<PAGE>
================================================================================
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
-------------
FORM 10-Q
(Mark One)
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
[X] OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 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 June 30, 2000 was 13,663,700.
1
<PAGE>
================================================================================
HIGHLANDS INSURANCE GROUP, INC.
TABLE OF CONTENTS
PART I - Financial Information
Item Page
---- ----
1. Financial Statements:
Consolidated Balance Sheets
June 30, 2000 (Unaudited) and
December 31, 1999 3
Consolidated Statements of Operations
(Unaudited) - Three and Six Months Ended
June 30, 2000 and 1999 5
Consolidated Statements of Stockholders' Equity
Six Months Ended June 30, 2000 (Unaudited)
and Year Ended December 31, 1999 6
Consolidated Statements of Comprehensive Income (Loss)
(Unaudited) - Three and Six Months Ended
June 30, 2000 and 1999 7
Consolidated Statements of Cash Flows
(Unaudited) - Six Months Ended June 30, 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
2
<PAGE>
HIGHLANDS INSURANCE GROUP, INC.
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)
<TABLE>
<CAPTION>
June 30, December 31,
ASSETS 2000 1999
------ -------- -------------
(Unaudited)
<S> <C> <C>
Investments:
Fixed maturity securities - available-for-sale, at fair
value (amortized cost of $795,499 at 6/30/00 and
$802,594 at 12/31/99) $ 752,796 762,478
Equity securities, at fair value (cost of $32,376 at 6/30/00
and $31,376 at 12/31/99) 30,016 26,594
Other investments, at cost 2,613 3,100
---------- ----------
Total investments 785,425 792,172
Cash and cash equivalents 90,461 78,283
Premiums in course of collection, net 71,518 56,574
Premiums due under retrospectively rated policies 141,703 142,849
Receivable from reinsurers 648,859 684,525
Prepaid reinsurance premiums 10,273 3,777
Funds on deposit with reinsurers 16,747 17,534
Net deferred tax asset 81,152 82,536
Accrued investment income 10,866 11,396
Deferred policy acquisition costs 42,290 33,556
Other assets 49,430 58,085
---------- ----------
Total assets $1,948,724 1,961,287
========== ==========
</TABLE>
See Condensed Notes to Unaudited Consolidated Financial Statements.
3
<PAGE>
HIGHLANDS INSURANCE GROUP, INC.
CONSOLIDATED BALANCE SHEETS, (Continued)
(Dollars in thousands)
<TABLE>
<CAPTION>
June 30, December 31,
LIABILITIES AND STOCKHOLDERS' EQUITY 2000 1999
------------------------------------ -------- ------------
(Unaudited)
<S> <C> <C>
Loss and loss adjustment expense reserves $1,303,452 1,353,524
Unearned premiums 189,899 146,832
Senior bank debt 54,004 59,004
Convertible subordinated debentures 58,221 57,816
Accounts payable and accrued liabilities 68,510 75,069
---------- ----------
Total liabilities 1,674,086 1,692,245
---------- ----------
Mandatorily redeemable preferred stock 4,782 4,641
---------- ----------
Commitments and contingent liabilities
Stockholders' equity:
Common stock, $.01 par value; 50,000,000 shares authorized; 13,217,800
issued and outstanding in 2000 and 13,217,903 issued and outstanding in
1999 (excluding 739,400 shares held in the treasury or by subsidiaries
in 2000 and 1999) 140 140
Additional paid-in capital 231,495 231,515
Accumulated other comprehensive loss (29,291) (29,184)
Treasury stock, at cost (739,400 shares in 2000 and 1999) (9,459) (9,459)
Deferred compensation on restricted stock (3,097) (3,147)
Retained earnings 80,068 74,536
---------- ----------
Total stockholders' equity 269,856 264,401
---------- ----------
Total liabilities and stockholders' equity $1,948,724 1,961,287
========== ==========
</TABLE>
See Condensed Notes to Unaudited Consolidated Financial Statements.
