-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, K8Mqtev241iKxL7YkXKXkOt6MkKLXdg2TQQjq7t3CWM8pZaDLpn3he1AqvVOXlJ4 Ut07c+13r5KgeONhaPXZ+Q== 0000950150-98-001631.txt : 19981019 0000950150-98-001631.hdr.sgml : 19981019 ACCESSION NUMBER: 0000950150-98-001631 CONFORMED SUBMISSION TYPE: 10-Q/A PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19970930 FILED AS OF DATE: 19981016 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: SUPERIOR NATIONAL INSURANCE GROUP INC CENTRAL INDEX KEY: 0000810463 STANDARD INDUSTRIAL CLASSIFICATION: INSURANCE AGENTS BROKERS & SERVICES [6411] IRS NUMBER: 954610936 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q/A SEC ACT: SEC FILE NUMBER: 000-25984 FILM NUMBER: 98727040 BUSINESS ADDRESS: STREET 1: 26601 AGOURA RD STREET 2: ` CITY: CALABASAS STATE: CA ZIP: 91302 BUSINESS PHONE: 8188801600 MAIL ADDRESS: STREET 1: 26601 AGOURA ROAD CITY: CALABASAS STATE: CA ZIP: 91302 10-Q/A 1 FORM 10-Q, AMENDMENT #1 1 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 ------------------------ FORM 10-Q/A (AMENDMENT NO. 1) (MARK ONE) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1997 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM TO COMMISSION FILE NUMBER 0-25984 ------------------------ SUPERIOR NATIONAL INSURANCE GROUP, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 95-4610936 (STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
26601 AGOURA ROAD CALABASAS, CA 91302 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (818) 880-1600 (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 [ ] No [X] Number of shares of Common Stock, $.01 par value per share, outstanding as of close of business on November 7, 1997: 5,859,269 shares. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 2 SUPERIOR NATIONAL INSURANCE GROUP, INC. INDEX TO FORM 10-Q PART I. FINANCIAL INFORMATION
PAGE ---- Item 1. Financial Statements Condensed consolidated balance sheets as of September 30, 1997 (unaudited) and December 31, 1996.................................... 1 Condensed consolidated statements of operations for the three and nine months ended September 30, 1997 (unaudited) (restated) and September 30, 1996 (unaudited)........................ 2 Condensed consolidated statement of changes in stockholders' equity for the nine months ended September 30, 1997 (unaudited)................. 3 Condensed consolidated statements of cash flows (restated) for the nine months ended September 30, 1997 (unaudited) and September 30, 1996 (unaudited)... 4 Notes to condensed consolidated financial statements (unaudited)........................................... 5 Item 2. Management's Discussion and Analysis of Consolidated Financial Condition and Results of Operations....................... 8 PART II. OTHER INFORMATION Item 5. Other Information................................. 15 Item 6. Exhibits and Reports on Form 8-K.................. 16 SIGNATURE................................................... 17
i 3 PART I -- FINANCIAL INFORMATION ITEM 1 -- FINANCIAL STATEMENTS SUPERIOR NATIONAL INSURANCE GROUP, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT PER SHARE DATA) ASSETS
SEPTEMBER 30, DECEMBER 31, 1997 1996 ------------- ------------ (UNAUDITED) (*) Investments: Bonds and notes: Available-for-sale, at market (cost: 1997, $203,354; 1996, $46,549)......................................... $204,732 $ 46,330 Equity securities, at market (cost: 1997, $686; 1996, $1,199)................................................ 849 1,173 Short-term investments, at cost......................... 7,613 67,514 -------- -------- Total Investments.................................. 213,194 115,017 Cash and cash equivalents (restricted cash: 1997, $476; 1996, $297)............................................ 25,610 34,423 Reinsurance receivable.................................. 54,887 25,274 Premiums receivable (less allowance for doubtful accounts: 1997, $3,604; 1996, $300)........................................... 23,232 9,390 Earned but unbilled premiums receivable................. 9,123 5,251 Deferred policy acquisition costs....................... 5,834 3,042 Deferred income taxes................................... 27,133 9,520 Funds held by reinsurer................................. 3,815 1,948 Receivable from reinsurer............................... -- 110,527 Goodwill................................................ 25,766 -- Prepaid and other....................................... 22,634 9,438 -------- -------- Total Assets....................................... $411,228 $323,830 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY Liabilities: Claims and claim adjustment expenses.................... 222,625 115,529 Unearned premiums....................................... 14,988 9,702 Reinsurance Payable..................................... 9,833 874 Long-term debt.......................................... 42,366 98,961 Discontinued operations liability....................... 14,036 17,261 Accounts payable and other liabilities.................. 24,904 12,741 -------- -------- Total Liabilities.................................. 328,752 255,068 Preferred securities issued by affiliate; authorized 1,100,000 shares; issued and outstanding 1,062,920 shares in 1997, and 1,013,753 shares in 1996........... 25,672 23,571 Stockholders' Equity: Common stock, $0.01 par value; authorized 25,000,000 shares; issued and outstanding 5,837,173 shares in 1997 and 3,446,492 shares in 1996.................................. 58 -- Paid-in capital excess of par............................. 34,070 16,022 Paid in capital -- warrants................................. 2,206 2,206 Unrealized gain on equity securities, net of taxes.......... 108 (17) Unrealized gain (loss) on available-for-sale investments, net of income taxes....................................... 879 (145) Retained earnings........................................... 19,483 27,125 -------- -------- Total Stockholders' Equity......................... 56,804 45,191 -------- -------- Total Liabilities and Stockholders' Equity......... $411,228 $323,830 ======== ========
- --------------- * Derived from audited financial statements See Notes to Condensed Consolidated Financial Statements. 1 4 SUPERIOR NATIONAL INSURANCE GROUP, INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) (UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ------------------- -------------------- 1997 1996 1997 1996 -------- -------- ---------- ------- (RESTATED) Revenues: Premiums written, net of reinsurance ceded............. $32,890 $23,337 $ 96,596 $66,133 Net change in unearned premiums........................ 1,870 (330) 2,552 (93) ------- ------- -------- ------- Net premiums earned.................................... 34,760 23,007 99,148 66,040 Net investment income.................................. 3,723 2,129 9,244 6,394 ------- ------- -------- ------- Total Revenues................................. 38,483 25,136 108,392 72,434 Expenses: Claims and claim adjustment expenses, net of reinsurance recoveries.............................. 21,316 14,201 66,311 36,801 Commissions, net of reinsurance commissions............ 2,773 2,607 9,661 7,865 Policyholder dividends................................. -- (715) -- (2,121) Interest expense....................................... 1,158 2,126 5,302 6,922 General and administrative expenses Underwriting........................................ 7,140 5,304 18,101 18,681 Loss on termination of financing transaction with a related party reinsurer........................... -- -- 15,699 -- Other............................................... 296 173 817 (216) Goodwill............................................ 340 -- 477 -- ------- ------- -------- ------- Total Expenses................................. 33,023 23,696 116,368 67,932 ------- ------- -------- ------- Income before income taxes and preferred securities dividends and accretion, and extraordinary items....... 5,460 1,440 (7,976) 4,502 Income tax expense....................................... 2,052 300 (2,517) 1,348 ------- ------- -------- ------- Income before preferred securities dividends and accretion, and extraordinary items..................... 3,408 1,140 (5,459) 3,154 Preferred securities dividends and accretion, net of income taxes........................................ (480) (428) (1,387) (1,238) Extraordinary loss on redemption of Pac Rim's debentures, net of income tax benefit of $327....... (635) -- (635) -- Extraordinary loss on early retirement of Imperial Bank loan, net of income tax benefit of $83.............. (161) -- (161) -- ------- ------- -------- ------- Net (loss) Income.............................. $ 2,132 $ 712 $ (7,642) $ 1,916 ======= ======= ======== ======= Earnings per common and dilutive common equivalent shares: Income before preferred securities dividends accretion, and extraordinary items................................ $ 0.44 $ 0.23 $ (1.09) $ 0.64 Preferred securities dividends and accretion........... (0.06) (0.08) (0.28) (0.23) Extraordinary loss on redemption of Pac Rim's debentures, net of income tax benefit............... (0.08) -- (0.12) -- Extraordinary loss on early retirement of Imperial Bank loan, net of income tax benefit..................... (0.02) -- (0.03) -- ------- ------- -------- ------- Net (loss) Income.............................. $ 0.28 $ 0.15 $ (1.52) $ 0.41 ======= ======= ======== =======
