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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997
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: 0-25508
RTW, INC.
(Exact name of registrant as specified in its charter)
MINNESOTA 41-1440870
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(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization
8500 NORMANDALE LAKE BOULEVARD, SUITE 1400
BLOOMINGTON, MN 55437
(Address of principal executive offices and zip code)
Registrant's telephone number, including area code: (612) 893-0403
Securities registered pursuant to 12(b) of the Act: None
Securities registered pursuant to 12(g) of the Act: Common Stock, no par value
Series A Junior Participating Preferred Stock
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
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Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K: ( X )
As of March 10, 1998, 11,907,823 shares of Common Stock, no par value, were
outstanding. As of March 10, 1998, assuming as fair value the last sale price
of $8.625 per share on The Nasdaq Stock Market, the aggregate fair value of
shares held by non-affiliates was approximately $78,701,000.
DOCUMENTS INCORPORATED BY REFERENCE:
The Company's Proxy Statement for its annual meeting of shareholders to be held
in May 1998, a definitive copy of which will be filed with the Securities and
Exchange Commission within 120 days of December 31, 1997, is incorporated by
reference in Part III of this Report on Form 10-K.
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TABLE OF CONTENTS
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<TABLE>
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PART I PAGE
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Item 1. Business 3
Executive Officers of the Registrant 9
Item 2. Properties 10
Item 3. Legal Proceedings 10
Item 4. Submission of Matters for a Vote of Security Holders 10
PART II
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Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters 10
Item 6. Selected Financial Data 11
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations 12
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 22
Item 8. Financial Statements and Supplementary Data 22
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure 40
PART III
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Item 10. Directors and Executive Officers of the Registrant 40
Item 11. Executive Compensation 40
Item 12. Security Ownership of Certain Beneficial Owners and Management 40
Item 13. Certain Relationships and Related Transactions 40
PART IV
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Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K 41
Signatures 43
</TABLE>
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PART I
ITEM 1. BUSINESS
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OVERVIEW
RTW, Inc. (the "Company") provided comprehensive management products and
services to employers for their workers' compensation programs in Minnesota,
Wisconsin, Colorado, Missouri, Illinois, Michigan and Massachusetts during
1997. The Company also had obtained licenses but was not yet operating in
Pennsylvania, Connecticut, Tennessee and South Dakota. The Company believes
its proprietary management approach substantially reduces wage replacement
costs and medical expenses resulting from workplace injuries. The Company
focuses on controlling costs by returning injured employees to work as soon as
possible and by actively managing all participants in the workers' compensation
system, including employers, employees and medical care providers, as well as
legal and judicial participants in the workers' compensation system. Elements
of the Company's management approach include:
- thorough on-site evaluation of potential customers;
- active training of customers in the Company's procedures;
- prompt identification of potentially high-cost injuries; and
- rapid intervention in, and intensive management of, potentially
high-cost injuries.
The Company also uses management techniques such as designated health care
providers, medical fee schedule review, utilization review and peer review to
control medical costs. In order to benefit directly from the use of its
proprietary methods, the Company combines its management services with workers'
compensation insurance products underwritten by its wholly-owned subsidiary,
American Compensation Insurance Company ("ACIC").
INDUSTRY
Workers' compensation benefits are mandated and regulated by individual
states, and every state requires employers to provide wage replacement and
medical benefits to work accident victims regardless of fault. Virtually all
employers in the United States are required either to purchase workers'
compensation insurance from a private insurance carrier, to obtain coverage
from a state managed fund or, if permitted by their state, to be self-insured.
Workers' compensation laws generally mandate two types of benefits for injured
employees: (i) indemnity payments that consist of temporary wage replacement or
permanent disability payments and (ii) medical benefits that include expenses
related to diagnosis and treatment of the injury as well as rehabilitation, if
necessary. On an industry-wide basis, indemnity payments represent
approximately 60% of benefits paid, while medical benefits account for the
remaining 40%.
Workers' compensation costs grew approximately 11.5% annually from 1960 to
1990. Premium growth flattened from 1991 to 1992 and has since declined by
approximately 8% through 1996. Estimated insurance premiums and self-insurance
costs totaled approximately $53 billion nationwide in 1996. This $53 billion
includes: (i) the traditional, or private residual market, estimated at $25
billion, including commercial insurers and state operated assigned risk pools
established for high risk employers; (ii) state funds, estimated at $10
billion, operated in 27 states in order to increase competition and stabilize
the market; and (iii) self-funded employers, estimated at $18 billion.
Indemnity payments, which are established by legislative action, have
risen, in part, because of higher wage levels and increased state mandated
benefits. Medical expenses have also increased due to the general rise in the
cost of health care and the statutory requirement that employers provide
coverage of all compensable medical costs, without any copayment by the
employee. The Company believes the most significant factor affecting the cost
of workers' compensation, however, results from incentives in the system for
injured employees to remain away from work and to continue collecting indemnity
payments and receiving medical treatment beyond the point that is necessary.
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The Company believes that workers' compensation insurance companies have
not effectively controlled costs in the industry. Traditional insurance
company practices have focused on managing specific aspects of the system, such
as workplace safety, and on implementing certain medical cost containment
measures.
While traditional efforts have reduced costs in certain areas, the Company
believes these efforts have not had a significant effect on the overall system
because they have not focused effectively on controlling indemnity payments.
In addition, the Company believes traditional efforts have addressed only
certain components of the workers' compensation system, and have not provided a
comprehensive management approach specifically designed for the workers'
compensation system.
THE COMPANY'S MANAGEMENT APPROACH
The Company seeks to control workers' compensation costs through a
proprietary management approach that is specifically designed for the workers'
compensation system. The Company's management strategy seeks to reduce
workers' compensation costs significantly through early intervention in each
employee injury and intensive management of all participants in the system,
including employers, injured employees and medical care providers, as well as
legal and judicial participants in the workers' compensation system. Through
early intervention, the Company promptly identifies cases that have the
potential to result in significant expenses and acts to control these expenses
before they are incurred. The Company focuses on controlling indemnity
payments for lost wages, the largest component of workers' compensation costs,
by quickly returning employees to work. As part of this strategy, the Company
attempts to return an injured employee to his or her original position if the
employee is capable, or to place the employee in a transitional, light-duty
position until the employee is able to resume his or her former position. By
promptly returning an employee to work, the Company has found that not only
indemnity payments, but also medical expenses per injury, are substantially
reduced. In addition, the Company uses management techniques such as
designated health care providers, medical fee schedule review, utilization
review and peer review to control medical costs.
The Company uses six-person operating teams to implement its management
approach. An operating team handles all of the claims for a specific group of
customers and is accountable within the Company for the loss experience of
these customers. Each team generally consists of three nurses, a statutory
claims administrator, an assistant claims administrator and a clerical support
person. A team's nurses are responsible for evaluating the medical condition
of an injured employee and monitoring the employee's medical treatment. The
claims administrators are responsible for determining the eligibility of
claims, paying benefits in a timely manner and following statutory requirements
for administration of claims. The operating teams meet regularly to discuss
strategies for managing difficult claims and to review strategies and
procedures that have been particularly successful in resolving disputes.
The following sections summarize the Company's approach to managing the
various participants in the system.
EMPLOYERS. Generally, each customer is assigned to an operating team
responsible for managing the customer relationship. Prior to accepting an
employer as a customer, members of an operating team conduct a risk assessment
and provide an explanation of the Company's methods and procedures to the
employer. The risk assessment forms a part of the Company's underwriting
process and includes an evaluation of the employer's willingness to follow the
Company's procedures. Before the Company accepts an employer as a customer,
the Company and the employer sign an agreement in which the employer agrees to
comply with the Company's early intervention methods and to provide
transitional, light-duty work for injured employees until such time as they are
able to resume their normal positions. To ensure that the Company's early
intervention techniques succeed, the Company requests prompt notification from
the employer of all injuries, typically 24 to 48 hours after the employer
learns of the injury.
The operating team is responsible for implementing a workers' compensation
program for the customer, training the customer's personnel in the Company's
methods and procedures and managing all reported injuries for this customer.
The operating team meets with the customer, provides loss reports showing
current claims status, conducts an annual account review and maintains active
communications on open injury matters. The operating team may make workplace
safety recommendations or retain a workplace safety engineering firm to assist
its customers to remedy work conditions that the operating team determines
constitute an inappropriate risk. In
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addition, the operating team may recommend to the Company's management the
cancellation or non-renewal of the policy for a customer that fails to comply
with the Company's procedures. To date, there have not been a material
number of policy cancellations or non-renewals due to the failure by
customers to comply with the Company's policies.
EMPLOYEES. The Company focuses on identifying injuries that have the
greatest potential to result in significant expenses and acts quickly to
control expenses resulting from these injuries. The Company's experience has
been that approximately 15% of all injuries result in 85% of all workers'
compensation expenses and that early identification of, and intervention in,
these cases can lead to significant cost savings. Within 48 hours of notice of
an injury, the operating team typically evaluates several factors, including
the type of injury, the employee's history of injuries and whether the employee
is absent from work, to determine whether the injury is likely to involve
significant expenses. In potentially high-cost cases, a member of the
operating team intervenes quickly by meeting with the injured employee to
assess the injury, assisting the injured employee in obtaining medical care and
rehabilitation and developing a plan to get the employee back to work as soon
as is appropriate. If the employee cannot immediately return to his or her
original position, the employer is required, according to the terms of the
insurance agreement, to provide a transitional light-duty job that is
consistent with the limits defined by the employee's medical care provider. If
the employee refuses this transitional position, the Company may terminate
indemnity payments, but is required to continue to provide appropriate medical
benefits.
MEDICAL CARE PROVIDERS. The operating teams actively assess each injury,
monitor and manage the medical treatment and review the medical expenses of
each employee's injury. Each injury report is reviewed by one of the Company's
nurses. The nurse typically contacts the physician treating the employee in
cases that involved days off from work or injuries that could involve
significant expense. In these cases, the physician is asked to provide his or
her diagnosis, plan of treatment and assessment of the employee's physical
capabilities for transitional work. The Company has contracts with medical and
chiropractic physicians to provide consulting services and assessment of
proposed treatment plans for injured employees to the operating teams. These
physicians also discuss injured employee treatment plans with the employee's
medical care providers. The goal is to ensure both an accurate diagnosis and
treatment of the injury and an understanding of the nature and extent of the
limits the diagnosis places on the employee's ability to return to work in
either the original job or a transitional, light-duty position. The operating
team also monitors the health care provided to the injured employee to ensure
that the employee receives proper treatment for the injury and that the
employee does not receive services or procedures that are excessive,
unnecessary or unrelated to the particular injury. In addition, when the
operating team believes the diagnosis of an injury or the proposed
rehabilitation treatment is not appropriate, the operating team will arrange
for a second opinion with an independent medical examiner.
The medical cost management team reviews all bills submitted by medical
care providers to determine if the amounts charged for the treatments are
appropriate according to statutory fee schedules.
In Minnesota, Illinois and many other states, the Company cannot require
that an injured employee go to a specific physician or seek treatment from a
specific provider. Nevertheless, the Company attempts to assist the injured
employee in the selection of appropriate medical care providers. In Colorado,
Missouri and Michigan (for the first ten days after the injury) the Company can
require injured employees to go to a physician within a designated network of
medical care providers.
MANAGEMENT OF LEGAL AND JUDICIAL PARTICIPANTS. The Company, through early
intervention, seeks to limit the number of disputes with injured employees. As
part of its early intervention process, the Company identifies injuries that
are not eligible for medical or indemnity payments, and denies the claim. The
Company may also deny a claim for indemnity payments when it determines that no
further payments are appropriate (for example, when an employee has been
offered transitional, light-duty work and has refused it). In these and other
sets of circumstances, the employee may engage a lawyer to represent his or her
interests. Generally, if the parties are unable to resolve the matter, the
workers' compensation law mandates arbitration, subject to judicial review.
For cases that involve adversary proceedings, the Company engages one of
several lawyers who are familiar with the Company's philosophy and actively
seeks to resolve the dispute with the employee's attorney. The Company's
policy is to contest all cases where the Company believes benefits are not
appropriate under applicable law.
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CUSTOMERS
The Company targets employers and associations that operate in industries
with relatively high workers' compensation costs, such as manufacturing,
retail, wholesale, health care or hospitality industries, and employers with a
history of workers' compensation claim costs higher than the average in their
industry.
The Company's average annual premium decreased to $22,000 in 1997 from
$24,000 in 1996 and $52,000 in 1995 due primarily to increased association
business with smaller average individual member premiums written in 1997 and
1996 and decreases in premium rates on new and renewal policies. The Company's
ten largest customers accounted for approximately $5.3 million or 6.7% of the
Company's premiums in force in 1997 as compared to $5.1 million or 7.4% of
premiums in force in 1996 and $4.8 million or 9.3% of premiums in force in
1995. No customer accounted for more than 5% of in force premiums in 1997,
1996 or 1995. Approximately 78% of the policies scheduled to expire in 1997
were renewed by the Company's customers whereas approximately 83% were renewed
in 1996.
Currently, all of the Company's customers are in Minnesota, Wisconsin,
Colorado, Missouri, Illinois, Kansas, Michigan, Indiana, Massachusetts, Rhode
Island, Connecticut and New Hampshire. In addition to these states, the
Company is also currently licensed in Pennsylvania, Tennessee, South Dakota,
Iowa and Maryland. The Company is applying for authorization to begin
insurance operations in 10 additional jurisdictions. The Company expects it
will primarily enter states that have a workers' compensation regulatory
structure that allows the Company to set its own premium rates and that also
have a substantial portion of the employers in that state insured through a
state sponsored fund. The Company currently has no intention to expand
operations internationally but will reevaluate the circumstances as
opportunities arise.
PRODUCTS
Substantially all of the Company's workers' compensation products and
services are guaranteed-cost insurance policies. Under a guaranteed-cost
policy, the customer purchases an insurance policy underwritten by ACIC and
pays the Company a premium based on the customers' aggregate payroll. The
Company assumes responsibility for all the indemnity and medical costs
associated with the customers' workers' compensation injuries and works closely
with the customer in managing the employer's entire workers' compensation
program.
The Company determines the premium to be charged a customer based on
several factors, including: (i) the expected dollar loss per $100 of payroll
for the customers' industry, (ii) the customer's experience modifier, a
measurement of the difference between the customer's past claims experience and
its industry average and (iii) an upward or downward adjustment to the premium
by the Company based on its assessment of the risks associated with providing
the coverage for the specific customer and on competitive market prices. A
customer's expected dollar loss and experience modifier are each determined by
an independent rating agency established by its state, based on a three-year
average of the claims experience of the customer and its industry.
In addition to standard guaranteed-cost policies, the Company offers, on a
limited basis, a deductible guaranteed-cost policy under which the customer is
responsible for all medical and indemnity expenses up to a specific dollar
amount, while the Company is responsible for medical and indemnity expenses
over this level. The Company provides the same comprehensive management
services for the deductible guaranteed-cost policies and the standard
guaranteed-cost policies.
SALES AND MARKETING
The Company's workers' compensation products and services are sold by
independent insurance agencies, including several large national agencies, as
well as one- or two-person agencies. Agencies are paid a commission, which
averaged 7.8% of the Company's gross premiums earned in 1997 compared to 7.3%
of gross premiums earned in 1996. The Company's ten highest producing agencies
accounted for approximately $21.1 million or 26.9% of premiums in force in 1997
compared to $25.7 million or 37.0% of premiums in force in 1996. No agency
accounted for more than 4.3% of premiums in force in 1997 and 6.2% of premiums
in force in 1996. The Company continually markets its products and services to
its agencies to keep them aware of developments in the Company's business.
Each state's management group and underwriting team is responsible for
establishing and maintaining agency relationships.
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REINSURANCE
The Company shares the risks and benefits of the insurance it underwrites
through reinsurance. The Company has in effect "excess of loss" policies under
which the Company pays a reinsurer a percentage of its gross premiums earned,
and the reinsurer agrees to assume all risks relating to injuries over a
specific dollar amount on a per occurrence basis. The 1997 and 1996 per
occurrence levels in Minnesota were $1,080,000 and $1,040,000, respectively.
The Company selected $280,000 for its retention level in Minnesota for 1998.
The excess of loss coverage in Minnesota is provided by a state established
organization, the Minnesota Workers' Compensation Reinsurance Association. In
non-Minnesota states, excess of loss coverage is purchased through private
reinsurers. In 1997, the Company purchased non-Minnesota excess of loss
policies primarily through General Reinsurance Corporation, rated A++
(Superior) by A.M. Best. The excess of loss policies in effect during 1997
provided reinsurance up to $9.5 million in excess of $500,000 per person per
any one loss and up to $40 million in excess of $10 million per occurrence
ultimate net loss. This excess of loss coverage continues into 1998, was
effective January 1, 1997, and replaced excess of loss policies which were
terminated on December 31, 1996. The non-Minnesota excess of loss policies in
effect during 1996 and 1995 provided reinsurance up to $9.5 million in excess
of $500,000 per person per any one loss and up to $49.5 million in excess of
$500,000 per occurrence ultimate net loss. Transatlantic Reinsurance Company,
rated A+ (Superior) by A.M. Best, is the only reinsurance company that received
more than 15% of the premiums paid for reinsurance coverage under the 1996 and
1995 excess of loss coverage.
During 1994, 1993 and 1992, the Company maintained a quota-share
reinsurance agreement with Reliance Insurance Company ("Reliance") under which
the Company ceded to Reliance a percentage of all written premium dollars, and
Reliance assumed that same percentage of all risks and related costs. The
Company did not have any quota-share reinsurance agreements in effect for 1997,
1996 or 1995 and has none in effect for 1998. Reliance currently is rated A-
(Excellent) by A.M. Best.
A.M. Best ratings are ratings based on a comparative analysis of the
financial condition and operating performance of insurance companies. A.M.
Best ratings are based upon factors of concern to insureds and are not directed
toward the protection of investors. See "Competition."
COMPETITION
The workers' compensation industry is highly competitive. The Company
competes with large insurance companies, managed health care organizations,
state sponsored insurance pools and risk management consultants. Unlike the
Company, which offers only workers' compensation products and services, these
competitors may offer additional products and services to employers, including
other forms of insurance. As a consequence, these competitors may have certain
advantages in pricing their workers' compensation products. In addition,
certain of these competitors are offering a management approach similar to that
offered by the Company. Many of the Company's competitors have greater
financial and operating resources than the Company.
Competitive factors in the industry include premium rates, level of
service and ability to reduce claims expense. The Company believes that its
workers' compensation insurance products are competitively priced and its
premium rates are typically lower than those for customers assigned to the
state sponsored risk pools. The Company also believes that its level of
service and its ability to reduce claims are strong competitive factors that
have enabled it to retain existing customers and attract new customers.
Large insurance companies exit and enter the workers' compensation market
in different states depending on their appraisal of current market conditions.
As a result, many insurance companies stopped underwriting workers'
compensation insurance during the early 1990's due to rising costs that were
not matched by reductions in statutory benefits or higher premium rates. In
1997, 1996 and 1995, the Company experienced increased market pressure as new
carriers, including large insurance companies and single line workers'
compensation insurance companies, entered the market.
These large insurance companies compete primarily with the Company for
customers that have lower past claims experience or lower experience
"modifiers." In Minnesota, decreases in statutory benefits during the past
three years have made it more attractive for large insurance companies to
underwrite workers' compensation policies for these lower experience modifier
customers. As a result, the Company has experienced increased
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competition for the renewal of workers' compensation policies with customers
that have reduced their experience modifiers, and it expects to continue to
experience increased competition from large insurance companies.
An additional competitive factor results from the fact that some employers
will not purchase workers' compensation products from carriers with an A.M.
Best rating less than "A". In addition, certain insurance carriers that write
umbrella policies will not provide coverage to an employer if a portion of the
employer's underlying insurance policy, such as the workers' compensation
portion is written by a carrier with a less than "A" rating. Although some
rated insurance carriers currently provide umbrella policies to customers of
the Company, the Company believes that its B++ letter rating from A.M. Best may
make it difficult, in certain instances, for the Company to provide its
products to certain employers.
The Company's insurance subsidiary was assigned an initial rating of B++
(Very Good) on a scale of A++ (Superior) to F (In Liquidation) on December 16,
1996. This rating was reaffirmed in January 1998. A Best's Rating is assigned
after an extensive quantitative and qualitative evaluation of the Company's
financial condition and operating performance. A.M. Best ratings are based
upon factors of concern to insureds and are not directed toward the protection
of investors. Furthermore, A.M. Best ratings are not ratings of the Company or
any of its securities. A.M. Best ratings include Secure Ratings, consisting of
A++ and A+ (Superior); A and A- (Excellent); B++ and B+ (Very Good); Vulnerable
Ratings, consisting of B and B- (Adequate); C++ and C+ (Fair); C and C-
(Marginal); D (Very Vulnerable); E (Under State Supervision); and F (In
Liquidation).
DATA MANAGEMENT
In 1997 and 1996, the Company contracted with unrelated third parties for
certain computer information systems and other software licenses. In 1996, the
Company developed and implemented its own proprietary claims management and
medical fee adjudicating systems to manage claims, audit medical fees, pay
claims, provide reports to policyholders and analyze claims data. These
systems replaced third party contracts for claims management and medical fee
adjudicating systems. In 1995, the Company developed and implemented its own
proprietary policy management system to process insurance applications and
issue policies and endorsements. This system replaced a third party contract
for a policy management system. The Company continues to utilize third party
software to maintain financial information, prepare accounting reports and
financial statements, perform billing and collections, pay vendors and track
agent commissions. The Company also contracts with a third party provider of
payroll services for payroll, benefit and human resource software services.
The Company utilizes other licensed software from national vendors to maintain
its financial records, file statutory statements with insurance regulators and
perform other general business.
EMPLOYEES
The Company had 302 full-time employees at December 31, 1997. Of the
Company's employees, approximately 126 work in the Company's administrative and
financial functions and 176 serve on approximately 29 different operating
teams. None of the Company's employees are subject to collective bargaining
agreements. The Company believes its employee relations are good.
REGULATION
The Company's insurance subsidiary is subject to substantial regulation by
the governmental agencies in the states in which it operates, and will be
subject to such regulation in any state in which it provides workers'
compensation products and services in the future. State regulatory agencies
have broad administrative power with respect to all aspects of the business of
the Company, including premium rates, benefit levels, policy forms, dividend
payments, capital adequacy and the amount and type of its investments. These
regulations are primarily intended to protect covered employees and
policyholders rather than the insurance company. Both the legislation covering
insurance companies and the regulations adopted by state agencies are subject
to change.