4
<PAGE>
HIGHLANDS INSURANCE GROUP, INC
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(Dollars in thousands, except per share data)
<TABLE>
<CAPTION>
Three Months Six Months
Ended June 30, Ended June 30,
----------------------------- --------------------------------
2000 1999 2000 1999
-------- --------- --------- -------
<S> <C> <C> <C> <C>
Revenues:
Net premiums earned $ 90,510 78,158 171,908 159,863
Net investment income 15,678 17,185 31,082 34,941
Net realized investment gains 162 1,291 958 1,794
-------- ------- -------- --------
Total revenues 106,350 96,634 203,948 196,598
-------- ------- -------- --------
Expenses:
Loss and loss adjustment expense incurred 65,385 55,924 126,736 116,670
Underwriting expenses 32,894 33,511 63,210 65,928
Debt interest and amortization expense 3,053 2,965 6,120 5,888
Other expenses, net 446 634 790 925
-------- ------- -------- --------
Total expenses 101,778 93,034 196,856 189,411
-------- ------- -------- --------
Income before income taxes 4,572 3,600 7,092 7,187
Income tax expense 1,006 801 1,560 1,636
-------- ------- -------- --------
Net income $ 3,566 2,799 5,532 5,551
======== ======= ======== ========
Earnings per common share:
Basic $ .27 .22 .42 .44
Diluted $ .27 .20 .42 .40
======== ======= ======== ========
Weighted average number of common shares
outstanding:
Basic 13,216 12,881 13,217 12,688
Diluted 13,218 13,797 13,219 13,946
======== ======= ======== ========
</TABLE>
See Condensed Notes to Unaudited Consolidated Financial Statements.
5
<PAGE>
HIGHLANDS INSURANCE GROUP, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(Dollars in thousands)
<TABLE>
<CAPTION>
For the six For the year
months ended ended
June 30, 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
Net (retirement) issuance of common stock (20) 7,539
-------- --------
Balance, end of period 231,495 231,515
-------- --------
Accumulated other comprehensive income (loss):
Balance, beginning of year (29,184) 16,803
Changes in net unrealized gain or loss, net of tax (107) (46,138)
Net unrealized investment losses of written-off subsidiary, net of tax -- 151
-------- --------
Balance, end of period (29,291) (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 retirement (issuance) of restricted stock 50 (2,073)
-------- --------
Balance, end of period (3,097) (3,147)
-------- --------
Retained earnings:
Balance, beginning of year 74,536 87,985
Net income (loss) 5,532 (13,449)
-------- --------
Balance, end of period 80,068 74,536
-------- --------
Total stockholders' equity $269,856 264,401
======== ========
</TABLE>
See Condensed Notes to Unaudited Consolidated Financial Statements.
6
<PAGE>
HIGHLANDS INSURANCE GROUP, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(Unaudited)
(Dollars in thousands)
<TABLE>
<CAPTION>
Three Months Six Months
Ended June 30, Ended June 30,
--------------------------- -----------------------
2000 1999 2000 1999
------- ------- ------- -------
<S> <C> <C> <C> <C>
Net income $ 3,566 2,799 5,532 5,551
------- ------- ------- -------
Other comprehensive income (loss), net of taxes:
Increase (decrease) in unrealized gain or loss on
investments, net of taxes of $(1,752) and
$(8,153) for the three months and $278 and
$(13,232) for the six months ended June 30,
2000 and 1999, respectively (3,254) (15,141) 516 (24,574)
Reclassification adjustments for realized gains in
net income, net income, net of taxes of $(57) and
$(452) for the three months and $(335) and $(628)
for the six months ended June 30, 2000 and 1999, respectively (105) (839) (623) (1,166)
------- ------- ------- -------
Other comprehensive income (loss), net of taxes (3,359) (15,980) (107) (25,740)
------- ------- ------- -------
Comprehensive income (loss) $ 207 (13,181) 5,425 (20,189)
======= ======= ======= =======
</TABLE>
See Condensed Notes to Unaudited Consolidated Financial Statements.
