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, 1998
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 0-22316
Penn-America Group, Inc.
(Exact name of registrant as specified in its charter)
Pennsylvania 23-2731409
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
420 South York Road, Hatboro, Pennsylvania 19040
(Address of principal executive offices, including zip code)
(215) 443-3600
(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 other 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 .
At November 12, 1998, 9,416,799 shares of the registrant's common stock, $.01
par value, were outstanding.
Page 1
<PAGE>
PENN-AMERICA GROUP, INC. AND SUBSIDIARIES
Index
Page Number
Part I - Financial Information
Consolidated Unaudited Balance Sheets - September 30, 1998 and
December 31, 1997 3
Consolidated Unaudited Statements of Earnings - For the three
and nine months ended September 30, 1998 and 1997 4
Consolidated Unaudited Statement of Stockholders' Equity -
For the nine months ended September 30, 1998 5
Consolidated Unaudited Statements of Cash Flows -
For the nine months ended September 30, 1998 and 1997 6
Notes to Unaudited Consolidated Financial Statements 7
Management's Discussion and Analysis of Financial Condition
and Results of Operations 10
Part II - Other Information 19
Page 2
<PAGE>
PENN-AMERICA GROUP, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(Unaudited)
(In thousands, except share and per share data)
<TABLE>
<CAPTION>
<S> <C> <C>
September 30, December 31,
1998 1997
--------- ---------
ASSETS
Investments:
Fixed Maturities:
Available for sale, at fair value (amortized cost 1998 $109,643; 1997 $89,185) $ 112,746 $ 89,979
Held to maturity, at amortized cost (fair value 1998 $33,397; 1997 $47,034) 32,750 46,842
Equity securities, at fair value (cost 1998 $24,742; 1997 $25,662) 25,789 27,380
Short-term investments, at cost, which approximates fair value 9,660 11,455
--------- ---------
Total Investments 180,945 175,656
Cash 2,449 2,163
Receivables:
Accrued investment income 2,304 1,973
Premiums receivable, net 11,575 12,414
Reinsurance recoverable 19,083 16,605
--------- ---------
Total receivables 32,962 30,992
Prepaid reinsurance premiums 2,808 3,065
Deferred policy acquisition costs 8,923 8,563
Capital lease 2,076 1,865
Deferred income taxes 2,127 2,302
Income tax recoverable 660 40
Other assets 478 511
--------- ---------
Total assets $ 233,428 $ 225,157
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Unpaid losses and loss adjustment expenses $ 90,323 $ 84,566
Unearned premiums 35,692 36,173
Accounts payable and accrued expenses 1,252 2,338
Capitalized lease obligations 2,112 1,920
Other liabilities 2,748 2,853
--------- ---------
Total liabilities 132,127 127,850
--------- ---------
Stockholders' equity:
Preferred stock, $.01 par value; authorized 2,000,000 shares;
none issued -- --
Common stock, $.01 par value; authorized 20,000,000 shares;
issued 9,921,576 and 9,883,384 shares in 1998
and 1997, respectively 99 99
Additional paid-in capital 68,855 68,221
Accumulated other comprehensive income 2,699 1,649
Retained earnings 33,258 27,849
--------- ---------
104,911 97,818
Treasury stock, at cost, 285,900 shares (3,217) --
Unearned compensation from restricted stock awards (393) (511)
--------- ---------
Total stockholders' equity 101,301 97,307
--------- ---------
Total liabilities and stockholders' equity $ 233,428 $ 225,157
========= =========
</TABLE>
See accompanying notes to unaudited consolidated financial statements.
Page 3
<PAGE>
PENN-AMERICA GROUP, INC. AND SUBSIDIARIES
Consolidated Statements of Earnings
(Unaudited)
For the three and nine months ended September 30, 1998 and 1997
(In thousands, except per share data)
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C>
Three months ended Nine months ended
September 30, September 30,
1998 1997 1998 1997
Revenues:
Premiums earned $ 22,628 $ 23,950 $ 67,737 $ 67,883
Net investment income 2,667 2,521 8,191 6,446
Net realized investment (losses) gains (418) 479 25 588
-------- -------- -------- --------
Total revenues 24,877 26,950 75,953 74,917
-------- -------- -------- --------
Losses and expenses:
Losses and loss adjustment expenses 14,338 14,876 42,483 42,483
Amortization of deferred policy acquisition costs 6,351 6,425 18,775 18,396
Other underwriting expenses 1,693 1,639 4,867 4,254
Interest expense 44 91 133 477
-------- -------- -------- --------
Total losses and expenses 22,426 23,031 66,258 65,610
-------- -------- -------- --------
Earnings before income tax 2,451 3,919 9,695 9,307
Income tax 667 1,331 2,806 2,951
-------- -------- -------- --------
Net earnings $ 1,784 $ 2,588 $ 6,889 $ 6,356
======== ======== ======== ========
Net earnings per share
Basic
$ 0.18 $ 0.28 $ 0.70 $ 0.84
Diluted
$ 0.18 $ 0.28 $ 0.69 $ 0.83
Weighted average number of shares outstanding
Basic
9,797 9,134 9,859 7,534
Diluted
9,873 9,223 9,962 7,613
Cash dividends per share
$ 0.05 $ 0.04 $ 0.15 $ 0.12
</TABLE>
See accompanying notes to unaudited consolidated financial statements.
