<PAGE>
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2000
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _________ to ________
HIGHLANDS INSURANCE GROUP, INC.
(Exact Name of Registrant as Specified in its Charter)
1-14028
(Commission File Number)
DELAWARE 75-2370945
(State or Other Jurisdiction (I.R.S. Employer
Of Incorporation Or Organization) Identification Number)
1000 LENOX DRIVE,
LAWRENCEVILLE, NEW JERSEY 08648
(Address of Principal Executive Offices) (Zip Code)
(609) 896-1921
(Registrant's Telephone Number, Including Area Code)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No
----- -----
The number of shares of the Registrant's Common Stock, par value $.01 per
share, outstanding at March 31, 2000 was 13,957,303.
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1
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HIGHLANDS INSURANCE GROUP, INC.
TABLE OF CONTENTS
PART I - Financial Information
Item Page
- ---- ----
<TABLE>
<S> <C>
1. Financial Statements:
Consolidated Balance Sheets
March 31, 2000 (Unaudited) and
December 31, 1999 3
Consolidated Statements of Operations
(Unaudited) - Three Months Ended
March 31, 2000 and 1999 5
Consolidated Statements of Stockholders' Equity
Three Months Ended March 31, 2000 (Unaudited)
and Year Ended December 31, 1999 6
Consolidated Statements of Comprehensive Income (Loss)
(Unaudited) - Three Months Ended
March 31, 2000 and 1999 7
Consolidated Statements of Cash Flows
(Unaudited) - Three Months Ended March 31,
2000 and 1999 8
Condensed Notes to Unaudited Consolidated
Financial Statements 9
2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 12
3. Quantitative and Qualitative Disclosures About
Market Risk 14
PART II - Other Information
1. Legal Proceedings 15
4. Submission of Matters to a Vote of Security Holders 15
6. Exhibits and Reports on Form 8-K 15
Signatures 16
</TABLE>
2
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HIGHLANDS INSURANCE GROUP, INC.
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)
<TABLE>
<CAPTION>
March 31, December 31,
ASSETS 2000 1999
---------- -----------
(Unaudited)
<S> <C> <C>
Investments:
Fixed maturity securities - available-for-sale, at fair
value (amortized cost of $789,837 at 3/31/00 and
$802,594 at 12/31/99) $ 752,599 762,478
Equity securities, at fair value (cost of $32,375 at
3/31/00 and $31,376 at 12/31/99) 29,718 26,594
Other investments, at cost 3,004 3,100
---------- ---------
Total investments 785,321 792,172
Cash and cash equivalents 81,668 78,283
Premiums in course of collection, net 72,213 56,574
Premiums due under retrospectively rated policies 140,950 142,849
Receivable from reinsurers 664,025 684,525
Prepaid reinsurance premiums 3,963 3,777
Funds on deposit with reinsurers 16,728 17,534
Net deferred tax asset 80,305 82,536
Accrued investment income 11,315 11,396
Deferred policy acquisition costs 38,895 33,556
Other assets 47,675 58,085
---------- ---------
Total assets $1,943,058 1,961,287
========== =========
</TABLE>
See Condensed Notes to Unaudited Consolidated Financial Statements.
3
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HIGHLANDS INSURANCE GROUP, INC.
CONSOLIDATED BALANCE SHEETS, (Continued)
(Dollars in thousands)
<TABLE>
<CAPTION>
March 31, December 31,
LIABILITIES AND STOCKHOLDERS' EQUITY 2000 1999
---------- ---------
(Unaudited)
<S> <C> <C>
Loss and loss adjustment expense reserves $1,319,412 1,353,524
Unearned premiums 166,412 146,832
Senior bank debt 54,004 59,004
Convertible subordinated debentures 58,018 57,816
Accounts payable and accrued liabilities 70,882 75,069
---------- ---------
Total liabilities 1,668,728 1,692,245
---------- ---------
Mandatorily redeemable preferred stock 4,711 4,641
---------- ---------
Commitments and contingent liabilities
Stockholders' equity:
Common stock, $.01 par value; 50,000,000 shares authorized;
13,957,303 issued and outstanding in 2000 and in 1999 140 140
Additional paid-in capital 231,515 231,515
Accumulated other comprehensive loss (25,932) (29,184)
Treasury stock, at cost (739,400 shares in 2000 and 1999) (9,459) (9,459)
Deferred compensation on restricted stock (3,147) (3,147)
Retained earnings 76,502 74,536
---------- ---------
Total stockholders' equity 269,619 264,401
---------- ---------
Total liabilities and stockholders' equity $1,943,058 1,961,287
========== =========
</TABLE>
See Condensed Notes to Unaudited Consolidated Financial Statements.
