<PAGE> 1
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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
___________________________
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 1997
Commission File Number 0-20995
EXSTAR FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 77-0321240
(State or other jurisdiction (IRS Employer Identification No.)
of incorporation or organization)
2029 Village Lane, Solvang, California 93463-2275
(Address of principal executive offices and zip code)
Registrant's telephone number, including area code: (805) 688-8013
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes No X
----- -----
The aggregate number of shares of the Registrant's common stock
outstanding, all of which constitute a single class, was 5,497,500 as of March
31, 1997.
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EXSTAR FINANCIAL CORPORATION
QUARTER ENDED MARCH 31, 1997
INDEX
<TABLE>
<S> <C>
Page
----
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets as of March 31, 1997 (Unaudited)
and December 31, 1996.................................................... 3
Consolidated Statements of Operations (Unaudited) for the three months
ended March 31, 1997 and 1996............................................ 5
Consolidated Statement of Changes in Stockholders' Equity (Unaudited)
for the three months ended March 31, 1997................................ 6
Consolidated Statements of Cash Flows (Unaudited) for the three months
ended March 31, 1997 and 1996............................................ 7
Notes to the Consolidated Financial Statements........................... 8
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.................................................... 13
SIGNATURE........................................................................... 19
</TABLE>
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<PAGE> 3
PART 1 - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
EXSTAR FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
March 31, December 31,
1997 1996
-------- -----------
(Unaudited) (Audited)
(Dollars in thousands)
<S> <C> <C>
ASSETS
Fixed maturities available for sale, at market
(amortized cost: 1997 - $32,895; 1996 - $39,330) $ 31,812 $ 38,800
Equity securities, at market (cost: 1997 - $1,250;
1996 - $1,250) 1,566 1,531
Mortgage loans - unaffiliated 4,021 4,225
Mortgage loans - affiliated 905 908
Real estate held for investment 4,231 4,255
Real estate held for sale 6,251 6,391
Real estate acquired through foreclosure 493 493
Short-term investments 2,732 4,944
-------- --------
Total investments 52,011 61,547
Cash and cash equivalents - restricted 1,175 1,129
Cash and cash equivalents - unrestricted 4,322 1,390
Accounts receivable - affiliated 2,320 2,443
Reinsurance recoverable
Paid losses and loss adjustment expenses 1,860 1,576
Unpaid losses and loss adjustment expenses 33,619 33,921
Prepaid reinsurance premiums 44 386
Accrued investment income 569 822
Deferred acquisition costs 0 307
Property and equipment, net 793 797
Deferred income taxes 1,877 1,700
Other assets 2,786 2,136
-------- --------
Total assets $101,376 $108,154
======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
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<PAGE> 4
EXSTAR FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
March 31, December 31,
1997 1996
-------- -----------
(Unaudited) (Audited)
(Dollars in thousands)
<S> <C> <C>
LIABILITIES
Unpaid loss and loss adjustment expenses $ 78,786 $ 86,927
Unearned premium 172 1,365
Reinsurance balances payable 1,206 1,106
-------- --------
Total policy liabilities and accruals 80,164 89,398
Notes payable 1,545 1,588
Current income taxes 375 375
Accumulated equity in losses of affiliates 3,476 3,020
Other liabilities 804 1,247
-------- --------
Total liabilities 86,364 95,628
-------- --------
STOCKHOLDERS' EQUITY
Common stock, $.01 par value, 30,000,000 shares
authorized; issued and outstanding: 1997 and 1996 -
5,497,500 shares 55 55
Paid in capital 26,865 26,865
Net unrealized investment losses (411) (68)
Preferred stock investment - contra equity (12,314) (12,314)
Retained deficit 817 (2,012)
-------- --------
Total equity 15,012 12,526
-------- --------
Total liabilities and stockholders' equity $101,376 $108,154
======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
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<PAGE> 5
EXSTAR FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
<TABLE>
<CAPTION>
Three months ended March 31,
---------------------------
1997 1996