Workers' compensation coverage is a creation of state law, subject to
change by the state legislature, and is influenced by the political processes
in each state. Several states have mandated that employers receive coverage
only from state operated funds. New laws affecting the workers' compensation
system in Minnesota, Colorado, Missouri, Illinois, Michigan and Massachusetts
and any other state where the Company may operate in the future,
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including laws that require all employers to participate in state sponsored
funds or that mandate premium reductions, could have a material adverse
effect on the Company.
EXECUTIVE OFFICERS OF THE REGISTRANT
The following are the executive officers of the Company:
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Name Age Position
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David C. Prosser 73 Chairman of the Board
Carl B. Lehmann 43 President and Chief Executive Officer
Vina L. Marquart 46 Chief Operating Officer - Operations
Alfred L. LaTendresse 49 Chief Financial Officer, Secretary and Treasurer
Marguerite K. Downey 47 Vice President, Chief Information Officer
Daniel R. Haag 41 Vice President, Human Resources
</TABLE>
David C. Prosser, the founder of the Company and Chairman of the Board,
served as President and Chief Executive Officer through January 1998, and has
been a Director of the Company since its formation in 1983. From 1965 through
1985, Mr. Prosser was the owner and President of Vocational Personnel Services,
Inc., which merged into the Company in 1986.
Carl B. Lehmann became a Director of the Company in November 1997 and was
appointed President and Chief Executive Officer in January 1998. Mr. Lehmann
served as President of the Stored Value Group, a division of American Express
Travel Related Services, Inc. (AMEX) from 1993 to 1997. Prior to that time,
Mr. Lehmann served as Vice President of various departments at AMEX from 1987
to 1993 and Citicorp Retail Services from 1984 to 1987.
Vina L. Marquart joined the Company in 1984 as a Workers' Compensation
Manager, served as Vice President, Operations beginning in 1990 and became
Chief Operating Officer - Operations in October 1996. Ms. Marquart served as a
Director of the Company from October 1990 until January 1995. Ms. Marquart is
a member of the American Association of Occupational Health Nursing and
Minnesota Association of Occupational Health Nursing. She has held a
registered nursing license since 1974.
Alfred L. LaTendresse joined the Company as Chief Financial Officer in
1990 and became Secretary and Treasurer in October 1990. Mr. LaTendresse
served as a Director of the Company from July 1993 until January 1995. Prior
to joining the Company, Mr. LaTendresse served as the Chief Financial Officer
for several companies since 1982. Mr. LaTendresse is a member in the American
Institute of Certified Public Accountants and the Minnesota Society of
Certified Public Accountants.
Marguerite K. Downey joined the Company in December 1997 as Vice
President, Chief Information Officer. Prior to joining the Company, Ms. Downey
served as the Vice President of Technology for Performark, Inc. from 1996 to
1997 and as the Vice President, Information Services for Fortis from 1988 to
1996. Ms. Downey also served in other information system positions at Fortis
from 1972 to 1988.
Daniel R. Haag joined the Company in June 1996 as the Director of Human
Resources and became Vice President, Human Resources in August 1996. Prior to
joining the Company, Mr. Haag served as the Director of Human Resources,
Scholastic and Recognition Division for Jostens in 1994 and 1995 and served in
numerous human resource positions with SPX Corporation from 1979 to 1994
including Director of Human Resource positions for SPX divisions from 1990 to
1994.
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ITEM 2. PROPERTIES
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The following is a summary of properties leased by the Company at December 31,
1997:
<TABLE>
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Area leased
Location and description (in square feet) Termination
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<S> <C> <C>
Bloomington, Minnesota; Headquarters space 41,918 September 1999 (1)
Brainerd, Minnesota; Minnesota satellite office 4,274 October 2000
Denver, Colorado; Colorado office space 19,779 February 2000
St. Louis, Missouri; Missouri office space 9,591 September 2000
Overland Park, Kansas; Missouri office space 3,604 November 2002
Detroit, Michigan; Michigan office space 11,008 June 2002
Boston, Massachusetts; Massachusetts office space 12,381 May 2002
</TABLE>
(1) The Company amended its lease in February 1997 to increase the area leased
in its Headquarters space by 6,013 square feet to 41,918 square feet. This
amendment extends to March 2000 only for the new space leased.
ITEM 3. LEGAL PROCEEDINGS
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In the ordinary course of administering its workers' compensation
management program, the Company is routinely involved in the adjudication of
claims resulting from workplace injuries. The Company is not involved in any
legal or administrative claims that it believes are likely to have a material
adverse effect on the Company's operations or financial condition.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
- -------------------------------------------------------------
None.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
- -------------------------------------------------------------------------------
The Company's shares are publicly traded on The Nasdaq Stock Market under the
symbol RTWI. The table below sets forth the range of high and low sales prices
for the Company's stock for each quarter during the past two years. All amounts
presented reflect the effect of a 3-for-2 stock split in the form of a 50
percent stock dividend to shareholders of record in 1996. On March 1, 1998,
the Company had approximately 3,000 shareholders.
<TABLE>
<CAPTION>
First Second Third Fourth
Fiscal Year: Quarter Quarter Quarter Quarter
------------ ------- ------- ------- -------
<S> <C> <C> <C> <C> <C>
1997 High 19 1/4 10 3/8 9 7/8 9 3/4
Low 7 7 3/8 6 7/8 5 1/4
1996 High 24 7/8 33 1/2 33 28 1/8
Low 16 1/3 23 2/3 23 3/4 14 3/4
</TABLE>
The Company has never paid cash dividends on its common stock. The Company
currently intends to retain any and all income for use in its business and does
not anticipate paying cash dividends in the foreseeable future. Any future
determination as to payment of dividends will depend on the financial condition
and results of operations of the Company and such other factors deemed relevant
by the Board of Directors. Under the Indenture dated December 1, 1994, under
which the Company issued our $10.0 million in Senior Notes, the Company is
prohibited from paying cash dividends unless it is able to maintain compliance
with certain covenants after paying dividends.
10
<PAGE>
ITEM 6. SELECTED FINANCIAL DATA
The consolidated statements of income data set forth below for each of the
three years in the period ended December 31, 1997, and the consolidated
balance sheet data at December 31, 1997 and 1996, are derived from, and are
qualified by reference to, the audited consolidated financial statements
included elsewhere in this Form 10-K. The consolidated statements of income
data set forth below for each of the two years in the period ended December
31, 1994, and the consolidated balance sheet data at December 31, 1995, 1994
and 1993, are derived from audited consolidated financial statements not
included herein. The information set forth below should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and the Company's consolidated financial
statements and related notes included elsewhere in this Form 10-K.
<TABLE>
<CAPTION>
1993 1994 1995 1996 1997
------- ------- -------- -------- --------
(In thousands, except per share data)
<S> <C> <C> <C> <C> <C>
Total revenues $ 7,828 $28,241 $ 49,433 $ 68,725 $ 88,263
Income from operations 2,571 7,879 12,569 14,808 9,446
Net income 1,450 4,195 7,058 8,982 5,799
Basic income per share (1) 0.18 0.49 0.67 0.76 0.49
Diluted income per share (1) 0.18 0.49 0.64 0.74 0.48
Premiums in force at year end 29,000 39,900 51,700 69,500 78,400
Total assets 28,224 56,765 101,124 123,731 141,986
Notes payable 933 9,993 8,891 6,739 4,875
Total shareholders' equity 2,466 6,136 41,438 51,311 58,357
</TABLE>
- --------------------------------
(1) Adjusted to reflect a three-for-two stock split in May 1996 and a five-
for-one stock split in 1995. For additional information relating to
income per share, see Note 2 of Notes to Consolidated Financial
Statements.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATION
OVERVIEW
THE COMPANY - RTW, Inc. (RTW) and its wholly owned insurance subsidiary,
American Compensation Insurance Company (ACIC), provide disability management
services to employers. Collectively, "we", "our" and "us" will refer to
these entities in this "Management's Discussion and Analysis of Financial
Condition and Results of Operations".
We developed a proprietary management system, the RTW
SOLUTION-Registered Trademark-, designed to lower employers' workers'
compensation costs and return injured employees to work as soon as possible.
We combine our management system with insurance products underwritten by our
insurance subsidiary to offer services to customers. We currently provide
workers' compensation management services solely to employers insured through
our insurance subsidiary. We operated in Minnesota, Colorado, Missouri,
Michigan, Massachusetts, Illinois and Wisconsin during 1997.
OPERATING RESULTS - The following table provides an overview of our key
operating results (000's):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
1997 1996 1995
------- ------- --------
<S> <C> <C> <C>
Premiums in force at year-end $78,400 $69,500 $51,700
Total revenues 88,263 68,725 49,433
Net income 5,799 8,982 7,058
</TABLE>
We continued our focus on growth in 1997 resulting in a 12.8% growth in
premiums in force. This focus, combined with increased earnings on our
investment portfolio, resulted in record revenues of $88.3 million in 1997,
11
<PAGE>
a 28.4% growth over 1996. Several years of price declines and increased
competition resulted in a decrease in net income from 1996. Factors
affecting our 1997 results include:
- Continued price declines due to legislative benefit changes and increased
competition in our markets;
- Increased final audit premiums;
- Declining average cost per claim;
- Increased agent commissions as a percent of premiums earned;
- Increased operating costs resulting from opening the Michigan office in
late 1996 and the Massachusetts office in the second quarter of 1997; and
- Decreased effective income tax rates resulting from the decrease in net
income.
TOTAL REVENUES: Our total revenues include premiums earned and investment
income.
PREMIUMS EARNED - Premiums on workers' compensation insurance policies are
our largest source of revenue. Premiums earned are the gross premiums
earned by us on in force workers' compensation policies, net of the effects
of ceded premiums under reinsurance agreements.
Reinsurance agreements allow us to share certain risks with other
insurance companies. The primary purpose of ceded reinsurance is to
protect us from potential losses in excess of the level we are willing to
accept. Our primary ceded reinsurance is excess of loss coverage that
limits our per incident exposure. We expect the companies to which we have
ceded reinsurance to honor their obligations. In the event that these
companies are unable to honor their obligations to us, we will be required
to pay these obligations ourselves. We are not aware of any developments
with respect to any of our reinsurers that would prevent them from honoring
any of their obligations to us.
INVESTMENT INCOME - Our investment income includes earnings on our
investment portfolio and realized capital gains and losses from sales of
investments.
TOTAL EXPENSES: Our expenses include claim and claim settlement expenses,
policy acquisition costs, general and administrative expenses, interest
expense and income taxes.
CLAIM AND CLAIM SETTLEMENT EXPENSES - Claim expenses refer to amounts
that we paid or expect to pay to claimants for events that have occurred.
The costs of investigating, resolving and processing these claims are
referred to as claim settlement expenses. We record these expenses, net of
amounts recoverable under reinsurance contracts, to claim and claim
settlement expenses in the Consolidated Statements of Income.
POLICY ACQUISITION COSTS - Policy acquisition costs are costs directly
related to writing an insurance policy and consist of commissions, state
premium taxes, underwriting personnel costs and expenses, sales and
marketing costs and other underwriting expenses, offset by ceding
commissions received from our reinsurers. Ceding commissions are amounts
that reinsurers pay to us for placing reinsurance with them. Ceding
commissions represent adjustments based on actual claim and claim
settlement expenses related to premiums ceded in prior years. Under
reinsurance agreements, our ceding commission is adjusted to the extent
that actual claim and claim settlement expenses vary from levels specified
in the agreement.
GENERAL AND ADMINISTRATIVE EXPENSES - Our general and administrative
expenses include personnel costs, office rent, certain state administrative
charges based on premiums and other costs and expenses not specific to
claim and claim settlement expenses or policy acquisition costs.
INTEREST EXPENSE - We incurred interest charges on our Senior Notes and
our Series 1991A and 1991B Notes. The Series 1991A and 1991B Notes were
paid in full in December 1996. The Senior Notes mature in series during the
years 1995 through 1999.
INCOME TAXES - We incur federal income taxes on our combined service
organization (RTW) operations and insurance (ACIC) operations. We incur
state income taxes on the results of our service organization's operations
and incur premium taxes in lieu of state income taxes for substantially all
of our insurance operations. In certain instances, we may incur state
income taxes on our insurance operations. Additionally, certain provisions
of the Internal Revenue Code adversely affect our taxable income by
accelerating recognition and payment of income taxes. Adjustments to book
income generating current tax liabilities include limitations
12
<PAGE>
on the deductibility of unpaid claim and claim settlement expenses,
limitations on the deductibility of unearned premium reserves and
limitations on deductions for bad debt reserves.
In the following pages, we take a look at the 1997, 1996 and 1995 results
for these areas and also explain key balance sheet accounts in greater detail.
RESULTS OF OPERATIONS
The following table summarizes the components of our revenues and premiums in
force (000's):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
1997 1996 1995
------- ------- -------
<S> <C> <C> <C>
Gross premiums earned $81,385 $63,755 $47,507
Premiums ceded (342) (697) (2,099)
------- ------- -------
Premiums earned 81,043 63,058 45,408
Investment income 7,220 5,667 4,025
------- ------- -------
Total revenues $88,263 $68,725 $49,433
------- ------- -------
------- ------- -------
Premiums in force at year-end 1997 1996 1995
------- ------- -------
Minnesota $44,400 $52,400 $47,700
Colorado 12,900 12,000 4,000
Missouri 12,700 4,700 -
Michigan 5,200 400 -
Illinois 1,600 - -
Massachusetts 1,400 - -
Wisconsin 200 - -
------- ------- -------
Total premiums in force $78,400 $69,500 $51,700
------- ------- -------
------- ------- -------
</TABLE>
GROSS PREMIUMS EARNED: The premium we charge a policyholder is a function of
their payroll, industry and prior workers' compensation claims experience. In
underwriting a policy, we receive policyholder payroll estimates for the
ensuing year. We record premiums written on an installment basis matching
billing to the policyholder and earn premiums on a daily basis over the life of
each insurance policy based on the payroll estimate. We record the excess of
premiums billed over premiums earned for each policy as unearned premiums on
our balance sheet. When a policy expires, we audit employer payrolls for the
policy period and adjust the estimated payroll to its actual value. The result
is a "final audit" adjustment recorded to premiums earned when the adjustment
becomes known.
Our gross premiums earned in 1997 increased 27.6% to $81.4 million from $63.8
million in 1996. This increase resulted, in part, from the 12.8% increase in
premiums in force to $78.4 million at December 31, 1997 from $69.5 million at
December 31, 1996. Additionally, gross premiums earned increased as we
recognized $7.5 million of final audit premiums in 1997 compared to $500,000
recognized in 1996.
Gross premiums earned in 1996 increased 34.2% to $63.8 million from $47.5
million in 1995. This increase resulted from the 34.4% increase in premiums in
force to $69.5 million at December 31, 1996 from $51.7 million at December 31,
1995. Additionally, final audit premiums decreased to $500,000 in 1996 from
$1.2 million in 1995.
Underlying these increases in gross premiums earned is another trend. The
premium rate that we charge policyholders per payroll dollar has declined for
several years. This is the result, in part, of the following:
- Many state legislatures where we provide coverage have reduced
benefits that injured employees are paid, resulting in lower loss costs
of workers' compensation insurance and decreased corresponding premiums
to the policyholder;
- As the loss cost structure of workers' compensation has declined, more
insurance companies have entered or re-entered the workers' compensation
insurance market, resulting in increased competition; and
- We continue to experience reduced pricing on renewal policies due, in
part, to our success in lowering our policyholders' loss experience
which then improves their claims history, lowering the premium that they
have to pay for insurance. The improvement that we do for our customers
also has the effect of making them more desirable to our competition,
thus increasing price competition on these accounts.
13
<PAGE>
PREMIUMS CEDED: We pay reinsurers, under excess of loss reinsurance
policies, to limit our per incident exposure and record this cost as a
reduction to gross premiums earned. We are required to purchase excess of
loss coverage for Minnesota policies from the Minnesota Workers' Compensation
Reinsurance Association (WCRA). Our selected retention levels in Minnesota
were approximately $1.1 million in 1997, $1.0 million in 1996 and $450,000 in
1995. In other states, we have chosen to limit our per incident exposure to
$500,000 and purchased this coverage from various reinsurers.
Premiums ceded to reinsurers decreased 50.9% to a cost of $342,000 in 1997
from a cost of $697,000 in 1996. The decrease in premiums ceded resulted from
(i) reduced premium rates in 1997 from 1996 for our selected excess of loss
reinsurance coverage levels in Minnesota, (ii) reduced premiums for excess of
loss coverage in other states, and (iii) the recognition of a refund received
from the WCRA of $358,000 in 1997.
Premiums ceded to reinsurers decreased 66.8% to a cost of $697,000 in 1996
from a cost of $2.1 million in 1995. The decrease in premiums ceded to
reinsurers resulted from (i) the increase to approximately $1.0 million in
1996 from $450,000 in 1995 in the Minnesota retention level under the WCRA
excess of loss reinsurance coverage, (ii) reduced rates charged for excess of
loss reinsurance in Minnesota during 1996, (iii) the recognition of a benefit
of $251,000 in the second quarter of 1996 due to an over-estimate of ceded
premiums at December 31, 1995, and (iv) the decrease in ceded premium cost in
other states due to exceeding the minimum premium threshold.
1998 OUTLOOK: The 1998 outlook for gross premiums earned and premiums ceded
include the following factors:
- We expect continued growth in premiums in force in our non-Minnesota
markets which will lead to growth in gross premiums earned;
- We expect continued downward pressure on the amount we charge for our
products and services; and
- Premiums ceded will increase due to reducing our selected retention level
in Minnesota from approximately $1.1 million to $280,000. This reduction
will result in additional excess of loss policy cost.
INVESTMENT INCOME: We currently invest entirely in fixed maturity
investments and classify our investments as available-for-sale. We intend to
hold our available-for-sale investments to maturity but may sell before
maturity in response to changes in interest rates, prepayment risk and
funding sources or terms, or to address liquidity needs. Our primary
investment objective is to maintain a diversified, high quality, fixed
investment portfolio structured to maximize our after-tax investment income
without taking inappropriate credit risk. For further discussion of
investments, see the "Investments" section of this Management's Discussion
and Analysis.
Investment income increased 27.4% to $7.2 million in 1997 from $5.7 million
in 1996, due to increased funds available for investment and net capital
gains totaling $399,000 realized on securities sold. Funds available for
investment increased to $112.3 million at December 31, 1997 from $89.8
million at December 31, 1996, due to increased net cash provided by operating
activities, resulting primarily from (i) the difference in timing between the
receipt of premiums and the payment of claim and claim settlement expenses
and (ii) net cash provided by investment income. Investment yields increased
to 6.3% in 1997 from 6.2% in 1996 due to portfolio diversification during
1997. The investment yield realized in future periods will be affected by
yields attained on new investments.
Investment income increased 40.8% to $5.7 million in 1996 from $4.0 million
in 1995, due to increased funds available for investment and increased yields
on amounts invested. Funds available for investment increased to $89.8
million at December 31, 1996 from $68.5 million at December 31, 1995, due to
increased net cash provided by operating activities, resulting primarily from
(i) the difference in timing between the receipt of premiums and the payment
of claim and claim settlement expenses and (ii) net cash provided by
investment income. Investment yields increased to 6.2% in 1996 from 6.1% in
1995 due to higher interest rates on U.S. government securities purchased in
1996 from rates on U.S. government securities purchased in prior years.
1998 OUTLOOK: In December 1997, we reclassified our entire held-to-maturity
portfolio, invested in U.S. government securities to available-for-sale
investments. We reclassified these securities to enable us to more actively
manage our investment yield and overall portfolio risk. The held-to-maturity
portfolio had a net unrealized gain of approximately $900,000 at December
31, 1997 while the total portfolio net unrealized gain at December 31, 1997
was $1.4 million. Barring significant changes in interest rates or
operational cash flows, we expect that the 1998 after-tax yield from our
investment portfolio will be affected by the following:
- Increased funds will become available for investment due to increased net
cash provided by operating and investment activities;
14
<PAGE>
- Realized gains may increase as we diversify the previously classified
held-to-maturity securities from U.S. government securities to other
fixed maturity securities; and
- We will broaden our investment portfolio in 1998 to include fixed
maturity tax-exempt securities to increase after-tax yields. Fixed
maturity tax-exempt securities may have the effect of reducing investment
income recognized but are expected to contribute more to after-tax net
income as a result of the treatment they receive for federal tax
purposes.
CLAIM AND CLAIM SETTLEMENT EXPENSES: Claim and claim settlement expenses are
our largest expense and result in our largest liability. We establish reserves
that reflect our estimates of the total claim and claim settlement expenses we
will ultimately have to pay under our workers' compensation insurance policies.
These include claims that have been reported but not settled and claims that
have been incurred but not yet reported to us. For further discussion of
reserve determination, see the "Unpaid Claim and Claim Settlement Expenses"
section of this Management's Discussion and Analysis.
Claim and claim settlement expenses increased to $55.5 million in 1997 from
$39.1 million in 1996. As a percent of premiums earned, claim and claim
settlement expenses increased to 68.5% in 1997 from 62.0% in 1996. These
changes are due to the following:
- Premiums earned increased to $81.0 million in 1997 from $63.1 million in
1996 resulting in increased claim and claim settlement expenses as we
provided coverage for more employers;
- During 1997, we reduced our estimate of the pre-1997 liability for unpaid
claim and claim settlement expenses by $3.1 million as a result of
favorable claims experience for those periods. This reduction was $5.0
million less than the reduction that we recorded in 1996. At
December 31, 1997, we had gross reserves for unpaid claim and claim
settlement expenses of $61.1 million including $36.7 million for 1997
claims and $24.4 million for claims relating to years prior to 1997;
- Reduced premiums due to legislative changes in estimated loss costs,
increased competition and improving customer loss experience, have
resulted in an increase in claim and claim settlement expenses as a
percentage of premiums earned; and
- Average claim cost continued to decrease in 1997 due to realized
operating efficiencies and effectiveness and legislative changes in
benefits to claimants. These decreases did not keep pace, however, with
decreases in pricing.
Claim and claim settlement expenses increased to $39.1 million in 1996 from
$28.1 million in 1995. As a percent of premiums earned, claim and claim
settlement expenses increased to 62.0% in 1996 from 61.8% in 1995. These
changes are due to the following:
- Premiums earned increased to $63.1 million in 1996 from $45.4 million in
1995 resulting in increased claim and claim settlement expenses as we
provided coverage for more employers;
- Operating results for 1996 claim and claim settlement expenses in
Colorado were higher than expected;
- During the fourth quarter of 1996, we experienced the four largest claims
in our history, incurring approximately $2.0 million of expense. Three of
these occurred in Minnesota and one occurred in Missouri;
- Average claim cost decreased in 1996 from 1995 due to realized operating
efficiencies and effectiveness and legislative changes in benefits to
claimants; and
- During 1996, we reduced our estimate of the pre-1996 liability for unpaid
claim and claim settlement expenses by $8.1 million as a result of
favorable claims experience for those periods. This reduction was $6.6
million greater than the reduction that we recorded in 1995.
