SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
(x) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1996
------------------------------------------------
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
-------------------- ------------------------
Commission file Number: 0-22016
--------------------------------------------------------
HOME STATE HOLDINGS, INC.
-----------------------------------------------------
(Exact name of Registrant as specified in its charter)
Delaware 13-3429087
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
Three South Revmont Drive, Shrewsbury, New Jersey 07702
-------------------------------------------------------
(Address of principal executive offices)
(Zip Code)
(908) 935-2600
---------------------------------------------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes x No .
-------- -----
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
On November 11, 1996, there were outstanding
5,660,000 shares of Common Stock, $.01 par
value, of the registrant.
<PAGE>
PART I
FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS
Page
----
Condensed Consolidated Balance Sheets........................................3-4
Condensed Consolidated Statements of Operations.............................. 5
Condensed Consolidated Statements of Cash Flows............................... 6
Notes to Condensed Consolidated Financial Statements.......................... 7
-2-
<PAGE>
HOME STATE HOLDINGS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
<TABLE>
<CAPTION>
ASSETS September 30, December 31,
1996 1995
------------ ------------
(Unaudited)
<S> <C> <C>
Investments
Fixed maturity securities available for sale, at market
value (amortized cost $8,842 and $11,385, respectively) $8,898 $11,523
Fixed maturity securities held - to - maturity, at amortized cost
(market value $69,778 and $65,472, respectively) 69,474 64,115
Common stocks, at market value 378 --
Short term investments at cost, which approximates market 8,911 3,157
-------- --------
Total investments 87,661 78,795
Cash and cash equivalents 6,956 9,544
Premiums receivable 47,774 40,068
Reinsurance recoverable 82,583 50,581
Prepaid reinsurance premium 43,679 35,487
Salvage and subrogation receivable 4,761 2,972
Deferred policy acquisition costs 10,829 7,086
Premium financing notes receivable 6,937 1,967
Surplus notes receivable (at cost, less allowance of $500 and $0,
respectively) 4,470 4,500
Furniture and equipment (at cost less accumulated depreciation
and amortization of $1,155 and $732) 3,967 3,059
Income taxes recoverable, net 4,674 974
Deferred tax assets, net 1,948 1,889
Other assets 5,746 3,599
-------- --------
Total assets $311,985 $240,521
======== ========
</TABLE>
See notes to condensed consolidated financial statements.
-3-
<PAGE>
HOME STATE HOLDINGS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except par value and share amounts)
<TABLE>
<CAPTION>
LIABILITIES AND STOCKHOLDERS' EQUITY September 30, December 31,
1996 1995
---- ----
(Unaudited)
<S> <C> <C>
Insurance losses and loss adjustment expense reserves $138,015 $95,790
Unearned premiums 92,829 71,291
Reinsurance balance payable 9,243 8,533
Accrued expenses and other liabilities 6,070 3,203
Excess of fair value of acquired net assets over cost 1,253 3,053
Subordinated notes payable, net of original issue discount 16,360 16,300
Notes payable, bank 11,275 2,000
Minority interest 1,161 1,299
-------- --------
Total liabilities 276,206 201,469
-------- --------
Commitments and contingencies
Stockholders' equity
Preferred stock, $.01 par value; 100,000 shares authorized
and none issued and outstanding -- --
Common stock, $.01 par value; 10,000,000 shares authorized,
5,660,000 shares issued and outstanding 57 57
Additional paid-in capital 20,973 20,973
Unrealized appreciation (depreciation) of fixed maturities available for
sale, net of taxes 148 (58)
Retained earnings 14,601 18,080
-------- --------
Total stockholders' equity 35,779 39,052
-------- --------
Total liabilities and stockholders' equity $311,985 $240,521
======== ========
</TABLE>
See notes to condensed consolidated financial statements.
