10-Q 1 d10q.txt FORM 10-Q DATED MARCH 31, 2002 SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10Q QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Quarter Ended March 31, 2002 Commission File No. 0-3681 MERCURY GENERAL CORPORATION (Exact name of registrant as specified in its charter) California 95-221-1612 (State or other jurisdiction (I.R.S. Employer of incorporation or organization) Identification No.) 4484 Wilshire Boulevard, Los Angeles, California 90010 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (323) 937-1060 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 May 1, 2002, the Registrant had issued and outstanding an aggregate of 54,303,098 shares of its Common Stock. Item 1. Financial Statements MERCURY GENERAL CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (UNAUDITED) AMOUNTS EXPRESSED IN THOUSANDS, except share amounts
A S S E T S March 31, December 31, 2002 2001 --------- ------------ Investments: Fixed maturities available for sale (amortized cost $1,594,268 in 2002 and $1,560,180 in 2001) .............. $1,599,637 $1,586,433 Equity securities available for sale (cost $276,917 in 2002 and $277,925 in 2001) ........................... 277,583 277,787 Short-term cash investments, at cost, which approximates market ..................................... 98,077 71,951 ---------- ---------- Total investments ............................. 1,975,297 1,936,171 Cash ........................................................ 8,439 3,851 Receivables: Premiums receivable ...................................... 159,439 143,612 Premium notes ............................................ 18,644 17,256 Accrued investment income ................................ 26,330 27,979 Other .................................................... 24,080 29,529 ---------- ---------- 228,493 218,376 Deferred policy acquisition costs ........................... 90,307 83,440 Fixed assets, net ........................................... 45,900 44,448 Deferred income taxes ....................................... 8,682 1,252 Other assets ................................................ 30,116 29,002 ---------- ---------- Total assets .................................. $2,387,234 $2,316,540 ========== ========== LIABILITIES AND SHAREHOLDERS' EQUITY Losses and loss adjustment expenses ......................... $ 552,465 $ 534,926 Unearned premiums ........................................... 455,845 421,342 Notes payable ............................................... 129,602 129,513 Loss drafts payable ......................................... 57,246 53,629 Accounts payable and accrued expenses ....................... 47,573 46,638 Current income taxes ........................................ 6,120 4,367 Other liabilities ........................................... 68,208 56,414 ---------- ---------- Total liabilities ............................. 1,317,059 1,246,829 ---------- ---------- Shareholders' equity: Common stock without par value or stated value. Authorized 70,000,000 shares; issued and outstanding 54,298,898 shares in 2002 and 54,276,798 shares in 2001 ................................................... 54,563 53,955 Accumulated other comprehensive income ................... 3,908 16,975 Unearned ESOP compensation ............................... (750) (1,000) Retained earnings ........................................ 1,012,454 999,781 ---------- ---------- Total shareholders' equity ..................... 1,070,175 1,069,711 ---------- ---------- Commitments and contingencies ............................ $2,387,234 $2,316,540 ========== ==========
2 MERCURY GENERAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (Unaudited) Three Months Ended March 31, Amounts expressed in thousands, except share and per share data
2002 2001 ---- ---- Revenues: Earned premiums .................................... $386,637 $323,772 Net investment income .............................. 29,504 28,019 Net realized investment gains ...................... 238 4,384 Other .............................................. 418 1,274 -------- -------- Total revenues ............................ 416,797 357,449 -------- -------- Expenses: Incurred losses .................................... 278,101 240,217 Policy acquisition costs ........................... 85,600 71,501 Other operating expenses ........................... 17,142 15,271 Interest ........................................... 1,116 1,863 -------- -------- Total expenses ............................ 381,959 328,852 -------- -------- Income before income taxes ......................... 34,838 28,597 Income taxes .............................................. 5,884 3,889 -------- -------- Net income ......................................... $ 28,954 $ 24,708 ======== ======== BASIC EARNINGS PER SHARE (average shares outstanding 54,265,041 in 2002 and 54,154,216 in 2001) .............. $ 0.53 $ 0.46 ======== ======== DILUTED EARNINGS PER SHARE (adjusted weighted average shares 54,462,002 in 2002 and 54,350,923 in 2001) ....... $ 0.53 $ 0.45 ======== ======== Dividends declared per share .............................. $ 0.30 $ 0.265 ======== ========