Page 4
<PAGE>
PENN-AMERICA GROUP, INC. AND SUBSIDIARIES
Consolidated Statement of Stockholders' Equity
(Unaudited)
For the nine months ended September 30, 1998
(In thousands, except share data)
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Unearned
Compensation
Accumulated From
Additional Other Restricted
Common Stock Paid-In Comprehensive Retained Treasury Stock
Shares Amount Capital Income Earnings Stock Awards Total
Balance at December 31, 1997 9,883,384 $ 99 $ 68,221 $ 1,649 $ 27,849 -- $ (511) $ 97,307
Net earnings 6,889 6,889
Other comprehensive income, net of tax:
Unrealized gains on investments, net of
reclassification adjustment 1,050 1,050
--------
Comprehensive income 7,939
--------
Issuance of common stock 38,192 634 634
Amortization of compensation expense
from restricted stock awards 118 118
Cash dividends paid (1,480) (1,480)
Purchase of treasury stock (3,217) (3,217)
-------------------------------------------------------------------------------------------
Balance at September 30, 1998 9,921,576 $ 99 $ 68,855 $ 2,699 $ 33,258 $(3,217) $ (393) $ 101,301
===========================================================================================
</TABLE>
See accompanying notes to unaudited consolidated financial statements.
Page 5
<PAGE>
PENN-AMERICA GROUP, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(Unaudited)
For the nine months ended September 30, 1998 and 1997
(In thousands)
<TABLE>
<CAPTION>
<S> <C> <C>
Nine months ended September 30,
1998 1997
Cash flows from operating activities:
Net earnings $ 6,889 $ 6,356
Adjustments to reconcile net earnings to net cash provided by
Operating activities:
Amortization and depreciation expense 511 292
Net realized investment gains (25) (588)
Deferred income tax (421) (295)
Net decrease in premiums receivable, prepaid reinsurance premiums
and unearned premiums 615 3,516
Net increase in unpaid losses and loss adjustment expenses
and reinsurance recoverable 3,279 9,629
(Increase) in:
Accrued investment income (331) (336)
Deferred policy acquisition costs (360) (1,371)
Income tax recoverable (620) (303)
Other assets (71) (79)
Increase (decrease) in:
Accounts payable and accrued expenses (1,086) 231
Other liabilities (105) 1,666
-------- --------
Net cash provided by operating activities 8,275 18,718
-------- --------
Cash flows from investing activities:
Purchases of equity securities (15,539) (16,484)
Purchases of fixed maturities available for sale (45,514) (53,426)
Purchases of fixed maturities held to maturity (1,015) (2,027)
Proceeds from sales of equity securities 16,431 3,412
Proceeds from sales and maturities of fixed maturities available for sale 24,743 9,046
Proceeds from maturities and calls of fixed maturities held to maturity 15,268 11,591
Change in short-term investments 1,795 7,000
-------- --------
Net cash used by investing activities (3,831) (40,888)
-------- --------
Cash flows from financing activities:
Issuance of common stock 634 45,897
Purchase of treasury stock (3,217) --
Principal payments on note payable, bank -- (9,000)
Principal payments on capital lease obligations (95) (83)
Dividends paid (1,480) (933)
-------- --------
Net cash (used) provided by financing activities (4,158) 35,881
-------- --------
Increase in cash 286 13,711
Cash, beginning of period 2,163 2,979
-------- --------
Cash, end of period $ 2,449 $ 16,690
======== ========
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest $ 133 $ 31
Income tax 3,800 3,196
Supplemental non-cash disclosure:
Cost of securities transferred from available for sale to held to maturity -- $ 8,002
Additional capitalization of capital lease obligation and asset $ 287 --
</TABLE>
See accompanying notes to unaudited consolidated financial statements.