-4-
<PAGE>
HOME STATE HOLDINGS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except earnings per share)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------------------------------------
1996 1995 1996 1995
-------- -------- -------- --------
(Unaudited) (Unaudited)
<S> <C> <C> <C> <C>
Revenues:
Net premiums earned $ 26,437 $ 16,091 $ 75,460 $ 39,464
Recoveries on reinsurance premiums 1,485 2,324 3,600 4,172
Net investment income 1,259 850 3,345 2,417
Financial services group income 1,054 831 3,023 2,290
Other income (expense), net (121) 22 63 278
Net realized capital gains (losses) (1) 13 (5) 176
------- ------- ------- -------
Total revenues 30,113 20,131 85,486 48,797
------- ------- ------- -------
Expenses:
Insurance losses and loss adjustment
expenses 20,542 13,647 72,413 32,483
Underwriting expenses, principally
acquisition costs 6,215 3,130 17,557 8,291
Other general and administrative expenses 1,182 332 783 758
Interest expense 777 509 2,033 1,527
------- ------- ------- -------
Total expenses 28,716 17,618 92,786 43,059
------- ------- ------- -------
Income (loss) before income tax (benefit) and
minority interest 1,397 2,513 (7,300) 5,738
Income tax (benefit) 213 601 (3,828) 1,539
Minority interest 51 8 7 40
------- ------- ------- -------
Net income (loss) $ 1,133 $ 1,904 $ (3,479) $ 4,159
======== ======== ======== ========
Net income (loss) per common share and common share
equivalent $ 0.20 $ 0.34 $ (0.61) $ 0.74
======== ======== ======== ========
Weighted average number of common shares
and common share equivalents outstanding 5,660 5,660 5,660 5,660
======== ======== ======== ========
</TABLE>
See notes to condensed consolidated financial statements.
-5-
<PAGE>
HOME STATE HOLDINGS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
1996 1995
-------- ------
(Unaudited)
<S> <C> <C>
Net cash from operating activities $4,005 $11,561
------ -------
Investing activities:
Purchase of fixed maturity investment securities (14,284) (23,504)
Proceeds from sale/maturity of fixed maturity investments,
available for sale 2,560 5,278
Proceeds from maturity of fixed maturity investments,
held to maturity 3,150 4,009
Purchases of common stock (378) --
Purchase of surplus note receivable (470) --
Net cash acquired from the purchase of Merchant Bakers -- 2,714
Purchase of notes receivable, net -- 113
Purchase of furniture and equipment (1,330) (703)
------ -------
Net cash used in investing activities (10,752) (12,093)
------ -------
Financing activities:
Net borrowings on notes payable - bank 9,275 2,000
Purchase of premium financing note receivables, net (4,971) (4,301)
Redemption of minority interest common stock (145) --
------ -------
Net cash (used in) provided by financing activities 4,159 (2,301)
------ -------
Net decrease in cash and cash equivalents (2,588) (2,833)
Cash and cash equivalents, beginning of year 9,544 6,183
------ -------
Cash and cash equivalents, end of period $6,956 $3,350
====== ======
Cash paid during the period for income taxes $ -- $2,890
====== ======
Cash paid during the period for interest $2,033 $1,466
====== ======
</TABLE>
See notes to condensed consolidated financial statements.
-6-
<PAGE>
HOME STATE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. GENERAL
The accompanying unaudited condensed consolidated financial statements
have been prepared pursuant to the rules and regulations of the
Securities and Exchange Commission. In the opinion of management, all
adjustments, consisting of normal recurring adjustments, which are
necessary for a fair presentation of financial position and results of
operations, have been made. Interim results are not necessarily
indicative of the results for the full year. It is recommended that
these condensed consolidated financial statements be read in
conjunction with the consolidated financial statements as of December
31, 1995 and 1994, and for each of the three years in the period ended
December 31, 1995, and related notes thereto, included in the Annual
Report of Home State Holdings, Inc. (the "Company") on Form 10-K for
the year ended December 31, 1995.
2. PREMIUM FINANCING NOTE RECEIVABLES
Insurance premium finance notes typically do not exceed twelve months.
Premium finance charges are earned, beginning with the effective month
of the policy, over the applicable installment period and reflected in
income using the sum-of-the-months-digits method, a method that
provides results that are not materially different from the effective
interest method. Accordingly, unearned premium finance charges are
established for the unamortized portion of finance charges applicable
to the premium financing notes receivable.
