<PAGE> 1
SCHEDULE 14A
(RULE 14A-101)
INFORMATION REQUIRED IN PROXY STATEMENT
SCHEDULE 14A INFORMATION
PROXY STATEMENT PURSUANT TO SECTION 14(A) OF THE SECURITIES
EXCHANGE ACT OF 1934
Filed by the Registrant [X]
Filed by a Party other than the Registrant [ ]
Check the appropriate box:
[X] Preliminary Proxy Statement [ ] Confidential, for Use of the
Commission Only (as permitted by
Rule 14a-6(e)(2))
[ ] Definitive Proxy Statement
[ ] Definitive Additional Materials
[ ] Soliciting Material Pursuant to sec. 240.14a-11(c) or sec. 240.14a-12
AMERICAN EAGLE GROUP, INC.
- --------------------------------------------------------------------------------
(Name of Registrant as Specified in its Charter)
- --------------------------------------------------------------------------------
(Name of Person(s) Filing Proxy Statement, if other than the Registrant)
Payment of Filing Fee (Check the appropriate box):
[X] No fee required.
[ ] $500 per each party to the controversy pursuant to Exchange Act Rule
14a-6(i)(3).
[ ] Fee computed on table below per Exchange Act Rules 14a-6(i)(4) and
0-11.
(1) Title of each class of securities to which transaction applies:
- --------------------------------------------------------------------------------
(2) Aggregate number of securities to which transaction applies:
- --------------------------------------------------------------------------------
(3) Per unit price or other underlying value of transaction computed
pursuant to Exchange Act Rule 0-11 (Set forth the amount on which the filing fee
is calculated and state how it was determined):
- --------------------------------------------------------------------------------
(4) Proposed maximum aggregate value of transaction:
- --------------------------------------------------------------------------------
(5) Total fee paid:
- --------------------------------------------------------------------------------
[ ] Fee paid previously with preliminary materials.
- --------------------------------------------------------------------------------
[ ] Check box if any part of the fee is offset as provided by Exchange Act
Rule 0-11(a)(2) and identify the filing for which the offsetting fee was paid
previously. Identify the previous filing by registration statement number, or
the Form or Schedule and the date of its filing.
(1) Amount Previously Paid:
- --------------------------------------------------------------------------------
(2) Form, Schedule or Registration Statement No.:
- --------------------------------------------------------------------------------
(3) Filing Party:
- --------------------------------------------------------------------------------
(4) Date Filed:
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<PAGE> 2
'[AMERICAN EAGLE LOGO]
AMERICAN EAGLE GROUP, INC.
12801 N. CENTRAL EXPRESSWAY, SUITE 800
DALLAS, TEXAS 75243
December , 1996
Dear Stockholder:
You are cordially invited to attend a special meeting (the "Special
Meeting") of the stockholders of American Eagle Group, Inc. (the "Company") to
be held on December 30, 1996 at 9:00 a.m. local time at
, Dallas, Texas .
At the Special Meeting, you will be asked to approve a transaction in which
the Company will issue 350,000 shares of the Company's Series D Preferred Stock,
par value $.01 (the "Series D Preferred Stock"), to American Financial Group,
Inc. for $35 million in cash. The Series D preferred stock will initially be
convertible into an aggregate of 6,666,667 shares of the Common Stock of the
Company, par value $.01 (the "Common Stock"), or approximately 48.6% of the
Common Stock outstanding after such conversion. In addition, up to 196,200
shares of Series D Preferred Stock (the "PIK Shares") may be issued as dividends
in kind on the shares of Series D Preferred Stock and such PIK Shares would be
convertible into an aggregate of 3,736,724 shares of Common Stock, or 21.4% of
the shares of Common Stock outstanding after such conversion. If all shares of
the Series D Preferred Stock are converted and the full amount of PIK Shares are
issued and fully converted, AFG would own approximately 59.6% of the shares of
the Common Stock then outstanding, assuming the Company does not issue any
shares of Common Stock other than upon conversion of Series D Preferred Stock
(including PIK Shares) or reduce any outstanding shares of Common Stock. The
transaction will provide the Company with a significant capital infusion that
will enable the Company to contribute capital to its subsidiary, American Eagle
Insurance Company, and to pay down bank debt; the remainder, after transaction
expenses, will be used for general corporate purposes. In addition to the
capital investment, the transaction embodies a strategic alliance that will
allow the Company to market and underwrite both new and expanded aviation
insurance product lines, and permit the Company to offer products to its
insureds providing the financial security of an insurer rated "A" (Excellent) by
A.M. Best Company. The attached Proxy Statement describes the transaction in
detail and you are urged to review the Proxy Statement carefully.
CS First Boston Corporation, the investment banking firm retained by the
Company to act as financial advisor in connection with the transaction, has
rendered its written opinion to the Board of Directors of the Company to the
effect that, as of November 5, 1996 and based upon and subject to certain
matters stated in such opinion, the cash consideration to be received by the
Company in the sale of the securities issued in the transaction is fair to the
Company from a financial point of view.
THE BOARD OF DIRECTORS OF THE COMPANY HAS UNANIMOUSLY APPROVED THE
TRANSACTION AND HAS DETERMINED THAT IT IS FAIR TO AND IN THE BEST INTERESTS OF
THE COMPANY AND ITS STOCKHOLDERS. THE BOARD OF DIRECTORS UNANIMOUSLY RECOMMENDS
THAT STOCKHOLDERS VOTE FOR THE PROPOSAL TO BE CONSIDERED AT THE SPECIAL MEETING.
IT IS IMPORTANT THAT YOUR SHARES BE REPRESENTED AND VOTED AT THE SPECIAL
MEETING. THEREFORE, PLEASE COMPLETE, SIGN, DATE AND PROMPTLY RETURN THE ENCLOSED
PROXY CARD. IF YOU ATTEND THE MEETING AND VOTE IN PERSON, YOUR VOTE WILL
SUPERSEDE YOUR PROXY.
Sincerely,
/s/ M. PHILIP GUTHRIE
M. PHILIP GUTHRIE
Chairman of the Board, Chief
Executive
Officer and President
<PAGE> 3
[AMERICAN EAGLE LOGO]
AMERICAN EAGLE GROUP, INC.
12801 N. CENTRAL EXPRESSWAY, SUITE 800
DALLAS, TEXAS 75243
NOTICE OF SPECIAL MEETING OF STOCKHOLDERS
TO BE HELD ON DECEMBER 30, 1996
TO THE STOCKHOLDERS OF AMERICAN EAGLE GROUP, INC.:
NOTICE IS HEREBY GIVEN that a special meeting (the "Special Meeting") of
stockholders of American Eagle Group, Inc., a Delaware corporation (the
"Company"), will be held on December 30, 1996, commencing at 9:00 a.m., local
time, at , Dallas, Texas to consider and
act upon the following matters which are described in more detail in the
accompanying Proxy Statement:
1. To consider and vote upon a proposal (the "Proposal") to approve a
Securities Purchase Agreement dated as of November 5, 1996 (the "Securities
Purchase Agreement") between the Company and American Financial Group,
Inc., an Ohio corporation ("AFG"), and the performance by the Company of
all transactions and acts contemplated thereby (collectively, the
"Transaction"), including, among other things, (a) the sale and issuance to
AFG for an aggregate purchase price of $35 million of 350,000 shares of the
Company's Series D Preferred Stock, par value $.01 per share (the "Series D
Preferred Stock"), which shall initially be convertible into an aggregate
of 6,666,667 shares of the Company's Common Stock, par value $.01 per share
(the "Common Stock"), at a conversion price of $5.25 per share (subject to
antidilution provisions), (b) the issuance of up to an additional 196,200
shares of Series D Preferred Stock that may be issued by the Company as
dividends in kind on the shares of Series D Preferred Stock, (c) the
issuance of up to 10,403,810 warrants ("Warrants") (subject to antidilution
provisions) to purchase shares of Common Stock that the Company will be
required to issue if the Company elects to redeem the Series D Preferred
Stock prior to the seventh anniversary of the date of initial issuance, and
(d) the issuance of up to 10,403,810 shares (subject to antidilution
provisions) of Common Stock issuable upon conversion of shares of Series D
Preferred Stock and exercise of Warrants.
2. To consider and act upon such other business as may properly be
brought before the meeting or any adjournment or postponement thereof.
Holders of record of shares of the Company's Common Stock, at the close of
business on December 4, 1996, the record date for the Special Meeting, are
entitled to notice of, and to vote at, the Special Meeting and any adjournment
or postponement thereof.
When a proxy is returned properly executed, the shares represented thereby
will be voted in accordance with the indicated instructions. However, if no
instructions have been specified on the returned proxy, the shares represented
thereby will be voted "FOR" approval of the Proposal. The affirmative vote of a
majority of the outstanding shares of Common Stock present, in person or by
proxy, and entitled to vote at the Special Meeting is required to approve the
Proposal, provided that the total votes cast on the Proposal constitute a
majority of the outstanding shares of Common Stock.
<PAGE> 4
Any stockholder giving a proxy has the right to revoke it at any time
before it is voted by filing, with the Secretary of the Company, either an
instrument revoking the proxy or a duly executed proxy bearing a later date.
Proxies also may be revoked by attending the meeting and voting in person.
By Order of the Board of Directors
AMERICAN EAGLE GROUP, INC.
/s/ M. PHILIP GUTHRIE
M. PHILIP GUTHRIE
Chairman of the Board, Chief Executive
Officer and President
YOUR VOTE IS IMPORTANT. TO ASSURE YOUR REPRESENTATION AT THE SPECIAL
MEETING, PLEASE DATE THE ENCLOSED PROXY CARD, WHICH IS SOLICITED BY THE BOARD OF
DIRECTORS OF THE COMPANY, SIGN EXACTLY AS YOUR NAME APPEARS THEREON AND RETURN
IT IMMEDIATELY.
December , 1996
<PAGE> 5
'[AMERICAN EAGLE LOGO]
AMERICAN EAGLE GROUP, INC.
12801 N. CENTRAL EXPRESSWAY, SUITE 800
DALLAS, TEXAS 75243
PROXY STATEMENT
SPECIAL MEETING OF STOCKHOLDERS
TO BE HELD DECEMBER 30, 1996
This Proxy Statement is being furnished to holders of Common Stock, par
value $.01 per share (the "Common Stock"), of American Eagle Group, Inc., a
Delaware corporation (the "Company"), in connection with the solicitation of
proxies by the Board of Directors of the Company for use at a special meeting of
stockholders of the Company (the "Special Meeting"), to be held at 9:00 a.m.,
local time, on December 30, 1996, at ,
Dallas, Texas, and at any and all adjournments or postponements thereof.
At the Special Meeting, holders of Common Stock will be asked to consider
and vote upon a proposal (the "Proposal") to approve a Securities Purchase
Agreement dated as of November 5, 1996 (the "Securities Purchase Agreement")
between the Company and American Financial Group, Inc., an Ohio corporation
("AFG"), and the performance by the Company of all transactions and acts
contemplated thereby (collectively, the "Transaction"), including, among other
things, (a) the sale and issuance to AFG for an aggregate purchase price of $35
million of 350,000 shares of the Company's Series D Preferred Stock, par value
$.01 per share (the "Series D Preferred Stock"), which shall initially be
convertible into an aggregate of 6,666,667 shares of Common Stock at a
conversion price of $5.25 per share (subject to antidilution provisions), (b)
the issuance of up to an additional 196,200 shares of Series D Preferred Stock
that may be issued by the Company as dividends in kind on the shares of Series D
Preferred Stock, (c) the issuance of up to 10,403,810 warrants ("Warrants")
(subject to antidilution provisions) to purchase shares of Common Stock that the
Company will be required to issue if the Company elects to redeem the Series D
Preferred Stock prior to the seventh anniversary of the date of initial
issuance, and (d) the issuance of up to 10,403,810 shares (subject to
antidilution provisions) of Common Stock issuable upon conversion of shares of
Series D Preferred Stock and exercise of Warrants.
The Securities Purchase Agreement also embodies a strategic alliance with
AFG that will allow the Company to market and underwrite new and expanded
aviation insurance product lines, and permit the Company to offer products to
its insureds providing them the financial security of an insurer rated "A"
(Excellent) by A.M. Best Company.
This Proxy Statement and the accompanying Notice of Special Meeting of
Stockholders and Proxy were first mailed to stockholders on or about December ,
1996.
<PAGE> 6
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
SUMMARY.................................... 3
The Special Meeting...................... 3
Time and Place......................... 3
Purpose................................ 3
Voting; Votes Required for Approval.... 3
The Transaction.......................... 3
Securities Purchase Agreement.......... 3
Reasons for the Transaction............ 6
Opinion of Financial Advisor........... 7
Conditions to the Transaction.......... 7
No Dissenters' Rights or Preemptive
Rights............................... 7
Certain Considerations................. 7
Interests of Certain Persons in the
Transaction.......................... 8
THE SPECIAL MEETING........................ 9
Time and Place; Purpose.................. 9
Voting; Vote Required for Approval....... 9
Proxies.................................. 9
Solicitation............................. 10
THE TRANSACTION............................ 10
General.................................. 10
Reasons for the Transaction.............. 13
Opinion of Financial Advisor............. 17
Use of Proceeds.......................... 21
Regulatory Approvals..................... 21
No Dissenters' Rights or Preemptive
Rights................................. 22
Interests of Certain Persons in the
Transaction............................ 22
CERTAIN CONSIDERATIONS..................... 24
Impact on Voting and Other Rights of
Stockholders; Impact on Future Share
Issuances.............................. 24
Substantial Equity Ownership on
Conversion and Dilution to Existing
Stockholders........................... 24
Restrictions on the Ability of AFG to
Effect a Business Combination with the
Company................................ 25
Strategic Alliance Arrangements.......... 26
Effect on Capital and Earnings Available
for Common Stockholders................ 26
CAPITALIZATION............................. 27
THE SECURITIES PURCHASE AGREEMENT AND
RELATED AGREEMENTS....................... 28
Issuance and Sale of Series D Preferred
Stock.................................. 28
<CAPTION>
PAGE
----
<S> <C>
Recapitalization Charge.................. 28
Certain Covenants........................ 28
AFG Representation on Board of
Directors.............................. 28
AFG Voting Agreement..................... 28
Strategic Alliance....................... 29
Conditions Precedent..................... 29
Restriction on Transferability of Series
D Preferred Stock...................... 29
Certain Representations and Warranties... 29
No Solicitation.......................... 30
Termination.............................. 30
Break-up Warrants........................ 31
Warrants Issuable Upon Early
Redemption............................. 31
Registration Rights Agreements........... 32
Amended Registration Rights Agreement.... 32
DESCRIPTION OF SERIES D PREFERRED STOCK.... 33
Priority................................. 33
Dividends................................ 33
Voting Rights............................ 33
Conversion............................... 34
Redemption............................... 34
Liquidation Preference................... 35
Restriction on Transfer.................. 35
Preemptive Rights........................ 35
AFG'S DESIGNEES FOR DIRECTORS.............. 35
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF
OPERATIONS............................... 36
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL
OWNERS, DIRECTORS AND MANAGEMENT......... 52
STOCKHOLDER PROPOSALS...................... 54
AVAILABLE INFORMATION...................... 54
INDEX TO CONSOLIDATED FINANCIAL
STATEMENTS............................... F-1
APPENDIX I -- OPINION OF CS FIRST BOSTON
CORPORATION
APPENDIX II -- SECURITIES PURCHASE AGREEMENT
APPENDIX III -- CERTIFICATE OF DESIGNATION
</TABLE>
2
<PAGE> 7
SUMMARY
The following is only a summary of certain information contained elsewhere
in this Proxy Statement and does not purport to be complete. Reference is made
to, and this Summary is qualified in its entirety by, the more detailed
information contained elsewhere in this Proxy Statement, including the attached
Appendices. Stockholders are urged to read this Proxy Statement and the
Appendices in their entirety.
THE SPECIAL MEETING
TIME AND PLACE
The Special Meeting will be held at 9:00 a.m., local time, on December 30,
1996, at
, Dallas, Texas.
PURPOSE
At the Special Meeting, holders of the Company's Common Stock will be asked
to consider and vote on the Proposal. If the Proposal is approved and the
Transaction is consummated, the Company will issue to American Financial Group,
Inc. ("AFG") 350,000 shares of Series D Preferred Stock for an aggregate
purchase price of $35 million. The Company will use the net proceeds from the
Transaction to provide capital to its insurance company subsidiary, American
Eagle Insurance Company ("AEIC"), and to pay down bank debt; the remainder,
after transaction expenses, will be used for general corporate purposes.
VOTING; VOTES REQUIRED FOR APPROVAL
The Board of Directors of the Company has established December 4, 1996 as
the record date (the "Record Date") for the determination of stockholders
entitled to notice of and to vote at the Special Meeting. Each share of Common
Stock is entitled to one vote. On the Record Date, there were shares
of Common Stock outstanding.
Because the Transaction will involve the issuance of securities convertible
into Common Stock in an amount in excess of 20% of the aggregate number of
shares of Common Stock outstanding, the New York Stock Exchange (the "NYSE")
requires that the Proposal be approved by the affirmative vote of the holders of
a majority of the outstanding shares of Common Stock entitled to vote and
present, in person or by proxy, at the Special Meeting, provided that the total
votes cast on the Proposal constitute at least a majority of the outstanding
shares of Common Stock.
Mason Best Company, L.P. ("Mason Best"), which owns 2,960,772 shares of
Common Stock, representing approximately 42% of the outstanding shares of Common
Stock, has entered into an agreement with AFG (the "Mason Best Voting
Agreement") to vote all of such shares for approval of the Proposal. Elvis L.
Mason, the General Partner of Mason Best, is a director of the Company. Mr.
Philip Guthrie, Chairman of the Board, Chief Executive Officer and President of
the Company, is a Managing Director of Mason Best.
THE TRANSACTION
SECURITIES PURCHASE AGREEMENT
On November 5, 1996, the Company and AFG entered into the Securities
Purchase Agreement, which, subject to the terms and conditions thereof, provides
for the sale and issuance by the Company to AFG of 350,000 shares of Series D
Preferred Stock for an aggregate purchase price of $35 million. Consummation of
the Securities Purchase Agreement is subject to certain conditions, including
approval of the Proposal by the stockholders of the Company.
Terms of the Series D Preferred Stock. The Series D Preferred Stock will be
entitled to a per annum cumulative dividend equal to 9% payable quarterly, with
payment commencing April 1, 1997. At the option of
3
<PAGE> 8
the Company, during the first five years after the date of closing of the
Securities Purchase Agreement (the "Closing Date"), dividends may be paid in
cash or in kind (whereby a holder, in lieu of cash, receives shares of Series D
Preferred Stock having a liquidation value equal to the dividends declared).
The Series D Preferred Stock will be convertible into shares of Common
Stock at any time at a conversion price of $5.25 per share (subject to
antidilution provisions). The Series D Preferred Stock will initially be
convertible into an aggregate of 6,666,667 shares of the Common Stock or
approximately 48.6% of the Common Stock outstanding after such conversion. In
addition, up to 196,200 shares of Series D Preferred Stock (the "PIK Shares")
may be issued as dividends in kind on the shares of Series D Preferred Stock and
such PIK Shares would be convertible into an aggregate of 3,736,724 shares of
Common Stock, or 21.4% of the shares of Common Stock outstanding after such
conversion. If all shares of the Series D Preferred Stock are converted and the
full amount of PIK Shares are issued and fully converted, AFG would own
approximately 59.6% of the shares of the Common Stock then outstanding, assuming
the Company does not issue any shares of Common Stock other than upon conversion
of Series D Preferred Stock (including PIK Shares) or reduce any outstanding
shares of Common Stock. The Series D Preferred Stock may be redeemed at any time
at the Company's option; provided, however, if the Company redeems any shares of
Series D Preferred Stock prior to the seventh anniversary of the Closing Date,
the Company shall, in addition to the cash payable to the holder, issue to the
holder, for each share of Common Stock into which the redeemed shares of Series
D Preferred Stock are then convertible, a Warrant to purchase one share of
Common Stock of the Company at an exercise price of $5.25 per share (subject to
antidilution provisions). The Company is required to redeem 10% of the
outstanding shares of Series D Preferred Stock on the first business day of each
year, commencing with the first business day in January 2008, and all remaining
outstanding shares are required to be redeemed on the first business day in
January 2017. The redemption price for the Series D Preferred Stock is $100.00
per share plus an amount equal to all accrued and unpaid dividends to the date
of redemption.
Until AFG and its affiliates no longer own Series D Preferred Stock and
shares ("Underlying Shares") of Common Stock issued or issuable upon exercise of
conversion rights relating to the Series D Preferred Stock or upon the exercise
of the Warrants representing in the aggregate the ownership, or the right to
acquire ownership, of 51% of the Underlying Shares or until the seventh
anniversary of the Closing Date, whichever is earlier, AFG shall be entitled to
nominate for election 30% of the Company's directors and, if elected, at least
one director representing AFG shall serve on each standing committee of the
Board of Directors. Notwithstanding the foregoing, the number of directors that
AFG is entitled to nominate shall be reduced by the number of directors that the
holders of the Series D Preferred Stock are entitled to elect as a class under
the terms of the Certificate of Designation for the Series D Preferred Stock
(the "Certificate of Designation"). Mason Best has agreed to vote all shares
owned by it in favor of the election of AFG's nominees. If AFG's nominees fail
to be elected to the Board of Directors, AFG shall nevertheless be entitled to
have an equal number of representatives attend each meeting of the Board of
Directors. The Certificate of Designation provides that, upon the occurrence and
continuation of a default in dividend payments for at least two consecutive
quarters or a default in any mandatory redemption payment on the Series D
Preferred Stock, the holders of the Series D Preferred Stock, voting as a
separate class, shall be entitled at the next annual or special meeting of
stockholders to elect a majority of the directors of the Company to be elected.
The Certificate of Designation provides that the holders of the Series D
Preferred Stock, for the seven years following the Closing Date, shall be
entitled collectively to cast 20% of the votes eligible to be cast on each
matter submitted to a vote of the holders of capital stock of the Company,
except that if the aggregate number of shares of Common Stock issuable upon
conversion of the Series D Preferred Stock represents less than 20% of the
outstanding shares of Common Stock on a fully diluted basis, then each share of
Series D shall be entitled to the number of votes equal to the number of shares
of Common Stock into which such share of Series D Preferred Stock is then
convertible. In addition, the Securities Purchase Agreement provides that until
the date which is three years and 180 days after the Closing Date, so long as
AFG and any affiliate of AFG shall beneficially own Series D Preferred Stock or
Underlying Shares which represent in the aggregate the ownership, or right to
acquire ownership, of at least 51% of the Underlying Shares, AFG shall, if it
and its Affiliates hold any combination of Series D Preferred Stock and Common
Stock representing the right to vote more than 20% of the total votes eligible
to be voted on a matter on which the holders of Common Stock have
4
<PAGE> 9
the right to vote, cast all votes in excess of such 20% in proportion to the
actual vote of holders of all remaining votes (including AFG's 20% vote).
AFG and its affiliates may assign or transfer to any person shares of the
Series D Preferred Stock or the Underlying Shares, representing in the aggregate
ownership, or the right to acquire ownership, of at least 51% of the Underlying
Shares and the right of AFG in the Securities Purchase Agreement to nominate 30%
of the Company's directors only if such person assumes the voting restrictions
in the Securities Purchase Agreement which are described in the immediately
preceding paragraph.
The Company will enter into a Registration Rights Agreement with AFG
pursuant to which AFG will be granted certain demand and "piggyback"
registration rights.
For a more complete description of the Series D Preferred Stock and AFG's
rights as a holder of Series D Preferred Stock, see "Description of Series D
Preferred Stock", and "The Securities Purchase Agreement and Related
Agreements."
Strategic Alliance with AFG. The Securities Purchase Agreement embodies a
strategic alliance with AFG that will allow the Company to market and underwrite
both new and expanded aviation insurance product lines. For example, AFG has
agreed to provide a facility for the Company to offer workers compensation
coverage for its aviation insureds.
The Company also anticipates that the strategic alliance will permit the
Company to offer, when required by an insured, products providing the financial
security of an insurer rated "A" (Excellent) by Best. The Company anticipates
that this arrangement will, over the long term, reduce the costs the Company is
currently incurring for similar arrangements with other insurers. These new and
expanded products are expected to provide the Company with enhanced
opportunities for additional business by attracting and retaining preferred
accounts.
In accordance with the provisions of the Securities Purchase Agreement, AFG
intends to nominate two of its senior executives to serve on the Company's Board
of Directors. See "AFG's Designees for Directors." The Company expects to
benefit from the experience and expertise of these executives.
American Financial Group, Inc. ("AFG") was incorporated as an Ohio
corporation in 1994. Its address is One East Fourth Street, Cincinnati, Ohio
45202; its phone number is (513) 579-2121. AFG is a holding company which,
through its subsidiaries, is engaged primarily in specialty and multi-line
property and casualty insurance businesses and in the sale of tax-deferred
annuities. AFG's property and casualty operations originated in 1872 and in 1995
had statutory net premiums written of $3.1 billion. AFG was formed for the
purpose of acquiring American Financial Corporation and American Premier
Underwriters, Inc. in merger transactions completed on April 3, 1995. AFG's
common stock is listed on the NYSE. At December 31, 1995, AFG had stockholders'
equity of approximately $2.9 billion. AFG's principal insurance company
subsidiaries are rated "A" (Excellent) by A. M. Best Company ("Best"). The
Series D Preferred Stock will be purchased from surplus funds of a subsidiary of
AFG available for investment. No funds will be borrowed by AFG in connection
with this transaction.
Recapitalization Charge. The Securities Purchase Agreement provides that
the Company will record a $15 million (pre-tax) recapitalization charge in its
financial results for the quarter in which the Transaction is recorded. The
recapitalization charge will provide additional strengthening of the Company's
balance sheet and overall reserve levels, and is intended to cover contingencies
and estimated exposures associated with various previously reported strategic
actions and product line discontinuations.
Certain other provisions. Concurrently with the execution of the Securities
Purchase Agreement, the Company issued to AFG 800,000 warrants (the "Break-up
Warrants") to purchase an aggregate of 800,000 shares of Common Stock at an
exercise price of $3.45 per share. The Break-up Warrants will be exercisable
only if the Securities Purchase Agreement is terminated prior to the approval of
the Proposal by the stockholders of the Company (i) by the Company if the Board
of Directors of the Company determines in the exercise of its fiduciary duties
that such termination is required by reason of a Competing Proposal (as defined
in the Securities Purchase Agreement), or (ii) by the Company or AFG if the
Company's Board of Directors withdraws or modifies in a manner materially
adverse to AFG its approval of the Securities Purchase
5
<PAGE> 10
Agreement and recommends a Competing Proposal to the stockholders of the
Company. Upon the closing (the "Closing") of the Securities Purchase Agreement
and issuance of the Series D Preferred Stock, the Break-up Warrants will expire.
REASONS FOR THE TRANSACTION
Financial Condition. The Company's financial condition and operating
results have been significantly adversely affected as a result of the poor
financial performance of certain of the Company's lines of business and a
special charge to earnings of $20.6 million after tax taken by the Company in
the fourth quarter of 1995 (the "Special Charge").
The Company recorded the Special Charge for certain discontinued lines and
classes of business and increased reserves for incurred but not reported losses
("IBNR") and unearned premium. The majority of the Special Charge related to the
Company's poor financial performance in, and decision to withdraw from, the
franchised new automobile dealer line of business and certain classes of
commercial aviation business. As a result of the Special Charge, net book value
declined from $10.11 at September 30, 1995 to $7.58 at December 31, 1995. Based
on the Special Charge, Best lowered AEIC's rating from "A-" (Excellent) to "B++"
(Very Good) on March 4, 1996. Subsequent to Best's rating action, the Company
announced that it was pursuing various alternatives for increasing the capital
and surplus of AEIC.
In May 1996, the Company reported a net loss of $2.8 million for the first
quarter of 1996, due mainly to an increase in reported claims in the
transportation line of business and weather related claims, and a decrease in
net book value to $7.01 at March 31, 1996. Due to the Company's first quarter
financial performance and the further deterioration of its capitalization, Best
further downgraded AEIC's rating to "B" (Adequate) on May 24, 1996. Best
additionally placed a negative outlook on the rating, pending the outcome of
ongoing capital-raising efforts of the Company. Best further stated that if the
Company is unsuccessful in raising capital or if operating results do not
improve, Best would likely downgrade the rating further.
In October 1996, the Company withdrew from the transportation line of
business in connection with a strategic refocusing by the Company on the
aviation, marine and artisan contractor product lines where, in the view of
management, historic profitability and the Company's competitive advantages are
the greatest. During 1996, the Company's transportation line of business had
been its primary source of unacceptable underwriting results. The Company also
discontinued the quarterly dividend on its Common Stock in order to preserve
capital. In the second and third quarters of 1996, the Company reported net
losses of $0.6 million and $1.2 million, respectively, decreasing net book value
to $6.68 at September 30, 1996.
The third quarter results and the Company's performance over the first nine
months of 1996 increased the likelihood that Best might further downgrade AEIC's
rating if the Company were unable to obtain additional capital. In the opinion
of management, a further downgrade by Best could have a significant adverse
effect on the Company's business.
Decision to Pursue Strategic Relationship. In February 1996, the Board of
Directors of the Company began discussing the Company's need for additional
capital in light of the Special Charge. After the downgrade of AEIC's rating by
Best in March 1996, management began an in-depth review of various forms of
capital transactions. The Board met on six separate occasions from May through
November 4, 1996 to review the status and proposed terms of various potential
transactions. Ultimately determining that a properly structured strategic
alliance would offer stockholders the best opportunity to maximize stockholder
value, the Board deliberated the AFG proposal at length and determined that the
proposed Transaction with AFG was the best available transaction.
Recommendation of the Board of Directors. In light of the financial
background described above, the Transaction involves matters of great importance
to the Company and its stockholders. The Board of Directors has unanimously
approved the Securities Purchase Agreement and believes that the Transaction is
in the best interests of the Company and its stockholders.
The Board of Directors, in approving the Transaction and recommending
stockholder approval of the Proposal, considered a number of factors, including
the following: (i) consummation of the Transaction will
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<PAGE> 11
provide the Company with $35 million of new capital (before deducting the
estimated expenses of the Transaction), a majority of which will be utilized to
provide capital to AEIC and pay down bank debt; (ii) consummation of the
Transaction, barring any unforeseen events, would likely avoid a further ratings
downgrading by Best, although it will not ensure that a downgrading will not
occur in the future; (iii) the anticipated benefits to the Company of the
strategic alliance with AFG; (iv) the expected benefits from the addition of
members of AFG's senior management to the Board of Directors; (v) the lack of
certainty that any of the possible alternative transactions considered by the
Board of Directors would be successful on an expedited basis and on terms as
favorable to the Company as the Transaction; (vi) the existing assets,
operations, earnings and prospects of the Company in light of the economic and
regulatory climate; (vii) the terms of the Securities Purchase Agreement,
including the voting rights, conversion rights, preferences and other rights of
the Series D Preferred Stock; (viii) the written opinion of CS First Boston
Corporation ("CS First Boston"), the financial advisor to the Company, described
below; (ix) the high probability of consummation of the Transaction (including
the absence of a material adverse change condition to AFG's obligation to
close); and (x) the potential adverse consequences of delaying a transaction.
See "The Transaction -- Reasons for the Transaction."
OPINION OF FINANCIAL ADVISOR
CS First Boston, financial advisor to the Company, has rendered to the
Board of Directors of the Company a written opinion, dated November 5, 1996, to
the effect that, as of such date and based upon and subject to certain matters
stated in such opinion, the cash consideration to be received by the Company in
the Transaction was fair to the Company from a financial point of view. A copy
of the opinion of CS First Boston dated November 5, 1996 is attached hereto as
Appendix I and should be read carefully in its entirety with respect to the
assumptions made, matters considered and limitations on the review undertaken in
connection with such opinion. The opinion of CS First Boston is directed only to
the fairness of the cash consideration to be received by the Company in the
Transaction from a financial point of view, does not address any other aspect of
the Transaction or any related transaction and does not constitute a
recommendation to any stockholder as to how such stockholder should vote at the
Special Meeting. See "The Transaction -- Opinion of Financial Advisor."
CONDITIONS TO THE TRANSACTION
Consummation of the Transaction is subject to a number of conditions,
including approval of the Proposal by the stockholders of the Company, and
receipt of regulatory approvals from applicable state insurance commissions in
the States of Texas and California. See "The Transaction -- Regulatory
Approvals" and "The Securities Purchase Agreement and Related
Agreements -- Conditions Precedent."
NO DISSENTERS' RIGHTS OR PREEMPTIVE RIGHTS
Under Delaware law, holders of Common Stock are not entitled to dissenters'
appraisal rights or preemptive rights in connection with the Transaction and the
issuance of the Series D Preferred Stock.
CERTAIN CONSIDERATIONS
Stockholders should refer to the information under "Certain Considerations"
for a discussion of certain matters that should be considered in connection with
an evaluation of the Proposal.
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INTERESTS OF CERTAIN PERSONS IN THE TRANSACTION
Certain officers, directors and stockholders of the Company have certain
interests or obligations with respect to the Transaction that are different
from, or in addition to, the interests of stockholders of the Company generally.
The Securities Purchase Agreement provides as a condition to AFG's obligation to
close that the Company shall have adjusted the exercise price of existing stock
options granted to the current officers and directors of the Company or its
subsidiaries pursuant to its 1991 Nonqualified Stock Option Plan, 1994 Stock
Incentive Plan and 1994 Directors Option Plan to the market price on the date of
adjustment and shall provide that all such options shall have a vesting period
of three years, with one-third of the options vesting on each anniversary date
of the date of adjustment. The Company will make such adjustment on the Closing
Date. See "The Transaction -- Interests of Certain Persons in the Transaction."
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<PAGE> 13
THE SPECIAL MEETING
This Proxy Statement is being furnished in connection with the solicitation
of proxies from the holders of Common Stock by the Company's Board of Directors
for use at the Special Meeting.
TIME AND PLACE; PURPOSE
The Special Meeting will be held on December 30, 1996, at ,
Dallas, Texas, , commencing at 9:00 a.m. local time. At the Special
Meeting, holders of Common Stock will consider and vote upon the Proposal. No
other business will be presented at the Special Meeting other than those matters
incidental to the conduct of the Special Meeting.
It is a condition to the consummation of the Transaction that the Proposal
be approved. Therefore, unless the Proposal is approved by the stockholders, the
Transaction will not be consummated.
VOTING; VOTE REQUIRED FOR APPROVAL
The Board of Directors has established December 4, 1996 as the Record Date
for the determination of stockholders entitled to notice of and to vote at the
Special Meeting. Only holders of record of Common Stock at the close of business
on such date are entitled to vote at the Special Meeting. On the Record Date,
the Company had outstanding and entitled to vote shares of Common
Stock.
The presence, either in person or by proxy, of the holders of at least a
majority of the outstanding shares of Common Stock entitled to vote is necessary
to constitute a quorum at the Special Meeting.
Because the Transaction will involve the issuance of securities convertible
into Common Stock in an amount in excess of 20% of the aggregate number of
shares of Common Stock outstanding, the NYSE requires that the Proposal be
approved by the affirmative vote of the holders of a majority of the outstanding
shares of Common Stock entitled to vote and present, in person or by proxy, at
the Special Meeting, provided that the total votes cast on the Proposal
constitute at least a majority of the outstanding shares of Common Stock.
Pursuant to the Mason Best Voting Agreement, Mason Best has agreed to vote
all shares of Common Stock owned by it in favor of the Proposal. Mason Best owns
2,960,772 shares of Common Stock, representing approximately 42% of the shares
of Common Stock outstanding.
The holder of each outstanding share of Common Stock is entitled to one
vote per share on each matter considered at the Special Meeting. On all matters
considered at the Special Meeting, broker non-votes will be treated as neither a
vote "for" nor "against" the matter, although they will be counted in
determining if a quorum is present. In addition, abstentions are considered in
determining the number of votes required to attain a majority of the shares
present or represented at the Special Meeting and entitled to vote. Accordingly,
an abstention from voting on the Proposal by a stockholder present in person or
represented by proxy at the meeting has the same legal effect as a vote
"against" the Proposal because it represents a share present or represented at
the Special Meeting and entitled to vote, thereby increasing the number of
affirmative votes required to approve the Proposal.
PROXIES
All shares of Common Stock represented by properly executed proxies will be
voted at the Special Meeting in accordance with the directions indicated on the
respective proxies unless the proxies have been previously revoked. Unless
contrary direction is given, all shares of Common Stock represented by proxies
will be voted FOR approval of the Proposal and in the proxy holder's discretion
as to such other matters incident to the conduct of the Special Meeting. If any
other matters are properly presented at the Special Meeting for action,
including a question of adjourning the meeting from time to time, the persons
named in the proxies and acting thereunder will have discretion to vote on those
matters in accordance with their best judgment.
All holders of Common Stock are requested to complete, sign, date and
promptly return the enclosed proxy card in the postage paid envelope provided
for this purpose in order to ensure that their shares are voted.
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A stockholder executing and returning a proxy has the power to revoke the proxy
at any time before it is voted. A stockholder who wishes to revoke a proxy can
do so by executing a later-dated proxy relating to the same shares and
delivering it to the Secretary of the Company prior to the vote at the Special
Meeting or by appearing in person at the Special Meeting and voting in person
the shares to which the proxy relates. Any written notice revoking the proxy
should be sent to American Eagle Group, Inc., 12801 N. Central Expressway, Suite
800, Dallas, Texas 75243, Attention: Secretary.
SOLICITATION
The Company will bear the expenses in connection with this solicitation,
including the cost of preparing and mailing this Proxy Statement. In addition to
solicitation by use of the mails, proxies may be solicited by directors,
officers and employees of the Company in person or by telephone, telegram or
other means of communication. Such directors, officers and employees will not be
additionally compensated, but may be reimbursed for reasonable out-of-pocket
expenses in connection with such solicitation. Arrangements will also be made
with custodians, nominees and fiduciaries for forwarding of proxy solicitation
materials to beneficial owners of shares held of record by such custodians,
nominees and fiduciaries, and the Company will reimburse such custodians,
nominees and fiduciaries for reasonable expenses incurred in connection
therewith. In addition, the Company has retained Morrow & Co., Inc. to assist in
the solicitation of proxies for a fee of approximately $3,500, plus
reimbursement of reasonable out-of-pocket expenses incurred in connection with
this solicitation.
THE TRANSACTION
GENERAL
On November 5, 1996, the Company and AFG entered into the Securities
Purchase Agreement, which, subject to the terms and conditions thereof, provides
for the sale and issuance by the Company to AFG of 350,000 shares of Series D
Preferred Stock for an aggregate purchase price of $35 million. Consummation of
the Securities Purchase Agreement is subject to certain conditions, including
approval of the Proposal by the stockholders of the Company.
Terms of the Series D Preferred Stock. The Series D Preferred Stock will be
entitled to a per annum cumulative dividend equal to 9% payable quarterly, with
payment commencing April 1, 1997. At the option of the Company, during the first
five years after the Closing Date, dividends may be paid in cash or in kind
(whereby a holder, in lieu of cash, receives shares of Series D Preferred Stock
having a liquidation value equal to the dividends declared).
The Series D Preferred Stock will be convertible into shares of Common
Stock at any time at a conversion price of $5.25 per share (subject to
antidilution provisions). The Series D Preferred Stock may be redeemed at any
time at the Company's option; provided, however, if the Company redeems any
shares of Series D Preferred Stock prior to the seventh anniversary of the
Closing Date, the Company shall, in addition to the cash payable to the holder,
issue to the holder, for each share of Common Stock into which the redeemed
shares of Series D Preferred Stock are then convertible, a Warrant to purchase
one share of Common Stock of the Company at an exercise price of $5.25 per share
(subject to antidilution provisions). The Company is required to redeem 10% of
the outstanding shares of Series D Preferred Stock on the first business day of
each year, commencing with the first business day in January 2008, and all
remaining outstanding shares are required to be redeemed on the first business
day in January 2017. The redemption price for the Series D Preferred Stock is
$100.00 per share plus an amount equal to all accrued and unpaid dividends to
the date of redemption.
Until AFG and its affiliates no longer own Series D Preferred Stock and
Underlying Shares representing in the aggregate the ownership, or the right to
acquire ownership, of 51% of the Underlying Shares or until the seventh
anniversary of the Closing Date, whichever is earlier, AFG shall be entitled to
nominate for election 30% of the Company's directors and, if elected, at least
one director representing AFG shall serve on each standing committee of the
Board of Directors. Notwithstanding the foregoing, the number of directors that
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<PAGE> 15
AFG is entitled to nominate shall be reduced by the number of directors that the
holders of the Series D Preferred Stock are entitled to elect as a class under
the terms of the Certificate of Designation for the Series D Preferred Stock.
Mason Best has agreed to vote all shares owned by it in favor of the election of
AFG's nominees. The Company currently has a seven member Board of Directors,
with six existing directors and one vacancy. Under the terms of the Securities
Purchase Agreement, based on the current size of the Company's board AFG is
entitled to nominate three additional directors. At this time AFG has designated
two nominees for the board. See "AFG's Designee's for Director." The Company's
Certificate of Incorporation provides that the Board shall be divided into three
classes, as nearly equal in number as the then-authorized number of directors
constituting the Board permits, with the term of office of one class expiring
each year and with each director serving for a term ending at the third annual
meeting of stockholders of the Company following the annual meeting at which
such director was elected. The Company intends to have one of AFG's designees
fill the existing Board vacancy and create a new Board seat for the second
designee. The initial term of the new Board position will be set to comply with
the provisions described above. If AFG's nominees fail to be elected to the
Board of Directors, AFG shall nevertheless be entitled to have an equal number
of representatives attend each meeting of the Board of Directors. The
Certificate of Designation provides that, upon the occurrence and continuation
of a default in dividend payments for at least two consecutive quarters or a
default in any mandatory redemption payment on the Series D Preferred Stock, the
holders of the Series D Preferred Stock, voting as a separate class, shall be
entitled at the next annual or special meeting of stockholders to elect a
majority of the directors of the Company to be elected. Without the approval of
holders of a majority of the outstanding shares of Series D Preferred Stock
voting separately as a class, the Company will not, in any manner (including by
merger or consolidation) (i) amend, alter or repeal any provisions of the
resolutions establishing the Series D Preferred Stock so as to adversely affect
the powers, preferences or special rights of such Series D Preferred Stock, or
(ii) authorize the issuance of, or authorize any obligation or security
convertible into or evidencing the right to purchase shares of, any additional
class or series of stock ranking prior to the Series D Preferred Stock in the
payment of dividends or the preferential distribution of assets. The foregoing
shall not be interpreted to require any vote or consent of the Series D
Preferred Stock in connection with the authorization or issuance of any series
of Preferred Stock ranking on a parity with or junior to the Series D Preferred
Stock as to dividends and/or the distribution of assets.
The Certificate of Designation provides that, for the seven years following
the Closing Date, the holders of the Series D Preferred Stock shall be entitled
collectively to cast 20% of the votes eligible to be cast on each matter
submitted to a vote of the holders of capital stock of the Company, except that
if the aggregate number of shares of Common Stock issuable upon conversion of
the Series D Preferred Stock represents less than 20% of the outstanding shares
of Common Stock on a fully diluted basis, then each share of Series D Preferred
Stock shall be entitled to the number of votes equal to the number of shares of
Common Stock into which such share of Series D Preferred Stock is then
convertible. In addition, the Securities Purchase Agreement provides that until
the date which is three years and 180 days after the Closing Date, so long as
AFG or any affiliate of AFG shall beneficially own Series D Preferred Stock or
Underlying Shares which represent in the aggregate the ownership, or right to
acquire ownership, of at least 51% of the Underlying Shares, AFG shall, if it
and its Affiliates hold any combination of Series D Preferred Stock and Common
Stock representing the right to vote more than 20% of the total votes eligible
to be voted on a matter on which the holders of Common Stock have the right to
vote, vote all votes in excess of such 20% in proportion to the actual vote of
holders of all remaining votes (including AFG's 20% vote).
AFG and its affiliates may assign or transfer to any person shares of the
Series D Preferred Stock or the Underlying Shares, representing in the aggregate
ownership, or the right to acquire ownership, of at least 51% of the Underlying
Shares and the right of AFG in the Securities Purchase Agreement to nominate 30%
of the Company's directors only if such person assumes the voting restrictions
in the Securities Purchase Agreement which are described in the immediately
preceding paragraph.
The Company will enter into a Registration Rights Agreement with AFG
pursuant to which AFG will be granted three demand and unlimited "piggyback"
registration rights.
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For a more complete description of the Series D Preferred Stock and AFG's
rights as a holder of Series D Preferred Stock, see "Description of Series D
Preferred Stock", and "The Securities Purchase Agreement and Related
Agreements."
Strategic Alliance with AFG. The Securities Purchase Agreement embodies a
strategic alliance with AFG that will allow the Company to market and underwrite
both new and expanded aviation insurance product lines. For example, AFG has
agreed to provide a new facility for the Company to offer workers compensation
coverage to its aviation insureds.