Page 6
<PAGE>
PENN-AMERICA GROUP, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
Note 1 - Organization and Basis of Presentation
Penn-America Group, Inc. ("PAGI") is an insurance holding company whose
principal asset is the common stock of Penn-America Insurance Company
("Penn-America"). The "Company" refers to PAGI and Penn-America, as well as to
Penn-America's wholly-owned subsidiary, Penn-Star Insurance Company. On July 1,
1998, Penn-America Insurance Company and its wholly-owned subsidiary, Penn-Star
Insurance Company, entered into an inter-company pooling agreement whereby all
premiums written would be pooled amongst both companies in a ratio of 65% to
Penn-America and 35% to Penn-Star. Previously, the two companies had a
reinsurance agreement, whereby all automobile premiums were reinsured by
Penn-Star. This agreement was cancelled effective June 30, 1998. Penn
Independent Corporation ("Penn Independent") currently owns approximately 32.0%
of the outstanding common stock of PAGI.
The accompanying unaudited consolidated financial statements should be
read in conjunction with the financial statements and notes for the year ended
December 31, 1997. In the opinion of management, the financial information
reflects all adjustments (consisting only of normal recurring adjustments) which
are necessary for a fair presentation of the Company's financial position,
results of operations, and cash flows for the interim periods. The Company's
results of operations for interim periods are not necessarily indicative of the
results to be expected for the entire year.
Note 2 - Reinsurance
Premiums earned are net of amounts ceded to reinsurers of $1.9 and $2.0
million for the three months ended September 30, 1998 and 1997, respectively.
Losses and loss adjustment expenses are net of amounts ceded to reinsurers of
$1.9 million and $1.5 million for the three months ended September 30, 1998 and
1997, respectively.
Premiums earned are net of amounts ceded to reinsurers of $5.7 million
for both the nine months ended September 30, 1998 and September 30, 1997. Losses
and loss adjustment expenses are net of amounts ceded to reinsurers of $5.1
million and $5.2 million for the nine months ended September 30, 1998 and
September 30, 1997, respectively.
Note 3 - Comprehensive Income
In 1997, the Financial Accounting Standards Board issued SFAS No. 130,
"Comprehensive Income". This statement was implemented retroactively by the
Company in 1998. The statement requires that an enterprise (a) classify items of
other comprehensive income by their nature in a financial statement and (b)
display the accumulated balance of other comprehensive income separately from
retained earnings and additional paid-in capital in the equity section of a
statement of financial position. Accumulated other comprehensive income of the
Company consists solely of net unrealized gains on investment securities.
Page 7
<PAGE>
PENN-AMERICA GROUP, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
(continued)
The following are components of other comprehensive income (in thousands):
<TABLE>
<CAPTION>
Nine months ended September 30, 1998
Before Tax Tax Net of Tax
Amount Expense Amount
<S> <C> <C> <C>
Unrealized gains on investments:
Unrealized holding gains arising
during period $ 1,664 $ (598) $ 1,066
Less: reclassification adjustment for
gains realized in net income (25) 9 (16)
------------------------------------------------------------
Other comprehensive income $ 1,639 $ (589) $ 1,050
=============================================================
Nine months ended September 30, 1997
Before Tax Tax Net of Tax
Amount Expense Amount
Unrealized gains on investments:
Unrealized holding gains arising
during period $ 1,493 $ (508) $ 985
Less: reclassification adjustment for
gains realized in net income (588) 200 (388)
Plus: accretion of net loss on fixed
maturities transferred to held to maturity 30 (10) 20
------------------------------------------------------------
Other comprehensive income $ 935 $ (318) $ 617
=============================================================
</TABLE>
Comprehensive income for the three months ended September 30, 1998 was
$2,676,000 and included net income of $1,784,000 and other comprehensive income,
net of tax, of $892,000.
Comprehensive income for the three and nine months ended September 30, 1997 was
$3,050,000 and $6,973,000 and included net income of $2,588,000 and $6,356,000
and other comprehensive income, net of tax, of $463,000 and $617,000,
respectively.
