<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
Quarterly Report under Section 13 or 15(d) of the
Securities Exchange Act of 1934
For Quarter Ended September 30, 1998 Commission File Number 1-9828
GAINSCO, INC.
(Exact name of registrant as specified in its charter)
Texas 75-1617013
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
500 Commerce Street Fort Worth, Texas 76102
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (817) 336-2500
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 twelve (12) months, and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
---- ----
As of September 30, 1998, there were 20,896,563 shares outstanding of the
registrant's Common Stock, $.10 par value.
<PAGE> 2
GAINSCO, INC. AND SUBSIDIARIES
INDEX
<TABLE>
<CAPTION>
Page
<S> <C> <C>
PART I. FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS:
Consolidated Balance Sheets as of September 30, 1998
(unaudited) and December 31, 1997 3
Consolidated Statements of Operations for the Three Months
and Nine Months Ended September 30, 1998 and 1997
(unaudited) 5
Consolidated Statements of Cash Flows for the Nine Months
Ended September 30, 1998 and 1997 (unaudited) 6
Notes to Consolidated Financial Statements
September 30, 1998 and 1997 (unaudited) 8
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS 13
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS 18
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 18
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. 19
SIGNATURE 20
</TABLE>
2
<PAGE> 3
PART I. FINANCIAL INFORMATION
GAINSCO, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
<TABLE>
<CAPTION>
September 30
1998 December 31
Assets (unaudited) 1997
------------ ------------
<S> <C> <C>
Investments
Fixed maturities:
Bonds held to maturity, at amortized cost (fair
value: $68,186,025 - 1998, $90,527,669 - 1997) $ 66,876,686 89,733,503
Bonds available for sale, at fair value (Amortized cost:
$104,055,736 - 1998, $122,022,184 - 1997) 106,692,901 123,650,289
Certificates of deposit, at cost (which approximates
fair value) 595,000 595,000
Short-term investments, at cost (which approximates
fair value) 41,601,759 2,823,393
------------ ------------
Total investments 215,766,346 216,802,185
Cash 2,122,752 696,513
Accrued investment income 3,245,337 4,714,828
Premiums receivable (net of allowance for doubtful
accounts: $81,000 - 1998 and 1997) 10,494,163 14,249,890
Reinsurance balances receivable 3,266,037 2,604,511
Ceded unpaid claims and claim adjustment expenses 33,975,408 29,524,026
Ceded unearned premiums 22,710,529 19,146,272
Deferred policy acquisition costs 10,111,023 11,618,136
Property and equipment (net of accumulated depreciation
and amortization: $6,680,437 - 1998, $5,710,365 - 1997) 6,329,757 6,941,232
Current Federal income taxes recoverable (note 1) 4,920,038 796,631
Deferred Federal income taxes recoverable (note 1) 6,981,744 2,676,555
Management contract 1,700,070 1,737,570
Other assets 2,675,716 2,176,957
------------ ------------
Total assets $324,298,920 313,685,306
============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
3
<PAGE> 4
GAINSCO, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
<TABLE>
<CAPTION>
September 30
1998 December 31
Liabilities and Shareholders' Equity (unaudited) 1997
------------- -------------
<S> <C> <C>
Liabilities:
Unpaid claims and claim adjustment expenses $ 137,555,970 113,227,009
Unearned premiums 62,059,948 64,004,507
Commissions payable 3,410,289 2,207,421
Accounts payable 2,431,946 3,542,075
Reinsurance balances payable 3,320,101 745,805
Deferred revenue 893,340 635,807
Drafts payable 7,205,599 9,393,375
Dividends payable (note 3) 365,690 365,300
Other liabilities 700,660 1,001,747
------------- -------------
Total liabilities 217,943,543 195,123,046
------------- -------------
Shareholders' Equity (note 3):
Preferred stock ($100 par value, 10,000,000 shares
authorized, none issued) -- --
Common stock ($.10 par value, 250,000,000 shares
authorized, 21,740,657 issued at September 30, 1998
and 21,701,118 issued at December 31, 1997) 2,174,066 2,170,112
Additional paid-in capital 87,778,548 87,697,754
Accumulated other comprehensive income (note 1) 1,714,157 1,058,268
Retained earnings 22,383,131 35,188,460
Treasury stock (844,094 shares at September 30, 1998
and 826,894 shares at December 31, 1997) (7,694,525) (7,552,334)
------------- -------------
Total shareholders' equity 106,355,377 118,562,260
------------- -------------
Total liabilities and shareholders' equity $ 324,298,920 313,685,306
============= =============
</TABLE>
See accompanying notes to consolidated financial statements.