7
<PAGE>
HIGHLANDS INSURANCE GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(Dollars in thousands)
<TABLE>
<CAPTION>
Six Months Ended
June 30,
----------------------------
2000 1999
-------- ---------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 5,532 5,551
-------- --------
Adjustments to reconcile net income to net cash used in operating activities:
Depreciation and amortization 2,750 885
Net realized investment gains (958) (1,794)
Deferred tax expense 1,504 1,623
Change in:
Premiums in course of collection (14,944) (6,117)
Premiums due under retrospectively rated policies 1,146 6,227
Receivable from reinsurers 35,666 (264)
Prepaid reinsurance premiums (6,496) 932
Funds on deposit with reinsurers 787 1,027
Deferred policy acquisition costs (8,734) 555
Loss and loss adjustment expense reserves (50,072) (69,987)
Unearned premiums 43,067 (3,030)
Other operating assets and liabilities 1,416 (7,192)
-------- --------
Total adjustments 5,132 (77,135)
-------- --------
Net cash provided by (used in) operating activities 10,664 (71,584)
-------- --------
Cash flows from investing activities:
Proceeds from sales:
Fixed maturity securities available-for-sale 41,467 96,122
Equity securities -- 2,260
Other invested assets 815 --
Maturities or calls:
Fixed maturity securities available-for-sale 24,581 108,838
Investment purchases:
Fixed maturity securities available-for-sale (58,415) (123,237)
Equity securities (1,000) (9,188)
Net additions to property and equipment (934) (1,539)
-------- --------
Net cash provided by investing activities 6,514 73,256
-------- --------
Cash flows from financing activities:
Repayment of senior bank debt (5,000) (5,000)
Issuance of common stock -- 5,140
Acquisition of treasury stock -- (191)
-------- --------
Net cash used in financing activities (5,000) (51)
-------- --------
Net increase in cash and cash equivalents 12,178 1,621
Cash and cash equivalents at beginning of period 78,283 70,747
-------- --------
Cash and cash equivalents at end of period $ 90,461 72,368
======== ========
Supplemental disclosure of cash flow information:
Interest paid $ 5,316 $ 5,081
======== ========
</TABLE>
See Condensed Notes to Unaudited Consolidated Financial Statements.
8
<PAGE>
HIGHLANDS INSURANCE GROUP, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2000
1. Basis of Presentation
The accompanying consolidated financial statements as of June 30, 2000 and
for the three and six months ended June 30, 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, the Company wrote-off in December 1999 its remaining
investment in and deferred taxes associated with LMI Insurance Company (LMI).
The assets and liabilities of LMI were not included in the accompanying balance
sheet as of December 31, 1999. The June 30, 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
Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for
Derivative Instruments and for Hedging Activities," requires companies to
recognize all derivatives as either assets or liabilities in the statement of
financial condition and to measure all derivatives at fair value. SFAS No. 133
requires that changes in fair value of a derivative be recognized currently in
earnings unless specific hedge accounting criteria are met. Upon implementation
of SFAS No. 133, hedging relationships may be redesignated, and securities held
to maturity may be transferred to available for sale or trading. SFAS No. 137,
"Accounting for Derivative Instruments and Hedging Activities - Deferral of the
Effective Date of FASB Statement No. 133," deferred the effective date of SFAS
No. 133 to fiscal years beginning after June 15, 2000. SFAS No. 138,
"Accounting for Certain Derivative Instruments and Certain Hedging Activities"
amended the accounting and reporting standards of SFAS No. 133 for certain
derivative instruments, hedging activities, and decisions made by the
Derivatives Implementation Group. The Company anticipates that the adoption of
the provisions of SFAS 133, SFAS 137, and SFAS 138 will not have a material
impact on the results of operations, financial condition or cash flows.