3 MERCURY GENERAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited) Three Months Ended March 31, Amounts expressed in thousands
2002 2001 -------- -------- Net income ............................................... $ 28,954 $ 24,708 Other comprehensive income (loss), before tax: Unrealized gains (losses) on securities: Unrealized holding gains (losses) arising during period ...................................... (20,385) 7,610 Less: reclassification adjustment for net (gains) losses included in net income ...................... 305 (4,065) -------- -------- Other comprehensive income (loss) before tax .... (20,080) 3,545 Income tax expense (benefit) related to unrealized holding gains (losses) arising during period .................... (7,120) 2,664 Income tax expense (benefit) related to reclassification adjustment for (gains) losses included in net income .... 107 (1,423) -------- -------- Comprehensive income, net of tax ......................... $ 15,887 $ 27,012 ======== ========
4 MERCURY GENERAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) THREE MONTHS ENDED MARCH 31 Amounts expressed in thousands
2002 2001 ---- ---- Cash flows from operating activities: Net income ......................................................... $ 28,954 $ 24,708 Adjustments to reconcile net income to net cash provided from operating activities: Increase (decrease) in unpaid losses and loss adjustment expenses ....................................................... 17,539 (9,504) Increase in unearned premiums ................................... 34,503 15,822 Increase in premium notes receivable ............................ (1,388) (680) Increase in premiums receivable ................................. (15,827) (6,902) (Increase) decrease in reinsurance recoveries ................... (410) 299 Increase in deferred policy acquisition costs ................... (6,867) (3,474) Increase in loss drafts payable ................................. 3,617 4,130 Increase in accrued income taxes, excluding deferred tax on change in unrealized gain ............................... 1,351 68 Increase in accounts payable and accrued expenses ............... 934 1,508 Depreciation .................................................... 2,203 1,482 Net realized investment gains ................................... (238) (4,384) Bond accretion, net ............................................. (2,318) (2,162) Increase in premiums collected in advance ....................... 7,446 4,521 Other, net ...................................................... (2,979) 10,940 -------- -------- Net cash provided from operating activities ................ 66,520 36,372 Cash flows from investing activities: Fixed maturities available for sale: Purchases ....................................................... (125,266) (85,285) Sales ........................................................... 67,103 73,059 Calls or maturities ............................................. 25,265 8,310 Equity securities available for sale: Purchases ....................................................... (32,564) (24,425) Sales ........................................................... 34,921 23,739 Increase (decrease) in receivable for securities ................... 15,144 (1,266) Increase in short-term cash investments, net ....................... (26,126) (12,212) Purchase of fixed assets ........................................... (4,107) (4,375) Sale of fixed assets ............................................... 424 600 -------- -------- Net cash used in investing activities ...................... $(45,206) $(21,855)
(Continued) 5 MERCURY GENERAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
2002 2001 ---- ---- Cash flows from financing activities: Increase in notes payable ........................... $ 89 $ 189 Net payments under credit arrangement ............... -- (500) Dividends paid to shareholders ...................... (16,281) (14,350) Proceeds from stock options exercised ............... 466 78 Net decrease in ESOP loan ........................... (1,000) (1,000) -------- -------- Net cash used in financing activities .... (16,726) (15,583) -------- -------- Net increase (decrease) in cash ........................ 4,588 (1,066) Cash: Beginning of the year ............................... 3,851 5,935 -------- -------- End of the period ................................... $ 8,439 $ 4,869 ======== ======== Supplemental disclosures of cash flow information and non-cash financing activities: Interest paid during the period ..................... $ 4,305 $ 1,888 Income taxes paid during the period ................. $ 4,400 $ 3,734 Tax benefit realized on stock options exercised ..... $ 147 $ 16