4
<PAGE> 5
GAINSCO, INC. AND SUBSIDIARIES
Consolidated Statements of Operations
(Unaudited)
<TABLE>
<CAPTION>
Three months Nine Months
ended September 30 ended September 30
--------------------------------- ---------------------------------
1998 1997 1998 1997
----- ----- ----- -----
<S> <C> <C> <C> <C>
Revenues:
Premiums earned (note 2) $ 22,961,060 25,171,706 69,735,212 76,799,876
Net investment income 2,536,044 2,488,573 7,505,167 7,183,069
Net realized gains (note 1) 242,249 177,075 556,116 213,561
Insurance services 633,180 646,873 1,850,400 1,932,514
------------ ------------ ------------ ------------
Total revenues 26,372,533 28,484,227 79,646,895 86,129,020
------------ ------------ ------------ ------------
Expenses:
Claims and claim adjustment expenses
(note 2) 15,737,047 17,681,193 69,433,537 46,003,584
Commissions 4,842,508 4,959,806 16,506,909 15,185,086
Change in deferred policy acquisition costs 273,729 582,810 1,507,113 1,187,950
Underwriting and operating expenses 4,158,087 4,029,910 12,695,372 12,425,518
------------ ------------ ------------ ------------
Total expenses 25,011,371 27,253,719 100,142,931 74,802,138
------------ ------------ ------------ ------------
Income (loss) before Federal income taxes 1,361,162 1,230,508 (20,496,036) 11,326,882
Federal income taxes:
Current expense (benefit) (140,694) (13,978) (4,105,685) 2,511,972
Deferred expense (benefit) 104,809 (218,919) (4,658,360) (221,942)
------------ ------------ ------------ ------------
Total taxes (35,885) (232,897) (8,764,045) 2,290,030
------------ ------------ ------------ ------------
Net income (loss) $ 1,397,047 1,463,405 (11,731,991) 9,036,852
============ ============ ============ ============
Earnings (loss) per share:
Basic $ .07 .07 (.56) .43
============ ============ ============ ============
Diluted (note 1) $ .07 .07 .42
============ ============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
5
<PAGE> 6
GAINSCO, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(Unaudited)
<TABLE>
<CAPTION>
Nine Months ended September 30
---------------------------------
1998 1997
------------ ------------
<S> <C> <C>
Cash flows from operating activities:
Net income (loss) $(11,731,991) 9,036,852
Adjustments to reconcile net income (loss) to cash
provided by operating activities:
Depreciation and amortization 3,573,219 3,630,837
Change in accrued investment income 1,469,491 201,083
Change in premiums receivable 3,755,727 5,255,261
Change in reinsurance balances receivable (661,526) 1,285,659
Change in ceded unpaid claims and claim adjustment
expenses (4,451,382) (1,929,515)
Change in ceded unearned premiums (3,564,257) (4,070,439)
Change in deferred policy acquisition costs 1,507,113 1,187,950
Change in current Federal income taxes recoverable (4,100,365) (663,028)
Change in deferred Federal income taxes recoverable (4,658,360) (221,942)
Change in management contract 37,500 37,500
Change in other assets (498,759) 53,959
Change in unpaid claims and claim adjustment
expenses 24,328,961 10,187,403
Change in unearned premiums (1,944,559) (924,284)
Change in commissions payable 1,202,868 (1,363,071)
Change in accounts payable (1,110,129) (48,870)
Change in reinsurance balances payable 2,574,296 (690,123)
Change in deferred revenue 257,533 223,946
Change in drafts payable (2,187,776) (1,652,287)
Change in other liabilities (301,087) (227,270)
------------ ------------
Net cash provided by operating activities $ 3,496,517 19,309,621
------------ ------------
</TABLE>
See accompanying notes to consolidated financial statements.
6
<PAGE> 7
(continued)
GAINSCO, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(Unaudited)
<TABLE>
<CAPTION>
Nine Months ended September 30
---------------------------------
1998 1997
------------ ------------
<S> <C> <C>
Cash flows from investing activities:
Bonds held to maturity:
Matured $ 22,873,069 16,562,231
Purchased (1,210,688) (3,434,617)
Bonds available for sale:
Sold 38,576,136 22,137,930
Matured 1,520,000 5,760,110
Purchased (23,538,400) (68,578,203)
Certificates of deposit matured 545,000 370,000
Certificates of deposit purchased (545,000) (370,000)
Property and equipment purchased (358,597) (867,050)
Net change in short-term investments (38,778,366) 11,459,631
------------ ------------
Net cash used for investing activities (916,846) (16,959,968)
------------ ------------
Cash flows from financing activities:
Cash dividends paid (1,095,989) (947,787)
Proceeds from exercise of stock options 84,748 90,450
Treasury stock acquired (142,191) (1,763,357)
------------ ------------
Net cash used for financing activities (1,153,432) (2,620,694)
------------ ------------
Net increase (decrease) in cash 1,426,239 (271,041)
Cash at beginning of period 696,513 1,044,740
------------ ------------
Cash at end of period $ 2,122,752 773,699
============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
7
<PAGE> 8
GAINSCO, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
(1) Summary of Accounting Policies
(a) Basis of Consolidation
In the opinion of management, the accompanying consolidated
financial statements contain all adjustments, consisting only
of normal recurring adjustments, necessary to present fairly
the financial position of GAINSCO, INC. and subsidiaries (the
"Company") as of September 30, 1998, the results of operations
and the statements of cash flows for the three months and nine
months ended September 30, 1998 and 1997, on the basis of
generally accepted accounting principles. The December 31,
1997 balance sheet included herein is derived from the
consolidated financial statements included in the Company's
1997 Annual Report to Shareholders.
The accompanying consolidated financial statements are
prepared in conformity with generally accepted accounting
principles. The preparation of financial statements in
conformity with generally accepted accounting principles
requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues
and expenses during the reporting period. Actual results could
differ from those estimates.