----------- -----------
(Dollars in thousands except per share data)
<S> <C> <C>
REVENUES
Premiums earned $2,090 $15,224
Premiums ceded (748) (7,352)
------ -------
Net premiums earned 1,342 7,872
Net investment income - unaffiliated 719 1,004
Net investment income - affiliated 25 151
Net realized investment gains 8 198
Other income 3,264 56
------ -------
Total revenue 5,358 9,281
------ -------
EXPENSES
Loss and loss adjustment expense 1,267 9,156
Reinsurance ceded (449) (4,411)
------ -------
Net loss and loss adjustment expense 818 4,745
Policy acquisition costs amortized 469 2,692
Profit sharing - affiliated 0 627
Interest expense 61 17
Other expenses 1,428 1,286
------ -------
Total expenses 2,776 9,367
------ -------
Income (loss) before equity in income of affiliates
and income tax expense 2,582 (86)
------ -------
Equity in income of affiliates 247 676
Income tax expense 0 0
------ -------
Net income $2,829 $ 590
====== =======
Net income per common share $ 0.51 $ 0.11
====== =======
Shares used in computation of net income per
common share (in thousands) 5,498 5,498
====== =======
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
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EXSTAR FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES
IN STOCKHOLDERS' EQUITY
(Unaudited)
<TABLE>
<CAPTION>
Net Preferred
Unrealized Stock
Investment Investment Retained
Common Paid in (Losses) Contra (Deficit) Total
Stock Capital Gains Equity Earnings Earnings
------ ------- ---------- ---------- --------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1996 $55 $26,865 $ (68) $(12,314) $(2,012) $12,526
Change in net unrealized
investment losses
Fixed maturities (552) $ (552)
Equity securities 32 $ 32
Deferred tax benefit 177 $ 177
Net income 2,829 $ 2,829
--- ------- ----- -------- ------- -------
Balance at March 31, 1997 $55 $26,865 $(411) $(12,314) $ 817 $15,012
=== ======= ===== ======== ======= =======
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
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<PAGE> 7
EXSTAR FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
<TABLE>
<CAPTION>
Three months ended March 31,
----------------------------
1997 1996
--------- ----------
(Dollars in thousands)
<S> <C> <C>
Cash flows (applied to) provided by operating activities:
Premiums collected $ 713 $ 6,748
Investment income received 1,079 1,343
Loss and loss adjustment expense paid, net (8,657) (7,366)
Interest paid (61) (17)
Policy acquisition and other expenses paid (2,313) (4,627)
Other 2,979 4
------- --------
Cash flows applied to operating activities (6,260) (3,915)
------- --------
Cash flows provided by (applied to) investment activities:
Purchase of marketable securities 0 (10,742)
Purchase of property, equipment and real estate (52) (13)
Sale or maturity of marketable securities 6,383 13,483
Sale of property, equipment and real estate 140 308
Short-term investments, net 2,212 3,239
Mortgage loans funded 0 (280)
Repayment of mortgage loans 207 227
------- --------
Net cash provided by investing activities 8,890 6,222
------- --------
Cash flows provided by (applied to) financing activities
Repayment of notes payable (43) (123)
Transfers from affiliates 703 448
Other (312) 266
Transfers to restricted cash and cash equivalents (46) (56)
------- --------
Net cash provided by financing activities 302 535
------- --------
Net increase in unrestricted cash and cash equivalent 2,932 2,842
Unrestricted cash and cash equivalents - beginning of period 1,390 4,028
------- --------
Unrestricted cash and cash equivalents - end of period $ 4,322 $ 6,870
======= ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
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<PAGE> 8
EXSTAR FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
The consolidated financial statements of Exstar Financial Corporation and
subsidiaries ("Exstar" if referring to the parent company only, or the
"Company" if referring to Exstar and its direct and indirect subsidiaries)
include the financial statements of Exstar, its direct subsidiary, Alpine
Holdings, Inc., Exstar's indirect subsidiaries, Alpine Insurance Company
("Alpine"), a direct subsidiary of Alpine Holdings, Inc., Alpine Premium
Finance Co., Inc. and Transco Premium Finance Co., Inc., both of which are
direct subsidiaries of Alpine, and the equity in the income and losses of
TCO Holdings, Inc. ("TCO Holdings") and subsidiaries (collectively "TCO"),
a group of companies affiliated with Exstar through common majority
ownership.
