturity securities at
June 30, 1998 as follows:
GROSS UNREALIZED
MARKET -----------------------
COST VALUE GAIN (LOSS)
---------- ---------- ---------- ----------
U.S. government securities $ 31,855 $ 32,473 $ 622 $ (4)
Corporate securities 26,637 26,651 423 (409)
Mortgage- and asset-backed securities 20,478 20,741 263 --
Municipal bonds, tax-exempt 47,784 48,061 300 (23)
---------- ---------- ---------- ----------
Totals $ 126,754 $ 127,926 $ 1,608 $ (436)
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
After several years of purchasing solely U.S. government securities, we
engaged an investment manager in the second quarter of 1997 to diversify our
portfolio to other taxable fixed maturity investments and maximize our
after-tax investment income without taking inappropriate credit risk. During
the second quarter of 1998, we transferred our portfolio to a new investment
manager and further diversified our portfolio to include investment grade
tax-exempt fixed maturity investments. We manage our fixed maturity
portfolio conservatively, investing primarily in investment grade (BBB or
better rating from Standard and Poor's) securities. We do not invest in
derivative securities. Additionally, in December 1997, we reclassified our
entire held-to-maturity portfolio, invested in U.S. government securities
with a historical cost, net of amortization, of $53.8 million and a fair
value of $54.7 million, to available-for-sale investments. We reclassified
these securities to enable us to more actively manage our investment yield
and overall portfolio risk.
Funds provided by our operating cash flows and investment cash flows are
the source of growth in our investment portfolio. Operating cash flows
consist of the excess of premiums collected over claim and claim settlement
expenses and other operating expenses paid. Investment cash flows consist of
income on existing investments and proceeds from sales and maturities of
investments. Our investment portfolio grew 29.8% or $29.4 million to $127.9
million at June 30, 1998, from $98.5 million at June 30, 1997, as a result of
these factors. We invest solely in available-for-sale securities and intend
to continue this investment strategy for the foreseeable future.
We record investments on our balance sheet at fair value, with the
corresponding appreciation or depreciation from amortized cost recorded in
shareholders' equity, net of taxes. Because value is based on the
relationship between the portfolio's stated yields and prevailing market
yields at any given time, interest rate fluctuations can have a swift and
significant impact on the carrying value of these securities. As a result of
the increased holdings in securities classified as available-for-sale, and
thus carried at fair value, we expect to encounter larger adjustments in
shareholders' equity as market interest rates and other factors change.
UNPAID CLAIM AND CLAIM SETTLEMENT EXPENSES
Our unpaid claim and claim settlement expenses represent established,
undiscounted reserves for the estimated total unpaid cost of claim and claim
settlement expenses, which cover events that occurred through June 30, 1998.
These reserves reflect our estimates of the total costs of claims that were
reported, but not yet paid, and the cost of claims incurred but not yet
reported (IBNR). For reported claims, we establish reserves on a "case"
basis. For IBNR claims, we estimate reserves using established actuarial
methods. Both our case and IBNR reserve estimates reflect such variables as
past claims experience, current claim trends and prevailing social, economic
and legal environments. Due to commencing operations in 1992, we have limited
historical data to estimate our reserves for unpaid claim and claim
settlement expenses and accordingly supplement our experience with external
industry data, as adjusted, to reflect anticipated differences between our
results and the industry. We reduce the unpaid claim and claim settlement
expenses for estimated amounts of subrogation.
We believe our reserves for unpaid claim and claim settlement expenses
are adequate to cover the ultimate costs of claim and claim settlement
expenses. The ultimate cost of claim and claim settlement expenses may differ
from the established reserves, particularly when claims may not be settled
for many years. Reserves for unpaid claim and claim settlement expenses and
assumptions used in their development are continually reviewed. We record
adjustments to prior estimates of unpaid claim and claim settlement expenses
to operations in the year in which the adjustments are made.
16
LIQUIDITY AND CAPITAL RESOURCES
Liquidity refers to our ability to generate sufficient cash flows to meet the
short- and long-term cash requirements of our operations. Capital resources
represent those funds deployed or available to be deployed to support our
business operations.
Our primary sources of cash from operations are premiums collected and
investment income. Our investment portfolio is also a source of liquidity,
through the sale of readily marketable fixed maturity investments, as well as
longer-term investments that have appreciated in value. Our primary cash
requirements consist of payments for (i) claim and claim settlement expenses,
(ii) policy acquisition costs, (iii) general and administrative expenses,
(iv) capital expenditures, (v) income taxes, and (vi) debt service or
principal repayment on our outstanding Senior Notes. We generate positive net
cash from operations due, in part, to timing differences between the receipt
of premiums and the payment of claim and claim settlement expenses. Cash
generated is either invested in short-term cash and cash equivalents or
longer term available-for-sale securities pending future payments for such
expenses as indemnity, medical benefits and other operating expenses. Cash
and cash equivalents consist of U.S. government securities acquired under
repurchase agreements, tax-exempt municipal securities and corporate
securities all with maturities of 90 days or less, with the remaining
balances in cash and a money market fund that invests primarily in short-term
government securities.