4
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HIGHLANDS INSURANCE GROUP, INC
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(Dollars in thousands, except per share data)
<TABLE>
<CAPTION>
Three Months
Ended March 31,
---------------------------------------
2000 1999
-------- --------
<S> <C> <C>
Revenues:
Net premiums earned $81,398 81,705
Net investment income 15,404 17,756
Net realized investment gains 797 503
------- ------
Total revenues 97,599 99,964
------- ------
Expenses:
Loss and loss adjustment expense incurred 61,351 60,746
Underwriting expenses 30,315 32,417
Debt interest and amortization expense 3,067 2,923
Other expenses, net 345 291
------- ------
Total expenses 95,078 96,377
------- ------
Income before income tax 2,521 3,587
Income tax expense 555 835
------- ------
Net income $ 1,966 2,752
======= ======
Earnings per common share:
Basic $.15 .22
Diluted $.15 .20
======= ======
Weighted average number of common shares outstanding:
Basic 13,218 12,494
Diluted 13,219 14,110
======= ======
</TABLE>
See Condensed Notes to Unaudited Consolidated Financial Statements.
5
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HIGHLANDS INSURANCE GROUP, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(Dollars in thousands)
<TABLE>
<CAPTION>
For the three For the year
months ended ended
March 31, December 31,
2000 1999
----------- -------------
(Unaudited)
<S> <C> <C>
Common stock:
Balance, beginning of year $ 140 132
Issuance of common stock, par value -- 8
-------- -------
Balance, end of period 140 140
-------- -------
Additional paid-in capital:
Balance, beginning of year 231,515 223,976
Issuance of common stock, net -- 7,539
-------- -------
Balance, end of period 231,515 231,515
-------- -------
Accumulated other comprehensive income (loss):
Balance, beginning of year (29,184) 16,803
Changes in net unrealized gain or loss, net of tax 3,252 (46,138)
Net unrealized investment losses of written-off subsidiary, net of tax -- 151
-------- -------
Balance, end of period (25,932) (29,184)
-------- -------
Treasury stock, at cost:
Balance, beginning of year (9,459) (9,268)
Acquisition of treasury stock -- (191)
-------- -------
Balance, end of period (9,459) (9,459)
-------- -------
Deferred compensation on restricted stock:
Balance, beginning of year (3,147) (1,074)
Net issuance of restricted stock -- (2,073)
-------- -------
Balance, end of period (3,147) (3,147)
-------- -------
Retained earnings:
Balance, beginning of year 74,536 87,985
Net income (loss) 1,966 (13,449)
-------- -------
Balance, end of period 76,502 74,536
-------- -------
Total stockholders' equity $269,619 264,401
======== =======
</TABLE>
See Condensed Notes to Unaudited Consolidated Financial Statements.
6
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HIGHLANDS INSURANCE GROUP, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(Unaudited)
(Dollars in thousands)
<TABLE>
<CAPTION>
Three Months
Ended March 31,
-------------------------------
2000 1999
------ ------
<S> <C> <C>
Net income $1,966 2,752
------ ------
Other comprehensive income (loss), net of taxes
Increase (decrease) in unrealized gain or loss on investments, net of
taxes of $2,030 and ($5,079) 3,770 (9,433)
Reclassification adjustments for realized gains in net income,
net of taxes of ($279) and ($176) (518) (327)
------ ------
Other comprehensive income (loss), net of taxes 3,252 (9,760)
------ ------
Comprehensive income (loss) $5,218 (7,008)
====== ======
</TABLE>
See Condensed Notes to Unaudited Consolidated Financial Statements.