The consolidated financial statements have been prepared in accordance with
generally accepted accounting principles and accordingly include all normal
recurring adjustments management considers necessary for fair presentation.
These consolidated financial statements should be read in conjunction with
audited financial statements included in the Form 10-K for the year ended
December 31, 1996.
The results of operations for the three months ended March 31, 1997 and 1996
are not necessarily indicative of the results to be expected for the full
year.
2. EQUITY IN INCOME OF AFFILIATES
Although TCO is not a direct or indirect subsidiary of Exstar, its income or
loss is included in the Company's consolidated financial statements in
accordance with a form of equity accounting.
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<PAGE> 9
EXSTAR FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
The following sets forth the financial position and results of operations of
TCO:
<TABLE>
<CAPTION>
March 31, December 31,
1997 1996
---- ----
(Dollars in thousands)
<S> <C> <C>
ASSETS:
Cash and investments .............................. $ 4,360 $ 4,931
Accounts receivable ............................... 4,279 4,915
Property and equipment ............................ 94 119
Other assets ...................................... 815 914
------- -------
Total assets .................................... 9,548 10,879
======= =======
LIABILITIES:
Premiums payable--affiliated ...................... 18,771 19,304
Notes payable ..................................... 4,500 4,581
Due to affiliates ................................. 591 718
Net unearned commission income .................... -0- 659
Other liabilities ................................. 3,364 3,428
------- -------
Total liabilities ............................... 27,226 28,690
------- -------
PREFERRED STOCK:
Series A 11.3% cumulative redeemable, nonvoting,
stated value $10,000 per share, 3,500 shares
authorized; issued and outstanding - 1,075 ...... 12,035 12,035
STOCKHOLDER'S EQUITY:
Stockholder's accumulated deficiency .............. (29,713) (29,846)
------- -------
Total liabilities, preferred stock, and
stockholder's accumulated deficiency .............. $ 9,548 $10,879
======= =======
</TABLE>
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<PAGE> 10
EXSTAR FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
For the
three months
ended
March 31,
-----------------
1997 1996
---- ----
(Dollars in thousands)
<S> <C> <C>
Revenues:
Net commissions earned ......................... $ 333 $ 2,921
Other revenues ................................. 153 430
------- -------
Total revenues ............................... 486 3,351
------- -------
Expenses:
Personnel costs ................................ 43 1,643
Office and selling expenses .................... 48 706
Depreciation ................................... 19 35
Interest ....................................... 132 206
Other expenses ................................. (7) 277
------- -------
Total expenses ............................... 235 2,867
------- -------
Income before Federal income taxes ......... 251 484
Federal income tax expense ................... -0- 25
------- -------
Net income ................................. 251 459
======= =======
Beginning stockholder's accumulated deficiency ... 29,846 30,900
------- -------
Net income ..................................... (251) (459)
Increase in subscription note receivable ....... 118 125
------- -------
Net change .............................. (133) (334)
------- -------
Ending stockholder's accumulated deficiency ...... $29,713 $30,566
======= =======
</TABLE>
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<PAGE> 11
EXSTAR FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
The following sets forth the computation of the equity in income of affiliates
included in the Statement of Operations:
<TABLE>
<CAPTION>
For the
three months
ended
March 31,
-----------------
1997 1996
---- ----
(Dollars in thousands)
<S> <C> <C>
Increase in net equity of TCO ..................... $ (133) $ (334)
Reclassification:
Interest on advances ............................ (114) (342)
------- -------
Equity in income of affiliates ................ $ (247) $ (676)
======== =======
</TABLE>
Accumulated equity in losses of affiliates comprises:
<TABLE>
<CAPTION>
March 31, December 31,
1997 1996
---- ----
(Dollars in thousands)
<S> <C> <C>
Cumulative adjusted losses ........................ $18,230 $18,363
Amounts advanced by and other amounts due to the
Company from TCO ................................ 14,754 15,343
------- -------
Accumulated equity in losses of affiliates .... $ 3,476 $ 3,020
======= =======
</TABLE>
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<PAGE> 12
EXSTAR FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
3. NET INCOME PER COMMON SHARE
Net income per common share is computed by dividing net income by the
weighted average number of shares of common stock and common stock
equivalents outstanding. The weighted average number of shares of common
stock outstanding for the three months ended March 31, 1997 and 1996 was
5,498,000. There were no common stock equivalents.