1998 OUTLOOK: We expect that claim and claim settlement expenses will be
affected by the following factors:
- Average claim costs are expected to have downward pressure in 1998 as a
result of increases in operating efficiency and effectiveness realized
through enhancements to our internal processes and procedures, including
changes to our propriety computer systems. We also expect that
legislative changes in estimated loss costs will create further downward
pressure on average claim costs;
15
<PAGE>
- Inflation will put pressure on the medical and indemnity
components of claim and claim settlement expenses; and
- Continued application of our claims management technology and methods to
all open claims at December 31, 1997 will benefit future periods. The
magnitude of that benefit cannot be quantified at this time.
The ultimate result of the above factors, combined with the change in
premium rates, on 1998 claim and claim settlement expenses as a percent of
premiums earned is unknown at this time.
POLICY ACQUISITION COSTS. The following table summarizes policy acquisition
costs (000's):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
1997 1996 1995
------- -------- --------
<S> <C> <C> <C>
Commission expense $ 6,369 $ 4,670 $ 2,443
Premium tax expense 1,651 1,312 955
Other policy acquisition costs 3,637 2,216 1,024
------- -------- --------
Direct policy acquisition costs 11,657 8,198 4,422
Ceding commissions resulting from unpaid
claim and claim settlement liability
adjustments from 1992 to 1994 1 (1,871) (1,733)
------- -------- --------
Policy acquisition costs $11,658 $ 6,327 $ 2,689
------- -------- --------
------- -------- --------
</TABLE>
Policy acquisition costs increased to $11.7 million in 1997 from $6.3 million
in 1996 and $2.7 million in 1995. As a percent of gross premiums earned,
policy acquisition costs increased to 14.3% in 1997 from 9.9% in 1996 and
5.7% in 1995. These increases reflect the following:
- - Commission expense increased to 7.8% of gross premiums earned in 1997
from 7.3% in 1996 and 5.1% in 1995. The increased commission percent is the
result of marketing programs we initiated during 1995 and the first quarter
of 1996, including volume based incentive programs and higher commissions
for new business, that increased commission rates to agents resulting in
increased average commissions and increased commission expense.
Additionally, as we entered new markets, we introduced higher commission
rates to attract business from established agents. These rates have
continued into current policy periods and will have a greater impact on the
commission expense percent as the non-Minnesota states continue to grow
relative to Minnesota. In all of our markets, we believe the commission
rates we pay are marketplace competitive;
- - Premium tax expense remained consistent at 2.0% of gross premiums earned
in 1997 compared to 2.1% in 1996 and 2.0% in 1995. Premium tax expense was
slightly higher in 1996 due to higher premium tax rates paid for premiums
earned in Colorado. The rates in Colorado decreased from 2.25% in 1996 to
2.15% in 1997 and will be 2.10% in 1998;
- - Other policy acquisition costs increased to 4.5% of gross premiums
earned in 1997 from 3.5% in 1996 and 2.2% in 1995, due to increased focus
on marketing programs as we expanded into new states and continued to grow in
our more established markets and increased personnel costs necessary for
the growth in premiums in force; and
- - Total ceding commissions decreased to a cost of $1,000 from benefits of
$1.9 million in 1996 and $1.7 million in 1995. We recognized adjustments to
our claims experience for accident years 1992 through 1994 resulting in the
1996 and 1995 benefits realized.
1998 OUTLOOK: We expect that policy acquisition costs as a percent of gross
premiums earned will stabilize or remain relatively constant as a percent of
gross premiums earned during 1998 due to the following:
- - We expect commission expense as a percent of gross premiums earned to
increase during 1998 as the non-Minnesota states continue to grow in size
relative to Minnesota;
- - We expect premium tax expense as a percent of gross premiums earned in
1998 to remain consistent with 1997; and
- - We expect that other policy acquisition costs will decrease as a result
of increases in operating efficiency and effectiveness in 1998 realized
through enhancements to our internal processes and procedures, including
changes to our propriety computer systems. We also expect that these costs
will decrease as a percent of gross premiums
16
<PAGE>
earned as we increase premiums in force and generate additional revenues to
cover the relatively fixed policy acquisition costs.
GENERAL AND ADMINISTRATIVE EXPENSES. Our general and administrative expenses
increased to $11.6 million in 1997 from $8.5 million in 1996 and $6.1 million
in 1995. As a percent of gross premiums earned, general and administrative
expenses increased to 14.3% in 1997 from 13.3% in 1996 and 12.9% in 1995.
These increases reflect:
- expenses incurred for expansion in Michigan and Massachusetts in 1997,
Missouri in 1996 and Colorado in 1995, not offset by revenues from
premiums in force in those states;
- additional personnel costs for new employees resulting from the growth in
in force premium;
- higher compensation for existing employees; and
- increased fees for professional services, primarily legal and consulting
services.
1998 OUTLOOK: We expect that general and administrative expenses will be
affected by the following:
- We expect to aggressively manage general and administrative expenses,
specifically legal and consulting expenses to decrease relative costs
during 1998;
- We have no plans to open new state offices in 1998 and expect growth in
premiums in force in Michigan and Massachusetts will result in
additional revenues to cover the fixed costs in those states;
- We expect to increase operational efficiency during 1998 through
enhancements to our internal processes and procedures, including changes
to our internal propriety computer systems; and
- We will limit our salary increases.
INTEREST EXPENSE: We paid interest at rates ranging from 9.00% to 9.50% on
the outstanding balance on our Senior Notes during 1997.
Interest expense decreased to $777,000 in 1997 from $1.1 million in 1996
and $1.3 million in 1995 due to principal payments on the Senior Notes in
December 1997, 1996 and 1995 and payments on the Series 1991A and 1991B Notes
in December 1996 and 1995. The Series 1991A and 1991B Notes were paid in full
in 1996.
1998 OUTLOOK: Interest expense on the Senior Notes is expected to decrease
from $777,000 in 1997 to $546,000 in 1998 as a result of principal payments
of $2.0 million made in December 1997.
INCOME TAXES: The provision for income taxes was $2.9 million in 1997, $4.7
million in 1996 and $4.2 million in 1995. As a percent of income before
income taxes, the provision for income taxes decreased to 33.1% in 1997 from
34.5% in 1996 and 37.5% in 1995. The decrease in 1997 is the result of
decreased taxable net income from the service organization (RTW) in 1997
which is subject to both federal and state income taxes and decreases in the
profitability of ACIC which paid state income taxes in 1995 in addition to
premium taxes.
1998 OUTLOOK: We expect that the provision for income taxes will continue to
decrease as a percent of income before taxes during 1998 as we include
non-taxable municipal fixed investments in our investment portfolio. The
ultimate decrease is unknown at this time.
INVESTMENTS
Our portfolio consisted entirely of taxable fixed maturity securities at
December 31, 1997 and included U.S. government securities (60.8%), corporate
securities (20.0%), mortgage-backed securities (12.9%) and asset-backed
securities (6.3%). After several years of purchasing solely U.S. government
securities, we engaged an investment manager in the second quarter of 1997 to
diversify our portfolio to other fixed maturity investments and maximize our
after-tax investment income without taking inappropriate credit risk. We
manage our fixed maturity portfolio conservatively, investing exclusively in
investment grade (BBB or better rating from Standard and Poor's) securities.
In 1998, we expect to further diversify our portfolio to investment grade
tax-exempt securities. We do not invest in derivative securities.
Additionally, in December 1997, we reclassified our entire held-to-maturity
portfolio, invested in U.S. government securities with a historical cost, net
of amortization, of $53.8 million and a fair value of $54.7 million, to
available-for-sale investments. We reclassified these securities to enable us
to more actively manage our investment yield and overall portfolio risk.
17
<PAGE>
Funds provided by our operating cash flows and investment cash flows are
the source of growth in our investment portfolio. Operating cash flows
consist of the excess of premiums collected over claim and claim settlement
expenses and other operating expenses paid. Investment cash flows consist of
income on existing investments and proceeds from sales and maturities of
investments. Our investment portfolio grew 25.0% or $22.5 million to $112.3
million at December 31, 1997 from $89.8 million at December 31, 1996 as a
result of these factors. During 1997, we invested solely in
available-for-sale securities and intend to continue this investment strategy
for the foreseeable future.
We record investments on our balance sheet at fair value, with the
corresponding appreciation or depreciation from amortized cost recorded in
shareholders' equity net of taxes. Because value is based on the relationship
between the portfolio's stated yields and prevailing market yields at any
given time, interest rate fluctuations can have a swift and significant
impact on the carrying value of these securities. As a result of the
increased holdings in securities classified as available-for-sale, and thus
carried at fair value, we expect to encounter larger adjustments in
shareholders' equity as market interest rates and other factors change.
UNPAID CLAIM AND CLAIM SETTLEMENT EXPENSES
Our "unpaid claim and claim settlement expenses" represent established,
undiscounted reserves for the estimated total unpaid cost of claim and claim
settlement expenses, which cover events that occurred in 1997 and prior
years. These reserves reflect our estimates of the total costs of claims that
were reported, but not yet paid, and the cost of claims incurred but not yet
reported (IBNR). For reported claims, we establish reserves on a "case"
basis. For IBNR claims, we estimate reserves using established actuarial
methods. Both our case and IBNR reserve estimates reflect such variables as
past claims experience, current claim trends and prevailing social, economic
and legal environments. Due to commencing operations in 1992, we have limited
historical data to estimate our reserves for unpaid claim and claim
settlement expenses and accordingly supplement our experience with external
industry data, as adjusted, to reflect anticipated differences between our
results and the industry. We reduce the unpaid claim and claim settlement
expenses for estimated amounts of subrogation.
We believe our reserves for unpaid claim and claim settlement expenses are
adequate to cover the ultimate costs of claim and claim settlement expenses.
The ultimate cost of claim and claim settlement expenses may differ from the
established reserves, particularly when claims may not be settled for many
years. Reserves for unpaid claim and claim settlement expenses and
assumptions used in their development are continually reviewed. We record
adjustments to prior estimates of unpaid claim and claim settlement expenses
to operations in the year in which the adjustments are made. See Notes 1 and
5 of Notes to Consolidated Financial Statements.
The following two tables reconcile the beginning and ending insurance
reserves, displayed individually for each of the last three years.
The following table sets forth reserves on a gross (before reinsurance) basis
(000's):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
1997 1996 1995
------- -------- -------
<S> <C> <C> <C>
GROSS RESERVES FOR CLAIM AND CLAIM SETTLEMENT EXPENSES:
Gross reserves for claim and claim settlement expenses,
beginning of year $49,256 $ 37,138 $28,165
Provision increases (decreases) for claim and claim
settlement expenses:
Current year 60,265 49,440 30,137
Prior years (4,394) (11,051) (4,701)
------- -------- -------
Total provision 55,871 38,389 25,436
Payments for claim and claim settlement expenses:
Current year 23,529 16,239 8,860
Prior years 20,529 10,032 7,603
------- -------- -------
Total payments 44,058 26,271 16,463
------- -------- -------
Gross reserves for claim and claim settlement expenses,
end of year $61,069 $ 49,256 $37,138
------- -------- -------
------- -------- -------
</TABLE>
18
<PAGE>
The following table sets forth reserves on a net (after reinsurance) basis
(000's):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
1997 1996 1995
------- ------- -------
<S> <C> <C> <C>
NET RESERVES FOR CLAIM AND CLAIM SETTLEMENT EXPENSES:
Net reserves for claim and claim settlement expenses,
beginning of year $43,073 $28,826 $14,263
Provision increases (decreases) for claim and claim
settlement expenses:
Current year 58,675 47,155 29,536
Prior years (3,085) (8,075) (1,474)
------- ------- -------
Total provision 55,590 39,080 28,062
Payments for claim and claim settlement expenses:
Current year 23,529 16,238 8,860
Prior years 19,439 8,595 4,639
------- ------- -------
Total payments 42,968 24,833 13,499
------- ------- -------
Net reserves for claim and claim settlement expenses,
end of year $55,695 $43,073 $28,826
------- ------- -------
------- ------- -------
</TABLE>
As determined under Generally Accepted Accounting Principles (GAAP), the
1997 year-end reserves of $61.1 million for claim and claim settlement
expenses were $5.4 million more than the reserves of $55.7 million recorded
on the basis of statutory accounting principles for reports provided to state
regulatory authorities. The difference is the reinsurance recoverable from
third-party reinsurance carriers totaling $5.4 million that reduces reserves
for statutory reporting and is recorded as an asset, reinsurance recoverables,
for GAAP reporting.
The following loss reserve development table sets forth the change, over
time, of reserves established for claim and claim settlement expenses at the
end of the last six years. The following loss reserve development table is
cumulative and, therefore, ending balances should not be added since the
amount at the end of each calendar year includes activity for both current
and prior years (000's):
<TABLE>
<CAPTION>
DECEMBER 31,
1997 1996 1995 1994 1993 1992
------- ------- ------- ------- ------- ------
<S> <C> <C> <C> <C> <C> <C>
LOSS RESERVE DEVELOPMENT:
Gross reserves for unpaid claim and claim
settlement expenses $61,069 $49,256 $37,138 $28,165 $13,279 $2,688
Deduct reinsurance recoveries 5,374 6,183 8,312 13,902 9,593 1,886
------- ------- ------- ------- ------- ------
Net reserves for unpaid claim and
claim settlement expenses $55,695 $43,073 $28,826 $14,263 $ 3,686 $ 802
------- ------- ------- ------- ------- ------
------- ------- ------- ------- ------- ------
Paid (cumulative) as of:
One year later $19,439 $ 8,595 $ 4,639 $ 1,436 $ 583
Two years later 12,894 6,476 2,150 678
Three years later 7,863 2,348 815
Four years later 2,654 856
Five years later 925
Reserves re-estimated as of:
End of year $55,695 $43,073 $28,826 $14,263 $ 3,686 $ 802
One year later 39,988 20,751 12,789 3,784 1,075
Two years later 18,469 9,318 3,416 1,008
Three years later 8,984 2,782 950
Four years later 2,861 912
Five years later 949
Initial reserves in excess of (less than) re-estimated reserves
Amount $ 3,085 $10,357 $ 5,279 $ 825 $ (147)
Percent 7.2% 35.9% 37.0% 22.4% (18.3%)
</TABLE>
19
<PAGE>
The following table is derived from the loss reserve development table and
summarizes the effect of reserve re-estimates, net of reinsurance, on
calendar year operations for the same six-year period ended December 31,
1997. The total of each column details the amount of reserve re-estimates
made in the indicated calendar year and shows the accident years to which the
re-estimates are applicable. The amounts in the total accident year column
represent the cumulative reserve re-estimates for the indicated accident
year (000's).
<TABLE>
<CAPTION>
CUMULATIVE
RE-ESTIMATES
FOR EACH
CALENDAR YEAR ACCIDENT
1997 1996 1995 1994 1993 YEAR
------ ------ ------ ----- ----- -------
<S> <C> <C> <C> <C> <C> <C>
EFFECT OF RESERVE RE-ESTIMATES ON
CALENDAR YEAR OPERATIONS:
Accident Years:
1992 $ (37) $ 38 $ 58 $ 67 $ (273) $ (147)
1993 (42) 596 310 (165) 699
1994 413 2,837 1,106 4,356
1995 1,948 4,604 6,552
1996 803 803
------ ------ ------ ----- ----- -------
Total $ 3,085 $ 8,075 $ 1,474 $ (98) $ (273) $ 12,263
------ ------ ------ ----- ----- -------
------ ------ ------ ----- ----- -------
</TABLE>
LIQUIDITY AND CAPITAL RESOURCES
Liquidity refers to our ability to generate sufficient cash flows to meet the
short and long-term cash requirements of our operations. Capital resources
represent those funds deployed or available to be deployed to support our
business operations.
Our primary sources of cash from operations are premiums collected and
investment income. Our investment portfolio is also a source of liquidity,
through the sale of readily marketable fixed maturity investments, as well as
longer-term investments that have appreciated in value. Our primary cash
requirements consist of payments for (i) claim and claim settlement
expenses, (ii) policy acquisition costs, (iii) general and administrative
expenses, (iv) capital expenditures, (v) income taxes, and (vi) debt service
or principal repayment on our outstanding Senior Notes. We generate positive
net cash from operations due, in part, to timing differences between the
receipt of premiums and the payment of claim and claim settlement expenses.
Cash generated is either invested in short-term cash and cash equivalents or
longer term available-for-sale securities pending future payments for such
expenses as indemnity, medical benefits and other operating expenses. Cash
and cash equivalents consist primarily of U. S. government securities
acquired under repurchase agreements with maturities of 90 days or less, with
the remaining balances in cash and a money market fund that invests in
short-term government securities.
Cash provided by operating activities in 1997 was $20.4 million. This is
primarily a result of our net income of $5.8 million, an increase of $11.8
million in unpaid claim and claim settlement expenses which are non-cash
accruals for future claims, and an decrease of $2.6 million in amounts due
from reinsurers. Net cash used in investing activities was $23.3 million,
primarily the result of purchases of $62.4 million of available-for-sale
investments, $2.4 million in purchases of furniture and equipment offset by
proceeds from sales of available-for-sale investments of $39.1 million and
maturities of $2.5 million of held-to-maturity investments. Net cash used in
financing activities was $1.7 million, primarily due to payments totaling
$2.0 million on outstanding Senior Notes in December 1997.
Our need for additional capital is primarily the result of regulations
which require certain ratios of capital to premiums written. As we grew,
additional capital was required to support the higher premium levels. As a
result, we raised approximately $27.0 million in April 1995 through an
initial public offering and contributed $18.0 million in 1995 to our
insurance subsidiary. In the future, we expect that our need for additional
capital will be primarily related to the growth of our insurance subsidiary
and the need to maintain appropriate capital to premium ratios as defined by
state regulatory bodies. As an alternative to raising additional capital, we
believe we could secure quota-share or other reinsurance which would have the
effect of reducing the ratio of premiums to capital and could be used to
satisfy state regulatory requirements.
State insurance regulations limit distributions, including dividends, from
our insurance subsidiary to us. The maximum amount of dividends that can be
paid by ACIC to us in any year is equal to the greater of: (i) 10% of ACIC's
statutory surplus as of the end of the previous fiscal year, or (ii) the
statutory net gain from operations (not
20
<PAGE>
including realized capital gains) of ACIC in its most recent fiscal year.
Based on this limitation, the maximum dividend that ACIC could pay to us in
1998, without regulatory approval, is approximately $4.5 million. (See Note 9
of Notes to Consolidated Financial Statements.) ACIC may be subject to more
restrictive limitations on dividends as we enter additional states. ACIC has
never paid a dividend to us and, for the foreseeable future, we intend to
retain capital in the insurance subsidiary to enable us to expand our
operations.
We believe that cash flow generated by our operations and our cash and
investment balances will be sufficient to fund continuing operations,
principal repayments and debt service on our outstanding Senior Notes,
including principal repayments of $2.5 million due in December 1998, and
capital expenditures for the next 12 months.
NEW ACCOUNTING STANDARDS
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 130 (SFAS 130), Reporting Comprehensive
Income, and Statement of Financial Accounting Standards No. 131 (SFAS 131),
Disclosures About Segments of an Enterprise and Related Information. SFAS
130 and SFAS 131 are effective for years beginning after December 15, 1997.
We do not expect these standards to have an impact on our Consolidated
Financial Statements
IMPACT OF THE YEAR 2000 ON COMPUTER APPLICATIONS
The year 2000 is a critical year for computer applications. Many computer
programs were historically written using two digits rather than four to define
the appropriate year. As a result, many computer programs that have date
sensitive fields may recognize a date using "00" as the year 1900 rather than
the year 2000. This could result in system failures or miscalculations causing
disruption of operations, including, among other things, a temporary inability
to process transactions, send invoices, or engage in other critical business
activities.
Our insurance subsidiary operations began in 1992. Since 1992, we have
developed our own internal computer systems to manage our claims and related
claim settlement expenses and administer our policy information. These
computer systems are year 2000 compliant. Additionally, during 1998 we will
implement third party provided general ledger and accounts payable software and
develop internally a billing and cash receipt system which will be year 2000
compliant. These system replacements and software development are occurring as
a part our ongoing operations and are not specifically occurring as a result of
the year 2000 issue. We anticipate that our computer hardware and software
systems will be fully year 2000 compliant in 1998 and we are taking steps to
ensure that our significant vendors are compliant during 1999.
The cost of any hardware and software changes required to comply with the
year 2000, other than those contemplated as routine upgrades in our operations,
are not expected to have a material adverse effect on our results of
operations.
NAIC RISK-BASED CAPITAL STANDARDS
The National Association of Insurance Commissioners ("NAIC") has risk-based
capital standards to determine the capital requirements of a property and
casualty insurance carrier based upon the risks inherent in its operations.
These standards require the computation of a risk-based capital amount which
is then compared to a carrier's actual total adjusted capital. The
computation involves applying factors to various financial data to address
four primary risks: asset risk, insurance underwriting risk, credit risk and
off-balance sheet risk. These standards provide for regulatory intervention
when the percent of total adjusted capital to authorized control level
risk-based capital is below certain levels. Based upon the risk-based capital
standards, our percent of total adjusted capital is substantially in excess
of authorized control level risk-based capital.
REGULATION
Our insurance subsidiary is subject to substantial regulation by governmental
agencies in the states in which we operate, and will be subject to such
regulation in any state in which we provide workers' compensation products
and services in the future. State regulatory agencies have broad
administrative power with respect to all aspects of our business, including
premium rates, benefit levels, policy forms, dividend payments, capital
adequacy and the amount and type of investments. These regulations are
primarily intended to protect covered employees and policyholders rather than
the insurance company. Both the legislation covering insurance companies and
the regulations adopted by state agencies are subject to change. At December
31, 1997, our insurance subsidiary was licensed to do business in Minnesota,
21
<PAGE>
Colorado, Missouri, Michigan, Massachusetts, Pennsylvania, Illinois, Kansas,
Connecticut, South Dakota, Tennessee and Wisconsin. We received Indiana,
Iowa, Rhode Island and Maryland licenses so far in 1998.
The NAIC is in the process of codifying statutory accounting principles.
The ultimate completion date is expected in 1999 and impact of this project
on current statutory policies and practices is unknown.