7
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HIGHLANDS INSURANCE GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(Dollars in thousands)
<TABLE>
<CAPTION>
Three Months Ended
March 31,
------------------------------
2000 1999
-------- --------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 1,966 2,752
-------- --------
Adjustments to reconcile net income to net cash used in operating activities:
Depreciation and amortization 1,483 322
Net realized investment gains (797) (503)
Deferred tax expense 547 828
Change in:
Premiums in course of collection (15,639) (9,789)
Premiums due under retrospectively rated policies 1,899 13,483
Receivables from reinsurers 20,500 10,962
Prepaid reinsurance premiums (186) 528
Funds on deposit with reinsurers 806 (2)
Deferred policy acquisition costs (5,339) 1,132
Loss and loss adjustment expense reserves (34,112) (36,534)
Unearned premiums 19,580 (5,034)
Other operating assets and liabilities 5,672 (12,553)
-------- --------
Total adjustments (5,586) (37,160)
-------- --------
Net cash used in operating activities (3,620) (34,408)
-------- --------
Cash flows from investing activities:
Proceeds from sales:
Fixed maturity securities available-for-sale 25,457 45,111
Other invested assets 324 --
Maturities or calls:
Fixed maturity securities available-for-sale 16,833 63,314
Investment purchases:
Fixed maturity securities available-for-sale (29,090) (68,385)
Equity securities (1,000) (4,944)
Net additions to property and equipment (519) (1,085)
-------- --------
Net cash provided by investing activities 12,005 34,011
-------- --------
Cash flows from financing activities:
Repayment of senior bank debt (5,000) --
Issuance of common stock -- 100
Acquisition of treasury stock -- (191)
-------- --------
Net cash used in investing activities (5,000) (91)
-------- --------
Net increase (decrease) in cash and cash equivalents 3,385 (488)
Cash and cash equivalents at beginning of period 78,283 70,747
-------- --------
Cash and cash equivalents at end of period $ 81,668 70,259
======== ========
Supplemental disclosure of cash flow information:
Interest paid $ 1,191 $ 1,068
======== ========
</TABLE>
See Condensed Notes to Unaudited Consolidated Financial Statements.
8
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HIGHLANDS INSURANCE GROUP, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2000
1. Basis of Presentation
The accompanying consolidated financial statements as of March 31, 2000 and
for the three months ended March 31, 2000 and 1999 are unaudited and include the
accounts of Highlands Insurance Group, Inc., ("Highlands Group") and its
subsidiaries (the "Company"). In the opinion of management, all adjustments,
consisting of normal recurring adjustments necessary for a fair presentation,
have been reflected. The results for the period are not necessarily indicative
of the results to be expected for the entire year. The accompanying
consolidated financial statements should be read in conjunction with the
consolidated financial statements and related notes included in the Company's
Form 10-K for the year ended December 31, 1999.
Highlands Group is an insurance holding company for Highlands Insurance
Company and its subsidiaries ("Highlands"), American Reliance, Inc. and its
subsidiaries ("American Reliance"), and Highlands Holdings (U.K.) Limited and
its subsidiary ("Highlands UK") (a foreign reinsurance company located in the
United Kingdom), and certain other immaterial companies. For reporting
purposes, the Company considers all of its property and casualty insurance
operations as one segment. All material intercompany accounts and transactions
have been eliminated.
As discussed in Note 3, on December 31, 1999 the Company wrote-off its
remaining investment in and deferred taxes associated with LMI Insurance Company
(LMI). The assets and liabilities of LMI have not been included in the
accompanying balance sheet as of March 31, 2000. The March 31, 1999
consolidated financial statements have not been restated.
Certain financial information that is normally included in annual financial
statements prepared in accordance with generally accepted accounting principles
but is not required for interim reporting purposes has been condensed or
omitted. Certain reclassifications have been made to the prior year's financial
statements to conform to the current year's presentation.
2. Changes in Accounting Principles
In June 1999, FASB issued Statement of Financial Accounting Standards No. 137,
"Accounting for Derivative Instruments and Hedging Activities - Deferral of the
Effective Date of FASB Statement No. 133, an Amendment of FASB Statement
No. 133" (SFAS 137). SFAS 137 defers the effective date of FASB Statement 133,
"Accounting for Derivative Instruments and Hedging Activities" (SFAS 133) for
one year. SFAS 133, as amended, is now effective for all fiscal quarters of all
fiscal years beginning after June 15, 2000. SFAS 133 establishes new accounting
and reporting standards requiring that all derivative instruments (including
certain derivative instruments embedded in other contracts) be recorded in the
balance sheet as either an asset or liability measured at its fair value. The
statement requires that changes in the derivative's fair value be recognized
currently in earnings unless specific hedge accounting criteria are met. Special
accounting for qualifying hedges allows a derivative's gains and losses to
offset related results on the hedged item in the income statement and requires
that a company must formally document, designate, and assess the effectiveness
of transactions that receive hedge accounting. The Company anticipates that the
adoption of the provisions of SFAS 133 and SFAS 137 will not have a material
impact on the results of operations, financial condition or cash flows.