Reference is made to the Company's annual consolidated
financial statements for the year ended December 31, 1997 for
a description of all other accounting policies. Certain
reclassifications have been made to the 1997 amounts to
conform to the 1998 presentation.
(b) Investments
Bonds held to maturity are stated at amortized cost, bonds
available for sale are stated at fair value. Short-term
investments are stated at cost. The "specific identification"
method is used to determine costs of investments sold. Since
investments not available for sale are held until maturity,
provisions for possible losses are recorded only when the
values have experienced impairment considered "other than
temporary". The bonds available for sale had an unrealized
gain of $1,714,157 at September 30, 1998, net of the deferred
tax expense of $923,008, and an unrealized gain at December
31, 1997 of $1,058,268 net of the deferred tax expense of
$569,837.
Proceeds from the sale of bond securities totaled $24,292,490
and $8,845,390 for the three months ended September 30, 1998
and 1997, respectively, and $38,576,136 and $22,137,930 for
the nine months ended September 30, 1998 and 1997,
respectively. Realized gains were $247,572 and $183,409 for
the three months ended September 30, 1998 and 1997,
respectively, and $572,505 and $251,198 for the nine months
ended September 30, 1998 and 1997, respectively. Realized
losses were $5,323 and $6,334 for the three months ended
September 30, 1998 and 1997, respectively, and $16,389 and
$37,637 for the nine months ended September 30, 1998 and 1997,
respectively.
8
<PAGE> 9
GAINSCO, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
(c) Federal Income Taxes
The Company and its subsidiaries file a consolidated Federal
income tax return. Deferred income tax items are accounted for
under the liability method which provides for temporary
differences between the reporting of earnings for financial
statement purposes and for tax purposes, primarily deferred
policy acquisition costs, the discount on unpaid claims and
claim adjustment expenses and the nondeductible portion of the
change in unearned premiums. The Company paid no income taxes
during the 1998 periods. The Company paid income taxes of
$1,200,000 and $3,175,000 during the three months and nine
months ended September 30, 1997, respectively.
(d) Earnings Per Share
In February 1997, the Financial Accounting Standards Board
(FASB) issued Statement 128, "Earnings Per Share". The
Statement was effective for financial statements issued for
periods ending after December 15, 1997 and was implemented by
the Company in the fourth quarter of 1997. Earnings per share
for prior periods presented in these financial statements have
been restated to comply with Statement 128.
The following table sets forth the computation of basic and
diluted earnings per share:
<TABLE>
<CAPTION>
Three months Nine months
ended September 30 ended September 30
------------------------------ -------------------------------
1998 1997 1998 1997
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Numerator:
Net income (loss) $ 1,397,047 1,463,405 (11,731,991) 9,036,852
----------- ----------- ----------- -----------
Denominator:
Denominator for basic
earnings per share-
weighted average shares 20,896,563 20,941,011 20,876,795 21,027,843
Effect of dilutive securities:
Employee stock options 342,671 265,052 405,037 265,052
----------- ----------- ----------- -----------
Denominator for diluted
earnings per share-
weighted average shares
and assumed conversions 21,239,234 21,206,063 21,281,832 21,292,895
=========== =========== =========== ===========
Basic earnings (loss) per share $ .07 .07 (.56) .43
=========== =========== =========== ===========
Diluted earnings (loss) per share $ .07 .07 .42
=========== =========== ===========
</TABLE>
9
<PAGE> 10
GAINSCO, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
The effects of common stock options are antidilutive for the
nine months ended September 30, 1998 due to the net loss for
these periods; therefore, diluted loss per share is not
presented.
(e) Accumulated Comprehensive Income
In June 1997, the FASB issued Statement of Financial
Accounting Standards No. 130, "Reporting Comprehensive Income"
(Statement 130). Statement 130 requires that a company include
in accumulated comprehensive income certain amounts which were
previously recorded directly to shareholders' equity. The
other comprehensive income amounts included in accumulated
comprehensive income consisted of net unrealized gains on
fixed maturities of $1,714,157 and $1,058,268 at September 30,
1998 and December 31, 1997, respectively. Total comprehensive
income (loss), consisting of net income (loss) and the change
in unrealized gains on fixed maturities, was $1,655,080 and
$2,389,054 for the three months ended September 30, 1997 and
1998, respectively, and $9,156,202 and $(11,076,102) for the
nine months ended September 30, 1997 and 1998, respectively.
(2) Reinsurance
The amounts deducted in the Consolidated Statements of Operations for
reinsurance ceded for the three months and nine months ended September
30, 1998 and 1997, respectively, are set forth in the following table.
Premiums and claims ceded to the commercial automobile plans of
Arkansas, California, Louisiana, Mississippi and Pennsylvania are
designated as "plan servicing".