Page 8
<PAGE>
PENN-AMERICA GROUP, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
(continued)
Note 4 - Basic and Diluted Earnings Per Share
The following is a reconciliation of the numerators and denominators of
the basic and diluted earnings per share computations (in thousands, except per
share data):
<TABLE>
<CAPTION>
Three months ended Nine months ended
September 30, September 30,
1998 1997 1998 1997
<S> <C> <C> <C> <C>
Basic EPS:
Net Earnings $1,784 $2,588 $6,889 $6,356
------ ------ ------ ------
Weighted average common
shares outstanding 9,797 9,134 9,859 7,534
------ ------ ------ ------
Basic EPS $ 0.18 $ 0.28 $ 0.70 $ 0.84
====== ====== ====== ======
Diluted EPS:
Net Earnings $1,784 $2,588 $6,889 $6,356
------ ------ ------ ------
Weighted average common
shares outstanding 9,797 9,134 9,859 7,534
Additional shares outstanding
after the assumed exercise
of options by applying the
treasury stock method 76 89 103 79
------ ------ ------ ------
Total weighted average common
shares outstanding 9,873 9,223 9,962 7,613
====== ====== ====== ======
Diluted EPS $ 0.18 $ 0.28 $ 0.69 $ 0.83
====== ====== ====== ======
</TABLE>
Page 9
<PAGE>
PENN-AMERICA GROUP, INC. AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition
and Results of Operations
Results of Operations
Three Months Ended September 30, 1998 and 1997
Gross written premiums decreased 10.6% to $24.3 million for the three
months ended September 30, 1998, from $27.2 million for the three months ended
September 30, 1997. The decrease resulted from a 38.6% decline in personal lines
automobile gross written premiums to $5.9 million that is partially offset by a
4.6% increase in commercial lines gross written premiums to $18.5 million. The
slow down in the growth in the commercial lines, from a five year cumulative
average growth of 27.7% to 4.6% for the quarter, is due to the continued soft
market conditions in this segment. The decrease in personal lines automobile
gross written premium was due to continued actions taken by the Company to
improve profitability. Specifically, the Company terminated its relationship
with one agent and reduced two agents' personal lines automobile writings by
approximately 38.0%. Effective July 1, 1998, the Company filed and received from
the State of California a 14.2% rate reduction in its non-standard automobile
rates. This action was taken in order to remain competitive with the new
competition that has entered this marketplace at lower premium rates. One agent
accounts for all the California automobile premiums of $3.6 million, or 61.4% of
the $5.9 million total personal automobile direct written premium written by the
Company for the three months ended September 30, 1998.
Net written premiums decreased 10.6% to $22.5 million for the three
months ended September 30, 1998, from $25.2 million for the three months ended
September 30, 1997. During the same periods, net premiums earned decreased 5.5%
to $22.6 million, from $24.0 million. Net premiums earned decreased primarily
due to the decline in personal lines automobile gross written premiums in 1998.
Net investment income increased 5.8% to $2.7 million for the three
months ended September 30, 1998, from $2.5 million for the three months ended
September 30, 1997. This increase resulted principally from growth in invested
assets funded primarily by cash flows from operating activities, partially
offset by an increase in the investment in tax-exempt municipal securities to
approximately $35.8 million at September 30, 1998 compared to $550,000 at
September 30, 1997.
The tax-equivalent average investment yield of the fixed maturity
portfolio for the three months ended September 30, 1998 was 6.51%, compared to
6.76% for the three months ended September 30, 1997. Net realized investment
losses before taxes were $418,000 for the three months ended September 30, 1998,
as compared to net realized investment gains before taxes of $479,000 for the
three months ended September 30, 1997.
Page 10
<PAGE>
PENN-AMERICA GROUP, INC. AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition
and Results of Operations
(continued)
Losses and loss adjustment expenses decreased 3.6% to $14.3 million for
the three months ended September 30, 1998, from $14.9 million for the three
months ended September 30, 1997, primarily due to a decline in net premiums
earned.
Amortization of deferred policy acquisition costs remained relatively
flat for the three months ended September 30, 1998, as compared to the three
months ended September 30, 1997 at $6.4 million for both periods. Other
underwriting expenses increased 3.3% to $1.7 million for the three months ended
September 30, 1998, compared to $1.6 million for the three months ended
September 30, 1997.
The loss ratio increased to 63.4% for the three months ended September
30, 1998, from 62.1% for the three months ended September 30, 1997. The
statutory expense ratio increased to 35.2% for the three months ended September
30, 1998, from 32.1% for the three months ended September 30, 1997. The
principal causes for the increase in the expense ratio were the 10.6% decline in
net premiums written for the quarter ended September 30, 1998 compared to the
same quarter in 1997, an increase in the commercial lines commission rate to 22%
from 20%, effective May 1, 1998, and additional underwriting expenses related to
the start-up of new programs. The statutory combined ratio increased to 98.6%
for the three months ended September 30, 1998, from 94.2% for the three months
ended September 30, 1997.