9
<PAGE>
3. Write-off of Subsidiary
On December 31, 1999, the Company wrote-off its remaining investment in and
deferred taxes associated with LMI. In March 2000, the Court of Common Pleas in
Franklin County, Ohio, entered an order appointing the Superintendent of
Insurance of the State of Ohio as the Rehabilitator of LMI. As Rehabilitator,
the Superintendent is by operation of law vested with control of LMI, including
title to all LMI assets. Since 1997, the Company supported LMI; however, based
upon a year-end assessment of the value of LMI, the Company concluded that
continued support of LMI was no longer in the best interest of the Company and
its shareholders. Management believes that the regulatory matters concerning
LMI will not have a material impact on the Company's ongoing operations. The
March 31, 1999 consolidated financial statements have not been restated to
reflect the write-off of LMI.
4. Earnings Per Share
The following tables set forth the computation of basic and diluted earnings
per share (in thousands, except per share data):
<TABLE>
<CAPTION>
Three Months Ended
March 31,
-------------------------------
2000 1999
------- ------
<S> <C> <C>
NUMERATOR:
Net income, as reported and for basic earnings per share $ 1,966 2,752
Effect of dilutive securities - after tax debt expense applicable
to convertible subordinated debentures, if appropriate -- --
------- ------
Numerator for diluted earnings per common share - income available
to common stockholders after assumed conversions, if appropriate $ 1,966 2,752
======= ======
DENOMINATOR:
Denominator for basic earnings per share - weighted
average shares outstanding 13,218 12,494
Effect of dilutive securities:
Common stock warrants and outstanding stock options
(based on treasury stock method) 1 1,616
Convertible subordinated debentures, if appropriate -- --
------- ------
Denominator for diluted earnings per share - adjusted
weighted average shares and assumed conversions 13,219 14,110
======= ======
Basic earnings per share $ .15 .22
Diluted earnings per share $ .15 .20
======= ======
</TABLE>
The Debentures, which are convertible into approximately 3.9 million shares,
were outstanding during the three months ended March 31, 2000 and 1999, but were
not included in the computation of diluted earnings per share because the
assumed conversion would be antidilutive.
5. Warrant Price Adjustment
The exercise price of the Series A, A-2, B and B-2 common stock purchase
warrants which were issued with the convertible subordinated debentures are, for
the life of the stock purchase warrants, subject to adjustment due to adverse
loss reserve and uncollectible reinsurance development for years prior to 1996.
No adjustment to the exercise price has been recorded during the three months
ended March 31, 2000.
10
<PAGE>
6. Contingent Liabilities:
The information set forth in Item 1 of Part II of this report is incorporated
herein by reference.
Halliburton - Environmental
From 1958 to 1986, the Company issued fixed premium, guaranteed cost (not-
retrospectively rated) insurance policies to Brown & Root Company ("Brown &
Root"), a subsidiary of Halliburton Company ("Halliburton"), formerly the
Company's parent and largest customer. Since 1987, the Company's insurance
policies with Halliburton (including Brown & Root) have been written on a
retrospectively rated or high-deductible basis. Since the mid-1990's,
approximately 22,000 third party asbestos claims have been made against Brown &
Root. Through March 31, 2000, the Company paid Brown & Root $1.1 million under
the fixed premium policies on account of the asbestos claims, and billed Brown &
Root $5.2 million under the retrospectively rated and high-deductible policies
on account of asbestos claims. Brown & Root has not paid this billed amount and
has questioned the proper allocation of the asbestos claims between the fixed
premium and the retrospectively rated and high-deductible policies.