See Notes to Condensed Consolidated Financial Statements. 2 5 SUPERIOR NATIONAL INSURANCE GROUP, INC. CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY (AMOUNTS IN THOUSANDS, EXCEPT SHARE AMOUNTS) (UNAUDITED)
COMMON STOCK ------------------------------ UNREALIZED NET UNREALIZED PAID-IN GAIN GAIN (LOSS) CAPITAL (LOSS) ON AVAILABLE- PAID IN TOTAL SHARES $.01 PAR EXCESS ON EQUITY FOR-SALE CAPITAL- RETAINED SHAREHOLDERS' ISSUED VALUE OF PAR SECURITIES INVESTMENTS WARRANTS EARNINGS EQUITY --------- -------- ------- ---------- -------------- -------- -------- ------------- Balance at December 31, 1996....................... 3,446,492 -- $16,022 $(17) $ (145) $2,206 $27,125 $45,191 Net loss..................... -- -- -- -- -- -- (7,642) (7,642) Change in unrealized gain on equity Securities.......... -- -- -- 125 -- -- -- 125 Change in unrealized gain (loss) on investments, net of taxes................... -- -- -- -- 1,024 -- -- 1,024 Common stock issued.......... 2,390,681 58 18,048 -- -- -- -- 18,106 --------- --- ------- ---- ------ ------ ------- ------- Balance at September 30, 1997....................... 5,837,173 $58 $34,070 $108 $ 879 $2,206 $19,483 $56,804 ========= === ======= ==== ====== ====== ======= =======
See Notes to Condensed Consolidated Financial Statements. 3 6 SUPERIOR NATIONAL INSURANCE GROUP, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS AS RESTATED (AMOUNTS IN THOUSANDS) (UNAUDITED)
NINE MONTHS ENDED SEPTEMBER 30, --------------------- 1997 1996 --------- -------- Cash flows from operating activities: Net (loss) income......................................... $ (7,642) $ 1,916 --------- -------- Adjustments to reconcile net (loss) income to net cash provided by (used in) operating activities: Amortization of bonds and preferred stock............... (1,004) (705) Loss (gain) on sale of investments...................... 95 (33) Gain on sale of Centre Re Investments................... -- (2,261) Amortization of Goodwill................................ 477 -- Extraordinary Loss -- retirement of long-term debt...... 11,157 -- Interest expense on long-term debt...................... 4,225 -- Preferred securities dividends and accretion............ 1,387 1,876 Increase in reinsurance receivable...................... (25,593) (1,292) (Increase) decrease in premiums receivables............. (716) 1,009 Decrease (increase) in earned but unbilled premiums receivable............................................. 270 (1,656) (Increase) decrease in accrued investment income........ (637) 339 Increase in deferred policy acquisition costs........... (2,792) (340) Decrease in deferred income taxes....................... 2,821 706 Increase in funds held by reinsurer..................... (1,867) (413) Decrease in investments withheld from a related party reinsurer.............................................. -- 38,586 (Increase) decrease in prepaid reinsurance premiums..... (5,278) 498 Increase in other assets................................ (1,411) (855) Decrease in claims and claim adjustment expense reserves............................................... (979) (25,268) Decrease in unearned premium reserves................... (1,573) (404) Increase in reinsurance payable......................... 8,959 122 Decrease in policyholder dividends payable.............. -- (3,577) (Decrease) increase in accounts payable and other liabilities............................................ (6,354) 8,659 --------- -------- Total adjustments................................... (18,813) 14,991 --------- -------- Net cash used in operating activities............... (26,455) 16,907 --------- -------- Cash flows from financing activities: Paid-in-capital -- restricted stock....................... 106 13 Proceeds from issuance of common stock.................... 18,000 -- Long-term debt -- Chase Manhattan Bank.................... 41,257 -- Retirement of long-term debt -- Imperial Bank............. (7,250) (900) Prepayment penalty on early retirement of long-term debt.................................................... (244) -- Proceeds from repurchase transaction...................... -- 3,596 --------- -------- Net cash provided by financing activities........... 51,869 2,709 --------- -------- Cash flows from investing activities: Purchases of bonds and notes: Investments available-for-sale.......................... (93,936) (29,119) Purchase of equity security............................... (145) -- Acquisition of Pac Rim.................................... (44,016) -- Investments and cash for discontinued operations.......... (3,225) -- Sales of bonds and notes; Investments available-for-sale...................................... 37,906 22,414 Maturities of bonds and notes: Investments available-for-sale...................................... 8,771 12,286 Sale of equity security................................... 517 -- Net decrease in short term investment..................... 59,901 1,549 --------- -------- Net cash (used in) provided by investing activities..... (34,227) 7,130 --------- -------- Net (decrease) increase in cash......................... (8,813) 26,746 --------- -------- Cash and invested cash at beginning of period............... 34,423 6,188 --------- -------- Cash and invested cash at end of period..................... $ 25,610 $ 32,934 ========= ======== Supplemental disclosure of cash flow information: Cash paid during the year for income taxes.................. $ 4 $ 4 ========= ======== Cash paid during the year for interest...................... $ 1,124 $ 488 ========= ========
See Notes to Condensed Consolidated Financial Statements 4 7 SUPERIOR NATIONAL INSURANCE GROUP, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 1997 (UNAUDITED) NOTE A. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES A.1 Basis of Presentation Superior National Insurance Group, Inc. ("SNIG") is a holding company that through its wholly-owned subsidiaries, Superior National Insurance Company ("SNIC") and Superior Pacific Casualty Company ("SPCC"), is engaged in writing workers' compensation insurance principally in the States of California and Arizona, and until September 30, 1993, was engaged in writing commercial property and casualty insurance. The "Company" refers to SNIG and its subsidiaries. The accompanying unaudited condensed consolidated financial statements of the Company have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments, including normally occurring accruals, considered necessary for a fair presentation have been included. Certain reclassifications of prior year amounts have been made to conform with the 1997 presentation. Operating results for the nine months ended September 30, 1997 are not necessarily indicative of the results to be expected for the year ended December 31, 1997. These consolidated financial statements should be read in conjunction with the consolidated financial statements and footnotes thereto contained in the Company's annual report on Form 10-K for the year ended December 31, 1996. A.2 Acquisition of Pac Rim Holding Corporation On April 11, 1997, the Company completed its acquisition of Pac Rim Holding Corporation ("PRHC") and its wholly-owned subsidiary, The Pacific Rim Assurance Company, for total consideration of approximately $42 million in cash. The consideration paid by SNIG resulted in payment of approximately $20 million ($2.105 per share) to PRHC's common stockholders; $20 million to PRHC's debenture holders; and the remainder to PRHC's warrant and option holders. The Pacific Rim Assurance Company was renamed Superior Pacific Casualty Company upon its acquisition by the Company. SNIG financed the acquisition with the issuance and sale in a private transaction, of approximately $18.0 million in common stock, (2,390,438 shares) to a group of investors including Insurance Partners, L.P., TJS Partners, L.P., and SNIG management and the incurrence of a $44 million term loan by a bank syndicate led by The Chase Manhattan Bank ("Chase"). Approximately $6.6 million of the loan proceeds was used to prepay SNIG's previously outstanding long-term debt, and approximately $10 million was contributed by SNIG to the capital of SPCC. The Company accounted for the acquisition of PRHC as a purchase, and accordingly, assets and liabilities of PRHC were adjusted to their fair value at the time of the purchase. As of September 30, 1997, the Company had recorded $25.8 million in goodwill, the excess of purchase price over amounts assigned to identifiable assets acquired less liabilities assumed. In connection with the Company's SEC reporting obligations the Company has prepared pro forma financial information. The following is a comparison, between the actual and pro forma information presented. The following pro forma amounts are presented as if the acquisition of PRHC by SNIG had occurred as of the beginning of each period presented.
PRO FORMA --------------------------------------------- SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, DECEMBER 31, 1997(1) 1997(2) 1997(3) 1996(4) ------------- ------------- ------------- ------------ (IN THOUSANDS, EXCEPT PER SHARE DATA) Total Revenues........................... $ 108,392 $ 128,609 $ 129,348 $ 187,732 Net income (loss) from continuing operations............................. $ (5,459) $ (1,985) $ (23,543) $ (20,417) Net loss................................. $ (7,642) $ (9,666) $ (25,726) $ (22,880) Earnings (loss) per common share from continuing operations.................. $ (1.09) $ (0.34) $ (4.03) $ (2.65) Loss per common share.................... $ (1.52) $ (1.66) $ (4.41) $ (2.97) Weighted average shares outstanding...... 5,040,360 5,837,173 5,837,173 7,706,108
5 8 SUPERIOR NATIONAL INSURANCE GROUP, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 1997 (UNAUDITED) - --------------- (1) Represents the results of operations of the Company for the nine months ended September 30, 1997. The acquired Company's results are incorporated in the Company's results for periods after April 1, 1997. Balances reflect all purchase accounting adjustments known to date. (2) Represents the pro forma combined balances of SNIG and PRHC at September 30, 1997 adjusted for purchase accounting; the restatement of PRHC's December 31, 1996 audited financial statements; and the expected savings from management's implementation of its integration plan for PRHC. (3) Represents the pro forma combined balances of SNIG and PRHC as if the transaction had occurred on January 1, 1997. The balances have been adjusted for the results of PRHC's first quarter results; purchase accounting and the restatement of PRHC's December 31, 1996 audited financial statements as filed in Form 8-K/A dated September 5, 1997. (4) Represents the pro forma combined balances of SNIG and PRHC as if the transaction had occurred on January 1, 1996. The balances have been adjusted for purchase accounting adjustments and the restatement of PRHC's December 31, 1996 audited financial statements as filed in Form 8-K/A dated September 5, 1997. A.3 Earnings Per Share ("EPS") Earnings per common and dilutive common equivalent shares for the three and nine months ended September 30, 1997, and 1996, are based on the average number of common shares outstanding during each period and the number of common shares that would be outstanding if all outstanding stock options and warrants were exercised. While the assumed conversion of common stock equivalents, such as stock options and warrants, generally has a dilutive effect on EPS, if the assumed conversion of all common stock equivalents is antidilutive to the EPS calculation, then such common stock equivalents are excluded from EPS amounts. The number of shares used in the EPS calculations are 7,692,289 and 5,040,360 shares for the three and nine months ended September 30, 1997, respectively, and 5,316,873 shares for the three and nine months ended September 30, 1996. In February 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standard presentation No. 128, and "Earnings per Share" ("SFAS 128"), which establishes the computation, presentation, and disclosure requirements for earnings per share. SFAS 128 is effective for fiscal periods ending after December 15, 1997. The effects of SFAS 128 on the Company's earnings per share calculation is not expected to be materially different from that historically presented. In June 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standard No. 130, "Reporting Comprehensive Income" ("SFAS No. 130"). SFAS 130 is effective for periods ending after December 15, 1997, including interim periods. SFAS No. 130 requires companies to report comprehensive income and its components in a financial statement and display the accumulated balance of other comprehensive income separately from retained earnings and additional paid-in-capital. Comprehensive income includes all changes in equity during a period except those resulting from investments by stockholders and distributions to stockholders. The Company has not determined the impact of SFAS No. 130. Also, in June 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards, No. 131, "Disclosures about Segments of an Enterprise and Related Information" ("SFAS No. 131"). This statement specifies revised guidelines for determination of an entity's operating segments and the type and level of financial information to be disclosed. SFAS No. 131 is effective for periods ending after 6 9 SUPERIOR NATIONAL INSURANCE GROUP, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 1997 (UNAUDITED) December 15, 1997, including interim periods. The Company has not determined the impact of SFAS No. 131. A.4 Claim and Claim Adjustment Expense Reserves The liability for unpaid claim and claim adjustment expenses is based on an evaluation of reported losses and on estimates of incurred but unreported losses. The reserve liabilities are determined using adjusters' individual case estimates and statistical projections, which can be affected by many external factors that are difficult to predict, including changes in the economy, trends in medical treatments and litigation, changes in regulatory environment, medical services, and employment rights. The liability is reported net of estimated salvage and subrogation recoverables. Adjustments to the liability resulting from subsequent developments or revisions to the estimate are reflected in results of operations in the period in which such adjustments become known. While there can be no assurance that reserves at any given date are adequate to meet SNIG's obligations, the amounts reported on the balance sheet are management's best estimate of that amount. NOTE B. FINANCING AGREEMENT During 1996, the Company entered into a financing transaction involving Centre Re and Chase. Chase extended a $93.1 million term loan (net of transaction costs). The Company used the proceeds from the financing to purchase from SNIC reinsurance receivables due from Centre Re. The principal balance of the loan was collateralized by receivables due from the reinsurer and amortized based upon the payout pattern of the underlying claims of the reinsurance receivables. In June 1997, the $93.1 million term loan was retired, $110.5 million of receivables from a related party reinsurer, in connection with a financing transaction, was transferred to Chase in exchange for the cancellation of the Company's $94.9 million debt due to Chase under the loan. The retirement of this collateralized financing resulted in the Company's recognizing a $15.7 million charge. NOTE C. DEBT AGREEMENT Upon the close of the PRHC acquisition on April 11, 1997, the Company obtained a term loan in the amount of $44 million. The loan is collateralized by the stock of the Company's intermediate holding company Superior Pacific Insurance Group, Inc. ("SPIG") and certain of SPIG's subsidiaries. The Company used the proceeds of the term loan for the acquisition and related expenses, a capital contribution to SPCC, and to prepay existing indebtedness. The loan is due six years from April 11, 1997. Principal payments are due semi-annually in eleven consecutive installments of $3.65 million commencing October 11, 1997, with a final installment of $3.85 million. The interest rate on the debt is a LIBOR-based variable rate that will not exceed Chase's prime commercial lending rate unless default interest becomes due. NOTE D. DISCONTINUED OPERATIONS Outstanding discontinued operations claim and claim adjustment expense reserves were $21.2 million at September 30, 1997, which was consistent with management's expectations. Offsetting these liabilities are $7.4 million of reinsurance recoverables on paid and unpaid claim and claim adjustment expenses. 