6 MERCURY GENERAL CORPORATION & SUBSIDIARIES NOTE TO THE CONSOLIDATED FINANCIAL STATEMENTS 1. Basis of Presentation --------------------- The financial data included herein have been prepared by the Company, without audit. In the opinion of management, all adjustments of a normal recurring nature necessary to present fairly the Company's financial position at March 31, 2002 and the results of operations, comprehensive income and cash flows for the periods presented have been made. Operating results for the three months ended March 31, 2002 are not necessarily indicative of the results that may be expected for the year ending December 31, 2002. This interim information should be read in conjunction with the financial statements and notes thereto included in the Company's latest annual report on Form 10-K. Item 2. Management's Discussion and Analysis of Financial Condition and Results ----------------------------------------------------------------------- of Operations ------------- General ------- The operating results of property and casualty insurance companies are subject to significant fluctuations from quarter-to-quarter and from year-to-year due to the effect of competition on pricing, the frequency and severity of losses, including the effect of natural disasters on losses, general economic conditions, the general regulatory environment in those states in which an insurer operates, state regulation of premium rates and other factors such as changes in tax laws. The property and casualty industry has been highly cyclical, with periods of high premium rates and shortages of underwriting capacity followed by periods of severe price competition and excess capacity. These cycles can have a large impact on the ability of the Company to grow and retain business. The Company operates primarily in the state of California, which was the only state it produced business in prior to 1990. The Company expanded its operations into Georgia and Illinois in 1990. With the acquisition of American Fidelity Insurance Group ("AFI") in December 1996, now American Mercury Insurance Group ("AMI"), the Company expanded into the states of Oklahoma and Texas. The Company further expanded its operations into the state of Florida during 1998. Further expansion into Texas occurred with the Concord Insurance Services, Inc. transaction in December 1999 and the Mercury County Mutual Insurance Company ("MCM") transaction in September 2000. In 2001, the Company expanded into Virginia and New York. During 2001, approximately 87.5% of the Company's net premiums written were derived from California. In California, as in various other states, all property and casualty rates must be approved by the Insurance Commissioner before they can be used. On March 1, 2002, the Company implemented a 4.1% rate increase for private passenger automobile insurance written by Mercury Insurance Company, which in 2001 represented approximately 55% of company-wide premiums written, and a 6.9% combined rate increase for private passenger automobile insurance written by Mercury Casualty Company and California Automobile Insurance Company, which in 2001 collectively represented approximately 24% of 7 company-wide premiums written. These increases went into effect for all new and renewal California business as of March 1, 2002. A 6.9% rate increase on the California homeowner's line of business was approved and will go into effect for business written or renewed on or after May 15, 2002. The Company has also filed and is awaiting approval for an additional 6.9% California homeowner's rate increase. The Company has filed for a 5% rate increase for California private passenger automobile insurance written by Mercury Insurance Company, which in 2001 represented approximately 55% of company-wide premiums and a 6.9% rate increase in California private passenger automobile insurance writtten by Mercury Casualty Company and California Automobile Insurance Company, which in 2001, collectively represented approximately 24% of company-wide premium written. Certain statements in this report on Form 10-Q are not historical fact and constitute "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These forward-looking statements may address, among other things, our strategy for growth, business development, regulatory approvals, market position, expenditures, financial results and reserves. Forward-looking statements are not guarantees of performance and are subject to important factors and events that could cause our actual business, prospects and results of operations to differ materially from the historical information contained in this Form 10-Q and from those that may be expressed or implied by the forward-looking statements. Factors that could cause or contribute to such differences include, among others: the intense competition currently existing in the California automobile insurance markets, our success in expanding our business in states outside of California, the impact of potential third party "bad-faith" legislation, changes in laws or regulations, third party relations and approvals, and decisions of courts, regulators and governmental