<TABLE>
<CAPTION>
Three months Nine months
ended September 30 ended September 30
------------------------------ ------------------------------
1998 1997 1998 1997
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Premiums earned $ 180,563 437,469 977,157 1,257,830
Premiums earned -
plan servicing $ 925,602 1,019,691 2,793,577 3,066,549
Premiums earned -
fronting arrangements $11,015,983 8,781,263 29,654,146 23,926,462
Claims and claim
adjustment expenses $ 1,360,804 196,734 3,611,114 (979,324)
Claims and claim
adjustment expenses - $ 812,097 897,735 3,681,997 3,616,849
plan servicing
Claims and claim
adjustment expenses -
fronting arrangements $ 7,540,188 6,292,816 23,574,857 17,728,959
</TABLE>
10
<PAGE> 11
GAINSCO, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
The amounts included in the Consolidated Balance Sheets for reinsurance ceded to
the commercial automobile plans of Arkansas, California, Louisiana, Mississippi
and Pennsylvania, and the fronting arrangements as of September 30, 1998 and
December 31, 1997 were as follows:
<TABLE>
<CAPTION>
1998 1997
----------- -----------
<S> <C> <C>
Unearned premiums -
plan servicing $ 1,826,263 1,522,654
Unearned premiums -
fronting arrangements $19,892,656 17,160,782
Unpaid claims and claim
adjustment expenses -
plan servicing $ 9,898,649 9,431,814
Unpaid claims and claim
adjustment expenses -
fronting arrangements $12,332,740 8,623,890
</TABLE>
The Company remains directly liable to its policyholders for all policy
obligations and the reinsuring companies are obligated to the Company
to the extent of the reinsured portion of the risks. The Company does
not have a provision for uncollectible reinsurance and does not feel
one is warranted since all of the reinsurers on its treaties are rated
"A" or better by A.M. Best Company and/or the Company is adequately
collateralized on existing and anticipated claim recoveries.
The Company has not and does not intend to utilize retrospectively
rated reinsurance contracts with indefinite renewal terms. This form of
reinsurance is commonly known as a "funded cover". Under a funded cover
reinsurance arrangement, an insurance company essentially deposits
money with a reinsurer to help cover future losses and records the
"deposit" as an expense instead of as an asset; or, the insurance
company can borrow from a reinsurer recording the "loan" as income
instead of as a liability with the future "loan" payments recorded as
expense as the payments are made over time.
(3) Shareholders' Equity
As of September 30, 1998 there were 294,777 options, at an average
exercise price of $2.47 per share, that had been granted to officers
and directors of the Company under the 1990 Stock Option Plan, 666,153
options, at an average exercise price of $8.75 per share, that had been
granted to officers and directors of the Company under the 1995 Stock
Option Plan and 579,710 options, at an average exercise price of $5.75
per share that had been granted to Glenn W. Anderson.
11
<PAGE> 12
GAINSCO, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
During 1997, the Company had repurchased 714,634 shares of its common
stock at a cost of $6,539,742. During the first quarter of 1998, the
Company purchased 17,200 shares at a cost of $142,191. The Company has
no plans to purchase additional shares.
The Company's policy is to pay a quarterly cash dividend of $.0175 per
share every quarter until further action is taken by the Board of
Directors. A cash dividend of $365,690 was paid on October 15, 1998.
The Board of Directors has declared a regular cash dividend of $.0175
per share payable on January 15, 1999, to shareholders of record on
December 31, 1998.
(4) Subsequent Event
On October 23, 1998, the Company completed the acquisition of the
Lalande Group of Miami, Florida. The Lalande Group has two principal
corporations, National Specialty Lines, Inc. (NSL) and De la Torre
Insurance Adjusters, Inc. (DLT). NSL is a managing general agency which
markets nonstandard private passenger automobile insurance through
approximately 800 retail agencies in Florida. DLT is an automobile
claims adjusting firm that provides claim services on NSL produced
business and to outside parties. The purchase price was for $18 million
in cash plus up to an additional $22 million in cash over approximately
five years linked directly to operating performance.
12
<PAGE> 13
GAINSCO, INC. AND SUBSIDIARIES
Management's Discussion and Analysis of
Financial Condition and Results of Operations
Results of Operations
Gross premiums written for the third quarter of 1998 were approximately
$22,722,000 versus $23,055,000 for the comparable 1997 period representing a 1%
decrease that was largely attributable to continued strong competition and
discontinuance of certain programs. For the first nine months of 1998 gross
premiums written have decreased 11% from the comparable 1997 period. The
following table presents, for each major product line, gross premiums written
for the periods indicated:
<TABLE>
<CAPTION>
Three months Nine months
ended September 30 ended September 30
-----------------------------------------------------------------------------------------------
1998 1997 1998 1997
------------------- ------------------- ------------------- --------------------
(Amounts in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Commercial auto $11,959 53% $11,947 52% $35,774 55% $41,182 56%
Auto garage 5,172 23% 6,089 26% 15,019 23% 17,417 24%
General liability 4,523 20% 4,353 19% 12,541 19% 12,973 18%
Other lines 1,068 4% 666 3% 1,684 3% 1,441 2%
------- ------- ------- ------- ------- ------- ------- -------
Total $22,722 100% $23,055 100% $65,018 100% $73,013 100%
======= ======= ======= ======= ======= ======= ======= =======
</TABLE>
For the third quarter of 1998 COMMERCIAL AUTO is flat, AUTO GARAGE is down 15%
and GENERAL LIABILITY is up 4%. For the first nine months of 1998 COMMERCIAL
AUTO is down 13%, AUTO GARAGE is down 14% and GENERAL LIABILITY is down 3%.