FORWARD LOOKING STATEMENTS
Information included in this annual report which can be identified by the use
of forward-looking terminology such as "may", "will", "expect", "anticipate",
"estimate", or "continue" or the negative thereof or other variations thereon
or comparable terminology constitutes forward-looking information. The
following important factors, among others, in some cases have affected and in
the future could affect our actual results and could cause our actual financial
performance to differ materially from that expressed in any forward-looking
statement: (i) competition from traditional workers' compensation insurance
carriers, (ii) our ability to manage both our existing claims and our new
claims in an effective manner, (iii) our ability to further penetrate our
existing markets, (iv) changes in workers' compensation regulation by states,
including changes in mandated benefits or insurance company regulation, (v) our
ability to retain our existing customers at favorable beneficial premium rates
when their policies renew, and (vi) our ability to expand into new states and
attract customers in those states, and (vii) our ability to successfully
introduce new products and services.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO FINANCIAL STATEMENTS
FINANCIAL STATEMENTS Page
Independent Auditors' Report 23
Consolidated Balance Sheets - December 31, 1997 and 1996 24
Consolidated Statements of Income - Years Ended December 31, 1997,
1996 and 1995 25
Consolidated Statements of Shareholders' Equity - Years Ended
December 31, 1997, 1996 and 1995 26
Consolidated Statements of Cash Flows - Years Ended December 31,
1997, 1996 and 1995 27
Notes to Consolidated Financial Statements - Years Ended December 31,
1997, 1996 and 1995 28
22
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Shareholders
RTW, Inc.
Minneapolis, Minnesota
We have audited the accompanying consolidated balance sheets of RTW,
Inc. and subsidiary (the Company) as of December 31, 1997 and 1996 and the
related statements of income, shareholders' equity, and cash flows for each
of the three years in the period ended December 31, 1997. These consolidated
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the consolidated financial statements
are free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used
and significant estimates made by management, as well as evaluating the overall
consolidated financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position
of the Company at December 31, 1997 and 1996, and the results of its
operations and its cash flows for each of the three years in the period ended
December 31, 1997 in conformity with generally accepted accounting principles.
/s/ DELOITTE & TOUCHE LLP
Minneapolis, Minnesota
January 23, 1998
23
<PAGE>
RTW, INC.
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1997 AND 1996
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
1997 1996
---------- ----------
ASSETS
<S> <C> <C>
Investments:
Available-for-sale, at fair value, amortized cost of $110,880 and $35,854 $ 112,294 $ 35,872
Held-to-maturity, at amortized cost, fair value of $54,396 in 1996 - 53,977
---------- ----------
Total investments 112,294 89,849
Cash and cash equivalents 5,798 10,410
Accrued investment income 1,836 1,724
Premiums receivable, less allowance of $182 and $105 5,763 4,476
Reinsurance recoverables 5,374 6,183
Reinsurance receivables 743 2,555
Deferred policy acquisition costs 1,559 1,624
Furniture and equipment, net 4,927 3,423
Other assets 3,692 3,487
---------- ----------
Total assets $ 141,986 $ 123,731
---------- ----------
---------- ----------
LIABILITIES AND SHAREHOLDERS' EQUITY
Unpaid claim and claim settlement expenses $ 61,069 $ 49,256
Unearned premiums 13,580 13,308
Accrued expenses and other liabilities 4,105 3,117
Notes payable 4,875 6,739
---------- ----------
Total liabilities 83,629 72,420
Shareholders' equity:
Common stock, no par value; authorized 25,000,000 shares;
issued and outstanding 11,841,000 and 11,808,000 shares 28,976 28,610
Retained earnings 28,489 22,690
Unrealized gain on available-for-sale investments, net of tax 892 11
---------- ----------
Total shareholders' equity 58,357 51,311
---------- ----------
Total liabilities and shareholders' equity $ 141,986 $ 123,731
---------- ----------
---------- ----------
</TABLE>
See notes to consolidated financial statements.
24
<PAGE>
RTW, INC.
CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
<TABLE>
<CAPTION>
1997 1996 1995
--------- --------- ---------
<S> <C> <C> <C>
Revenues:
Premiums earned $ 81,043 $ 63,058 $ 45,408
Investment income 7,220 5,667 4,025
--------- --------- ---------
Total revenues 88,263 68,725 49,433
Expenses:
Claim and claim settlement expenses 55,543 39,080 28,062
Policy acquisition costs 11,658 6,327 2,689
General and administrative expenses 11,616 8,510 6,113
--------- --------- ---------
Total expenses 78,817 53,917 36,864
--------- --------- ---------
Income from operations 9,446 14,808 12,569
Interest expense 777 1,086 1,285
--------- --------- ---------
Income before income taxes 8,669 13,722 11,284
Provision for income taxes 2,870 4,740 4,226
--------- --------- ---------
Net income $ 5,799 $ 8,982 $ 7,058
--------- --------- ---------
--------- --------- ---------
Income per share:
Basic income per share $ 0.49 $ 0.76 $ 0.67
--------- --------- ---------
--------- --------- ---------
Diluted income per share $ 0.48 $ 0.74 $ 0.64
--------- --------- ---------
--------- --------- ---------
Weighted average shares outstanding:
Basic shares outstanding 11,833,000 11,774,000 10,607,000
---------- ---------- ----------
---------- ---------- ----------
Diluted shares outstanding 12,079,000 12,137,000 10,959,000
---------- ---------- ----------
---------- ---------- ----------
</TABLE>
See notes to consolidated financial statements.
25
<PAGE>
RTW, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(IN THOUSANDS)
<TABLE>
<CAPTION>
UNREALIZED
APPRECIATION
(DEPRECIATION)
ON SECURITIES TOTAL
COMMON RETAINED AVAILABLE- SHAREHOLDERS'
STOCK EARNINGS FOR-SALE EQUITY
-------- -------- ------------ ------------
<S> <C> <C> <C> <C>
Balance at January 1, 1995 $ 199 $ 5,951 $ (14) $ 6,136
Net income - 7,058 - 7,058
Net proceeds from initial public offering 27,039 - - 27,039
Reclassification of ESOP liability 322 699 - 1,021
Change in unrealized gains on available-
for-sale investments, net of taxes
of $70 - - 138 138
Qualified stock options and warrants
exercised 48 - - 48
Retirement of common stock (2) - - (2)
-------- -------- ------------ ------------
Balance at December 31, 1995 27,606 13,708 124 41,438
Net income - 8,982 - 8,982
Change in unrealized gains on available-
for-sale investments, net of a tax
benefit of $63 - - (113) (113)
Non-qualified stock options exercised,
including tax benefit of $510 608 - - 608
Qualified stock options and warrants
exercised 32 - - 32
Issuance of shares to ESOP 236 - - 236
Issuance of shares under ESPP 129 - - 129
Retirement of common stock (1) - - (1)
-------- -------- ------------ ------------
Balance at December 31, 1996 28,610 22,690 11 51,311
Net income - 5,799 - 5,799
Change in unrealized gains on available-
for-sale investments, net of taxes
of $515 - - 881 881
Qualified stock options exercised 1 - - 1
Issuance of non-qualified options 96 - - 96
Issuance of shares to ESOP 115 - - 115
Issuance of shares under ESPP 154 - - 154
-------- -------- ------------ ------------
Balance at December 31, 1997 $ 28,976 $ 28,489 $ 892 $ 58,357
-------- -------- ------------ ------------
-------- -------- ------------ ------------
</TABLE>
See notes to consolidated financial statements.
26
<PAGE>
RTW, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(IN THOUSANDS)
<TABLE>
<CAPTION>
1997 1996 1995
--------- --------- ---------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Reconciliation of net income to net cash provided
by operating activities:
Net income $ 5,799 $ 8,982 $ 7,058
Adjustments to reconcile net income to net
cash provided by operating activities:
Gains on available-for-sale-investments (399) - -
Depreciation and amortization 1,237 1,071 933
Deferred income taxes (200) (767) (992)
Changes in assets and liabilities:
Amounts due from reinsurers 2,621 1,143 5,131
Unpaid claim and claim settlement expenses 11,813 12,118 8,973
Unearned premiums, net of premiums receivable (1,015) 2,129 1,669
Other, net 517 (1,540) (1,847)
-------- -------- --------
Net cash provided by operating activities 20,373 23,136 20,925
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of held-to-maturity investments - - (27,828)
Maturities of held-to-maturity investments 2,500 3,500 500
Purchases of available-for-sale investments (62,403) (25,273) (8,176)
Proceeds from sales of available-for-sale investments 39,095 - -
Purchases of furniture and equipment (2,447) (2,047) (1,265)
-------- -------- --------
Net cash used in investing activities (23,255) (23,820) (36,769)
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments on notes payable (2,000) (2,362) (1,362)
Proceeds from initial public offering - - 29,900
Equity financing costs - - (2,861)
Stock options and warrants exercised 1 130 48
Issuance of common stock to ESOP 115 236 -
Issuance of common stock under ESPP 154 129 -
Retirement of common stock - (1) (2)
-------- -------- --------
Net cash provided by (used in)
financing activities (1,730) (1,868) 25,723
-------- -------- --------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (4,612) (2,552) 9,879
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 10,410 12,962 3,083
-------- -------- --------
CASH AND CASH EQUIVALENTS AT END OF YEAR $ 5,798 $ 10,410 $ 12,962
-------- -------- --------
-------- -------- --------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the year for:
Interest $ 664 $ 898 $ 1,042
-------- -------- --------
-------- -------- --------
Income taxes $ 3,536 $ 6,338 $ 5,285
-------- -------- --------
-------- -------- --------
</TABLE>
See notes to consolidated financial statements.
27
<PAGE>
RTW, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1997, 1996, AND 1995
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION - RTW, Inc. (RTW) provides workers' compensation insurance
coverage to employers through its wholly-owned insurance subsidiary, American
Compensation Insurance Company (ACIC). Collectively, "we", "our" and "us"
will refer to these entities in these "Notes to Consolidated Financial
Statements".
We benefit from our ability to reduce workers' compensation costs and
provide employers the ability to control their workers' compensation
programs. We are domiciled in Minnesota and were licensed in Minnesota,
Colorado, Missouri, Pennsylvania, Michigan, Massachusetts, Illinois, Kansas,
Connecticut, Tennessee, South Dakota, and Wisconsin at December 31, 1997. We
also received our license to write workers' compensation insurance coverage
for companies covered under the Longshoreman's Act in 1997 and received Iowa,
Indiana and Maryland licenses in January 1998. We wrote policies primarily
in Minnesota, Colorado, Missouri, Illinois, Michigan, Massachusetts and
Wisconsin during 1997.
In April 1995, we raised $27,039,000 (net of underwriting discounts and
other offering expenses totaling $2,861,000) through an initial public
offering of 3,450,000 shares of common stock at $8.67 per share. We
contributed $18,000,000 of the net proceeds of the offering to ACIC to expand
operations to other states, as well as to support the increase of premium in
Minnesota. We retained the remaining net proceeds for working capital and
general corporate purposes in RTW, including, if appropriate, additional
future contributions to ACIC.
The following explain the accounting policies we use to arrive at some of
the more significant amounts in our financial statements.
ACCOUNTING PRINCIPLES - We prepare our financial statements in accordance
with general accepted accounting principles (GAAP). We follow the accounting
standards established by the Financial Accounting Standards Board and the
American Institute of Certified Public Accountants.
CONSOLIDATION - Our consolidated financial statements include RTW and ACIC.
We eliminate all intercompany accounts and transactions in consolidation.
USE OF ESTIMATES - We make estimates and assumptions that affect the
reported amounts of assets and liabilities, the disclosure of contingent
assets and liabilities at the financial statement date and the recorded
amounts of revenues and expenses during the reporting period. Our most
significant estimates are those relating to our unpaid claim and claim
settlement expenses and accrual for premium adjustments. We continually
review our estimates and assumptions and make adjustments as necessary, but
actual results could vary significantly from what we envisioned when we made
these estimates.
INVESTMENTS - We invest entirely in fixed maturity investments and classify
our investments as available-for-sale or held-to-maturity in accordance with
Statement of Financial Accounting Standards (SFAS) No. 115, "Accounting for
Certain Investments in Debt and Equity Securities". We do not classify any of
our securities as trading securities.
AVAILABLE-FOR-SALE INVESTMENTS: We intend to hold our available-for-sale
investments to maturity, but may sell before maturity in response to changes
in interest rates, prepayment risk and funding sources or terms, or to
address liquidity needs. Our available-for-sale investments are carried at
fair value with unrealized gains or losses, net of deferred taxes, reported
as a separate component of shareholders' equity.
HELD-TO-MATURITY INVESTMENTS: Our held-to-maturity investments in 1996
consisted solely of U.S. government securities and were carried at amortized
cost. In December 1997, we reclassified our entire held-to-maturity
portfolio, invested in U.S. government securities with a historical cost, net
of amortization of $53.8 million and a fair value of $54.7 million, to
available-for-sale investments. We reclassified these securities to enable
us to more actively manage our investment yield and overall portfolio risk.
REALIZED INVESTMENT GAINS AND LOSSES: We include realized investment gains
and losses in the "Investment income" section of our Consolidated Statements
of Income. Cost of investments sold is determined by the specific
identification method.
28
<PAGE>
We continually monitor the difference between investment cost and fair
value for each of our securities. If any security experienced a decline in
value that is determined to be other than temporary, we would reduce the
security's carrying value for the decline and record a realized loss in the
Consolidated Statements of Income. No securities were reduced for declines in
fair value in 1997 or 1996.
CASH AND CASH EQUIVALENTS - We generally consider all highly liquid
investments with a maturity of three months or less when purchased to be cash
equivalents.
DEFERRED POLICY ACQUISITION COSTS - The costs directly related to writing an
insurance policy are referred to as policy acquisition costs and consist of
commissions, state premium taxes and other direct underwriting expenses.
Although these costs arise when we issue a policy, we defer certain costs,
principally commissions and state premium taxes, and amortize these costs to
expense as premium revenue is recognized.
If deferred policy acquisition costs were to exceed the sum of unearned
premiums and related anticipated investment income less expected claim and
claim settlement expenses, we would immediately expense the excess costs.
DEPRECIATION - We depreciate furniture and equipment on a straight-line basis
over the estimated useful lives of the assets (five to ten years).
Accumulated depreciation in 1997 and 1996 was $2,309,000 and $1,366,000,
respectively.
UNPAID CLAIM AND CLAIM SETTLEMENT EXPENSES - Claim expenses refer to amounts
that we paid or expect to pay to claimants for events that have occurred.
The costs of investigating, resolving and processing these claims are
referred to as claim settlement expenses. We record these expenses, net of
amounts recovered under reinsurance contracts, to "Claim and claim settlement
expenses" in the Consolidated Statements of Income.
Our "Unpaid claim and claim settlement expenses" represent established,
undiscounted reserves for the estimated total unpaid cost of claim and claim
settlement expenses, which cover events that occurred in 1997 and prior
years. These reserves reflect our estimates of the total costs of claims that
were reported, but not yet paid, and the cost of claims incurred but not yet
reported. Our estimates consider such variables as past loss experience,
current claim trends and prevailing social, economic and legal environments.
We have limited historical data to estimate our reserves for unpaid claim and
claim settlement expenses due to commencing operations in 1992 and supplement
our experience with external industry data, as adjusted, to reflect
anticipated differences between our results and the industry. We reduce the
unpaid claim and claim settlement expenses for estimated amounts of
subrogation.
We believe our reserves for unpaid claim and claim settlement expenses
are adequate to cover the ultimate costs of claim and claim settlement
expenses. The ultimate cost of claim and claim settlement expenses may differ
from the established reserves, particularly when claims may not be settled
for many years. Reserves for unpaid claim and claim settlement expenses and
assumptions used in their development are continually reviewed. We record
adjustments to prior estimates of unpaid claim and claim settlement expenses
to operations in the year in which the adjustments are made.
DEBT ISSUE COSTS - We report debt issue costs associated with the Senior
Notes payable as a reduction in notes payable and amortize the cost over the
term of the Senior Notes.
PREMIUMS EARNED - Premiums on workers' compensation insurance policies are
our largest source of revenue. We record premiums written on an installment
basis matching billing to the policyholder and earn premiums on a daily basis
over the life of each insurance policy. Premiums earned includes an estimate
for earned but unbilled audit premiums. We record the excess of premiums
billed over premiums earned for each policy as unearned premiums on our
balance sheet.
NOTE 2 - INCOME PER SHARE
Effective December 1997, we adopted SFAS No. 128, "Earnings Per Share." SFAS
No. 128 requires dual presentation of a basic income per share (IPS), which
excludes dilution, and a diluted IPS, which reflects the potential dilution
that could occur if actions taken in respect of dilutive securities resulted
in the issuance of common stock. Dilutive securities consist of stock
options and warrants. Basic IPS is computed by dividing net income by the
weighted average number of common shares outstanding for the period. Diluted
IPS is computed by dividing net income by the weighted average number of
common shares and dilutive securities outstanding for the period. Dilutive
securities issued after April 1995 are considered outstanding from the date
of grant after applying the treasury stock method for determining the
dilutive effect. Dilutive securities issued prior to that date are considered
outstanding for all periods after applying the treasury stock method for
determining the dilutive effect.
29
<PAGE>
The following is a reconciliation of the numerators and denominators of basic
and diluted income per share:
<TABLE>
<CAPTION>
1997 1996 1995
----------- ----------- -----------
<S> <C> <C> <C>
Net Income - basic and diluted income per share (000's) $ 5,799 $ 8,982 $ 7,058
----------- ----------- -----------
----------- ----------- -----------
Basic weighted average shares outstanding 11,833,000 11,774,000 10,607,000
Effect of dilutive securities
Warrants - 4,000 55,000
Stock options 246,000 359,000 297,000
----------- ----------- -----------
Diluted weighted average shares outstanding 12,079,000 12,137,000 10,959,000
----------- ----------- -----------
----------- ----------- -----------
Basic income per share $0.49 $0.76 $0.67
----------- ----------- -----------
----------- ----------- -----------
Diluted income per share $0.48 $0.74 $0.64
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
Options to purchase 105,250 shares of common stock at prices ranging from
$9.00 to $28.75 were outstanding during 1997 but were not included in the
computation of diluted IPS because the options' exercise price was greater
than the average market price of the common shares. These options were still
outstanding at the end of 1997. Additionally, in January 1998, we granted
options to purchase 150,000 shares of common stock at $7.00 under the 1994
Stock Plan.
NOTE 3 - INVESTMENTS
VALUATION OF INVESTMENTS - The following tables present amortized cost, gross
unrealized gains and losses, and estimated fair values of investments (000's):
<TABLE>
<CAPTION>
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
1997 Cost Gains Losses Value
--------- ---------- ---------- -----------
<S> <C> <C> <C> <C>
Available-for-sale securities:
U.S. government securities $ 66,916 $ 1,345 $ (18) $ 68,243
Corporate securities 22,582 355 (428) 22,509
Asset-backed securities 6,997 44 - 7,041
Mortgage-backed securities 14,385 120 (4) 14,501
--------- ---------- ---------- -----------
Total investments $ 110,880 $ 1,864 $ (450) $ 112,294
--------- ---------- ---------- -----------
--------- ---------- ---------- -----------
<CAPTION>
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
1996 Cost Gains Losses Value
--------- ---------- ---------- -----------
<S> <C> <C> <C> <C>
Available-for-sale securities:
U.S. government securities $ 35,854 $ 128 $ (110) $ 35,872
Held-to-maturity securities
U.S. government securities 53,977 732 (313) 54,396
--------- ---------- ---------- -----------
Total investments $ 89,831 $ 860 $ (423) $ 90,268
--------- ---------- ---------- -----------
--------- ---------- ---------- -----------
</TABLE>
STATUTORY DEPOSITS - Included in investments are U.S. government securities
on deposit with various regulatory authorities as required by law with a fair
value of $2,828,000 and $2,073,000 in 1997 and 1996, respectively.
30
<PAGE>
FIXED MATURITIES BY MATURITY DATE - The following table presents the amortized
cost and fair value of investments by contractual maturity in 1997. Actual
maturities may differ from those stated as a result of calls and prepayments
(000's):
<TABLE>
<CAPTION>
ESTIMATED
AMORTIZED FAIR
MATURING: COST VALUE
- -------- ---------- ----------
<S> <C> <C>
One year or less $ 13,436 $ 13,463
Over one year through five years 52,552 53,536
Over five years through ten years 28,007 28,285
Over ten years 2,500 2,509
Mortgage-backed securities with various maturities 14,385 14,501
---------- ----------
Total investments $ 110,880 $ 112,294
---------- ----------
---------- ----------
</TABLE>
INVESTMENT INCOME -- Investment income includes income from the following
sources (000's):
<TABLE>
<CAPTION>
1997 1996 1995
-------- -------- --------
<S> <C> <C> <C>
Held-to-maturity and available-for-sale investments $ 6,129 $ 5,004 $ 3,337
Short-term investments 692 663 591
Realized investment gains 479 - -
Realized investment losses (80) - -
Other - - 97
-------- -------- --------
Total investment income $ 7,220 $ 5,667 $ 4,025
-------- -------- --------
-------- -------- --------
</TABLE>
There were no significant investment expenses associated with the above
investment income in 1997 or 1996 and there were no sales of securities
during 1996 or 1995.
NOTE 4 -- REINSURANCE
Our financial statements reflect the effects of ceded reinsurance transactions.
The primary purpose of ceded reinsurance is to protect us from potential losses
in excess of the level that we are willing to accept.
We report reinsurance transactions on a "gross" basis on the balance
sheet, resulting in reinsurance receivable amounts on unpaid claim and claim
settlement expenses recorded as assets. We estimate amounts recoverable from
reinsurers in a manner consistent with the claim liability associated with
the reinsured policy.
We ceded Minnesota claims in excess of $1,080,000, $1,040,000 and
$450,000 per occurrence during 1997, 1996 and 1995, respectively, to the
Minnesota Workers' Compensation Reinsurance Association. Non-Minnesota state
claims in excess of $500,000 were ceded to various reinsurers in 1997, 1996
and 1995.