4. STATUTORY INFORMATION
The surplus as regards policyholders of Alpine determined in accordance with
statutory accounting practices as of March 31, 1997 and 1996 was $13,367,000
and $10,373,000, respectively. The net income of Alpine determined in
accordance with statutory accounting practices for the three months ended
March 31, 1997 and 1996 was $36,000 and $419,000, respectively.
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<PAGE> 13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
GENERAL
This discussion should be read in conjunction with management's discussion
and analysis included in the Form 10-K for the year ended December 31, 1996.
The Company's operations and business have undergone fundamental changes
since the beginning of 1996. Some of the most important changes include the
following:
(i) At the beginning of 1996, the Company was engaged principally in
"direct" underwriting ("direct" underwriting consists of issuing insurance
policies directly to insureds) -- since August 1996 the Company has ceased
issuing direct insurance as a consequence of A.M. Best Company ("Best") rating
downgrades and certain regulatory restrictions relating to the Company's
insurance company subsidiaries;
(ii) At the beginning of 1996, Alpine Insurance Company ("Alpine") had a
Best rating of A- (Excellent) and Transco Syndicate #1 Ltd. ("Syndicate") had a
Best rating of B+ (Very Good) -- in April 1996 both companies' Best ratings
were reduced to C's (Marginal) (under review) and both ratings have remained
unchanged since then;
(iii) At the beginning of 1996, the Company's insurance company
subsidiaries were authorized to operate on a surplus lines basis in
approximately 45 states -- during the second half of 1996 these authorizations
were lost or restricted in nine jurisdictions, representing in excess of 80% of
the Company's historical premium revenues, and additionally Alpine was placed
under an order ("Illinois Order") requiring prior approval of all of its
significant expenditures and commitments by the Illinois Department of
Insurance ("Illinois DOI");
(iv) At the beginning of 1996, the Company's insurance business was
conducted through two insurance company subsidiaries, Alpine and Syndicate --
effective December 31, 1996, Syndicate's operations were merged into Alpine and
since then Alpine has been the Company's only significant operating subsidiary;
and
(v) At the beginning of 1996, almost all of the management,
underwriting, claims handling, investment and other functions of the Company
were performed by staff of TCO and compensation and general and administrative
costs associated with that performance were borne directly by TCO -- since
August 1996, most of the compensation expense and general administrative costs
have been borne directly by the Company.
For more complete descriptions of these and other changes, see the
Company's Form 10-K for the year ended December 31, 1996.
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<PAGE> 14
Because of the foregoing and other changes that are continuing in 1997,
differences in the Company's results of operations between 1996 and 1997 are
not necessarily indicative of trends or likely results of operations for 1997
or future periods.
This Form 10-Q contains certain "forward looking statements" (within the
meaning of the Private Securities Litigation Reform Act of 1995) that involve
substantial risks and uncertainties. When used in this Form 10-Q, the words
"anticipate," "believe," "estimate," and "expect" and similar expressions as
they relate to the Company and its management are intended to identify such
forward looking statements. A number of important factors could cause the
actual future results, performance and achievements of the Company to differ
materially from those expressed in such forward looking statements. These
include, without limitation (i) any discontinuation or material adverse change
in the terms and conditions of the Company's and its affiliates' business
arrangements with third parties, including in particular Alpine's casualty
quota share reinsurance agreement ("Quota Share Arrangement") with United
Capitol Insurance Company (together with its affiliates, "UCIC"), which became
effective April 1, 1997, and pursuant to which Alpine assumes a portion of the
business placed with UCIC by Transre Insurance Services ("Transre") and Exstar
E&S Insurance Services ("Exstar E&S"), two entities affiliated with, but not
part of, the Company; (ii) any material adverse changes in UCIC's financial
condition or regulatory authorities; (iii) any material increase in
competition; and (iv) any material adverse changes in the Illinois DOI's
oversight of Alpine.