Commercial auto is down largely due to the discontinuance of the Kentucky coal
truck business in the last half of 1997. Auto garage is down largely because of
competition in California, Connecticut, Florida, Pennsylvania and Texas. General
liability is up 4% for the quarter as a result of marketing efforts in
Pennsylvania and Texas. For the first nine months of 1998, gross premium written
percentages by state/product line are as follows: Texas commercial auto (23%),
Texas general liability (7%), Pennsylvania commercial auto (5%), and Florida
garage (5%) with no other state/product line comprising 5% or more. The
persistency rate decreased from 46% to 45% in 1998. Premiums earned decreased 9%
for the three months and nine months ended September 30, 1998, respectively, as
a result of the decrease in premiums written.
Net investment income increased 2% for the third quarter and 4% for the first
nine months of 1998 as a result of positive cash flows from operations. At
September 30, 1998, 71% of the Company's investments were in investment grade
tax-exempt bonds with an average maturity of 2.9 years. On a taxable equivalent
basis the return on average investments is 6.2% for 1998 and 6.3% for 1997. The
Company has the ability to hold its bond securities until their maturity date.
The Company does not actively trade its bonds, however, it does classify
certain bond securities as available for sale. At September 30, 1998,
approximately 9% of the Company's investments were in U.S. Treasury securities
and 20% were in short-term
13
<PAGE> 14
money market funds. The Company has not invested and does not intend to invest
in derivatives or high-yield ("junk") securities, nor equity securities in
issuers of "junk" debt securities. The Company does not have any non-performing
fixed maturity securities.
The Company recorded net realized capital gains of $242,249 during the third
quarter of 1998 versus $177,075 for the comparable 1997 period, which brings net
realized capital gains for the nine months to $556,116 versus $213,561 for the
same period in 1997. All of the gains were generated from the bonds available
for sale category of the fixed maturity portfolio.
Insurance services revenues decreased $13,693 in the third quarter of 1998 from
the third quarter of 1997. For the first nine months of 1998 a decrease of
$82,114 has been recorded from the comparable 1997 period. The following table
presents the components:
<TABLE>
<CAPTION>
Three months Nine months
ended September 30 ended September 30
------------------------- -------------------------
1998 1997 1998 1997
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Plan servicing $ 234,067 265,018 727,668 786,092
Fee income 187,344 150,827 512,902 445,463
Computer software 185,545 146,564 479,849 448,736
Premium finance 22,881 76,251 122,605 225,249
Other income 3,343 8,213 7,376 26,974
--------- --------- --------- ---------
Total $ 633,180 646,873 1,850,400 1,932,514
========= ========= ========= =========
</TABLE>
Plan servicing revenues from commercial automobile plans decreased $30,951 in
the third quarter of 1998 when compared to the third quarter of 1997 and are
$58,424 below the comparable nine month period of 1997. The Company gave notice
in June, 1998 to each of the state plans informing them that it would no longer
accept business as a servicing carrier after December 31, 1998. This decision
was the conclusion of an analysis that the margins from this operation were not
adequate.
Fee income increased $36,517 and $67,439 for the third quarter and nine months
ended 1998, respectively, as a result of growth in reinsurance fronting.
Revenues in the computer software operation are up 27% and 7% for the third
quarter and nine months ended 1998, respectively, versus the comparable 1997
periods as a result of several system sales during the third quarter of 1998.
Revenues from the premium finance operation are down 70% in the third quarter of
1998 from the third quarter of 1997 and are down 46% for the first nine months
of 1998 as a result of the decision to offer an interest free payment plan on
the policies of the affiliated insurance companies. The Company decided in the
second quarter to exit the premium finance business, but will continue to offer
interest free payment plans on its own policies.
Claims and claim adjustment expenses (C & CAE) decreased $1,944,146 in the third
quarter of 1998 from the third quarter of 1997. The C & CAE ratio was 68.5% in
the third quarter of 1998 versus 70.2% in 1998 for
14
<PAGE> 15
the comparable period. C & CAE have increased $23,429,953 for the first nine
months of 1998 over the comparable 1997 period. This included approximately
$24,380,000 in development from prior accident years. The C & CAE ratio was
99.6% for the first nine months of 1998 and 59.9% for the comparable 1997
period. The increase in the C & CAE ratio for the first nine months of 1998 was
the result of unfavorable claim development from prior accident years which
surfaced in the first six months of 1998, unfavorable claim adjustment expense
development from prior accident years and implementation of a more conservative
reserving approach. During the first nine months of 1998 outstanding claims
were reduced approximately 26%.
The ratio of commissions to gross premiums written was 21% for the third quarter
of 1998 versus 22% for the comparable 1997 period and it was 25% for the first
nine months of 1998 as compared to 21% for the comparable 1997 period.