Reinsurance contracts do not relieve us from our obligations to
policyholders. We expect reinsurers to which we have ceded reinsurance to
honor their obligations. Failure of these reinsurers to honor their
obligations could result in losses to us. We do not anticipate any such losses,
and accordingly, no provision for amounts deemed uncollectible are included in
our financial statements. We attempt to minimize our exposure to significant
losses from reinsurer insolvency by monitoring the financial condition of our
reinsurers. Reinsurance receivables associated with reinsurers are as follows
(000's):
<TABLE>
<CAPTION>
1997 1996
------- -------
<S> <C> <C>
Quota-share reinsurance for 1992 to 1994 through a single insurer $ 723 $ 1,673
Excess of loss reinsurance through various reinsurers 4,651 4,510
------- --------
Reinsurance receivable $ 5,374 $ 6,183
------- --------
------- --------
</TABLE>
31
<PAGE>
The effect of ceded reinsurance on premiums written, premiums earned and claim
and claim settlement expenses are as follows (000's):
<TABLE>
<CAPTION>
1997 1996 1995
--------- --------- --------
<S> <C> <C> <C>
Premiums written:
Direct $ 81,657 $ 67,457 $ 50,070
Ceded (342) (697) (2,099)
--------- --------- ---------
Net premiums written $ 81,315 $ 66,760 $ 47,971
--------- --------- ---------
--------- --------- ---------
Premiums earned:
Direct $ 81,385 $ 63,755 $ 47,507
Ceded (342) (697) (2,099)
--------- --------- ---------
Net premiums earned $ 81,043 $ 63,058 $ 45,408
--------- --------- ---------
--------- --------- ---------
Claim and claim settlement expenses:
Direct $ 55,825 $ 38,389 $ 25,436
Ceded (282) 691 2,626
--------- --------- ---------
Net claim and claim settlement expenses $ 55,543 $ 39,080 $ 28,062
--------- --------- ---------
--------- --------- ---------
</TABLE>
Reinsurance receivables consist of the following at
December 31 (000's):
<TABLE>
<CAPTION>
1997 1996
------ ------
<S> <C> <C>
Reinsurance receivables from paid claim and claim settlement expenses $ 743 $ 75
Ceding commission receivable - 2,480
------- ------
Reinsurance receivables $ 743 $ 2,555
------- -------
------- -------
</TABLE>
Ceding commissions earned, which is based upon final settlement of
claim and claim settlement expenses, will range between 10% and 48% during
accident years 1994 and 1993 and 15% and 25% during accident year 1992.
Ceding commissions earned of $1,871,000, and $1,733,000 for fiscal years 1996
and 1995, respectively, are reported as a reduction in policy acquisition
costs in the Consolidated Statements of Income.
NOTE 5 - UNPAID CLAIM AND CLAIM SETTLEMENT EXPENSES
The following table represents a reconciliation of beginning and ending unpaid
claim and claim settlement expense reserves for each of the last three years
(000's):
<TABLE>
<CAPTION>
1997 1996 1995
--------- --------- --------
<S> <C> <C> <C>
Balance at January 1 $ 49,256 $ 37,138 $ 28,165
Less reinsurance recoverables 6,183 8,312 13,902
--------- --------- --------
Net balance at January 1 43,073 28,826 14,263
Incurred related to:
Current year 58,675 47,155 29,536
Prior years (3,085) (8,075) (1,474)
--------- --------- --------
Total incurred 55,590 39,080 28,062
Paid related to:
Current year 23,529 16,238 8,860
Prior years 19,439 8,595 4,639
--------- --------- --------
Total paid 42,968 24,833 13,499
--------- --------- --------
Net balance at December 31 55,695 43,073 28,826
Plus reinsurance recoverables 5,374 6,183 8,312
--------- --------- --------
Balance at December 31 $ 61,069 $ 49,256 $ 37,138
--------- --------- --------
--------- --------- --------
</TABLE>
Changes in estimates of unpaid claim and claim settlement expenses for
prior years decreased the provision for claim and claim settlement expenses
by $3,085,000, $8,075,000 and $1,474,000 in 1997, 1996 and 1995,
respectively. The incurred related to prior years in 1997, 1996 and 1995
reflects our ability to manage and close prior year claims more favorably
than initially anticipated.
32
<PAGE>
NOTE 6 - NOTES PAYABLE
Unsecured notes payable consist of the following (000's):
<TABLE>
<CAPTION>
1997 1996
------- -------
<S> <C> <C>
Senior Notes payable with principal maturities and
monthly interest due as follows:
Maturity Interest Rate
- -------- -------------
December 15, 1997 9.00% $ 2,000
December 15, 1998 9.25% $ 2,500 2,500
December 15, 1999 9.50% 2,500 2,500
-------- -------
Notes payable -- Principal 5,000 7,000
Less: Unamortized debt issue cost (125) (261)
-------- -------
Notes payable $ 4,875 $ 6,739
-------- -------
-------- -------
</TABLE>
We may redeem some or all of the Senior Notes payable on any interest
date at the principal amount of the redeemed notes plus accrued interest and
a premium of 2% through December 15, 1998 and 1% thereafter.
SENIOR NOTES PAYABLE -- The Senior Notes payable contain various restrictive
provisions which require that certain financial ratios, primarily debt coverage
and net worth restrictions, be met before incurring additional indebtedness or
paying dividends or other distributions to shareholders. At December 31, 1997,
we were in compliance with these covenants.
Based on borrowing rates currently available us for loans with similar
terms and average maturities (prime at December 31, 1997 and 1996 was 8.50%
and 8.25%, respectively), the fair value of notes payable was approximately
$5,116,000 and $7,254,000 at December 31, 1997 and 1996, respectively.
NOTE 7 -- INCOME TAXES
We compute the provision for income taxes under the liability method. This
means deferred income taxes reflect the estimated future tax effects of
temporary differences between the carrying value of assets and liabilities
for financial reporting purposes and the carrying value of assets and
liabilities for income tax purposes.
The provision for income taxes consists of the following (000's):
<TABLE>
<CAPTION>
1997 1996 1995
-------- ------- ---------
<S> <C> <C> <C>
Current:
Federal $ 3,714 $ 5,165 $ 4,787
State (129) 342 501
-------- -------- --------
Total current tax expense 3,585 5,507 5,288
Deferred:
Federal (721) (650) (949)
State 6 (117) (113)
-------- -------- --------
Total deferred tax benefit (715) (767) (1,062)
-------- -------- --------
Provision for income taxes $ 2,870 $ 4,740 $ 4,226
-------- -------- --------
-------- -------- --------
</TABLE>
Our provision for income taxes differs from the statutory rate of 35% of pretax
income as follows (000's):
<TABLE>
<CAPTION>
1997 1996 1995
-------- ------- ---------
<S> <C> <C> <C>
Federal income tax expense at statutory rates $ 3,034 $ 4,803 $ 3,949
Increase (reduction) in income taxes resulting from:
State income taxes, net of federal income tax benefit (64) 126 310
Other (100) (189) (33)
-------- ------- ---------
Total $ 2,870 $ 4,740 $ 4,226
-------- ------- ---------
-------- ------- ---------
</TABLE>
33
<PAGE>
Differences between the tax basis of assets and liabilities and their
reported amounts in the Consolidated Financial Statements that will result in
taxable or deductible amounts in future years are called temporary
differences. The tax effects of temporary differences that gave rise to net
deferred tax asset balances, included within other assets, are as follows
(000's):
<TABLE>
<CAPTION>
1997 1996
-------- --------
<S> <C> <C>
Unpaid claim and claim settlement expenses $ 3,512 $ 2,731
Unearned premiums 1,002 1,001
Other 202 124
-------- --------
Deferred tax assets 4,716 3,856
Deferred policy acquisition costs (575 (611)
Unrealized gain on securities (522) (7)
Depreciation (447) (266)
-------- --------
Deferred tax liabilities (1,544) (884)
-------- --------
Net deferred tax assets $ 3,172 $ 2,972
-------- --------
-------- --------
</TABLE>
No valuation allowance was provided against the deferred tax assets
recorded in 1997 or 1996, as we expect to generate sufficient taxable income
in the future to offset reversing temporary differences.
Income taxes receivable at December 31, 1997 and 1996 were approximately
$1,011,000 and $1,059,000, respectively.
NOTE 8 -- EMPLOYEE BENEFITS AND PLANS
STOCK BASED COMPENSATION -- We account for our stock-based compensation
plans, the RTW, Inc. 1995 Employee Stock Purchase Plan and Trust (ESPP) and
the 1994 Stock Plan, using Accounting Principles Board Opinion No. 25 (APB
25), "Accounting for Stock Issued to Employees," and related Interpretations.
Under APB 25, compensation cost for stock options is measured as the excess,
if any, of the quoted market price of our stock at the date of the grant over
the amount an employee must pay to acquire the stock.
1995 EMPLOYEE STOCK PURCHASE PLAN -- The ESPP provides employees the
opportunity to purchase shares of our stock at option prices as set forth in
the plan. We reserved 75,000 shares for distribution under the plan. The
ESPP terminates in ten years and will be carried out in phases, each
consisting of one year or a period of time approved by the board of
directors. Any employee completing two weeks of service prior to commencing
a phase of the plan may participate. Employees may elect to contribute from
$10 to 10% of monthly salary to the plan through payroll withholdings. The
following summarizes shares purchased and purchase prices for each phase
completed through 1997:
SHARES PURCHASE
PURCHASED PRICE
--------- --------
Phase:
Beginning April 1995, expiring April 1996 14,891 $8.67
Beginning April 1996, expiring April 1997 20,092 $7.65
The third one year phase began in April 1997 and expires in April 1998.
Our liability for employee contributions withheld at December 31, 1997 and 1996
for the purchase of shares in April 1998 and April 1997 under the ESPP were
approximately $202,000 and $154,000, respectively.
1994 STOCK PLAN -- The 1994 Stock Plan provides for awards of incentive and
non-qualified stock options. In January 1997 the shares reserved for
distribution under the plan were increased to 1,500,000. Option price,
option term, vesting provisions and other limits and restrictions are
determined at the time of grant by the board of directors or, if established,
by a separate committee. The exercise price for all options granted was the
market price of the common stock at the date of grant.
34
<PAGE>
Options granted, exercised, canceled and outstanding under the 1994 Stock Plan
are as follows:
<TABLE>
<CAPTION>
QUALIFIED NON-QUALIFIED
------------------------- -------------------------
WEIGHTED WEIGHTED
AVERAGE AVERAGE
OPTION EXERCISE OPTION EXERCISE
SHARES PRICE SHARES PRICE
-------- --------- ------- --------
<S> <C> <C> <C> <C>
Balance, January 1, 1995: 75,000 $2.67 3,750 $2.67
Granted 85,875 9.49 - -
Exercised (300) 8.67 - -
-------- --------- ------- --------
Balance, December 31, 1995: 160,575 8.06 3,750 2.67
Granted 60,000 21.13 - -
Exercised (2,400) 8.67 - -
Canceled (300) 8.67 - -
-------- --------- ------- --------
Balance, December 31, 1996 217,875 8.34 3,750 2.67
Granted 112,500 10.68 510,000 6.93
Exercised (150) 8.67 - -
Canceled (10,975) 18.10 - -
-------- --------- ------- --------
Balance, December 31, 1997 319,250 $10.21 513,750 $6.90
-------- --------- ------- --------
-------- --------- ------- --------
</TABLE>
Each of the qualified options expire ten years from the date of grant,
subject to continued employment with us. Each of the non-qualified options
expire ten years from the date of grant. Certain of the options are subject to
vesting provisions which restrict exercise of the option.
The following table summarizes the options outstanding and exercisable in 1997:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
----------------------------------------- -----------------------
WEIGHTED AVERAGE WEIGHTED
NUMBER -------------------------- NUMBER AVERAGE
OF CONTRACTUAL EXERCISE OF EXERCISE
EXERCISE PRICE RANGE OPTIONS LIFE PRICE OPTIONS PRICE
- -------------------- ------- ----------- -------- ------- --------
<S> <C> <C> <C> <C> <C>
Qualified options:
$ 2.67 - $ 9.00 161,500 7.3 years $5.84 77,100 $6.33
10.75 - 19.33 147,750 8.7 years 13.91 15,750 17.40
22.88 - 28.75 10,000 8.6 years 26.14 2,000 26.14
----------------- ------- ---------- ------- ------ -------
$ 2.67 - $ 28.75 319,250 8.0 years $10.21 94,850 $8.59
----------------- ------- ---------- ------- ------ -------
----------------- ------- ---------- ------- ------ -------
Non-qualified options:
$ 2.67 3,750 6.8 years $2.67 3,750 $2.67
$ 6.75 - 15.88 510,000 9.9 years 6.93 10,000 15.88
------------------ ------- ---------- ------- ------ -------
$ 2.67 - $ 15.88 513,750 9.9 years $6.90 13,750 $12.27
------------------ ------- ---------- ------- ------ -------
------------------ ------- ---------- ------- ------ -------
</TABLE>
NON-QUALIFIED COMMON STOCK OPTIONS -- Certain non-qualified options were
issued prior to the onset of the 1994 Stock Plan. These non-qualified
options are all exercisable. Non-qualified options granted, exercised and
outstanding are as follows:
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE
OPTION EXERCISE EXERCISE
SHARES PRICE PRICE
-------- -------------- ---------
<S> <C> <C> <C>
Balance, January 1, 1995 413,903 $ 0.53 - 2.00 $2.00
Exercised in 1995 (1,403) 0.53 0.53
-------- -------------- ---------
Balance, December 31, 1995 412,500 2.00 2.00
Exercised in 1996 (49,000) 2.00 2.00
-------- -------------- ---------
Balance, December 31, 1996 and 1997 363,500 $2.00 $2.00
-------- -------------- ---------
-------- -------------- ---------
</TABLE>
35
<PAGE>
The weighted average remaining contractual life for these outstanding
and exercisable options is 5.9 years. Each of the non-qualified options
expires ten years from the date of grant subject to early termination when
the optionee leaves our employment.
For the remaining outstanding non-qualified stock options, we are
permitted a tax deduction equal to the difference between the option exercise
price and the fair value on the option exercise date. Upon exercise, the
proceeds and the amount of the deduction are recorded to common stock. In
1996, we recorded a reduction in income taxes payable and increased common
stock by $510,000 to reflect exercises during the year. No exercises
occurred in 1997. Future exercises of these non-qualified options will
reduce future taxes payable based on the fair value of the options on the
date of exercise.
PRO FORMA INFORMATION -- Had we calculated compensation expense for our option
grants under the 1994 Stock Plan and stock purchases under the ESPP based on
the fair value method described in SFAS No. 123, "Accounting for Stock-Based
Compensation," our net income, basic net income per share and dilutive net
income per share would approximate the following pro forma amounts (in 000's,
except per share data):
<TABLE>
<CAPTION>
1997 1996 1995
-------- -------- -------
<S> <C> <C> <C>
Net income:
As reported $ 5,799 $ 8,982 $ 7,058
Pro forma $ 5,238 $ 8,788 $ 6,924
Basic net income per share:
As reported $ 0.49 $ 0.76 $ 0.67
Pro forma $ 0.44 $ 0.74 $ 0.65
Dilutive net income per share:
As reported $ 0.48 $ 0.74 $ 0.64
Pro forma $ 0.43 $ 0.72 $ 0.63
</TABLE>
The pro forma effect on net income for 1997, 1996 and 1995 is not
representative of the pro forma effect on net income in future years because
it does not include pro forma compensation expense related to pre-1995 option
grants.
The weighted average fair value of options granted under the ESPP and
1994 Stock Plan during 1997, 1996 and 1995 is estimated at $4.06, $12.36 and
$5.29, respectively, on the date of grant using the Black-Scholes
option-pricing model with the following assumptions: no dividend yield;
volatility of 76.1% in 1997 and 65.3% in 1996 and 1995; risk-free interest
rates ranging from 5.41% to 7.70%; and an expected life of 1 to 5 years.
EMPLOYEE CONTRACTS -- We entered into a three-year employment agreement with
our new President and Chief Executive Officer (CEO) beginning January 15,
1998. Under this agreement, he receives a base salary of $400,000, subject to
review annually for increase by our board of directors. In addition to base
salary, he is eligible for bonuses, reimbursements and fringe benefits
including a $1,000,000 term life insurance policy and an additional payment
sufficient to reimburse him for a long-term disability policy paying monthly
benefits of $5,000. We also provide this individual with health, dental,
life and disability insurance consistent with that provided other officers.
Under this agreement, we have agreed to indemnify him for his actions on
behalf of us. In the event of termination without cause or resignation for
good reason, we are obligated to continue to pay his then-current base salary
and bonuses for the remaining term of the agreement or twelve months,
whichever is shorter.
We entered into an Employment and Salary Continuation Agreement with our
former President and CEO beginning November 1993 and ending November 1998.
Under this agreement, he receives a base salary of $357,500, which is
increased each year by a cost of living adjustment or other amount as
determined by our board of directors. In addition to base salary, he is
eligible for bonuses, reimbursements and fringe benefits including the use of
and insurance for an automobile. We also provide him with health and dental
insurance. Under this agreement, we have agreed to indemnify him for his
actions on behalf of us. In the event of his disability, we are obligated to
continue to pay his then-current base salary and bonuses consistent with
other officers for the remaining term of the Agreement.
401(K) RETIREMENT PLAN -- We sponsor a defined contribution retirement plan
under Section 401(K) of the Internal Revenue Code for eligible employees.
Employees become eligible to participate in the 401(K) on the first day of
the calendar quarter after completing of 3 months service and attaining age
21. Our contributions to the plan are
36
<PAGE>
discretionary and are based on contributions made by employees to the plan.
Expense recognized under the plan for 1997, 1996 and 1995, was $94,000,
$52,000 and $35,000, respectively.
EMPLOYEE STOCK OWNERSHIP PLAN -- We maintain an Employee Stock Ownership Plan
(ESOP) for our qualified employees. Any employee who had attained age 21 and
was employed on May 1, 1993 became a participant in the ESOP on its effective
date, May 1, 1993. All other employees are eligible to participate in the
ESOP on the first day of the calendar quarter after completing 1,000 hours of
service during 12 consecutive months with us and attaining age 21. Our
contributions to the plan are discretionary. We may contribute cash or shares
of our common stock.
In March 1997, we contributed 13,205 shares to the plan for fiscal 1996 at
a fair value of $8.75 per share. In January 1996, we contributed 12,196
shares to the plan for fiscal 1995 at a fair value of $19.33 per share.
Compensation expense recognized under the plan for 1996 and 1995 was $116,000
and $236,000, respectively. No expense was recorded in 1997.
COMBINED RETIREMENT PLAN -- In January 1998, we combined our 401(K)
Retirement Plan and ESOP into a single retirement plan, the KSOP. The KSOP
retains the features of each separate plan except for eligibility and vesting
provisions. Under the plan, employees become eligible to participate in the
plan on the first day of the month after beginning employment.
OTHER EMPLOYEE BENEFIT PLANS -- We maintained bonus plans in 1997, 1996 and
1995 under which all employees, including officers, were eligible for a bonus
based on our operating results. These bonuses aggregated $643,000, $498,000,
and $350,000 in 1997, 1996 and 1995, respectively.
NOTE 9 -- SHAREHOLDERS' EQUITY
On April 25, 1996, our board of directors approved a 3-for-2 stock split in
the form of a 50 percent stock dividend to shareholders of record on the
close of business on May 6, 1996. The shares were distributed to
shareholders on May 17, 1996. Additionally, on February 2, 1995, we declared
a five-for-one stock split, effective as of that date. All share and per
share amounts have been adjusted to reflect the effect of the stock splits.
SHAREHOLDER RIGHTS PLAN -- In April 1997, we adopted a shareholder rights
plan and declared a dividend of one right for each outstanding share of
common stock to shareholders of record at the close of business on June 30,
1997. The rights become exercisable only after any person or group (the
"Acquiring Person") becomes the beneficial owner of 15% or more of the voting
power of our common stock. Certain shares held by our Chairman and his wife
are excluded from the computation for determining whether a person is an
Acquiring Person. Each right entitles its registered holder to purchase from
us one one-hundredth share of a new Series A Junior Participating Preferred
Stock, no par value, at a price of $85 per one one-hundredth share, subject
to adjustment. If any Acquiring Person acquires beneficial ownership of 15%
or more of our voting power, each right will entitle its holder (other than
such Acquiring Person) to purchase, at the then current purchase price of the
right, that number of shares of our common stock having a market value of two
times the purchase price of the right, subject to certain possible
adjustments. In addition, if we are acquired in a merger or other business
combination transaction, each right will entitle its holder to purchase, at
the then current purchase price of the right, that number of common shares of
the acquiring company having a market value of two times the purchase price
of the right. Following the acquisition of a beneficial ownership of 15% or
more of our outstanding common stock by any Acquiring Person and prior to an
acquisition by any Acquiring Person of 50% or more of our outstanding common
stock, our board of directors may exchange the outstanding rights (other than
rights owned by such Acquiring Person), in whole or in part, at an exchange
ratio of one share of common stock, or one one-hundredth share of Preferred
Stock (or equivalent securities) per right, subject to adjustment. We may
redeem the rights, in whole, at $.001 per right, at any time prior to an
acquisition by any Acquiring Person of 15% or more of our outstanding common
stock and prior to the expiration of the rights. The rights expire on
April 17, 2007, unless extended or earlier redeemed by us.
DIVIDEND RESTRICTIONS -- Dividends are paid as determined by our board of
directors. No dividends have ever been paid us.
Our ability to pay cash dividends to shareholders may depend upon the
amount of dividends received from our insurance subsidiary. ACIC's ability
to pay dividends is restricted by law or subject to approval of the insurance
regulatory authorities of Minnesota.
Under Minnesota insurance law regulating the payment of dividends by ACIC,
any such payments must be an amount deemed prudent by ACIC's board of
directors and, unless otherwise approved by the Commissioner of the
37
<PAGE>
Minnesota Department of Commerce (CMDC), must be paid solely from the
adjusted earned surplus of ACIC. Adjusted earned surplus means the earned
surplus as determined in accordance with statutory accounting practices
(unassigned funds), less 25% of the amount of such earned surplus which is
attributable to unrealized capital gains. Further, without approval of the
CMDC, ACIC may not pay a dividend in any calendar year which, when combined
with dividends paid in the preceding twelve months, exceeds the greater of (i)
10% of ACIC's statutory capital and surplus at the prior year end or (ii)
100% of ACIC's statutory net gain from operations (not including realized
capital gains) for the prior calendar year. For 1998, dividends in excess of
$4,537,000 would require prior consent of the CMDC.
STATUTORY SURPLUS AND STATUTORY NET INCOME - Our insurance subsidiary is
required to file financial statements with state regulatory agencies. The
accounting principles used to prepare the statutory financial statements
follow prescribed accounting practices which differ from GAAP. Statutory
policyholders' surplus in 1997 and 1996, and statutory net income for 1997,
1996 and 1995 are as follows (000's):
<TABLE>
<CAPTION>
STATUTORY STATUTORY
POLICYHOLDERS' NET
SURPLUS INCOME
-------------- ---------
<S> <C> <C>
December 31, 1997 $ 45,367 $ 5,871
December 31, 1996 39,543 6,658
December 31, 1995 4,551
</TABLE>
STOCK WARRANTS -- The Series 1991B notes payable, paid in full in December 1996,
included attached warrants to purchase our common stock at an exercise price of
$.53 per share. All remaining warrants were exercised in 1996.
NOTE 10 -- COMMITMENTS AND CONTINGENCIES
OPERATING LEASES - We conduct our operations in leased office facilities under
operating lease agreements. The agreements provide for monthly base lease
payments plus contingent rentals based on an allocable portion of certain
operating expenses incurred by the lessor.