On April 5, 2000, the Company filed an action in the Delaware Court of
Chancery asserting that indemnification obligations exist pursuant to the
Distribution Agreement dated October 10, 1995 between the Company and
Halliburton, which was executed as part of the distribution by Halliburton of
the shares of the Company's common stock to Halliburton's stockholders and the
public. The action is seeking (i) a declaratory judgment that Halliburton is
responsible for indemnifying the Company for losses and expenses incurred on the
Halliburton/Brown & Root policies; (ii) an injunction ordering Halliburton to
assume responsibility for such losses and expenses; (iii) a judgment against
Halliburton for non-payment of the amounts billed under the retrospectively
rated and high-deductible policies; and (iv) a declaration estopping Brown &
Root from invoking insurance under the fixed premium policies.
On April 24, 2000, Halliburton filed an action in the District Court of Harris
County, Texas seeking (i) a declaratory judgment that the Company is liable for
costs and expenses under the fixed premium policies; (ii) a declaratory judgment
that Halliburton has the right to select the policy under which such coverage is
to be paid; and (iii) damages.
If the Company is not successful in the litigation described above, it could
have a material adverse impact on the Company. The Company believes that the
asbestos claims have been consistently and appropriately allocated and that the
Company will not be ultimately responsible for a material amount of asbestos
liability on the Brown & Root policies.
Other
The Company is a party to various claims and legal actions arising in the
ordinary course of its insurance business which, in the opinion of management,
will not have a material effect on the Company's financial position or results
of operations.
11
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RESULTS OF OPERATIONS
The results of the Company's consolidated operations for the periods indicated
are set forth below:
<TABLE>
<CAPTION>
Three Months Ended
March 31,
-----------------------------
2000 1999
-------- -------
(Dollars in thousands)
<S> <C> <C>
Consolidated Results:
Gross premiums written $115,671 84,831
Net premiums written $100,792 77,198
======== =======
Net premiums earned $ 81,398 81,705
Loss and loss adjustment expense incurred (61,351) (60,746)
Underwriting expenses (30,315) (32,417)
-------- -------
Underwriting loss (10,268) (11,458)
Net investment income 15,404 17,756
Net realized investment gains 797 503
Debt interest and amortization expense (3,067) (2,923)
Other (expenses) income, net (345) (291)
-------- -------
Income before taxes 2,521 3,587
Income tax expense (555) (835)
-------- -------
Net income $ 1,966 2,752
======== =======
Earnings per common share:
Basic $ .15 .22
======== =======
Diluted $ .15 .20
======== =======
Ratios:
Loss 75.4% 74.3%
Expense 37.2% 39.7%
-------- -------
Combined 112.6% 114.0%
======== =======
</TABLE>
PERIOD TO PERIOD COMPARISONS
Gross Premiums Written. Gross premiums written for the three months ended
March 31, 2000 and 1999 were $115.7 million and $84.8 million, respectively.
The $30.9 million or 36.4% increase in 2000 compared to 1999 is due primarily to
internal growth in the core commercial and personal lines and growth from new
business. The Company continues to focus on underwriting standards and adequate
pricing during a period of competitive pricing in both commercial and personal
lines.
Gross premiums written for retrospectively rated policies may be adjusted up
or down, subject to certain limitations contained in the policy, based on the
estimated loss experience of the insured during the policy period. The Company
estimates ultimate losses for retrospectively rated policies and then adjusts
gross premiums written and premiums due from policyholders for changes in
estimated ultimate losses and loss adjustment expenses from the date of the
prior valuation. These adjustments may cause gross premiums written, net
premiums written and
12
<PAGE>
net premiums earned to fluctuate significantly from period to period. Experience
rated contracts reduce but do not eliminate risk to the insurer.
Net Premiums Written. Net premiums written for the three months ended
March 31, 2000 and 1999 were $100.8 million and $77.2 million, respectively. The
increase of $23.6 million or 30.6% in 2000 compared to 1999 is related to the
same issues affecting gross premiums written.
Net Premiums Earned. Net premiums earned for the three months ended March 31,
2000 and 1999 were $81.4 million and $81.7 million, respectively. The decrease
of $.3 million or 0.4% in 2000 compared to 1999 is related to the earnings
pattern of net premiums written. Net premiums written are initially deferred
and earned based upon the terms of the underlying policies which creates a lag
in earnings during periods of increasing or decreasing net premiums written.