7 10 SUPERIOR NATIONAL INSURANCE GROUP, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 1997 (UNAUDITED) NOTE E. RECONCILIATION WITH PREVIOUSLY REPORTED AMOUNTS The amounts shown in the Condensed Consolidated Statement of Cash Flows differ from those previously reported as a result of reclassifications made to the Condensed Consolidated Balance Sheet. A reconciliation of amounts restated are as follows:
NINE MONTHS ENDED SEPTEMBER 30, -------------------- 1997 1996 -------- -------- Net cash (used in) provided by financing activities As previously reported.................................... $(26,455) $(21,679) Reclass of investments withheld from reinsurer............ -- $ 38,586 -------- -------- As restated............................................. $(26,455) $ 16,907 ======== ======== Net cash (used in) provided by financing activities As previously reported.................................... $ 48,644 $ 2,709 Reclass of investments and cash for discontinued operations.............................................. 3,225 -- -------- -------- As restated............................................. $ 51,869 $ 2,709 ======== ======== Net cash (used in) provided by investing activities As previously reported.................................... $(90,903) $ 52,098 Reclass of investment funds withheld from reinsurer....... -- 71,061 Reclass of funds withheld from reinsurers................. -- (110,098) Reclass of investments held for sale...................... 55,339 -- Reclass of investments and cash for discontinued operations.............................................. (3,225) -- Reclass of invested cash from cash and cash equivalents to short term investments.................................. 4,562 (5,931) -------- -------- As restated............................................. $(34,227) $ 7,130 ======== ======== Cash and cash equivalents at the end of the period As previously reported.................................... $ 33,223 $ 36,080 Reclass of invested cash from cash and cash equivalents to short term investments.................................. (7,613) (3,146) -------- -------- As restated............................................. $ 25,610 $ 32,934 ======== ========
8 11 ITEM 2 -- MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL CONDITION AND RESULTS OF OPERATIONS References to "SNIG" and "the Company" in this quarterly report include the results of operations of the newly acquired subsidiary Superior Pacific Casualty Company ("SPCC"), formerly known as The Pacific Rim Assurance Company for the period beginning April 1, 1997. This discussion and analysis contains statements that constitute "forward-looking" statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements relate to future events or the future financial performance of the Company and involve known and unknown risks, uncertainties and other factors that may cause the actual results, performance or achievements of the Company to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. Such factors include, among other things, inherent uncertainties related to the effect of the acquisition of Pac Rim Holding Corporation ("PRHC") and its subsidiary SPCC, the Company's leverage, and general conditions in the economy and in the workers' compensation insurance market in particular, and such factors could cause actual results to differ materially from those indicated by such forward-looking statements. OVERVIEW The Company recorded an underwriting profit from continuing operations of $3.5 million in the three month period ended September 30, 1997, versus an underwriting profit of $1.6 million in the corresponding period in the prior year, and an underwriting profit of $5.1 million for the nine month period ended September 30, 1997, versus an underwriting profit of $4.8 million in the corresponding period in the prior year. The increase in underwriting profit from continuing operations was primarily the result of an increase in premiums as a result of the SPCC acquisition. During the three months ended September 30, 1997 the Company realized net income of $2.1 million or $0.28 per share as compared to $0.7 million or $0.15 per share for the three months ended September 30, 1996. The primary reason for the increase in net income was the increase in investment income, resulting from the increase in invested assets. The Company incurred a net loss of $7.6 million or $1.52 per share for the nine month period ended September 30, 1997, versus income of $1.9 million or $0.41 per share in the corresponding period of the prior year. The loss in the current year relates to a $15.7 million charge due to the termination of a financing transaction with a related party reinsurer, (namely, Centre Reinsurance Limited "Centre Re"). The Company acquired PRHC for approximately $42 million on April 11, 1997, and thereupon SPCC became a subsidiary of the Company. The acquisition was accounted for as a purchase. Total assets, including goodwill, increased to $411.2 million at September 30, 1997, from $323.8 million at December 31, 1996, primarily as a result of the acquisition. As of September 30, 1997, the Company had recorded $25.8 million in goodwill, the excess of purchase price over amounts assigned to identifiable assets acquired less liabilities assumed. The previously announced audit by the Company's independent auditors of the financial statements of PRHC for the fiscal years ended December 31, 1996, 1995, and 1994 was completed August 28, 1997. See "Item 6(b) -- Reports on Form 8K." GENERAL FINANCIAL CONDITION Total assets increased $183.1 million or 80.3% to $411.2 million at September 30, 1997, as compared to the same period in 1996. The increase was due to approximately $189.3 million in assets recorded related to the acquisition of PRHC, which was partially offset by a reduction of approximately $91.6 million in receivables due from a related party reinsurer that were transferred to Chase in exchange for cancellation of debt. Total liabilities increased $168.6 million or 105.2% to $328.8 million at September 30, 1997, as compared to the same period in 1996. The increase was due to approximately $171.2 million in liabilities recorded 9 12 related to the acquisition of PRHC, which was partially offset by the cancellation of the $94.9 million debt to Chase and $6.6 million Imperial Bank debt. Total equity increased $11.7 million or 25.9% to $56.8 million at September 30, 1997, as compared to the same period in 1996. Approximately $18 million in additional capital was related to the April 11, 1997, private stock issuance and sale. This increase was partially offset by expenditures and increases in claims reserves associated with the acquisition of PRHC and the $15.7 million charge due to the termination of a financing transaction with a related party reinsurer. RESULTS OF OPERATIONS The following selected financial data and analysis provide an assessment of SNIG's financial results for the three months ended September 30, 1997, as compared to the three months ended September 30, 1996. Certain prior period amounts have been reclassified to conform to the current period presentation. Selected financial data as reported for the three months ended September 30, 1997 and 1996 are presented below.