3. NOTES PAYABLE - BANK
The Company maintains an $18.0 million revolving credit facility with a
bank, of which $11.3 million was outstanding as of September 30, 1996.
The credit line bears interest at the bank's libor rate plus 2% and
approximated 8.00% at September 30, 1996. Interest is payable on a
monthly basis.
4. SURPLUS NOTES RECEIVABLE
The Company holds surplus notes in Home Mutual Insurance Company of
Binghamton, NY ("Home Mutual"), aggregating $4.97 million, recorded at
cost less a $500,000 valuation allowance at September 30, 1996. The
demand notes bear interest and New York Department of Insurance
approval is required before any interest and principal can be repaid.
Such approval has not been made and accordingly, the Company does not
accrue interest on these notes.
Home Mutual has incurred operating losses for the first nine months of
1996 and as of September 30, 1996, its statutory based surplus is
approximately $2.6 million. As a result, the Company recorded a charge
to operations of $500,000 during the third quarter of 1996,
representing a write down of its surplus notes in Home Mutual to their
estimated net realizable value of $4.47 million. The Company is in the
process of performing a more definitive determination of net realizable
value which may require an additional adjustment to the valuation
allowance. The amount of the adjustment, if any, is not yet
determinable. This valuation will be based on the net present value of
estimated future cash flows and will consider certain new
-7-
<PAGE>
operational strategies recently put into effect at Home Mutual
including an 18.2% increase in personal automobile rates approved by
the NY Department of Insurance which becomes, effective January
15, 1997.
5. ACQUISITION
On March 2, 1995, the New York State Insurance Department (the
"Superintendent") approved the acquisition of control of Merchant
Bakers (which had been managed by the Company since December 28, 1992)
by the Company pursuant to a Plan of Conversion (the "Plan"),
converting Merchant Bakers from a mutual to a stock insurance company.
The closing of this transaction occurred on March 31, 1995, and has
been accounted for as a purchase, and accordingly, the net assets and
results of operations of Merchant Bakers are included in the financial
statements beginning March 31, 1995. A portion of the purchase price
has been allocated to the assets and liabilities of Merchant Bakers'
eligible policy holders in satisfaction of their equitable interests in
Merchant Bakers. The Company, at the date of acquisition, had $6.0
million in surplus notes issued by Merchant Bakers and accrued interest
related to such surplus notes of $439,000. Two million dollars of these
notes were converted to Merchant Bakers common stock and additional
paid-in capital on March 31, 1995. The remaining $4.0 million of notes
and the accrued interest, which have been eliminated in consolidation,
will be converted to additional paid-in capital upon approval by the
Superintendent. The fair value of net assets acquired exceeded the cost
by $3.6 million, which has been included in "excess of fair value over
cost of business acquired" on the consolidated balance sheets, and was
being amortized straight line over a five year period.
During the second quarter of 1996, the Company reviewed the excess of
fair value of acquired net assets over cost, after considering the
effects of increased provisions for net loss and LAE reserves recorded
during that quarter. As a result of this review, the Company reduced
the amortization period of the excess from five years to three years
and accelerated the related amortization during the quarter ended June
30, 1996, recognizing a benefit of $1.5 million or $0.26 per share, net
of taxes. The remaining unamortized balance of the excess is being
ratably amortized through December 31, 1997.
Total revenues, net income and net income per share for the nine months
ending September 30, 1995 on a pro forma basis, as if the purchase of
Merchant Bakers had been made as of January 1, 1995, would have been
$54.5 million, $5.8 million and $1.02, respectively.
6. SUBSEQUENT EVENT
On October 4, 1996, the Company completed the sale of 10,000 shares of
its Series A Cumulative Voting Preferred Stock (the "Preferred Stock").
Each holder purchased $5,000,000 of the Preferred Stock and one such
holder was granted the right to purchase an additional 5,000 shares of
Preferred Stock for $5,000,000 at any time until April 4, 1997.
Proceeds of the sale were used to increase the surplus of Merchant
Bakers.
Each share of Preferred Stock is entitled to one vote along with the
Company's common stock and carries a dividend rate of 7.5%. The Company
may call the Preferred Stock for redemption at any time after the
fourth anniversary of the closing subject to a declining prepayment
penalty. The Preferred Stock must be redeemed at $1,000 per share plus
any accumulated dividends in five equal tranches at the 10th through
14th anniversaries of the closing.