9
<PAGE>
3. Write-off of Subsidiary
In December 1999, the Company wrote-off its remaining investment in and
deferred taxes associated with LMI. Since 1997, the Company had supported LMI;
however, based upon an 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. 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. On May 22, 2000, a Final Order of Liquidation and Appointment of
Liquidator was entered against LMI by the Court of Common Pleas in Franklin
County, Ohio. Management believes that the regulatory matters concerning LMI
will not have a material impact on the Company's ongoing operations. The June
30, 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 Six Months Ended
June 30, June 30,
------------------------------------------------------
2000 1999 2000 1999
------- ------- ------- -------
<S> <C> <C> <C> <C>
NUMERATOR:
Net income, as reported and for basic earnings per $ 3,566 2,799 5,532 5,551
share
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 $ 3,566 2,799 5,532 5,551
======= ======= ======= =======
DENOMINATOR:
Denominator for basic earnings per share - weighted
average shares outstanding 13,216 12,881 13,217 12,688
Effect of dilutive securities:
Common stock warrants and outstanding stock
options (based on treasury stock method) 2 916 2 1,258
Convertible subordinated debentures, if appropriate -- -- -- --
------- ------- ------- -------
Denominator for diluted earnings per share - adjusted
weighted average shares and assumed conversions 13,218 13,797 13,219 13,946
======= ======= ======= =======
Basic earnings per share $ .27 .22 .42 .44
Diluted earnings per share $ .27 .20 .42 .40
======= ======= ======= =======
</TABLE>
The Debentures, which are convertible into approximately 3.9 million shares,
were outstanding during the six months ended June 30, 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 six months
ended June 30, 2000.
10
<PAGE>
6. Contingent Liabilities:
The information set forth in Item 1 of Part II of this report is incorporated
herein by reference.
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 Six Months Ended
June 30, June 30,
---------------------------- ----------------------------
2000 1999 2000 1999
-------- ------- -------- -------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Gross premiums written $116,241 86,935 231,913 171,766
Net premiums written $107,687 80,566 208,479 157,764
======== ======== ======== ========
Net premiums earned $ 90,510 78,158 171,908 159,863
Loss and loss adjustment expense incurred (65,385) (55,924) (126,736) (116,670)
Underwriting expenses (32,894) (33,511) (63,210) (65,928)
-------- -------- -------- --------
Underwriting loss (7,769) (11,277) (18,038) (22,735)
Net investment income 15,678 17,185 31,082 34,941
Net realized investment gains 162 1,291 958 1,794
Debt interest and amortization expense (3,053) (2,965) (6,120) (5,888)
Other expenses, net (446) (634) (790) (925)
-------- -------- -------- --------
Income before income taxes 4,572 3,600 7,092 7,187
Income tax expense 1,006 801 1,560 1,636
-------- -------- -------- --------
Net income $ 3,566 2,799 5,532 5,551
======== ======== ======== ========
Earnings per common share:
Basic $ .27 .22 .42 .44
======== ======== ======== ========
Diluted $ .27 .20 .42 .40
======== ======== ======== ========
Ratios:
Loss 72.2% 71.5% 73.7% 73.0%
Expense 36.3% 42.9% 36.8% 41.2%
-------- -------- -------- --------
Combined 108.5% 114.4% 110.5% 114.2%
======== ======== ======== ========
</TABLE>
Period to Period Comparisons
Gross Premiums Written. Gross premiums written for the three months and six
months ended June 30, 2000 and 1999 were $116.2 million, $86.9 million, $231.9
million and $171.8 million, respectively. The $29.3 million and $60.1 million
or 33.7% and 35% increase for the three months and six months ended June 30,
respectively, is due primarily to new business growth in the core commercial
lines. The Company continues to focus on underwriting standards and adequate
pricing during a period of competitive pricing in both commercial and personal
lines.
Net Premiums Written. Net premiums written for the three months and six
months ended June 30, 2000 and 1999 were $107.7 million, $80.6 million, $208.5
million and $157.8 million, respectively. The increase of $27.1 million and
$50.7 million or 33.7% and 32.1% in 2000 compared to 1999 is related to the same
issues affecting gross premiums written.
12
<PAGE>
Net Premiums Earned. Net premiums earned for the three months and six months
ended June 30, 2000 and 1999 were $90.5 million, $78.2 million, $171.9 million
and $159.9 million, respectively. The increase of $12.4 million and $12 million
or 15.8% and 7.5% in 2000 compared to 1999 is related to the growth of gross and
net premiums written as discussed above. 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 and six months ended June 30, 2000 and
1999 were $65.4 million, $55.9 million, $126.7 million and $116.7 million,
respectively. The loss and loss adjustment expense ratio for the three months
and six months ended June 30, 2000 and 1999 was 72.2%, 71.5%, 73.7% and 73.0%,
respectively. The increase for the 2000 ratios compared to the 1999 ratios was
primarily attributable to lower incurred losses in 1999 due to favorable
development in 1999 on prior year loss reserves.