THREE MONTHS ENDED SEPTEMBER 30, ---------------------- 1997 1996 --------- --------- (DOLLARS IN THOUSANDS) Gross premiums written.................................... $ 43,121 $ 26,033 Net premiums written...................................... $ 32,890 $ 23,337 Net premiums earned....................................... $ 34,760 $ 23,007 Less: Claim and claim adjustment expenses, net of reinsurance.......................................... (21,316) (14,201) Underwriting and general and administrative expenses.... (9,913) (7,911) Policyholder dividends.................................. -- 715 --------- --------- Underwriting profit....................................... 3,531 1,610 Net investment income (excluding capital gains and losses)................................................. 3,696 2,117 Net investment gains...................................... 27 12 Interest expense.......................................... (1,158) (2,126) Other income (expense), net............................... (296) (173) Goodwill amortization..................................... (340) -- --------- --------- Income from continuing operations -- pre-tax.............. 5,460 1,440 Income tax expense........................................ 2,052 300 --------- --------- Income before preferred securities dividends, accretion and extraordinary items................................. 3,408 1,140 Preferred securities dividends and accretion, net of taxes................................................... (480) (428) Extraordinary loss on retirement of long-term debt, net of taxes................................................... (796) -- --------- --------- Net Income...................................... $ 2,132 $ 712 ========= ========= UNDERWRITING RATIOS (GAAP BASIS): Net claims and claim adjustment expense ratio............. 61.3% 61.7% Underwriting expense ratio................................ 28.5% 34.4% Policyholder dividends ratio.............................. -- (3.1%) --------- --------- Combined ratio............................................ 89.8% 93.0% ========= =========
Gross premiums written increased $17.1 million or 65.6% to $43.1 million in the third quarter of 1997 as compared to the same period in 1996. Substantially all of this increase can be attributed to the addition of business written by SPCC. Net premiums written increased $9.6 million or 40.9% to $32.9 million in the third quarter of 1997 as compared to the same period in 1996, reflecting the increase in gross premiums written. Net 10 13 premiums earned increased $11.8 million or 51.1% to $34.8 million in the third quarter of 1997 as compared to the same period in 1996, reflecting the increase in net premiums written. Net claim and claim adjustment expenses increased $7.1 million or 50.1% to $21.3 million in the third quarter of 1997 as compared to the same period in 1996, $1.4 million of which resulted from the addition of business written by SPCC. The remaining $5.7 million increase was due to the return of results in 1997 to historical averages and to unfavorable development in the 1995 accident year. The net claim and claim adjustment expense ratio slightly decreased to 61.3% in the third quarter of 1997 from 61.7% in the same period of 1996. Although the Company has been experiencing a reduction in the frequency of claims, at the same time there may be an increase in claims severity for injuries sustained in 1995 and thereafter. Management currently intends to address this potential trend with the planned severity management program, which is intended to reduce the Company's average ultimate claim and claim adjustment expense per claim for 1995 and subsequent dates of injury. See "Item 5 -- Other Information." Underwriting and general and administrative expenses, excluding policyholder dividends, increased $2.0 million or 25.3% to $9.9 million in the third quarter of 1997, as compared to the same period in 1996. Net commission expense increased $0.2 million or 6.4% to $2.8 million in the third quarter of 1997, as compared to the same period in 1996. The increase in net commission expense is due to an increase in premiums. Net underwriting and general and administrative expenses increased 35% to $7.1 million in the third quarter of 1997 from $5.3 million in the same period of 1996. The Company's underwriting expense ratio decreased 5.9% to 28.5% for the third quarter of 1997 from 34.4% for the same period in 1996, due primarily to a reduction in commission expense relative to the related premium level. Commission expense decreased relative to premium levels due to an increase in ceding commissions received. No policyholder dividends were paid during the third quarter of 1997, as compared to the payment of $0.8 million of such dividends during the same period in 1996. Prior to the elimination of required minimum rates in California ("open rating"), policyholder dividends served both as an economic incentive to employers for safe operations and as a means of price differentiation. Estimated amounts to be returned to policyholders were accrued when the related premium was earned by the Company, and dividends were paid to the extent that a surplus was accumulated from premiums on workers' compensation policies. As a result of consumers' preference for the lowest net price at the policy's inception under open rating, dividends are no longer a significant factor in the marketing of workers' compensation insurance in California. In 1995, as a result of the diminishing value of policyholder dividends, SNIC's management declared a moratorium on the payment of policyholder dividends for California policies. In December 1996, the Company discontinued policyholder dividend payments. The Company recorded an underwriting profit from continuing operations of $3.5 million in the third quarter of 1997, versus $1.6 million for the same period in 1996. The increase in underwriting profit from continuing operations was primarily the result of an increase in premiums as a result of the SPCC acquisition, coupled with a decrease in related expenses relative to the premium level. Net investment income, excluding realized investment gains/losses, increased $1.6 million or 74.6% to $3.7 million in the third quarter of 1997 compared to the same period in 1996. The improvement is due to the increase in assets available for investment resulting from the SPCC acquisition. Excluding SPCC, net investment income decreased $0.3 million or 13% to $1.8 million in the third quarter of 1997 as compared to the same period in 1996. This 13% decrease was due to a decline in the average amount of invested assets by $21.9 million or 14.4% to $130.3 million in the third quarter of 1997 as compared to the same period in 1996. Essentially no realized investment gains or losses were recorded in the quarters ended September 30, 1997 and 1996. Interest expense decreased $1.0 million or 45.5% to $1.2 million in the third quarter of 1997 as compared to the same period in 1996, due primarily to the termination of interest payments on the funds withheld balance connected with a 1993 contract with a related party reinsurer and the retirement of approximately $6.6 million in outstanding debt, offset by the Company's incurrence of a $44.0 million term loan in connection with its acquisition of Pac Rim. 11 14 Selected financial data as reported for the nine months ended September 30, 1997 and 1996 are presented below.