-8-
<PAGE>
Each share of Preferred Stock carries with it detachable Series A
Warrants ("Warrants") to purchase 140 shares of the Company's common
stock for $9.50 per share at any time until October 4, 2003. The number
of shares of the Company's common stock deliverable upon exercise of
the warrants, and the exercise price thereof, are subject to
adjustment. If all of the Warrants issued in connection with the
$10,000,000 of Preferred Stock issued were to be exercised, the common
stock purchased would represent approximately 19.8% of the Company's
issued and outstanding common stock.
-9-
<PAGE>
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Results of Operations:
Three months ended September 30, 1996 compared to three months ended September
30, 1995.
In 1996, New York Merchant Bakers Insurance Company ("Merchant Bakers") entered
into a pooling arrangement with Home Mutual Insurance Company of Binghamton,
New York ("Home Mutual"), which provides for an 85%/15% sharing of their
combined net underwriting results between Merchant Bakers and Home Mutual,
respectively. Accordingly, the inclusion of Home Mutual in the pooling
arrangement has impacted the Company's results of operations during the three
months and nine months ended September 30, 1996. Home Mutual has been a managed
affiliate of the Company since the purchase of $4.5 million of Home Mutual
surplus notes in 1993. The Company purchased an additional $470,000 surplus note
in June 1996.
Home Mutual has incurred operating losses for the first nine months of 1996
and as of September 30, 1996, its statutory based surplus is approximately $2.6
million. As a result, the Company recorded a charge to operations of $500,000
during the third quarter of 1996, representing a write down of its surplus notes
in Home Mutual to their estimated net realizable value of $4.47 million. The
Company is in the process of performing a more definitive determination of net
realizable value which may require an additional adjustment to the valuation
allowance. The amount of the adjustment, if any, is not yet determinable. This
valuation will be based on the net present value of estimated future cash flows
and will consider certain new operational strategies recently put into effect at
Home Mutual including an 18.2% increase in personal automobile rates approved by
the NY Department of Insurance which becomes effective January 15, 1997.
Gross premiums written by the Company increased 10% from $39.0 million in the
third quarter of 1995 to $42.8 million in the comparable period of 1996. The
Company's net earned premiums increased 64% from $16.1 million in the third
quarter of 1995 to $26.4 million in the comparable period of 1996. The increase
in net earned premiums resulted from increased premium volume, as well as the
pooling of Home Mutual's underwriting results.
-10-
<PAGE>
Recoveries on reinsurance premiums decreased from $2.3 million in the third
quarter of 1995 to $1.5 million in the comparable period of 1996, primarily as a
result of an assessment of loss reserve assumptions and resulting reserve
adjustments and increases to estimates of direct and ceded losses made by the
Company during the second quarter.
Net investment income increased from $850,000 in the third quarter of 1995 to
$1.3 million in the comparable period of 1996. The increase in net investment
income was primarily a result of an increase in invested assets. Cash and
invested assets were $94.6 million as of September 30, 1996 compared to $81.1
million as of September 30, 1995.
The Company had $13,000 of realized gains from the sale of securities in the
third quarter of 1995 as compared to $1,000 of realized losses in the comparable
period of 1996. The realized loss in 1996 was derived from the call of fixed
maturity investments.
Income from the Company's financial services subsidiaries increased from
$831,000 in the third quarter of 1995 to $1.1 million in the comparable period
of 1996. The financial services group is comprised of Aspen Intermediaries, Inc.
("Aspen"), which provides reinsurance brokerages services; Tower Hill, Inc.
("Tower Hill"), which provides premium finance services; and HSIM L.L.C.
("HSIM") which provides certain administrative services to the Company. Aspen's
reinsurance brokerages fees increased to $565,000 in the third quarter of 1996
from $400,000 in the comparable period of 1995. Tower Hill earned $487,000 in
premium financing income in the third quarter of 1996 compared to $205,000 in
the third quarter of 1995. HSIM earned $225,000 in management fees from Home
Mutual in the third quarter of 1995 compared to no such fees in the third
quarter of 1996.