The Company ceased issuing direct insurance in August 1996. This directly
resulted in a sharp decline in the Company's earned premium revenue during the
second half of 1996, and has and will continue to cause a further decline in
the Company's earned premium from direct insurance during 1997. The Company,
however, beginning in the second quarter of 1997, will earn premium revenue
through the Quota Share Arrangement with UCIC which became effective April 1,
1997. The premium assumed by the Company initially will be 30% of the net
premiums accruing to UCIC on such business, including premiums unearned as of
April 1, 1997 (estimated to be approximately $13.6 million) and premiums on
policies issued after such date. The Company has engaged in discussions with
UCIC concerning increasing the quota share percentage to as much as 50% later
in 1997. No commitments have been made regarding the amount of, timing of, or
terms and conditions relating to any such increase, and the increase also would
have to be submitted for approval to appropriate regulatory authorities.
The Company also will earn investment income on premium assumed by
Alpine under the Quota Share Arrangement. Because most of the premium funds
initially will be held by UCIC, however, the Quota Share Arrangement will not
benefit the Company's cash flow to the same extent it is expected to benefit
the Company's net income (assuming the Quota Share Arrangement underwriting
results are as profitable as or more profitable than Alpine's underwriting
results have been over the last three years). The Company has discussed with
UCIC modifying the Quota Share Arrangement to allow Alpine to receive some or
all of the premium funds that otherwise would be held by UCIC pursuant to the
current terms and conditions of the Quota Share Arrangement. No commitments
have been
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<PAGE> 15
made regarding the timing of or terms and conditions relating to any such
modification, and the modification also would have to be submitted for approval
to appropriate regulatory authorities.
The Company reduced its underwriting expenses during 1996 by terminating
its insurance company subsidiaries' management agreements with TCO, thereby
terminating the Company's obligation to pay commissions and profit-sharing
amounts to TCO (subject to a final determination of obligations between the
parties, if any), and such expenses were virtually eliminated following the
Company's decision to cease issuing new and renewal insurance policies in
August 1996. The Company, however, will incur significant underwriting
expenses under the Quota Share Arrangement. Of the net premium assumed by
Alpine, Alpine will (i) allow UCIC to retain 30% as a ceding commission and
(ii) pay 3.75% to TCO Holdings as an override commission. Additionally, during
the second half 1996 the Company began assuming a substantial amount of
personnel costs and operating expenses previously borne by TCO. These
expenses, which previously would have been included in the Company's
underwriting expenses, have been included in the Company's other expenses since
August 1, 1996. These expenses are being offset in part by reimbursements from
Transre and E&S.
RESULTS OF OPERATIONS
Gross written premiums were $897,000 for the first quarter of 1997,
compared to $10.8 million for the first quarter of 1996. The gross written
premiums for the first quarter of 1997 represent principally residual audit
premiums on direct insurance issued prior to the Company's ceasing to issue
direct insurance in August 1996. No gross written premiums relating to the
Quota Share Arrangement were included in either first quarter's results as the
Quota Share Arrangement did not become effective until April 1, 1997. The
Company expects gross written premiums to increase significantly during the
remainder of 1997 as a consequence of the Quota Share Arrangement, with a
proportionally greater increase if Alpine's participation is increased from the
current 30%.
Net premiums earned, consisting of premiums earned less premiums ceded
(generally earned ratably over individual policy periods), for the first
quarter of 1997 were $1.3 million, compared to $7.9 million for the first
quarter of 1996. The decrease directly resulted from the decrease in gross
written premiums. No net premiums earned relating to the Quota Share
Arrangement were included in either first quarter's results as the Quota Share
Arrangement did not become effective until April 1, 1997. The Company expects
net premiums earned to increase during the remainder of 1997 as a consequence
of the Quota Share Arrangement. The increase will be greater than it would be
if Alpine were assuming premium only with respect to insurance policies written
on or after April 1, 1997 because under the Quota Share Arrangement Alpine also
will be assuming a 30% portion of premiums unearned as of April 1, 1997 on
policies issued prior to that date (estimated to be approximately $13.6
million).
-15-
<PAGE> 16
Net investment income for the first quarter of 1997 was $700,000, a
decrease of $400,000 or 35.6% from $1.1 million for the first quarter of 1996.