Commissions increased in the first nine months of 1998 over the first nine
months of 1997 primarily due to a decrease in commission income of approximately
$2,592,000 for the first nine months of 1998 as a result of reducing previously
accrued reinsurance commission. The reinsurance commission had been accrued
based on a lower expected ultimate C & CAE ratio. The ratio of commissions to
premiums earned is higher in the 1998 periods than in the 1997 periods largely
for the same reason.
The change in deferred policy acquisition costs resulted in a net decrease to
income of $273,729 for the third quarter of 1998 versus a net decrease of
$582,810 in the third quarter of 1997. A net decrease of $1,507,113 was recorded
for the first nine months of 1998 versus a net decrease of $1,187,950 in the
comparable 1997 period. The change in the amount of the decrease in DAC between
comparable periods is directly related to the rate at which unearned premiums
are declining as a result of the decrease in premium writings. Since DAC (asset)
is a function of unearned premiums (liability) the change in DAC correlates to
the change in unearned premiums. The ratio of DAC to net unearned premiums was
26% at September 30, 1998 and 1997.
Underwriting and operating expenses were up only 3% in the third quarter of 1998
over 1997 and were up only 2% for the first nine months of 1998 over 1997, as a
result of the decrease in premium taxes and bureaus expense largely offsetting
increases in other expenses. The ratio to operating revenues increased to 17.7%
in the first nine months of 1998 from 15.8% in the first nine months of 1997
primarily due to the decrease in earned premiums.
For the nine months ended September 30, 1998, the Company generated a current
tax benefit as a result of the loss recorded during this period. The deferred
tax benefit is the result of the tax discounting of the large increase to C &
CAE reserves recorded during this period.
Liquidity and Capital Resources
The primary sources of the Company's liquidity are funds generated from
insurance premiums, net investment income and maturing investments. The
short-term investments and cash are intended to provide adequate funds to pay
claims without selling the fixed maturity investments. At September 30, 1998 the
Company held short-term investments and cash of $43,724,511 which the Company
believes is adequate liquidity for the payment of claims and other short-term
commitments.
With regard to long term liquidity, the average duration of the investment
portfolio is 2.8 years which approximates the average payout period of claims.
The fair value of the fixed maturity portfolio at September 30, 1998 was
$3,946,504 above amortized cost.
15
<PAGE> 16
Cash and accrued investment income decreased because of the decrease in bonds
available for sale and related increase in short-term investments. Premiums
receivable decreased as a result of a larger level of premium writings in the
fourth quarter of 1997 than in the third quarter of 1998. Ceded unpaid claims
and claim adjustment expenses, as well as ceded unearned premiums, increased due
to increases from fronting reinsurance. Deferred policy acquisition costs (DAC)
decreased as a direct result of the decrease in unearned premiums. DAC was 26%
of net unearned premiums at September 30, 1998 and at December 31, 1997. Current
Federal income taxes recoverable increased as a result of the loss recorded
during the first nine months of 1998. Deferred Federal income taxes recoverable
increased because of the tax discount effect on the large increase in C & CAE
reserves recorded during the nine months ended September 30, 1998.
Unpaid claims and claim adjustment expenses increased as a result of unfavorable
claim and claim adjustment expense development from prior accident years and a
more conservative reserving approach for the current accident year. Unearned
premiums decreased as a result of the decline in gross premiums written. The
increase in reinsurance balances payable is largely attributable to increases in
fronting reinsurance. Drafts payable decreased because an unusually large amount
of drafts were issued late in the fourth quarter of 1997 and cleared or reversed
during the first quarter of 1998.
Accumulated other comprehensive income of $1,714,157 was recorded at September
30, 1998 as a result of the net unrealized gains on the bonds available for
sale.
The Company purchased 17,200 shares of its common stock during the first quarter
of 1998 at a cost of $142,191 or $8.27 per share which accounts for the increase
in Treasury stock. The Company has no plans to purchase additional shares.
The Company is not aware of any current recommendations by the regulatory
authorities, which if implemented, would have a material effect on the Company's
liquidity, capital resources or results of operations.
Year 2000 Readiness
A "Year 2000 problem" exists worldwide because many existing computer programs
use only the last 2 digits to refer to a year. Therefore these computer programs
do not properly recognize a year that begins with "20" instead of the familiar
"19". If not corrected, many computer applications could fail or create
erroneous results. In addition to the two-digit portion of the problem, other
date issues can generate erroneous results. These include Year 2000 being a leap
year and the use of Gregorian date of 9999 or the use of Julian date 9999 in a
date field to alert the program to perform special handling, while Gregorian
September 9, 1999 and Julian April 9, 1999 are actual dates.
The Company was well aware of these impacts and began addressing its Year 2000
readiness in 1996, excluding the Lalande Group whose acquisition by the Company
was completed on October 23, 1998 [see Note (4) of Notes to Consolidated
Financial Statements included in Item 6.(b)(1)]. The Company appointed a Year
2000 team involving personnel from all business units responsible for
implementing the project, while the department Vice Presidents formed the Year
2000 steering committee. The project scope encompassed all information
technology, including hardware and software whether developed internally or
externally, vendors, producers, and the Company's exposure relating to policy
coverage.