Loss and Loss Adjustment Expense Incurred. Loss and loss and adjustment
expenses incurred for the three months ended March 31, 2000 and 1999 were $61.4
million and $60.7 million, respectively. The loss and loss adjustment expense
ratio for the three months ended March 31, 2000 and 1999 was 75.4% and 74.3%,
respectively. The increase in the ratio was due to increased accident year loss
and loss adjustment expense ratios.
Underwriting Expenses. Underwriting expenses for the three months ended
March 31, 2000 and 1999 were $30.3 million and $32.4 million, respectively. The
underwriting expense ratio for the three months ended March 31, 2000 and 1999
was 37.2% and 39.7%, respectively. The decline in the underwriting expense ratio
is the result of the Company's previous expense saving initiatives.
Investment Results. Net investment income for the three months ended
March 31, 2000 and 1999 was $15.4 million and $17.8 million, respectively. Net
investment income decreased $2.4 million from 1999 due to the continued
reduction in the size of the investment portfolio due to payout of old reserves
and the elimination of a former subsidiary. Net realized investment gains for
the Company were $.8 million and $.5 million for the three months ended
March 31, 2000 and 1999, respectively.
Debt Interest and Amortization Expense. Debt interest and amortization
expense for the three months ended March 31, 2000 and 1999 was $3.1 million and
$2.9 million, respectively.
Other Expenses. Other expenses consist of parent company expenses and
miscellaneous expenses from the insurance subsidiaries offset by miscellaneous
income.
Income Taxes. The Company provides for income taxes on its statements of
operations pursuant to Statement of Financial Accounting Standards No. 109,
"Accounting for Income Taxes" (SFAS 109). The total tax expense for the three
months ended March 31, 2000 and 1999 was $.6 million and $.8 million,
respectively. The company's effective tax rate reflects the amount of net
investment income from tax advantaged fixed income securities and the magnitude
of the underwriting loss in relation to net taxable investment income.
Liquidity and Capital Resources
Highlands Group is a holding company, the principal assets of which at
March 31, 2000 are all of the capital stock of Highlands Insurance Company and
American Reliance, Inc. The Company's property and casualty insurance business
is conducted by its direct and indirect wholly-owned insurance subsidiaries. The
liquidity and capital resource considerations for the Highlands Group are
different than those of the Company's insurance operations.
Holding Company
As a holding company, Highlands Group's principal requirements for funds are
to pay operating expenses, franchise and other taxes, debt service and
dividends. Operating expenses and franchise and other taxes imposed on the
Company are not expected to be material. The annual cash interest requirements
relating to the Company's outstanding 10% convertible subordinated debentures
(the "Debentures") and the loan under the Credit Agreement
13
<PAGE>
are approximately $10.0 million. Effective December 31, 1999, the Company and
its lenders amended the Credit Agreement to amend certain financial covenants
and to provide for the payment of $10.0 million in principal during 2000. The
Company paid $5.0 million of principal during the first quarter of 2000. The
Company is in compliance with the amended covenants in the Credit Agreement.
Highlands Group does not currently intend to pay dividends on its Common Stock.
Highlands Group's principal sources of funds are dividends and tax sharing
payments from its subsidiaries, if any, and funds that may be raised from time
to time from the issuance of additional debt or equity securities. The payment
of dividends by the insurance subsidiaries is subject to restrictions and
limitations imposed by the insurance regulatory authorities. Dividend payments
to Highlands Group from its insurance subsidiaries are limited to $30.9 million
in 2000 without prior regulatory approval. Both the issuance of additional debt
and the issuance of additional equity securities at a price less than current
market price would require the consent of the holders of a majority interest of
the Debentures pursuant to the covenants contained in the Debentures.
Management believes that Highlands Group's liquid assets and access to the
capital markets enable it to meet its liquidity needs.
Insurance Subsidiaries
Insurance Operations. The principal sources of funds for the insurance
subsidiaries are premiums and amounts earned from the investment of such
premiums. The principal uses of funds by these subsidiaries are loss payments
and related expenses, underwriting expenses, other operating expenses and
dividends and tax sharing payments to Highlands Group.