bodies, particularly in California, our ability to obtain the approval of the California Insurance Commissioner for premium rate changes for private passenger automobile policies issued in California and similar rate approvals in other states where we do business, our success in integrating and profitably operating the businesses we have acquired, the level of investment yields we are able to obtain with our investments in comparison to recent yields, the cyclical and general competitive nature of the property and casualty insurance industry and general uncertainties regarding loss reserve estimates, and other uncertainties, all of which are difficult to predict and many of which are beyond our control. We assume no obligation to update any forward-looking statements as a result of new information or future events or developments. Investors are cautioned not to place undue reliance on any forward-looking statements, which speak only as of the date of this Form 10-Q or, in the case of any document we incorporate by reference, the date of that document. Investors also should understand that it is not possible to predict or identify all factors and should not consider the risks set forth above to be a complete statement of all potential risks and uncertainties. If the expectations or assumptions underlying our forward-looking statements prove inaccurate or if risks or uncertainties arise, actual results could differ materially from those predicted in any forward-looking statements. Results of Operations --------------------- Three Months Ended March 31, 2002 compared to Three Months Ended March 31, 2001 Premiums earned in the first quarter of 2002 increased 19.4% from the corresponding period in 2001. Premiums written in the first quarter of 2002 increased 22.8% from the corresponding period in 2001. California private passenger automobile premiums and Florida 8 private passenger automobile premiums were the largest contributors to first quarter written premium growth. California premiums written, representing 85% of the Company's total premiums, grew approximately 18.6% in the first quarter of 2002 compared to an increase of 6.4% for the comparable period of 2001. Florida premiums written, representing 5% of the Company's total premiums, grew by 91% in the first quarter of 2002 compared to an increase of 20% for the comparable period of 2001. Both states' premium growth was primarily due to an increase in unit sales and recent rate increases on private passenger automobile business. The loss ratio in the first quarter (loss and loss adjustment expenses related to premiums earned) was 71.9% in 2002 and 74.2% in 2001. The lower loss ratio in the quarter, as compared to the first quarter of 2001, was largely due to a decrease in loss frequency on California automobile claims that was likely the result of relatively mild weather in the quarter. The expense ratio (policy acquisition costs and other expenses related to premiums earned) in the first quarter of 2002 was 26.6% compared to 26.8% in the corresponding period of 2001. Total expenses increased at essentially the same rate as premium volume. The combined ratio of losses and expenses (GAAP basis) was 98.5% in the first quarter of 2002 compared with 101.0% in 2001, resulting in an underwriting gain for the period of $5.8 million, compared with a loss of $3.2 million in the corresponding period of 2001. Investment income for the first quarter of 2002 was $29.5 million, compared with $28.0 million in the first quarter of 2001. The after-tax yield on average investments (fixed maturities and equities valued at cost) was 5.23% in the first quarter of 2002 compared to 5.52% in the corresponding period of 2001 on average invested assets of $1,950.2 million and $1,769.9 million, respectively. Interest expense was $1.1 million for the first quarter of 2002 compared to $1.9 million for the first quarter of 2001. An interest rate swap from fixed to floating on the $125 million senior notes was implemented on January 2, 2002 and accounted for as a fair value hedge. Due to the current environment of low short-term interest rates, the swap reduced the Company's interest expense by approximately $1.2 million when compared to what would have been expensed had the swap not been entered into. The income tax provision in the first quarter of 2002 of $5.9 million represented an effective tax rate of 16.9%, compared with an effective rate of 13.6% in the corresponding period of 2001. The higher rate in 2002 is primarily attributable to the increased proportion of underwriting income which is taxed at the full corporate rate of 35%, in contrast with investment income which consists primarily of tax exempt interest and tax sheltered dividend income. Net income for the first quarter 2002 of $29.0 million, or $.53 per share (diluted), compares with $24.7 million or $.45 per share (diluted) in the corresponding period of 2001. Basic net income per share was $.53 in 2002 and $.46 in 2001. 