The Company completed the assessment phase, the strategy phase, the analysis
phase and the planning phase for all hardware and software systems,
non-information technology equipment and strategic business relationships. The
Company believes that it has completed the remediation and testing phase of all
mission critical systems and all hardware. The Company is either in the
remediation or testing phase of its non-mission critical software. The Company
anticipates that its non-mission critical software will be ready by March 30,
1999.
During 1998 the Company contracted with a major consulting vendor to perform due
diligence assessment and testing of our Year 2000 project. While assessing the
Company's readiness, the vendor identified some programs that required
additional remediation and re-testing. The Company believes the non-conforming
issues not to be material. However, the Company is endeavoring to correct all
the identified non-conforming programs and expects them to be complete by
December 31, 1998.
The Company has performed a written survey of all strategic business partners
including producers, material vendors, reinsurers, reinsurance intermediaries,
utilities, telecommunications services, web hosting providers, Internet service
providers, hardware providers, software providers and financial institutions.
The Company is monitoring the progress of the partners, which if impaired by a
Year 2000 problem, would have a material impact on the Company. The Company is
developing contingency plans in the event that a material business partner is
not Year 2000 ready. However, there can be no assurance that all material
business partners will be Year 2000 ready and such could have a material effect
on the Company's financial position. The Company expects to complete its review
of all business partners by December 31, 1998.
A comprehensive review was performed by the Company of the insurance policies
written by it and its underwriting guides to determine Year 2000 exposure. The
Company made a decision to exclude Year 2000 exposures from all insurance
policies written by it and began adding exclusions in November, 1997. The
Company believes Year 2000 liabilities are not fortuitous in nature and would
not be covered under its insurance policies. The Company contends that its
coverage exposure with respect to Year 2000 losses will not be material.
However, changes in social and legal trends may establish coverage unintended
for Year 2000 exposures by re-interpreting insurance contracts and exclusions.
It is impossible to predict what exposure insurance companies may bear for the
Year 2000 losses.
The Company estimates that its costs of addressing the year 2000 problem will
aggregate approximately $850,000, including modifying or replacing software and
other systems, hiring Year 2000 solution providers and internal assessment,
remediation and testing. Of this amount, approximately $435,000 was expensed
prior to 1998, approximately $75,000 was expensed in the nine months ended
September 30, 1998 and approximately $40,000 remains to be expended.
The Company is establishing contingency plans for hardware and software failures
with respect to the Year 2000 problem. Since all of the Company's mission
critical systems and hardware are believed to be Year 2000 ready and have been
assessed by an outside vendor, the Company does not expect any material Year
2000 failures. As of September 30, 1998, the Company is not aware of any
material business partner that will not be Year 2000 ready. The Company expects
to review all business partners' readiness by December 31, 1998. If, in the
event the Company becomes aware of a strategic partner's failure to be prepared,
the Company will evaluate using another vendor.
The Lalande Group has been addressing their Year 2000 readiness since 1997. As
of September 30, 1998, Lalande is performing remediation and testing of their
mission critical systems. Lalande expects its mission critical systems to be
Year 2000 ready by December 31, 1998. The Company expects that Lalande's
non-mission critical system will be Year 2000 ready by September 30, 1999. The
Company believes expenses remaining to be expended on Lalande's Year 2000
project to be immaterial.
Forward Looking Statements
This Form 10-Q Report contains forward-looking statements within the meaning of
the Private Securities Litigation Reform Act of 1995. Investors are cautioned
that all forward-looking statements involve certain risks and uncertainties that
could cause actual results to differ materially from those contained in the
forward-looking statements. Important factors include, but are not limited to,
(i) heightened competition, including price competition from existing
competitors, from newly formed competitors and from the entry into the Company's
markets of standard insurance companies which historically have not competed in
the Company's specialty markets, (ii) contraction of the markets for the
Company's various lines of business, (iii) development and performance of new
specialty programs, (iv) the ongoing level of claims and claims-related
expenses, (v) adequacy of claim reserves, (vi) Year 2000 developments, and (vii)
general economic conditions.
16
<PAGE> 17
PART II. OTHER INFORMATION
GAINSCO, INC. AND SUBSIDIARIES
Item 1. Legal proceedings
The Company is a defendant in the proceedings styled William Steiner v.
GAINSCO, INC., Joseph D. Macchia, Glenn W. Anderson and Daniel J.
Coots, filed in the United States District Court for the Northern
District of Texas, Fort Worth Division. In that case, the plaintiff
asserts claims on behalf of a putative class of persons who purchased
the Company's common stock between November 5, 1997 and May 15, 1998,
inclusive. The plaintiff asserts claims under sections 10(b) and 20(a)
of the Securities Exchange Act of 1934, alleging that the Company's
reported financial results did not reflect the Company's true financial
position and results of operations in accordance with generally
accepted accounting principles in that they understated reserves for
claims and claim adjustment expenses. The Company believes that there
is no merit to plaintiff's claims and intends to vigorously defend the
action.
In the normal course of its operations, the Company is defending its
insureds who have been named as defendants in various legal actions
seeking damages (no bad faith claims are pending against the Company).
In the opinion of the Company's management, the ultimate liability, if
any, resulting from these will not have a material adverse effect on
the Company's consolidated financial position or results of operations.