As a result of the factors described above, the Company's net income
for the three months ended September 30, 1998 decreased 31.0% to $1.8 million or
$0.18 per share (basic and diluted), from $2.6 million or $0.28 per share (basic
and diluted) for the three months ended September 30, 1997.
Nine Months Ended September 30, 1998 and 1997
Gross written premiums decreased 7.4% to $72.9 million for the nine
months ended September 30, 1998, from $78.7 million for the nine months ended
September 30, 1997. The decrease resulted from a 33.8% decline in personal lines
automobile gross written premiums to $18.7 million, which was partially offset
by a 7.5% increase in commercial lines gross written premiums to $54.2 million.
The decrease in personal lines automobile gross written premium was due to
actions taken by the Company to improve profitability. Specifically, the Company
terminated its relationship with one agent and reduced two agents' personal
lines automobile writings by approximately 31.0%. One agent in California
accounted for all of the $11.2 million of automobile premium written in that
state, or 59.6% of the $18.8 million of all personal automobile direct written
premium written by the Company in the first nine months of 1998.
Page 11
<PAGE>
PENN-AMERICA GROUP, INC. AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition
and Results of Operations
(continued)
Net written premiums decreased 7.2% to $67.5 million for the nine
months ended September 30, 1998, from $72.8 million for the nine months ended
September 30, 1997. During the same periods, net premiums earned decreased 0.2%
to $67.7 million from $67.9 million.
Net investment income increased 27.1% to $8.2 million for the nine
months ended September 30, 1998, from $6.4 million for the nine months ended
September 30, 1997. This increase resulted principally from growth in invested
assets funded primarily by the net proceeds from the Company's secondary stock
offering in July 1997, and from the net cash provided by operating activities.
In 1998, the Company purchased approximately $35.8 million in
tax-exempt municipal securities as compared to $550,000 held during the
comparable period, September 30, 1997. The tax-equivalent average investment
yield of the fixed maturity portfolio for the nine months ended September 30,
1998 was 6.58%, compared to 6.59% for the nine months ended September 30, 1997.
Net realized investment gains before taxes were $25,000 for the nine months
ended September 30, 1998, as compared to net realized investment gains before
taxes of $588,000 for the nine months ended September 30, 1997.
Losses and loss adjustment expenses were $42.5 million for both nine
month periods ended September 30, 1998 and 1997, primarily due to the negligible
decline in net premiums earned.
Amortization of deferred policy acquisition costs increased 2.1% to
$18.8 million for the nine months ended September 30, 1998, from $18.4 million
for the nine months ended September 30, 1997. The increase is attributable
primarily to the increase in the commercial agents' commission to 22% from 20%.
Other underwriting expenses increased 14.4% to $4.9 million for the
nine months ended September 30, 1998, from $4.3 million for the nine months
ended September 30, 1997. The increase is attributable to expenses related to
new programs and other non-recurring expenses of the holding company.
The loss ratio increased to 62.7% for the nine months ended September
30, 1998, from 62.6% for the nine months ended September 30, 1997. The statutory
expense ratio increased to 34.0% for the nine months ended September 30, 1998,
from 32.1% for the nine months ended September 30, 1997. The statutory combined
ratio increased to 96.7% for the nine months ended September 30, 1998, from
94.7% for the nine months ended September 30, 1997.
As a result of the factors described above, the Company's net income
for the nine months ended September 30, 1998 increased 8.4% to $6.9 million or
$0.70 per share (basic) and $0.69 per share (diluted), from $6.4 million or
$0.84 per share (basic) and $0.83 per share (diluted) for the nine months ended
September 30, 1997.
Page 12
<PAGE>
PENN-AMERICA GROUP, INC. AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition
and Results of Operations
(continued)
Liquidity and Capital Resources
PAGI is a holding company, the principal asset of which is the common
stock of Penn-America. PAGI's cash flows depend primarily on dividends and other
payments from Penn-America. PAGI uses these funds to pay (i) operating expenses,
(ii) taxes and other payments and (iii) dividends to PAGI stockholders.
Penn-America's sources of funds consist primarily of premiums, investment income
and proceeds from sales and redemptions of investments. Funds are used by
Penn-America principally to pay claims and operating expenses, to purchase
investments and to make dividend and other payments to PAGI.