9 Liquidity and Capital Resources ------------------------------- Net cash provided from operating activities during the first three months of 2002 was $66.5 million, while funds derived from the sale, redemption or maturity of investments was $127.3 million. Fixed-maturity investments, at amortized cost, increased by $34.1 million during the period. Equity investments, including perpetual preferred stocks, decreased by $1.0 million at cost, and short-term cash investments increased by $26.1 million. The amortized cost of fixed-maturities available for sale which were sold or called during the period was $93.4 million. The market value of all investments (fixed-maturities and equities) held at market as "Available for Sale" exceeded amortized cost of $1,871.2 million at March 31, 2002 by $6.0 million. That unrealized gain, reflected as accumulated other comprehensive income, net of applicable tax effects, was $3.9 million at March 31, 2002 compared with an unrealized gain of $17.0 million at December 31, 2001. The decrease in unrealized gains was largely due to an increase in market interest rates and a reduction in market values on certain investments resulting from reduced credit worthiness as perceived by the market. The Company monitors its investments closely. If an unrealized loss is determined to be other than temporary it is written off as a realized loss through the Statement of Income. No unrealized losses were written off as other than temporary during the first quarter 2002 or 2001. The Company's cash and short term investments totaled $106.5 million at March 31, 2002. Together with funds generated internally, such liquid assets are adequate to pay claims without the forced sale of investments. Approximately $56.0 million (at cost) of total fixed maturities representing 2.35% of total assets at March 31, 2002 were rated below investment grade. This compares to approximately $40.2 million representing 1.75% of total assets at December 31, 2001. The average rating of the $1,579.2 million bond portfolio (at amortized cost) was AA compared to A at December 31, 2001. Bond holdings are broadly diversified geographically, within the tax-exempt sector. Holdings in the taxable sector consist principally of investment grade issues. Fixed-maturity investments of $1,594.3 million (at cost) include $15.1 million of sinking fund preferreds, principally utility issues. Except for company-occupied buildings and land being used for construction of company owned space, the Company has no direct investments in real estate and no holdings of mortgages secured by commercial real estate. Equity holdings of $277.6 million at market (cost $276.9 million), including perpetual preferred issues, are largely confined to the public utility and banking sectors and represent 25.9% (at cost) of total shareholders' equity. Over the next twelve to eighteen months the Company anticipates spending approximately $10 million of internally generated funds for the construction of a new office building in Rancho Cucamonga, California. Industry and regulatory guidelines suggest that the ratio of a property and casualty insurer's annual net premiums written to statutory policyholders' surplus should not exceed 3 to 1. Based on the combined surplus of all of the licensed insurance subsidiaries of $1,029 10 million at March 31, 2002 and net written premiums for the twelve months ended on that date of $1,521 million, the ratio of writings to surplus was approximately 1.5 to 1. The Company's book value per share at March 31, 2002 was $19.72 per share. Item 3. Quantitative and Qualitative Disclosures About Market Risk ---------------------------------------------------------- There have been no material changes in the Company's investment strategies, types of financial instruments held or the risks associated with such instruments which would materially alter the market risk disclosures made in the Company's Annual Statement on Form 10-K for the year ended December 31, 2001. An increase in market interest rates during the first three months of the year negatively impacted the value of the Company's investments. The impact is described in the Liquidity and Capital Resources section above. PART II - OTHER INFORMATION Item 1. Legal Proceedings ----------------- None Item 2. Changes in Securities and Use of Proceeds ----------------------------------------- None Item 3. Defaults Upon Senior Securities ------------------------------- None Item 4. Submission of Matters to a Vote of Securities Holders ----------------------------------------------------- None Item 5. Other Information ----------------- None Item 6. Exhibits and Reports on Form 8-K -------------------------------- (a) None (b) None 11 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. MERCURY GENERAL CORPORATION Date: May 7, 2002 By: /s/ George Joseph ---------------------------------- George Joseph Chairman and Chief Executive Officer Date: May 7, 2002 By: /s/ Theodore Stalick ---------------------------------- Theodore Stalick Chief Financial Officer 12