NINE MONTHS ENDED SEPTEMBER 30, 1997 1996 ---------- ---------- (DOLLARS IN THOUSANDS) Gross premiums written.................................... $ 114,211 $ 74,192 Net premiums written...................................... $ 96,596 $ 66,133 Net premiums earned....................................... $ 99,148 $ 66,040 Less: Claim and claim adjustment expenses, net of reinsurance.......................................... (66,311) (36,801) Underwriting and general and administrative expenses.... (27,762) (26,546) Policyholder dividends.................................. -- 2,121 ---------- ---------- Underwriting profit....................................... 5,075 4,814 Net investment income (excluding capital gains and losses)................................................. 9,198 6,361 Net investment gains (losses)............................. 46 33 Interest expense.......................................... (5,302) (6,922) Loss on termination of financing transaction with a related party reinsurer................................. (15,699) -- Other income (expense), net............................... (817) 216 Goodwill amortization..................................... (477) -- ---------- ---------- Income from continuing operations -- pre-tax.............. (7,976) 4,502 Income tax expense........................................ (2,517) 1,348 ---------- ---------- Income before preferred securities dividends and accretion and extraordinary items................................. (5,459) 3,154 Preferred securities dividends and accretion, net of taxes................................................... (1,387) (1,238) Extraordinary loss on retirement of long-term debt, net of taxes................................................... (796) -- ---------- ---------- Net (Loss) Income......................................... $ (7,642) $ 1,916 ========== ========== UNDERWRITING RATIOS (GAAP BASIS): Net claims and claim adjustment expense ratio............. 66.9% 55.7% Underwriting expense ratio................................ 28.0% 40.2% Policyholder dividends ratio.............................. -- (3.2%) ---------- ---------- Combined ratio............................................ 94.9% 92.7% ========== ==========
Gross premiums written increased $40.0 million or 53.9% to $114.2 million in the first nine months of 1997 as compared to the same period in 1996. Substantially all of this increase can be attributed to the addition of business written by SPCC. Net premiums written increased $30.5 million or 46.1% to $96.6 million in the first nine months of 1997 as compared to the same period in 1996, reflecting the increase in gross premiums written. Net premiums earned increased $33.1 million or 50.1% to $99.1 million in the first nine months of 1997 as compared to the same period in 1996, reflecting the increase in net premiums written. Net claims and claim adjustment expenses increased $29.5 million or 80.2% to $66.3 million in the first nine months of 1997 as compared to the same period in 1996, $19.9 million or 67.5% of which resulted from business written by SPCC. The net claims and claim adjustment expense ratio increased to 66.9% in the first nine months of 1997 from 55.7% in the same period of 1996, due primarily to business written by SPCC. Excluding SPCC, SNIC's net claim and claim adjustment expense ratio increased to 68.3% in the first nine months of 1997 from 55.7% in the same period of 1996, due to the return of results in 1997 to historical averages and to unfavorable development in the 1995 accident year. Although the Company has been experiencing a reduction in the frequency of claims, at the same time there may be an increase in claims severity for injuries sustained in 1995 and thereafter. Management currently intends to address this potential trend with the planned severity management program, which is intended to reduce the Company's average 12 15 ultimate claim and claim adjustment expense per claim for 1995 and subsequent dates of injury. See "Item 5 -- Other Information." Underwriting expenses, excluding policyholder dividends and a loss on the termination of a financing transaction with a related party reinsurer, increased $1.2 million or 4.6% to $27.8 million in the first nine months of 1997 as compared to the same period in 1996. Net commission expense increased $1.8 million or 22.8% to $9.7 million in the first nine months of 1997 from the same period in 1996. Excluding the one-time expense of $5.3 million for the cancellation of a reinsurance contract recorded during the second quarter of 1996, underwriting expenses increased $6.5 million or 31.0% to $27.8 million in the first nine months of 1997 as compared to the same period in 1996 as a result of the SPCC acquisition. The Company's expense ratio decreased to 28.0% for the nine months ended September 30, 1997 from 37.0% for the same period in 1996, due primarily to the 1996 expense of $5.3 million in connection with a negotiated settlement of a reinsurance contract with Centre Re. Excluding SPCC, the Company's expense ratio decreased to 37.3% for the first nine months of 1997 from 37.0% for the same period during 1996. No policyholder dividends were paid during the first nine months of 1997 as compared to the payment of $1.3 million of such dividends during the same period in 1996. Prior to open rating, policyholder dividends served both as an economic incentive to employers for safe operations and as a means of price differentiation. Estimated amounts to be returned to policyholders were accrued when the related premium was earned by the Company. Dividends were paid to the extent that a surplus was accumulated from premiums on workers' compensation policies. As a result of consumers' preference for the lowest net price at the policy's inception under open rating, dividends are no longer a significant factor in the marketing of workers' compensation insurance in California. In 1995, as a result of the diminishing value of policyholder dividends, SNIC's management declared a moratorium in the payment of policyholder dividends for California policies. In December 1996, the Company discontinued policyholder dividend payments. The Company recorded an underwriting profit, excluding the loss on the termination of a financing transaction with a related party reinsurer, from continuing operations of $5.1 million for the nine months ended September 30, 1997, versus $4.8 million for the same period in 1996. The increase in underwriting profit from continuing operations was primarily the result of a decrease in underwriting expenses relative to the related premiums. The Company incurred a net loss of $7.6 million or $1.52 per share for the nine month- period ended September 30, 1997, versus income of $1.9 million or $0.41 per share in the corresponding period of the prior year. The loss in the current year relates to a $15.7 million pretax charge due to the termination of a financing transaction with a related party reinsurer. Net investment income, excluding investment gains/losses, increased $2.8 million or 44.6% to $9.2 million in the first nine months of 1997 as compared to the same period in 1996 as a result of the acquisition of SPCC. Excluding SPCC, net investment income decreased 8.5% or $0.5 million in the first nine months of 1997 as compared to the same period in 1996. This 8.5% decrease was due to a decline in the average amount of invested assets by $19.8 million or 12.6% to $137.7 million in the nine months of 1997 as compared to the same period in 1996. Essentially no realized investment gains or losses were recorded for the nine months ended September 30, 1997 and 1996. Interest expense decreased $1.6 million or 23.4% to $5.3 million for the first nine months of 1997 as compared to the same period in 1996, due primarily to the elimination of funds withheld balance and the retirement of approximately $6.6 million in outstanding debt, partially offset by the Company's incurrence of a $44.0 million term loan in connection with its acquisition of Pac Rim. In June 1997, the Company recorded a $15.7 million charge related to the termination of a financing transaction with a related party reinsurer. The termination of the financing transaction transferred $110.5 million in receivables from a related party reinsurer in exchange for the cancellation of $94.9 million in indebtedness to Chase. No such charges were incurred in the 1996 period. 13 16 A summary of net investment income, excluding capital gains (losses), for the three and nine months ended September 30, 1997 and 1996 are as follows:
THREE MONTHS NINE MONTHS ENDED ENDED SEPTEMBER 30, SEPTEMBER 30, --------------- --------------- 1997 1996 1997 1996 ------ ------ ------ ------ (DOLLARS IN THOUSANDS) Interest on bonds and notes................. $3,234 $1,909 $6,032 $6,060 Interest on invested cash................... 662 324 3,714 656 ------ ------ ------ ------ Total investment income..................... 3,896 2,233 9,746 6,716 Capital gains............................... 27 12 46 33 Investment expense.......................... 200 116 548 355 ------ ------ ------ ------ Net investment income....................... $3,723 $2,129 $9,244 $6,394 ====== ====== ====== ======
The distribution of SNIG's consolidated investment portfolio is as follows (in thousands):
SEPTEMBER 30, 1997 DECEMBER 31, 1996 ------------------- ------------------ CARRYING MARKET CARRYING MARKET AVAILABLE FOR SALE: VALUE VALUE VALUE VALUE ------------------- -------- -------- -------- ------- U.S. Government Agencies and Authorities......................... $ 49,823 $ 49,823 $22,484 $22,484 Collateralized Mortgage Obligations... 48,189 48,189 12,855 12,855 Corporate Instruments................. 43,383 43,383 9,867 9,867 Special Revenue and Special Assessment.......................... 63,337 63,337 -- -- State and Political Subdivisions...... -- -- 1,124 1,124 -------- -------- ------- ------- Total Available for Sale.............. $204,732 $204,732 $46,330 $46,330 ======== ======== ======= =======
SEPTEMBER 30, DECEMBER 31, 1997 1996 ------------- --------------- MARKET MARKET EQUITY SECURITIES COST VALUE COST VALUE ----------------- ---- ------ ------ ------ DOLLARS IN THOUSANDS) Corporate..................................... $686 $849 $1,199 $1,173 ---- ---- ------ ------ Total......................................... $686 $849 $1,199 $1,173 ==== ==== ====== ======
The Company's management monitors the matching of assets and liabilities and attempts to maintain its investment duration at the mid-point of the length of its net claim and claim adjustment expenses payout pattern. Investment duration is the weighted average measurement of the current maturity of a fixed income security, in terms of time, of the present value of the future payments to be received from that security. However, in selecting assets to purchase for its investment portfolio, the Company considers each security's modified duration and the effect of that security's modified duration on the portfolio's overall modified duration. Modified duration is a measurement that estimates the percentage change in market value of an investment for a small change in interest rates. The modified duration of fixed maturities at September 30, 1997, was 2.91 years compared to 4.69 years at December 31, 1996. At September 30, 1997, 98.0% of the carrying values of investments in the fixed maturities portfolio were rated as investment grade by the Securities Valuation Office of the National Association of Insurance Commissioners. DISCONTINUED OPERATIONS Outstanding discontinued operations claims counts and losses were 216 and $21.2 million, respectively, as of September 30, 1997, which was consistent with management's expectations. The Company has significant exposure to construction defect liabilities on property and casualty insurance policies underwritten from 1986 to 1993. Management continues to closely monitor its potential exposure to construction defect claims and has not changed its estimates of ultimate claim and claim adjustment expenses on discontinued operations since 1995. Management believes its current reserves are adequate to cover its claims activity. There can be no assurance, however, that further upward development of ultimate loss costs associated with construction defect 14 17 claims will not occur. Offsetting these liabilities are $7.4 million of reinsurance recoverables on paid and unpaid claim and claim adjustment expenses. The Company will continue to closely monitor the adequacy of its loss reserves in the discontinued operations. LIQUIDITY AND CAPITAL RESOURCES Liquidity is a measure of an entity's ability to secure sufficient cash to meet its contractual obligations and operating needs. The Company's cash inflows are generated from cash collected for policies sold, investment income on the existing portfolio and sales and maturities of investments. The Company's cash outflows consist primarily of payments for policyholders' claims, operating expenses, and debt service. For their insurance operations, SNIC and SPCC must have available cash and liquid assets to meet their obligations to policyholders and claimants in accordance with contractual obligations in addition to meeting their ordinary operating costs. Absent adverse material changes in the workers' compensation insurance market, management believes that the Company's present cash resources are sufficient to meet the needs of the Company for the foreseeable future. During the first nine months of 1997, the Company used $26.5 million of cash in its operations versus cash generated of $16.9 million during the same period in 1996. The Company's continued negative cash flow is the result of the Company's historical inforce premium base being significantly higher than its current level. The Company anticipates it will continue to experience negative cash flow from operations until the claims related to the historically higher premium base have been paid out. The $43.4 million increase in cash used in operations during the first nine months of 1997 is partially due to $4.8 million from the addition of SPCC operations for the second and third quarters of 1997 and a $38.6 million decrease in 1996 from investments withheld from related party reinsurer. The Company believes that it has adequate short-term investments and readily marketable investment grade securities to cover both claim payments and expenses. As of September 30, 1997, the Company had total cash, cash equivalents and investments of $238.8 million and had 99.7% of its investment portfolio invested in cash, cash equivalents, and fixed maturities. In addition, 85.8% of the Company's fixed-income portfolio had ratings of "AA" or equivalent or better and 98.0% had ratings of "BBB" or equivalent or better. The Company generated $51.9 million in cash from financing activities for the nine months ended September 30, 1997, as compared to $2.7 million for the corresponding period in 1996. The Company substantially increased its financing activities in the first nine months of 1997 compared to the same period in 1996 because of its need to fund its acquisition in April 1997 of Pac Rim and to repay outstanding bank debt. The Company generated the necessary cash with the proceeds from a $44.0 million term loan and the issuance and sale by the Company of approximately $18.0 million in Common Stock. Of the approximately $62.0 million raised in such financing transactions, approximately $6.6 million was used to prepay the Company's then outstanding bank debt, $10 million was contributed as capital to SPCC, and the remainder was used for general corporate purposes, including the payment of related transaction costs. During the first nine months of 1997, the Company's working cash flow increased approximately $44.0 million as a result of the California Department of Insurance's (the "DOI") release of excess assets pledged by SNIC to secure future workers' compensation claims. In addition, the Company has been informed by the DOI that it will release in the fourth quarter of 1997, an additional $20 million of excess assets currently pledged by SPCC to secure future workers' compensation claims. In November 1996, the Company entered into a financing transaction involving Centre Re and Chase pursuant to which Chase extended a $93.1 million term loan (net of transaction costs). The Company used the proceeds from the transaction to purchase from SNIC reinsurance receivables due from Centre Re. As a result of these actions, the Company's investable assets increased $93.1 million. The additional investments contributed to the increase in investment income in 1997. In June 1997, the term loan was retired when $110.5 million of receivables from Centre Re were transferred to Chase in exchange for cancellation of the Company's $94.9 million debt due to Chase under the term loan. The retirement of the term loan resulted in the Company recognizing a $15.7 million charge. 