Net cash provided by operating activities decreased 55.8% to $8.3
million for the nine months ended September 30, 1998, from $18.7 million for the
nine months ended September 30, 1997, primarily due to the reduction in personal
lines automobile gross written premiums in 1998 and a slowing of growth in
commercial lines.
Net cash used by investing activities was $3.8 million for the nine
months ended September 30, 1998, compared to $40.9 million for the nine months
ended September 30, 1997. The decrease is primarily due to the investment of net
proceeds of $35.9 million from a secondary offering in July 1997.
Net cash used by financing activities was $4.2 million for the nine
months ended September 30, 1998, compared to net cash provided by financing
activities of $35.9 million for the same period in 1997. In 1998, the Company
purchased 285,900 shares on the open market for an average price of $11.21 and
has recorded these shares as treasury shares. The majority of the $35.9 million
in cash provided by financing activities in 1997 was due to the net proceeds
from the secondary offering in July of 1997.
The Company believes that it has sufficient liquidity to meet its
anticipated insurance obligations and operating and capital expenditure needs.
The Company's investment strategy emphasizes quality, liquidity and
diversification, as well as total return. With respect to liquidity, the Company
considers liability durations, specifically related to loss reserves, when
determining desired investment maturities. In addition, maturities have been
staggered to produce cash flows for loss payments and reinvestment
opportunities. The average duration of the fixed maturity portfolio as of
September 30, 1998 was approximately 3.37 years.
The Company's fixed maturity portfolio of $145.5 million was 80.4% of
the total investment portfolio as of September 30, 1998. Approximately 98% of
these securities were rated "A-" or better by Standard & Poor's or Moody's.
Equities, the majority of which consist of preferred stocks, were $25.8 million
or 14.2% of total investments as of September 30, 1998.
Page 13
<PAGE>
PENN-AMERICA GROUP, INC. AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition
and Results of Operations
(continued)
As of September 30, 1998, the investment portfolio contained $35.1
million of mortgage/asset-backed obligations, which represents 19.4% of the
total investments as of September 30, 1998. All of these securities are "AAA"
rated securities issued by government, government-related agencies or publicly
held corporations, are publicly traded, and have market values obtained from an
independent pricing service. Changes in estimated cash flows due to changes in
prepayment assumptions from the original purchase assumptions are revised based
on current interest rates and the economic environment. The Company had no other
derivative financial instruments, real estate or mortgages in the investment
portfolio as of September 30, 1998.
The principal source of cash to use for the payment of dividends to
PAGI's stockholders is dividends from Penn-America. Penn-America is required by
law to maintain a certain minimum surplus on a statutory basis and is subject to
risk-based capital requirements and regulations under which payment of dividends
from statutory surplus may require prior approval from the Pennsylvania
regulatory authorities. The maximum dividend that may be paid in 1998 by
Penn-America to PAGI without prior approval of regulatory authorities is
$9,531,000.
In June of 1998, the Board of Directors initially authorized a stock
buy-back program of up to 350,000 shares of PAGI's stock. This buy-back program
was subsequently increased to 1,000,000 shares. Through September 30, 1998, PAGI
has repurchased 285,900 shares of its stock on the open market and through block
trades. PAGI's funding source for this program will be through ordinary
dividends from its insurance subsidiary, existing cash of the holding company,
as well as draws from its revolving line of credit. On September 30, 1998, PAGI
completed a revolving credit facility with First Union National Bank for $25
million, which will be used for general corporate purposes and the stock
buy-back program.
On August 4, 1998, PAGI's common stock began trading on the New York
Stock Exchange (NYSE) under the symbol "PNG."
The Year 2000
Introduction
The "Year 2000", or Y2K, refers to the problems that automated systems
could encounter as the year 2000 approaches due to a computer or other
electronic device's inability to correctly register the year 2000 as just that,
the year 2000, rather than the year 1900. In this regard, the Company relies on
its existing information technology systems ("IT systems") to operate and
monitor all major aspects of the Company's business, including underwriting,
claims and various financial systems. The Company also relies, to a lesser
extent, on the IT systems of its general
Page 14
<PAGE>
PENN-AMERICA GROUP, INC. AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition
and Results of Operations
(continued)
agents and, indirectly, those of the producing retail insurance brokers.
Finally, the Company relies on certain critical non-information technology
systems ("non-IT systems"), such as electricity, telephones, facsimile machines,
heating and air-conditioning and fire protection systems. Any disruption in the
operation of the IT and non-IT systems of either the Company or any of its
critical customers, vendors or suppliers could have a material adverse effect on
the Company's business, results of operations or financial condition.