-11-
<PAGE>
Other income or expense, net, decreased from income of $22,000 in the third
quarter of 1995 to expenses of $121,000 in the comparable period of 1996.
Expenses in 1996 consisted primarily of premium receivable write-offs.
Insurance losses and LAE increased from $13.6 million in the third quarter of
1995 to $20.5 million in the comparable period of 1996 as a result of the
increase in volume and risks assumed under premiums in force, however, the GAAP
loss ratio in the third quarter of 1996 remained level with the third quarter of
1995 at 74%.
The Company's GAAP expense ratio increased to 22% in the third quarter of 1996
from 17% in the comparable period of 1995. The increase in the GAAP expense
ratio in 1996 is the result of a reduction in the Company's ceding commission
rates under its new reinsurance agreements which has the effect of increasing
net commission expenses. Additionally, Home Mutual entered into a service
agreement to sell its assigned risk business which has resulted in a shift of
expenses from losses to underwriting expense. The associated expense for
servicing this business is now being reflected in the statement of operations as
a result of the pooling agreement entered into in 1996 between Home Mutual and
Merchant Bakers.
Interest expense on the Company's subordinated notes payable and notes payable
to bank increased to $777,000 in the third quarter of 1996 from $509,000 in the
comparable period of 1995 due to the interest expense related to the bank credit
facilities. During the third quarter of 1996, the average balance outstanding
under the facilities was $13.2 million and was used primarily to support the
Company's premium financing operations. These lines of credit carried an average
interest rate of approximately 8% during the quarter. These lines of credit were
not utilized during the third quarter of 1995.
-12-
<PAGE>
Tax expense decreased from $601,000 in the third quarter of 1995 to $213,000 in
the comparable period of 1996 due primarily to the lower level of pre-tax income
and a true-up adjustment to prior year tax accruals. Accordingly, the Company's
effective tax rate decreased from 23.9% in the third quarter of 1995 to 15.2% in
the comparable period of 1996.
Net income decreased from $1.9 million in the third quarter of 1995 to $1.1
million in the comparable period of 1996 and the Company's GAAP combined ratio
increased from 91% in the third quarter of 1995 to 96% in the comparable period
of 1996 as a result of the factors noted above.
Nine months ended September 30, 1996 compared to nine months
ended September 30, 1995
During the second quarter of 1996, the Company undertook an assessment of its
loss reserve assumptions underlying the ultimate loss ratios in light of adverse
development occurring in 1996 on its auto liability lines of business.
Management performed the assessment in conjunction with the stated desire of the
Board of Directors to strengthen loss and loss adjustment expense ("LAE")
reserves given the continuing adverse loss reserve development, severe winter
storm losses in 1996, rapid growth in the Company's premium volume and
continuing price competition in the Company's commercial auto lines. This review
was conducted with the assistance of the Company's external actuaries and newly
hired internal actuary with the express goal of increasing the level of
conservatism in the Company's loss and LAE reserve estimates in light of these
factors. Expected loss ratios for new business have been similarly adjusted to
reflect current reserving trends.
As a result of this review, during the second quarter of 1996, the Company
increased its insurance loss and LAE reserves by $7.5 million or $1.32 per
share, after taxes. In addition, the Company increased its estimates of direct
and ceded losses, recognizing a decrease in recoveries on reinsurance premiums
in the amount of $610,000 or $0.11 per share, after taxes.
-13-
<PAGE>
The Company also reviewed the excess of fair value of acquired net assets over
cost, related to the 1995 acquisition of Merchant Bakers (the "excess"), in
light of the increased provision for net loss and LAE reserves. As a result of
this review, the Company reduced the amortization period of the excess from five
years to three years and accelerated the related amortization during the quarter
ended June 30, 1996, recognizing a benefit of $1.5 million or $0.26 per share,
net of taxes. The remaining unamortized balance of the excess is being ratably
amortized through December 31, 1997.