Future minimum (base) rental payments required under the leases, as of
December 31, 1997, are as follows (000's):
1998 $ 1,454
1999 1,353
2000 717
2001 530
2002 249
--------
$ 4,303
--------
--------
Rent expense, including contingent rentals, was $1,776,000, $1,063,000 and
$803,000 for 1997, 1996 and 1995, respectively.
38
<PAGE>
NOTE 11 -- QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The following tables present unaudited quarterly results of operations for the
eight quarters ended December 31, 1997:
<TABLE>
<CAPTION>
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
-------- -------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C>
1997
Premiums in force $ 72,600 $ 72,700 $ 75,500 $ 78,400
-------- -------- -------- --------
-------- -------- -------- --------
Revenues:
Gross premiums earned $ 19,308 $ 19,814 $ 20,279 $ 21,984
Premiums ceded (105) (162) 144 (219)
-------- -------- -------- --------
Premiums earned 19,203 19,652 20,423 21,765
Investment income 1,567 1,610 1,906 2,137
-------- -------- -------- --------
Total revenues 20,770 21,262 22,329 23,902
Expenses:
Claim and claim settlement expenses 12,980 12,886 14,250 15,427
Policy acquisition costs 2,614 2,992 2,876 3,176
General and administrative expenses 2,848 2,872 2,329 3,567
-------- -------- -------- --------
Total expenses 18,442 18,750 19,455 22,170
-------- -------- -------- --------
Income from operations $ 2,328 $ 2,512 $ 2,874 $ 1,732
-------- -------- -------- --------
-------- -------- -------- --------
Net income $ 1,340 $ 1,466 $ 1,705 $ 1,288
-------- -------- -------- --------
-------- -------- -------- --------
Basic income per share $ 0.11 $ 0.12 $ 0.14 $ 0.11
-------- -------- -------- --------
-------- -------- -------- --------
Diluted income per share $ 0.11 $ 0.12 $ 0.14 $ 0.11
-------- -------- -------- --------
-------- -------- -------- --------
1996
Premiums in force $ 56,100 $ 62,200 $ 66,500 $ 69,500
-------- -------- -------- --------
-------- -------- -------- --------
Revenues:
Gross premiums earned $ 14,040 $ 15,242 $ 17,161 $ 17,312
Premiums ceded (276) 102 (247) (276)
-------- -------- -------- --------
Premiums earned 13,764 15,344 16,914 17,036
Investment income 1,288 1,378 1,465 1,536
-------- -------- -------- --------
Total revenues 15,052 16,722 18,379 18,572
Expenses:
Claim and claim settlement expenses 7,858 8,503 10,025 12,694
Policy acquisition costs 1,420 1,877 2,132 898
General and administrative expenses 1,844 2,108 1,815 2,743
-------- -------- -------- --------
Total expenses 11,122 12,488 13,972 16,335
-------- -------- -------- --------
Income from operations $ 3,930 $ 4,234 $ 4,407 $ 2,237
-------- -------- -------- --------
-------- -------- -------- --------
Net income $ 2,283 $ 2,481 $ 2,582 $ 1,636
-------- -------- -------- --------
-------- -------- -------- --------
Basic income per share $ 0.19 $ 0.21 $ 0.22 $ 0.14
-------- -------- -------- --------
Diluted income per share $ 0.19 $ 0.20 $ 0.21 $ 0.13
-------- -------- -------- --------
-------- -------- -------- --------
</TABLE>
Our premiums in force have increased in each of the last eight quarters.
Quarterly revenues are affected by (i) premiums in force at the beginning of
the quarter, (ii) new policies written in the quarter, (iii) final audit
premiums recognized during the quarter, and (iv) our policy renewal rate in
the quarter. Historically, a majority of new policies written and policy
renewals have occurred in the first, second and fourth quarters. In
addition, our quarterly results for 1997 and 1996 were affected favorably by
adjustments to the liability for unpaid claim and claim settlement expenses
and ceding commissions relating to those years and prior years as follows
(000's):
39
<PAGE>
<TABLE>
<CAPTION>
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
------- ------- -------- -------
<S> <C> <C> <C> <C>
1997
Claim and claim settlement expenses, net $ 675 $ 850 $ 850 $ 710
Policy acquisition costs - - - (1)
------- ------- -------- -------
Quarterly effect on income from operations $ 675 $ 850 $ 850 $ 709
------- ------- -------- -------
------- ------- -------- -------
1996
Claim and claim settlement expenses, net $ 425 $ 650 $ 608 $ 6,392
Policy acquisition costs 225 50 142 1,454
------- ------- -------- -------
Quarterly effect on income from operations $ 650 $ 700 $ 750 $ 7,846
------- ------- -------- -------
------- ------- -------- -------
</TABLE>
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information with respect to Directors is contained in the Section entitled
"Election of Directors" in the Company's 1998 Proxy Statement and is
incorporated herein by reference.
Information with respect to Executive Officers of the Company is included in
PART I of this Report on Form 10-K.
ITEM 11. EXECUTIVE COMPENSATION
Information required under this item is contained in the Section entitled
"Executive Compensation and Other Information" in the Company's 1998 Proxy
Statement and is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information required under this item is contained in the Section entitled
"Security Ownership of Principal Shareholders and Management" in the Company's
1998 Proxy Statement and is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information required under this item is contained in the Section entitled
"Certain Transactions" in the Company's 1998 Proxy Statement and is
incorporated herein by reference.
40
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) DOCUMENTS FILED AS PART OF THIS REPORT
(1) FINANCIAL STATEMENTS. The following consolidated financial
statements of the Company are set forth on pages 22 through 40 of
Part II, Item 8 of this Report.
Independent Auditors' Report
Consolidated Balance Sheets - December 31, 1997 and 1996
Consolidated Statements of Income - Years Ended December 31, 1997,
1996 and 1995
Consolidated Statements of Shareholders' Equity - Years Ended
December 31, 1997, 1996 and 1995
Consolidated Statements of Cash Flows - Years Ended December 31,
1997, 1996 and 1995
Notes to Consolidated Financial Statements - Years Ended December 31,
1997, 1996 and 1995
(2) FINANCIAL STATEMENT SCHEDULES FOR THE THREE YEARS ENDED
DECEMBER 31, 1997
Page
----
Independent Auditors' Report on Schedules for the Years Ended
December 31, 1997, 1996 and 1995. . . . . . . . . . . . . . . . S-1
Schedule I - Summary of Investments . . . . . . . . . . . . . . . S-2
Schedule II - Condensed Financial Information (Parent Company). . S-3
Schedule IV - Reinsurance . . . . . . . . . . . . . . . . . . . . S-7
Schedule V - Valuation and Qualifying Accounts. . . . . . . . . . S-8
Schedule VI - Supplemental Information Concerning Insurance
Operations. . . . . . . . . . . . . . . . . . . . . . . . . . . S-9
All other schedules are omitted because they are not applicable or the
required information is presented in the Financial Statements or the notes
thereto.
(b) REPORTS ON FORM 8-K
None.
(c) LISTING OF EXHIBITS (*indicates compensatory plan)
3.1 Amended Articles of Incorporation (1)
3.2 Amended Bylaws (1)
4.1 Indenture dated December 1, 1993 between RTW, Inc. and First Trust
National Association, Trustee (2)
4.2 Registration Rights Agreement (2)
10.1* Employment and Salary Continuation Agreement between RTW and David C.
Prosser (2)
10.2* Employment Agreement Letter dated November 24, 1997 between RTW and
Carl B. Lehmann
10.3* Employment Contract between RTW and J. Alexander Fjelstad, III (2)
10.4* Stock Option Agreement between RTW and J. Alexander Fjelstad, III (2)
10.5* Non-Qualified Stock Option Agreement dated November 24, 1997 between
RTW and Carl B. Lehmann
10.6* Letter Agreement dated January 15, 1998 Amending the Non-Qualified
Stock Option Agreement between RTW and Carl B. Lehmann
10.7* Incentive Stock Option Agreement dated January 15, 1998 between RTW
and Carl B. Lehmann
10.8* RTW, Inc. Employee Stock Ownership Plan (2)
10.9* Amended RTW, Inc. 1994 Stock Plan (1)
10.10* RTW, Inc. 1995 Employee Stock Purchase Plan (3)
10.11 Contract between RTW and ACIC dated January 1, 1992 (2)
10.12 Service Agreement between RTW and ACIC dated February 1, 1992 (2)
10.13* Description of the 1998 Gain Sharing Program
10.14* 401(k) Plan Adoption Agreement (1)
11 Statement re Computation of Income Per Share
41
<PAGE>
21 Subsidiaries of the Registrant:
The Company has one wholly-owned subsidiary, American Compensation
Insurance Company, a Minnesota corporation.
23 Consent of Deloitte & Touche LLP
24 Power of Attorney, included in Signature page
27.1 Financial Data Schedule - Year ended December 31, 1997
27.2 Restated Financial Data Schedules - Quarters ended March 31, 1997
June 30, 1997 and September 30, 1997
27.3 Restated Financial Data Schedules - Quarters ended March 31, 1996,
June 30, 1996 and September 30, 1996 and Year ended December 31, 1996
27.4 Restated Financial Data Schedule - Year ended December 31, 1995
- --------------
(1) Incorporated by reference to the Company's Registration Statement on Form
S-1 (Reg. No. 33-89164).
(2) Incorporated by reference to the Company's Registration Statement on Form
SB-2 (Reg. No. 33-2002C).
(3) Incorporated by reference to the Company's Registration Statement on Form
S-8 (Reg. No. 33-91372).
(4) Incorporated by reference to the Company's 1995 Report on Form 10-K.
(5) Incorporated by reference to the Company's 1996 Report on Form 10-K.
42
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 15(d) or 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.
RTW, INC.
Date: March 20, 1998 By /s/ Carl B. Lehmann
--------------------------------------------
Carl B. Lehmann
President, Chief Executive Officer and Director
(Principal Executive Officer)
SIGNATURES AND POWER OF ATTORNEY
Pursuant to the requirements of the Securities Exchange Act of 1934,
this Report has been signed by the following persons on behalf of the
Registrant, in the capacities, and on the dates, indicated. Each person
whose signature appears below constitutes and appoints Carl B. Lehmann and
Alfred L. LaTendresse as his true and lawful attorney-in-fact and agents,
each acting alone, with full power of substitutions and resubstitution, for
him and in his name, place, and stead, in any and all capacities, to sign any
or all amendments to this Annual Report on Form 10-K and to file the same,
with the exhibits thereto, and other documents in connection therewith, with
the Securities and Exchange Commission.
Date Signature and Title
---- -------------------
March 20, 1998 By /s/ Carl B. Lehmann
--------------------------------------------
Carl B. Lehmann
President, Chief Executive Officer and Director
(Principal Executive Officer)
March 20, 1998 By /s/ Alfred L. LaTendresse
--------------------------------------------
Alfred L. LaTendresse
Secretary, Treasurer and Chief FinancialOfficer
(Principal Financial and Accounting Officer)
March 20, 1998 By /s/ David C. Prosser
--------------------------------------------
David C. Prosser
Chairman of the Board
March 20, 1998 By /s/ J. Alexander Fjelstad, III
--------------------------------------------
J. Alexander Fjelstad, III
Director
March 20, 1998 By /s/ William Cooper
--------------------------------------------
William Cooper
Director
March 20, 1998 By /s/ Mark E. Hegman
--------------------------------------------
Mark E. Hegman
Director
March 20, 1998 By /s/ Steven M. Rothschild
--------------------------------------------
Steven M. Rothschild
Director
43
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Shareholders
RTW, Inc.
Minneapolis, Minnesota
We have audited the consolidated financial statements of RTW, Inc. and
subsidiary (the Company) as of December 31, 1997 and 1996 and for each of the
three years in the period ended December 31, 1997 and have issued our report
thereon dated January 23, 1998. Our audits also included the consolidated
financial statement schedules listed in Item 14(a)(2) of this Report on Form
10-K. These consolidated financial statement schedules are the responsibility
of the Company's management. Our responsibility is to express an opinion
based on our audits. In our opinion, such consolidated financial statement
schedules, when considered in relation to the basic consolidated financial
statements taken as a whole, present fairly in all material respects the
information set forth therein.
/s/ DELOITTE & TOUCHE LLP
Minneapolis, Minnesota
January 23, 1998
S-1
<PAGE>
SCHEDULE I
RTW, INC.
SUMMARY OF INVESTMENTS
DECEMBER 31, 1997
(IN THOUSANDS)
<TABLE>
<CAPTION>
AMOUNT AT
WHICH SHOWN
AMORTIZED FAIR IN THE BALANCE
TYPE OF INVESTMENT COST VALUE SHEET
- ---------------------------------------- --------- -------- ------------
<S> <C> <C> <C>
FIXED MATURITIES:
Available-for-sale:
United States government, government
agencies and authorities $ 66,916 $ 68,243 $ 68,243
Corporate securities 22,582 22,509 22,509
Asset-backed securities 6,997 7,041 7,041
Mortgage-backed securities 14,385 14,501 14,501
--------- --------- ---------
Total Investments $ 110,880 $ 112,294 $ 112,294
--------- --------- ---------
--------- --------- ---------
</TABLE>
S-2
<PAGE>
SCHEDULE II
RTW, INC.
CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT
BALANCE SHEETS
DECEMBER 31, 1997 AND 1996
(IN THOUSANDS)
<TABLE>
<CAPTION>
1997 1996
-------- --------
ASSETS
<S> <C> <C>
Cash and cash equivalents 936 6,888
Furniture and equipment, net 4,927 3,423
Investment in and advances to subsidiary 57,783 48,391
Income tax receivable 720 99
Other assets 520 515
-------- --------
$ 64,886 $ 59,316
-------- --------
-------- --------
</TABLE>
LIABILITIES AND SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
<S> <C> <C>
Accrued expenses and other liabilities $ 1,342 $ 1,085
Deferred income taxes 312 181
Notes payable 4,875 6,739
-------- --------
Total liabilities 6,529 8,005
Shareholders' equity 58,357 51,311
-------- --------
$ 64,886 $ 59,316
-------- --------
-------- --------
</TABLE>
See notes to condensed financial statements.
S-3
<PAGE>
RTW, INC.
CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT
STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(IN THOUSANDS)
<TABLE>
<CAPTION>
1997 1996 1995
-------- -------- --------
<S> <C> <C> <C>
Revenues:
Intercompany fee income $ 22,364 $ 17,699 $ 13,087
Investment income 249 408 366
-------- -------- --------
Total revenues 22,613 18,107 13,453
Expenses:
General and administrative expenses 23,097 15,555 10,731
-------- -------- --------
Income (loss) from operations (484) 2,552 2,722
Interest expense 777 1,086 1,285
-------- -------- --------
Income (loss) before income taxes and equity in
undistributed net income of subsidiary (1,261) 1,466 1,437
Provision for income taxes (429) 614 605
-------- -------- --------
Income (loss) before equity in undistributed net
income of subsidiary (832) 852 832
Equity in undistributed net income of subsidiary 6,631 8,130 6,226
-------- -------- --------
Net income $ 5,799 $ 8,982 $ 7,058
-------- -------- --------
-------- -------- --------
</TABLE>
See notes to condensed financial statements.
S-4
<PAGE>
RTW, INC.
CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT
STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(IN THOUSANDS)
<TABLE>
<CAPTION>
1997 1996 1995
-------- -------- --------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Reconciliation of net income to net cash provided
by operating activities:
Net income $ 5,799 $ 8,982 $ 7,058
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization 1,079 793 618
Equity in net income from subsidiary (6,631) (8,130) (6,226)
Deferred income taxes 131 122 32
Changes in assets and liabilities:
Accrued expenses and other liabilities 257 263 230
Other, net 351 345 (12)
-------- -------- --------
Net cash provided by operating activities 986 2,375 1,700
CASH FLOWS FROM INVESTING ACTIVITIES:
Investment in and advances to subsidiary (2,761) (988) (17,800)
Purchases of furniture and equipment (2,447) (2,047) (1,265)
-------- -------- --------
Net cash used in investing activities (5,208) (3,035) (19,065)
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments on notes payable (2,000) (2,362) (1,362)
Proceeds from initial public offering - - 29,900
Equity financing costs - - (2,861)
Stock options and warrants exercised 1 130 48
Issuance of common stock to ESOP 115 236 -
Issuance of common stock under ESPP 154 129 -
Retirement of common stock - (1) (2)
-------- -------- --------
Net cash provided by (used in) financing activities (1,730) (1,868) 25,723
-------- -------- --------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (5,952) (2,528) 8,358
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 6,888 9,416 1,058
-------- -------- --------
CASH AND CASH EQUIVALENTS AT END OF YEAR $ 936 $ 6,888 $ 9,416
-------- -------- --------
-------- -------- --------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the year for:
Interest $ 664 $ 898 $ 1,042
-------- -------- --------
-------- -------- --------
Income taxes $ 61 $ 45 $ 127
-------- -------- --------
-------- -------- --------
</TABLE>
See notes to condensed financial statements.
S-5
<PAGE>
SHEDULE II
RTW, INC.
CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT
NOTES TO CONDENSED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
NOTE 1 - ACCOUNTING POLICIES
The accompanying condensed financial information should be read in
conjunction with the consolidated financial statements and notes included in
the RTW, Inc. 1997 Annual Report.
NOTE 2 - RELATED PARTY TRANSACTIONS
RTW provides American Compensation Insurance Company ("ACIC") with management
services, including preparing and submitting filings, maintaining books and
records, collecting premiums, administering and adjudicating claims, and
performing other administrative services. RTW receives 10% of ACIC's gross
premiums earned each month for these services, which amounted to $8,057,000,
$6,327,000 and $4,724,000 for the years ended December 31, 1997, 1996 and
1995, respectively. In addition, RTW receives 15% of ACIC's gross premiums
earned for claims administration during the year in which the premiums are
earned and a total of 4% of gross premiums earned in subsequent years which
amounted to $14,307,000, $11,372,000 and $8,363,000 for the years ended
December 31, 1997, 1996 and 1995, respectively.
RTW files a consolidated federal tax return with ACIC. Taxes are allocated
between the companies based on a tax allocation agreement under which
allocation is made primarily on a separate return basis for taxes incurred
with current credit for any net operating losses or other items utilized in
the consolidated tax return. This allocation is settled annually after
completing and filing the federal tax return.
Amounts due (to) from ACIC related to the above transactions are included in
the balance sheet account caption "Investment in and advances to subsidiary"
and totaled approximately $6,208,000 and $2,558,000 at December 31, 1997 and
1996, respectively.
S-6
<PAGE>
SCHEDULE IV
RTW, INC.
REINSURANCE
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(IN THOUSANDS)
<TABLE>
<CAPTION>
PREMIUMS EARNED
-------------------------------------------------------- PERCENTAGE
CEDED TO ASSUMED OF AMOUNT
OTHER FROM OTHER ASSUMED
DESCRIPTION DIRECT COMPANIES COMPANIES NET TO NET
- ----------------------------------- -------- --------- ---------- --------- ----------
<S> <C> <C> <C> <C>
1997
PREMIUMS - Workers' Compensation $ 81,385 $ 342 $ - $ 81,043 0.00%
1996
PREMIUMS - Workers' Compensation $ 63,755 $ 697 $ - $ 63,058 0.00%
1995
PREMIUMS - Workers' Compensation $ 47,507 $ 2,099 $ - $ 45,408 0.00%
</TABLE>
S-7
<PAGE>
SCHEDULE V
RTW, INC.
VALUATION AND QUALIFYING ACCOUNTS
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(IN THOUSANDS)
<TABLE>
<CAPTION>
ADDITIONS
--------------------------
BALANCE AT CHARGED TO CHARGED TO BALANCE AT
BEGINNING COSTS AND OTHER END
DESCRIPTION OF PERIOD EXPENSES ACCOUNTS WRITE-OFFS OF PERIOD
- -------------------------------------- ------------- ------------ ------------ ------------- ------------
<S> <C> <C> <C> <C> <C>
1997
Allowance for Doubtful Accounts $ 105 $ 250 $ - $ 173 $ 182
1996
Allowance for Doubtful Accounts $ 73 $ 128 $ - $ 96 $ 105
1995
Allowance for Doubtful Accounts $ - $ 120 $ - $ 47 $ 73
</TABLE>
S-8
<PAGE>
SCHEDULE VI
RTW, INC.
SUPPLEMENTAL INFORMATION CONCERNING INSURANCE OPERATIONS
(IN THOUSANDS)
<TABLE>
<CAPTION>
(COLUMN C) CLAIM AND CLAIM
RESERVES FOR SETTLEMENT EXPENSES
DEFERRED UNPAID CLAIM DISCOUNT, INCURRED RELATED TO:
POLICY AND CLAIM IF ANY, ----------------------
ACQUISITION SETTLEMENT DEDUCTED IN UNEARNED EARNED INVESTMENT CURRENT PRIOR
YEAR COSTS EXPENSES COLUMN C PREMIUMS PREMIUMS INCOME YEAR YEARS
- ----- ------------- ------------ ------------- ----------- ---------- ---------- --------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
1997 $ 1,559 $ 61,069 - $ 13,580 $ 81,043 $ 6,971 $ 58,675 $(3,085)
1996 $ 1,624 $ 49,256 - $ 13,308 $ 63,058 $ 5,259 $ 47,155 $(8,075)
1995 $ 858 $ 37,138 - $ 9,606 $ 45,408 $ 3,659 $ 29,536 $(1,474)
<CAPTION>
AMORTIZATION
OF DEFERRED PAID CLAIM
POLICY AND CLAIM
ACQUISITION SETTLEMENT PREMIUMS
YEAR COSTS EXPENSES WRITTEN
- ----- ------------- ------------ -------------
<S> <C> <C> <C>
1997 $ 11,658 $ 42,968 $ 81,315
1996 $ 6,327 $ 24,833 $ 66,760
1995 $ 2,689 $ 13,499 $ 47,971
</TABLE>
S-9
<PAGE>
[LETTERHEAD]
November 24, 1997
Mr. Carl B. Lehmann
2626 Hillsden Drive
Salt Lake City, UT 84117
Dear Mr. Lehmann:
We write to set forth our agreement with respect to your employment as the
President and Chief Executive Officer of RTW, Inc. (the "Company"),
commencing January 15, 1998 (the "Employment Date"). Upon execution of this
letter by the parties hereto, this letter shall be effective and shall bind
the Company from and after the date hereof, but shall be operative only upon
your actual commencement of employment with the Company. Prior to the date
your employment commences under this letter, you agree to provide consulting
services to the Company in accordance with the terms set forth on the
consulting agreement attached hereto as Exhibit 1 (the "Consulting
Agreement").