The Company also anticipates that the strategic alliance will permit the
Company to offer, when required by an insured, products providing the financial
security of an insurer rated "A" (Excellent) by Best. The Company anticipates
that this arrangement will, over the long term, reduce the costs the Company is
currently incurring for similar arrangements with other insurers. The Company
also expects that this arrangement will allow it to expand its marketing of its
aviation product liability coverage for noncritical components and its aviation
property coverages for buildings and hangars on airport premises, airport,
ground equipment and aviation spare parts inventories. These new and expanded
products are expected to provide the Company with enhanced opportunities for
additional business by attracting and retaining preferred accounts.
In accordance with the provisions of the Securities Purchase Agreement, AFG
intends to nominate two of its senior executives to serve on the Company's Board
of Directors. See "AFG's Designees for Directors." The Company expects to
benefit from the experience and expertise of these executives.
Recapitalization Charge. The Securities Purchase Agreement provides that
the Company will record a $15 million (pre-tax) recapitalization charge in its
financial results for the quarter in which the Transaction is recorded. The
recapitalization charge will provide additional strengthening of the Company's
balance sheet and overall reserve levels, and is intended to cover contingencies
and estimated exposures associated with various previously reported strategic
actions and product line discontinuations.
Certain other provisions. Concurrently with the execution of the Securities
Purchase Agreement, the Company issued to AFG 800,000 Break-up Warrants to
purchase an aggregate of 800,000 shares of Common Stock at an exercise price of
$3.45 per share. The Break-up Warrants will be exercisable only if the
Securities Purchase Agreement is terminated prior to the approval of the
Proposal by the stockholders of the Company (i) by the Company if the Board of
Directors of the Company determines in the exercise of its fiduciary duties that
such termination is required by reason of a Competing Proposal (as defined
below), or (ii) by the Company or AFG if the Company's Board of Directors
withdraws or modifies in a manner materially adverse to AFG its approval of the
Securities Purchase Agreement and recommends a Competing Proposal to the
stockholders of the Company. Upon the Closing of the Securities Purchase
Agreement and issuance of the Series D Preferred Stock, the Break-up Warrants
will expire. "Competing Proposal" means any proposal or offer to the Company or
the stockholders of the Company with respect to (i) any merger, consideration,
share exchange, business combination, or other similar transaction, (ii) any
sale, lease, exchange, transfer or other disposition of all or substantially all
of the assets of the Company and its material subsidiaries, taken as a whole, in
a single transaction or series of related transactions, or (iii) any tender
offer or exchange offer for shares of the Common Stock.
AFG. AFG was incorporated as an Ohio corporation in 1994. Its address is
One East Fourth Street, Cincinnati, Ohio 45202; its phone number is (513)
579-2121. AFG is a holding company which, through its subsidiaries, is engaged
primarily in specialty and multi-line property and casualty insurance businesses
and in the sale of tax-deferred annuities. AFG's property and casualty
operations originated in 1872 and in 1995 had statutory net premiums written of
$3.1 billion. AFG was formed for the purpose of acquiring American Financial
Corporation and American Premier Underwriters, Inc. in merger transactions
completed on April 3, 1995. AFG's common stock is listed on the NYSE. At
December 31, 1995, AFG had stockholders' equity of approximately $2.9 billion.
AFG's principal insurance company subsidiaries are rated "A" (Excellent) by
Best. The Series D Preferred Stock will be purchased from surplus funds of a
subsidiary of AFG available for investment. No funds will be borrowed by AFG in
connection with the transaction.
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<PAGE> 17
REASONS FOR THE TRANSACTION
Financial Condition. The Company's financial condition and operating
results have been significantly adversely affected as a result of the poor
financial performance of certain of the Company's lines of business and a
special charge to earnings of $20.6 million after tax taken by the Company in
the fourth quarter of 1995 (the "Special Charge").
During 1995, the Company saw two developing issues which were adversely
affecting financial results. First, the auto dealer line of business was
generating an unacceptably high loss ratio. This loss ratio exceeded 100% in
1995, after having begun to trend unacceptably in 1994. Second, adverse loss
experience in the commercial aviation line of the general aviation business had
been observed earlier in 1995, and continued to develop adversely at an even
greater rate during the fourth quarter. Based on additional analysis, the
Company withdrew from the auto dealer line of business and discontinued writing
certain classes of business in the three
troublesome segments of its eight commercial aviation segments, the flying
clubs, instruction and rental, and charter segments. In addition, during the
latter half of 1995 and the beginning of 1996, the Company implemented a number
of underwriting actions, including underwriting policy changes, revisions in
risk selection criteria, tightening of underwriting standards and guidelines,
and expanded systems of pricing and underwriting control.
As a result primarily of these two factors, the Company recorded the
Special Charge for certain discontinued lines and classes of business and
increased reserves for IBNR and unearned premium. Approximately $8.9 million of
the Special Charge resulted from additional case reserves and related costs for
the three segments of the commercial general aviation business in which coverage
was discontinued. Approximately $0.7 million of the Special Charge resulted from
additional case reserves and related costs from the auto dealer program. The
remainder of the Special Charge, approximately $11.0 million, resulted from an
increase of IBNR and unearned premium reserves, which included reserves for the
discontinued lines and classes of business. As a result of the Special Charge,
net book value declined from $10.11 at September 30, 1995 to $7.58 at year end
1995.
Based on the Special Charge taken by the Company, on March 4, 1996, Best
lowered AEIC's rating from "A-" (Excellent) to "B++" (Very Good). This action
was based on Best's expectations regarding the Company's ability to raise new
capital in a relatively short period, and that satisfactory operating
performance would resume, allowing the Company to generate internal capital.
Subsequent to Best's rating action, the Company stated in its 1995 Annual Report
that it was pursuing various alternatives for increasing the capital and surplus
of AEIC.
In the first quarter of 1996, the Company experienced a deterioration in
the performance of the transportation line of business and instituted a full
review of the internal and external factors affecting its performance. On May
13, 1996, the Company reported a net loss of $2.8 million for the first quarter
of 1996, due mainly to an increase in reported claims in the transportation line
of business and weather related claims, and a decrease in net book value to
$7.01 at March 31, 1996.
On May 24, 1996, Best downgraded AEIC's rating from "B++" (Very Good) to
"B" (Adequate) due to the Company's poor first quarter financial performance and
the further deterioration of its capitalization. Best stated that the first
quarter 1996 loss placed additional pressure on the Company to raise capital in
a timely fashion while making it more difficult for the Company to do so. Best
additionally placed a negative outlook on the rating, pending the outcome of
ongoing capital-raising efforts of the Company. Best acknowledged that the
Company was exploring capital-raising alternatives, and stated that Best would
review the rating for possible upgrade or removal of the negative outlook. If,
however, the Company proved unsuccessful in raising capital or if operating
results did not improve, Best stated that it would likely downgrade the rating
further. Any further downgrade would likely have a significant adverse effect on
the Company, its competitive position, and its future performance.
Due to the poor financial performance of the transportation line of
business and the dramatic and sustained increase in price competition in this
market, on October 1, 1996, the Company withdrew from the transportation line of
business. During 1996 the Company's transportation line of business had been its
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<PAGE> 18
primary source of unacceptable underwriting results. In connection with this
withdrawal, the Company began a strategic refocusing on those product lines
where the Company believes historic profitability and sustainable competitive
advantages are the greatest -- Aviation, Marine, and Artisan Contractors. The
Company believes that the changes made in the commercial aviation segment have
continued to produce increasing improvements, and that withdrawing from
transportation allows the Company to devote increasing amount of capital and
resources to the remaining lines. On September 30, 1996, the Company also
discontinued the quarterly dividend on its common stock in order to more quickly
build the capital level of the Company.
In the second and third quarters of 1996, the Company reported net losses
of $0.6 million and $1.2 million, respectively, decreasing net book value to
$6.68 at September 30, 1996, increasing the net loss for the three quarters
ended September 30, 1996 to $4.5 million, and making the possibility of a
further Best downgrade more likely without a timely infusion of capital.
In connection with each quarter of reported losses, the Company has
renegotiated its bank credit agreement so that no default would occur under the
financial covenants. Amendments to its Amended and Restated Credit Agreement
were entered into on February 23, March 18, May 3, September 20, and November 6,
1996, to effect these negotiations. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Liquidity and Capital
Resources."
Decision to Pursue a Strategic Relationship. At the February 23, 1996
meeting of the Company's Board of Directors (the "Board"), Board members began
discussing the Company's need for additional capital in light of the Special
Charge. While access to the public markets was unlikely, CS First Boston had
informed management that it believed an opportunity existed in the private
markets to place equity linked securities. After the initial Best downgrade and
a review of the first quarter results, management began an in-depth review of
the potential benefits and problems with various forms of capital transactions.
At its next meeting, the Board analyzed a proposed term sheet prepared by
management and CS First Boston for a private equity linked offering. In May
1996, the Board approved the retention of CS First Boston to advise the Company
with respect to potential transactions, and management was authorized to pursue
a capital raising transaction. See "-- Opinion of Financial Advisor."
CS First Boston and, to a limited extent, officers of the Company, then
began a process of selectively canvassing the private markets for indications of
interest in a capital raising transaction. During the course of these efforts,
CS First Boston or the Company initiated nine contacts, and received eight
unsolicited inquiries.
From May through October of 1996, six parties conducted extensive due
diligence reviews of the Company. Three of these parties determined to proceed
as a group with discussions regarding a potential investment in up to $20
million of convertible preferred stock of the Company. The three parties
designated one of the parties as the lead for purposes of negotiating the
potential transactions. The Company and the lead negotiator exchanged proposed
term sheets and held numerous discussions regarding the potential transaction.
The terms discussed did not include any matters in the nature of a strategic
alliance other than the investment of additional capital in the Company. In late
October, the lead negotiator informed the Company that it preferred not to
proceed with the potential investment transaction, but would consider acquiring
the Company at no premium to the market price. Two other parties declined to
enter into further discussions after completing their due diligence review. One
of the unsolicited inquiries resulted in preliminary discussions of due
diligence issues and potential transaction structures and terms, but no due
diligence review was conducted.
The first contact with AFG with respect to a possible investment in the
Company was initiated by CS First Boston in early August 1996. CS First Boston
provided AFG with certain publicly available information about the Company and
the basic terms of a proposed $20 million private offering of preferred stock.
The initial meeting between management of the Company and AFG occurred on
September 20, 1996 at the offices of AFG in Cincinnati, Ohio. At this meeting,
Mr. Phil Guthrie, the Company's chairman and chief executive officer, made a
presentation about the Company to a group of AFG's executives, including
information about the Company's product lines and competition, historical
financial results, and business strategy. AFG's representatives stated that they
were potentially interested in investing in, and developing a strategic
relationship with, the Company. Mr. Carl Lindner III, co-president of AFG,
indicated that AFG was considering alternative structures to the terms proposed
by CS First Boston, which might involve an
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investment in the Company of $35 million or more and that they would like to
proceed immediately with their due diligence review of the Company. Mr. Carl
Lindner, the chairman and chief executive officer of AFG, also participated in
portions of this meeting.
From September 24 through September 26, 1996, a team of 17 people from AFG
led by Mr. Carl Lindner III conducted extensive due diligence at the offices of
the Company in Dallas, Texas. In addition, Mr. Guthrie and Mr. Lindner III
reviewed the senior management team of the Company and discussed potential
business strategies for developing the aviation product lines of the Company and
the long-term opportunities and alternatives for the Company's non-aviation
product lines.
Following these due diligence meetings, Mr. Lindner III contacted Mr.
Guthrie to express AFG's interest in meeting to discuss the terms of a strategic
investment by AFG in the Company and a meeting was scheduled for October 6,
1996. At this meeting, Mr. Guthrie, on behalf of the Company, and four senior
executives of AFG, including Mr. Carl Lindner III and Mr. Carl Lindner, engaged
in a discussion of the strategic benefits that a relationship with AFG could
bring to the Company. AFG presented the outlines of a proposal to invest $35
million in redeemable preferred stock of the Company with separate long-term
warrants.
Following this meeting, Mr. Guthrie reviewed the proposals made by AFG with
senior management of the Company and in individual conversations with directors
of the Company. On October 8, 1996, Mr. Guthrie again met with Mr. Lindner III
and two other representatives of AFG. At this meeting, Mr. Guthrie indicated
that the Company's senior management and Board of Directors were interested in
pursuing negotiations with AFG along the lines previously presented by AFG and
communicated to AFG certain elements of an agreement between the Company and AFG
that would be important to the Company, including the view of certain directors
that there be no material contingencies to the proposed investment by AFG. The
representatives of AFG requested additional financial information about the
Company, which was provided to AFG following the meeting by Mr. Dick Kurz, the
Company's chief financial officer.
From October 9 through October 11, 1996, AFG conducted additional due
diligence at the Company's offices in Dallas, Texas, focusing primarily on
financial, accounting and reinsurance issues. On October 10 and October 11,
1996, AFG conducted due diligence related to the Company's non-aviation lines of
business at the Company's offices in Sacramento, California, and during the
following week AFG conducted due diligence related to the Marine Division at the
offices of the Company in Baltimore, Maryland.
On October 15, 1996, Mr. Guthrie, Mr. Elvis Mason, a director of the
Company and the general partner of Mason Best (the Company's largest
stockholder), and the Company's financial advisor met with representatives of
AFG, including Mr. Lindner III and Mr. Lindner, to discuss the terms of an
investment by AFG in the Company and the elements of the proposed strategic
relationship between AFG and the Company. Among the issues discussed, many of
which had been previously been discussed on a preliminary basis, were corporate
governance, including voting rights and representation of AFG on the Company's
Board of Directors, a potential recapitalization charge to be taken by the
Company to address contingencies and expenses associated with discontinued lines
of business, a request by AFG for a right of first refusal on Mason Best's
shares in the Company (which was rejected by Mr. Mason), a stand-still on the
acquisition by AFG of additional shares in the Company (which was rejected by
AFG), the dividend rate, conversion price and the ability to pay dividends in
kind on the preferred stock for up to five years, treatment of the Company's
bank credit facility and aspects of the strategic relationship between AFG and
the Company. This discussion continued at a meeting on October 23, 1996 at AFG's
offices in Cincinnati, Ohio attended by Mr. Guthrie, Mr. Kurz, representatives
of CS First Boston and Mr. Lindner III and three other representatives of AFG.
This meeting focused on the proposed strategic relationship between AFG and the
Company, including the proposed approach to rating agencies, terms on which the
Company would offer workers compensation coverage, and the ability of the
Company, with AFG's assistance, to offer products providing the financial
security of an insurer rated "A" (Excellent) by Best. In addition, the parties
continued negotiations over the terms of the preferred stock and corporate
governance provisions and the terms of certain warrants exercisable only if the
closing of the Transaction did not occur. During these meetings AFG proposed a
conversion price for the preferred stock of $5.00 per share of Common Stock and
the Company requested $5.50 per share,
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<PAGE> 20
based on, among other considerations, the Company's desire to obtain a higher
premium to market and a lower dilution impact on current stockholders, the
projected net book value per share of Common Stock following the $35 million
investment by AFG and the recapitalization charge, and consultations with the
Company's financial advisors. At the October 23 meeting, the Company and AFG
agreed to the conversion price of $5.25 per share which is contained in the
Securities Purchase Agreement. AFG also rejected proposals by the Company that
any other party be permitted to participate in the sale and issuance by the
Company of the Series D Preferred Stock.
Following this meeting, AFG began preparation of a definitive agreement. A
first draft of the agreement was delivered to the Company on October 28, 1996
and from October 28 through November 4, 1996, representatives of the Company and
AFG negotiated the terms of the definitive agreement, the Series D Preferred
Stock and related agreements.
The Board met on six occasions from May through November 4, 1996 and
reviewed the status of the various negotiations. With each developing
negotiation, the Board considered a wide range of factors, such as potential
ultimate terms, earnings per share impact, dilutive impact, possible strategic
synergies, reserving questions, expectations of Best, timing and special factors
unique to each proposal. On several occasions the Board analyzed alternative
types of transactions, such as a private offering of equity linked securities, a
strategic alliance and a sale of the Company, and ultimately determined that a
transaction involving not only additional capital but the strong potential for
strategic synergies presented the best opportunity for maximizing stockholder
value. At its final two meetings during which it considered and ultimately
approved the proposed Transaction with AFG, the Board, with its financial and
legal advisors, again reviewed in detail all of the contacts that had been made,
the various proposals and indications of interest that had been received, and
the current status of all discussions and negotiations with all parties that had
expressed interest in a transaction of any type with the Company. The Board
analyzed the relative economic factors (including dilutive effects and the
benefits of potential synergies with a strategic partner), the approximate 50%
premium of the conversion price over the market price of the Common Stock on the
dates of the meetings, corporate governance and control, contingencies to
closing, timing of closing, operating results and financial condition of the
Company, exposure to a further downgrade of its Best rating, and other business
risks attendant to the various proposals or expressions of interest that were
outstanding, and determined that its strategy of pursuing a transaction
involving raising additional capital provided by a strategic partner remained
the best opportunity for maximizing stockholder value.
At the meeting of the Board of Directors on Friday, November 1, 1996, the
Board met for approximately five hours and considered, among other matters, the
terms of the proposed definitive agreement with AFG and alternatives to the
Transaction. The Board objected to the inclusion of a material adverse change
condition to closing in the proposed definitive agreement and instructed Mr.
Guthrie to communicate this position to AFG. Another meeting of the Board was
scheduled for Monday, November 4, 1996, to permit the Board to review in greater
detail the materials presented at the meeting and to consider the proposed terms
of the Transaction and the alternatives to going forward with the Transaction.
Following the meeting on November 1, Mr. Guthrie communicated to AFG the Board's
concern over the inclusion in the proposed definitive agreement of a material
adverse change condition to AFG's obligation to acquire the Series D Preferred
Stock and AFG agreed to delete the material adverse change condition to closing.
On November 4, 1996, the Board met by conference call, determined that the
Transaction offered the best available transaction for the Company and its
stockholders and that it was in the best interest of the Company and its
stockholders to complete the Transaction and approved the Transaction subject to
obtaining the requisite stockholder and regulatory approvals.
Recommendation of the Board of Directors. In light of the financial
background described above, the Transaction involves matters of great importance
to the Company and its stockholders. The Board of Directors has unanimously
approved the Securities Purchase Agreement and believes that the Transaction is
in the best interests of the Company and its stockholders.
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<PAGE> 21
The Board of Directors, in approving the Transaction and recommending
stockholder approval of the Proposal, considered a number of factors, including
the following: (i) consummation of the Transaction will provide the Company with
$35 million of new capital (before deducting the estimated expenses of the
Transaction), a majority of which will be utilized to provide capital to AEIC
and pay down bank debt; (ii) consummation of the Transaction, barring any
unforeseen events, would likely avoid a further ratings downgrading by Best,
although it will not ensure that a downgrading will not occur in the future;
(iii) the expected benefits to the Company of the strategic alliance with AFG
(See "The Transaction -- General -- Strategic Alliance with AFG"); (iv) the
expected benefits from the addition of members of AFG's senior management to the
Board of Directors due to their extensive experience and expertise in the
insurance industry (See "AFG's Designee's For Directors"); (v) the lack of
certainty that any of the possible alternative transactions considered by the
Board of Directors would be successful on an expedited basis and on terms as
favorable to the Company as the Transaction; (vi) the existing assets,
operations, earnings and prospects of the Company in light of the Company's
existing financial condition (see "-- Financial Condition"); (vii) the terms of
the Securities Purchase Agreement, including the voting rights, conversion
rights, preferences and other rights of the Series D Preferred Stock; (viii) the
written opinion of CS First Boston delivered to the Board of Directors of the
Company on November 5, 1996, to the effect that, as of November 5, 1996 and
based upon and subject to certain matters stated in such opinion, the cash
consideration to be received by the Company in the Transaction is fair to the
Company, from a financial point of view; (ix) the high probability of
consummation of the transaction (including the absence of a material adverse
change condition to AFG's obligation to close); and (x) the potential adverse
consequences of delaying a transaction, including, but not limited to, a further
Best downgrade of the Company. See "-- Financial Condition". For a discussion of
additional factors considered by the Board of Directors see "-- Decision to
Pursue a Strategic Relationship."
If the Transaction does not receive stockholder approval, there is no
alternative transaction known to management that would be immediately available
to raise additional capital. The Board of Directors would, after consultation
with its financial and legal advisors, determine a course of action based upon
the circumstances then existing, which could include, among other possible
courses of action, initiating further discussions with parties with whom
discussions have already occurred and contacting parties with whom no
discussions have occurred. It cannot be determined at this time whether an
alternative transaction would be available, and if available, the terms upon
which it would be available.
OPINION OF FINANCIAL ADVISOR
CS First Boston has acted as financial advisor to the Company in connection
with the Transaction. CS First Boston was selected by the Company based on CS
First Boston's experience, expertise and familiarity with the Company and its
business. CS First Boston is an internationally recognized investment banking
firm and is regularly engaged in the valuation of businesses and securities in
connection with mergers and acquisitions, leveraged buyouts, negotiated
underwritings, competitive biddings, secondary distributions of listed and
unlisted securities, private placements and valuations for corporate, estate and
other purposes.
In connection with CS First Boston's engagement, the Company requested that
CS First Boston evaluate the fairness of the cash consideration to be received
by the Company in the Transaction from a financial point of view. On November 5,
1996, CS First Boston rendered to the Company's Board of Directors a written
opinion to the effect that, as of such date and based upon and subject to
certain matters stated in such opinion, the cash consideration to be received by
the Company in the Transaction was fair to the Company from a financial point of
view.
The full text of CS First Boston's written opinion to the Board of
Directors of the Company dated November 5, 1996, which sets forth the
assumptions made, matters considered and limitations on the review undertaken,
is attached as Appendix I to this Proxy Statement and is incorporated herein by
reference. Stockholders of the Company are urged to read this opinion carefully
in its entirety. CS First Boston's opinion is directed only to the fairness of
the cash consideration to be received by the Company in the Transaction from a
financial point of view, does not address any other aspect of the proposed
Transaction or any related transaction and does not constitute a recommendation
to any stockholder as to how such stockholder should
17
<PAGE> 22
vote at the Special Meeting. The summary of the opinion of CS First Boston set
forth in this Proxy Statement is qualified in its entirety by reference to the
full text of such opinion. CS First Boston has consented to the Company's
inclusion of the full text of its written opinion in this Proxy Statement.
In arriving at its opinion, CS First Boston reviewed the Securities
Purchase Agreement and certain related documents and certain publicly available
business and financial information relating to the Company. CS First Boston also
reviewed certain other information, including financial forecasts, provided to
CS First Boston by the Company and met with the management of the Company to
discuss the business and prospects of the Company, including the distressed
financial position of the Company and the near-term liquidity needs of, and
capital resources available to, the Company. CS First Boston also considered
certain financial and stock market data of the Company and compared that data
with similar data for other publicly held companies in businesses similar to
those of the Company and considered, to the extent publicly available, the
financial terms of certain other significant equity and equity-linked
investments in other publicly traded companies. CS First Boston also considered
such other information, financial studies, analyses and investigations and
financial, economic and market criteria which CS First Boston deemed relevant.
In connection with its review, CS First Boston did not assume any
responsibility for independent verification of any of the information provided
to or otherwise reviewed by CS First Boston and relied upon such information
being complete and accurate in all material respects. With respect to the
financial forecasts, CS First Boston assumed that such forecasts were reasonably
prepared on bases reflecting the best currently available estimates and
judgments of the management of the Company as to the future financial
performance of the Company. In addition, CS First Boston did not make an
independent evaluation or appraisal of the assets or liabilities (contingent or
otherwise) of the Company, nor was CS First Boston furnished with any such
evaluations or appraisals. CS First Boston's opinion was necessarily based on
information available to CS First Boston, and financial, stock market and other
conditions as they existed and could be evaluated, on the date of its opinion.
In connection with its engagement, CS First Boston was not requested to, and did
not, solicit third party indications of interest in acquiring all or
substantially all of the Company. Although CS First Boston evaluated the cash
consideration to be received by the Company in the Transaction from a financial
point of view, CS First Boston was not requested to, and did not, recommend the
specific consideration payable in the Transaction, which consideration was
determined through negotiation between the Company and AFG. No other limitations
were imposed by the Company on CS First Boston with respect to the
investigations made or procedures followed by CS First Boston in rendering its
opinion.
In preparing its opinion to the Board of Directors of the Company, CS First
Boston performed a variety of financial and comparative analyses, including
those described below. The summary of CS First Boston's analyses set forth below
does not purport to be a complete description of the analyses underlying CS
First Boston's opinion. The preparation of a fairness opinion is a complex
analytic process involving various determinations as to the most appropriate and
relevant methods of financial analyses and the application of those methods to
the particular circumstances and, therefore, such an opinion is not readily
susceptible to summary description. In arriving at its opinion, CS First Boston
made qualitative judgments as to the significance and relevance of each analysis
and factor considered by it. Accordingly, CS First Boston believes that its
analyses must be considered as a whole and that selecting portions of its
analyses and factors, without considering all analyses and factors, could create
a misleading or incomplete view of the processes underlying such analyses and
its opinion. In its analyses, CS First Boston made numerous assumptions with
respect to the Company, industry performance, regulatory, general business,
economic, market and financial conditions and other matters, many of which are
beyond the control of the Company. No company, transaction or business used in
such analyses as a comparison is identical to the Company or the Transaction,
nor is an evaluation of the results of such analyses entirely mathematical;
rather, such analyses involve complex considerations and judgments concerning
financial and operating characteristics and other facts that could affect the
acquisition, public trading or other values of the companies, business segments
or transactions being analyzed. The estimates contained in such analyses and the
ranges of valuations resulting from any particular analysis are not necessarily
indicative of actual values or predictive of future results or values, which may
be significantly more or less favorable than those suggested by such analyses.
In addition, analyses relating to the value of businesses or securities do not
purport to be appraisals or to reflect the prices at which businesses or
securities actually
18
<PAGE> 23
may be sold. Accordingly, such analyses and estimates are inherently subject to
substantial uncertainty. CS First Boston's opinion and financial analyses were
only one of many factors considered by the Board of Directors of the Company in
its evaluation of the Transaction and should not be viewed as determinative of
the views of the Company's Board or management with respect to the proposed
Transaction or the cash consideration to be received by the Company in the
Transaction.
The following is a summary of the material financial analyses performed by
CS First Boston in arriving at its written opinion dated November 5, 1996, but
does not purport to be a complete description of the analyses performed by CS
First Boston for such purposes.
Comparison With Other Transactions. CS First Boston examined 64
transactions involving significant equity or equity-linked investments in
various companies in a variety of industries that had occurred since 1984, or
were pending as of October 28, 1996. In addition, CS First Boston examined the
following recent transactions and proposed transactions in the insurance
industry involving significant equity or equity-linked investments: the
investment by American Financial Group Inc. in Midland Financial Group Inc.
through a term loan and warrants; the sale of preferred stock and warrants by
Home State Holdings Inc. to Swiss Reinsurance America Corp. and Reliance
Insurance Company; the sale of convertible preferred stock by Crop Growers
Corporation to Fireman's Fund; the sale of common stock and options by Seibels
Bruce Group Inc. to the Powers family; the sale of convertible preferred stock
and warrants by 20th Century Industries to American International Group, Inc.;
and the sale of convertible preferred stock by Alexander & Alexander Services,
Inc. to American International Group, Inc. CS First Boston then analyzed the
proposed terms of the Transaction as compared to the corresponding terms of such
prior transactions, including, without limitation, the size of the investment,
voting power acquired by the investor, whether board representation was acquired
by the investor, dividend or interest rates applicable to the investment, the
relationship between conversion price and market price of the underlying common
stock (in the case of investments in convertible preferred stock or convertible
debentures), the relationship between exercise price and market price (in the
case of investments that included warrants or options to purchase common stock),
and the relationship between purchase price and market price (in the case of
direct common stock investments). In particular, such analysis indicated that
the average conversion premiums for convertible securities and warrant or option
exercise price premiums was 18.1% and the average of dividend and interest rates
applicable to such investments was 8.7% for all examined transactions and 18.9%
and 7.4%, respectively for the insurance industry transactions.
Pro Forma Analysis. CS First Boston analyzed the estimated pro forma
effects of the Transaction on the Company's balance sheet at June 30, 1996 and
anticipated operating results for 1996 (as if the Transaction had been completed
at the beginning of the year) and 1997-1999, based on managements's then-current
expectations for results for such periods and certain other assumptions supplied
by the Company to CS First Boston. In particular, CS First Boston analyzed the
pro forma capitalization of the Company at June 30, 1996, assuming the
transaction occurred on such date, which indicated a dilution in fully diluted
book value per share on a pro forma basis and also analyzed the pro forma
effects on projected book value per share assuming the transaction occurred on
January 1, 1997, which analysis indicated a dilutive effect at each of December
31, 1997, 1998 and 1999. CS First Boston also analyzed the pro forma effect of
the Transaction on projected fully diluted earnings per share, and found that
the transaction was accretive as a result of the various strategic elements of
the Transaction to the projected fully diluted earnings per share for each of
the years 1997, 1998 and 1999. Such pro forma results should in no way be viewed
as indicative of actual future results. The pro forma results are based on
numerous assumptions, some or all of which may not occur, and are subject to
significant economic and competitive uncertainties and contingencies which are
difficult or impossible to predict. CS First Boston does not assume any
responsibility for the accuracy of such pro forma results.
Public or Rule 144A Offering Analysis. CS First Boston analyzed public
offerings and Rule 144A offerings of convertible securities and non-convertible
preferred securities completed during 1996 by companies in a variety of
industries. Using such analysis and estimates of the terms on which the Company
might successfully issue convertible preferred stock as an alternative financing
method to raise capital, CS First Boston made certain comparisons, including,
but not limited to, dividend rates and payment options, optional redemption
provisions, and conversion features, with those of the Transaction. In addition,
CS First Boston analyzed the likelihood of completing a public or Rule 144A
offering for the Company based on then-
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<PAGE> 24
current market conditions. CS First Boston examined nine transactions in which
non-convertible preferred securities with either "ba" preferred stock ratings or
no preferred stock ratings from Moody's Investor Service ("Moody's") were issued
in public or Rule 144A transactions, including transactions by the following
companies or their special-purpose financing subsidiaries: Consumers Power
Company, TCI Communications, Avalon Properties, Sun Company, Paxson
Communications, K-III Communications, Cablevision Systems and Intelcom Group. CS
First Boston noted, based on information publicly available to CS First Boston,
that the dividend rate in these transactions ranged from a low of 6.55% to a
high of 14.25%. In addition, CS First Boston examined 43 transactions in which
equity-linked securities with either Ba (or "ba" in the case of preferred stock)
ratings from Moody's, BB ratings from Standard & Poor's Ratings Services ("S&P")
or no ratings from either of the two agencies were issued in public or Rule 144A
transactions. Examples of such transactions include convertible subordinated
debentures issued by Ashanti Capital, Robbins & Meyers, BankAtlantic Bancorp and
Nabors Industries and convertible preferred securities issued by Walden
Residential, Felcor Suites Hotels, Security Capital and TCI Communications. CS
First Boston noted, based on information publicly available to CS First Boston,
that the interest rate or dividend yield in such transactions ranged from a low
of 4.25% to a high of 7.8% for securities with ratings from Moody's and/or S&P
and a low of 5.5% to a high of 10.0% for securities with ratings from neither of
the two rating agencies and that conversion premiums ranged from a low of 5.0%
to a high of 45.0% for all of these equity-linked transactions. CS First Boston
noted that the Series D Preferred Stock will not be rated by Moody's or S&P upon
issuance. CS First Boston also informed the Board that any public offering
attempted by the Company would have uncertainty of execution due to size of the
proposed offering and the ratings of the securities proposed to be offered and
that, although there could be no certainty that such an attempted offering would
fail, CS First Boston believed such an offering was not achievable by the
Company on reasonably acceptable terms under then-current market conditions.
Historical Relative Trading and Valuation Comparisons. CS First Boston
examined the history of the trading prices for the Common Stock from the
Company's initial public offering to November 4, 1996, noting that the range of
closing prices was $3 3/8 to $12 1/8, and the relationship between the movements
in the prices of such shares and movements in certain stock indices. In
particular, it was noted that while the price of the Company's common stock in
the May 11, 1994 initial public offering was $10 per share and the closing price
on February 23, 1996 (the date of the Board meeting at which the Board members
began discussing the Company's need for additional capital in light of the
Special Charge) was $9 1/2 per share, representing a 5.0% decline from the
initial public offering price, the closing level of the S&P 500 Index on May 11,
1994 was 441.49 and on February 23, 1996 was 659.08, representing a 49.3% gain.
In addition, it was noted that the closing price of the Company's common stock
was $3 3/8 on November 4, 1996, representing a 66.3% decline from the initial
public offering price, while the closing level of the S&P 500 Index on November
4, 1996 was 706.73, representing a 60.1% gain from May 11, 1994. CS First Boston
also compared the consideration to be received by the Company pursuant to the
Transaction to the historical public trading prices of the Common Stock.
Miscellaneous. Pursuant to the terms of CS First Boston's engagement, the
Company has agreed to pay CS First Boston for its services in connection with
the Transaction an aggregate financial advisory fee equal to 4% of the gross
proceeds raised by the Company in the Transaction. The Company also has agreed
to reimburse CS First Boston for out-of-pocket expenses incurred by CS First
Boston in performing its services, including the reasonable fees and expenses of
legal counsel and any other advisor retained by CS First Boston, and to
indemnify CS First Boston and certain related persons and entities against
certain liabilities, including liabilities under the federal securities laws,
arising out of CS First Boston's engagement.
CS First Boston has in the past provided financial services to the Company
and AFG unrelated to the proposed Transaction, for which services CS First
Boston has received compensation. In the ordinary course of business, CS First
Boston and its affiliates may actively trade the equity securities of the
Company and both the debt and equity securities of AFG for their own account and
for accounts of customers and, accordingly, may at any time hold a long or short
position in such securities.
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<PAGE> 25
USE OF PROCEEDS
The net proceeds to the Company from the Transaction are estimated to be
approximately $33 million, after the deduction of the expenses of the
Transaction, which are expected to total approximately $2 million. The net
proceeds will be used to contribute approximately $17 million of capital to AEIC
and to pay down approximately $13.25 million of bank debt; the remaining $2.75
million will be retained by the Company for general corporate purposes. See
"Capitalization."
The Company has recently begun discussions with its bank regarding
replacing its current credit facility with a new or amended credit facility. If
a new credit facility is executed at approximately the same time as the closing
of the Transaction, the Company anticipates that it will immediately borrow an
amount to contribute to the capital and surplus of AEIC in order to bring its
capital and surplus to approximately $50 million. The Company expects that it
would not borrow over $5 million. If a new credit facility is not then executed,
the Company may elect not to pay the entire amount of the outstanding debt, and
contribute to AEIC the proceeds of the Transaction that would otherwise have
been used to repay debt.
REGULATORY APPROVALS
Under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended
(the "HSR Act"), and the rules promulgated thereunder, certain transactions,
including certain of the transactions contemplated by the Securities Purchase
Agreement, may not be consummated unless certain information has been furnished
to the Federal Trade Commission (the "FTC") and the Antitrust Division of the
Justice Department (the "Antitrust Division") and certain waiting period
requirements have been satisfied. Pursuant to the HSR Act, AFG and the Company
have filed Notification and Report Forms with the FTC and the Antitrust Division
for review in connection with the Securities Purchase Agreement. On December 4,
1996, the FTC notified the Company that the waiting period under the HSR Act was
terminated. Notwithstanding the termination of the HSR Act waiting period, at
any time before or after the consummation of the transactions contemplated by
the Securities Purchase Agreement, any person may take action under the
antitrust laws, including seeking to enjoin the consummation of the transactions
contemplated by the Securities Purchase Agreement or seeking the divestiture by
AFG of all or any part of the securities received by it pursuant to the
Securities Purchase Agreement. There can be no assurance that a challenge to the
transactions contemplated by the Securities Purchase Agreement on antitrust
grounds will not be made or that, if such a challenge is made, it would not be
successful.
The Company's insurance subsidiaries are subject to regulation by
government agencies in the states in which they do business. The nature and
extent of such regulation vary from jurisdiction to jurisdiction, but typically
involve prior approval of the acquisition of control of an insurance company or
of any company controlling an insurance company, regulation of certain
transactions entered into by an insurance company with any of its affiliates,
approval of premium rates for many lines of insurance, standards of solvency and
minimum amounts of capital and surplus which must be maintained, limitations on
types and amounts of investments, restrictions on the size of risks which may be
insured by a single company, licensing of insurers and agents, deposits of
securities for the benefit of policyholders, approval of policy forms, methods
of accounting, establishing reserves for losses and LAE, regulation of
underwriting and marketing practices, regulation of reinsurance and filing of
annual and other reports with respect to financial condition and other matters.
Such regulation is generally intended for the protection of policyholders rather
than security holders. In addition, state regulatory examiners perform periodic
examinations of insurance companies.
In addition to the regulatory supervision of the Company's insurance
subsidiaries, American Eagle is also subject to regulation under the Texas and
California Insurance Holding Company System Regulatory Acts (the "Holding
Company Acts"). The Holding Company Acts contain certain reporting requirements
including those requiring AEIC to register and annually file certain reports
with the Texas Insurance Commissioner (the "Texas Commissioner") and the
California Insurance Commissioner (the "California Commissioner"). The annual
registration statements call for current information regarding the capital
structure, general financial condition, ownership and management of AEIC and
persons controlling it, and for the disclosure of the identity and relationship
of every member of its insurance holding company system. The
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<PAGE> 26
registration statement must also disclose certain agreements and transactions
between AEIC and its affiliates, which agreements and transactions must satisfy
certain standards set forth in the Texas Insurance Code and the California
Insurance Code.
In general, the Texas and California Insurance Codes require a person
seeking to acquire control, directly or indirectly, of a domestic insurance
company or of any person controlling a domestic insurance company to file with
the relevant insurance regulatory authority an application for change of control
(commonly known as a "Form A") containing certain information required by
statute and published regulations and provide a copy of such Form A to the
domestic insurer. For the purposes of the Texas and California Insurance Codes,
any person acquiring, directly or indirectly, or holding proxies with respect
to, 10% or more of the voting securities of any other person is presumed to have
acquired "control" of such other person. AFG filed a Form A dated November 14,
1996 with each of the Texas and California Departments of Insurance regarding
the acquisition of the Preferred Stock. The Company expects to receive approval
from each Department of Insurance by year end, although no assurances can be
given the approval will be received by any particular date if at all.
NO DISSENTERS' RIGHTS OR PREEMPTIVE RIGHTS
Stockholders have no dissenters' rights or preemptive rights in connection
with the issuance of the Series D Preferred Stock.
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<PAGE> 27
INTERESTS OF CERTAIN PERSONS IN THE TRANSACTION
Certain officers, directors and stockholders of the Company have certain
interests or obligations with respect to the Transaction that are different
from, or in addition to, the interests of stockholders of the Company generally.
The Securities Purchase Agreement provides as a condition to AFG's obligation to
close that the Company shall have adjusted the exercise price and vesting period
of existing stock options granted to the current officers and directors of the
Company or its subsidiaries pursuant to its 1991 Nonqualified Stock Option Plan,
1994 Stock Incentive Plan and 1994 Directors Option Plan to the market price on
the date of adjustment and shall provide that all such options shall have a
vesting period of three years, with one-third of the options vesting on each
anniversary date of the date of adjustment. The Company will make such
adjustment on the Closing Date and all such options will, subject to Closing of
the Securities Purchase Agreement, be exercisable at the market price (as
defined in the applicable plan agreement) on the Closing Date. The market price
of the Common Stock at the close of trading on November 4, 1996 was $3.375 and
was $4.00 at the close of trading on December 6, 1996. The following table sets
forth certain information concerning stock options owned by certain executive
officers and directors of the Company that are affected by the adjustment.
<TABLE>
<CAPTION>
TOTAL TOTAL WEIGHTED
OUTSTANDING VESTED AVG. PRIOR
NAME AND POSITION OPTIONS(1) OPTIONS(1) EXERCISE PRICE(1)
- ------------------------------------------------------------------ ---------- -----------------
<S> <C> <C> <C>
M. Philip Guthrie...................................... 230,714 190,659 $ 10.73
Chairman of the Board, Chief Executive
Officer and President
Frederick G. Anderson.................................. 72,695 57,088 $ 10.75
Senior Vice President/General
Counsel and Secretary
Richard M. Kurz........................................ 66,334 41,874 $ 10.26
Senior Vice President/
Chief Financial Officer
Allen N. Walton III.................................... 62,643 44,939 $ 10.67
President/Aviation Division
AEIC
George C. Hill III..................................... 77,825 70,639 $ 11.27
Senior Vice President/AEIC
Joseph M. Grant........................................ 15,000 7,500 $ 9.10
Director
Keith W. Hughes........................................ 11,389 2,963 $ 9.88
Director
James E. Maser......................................... 12,890 3,463 $ 8.73
Director
Elvis L. Mason......................................... 15,000 7,500 $ 9.10
Director
</TABLE>
- ---------------
(1) The exercise price of all outstanding options shown in the table, including
vested options, will be adjusted on the Closing Date to the market price on
the Closing Date and thereafter all such options will be subject to a new
three-year vesting period.
23
<PAGE> 28
CERTAIN CONSIDERATIONS
While the Board of Directors is of the opinion that the Transaction is fair
to, and in the best interests of, the Company and its stockholders, stockholders
should consider the following possible effects in evaluating the Proposal.
IMPACT ON VOTING AND OTHER RIGHTS OF STOCKHOLDERS; IMPACT ON FUTURE SHARE
ISSUANCES
The Transaction involves the issuance of securities that will entitle the
holders to special voting rights. Until AFG and its affiliates no longer own
Series D Preferred Stock and Underlying Shares representing in the aggregate the
ownership, or the right to acquire ownership, of 51% of the Underlying Shares,
or until the seventh anniversary of the Closing Date, whichever is earlier, AFG
shall be entitled to nominate for election 30% of the Company's directors and,
if elected, at least one director representing AFG shall serve on each standing
committee of the Board of Directors. Notwithstanding the foregoing, the number
of directors that AFG is entitled to nominate shall be reduced by the number of
directors that the holders of the Series D Preferred Stock are entitled to elect
as a class under the terms of the Certificate of Designation for the Series D
Preferred Stock. Mason Best has agreed to vote all shares owned by it in favor
of the election of AFG's nominees. If AFG's nominees fail to be elected to the
Board of Directors, AFG shall nevertheless be entitled to have an equal number
of representatives attend each meeting of the Board of Directors. The
Certificate of Designation provides that, upon the occurrence and continuation
of a default in dividend payments for at least two consecutive quarters or a
default in any mandatory redemption payment on the Series D Preferred Stock, the
holders of the Series D Preferred Stock, voting as a separate class, shall be
entitled at the next annual or special meeting of stockholders to elect a
majority of the directors of the Company to be elected. See "The Securities
Purchase Agreement and Related Agreements."
For the seven years following the Closing Date, the holders of the Series D
Preferred Stock shall be entitled collectively to cast 20% of the votes eligible
to be cast in each matter submitted to a vote of the holders of capital stock of
the Company, except that if the aggregate number of shares of Common Stock
issuable upon conversion of the Series D Preferred Stock represents less than
20% of the outstanding shares of Common Stock on a fully diluted basis, then
each share of Series D Preferred Stock shall be entitled to the number of votes
equal to the number of shares of Common Stock into which such share of Series D
preferred Stock is then convertible. In addition, without the approval of
holders of a majority of the outstanding shares of Series D Preferred Stock
voting separately as a class, the Company cannot (i) in any manner (including by
merger or consolidation), amend, alter or repeal any provisions of the
resolutions establishing the Series D Preferred Stock so as to adversely affect
the powers, preferences or special rights of such Series D Preferred Stock, or
(ii) authorize the issuance of, or authorize any obligation or security
convertible into or evidencing the right to purchase shares of, any additional
class or series prior to the Series D Preferred Stock in the payment of
dividends or the preferential distribution of assets.
The holders of Series D Preferred Stock will be entitled to certain
preferences over holders of Common Stock. The shares of Series D Preferred Stock
will be entitled to a per annum dividend equal to 9% payable quarterly prior to
the payment of any dividends on shares of Common Stock, although dividends on
the Series D Preferred Stock may be paid in kind (in lieu of cash) by the
Company during the first five years following the Closing Date. The Series D
Preferred Stock will also rank prior to Common Stock with respect to rights upon
liquidation, winding up or dissolution of the Company. The Series D Preferred
Stock will rank junior to the Company's Series B Cumulative Preferred Stock with
respect to dividends and rights upon liquidation. See "Description of Series D
Preferred Stock." Sales of substantial amounts of the Company's common stock
received by AFG upon conversion of the Preferred Stock in the public market, or
the perception that such sales could occur, could adversely affect the market
price of the Common Stock and may make it more difficult for the Company to sell
its equity securities in the future at a time and price which it deems
appropriate.