The decrease was caused principally by a 29.9% decrease in average investable
assets from $86.7 million as of December 31, 1996 to $60.8 million as of March
31, 1997, resulting from negative cash flow from operations as loss payments
and expenses have exceeded revenues since the Company ceased issuing direct
insurance in August, 1996. The Company expects net investment income to
continue to decline during the remainder of 1997 as prior years' losses and
expenses continue to be paid, though the decline is expected to be offset to
some extent by investment income earned by Alpine on premium assumed by Alpine
under the Quota Share Arrangement effective April 1, 1997.
Other income was $3.3 million for the first quarter of 1997, compared to
virtually nothing for the first quarter of 1996. The income in 1997,
reflecting proceeds less certain related expenses, was principally a
consequence of a one-time settlement of a lawsuit against the Company's former
independent auditors. The Company expects other income for the remainder of
1997 to be limited, though it anticipates resolving a disagreement over
payments due from an unaffiliated insurance company to TCO, which payments have
been assigned to Exstar, which could result in more than $1.0 million of
additional other income prior to the end of 1997.
Net loss and loss adjustment expense incurred during the first quarter of
1997 totaled $800,000, down 82.8% from $4.7 million in the first quarter of
1996. Net loss and loss adjustment expense as a portion of net premiums earned
was 61.0% in the first quarter of 1997 compared to 60.3% in the first quarter
of 1996. The decrease in net loss and loss adjustment expense incurred between
the periods resulted from the decrease in net premiums earned. No loss and
loss adjustment expense relating to the Quota Share Arrangement were included
in either first quarter's results, as the Quota Share Arrangement did not
become effective until April 1, 1997. The Company expects net loss and loss
adjustment expense during the remainder of 1997 to increase in proportion to
the increase in net premiums earned as a consequence of the Quota Share
Arrangement, with the ratio of net loss and loss adjustment expense to net
premiums earned initially being in the 60% range.
Other underwriting expenses historically have consisted of (i) policy
acquisition costs, which equaled a fixed percentage of gross written premiums
less reinsurance commissions, plus (ii) the allocated portion of profit sharing
payments to TCO. Following termination of the management agreements between
the Company's insurance company subsidiaries and TCO in 1996, the fees and
commissions that otherwise would have been paid by the Company to TCO were
eliminated.
The Company's other underwriting expenses for the first quarter of 1997
were $500,000, compared to $3.3 million in the first quarter of 1996. The
ratio of the Company's other underwriting expenses to net premiums earned was
35.0% in the first quarter of 1997 compared to 42.2% in the first quarter of
1996. The decrease in other underwriting expenses between the periods was
attributable to the decrease in net premiums earned and
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<PAGE> 17
to reduced net expenses resulting from termination of the management agreements
with TCO. No other underwriting expenses relating to the Quota Share
Arrangement are included in either first quarter's results, as the Quota Share
Arrangement did not become effective until April 1, 1997. The Company expects
other underwriting expenses during the remainder of 1997 to increase in
proportion to the increase in net premiums earned, as under the Quota Share
Arrangement Alpine will (i) allow UCIC to retain a ceding commission of 30% of
the premiums assumed by Alpine and (ii) pay 3.75% of the premiums assumed by
Alpine to TCO Holdings as an override commission.
Other expenses, consisting of professional fees, personnel costs and
other costs, were $1.4 million in the first quarter of 1997, compared to $1.3
million in the first quarter of 1996. The slight increase was principally due
to Alpine's assuming a portion of the personnel and general and administrative
costs previously borne by TCO, offset by a reduction in legal and professional
expenses. The Company anticipates a continuing decrease in other expenses
during the remainder of 1997 as a consequence of (i) reduced fees and costs
resulting from settlement of the lawsuit against the Company's former
independent auditors, reduced fees resulting from a decrease in regulatory and
operational issues and a gradual shifting of personnel, general and
administrative costs to Transre and E&S, offset by (ii) an increase in overall
personnel and general and administrative costs (a) to pay bonuses for personnel
to compensate, in part, for compensation reductions during 1996, and otherwise
to provide incentives to personnel to continue with the Company, and (b) to
improve the Company's overall level of management experience and otherwise
replace certain employees and restore or improve certain operating
capabilities.