1. EMPLOYMENT. The Company hereby agrees to employ you, and you agree to
be employed by the Company, during the term stated in Section 6, and on the
terms and conditions hereinafter set forth. You will serve as the President
and Chief Executive Officer of the Company and its insurance subsidiary,
American Compensation Insurance Company, and, in addition, at no additional
compensation, be elected as a member of the Board of Directors, and in such
other directorships, Board committee memberships and offices of the Company
and its subsidiaries to which you may from time to time be elected or
appointed by the Chairman of the Board. You agree to serve the Company
faithfully and, to the best of your ability, to promote the Company's
interest, and to devote your full working time, energy and skill to the
Company's business. You may attend to personal business and investments,
engage in charitable activities and community affairs, and serve on a
reasonable number of corporate, educational and civic boards, including
Westminister College, so long as those activities do not interfere with your
duties under this Agreement and provided that service on any corporate boards
shall be subject to prior approval by the Board of Directors.
You will assume all of the duties and responsibilities as President and
Chief Executive Officer immediately upon the Employment Date. You will have
such authority, powers, functions, duties, and responsibilities as are
normally accorded chief executive officers. You will discharge your duties
at all times in accordance with any and all policies established by the Board
of Directors and will report to, and be subject to the direction of, the
Board of Directors. You will assume all the duties and responsibilities as a
director effective upon your election to the Board of Directors.
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Mr. Carl B. Lehmann
November 24, 1997
Page 2
2. BASE SALARY.
As partial compensation for all of your services (including services as
director, Board committee member or officer of the Company and its
subsidiaries) during your term of employment hereunder, you will receive a
base salary at the rate of Four Hundred Thousand Dollars ($400,000) per
annum, payable in semi-monthly installments, which base salary will be
prorated for any partial years. Such base salary shall be reviewed annually
for increase at the discretion of the Board.
3. BONUS; STOCK OPTIONS.
(a) As additional compensation for your services, you shall be eligible
to earn bonus compensation for each fiscal year of the Company commencing
with the fiscal year ending December 31, 1998 during your term of employment
hereunder, based on a "target bonus" of $400,000 per annum and otherwise in
accordance with the criteria considered in an incentive compensation plan to
be mutually agreed to in advance of each such fiscal year by you and the
Company's Board of Directors.
(b) Pursuant to the Consulting Agreement, you received ten-year,
non-qualified stock options to purchase 500,000 shares of the Company's
Common Stock (the "NQSOs"). After your Employment Date but prior to February
1, 1998, you may request that the Company grant to you up to the maximum
number of incentive stock options ("ISO's") that may be issued to you (to
become exercisable during the period beginning on the Employment Date and
ending on the day after the third anniversary of your initial election to the
Board) under the Company's Amended 1994 Stock Plan and applicable law,
provided that a like number of NQSO's shall be surrendered by you for
cancellation. Such ISOs shall be exercisable at the same times and during
the same periods as the NQSOs and otherwise shall have substantially
identical provisions to the NQSOs, except to the extent contrary to
applicable law.
(c) You shall be eligible to receive additional stock options annually,
at the discretion of the Board.
(d) The Company will maintain in effect, throughout the periods that
the stock options described in this Section 3 remain exercisable, a
registration statement on Form S-8 or other appropriate form, registering
the shares of its Common Stock issuable pursuant to such options under the
Securities Act of 1933, as amended. If requested by you, the Company shall
prepare, file and maintain in effect any resale prospectuses under such
registration statement as may be required to permit you to resell your option
shares without restriction.
4. FRINGE BENEFITS.
(a) You will be eligible to participate in any and all Company
sponsored insurance (including medical, dental, life and disability
insurance), retirement, and other fringe benefit programs that it
maintains for its executive officers, subject to and on a basis
consistent with the terms of each such plan or program. A summary
of the benefits
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Mr. Carl B. Lehmann
November 24, 1997
Page 3
currently in effect is set forth on the attached Exhibit 2. In
addition, the Company will, at the Company's expense, (i) provide
you with an additional $1,000,000 of term life insurance and (ii)
pay you an amount sufficient to enable you to maintain an
additional "own occupation" long-term disability policy (with a
three month waiting period) paying monthly benefits of $5,000. The
Company shall also maintain in effect directors and officers
liability insurance coverage during the term of this Agreement with
limits of $5,000,000, unless the cost thereof is uneconomic as
determined by the Board of Directors.
(b) You will be entitled to six weeks of paid vacation annually.
(c) The Company will provide for your relocation to
Minneapolis-St. Paul in accordance with the terms of the relocation
plan described on the attached Exhibit 3.
(d) The Company will pay you an additional amount required to pay
any income and payroll taxes payable by you, at the maximum
marginal rate, on the amounts paid by the Company pursuant to
clause (ii) of Section 4(a) and under Section 4(c) and on any
amounts paid pursuant to this Section 4(d).
5. EXPENSES. During the term of your employment, the Company will
reimburse you for your reasonable travel and other expenses incident to your
rendering of services in conformity with its regular policies regarding
reimbursement of expenses as in effect from time to time. Payments to you
under this paragraph will be made upon presentation of expense vouchers in
such detail as the Company may from time to time reasonably require.
6. TERM AND TERMINATION.
(a) TERM. The term of this Agreement will begin on January 15, 1998
and will continue for a period of three (3) years thereafter,
unless and until terminated in accordance with the terms of this
Agreement (the "Original Term"). Upon the expiration of the
Original Term of this Agreement, and on each successive anniversary
thereafter, the term of your employment under this Agreement will
be automatically extended for one (1) additional year, unless at
least 90 days prior to any such anniversary, either you or the
Company delivers to the other written notice of the notifying
party's desire not to extend the term of your employment. Notice by
the Company of its desire not to extend the term of your employment
as provided in this Section shall constitute termination without
Cause and entitle you to the benefits of Section 7(b) below.
(b) TERMINATION. This Agreement and your employment may be
terminated:
(i) By your resignation upon 30 days prior written notice to
the Company;
(ii) By you for Good Reason (as defined in this Agreement) upon
30 days prior written notice to the Company, provided that, with
respect to Good Reason
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Mr. Carl B. Lehmann
November 24, 1997
Page 4
as defined in subsection (d)(iii)(E) of this Section, such
notice may not be given earlier than 90 days after a Change in
Control as defined in the NQSOs;
(iii) By the Company for Cause (as defined in this Agreement)
immediately upon written notice to you.
(iv) By the Company for any reason and at any time upon 30 days
prior written notice to you.
(v) By the Company at any time in the event of your Disability
(as defined in this Agreement.)
In the event of your termination of employment for any of the
foregoing reasons, you shall immediately resign as a director of the
Company and any of its subsidiaries.
(c) DEATH. This Agreement will automatically terminate upon your death.
(d) DEFINITIONS. For purposes of this Agreement, the following terms will
have the meanings set forth below:
(i) DISABILITY. "Disability" means that you are deemed to be
disabled under the terms of the Company's long term disability
plan and have satisfied the qualifying period for entitlement to
benefits under such plan (3 months of disability provided you do
not return to work for 15 consecutive days).
(ii) CAUSE. "Cause" means that you have (A) committed an act
of dishonesty or fraud or involving a breach of trust; (B)
committed any act or omission by you that is a substantial
cause for a regulatory body with jurisdiction over the Company
or any of its affiliates to request or recommend your
suspension or removal or to take punitive action against you,
the Company, or any of its affiliates; (C) failed to follow
any reasonable and material policy of the Company or
reasonable and material instructions of the Company's Board of
Directors; (D) been indicted for or convicted of any felony;
(E) engaged in any gross misconduct or gross negligence in the
performance of your duties; or (F) have otherwise materially
breached this Agreement; provided, however, that in the case
of conduct described in clauses (C), (E), and (F), the Company
must give you written notice of that failure or breach and you
will have 30 days to correct the same. You will be entitled
to a hearing before the Board of Directors of the Company
before any termination for Cause described in clauses (A),
(C), (E) and (F) becomes effective.
(iii) GOOD REASON. "Good Reason" means the Company, without
your express written consent, (A) materially reduces your
principal duties, responsibilities, or authority as President
and Chief Executive Officer, including by requiring you to
report to any person or body other than the Board of Directors
of the
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Mr. Carl B. Lehmann
November 24, 1997
Page 5
Company; (B) reduces your annual base compensation as
described in Section 2 (including any increases given under
Section 2(b)) or your target bonus as described in Section 3,
or reduces the benefits provided you under any fringe benefit
plan; provided, however, that the Company alter, amend or
terminate any benefit plan not expressly provided for under
Sections 2 and 3 so long as any such change applies to
executive officers generally; (C) relocates the Company's
corporate headquarters or your principal place of work to a
state other than Minnesota; (D) materially breaches this
Agreement or (E) undergoes a Change in Control, as such term
is defined in the NQSOs. The occurrence of an event described
in this subparagraph (d)(iii) will not constitute Good Reason
unless, within 60 days thereof (90 days in the case of a
Change in Control), you give the Company written notice
stating that an event of Good Reason has occurred and
describing that event, and the Company does not correct the
same if the same is correctable within 30 days.
7. CONSEQUENCES OF TERMINATION.
(a) TERMINATION FOR CAUSE; RESIGNATION WITHOUT GOOD REASON. If
your employment is terminated by the Company for Cause or by you
without Good Reason, then you will be paid your base salary to the
date of termination and the unpaid portion of any bonus or
incentive amount earned by you for the fiscal year ending prior to
the termination of your employment which you are entitled to
receive under the terms of the annual incentive plan. You will not
be entitled to receive any base salary or fringe benefits for any
period after the date of termination, except for the right to
receive benefits which have become vested under any benefit plan or
to which you are entitled as a matter of law.
(b) TERMINATION WITHOUT CAUSE; RESIGNATION FOR GOOD REASON. If
the Company terminates your employment without Cause or does not
extend the term of your employment, or if you resign your
employment for Good Reason, then:
(i) For the remainder of the term of this Agreement or a
period of 12 months after the effective date of the termination
of your employment whichever is greater;
(A) The Company will continue to pay your then current
base salary in accordance with the Company's normal
payroll practice; and
(B) All stock options issued to you by the Company described
in your Consulting Agreement in consideration for your
employment hereunder or pursuant to Section 3(b) above
shall immediately become exercisable in full; and
(C) The Company will pay the unpaid portion of any bonus or
incentive
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Mr. Carl B. Lehmann
November 24, 1997
Page 6
amount earned by you for the fiscal year ending prior to
the termination of your employment which you are entitled
to receive under the terms of the applicable incentive
plan; and
(D) You will be entitled to continued participation in the
health care coverage, and life insurance benefit plans of
the Company, as in effect on the date of your
termination. The Company will continue to pay its share
of the health care and life insurance premiums for this
coverage, and you shall pay your share of the cost
associated with that coverage as if you were still
actively employed by the Company. In addition, the
Company shall pay you the amount described in Section
4(a)(ii) and 4(d) to enable you to maintain the long term
disability policy described therein. If you cannot be
covered under any of the Company's group plans or
policies, the Company will reimburse you for your full
cost of obtaining comparable alternative or individual
coverage elsewhere, less any contribution that you would
have been required to make under the Company's group
plans or policies, together with the amount contemplated
by Section 4(d) with respect to any such payment. If,
during the aforesaid 12-month period, you are employed by
a third party and become eligible for any health care
coverage provided by that third party, the Company will
not, thereafter, be obligated to provide you with the
insurance benefits described in this clause (D). This
12-month coverage shall run concurrently with COBRA and
thereafter you shall be responsible for the full cost of
any such coverage for which you may be entitled by law.
(ii) The Company will pay a reasonable amount for
out-placement and job search services for you by a nationally
recognized out-placement firm selected by you and reasonably
acceptable to the Company.
(c) TERMINATION IN THE EVENT OF DEATH OR DISABILITY. If your
employment terminates due to your death or if the Company
terminates your employment due to a Disability, then
(i) The Company will continue to pay your base salary to your
estate or to you for the remainder of the month in which your
death occurs or in which your employment is terminated due to
Disability, together with the unpaid portion of any bonus or
incentive amount earned by you for the fiscal year ending
prior to the termination of your employment which you are
entitled to receive under the terms of the applicable
incentive plan; and in the event of termination due to
Disability, you will continue to receive, during that month,
all of the fringe benefits then being paid or provided to you;
and
(ii) You will be entitled to receive all Disability and other
benefits, such as
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Mr. Carl B. Lehmann
November 24, 1997
Page 7
continued health coverage or life insurance proceeds, provided
in accordance with the terms and condition of the health care
coverage, life insurance, disability, or other employee
benefit plans of the Company and applicable law; and
(iii) All stock options issued to you by the Company described in
your Consulting Agreement or pursuant to Section 3(b) above shall
immediately become exercisable in full.
(d) The benefits provided you under this Section 7 are in lieu of any
benefits that would otherwise be provided to you under any severance
pay or other policies of the Company.
(e) In connection with your voluntary termination of this Agreement
(including for Good Reason other than by
reason of a material breach of this
Agreement by the Company), you agree to
cooperate with the Company in recruiting
and orienting your successor as chief
executive officer. You recognize and
agree that the foregoing obligation may
require a portion of your time and effort
following termination of your employment,
and you agree to devote such time and
effort as is reasonably requested by the
Company to carry out the foregoing
obligations, provided that no such
obligations shall extend beyond 180 days
after the effective date of termination.
8. EFFECT OF TERMINATION ON STOCK OPTIONS.
(a) In the event of (i) the termination of your employment by the Company
for Cause, or (ii) your termination of your employment prior to the end
of the Original Term other than for Good Reason and other than reason of
death of Disability, the stock options granted to you under Section 3,
to the extent unexercised, shall immediately terminate and be without
further force or effect.
(b) In the event of your violation in any material respect of your
obligations under Section 10 following termination of your employment
and during such period as such provisions remain in effect:
(i) The stock options granted to you under Section 3, to the
extent unexercised, shall immediately terminate and be without
further force or effect.
(ii) The Company shall have the right to repurchase for cash any
shares of
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Mr. Carl B. Lehmann
November 24, 1997
Page 8
Company's stock acquired by you as a result of the exercise of
any portion or all of the options and held by either you or by
any member of your family or by any trust or other entity in
which you or any member of your family has a beneficial
interest. The Company shall give you written notice of the
exercise of its right to repurchase and shall close on the
repurchase no later than six months after the date of notice.
The purchase price for the shares shall be the option exercise
price or the closing bid price for shares of the Company's
common stock on the date of notice, whichever is lower.
(iii) If you sell or have sold any shares acquired by you as a
result of the exercise of any portion or all of the options at
any time after the date which is 12 months prior to the date
of the termination of your employment, you shall pay to the
Company in cash, upon demand, all gains or other economic
value actually or constructively received by you, any member
of your family or any trust or other entity in which you or
any member of your family has a beneficial interest, upon the
sale of any such shares equal to the difference between the
option exercise price and the value received.
Notwithstanding the foregoing, the maximum value of the right to
repurchase under clause (ii) above and the recovery of gain under clause
(iii) above which the Company may recover shall be $1,000,000. The
foregoing limitation shall be applied first against the recovery of gain
on the sale of shares under clause (iii) and then from the repurchase of
any shares under clause (ii) based on the amount by which the closing
bid price on the date of notice exceeds the option exercise price. The
Company agrees that the $1,000,000 limit will be reduced to the extent
that you do not derive a federal income tax benefit from the payments
under this paragraph equal to the tax cost of the exercise of the
options and/or the sale of the shares.
9. NO MITIGATION. Following termination of your employment for any reason,
you will be under no obligation to mitigate your damages by seeking other
employment, and there will be no offset against the amounts due you under
Section 7, except as specifically provided in Section 7(b)(i)(D), or for any
claims which the Company may have against you.
10. CONFIDENTIAL INFORMATION, INVENTIONS AND NON-COMPETITION. In
consideration of the benefits provided you under this Agreement, you will,
concurrently with the execution of this Agreement, sign the form of Agreement
Regarding Confidential Information, Inventions and Non-Competition attached
as Exhibit 5 (the "Non-Competition Agreement"), and the Non-Competition
Agreement is, by this reference, incorporated in and made a part of this
Agreement. The remedies provided in the Non-Competition Agreement for
resolution of disputes under the Non-Competition Agreement will be in
addition to and not limited by Section 12 of this Agreement. In the event
that you breach the terms of the Non-Competition Agreement, the Company will
be relieved of the obligation to make any further payments to you under
Section 7(b).
11. INDEMNIFICATION. Concurrently with the execution of this Agreement, the
Company will enter into the form of Indemnification Agreement attached as
Exhibit 6.
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Mr. Carl B. Lehmann
November 24, 1997
Page 9
12. ARBITRATION. Any disputes arising under or in connection with this
Agreement (including without limitation the making of this Agreement) shall
be resolved by final and binding arbitration to be held in Minneapolis,
Minnesota in accordance with the rules and procedures of the American
Arbitration Association. The parties shall select a mutually acceptable
single arbitrator to resolve the dispute or if they fail or are unable to do
so, each side shall within the following ten (10) business days select a
single arbitrator and the two so selected shall select a third arbitrator
within the following ten (10) business days. The arbitration award or other
resolution may be entered as a judgment at the request of the prevailing
party by any court of competent jurisdiction in Minnesota or elsewhere. The
party prevailing as to a substantial preponderance of the issues as
determined by the arbitration panel in the proceeding shall be entitled to be
reimbursed for the cost and expenses thereof, including without limitation,
the reasonable attorneys fees of the prevailing party, by the other party.
The arbitrator shall have no power to award any punitive or exemplary
damages. The arbitrator may construe or interpret, but shall not ignore or
vary the terms of this Agreement, and shall be bound by controlling law. You
acknowledge that your failure to comply with the terms of the Agreement
regarding Confidential Information, Inventions, and Non-Competition could
cause immediate and irreparable injury to the Company and that therefore, the
arbitrators, or a court of competent jurisdiction, if an arbitration panel
cannot immediately be convened, will be empowered to provide injunctive
relief, including temporary or preliminary relief, to restrain any such
failure to comply.
13. GENERAL PROVISIONS.
(a) This Agreement may not be amended or modified except by a
written agreement signed by both of us.
(b) In the event that any provision or portion of this agreement
are determined to be invalid or unenforceable for any reason, the
remaining provisions of this Agreement will remain in full force
and effect to the fullest extent permitted by law.
(c) This Agreement shall bind and benefit the parties hereto and
their respective successors and assigns, but none of your rights or
obligations hereunder may be assigned by either party hereto
without the written consent of the other, except by operation of
law upon your death.
(d) This Agreement has been made in and shall be governed and
construed in accordance with the laws of the State of Minnesota
without giving effect to the principles of conflict of laws of any
jurisdiction.
(e) No failure on the part of either party to exercise, and no delay in
exercising, any right or remedy under this Agreement will operate
as a waiver; nor will any single or partial exercise of any right
or remedy preclude any other or further exercise of any right or
remedy.
(f) Any notice or other communication under this Agreement must be
in writing and
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Mr. Carl B. Lehmann
November 24, 1997
Page 10
will be deemed given when delivered in person, by overnight courier
(with receipt confirmed), by facsimile transmission (with receipt
confirmed by telephone or by automatic transmission report), or
upon receipt if sent by certified mail, return receipt requested,
as follows (or to such other persons and/or addresses as may be
specified by written notice to the other party):
If to RTW:
RTW, Inc.
Attention: Chairman of the Board of Directors
8500 Normandale Lake Blvd., Suite 1400
Minneapolis, MN 55437
With a copy to:
Lindquist & Vennum, PLLP
4200 IDS Center
Minneapolis, MN 55402
Attn: Ronald G. Vantine
If to Carl B. Lehmann:
Carl B. Lehmann
2626 Hillsden Drive
Salt Lake City, UT 84117
With a copy to:
Christy & Viener
620 Fifth Avenue
New York, New York 10020
Attn: Lanny A. Oppenheim
(g) This Agreement, together with the Consulting Agreement and the
various agreements ancillary hereto and thereto, contains our
entire understanding and agreement with respect to these matters
and supersedes all previous agreements, discussions, or
understandings, whether written or oral, between us on the same
subjects.
(h) In the event any provision of this Agreement is held
unenforceable, that provision will be severed and shall not affect
the validity or enforceability of the remaining provisions. In the
event any provision is held to be overbroad, that provision shall
be deemed amended to narrow its application to the extent necessary
to render the provision enforceable according to applicable law.
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Mr. Carl B. Lehmann
November 24, 1997
Page 11
(i) All terms of this Agreement intended to be observed and
performed after the termination of this Agreement will survive such
termination and will continue in full force and effect thereafter,
including without limitation, Sections 7, 8, 9, 10, 11, 12, and 13.
(j) The headings contained in this Agreement are for convenience
only and shall in no way restrict or otherwise affect the
construction of the provisions hereof. Unless otherwise specified
herein, references in this Agreement to Sections and Exhibits are
to the sections of and exhibits to this Agreement. This Agreement
may be executed in multiple counterparts, each of which shall be an
original and all of which together shall constitute one and the
same instrument.
------------------------------------------
If the foregoing correctly sets forth your understanding of our agreement,
please so indicate by signing and returning to us a copy of this letter.
Very truly yours,
RTW, INC.
/s/ David C. Prosser
--------------------------
By: David C. Prosser
Chairman
Accepted and agreed to:
/s/ Carl B. Lehmann
- --------------------------
Carl B. Lehmann
<PAGE>
RTW, INC.
NON-QUALIFIED STOCK OPTION AGREEMENT
THIS OPTION AGREEMENT is made as of the 24th day of November, 1997,
between RTW, INC., a Minnesota corporation (the "Company"), and Carl B.
Lehmann (the "Optionee").
The Optionee has agreed to become employed by the Company on or about
January 15, 1998 (the "Employment Date") as its President and Chief Executive
officer under a written employment letter dated November 24, 1997 (the
"Employment Agreement") and has further agreed to serve as a director and as
a consultant to the Company prior thereto; and
In consideration for his services as a director, consultant and as an
executive employee, the Company desires to grant him options to purchase
shares of its common stock, no par value (the "Common Stock");
The Company desires, by affording the Optionee an opportunity to
purchase its Common Stock as hereinafter provided, to carry out the purpose
of the Amended 1994 Stock Plan of the Company approved by its shareholders
(the "Plan").
THEREFORE, the parties hereby agree as follows:
1. GRANT OF OPTION. The Company hereby grants to the Optionee the
right and option (hereinafter called the "Option") to purchase from the
Company all or any part of an aggregate amount of 500,000 shares of the
Common Stock of the Company (the "Option Shares") on the terms and conditions
herein set forth. If the Optionee elects, pursuant to the terms of Section
3(a) of his Employment Agreement, to reduce the number options to purchase
shares granted hereunder for options to purchase shares that qualify as
Incentive Stock Options under Internal Revenue Code Section 422, then and in
that event, the Optionee shall surrender for cancellation under this Option
that number of shares equal to the number of shares to which he is granted
under the Incentive Stock Option without regard to the exercise price of the
shares of each option. To the extent that the options awarded under the
Incentive Stock Option are exercisable in installments, the installments
under this Option shall be reduced accordingly. Other than the reduction in
the number of shares subject to this Option, the cancellation of shares shall
not affect any other term or condition of this Option.