SUBSTANTIAL EQUITY OWNERSHIP ON CONVERSION AND DILUTION TO EXISTING STOCKHOLDERS
The Series D Preferred Stock will entitle AFG to acquire a substantial
percentage of the outstanding shares of Common Stock. If the 350,000 shares of
Series D Preferred Stock were fully converted into shares of Common Stock, AFG
would receive 6,666,667 shares of Common Stock. In addition, the Company is
entitled
24
<PAGE> 29
to pay dividends on outstanding shares of Series D Preferred Stock during the
first five years following the Closing Date by the payment in kind of additional
shares of Series D Preferred Stock ("PIK Shares") having a liquidation value
equal to the amount of dividends owed. The PIK Shares would also be convertible
into additional shares of Common Stock. Furthermore, if the Company elects to
redeem shares of Series D Preferred Stock prior to the seventh anniversary of
the Closing Date, the Company must issue to the holder one Warrant to purchase
one share of Common Stock for each share of Common Stock into which the redeemed
shares of Series D Preferred Stock are then convertible. Conversion of the
Series D Preferred Stock would result in substantial dilution of the equity
interests of existing stockholders. The table below shows the number of shares
of Common Stock and the percentage of the fully diluted shares of Common Stock
outstanding that AFG could acquire on conversion of the Series D Preferred
Stock.
<TABLE>
<CAPTION>
PERCENTAGE
NUMBER OF OF SHARES
SHARES OUTSTANDING
---------- -----------
<S> <C> <C>
Common Stock purchasable on full conversion of the
original 350,000 shares of Series D Preferred Stock..... 6,666,667 48.6(1)
Common Stock purchasable on full exercise of the 196,178
PIK Shares(2)........................................... 3,736,724 21.4(3)
----------
Total Potential Holdings........................ 10,403,391 59.6(3)
==========
</TABLE>
- ---------------
(1) Based on the number of shares of Common Stock outstanding as of September
30, 1996 (7,047,498 shares), as adjusted to give effect to the issuance of
shares of Common Stock issuable on conversion of the original 350,000 shares
of Series D Preferred Stock.
(2) Assuming all dividends payable on outstanding shares of Series D Preferred
Stock during the first five years following the Closing Date were paid by
the issuance of PIK Shares.
(3) Based on the number of shares of Common Stock outstanding as of September
30, 1996 (7,047,498 shares), as adjusted to give effect to the issuance of
shares of Common Stock issuable on conversion of the original 350,000 shares
of Series D Preferred Stock and on conversion of 196,178 PIK Shares,
assuming the Company does not issue any shares of Common Stock other than
upon conversion of shares of Series D Preferred Stock (including PIK Shares)
or redeem or otherwise repurchase, retire or cancel any outstanding shares
of Common Stock.
RESTRICTIONS ON THE ABILITY OF AFG TO EFFECT A BUSINESS COMBINATION WITH THE
COMPANY
The Series D Preferred Stock will initially be convertible into an
aggregate of 6,666,667 shares of Common Stock, or approximately 48.6% of the
outstanding Common Stock (including the Underlying Shares) as of the Closing
Date. In addition to the voting restrictions described under the heading "The
Transaction -- General -- Terms of the Series D Preferred Stock," the Company's
certificate of incorporation (the "Certificate") contains certain provisions
that will restrict the ability of AFG to effect a business combination with the
Company following the Closing. The Certificate provides that, in addition to any
other vote required by law, a "business combination" (which is defined in the
Certificate to generally include: (i) any merger or consolidation with or into;
(ii) any sale or other transfer of assets aggregating $1.0 million or more to;
or (iii) certain other material corporate transactions with, a "related person"
(which is defined in the Certificate to generally include any person, entity or
group which beneficially owns 10% or more of the outstanding voting stock of the
Company; provided, however, that Mason Best and its affiliates and certain of
its assigns are deemed not to be a "related person")) shall require the
affirmative vote of the holders of at least 75% or more of the combined voting
power of the then outstanding shares of voting capital stock of the Company,
voting together as a single class; provided, however, if there are one or more
"continuing directors" then in office, and such business combination has been
approved by a majority of the Board of Directors (including at least a majority
of the "continuing directors"), then such "business combination" shall only
require such vote as is required by law or by other provisions of the
Certificate. A "continuing director" means
25
<PAGE> 30
generally, as to any related person, any member of the Board of Directors who:
(i) is not, and is not affiliated with, the related person; and (ii) became a
member of the Board of Directors prior to the time the related person became a
related person or is a successor to a continuing director. Following the
Transaction, AFG will be a "related person" within the meaning of the business
combination provisions of the Certificate and, as such, will be subject to such
provisions.
Following the termination of the voting restrictions, which will occur
approximately 3 1/2 years after the Closing Date, AFG may have the ability to
exert substantial control over the Company subject to the foregoing business
combination restrictions.
STRATEGIC ALLIANCE ARRANGEMENTS
Pursuant to the Securities Purchase Agreement, the Company and AFG will
enter into a strategic alliance. See "The Transaction -- General -- Strategic
Alliance with AFG." The strategic alliance will enable the Company to move into
areas in which it is not currently selling insurance and expand its current line
of business. The strategic alliance, however, will not be under the complete
control of the Company, and the parties have not yet addressed policies and
procedures that will be put in place for the management of such alliance.
Although the Company expects that all such matters will be resolved in future
negotiations, no assurances can be made that the Company and AFG will be able to
agree upon the definitive terms of the strategic alliance or that, when the
alliance is formed, it will be profitable or otherwise beneficial to the
Company.
In conjunction with the strategic alliance with AFG, AFG has agreed to
provide a new facility for the Company to offer workers compensation insurance
to its aviation insureds. This will be a new product line marketed by the
Company. It is currently anticipated that AFG would be responsible for the
underwriting of all risks, setting risk selection and pricing criteria, handling
all claims, and providing other necessary expertise. AFG currently writes a
substantial amount of workers compensation insurance. The Company expects to
participate in the revenues and risks of this business on a basis to be
negotiated with AFG, and will be responsible for its marketing. While the
anticipated reliance on AFG's expertise in workers compensation should lessen
the inherent risks to the Company of offering a new type of insurance, there can
be no assurances that, if offered, it will be profitable or otherwise beneficial
to the Company. Other than workers compensation, the expansion plans currently
being considered by the Company do not involve any products or lines of business
where the Company does not already have expertise and an historical market
presence.
EFFECT ON CAPITAL AND EARNINGS AVAILABLE FOR COMMON STOCKHOLDERS
After giving effect to the estimated expenses of the Transaction and the
recapitalization charge (see "The Securities Purchase Agreement and Related
Agreements -- Recapitalization Charge"), the sale of the Series D Preferred
Stock to AFG would increase the Company's capital by approximately $12.0 million
after the recapitalization charge of $15 million. Dividends on the Series D
Preferred Stock would reduce earnings available for common stockholders by
approximately $3.2 million per annum before PIK shares. Based upon the number of
shares of Common Stock outstanding as of September 30, 1996 and without giving
effect to the conversion of any shares of Series D Preferred Stock, the
quarterly dividends on outstanding shares of Series D Preferred Stock would
reduce the Company's primary earnings per share by approximately $.45 per year.
26
<PAGE> 31
CAPITALIZATION
The following table sets forth the summary capitalization of the Company
and its subsidiaries as of September 30, 1996, and adjustments to give effect to
the consummation of the Transaction, the application of the estimated net
proceeds therefrom and the incurrence of the recapitalization charge.
<TABLE>
<CAPTION>
SEPTEMBER 30, PRO FORMA
1996 ADJUSTMENTS PRO FORMA
------------- ----------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Note payable.............................................. $13,250 $13,250(a) $ -0-
Series B cumulative preferred stock, $.01 par value;
162,857 shares authorized, 162,857 shares issued and
outstanding............................................. 1,629 1,629
Series D cumulative convertible redeemable preferred
stock, $.01 par value; no shares authorized or issued;
546,200 shares authorized pro forma, 350,000 shares
issued pro forma(c)..................................... -- 33,000(a) 33,000
Stockholders' equity
Common Stock, $.01 par value; 21,000,000 shares
authorized, 7,121,380 shares issued.................. 71 71
Additional paid-in capital.............................. 45,555 45,555
Unrealized investments losses........................... (252) (252)
Retained earnings....................................... 1,819 (9,750)(b) (7,931)
Less 73,882 shares of Common Stock held in treasury,
at cost............................................ (87) (87)
------- ------- -------
Total stockholders' equity...................... 47,106 (9,750) 37,356
------- ------- -------
Total capitalization............................ $61,985 $36,500 $71,985
======= ======= =======
</TABLE>
- ---------------
(a) Adjustment to give effect to the sale by the Company of 350,000 shares of
Series D Preferred Stock at a price of $100 per share for an aggregate
purchase price of $35 million net of an estimated $2 million of issuance
costs and the repayment of the note payable. See, however, "The
Transaction -- Use of Proceeds."
(b) Adjustments to record $15 million recapitalization charge and related tax
benefit of $5.25 million.
(c) The Company's Certificate of Incorporation authorizes the Company to issue
an aggregate of 5 million shares of preferred stock, par value $.01 per
share, of which the Company has issued 162,857 shares as Series B
Cumulative Preferred Stock and has reserved 546,200 shares for issuance as
Series D Preferred Stock.
27
<PAGE> 32
THE SECURITIES PURCHASE AGREEMENT AND RELATED AGREEMENTS
The following is a summary of certain provisions of the Securities Purchase
Agreement and certain related agreements. A copy of the Securities Purchase
Agreement is attached hereto as Appendix II. Stockholders are urged to read the
Securities Purchase Agreement and related agreements in their entirety.
The Board of Directors reserves its right to amend or waive the provisions
of the Securities Purchase Agreement and the other documents related thereto in
all respects before or after the approval of the Proposal by the stockholders.
In addition, the Board of Directors reserves the right to terminate the
Securities Purchase Agreement in accordance with its terms before or after
stockholder approval of the Proposal.
ISSUANCE AND SALE OF SERIES D PREFERRED STOCK
Pursuant to the Securities Purchase Agreement, the Company will sell, and
AFG will purchase, 350,000 shares of Series D Preferred Stock for $35 million.
RECAPITALIZATION CHARGE
In addition, the Company will record a $15 million (pre-tax)
recapitalization charge in its financial results for the quarter in which the
Transaction is recorded. The recapitalization charge will provide additional
strengthening of the Company's balance sheet and overall reserve levels, and is
intended to cover contingencies and estimated exposures associated with various
previously reported strategic actions and product line discontinuations.
CERTAIN COVENANTS
Pursuant to the Securities Purchase Agreement, the Company has agreed that,
if the Company has no securities registered under Section 12 of the Securities
Exchange Act of 1934, as amended, it will deliver copies of its annual and
quarterly financial statements to AFG and will furnish AFG with copies of any
documents required to be filed with the SEC or other governmental agencies. The
Company has agreed that, prior to the Closing Date, it will conduct its business
in the ordinary course and properly maintain its existence and property.
AFG REPRESENTATION ON BOARD OF DIRECTORS
Until AFG and its affiliates no longer own Series D Preferred Stock and
Underlying Shares representing in the aggregate the ownership, or right to
acquire ownership, of 51% of the Underlying Shares or until the seventh
anniversary of the Closing, whichever is earlier, AFG shall be entitled to
nominate for election 30% of the Company's directors and, if elected, at least
one director representing AFG shall serve on each standing committee of the
Board of Directors. Notwithstanding the foregoing, the number of directors that
AFG is entitled to nominate shall be reduced by the number of directors that the
holders of the Series D Preferred Stock are entitled to elect as a class under
the terms of the Certificate of Designation for the Series D Preferred Stock. If
AFG's designees fail to be elected to the Board of Directors, AFG shall
nevertheless be entitled to have an equal number of representatives attend each
meeting of the Board of Directors. Such representatives shall be entitled to
receive all materials and information provided to the Company's Board of
Directors and shall receive the same notices as are given to the Company's Board
of Directors.
AFG VOTING AGREEMENT
The Securities Purchase Agreement also provides that, until the date which
is three years and 180 days after the Closing Date, so long as AFG and any
affiliate of AFG shall beneficially own Series D Preferred Stock or Underlying
Shares which represent in the aggregate the ownership, or right to acquire
ownership, of at least 51% of the Underlying Shares, AFG shall, if it and its
Affiliates hold any combination of Series D Preferred Stock and Common Stock
representing the right to vote more than 20% of the total votes eligible to be
voted on a matter on which the holders of Common Stock have the right to vote,
vote all votes in excess of such 20% in proportion to the actual vote of holders
of all remaining votes (including AFG's 20% vote).
28
<PAGE> 33
STRATEGIC ALLIANCE
Pursuant to the Securities Purchase Agreement, the Company and AFG will
enter into a strategic alliance. See "The Transaction -- General -- Strategic
Alliance with AFG."
CONDITIONS PRECEDENT
The Securities Purchase Agreement provides that the obligations of AFG to
consummate the transactions contemplated by the Securities Purchase Agreement
are subject to the fulfillment prior to or on the Closing Date of certain
conditions precedent, or the waiver thereof by AFG, including the following: (a)
the Proposal shall have been approved by the requisite vote of the Company's
stockholders; (b) the representations and warranties of the Company shall be
true and correct when made; (c) no change in applicable law shall have occurred
as a consequence of which it shall have become and continue to be unlawful for
AFG to perform any of its agreements or obligations under the Securities
Purchase Agreement, or under any of the other agreements contemplated by the
Securities Purchase Agreement (the "Transaction Documents") or for the Company
or any subsidiary of the Company to perform any of its agreements or obligations
under the Securities Purchase Agreement or under any of the other Transaction
Documents; (d) the Company shall have performed and complied in all material
respects with all agreements and conditions contained in the Securities Purchase
Agreement required to be performed or complied with by the Company prior to or
at the Closing; (e) the Company shall have furnished to AFG a written legal
opinion in form reasonably acceptable to AFG; (f) the Company and AFG shall have
received all consents necessary for completion of the transactions contemplated
by the Securities Purchase Agreement including regulatory approvals; (g) Mason
Best and the Company shall have entered into an Amended Registration Rights
Agreement; (h) Mason Best shall have entered into the Voting Agreement; and (i)
the Company shall have adjusted the exercise price of existing stock options
granted to continuing officers and directors of the Company or its Subsidiaries
pursuant to its 1991 Nonqualified Stock Option Plan, 1994 Stock Incentive Plan
and 1994 Directors Option Plan to the market price on the date of adjustment and
shall have set the vesting period of such stock options to three years, with
one-third of the options vesting on each anniversary of the adjustment date.
The obligations of the Company to consummate the transactions contemplated
by the Securities Purchase Agreement are subject AFG's fulfillment, prior to or
on the Closing Date, of certain conditions precedent reciprocal to the
conditions contained in paragraphs (a), (b), (c), and (f) above.
RESTRICTION ON TRANSFERABILITY OF SERIES D PREFERRED STOCK
As long as AFG has certain rights or obligations regarding Board
representation and voting agreements pursuant to the Securities Purchase
Agreement, AFG and any of its Affiliates may assign or transfer to any person
shares of Series D Preferred Stock or Underlying Shares, representing in the
aggregate ownership, or the right to acquire ownership, of at least 51% of the
Underlying Shares and all of their rights described under "-- AFG Representation
on Board of Directors", so long as such person assumes all of the obligations
described under "-- AFG Voting Agreement."
CERTAIN REPRESENTATIONS AND WARRANTIES
Under the Securities Purchase Agreement, the Company has made certain
representations and warranties to AFG as to the Company, including (i) corporate
existence, organization and qualification; (ii) corporate power and authority;
(iii) enforceability of the various agreements entered into; (iv) absence of
conflicts; (v) litigation; (vi) financial condition; (vii) absence of certain
changes to its business, financial condition or capitalization; (viii) absence
of material defaults; (ix) compliance with laws; (x) taxes; (xi) employee
benefits plans; (xii) compliance with environmental laws; (xiii) investment
company status; (xiv) capitalization of the Company and its Subsidiaries; (xv)
title to properties; (xvi) absence of undisclosed liabilities; and other
matters.
Under the Securities Purchase Agreement, AFG has made certain
representations and warranties to the Company as to AFG, including (i) corporate
existence and organization; (ii) corporate authorization and compliance with
law; (iii) required consents, approvals and licenses from governmental
authorities or other
29
<PAGE> 34
third parties; (iv) enforceability of the various agreements entered into; (v)
investment intent; and (vi) commissions.
NO SOLICITATION
After the date of the Securities Purchase Agreement, the Company shall not,
and the Company shall direct and use its reasonable best efforts to cause the
officers, directors, employees, agents, advisors and other representatives of
the Company not to, directly or indirectly, (i) solicit, initiate, knowingly
encourage, or participate in discussions or negotiations regarding, any
proposals or offers from any person, entity or group (an "Offeror") relating to
any Competing Proposal, or (ii) furnish to any other Offeror any non-public
information or access to such information with respect to, or otherwise
concerning, any Competing Proposal. The Company shall immediately cease and
cause to be terminated any existing discussions or negotiations with any third
parties conducted heretofore with respect to any proposed Competing Proposal.
Notwithstanding the foregoing, until the stockholders of the Company have
approved the transactions contemplated by the Securities Purchase Agreement, the
Company shall not be prohibited by the Securities Purchase Agreement from (i)
participating in discussions or negotiations with, and, during such period, the
Company may furnish information to, an Offeror that seeks to engage in
discussions or negotiations, requests information or makes a proposal to acquire
the Company pursuant to a Competing Proposal, if the Company's directors
determine in good faith that such action is required for the discharge of their
fiduciary obligations, after consultation with independent legal counsel, who
may be the Company's regularly engaged legal counsel and financial advisors (a
"Director Duty"); (ii) complying with Rule 14d-9 or Rule 14e-2 promulgated under
the Securities Exchange Act of 1934 (the "Exchange Act") with regard to a tender
or exchange offer; (iii) making any disclosure to the Company's stockholders in
accordance with a Director Duty; (iv) failing to make, modifying or amending its
recommendations, consents or approvals referred to herein in accordance with a
Director Duty; or (v) terminating the Securities Purchase Agreement and entering
into an agreement providing for a Competing Proposal in accordance with a
Director Duty. In the event that the Company or any of its officers, directors,
employees, agents, advisors or other representatives participate in discussions
or negotiations with, or furnish information to an Offeror that seeks to engage
in such discussions or negotiations, requests information or makes a proposal to
acquire the Company pursuant to a Competing Proposal, then subject to any
confidentiality requirements of an Offeror: (i) the Company shall immediately
disclose to AFG the decision of the Company's directors; (ii) the identity of
the Offeror; and (iii) copies of all information or material not previously
furnished to AFG which the Company, or its agents, provides or causes to be
provided to such Offeror or any of its officers, directors, employees, agents,
advisors or representatives.
TERMINATION
The Securities Purchase Agreement may be terminated at any time prior to
the Closing Date: (a) by mutual written consent of the Company and AFG; (b) by
the Company or AFG upon written notice to the other party, if the Closing shall
not have occurred on or prior to March 31, 1997 (the "Outside Date"), unless
such failure of consummation shall be due to the failure of the party seeking
such termination to perform or observe in all material respects the covenants
and agreements hereof to be performed or observed by such party; (c) by the
Company or AFG, upon written notice to the other party, if a governmental
authority of competent jurisdiction shall have issued an injunction, order or
decree enjoining or otherwise prohibiting the consummation of the transactions
contemplated by the Securities Purchase Agreement, and such injunction, order or
decree shall have become final and nonappealable or if a governmental authority
has otherwise made a final determination that any required regulatory consent
would not be forthcoming; provided, however, that the party seeking to terminate
the Securities Purchase Agreement pursuant to this clause has used all required
efforts to remove such injunction, order or decree; (d) by the Company, if prior
to approval by the stockholders of the Company of the Proposal, the Board of
Directors of the Company determines in accordance with a Director Duty that such
termination is required by reason of a Competing Proposal; or (e) by the Company
or AFG, if prior to approval of the stockholders of the Company of the Proposal,
the Board of Directors of the Company shall have withdrawn or modified in a
manner materially adverse to AFG
30
<PAGE> 35
its approval of the adoption of the Proposal, because the Board of Directors has
determined to recommend to the Company's stockholders or approve a Competing
Proposal, in accordance with a Director Duty.
In the event that the Securities Purchase Agreement is terminated by reason
of (d) or (e) above, the Break-up Warrants issued to AFG under the Securities
Purchase Agreement shall become immediately exercisable and AFG shall have all
of the benefits of the Warrant Registration Rights Agreement relating to such
Break-up Warrants. In the event that the Securities Purchase Agreement is
terminated due to any other reason described above, the Break-up Warrants shall
be cancelled and neither party shall have any further rights or obligations
under the Securities Purchase Agreement or the Registration Rights Agreement.
If either party shall default in the performance of its obligations under
the Securities Purchase Agreement, the non-defaulting party shall retain all
rights and remedies, whether arising in equity or at law, including actions for
specific performance and damages, as a result of the default by the other party
under the Securities Purchase Agreement.
BREAK-UP WARRANTS
The Break-up Warrants were issued to AFG upon execution of the Securities
Purchase Agreement pursuant to a Warrant Subscription Agreement dated as of
November 5, 1996 between the Company and AFG. Pursuant to the Warrant
Subscription Agreement, the Company issued AFG the Break-up Warrants for 800,000
shares of Common Stock exercisable for $3.45 per share. The Break-up Warrants
may be exercised commencing the first business day following the termination of
the Securities Purchase Agreement pursuant to the provisions described above
permitting such termination in order to accept a Competing Proposal, and
thereafter remain exercisable until November 4, 2003. The Break-up Warrants
shall be cancelled simultaneously with the Closing under the Securities Purchase
Agreement.
The exercise price and number of shares subject to the Break-up Warrants
are subject to adjustment pursuant to customary antidilution provisions. In
addition, in case of any consolidation of the Company with or merger of the
Company into another corporation or in case of any sale, transfer or lease to
another corporation of all or substantially all the property of the Company,
each holder of Break-up Warrants shall thereafter be entitled, upon payment of
the exercise price in effect immediately prior to such action, to purchase upon
exercise of each Break-up Warrant the kind and amount of cash, shares and other
securities and property which such holder would have owned or have been entitled
to receive after the happening of such consolidation, merger, sale, transfer or
lease had such Break-up Warrant been exercised immediately prior to such action,
provided, however, that no adjustment in respect of dividends, interest or other
income on or from such shares or other securities and property shall be made
during the term or upon the exercise of a Break-up Warrant.
Subject to compliance with applicable securities laws, the Break-up
Warrants are transferable. In addition, the holders thereof are entitled to
certain demand and piggyback registration rights.
WARRANTS ISSUABLE UPON EARLY REDEMPTION
Certain warrants (the "Warrants") shall be issued upon the early redemption
of the Series D Preferred Stock, which may be done at any time at the Company's
option. In the event of a redemption of Series D Preferred Stock prior to the
seventh anniversary of the Closing Date, the Company shall, in addition to the
cash payable to the holder, issue to the holder, for each share of Common Stock
into which the redeemed shares of Series D Preferred Stock are then convertible,
a Warrant to purchase one share of Common Stock of the Company at an exercise
price of $5.25 per share (subject to antidilution provisions) under the terms of
the Form of Warrant Subscription Agreement attached as an exhibit to the
Securities Purchase Agreement. The Warrants may be exercised commencing the
first business day following their issuance and thereafter remain exercisable
until November 4, 2003, at which time all unexercised Warrants will expire.
The exercise price and number of shares subject to the Warrants are subject
to adjustment pursuant to customary antidilution provisions. In addition, in
case of any consolidation of the Company with or merger of the Company into
another corporation or in case of any sale, transfer or lease to another
corporation of all or
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<PAGE> 36
substantially all the property of the Company, each holder of Warrants shall
thereafter be entitled, upon payment of the exercise price in effect immediately
prior to such action, to purchase upon exercise of each Warrant the kind and
amount of cash, shares and other securities and property which such holder would
have owned or have been entitled to receive after the happening of such
consolidation, merger, sale, transfer or lease had such Warrant been exercised
immediately prior to such action, provided, however, that no adjustment in
respect of dividends, interest or other income on or from such shares or other
securities and property shall be made during the term or upon the exercise of a
Warrant.
Subject to compliance with applicable securities laws, the Redemption
Warrants are transferable. In addition, the holders thereof are entitled to
certain demand and piggyback registration rights.
REGISTRATION RIGHTS AGREEMENTS
The Company will enter into a Registration Rights Agreement with AFG with
respect to the shares of Series D Preferred Stock, the shares of Common Stock
purchased upon conversion of the Series D Preferred Stock (the "Common Shares")
and the Warrants issuable upon optional redemption of the Series D Preferred
Stock by the Company prior to the seventh anniversary of the Closing Date
(collectively, the "Registrable Securities"). Pursuant to the Registration
Rights Agreement, AFG shall have the right on three occasions to demand
registration under the Securities Act of 1933, as amended (the "Securities
Act"), of the Registrable Securities; provided, however, that the Company shall
in no event (including by reason of any assignment of rights by AFG or any other
holder of Registrable Securities) be subject to more than three demand
registrations under such agreement and shall not be obligated at any time to
register the lesser of (i) 25% of the total outstanding number of Series D
Preferred Stock, Common Shares or Warrants, whichever is the case, or (ii)
Registrable Securities with a market value (based on the market value of the
underlying shares of Common Stock) of less than $1.0 million pursuant to any
such request. The Registration Rights Agreement also provides that, in the event
the Company proposes to register any of its securities under the Securities Act
for its own account or for the account of any other person, AFG will be entitled
to include Registrable Shares in any such registration, subject to the right of
the managing underwriter of any such offering in certain circumstances to
exclude some or all of such Registrable Shares from such registration.
The Company will also enter into a Warrant Registration Rights Agreement
with AFG with respect to the Break-up Warrants and the shares of Common Stock
acquired upon exercise of the Break-up Warrants (the "Warrant Shares, and
together with the Break-up Warrants, the "Break-up Securities"). Pursuant to the
Warrant Registration Rights Agreement, AFG shall have the right on three
occasions to demand registration of the Break-up Securities under the Securities
Act; provided, however, that the Company shall in no event (including by reason
of any assignment of rights by AFG or any other holder of Break-up Securities)
be subject to more than three demand registrations under such agreement and
shall not be obligated at any time to register the lesser of (i) 25% of the
total number of Break-up Warrants or Warrant Shares outstanding or (ii) Warrant
Shares with a market value (based on the market value of the underlying shares
of Common Stock) of less than $1.0 million pursuant to any such request. The
Warrant Registration Rights Agreement also provides that, in the event the
Company proposes to register any of its securities under the Securities Act for
its own account or for the account of any other person, AFG will be entitled to
include Break-up Securities in such registration, subject to the right of the
managing underwriter of any such offering in certain circumstances to exclude
some or all of such Break-up Securities from such registration.
AMENDED REGISTRATION RIGHTS AGREEMENT
The Company and Mason Best will amend the Existing Registration Rights
Agreement dated March 21, 1994 to provide that holders of registrable securities
under such agreement will not have the right to include their shares in a
registration statement filed by the Company for an underwritten offering of
securities by AFG if the managing underwriter shall have rendered an opinion
that such registration materially would impair AFG's ability to sell the
securities being registered for sale by AFG.
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DESCRIPTION OF SERIES D PREFERRED STOCK
The following is a summary of the terms of the Series D Preferred Stock.
The rights, preferences and privileges of the Series D Preferred Stock are
contained in the Certificate of Designation, a copy of which is attached hereto
as Appendix III. Stockholders are urged to read the Certificate of Designation
in its entirety.
PRIORITY
The Series D Preferred Stock will have a liquidation value of $100 per
share (the "Liquidation Value"). The Series D Preferred Stock will rank prior to
the Common Stock and to all other shares of capital stock of the Company that
are junior to the Series D Preferred Stock with respect to the payment of
dividends and payments or distributions upon liquidation (the Common Stock and
all such shares are referred to herein as the "Junior Stock"). The Series D
Preferred Stock will rank junior to the Company's Series B Cumulative Preferred
Stock (the "Series B Preferred Stock") with respect to dividends and rights upon
liquidation and will be subject to the creation of other stock ranking senior
to, on a parity with, or junior to, the Series D Preferred Stock to the extent
not prohibited by the Company's Certificate of Incorporation, except that
creation of stock ranking senior to the Series D Preferred Stock is subject to
the approval of the holders of two-thirds of the outstanding shares of Series D
Preferred Stock voting separately as a class. See "-- Voting Rights."
DIVIDENDS
The Series D Preferred Stock will be entitled to a per annum cumulative
dividend equal to 9% payable quarterly as declared by the Board beginning April
1, 1997. At the option of the Company, dividends will be payable either in cash
or in kind (whereby the holder receives, in lieu of cash, shares of Series D
Preferred Stock having a liquidation value equal to the dividends declared)
during the first five years after the Closing Date. Following the fifth
anniversary of the Closing Date, dividends will be payable quarterly only in
cash.
Subject to the rights of holders of the Series B Preferred Stock, the
Company shall not declare or pay or set apart for payment any dividend (other
than dividends payable in shares of Junior Stock) for any period upon any Junior
Stock or any stock of the Company ranking on a parity with the Series D
Preferred Stock as to dividends, nor shall the Company redeem or purchase any
such shares or pay any money to a sinking fund for the redemption or repurchase
of any such shares unless all dividends on the Series D Preferred Stock,
including all accrued and unpaid dividends, have been paid in full.
Notwithstanding the foregoing, the Company may pay dividends on the shares of
the Series D Preferred Stock and shares of stock of the Company ranking on a
parity therewith as to dividends ratably in proportion to the sums which would
be payable on such shares if all dividends, including accumulations, if any,
were declared and paid in full. Accumulations of dividends on any shares of the
Series D Preferred Stock shall bear interest at 9% per annum, compounded
quarterly.
VOTING RIGHTS
The holders of shares of Series D Preferred Stock shall be entitled to the
following voting rights for the seven year period commencing on the Closing
Date. Thereafter, holders of Series D Preferred Stock will have no voting rights
except as set forth in (b) and (c) or as otherwise provided by law:
(a) With regard to any matter submitted to a vote of the holders of
capital stock of the Company, the holders of the Series D Preferred Stock
shall be entitled collectively to cast 20% of the votes eligible to be cast
in such matters; provided, however, in the event that the aggregate number
of shares of Common Stock into which the Series D Preferred Stock is
convertible represents less than 20% of the aggregate number of all shares
of Common Stock outstanding (on a fully diluted basis), then each holder of
a share of Series D Preferred Stock shall be entitled to cast one vote for
each full share of Common Stock into which such share is then convertible
with respect to any such matter;
(b) Notwithstanding the foregoing, upon the occurrence and
continuation of an Event of Default (defined as a default in dividend
payments for at least two consecutive quarters or a default in any
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<PAGE> 38
mandatory redemption payment on the Series D Preferred Stock), each share
of Series D Preferred Stock shall be entitled to cast the number of votes
equal to the number of shares of Common Stock into which such share is then
convertible on any matter submitted for the consideration of the
stockholders of the Company, and the holders of the Series D Preferred
Stock, voting separately, as a class shall be entitled at the next annual
or special meeting of stockholders to elect such number of directors which
is a majority (rounded up) of the directors to be elected. The term of
office of directors elected under these circumstances shall end upon the
earlier of the termination of the Event of Default and the next annual
meeting of stockholders; and
(c) Without the approval of holders of a majority of the outstanding
shares of Series D Preferred Stock voting separately as a class, the
Company will not, in any manner (including by merger or consolidation) (i)
amend, alter or repeal any provisions of the resolutions establishing the
Series D Preferred Stock so as to adversely affect the powers, preferences
or special rights of such Series D Preferred Stock, or (ii) authorize the
issuance of, or authorize any obligation or security convertible into or
evidencing the right to purchase shares of, any additional class or series
of stock ranking prior to the Series D Preferred Stock in the payment of
dividends or the preferential distribution of assets. The foregoing shall
not be interpreted to require any vote or consent of the Series D Preferred
Stock in connection with the authorization or issuance of any series of
Preferred Stock ranking on a parity with or junior to the Series D
Preferred Stock as to dividends and/or the distribution of assets.
In addition, pursuant to the Securities Purchase Agreement, until AFG and
its affiliates no longer own Series D Preferred Stock and Underlying Shares
representing in the aggregate the ownership, or the right to acquire ownership,
of 51% of the Underlying Shares, or until the seventh anniversary of the Closing
Date, whichever is earlier, AFG shall be entitled to nominate for election to
the Company's Board of Directors at least the number of directors which
represents 30% (rounded up to the next director) of the number of directors
serving at any one time, and, if elected, at least one of the directors
representing AFG shall serve on each of the standing committees of the Board of
Directors. Notwithstanding the foregoing, the number of directors that AFG shall
be entitled to nominate shall be reduced to the extent and by the number of
directors the holders of Series D Preferred Stock are entitled to elect as a
class under the terms of the Certificate of Designation. In the event AFG's
representatives fail to be elected as directors, the Company agrees that AFG
shall be entitled to have an equal number of representatives in place of such
directors attend each meeting of the Board of Directors. Such representatives
shall be entitled to receive all materials and information provided to the
Company's Board of Directors and shall receive the same notices as are given to
the Company's Board of Directors.
CONVERSION
The Series D Preferred Stock will be convertible at any time, in whole or
in part, at the option of the holder into shares of the Common Stock at a per
share conversion price equal to $5.25 per share of Common Stock (the "Conversion
Price"). The Conversion Price is subject to certain post-closing antidilution
adjustments upon the occurrence of certain events such as (i) stock dividends,
stock splits and reverse stock splits, (ii) stock reclassifications or
combinations, (iii) issuances of rights, warrants or securities convertible or
exchangeable into Common Stock, which rights, options, warrants or securities
have a conversion or exercise price per share less than the market value of the
Common Stock, and (v) distributions of evidences of indebtedness or of assets to
holders of Common Stock. In the case of a merger or consolidation, holders of
Series D Preferred Stock shall have the right to convert the shares into the
kind and amount of shares and other property receivable in such transaction by
the holders of the Common Stock.
REDEMPTION
The Company may, at its option, redeem shares of Series D Preferred Stock
for cash, at any time and from time to time, in whole or in part, by vote of its
Board of Directors; provided, however, in the event that any share of Series D
Preferred Stock is redeemed by the Company on or before the seventh anniversary
of the Closing Date, in addition to the cash payable to the holder of each such
share, the holder shall, for each share of Common Stock into which the redeemed
share of Series D Preferred Stock is then convertible, receive a
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<PAGE> 39
Warrant to purchase one share of Common Stock of the Company at an exercise
price of $5.25 per share, or, in the event of any adjustment to the Conversion
Price hereunder, at the adjusted Conversion Price, at any time prior to the
seventh anniversary of the Closing Date. The Company is required to redeem 10%
of the outstanding shares of Series D Preferred Stock on the first business day
of each year, commencing with the year 2008, and all remaining outstanding
shares are required to be redeemed on the first business day of the year 2018.
The redemption price of each share of Series D Preferred Stock is $100.00 per
share plus an amount equal to accrued and unpaid dividends to the date fixed for
redemption. Any redemption made shall be on a pro rata basis.
LIQUIDATION PREFERENCE
Subject to the rights of holders of the Series B Preferred Stock, in the
event of liquidation of the Company, the holders of shares of Series D Preferred
Stock shall be entitled to receive a liquidation payment of $100.00 per share
plus all accrued and unpaid dividends thereon to the date of payment before any
payment or distribution of assets may be made to holders of Junior Stock.
RESTRICTION ON TRANSFER
In addition to the restrictions on transfer of the Series D Preferred Stock
applicable to AFG, which are contained in the Securities Purchase Agreement, the
Certificate of Designation requires that certificates for shares of Series D
Preferred Stock contain a restrictive legend noting the fact that such shares
have not been registered under the Securities Act of 1933. Holders of Series D
Preferred Stock also agree to notify the Company in writing of any proposed
transfer of such stock, accompanied by written opinions of counsel and written
assurances of appropriate securities regulatory agencies as to the legality of
the proposed transfer.
PREEMPTIVE RIGHTS
Holders of the Series D Preferred Stock have no preemptive rights.
AFG'S DESIGNEES FOR DIRECTORS
AFG has advised the Company that it intends to nominate the persons named
below to serve as directors of the Company until the next annual meeting of
stockholders and until their successors are elected and have been duly
qualified. AFG has advised the Company that it currently does not know of any
circumstance which could render any of these individuals unable to take office.
Gary J. Gruber. Mr. Gruber, age 41, is a Senior Vice President of Great
American Insurance Company ("Great American"), a subsidiary of AFG, and has
served in such capacity for more than the past five years. From October 1990 to
June 1995, Mr. Gruber also served as the treasurer of Great American.
Thomas A. Hayes. Mr. Hayes, age 53, is a Senior Vice President and
President of the Commercial Division of Great American and has served in such
capacities since June 30, 1995. Mr. Hayes has also served as a director of Great
American for more than the past five years. Prior to June 30, 1995, Mr. Hayes
served as an Executive Vice President of Great American for more than five
years.
At the Closing, the Company's Board of Directors will appoint the nominees
of AFG to positions on the Board of Directors.
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<PAGE> 40
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The following discussion and analysis of financial condition and results of
operations should be read in conjunction with the audited and unaudited
Consolidated Financial Statements and Notes thereto of American Eagle Group,
Inc. and its subsidiaries (the "Company") starting at page F-1.
AFG TRANSACTION
On November 5, 1996, the Company and AFG entered into the Securities
Purchase Agreement, which, subject to the terms and conditions thereof, provides
for the sale and issuance by the Company to AFG of 350,000 shares of Series D
Preferred Stock for an aggregate purchase price of $35 million. See "The
Transaction."
GROSS PREMIUMS PRODUCED
As used in this discussion, gross premiums produced means the gross
premiums written by American Eagle Insurance Company ("AEIC"), the Company's
significant subsidiary, and by other companies for which the Company has
authority to issue policies that are marketed, underwritten and serviced by the
Company.
Set forth below in this discussion are the total amount of gross premiums
produced by the Company, the portion of the gross premiums produced that were
gross premiums written for other companies, and the amount of premiums which
AEIC has assumed from such other companies. Gross premiums written is the
portion of the gross premiums produced for AEIC together with the premiums AEIC
assumes from such other companies. AEIC cedes a portion of its gross premiums
written to reinsurers for reinsurance protection. The ceded premiums reduce the
amount of gross premiums written, resulting in the net premiums written by AEIC.
The gross premiums produced for other companies may generate commission income
for the Company, but do not provide an opportunity to generate an underwriting
profit unless AEIC assumes premiums and related risk from the other companies.
The net premiums written by AEIC provide an opportunity to generate underwriting
profit but can result in underwriting losses.
The Company obtains reinsurance coverage primarily through excess-of-loss
treaty reinsurance. Under excess-of-loss reinsurance treaties, the reinsurer
assumes losses above specified amounts as stipulated in the reinsurance contract
for an agreed-upon premium. The agreed-upon premium may vary within
predetermined ranges based upon the level of losses experienced by the
reinsurer. AEIC's maximum net retention is $200,000 for liability loss and
$150,000 for hull loss in the Aviation Division, $250,000 per occurrence in the
P&C Division and $75,000 per occurrence in the Marine Division.
1995 SPECIAL CHARGE TO EARNINGS
During the fourth quarter of 1995, the Company recorded a special charge to
earnings of $20.6 million (after tax) for certain discontinued lines and classes
of business and increased reserves for incurred but not reported (IBNR) losses
and unearned premiums.
Approximately $8.9 million of the special charge resulted from additional
case reserves and related costs for three segments of the Aviation Division in
which certain classes of coverage have been discontinued. Approximately $.7
million of the special charge resulted from additional case reserves and related
costs for the auto dealer program of the P&C Division from which the Company
withdrew in the fourth quarter of 1995. The remainder of the special charge,
approximately $11.0 million, resulted from an increase in IBNR and unearned
premium reserves, which includes reserves for the discontinued lines and classes
of business. Of the increase in IBNR and unearned premium reserves, $7.1 million
is attributed to the Aviation Division, and $3.9 million to the P&C Division.
The early indications that additional IBNR was required were increases in
the frequency of larger aviation liability losses and an increase in the loss
ratio for the auto dealer program which were discussed in the Company's
Quarterly Report on Form 10-Q for the quarter ended June 30, 1995. These early
indicators
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<PAGE> 41
resulted in a review of the Aviation Division pricing, risk selection and
underwriting criteria for high limits of liability. For the auto dealer program
a review of all aspects of the program, including pricing, risk selection and
underwriting criteria was undertaken.
The trends noted in the second quarter for the Aviation Division larger
aviation liability losses continued in the third quarter and the Company
continued to evaluate and refine the action plan previously implemented to
improve the underwriting performance of the commercial aviation line of
business. The Company's continued review in the third quarter of the auto dealer
program resulted in a decision to withdraw from this program. As the full impact
of withdrawing from the auto dealer program and the development of the aviation
liability exposure was being evaluated prior to the end of 1995, the Company
indicated that taking a special reserve addition for the fourth quarter may be
prudent.
These trends together with the four quarter trends and reviews and
evaluations resulted in the decision to record the special charge in the fourth
quarter of 1995.
The Aviation Division has discontinued writing coverages for the flying
club segment and certain classes in the instruction and rental and the charter
segments. The discontinued segment and classes together represented less than
10% of the Aviation Division's total book of business in 1995, but had
significant adverse impact on the overall underwriting results of the Division.
The P&C Division discontinued its franchised auto dealer program, which
represented the smallest of the three P&C Division segments. This segment had
gross premiums produced of $9.9 million in 1995, or 19.7% of total P&C Division
gross premiums produced.
The decisions to discontinue the lines of businesses noted above were made
in the fourth quarter of 1995 and first quarter of 1996. The estimated unearned
premium attributed to the discontinued operations at December 31, 1995 is
approximately $5 million for the P&C Division and approximately $12 million for
the segments of the commercial aviation line of business of the Aviation
Division.
Case and IBNR reserves do not represent an exact calculation of liability,
but rather are estimates involving actuarial and statistical projections at a
given time to reflect the Company's expectations of the ultimate costs of
administration and settlement of claims. Such estimates are based on facts and
circumstances then known, predictions of future events, estimates of future
trends in claims reporting frequency and severity and other variable factors. As
a consequence, although the Company believes that its reserves are adequate to
meet its future obligations under existing policies, actual losses may deviate,
perhaps substantially, from reserves reflected in the Company's financial
statements. There are a number of factors that could cause losses to deviate
from estimates. Such factors include assumptions proving incorrect regarding the
positive effect of underwriting and claims handling improvements on future
trends in claims reporting, frequency and severity, and increases in claims
settlement costs due to higher inflation or new theories of liability. To the
extent reserves prove inadequate, the Company would have to increase reserves
and incur a charge to earnings in the period in which the reserves are
increased, which could have a material adverse effect on the financial results
of the Company for such period.
A.M. BEST COMPANY RATING
As a result of the effect of the 1995 special charge on the statutory
policyholders' surplus and operating results of AEIC, A.M. Best Company lowered
its rating of AEIC by one level to "B++" (Very Good). As a result of the net
loss of $2.8 million reported in the first quarter of 1996, A.M. Best lowered
its rating of AEIC to "B" (Adequate). Some insureds and agents, primarily in the
airport segment of the Aviation Division, require their insurance carriers to
maintain an A.M. Best rating of at least "A-." Through various agreements, AEIC
has authority to offer policies issued by an insurance carrier with a rating of
at least "A-" to its aviation accounts. AEIC reinsures and services these
policies. These agreements are limited in scope, have an annual term and are
subject to regulatory requirements. During 1996, AEIC has renewed or replaced
these agreements, and is completing the related regulatory filings. The required
regulatory approvals involve the routine filing of proposed policy form and
rating information with the Department of Insurance of each state where such
forms are to be issued. All currently anticipated filings have been made and
AEIC is awaiting review and approval of these filings. While no assurances can
be made regarding approval by the individual state's Department of Insurance,
the forms filed were previously approved by each such department when filed on
behalf of AEIC. As discussed below, management believes that a portion of the
decrease in gross
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premiums produced during the first nine months of 1996 resulted from AEIC's
inability to provide certain insureds with policies issued by an insurer rated
at least "A-" while AEIC was completing these renewals or replacements and
regulatory filings. No assurance can be given that these agreements will be
renewed or replaced upon the expiration of the current agreements. However, in
the event of the closing of the Transaction with AFG, Section 5.4 of the
Securities Purchase Agreement provides that the Company and AFG shall negotiate,
in good faith, the terms of an underwriting management agreement pursuant to
which AFG shall offer to provide the Company, where commercially desirable,
underwriting capacity of an insurance carrier rated "A" by A.M. Best. See "The
Transaction -- General -- Strategic Alliance with AFG."
WITHDRAWAL FROM TRANSPORTATION LINE OF BUSINESS
On September 30, 1996, the Company announced that it was withdrawing from
the transportation line of business. During 1996, this line of business had been
its primary source of unacceptable underwriting results. At September 30, 1996,
the Company's in-force premiums in this line of business were approximately $20
million. The Company expects the gross premiums produced by this line of
business to run-off to zero during the fourth quarter of 1997.
RECAPITALIZATION CHARGE
The Securities Purchase Agreement provides that the Company will record a
$15 million (pre-tax) recapitalization charge in its financial results for the
quarter in which the Transaction is recorded. The recapitalization charge will
provide additional strengthening of the Company's balance sheet and overall
reserve levels, and is intended to cover contingencies and estimated exposures
associated with various previously reported strategic actions and product line
discontinuations.