Cash provided by operating activities for the six months ended June 30,
1998 was $10.0 million. This is primarily a result of an increase of $11.8
million in unpaid claim and claim settlement expenses which are non-cash
accruals for future claims and an increase of $1.4 million in unearned
premiums, net of premiums receivable, offset by our net loss of $626,000, an
increase in deferred tax assets of $1.1 million and net realized investment
gains of $719,000. Net cash used by investing activities was $15.7 million,
primarily the result of $51.8 million in purchases of available-for-sale
securities offset by $35.7 million in proceeds from sales of
available-for-sale securities and maturities of $1.0 million of
available-for-sale investments. Net cash provided by financing activities was
$562,000, primarily due to proceeds from the exercise of stock options
totaling $333,000.
Our need for additional capital is primarily the result of regulations
which require certain ratios of capital to premiums written. In the future,
we expect that our need for additional capital will be primarily related to
the growth of our insurance subsidiary and the need to maintain appropriate
capital to premium ratios as defined by state regulatory bodies. As an
alternative to raising additional capital, we believe we 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 our insurance subsidiary to us. The maximum amount of dividends that can
be paid by ACIC to us in any year is equal to the greater of: (i) 10% of
ACIC's statutory surplus as of the end of the previous fiscal year, or (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 us in 1998, without regulatory approval, is
approximately $4.5 million. ACIC may be subject to more restrictive
limitations on dividends as we enter additional states. ACIC has never paid a
dividend to us and, for the foreseeable future, we intend to retain capital
in the insurance subsidiary to enable us to expand our operations.
We believe that cash flow generated by our operations and our cash and
investment balances will be sufficient to fund continuing operations,
principal repayments and debt service on our outstanding Senior Notes,
including principal repayments of $2.5 million due in December 1998, and
capital expenditures for the next 12 months.
IMPACT OF THE YEAR 2000 ON COMPUTER APPLICATIONS
The year 2000 is a critical year for computer applications. Historically,
many computer programs were written using two digits rather than four to
define the appropriate year. As a result, many computer programs that have
date sensitive fields may recognize a date using "00" as the year 1900 rather
than the year 2000. This could result in system failures or miscalculations
causing disruption of operations, including, among other things, a temporary
inability to process transactions, send invoices or engage in other critical
business activities.
Year 2000 readiness includes addressing information technology systems
(computer equipment, computer software, network hardware and software, etc.),
non-information technology systems (systems which include embedded technology
such as microcontrollers including telephone systems) and issues relating to
third parties with whom we have a material relationship (customers and
vendors).
17
INFORMATION TECHNOLOGY SYSTEMS: Our insurance subsidiary operations
began in 1992. Since 1992, we developed our own internal computer systems to
manage our claims and related claim settlement expenses and administer our
policy information. These computer systems are year 2000 compliant.
Additionally, during the second quarter of 1998 we implemented third-party
provided, general ledger and accounts payable software which is year 2000
compliant. Also, we are in the process of internally developing a billing
and cash receipt system to be completed by the first quarter of 1999 which
will be year 2000 compliant. These system replacements and software
developments are occurring as a part of our ongoing operations and are not
specifically occurring as a result of the year 2000 issue. We anticipate that
our critical computer hardware and software systems will be fully year 2000
compliant in early 1999 and non-critical hardware and software systems are
compliant during the second quarter of 1999. The cost of any hardware and
software changes required to comply with the year 2000, other than those
contemplated as routine upgrades in our operations, are not expected to have
a material adverse effect on our results of operations.
NON-INFORMATION TECHNOLOGY SYSTEMS: We are in the process of reviewing
our operationally critical non-information technology systems (non-IT
systems) which may have embedded technology that is reliant on the year 2000.
We are in the assessment stage of this process which we expect to complete
early in the fourth quarter of 1998 and will develop a formal plan to address
any non-IT system year 2000 issues in the fourth quarter of 1998. We expect
that our non-IT systems will be fully year 2000 compliant by the end of the
second quarter of 1999. We are currently unable to determine the ultimate
costs relating to non-information technology systems.
THIRD PARTY READINESS: We are taking steps to ensure that our
significant customers and vendors are year 2000 compliant through surveys and
further information requests. We expect to have received preliminary
information from our critical vendors by the third quarter of 1998 and
anticipate follow-up based on information received through mid-1999 until we
are comfortable that our vendors are year 2000 compliant.
We have not yet established a year 2000 contingency plan. After
completing the assessment stages for the non-IT systems and third party
readiness, we will to determine our year 2000 areas of risk and will develop
a contingency plan.
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.
These 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 percent of total adjusted capital to authorized control level
risk-based capital is below certain levels. Based upon the risk-based capital
standards, our percent of total adjusted capital is substantially in excess
of authorized control level risk-based capital.