Item 4. Submission of Matters to a Vote of Security Holders
The Company's Annual Meeting of Shareholders was held on July 17, 1998,
in Fort Worth, Texas. At the Annual Meeting, shareholders elected
directors for the ensuing year and until their successors are duly
elected and qualified, ratified the selection by the Board of Directors
of KPMG Peat Marwick LLP as the Company's independent auditors for the
year ending December 31, 1998 and ratified the adoption of the 1998
Long-Term Incentive Plan. The results of the voting were as follows:
<TABLE>
<CAPTION>
Election of Directors For Withheld
- - -------------------- --- --------
<S> <C> <C>
Glenn W. Anderson 15,180,794 4,249,700
Daniel J. Coots 17,437,718 1,992,776
John C. Goff 15,164,118 4,266,376
Robert J. McGee, Jr. 15,164,218 4,266,276
Joel C. Puckett 15,235,176 4,195,318
Sam Rosen 14,917,846 4,512,648
Harden H. Wiedemann 15,174,586 4,255,908
John H. Williams 15,161,073 4,269,421
</TABLE>
Ratification of appointment of independent auditors:
<TABLE>
<CAPTION>
Abstentions and Brokers
-----------------------
For Against Non-Votes
--- ------- ---------
<S> <C> <C>
17,808,279 36,005 1,586,210
</TABLE>
Ratification of 1998 Long-Term Incentive Plan:
<TABLE>
<CAPTION>
Abstentions and Brokers
-----------------------
For Against Non-Votes
--- ------- ---------
<S> <C> <C>
13,676,790 5,608,766 144,938
</TABLE>
17
<PAGE> 18
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
11. The statement re computation of per share earnings is
included in the notes to consolidated financial
statements.
27. Financial Data Schedule for the period ended September 30,
1998.
(b) Reports on Form 8-K. The Company filed reports on Form 8-K
during the quarter ended September 30, 1998 as follows:
(1) Form 8-K Report filed August 26, 1998 reporting under
Item 5 that on August 17, 1998 the Company entered into
agreements for the Company's acquisition of all the
outstanding capital stock of National Specialty Lines,
Inc. ("NSL"), a licensed managing general agency
specializing in the underwriting and servicing of
non-standard private passenger automobile insurance in
Florida, De la Torre Insurance Adjusters, Inc. ("DLT"), a
claim adjustment company, and Lalande Financial Group,
Inc., a servicing company which provides services to NSL
and DLT. No financial statements were filed with the Form
8-K Report. See Note 4 of Notes to Consolidated Financial
Statements included in Item 1 of this Form 10-Q Report.
(2) Form 8-K Report filed September 14, 1998 disclosing under
Item 5 that on August 28, 1998 the Board of Directors of
the Company determined to commence pursuit of additional
strategic alternatives to maximize shareholder value,
including a possible sale of the Company, and has engaged
the investment banking firm of Wasserstein Perella & Co.
as financial advisor in this process. No financial
statements were filed with the Form 8-K Report.
18
<PAGE> 19
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 to sign on behalf of the Registrant as
well as in his capacity as Chief Financial Officer.
GAINSCO, INC.
Date: November 13, 1998
By /s/ DANIEL J. COOTS
----------------------------------
Daniel J. Coots
Senior Vice President, Treasurer and
Chief Financial Officer
19
<PAGE> 20
INDEX TO EXHIBITS
Exhibit No. Description
11. The statement re computation of per share earnings is included in
the notes to consolidated financial statements.
27. Financial Data Schedule for the period ended September 30, 1998.
<TABLE> <S> <C>
<ARTICLE> 7
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<DEBT-HELD-FOR-SALE> 106,692,901
<DEBT-CARRYING-VALUE> 66,876,686
<DEBT-MARKET-VALUE> 68,186,025
<EQUITIES> 0
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 215,766,346
<CASH> 2,122,752
<RECOVER-REINSURE> 3,266,037
<DEFERRED-ACQUISITION> 10,111,023
<TOTAL-ASSETS> 324,298,920
<POLICY-LOSSES> 137,555,970
<UNEARNED-PREMIUMS> 62,059,948
<POLICY-OTHER> 0
<POLICY-HOLDER-FUNDS> 0
<NOTES-PAYABLE> 0
0
0
<COMMON> 2,174,066
<OTHER-SE> 0
<TOTAL-LIABILITY-AND-EQUITY> 324,298,920
69,735,212
<INVESTMENT-INCOME> 7,505,167
<INVESTMENT-GAINS> 556,116
<OTHER-INCOME> 1,850,400
<BENEFITS> 69,433,537
<UNDERWRITING-AMORTIZATION> 1,507,113
<UNDERWRITING-OTHER> 12,695,372
<INCOME-PRETAX> (20,496,036)
<INCOME-TAX> (8,764,045)
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (11,731,991)
<EPS-PRIMARY> (.56)
<EPS-DILUTED> 0
<RESERVE-OPEN> 0
<PROVISION-CURRENT> 0
<PROVISION-PRIOR> 0
<PAYMENTS-CURRENT> 0
<PAYMENTS-PRIOR> 0
<RESERVE-CLOSE> 0
<CUMULATIVE-DEFICIENCY> 0
</TABLE>