FIRST NINE MONTHS OF 1996 COMPARED TO THE FIRST NINE MONTHS OF 1995
Gross Premiums Produced
Gross premiums produced for the first nine months of 1996 as compared to
the first nine months of 1995 were as follows (in millions):
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
-----------------
1995 1996
------ ------
<S> <C> <C>
Gross premiums produced............................................ $138.7 $121.1
For other companies................................................ (12.4) (13.4)
Assumed from other companies....................................... 5.1 8.8
------ ------
Gross premiums written............................................. 131.4 116.5
Ceded premiums..................................................... (42.8) (29.2)
------ ------
Net premiums written............................................... $ 88.6 $ 87.3
====== ======
</TABLE>
Gross premiums produced decreased 12.7% to $121.1 million for the first
nine months of 1996 from $138.7 million in the first nine months of 1995. Of
this decrease, 8.4% was in the Aviation Division, and 6.2% was in the P&C
Division. The Marine Division gross premium produced increased 1.9%. The
decreases in the Aviation and P&C Divisions' gross premiums produced result
primarily from previously announced actions taken during 1995 and the first nine
months of 1996 to eliminate unprofitable segments of the operations. In
addition, in the Aviation Division, primarily in the airport segment, certain
insureds require insurance written by an insurer with an A.M. Best Company
rating of "A-" or better, which management believes resulted in a portion of the
decrease in gross premiums produced. The Company is completing arrangements and
regulatory filings that will permit it to offer insureds the financial security
of an insurer rated "A-" or better. The increase in the Marine Division's gross
premiums produced is due to an increase in policies in force.
The gross premiums produced for other companies increased 8.1% to $13.4
million in the first nine months of 1996 from $12.4 million in the first nine
months of 1995. This increase is primarily a result of the
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<PAGE> 43
increased use of arrangements that provide the Company the ability to offer its
insureds the financial security of insurance companies with an A.M. Best Company
rating of "A-" or better.
The gross premiums assumed from other companies increased 72.5% to $8.8
million in the first nine months of 1996 from $5.1 million in the first nine
months of 1995, primarily as a result of the increase in business produced for
other companies.
Gross premiums written decreased 11.3% to $116.5 million in the first nine
months of 1996 from $131.4 million in the first nine months of 1995 primarily as
a result of the decrease in gross premiums produced.
Ceded premiums decreased 31.8% to $29.2 million in the first nine months of
1996, compared to $42.8 million in the first nine months of 1995. This decrease
is a result of a decline in business written in the airport segment that is
reinsured with other companies under a facultative reinsurance agreement and,
also, a decrease in ceded excess of loss reinsurance premiums for both Aviation
and P&C Divisions.
Net premiums written decreased 1.5% to $87.3 million in the first nine
months of 1996, compared to $88.6 million in the first nine months of 1995, as a
result of the decrease in gross premiums.
Revenues
Earned premiums, net of reinsurance, increased 29.8% to $94.0 million in
the first nine months of 1996 from $72.4 million in the first nine months of
1995. Of this increase, 22.4% was related to the Aviation Division, 3.3% to the
Marine Division, and 4.1% to the P&C Division. The growth in earned premiums,
net of reinsurance, in comparison to the decline in net written premiums, is due
to a higher level of written premiums in earlier quarters, which is now becoming
earned premiums.
Agency operations, net, decreased 66.1% to a minimal gain in the first nine
months of 1996 from a gain of $0.5 million in the first nine months of 1995.
Investment income, net, decreased 16.4% to $3.5 million in the first nine
months of 1996 from $4.2 million in the first nine months of 1995. The net
tax-effected investment yield on average invested assets for the first nine
months of 1996 decreased to 4.3% from 4.4% for the comparable period in 1995.
This decrease was a result of a decrease of $14.4 million in average invested
assets in the first nine months of 1996 compared to the first nine months of
1995 primarily as a result of cash flow used in operating activities, as
described below, and a general market decline in investment yields for fixed
maturities.
Realized investment gains, net, were insignificant in the first nine months
of 1996 as compared to a gain of $0.5 million in the first nine months of 1995.
Expenses
Losses and loss adjustment expenses, net of reinsurance, were 70.5% of
earned premiums, net of reinsurance, in the first nine months of 1996, compared
to 63.0% in the first nine months of 1995. The Aviation Division loss ratio
decreased 4.4 percentage points to 57.6% in the first nine months 1996, from
62.0% in the first nine months of 1995, and the P&C Division loss ratio
increased 36.2 percentage points to 100.4% in the first nine months of 1996 from
64.2% in the first nine months of 1995. The increase in the P&C Division loss
ratio is driven primarily by a high level of reported claims for the
transportation segment of the P&C Division. The Marine Division loss ratio for
the first nine months of 1996 was 74.4%.
Policy acquisition and other underwriting expenses were 39.2% of earned
premiums in the first nine months of 1996 and 32.6% of earned premiums in the
first nine months of 1995. The increase in the expense ratio in the first nine
months of 1996 results from the net amortization of previously deferred policy
acquisition costs due to the decline in the level of net premiums written in the
first nine months of 1996, compared to 1995, and an adjustment of estimated
reinsurance ceding commission income to actual. When net premiums written
decline and there is not an equal or greater percentage decline in acquisition
expenses incurred, the expense ratio increases as there is a greater amount of
expenses applicable to each dollar of premiums earned.
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<PAGE> 44
The Company's combined ratio increased 14.1 percentage points to 109.7% in
the first nine months of 1996 from 95.6% in the first nine months of 1995 as a
result of the factors discussed above. A combined ratio below 100% generally
indicates profitable underwriting prior to the consideration of investment
income.
Interest expense increased 13.8% to $0.83 million in the first nine months
of 1996 from $0.73 million in the first nine months of 1995 due primarily to an
increase in the Company's note payable of $2.0 million.
Income
The income tax benefit was 28.7% of loss before tax benefit in the first
nine months of 1996, and income tax expense was 31.0% of income before tax
expense in the first nine months of 1995. The decrease in the effective tax rate
in the third quarter of 1996 is due to adjusting the year-end estimated tax
provision to equal the actual filed 1995 federal income tax return.
Net loss for the first nine months of 1996 was $4.5 million, compared to
net income of $5.2 million in the first nine months of 1995. The decrease
resulted from the revenue and expense factors discussed above. Operating income
(loss), defined as net income (loss) less net realized investment gains or
losses, net of the associated income tax effect, was a loss of $4.5 million in
the first nine months of 1996, compared to income of $4.9 million in the first
nine months of 1995.
Net income (loss) available for common stockholders was ($4.5) million, or
($0.64) per share in the first nine months of 1996, compared to $5.2 million, or
$0.73 per share, in the first nine months of 1995.
YEAR ENDED DECEMBER 31, 1995 COMPARED TO YEAR ENDED DECEMBER 31, 1994
Gross Premiums Produced
Gross premiums produced for the years 1993 through 1995 were as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------
1993 1994 1995
-------- -------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Gross premiums produced.............................. $139,847 $167,207 $181,561
For other companies.................................. (21,410) (15,332) (15,560)
Assumed from other companies......................... 10,780 7,268 6,235
-------- -------- --------
Gross premiums written............................... 129,217 159,143 172,236
Ceded premiums....................................... (57,348) (63,146) (51,279)
-------- -------- --------
Net premiums written................................. $ 71,869 $ 95,997 $120,957
======== ======== ========
</TABLE>
Gross premiums produced increased 8.6% to $181.6 million in 1995 from
$167.2 million in 1994. Of this increase, 4.1% was produced by the P&C Division,
2.5% was produced by the Aviation Division, and 2.0% was produced by the Marine
Division. The Aviation Division's gross premiums produced increased 3.4% to
$128.1 million in 1995 from $123.9 million in 1994. This growth was due to an
increase in policies in force, rate increases and continued increases in the
value of private aircraft. Gross premiums produced by the P&C Division increased
15.7% to $50.1 million in 1995 from $43.3 million in 1994. This growth relates
to increased policies in force and expansion into additional states. The Marine
Division, which began operations in 1995, produced gross premiums of $3.3
million.
Gross premiums produced for other companies is comprised of premiums
written for other companies which are assumed by the Company and those premiums
written for other companies for higher coverage limits which are retained by the
other companies. Such amounts increased 1.5% to $15.6 million in 1995 from $15.3
million in 1994 as a result of an increase in underwriting airport risks in the
Aviation Division. Due to the size of coverage limits involved in airport
liability policies, more of these risks are retained by the other companies.
40
<PAGE> 45
The gross premiums assumed from other companies decreased 14.2% to $6.2
million in 1995 from $7.3 million in 1994 as a result of more of the gross
premiums produced for other companies being retained by such companies.
Gross premiums written increased 8.2% to $172.2 million in 1995 from $159.1
million in 1994 primarily as a result of the factors noted in the three
preceding paragraphs.
Ceded premiums decreased 18.8% to $51.3 million in 1995 from $63.1 million
in 1994. As part of the 1994 and 1995 aviation treaty renewals, a change was
made whereby the Company receives less ceding commission and cedes less
premiums. The result of this change is to leave unaltered the agreed-upon net
cost of reinsurance, but it increases the expense ratio due to the reduction in
ceding commission income, and decreases the loss ratio due to having more
retained premium. The full financial impact of this change has occurred in 1995.
Also, the P&C Division treaties were renewed at lower costs.
Net premiums written increased 26.0% to $121.0 million in 1995 from $96.0
million in 1994 as a result of the increase in gross premiums written and the
Company retaining more of the gross premiums written.
Revenues
Earned premiums, net of reinsurance, increased 23.8% to $102.4 million in
1995 from $82.7 million in 1994. Of this increase, 17.5% was related to the
Aviation Division, 5.1% to the P&C Division, and 1.2% to the Marine Division.
The reasons for the changes in the components of gross premiums produced
resulted in the increase.
Investment income, net of related expenses, increased 33.9% to $5.5 million
in 1995 from $4.1 million in 1994, while average invested assets increased 22.3%
to $100.3 million in 1995 from $82.0 million in 1994. A portion of the increase
in average invested assets was a result of having the proceeds for the initial
public offering for a full year in 1995. These proceeds increased the Company's
investment portfolio by approximately $20.1 million in May 1994. The yield for
the year increased to 5.5% (5.7% on a tax-adjusted basis) from 5.0% (5.2% on a
tax-adjusted basis) as a result of investing the proceeds of the initial public
offering for a full year in 1995, and significantly reducing the level of equity
securities in September of 1994. At the end of 1995, there were no equity
investments.
Realized investment gains, net, were $0.5 million in 1995 compared to an
immaterial realized investment loss in 1994.
Agency operations is that portion of business not focused on
premium-generating insurance company underwriting operations. The operations
consisted of the generation of commission income offset by operating expense.
Agency operations, net, declined from $0.9 million in 1994 to $0.4 million in
1995 primarily as a result of the charge-off of certain uncollectible balances.
Expenses
Losses and loss adjustment expenses, net of reinsurance, were 88.8% (59.9%
excluding special charge) of earned premiums, net of reinsurance in 1995 as
compared to 63.7% in 1994. The ratio of losses and loss adjustment expenses to
earned premiums, net of reinsurance, is referred to as the loss ratio. The
Aviation Division loss ratio increased to 92.2% (58.2% excluding the special
charge) in 1995 from 57.7% in 1994, and the P&C Division loss ratio increased to
82.6% (62.6% excluding the special charge) in 1995 from 73.9% in 1994. The
Marine Division loss ratio was 80.0% in 1995. The Aviation Division loss ratio,
excluding the special charge, was within normal operating ranges in both 1995
and 1994. The increase in the Aviation Division loss ratio in 1995 is primarily
attributed to the adverse results in the three classes of coverages which have
been discontinued in 1995 and a higher than expected number of severe liability
losses and hull losses reported in 1995 for the 1994 and prior accident years.
The P&C Division loss ratio increased due to the continued adverse results of
the franchised auto dealer program and a longer than anticipated development
period for the other liability coverages line of business.
41
<PAGE> 46
Policy acquisition and other underwriting expenses were 36.4% of earned
premiums, net of reinsurance in 1995 and 28.6% of earned premiums, net of
reinsurance, in 1994. The ratio of policy acquisition and other underwriting
expenses, computed on a GAAP basis, to earned premiums, net of reinsurance, is
referred to as the expense ratio. The increase in the expense ratio in 1995
compared to 1994 was due to a decrease in ceding commission income, and growth
in policy acquisition and other underwriting expense levels in 1995. Policy
acquisition and other underwriting expense levels in the P&C Division grew
partially as a result of increased commission expenses due to changes in the
local and intermediate haul transportation program's method of distribution.
A measure of the Company's underwriting performance is its combined ratio,
which is the total of its loss ratio and expense ratio. A combined ratio below
100% generally indicates profitable underwriting prior to the consideration of
investment income. The Company's combined ratio increased to 125.2% (94.9%
excluding the special charge) in 1995 from 92.3% in 1994 as a result of the
factors discussed above.
Interest expense increased 23.4% to $1.0 million in 1995 from $0.8 million
in 1994 due to an increase of $2.0 million in the outstanding note payable. As
of December 1995 the outstanding note payable balance is $11.3 million.
Income
Income (loss) before income tax expense (benefit) was a loss of $(20.4)
million in 1995 as compared to income of $10.5 million in 1994 as a result of
the revenue and expense factors described above. Excluding the effect of the
special charge in 1995, income before tax expense increased 3.1% to $10.8
million.
Income tax expense (benefit) was a tax benefit of (35.8)% of the loss
before income tax benefit in 1995 compared to income tax expense of 31.9% in
1994. The income tax benefit in 1995 generally results from the Company's
ability to carryback current year taxable losses to prior years and recover
previously paid taxes.
Net income (loss) was a net loss of $(13.1) million in 1995 as compared to
net income of $7.1 million in 1994. Excluding the effect of the special charge,
net income for 1995 increased 5.2% to $7.5 million.
YEAR ENDED DECEMBER 31, 1994 COMPARED TO YEAR ENDED DECEMBER 31, 1993
Gross Premiums Produced
Gross premiums produced increased 19.6% to $167.2 million in 1994 from
$139.8 million in 1993. Of this increase, 7.8% was produced by the P&C Division,
and 11.8% was produced by the Aviation Division. The Aviation Division's gross
premiums produced increased 15.3% to $123.9 million in 1994 from $107.5 million
in 1993. This growth was due to an increase in policies in force, rate increases
and continued increases in the value of private aircraft. During 1994, as a
result of continued adverse underwriting results for helicopters, the Company
continued to refine and tighten the underwriting standards and increase prices
for helicopter risks. This action resulted in the non-renewal of over $6.1
million in aviation revenues. Gross premiums produced by the P&C Division
increased 33.8% to $43.3 million in 1994 from $32.4 million in 1993. This growth
relates to increased policies in force and expansion into additional states.
Gross premiums produced for other companies decreased 28.4% to $15.3
million in 1994 from $21.4 million in 1993 as a continued result of the
Company's shift in strategy to premium-generating underwriting operations.
The gross premiums assumed from other companies decreased 32.6% to $7.3
million in 1994 from $10.8 million in 1993 as a result of the decrease in gross
premiums produced for other companies.
Gross premiums written increased 23.2% to $159.1 million in 1994 from
$129.2 million in 1993 primarily as a result of the factors noted in the three
preceding paragraphs.
Ceded premiums increased 10.1% to $63.1 million in 1994 from $57.3 million
in 1993. This increase is primarily a result of the increase in gross premiums
produced by the Company. The aviation treaties were renewed in 1994 at higher
costs which were generally consistent with the rate increases received on gross
42
<PAGE> 47
premiums produced. As part of the 1994 aviation treaty renewal, a change was
made whereby the Company received less ceding commission and ceded less
premiums. The result of this change is to leave unaltered the agreed-upon net
cost of reinsurance for 1994 but should result in an increase in the expense
ratio, due to the reduction in ceding commission income, offset by a decrease in
the loss ratio due to having more retained premium. The full financial impact of
this change occurred in 1995. The P&C Division treaties were renewed at lower
costs.
Net premiums written increased 33.6% to $96.0 million in 1994 from $71.9
million in 1993 as a result of the increase in gross premiums written and the
Company retaining more of the gross premiums written.
Revenues
Earned premiums, net of reinsurance, increased 25.2% to $82.7 million in
1994 from $66.1 million in 1993. Of this increase, 14.3% was related to the
Aviation Division and 10.9% to the P&C Division. The reasons for the changes in
the components of gross premiums produced resulted in the increase.
Investment income, net, increased 40.7% to $4.1 million in 1994 from $2.9
million in 1993 as a result of an increase in average invested assets to $82.0
million in 1994 from $56.0 million in 1993 and a decline in yield. The yield
decreased to 5.0% (5.2% on a tax-adjusted basis) from 5.2% as a result of
holding more investments in shorter term securities in the first eight months of
1994. The proceeds of the initial public offering increased invested assets by
approximately $20.1 million in May 1994.
Realized investment gains (losses), net, were an immaterial loss in 1994
and a $1.4 million gain in 1993. In 1993, the Company was changing the strategic
focus of the portfolio to reduce the level of equity securities and also
increase the quality of the fixed income portfolio. In 1994, the Company sold
substantially all of the remainder of its equity investments and invested the
proceeds in fixed income investments.
Agency operations, net, improved from a $0.2 million loss in 1993 to a $0.9
million profit in 1994 as a result of increased revenues, continued management
of agency expenses, and the realignment of expenses between agency operations
and policy acquisition and other underwriting expenses.
Expenses
Losses and loss adjustment expenses, net of reinsurance, were 63.7% of
earned premiums, net of reinsurance, in 1994 as compared to 62.3% in 1993. The
ratio of losses and loss adjustment expenses to earned premiums, net of
reinsurance, is referred to as the loss ratio. The Aviation Division loss ratio
decreased to 57.7% in 1994 from 60.1% in 1993, and the P&C Division loss ratio
increased to 73.9% in 1994 from 66.3% in 1993. The Aviation Division loss ratio
was within normal operating ranges in both 1994 and 1993. The P&C Division loss
ratio increased due to adverse development of the 1993 accident year resulting
from slower than anticipated reporting of incurred losses in the auto liability
and other liability lines of business.
Policy acquisition and other underwriting expenses were 28.6% of earned
premiums, net of reinsurance, in 1994 and 29.8% of earned premiums, net of
reinsurance, in 1993. The growth in earned premiums, net of reinsurance, in 1994
compared to 1993, together with lower growth in policy acquisition and other
underwriting expense due to continued expense management, resulted in the
reduction in the expense ratio.
A measure of the Company's underwriting performance is its combined ratio,
which is the total of its loss ratio and expense ratio. The Company's combined
ratio increased to 92.3% in 1994 from 92.1% in 1993 as a result of the factors
discussed above.
Interest expense increased 13.0% to $0.8 million in 1994 from $0.7 million
in 1993 due to an increase in the floating interest rate of the Company's note
payable. Just prior to the 1994 year end, the Company amended its note agreement
to a revolving credit facility. The interest rate on the facility has been
lowered to the bank's corporate base rate from 0.5% plus such base.
43
<PAGE> 48
Income
Income before income tax expense increased 21.1% to $10.5 million in 1994
from $8.7 million in 1993 as a result of the revenue and expense factors
described above.
Income tax expense was 31.9% of income before income tax expense in 1994
and 34.0% in 1993. The decline in the effective tax rate generally results from
an increase in tax-exempt interest income.
Net income increased 24.9% to $7.1 million in 1994 from $5.7 million in
1993.
LIQUIDITY AND CAPITAL RESOURCES
As a holding company, AEIC is the principal asset of the Company. The
Company's cash flow depends primarily on dividends and tax allocation payments
from AEIC and cash advances under the Company's credit facility with its bank
described below. The ability of AEIC to pay dividends to its parent is subject
to certain regulatory restrictions and restrictions contained in the Company's
bank credit agreement.
During 1995, AEIC paid $0.5 million in dividends to the Company. During
1996, AEIC paid no dividends to the Company. Based on regulatory restrictions
presently in effect, the maximum amount available for payment as dividends to
the Company by AEIC without the prior approval of regulatory authorities is $5.0
million, if at the time of payment AEIC has earned surplus at least equal to the
amount of dividends. At September 30, 1996, AEIC had earned surplus (deficit) of
approximately $(14.7) million. However, the Company believes that upon
completion of the Transaction, it will have adequate liquidity to meet all of
its cash needs for the next twelve months.
AEIC's sources of funds are premiums collected, reinsurance recoveries,
investment income and proceeds from sales and maturities of investments. Funds
are applied primarily to the payments of claims and expenses and to the purchase
of investments. Premiums are typically received in advance of related claim
payments. Because AEIC has $26.3 million of cash, short-term investments and
U.S. Treasury securities, and $42.9 million of other fixed income,
investment-grade securities, at September 30, 1996, the Company believes that
AEIC will have adequate liquidity to meet all of its cash needs for the next
twelve months.
The agency operations cash flow on business written for others since 1993
relates to the collection of and payment of premiums and operating expenses. For
business written for others in earlier years, cash flow depends primarily on the
collection of premiums and reinsurance recoverable and the payment of claims on
behalf of the insurers for which it has managed aviation business. Claims are
typically paid before the related reinsurance recoverable is collected. In 1993,
AEIC and the other primary insurer for which the agency managed business began
paying claims directly, which eliminated the negative cash flow impact on the
agency operations.
The Company's consolidated cash flow used in operations was $35.5 million
in the first nine months of 1996. The Company's consolidated cash flow provided
by operations was $4.0 million in 1995. Consolidated cash flow used by
operations was $4.1 million in 1994, and cash flow provided by operations was
$40.4 million in 1993. The funds used in the first nine months of 1996 relate
primarily to the settlement of a large claim incurred in 1995 and the payment of
prior periods' retrospectively rated reinsurance premiums and the reduction in
written premiums, which was not offset by an equal reduction in claim payments.
The large claim noted above was incurred and fully reserved in 1995 as a result
of a single aviation liability claim totaling approximately $10 million, prior
to reinsurance recoveries. Cash payment of this claim was ultimately made in
early 1996, thereby resulting in a timing difference of the reserving of the
claim in 1995 and its payment in 1996. Cash flow provided by operations in 1995
resulted primarily from settlement of balances with reinsurers, as well as
positive cash flow from increases in written premiums and premium collections.
Cash flow used by operations in 1994 resulted primarily from an increase in
reinsurance recoverable, as well as reinsurers' accelerating the payment for
premiums due them in the 1994 reinsurance renewal. The level of cash flow
provided by operations in 1993 resulted primarily from the collection from
reinsurers in the first half of the year of monies paid out on an unusually high
level of gross claims during the latter part of 1992. The unusually high level
of claims resulted from Hurricane Andrew and other large losses earlier in 1992.
Cash flow in 1993 was also favorably affected by increases in premiums written
and premium collections. Cash proceeds from the sales and maturities of fixed
income securities and sales of equity securities were $41.1 million in 1995,
$72.9 million in 1994, and $35.5 million in 1993.
44
<PAGE> 49
As described in "The Transaction" and "The Securities Purchase Agreement
and Related Agreements", the Company announced the terms of a $35 million
investment in the Company's Series D Preferred Stock and the formation of a
strategic alliance with American Financial Group, Inc.
In May 1994, the Company issued 3,563,750 shares of common stock through an
initial public offering, which resulted in $32.0 million of proceeds, net of
issuance costs. Of the net proceeds, $10.1 million was used to redeem all of the
Series C Cumulative Preferred Stock, including accrued dividends, $20.1 million
was contributed to the capital and surplus of AEIC, and the remainder was used
for general corporate purposes.
At September 30, 1996 and December 31, 1995 and 1994, the carrying value of
the Company's total investments, including cash and cash equivalents, was $69.2
million, $106.8 million and $98.2 million, respectively. The decrease in total
investments in the first nine months of 1996 was primarily a result of the cash
flow used in insurance operations as discussed above.
The Company's fixed income securities are segregated into two categories at
September 30, 1996. Fixed income securities expected to be held to maturity are
carried at amortized cost; the carrying value of such securities was $23.5
million and the market value was $23.2 million, both at September 30, 1996. The
remaining fixed income securities are available for sale and were carried at a
market value of $36.6 million at September 30, 1996.
In December 1994, the Company entered into a revised credit facility with
its bank. In February 1996, revisions were made to the credit facility as a
result of the special charge taken in the fourth quarter of 1995. In March, May
and September 1996, revisions were made to certain financial covenants in the
credit facility so that no default would occur thereunder as a result of
operating results in the first and second quarters of 1996. In March 1996, the
consolidated tangible net worth covenant was amended. In May 1996, the
consolidated tangible net worth, the statutory capital and surplus and the ratio
of net premiums written to statutory capital and surplus covenants were amended.
In September 1996, the consolidated tangible net worth covenant was amended and
a liquidity ratio covenant was added. In November 1996, the Company and its bank
amended the Company's credit facility to, among other things, revise the
consolidated tangible net worth, the statutory capital and surplus, the combined
ratio and the ratio of net premiums written to statutory capital and surplus
financial covenants so that no default would occur thereunder at September 30,
1996, and to add certain covenant and default provisions requiring the Company
to close the Transaction with AFG by March 31, 1997. In addition, the new
covenants require that, upon closing of such Transaction, the principal amount
of the loan will be reduced to $10 million, that additional principal payments
will reduce the bank's commitment by an equal amount, and that the Company must
hold $10 million of proceeds from such Transaction for use only to pay loan
obligations, dividends and redemptions required by the terms of the Company's
Series B Cumulative Preferred Stock and operating expenses. Currently, the bank
commitment is $15 million, of which $13.25 million was outstanding at September
30, 1996. Under this credit facility, the Company pays an annual facility fee of
1/2% per year on the available principal amount of the loan, whether used or
unused, while AEIC has no earned surplus, and a fee of 1/4% per year at all
other times. The loan commitment will be reduced by an additional $1 million in
1996, $3 million annually in 1997 and 1998, and $4 million annually in the last
two years. The loan is secured by all of the outstanding stock of AEIC and the
other directly owned subsidiaries of the Company. The revised agreement with the
bank prohibits the payment of dividends on common or preferred stock in excess
of $1.5 million in the aggregate during any four consecutive quarters, incurring
other indebtedness with certain exceptions, entering into a merger or sale of
material assets or making capital expenditures above $1.6 million. The agreement
also requires the Company to maintain certain financial ratios, including a
fixed charge coverage ratio, a combined ratio, a ratio of net premiums written
to statutory capital, and minimum capital and surplus levels. The Company was in
compliance with these covenants at September 30, 1996. Since the agreement
requires the Company to reduce the principal amount of the loan to $10 million
and to hold $10 million of proceeds of the Transaction for the limited purposes
stated above, the Company anticipates that it will be able to meet its financial
and other convenants in the agreement in the future, or that any noncompliance
will not have any material adverse effect on the Company.
45
<PAGE> 50
The Company plans to spend up to $1.6 million on capital expenditures in
1996 primarily for computer hardware and software which will be funded out of
operating cash flow. The Company has no plans for other material capital
expenditures in 1996.
RESERVES
The Company establishes loss and loss adjustment expenses ("LAE") reserves
to provide for the ultimate cost of administration and settlement of claims
under insurance and reinsurance policies issued by the Company, including claims
that have been reported to it by its reinsurance and claims for losses that have
occurred but have not yet been reported to the Company.
The reserves for losses and LAE established by the Company are estimates of
amounts needed to pay reported and unreported claims and related LAE incurred as
of the end of each accounting period, net of estimated related salvage and
subrogation claims and recoverable reinsurance. These reserves do not represent
an exact calculation of liability, but rather are estimates involving actuarial
and statistical projections at a given time to reflect the Company's
expectations of the ultimate costs of administration and settlement of claims.
Such estimates are based on facts and circumstances then known, predictions of
future events, estimates of future trends in claims reporting, frequency and
severity and other variable factors. As a consequence, although the Company
believes that its reserves at December 31, 1995 are adequate to meet its
obligations under existing policies, actual losses and LAE may deviate, perhaps
substantially, from reserves reflected in the Company's financial statements. To
the extent reserves prove inadequate, the Company increases such reserves and
incurs a charge to earnings in the period in which the reserves are increased,
which could have a material adverse effect on the financial results of the
Company for such period. Because of the nature of the business written by the
Company, the Company does not believe that it has material latent exposures
related to toxic waste, asbestos and other environmental claims that would have
a material adverse effect on the Company's financial condition or results of
operations. To verify the adequacy of its reserves, the Company engages
independent actuarial consultants to perform annual loss reserve analyses. For
additional discussion see "1995 Special Charge to Earnings" above.
For reported claims, the Company first establishes case reserves pursuant
to the Company's guidelines when it receives notice of the claim. The initial
estimate is adjusted periodically based upon the receipt of additional facts and
documentation, the informed judgment of personnel in the Company's claims
department based on general insurance reserving practices and the experience and
knowledge of such personnel regarding the nature and value of the specific type
of claim, jurisdiction of the occurrence, circumstances surrounding the claim,
severity of injury or damage, potential for ultimate exposure, the line of
business and policy provisions relating to the particular type of claim.
A variety of methods have been developed in the insurance industry for
determining reserves for incurred but not reported losses and liabilities. In
general, these methods involve the extrapolation of reported loss data to
estimate ultimate losses. The Company's loss calculation methods generally rely
upon a projection of ultimate losses based upon the Company's historical
patterns of reported loss development in aviation lines. The effects of
inflation are not specifically estimated by the Company in calculating its
reserves, but are reflected in the Company's historical pattern of loss
development.
The following table provides a reconciliation of beginning and ending loss
and LAE reserves established in accordance with generally accepted accounting
principles ("GAAP"), net of reinsurance recoverables, for the years ended
December 31, 1993, 1994 and 1995. The Company does not discount its reserves;
that is, it
46
<PAGE> 51
does not calculate them on a present value basis. Loss and LAE reserves are
stated on a net basis after deduction for losses recoverable from reinsurers.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------
1993 1994 1995
------- ------- -------
<S> <C> <C> <C>
(DOLLARS IN THOUSANDS)
Reserve for losses and LAE at beginning of year........... $38,275 $40,855 $50,451
Provision for losses and LAE for current year claims...... 44,811 48,567 72,072
Increase (decrease) in estimated losses and LAE for prior
year claims............................................. (3,639) 4,162 18,861
------- ------- -------
Total incurred losses and LAE................... 41,172 52,729 90,933
Losses and LAE payments for claims attributable to:
Current year............................................ 25,648 26,552 42,066
Prior years............................................. 12,944 16,581 41,466
------- ------- -------
Total payments.................................. 38,592 43,133 85,532
Reserve for losses and LAE at end of period............... $40,855 $50,451 $57,852
======= ======= =======
</TABLE>
The table below reconciles reserves for losses and LAE, net of reinsurance
recoverable, at December 31, 1993, 1994 and 1995, to the Company's Consolidated
Balance Sheet.
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------------------
1993 1994 1995
-------- -------- --------
<S> <C> <C> <C>
(DOLLARS IN THOUSANDS)
Reserve for losses and LAE................................ $122,342 $142,768 $136,528
Reinsurance recoverable-loss reserves..................... 81,487 92,317 78,676
-------- -------- --------
Reserve for losses and LAE, net of reinsurance
recoverable............................................. $ 40,855 $ 50,451 $ 57,852
======== ======== ========
</TABLE>
The Aviation Division had an increase in estimated reserves for losses and
LAE (i.e., unfavorable loss development) for prior year claims of $11.9 million
in 1995, as compared to favorable loss development of $1.4 million in 1994, and
favorable loss development of $4.0 million in 1993. The P&C Division had
unfavorable loss development for prior year claims of $7.0 million in 1995, $5.6
million in 1994, and $0.4 million in 1993.
The unfavorable loss development in 1995 for the Aviation Division relates
primarily to the 1994 year. The unfavorable development results from a higher
than expected number of severe liability losses and hull losses reported in 1995
for 1994 occurrences. The unfavorable loss development in 1995 for the P&C
Division relates primarily to the other liability lines of business and related
to accident years 1992, 1993 and 1994. The unfavorable loss development for the
other liability line was due primarily to continued late reporting of claims for
construction defects and personal injury in 1995. The changes noted in reporting
patterns have been considered by the Company in recording its reserves for
incurred but reported losses. For additional discussion see "1995 Special Charge
to Earnings" above.
The following table presents the development of the Company's GAAP
liability for losses and LAE for each of the fiscal years ended December 31,
1985 through 1995, excluding American Meridian. The top line of the table shows
the estimated amounts of losses and LAE for claims arising in that year and all
prior years that are unpaid at the balance sheet date, including losses incurred
but not yet reported to the Company. The upper portion of the table shows the
cumulative amounts subsequently paid as of successive years with respect to the
liability. The table also shows the reestimated amount of the previously
recorded liability based on experience as of the end of each succeeding year.
The estimates change as more information becomes known about the frequency and
severity of claims for individual years. A redundancy exists when the
reestimated liability at each December 31 is less than the prior liability
estimate and a deficiency exists when such reestimated liability is greater than
the prior liability estimate. The cumulative redundancy or deficiency depicted
in the table, for any particular calendar year, represents the aggregate change
in the initial estimates over all
47
<PAGE> 52
subsequent calendar years. Each amount in the table below includes the effects
of all changes in amounts for prior periods. The table does not present accident
or policy year development date.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------------------------------------------------------------------------------
1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995
------- ------- ------- ------- ------- ------- ------- ------- -------- -------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
(DOLLARS IN THOUSANDS, EXCEPT PERCENTAGES)
RESERVE FOR LOSSES
AND LAE, AS
STATED........... $ 9,478 $21,094 $31,825 $39,573 $37,307 $31,124 $30,411 $35,153 $ 38,544 $ 48,971 $56,620
Cumulative paid as
of:
1 year later....... $ 4,672 $ 4,721 $ 7,615 $ 8,325 $ 9,751 $ 5,797 $ 7,183 $12,824 $ 16,116 $ 42,092
2 years later...... 7,250 8,266 4,605 15,638 15,029 10,397 14,058 19,815 37,577
3 years later...... 9,773 9,966 9,319 19,153 18,701 15,799 17,179 27,514
4 years later...... 10,630 12,167 11,441 21,892 23,853 17,413 21,825
5 years later...... 11,539 13,401 13,191 23,533 24,996 20,709
6 years later...... 12,109 13,752 14,374 23,167 27,866
7 years later...... 12,393 14,339 14,678 24,912
8 years later...... 12,683 14,627 15,058
9 years later...... 12,862 14,287
10 years later..... 13,178
RESERVE
RE-ESTIMATED AS
OF:
1 year later....... $12,389 $20,723 $24,926 $34,442 $34,270 $30,537 $26,653 $32,205 $ 43,072 $ 68,706
2 years later...... 12,081 20,393 21,206 32,999 36,045 25,890 26,801 31,901 51,534
3 years later...... 12,579 20,701 18,108 34,420 31,635 25,760 27,007 35,315
4 years later...... 12,785 18,909 21,837 31,186 32,075 25,328 27,890
5 years later...... 15,900 19,463 20,064 29,827 30,886 25,465
6 years later...... 15,502 17,649 19,425 26,824 31,645
7 years later...... 14,753 17,799 16,392 27,160
8 years later...... 14,916 15,763 16,663
9 years later...... 13,297 15,887
10 years later..... 13,597
INITIAL RESERVE IN
EXCESS OF (LESS
THAN)
RE-ESTIMATED
RESERVE:
Amount............. $(4,119) $ 5,207 $15,162 $12,413 $ 5,662 $ 5,659 $ 2,521 $ (162) $(12,990) $(19,735)
Percent............ -43.5% 24.7% 47.6% 31.4% 15.2% 18.2% 8.3% -0.5% -33.7%
</TABLE>
Conditions and trends that have affected reserve development in the past
may not necessarily occur in the future. Accordingly, it is not appropriate to
extrapolate future redundancies or deficiencies based on the foregoing.
REINSURANCE
The Company follows the customary industry practice of reinsuring a portion
of the exposure under its policies and, as consideration, pays to its reinsurers
a portion of the premium received on its policies. Under certain treaties, the
agreed-upon premium may vary within predetermined ranges based upon the level of
losses experienced by the reinsurer. Insurance is ceded principally to reduce an
insurer's liability on individual risks and to protect against catastrophic
losses. Although reinsurance does not legally discharge an insurer from its
primary liability to policyholders for the full amount of coverage provided by
its policies, it does make the assuming reinsurer liable to the insurer to the
extent of the reinsurance ceded.
The Company is a party to reinsurance contracts under which certain types
of policies are automatically reinsured without the need for approval by the
reinsurer with respect to the individual risks that are covered ("treaty
reinsurance"). The Company also is a party to reinsurance contracts which are
handled on an individual policy or per risk basis and require the specific
agreement of the reinsurer as to each risk insured ("facultative reinsurance").
The Company may secure facultative reinsurance to supplement its coverage under
treaty reinsurance.
48
<PAGE> 53
The Company structures separate reinsurance programs for the Aviation
Division, the P&C Division and the Marine Division. Under its current aviation
reinsurance protections, the Company has limited its net retained loss for any
one occurrence to a maximum of $200,000 for liability loss and $150,000 for hull
loss. Under its current property and casualty reinsurance protections, the
Company has limited its net retained loss to a maximum of $250,000 for any one
occurrence. Under its current marine reinsurance protections, the Company has
limited its net retained loss for any one occurrence to a maximum of $75,000. In
addition, the Company purchased catastrophe protection to limit its retention to
$250,000 for the Aviation Division, $500,000 for the P&C Division, and $75,000
for the Marine Division in a single occurrence involving multiple policyholders,
such as a hurricane, flood or earthquake, up to $1,000,000. Occurrences above
$1,000,000 are protected by a combined catastrophe program which reinsures 95%
of a single occurrence above $1,000,000 up to $10,000,000. The 1966 renewal of
the catastrophe program extends the coverage up to $20,000,000. The Company also
reinsures on a facultative basis when it writes a risk with limits of liability
exceeding the maximum limits of its treaties or when it otherwise considers such
action appropriate.
Treaty reinsurance may be ceded under treaties on both a proportionate
basis (where the reinsurer shares proportionately in premiums and losses) and an
excess-of-loss basis (where only losses above a specified amount are reinsured).
One of the most significant steps taken by the Company in its emphasis on
retaining more of the aviation premiums originated by it was the restructuring
of its aviation reinsurance program in 1992. The Company changed its primary
aviation reinsurance program from proportional treaty reinsurance placed
primarily in the foreign market to primarily excess-of-loss treaty reinsurance
with 100% of the working layers (covering hull losses up to $3,000,000 and
liability losses up to $5,000,000) placed in the domestic market. Largely as a
result, the Company retained 42.9%, 45.5% and 60.1% of its aviation gross
premiums produced in 1993, 1994 and 1995, respectively.
The availability, cost and limits of reinsurance purchased can vary from
year to year based upon prevailing market conditions and the Company's desired
retention levels. A majority of the Company's reinsurance programs renew on July
1 or October 1 of each year. In the process of renewing its 1996 aviation
reinsurance protections, the Company was able to successfully renew its
reinsurance protections at a reduced cost. The Company successfully renewed its
property and casualty reinsurance protections in 1996 at a reduced cost.
In formulating its reinsurance programs, the Company is selective in its
choice of reinsurers and considers numerous factors, the most important of which
is the financial stability of the reinsured. In an effort to minimize its
exposure to the insolvency of any reinsurer, the Company carefully evaluates the
acceptability of each reinsurer. As part of American Eagle's acquisition of AEIC
and AOA in 1986, American Eagle agreed that AEIC should assume the risk of
uncollectible reinsurance relating to reinsurance arranged by AOA for aviation
business AOA managed between June 30, 1986 and December 31, 1992 for its
formerly affiliated insurers. Since the acquisition, AEIC has not written off
any reinsurance recoverables; however, the Company has provided an allowance of
$816,000 for uncollectible reinsurance.
49
<PAGE> 54
The following table sets forth certain information related to the Company's
15 largest reinsurers based on ceded reinsurance premiums during 1995.
<TABLE>
<CAPTION>
CEDED NET
REINSURANCE REINSURANCE
REINSURERS PREMIUMS RECOVERABLE(1) RATING(2)
- ---------------------------------------------------------------- -------------- -----------
<S> <C> <C> <C>
(DOLLARS IN THOUSANDS, EXCEPT PERCENTAGES)
Zurich Reinsurance Centre, Inc....................... $12,349 $ 24,236 A
Lloyds of London..................................... 11,140 11,950 (3)
NAC Reinsurance Corporation.......................... 8,908 35,976 A
Kemper Reinsurance Company........................... 2,751 4,061 A-
Chartwell Reinsurance Company........................ 1,506 2,394 A-
St. Paul Fire & Marine Insurance Company............. 1,426 835 A+
Signet Star Reinsurance Corporation.................. 1,414 2,180 A
Frankona Ruckversicherungs........................... 1,345 1,514 ISI*AA(4)
Transatlantic Reinsurance Company.................... 1,323 2,161 A+
Western Atlantic Reinsurance Corporation............. 1,249 658 A-
American Reinsurance Company......................... 1,116 1,020 A+
Transamerica Reinsurance Company..................... 871 454 A
Prudential Reinsurance Company....................... 675 1,013 A
Zurich Reinsurance Co. (UK) Ltd...................... 531 646 ISI*BBB(4)
Hanover Ruckversicherungs............................ 452 184 ISI*AA+(4)
------- --------
Top 15 reinsurers.......................... $47,056 $ 89,282
======= ========
All reinsurers............................. $51,279 $106,456
Percentage of total represented by top 15
reinsurers............................... 91.8% 83.9%
* Insurance Solvency International
</TABLE>
- ---------------
(1) Includes losses and LAE paid, outstanding losses and LAE, incurred but not
reported reserves and unearned premium reserves net of ceded reinsurance
premiums payable as of December 31, 1995.
(2) Except as otherwise indicated, A.M. Best rating currently assigned.
(3) See discussion of Lloyd's syndicates below.
(4) Insurance Solvency International ranking.
Lloyd's of London is a collection of underwriters, known as "names," who
generally group together annually to form syndicates. Lloyd's reported material
aggregate losses for its underwriting years of account prior to 1993. These
losses had serious effects on Lloyd's in general, and on certain syndicates in
particular. In addition, Lloyd's is currently subject to a number of lawsuits
and state regulatory actions. Several groups of Lloyd's members have pursued and
won claims against certain managing agents of Lloyd's syndicates alleging, among
other things, negligence on the part of the managing agents in the operation of
an underwriting syndicate. Some state regulatory agencies instituted proceedings
seeking to freeze the Lloyd's American Trust Fund and to deny Lloyd's the
ability to draw on syndicate members' letters of credit, alleging that Lloyd's
agents fraudulently recruited members by failing to disclose certain
environmental and asbestos liabilities and that Lloyd's memberships sold in
various states were unlicensed securities. There has also been a substantial
decrease in the underwriting capacity of certain Lloyd's syndicates in recent
years. These and other adverse developments could affect the ability of certain
syndicates to continue to underwrite risk and the ability of insureds to
continue to place business with particular syndicates. Although it is not
possible to predict what effects the circumstance described above may have on
Lloyd's and the Company's contractual relationship with Lloyd's syndicates in
the future, Lloyd's Reconstruction and Renewal Plan has recently been
implemented. The Company is not currently aware of any circumstances that would
lead the Company to believe that the amounts recoverable from any Lloyd's
syndicate may be uncollectible.
50
<PAGE> 55
S&P has published stability rankings for Lloyd's syndicates, which rate,
based on a five-tier system, a syndicate's financial characteristics over the
most recent four years of reported results. Under this system, a ranking of one
asterisk is assigned to syndicates that have demonstrated the least favorable
financial characteristics, a ranking of three asterisks is assigned to
syndicates that have demonstrated middle-range financial characteristics and a
ranking of five asterisks is assigned to syndicates that have demonstrated the
most favorable financial characteristics. No ranking is given for syndicates
that have not closed at least two underwriting years. In the most recent S&P
ranking, which is based on underwriting years up to and including 1993, all
ranked syndicates to which the Company cedes risk were ranked either ***, ****
or *****.
51
<PAGE> 56
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS,
DIRECTORS AND MANAGEMENT
The following table sets forth certain information, with respect to the
beneficial ownership of the Company's Common Stock, as of October 31, 1996, by
(i) all persons who are known by the Company to be beneficial owners of five
percent or more of such stock, (ii) each director of the Company, (iii) each
named executive officer and (iv) all executive officers and directors of the
Company as a group. Unless otherwise noted, the persons named below have sole
voting and investment power with respect to such shares. No effect has been
given to shares reserved for issuance under outstanding stock options except
where otherwise indicated.