Equity in income of affiliates, included in the Company's results due
to the Company's adoption of a form of equity accounting in 1995, generally
reflects TCO's net income for the period after certain adjustments. Equity in
income of affiliates for the first quarter of 1997 was $200,000, compared to
$700,000 for the first quarter of 1996. The smaller amount in 1997 reflects
the minimal revenues generated by TCO after Exstar's insurance company
subsidiaries ceased issuing direct insurance in August 1996 and the management
agreements with TCO were terminated. The Company anticipates that equity in
income or losses of affiliates during the remainder of 1997 generally should be
minimal, as TCO will have virtually no revenues and no expenses relating to
operations. The Company believes, however, that additional equity in income of
affiliates could be generated if TCO is successful in settling certain of its
existing liabilities (other than liabilities to the Company) at less than their
book values.
Net income per common share was $0.51 for the first quarter of 1997,
compared to $0.11 for the first quarter of 1996. This increase was almost
entirely a consequence of the settlement of the lawsuit against the Company's
former independent auditors, offset somewhat by the decrease in equity in
income of affiliates.
LIQUIDITY AND CAPITAL RESOURCES
At March 31, 1997, cash and investments totaled $57.5 million compared to
$64.1 at December 31, 1996. The decrease resulted from net cash applied to
operations which
-17-
<PAGE> 18
was $6.3 million for the first quarter of 1997 (after a cash inflow of $3.0
million of other income), compared to $3.9 million of cash applied to
operations for the first quarter of 1996. The increase in net cash applied to
operations in the first quarter of 1997 resulted principally from an increase in
payments of loss and loss adjustment expenses (offset to some extent by a
decrease in payments of policy acquisition and other expenses), while premium
revenues were minimal as a consequence of the cessation of direct premium
writings in 1996. The Quota Share Arrangement had no impact on the Company's
cash flows for either first quarter, as it did not become effective until April
1, 1997.
In order to fund the cash applied to operations during the first quarter
of 1997, the Company continued to liquidate investments at more accelerated
rates than historically had been necessary.
The Company currently does not anticipate that it will issue direct
insurance in 1997. Additionally, under the Quota Share Arrangement, most of
the premiums ultimately due to Alpine will be withheld by UCIC for some time
(perhaps several years), unless the Quota Share Arrangement is modified to
allow Alpine to receive some or all of the premium funds that otherwise would
be held by UCIC pursuant to the current terms and conditions of the Quota Share
Arrangement (no commitments have been made or regulatory approvals sought
regarding any such modification), and the investment income payable to and
earned by Alpine initially will be relatively insignificant. The Company's
cash available to fund operations, consequently, will be very limited.
Management expects the Company will need, for at least the remainder of
1997, to continue to liquidate investments as the Company's principal source of
cash to fund its operations. Based on historical loss payout patterns and
expected operating costs, the Company anticipates these liquidations could
result in realized losses on the liquidated investments, particularly if
interest rates rise significantly during the remainder of 1997. Notwithstanding
the foregoing, the Company has a substantial portion of its investments in
mid-term fixed maturities, and because the Company expects the cash required
for payments of loss and loss adjustment expenses to decline during the
remainder of 1997, the realized losses on liquidated investments are expected
to be relatively small (less than $500,000 for the year, depending on interest
rate movements).
To satisfy the Company's cash needs beyond 1997, the Company is
considering a number of alternatives. Such alternatives currently include (i)
issuing shares of its Common Stock in a private placement or a public offering;
(ii) seeking funding from or engaging in other transactions with UCIC (based on
the most recent discussions with UCIC, such funding, if any, could involve
Exstar's acquisitions of the TCO claims operations and the Transre and Exstar
E&S insurance brokerage operations); and (iii) merging with one or more other
insurance operations. The Company has not yet determined which of these or
other courses of actions to pursue, or which would be likely to be successful,
and has not made any commitments with respect to any such or other courses of
action.
-18-
<PAGE> 19
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized to sign on behalf of the Registrant as
well as in his capacity as Chief Financial Officer.
EXSTAR FINANCIAL CORPORATION
Date: May 28, 1997 By /s/ Mark Rosenberg
--------------------------
Mark Rosenberg
Chief Financial Officer
-19-
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