State of Readiness
IT systems: In an effort to remediate the problems associated with the
Year 2000, the Company, in 1996, evaluated all its computer codes to determine
what software programs would be affected by date-sensitive fields. After this
identification process was completed, the Company hired an outside vendor to
implement the recoding that was required. In July of 1997, the Company
successfully ran its first trial of all the revised programs. While the Company
cannot provide any guarantees, the Company believes that its programs are Year
2000 compliant. The Company, however, continues to run tests on a semi-annual
basis to make sure the programs will function properly.
The Company's IT systems have also been tested against hypothetical
information supplied by its general agents. The IT systems are currently able to
properly read the information provided. Assuming the general agents don't alter
their records, the Company reasonably believes that its IT systems will function
properly. To the extent the general agents' records change, the Company has
demanded that the agents provide notice.
The Company's management information systems rely primarily on an
integrated property-casualty software package that is processed on an IBM AS/400
computer system. The system is leased from IBM and kept current or near current
in both hardware and operating systems. Currently, the IBM AS/400 model is
scheduled in the fourth quarter of 1998 to be upgraded to Version 4 which is
reported by IBM to be fully Year 2000 compliant.
The Company uses a Novell Local Area Network (LAN) to connect all
employees to the computer system. The LAN is reported to be Year 2000 compliant.
The LAN is used primarily for "service" applications, including word processing,
spreadsheets, and e-mail. The majority of the LAN-based applications are
Microsoft products and are current or near current in their software releases.
Page 15
<PAGE>
PENN-AMERICA GROUP, INC. AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition
and Results of Operations
(continued)
The LAN also consists of personal computers ("PCs") that are attached
to a series of servers. All PCs have been tested and recognize the Year 2000.
The IT Department of the Company supports an Internet web site and various
standalone third party PC software applications. These packages are being
assessed for any Year 2000 problems. The Company anticipates completing this
assessment by the end of December, 1998, and believes that it will implement any
necessary changes and complete any testing by June, 1999. The IT Department also
supports FormMaker, a document management software package developed by DocuCorp
which is used by the majority of general agents to produce Penn-America
policies. FormMaker has been tested and, in its current release, is reported by
DocuCorp to be Year 2000 compliant.
Non-IT systems: The Company has identified, and relies on, the
following non-IT systems in its daily operations: telephones, voicemail,
facsimile machines and heating and air conditioning and fire protection systems.
The telephone system was tested as compliant. The voicemail system was
identified as non-compliant and was replaced with a compliant system in
September of 1998. The heating and air conditioning systems are currently being
scheduled for testing. The Company has been informed that all of the remaining
systems will not be effected by the year 2000; and the Company is awaiting
written confirmation to this effect.
Key Customers, Suppliers and Vendors: As part of its remediation plan,
the Company is analyzing the Year 2000 readiness of the Company's critical
outside customers (including general agents), vendors and suppliers. Each
department of the Company was asked to identify key customers, suppliers and
vendors with whom we have an interdependent, material business relationship. In
September of 1998, the Company sent approximately 188 surveys to those
identified customers/suppliers/vendors to ask them: to provide the current
status of their Y2K plan; whether they will be compliant; and what plans they
have in place in the event they will not be compliant. As of October 29, 1998,
the responses were as follows: 37 indicated they were already compliant; 63
indicated they would be compliant before January 1, 2000 and 88 have yet to
respond. For those who have yet to respond, a follow-up request will be sent in
early November of 1998. For those that have indicated their compliance within
the next year, the Company intends to contact them quarterly throughout 1999 to
ascertain their compliance status.
Despite all the procedures the Company has in place, there can be no
guarantee that the systems of other companies on which the Company's business
relies will be timely converted, or that failure to convert by another company
or a conversion that is incompatible with the Company's systems will not have a
materially adverse effect on the Company and its operations.
Page 16
<PAGE>
PENN-AMERICA GROUP, INC. AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition
and Results of Operations
(continued)
Cost
The Company incurred approximately $60,000 to recode its internal
programs. The costs incurred by the Company to test significant insurance
hardware and software that the Company believes is compliant are (and will be)
minimal as these costs are built in to the Company's standard Disaster Recovery
testing program. The current standard testing costs approximately $28,000 per
year. The Company does not separately track the internal costs incurred for the
Y2K project. Such costs are primarily related to payroll costs for the Company's
information services personnel. The Company also incurred an additional $13,000
to upgrade its voicemail system. Additional expenses may arise in the upcoming
year. Management believes that at this time these costs will approximate
$10,000.