<TABLE>
<CAPTION>
BENEFICIAL OWNERSHIP
----------------------------
NAME AND ADDRESS OF OWNER NUMBER OF % OF CLASS
OR IDENTITY OF GROUP SHARES OUTSTANDING(1)
- ------------------------------------------------------------------- --------- --------------
<S> <C> <C>
Mason Best Company, L.P.(2)........................................ 2,960,772 42.0
2121 San Jacinto, Ste. 1000
Dallas, Texas 75201
Heartland Advisors, Inc.(3)........................................ 443,000 6.3
790 North Milwaukee Street
Milwaukee, Wisconsin 53202
M. Philip Guthrie(4)............................................... 197,665 2.7
Frederick G. Anderson(5)........................................... 59,223 *
George C. Hill III(6).............................................. 68,406 *
Richard M. Kurz(7)................................................. 43,584 *
Allen N. Walton III(8)............................................. 46,581 *
Joseph M. Grant(9)................................................. 7,500 *
James E. Maser(10)................................................. 8,927 *
Elvis L. Mason(11)................................................. 2,973,272 42.2
Keith W. Hughes(9)................................................. 2,963 *
All directors and executive officers as a group (23 persons
including those listed above).................................... 3,566,594 50.4
</TABLE>
- ---------------
* less than one percent
(1) Shares of Common Stock which are not outstanding but the beneficial
ownership of which can be acquired by a person upon exercise of an option
or warrant within sixty days of the date of this Proxy Statement are deemed
outstanding for the purpose of computing the percentage of outstanding
shares beneficially owned by such person. However, such shares are not
deemed to be outstanding for the purpose of computing the percentage of
outstanding shares beneficially owned by any other person.
(2) Based on a report on Schedule 13G filed with the Securities and Exchange
Commission dated February 9, 1995.
(3) Based on a report on Schedule 13G filed with the Securities and Exchange
Commission dated February 9, 1996.
(4) Includes 1,400 shares of Common Stock held by Mr. Guthrie's wife, 200
shares of Common Stock held by Mr. Guthrie's son, and 190,667 shares of
Common Stock which may be acquired upon the exercise of options.
(5) Includes 300 shares of Common Stock held by Mr. Anderson's wife, and 57,090
shares of Common Stock which may be acquired upon the exercise of options.
52
<PAGE> 57
(6) Includes 1,000 shares of stock held by a trust for which Mr. Hill is the
trustee, and 67,306 shares of Common Stock which may be acquired upon the
exercise of options.
(7) Includes 41,874 shares of Common Stock which may be acquired upon the
exercise of options.
(8) Includes 44,940 shares of Common Stock which may be acquired upon the
exercise of options.
(9) All amounts listed represent shares of Common Stock which may be acquired
upon the exercise of options.
(10) Includes 6,927 shares of Common Stock which may be acquired upon the
exercise of options.
(11) Elvis L. Mason, the Managing Partner of Mason Best Company, L.P., may be
deemed to be the beneficial owner of all shares held by Mason Best Company,
L.P. Includes 5,000 shares held in a qualified retirement plan of which Mr.
Mason is the sole beneficiary and 7,500 shares of Common Stock which may be
acquired upon exercise of options.
53
<PAGE> 58
STOCKHOLDER PROPOSALS
Any stockholder who wishes to submit a proposal for inclusion in the proxy
material and for presentation at the Company's 1997 Annual Meeting of
Stockholders must forward such proposal to the Secretary of the Company at the
address indicated on the second page of this proxy statement, so that the
Secretary receives it no later than November 30, 1996.
The Company's Bylaws also require that notice of nominations of persons for
election to the Board of Directors at the 1997 Annual Meeting Stockholders,
other than those made by or at the direction of the Board of Directors, must be
received by the Secretary not later than the close of business on the tenth day
following the date on which the Company first makes public disclosure of the
date of the meeting; provided, however, that in the event that the meeting is
adjourned, and the Company is required by Delaware law to give notice to
stockholders of the adjourned meeting date, written notice of such stockholder's
intent to make such nomination at such adjourned meeting must be delivered to or
received by the Secretary of the Company no later than the close of business on
the fifth day following the earlier of: (i) the date the Company makes public
disclosure of the date of the adjourned meeting; or (ii) the date on which
notice of such adjourned meeting is first given to stockholders. The notice must
present certain information concerning the nominees and the stockholder making
the nominations, as set forth in the Bylaws. The Secretary must receive a
statement of any such nominee's consent to serve if elected.
AVAILABLE INFORMATION
The Company is subject to the informational reporting requirements of the
Securities Exchange Act of 1934, as amended (the "Exchange Act"), and in
accordance therewith files reports and other information with the Securities and
Exchange Commission (the "SEC"). Such reports, proxy statements and other
information may be inspected and copied at the public reference facilities
maintained by the SEC at 450 Fifth Street, N.W., Washington, D.C. 20549; and at
its regional offices located at 7 World Trade Center, New York, New York 10048
and 500 West Madison Street, Suite 1400, Chicago Illinois 60661-2511. Copies of
such materials may also be obtained from the Public Reference Section of the SEC
at 450 Fifth Street, N.W., Washington, D.C. 20549, upon payment of certain fees
prescribed by the SEC. The SEC also maintains a site on the World Wide Web, the
address of which is http/www.sec.gov., that contains reports, proxy and
information statements and other information regarding reporting companies that
file electronically with the SEC. The Company's Common Stock is listed on the
NYSE and, accordingly, reports, proxy statements and other information are
available for inspection at the offices of the NYSE at 20 Broad Street, New
York, New York 10005.
54
<PAGE> 59
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<S> <C>
Report of Independent Public Accountants.............................................. F-2
Audited Consolidated Financial Statements:
Consolidated Balance Sheets at December 31, 1995 and December 31, 1994.............. F-3
Consolidated Statements of Income for each fiscal year in the three year period
ended December 31, 1995.......................................................... F-4
Consolidated Statements of Stockholders' Equity for each fiscal year in the three
year period ended December 31, 1995.............................................. F-5
Consolidated Statements of Cash Flows for each fiscal year in the three year period
ended December 31, 1995.......................................................... F-6
Notes to Consolidated Financial Statements.......................................... F-7
Unaudited Consolidated Financial Statements:
Unaudited Condensed Consolidated Balance Sheet at September 30, 1996................ F-21
Unaudited Condensed Consolidated Statements of Income for the nine months ended
September 30, 1996 and September 30, 1995........................................ F-22
Unaudited Condensed Consolidated Statements of Cash Flows for the nine months ended
September 30, 1996 and September 30, 1995........................................ F-23
Notes to Unaudited Condensed Consolidated Financial Statements...................... F-24
Unaudited Quarterly Financial Data.................................................. F-25
Pro Forma Consolidated Financial Statements:
Pro Forma Condensed Consolidated Balance Sheet at September 30, 1996................ F-26
Pro Forma Condensed Consolidated Statements of Income for the nine months ended
September 30, 1996 and the year ended December 31, 1995.......................... F-27
</TABLE>
F-1
<PAGE> 60
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
TO THE STOCKHOLDERS AND BOARD OF DIRECTORS OF AMERICAN EAGLE GROUP, INC.:
We have audited the accompanying consolidated balance sheets of American
Eagle Group, Inc. (a Delaware corporation) and subsidiaries as of December 31,
1995 and 1994, and the related consolidated statements of income, stockholders'
equity and cash flows for each of the three years in the period ended December
31, 1995. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of American Eagle Group, Inc.
and subsidiaries as of December 31, 1995 and 1994, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1995, in conformity with generally accepted accounting principles.
/s/ ARTHUR ANDERSEN LLP
ARTHUR ANDERSEN LLP
Dallas, Texas,
February 27, 1996
F-2
<PAGE> 61
AMERICAN EAGLE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT SHARE AMOUNTS)
ASSETS
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------
1995 1994
-------- --------
<S> <C> <C>
Investments:
Fixed Income Securities --
Available for Sale, at Fair Value (Cost $55,136 in 1995 and $54,016 in
1994)................................................................. $ 56,719 $ 50,793
Held to Maturity, at Amortized Cost (Fair Value $28,889 in 1995 and
$27,060 in 1994)...................................................... 28,952 29,134
Equity Securities, at Fair Value (Cost $264 in 1994)...................... -- 173
Short-Term Investments, at Cost (Which Approximates Fair Value)........... 18,199 16,551
-------- --------
Total Investments.................................................. 103,870 96,651
Cash and Cash Equivalents................................................... 2,922 1,530
Accrued Investment Income................................................... 1,606 1,604
Accounts Receivable:
Agents' Balances, Net..................................................... 24,866 31,512
Deferred Premiums......................................................... 31,393 24,674
Other, Net................................................................ 631 2,102
-------- --------
Total Accounts Receivable.......................................... 56,890 58,288
Reinsurance Recoverable, Net:
Insurance Operations -- Paid Losses....................................... 22,449 26,246
Insurance Operations -- Loss Reserves..................................... 78,676 92,317
-------- --------
Total Reinsurance Recoverable, Net................................. 101,125 118,563
Deferred Policy Acquisition Costs........................................... 15,296 15,048
Deferred Reinsurance Premiums............................................... 19,829 34,200
Other Assets................................................................ 16,731 11,219
-------- --------
Total Assets....................................................... $318,269 $337,103
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Policy Liabilities and Accruals --
Reserve for Losses and Loss Adjustment Expenses......................... $136,528 $142,768
Unearned Premiums....................................................... 79,605 66,812
Other Policy Liabilities................................................ 20,196 31,813
-------- --------
Total Policy Liabilities and Accruals.............................. 236,329 241,393
Agency Payables to Insurance Companies, Net............................. 1,736 7,336
Accounts Payable and Other Liabilities.................................. 13,859 13,160
Note Payable............................................................ 11,250 9,250
-------- --------
Total Liabilities.................................................. 263,174 271,139
Commitments and Contingent Liabilities --
Series B Cumulative Redeemable Preferred Stock, $.01 Par Value; 162,857
Shares Authorized, Issued and Outstanding................................. 1,629 1,629
Stockholders' Equity:
Common Stock, $.01 Par Value; 21,000,000 Shares Authorized, 7,124,580
Shares Issued in 1995 and 7,129,180 in 1994............................. 71 71
Additional Paid-In Capital................................................ 45,532 45,497
Unrealized Appreciation (Depreciation) on Investment Securities, Net of
Deferred Taxes (Benefit) of $554 in 1995 and $(1,163) in 1994........... 1,029 (2,151)
Retained Earnings......................................................... 6,921 21,005
Less -- 73,882 Shares of Common Stock Held in Treasury, at Cost........... (87) (87)
-------- --------
Total Stockholders' Equity......................................... 53,466 64,335
-------- --------
Total Liabilities and Stockholders' Equity......................... $318,269 $337,103
======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-3
<PAGE> 62
AMERICAN EAGLE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
FOR THE YEARS ENDED
(DOLLARS IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-------------------------------------
1995 1994 1993
--------- --------- ---------
<S> <C> <C> <C>
Revenues:
Earned Premiums, Net of Reinsurance..................... $ 102,447 $ 82,725 $ 66,091
Agency Operations, Net.................................. 396 919 (208)
Investment Income, Net.................................. 5,497 4,106 2,918
Realized Investment Gains (Losses), Net................. 496 (33) 1,414
--------- --------- ---------
Total Revenues.................................. 108,836 87,717 70,215
Expenses:
Losses and Loss Adjustment Expenses, Net of
Reinsurance.......................................... 90,933 52,729 41,172
Policy Acquisition and Other Underwriting Expenses...... 37,292 23,694 19,667
Interest Expense........................................ 987 800 708
--------- --------- ---------
Total Expenses.................................. 129,212 77,223 61,547
Income (Loss) Before Income Tax Expense (Benefit)......... (20,376) 10,494 8,668
Income Tax Expense (Benefit).............................. (7,300) 3,351 2,950
--------- --------- ---------
Net Income (Loss)......................................... $ (13,076) $ 7,143 $ 5,718
========= ========= =========
Net Income (Loss) Available for Common Stockholders....... $ (13,174) $ 6,588 $ 4,420
========= ========= =========
Income (Loss) Per Common Share (Primary and Fully
Diluted)................................................ $ (1.87) $ 1.16 $ 1.27
========= ========= =========
Weighted Average Number of Common Shares Outstanding:
Share and Share Equivalents (Primary and Fully
Diluted)............................................. 7,052,998 5,684,386 3,469,448
========= ========= =========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
<PAGE> 63
AMERICAN EAGLE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993
(DOLLARS IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
UNREALIZED
APPRECIATION
ADDITIONAL (DEPRECIATION) TOTAL
COMMON PAID-IN ON INVESTMENT RETAINED TREASURY STOCKHOLDERS'
STOCK CAPITAL SECURITIES EARNINGS STOCK EQUITY
------ ---------- -------------- -------- -------- -------------
<S> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1992................. $ 35 $ 13,465 $ 240 $ 10,632 $(87) $ 24,285
Net Income................................. -- -- -- 5,718 -- 5,718
Unrealized Gain on Investments, Net of
Deferred Taxes........................... -- -- 3 -- -- 3
Dividends on Series B and C Cumulative
Preferred Stock.......................... -- -- -- (1,298) -- (1,298)
--- ------- ------- -------- ---- --------
Balance, December 31, 1993................. 35 13,465 243 15,052 (87) 28,708
Net Income................................. -- -- -- 7,143 -- 7,143
Proceeds from Issuance of 3,563,750 shares
of Common Stock, Net of Issuance Costs... 36 32,001 -- -- -- 32,037
Unrealized Loss on Investments, Net of
Deferred Taxes........................... -- -- (2,394) -- -- (2,394)
Dividends on Series B and C Cumulative
Preferred Stock.......................... -- -- -- (555) -- (555)
Amortization of Unearned Compensation...... -- 31 -- -- -- 31
Common Stock Dividends..................... -- -- -- (635) -- (635)
--- ------- ------- -------- ---- --------
Balance, December 31, 1994................. 71 45,497 (2,151) 21,005 (87) 64,335
Net Loss................................... -- -- -- (13,076) -- (13,076)
Unrealized Gain on Investments, Net of
Deferred Taxes........................... -- -- 3,180 -- -- 3,180
Dividends on Series B Cumulative Preferred
Stock.................................... -- -- -- (91) -- (91)
Amortization of Unearned Compensation...... -- 35 -- -- -- 35
Common Stock Dividends..................... -- -- -- (917) -- (917)
--- ------- ------- -------- ---- --------
Balance, December 31, 1995................. $ 71 $ 45,532 $ 1,029 $ 6,921 $(87) $ 53,466
==== ======== ======== ======== ==== =========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-5
<PAGE> 64
AMERICAN EAGLE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------------------
1995 1994 1993
--------- --------- ---------
<S> <C> <C> <C>
Cash and Cash Equivalents Derived From:
Operating Activities --
Net Income (Loss).......................................... $ (13,076) $ 7,143 $ 5,718
Adjustments to Reconcile Net Income (Loss) to Net Cash
Provided by (Used in):
Operating Activities --
Depreciation and Amortization......................... 40,406 28,412 14,468
Provision for Allowance for Doubtful Accounts......... (711) 214 --
Realized Investment (Gains) Losses, Net............... (495) 33 (1,414)
Amortization of Bond Discount and Premium, Net........ 261 374 251
Deferral of Policy Acquisition Costs.................. (40,848) (33,551) (16,347)
Change in Accrued Investment Income................... (2) (524) (403)
Change in Accounts Receivable......................... 1,398 (4,492) (21,913)
Change in Reinsurance Recoverable, Net................ 18,149 (20,425) 6,925
Change in Deferred Reinsurance Premiums............... 14,371 (7,248) (21,810)
Change in Other Assets................................ (5,512) 1,968 (1,183)
Change in Reserve for Losses and Loss Adjustment
Expenses............................................ (6,240) 20,426 27,268
Change in Other Policy Liabilities.................... (11,617) 9,691 80
Change in Unearned Premiums........................... 12,793 8,309 30,618
Change in Agency Payables to Insurance Companies...... (5,600) (13,353) 16,873
Change in Accounts Payable and Other Liabilities...... 699 (1,107) 1,267
--------- --------- ---------
Total Provided by (Used in) Operating Activities.... 3,976 (4,130) 40,398
Investing Activities --
Proceeds from Maturities of Short-Term Investments......... 252,203 214,466 151,513
Purchases of Short-Term Investments........................ (253,851) (226,724) (149,062)
Purchases of Fixed Income Securities....................... (41,497) (92,937) (54,370)
Proceeds from Sales of Fixed Income Securities............. 36,509 58,612 19,848
Proceeds from Maturities of Fixed Income Securities........ 4,381 9,501 7,521
Purchases of Equity Securities............................. -- (1,032) (5,339)
Proceeds from Sales of Equity Securities................... 168 4,813 8,142
Purchases of Property and Equipment........................ (1,552) (1,170) (1,133)
--------- --------- ---------
Total Used in Investing Activities.................. (3,639) (34,471) (22,880)
Financing Activities --
Payments on Note Payable................................... -- (750) --
Proceeds from Note Payable................................. 2,000 -- --
Dividends Paid on Series B and C Cumulative Preferred
Stock................................................... (98) (555) (1,233)
Proceeds from issuance of common stock, net of issuance
costs................................................... -- 32,037 --
Retirement of Series C Cumulative Preferred Stock.......... -- (10,000) --
Dividends Paid on Common Stock............................. (847) (423) --
--------- --------- ---------
Total Provided by (Used in) Financing Activities.... 1,055 20,309 (1,233)
Net Change in Cash and Cash Equivalents........................ 1,392 (18,292) 16,285
Cash and Cash Equivalents, Beginning of Year................... 1,530 19,822 3,537
--------- --------- ---------
Cash and Cash Equivalents, End of Year......................... $ 2,922 $ 1,530 $ 19,822
========= ========= =========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-6
<PAGE> 65
AMERICAN EAGLE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1995 AND 1994
1. COMPANY OPERATIONS
American Eagle Group, Inc. (the "Company") is an insurance holding company
that, through its subsidiaries, markets and underwrites specialized property and
casualty insurance coverages in selected niche markets. The Company has
organized its business into three divisions: Aviation, Property & Casualty
("P&C") and Marine. The Aviation Division is one of the largest providers of
general aviation insurance in the United States based on net premiums written.
The Company's general aviation business consists primarily of non-airline
commercial aviation coverages, airport coverages and pleasure and business
aviation coverages. The P&C Division markets and underwrites commercial
insurance programs for local and intermediate-haul truckers, franchised
automobile dealers (discontinued in 1995), and selected artisan contractors. The
Marine Division markets and underwrites an insurance program for private yachts
navigating the inland and coastal waters of the United States.
In May 1994, the Company issued 3,563,750 shares of Common Stock through an
initial public offering, which resulted in $32,037 of proceeds, net of issuance
costs of $3,601, to the Company. Of the net proceeds, $10,156 was used to redeem
all of the Company's Series C Cumulative Preferred Stock, including accrued
dividends, $20,100 was contributed to the capital and surplus of American Eagle
Insurance Company ("AEIC"), the Company's significant subsidiary, and the
remainder was used for general corporate purposes.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Principles of Consolidation and Basis of Presentation
The consolidated financial statements include the accounts of the Company
prepared in conformity with generally accepted accounting principles, which
differ in some respects from those followed in reports to insurance regulatory
authorities. All significant intercompany balances and transactions have been
eliminated in consolidation. The term insurance operations refers to the
activities of AEIC and its wholly owned insurance subsidiary American Meridian
Insurance Company Limited ("AMIC"). The term agency operations refers to the
activities of Aviation Office of America ("AOA").
The preparation of financial statements requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities at the date of the financial statements and reported amounts of
revenues and expenses during the reporting period. Actual results could differ
from those estimates.
Investments
The Company follows the provisions of Statement of Financial Accounting
Standards No. 115, "Accounting for Certain Investments in Debt and Equity
Securities" ("SFAS No. 115"). SFAS No. 115 addresses the accounting and
reporting for investments in equity securities that have a readily determinable
fair value and for all investments in fixed income securities. Such investments
are classified in three categories and accounted for as follows:
- Held-to-maturity -- Investments in fixed income securities that the
Company has the positive intent and ability to hold to maturity and are
carried at amortized cost.
- Available-for-sale -- Investments in fixed income and equity securities
not classified as either held-to-maturity securities or trading
securities. These securities are purchased with the original intent to
hold for extended periods but may be available to be sold to maximize the
Company's investment yields and liquidity requirements in response to
market conditions or modifications in the Company's investment policy.
Available-for-sale securities are carried at fair value and changes in
unrealized gains and losses, net of deferred taxes, are recorded as a
direct increase or decrease to stockholders' equity.
F-7
<PAGE> 66
AMERICAN EAGLE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
- Trading securities -- Investments in fixed income and equity securities
that are bought and held principally for the purpose and objective of
selling them in the near term and generating profits on short-term
differences in price. Trading securities are carried at fair value and
changes in unrealized gains and losses are included in earnings. The
Company does not engage in securities trading activities.
Gains or losses on maturities or sales of investments are determined using
the specific identification method. If a decline in fair value of an equity or
fixed income security is other than temporary, the security is written down to
estimated fair value with the write-down recognized as a reduction of net
investment income. No such reductions were required in 1995, 1994 and 1993.
At December 31, 1995, fixed income and short-term investments with a book
value of $5,236 were on deposit with or pledged to state regulatory authorities
to meet statutory requirements, and short-term investments of approximately
$1,965 have been pledged under letter of credit arrangements to secure future
payments of losses.
Recognition of Revenue
Premiums due from agents and premiums payable to insurance companies,
together with applicable commission or fee income, are generally recorded as of
the effective date of the policies. Additional premiums, rate adjustments,
policy cancellations and contingent commissions are accrued as they become known
and estimable.
Insurance premiums are earned on a pro rata basis, net of reinsurance
premiums, over the terms of the respective policies. Unearned premiums represent
the portion of net premiums written applicable to the unexpired portion of the
coverage period.
Deferred Policy Acquisition Costs
Costs of acquiring business for the insurance operations which vary with
and are directly related to the production of such business are deferred and
amortized ratably over the related policy period. Policy acquisition costs
include commissions, brokerage fees and certain other policy issuance expenses.
Deferred policy acquisition costs are reviewed periodically to determine that
they do not exceed recoverable amounts after considering anticipated investment
income.
Property and Equipment
Expenditures for significant improvements or betterments are capitalized.
Maintenance and repair costs are expensed as incurred. Depreciation is provided
on a straight-line basis over the estimated useful lives of the assets (four to
ten years).
Property and equipment, net of accumulated depreciation, were recorded at
$3,265 and $2,769 at December 31, 1995 and 1994, respectively, as a component of
Other Assets. Accumulated depreciation of property and equipment totaled
approximately $3,247 and $3,494 at December 31, 1995 and 1994, respectively.
Intangible Assets
The excess of cost over the fair market value of net assets acquired of
AEIC and AOA and certain other intangibles are being amortized on a
straight-line basis over periods up to 25 years. Subsequent to the acquisitions,
the Company continually evaluates whether later events and circumstances have
occurred that indicate the remaining estimated useful life of intangible assets
may warrant revision or that the remaining balance of intangible assets may not
be recoverable.
F-8
<PAGE> 67
AMERICAN EAGLE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Intangible assets, net of accumulated amortization, were recorded at $5,309
and $5,659 at December 31, 1995 and 1994, respectively as a component of Other
Assets. Accumulated amortization of intangible assets totaled approximately
$3,254 and $2,915 at December 31, 1995 and 1994, respectively.
Reserve for Losses and Loss Adjustment Expenses
The reserve for losses and loss adjustment expenses includes estimates for
losses incurred but not reported as well as losses pending settlement. The
reserve is based upon management's best estimates, loss adjusters' evaluations,
and actuarial determinations and, in the opinion of management and the Company's
independent actuary, such reserve is adequate.
In the normal course of business, the Company reduces the loss that may
arise from catastrophes or other events that cause unfavorable underwriting
results through reinsurance arrangements. Losses recoverable from reinsurers are
estimated in a manner consistent with the associated claim.
Future adjustments to the amounts recorded at December 31, 1995, resulting
from the continued review process as well as differences between estimates and
ultimate payments or recoveries, will be reflected in the Company's statements
of income in future periods when such adjustments become known.
Reinsurance
Reinsurance premiums (including reinstatement premiums), commissions,
expense reimbursements, and reserves related to reinsured business are accounted
for on bases consistent with those used in accounting for the original policies
issued and the terms of the reinsurance contracts. Expense allowances received
in connection with reinsurance ceded have been accounted for as a reduction of
the related policy acquisition costs.
Income Taxes
The Company follows the provisions of Statement of Financial Accounting
Standards No. 109, "Accounting for Income Taxes" ("SFAS No. 109"). SFAS No. 109
requires an asset and liability approach for financial accounting and reporting
for income taxes.
Income Per Common Share
Income per common share has been computed by dividing income, after
deducting preferred stock dividends, by the weighted average number of common
shares and equivalent shares outstanding each year.
Stock Option Plans
The Company follows Accounting Principles Board Opinion No. 25, "Accounting
for Stock Issued to Employees" (APB 25) in accounting for its six stock option
plans for officers, directors and key employees of the Company. Under APB 25, no
compensation expense is recognized since the exercise price of the Company's
stock options equals the market price of its common stock on the date of grant.
Statements of Cash Flows
The Company includes as cash equivalents in the statements of cash flows,
temporary cash investments which generally have original maturities of 90 days
or less.
Interest expense paid during 1995, 1994 and 1993 was approximately $987,
$800 and $712, respectively. Income taxes paid during 1995, 1994 and 1993 were
approximately $1,284, $3,465 and $1,196, respectively.
F-9
<PAGE> 68
AMERICAN EAGLE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Reclassifications
The 1993 and 1994 consolidated financial statements differ from the
presentation previously reported as a result of certain reclassifications
between captions in the balance sheets and the statements of income to conform
to the 1995 presentation. These reclassifications had no effect on the Company's
stockholders' equity, net income or cash flows.
3. INSURANCE OPERATIONS:
Reinsurance Transactions
In the ordinary course of business, AEIC and AMIC purchase reinsurance for
the purpose of limiting their retained loss exposure and maintaining required
statutory surplus amounts.
Reinsurance does not relieve the Company from its liabilities under the
original policies to the extent that the reinsuring companies fail to meet their
obligations under reinsurance contracts. Management evaluates the financial
condition of its reinsurers and monitors concentrations of credit risk arising
from similar geographic regions, activities, or economic characteristics of the
reinsurers to minimize its exposure to significant losses from reinsurer
insolvencies and records allowances for future anticipated losses. Management
believes that the allowances at December 31, 1995, are adequate to cover known
and anticipated losses. At December 31, 1995 and 1994, the Company's balance
sheets reflected the following reinsurance recoverable balances and the related
allowances for doubtful accounts:
<TABLE>
<CAPTION>
1995 1994
-------- --------
<S> <C> <C>
Reinsurance recoverable........................................ $101,941 $119,864
Allowance for doubtful accounts................................ (816) (1,301)
-------- --------
Reinsurance recoverable, net................................... $101,125 $118,563
======== ========
</TABLE>
F-10
<PAGE> 69
AMERICAN EAGLE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The effect of reinsurance on premiums written and earned for the insurance
operations is as follows:
<TABLE>
<CAPTION>
WRITTEN EARNED
-------- --------
<S> <C> <C>
For the year ended December 31, 1995--
Direct premiums.................................................... $166,001 $152,579
Reinsurance assumed................................................ 6,235 7,164
Reinsurance ceded.................................................. (51,279) (57,296)
--------- ---------
Net premiums............................................... $120,957 $102,447
========= =========
Percentage assumed of net 5% 7%
========= =========
For the year ended December 31, 1994--
Direct premiums.................................................... $151,875 $136,445
Reinsurance assumed................................................ 7,268 5,040
Reinsurance ceded.................................................. (63,146) (58,760)
--------- ---------
Net premiums............................................... $ 95,997 $ 82,725
========= =========
Percentage assumed of net............................................ 8% 6%
========= =========
For the year ended December 31, 1993--
Direct premiums.................................................... $118,437 $ 93,813
Reinsurance assumed................................................ 10,780 12,811
Reinsurance ceded.................................................. (57,348) (40,533)
--------- ---------
Net premiums............................................... $ 71,869 $ 66,091
========= =========
Percentage assumed of net............................................ 15% 19%
========= =========
</TABLE>
The Company makes quarterly deposits for reinsurance contracts in the
normal course of business. At December 31, 1995 and 1994, the Company had
entered into reinsurance contracts with future deposits totaling $32,064 and
$26,319, respectively. These deposits are generally payable in the first nine
months of the subsequent year.
Deferred Policy Acquisition Costs
Changes in deferred policy acquisition costs for the years ended December
31, 1995, 1994 and 1993, are summarized below:
<TABLE>
<CAPTION>
1995 1994 1993
-------- -------- --------
<S> <C> <C> <C>
Balance, beginning of year................................. $ 15,048 $ 8,651 $ 5,829
Underwriting and acquisition costs....................... 40,848 33,551 16,347
Current period amortization.............................. (40,600) (27,154) (13,525)
--------- --------- ---------
Balance, end of year....................................... $ 15,296 $ 15,048 $ 8,651
========= ========= =========
</TABLE>
F-11
<PAGE> 70
AMERICAN EAGLE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Reserve for Losses and Loss Adjustment Expenses
Changes in the reserves for losses and loss adjustment expenses are
summarized as follows:
<TABLE>
<CAPTION>
1995 1994 1993
-------- -------- --------
<S> <C> <C> <C>
Balance at January 1....................................... $142,768 $122,342 $ 95,074
Less reinsurance recoverables.............................. (92,317) (81,487) (56,799)
--------- --------- ---------
Net Balance at January 1................................... 50,451 40,855 38,275
Incurred related to:
Current year............................................. 72,072 48,567 44,811
Prior years.............................................. 18,861 4,162 (3,639)
--------- --------- ---------
Total incurred............................................. 90,933 52,729 41,172
Paid related to:
Current year............................................. 42,066 26,552 25,648
Prior years.............................................. 41,466 16,581 12,944
--------- --------- ---------
Total paid................................................. 83,532 43,133 38,592
Net Balance at December 31................................. 57,852 50,451 40,855
Plus reinsurance recoverables.............................. 78,676 92,317 81,487
--------- --------- ---------
Balance at December 31..................................... $136,528 $142,768 $122,342
========= ========= =========
</TABLE>
4. INVESTMENTS:
Net investment income for the years ended December 31, 1995, 1994, and
1993, comprised primarily of interest and dividends, was derived from the
following sources:
<TABLE>
<CAPTION>
1995 1994 1993
------ ------ ------
<S> <C> <C> <C>
Interest and dividend income --
Fixed income securities................................ $5,567 $3,943 $2,755
Equity securities...................................... 66 241 187
Short-term investments................................. 172 339 281
------ ------ ------
Total interest and dividend income............. 5,805 4,523 3,223
Investment expenses...................................... (308) (417) (305)
------ ------ ------
Net investment income.................................... $5,497 $4,106 $2,918
====== ====== ======
</TABLE>
There are no investments in fixed income securities that have been
nonincome producing for the years ended December 31, 1995, 1994, and 1993.
Investment expenses include advisory fees paid to unrelated parties.
F-12
<PAGE> 71
AMERICAN EAGLE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Realized pretax gains (losses) on the sale of investments for the years
ended December 31, 1995, 1994, and 1993, are as follows:
<TABLE>
<CAPTION>
1995 1994 1993
---- ----- ------
<S> <C> <C> <C>
Fixed income securities available for sale --
Gross realized gains..................................... $643 $ 32 $1,112
Gross realized losses.................................... (50) (68) (53)
---- ----- ------
Net gain (loss).................................. 593 (36) 1,059
Equity securities --
Gross realized gains..................................... 1 340 723
Gross realized losses.................................... (98) (337) (368)
---- ----- ------
Net gain (loss).................................. (97) 3 355
---- ----- ------
Realized investment gains (losses), net.................... $496 $ (33) $1,414
==== ===== ======
</TABLE>
In connection with the Company's adoption of SFAS No. 115 effective
December 31, 1993, fixed income securities with a carrying value of $32,418 were
transferred from held to maturity to available for sale. Net unrealized
appreciation of these securities as of the date of transfer ($214 before income
taxes) was recorded as a component of stockholders' equity. The Company has made
no other transfers between classifications of fixed income securities during the
years ended December 31, 1995, 1994 and 1993.
Following is an analysis of the change in the unrealized appreciation
(depreciation) of investment securities available for sale, which is reported as
a component of stockholders' equity:
<TABLE>
<CAPTION>
1995 1994 1993
------- ------- -----
<S> <C> <C> <C>
Change in unrealized appreciation (depreciation) of equity
securities................................................ $ 91 $ (246) $(209)
Unrealized appreciation of fixed income securities
transferred from held to maturity to available for sale at
December 31, 1993 (date of adoption of SFAS No. 115)...... -- -- 214
Change in unrealized appreciation (depreciation) of fixed
income securities available for sale...................... 4,806 (3,437) --
Deferred income taxes....................................... (1,717) 1,289 (2)
------- ------- -----
Net change, during year..................................... 3,180 (2,394) 3
Balance, beginning of year.................................. (2,151) 243 240
------- ------- -----
Balance, end of year........................................ $ 1,029 $(2,151) $ 243
======= ======= =====
</TABLE>
F-13
<PAGE> 72
AMERICAN EAGLE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The amortized cost and estimated fair values of investments in fixed income
and equity securities at December 31, 1995 and 1994 are as follows:
<TABLE>
<CAPTION>
GROSS GROSS
UNREALIZED UNREALIZED FAIR CARRYING
DECEMBER 31, 1995 COST(1) GAINS LOSSES VALUE VALUE
- -------------------------------------------- -------- ---------- ---------- -------- --------
<S> <C> <C> <C> <C> <C>
Fixed income securities:
Available for sale --
U.S. Treasury securities and
obligations of U.S. government
corporations and
agencies............................. $ 9,733 $ 139 $ (49) $ 9,823 $ 9,823
Obligations of states and political
subdivisions......................... 3,117 138 -- 3,255 3,255
Corporate debt securities.............. 42,286 1,457 (102) 43,641 43,641
-------- ------ ----- -------- --------
Total fixed income securities
available
for sale........................ 55,136 1,734 (151) 56,719 56,719
-------- ------ ----- -------- --------
Held to maturity --
U.S. Treasury securities and
obligations of U.S. government
corporations and
agencies............................. 22,527 45 (115) 22,457 22,527
Obligations of states and political
subdivisions......................... 5,927 19 (25) 5,921 5,927
Corporate debt securities.............. 498 16 (3) 511 498
-------- ------ ----- -------- --------
Total fixed income securities held
to maturity..................... 28,952 80 (143) 28,889 28,952
-------- ------ ----- -------- --------
Total fixed income securities..... 84,088 1,814 (294) 85,608 85,671
-------- ------ ----- -------- --------
Short-term investments...................... 18,199 -- -- 18,199 18,199
-------- ------ ----- -------- --------
Total investments................. $102,287 $1,814 $ (294) $103,807 $103,870
======== ====== ====== ======== ========
</TABLE>
- ---------------
(1) Original cost of equity securities; original cost of fixed income securities
adjusted for amortization of premiums and accretion of discounts.
The amortized cost and estimated fair market value of fixed income
securities at December 31, 1995, by contractual maturity, are shown below.
Expected maturities may differ from contractual maturities because borrowers may
have the right to call or prepay obligations with or without call or prepayment
penalties.
<TABLE>
<CAPTION>
AVAILABLE FOR SALE HELD TO MATURITY
-------------------- --------------------
AMORTIZED FAIR AMORTIZED FAIR
COST VALUE COST VALUE
--------- ------- --------- -------
<S> <C> <C> <C> <C>
Less than one year........................... $ -- $ -- $ 5,271 $ 5,301
One year to three years...................... 5,677 5,787 11,200 11,133
Over three years to five years............... 14,305 14,436 7,252 7,220
Over five years to seven years............... 8,554 8,726 1,595 1,618
Over seven years to ten years................ 15,127 16,020 3,095 3,071
Over ten years............................... 11,473 11,750 539 546
------- ------- ------- -------
$55,136 $56,719 $28,952 $28,889
======= ======= ======= =======
</TABLE>
F-14
<PAGE> 73
AMERICAN EAGLE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
GROSS GROSS
UNREALIZED UNREALIZED FAIR CARRYING
DECEMBER 31, 1994 COST(1) GAINS LOSSES VALUE VALUE
- ----------------------------------------------- ------- ---------- ---------- ------- --------
<S> <C> <C> <C> <C> <C>
Fixed income securities:
Available for sale --
U.S. Treasury securities and obligations
of U.S. government corporations and
agencies................................ $17,912 $ -- $ (1,420) $16,492 $ 16,492
Obligations of states and political
subdivisions............................ 3,116 -- (132) 2,984 2,984
Corporate debt securities................. 32,988 30 (1,701) 31,317 31,317
------- ---- ------- ------- -------
Total fixed income securities
available for sale................. 54,016 30 (3,253) 50,793 50,793
------- ---- ------- ------- -------
Held to maturity --
U.S. Treasury securities and obligations
of U.S. government corporations and
agencies................................ 22,146 -- (1,544) 20,602 22,146
Obligations of states and political
subdivisions............................ 6,487 1 (477) 6,011 6,487
Corporate debt securities................. 501 -- (54) 447 501
------- ---- ------- ------- -------
Total fixed income securities held to
maturity........................... 29,134 1 (2,075) 27,060 29,134
------- ---- ------- ------- -------
Total fixed income securities........ 83,150 31 (5,328) 77,853 79,927
------- ---- ------- ------- -------
Equity securities (primarily common stocks).... 264 -- (91) 173 173
Short-term investments......................... 16,551 -- -- 16,551 16,551
------- ---- ------- ------- -------
Total investments.................... $99,965 $ 31 $ (5,419) $94,577 $ 96,651
======= ==== ======= ======= =======
</TABLE>
- ---------------
(1) Original cost of equity securities; original cost of fixed income securities
adjusted for amortization of premiums and accretion of discounts.
5. NOTE PAYABLE:
Note payable at December 31, 1995 and 1994, was as follows:
<TABLE>
<CAPTION>
1995 1994
------- ------
<S> <C> <C>
Note payable to a bank, bearing interest at the bank's corporate
base rate (8.5% and 9.0% at December 31, 1995 and 1994,
respectively), interest payable quarterly....................... $11,250 $9,250
======= ======
</TABLE>
The annual maturities of the Company's note payable at December 31, 1995
are as follows:
<TABLE>
<S> <C>
1996............................................................... $ --
1997............................................................... 250
1998............................................................... 3,000
1999............................................................... 4,000
2000............................................................... 4,000
-------
$11,250
=======
</TABLE>
The note payable is a revolving credit facility. The total commitment is
limited to $16 million and is reduced by $2 million during 1996, $3 million
annually during 1997 and 1998, and $4 million annually until expiration in the
year 2000.
F-15
<PAGE> 74
AMERICAN EAGLE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The Company pays an annual facility fee to the bank at a rate of 1/2% per
year of the bank's commitment, whether used or unused, while AEIC has no earned
surplus, and at a rate of 1/4% per year at all other times. Payments are made
on a quarterly basis. The outstanding borrowings are collateralized by the
capital stock of AEIC, AOA, and the other direct subsidiaries of the Company.
The Company is subject to certain operating restrictions pursuant to the credit
facility, including limitations on payment of dividends (see Note 7),
limitations on capital expenditures, and maintenance of certain financial
covenants.
Total interest expense for the years ended December 31, 1995, 1994 and 1993
was approximately $987, $800 and $708 respectively.
6. INCOME TAXES:
The federal income tax provision (benefit) for the years ended December 31,
1995, 1994 and 1993, consisted of the following:
<TABLE>
<CAPTION>
1995 1994 1993
------- ------ ------
<S> <C> <C> <C>
Current................................................. $(7,100) $1,871 $3,317
Deferred................................................ (200) 1,480 (367)
------- ------ ------
Total................................................... $(7,300) $3,351 $2,950
======= ====== ======
</TABLE>
The federal income tax provision differs from that computed at the federal
statutory corporate tax rate for the years ended December 31, 1995, 1994 and
1993, as follows:
<TABLE>
<CAPTION>
1995 1994 1993
-------- ------- ------
<S> <C> <C> <C>
Pre-tax financial reporting -- income (loss).................. $(20,376) $10,494 $8,668
Tax at 34% statutory rate..................................... (6,928) 3,568 2,947
Tax effect of:
Amortization of goodwill.................................... 117 120 113
Tax exempt interest income.................................. (245) (96) (30)
Dividends received deduction................................ (15) (52) (38)
"Fresh Start" loss reserve adjustment....................... -- -- 34
Discounting of "Fresh Start" adjustment..................... (35) (26) (97)
Other, net.................................................. (194) (163) 21
-------- ------- ------
Total federal income tax provision (benefit).................. $ (7,300) $ 3,351 $2,950
======== ======= ======
</TABLE>
Current federal income taxes payable (receivable) at December 31, 1995 and
1994 were $(7,100) and $335, respectively. These amounts are presented as a
component of Other Assets and Accounts Payable and Other Liabilities,
respectively. Certain income and expense items are recognized for financial
reporting purposes and for income tax purposes in different periods. Deferred
taxes are provided in the consolidated financial statements to account for these
"temporary" differences. The primary sources of the Company's temporary
differences are attributable to the discounting of reserves for losses and loss
adjustment expenses for income tax purposes, differences in depreciation
methods, provisions for uncollectible accounts and differences in the
amortization period for deferred acquisition costs. Except for the effects of
the reversal of such net deductible temporary differences, the Company is not
currently aware of any factors which would cause any significant differences
between taxable income and pre-tax book income in future years. However, there
can be no assurances that there will be no significant differences in the future
between consolidated taxable income and consolidated pre-tax book income if
circumstances change (such as, for example, changes in tax laws or the Company's
financial condition or performance).
F-16
<PAGE> 75
AMERICAN EAGLE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The components of and changes in the net deferred tax asset (liability)
during the years ended December 31, 1995 and 1994, were as follows:
<TABLE>
<CAPTION>
DEFERRED DEFERRED
DECEMBER 31, DECEMBER 31, BENEFIT DECEMBER 31, BENEFIT
1995 1994 (EXPENSE) 1993 (EXPENSE)
------------ ------------ --------- ------------ ---------
<S> <C> <C> <C> <C> <C>
Discounting of insurance loss
reserves......................... $ 3,274 $ 2,984 $ 290 $ 2,051 $ 933
Unearned policy premium income..... 2,461 1,586 875 1,282 304
Reserve for uncollectible
accounts......................... (392) (227) (165) (147) (80)
Deferred policy acquisition
costs............................ (6,034) (4,421) (1,613) (1,505) (2,916)
Salvage and subrogation............ (282) (282) -- (305) 23
Other, net......................... (8) 344 (352) 88 256
Net operating loss carryforward.... 1,165 -- 1,165 -- --
-------- -------- ------- -------- -------
184 (16) 200 1,464 (1,480)
Unrealized (appreciation)
depreciation on investment
securities....................... (554) 1,163 N/A (126) N/A
-------- -------- ------- -------- -------
Total net deferred tax asset
(liability)...................... $ (370) $ 1,147 $ 1,338
======== ======== ======= ======== =======
</TABLE>
No income, profit or capital gain taxes are levied in Bermuda and,
accordingly, no provision or benefit for such taxes has been recorded by AMIC.
In the event such taxes are levied, AMIC has an agreement with the Bermuda
government exempting it from all such taxes until March 2016.
7. STATUTORY INFORMATION:
Accounting Practices
Generally accepted accounting principles (GAAP) differ in certain respects
from accounting practices prescribed or permitted by the domiciliary insurance
regulatory authorities of the State of Texas and Bermuda. AEIC and AMIC are
required to report to certain regulatory agencies on the basis of Statutory
Accounting Practices ("SAP"). The principal differences between SAP and GAAP are
as follows:
- Under SAP, policy acquisition costs, such as commissions, premium taxes,
fees, and other costs of underwriting policies are charged to current
operations as incurred, whereas, the related written premium is included
in earnings on a pro-rata basis over the period covered by the policy;
- Under SAP, certain assets, designated as "Nonadmitted Assets" (such as
prepaid expenses) are charged against surplus;
- Under SAP, federal income taxes are only provided on taxable income for
which income taxes are currently payable, while under GAAP, deferred
income taxes are provided with respect to temporary differences.
- Under SAP, certain reserves are established in amounts which differ from
amounts which would be provided in conformity with GAAP.
Financial Information
The unaudited statutory capital and surplus of AEIC as of December 31, 1995
and 1994, was $50,465 and $65,107, respectively. Unaudited statutory net income
(loss) of AEIC for the years ended December 31, 1995, 1994 and 1993 was
$(15,735), $2,943 and $5,268, respectively.
The unaudited statutory capital and surplus of AMIC as of December 31, 1995
and 1994, was $3,761 and $2,536, respectively. Unaudited statutory net income of
AMIC for the years ended December 31, 1995, 1994 and 1993, was $1,143, $313 and
$394, respectively.
F-17
<PAGE> 76
AMERICAN EAGLE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Minimum Capital Requirements
The insurance subsidiaries must maintain a minimum amount of statutory
capital and surplus to satisfy regulatory requirements. At December 31, 1995,
AEIC had unaudited statutory capital and surplus of $50,465 with a minimum
requirement of $15,982 and AMIC had unaudited statutory capital and surplus of
$3,761 with a minimum requirement of $123.
Dividend Restrictions
The insurance subsidiaries are subject to various regulatory restrictions
which limit the maximum amount of annual dividends allowed to be paid.