In the insurance industry, liquidity refers to the ability of an enterprise to
generate adequate amounts of cash from its operations, including its investment
portfolio, in order to meet its financial commitments, which are principally
obligations under the insurance policies it has written. Liquidity requirements
of insurance companies are influenced significantly by product mix. Future
catastrophe claims, the timing and amount of which are inherently unpredictable,
may create increased liquidity requirements for the insurance subsidiaries. The
liquidity requirements of the insurance subsidiaries are met by that portion of
the investment portfolio that is held in cash and highly liquid securities.
YEAR 2000
As of the date of this filing, the Company has not experienced any Year 2000
problems that have materially affected its operations, the realization of
financial assets, or its results of operations. The Company will continue to
monitor its operations for non-compliant components. The Company is also
monitoring its open transactions with customers and vendors to ensure that there
are no undetected Year 2000 problems that could have a material adverse effect
on the Company or its operations.
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, 1999.
14
<PAGE>
PART II Other Information
ITEM 1. LEGAL PROCEEDINGS
From 1958 to 1986, the Company issued fixed premium, guaranteed cost (not-
retrospectively rated) insurance policies to Brown & Root Company ("Brown &
Root"), a subsidiary of Halliburton Company ("Halliburton"), formerly the
Company's parent and largest customer. Since 1987, the Company's insurance
policies with Halliburton (including Brown & Root) have been written on a
retrospectively rated or high-deductible basis. Since the mid-1990's,
approximately 22,000 third party asbestos claims have been made against Brown &
Root. Through March 31, 2000, the Company paid Brown & Root $1.1 million under
the fixed premium policies on account of the asbestos claims, and billed Brown &
Root $5.2 million under the retrospectively rated and high-deductible policies
on account of asbestos claims. Brown & Root has not paid this billed amount and
has questioned the proper allocation of the asbestos claims between the fixed
premium and the retrospectively rated and high-deductible policies.
On April 5, 2000, the Company filed an action in the Delaware Court of
Chancery asserting that indemnification obligations exist pursuant to the
Distribution Agreement dated October 10, 1995 between the Company and
Halliburton, which was executed as part of the distribution by Halliburton of
the shares of the Company's common stock to Halliburton's stockholders and the
public. The action is seeking (i) a declaratory judgment that Halliburton is
responsible for indemnifying the Company for losses and expenses incurred on the
Halliburton/Brown & Root policies; (ii) an injunction ordering Halliburton to
assume responsibility for such losses and expenses; (iii) a judgment against
Halliburton for non-payment of the amounts billed under the retrospectively
rated and high-deductible policies; and (iv) a declaration estopping Brown &
Root from invoking insurance under the fixed premium policies.
On April 24, 2000, Halliburton filed an action in the District Court of Harris
County, Texas seeking (i) a declaratory judgment that the Company is liable for
costs and expenses under the fixed premium policies; (ii) a declaratory judgment
that Halliburton has the right to select the policy under which such coverage is
to be paid; and (iii) damages.
If the Company is not successful in the litigation described above, it could
have a material adverse impact on the Company. The Company believes that the
asbestos claims have been consistently and appropriately allocated and that the
Company will not be ultimately responsible for a material amount of asbestos
liability on the Brown & Root policies.
ITEM 4. Submission of Matters to a Vote of Security Holders
At the Annual Meeting of Stockholders held on May 9, 2000, the
Stockholders
(a) elected the following directors:
Nominee Shares For Shares Withheld
------- ---------- ---------------
Willis T. King 11,347,122 528,843
Richard M. Haverland 11,327,980 547,985
Robert W. Shower 11,834,839 41,126
Approved by a vote of 11,811,776 shares for and 48,775 shares against with
15,414 abstentions a proposal to select KPMG LLP as the independent public
accountants of the Company for 2000.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
(27) Financial Data Schedule (Filed Electronically)
15
<PAGE>
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.
HIGHLANDS INSURANCE GROUP, INC.
(Registrant)
Date: May 15, 2000 By /s/ Willis T. King, Jr.
-----------------------
Willis T. King, Jr.
Chairman and Chief
Executive Officer
(Authorized Signatory)
Date: May 15, 2000 By /s/ Charles J. Bachand
------------------------
Charles J. Bachand
Vice President, Treasurer and
Principal Accounting Officer
(Authorized Signatory)
16
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