Risks
The risks associated with the Company's inability to resolve all Year
2000 issues include the possibility of system failures or miscalculations
causing disruption in operations including, among other things, an inability to
process transactions, send invoices, send or receive e-mail and voice mail, or
conduct similar normal business activities. Additionally, failure of third
parties upon whom the Company's business relies to timely remediate their Year
2000 problems could result in disruption in the receipt and processing of
insurance policies, claims, payment of receivables and general problems related
to the Company's daily operations. If any of these contingencies were to occur,
the disruption in business could be temporary or permanent, depending on the
degree of failure. Until the Company receives responses from a more significant
number of the Company's agents and suppliers, the overall risks associated with
the Year 2000 remain difficult to accurately describe and quantify; and there
can be no guarantee that the Year 2000 issue will not have a material adverse
effect on the Company and its operations.
If the Year 2000 problem is not solved by the Company and its business
partners, the Company could face business disruption, operational problems,
financial losses, legal liability and similar risks to the business.
These risks could have a material adverse impact on the Company.
Contingency Plan
The Company has not, to date, completed a Year 2000 Contingency Plan,
though the Company maintains a Disaster Recovery Plan to address various other
potential business interruptions. The current Disaster Recovery Plan addresses
the availability and compatibility of
Page 17
<PAGE>
PENN-AMERICA GROUP, INC. AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition
and Results of Operations
(continued)
hardware offsite that could be immediately placed into action by the Company.
The Company in September of 1998, tested the offsite facility and the operation
of significant insurance software that had been made Year 2000 compliant, as
well as the operation of the offsite hardware. Under these test conditions, all
dates were rolled forward to January 1, 2000. The test results indicated that
the Company's significant insurance related software would be compliant. The
testing facility has indicated that the majority of its hardware and equipment
will be fully compliant by December, 1998. The testing facility further noted
that it will not upgrade certain of its systems until the first quarter of 1999
so as to afford all subscribers an opportunity to upgrade their systems. The
testing facility is also available if electric, heat, water, telephones and
office space should be required. Management is continuing to develop a more Year
2000-related Contingency Plan as it identifies where potential operational
failures may occur. The Company anticipates completing this plan by June, 1999.
Readers are cautioned that forward-looking statements contained in the
Year 2000 disclosure contained herein should be read in conjunction with the
Company's disclosure titled "Safe Harbor Provisions of the Private Securities
Litigation Reform Act of 1995". Forward-looking statements include, but are not
limited to, whether the Company will timely complete its remediation and
testing, whether remediation will cost more than anticipated, the impact of
redeploying staff, and the effect of third parties on the Company's ability to
function after the century date change.
New Accounting Standards
In June 1998, Statement of Financial Accounting Standards (SFAS) No.
133, "Accounting for Derivative Instruments and Hedging Activities", was issued
and established standards for accounting and reporting of derivative instruments
and hedging activities. The statement is effective for all fiscal quarters of
fiscal years beginning after June 15, 1999. The Company is in the process of
determining the effect, if any, of this statement on its financial statements.
Safe Harbor Provisions
Matters discussed herein may constitute "forward-looking statements"
(within the meaning of Section 27A of the Securities Act and Section 21E of the
Exchange Act). Such forward-looking information reflects the Company's current
best estimates regarding its future operations. The Company's actual results
could differ materially from those estimated in the forward-looking statements
as a result of several factors, including those discussed herein.
Page 18
<PAGE>
PENN-AMERICA GROUP, INC. AND SUBSIDIARIES
PART II. OTHER INFORMATION
Item 1. Legal Proceedings - None
Item 2. Changes in Securities - None
Item 3. Default Upon Senior Securities - None
Item 4. Submission of Matters to a Vote by Security Holders - None
Item 5. Other Information - None
Item 6. Exhibits and Reports on Form 8-K - None
page 19
<PAGE>
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.
Penn-America Group, Inc.
Date: November 13, 1998 By: /s/ Jon S. Saltzman
----------------- -------------------------------
Jon S. Saltzman
President and
Chief Executive Officer
By: /s/ Rosemary R. Ferrero
-------------------------------
Rosemary R. Ferrero
Principal Finance and
Accounting Officer
Page 20
<TABLE> <S> <C>
<ARTICLE> 7
<LEGEND>
This schedule contains summary financial information extracted from the
Consolidated Balance Sheet and Statement of Earnings at September 30, 1998
(unaudited) and is qualified in its entirety by reference to such financial
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<NAME> Penn-America Group, Inc.
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