Generally, dividends may only be paid from earned surplus arising from the
business, and then the maximum dividend that may be paid without prior
regulatory approval is limited to the greater of (i) 10% of statutory surplus or
(ii) the lesser of 100% of net investment income, or net income, for the prior
year. Dividends exceeding these limitations can be made subject to approval by
the domiciliary insurance regulatory authorities. Based on regulatory
restrictions presently in effect, the maximum amount available for payment as
dividends to the Company by AEIC without the prior approval of regulatory
authorities is $5.0 million, if at the time of payment AEIC has earned surplus
at least equal to the amount of dividends. At December 31, 1995, AEIC had earned
surplus (deficit) of approximately $(8.8) million.
8. REDEEMABLE PREFERRED STOCK, COMMON STOCK AND OPTION PLANS:
Redeemable Preferred Stock
In June 1990, the Company issued 162,857 shares of Series B Cumulative
Preferred Stock in exchange for the cancellation of the outstanding principal
balance of the Company's acquisition notes payable. Cash dividends of 6% are
payable in quarterly installments. The preferred shares are redeemable by the
Company at any time at a price of $10 per share plus accrued and unpaid
dividends, and are mandatorily redeemable at $10 per share plus accrued and
unpaid dividends as follows: 20,000 shares -- December 31, 1996, 30,000
shares -- December 31, 1997, and all remaining shares on December 31, 1998.
Common Stock
The common stock of the Company is issuable in either of two classes,
Common Stock or Nonvoting Common Stock. Other than the voting rights, the two
classes are identical in every respect. As of December 31, 1995 and 1994,
7,044,698 and 7,049,298 shares of Common Stock were outstanding, respectively.
As of December 31, 1995 and 1994, 6,000 shares of Nonvoting Common Stock were
outstanding. The Company declared cash dividends of $0.13 and $0.09 per common
share in 1995 and 1994, respectively. No cash dividends were declared on Common
Stock in 1993.
Stock Option Plans
The Company has six stock option plans for officers, directors, and key
employees of the Company: the 1991 Non-Qualified Stock Option Plan, the three
Amended and Restated P&C Stock Option Plans, the 1994 Stock Incentive Plan, and
the Director Stock Option Plan. Under the plans, vesting periods are established
at the time of grant but typically range up to three years, and exercise prices
are at fair market value at the time of grant. Stock option expiration dates may
vary from 10 years to 15 years from the date of grant. Option prices at December
31, 1995 ranged from $9.57 to $11.52, with a weighted average of $10.73.
F-18
<PAGE> 77
AMERICAN EAGLE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
At December 31, 1995, the Company has 1,246,848 common shares reserved for
stock options. Option activity is as follows:
<TABLE>
<CAPTION>
1995 1994 1993
--------- ------- -------
<S> <C> <C> <C>
Outstanding, beginning of year..................... 993,680 589,424 371,168
Granted............................................ 173,779 441,702 235,342
Canceled........................................... (67,578) (37,446) (17,086)
--------- ------- -------
Outstanding, end of year........................... 1,099,881 993,680 589,424
========= ======= =======
Exercisable, end of year........................... 655,438 422,644 302,521
========= ======= =======
</TABLE>
1994 Employee Restricted Stock Plan
In February 1994, the board of directors approved the 1994 Employee
Restricted Stock Plan ("Restricted Stock Plan"). Under the Restricted Stock
Plan, all employees on the date of closing of the initial public offering
received a grant of 100 shares of Common Stock, subject to forfeiture upon
termination of employment within five years after the date of closing of the
initial public offering for any reason other than retirement, death, or
disability.
As of December 31, 1995, 17,200 shares of restricted stock remained
outstanding under this plan. Unearned compensation of $238 was recorded at the
date of award based on the market value of the shares. Unearned compensation,
which is a component of shareholders' equity, is being amortized to expense over
the five-year vesting period, or in certain circumstances upon normal
retirement.
9. SAVINGS AND PENSION PLANS:
Employee Profit Sharing and Savings Plan
Effective December 1, 1993, the Company's Employee Savings Plan was amended
and restated as the Employee Profit Sharing and Savings Plan (the "Savings
Plan"). Employees who have completed six months of service are eligible to
participate in the Savings Plan. Participants may make contributions to the
Savings Plan through payroll deductions of up to 15% of their base compensation
on a tax-deferred basis and up to 10% of their base compensation on an after-tax
basis. The Company matches 50% of each participant's tax deferred contributions
to the Savings Plan up to 6% of the participant's compensation. Participants are
100% vested in their contributions and the Company's matching contributions.
Contributions made by the Company to participant accounts totaled approximately
$210, $209 and $146 for the years ended December 31, 1995, 1994 and 1993,
respectively.
The Company may make annual profit sharing contributions to all employees
eligible to participate in the Savings Plan. The amount of the contribution is
within the discretion of the Board of Directors. Profit sharing contributions
are allocated among participants in proportion to their compensation.
Participants vest in profit sharing contributions on a graduated vesting
schedule over three years. The Company's profit sharing contribution to the
Savings Plan totaled $140, $175 and $150 for the years ended December 31, 1995,
1994 and 1993, respectively.
10. FAIR VALUE OF FINANCIAL INSTRUMENTS:
Statement of Financial Accounting Standards No. 107, "Disclosures about
Fair Value of Financial Instruments," requires the Company to disclose the
estimated fair value of its financial instrument assets and liabilities.
Approximately 34% of the Company's assets and 4% of its liabilities are
considered financial instruments as defined in Statement No. 107.
F-19
<PAGE> 78
AMERICAN EAGLE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Estimated fair values have been determined using an estimation methodology
suitable for each category of financial instruments. The estimation
methodologies used, estimated fair values, and recorded book balances at
December 31, 1995 and 1994, were as follows:
- Financial instruments actively traded in a secondary market have been
valued using quoted available market prices.
<TABLE>
<CAPTION>
ESTIMATED RECORDED
FAIR VALUE BOOK BALANCE
-------------------- --------------------
1995 1994 1995 1994
-------- ------- -------- -------
<S> <C> <C> <C> <C>
Cash and cash equivalents................. $ 2,922 $ 1,530 $ 2,922 $ 1,530
======== ======= ======== =======
Investments (Note 4)...................... $103,807 $94,577 $103,870 $96,651
======== ======= ======== =======
</TABLE>
- Financial instrument liabilities with variable rates have an estimated
fair value equal to the recorded book balance.
<TABLE>
<CAPTION>
ESTIMATED RECORDED
FAIR VALUE BOOK BALANCE
------------------ ------------------
1995 1994 1995 1994
------- ------ ------- ------
<S> <C> <C> <C> <C>
Note payable.................................. $11,250 $9,250 $11,250 $9,250
======= ====== ======= ======
</TABLE>
Changes in assumptions or estimation methodologies may have a material
effect on these estimated fair values. The Company's remaining assets and
liabilities which are not considered financial instruments have not been valued
differently than has been customary with historical cost accounting.
11. COMMITMENTS AND CONTINGENT LIABILITIES:
Litigation
In the ordinary course of business, the Company and its subsidiaries have
been named defendants in various lawsuits seeking both actual and punitive
damages. Although the ultimate outcome of these matters is uncertain,
management, based on consultation with outside legal counsel, is of the opinion
that their resolution will not have a material adverse effect on the Company's
financial position or results of operations.
Lease Commitments
The Company has entered into various noncancelable operating leases
(principally with respect to facilities and equipment) which call for future
minimum lease payments as follows:
<TABLE>
<S> <C>
1996................................................................ $1,050
1997................................................................ 1,048
1998................................................................ 782
1999................................................................ 760
2000 and thereafter................................................. 760
</TABLE>
Total rent expense for the years ended December 31, 1995, 1994 and 1993,
was approximately $1,035, $852 and $870, respectively.
Directors and Officers Liability
The Company is required to indemnify officers and directors for liability
and defense costs associated with litigation which might arise in connection
with the fulfillment of their responsibilities to the Company.
F-20
<PAGE> 79
AMERICAN EAGLE GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT SHARE AMOUNTS)
ASSETS
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
1995 1996
------------ -------------
(UNAUDITED)
<S> <C> <C>
Cash and investments................................................ $106,792 $ 69,178
Accounts receivable................................................. 56,890 55,229
Reinsurance recoverable, net........................................ 101,125 87,670
Deferred policy acquisition costs................................... 15,296 14,670
Deferred reinsurance premiums....................................... 29,355 22,594
Other assets........................................................ 18,337 15,969
-------- --------
Total assets.............................................. $327,795 $ 265,310
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Reserve for losses and loss adjustment expenses................... $136,528 $ 123,203
Unearned premiums................................................. 79,605 65,996
Other policy liabilities.......................................... 29,722 1,180
Agency payables to insurance companies, net....................... 1,736 751
Note payable...................................................... 11,250 13,250
Accounts payable and other liabilities............................ 13,859 12,195
-------- --------
Total liabilities......................................... 272,700 216,575
-------- --------
Commitments and contingent liabilities
Series B Cumulative Preferred Stock, $.01 par value; 162,857 shares
authorized, 162,857 shares issued and outstanding................. 1,629 1,629
Stockholders' equity:
Common Stock, $.01 par value, 21,000,000 shares authorized,
7,121,380 shares issued........................................ 71 71
Additional paid-in-capital........................................ 45,532 45,555
Unrealized apprec.(deprec.) on investment securities, net of
deferred taxes................................................. 1,029 (252)
Retained earnings................................................. 6,921 1,819
Less -- 73,882 shares of common stock held in the treasury, at
cost........................................................... (87) (87)
-------- --------
Total stockholders' equity................................ 53,466 47,106
-------- --------
Total liabilities and stockholders' equity................ $327,795 $ 265,310
======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-21
<PAGE> 80
AMERICAN EAGLE GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
FOR THE PERIODS ENDED
(UNAUDITED)
(DOLLARS IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
----------------------------- -----------------------------
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
1995 1996 1995 1996
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Revenues
Earned premiums, net of reinsurance......... $ 27,171 $ 27,634 $ 72,415 $ 93,965
Agency operations, net...................... 215 225 507 172
Investment income, net...................... 1,351 1,031 4,161 3,478
Realized investment gains (losses), net..... 452 (46) 458 52
--------- --------- --------- ---------
Total revenues...................... 29,189 28,844 77,541 97,667
--------- --------- --------- ---------
Expenses
Losses and loss adjustment expenses, net of
reinsurance.............................. 16,347 17,596 45,594 66,255
Policy acquisition and other underwriting
expenses................................. 9,109 12,371 23,614 36,845
Interest expense............................ 256 299 733 834
--------- --------- --------- ---------
Total expenses...................... 25,712 30,266 69,941 103,934
--------- --------- --------- ---------
Income (loss) before income tax expense....... 3,477 (1,422) 7,600 (6,267)
Income tax expense (benefit).................. 1,078 (263) 2,358 (1,800)
--------- --------- --------- ---------
Net income (loss)............................. $ 2,399 $ (1,159) $ 5,242 $ (4,467)
========= ========= ========= =========
Net income (loss) available for common
stockholders(1)............................. $ 2,375 $ (1,183) $ 5,169 $ (4,540)
========= ========= ========= =========
Weighted average number of common shares
outstanding................................. 7,052,898 7,048,498 7,053,698 7,049,098
========= ========= ========= =========
Net income (loss) per share of common
stock(1).................................... $ 0.34 $ (0.17) $ 0.73 $ (0.64)
</TABLE>
- ---------------
(1) After deduction of preferred dividends
The accompanying notes are an integral part of these financial statements.
F-22
<PAGE> 81
AMERICAN EAGLE GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED
(UNAUDITED)
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
SEPTEMBER 30, SEPTEMBER 30,
1996 1995
------------- -------------
<S> <C> <C>
Cash and cash equivalents derived from:
Total provided operating activities............................. $ (35,521) $ 2,198
Investing activities --
Net proceeds (purchases) of short-term investments........... 24,743 (3,917)
Purchases of fixed income securities......................... (23,715) (18,345)
Proceeds from sales of fixed income securities............... 26,882 16,862
Proceeds from maturities of fixed income securities.......... 6,885 3,009
Purchases of property and equipment.......................... (1,049) (1,308)
--------- ---------
Total provided by investing activities.................. 33,746 (3,699)
--------- ---------
Financing activities --
Dividends paid on Series B and C Cumulative Preferred
Stock....................................................... (73) (73)
Dividends paid on common stock............................... (846) (635)
Proceeds of note payable..................................... 2,000 2,000
Increase in common stock outstanding......................... -- 26
--------- ---------
Total provided by financing activities.................. 1,081 1,318
--------- ---------
Net change in cash and cash equivalents........................... (694) (183)
Cash and cash equivalents, beginning of period.................... 2,922 1,530
--------- ---------
Cash and cash equivalents, end of period.......................... $ 2,228 $ 1,347
========= =========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-23
<PAGE> 82
AMERICAN EAGLE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE PERIODS ENDED
SEPTEMBER 30, 1995 AND 1996
(UNAUDITED)
BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements of
American Eagle Group, Inc. (the "Company") and subsidiaries for the periods
ended September 30, 1995 and 1996 have been prepared in accordance with the
instructions to the Form 10-Q and do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements.
In the opinion of management, all adjustments (consisting of only normal
recurring accruals) considered necessary for a fair presentation of the results
for the interim period have been included. Operating results for the periods
ended September 30, 1996 are not necessarily indicative of the results that may
be expected for the year ending December 31, 1996. These statements should be
read in conjunction with the financial statements and notes thereto for the year
ended December 31, 1995 included in the Company's Annual Report.
SUBSEQUENT EVENT
On November 6, 1996, the Company announced the terms of a $35 million
investment in the Company and the formation of a strategic alliance with
American Financial Group, Inc. ("American Financial Group").
Under the capital terms of the strategic alliance, American Financial Group
has agreed to purchase 350,000 shares of the Company's Series D Preferred Stock
for $35 million. This security will have a 9% dividend, with an option for the
first five years to pay the dividends in kind with additional shares of Series D
Preferred Stock. The preferred stock is convertible at a conversion price of
$5.25 per share into common stock of the Company. At the time of issuance, the
Series D Preferred Stock will be convertible into approximately 48% of the
outstanding common stock (calculated on a fully converted basis). The preferred
stock matures in 20 years with mandatory redemption of 10% of principal per year
beginning in year eleven. The preferred stock is callable at par at any time. In
the event that the preferred stock is called prior to the seventh anniversary of
its issuance, the holder will receive warrants to purchase the Company's common
stock at $5.25 per share exercisable any time during the period between the call
date and the seventh anniversary of the issuance of the preferred stock. The
preferred stock carries limited voting rights equal to 20% of the total votes
eligible to be cast on matters submitted to holders of common stock. Until the
seventh anniversary of the issuance of the preferred stock, American Financial
Group has the right to nominate for election to the Company's Board of Directors
30% of the number of directors. As part of the overall transaction, the Company
has granted to American Financial Group warrants for 800,000 shares of the
Company's common stock with an exercise price of $3.45 per share. Such warrants
will become exercisable in the event that the Company terminates its agreement
with American Financial Group and enters into a competing transaction with
another party. These warrants will be canceled upon closing of the transaction
with American Financial Group.
Proceeds from the transaction will be utilized to contribute capital to the
Company's insurance company subsidiary, to reduce bank debt, and for other
general corporate purposes.
In connection with the transaction, the company would record, at the time
of closing of the transaction, a recapitalization charge of $15 million before
federal income tax. This recapitalization charge will provide additional
strengthening of American Eagle's balance sheet and overall reserve levels and
is intended to cover contingencies and estimated exposures associated with
various previously reported strategic actions and product line discontinuations.
F-24
<PAGE> 83
QUARTERLY FINANCIAL DATA
(UNAUDITED)
The table below sets forth the Company's operating results by quarter for
1995 and 1994.
<TABLE>
<CAPTION>
1995 1994
------------------------------------------------------------- ----------------------
MAR. 31 JUNE 30 SEPT. 30 DEC. 31 TOTAL MAR. 31 JUNE 30
--------- --------- --------- --------- --------- --------- ---------
(DOLLARS IN MILLIONS, EXCEPT SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C> <C> <C>
Revenues
Earned premiums, net of
reinsurance........................ $ 20.6 $ 24.6 $ 27.2 $ 30.0 $ 102.4 $ 16.7 $ 19.2
Agency operations, net.............. 0.3 0.0 0.2 (0.1) 0.4 0.2 0.4
Investment income, net.............. 1.3 1.5 1.4 1.3 5.5 0.9 1.0
Realized investment gains (losses),
net................................ 0.0 0.0 0.4 0.1 0.5 0.0 (0.1)
--------- --------- --------- --------- --------- --------- ---------
Total revenues............... 22.2 26.1 29.2 31.3 108.8 17.8 20.5
Expenses
Losses and loss adjustment expenses,
net of reinsurance................. 13.6 15.6 16.3 45.3 90.9 11.7 13.3
Policy acquisition and other
underwriting expenses.............. 7.0 7.6 9.1 13.6 37.3 4.8 5.2
Interest expense.................... 0.1 0.2 0.3 0.4 1.0 0.2 0.2
--------- --------- --------- --------- --------- --------- ---------
Total expenses............... 20.7 23.4 25.7 59.4 129.2 16.7 18.7
Income (loss) before income tax
expense (benefit).................. 1.5 2.7 3.5 (28.0) (20.4) 1.1 1.8
Income tax expense (benefit)........ 0.5 0.8 1.1 (9.7) (7.3) 0.4 0.5
--------- --------- --------- --------- --------- --------- ---------
Net income (loss)................... $ 1.0 $ 1.9 $ 2.4 $ (18.4) $ (13.1) $ 0.7 $ 1.3
========= ========= ========= ========= ========= ========= =========
Net income (loss) per common share
(primary and fully diluted)........ $ 0.14 $ 0.26 $ 0.34 $ (2.60) $ (1.87) $ 0.11 $ 0.22
========= ========= ========= ========= ========= ========= =========
Weighted average number of common
shares outstanding: share and share
equivalents (primary and fully
diluted)........................... 7,055,298 7,053,998 7,052,898 7,051,398 7,052,998 3,469,448 5,101,985
GAAP Ratios Loss and LAE ratio...... 65.9% 63.6% 60.2% 151.0% 88.8% 70.1% 69.3%
--------- --------- --------- --------- --------- --------- ---------
Expense ratio....................... 33.7 30.7 33.5 45.5 36.4 28.7 26.8
--------- --------- --------- --------- --------- --------- ---------
Combined ratio............... 99.6% 94.3% 93.7% 196.5% 125.2% 98.8% 96.1%
========= ========= ========= ========= ========= ========= =========
<CAPTION>
SEPT. 30 DEC. 31 TOTAL
--------- --------- ---------
<S> <C> <C> <C>
Revenues
Earned premiums, net of
reinsurance........................ $ 23.9 $ 22.9 $ 82.7
Agency operations, net.............. 0.5 (0.2) 0.9
Investment income, net.............. 1.1 1.1 4.1
Realized investment gains (losses),
net................................ 0.0 0.0 (0.1)
--------- --------- ---------
Total revenues............... 25.5 23.8 87.6
Expenses
Losses and loss adjustment expenses,
net of reinsurance................. 15.1 12.6 52.7
Policy acquisition and other
underwriting expenses.............. 6.8 6.9 23.7
Interest expense.................... 0.2 0.2 0.8
--------- --------- ---------
Total expenses............... 22.1 19.7 77.2
Income (loss) before income tax
expense (benefit).................. 3.4 4.1 10.4
Income tax expense (benefit)........ 1.0 1.4 3.3
--------- --------- ---------
Net income (loss)................... $ 2.4 $ 2.7 $ 7.1
========= ========= =========
Net income (loss) per common share
(primary and fully diluted)........ $ 0.33 $ 0.39 $ 1.16
========= ========= =========
Weighted average number of common
shares outstanding: share and share
equivalents (primary and fully
diluted)........................... 7,056,410 7,055,442 5,684,386
GAAP Ratios Loss and LAE ratio...... 63.5% 54.6% 63.7%
--------- --------- ---------
Expense ratio....................... 28.3 30.4 28.6
--------- --------- ---------
Combined ratio............... 91.8% 85.0% 92.3%
========= ========= =========
</TABLE>
Management believes that there has been a seasonality pattern in the
Aviation Division's loss ratio. Losses have historically been higher in the
first half of the year and then declined in the second half, with the highest
losses in the first quarter and the lowest losses in the fourth quarter. The
Company believes that this pattern results primarily from weather-related
factors which contribute to a higher loss frequency in the first two quarters of
the year. The fourth quarter of 1995 includes a special charge to operations of
$20.6 million (after tax) for certain discontinued lines and classes of business
and increases in reserves for incurred but not reported (IBNR) losses and
unearned premiums. The expense ratio has also been higher earlier in the year
primarily as a result of the growth in earned premiums in the latter part of the
year.
F-25
<PAGE> 84
The following pro forma financial information reflects the financial impact
of the issuance of the Series D Cumulative Convertible Preferred Stock as
described below. The pro forma financial information does not include
adjustments to the historical financial statements related to the timing of the
discontinuation of common stock dividends and related changes in the note
payable or the withdrawal from the transportation line of business. The pro
forma financial statements also do not include any incremental revenue and
income expected to be developed from the strategic alliance with the AFG as a
result of the Transaction.
AMERICAN EAGLE GROUP, INC. AND SUBSIDIARIES
PRO FORMA CONDENSED CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT SHARE AMOUNTS)
ASSETS
<TABLE>
<CAPTION>
SEPTEMBER 30, PRO FORMA
1996 ADJUSTMENTS PRO FORMA
------------- ----------- ---------
<S> <C> <C> <C>
(UNAUDITED)
Cash and investments............................................... $ 69,178 $ 19,750(a) $ 88,928
Accounts receivable................................................ 55,229 55,229
Reinsurance recoverable, net....................................... 87,670 87,670
Deferred policy acquisition costs.................................. 14,670 14,670
Deferred reinsurance premiums...................................... 22,594 22,594
Other assets....................................................... 15,969 5,250(b) 21,219
--------- --------- ---------
Total assets............................................. $ 265,310 $ 25,000 $ 290,310
========= ========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Reserve for losses and loss adjustment expenses.................. $ 123,203 $ 11,000(b) $ 134,203
Unearned premiums................................................ 65,996 65,996
Other policy liabilities......................................... 1,180 1,180
Agency payables to insurance companies, net...................... 751 751
Note payable..................................................... 13,250 (13,250)(a) 0
Accounts payable and other liabilities........................... 12,195 4,000(b) 16,195
--------- --------- ---------
Total liabilities........................................ 216,575 1,750 218,325
--------- --------- ---------
Commitments and contingent liabilities
Series B Cumulative Preferred Stock, $.01 par value; 162,857 shares
authorized, 162,857 shares issued and outstanding................ 1,629 1,629
Series D Cumulative Convertible redeemable preferred stock, $.01
par value; no shares authorized or issued; 546,200 shares
authorized pro forma; 350,000 shares issued; pro forma(c)........ 33,000(a) 33,000
Stockholders' equity:
Common Stock, $.01 par value, 21,000,000 shares authorized,
7,121,380 shares issued....................................... 71 71
Additional paid-in-capital....................................... 45,555 45,555
Unrealized apprec.(deprec.) on investment securities, net of
deferred taxes................................................ (252) (252)
Retained earnings................................................ 1,819 (9,750)(b) (7,931)
Less -- 73,882 shares of common stock held in the treasury, at
cost.......................................................... (87) (87)
--------- --------- ---------
Total stockholders' equity............................... 47,106 (9,750) 37,356
--------- --------- ---------
Total liabilities and stockholders' equity............... $ 265,310 $ 25,000 $ 290,310
========= ========= =========
</TABLE>
- ---------------
(a) Adjustment to give effect to the sale by the Company of 350,000 shares of
Series D Cumulative Convertible Preferred Stock at a price of $100 per share
for an aggregate purchase price of $35 million, net of $2 million of
issuance costs, and the repayment of the note payable. See, however, "The
Transaction -- Use of Proceeds."
(b) Adjustment to record $15 million recapitalization charge and related tax
benefit.
(c) The Company's Certificate of Incorporation authorizes the Company to issue
an aggregate of 5 million shares of preferred stock, par value $.01 per
share, of which the Company has issued 162,857 shares as Series B Cumulative
Preferred Stock and has reserved 546,200 shares for issuance as Series D
Preferred Stock.
F-26
<PAGE> 85
AMERICAN EAGLE GROUP, INC. AND SUBSIDIARIES
PRO FORMA CONDENSED CONSOLIDATED STATEMENTS OF INCOME
FOR THE PERIODS ENDED
(DOLLARS IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
NINE MONTHS ENDED YEAR ENDED
-------------------------------------------- -------------------------------------------
SEPTEMBER 30, PRO FORMA DECEMBER 31, PRO FORMA
1996 ADJUSTMENTS(1) PRO FORMA 1995 ADJUSTMENTS(1) PRO FORMA
------------- -------------- --------- ------------ -------------- ---------
<S> <C> <C> <C> <C> <C> <C>
Revenues
Earned premiums, net of
reinsurance............. $ 93,965 $ 93,965 $ 102,447 $ 102,447
Agency operations, net..... 172 172 396 396
Investment income, net..... 3,478 $ 1,111(a) 4,589 5,497 $ 1,481(a) 6,978
Realized investment gains
(losses), net........... 52 52 496 496
--------- --------- --------- --------- --------- ---------
Total revenues..... 97,667 1,111 98,778 108,836 1,481 110,317
--------- --------- --------- --------- --------- ---------
Expenses
Losses and loss adjustment
expenses, net of
reinsurance............. 66,255 66,255 90,933 15,000(b) 105,933
Policy acquisition and
other underwriting
expenses................ 36,845 36,845 37,292 37,292
Interest expense........... 834 (834)(c) 987 (987)(c)
--------- --------- --------- --------- --------- ---------
Total expenses..... 103,934 (834) 103,100 129,212 14,013 143,225
--------- --------- --------- --------- --------- ---------
Income (loss) before income
tax expense................ (6,267) 1,945 (4,322) (20,376) (12,532) (32,908)
Income tax expense
(benefit).................. (1,800) 681(d) (1,119) (7,300) (4,386)(d) (11,686)
--------- --------- --------- --------- --------- ---------
Net income (loss)............ $ (4,467) $ 1,264 $ (3,203) $ (13,076) $ (8,146) $ (21,222)
========= ========= ========= ========= ========= =========
Net income (loss) available
for common
stockholders(1)............ $ (4,540) $ (1,377) $ (5,917) $ (13,174) $ (11,404) $ (24,578)
========= ========= ========= ========= ========= =========
Weighted average number of
common shares
outstanding................ 7,049,098 7,049,098 7,049,098 7,052,998 7,052,998 7,052,998
========= ========= ========= ========= ========= =========
Net income (loss) per share
of common stock(2)......... $ (0.64) $ (0.20) $ (0.84) $ (1.87) $ (1.62) $ (3.49)
</TABLE>
- ---------------
(1) Assumes that the proposed transaction was effective January 1, 1995. No
adjustments have been made for the incremental revenue and income expected
to be developed from the strategic alliance with AFG, changes in the
Company's common stock dividend policy or any other adjustments not
described below.
(2) After deduction of preferred dividends
(a) Additional investment income related to the investment of the $35 million in
proceeds of the Series D Cumulative Convertible Preferred stock net of the
repayment of the note payable of $13.25 million and the payment of the
estimated costs of the issuance of $2.0 million.
(b) Recording of $15 million recapitalization charge.
(c) Elimination of interest expense as a result of the repayment of the note
payable of $13.25 million at September 30, 1996 ($11.25 million at December
31, 1995).
(d) Tax effect of items (a), (b) and (c) above.
F-27
<PAGE> 86
APPENDIX I
[CS FIRST BOSTON LETTERHEAD]
November 5, 1996
Board of Directors
American Eagle Group, Inc.
12801 North Central Expressway, Suite 800
Dallas, Texas 75243
Gentlemen:
You have asked us to advise you with respect to the fairness to American
Eagle Group, Inc. ("AEG") from a financial point of view of the cash
consideration to be received by AEG pursuant to the terms of a Securities
Purchase Agreement, dated November 5, 1996 (the "Purchase Agreement"), by and
between AEG and American Financial Group, Inc. ("AFG"). The Purchase Agreement
provides for, among other things, the purchase by AFG of an aggregate of 350,000
shares of newly authorized Series D Preferred Stock, par value $0.01 per share,
of AEG (the "Series D Preferred Stock") for an aggregate purchase price of $35
million in cash (the "Financing").
In arriving at our opinion, we have reviewed the Purchase Agreement and
certain related documents and certain publicly available business and financial
information relating to AEG. We have also reviewed certain other information,
including financial forecasts, provided to us by AEG, and have met with AEG's
management to discuss the business and prospects of AEG, including the
distressed financial position of AEG and the near-term liquidity needs of, and
capital resources available to, AEG.
We have also considered certain financial and stock market data for AEG,
and we have compared that data with similar data for other publicly traded
companies in businesses similar to those of AEG and we have considered, to the
extent publicly available, the financial terms of certain other significant
equity and equity-linked investments in other publicly traded companies. We also
considered such other information, financial studies, analyses, and
investigations and financial, economic and market criteria which we deem
relevant.
In connection with our review, we have not assumed any responsibility for
independent verification of any of the foregoing information and have relied on
its being complete and accurate in all material respects. With respect to the
financial forecasts, we have assumed that such forecasts have been reasonably
prepared on bases reflecting the best currently available estimates and
judgments of the management of AEG as to the future financial performance of
AEG. In addition, we have not made an independent evaluation or appraisal of the
assets or liabilities (contingent or otherwise) of AEG, nor have we been
furnished with any such evaluations or appraisals. Our opinion is necessarily
based on information available to us, and financial, economic, market and other
conditions as they exist and can be evaluated, on the date hereof. In connection
with our engagement we were not requested to, and did not, solicit third party
indications of interest in acquiring all or substantially all of AEG.
We have acted as financial advisor to AEG in connection with the Financing
and will receive a fee for our services, a significant portion of which is
contingent upon consummation of the Financing. CS First Boston has in the past
provided financial services to AEG and AFG unrelated to the proposed Financing,
for which services CS First Boston has received compensation. In the ordinary
course of our business, CS First Boston and its affiliates may actively trade
the equity securities of AEG and both the debt and equity securities of AFG for
their own account and for the accounts of customers and, accordingly, may at any
time hold a long or short position in such securities.
It is understood that this letter is for the information of the Board of
Directors of AEG in connection with its evaluation of the Financing, does not
constitute a recommendation to any stockholder as to how such
<PAGE> 87
stockholder should vote on the proposed Financing and is not to be quoted or
referred to, in whole or in part, in any registration statement, prospectus or
proxy statement, or in any other document used in connection with the offering
or sale of securities, nor shall this letter be used for any other purposes,
without CS First Boston's prior written consent.
Based upon and subject to the foregoing, it is our opinion that, as of the
date hereof, the cash consideration to be received by AEG pursuant to the
Financing is fair to AEG from a financial point of view.
Very truly yours,
CS FIRST BOSTON CORPORATION
By: /s/ JONATHAN PLUTZIK
------------------------------------
Jonathan Plutzik
Managing Director
<PAGE> 88
APPENDIX II
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SECURITIES PURCHASE AGREEMENT
BETWEEN
AMERICAN FINANCIAL GROUP, INC.,
PURCHASER
AND
AMERICAN EAGLE GROUP, INC.,
SELLER
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE> 89
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
------
<S> <C> <C>
ARTICLE 1 INTERPRETATION
1.1 Definitions................................................................ II-1
1.2 Rules of Construction...................................................... II-5
ARTICLE 2 SALE AND PURCHASE OF PURCHASED SECURITIES
2.1 Sale and Purchase of Purchased Securities.................................. II-5
2.2 Purchase Price............................................................. II-5
2.3 Delivery of Warrants....................................................... II-5
2.4 Closing.................................................................... II-5
2.5 Use of Proceeds............................................................ II-6
ARTICLE 3 REPRESENTATIONS AND WARRANTIES OF SELLER
3.1 Corporate Existence........................................................ II-6
3.2 Corporate Power; Authorization............................................. II-6
3.3 Enforceable Obligations.................................................... II-6
3.4 No Legal Bar............................................................... II-6
3.5 Absence of Conflicts....................................................... II-6
3.6 Litigation................................................................. II-6
3.7 Financial Condition........................................................ II-7
3.8 No Change.................................................................. II-7
3.9 No Default................................................................. II-7
3.10 Compliance with Laws....................................................... II-7
3.11 Taxes...................................................................... II-7
3.12 ERISA...................................................................... II-7
3.13 Environmental Matters...................................................... II-7
3.14 Investment Company Act..................................................... II-7
3.15 Capitalization of Seller................................................... II-7
3.16 Capitalization of Subsidiaries............................................. II-8
3.17 Title to Assets; Leases.................................................... II-8
3.18 Disclosure................................................................. II-8
3.19 Undisclosed Liabilities.................................................... II-8
3.20 Compliance with Federal Reserve Regulations................................ II-8
3.21 Survival of Representations and Warranties................................. II-8
ARTICLE 4 REPRESENTATIONS AND WARRANTIES OF PURCHASER
4.1 Representations and Warranties of Purchaser................................ II-8
4.2 Commissions................................................................ II-9
ARTICLE 5 AFFIRMATIVE COVENANTS
5.1 Financial Statements....................................................... II-10
5.2 Conduct of Business and Maintenance of Existence........................... II-10
5.3 Maintenance of Property; Insurance......................................... II-10
5.4 Strategic Alliance......................................................... II-11
5.5 Recapitalization Charge.................................................... II-11
ARTICLE 6 OTHER PROVISIONS
6.1 Shareholder Approval....................................................... II-11
6.2 Regulatory Approvals....................................................... II-11
6.3 Reservation of Shares...................................................... II-11
</TABLE>
II-i
<PAGE> 90
<TABLE>
<CAPTION>
PAGE
-----
<S> <C> <C>
6.4 Good Faith by Seller....................................................... II-11
6.5 Board of Directors......................................................... II-12
6.6 Voting Agreement........................................................... II-12
6.7 No Solicitation and Other Actions.......................................... II-12
ARTICLE 7 CONDITIONS PRECEDENT TO PURCHASER'S OBLIGATIONS
7.1 Conditions Precedent....................................................... II-13
ARTICLE 8 CONDITIONS PRECEDENT TO SELLER'S OBLIGATIONS
8.1 Conditions Precedent....................................................... II-14
ARTICLE 9 TERMINATION OF AGREEMENT
9.1 Termination................................................................ II-15
9.2 Effect of Termination...................................................... II-15
9.3 Default under the Agreement................................................ II-16
ARTICLE 10 MISCELLANEOUS
10.1 Amendments and Waivers..................................................... II-16
10.2 No Waiver; Cumulative Remedies............................................. II-16
10.3 Notices.................................................................... II-16
10.4 Successors and Assigns..................................................... II-17
10.5 Enforcement Costs.......................................................... II-17
10.6 Counterparts............................................................... II-17
10.7 Term....................................................................... II-17
10.8 Consent to Jurisdiction.................................................... II-17
</TABLE>
EXHIBITS
<TABLE>
<S> <C>
EXHIBIT A Amended Registration Rights Agreement
EXHIBIT B Preferred Stock Designation
EXHIBIT C Intentionally Omitted
EXHIBIT D Form of Registration Rights Agreement
EXHIBIT E Form of Warrant
EXHIBIT F Form of Warrant Registration Rights Agreement
EXHIBIT G Form of Mason Best Commitment
SCHEDULES
SCHEDULE 3.2 Consents
SCHEDULE 3.6 Litigation
SCHEDULE 3.8 Absence of Change
SCHEDULE 3.15 Capitalization of Seller
SCHEDULE 3.16 Capitalization of Subsidiaries
</TABLE>
II-ii
<PAGE> 91
SECURITIES PURCHASE AGREEMENT
THIS SECURITIES PURCHASE AGREEMENT is made this 5th day of November, 1996,
by and between AMERICAN EAGLE GROUP, INC., a Delaware corporation ("Seller"),
and AMERICAN FINANCIAL GROUP, INC., an Ohio corporation ("Purchaser").
ARTICLE 1
INTERPRETATION
SECTION 1.1 Definitions. The following capitalized terms are defined as
follows:
"Affiliate" means any Person which directly or indirectly controls, or is
controlled by, or is under common control with, any Person. The term "control"
means the possession, directly or indirectly, of the power to direct or cause
the direction of the management or policies of a Person, whether through the
ownership of voting securities, by contract or otherwise. The term "Affiliate"
does not include the Purchaser nor any of its subsidiaries or affiliates.
"AFG" shall mean American Financial Group, Inc., an Ohio corporation, and
any of its subsidiaries designated to purchase Seller's securities hereunder.
"Agreement" or "this Agreement" means this Securities Purchase Agreement
(including all exhibits and schedules annexed hereto) as originally executed, or
if supplemented, amended, or restated from time to time, as so supplemented,
amended, or restated.
"Amended Registration Rights Agreement" means the Amended Registration
Rights Agreement in the form of Exhibit A, to be executed by Seller and Mason
Best Company L.P. amending the Registration Rights Agreement between such
parties dated March 21, 1994.
"Bank Debt" means the indebtedness of Seller pursuant to the terms of an
Amended and Restated Credit Agreement dated as of December 29, 1994 among
Seller, the lenders described therein and The First National Bank of Chicago, as
Agent, as amended by Amendments to the Restated Credit Agreement dated as of
February 23, 1996, March 18, 1996, May 3, 1996 and September 20, 1996, and as
may be amended in the future.
"Business Day" means any day, except a Saturday, Sunday or legal holiday,
on which commercial banking institutions are open for business in Dallas, Texas,
Cincinnati, Ohio and New York, New York.
"Capitalized Lease" shall mean any lease the obligation for Rentals with
respect to which is required to be capitalized on a balance sheet of the lessee
in accordance with GAAP.
"Certificate of Designation" shall mean the Certificate of Designation of
the terms of the Preferred Stock, in the form of Exhibit B, to be executed and
filed by Seller authorizing the issuance of, and setting forth the terms of, the
Preferred Stock.
"Closing Date" means the fifth Business Day following the date on which all
conditions precedent specified in Article 7 hereof shall have been satisfied in
full or waived in writing, but in any event, such date shall be within one
hundred eighty (180) days of the execution of this Agreement.
"Code" means the Internal Revenue Code of 1986, as amended from time to
time.
"Commission" shall mean the United States Securities and Exchange
Commission and any successor federal agency having similar powers.
"Common Stock" shall mean the voting Common Stock of the Seller, par value
$.01 per share.
"Commonly Controlled Entity" means an entity, whether or not incorporated,
which is under common control with the Seller within the meaning of Section 4001
of ERISA or is part of a group which includes the Seller and which is treated as
a single employer under Section 414 of the Code.
<PAGE> 92
"Competing Proposal" means any proposal or offer to the Seller or the
stockholders of the Seller with respect to (i) any merger, consolidation, share
exchange, business combination, or other similar transaction, (ii) any sale,
lease, exchange, transfer or other disposition of all or substantially all of
the assets of the Seller and its material Subsidiaries, taken as a whole, in a
single transaction or series of related transactions, or (iii) any tender,
exchange or other offer for shares of the Seller's Stock.
"Contractual Obligation" means, with respect to any Person, any provision
or requirement of any security issued by such Person or of any agreement,
instrument or other undertaking to which such Person is a party or by which it
or any of its property is bound.
"Convertible Securities" shall mean evidence of indebtedness, shares of
stock or other securities which are directly or indirectly convertible into or
exchangeable for, with or without payment of additional consideration, shares of
Stock, either immediately or upon the arrival of a specified date or the
happening of a specified event.
"Director Duty" has the meaning set forth in Section 6.7 hereof.
"Employee Benefit Plan" means any employee benefit plan within the meaning
of Section 3(3) of ERISA, other than a Multiemployer Plan.
"Environmental Laws" means all federal, state and local laws, rules,
regulations, ordinances, permits, orders, writs, judgments, injunctions,
decrees, determinations, awards and consent decrees relating to hazardous
substances and environmental matters applicable to the business, operations or
activities of the Seller or any Subsidiary of the Seller.
"ERISA" means the Employee Retirement Income Security Act of 1974 and the
rules and regulations issued thereunder, as amended from time to time and any
successor statute.
"ERISA Affiliate" means, in relation to any Person, any trade or business
(whether or not incorporated) which is a member of a group of which that Person
is a member and which is under common control within the meaning of the
regulations promulgated under Section 414 of the Code.
"Exchange" means the New York Stock Exchange, Inc.
"Financial Statements" means those audited consolidated financial
statements of Seller and its Subsidiaries for the periods ended December 31,
1995 and those unaudited statements for the nine months ended September 30,
1996, previously delivered to the Purchaser.
"GAAP" means generally accepted accounting principles in the United States
at the time in effect.
"Guarantee Obligation" means, with respect to any Person, any obligation in
the nature of a guaranty, repurchase arrangement, loan or advancement agreement,
reimbursement obligation, comfort letter, hold harmless, indemnity or
counter-indemnity or similar obligation, with respect to any indebtedness,
lease, dividend or other obligations of any other Person, directly or
indirectly, fixed or contingent, matured or unmatured which is required to be
disclosed in the financial statements of Seller under GAAP; provided, however,
that the term shall not include endorsements of instruments for deposit or
collection in the ordinary course of business. The amount of any Guarantee
Obligation shall be deemed to be the maximum amount for which the guaranteeing
person may be liable pursuant to the terms of the instrument embodying such
Guarantee Obligation, or if not stated or determinable, the maximum reasonably
anticipated liability in respect thereof.
"Indebtedness" means, with respect to any Person at any date, (a) all
indebtedness of such Person for borrowed money, (b) indebtedness of such Person
for the deferred purchase price of services or property, which purchase price is
(i) due twelve (12) months or more from the date of incurrence of the obligation
in respect thereof or (ii) is evidenced by a note, bond, debenture or similar
instrument, (c) all obligations of such Person under Capitalized Leases, (d) all
obligations of such Person in respect of acceptances, letters of credit or
similar facilities issued or created for the account of such Person, and (e) all
liabilities secured by any Lien on any property owned by such Person even though
such Person has not assumed or otherwise become liable for the payment thereof.
II-2
<PAGE> 93
"Lien" means any mortgage, pledge, hypothecation, assignment, deposit
arrangement, encumbrance, lien (statutory or other), preference, priority or
other security agreement or preferential arrangement of any kind or nature
whatsoever (including, without limitation, any conditional sale or other title
retention agreement, any Capitalized Lease having substantially the same
economic effect as any of the foregoing, and the filing of any Financing
Statement under the Uniform Commercial Code or comparable law of any
jurisdiction in respect of any of the foregoing). The term "Lien" shall include
reservations, exceptions, encroachments, easements, rights-of-way, covenants,
conditions, restrictions, leases and other title exceptions and encumbrances
affecting property.
"Market Price" per share of Common Stock on any date shall be deemed to be
the average of the daily closing prices for the preceding five business days
before the day in question. The closing price for each day shall be the last
reported sale price regular way or, in case no such reported sale takes place on
such day, the average of the reported closing bid and asked prices regular way,
in either case on the Exchange or, if the Common Stock is not listed or admitted
to trading on the Exchange, on the principal national securities exchange on
which the Common Stock is listed or admitted to trading or, if not listed or
admitted to trading on any national securities exchange, the average of the
closing bid and asked prices as reported by the National Association of
Securities Dealers Automated Quotation System.
"Material Adverse Effect" means a material adverse effect on (a) the
business, operations, property or condition (financial or otherwise) of the
Seller and its Subsidiaries, considered as one entity, (b) the ability of the
Seller to perform its obligations under this Agreement or any other Transaction
Document to which it is a party, or (c) the validity or enforceability of this
Agreement or any of the other Transaction Documents or the rights or remedies of
the Purchaser.
"Multiemployer Plan" means a Plan which is a multiemployer plan as defined
in Section 4001(a)(3) of ERISA.
"Obligations" means, the obligations of the Seller to the Purchaser
presently existing or hereafter arising under any Transaction Documents,
including without limitation, the Seller's obligation to redeem or repurchase
the Preferred Stock in accordance with the terms of the Certificate of
Designation.
"Options" shall mean any options or other rights to subscribe for, purchase
or acquire any Stock.
"PBGC" means the Pension Benefit Guaranty Corporation.
"Permitted Liens" shall mean:
(a) liens securing the Bank Debt;
(b) liens arising by operation of law for taxes not yet due and
payable;
(c) statutory liens of mechanics, materialmen, shippers and
warehousemen for services or materials for which payment is not yet due and
which occur in the ordinary course of business;
(d) liens, charges, encumbrances and priority claims incidental to the
conduct of business or the ownership of properties and assets or other
liens of like general nature incurred in the ordinary course of business
and not in connection with the borrowing of money, provided in each case,
the obligation secured is not overdue or, if overdue is being contested in
good faith and by appropriate and lawful proceedings promptly initiated and
diligently conducted (of which the Seller has given prior written notice to
the Purchaser) and for which appropriate reserves (in accordance with GAAP)
have been established and so long as levy and execution have been and
continue to be stayed;
(e) liens incurred or pledges or deposits made in the ordinary course
of business in connection with workers' compensation, unemployment
insurance and other types of social security; and
(f) liens imposed by law, such as carriers', warehousemen's or
mechanics' liens, incurred by it in good faith in the ordinary course of
business, and liens arising out of a judgment or award against it with
respect to which it will currently be prosecuting an appeal, a stay of
execution pending such appeal having been secured.