REGULATION
Our insurance subsidiary is subject to substantial regulation by governmental
agencies in the states in which we operate, and will be subject to such
regulation in any state in which we provide workers' compensation products
and services in the future. State regulatory agencies have broad
administrative power with respect to all aspects of our business, 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. At December
31, 1997, our insurance subsidiary was licensed to do business in Minnesota,
Colorado, Missouri, Michigan, Massachusetts, Pennsylvania, Illinois, Kansas,
Connecticut, South Dakota, Tennessee and Wisconsin. We received Indiana,
Iowa, Rhode Island, Maryland and Florida licenses so far in 1998.
The codification of the statutory accounting principles is complete and
has been adopted by the NAIC. Implementation is expected in 2001and the
impact of this project on current statutory policies and practices is unknown.
18
RECENTLY ISSUED ACCOUNTING STANDARDS
In February 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 132, "Employers' Disclosures about
Pensions and Other Post-retirement Benefits." This Statement revises
employers' disclosures about pension and other post-retirement benefit plans.
It does not change the measurement or recognition of those plans. This
Statement standardizes the disclosure requirements for pensions and other
post-retirement benefits to the extent practicable, requires additional
information on changes in the benefit obligations and fair values of plan
assets that will facilitate financial analysis, and eliminates certain
disclosures. Restatement of disclosures for earlier periods is required. This
Statement is effective for financial statements for fiscal years beginning
after December 15, 1997. We do not expect this standard to have an impact on
our Consolidated Financial Statements.
In March 1998, the American Institute of Certified Public Accountants
issued Statement of Opinion ("SOP") 98-1, "Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use." This SOP provides
guidance on accounting for the costs of computer software developed or
obtained for internal use. This SOP requires that entities capitalize certain
internal-use software costs once certain criteria are met. Currently, we
expense the costs of developing or obtaining internal-use software as
incurred. We are currently evaluating SOP 98-1, but do not expect it to have
a material impact on our Consolidated Financial Statements. This SOP is
effective for financial statements for fiscal years beginning after December
15, 1998. Earlier application is encouraged in fiscal years for which annual
financial statements have not been issued.
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 our actual results and could cause our actual
financial performance to differ materially from that expressed in any
forward-looking statement: (i) competition from traditional workers'
compensation insurance carriers, (ii) our ability to manage both our existing
claims and our new claims in an effective manner, (iii) our ability to
further penetrate our existing markets, (iv) changes in workers' compensation
regulation by states, including changes in mandated benefits or insurance
company regulation, (v) our ability to retain our existing customers at
favorable beneficial premium rates when their policies renew (vi) our ability
to expand into new states and attract customers in those states, (vii) our
ability to successfully introduce new products and services, and (viii) our
ability to ensure that our operations are not adversely affected by year 2000
compliance including our dependence on outside vendors and customers and
their ability to become year 2000 compliant.
19
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
- ------------------------------------------------------------
The Company held its Annual Meeting of Shareholders on May 21, 1998
and shareholders voted on and approved the following proposals:
- Elected two directors, David C. Prosser and Steven M.
Rothschild, to hold office for a term of three years or
until their successors are elected. Shares voted for each
director were as follows:
David C. Steven M.
Prosser Rothschild
------------ ------------
For: 10,716,102 10,720,973
Withheld: 22,286 17,415
Abstain: -- --
Non-votes: 1,169,585 1,169,585
The terms of Carl B. Lehmann, Mark E. Hegman,
J. Alexander Fjelstad and William A. Cooper,
directors with unexpiring terms, continued
after the meeting.
- Approved an amendment of the Company's Articles of
Incorporation and By-Laws to provide that the number of
directors of the Company shall be no less than Three
and no more than Twelve members. Shares voted were as
follows:
For--10,619,870; Withheld--113,525; Abstain--4,993;
Non-votes--1,169,585
- Amended the RTW, Inc. 1995 Employee Stock Purchase Plan
to increase by 125,000 the number of shares authorized
under the plan. Shares voted were as follows:
For--10,556,030; Withheld--172,353; Abstain--10,005;
Non-votes--1,169,585
ITEM 5. OTHER INFORMATION
- --------------------------
None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
- -----------------------------------------
(a) Listing of Exhibits
-------------------
Exhibit 11 - STATEMENT REGARDING COMPUTATION OF BASIC AND
DILUTED INCOME (LOSS) PER SHARE
Exhibit 27 - FINANCIAL STATEMENT SCHEDULE
(b) Listing of Reports on Form 8-K
------------------------------
None
20
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: August 12, 1998 By /s/ Carl B. Lehmann
------------------------------------------------
Carl B. Lehmann
President, Chief Executive Officer and Director
(Principal Executive Officer)
Dated: August 12, 1998 By /s/ Tim C. Chan
------------------------------------------------
Tim C. Chan
Secretary, Treasurer and Chief Financial Officer
(Principal Financial and Accounting Officer)
21
EXHIBIT INDEX
Exhibit
Number DESCRIPTION PAGE
- ------ ------------------------------------------------- ----
11 Statement Regarding Computation of Basic and
Diluted Income (Loss) Per Share 23
27 Financial Statement Schedule 24
22