15 18 The Company has a reverse repurchase facility with a national securities brokerage firm that allows it to engage in up to $20 million in reverse repurchase transactions secured either by U.S. Treasury instruments, U.S. Agency debt, or corporate debt. This arrangement provides the Company with additional short-term liquidity. Reverse repurchase transactions may be rolled over from one period to the next, at which time the transaction is repriced. This type of financing allows the Company a great deal of flexibility to manage short-term investments, avoiding the unnecessary realization of losses to satisfy short-term cash needs. Further, this method of financing is less expensive than bank debt. As of September 30, 1997, the Company had no obligation outstanding under this facility. The Company, as a holding company, depends on dividends and intercompany tax allocation payments from its operating Subsidiaries for its net cash flow requirements, which consist primarily of periodic payments on its outstanding debt obligations. Absent other sources of cash flow, the Company cannot expend funds materially in excess of the amount of dividends or tax allocation payments that could be paid to it by SNIC and SPCC. Further, insurance companies are subject to restrictions affecting the amount of shareholder dividends and advances that may be paid within any year without the prior approval of the DOI. The California Insurance Code provides that amounts may be paid as dividends on an annual noncumulative basis (generally up to the greater of (i) net income for the preceding year and (ii) 10% of statutory surplus as regards policyholders as of the preceding December 31) without prior notice to, or approval by, the DOI. Dividends may only be paid out of "earned surplus" as defined in the California Insurance Code. No dividends were paid during the nine months ended September 30, 1997. The Company is a party to various leases principally associated with the Company's home and branch office space. Such leases contain provisions for scheduled lease charges and escalations in base rent over the lease term. The Company's minimum commitment with respect to these leases in 1997, is approximately $4.1 million. These leases expire from 1997 to 2002. The Company does not foresee any expenditures during the next twelve months other than those arising in the normal course of business. The Company is required to make principal payments on the Chase term loan of $3.65 million twice per annum commencing October 11, 1997. The Company made a $10 million capital contribution to SPCC upon consummation of the acquisition, and management believes SPCC is adequately capitalized for the foreseeable future. In connection with its acquisition of SPCC, the Company agreed with the DOI that SPCC would operate in a "run-off" situation and that all new and renewed business would be written only by SNIC. As a result, the Company has been integrating SPCC's pre-acquisition operations into SNIC's operations and has substantially completed the process. The effect of inflation on the revenues and net income during the three and nine months ended September 30, 1997 was not significant. PART II -- OTHER INFORMATION ITEM 5 -- OTHER INFORMATION In November 1997, the Company entered into a non-binding letter of intent with Risk Enterprise Management Limited ("REM"), an affiliate of Zurich Reinsurance Centre Holdings, Inc. ("Zurich"), that contemplates an agreement under which certain of the Company's claims management functions would be performed by REM. In connection with the Company's plan to enter into the claim management program, the Company and Zurich Reinsurance (North America), Inc. ("ZRNA"), another Zurich affiliate, have signed a non-binding letter of intent whereby ZRNA would provide average claims severity protection through accident year 2000 (together, with the claims management program, the "Severity Management Program"). The total cost of the Severity Management Program to the Company is expected to be approximately $35.0 million through December 31, 1998, with amounts thereafter to be determined. While the Company expects that definitive documents will be completed in the near future, the letters of intent are not binding on the parties; as a result, there can be no assurance that the Severity Management Program, if consummated, will take the form outlined in the letters of intent. 16 19 The letter of intent with REM contemplates that REM would provide certain claims management services, while the Company would provide claims facilities and data processing systems. REM would be bound by operational restrictions and performance standards designed to assure quality claims administration. The Company believes that combining REM's claims management techniques with its claims processing systems should produce material improvements in the Company's claims severity, more than offsetting the cost of such services. The Company believes that the Severity Management Program will reduce the Company's ultimate severity with favorable cost-benefit trade-offs. Under the proposed agreement with ZRNA, ZRNA would credit the Company direct claims costs by up to $3,500 per claim (up to an aggregate of $30 million) to the extent that the Company's open claims severity through 1997 exceeds $38,700, and for claims incurred after 1997, ZRNA will credit the Company direct claims costs by as yet undetermined per claim amounts to the extent that the Company's ultimate claims severity subsequent to 1997 exceeds expected severity targets. The Company would pay ZRNA $10 million in 1997, an estimated $10 million in 1998, and as yet unspecified amounts in 1999 and 2000. ITEM 6 -- EXHIBITS AND REPORTS ON FORM 8-K (a) EXHIBITS
EXHIBIT NUMBER DESCRIPTION ------- ----------- 10.1 Employment Agreement, dated June 1, 1997, by and between Mr. William L. Gentz, President and Chief Executive Officer of the Company, and the Company+ 10.3 Employment Agreement, dated June 1, 1997, by and between J. Chris Seaman, Executive Vice President and Chief Financial Officer of the Company, and the Company+ 10.40 State of California Department of Insurance Amended Certificate of Authority+ 10.65 Amendment No. 1 to 1997 Credit Agreement, dated as of September 25, 1997+ 11 Computation of Earnings per Share+ 27 Financial Data Schedule*
- --------------- + Included in original Form 10-Q as filed with the Commission. * Filed herewith. (b) REPORTS ON FORM 8-K: On July 10, 1997, the Company filed a Current Report on Form 8-K reporting under Item 5 the prepayment of approximately $88.6 million of long-term debt outstanding to The Chase Manhattan Bank. On April 25, 1997, the Company filed a Current Report on Form 8-K with respect to its April 11, 1997 acquisition of PRHC. Such Form 8-K was filed without the financial statements and pro forma financial information required by Item 7 of Form 8-K, as it was impractical to do so at that time. On July 25, 1997, the Company announced that it was investigating the possibility that errors contained in the historical financial statements of PRHC might have to be corrected in a filing with the Securities and Exchange Commission. SNIG had engaged its auditors, KPMG Peat Marwick LLP, to re-audit the financial statements of PRHC for the years ending December 31, 1996, 1995, and 1994. In SNIG's view, the financial statements provided to SNIG by PRHC's management and auditors prior to SNIG's April 11, 1997, acquisition of PRHC used methods and assumptions that may not have been consistent with generally accepted accounting principles. On September 5, 1997, the Company filed a Form 8-K/A in order to amend the Form 8-K filed on April 25, 1997, which included the re-audited financial statements of PRHC and the other financial statements and pro forma financial information required by Item 7 of Form 8-K with respect to the Company's acquisition of PRHC. The net effect of the audit was an overall adjustment to the December 31, 1996 financial statements of PRHC that resulted in an increase in net loss of $7 million and a net decrease in stockholders' equity of $7 million. 17 20 SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Dated: October 16, 1998 SUPERIOR NATIONAL INSURANCE GROUP, INC. By /s/ J. CHRIS SEAMAN ---------------------------------- Name: J. Chris Seaman Title: Executive Vice President and Chief Financial Officer 18 21 EXHIBIT INDEX
EXHIBIT NUMBER DESCRIPTION PAGE ------- ----------- ---- 10.1 Employment Agreement, dated June 1, 1997, by and between Mr. William L. Gentz, President and Chief Executive Officer of the Company, and the Company+ 10.3 Employment Agreement, dated June 1, 1997, by and between J. Chris Seaman, Executive Vice President and Chief Financial Officer of the Company, and the Company+ 10.40 State of California Department of Insurance Amended Certificate of Authority+ 10.65 Amendment No. 1 to 1997 Credit Agreement, dated as of September 25, 1997+ 11 Computation of Earnings per Share+ 27 Financial Data Schedule*
- --------------- + Included in original Form 10-Q as filed with the Commission. * Filed herewith. EX-27 2 FINANCIAL DATA SCHEDULE
7 1,000 9-MOS DEC-31-1997 JAN-01-1997 SEP-30-1997 204,732 0 0 849 0 0 213,194 25,610 852 5,834 411,228 222,625 14,988 0 1,370 42,366 25,672 0 34,128 22,676 411,228 99,148 9,244 46 0 66,311 13,647 14,115 (7,976) (2,517) (5,459) 0 (796) 0 (7,642) 0 (1.52) 195,131 61,472 4,839 12,362 80,490 168,590 4,839 1. RESERVES FOR UNPAID CLAIMS, PROVISION FOR INSURED EVENTS, AND PAYMENTS OF CLAIMS ARE STATED NET OF REINSURANCE 2. OPENING RESERVES INCLUDE AMOUNTS FROM PAC RIM AT ACQUISITION
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