II-3
<PAGE> 94
"Person" means an individual, partnership, corporation, business trust,
joint stock company, trust, unincorporated association, joint venture, limited
liability company, governmental authority or other entity of whatever nature.
"Preferred Stock" means the shares of Series D Preferred Stock of the
Seller issued pursuant to the terms of the Certificate of Designation.
"Preferred Stock Certificate" means the stock certificate of Seller
representing 350,000 shares of Preferred Stock to be issued to Purchaser.
"Purchased Securities" means the 350,000 shares of Preferred Stock
purchased pursuant to the terms of this Agreement.
"Registration Rights Agreement" means the Registration Rights Agreement to
be executed between Seller and Purchaser on or before the Closing in the form of
Exhibit D attached hereto.
"Rentals" shall mean and include all fixed rents (including as such all
payments which the lessee is obligated to make to the lessor on termination of
the lease or surrender of the property) payable by the Seller or its
Subsidiaries, as lessee or sublessee under a lease of real or personal property,
but shall be exclusive of any amounts required to be paid by the Seller or its
Subsidiaries (whether or not designated as rents or additional rents) on account
of maintenance, repairs, insurance, taxes and similar charges.
"Reportable Event" means any of the events set forth in Section 4043(b) of
ERISA, other than those events as to which the thirty (30) day notice period is
waived under subsections .13, .14, .16, .18, .19 or .20 of PBGC Reg. Section
2615.
"Requirements of Law" means, with respect to any Person, the Certificate of
Incorporation and By-Laws or other organizational or governing documents of such
Person, and any law, treaty, rule or regulation or determination of any
governmental or political subdivision of any agency, authority, bureau, central
bank, commission, department or any court, arbitrator, or grand jury, in each
case whether foreign or domestic, applicable to or binding upon such Person or
any of its property or to which such Person or any of its property is subject.
"Responsible Officer" means, with respect to any Person, the (i) chief
executive officer or the president of such Person, and (ii) with respect to
financial matters, the chief financial officer, or any vice president with
financial responsibilities of such Person.
"Stock" shall mean all classes and categories of the capital stock of the
Seller or any of its Subsidiaries whether then issued or issuable, including
without limitation, the Common Stock.
"Stock Purchase Rights" shall mean Options and Convertible Securities.
"Subsidiary" means, with respect to any Person, a corporation, partnership
or other entity of which shares of stock or other ownership interests having
ordinary voting power to elect a majority of the board of directors or other
managers of such corporation, partnership or other entity are at the time owned,
or the management of which is otherwise controlled, directly or indirectly,
through one or more intermediaries, or both, by such Person. Unless otherwise
qualified, all references to a "Subsidiary" or to "Subsidiaries" in this
Agreement shall refer to any Subsidiary or all Subsidiaries of the Seller,
whether now in existence or hereafter organized.
"Transaction Documents" means this Agreement, the Warrants, the Preferred
Stock Certificate, the Certificate of Designation, the Warrant Registration
Rights Agreement, the Registration Rights Agreement, the Amended Registration
Rights Agreement, and all other documents, instruments, certificates and other
agreements in connection with the sale of the Purchased Securities.
"Underlying Shares" means shares of Common Stock issued or issuable upon
exercise of conversion rights relating to the Preferred Stock or exercise of
warrants issued upon redemption of Preferred Stock.
"Uniform Commercial Code" or "UCC" means the Uniform Commercial Code in
each case in effect in the jurisdiction where the Collateral is located.
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"Warrant" or "Warrants" means one or more of the Warrants for the purchase
of 800,000 shares of Common Stock issued by Seller to the Purchaser on the date
hereof, a copy of which is attached hereto as Exhibit E.
"Warrant Holder" and "Warrant Holders" shall mean the Purchaser and any
subsequent holder of the Warrants.
"Warrant Registration Rights Agreement" means the Registration Rights
Agreement executed contemporaneously herewith and attached hereto as Exhibit F.
SECTION 1.2 Rules of Construction. (a) Use of Capitalized Terms. For
purposes of this Agreement, unless the context otherwise requires, the
capitalized terms used in this Agreement shall have the meanings herein assigned
to them, and such definitions shall be applicable to both singular and plural
forms of such terms.
(b) Construction. All references in this Agreement to the single number and
neuter gender shall be deemed to mean and include the plural number and all
genders, and vice versa, unless the context shall otherwise require.
(c) Headings. The underlined headings contained herein are for convenience
only and shall not affect the interpretation of this Agreement.
(d) Entire Agreement. This Agreement and the other Transaction Documents
shall constitute the entire agreement of the parties with respect to the subject
matter hereof.
(e) Severability. Any provision of this Agreement which is prohibited or
unenforceable in any jurisdiction shall, as to such jurisdiction, be ineffective
to the extent of such prohibition or unenforceability without invalidating the
remaining provisions hereof, and any such prohibition or unenforceability in any
jurisdiction shall not invalidate or render unenforceable such provision in any
other jurisdiction.
(f) Governing Law. This Agreement and the rights and obligations of the
parties under this Agreement shall be governed by, and construed and interpreted
in accordance with, the law of the State of Delaware.
ARTICLE 2
SALE AND PURCHASE OF PURCHASED SECURITIES
SECTION 2.1 Sale and Purchase of Purchased Securities. Subject to all of
the terms and conditions hereof and in reliance on the representations and
warranties set forth or referred to herein, the Seller agrees to issue and sell
to the Purchaser, and the Purchaser agrees to purchase, the Purchased Securities
from the Seller on the Closing Date.
SECTION 2.2 Purchase Price. The aggregate purchase price for the Purchased
Securities is Thirty-Five Million and 00/100 Dollars ($35,000,000.00) (the
"Purchase Price").
SECTION 2.3 Delivery of Warrants. In consideration for the execution and
delivery of this Agreement by Purchaser; contemporaneously with the execution of
this Agreement, the Seller shall deliver the Warrants and the Warrant
Registration Rights Agreement to Purchaser. If the Seller terminates this
Agreement on or before the Closing Date pursuant to Section 9.1(e) or (f)
hereof, the Warrants shall become immediately exercisable. Upon Closing (as
defined below), the Warrants and the Warrant Registration Rights Agreement will
be cancelled.
SECTION 2.4 Closing. The Closing of the purchase and sale of the Purchased
Securities (the "Closing") will take place at the offices of the Seller in
Dallas, Texas on the date that all conditions to closing have been met or waived
(the "Closing Date") or such other location and date as the parties may mutually
agree. At the Closing, the Seller will deliver the Purchased Securities to the
Purchaser against payment by the Purchaser of the Purchase Price in immediately
available funds. The Purchased Securities will be issued to the Purchaser on the
Closing Date and registered in the Purchaser's name on the Seller's records.
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SECTION 2.5 Use of Proceeds. Substantially all proceeds of the sale of the
Purchased Securities shall be used by the Seller to pay transaction expenses and
for general corporate purposes. Seller shall also use such proceeds to repay
Bank Debt to the extent repayment is consistent with banking, regulatory and
rating agency considerations of Seller.
ARTICLE 3
REPRESENTATIONS AND WARRANTIES OF SELLER
In order to induce the Purchaser to enter into this Agreement, the Seller
hereby represents and warrants to the Purchaser that:
SECTION 3.1 Corporate Existence. Each of the Seller and its Subsidiaries
now in existence is a corporation duly organized, validly existing, and in good
standing under the laws of its jurisdiction of incorporation, with full power
and authority to conduct its respective business as presently conducted. Each of
the Seller and its Subsidiaries is duly qualified as a foreign corporation and
in good standing in all other jurisdictions in which their respective activities
or ownership of property requires such qualification, except where the failure
to be so qualified would not have a Material Adverse Effect.
SECTION 3.2 Corporate Power; Authorization. Subject to the approval of the
stockholders of Seller of the transactions contemplated by this Agreement, the
Seller has the corporate power and authority to make, deliver and perform this
Agreement and such other Transaction Documents to which it is a party and has
taken, or by the Closing Date will have taken, all necessary corporate action to
authorize the issuance of the Purchased Securities on the terms and conditions
of this Agreement and to authorize the execution, delivery and performance of
this Agreement and such other Transaction Documents to which it is a party. No
consent or authorization of, or filing with, any Person (including, without
limitation, any governmental authority or agency having jurisdiction over the
Seller or its Subsidiaries), is required to be made or obtained by Seller in
connection with the issuance of the Purchased Securities or the execution,
delivery and performance by the Seller, and the validity or enforceability (with
respect to the Seller) of this Agreement, or such other Transaction Documents to
which Seller is a party, except for consents and filings referred to or
disclosed on Schedule 3.2.
SECTION 3.3 Enforceable Obligations. This Agreement, the Warrant and the
other Transaction Documents have been, or on or prior to the Closing Date will
be, duly executed and delivered on behalf of the Seller, and constitute, or will
constitute, the legal, valid and binding obligation of the Seller, enforceable
against it in accordance with their terms, except as enforceability may be
limited by applicable bankruptcy, insolvency, reorganization, moratorium, or
similar laws affecting the enforcement of creditors' rights generally and by
general principles of equity (regardless of whether enforcement is sought in a
proceeding in equity or at law).
SECTION 3.4 No Legal Bar. Except as set forth on Schedule 3.2, the
execution, delivery and performance of this Agreement, the Warrant and the other
Transaction Documents and the consummation of the transactions contemplated
thereby, will not violate any Requirements of Law or any Contractual Obligation
of the Seller or its Subsidiaries.
SECTION 3.5 Absence of Conflicts. Except as set forth on Schedule 3.2,
neither the execution and delivery of this Agreement, the Warrant or the other
Transaction Documents, the consummation of the transactions contemplated by such
documents nor the performance of or compliance with the terms and conditions of
such documents will (i) result in a breach of or a default under any agreement
or instrument to which the Seller or any Subsidiary of the Seller is a party or
by which their properties may be subject or bound, or (ii) except as
contemplated by such documents, result in the creation or imposition of any Lien
upon any property of the Seller or any Subsidiary of the Seller.
SECTION 3.6 Litigation. Except as set forth on Schedule 3.6, to the
knowledge of the Seller, no litigation, investigation or proceeding of or before
any arbitrator or governmental authority is pending or threatened by or
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against the Seller or against any Subsidiary of the Seller or any of their
properties or revenues, existing or future which could have a Material Adverse
Effect.
SECTION 3.7 Financial Condition. The Financial Statements delivered to
Purchaser fairly present the assets, liabilities and financial condition of the
Seller and its Subsidiaries, as of the dates thereof and in accordance with GAAP
(except that any unaudited Financial Statements may not contain any or all of
the footnotes required by GAAP and are subject to usual year-end audit
adjustments not materially affecting the results of operations). The Financial
Statements of Seller and its Subsidiaries contain no omissions or misstatements
which are or may be material to the Seller and its Subsidiaries, treated as one
entity. There has been no material adverse change in the assets, liabilities,
business or financial condition of the Seller and its Subsidiaries, treated as
one entity, since the date of such Financial Statements. Except for trade
payables arising in the ordinary course of business since the dates reflected in
such Financial Statements, the Seller and its Subsidiaries have no Indebtedness
and no Guarantee Obligations other than as reflected in such Financial
Statements. The Financial Statements of Seller and its Subsidiaries, including
the related schedules and notes thereto, have been prepared in accordance with
GAAP consistently applied throughout the periods involved (except that any
unaudited Financial Statements may not contain any or all of the footnotes
required by GAAP and are subject to year end audit adjustments).
SECTION 3.8 No Change. Except as set forth on Schedule 3.8, since September
30, 1996 through the date of this Agreement, to the knowledge of the Seller,
there has been no development or event, which has had or could reasonably be
expected to have a Material Adverse Effect, and no dividends or other
distributions have been declared, paid or made upon any shares of the Stock of
the Seller or its Subsidiaries, nor has any of such Stock been redeemed,
retired, purchased or otherwise acquired for value by the Seller or its
Subsidiaries.
SECTION 3.9 No Default. Neither the Seller nor any Subsidiary of the Seller
is in default under or with respect to any of its Contractual Obligations in any
respect which could reasonably be expected to have a Material Adverse Effect.
SECTION 3.10 Compliance with Laws. Except for any violation which,
individually or in the aggregate, would not have a Material Adverse Effect,
Seller and its Subsidiaries are in compliance with all Requirements of Law.
SECTION 3.11 Taxes. The Seller has filed or caused to be filed all tax
returns which are required to be filed by it or any of its Subsidiaries and all
taxes shown to be due and payable on said returns or on any assessments made
against it, any Subsidiary or any of their property, and all other taxes, fees
or other charges imposed on Seller, any Subsidiary of Seller or any of their
property by any governmental authority that are due and payable, have been paid
(other than any taxes, fees or other charges the amount or validity of which are
currently being contested in good faith by appropriate proceedings and with
respect to which adequate reserves in conformity with GAAP have been provided on
the books of the Seller or such Subsidiary); to the knowledge of Seller, no tax
Lien has been filed and no claim is being asserted, with respect to any such
tax, fee or other charge.
SECTION 3.12 ERISA. Seller and its ERISA Affiliates are in compliance, in
all material respects, with any applicable provisions of ERISA and the
regulations thereunder and the Code, with respect to all Employee Benefit Plans.
SECTION 3.13 Environmental Matters. Except for any violation which,
individually or in the aggregate, would not have a Material Adverse Effect,
neither the Seller nor any of its Subsidiaries is in violation of any
Environmental Law.
SECTION 3.14 Investment Company Act. Neither the Seller nor any of its
Subsidiaries is an "investment company" or a company "controlled" by an
"investment company," within the meaning of the Investment Company Act of 1940,
as amended.
SECTION 3.15 Capitalization of Seller. Schedule 3.15 hereto states the
authorized capitalization of the Seller and the number of shares of each class
of Stock of the Seller issued and outstanding thereof. All such issued and
outstanding shares have been duly authorized and validly issued, are fully paid
and nonassessable
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and free of any claims of preemptive rights. Other than as created pursuant to
this Agreement and stock option plans adopted prior to the date hereof by
Seller, there are no outstanding Stock Purchase Rights issued by the Seller.
SECTION 3.16 Capitalization of Subsidiaries. Schedule 3.16 attached hereto
contains a list of the Subsidiaries of the Seller, the jurisdictions of
incorporation applicable thereto and the percentage of the voting common stock
or other issued capital stock thereof owned by the Seller or its Subsidiaries.
There are no Stock Purchase Rights issued by any Subsidiary of the Seller. The
Seller or its Subsidiaries, as the case may be, have good and valid title to all
shares they purport to own of the capital stock of each such Subsidiary, free
and clear in each case of any Lien, except liens securing the Bank Debt. All
Stock of each Subsidiary has been duly issued and is fully paid and
non-assessable.
SECTION 3.17 Title to Assets; Leases. The Seller and its Subsidiaries will
own all of the assets reflected in the Financial Statements as of the Closing
Date, subject to no Liens other than Permitted Liens except for assets sold
prior thereto in the ordinary course of business. Each of the Seller and its
Subsidiaries enjoys peaceful and undisturbed possession, and is in compliance
with the terms of all leases of real property on which facilities operated by
them are situated and of all leases of personal property, except where failure
to enjoy such possession or such noncompliance would not have a Material Adverse
Effect.
SECTION 3.18 Disclosure. No representation or warranty made by the Seller
in this Agreement or in any other document furnished in connection herewith
contains any misrepresentation of a material fact or omits to state any material
fact necessary to make the statements herein or therein not misleading.
SECTION 3.19 Undisclosed Liabilities. Neither the Seller nor any Subsidiary
of Seller has any material obligation or liability (whether accrued, absolute,
contingent, unliquidated, or otherwise, whether due or to become due) arising
out of transactions entered into at or prior to the Closing Date, or any action
or inaction at or prior to the Closing Date, except liabilities reflected on the
Financial Statements or notes thereto; liabilities incurred in the ordinary
course of business (none of which are liabilities for breach of contract, breach
of warranty, torts, infringements, claims or lawsuits); liabilities or
obligations disclosed in the schedules hereto; and liabilities or obligations
incurred pursuant to the Transaction Documents.
SECTION 3.20 Compliance with Federal Reserve Regulations. None of the
transactions contemplated in the Agreement will violate or result in a violation
of Section 7 of the Securities Exchange Act of 1934, as amended, or any
regulation issued pursuant thereto, including, without limitation, Regulations
G, T, U and X of the Board of Governors of the Federal Reserve System, 12
C.F.R., Chapter II.
SECTION 3.21 Survival of Representations and Warranties. The foregoing
representations and warranties are made by the Seller with the knowledge and
intention that the Purchaser will rely thereon and shall survive the execution
and delivery of this Agreement until the Closing Date.
ARTICLE 4
REPRESENTATIONS AND WARRANTIES OF PURCHASER
SECTION 4.1 Representations and Warranties of Purchaser. In order to induce
the Seller to enter into this Agreement, the Purchaser hereby represents and
warrants to the Seller as set forth in this Section 4.1.
(a) Corporate Existence. The Purchaser is a corporation duly
organized, validly existing and in good standing under the laws of its
jurisdiction of incorporation.
(b) Corporate Power; Authorization.
(i) Authorization and Compliance With Law. The Purchaser has the
corporate power and authority to make, deliver and perform this
Agreement and the other Transaction Documents to which it is a party.
The execution, delivery and performance of this Agreement by the
Purchaser and such other Transaction Documents to which it is a party,
and the acquisition of the Warrant and the Purchased Securities pursuant
to the terms hereof or thereof, have been duly authorized by all
necessary action, corporate and otherwise, on the part of the Purchaser.
The execution, delivery and
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performance of this Agreement by the Purchaser and such other
Transaction Documents to which it is a party, the acquisition and
ownership of the Warrant or the Purchased Securities issued to the
Purchaser and the consummation of the transactions contemplated by the
foregoing, do not and will not violate any Requirements of Law
applicable to the Purchaser or any Contractual Obligation of the
Purchaser.
(ii) Approvals. No authorization, consent, approval, license or
filing with any Person (including, without limitation, any governmental
authority or agency having jurisdiction over the Purchaser) is or will
be necessary for the valid execution, delivery or performance of this
Agreement by the Purchaser and such other Transaction Documents to which
it is a party, the acquisition and ownership of the Warrant and/or the
Purchased Securities issued to the Purchaser or the consummation of the
transactions contemplated by the foregoing, or the validity or
enforceability (with respect to the Purchaser) of this Agreement, or
such other Transaction Documents to which the Purchaser is a party.
(c) Enforceable Obligations. This Agreement and the other Transaction
Documents to which the Purchaser, is a party have been, or on or prior to
the Closing Date will be, duly executed and delivered on behalf of the
Purchaser, and constitute or will constitute the legal, valid and binding
obligation of the Purchaser, enforceable against it in accordance with
their terms, except as enforceability may be limited by applicable
bankruptcy, insolvency, reorganization, moratorium, or similar laws
affecting the enforcement of creditors' rights generally and by general
principles of equity (regardless of whether enforcement is sought in a
proceeding in equity or at law).
(d) Investment Representations of the Purchaser.
(i) No Distributive Intent; Restricted Securities. The Purchaser is
acquiring the Purchased Securities and Warrants for its own account with
no present intention of reselling or otherwise distributing any of the
Purchased Securities or the Warrants or participating in a distribution
of such Purchased Securities or Warrants in violation of the Securities
Act, or any applicable state securities laws. The Purchaser acknowledges
that it has been advised and is aware that (A) the Seller is relying
upon an exception under the Securities Act predicated upon the
Purchaser's representations and warranties contained in this Agreement
in connection with the issuance of the Purchased Securities and the
Warrants pursuant to this Agreement, (B) the Purchased Securities and
the Warrants in the hands of the Purchaser will be "restricted
securities" within the meaning of Rule 144 promulgated by the Commission
pursuant to the Securities Act and, unless and until registered under
the Securities Act, will be subject to limitations on resale (including,
among others, limitations on the amount of securities that can be resold
and the timing and manner of resale) set forth in Rule 144 or in
administrative interpretations of the Securities Act by the Commission
or in other rules and regulations promulgated thereunder by the
Commission, in effect at the time of the proposed sale or other
disposition of the Purchased Securities or the Warrants, and (C) the
Purchaser has no registration rights except as provided for in the
Registration Rights Agreement, and the Seller has no plans to register
any securities except in accordance with those rights.
(e) Survival of Representations and Warranties. The foregoing
representations and warranties are made by the Purchaser with the knowledge
and intention that the Seller will rely thereon and shall survive the
execution and delivery of this Agreement.
SECTION 4.2 Commissions. (a) No Commissions of Purchaser. No outside
parties have participated with respect to the negotiation of this Agreement and
the transactions contemplated hereby on behalf of the Purchaser and the
Purchaser shall indemnify and hold the Seller harmless with respect to any claim
for any broker's or finder's fees or commissions with respect to the
transactions contemplated hereby by anyone found to have been acting on behalf
of the Purchaser.
(b) No Commissions of Seller. Seller shall indemnify and hold the Purchaser
harmless with respect to any claim for any broker's or finder's fees or
commissions with respect to the transactions contemplated hereby by anyone found
to have been acting on behalf of the Seller.
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ARTICLE 5
AFFIRMATIVE COVENANTS
SECTION 5.1 Financial Statements. So long as any of the Warrants or
Purchased Securities are outstanding, the Seller will comply, and will cause
each of its Subsidiaries, where applicable, to comply, with the following
provisions:
(a) Year End Report. If the Seller has no securities registered under
Section 12 of the Securities Exchange Act of 1934, as amended, as soon as
available, but in any event within ninety (90) days after the end of each
fiscal year of the Seller, Seller shall deliver to the Purchaser copies of
the audited consolidated financial statements of the Seller and its
Subsidiaries including the balance sheets as at the end of such year and
the related statements of income and retained earnings and of cash flows
for such year, in each case containing in comparative form the figures for
the previous year. Such financial statements shall be accompanied by an
opinion of a firm of independent certified public accountants of nationally
recognized standing reasonably acceptable to the Purchaser, stating that
such financial statements fairly present the respective financial positions
of the Seller and its Subsidiaries, as the case may be, and the results of
operations and changes in financial position for the fiscal year then ended
in conformity with GAAP.
(b) Quarterly Reports. If the Seller has no securities registered
under Section 12 of the Securities Exchange Act of 1934, as amended, as
soon as available, but in any event not later than forty-five (45) days
after the end of each fiscal quarter (except the last fiscal quarter) of
each fiscal year, the Seller shall deliver to the Purchaser copies of the
unaudited consolidated balance sheets of the Seller and its Subsidiaries as
at the end of such quarter and the related unaudited statements of income
and retained earnings and of cash flows for such quarter and the portion of
the fiscal year through the end of such quarter, setting forth in each case
in comparative form the figures for the previous year, certified by a
Responsible Officer of the Seller as being properly prepared, complete and
correct in all material respects (subject to normal year-end audit
adjustments).
All of such financial statements shall be complete and correct in all material
respects and be prepared in reasonable detail and in accordance with GAAP
applied consistently throughout the periods reflected therein and with prior
periods.
(c) Commission and Other Reports. Promptly upon becoming available,
Seller shall furnish, or if necessary cause its Subsidiaries to furnish,
one copy of each financial statement, report, notice or proxy statement
required to be sent by the Seller or any of its Subsidiaries to
stockholders generally and of each regular or periodic report filed by the
Seller or any of its Subsidiaries with any securities exchange or the
Commission or any successor agency, and copies of any orders in any
proceedings to which the Seller or any of its Subsidiaries is a party,
issued by any governmental agency, federal or state, having jurisdiction
over the Seller or any of its Subsidiaries, which could have a Material
Adverse Effect.
SECTION 5.2 Conduct of Business and Maintenance of Existence. Prior to the
Closing Date, Seller will, and will cause each of its Subsidiaries to, preserve,
renew and keep in full force and effect its corporate existence and take all
reasonable action to maintain all rights, privileges and franchises necessary or
desirable in the normal conduct of its business. Seller shall, and shall cause
each of its Subsidiaries to, comply with all Contractual Obligations and
Requirements of Law, except to the extent the failure to comply therewith could
not be reasonably expected to have a Material Adverse Effect.
SECTION 5.3 Maintenance of Property; Insurance. Prior to the Closing Date,
the Seller will maintain, preserve and keep, and will cause its Subsidiaries to
maintain, preserve and keep, its properties which are used or useful in the
conduct of its business (whether owned in fee or a leasehold interest) in good
repair and working order and from time to time make all necessary repairs,
replacements, renewals and additions so that at all times the efficiency
thereof, in all material respects, shall be maintained. Seller shall maintain,
and shall cause each of its Subsidiaries to maintain, with financially sound and
reputable insurance companies, insurance on all of their real and personal
property in such forms and amounts and against such risks as are
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usually insured against in the same general area by companies engaged in the
same or a similar business; and furnish to the Purchaser, upon written request,
full information as to the insurance carried.
SECTION 5.4 Strategic Alliance. (a) After the Closing, the Purchaser agrees
to provide to Seller a facility that will permit Seller to offer workers
compensation insurance to its aviation insureds.
(b) After the Closing, Purchaser and Seller shall negotiate, in good faith,
the terms of an underwriting management agreement pursuant to which Seller shall
offer to provide underwriting and claims management services to Purchaser for
those lines of aviation insurance that Seller currently underwrites, and
Purchaser shall offer to provide Seller, where commercially desirable,
underwriting capacity of an insurance carrier rated "A" by A.M. Best Company.
(c) The Purchaser and Seller agree to fulfill their respective obligations
under this Section through their appropriate subsidiaries. The Purchaser and
Seller agree to negotiate, in good faith, terms of agreements that are mutually
agreeable.
SECTION 5.5 Recapitalization Charge. Seller agrees that it will record a
Fifteen Million and 00/100 Dollar ($15,000,000.00) (pre-tax) recapitalization
charge in its financial results for the quarter in which this transaction is
recorded.
ARTICLE 6
OTHER PROVISIONS
SECTION 6.1 Shareholder Approval. The Seller shall take such action
necessary to obtain shareholder approval of the transactions contemplated herein
as promptly as practicable after the execution of this Agreement. As soon as
practicable following the date hereof, the Purchaser and the Seller shall
cooperate to prepare promptly and file with the SEC a Proxy or Information
Statement with respect to the transactions contemplated by this Agreement (the
"Information Statement"). Promptly after the approval by the staff of the
Commission of the Information Statement, the Seller shall mail the Information
Statement to all holders of the Seller's Common Stock. The Purchaser and the
Seller shall cooperate with each other in the preparation of the Information
Statement and shall advise the other in writing if, prior to the vote of the
shareholders of the Seller, any such party shall obtain knowledge of any facts
that might make it necessary or appropriate to amend or supplement the
Information Statement in order to make the statements contained or incorporated
by reference therein not misleading or to comply with applicable law.
Notwithstanding the foregoing, each party shall be responsible for the
information and disclosures which it makes or incorporates by reference in all
regulatory filings and the Information Statement.
SECTION 6.2 Regulatory Approvals. Seller and Purchaser shall promptly apply
for and use their commercially reasonable best efforts to obtain all applicable
federal and state regulatory approvals and other approvals required to
effectuate the provisions of this Agreement, including all filings under
Hart-Scott-Rodino and with the appropriate state insurance commissions.
SECTION 6.3 Reservation of Shares. The Seller agrees to authorize and
reserve for issuance a sufficient number of authorized but unissued shares of
Common Stock and Preferred Stock for the purposes of this Agreement and to take
such action as may be necessary to ensure that all shares of Common Stock issued
upon exercise of the Warrants or upon conversion of the Preferred Stock will be
duly and validly authorized and issued, fully paid and nonassessable and that
all shares of Preferred Stock issued at the Closing or thereafter issued to
Purchaser pursuant to the Certificate of Designation will be duly and validly
authorized and issued, fully paid and nonassessable.
SECTION 6.4 Good Faith by Seller. The Seller will not, by amendment to its
certificate of incorporation or through any reorganization, reclassification, or
any other means, avoid or seek to avoid the observance or performance of any of
the terms of Articles 6 hereof, but will at all times in good faith carry out
all such terms and take all such action as may be necessary or appropriate to
protect the rights of the Purchaser.
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SECTION 6.5 Board of Directors. Purchaser shall have the rights set forth
in this Section until the earlier of (i) the time that Purchaser and its
Affiliates no longer own Preferred Stock and Underlying Shares representing in
the aggregate the ownership, or right to acquire ownership, of fifty-one percent
(51%) of the Underlying Shares or (ii) the seventh anniversary of the Closing
Date. Purchaser may nominate for election to Seller's Board of Directors and the
Seller shall place on the proxy sent to its shareholders, applicable nominees
who represent thirty percent (30%) (rounded up to the next director) of the
number of directors serving at any one time, and at least one of the directors
representing the Purchaser shall serve on each of the standing committees of the
Board of Directors. Notwithstanding the foregoing, the number of directors which
the Purchaser shall be entitled to nominate pursuant to this Section 6.5 shall
be reduced to the extent and by the number of directors the holders of Preferred
Stock are entitled to elect as a class under the terms of the Certificate of
Designation. In the event the Purchaser's representatives fail to be elected as
directors, Seller agrees that Purchaser shall be entitled to have an equal
number of representatives in place of such directors attend each meeting of the
Board of Directors. Such representatives shall be entitled to receive all
materials and information provided to Seller's Board of Directors and shall
receive the same notice as is given to the Seller's Board of Directors.
SECTION 6.6 Voting Agreement. For so long as Purchaser and its Affiliates
shall beneficially own Preferred Stock or Underlying Shares which represent in
the aggregate the ownership, or right to acquire ownership, of at least
fifty-one percent (51%) of the Underlying Shares, the Purchaser shall and shall
cause its Affiliates, to vote all shares of Preferred Stock and Common Stock
held by Purchaser or its Affiliates as follows:
(a) With respect to any matter on which the holders of Common Stock
have the right to vote, if Purchaser and its Affiliates hold any
combination of Preferred Stock and Common Stock that represents the right
to vote more than 20% of the total votes eligible to be voted on such
matter, then Purchaser agrees to vote all of its votes in excess of such
20% in proportion to the actual vote of holders of all remaining votes
(including the Purchaser's 20% vote);
(b) The voting agreement contained in this Section will terminate and
expire on the date that is three years and one hundred eighty (180) days
after the Closing Date.
(c) Purchaser agrees that all certificates representing shares of
Preferred Stock or Underlying Shares shall contain a legend referencing the
foregoing restrictions on voting rights for so long as such restrictions
are applicable.
SECTION 6.7 No Solicitation and Other Actions. (a) From and after the date
of this Agreement and except as set forth in subsection 6.7(b), the Seller shall
not, and the Seller shall direct and use its reasonable best efforts to cause
the officers, directors, employees, agents, advisors and other representatives
of the Seller not to, directly or indirectly, (i) solicit, initiate, knowingly
encourage, or participate in discussions or negotiations regarding, any
proposals or offers from any Person (an "Offeror") relating to any Competing
Proposal, or (ii) furnish to any other Offeror any non-public information or
access to such information with respect to, or otherwise concerning, any
Competing Proposal. The Seller shall immediately cease and cause to be
terminated any existing discussions or negotiations with any Person conducted
heretofore with respect to any proposed Competing Proposal.
(b) Notwithstanding anything to the contrary contained in this Section 6.7
or in any other provision of this Agreement, until the Shareholders of the
Seller have approved the transactions contemplated by this Agreement, the Seller
shall not be prohibited by this Agreement from (i) participating in discussions
or negotiations with, and, during such period, the Seller may furnish
information to, an Offeror that seeks to engage in discussions or negotiations,
requests information or makes a proposal to acquire the Seller pursuant to a
Competing Proposal, if the Seller's directors determine in good faith that such
action is required for the discharge of their fiduciary obligations, after
consultation with independent legal and financial advisors, who may be the
Seller's regularly engaged legal counsel and financial advisors (a "Director
Duty"); (ii) complying with Rule 14d-9 or Rule 14e-2 promulgated under the
Securities Exchange Act of 1934 (the "Exchange Act") with regard to a tender or
exchange offer; (iii) making any disclosure to the Seller's shareholders in
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accordance with a Director Duty; (iv) failing to make, modifying or amending its
recommendations, consents or approvals referred to herein in accordance with a
Director Duty; (v) terminating this Agreement and entering into an agreement
providing for a Competing Proposal in accordance with a Director Duty; or (vi)
take any other action as may be appropriate in order for the Seller's Board of
Directors to act in a manner that is consistent with its fiduciary obligations
under applicable law. In the event that the Seller or any of its officers,
directors, employees, agents, advisors or other representatives participate in
discussions or negotiations with, or furnish information to an Offeror that
seeks to engage in such discussions or negotiations, requests information or
makes a Competing Proposal, then, subject to any confidentiality requirements of
an Offeror (i) the Seller shall immediately disclose to the Purchaser the
decision of the Seller's directors; (ii) the identity of the Offeror; and (iii)
copies of all information or material not previously furnished to Purchaser
which the Seller, or its agents, provides or causes to be provided to such
Offeror or any of its officers, directors, employees, agents, advisors or
representatives.
ARTICLE 7
CONDITIONS PRECEDENT TO PURCHASER'S OBLIGATIONS
SECTION 7.1 Conditions Precedent. The obligation of the Purchaser to
purchase the Purchased Securities pursuant to this Agreement on the Closing Date
is subject to the satisfaction or waiver in writing of the following conditions
precedent (in form, substance and action as is reasonably satisfactory to
Purchaser):
(a) Certified Copies of Charter Documents. The Purchaser shall have
received from the Seller and each of its Subsidiaries a copy, certified by
a duly authorized officer of the Seller to be true and complete on and as
of the Closing Date, of each of the charter or other organization documents
and by-laws of the Seller or each Subsidiary each as in effect on such date
of certification (together with all, if any, amendments thereto);
(b) Proof of Appropriate Action. The Purchaser shall have received
from the Seller a copy, certified by a duly authorized officer of the
Seller to be true and complete on and as of the Closing Date, of the
records of all action taken by the board of directors and shareholders of
the Seller to authorize the execution and delivery of this Agreement, each
of the Transaction Documents and any other agreements entered into on the
Closing Date and to which it is a party or is to become a party as
contemplated or required by this Agreement, and its performance in all
material respects of all of its agreements and obligations under each of
such documents;
(c) Incumbency Certificates. The Purchaser shall have received from
the Seller an incumbency certificate, dated the Closing Date, signed by a
duly authorized officer of the Seller and giving the name and bearing a
specimen signature of each individual who shall be authorized to sign, in
the name and on behalf of the Seller this Agreement and each of the other
Transaction Documents to which such person is or is to become a party on
the Closing Date, and to give notices and to take other action on behalf of
the Seller under such documents;
(d) Representations and Warranties. Each of the representations and
warranties made by and on behalf of the Seller and its Subsidiaries to the
Purchaser in this Agreement and in the other Transaction Documents shall be
true and correct when made and the representations and warranties contained
in Sections 3.15 and 3.16 hereof shall be true and correct as of the
Closing Date;
(e) Transaction Documents. Each of the Transaction Documents shall
have been duly and properly authorized, executed and delivered to the
Purchaser and filed by Seller, if required of Seller to be effective and
shall be in full force and effect on and as of the Closing Date;
(f) Legality of Transactions. No change in applicable law shall have
occurred as a consequence of which it shall have become and continue to be
unlawful for the Purchaser to perform any of its agreements or obligations
under this Agreement, or under any of the other Transaction Documents, or
for the Seller or any Subsidiary of the Seller to perform any of its
agreements or obligations under this Agreement or under any of the other
Transaction Documents;
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(g) Performance, Etc. The Seller shall have duly and properly
performed, complied with and observed its respective covenants, agreements
and obligations contained in each of the Transaction Documents in all
material respects.
(h) Legal Opinions. The Purchaser shall have received a written legal
opinion of counsel to Seller, addressed to the Purchaser, dated the Closing
Date, which shall be reasonably acceptable to the Purchaser;
(i) Consents. The Purchaser and Seller shall have received all
consents necessary for the completion of the transactions contemplated by
this Agreement and each of the Transaction Documents, including any
regulatory approvals and all instruments and documents incidental thereto.
(j) Amended Registration Rights Agreement. Mason Best Company L.P. and
Seller shall have entered into the Amended Registration Rights Agreement.
(k) Commitment of Mason Best Company L.P. Within five (5) days after
the date hereof, the Purchaser shall have received a written commitment
from Mason Best Company L.P. substantially in the form of the attached
Exhibit "G" that it will vote its shares of Common Stock in favor of (i)
the transactions contemplated herein and (ii) the representatives of
Purchaser to be elected as directors of the Seller.
(l) Adjustment to Stock Option Exercise Price. The Seller shall have
adjusted the exercise price of existing Stock Options granted to continuing
officers and directors of Seller or its Subsidiaries pursuant to its 1991
Nonqualified Stock Option Plan, 1994 Stock Incentive Plan and 1994
Directors Option Plan effective on the Closing Date to the market price on
the date of adjustment (the "Reset Options"). The Reset Options shall have
a vesting period of three (3) years, with one-third ( 1/3) of the Options
vesting on each anniversary of the date of the Reset Options.
ARTICLE 8
CONDITIONS PRECEDENT TO SELLER'S OBLIGATIONS
SECTION 8.1 Conditions Precedent. The obligation of the Seller to sell the
Purchased Securities pursuant to this Agreement on the Closing Date is subject
to the satisfaction or waiver in writing of the following conditions precedent
(in form, substance and action as is reasonably satisfactory to the Seller):
(a) Proof of Appropriate Action. The Seller shall have received from
the Purchaser a copy, certified by a duly authorized officer of the
Purchaser to be true and complete on and as of the Closing Date, of the
records of all action taken by the Board of Directors or Executive
Committee of the Purchaser to authorize the execution and delivery of this
Agreement and any other agreements entered into on the Closing Date and to
which it is a party or is to become a party as contemplated or required by
this Agreement, and its performance of all of its agreements and
obligations under each of such documents;
(b) Incumbency Certificates. The Seller shall have received from the
Purchaser an incumbency certificate, dated the Closing Date, signed by a
duly authorized officer of the Purchaser and giving the name and bearing a
specimen signature of each individual who shall be authorized (i) to sign,
in the name and on behalf of the Purchaser, this Agreement and each of the
other Transaction Documents to which such person is or is to become a party
on the Closing Date, and (ii) to give notices and to take other action on
behalf of the Purchaser under such documents;
(c) Representations and Warranties. Each of the representations and
warranties made by and on behalf of the Purchaser to the Seller in this
Agreement and in the other Transaction Documents shall be true and correct
when made;
(d) Transaction Documents. Each of the Transaction Documents shall
have been duly and properly authorized, executed and delivered to the
Seller by the respective party or parties thereto and shall be in full
force and effect on and as of the Closing Date;
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(e) Legality of Transactions. No changes in applicable law shall have
occurred as a consequence of which it shall have become and continue to be
unlawful (i) for the Purchaser to perform any of its agreements or
obligations under this Agreement, or under any of the other Transaction
Documents, or (ii) for the Seller or any Subsidiary of the Seller to
perform any of its agreements or obligations under this Agreement or under
any of the other Transaction Documents;
(f) Approvals and Consents. The Seller shall have received all
approvals and consents necessary for the completion of the transactions
contemplated by the Agreement and each of the Transaction Documents,
including Shareholder approval as contemplated by Section 6.1 hereof and
regulatory consent as contemplated by Section 6.2 hereof; and
(g) Performance, Etc. The Purchaser shall have duly and properly
performed, complied with and observed its respective covenants, agreements
and obligations contained in each of the Transaction Documents.
ARTICLE 9
TERMINATION OF AGREEMENT
SECTION 9.1 Termination. Notwithstanding any other provision of this
Agreement, this Agreement may be terminated at any time prior to the Closing
Date:
(a) by mutual written consent of the Seller and the Purchaser;
(b) by the Seller or the Purchaser, upon written notice to the other
party, if the Closing shall not have occurred on or prior to March 31, 1997
(the "Outside Date"), unless such failure of consummation shall be due to
the failure of the party seeking such termination to perform or observe in
all material respects the covenants and agreements hereof to be performed
or observed by such party;
(c) by the Seller or the Purchaser, upon written notice to the other
party, if a governmental authority of competent jurisdiction shall have
issued an injunction, order or decree enjoining or otherwise prohibiting
the consummation of the transactions contemplated by this Agreement, and
such injunction, order or decree shall have become final and non-appealable
or if a governmental authority has otherwise made a final determination
that any required regulatory consent would not be forthcoming; provided,
however, that the party seeking to terminate this Agreement pursuant to
this clause has used all required efforts to remove such injunction, order
or decree;
(d) by the Seller, if prior to approval by the Shareholders of the
Seller of the transactions contemplated by this Agreement, the Board of
Directors of the Seller determines in accordance with a Director Duty that
such termination is required by reason of a Competing Proposal; or
(e) by the Seller or the Purchaser, if prior to approval by the
Shareholders of the Seller of the transactions contemplated by this
Agreement, the Board of Directors of the Seller shall have withdrawn or
modified in a manner materially adverse to the Purchaser its approval of
the adoption of this Agreement, because the Board of Directors has
determined to recommend to the Seller's shareholders or approve a Competing
Proposal, in accordance with a Director Duty; provided, however, that any
communication that advises that Seller has received a Competing Offer or is
engaging in any activity permitted under Section 6.7(b) with respect to a
Competing Offer shall in no event be deemed a withdrawal or modification
adverse to the Purchaser of its approval of this Agreement.
SECTION 9.2 Effect of Termination. In the event that this Agreement is
terminated pursuant to clause 9.1(d) or 9.1(e) hereof, the Warrants issued to
the Purchaser pursuant to Section 2.3 hereof shall become immediately
exercisable and the Purchaser shall have all of the benefits of the Warrant
Registration Rights Agreement and Purchaser shall have no further rights
hereunder. In the event that this Agreement is terminated pursuant to any other
clause of Section 9.1, the Warrants shall be cancelled and neither party shall
have any further rights or obligations under this Agreement, the Warrant
Registration Rights Agreement or the Warrant Subscription Agreement.
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<PAGE> 106
SECTION 9.3 Default under the Agreement. If either party shall default in
the performance of its obligations hereunder, the non-defaulting party shall
retain all rights and remedies, whether arising in equity or at law, including
actions for specific performance and damages, as a result of the default by the
other party under this Agreement.
ARTICLE 10
MISCELLANEOUS
SECTION 10.1 Amendments and Waivers. The Seller and the Purchaser may amend
this Agreement or the other Transaction Documents to which they are parties, and
the Purchaser may waive future compliance by the Seller with any provision of
this Agreement or such other Transaction Documents, but no such amendment or
waiver shall be effective unless in a written instrument executed by an
authorized officer of the Purchaser and Seller.
SECTION 10.2 No Waiver; Cumulative Remedies. No failure to exercise and no
delay in exercising, on the part of the Purchaser or Seller, any right, remedy,
power or privilege hereunder, shall operate as a waiver thereof; nor shall any
single or partial exercise of any right, remedy, power or privilege hereunder
preclude any other or further exercise thereof or the exercise of any other
right, remedy, power or privilege. The Purchaser or Seller, as the case may be,
shall not be deemed to have waived any of its' rights hereunder or under any
other agreement, instrument or paper signed by it unless such waiver shall be in
writing and signed by the Purchaser or Seller, as the case may be. The rights,
remedies, powers and privileges herein provided are cumulative and not exclusive
of any rights, remedies, powers and privileges provided by law, and are
supplemental and in addition to such rights, remedies, powers and privileges
provided in Transaction Documents.
SECTION 10.3 Notices. All notices, consents, requests and demands to or
upon the respective parties hereto shall be in writing and, unless otherwise
expressly provided herein, shall be deemed to have been duly given or made when
delivered by hand, or when deposited in the mail, postage prepaid, or, in the
case of telex, telegraphic or telecopy notice, when sent, addressed as follows:
If to the Purchaser:
American Financial Group, Inc.
One East Fourth Street, Suite 919
Cincinnati, Ohio 45202
Attention: Samuel J. Simon
Telephone: (513) 579-2542
Telecopy: (513) 579-2113
With a copy to:
Keating, Muething & Klekamp, P.L.L.
1800 Provident Tower
Cincinnati, Ohio 45202
Attention: Paul V. Muething
Telephone: (513) 579-6517
Telecopy: (513) 579-6957
If to the Seller:
American Eagle Group, Inc.
12801 North Central Expressway, Suite 800
Dallas, Texas 75243
Attention: Chairman of the Board
Telephone: (972) 448-1460
Telecopy: (972) 448-1401
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<PAGE> 107
With a copy to:
Frederick G. Anderson
Senior Vice President and General Counsel
American Eagle Group, Inc.
12801 North Central Expressway, Suite 800
Dallas, Texas 75243
Telephone: (972) 448-1431
Telecopy: (972) 448-1401
Notices of changes of address shall be given in the same manner.