The winter storms of 1995-96 produced one of the worst catastrophic losses ever
recorded by the property and casualty industry. Particularly affected were
insurers like Home State with significant concentrations of insured risks in the
Northeast. These storms caused more than $2.5 billion of industry-wide losses
and resulted in increased physical damage and liability claims which impacted
the Company's net income and earnings per share by an estimated $1.5 million and
$0.27, respectively in the first quarter of 1996 and $660,000 or $0.12,
respectively in the second quarter of 1996.
In 1996, the inclusion of Home Mutual in the insurance pooling arrangement with
Merchant Bakers magnified the effects of the difficult winter on the Company's
results. Home Mutual writes primarily personal lines insurance predominantly in
upstate New York. The geographic concentration of Home Mutual's business in
areas most heavily affected by the storms, contributed significantly to the
negative impact on Home Mutual's earnings, which impact has in turn been
substantially realized by the Company.
Gross premiums written by the Company increased from $86.2 million in the first
nine months of 1995 to $142.5 million in the comparable period of 1996. The
Company's net earned premiums increased 91% from $39.5 million in the nine
months ended September 30, 1995 to $75.5 million in the comparable period of
1996. The increase in net earned premiums resulted from increased premium
writings and the inclusion of Merchant Bakers for the full nine months of 1996
and the Home Mutual business assumed under the 1996 pooling arrangement.
-14-
<PAGE>
Net investment income increased from $2.4 million in the first nine months of
1995 to $3.3 million in the comparable period of 1996. The increase in net
investment income was primarily a result of an increase in invested assets and
the inclusion of Merchant Bakers for the full nine months of 1996.
The Company had $176,000 of realized gains from the sale of securities in the
first nine months of 1995 as compared to $5,000 of realized losses in the
comparable period of 1996. The realized gains in 1995 were derived primarily
from the sale of U.S. Treasury Note investments whereas the net realized losses
in 1996 resulted from the call of fixed maturity investments.
Recoveries on reinsurance premiums decreased from $4.2 million in the first nine
months of 1995 to $3.6 million in the comparable period of 1996. This decrease
is a result of an increase in ceded earned premium volume offset by increased
loss reserve development on prior year risks ceded to reinsurers and the
adjustment to loss and LAE reserves previously discussed.
Income of the financial services subsidiaries increased from $2.3 million in the
first nine months of 1995 to $3.0 million in the comparable period of 1996. This
increase is primarily attributable to the expansion of the Company's premium
financing operations and increased ceded premiums subject to brokerage fees.
Aspen earned reinsurance brokerage fees of $1.1 million in the first nine months
of 1995 as compared to $1.8 million in the comparable period of 1996. HSIM
earned $675,000 in management fees from Home Mutual in the first nine months of
1995 as compared to zero in the comparable period of 1996 and Tower Hill earned
$466,000 in premium financing income in the first nine months of 1995 as
compared to $1.2 million for the first nine months of 1996.
-15-
<PAGE>
Other income, net, decreased from $278,000 in the first nine months of 1995 to
$63,000 in the comparable period of 1996. In 1995, other income consisted
primarily of book rollover fees. In 1996, other income consisted primarily of
finance and service charges earned, offset by premium receivable write-offs.
Insurance losses and loss adjustment expenses increased from $32.5 million in
the first nine months of 1995 to $72.4 million in the comparable period of 1996,
primarily as a result of an increase in volume and risks assumed under premiums
in force, the inclusion of Merchant Bakers and Home Mutual pooled results for
the full nine months of 1996 and the aforementioned reserve adjustment. The GAAP
loss ratio increased to 92% in the first nine months of 1996 compared to 74% in
the comparable period of 1995 as a result of these factors.
The GAAP expense ratio increased to 22% in the first nine months of 1996 from
19% in the comparable period of 1995. The Company reduced its ceding commission
rates under its new reinsurance agreements effective for 1996 which has the
effect of increasing net commission expenses. Additionally, Home Mutual entered
into a service agreement to sell its assigned risk business, which has resulted
in a shift of expenses from losses to underwriting expense. The associated
expense for servicing this business is now being reflected in the statement of
operations as a result of the pooling agreement entered into in 1996 between
Home Mutual and Merchant Bakers.