Underwriting Expenses. Underwriting expenses for the three months and six
months ended June 30, 2000 and 1999 were $32.9 million, $33.5 million, $63.2
million and $65.9 million, respectively. The underwriting expense ratio for the
three months and six months ended June 30, 2000 and 1999 was 36.3%, 42.9%, 36.8%
and 41.2%, respectively. The decline in the underwriting expense ratio is the
result of the Company's previous expense saving initiatives and higher net
premiums earned in 2000.
Investment Results. Net investment income for the three months and six months
ended June 30, 2000 and 1999 was $15.7 million, $17.2 million, $31.1 million and
$34.9 million, respectively. Net investment income decreased $1.5 million and
$3.8 million compared to 1999 due to the continued reduction in the size of the
investment portfolio due to payout of old reserves and the write-off of a former
subsidiary. Net realized investment gains for the Company were $.2 million, $1.3
million, $1.0 million and $1.8 million for the three months and six months ended
June 30, 2000 and 1999, respectively.
Debt Interest and Amortization Expense. Debt interest and amortization
expense for the three months and six months ended June 30, 2000 and 1999 was
$3.1 million, $3.0 million, $6.1 million and $5.9 million, respectively. The
increase is due to rate increases associated with the Company's senior bank
debt.
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 and six months ended June 30, 2000 and 1999 was $1.0 million, $.8
million, $1.6 million and $1.6 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
June 30, 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 are approximately
$10.0 million. Effective December 31, 1999, the Company and its lenders amended
the Credit
13
<PAGE>
Agreement to amend certain financial covenants and to provide for the payment of
$10.0 million in principal during 2000. The Company repaid $5.0 million of
principal during the first quarter of 2000 and $5.0 million during July 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. Beginning in 1987, the Company's
insurance policies with Halliburton (including Brown & Root) were written on a
retrospectively rated or high-deductible basis. Since the mid-1990's,
approximately 23,000 third party asbestos claims have been made against Brown &
Root. Through June 30, 2000, the Company paid $1.1 million on behalf of Brown &
Root under the fixed premium policies on asbestos claims, and billed Brown &
Root $5.2 million under the retrospectively rated and high-deductible policies
on 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 ("Delaware Action") 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 ("Texas Action") 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.
On July 13, 2000, the Company amended its complaint in the Delaware Action,
adding a count seeking a declaratory judgment that the Company is not liable
under the fixed premium policies because those policies were terminated pursuant
to the Investment Agreement dated October 10, 1995 among the Company,
Halliburton, Insurance Partners, L.P. and Insurance Partners Offshore (Bermuda)
L.P. The Company also filed a motion for a preliminary injunction enjoining
Halliburton from instituting, continuing or prosecuting any action in any other
jurisdiction arising out of or related to the subject matter of the Delaware
Action. On July 26, 2000, Halliburton filed motions to dismiss the Delaware
Action on the grounds of forum non conveniens and failure to state a claim upon
which relief can be granted. A hearing date on the motions in the Delaware
Action has not yet been scheduled.
The Company filed its answer in the Texas Action on July 26, 2000 denying the
allegations in Halliburton's complaint. Discovery in the Delaware Action and
the Texas Action has commenced.
If the Company is not successful in the litigation described above, it could
have a material adverse impact on the Company. The Company believes, however,
that the positions it has taken in the Delaware Action and Texas Action are
meritorious, and that, ultimately, the Company will not be responsible for a
material amount, if any, of Brown & Root's asbestos liability.
ITEM 4. Submission of Matters to a Vote of Security Holders
None
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: August 14, 2000 By /s/ Willis T. King, Jr.
Willis T. King, Jr.
Chairman and Chief
Executive Officer
(Authorized Signatory)
Date: August 14, 2000 By /s/ Charles J. Bachand
Charles J. Bachand
Vice President, Treasurer and
Principal Accounting Officer
(Authorized Signatory)
16