SECTION 10.4 Successors and Assigns. This Agreement shall be binding upon
and inure to the benefit of the Seller, the Purchaser and their respective
successors and permitted assigns. For so long as Purchaser has any rights or
obligations specified in Sections 6.5 and 6.6 hereof, the Purchaser and any of
its Affiliates may assign or transfer to any Person (including a group as
defined in Section 13(d)(3) of the Securities Exchange Act of 1934, as amended),
the shares of Preferred Stock or Underlying Shares, representing in the
aggregate ownership, or the right to acquire ownership, of at least fifty-one
percent (51%) of the Underlying Shares and all of their rights under Section 6.5
above, only if such Person assumes all of the obligations under Section 6.6
above.
SECTION 10.5 Enforcement Costs. All reasonable costs and expenses incurred
by a party to enforce the terms of this Agreement and performance by the other
party of its obligations hereunder including, without limitation, stationery and
postage, telephone and telegraph, secretarial and clerical expenses, the fees or
salaries of any collection agents utilized, and all attorneys' fees and legal
expenses incurred in connection herewith whether through judicial proceedings or
otherwise, or in enforcing or protecting its rights and interests under this
Agreement or under any other instrument or document delivered pursuant hereto,
or in protecting the rights of any holder or holders with respect thereto, or in
defending or prosecuting any actions or proceedings arising out of or relating
to the transactions contemplated hereby, shall be paid by the party which does
not prevail in such action or proceeding, upon demand.
SECTION 10.6 Counterparts. This Agreement may be executed by one or more of
the parties to this Agreement on any number of separate counterparts and all of
said counterparts taken together shall be deemed to constitute one and the same
instrument.
SECTION 10.7 Term. This Agreement shall terminate upon the latest of (i)
the redemption of all shares of the Preferred Stock, or (ii) seven (7) years
from the Date of Issuance.
SECTION 10.8 Consent to Jurisdiction. The Seller hereby absolutely and
irrevocably consents and submits to the jurisdiction of the courts of the State
of Ohio and of any federal court located in the said state in connection with
any actions or proceedings brought against the Seller by the Purchaser arising
out of or relating to this Agreement or any other Transaction Documents. The
Seller hereby waives and shall not assert in any such action or proceeding, in
each case, to the fullest extent permitted by applicable law, any claim that (a)
the Seller is not personally subject to the jurisdiction of any such court, (b)
the Seller is immune from any legal process (whether through service or notice,
attachment prior to judgment, attachment in aid of execution, execution or
otherwise) with respect to it or its property, (c) any such suit, action or
proceeding is brought in an inconvenient forum, (d) the venue of any such suit,
action or proceeding is improper, or (e) this Agreement or any Transaction
Documents may not be enforced in or by any such court. In any such action or
proceeding, the Seller hereby absolutely and irrevocably waives personal service
of any summons, complaint, declaration or other process and hereby absolutely
and irrevocably agrees that the service thereof may be made by certified,
registered first-class mail directed to the Seller. Anything hereinbefore to the
contrary notwithstanding, the Purchaser hereof may sue the Seller in the courts
of any other country, state of the United States or place where the Seller or
any of the property or assets may be found or in any other appropriate
jurisdictions.
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IN WITNESS WHEREOF, the parties have duly executed this Agreement by their
duly authorized officers as of the date first above written.
SELLER:
AMERICAN EAGLE GROUP, INC.
By:
------------------------------------
Its:
------------------------------------
PURCHASER:
AMERICAN FINANCIAL GROUP, INC.
By:
------------------------------------
Its:
------------------------------------
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<PAGE> 109
APPENDIX III
CERTIFICATE OF DESIGNATION
OF
SERIES D PREFERRED STOCK
AMERICAN EAGLE GROUP, INC., a corporation duly organized and existing under
the laws of the State of Delaware (the "Company"), DOES HEREBY CERTIFY:
That pursuant to authority conferred upon the Board of Directors of the
Company by the Certificate of Incorporation, as amended, of the Company (the
"Certificate of Incorporation") and pursuant to the provisions of Section 151 of
the General Corporation Law of the State of Delaware, the Board of Directors of
the Company duly adopted the following resolutions at a meeting held on November
4, 1996.
"RESOLVED: That pursuant to the authority vested in the Board of Directors
of the Company pursuant to the Certificate of Incorporation of the Company, the
Board of Directors of the Company hereby creates the Series D Preferred Stock of
the Company from the authorized but unissued preferred stock, $.01 par value, of
the Company and fixes the number of shares, designation, powers, preferences and
relative rights of such Series D Cumulative Preferred Stock as follows:
1. DESIGNATION AND NUMBER. The distinctive designation of the series shall
be the Series D Preferred Stock (the "Series D Preferred Stock"); the number of
shares of the Series D Preferred Stock which the Company is authorized to issue
shall be 546,200.
2. DEFINITIONS. For purposes of this resolution, the following terms shall
have the meanings indicated.
(a) As used herein:
(i) The term "Commission" means the Securities and Exchange Commission
or any other federal agency at the time administering the Securities Act.
(ii) The term "Common Stock" means the $0.01 par value voting Common
Stock of the Company.
(iii) The term "Current Market Price" per share of Common Stock on any
date shall be deemed to be the average of the daily closing prices for 30
consecutive business days commencing 45 business days before the day in
question. The closing price for each day shall be the last reported sale
price regular way or, in case no such reported sale takes place on such
day, the average of the reported closing bid and asked prices regular way
for such day, in each case on the New York Stock Exchange or, if the Common
Stock is not listed or admitted to trading on the New York Stock Exchange,
on the principal national securities exchange on which the shares of Common
Stock are listed or admitted to trading or, if not listed or admitted to
trading on any national securities exchange the average of the closing bid
and asked prices of the Common Stock in the over-the-counter market as
reported by the National Association of Securities Dealers Automated
Quotations National Market System (or any comparable system) or, if the
Common Stock is not quoted on such National Market System (or any
comparable system), the average of the closing bid and asked prices in the
over-the-counter market as furnished by any New York Stock Exchange member
firm selected from time to time by the Board of Directors for that purpose
or, in the absence of such quotations, such other method of determining
market value as the Board of Directors shall in good faith from time to
time reasonably deem to be fair. In the absence of one or more such
quotations, the Company shall determine the current market price on the
basis of such quotations as it considers appropriate.
(iv) The term "Date of Issuance" means the date on which the Company
initially issues any shares, regardless of the number of times transfer of
such share is made on the stock records maintained by or for the Company
and regardless of the number of certificates which may be issued to
evidence such share.
<PAGE> 110
(v) The term "Event of Default" with respect to the Preferred Stock
shall mean a continuing default in the payment of any dividend under
Section 3 hereof for at least two consecutive quarters or any mandatory
redemption payment under Section 7(b) hereof.
(vi) The term "Junior Stock" means the Common Stock and all other
shares of capital stock of the Company that are junior to the Series D
Preferred Stock with respect to the payment of dividends and payments or
distributions upon Liquidation.
(vii) The term "Liquidation" means the voluntary or involuntary
liquidation, distribution of assets (other than payment of dividends),
dissolution or winding-up of the Company.
(viii) The term "outstanding", when used with reference to shares of
stock, means issued shares, excluding shares held by the Company or a
subsidiary.
(ix) The term "Person" means any corporation, partnership, trust,
organization, association or other entity or individual.
(x) The term "Registration Rights Agreement" shall mean that certain
Registration Rights Agreement between the Company and American Financial
Group, Inc. in the form attached as Exhibit D to that certain Securities
Purchase Agreement between the Company and American Financial Group, Inc.
dated November 5, 1996.
(xi) The term "Securities Act" means the Securities Act of 1933, as
amended, or any successor federal statute, and the rules and regulations of
the Commission thereunder.
(xii) The term "Senior Stock" means the Series B Cumulative Preferred
Stock and all other shares of capital stock that are senior to the Series D
Preferred Stock with respect to the payment of dividends and payments and
distributions upon Liquidation.
(xiii) The term "Series D Preferred Stock" means the series of the
preferred stock, $0.01 par value, of the Company as defined by the terms
and provisions hereof and designated the Series D Preferred Stock.
(xiv) The term "Transfer" means any transfer or disposition of shares
of Series D Preferred Stock, or any interest thereon.
(xv) The term "Warrant Subscription Agreement" means that certain
Warrant Subscription Agreement between the Company and American Financial
Group, Inc. in the form attached hereto as Annex A.
(b) All accounting terms used herein and not expressly defined herein
shall have the meanings given to them in accordance with generally accepted
accounting principles as of the Date of Issuance.
3. DIVIDENDS. (a) Subject to the rights of the holders of Senior Stock, the
holders of each share of Series D Preferred Stock shall be entitled to receive,
when and as declared by the Company's Board of Directors and to the extent
permitted under the laws of the State of Delaware, cumulative preferential cash
dividends at an annual rate of $9.00 per share, of which cash dividends of $2.25
per share will be payable on the first business day of each January, April, July
and October beginning April 1, 1997; provided, however, in the event that the
Date of Issuance is not the first business day of either January, April, July or
October, the initial dividend payment shall be prorated based upon the actual
number of days elapsed since the Date of Issuance. The holders of record of the
Series D Preferred Stock entitled to receive a particular dividend payment shall
be determined on the date 15 days prior to the date scheduled for such payment.
(b) For a term of five years beginning on the first Date of Issuance for
any shares of Series D Preferred Stock, at the option of the Company, dividends
on outstanding shares of Series D Preferred Stock may be paid in shares of
Series D Preferred Stock having a liquidation preference approximately equal to
the amount of the dividend payable. No fractional shares of Series D Preferred
Stock will be issued. In the event that the Company elects to pay dividends by
issuing shares of Series D Preferred Stock, the Company may maintain an
accounting of the fractional shares that would have been issued to each holder
and at any time such fractions
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equal or exceed one share, such shares shall be issued with fractions remaining
in closed accounts paid in cash in lieu of fractional shares. In the
alternative, the Company may pay cash in lieu of fractional shares. Cash
payments in lieu of fractions will be based on the liquidation value of $100.00
per share.
(c) The Company shall not declare or pay or set apart for payment any
dividend (other than dividends payable in shares of Junior Stock) for any period
upon any Junior Stock or any stock of the Company ranking on a parity with the
Series D Preferred Stock as to dividends, nor shall the Company redeem or
purchase any such shares or pay any money to a sinking fund for the redemption
or repurchase of any such shares unless all dividends on the Series D Preferred
Stock, including all accrued and unpaid dividends, have been paid in full.
Notwithstanding this Paragraph 3(c), the Company may pay dividends on the shares
of the Series D Preferred Stock and shares of stock of the Company ranking on a
parity therewith as to dividends ratably in proportion to the sums which would
be payable on such shares if all dividends, including accumulations, if any,
were declared and paid in full.
(d) Cash dividends upon shares of the Series D Preferred Stock shall be
payable by check or wire transfer, at the option of the Company, and shares of
Series D Preferred Stock issued in lieu of cash dividends shall be issued to the
registered holders of Series D Preferred Stock at the address set forth in the
books and records of the Company or any transfer agent and/or registrar
appointed for the Series D Preferred Stock and shall commence to accrue and be
cumulative from their respective Dates of Issuance. Accumulations of dividends
on any shares of the Series D Preferred Stock shall bear interest at 9% per
annum, compounded quarterly.
4. LIQUIDATION. Subject to the rights of holders of Senior Stock, in the
event of any Liquidation, before any payment or distribution of the assets of
the Company (whether capital or surplus), or the proceeds thereof, shall be made
or set apart for the holders of shares of Junior Stock, holders of shares of
Series D Preferred Stock shall be entitled to receive payment of $100.00 per
share of Series D Preferred Stock held by them plus all accrued and unpaid
dividends thereon to the date of such payment. If the assets of the Company
shall be insufficient to pay in full such preferential amounts to the holders of
Series D Preferred Stock and the holders of any other shares of capital stock of
the Company ranking on a parity with holders of Series D Preferred Stock as to
payments or distributions upon Liquidation, then such assets shall be
distributed among such holders of Series D Preferred Stock and such other stock
ratably in accordance with the respective amounts which would be payable on such
shares of Series D Preferred Stock and such other stock if all amounts payable
thereon were paid in full.
5. VOTING RIGHTS. The holders of shares of Series D Preferred Stock shall
be entitled to the voting rights as set forth below for the first seven years
following the first Date of Issuance of any shares of Series D Preferred Stock.
After the seventh anniversary of the Date of Issuance, the holders of shares of
Series D Preferred Stock will have no voting rights, except as set forth in
subsections (c) and (d) below or as otherwise provided by law.
(a) With regard to any matter to be submitted to a vote of the holders
of the Common Stock of the Company either to be voted upon at a meeting
called for the purpose of considering such matter or submitted to holders
for purposes of obtaining their written consent, the holders of all
outstanding shares of Series D Preferred Stock shall (except as set forth
in subsection (b) below) be entitled to collectively exercise voting rights
which, in the aggregate, afford to such holders the right to cast votes
equal to 20% of the votes eligible to be cast with respect to any such
vote. In order to determine the number of votes which the holder of any
share of Series D Preferred Stock may cast in any such vote, the total
number of votes attributable to the Common Stock and any other class or
series of capital stock entitled to vote shall be divided by .80, and the
difference between such quotient and the total number of votes attributable
to the Common Stock and any other class or series of capital stock entitled
to vote with the Common Stock shall be the aggregate number of votes (the
"Total Series D Votes") which the holders of all outstanding shares of
Series D Preferred Stock shall be entitled to cast. The holder of each
share of Series D Preferred Stock shall be entitled to cast the number (or
a fraction thereof) of votes equal to the Total Series D Votes divided by
the number of shares of Series D Preferred Stock outstanding on the record
date established with respect to such vote.
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(b) Not withstanding the terms of paragraph (a) above, in the event
that the aggregate number of shares of Common Stock into which the
outstanding shares of Series D Preferred Stock is convertible represents
less than 20% of the aggregate number of all shares of Common Stock
outstanding, then each holder of a share of Series D Preferred Stock shall
be entitled to cast the number of votes equal to the number of shares of
Common Stock into which the Series D Preferred Stock is then convertible,
with respect to any such matter.
(c) Notwithstanding the other terms of this Section 5, upon the
occurrence and continuation of an Event of Default, each share of Series D
Preferred Stock shall be entitled to cast the number of votes equal to the
number of shares of Common Stock into which the Series D Preferred Stock is
then convertible, on any matter submitted for the consideration of the
holders of the Common Stock of the Company. In addition, the holders of the
Series D Preferred Stock voting as a separate class shall be entitled at
the next annual meeting of shareholders or the next special meeting of
shareholders, to elect such number of directors which is a majority
(rounded up) of the directors to be elected. Any director who shall have
been elected by the holders of the Series D Preferred Stock as a class
pursuant to this Section 5(c) shall hold office for a term expiring on the
earlier of the termination of the Event of Default and the next annual
meeting of shareholders and during such term may be removed for cause at
any time, but may be removed without cause only by the affirmative votes of
holders of record of a majority of the then outstanding shares of Series D
Preferred Stock given at a special meeting of such shareholders called for
such purpose.
(d) So long as any shares of Series D Preferred Stock are outstanding,
the Company shall not, in any manner, whether by amendment to its
Certificate of Incorporation or By-Laws, by merger (whether or not the
Company is the surviving corporation in such merger), by consolidation, or
otherwise, without the written consent or the affirmative vote at a meeting
called for that purpose of the holders of at least a majority of the votes
of the shares of Series D Preferred Stock then outstanding, voting
separately as a class, (i) amend, alter or repeal any of the provisions of
any resolution or resolutions establishing the Series D Preferred Stock so
as to affect adversely the powers, preferences or special rights of such
Series D Preferred Stock, or (ii) authorize the issuance of, or authorize
any obligation or security convertible into or evidencing the right to
purchase shares of, any additional class or series of stock ranking prior
to the Series D Preferred Stock in the payment of dividends or the
preferential distribution of assets.
Nothing in this Subsection (d) shall be deemed to require any vote or
consent of the holders of shares of Series D Preferred Stock in connection
with the authorization or issuance of any series of Preferred Stock ranking
on a parity with or junior to the Series D Preferred Stock as to dividends
and/or distribution of assets.
6. CONVERSION RIGHTS. (a) Shares of Series D Preferred Stock may be
converted at the option of the holder thereof at any time prior to the close of
business on the business day next preceding the date fixed for redemption of
such shares pursuant to Section 7 hereof, into fully paid and nonassessable
shares of Common Stock of the Corporation at the rate of 19.0476 shares of
Common Stock of the Company as now constituted for each share of Series D
Preferred Stock surrendered for conversion. The conversion rate expressed may
also be expressed as a conversion price of $5.25 (the "Conversion Price") taking
each share of Series D Preferred Stock at a value of $100.00. The Conversion
Price shall be subject to adjustment from time to time as follows:
(i) In case the Company shall declare a dividend or other distribution
on shares of Common Stock which is payable in Common Stock, then the
Conversion Price in effect immediately prior to the declaration of such
dividend or distribution shall be reduced to the quotient obtained by
dividing (a) the product of (x) the number of shares of Common Stock
outstanding immediately prior to such declaration, multiplied by (y) the
then effective Conversion Price, by (b) the total number of shares of
Common Stock outstanding immediately after such dividend or other
distribution is paid. The registered holder of each share of Series D
Preferred Stock shall thereafter be entitled to purchase, at the Conversion
Price resulting from such adjustment, the number of shares of Common Stock
obtained by
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multiplying the Conversion Price in effect immediately prior to such
adjustment by the number of shares of Common Stock issuable pursuant hereto
immediately prior to such adjustment and dividing the product thereof by
the Conversion Price resulting from such adjustment.
(ii) In case outstanding shares of Common Stock shall be subdivided
into a greater number of shares of Common Stock, the Conversion Price in
effect at the opening of business on the day immediately prior to the day
upon which such subdivision becomes effective shall be proportionately
reduced and the number of shares of Common Stock issuable pursuant hereto
immediately prior to such subdivision shall be proportionately increased,
and, conversely, in case outstanding shares of Common Stock shall be
combined into a smaller number of shares of Common Stock, the Conversion
Price in effect at the opening of business on the day immediately prior to
the day upon which such combination becomes effective shall be
proportionately increased and the number of shares of Common Stock issuable
pursuant hereto immediately prior to such combination shall be
proportionately reduced, such reduction or increase, as the case may be, to
become effective immediately after the opening of business on the day
following the day upon which such subdivision or combination becomes
effective.
(iii) The reclassification of Common Stock into securities other than
Common Stock (other than any reclassification upon a consolidation or
merger to which Section 6(h) below applies) shall be deemed to involve (x)
a distribution of securities other than Common Stock to all holders of
Common Stock (and the effective date of such reclassification shall be
deemed to be the Record Date within the meaning of Subparagraph 6(a)(iv)
below), and (y) a subdivision or combination, as the case may be, of the
number of shares of Common Stock outstanding immediately prior to such
reclassification into the number of shares of Common Stock outstanding
immediately thereafter (and the effective date of such reclassification
shall be deemed to be "the day upon which such subdivision becomes
effective" and "the day upon which such combination becomes effective" as
the case may be, within the meaning of Subparagraph 6(a)(ii) above.)
(iv) In case the Company shall issue rights, options, or warrants or
shall issue securities convertible or exchangeable for shares of Common
Stock ("Convertible Securities") to all holders of its outstanding Common
Stock, without any charge to such holders, entitling them (for a period
within forty five (45) days after the record date mentioned below) to
subscribe for or purchase shares of Common Stock at a price per share which
is lower at the record date fixed for the determination of stockholders
entitled to receive such rights, options, warrants or Convertible
Securities (other than pursuant to a dividend reinvestment plan or pursuant
to any employee or director benefit or stock option plan) (the "Record
Date") than the then Current Market Price per share of Common Stock, the
number of shares of Common Stock issuable pursuant hereto shall be
determined by multiplying the number of shares of Common Stock issuable
pursuant hereto upon Conversion of each share of Series D Preferred Stock
by a fraction, of which the numerator shall be the number of shares of
Common Stock outstanding at the close of business on the Record Date of
such rights, options, warrants or Convertible Securities plus the number of
additional shares of Common Stock offered for subscription or purchase, and
of which the denominator shall be the number of shares of Common Stock
outstanding at the close of business on the Record Date of such rights,
options, warrants or Convertible Securities plus the number of shares of
Common Stock which the aggregate offering price of the total number of
shares of Common Stock so offered would purchase at the then Current Market
Price per share of Common Stock. Such adjustment shall be made whenever
such rights, options, warrants or Convertible Securities are issued, and
shall become effective immediately after the opening of business on the day
following the Record Date for the determination of stockholders entitled to
receive such rights, options, warrants or Convertible Securities. Upon the
foregoing adjustment having been made, the Conversion Price then in effect
shall be adjusted by multiplying such Conversion Price in effect
immediately prior to such adjustment by a fraction, of which the numerator
shall be the number of shares of Common Stock issuable pursuant hereto
immediately prior to such adjustment, and of which the denominator shall be
the number of shares of Common Stock issuable pursuant hereto immediately
thereafter. For the purpose of this subparagraph 6(a)(iv), the number of
shares of Common Stock at any time outstanding shall not include shares
held in the treasury of the Company or issuable pursuant to warrants held
in or issued to treasury but
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shall include shares issuable in respect of scrip certificates issued in
lieu of fractions of shares of Common Stock.
(v) In case the Company shall distribute to all holders of its shares
of Common Stock evidences of its indebtedness or assets (excluding cash
dividends or distributions payable out of consolidated earnings or earned
surplus and the extraordinary events referred to in subparagraphs 6(a)(i)
through 6(a)(iii) above) or rights, options or warrants, or convertible or
exchangeable securities containing the right to subscribe for or purchase
evidences of such indebtedness or assets, then in each case the Conversion
Price shall be reduced by multiplying the Conversion Price in effect
immediately prior to the close of business on the date fixed for the
determination of stockholders entitled to receive such a distribution by a
fraction, of which the numerator shall be the then Current Market Price per
share of Common Stock on the date of such distribution, less the then fair
value (as determined in good faith by the Board of Directors of the
Company, whose determination shall in the absence of manifest error be
conclusive) of the portion of the assets or evidences of indebtedness so
distributed and of which the denominator shall be the then Current Market
Price per share of Common Stock. Such adjustment shall be made whenever any
such distribution is made, and shall become effective immediately prior to
the opening of business on the day following the record date for the
determination of stockholders entitled to receive such distribution.
In the event of a distribution by the Company to all holders of its
shares of Common Stock of capital stock of a subsidiary or rights, options,
warrants or Convertible Securities for such stock, then in lieu of an
adjustment in the Conversion Price, the holder of each share of Series D
Preferred Stock, upon the conversion thereof at any time after such
distribution shall be entitled to receive the stock or other securities to
which such holder would have been entitled if such holder had converted the
shares of Series D Preferred Stock into Common Stock immediately prior to
such distribution.
(vi) In case the Company shall issue or sell Convertible Securities
(excluding issuances or sales referred to in subparagraph 6(a)(iv) above),
there shall be determined the price per share for which shares of Common
Stock are issuable upon the conversion or exchange thereof, such
determination to be made by dividing (a) the total amount received or
receivable by the Company as consideration for the issue or sale of such
Convertible Securities, plus the average of the maximum and minimum
aggregate amount of additional consideration, if any, payable to the
Company upon the conversion or exchange of all such Convertible Securities
by (b) the maximum number of shares of Common Stock of the Company issuable
upon conversion or exchange of all of such Convertible Securities; and such
issue or sale shall be deemed to be an issue or sale for cash (as of the
date of issue or sale of such Convertible Securities) of such maximum
number of shares of Common Stock at the price per share so determined.
If such Convertible Securities shall by their terms provide for an
increase or increases, with the passage of time, in the amount of
additional consideration, if any, payable to the Company, or in the rate of
exchange, upon the conversion or exchange thereof, the adjusted Conversion
Price shall, forthwith upon any such increase becoming effective, be
readjusted (but to no greater extent than originally adjusted) to reflect
the same.
(vii) In case the Company shall grant any rights, warrants or options
to subscribe for, purchase or otherwise acquire shares of Common Stock
(excluding grants pursuant to employee or director stock option or benefit
plans), there shall be determined the minimum price per share for which a
share of Common Stock is issuable upon the exercise of all such rights,
warrants or options, such determination to be made by dividing (a) the
total amount, if any, received or receivable by the Company as
consideration for the granting of such rights, warrants or options, plus
the average of the maximum and minimum aggregate amount of additional
consideration payable to the Company upon the exercise of such rights,
warrants or options by (b) the maximum number of shares of Common Stock of
the Company issuable upon the exercise of all such rights, warrants or
options, and the granting of all such rights, warrants or options shall be
deemed to be an issue or sale for cash (as of the date of the granting of
such rights, warrants or options) of such maximum number of shares of
Common Stock at the price per share so determined.
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If such rights, warrants or options shall by their terms provide for
an increase or increases, with the passage of time, in the amount of
additional consideration payable to the Company upon the exercise thereof,
the adjusted Conversion Price shall, forthwith upon any such increase
becoming effective, be readjusted (but to no greater extent than originally
adjusted) to reflect the same.
(viii) In case the Company shall grant any rights, warrants or options
to subscribe for, purchase or otherwise acquire Convertible Securities,
such Convertible Securities shall be deemed, for the purposes of
subparagraph 6(a)(vi), to have been issued and sold (as of the actual date
of issue or sale of such Convertible Securities) for the total amount
received or receivable by the Company as consideration for the granting of
such rights, warrants or options plus the average of the maximum and
minimum aggregate amount of additional consideration, if any, payable to
the Company upon the exercise of all such rights, warrants or options.
If such rights, warrants or options shall by their terms provide for
an increase or increases, with the passage of time, in the amount of
additional consideration payable to the Company upon the exercise thereof,
the adjusted Conversion Price shall, forthwith upon any such increase
becoming effective, be readjusted (but to no greater extent than originally
adjusted) to reflect the same.
(ix) In case the Company shall issue or sell its shares of Common
Stock or be deemed to have issued or sold Common Stock in accordance with
the provisions of subparagraphs 6(a)(vi), 6(a)(vii) or 6(a)(viii) above,
for a consideration per share which is below the then Current Market Price
per share for its shares of Common Stock, then the following provisions
shall apply. An Adjusted Fair Market Value shall be computed (to the
nearest cent, a half cent or more being considered a full cent) by
dividing:
a) the sum of (x) the result obtained by multiplying the number of
shares of Common Stock of the Company outstanding immediately prior to
such issue or sale by the then Current Market Price, plus (y) the
consideration, if any, received by the Company upon such issue or sale;
by
b) the number of shares of Common Stock of the Company outstanding
immediately after such issue or sale.
The resulting number shall be deemed to be the Adjusted Fair Market
Value per share. Thereafter, the Conversion Price shall be adjusted to be
equal to the product of the Conversion Price in effect immediately prior to
such actions, multiplied by a fraction the numerator of which is the
Adjusted Fair Market Value per share and the denominator of which is the
Current Market Price per share immediately prior to such actions. Upon any
such adjustment of the Conversion Price hereunder, the number of shares of
Common Stock issuable upon conversion of a share of Series D Preferred
Stock will be adjusted to the number of shares determined by multiplying
the Conversion Price in effect immediately prior to such adjustment by the
number of shares of Common Stock issuable upon conversion of a share of
Series D Preferred Stock immediately prior to such adjustment and dividing
the product thereof by the Conversion Price resulting from such adjustment.
The provisions of this subparagraph 6(a)(ix) shall not apply to an
issuance or sale of shares of the Company's Common Stock in connection with
an underwritten public offering for cash, unless the underwritten public
offering is in the form of a transaction exempted from registration in the
United States under Regulation S.
(b) No adjustment in the number of shares of Common Stock issuable upon
conversion of shares of Series D Preferred Stock hereunder shall be required
unless such adjustment would require an increase or decrease of at least one
percent (1%) in the number of shares of Common Stock issuable upon conversion;
provided, however, that any adjustments which by reason of this paragraph 6(b)
are not required to be made shall be carried forward and taken into account in
any subsequent adjustment. All calculations shall be made to the nearest
one-thousandth of a share.
(c) No adjustment in the number of shares of Common Stock issuable upon
conversion need be made under subparagraphs 6(a)(iv) and 6(a)(v) if the Company
issues or distributes to each holder of shares of
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Series D Preferred Stock the rights, options, warrants, or convertible or
exchangeable securities, or evidence of indebtedness or assets referred to in
those subparagraphs which each holder of Shares of Series D Preferred Stock
would have been entitled to receive had the Series D Preferred Stock been
converted prior to the happening of such event or the record date with respect
thereto. No adjustment in the number of shares of Common Stock issuable upon
conversion need be made for sales of Common Stock pursuant to a Company plan for
reinvestment of dividends or interest. No adjustment need be made for a change
in the par value of the Common Stock. No such adjustment need be made in respect
of the issuance and subsequent exercise of employee or director benefit or stock
options shares of Common Stock.
(d) For the purpose of this Section 6, the term "shares of Common Stock"
shall mean (i) the class of stock designated as the Common Stock of the Company
at the date of this Agreement, or (ii) any other class of stock resulting from
successive changes or reclassification of such shares consisting solely of
changes in par value, or from par value to no par value, or from no par value to
par value. In the event that at any time, as a result of an adjustment made
pursuant to subparagraph 6(a)(iii) above, the Holders shall become entitled to
purchase any shares of the Company other than shares of Common Stock, thereafter
the number of such other shares so issuable upon conversion and the Conversion
Price of such shares shall be subject to adjustment from time to time in a
manner and on terms as nearly equivalent as practicable to the provisions with
respect to the Common Stock contained in subparagraph 6(a)(i) through 6(a)(ix),
inclusive, above, and the provisions of subsections 6(f) through 6(g),
inclusive, with respect to the Common Stock, shall apply on like terms to any
such other shares.
(e) Upon the expiration of any rights, options, warrants or conversion or
exchange privileges, if any thereof shall not have been exercised, the
Conversion Price and the number of shares of Common Stock issuable upon
conversion shall, upon such expiration, be readjusted and shall thereafter be
such as it would have been had it been originally adjusted (or had the original
adjustment not been required, as the case may be) as if (A) the only shares of
Common Stock so issued were the shares of Common Stock, if any, actually issued
or sold upon the exercise of such rights, options, warrants or conversion or
exchange rights and (B) such shares of Common Stock, if any, were issued or sold
for the consideration, if any, actually received by the Company for the
issuance, sale or grant of all such rights, options, warrants or conversion or
exchange rights whether or not exercised; provided, further, that no such
readjustment shall have the effect of increasing the Conversion Price by an
amount in excess of the amount of the adjustment initially made in respect to
the issuance, sale of grant of such rights, options, warrants or conversion or
exchange rights.
(f) Upon any issuance or sale for a consideration other than cash, or a
consideration part of which is other than cash, of any shares of Common Stock or
Convertible Securities or any rights or options to subscribe for, purchase or
otherwise acquire any shares of Common Stock or Convertible Securities, the
amount of the consideration other than cash received by the Company shall be
deemed to be the fair value of such consideration as determined in good faith by
the Board of Directors of the Company. In case any shares of Common Stock or
Convertible Securities or any rights, options or warrants to subscribe for,
purchase or otherwise acquire any shares of Common Stock or Convertible
Securities shall be issued or sold together with other shares, stock or
securities or other assets of the Company for a consideration which covers both,
the consideration for the issue or sale of such shares of Common Stock or
Convertible Securities or such rights or options shall be deemed to be the
portion of such consideration allocated thereto in good faith by the Board of
Directors of the Company.
(g) Whenever the number of shares of Common Stock issuable upon conversion
or the Conversion Price of the shares of Series D Preferred Stock is adjusted,
as herein provided, the Company shall promptly mail by first class mail, postage
prepaid, to each holder of shares of Series D Preferred Stock notice of such
adjustment or adjustments and shall obtain a certificate from a firm of
independent public accountants selected by the Board of Directors of the Company
(who may be the regular accountants employed by the Company) setting forth the
number of shares of Common Stock issuable upon conversion and the Conversion
Price after such adjustment, setting forth a brief statement of the facts
requiring such adjustment and setting forth the computation by which such
adjustment was made. Such certificate shall be conclusive evidence of the
correctness of such adjustment.
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(h) In case of any consolidation of the Company with or merger of the
Company into another corporation or in case of any sale, transfer or lease to
another corporation of all or substantially all the property of the Company, the
Company or such successor or purchasing corporation, as the case may be, shall
expressly provide that each holder of Series D Preferred Stock shall have the
right to receive upon conversion of the Series D Preferred Stock the kind and
amount of shares and other securities and property which he would have owned or
have been entitled to receive after the happening of such consolidation, merger,
sale, transfer or lease had such conversion taken place immediately prior to
such action; provided, however, that no adjustment in respect of dividends,
interest or other income on or from such shares or other securities and property
shall be made until conversion of the Shares of Series D Preferred Stock. The
provisions of this subsection (h) shall similarly apply to successive
consolidations, mergers, sales, transfers or leases.
(i) Irrespective of any adjustments in the Conversion Price or the number
or kind of shares purchasable upon conversion, shares of Series D Preferred
Stock theretofore or thereafter issued may continue to express the same price
and number and kind of shares as are stated in the Series D Preferred Stock
initially issuable pursuant to this Certificate of Designation.
(j) The holder of any shares of Series D Preferred Stock may exercise its
option to convert such shares into shares of Common Stock by surrendering for
such purpose to the Company at its principal office the certificates
representing the shares to be converted, accompanied by written notice that such
holder elects to convert such shares. Said notice shall also state the name in
which the certificate for shares of Common Stock which shall be issuable on such
conversion shall be issued. Each certificate or certificates surrendered for
conversion shall, unless the shares issuable on conversion are to be issued in
the same name as that in which such certificate or certificates are registered,
be accompanied by instruments of transfer, in form satisfactory to the Company,
duly executed by the holder or his duly authorized attorney. Each conversion
shall be deemed to have been effected on the date on which such certificate
shall have been surrendered and such notice received by the Company as
aforesaid. As promptly as practicable on or after the conversion date, the
Company shall issue and deliver to the person entitled to receive the same a
certificate representing the number of full shares of Common Stock issuable upon
such conversion.
(k) Upon any conversion of shares of Series D Preferred Stock, no
allowance, adjustment or payment shall be made with respect to accrued but
unpaid dividends upon such Series D Preferred Stock or with respect to dividends
on the Common Stock to be issued upon conversion.
(l) In connection with the conversion of shares of Series D Preferred Stock
into Common Stock, no fractional shares of Series D Preferred Stock or of Common
Stock shall be issued, but the Company shall pay a cash adjustment in respect of
such fractional interest, calculated based on the market price of the Common
Stock on the date of conversion.
(m) The issuance of stock certificates on conversions shall be made without
charge to converting shareholders for any tax in respect of the issuance
thereof. The Company shall not, however, be required to pay any tax which may be
payable in respect of any registration of transfer involved in the issue and
delivery of stock in any name other than that of the holder of the shares of
Series D Preferred Stock converted, and the Company shall not be required to so
issue or deliver any stock certificate unless and until the person or persons
requesting the registration of transfer shall have paid to the Company the
amount of such tax.
(n) The Company shall at all times reserve and keep available out of its
authorized Common Stock the full number of shares of Common Stock deliverable
upon the conversion of all outstanding shares of Series D Preferred Stock.
7. REDEMPTION. (a) The Company may, at its option, redeem shares of Series
D Preferred Stock for cash, at any time and from time to time, in whole or in
part, by vote of its Board of Directors; provided, however, in the event that
any share of Series D Preferred Stock is redeemed by the Company on or before
the seventh anniversary of the first Date of Issuance, in addition to the cash
payable to the holder of each such share, the holder shall receive a warrant to
purchase one share of Common Stock of the Company for each share of Common Stock
into which such share of Series D Preferred Stock is then convertible,
exercisable at $5.25 per share of Common Stock, or, in the event of any
adjustment to the Conversion Price hereunder, at
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the adjusted Conversion Price, at any time prior to the seventh anniversary of
the first Date of Issuance. Such warrants shall be issued in the form attached
to the Warrant Subscription Agreement and such warrants and the shares of Common
Stock issuable upon exercise of the warrants shall be entitled to the benefits
of the Registration Rights Agreement.
(b) To the extent permitted under the laws of the State of Delaware, the
Company shall redeem shares of Preferred Stock as follows: (i) 10% of the shares
of Series D Preferred Stock outstanding shall be redeemed on the first business
day of each year beginning 2008, and (ii) all remaining outstanding shares of
Series D Preferred Stock shall be redeemed on the first business day of the year
2018. If the Company cannot legally redeem all shares of Preferred Stock
required to be redeemed by it on any particular date, then the Company shall
redeem such shares as soon as it can legally do so. The redemption price of each
share of Series D Preferred Stock (the "Redemption Price") shall be $100.00 per
share plus an amount equal to all unpaid dividends, whether or not earned or
declared, accrued to the date fixed for redemption.
(c) Notice of any optional or mandatory redemption of all or any of the
shares of the Series D Preferred Stock shall be sent by the Secretary of the
Company by first-class mail, postage prepaid, at least 30 but not more than 60
days prior to the date fixed for such redemption (the "Redemption Date"), to the
holders of the shares of the Series D Preferred Stock to be redeemed, at their
respective addresses appearing on the books of the Company. The Company shall
pay the Redemption Price in immediately available funds to the holders of shares
to be redeemed on the latter of the Redemption Date or the date such holder
surrenders the certificate representing the shares to be redeemed to the Company
at its principal office. Notwithstanding that any certificate for Shares of
Series D Preferred Stock so called for redemption shall not have been
surrendered for cancellation, the shares represented thereby shall no longer be
deemed outstanding, the dividends thereon shall cease to accrue from and after
the Redemption Date, and all rights with respect to the Series D Preferred Stock
so called for redemption shall forthwith after such Redemption Date cease and
terminate, excepting only the right of the holder to receive the Redemption
Price thereof plus accrued and unpaid dividends to the Redemption Date without
interest.
(d) If any proposed redemption of shares of the Series D Preferred Stock
shall be of less than all then outstanding shares of Series D Preferred Stock,
such redemption shall be made on a pro rata basis, as nearly as possible, among
all holders of shares of the Series D Preferred Stock outstanding at the time of
redemption in the same proportion that each such holder's then respective
holding of such shares shall bear to the aggregate number of such shares then
outstanding.
8. RESTRICTIONS ON TRANSFER. (a) No transfer of any shares of Series D
Preferred Stock, nor any interest therein, shall be made except upon the
conditions specified in this Section 8, which conditions are intended to ensure
compliance with the provisions of the Securities Act and all applicable state
securities laws in respect of the Transfer of any of such securities or any
interest therein.
(b) Each certificate for shares of Series D Preferred Stock shall include a
legend in substantially the following form:
THE SECURITIES REPRESENTED BY THIS CERTIFICATE HAVE NOT BEEN REGISTERED
UNDER THE SECURITIES ACT OF 1933 AND NEITHER THESE SECURITIES NOR ANY
INTEREST THEREIN MAY BE SOLD, TRANSFERRED, PLEDGED OR OTHERWISE DISPOSED OF
IN THE ABSENCE OF SUCH REGISTRATION OR AN EXEMPTION THEREFROM UNDER SUCH
ACT, APPLICABLE STATE SECURITIES LAWS AND THE RULES AND REGULATIONS
THEREUNDER. BY ACCEPTANCE HEREOF, THE HOLDER OF THIS CERTIFICATE REPRESENTS
THAT IT IS ACQUIRING THESE SECURITIES FOR INVESTMENT AND AGREES TO COMPLY
IN ALL RESPECTS WITH SECTION 8 OF THE CERTIFICATE OF DESIGNATION OF THE
SERIES D CUMULATIVE PREFERRED STOCK OF THE COMPANY, A COPY OF WHICH MAY BE
OBTAINED AT NO COST BY WRITTEN REQUEST MADE BY THE HOLDER OF RECORD OF THIS
CERTIFICATE TO THE SECRETARY OF THE COMPANY AT ITS PRINCIPAL EXECUTIVE
OFFICE.
(c) The holder of each certificate representing Series D Preferred Stock by
acceptance thereof agrees to comply in all respects with the provisions of this
Section 8. Prior to any proposed Transfer of any Shares of
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Series D Preferred Stock, the holder thereof shall give written notice to the
Company of such holder's intention to effect such Transfer. Each such notice
shall describe the manner and circumstances of the proposed Transfer in
reasonable detail, and shall be accompanied by (a) a written opinion of counsel
to the Company, addressed to the Company, to the effect that the proposed
Transfer may be effected without registration under the Securities Act and any
applicable state securities laws of the Series D Preferred Stock, or (b) written
assurance from the staff of the Commission and any applicable state agency or
commission that it will not recommend that any action be taken by the Commission
or such agency or commission in the event such Transfer is effected without
registration under the Securities Act or any applicable state securities law.
Such proposed Transfer may be effected only if the Company shall have received
such notice and such opinion of counsel or written assurance, whereupon the
holder of such Shares shall be entitled to Transfer such Shares of Series D
Preferred Stock in accordance with the terms of the Notice delivered by the
holder to the Company. Each certificate evidencing the Series D Preferred Stock
so transferred shall bear the legend set forth in Paragraph (b) of this Section
8.
9. GENERAL. (a) The section headings contained in this resolution are for
reference purposes only and shall not affect, in any way, the meaning of this
resolution.
(b) Shares of Series D Preferred Stock which have been issued and have been
converted, redeemed, repurchased or reacquired in any manner by the Company
shall become authorized and unissued shares of the Company's undesignated
preferred stock, $.01 par value, but shall not be reissued as shares of Series D
Preferred Stock.
IN WITNESS WHEREOF, the Company has caused this Certificate to be signed by
the undersigned officers this day of , 1996.
AMERICAN EAGLE GROUP, INC.
By:
------------------------------------
Its:
------------------------------------
ATTEST:
- ------------------------------------------------------
III-11
<PAGE> 120
- --------------------------------------------------------------------------------
<TABLE>
<S> <C>
AMERICAN EAGLE GROUP, INC.
12801 NORTH CENTRAL EXPRESSWAY, SUITE 800, DALLAS, TEXAS 75243
SOLICITED BY THE BOARD OF DIRECTORS FOR THE
SPECIAL MEETING OF STOCKHOLDERS ON DECEMBER 30, 1996
P
R The undersigned hereby appoints M. Philip Guthrie and Frederick G. Anderson, and each of them, his/her
O Proxies, with full power to appoint his substitute, and hereby authorize them to represent and to
X vote, as designated hereon, all shares of capital stock of American Eagle Group, Inc. held of record
Y by the undersigned on December 4, 1996, at the Special Meeting of Stockholders to be held on December
30, 1996, and any adjournments thereof, and hereby further authorizes each of them, in their
discretion, to vote upon any other business that may properly come before the meeting.
</TABLE>
(Change of address)
-------------------------------
-------------------------------
-------------------------------
-------------------------------
If you have written in the
above space, please mark the
corresponding box on the
reverse side of this card.)
You are encouraged to specify your choice by marking the appropriate
boxes, SEE REVERSE SIDE, but you need not mark any boxes with regard to
the Proposal if you wish to vote FOR such Proposal. The Proxies cannot
vote your shares unless you sign and return this card.
SEE
REVERSE
SIDE
- --------------------------------------------------------------------------------
<PAGE> 121
<TABLE>
<C> <S>
PLEASE MARK YOUR
VOTES AS IN THIS
[X] EXAMPLE.
THIS PROXY WHEN PROPERLY EXECUTED WILL BE VOTED IN THE MANNER DIRECTED HEREIN. IF NO DIRECTION
IS MADE, THIS PROXY WILL BE VOTED FOR THE PROPOSAL.
</TABLE>
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------------------------
THE BOARD OF DIRECTORS RECOMMENDS A VOTE FOR THE PROPOSAL.
- --------------------------------------------------------------------------------------------------------------------------------
FOR AGAINST ABSTAIN
<S> <C> <C> <C> <C>
1. TO APPROVE THE [ ] [ ] [ ] 2. IN THEIR DISCRETION,
SECURITIES PURCHASE THE PROXIES ARE
AGREEMENT AND THE SALE AUTHORIZED TO VOTE
OF THE SERIES D UPON SUCH OTHER
PREFERRED STOCK AS BUSINESS AS MAY
FURTHER DESCRIBED IN THE PROPERLY COME
ACCOMPANYING PROXY BEFORE THE SPECIAL
STATEMENT MEETING.
ADDRESS CHANGE [ ]
</TABLE>
<TABLE>
<S> <C>
SIGNATURE(S)____________________________________ DATE ____________________ THE SIGNERS HEREBY REVOKES ALL PROXIES
NOTE: PLEASE SIGN EXACTLY AS NAME APPEARS HEREON, JOINT OWNERS SHOULD EACH SIGN. HERETOFORE GIVEN BY THE SIGNER TO VOTE AT SAID
WHEN SIGNING AS ATTORNEY, EXECUTOR, ADMINISTRATOR TRUSTEE OR GUARDIAN PLEASE MEETING OR ANY ADJOURNMENTS THEREOF.
GIVE FULL TITLE AS SUCH.
</TABLE>