Interest expense amounted to $2.0 million in the first nine months of 1996 as
compared to $1.5 million for the first nine months of 1995 as a result of using
the Company's and Tower Hill's bank credit facilities to support the growth of
the premium financing business. These credit facilities were not utilized during
the first nine months of 1995.
Tax expense decreased from $1.5 million in the first nine months of 1995 to a
tax benefit of $3.8 million in the comparable period of 1996 due primarily to
the increase in the loss and loss adjustment expense reserve and a true-up
adjustment to prior year tax accruals. The Company's effective tax rate
decreased from 26.8% in the first nine months of 1995 to a 52.4% tax benefit
rate in the comparable period of 1996.
-16-
<PAGE>
Net income was $4.9 million in the first nine months of 1995 compared to a net
loss of $3.5 million in the first nine months of 1996, and the Company's GAAP
combined ratio increased from 93% in the first nine months of 1995 to 114% in
the comparable period of 1996 as a result of the factors noted above.
Liquidity and Capital Resources
From its inception until the Company's 1993 initial public offering (the "IPO"),
the Company's operations were primarily funded by private placements of equity
and convertible debt securities and subsequently by cash flow from operations.
Since the IPO, until the last quarter of 1994, the Company's operations have
been financed by cash flow and IPO proceeds. In October 1994, the Company
completed a private placement of $17.0 million of subordinated notes and
warrants (the "Private Placement"). The subordinated notes were issued as part
of a financing strategy to provide additional funds for the Company's growth. In
1996, the Company negotiated a $18.0 million line of credit ($13.0 million in
favor of Tower Hill, its premium finance subsidiary and $5.0 million for use by
the Company). At September 30, 1996, $5.0 million and $6.3 million had been
drawn down by the Company and Tower Hill, respectively.
For the nine months ended September 30, 1996, cash flow from operations
decreased to $4.0 million as compared to $11.6 million for the nine months ended
September 30, 1995.
On October 4, 1996, the Company completed the sale of 10,000 shares of its
Series A Cumulative Voting Preferred Stock (the "Preferred Stock"). Each holder
purchased $5,000,000 of the Preferred Stock and one such holder was granted the
right to purchase an additional 5,000 shares of Preferred Stock for $5,000,000
at any time until April 4, 1997. See Note 6 to the condensed consolidated
financial statements. Proceeds of the sale were contributed to Merchant Bakers
to increase Merchant Bakers' surplus.
-17-
<PAGE>
The Company believes that cash flow from operations, remaining Private Placement
proceeds, its corporate and premium finance lines of credit with banks and the
proceeds from the sale of Preferred Stock noted above, will be sufficient to
fund current liquidity requirements and capital needs during the remainder of
1996. The Company's insurance subsidiaries are subject to certain restrictions
on their ability to transfer funds to the parent company in the form of cash
dividends, loans or advances without regulatory approval. These restrictions are
not expected to impair the ability of the Company to meet its cash obligations.
Purchases of investment securities were $14.3 million for the nine months ended
September 30, 1996. These purchases were primarily funded by operations and by
proceeds from the maturity of investments of $5.7 million. For the comparable
period in 1995, $23.5 million was used for the purchase of investment
securities, which was primarily funded by proceeds from the sale/maturity of
investments of $9.3 million and cash from operations.
The Company maintains a significant portion of its assets in high quality, fixed
income investments with relatively short maturities. An increase in interest
rates will generally cause a decline in the market value of fixed income
securities although presenting the opportunity to reinvest proceeds from
maturing securities at higher yields. A decline in interest rates may result
over time in lower yields as the proceeds from maturing securities are
reinvested although this may be offset by increases in the market value of fixed
income investments with longer maturities. Because of the relatively short
maturities of the Company's investments, the Company does not anticipate changes
in interest rates which will materially affect its liquidity and capital
resources.
-18-
<PAGE>
PART II
OTHER INFORMATION
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
3.1 By-laws of Registrant, as amended. (Incorporated by reference
to Exhibit 3.1 to Registrant's Current Report on Form 8-K filed
on October 21, 1996 (the "8-K")).
4.1 Certificate of Designations, Preferences and Rights of Series
A Cumulative Voting Preferred Stock of Registrant. (Incorporated
by Reference to Exhibit 4.1 to the 8-K).
4.2 Form of Class A Warrant issued to Swiss Reinsurance America
Corporation. (Incorporated by reference to Exhibit 4.2 to the
8-K).
4.3 Form of Class A Warrant issued to Reliance Insurance Company.
(Incorporated by reference to Exhibit 4.3 to the 8-K).
(b) Reports on Form 8-K. No reports on Form 8-K were filed during the
quarter ended September 30, 1996.
CAUTIONARY STATEMENT
The Private Securities Litigation Reform Act of 1995 provides a "safe harbor"
for forward-looking statements. This Form 10-Q, any Form 10-K, Form 8-K or any
other written or oral statements made by or on behalf of the Company may include
forward-looking statements which reflect the Company's current views with
respect to future events and financial performance. These forward-looking
statements are subject to certain uncertainties and other factors that could
cause actual results to differ materially from such statements. These
uncertainties and other factors (which are described in more detail elsewhere in
documents filed by the Company with the Securities and Exchange Commission)
include, but are not limited to, uncertainties relating to general economic
conditions and cyclical industry conditions, uncertainties relating to
government and regulatory policies, volatile and unpredictable developments
(include storms and catastrophes), the legal environment, the uncertainties of
the reserving process and the competitive environment in which the Company
operates. The words "believe," "expect," "anticipate," "project," "plan,"
"expect" and similar expressions identify forward-looking statements. Readers
are cautioned not to place undue reliance on these forward-looking statements,
which speak only as of their dates. The Company undertakes no obligation to
publicly update or revise any forward-looking statements, whether as a result of
new information, future events or otherwise.
-19-
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
HOME STATE HOLDINGS, INC.
(Registrant)
Date: November 12, 1996 By: /s/ MARK S. VAUGHN
--------------------------- ------------------------------
Mark S. Vaughn
President and
Chief Executive Officer
Date: November 12, 1996 By: /s/ ERIC A. REEHL
---------------------------- ------------------------------
Eric A. Reehl
Executive Vice President and
Chief Financial Officer
(Principal Financial Officer)
Date: November 12, 1996 By: /s/ KENNETH E. EDWARDS
---------------------------- ------------------------------
Kenneth E. Edwards
Senior Vice President - Finance
(Principal Accounting Officer)
<TABLE> <S> <C>
<ARTICLE> 7
<MULTIPLIER> 1,000
<CURRENCY> U.S.
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-END> SEP-30-1996
<EXCHANGE-RATE> 1
<DEBT-HELD-FOR-SALE> 8,898
<DEBT-CARRYING-VALUE> 69,474
<DEBT-MARKET-VALUE> 69,778
<EQUITIES> 378
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 78,750
<CASH> 15,867
<RECOVER-REINSURE> 82,583
<DEFERRED-ACQUISITION> 10,829
<TOTAL-ASSETS> 311,985
<POLICY-LOSSES> 138,015
<UNEARNED-PREMIUMS> 92,829
<POLICY-OTHER> 0
<POLICY-HOLDER-FUNDS> 0
<NOTES-PAYABLE> 27,635
0
0
<COMMON> 57
<OTHER-SE> 21,178
<TOTAL-LIABILITY-AND-EQUITY> 311,985
75,460
<INVESTMENT-INCOME> 3,345
<INVESTMENT-GAINS> (5)
<OTHER-INCOME> 6,686
<BENEFITS> 72,413
<UNDERWRITING-AMORTIZATION> 17,557
<UNDERWRITING-OTHER> 783
<INCOME-PRETAX> (7,300)
<INCOME-TAX> (3,828)
<INCOME-CONTINUING> (3,479)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (3,479)
<EPS-PRIMARY> (0.61)
<EPS-DILUTED> (0.61)
<RESERVE-OPEN> 45,209
<PROVISION-CURRENT> 52,199
<PROVISION-PRIOR> 20,214
<PAYMENTS-CURRENT> 22,906
<PAYMENTS-PRIOR> 27,993
<RESERVE-CLOSE> 66,723
<CUMULATIVE-DEFICIENCY> 18,193
</TABLE>