2. PURCHASE PRICE. The purchase price of the Option Shares shall be
$6.75 per share, which shall be the closing price on the date of grant.
3. TERM OF OPTION. The term of the Option shall be for a period of
ten (10) years from November 24, 1997 (the "Option Date"), subject to earlier
termination as hereinafter provided.
4. EXERCISE OF OPTION. Thereafter, subject to the terms and
conditions hereof, the Option may be exercised as follows:
(a) From the Employment Date, the Option may be exercised as of
125,000 shares.
(b) From and after 12 months from the Option Date, the Option may be
exercised as
<PAGE>
to an additional 125,000 shares.
(c) From and after 24 months from the Option Date, the Option may be
exercised as to an additional 125,000 shares.
(d) From and after 36 months from the Option Date, the Option may be
exercised as to an additional 125,000 shares.
5. NON-TRANSFERABILITY. The Option shall not be transferable
otherwise than by will or the laws of descent and distribution, and the
Option may be exercised, during the lifetime of the Optionee, only by the
Optionee.
6. TERMINATION OF EMPLOYMENT. If, after the date the Optionee
commences employment pursuant to the terms of the Employment Agreement, the
Optionee's employment with the Company shall be terminated other than (x) by
the Company for Cause (as defined in the Employment Agreement) or (y) by the
Optionee prior to the end of the Original Term of the Optionee's Employment
Agreement for other than Good Reason (as defined in the Employment
Agreement), the Option shall become exercisable in full to all the Option
Shares covered thereby. The Option may be exercised by the Optionee, his or
her legal representative, or, in the case of death, by the person to whom the
Option is transferred by will or the applicable laws of descent and
distribution for a period that shall extend to and shall expire immediately
upon the earlier of the expiration of the term specified in Section 3 hereof
or the date specified below:
(a) In the event of the death of Optionee, three (3) years from the
date of death; or
(b) In the event of termination of employment as a result of
Optionee's Disability, one (1) year from the date of the Disability; or
(c) In the event of termination of employment by the Company other
than for Cause or in the event of the termination of employment for Good
Reason, the later of November 24, 2003 or the date that is one (1) year
from the date of the Optionee's termination of employment.
7. TERMINATION OF EMPLOYMENT FOR CAUSE. If, after the date the
Optionee commences employment pursuant to the terms of the Employment Letter
and the employment of the Optionee shall be terminated for Cause (as defined
in the Employment Agreement) any unexercised Option shall terminate
immediately upon such termination of employment. In the event of termination
initiated by the Optionee prior to the end of the Original Term under the
Optionee's Employment Agreement, such Option shall be exercisable for the
period that shall extend to and shall expire immediately upon the earlier of
one (1) year after the date of the Optionee's termination of employment or
the term specified in Section 3 hereof as to only those shares as to which
the Option became exercisable prior to the termination of Optionee's
employment. So long as the Optionee shall continue to be an employee of the
Company or one or more of its subsidiaries, the Option shall not be affected
by any change of duties or position. Nothing in this Option Agreement shall
confer upon the Optionee any right to continue in the employ of the Company
or of any of its subsidiaries or interfere in any way with the rights of the
Company or any subsidiary to terminate the employment of the Optionee at any
time.
8. ACCELERATION IN EVENT OF CHANGE IN CONTROL. Notwithstanding the
provisions of Section
2
<PAGE>
4, in the event of a Change in Control (as defined in this Section 8) after
the date the Optionee commences employment pursuant to the terms of the
Employment Letter, the Option shall become exercisable in full as to all the
Option Shares covered thereby and will remain exercisable for the full term
of the Option, without regard to any installment exercise or vesting
provisions and regardless of whether the Optionee remains in the employ or
service of the Company. In addition, if a Change in Control of the Company
occurs, the Committee (as defined in the Plan), in its sole discretion and
without the consent of the Optionee, may determine that the Optionee will
receive, with respect to some or all of the Option Shares, as of the
effective date of any such Change in Control of the Company, cash in an
amount equal to the excess of the fair market value of such Option Shares
immediately prior to the effective date of such Change in Control of the
Company over the option exercise price per share of this Option. For
purposes of this Agreement, "fair market value" shall be established in the
manner set forth in the Plan.
"Change in Control" shall mean a change in control which would be
required to be reported in response to item 6(e) on Schedule 14A of
Regulation 14A promulgated under the Securities Exchange Act of 1934, as
amended (the "Exchange Act"), whether or not the Company is then subject to
such reporting requirement, including, without limitation, if:
(a) Any "person" (as such term is used in Sections 13(d) and 14(d)
of the Exchange Act), other than a person that beneficially owns five
percent (5%) or more of the Company's Common Stock as of the date
immediately prior to the effective date of the Company's initial public
offering, becomes a "beneficial owner" (as defined in Rule 13d-3 under
the Exchange Act), directly or indirectly, of securities of the Company
representing 30% or more of the combined voting power of the Company's
then outstanding securities and is required to file a Schedule 13D under
the Exchange Act; or
(b) The Incumbent Directors cease for any reason to constitute at
least a majority of the Board of Directors. The term, "Incumbent
Directors," shall mean those individuals (other than Optionee) who are
members of the Board of Directors on the effective date of this
Agreement and any individual who subsequently becomes a member of the
Board of Directors whose election or nomination for election by the
Company's shareholders was approved by a vote of at least a majority of
the then Incumbent Directors; or
(c) (i) The Company consummates a merger, consolidation, share
exchange, division or other reorganization of the Company with any
corporation or entity, unless the shareholders of the Company
immediately prior to such transaction beneficially own, directly or
indirectly (A) if the Company's is the surviving corporation in such
transaction, 60% or more of the combined voting power of the Company's
outstanding voting securities as well as 60% or more of the total market
value of the Company's outstanding equity securities, (B) if the Company
is not the surviving corporation, 80% of the combined voting power of
the surviving entity's outstanding voting securities as well as 80% or
more of the total market value of such entity's outstanding equity
securities or (C) in the case of a division, 80% or more of the combined
voting power of the outstanding voting securities of each entity
resulting from the division as well as 80% or more of the total market
value of each such entity's outstanding equity securities, in each case
in substantially the same proportion as such shareholders owned shares
of the company prior to such transaction; (ii) the shareholders of the
Company approve an agreement for the sale or disposition (in one
transaction or a series of transactions) of all or
3
<PAGE>
substantially all of the Company's assets, or (iii) the Company adopts a
plan of complete liquidation or winding-up of the Company.
(d) All or substantially all of the assets of the Company are
sold, leased, exchanged or otherwise transferred and immediately
thereafter, there is no substantial continuity of ownership with respect
to the Company and the entity to which such assets have been transferred.
9. METHOD OF EXERCISING OPTION. Subject to the terms and conditions
of this Option Agreement, the Option may be exercised by written notice to
the Board of Directors of the Company at the principal office of the Company.
Such notice shall state the election to exercise the Option and the number
of shares in respect of which it is being exercised, and shall be signed by
the person so exercising the Option. Such notice shall be accompanied by
payment of the full purchase price of such shares, which payment shall be
made in cash or by check or bank draft payable to the Company, or, provided
such form of payment does not result in a charge to earnings of the Company
for financial accounting purposes, by delivery of shares of Common Stock of
the Company with a fair market value equal to the purchase price or by a
combination of cash and such shares, whose fair market value shall equal the
purchase price. For purposes of this Agreement, the "fair market value" of
the Common Stock of the Company shall be established in the manner set forth
in the Plan. In the event the Option shall be exercised by any person other
than the Optionee, such notice shall be accompanied by appropriate proof of
such right of such person to exercise the Option.
10. FORFEITURE/REPURCHASE ON ENTERING INTO COMPETITION. In the event
the Optionee violates in any material respect the obligations under Section
10 of the Employment Agreement following termination of Optionee's employment
and during such period as such provisions remain in effect:
(a) The vested stock options granted to Optionee hereunder, to the
extent unexercised, shall immediately terminate and be without further
force or effect.
(b) The Company shall have the right to repurchase for cash any
shares of Company's stock acquired by Optionee as a result of the
exercise of any portion or all of the options and held by either
Optionee or by any member of Optionee's family or by any trust or other
entity in which Optionee or any member of Optionee's family has a
beneficial interest. The Company shall give Optionee written notice of
the exercise of its right to repurchase and shall close on the
repurchase no later than six months after the date of notice. The
purchase price for the shares shall be the option exercise price or the
closing bid price for shares of the Company's common stock on the date
of notice, whichever is lower.
(c) If Optionee sells or has sold any shares acquired by Optionee
as a result of the exercise of any portion or all of the options at any
time after the date which is 12 months prior to the date of the
termination of Optionee's employment, Optionee shall pay to the Company
in cash, upon demand, all gains or other economic value actually or
constructively received by Optionee, any member of Optionee's family or
any trust or other entity in which Optionee or any member of Optionee's
family has a beneficial interest, upon the sale of any such shares equal
to the difference between the option exercise price and the value
received. Notwithstanding the foregoing, the maximum value of the right
to repurchase under clause (b) above and the gain under clause (c) above
which the Company may recover shall be $1,000,000.
4
<PAGE>
The foregoing limitation shall be applied first against the recovery of
gain on the sale of shares under clause (c) and then from the repurchase
of any shares under clause (b) based on the amount by which the closing
bid price on the date of notice exceeds the option exercise price. The
Company agrees that the $1,000,000 limit will be reduced to the extent
that the Optionee does not derive a federal income tax benefit from the
payments under this paragraph equal to the tax cost of the exercise of
the options and/or the sale of the shares.
11. OPTION PLAN. This Option is subject to certain additional terms
and conditions set forth in the Amended 1994 Stock Plan pursuant to which
this Option has been issued. A copy of the Plan is on file with the
Secretary of the Company and by acceptance hereof Optionee agrees to and
accepts this Option subject to the terms of the Plan. Any capitalized terms
in this Agreement that are not defined herein shall have the meaning set
forth in the Plan.
12. DISPUTES. As a condition of the granting of the Option herein
granted, the Optionee agrees, for the Optionee and the Optionee's personal
representatives, that any dispute or disagreement which may arise under or as
a result of or pursuant to this Agreement, shall be determined by the
Company, in its sole discretion, and that any interpretation by the Company
of the terms of this Agreement shall be final, binding and conclusive.
13. BINDING EFFECT. This Agreement shall be binding upon the heirs,
executors, administrators and successors of the parties hereto.
IN WITNESS WHEREOF, the Company and the Optionee have executed this
Agreement as of the date and year first above written.
RTW, INC.
/s/ Carl B. Lehmann By: /s/ David C. Prosser
- ------------------------ ---------------------------------------
Optionee Its: President
---------------------------------------
5
<PAGE>
LETTER AGREEMENT
January 15, 1998
RTW, Inc.
8500 Normandale Lake Boulevard, Suite 1400
Bloomington MN 55439
Carl B. Lehmann
President and Chief Executive Officer
RTW, Inc.
8500 Normandale Lake Boulevard, Suite 1400
Bloomington MN 55439
Re: Election to Partially Convert Non-Qualified Stock Option Agreement
into Incentive Stock Option Agreement
This letter agreement is entered into as of January 15, 1998 by RTW, Inc., a
Minnesota corporation ("RTW" or the "Company"), and Carl B. Lehmann
("Lehmann"). The Company and Lehmann have entered into an employment letter
agreement dated November 24, 1997 (the "Employment Agreement"). Effective as
of November 24, 1997, the Company also granted to Lehmann a non-qualified
stock option to purchase 500,000 shares of RTW, Inc. Common Stock (the
"Option Agreement").
Pursuant to Section 3(a) of the Employment Agreement and in accordance with
Section 1 of the Option Agreement, Lehmann may, and desires to, prior to
February 1, 1998, elect to surrender a portion of the option shares under the
Option Agreement and have a separate Incentive Stock Option Agreement issued
to him for the same number of option shares as he surrenders.
NOW, THEREFORE, in consideration of the foregoing and other good and valuable
consideration, receipt of which is hereby acknowledged, RTW and Lehmann
hereby agree as follows:
1. Lehmann hereby surrenders the right to purchase 42,855 shares
pursuant to the Option Agreement and the Company agrees to issue an Incentive
Stock Option Agreement for 42,855 shares to Lehmann.
<PAGE>
2. Section 1 of the Option Agreement is amended to read as follows:
"1. GRANT OF OPTION. The Company hereby grants to the
Optionee the right and option (hereinafter called the
"Option") to purchase from the Company all or any part of
an aggregate amount of 457,145 shares of the Common Stock
of the Company (the "Option Shares") on the terms and
conditions herein set forth."
3. Section 4 of the Option Agreement is hereby amended to read as
follows:
"4. EXERCISE OF OPTION. Thereafter, subject to the terms and
conditions hereof, the Option may be exercised as follows:
(a) From the Employment Date, the Option may be
exercised as of 110,715 shares.
(b) From and after 12 months from the Option Date,
the Option may be exercised as to an additional
125,000 shares.
(c) From and after 24 months from the Option Date,
the Option may be exercised as to an additional
110,715 shares.
(d) From and after 36 months from the Option Date,
the Option may be exercised as to an additional
110,715 shares."
Accepted and agreed to by the undersigned as of the 15th day of
January, 1998.
RTW, INC.
By: /s/ Alfred L. Latendresse /s/ Carl B. Lehmann
----------------------------- -------------------------
Its: Chief Financial Officer Carl B. Lehmann
<PAGE>
RTW, INC.
INCENTIVE STOCK OPTION AGREEMENT
THIS OPTION AGREEMENT is made as of the 15th day of January, 1998,
between RTW, INC., a Minnesota corporation (the "Company"), and Carl B.
Lehmann (the "Optionee").
1. GRANT OF OPTION. The Company hereby grants to the Optionee the
right and option (hereinafter called the "Option") to purchase from the
Company all or any part of an aggregate amount of 42,855 shares of the Common
Stock of the Company (the "Option Shares") on the terms and conditions herein
set forth. The Option is intended to be an "incentive stock option" as that
term is defined in Section 422 of the Internal Revenue Code.
2. PURCHASE PRICE. The purchase price of the Option Shares shall be
$7.00 per share, which shall be the closing price on the date of grant.
3. TERM OF OPTION. The term of the Option shall be for a period of
ten (10) years from November 24, 1997 (the "Option Date"), subject to earlier
termination as hereinafter provided.
4. EXERCISE OF OPTION. Subject to the terms and conditions hereof,
the Option may be exercised as follows:
(a) From the Employment Date, the Option may be exercised as of
14,285 shares.
(b) From and after 24 months from the Option Date, the Option may
be exercised as to an additional 14,285 shares.
(c) From and after 36 months from the Option Date, the Option may
be exercised as to an additional 14,285 shares.
5. NON-TRANSFERABILITY. The Option shall not be transferable
otherwise than by will or the laws of descent and distribution, and the
Option may be exercised, during the lifetime of the Optionee, only by the
Optionee.
6. TERMINATION OF EMPLOYMENT. If, after the date the Optionee
commences employment pursuant to the terms of the Employment Agreement, the
Optionee's employment with the Company shall be terminated other than (x) by
the Company for Cause (as defined in the Employment Agreement) or (y) by the
Optionee prior to the end of the Original Term of the Optionee's Employment
Agreement for other than Good Reason (as defined in the Employment
Agreement), the Option shall become exercisable in full to all the Option
Shares covered thereby. The Option may be exercised by the Optionee, his or
her legal representative, or, in the case of death, by the person to whom the
Option is transferred by will or the applicable laws of descent and
distribution for a period that shall extend to and shall expire immediately
upon the earlier of the expiration of the term specified in Section 3 hereof
or the date specified below:
<PAGE>
(a) In the event of the death of Optionee, three (3) years from
the date of death; or
(b) In the event of termination of employment as a result of
Optionee's Disability, one (1) year from the date of the Disability; or
(c) In the event of termination of employment by the Company other
than for Cause or in the event of the termination of employment for Good
Reason, the later of November 24, 2003 or the date that is one (1) year
from the date of the Optionee's termination of employment.
7. TERMINATION OF EMPLOYMENT FOR CAUSE. If, after the date the
Optionee commences employment pursuant to the terms of the Employment Letter
and the employment of the Optionee shall be terminated for Cause (as defined
in the Employment Agreement) any unexercised Option shall terminate
immediately upon such termination of employment. In the event of termination
initiated by the Optionee prior to the end of the Original Term under the
Optionee's Employment Agreement, such Option shall be exercisable for the
period that shall extend to and shall expire immediately upon the earlier of
one (1) year after the date of the Optionee's termination of employment or
the term specified in Section 3 hereof as to only those shares as to which
the Option became exercisable prior to the termination of Optionee's
employment. So long as the Optionee shall continue to be an employee of the
Company or one or more of its subsidiaries, the Option shall not be affected
by any change of duties or position. Nothing in this Option Agreement shall
confer upon the Optionee any right to continue in the employ of the Company
or of any of its subsidiaries or interfere in any way with the rights of the
Company or any subsidiary to terminate the employment of the Optionee at any
time.
8. ACCELERATION IN EVENT OF CHANGE IN CONTROL. Notwithstanding the
provisions of Section 4, in the event of a Change in Control (as defined in
this Section 8) after the date the Optionee commences employment pursuant to
the terms of the Employment Letter, the Option shall become exercisable in
full as to all the Option Shares covered thereby and will remain exercisable
for the full term of the Option, without regard to any installment exercise
or vesting provisions and regardless of whether the Optionee remains in the
employ or service of the Company. In addition, if a Change in Control of the
Company occurs, the Committee (as defined in the Plan), in its sole
discretion and without the consent of the Optionee, may determine that the
Optionee will receive, with respect to some or all of the Option Shares, as
of the effective date of any such Change in Control of the Company, cash in
an amount equal to the excess of the fair market value of such Option Shares
immediately prior to the effective date of such Change in Control of the
Company over the option exercise price per share of this Option. For
purposes of this Agreement, "fair market value" shall be established in the
manner set forth in the Plan.
"Change in Control" shall mean a change in control which would be
required to be reported in response to item 6(e) on Schedule 14A of
Regulation 14A promulgated under the Securities Exchange Act of 1934, as
amended (the "Exchange Act"), whether or not the Company is then subject to
such reporting requirement, including, without limitation, if:
(a) Any "person" (as such term is used in Sections 13(d) and 14(d)
of the Exchange Act), other than a person that beneficially owns five
percent (5%) or more of the Company's Common Stock as of the date
immediately prior to the effective date of the Company's initial public
offering, becomes a "beneficial owner" (as defined in Rule 13d-3 under
the Exchange Act), directly or indirectly, of securities of the Company
representing 30% or more of the combined voting power of the Company's
then outstanding securities and is required to file a Schedule 13D under
the Exchange Act; or
2
<PAGE>
(b) The Incumbent Directors cease for any reason to constitute at
least a majority of the Board of Directors. The term, "Incumbent
Directors," shall mean those individuals (other than Optionee) who are
members of the Board of Directors on the effective date of this
Agreement and any individual who subsequently becomes a member of the
Board of Directors whose election or nomination for election by the
Company's shareholders was approved by a vote of at least a majority of
the then Incumbent Directors; or
(c) (i) The Company consummates a merger, consolidation, share
exchange, division or other reorganization of the Company with any
corporation or entity, unless the shareholders of the Company
immediately prior to such transaction beneficially own, directly or
indirectly (A) if the Company's is the surviving corporation in such
transaction, 60% or more of the combined voting power of the Company's
outstanding voting securities as well as 60% or more of the total market
value of the Company's outstanding equity securities, (B) if the Company
is not the surviving corporation, 80% of the combined voting power of
the surviving entity's outstanding voting securities as well as 80% or
more of the total market value of such entity's outstanding equity
securities or (C) in the case of a division, 80% or more of the combined
voting power of the outstanding voting securities of each entity
resulting from the division as well as 80% or more of the total market
value of each such entity's outstanding equity securities, in each case
in substantially the same proportion as such shareholders owned shares
of the company prior to such transaction; (ii) the shareholders of the
Company approve an agreement for the sale or disposition (in one
transaction or a series of transactions) of all or substantially all of
the Company's assets, or (iii) the Company adopts a plan of complete
liquidation or winding-up of the Company.
(d) All or substantially all of the assets of the Company are
sold, leased, exchanged or otherwise transferred and immediately
thereafter, there is no substantial continuity of ownership with respect
to the Company and the entity to which such assets have been transferred.
9. METHOD OF EXERCISING OPTION. Subject to the terms and conditions
of this Option Agreement, the Option may be exercised by written notice to
the Board of Directors of the Company at the principal office of the Company.
Such notice shall state the election to exercise the Option and the number
of shares in respect of which it is being exercised, and shall be signed by
the person so exercising the Option. Such notice shall be accompanied by
payment of the full purchase price of such shares, which payment shall be
made in cash or by check or bank draft payable to the Company, or, provided
such form of payment does not result in a charge to earnings of the Company
for financial accounting purposes, by delivery of shares of Common Stock of
the Company with a fair market value equal to the purchase price or by a
combination of cash and such shares, whose fair market value shall equal the
purchase price. For purposes of this Agreement, the "fair market value" of
the Common Stock of the Company shall be established in the manner set forth
in the Plan. In the event the Option shall be exercised by any person other
than the Optionee, such notice shall be accompanied by appropriate proof of
such right of such person to exercise the Option.
10. FORFEITURE/REPURCHASE ON ENTERING INTO COMPETITION. In the event the
Optionee violates in any material respect the obligations under Section 10 of
the Employment Agreement following termination of Optionee's employment and
during such period as such provisions remain in effect:
(a) The vested stock options granted to Optionee hereunder, to the
extent unexercised, shall immediately terminate and be without further
force or effect.
3
<PAGE>
(b) The Company shall have the right to repurchase for cash any
shares of Company's stock acquired by Optionee as a result of the
exercise of any portion or all of the options and held by either
Optionee or by any member of Optionee's family or by any trust or other
entity in which Optionee or any member of Optionee's family has a
beneficial interest. The Company shall give Optionee written notice of
the exercise of its right to repurchase and shall close on the
repurchase no later than six months after the date of notice. The
purchase price for the shares shall be the option exercise price or the
closing bid price for shares of the Company's common stock on the date
of notice, whichever is lower.
(c) If Optionee sells or has sold any shares acquired by Optionee
as a result of the exercise of any portion or all of the options at any
time after the date which is 12 months prior to the date of the
termination of Optionee's employment, Optionee shall pay to the Company
in cash, upon demand, all gains or other economic value actually or
constructively received by Optionee, any member of Optionee's family or
any trust or other entity in which Optionee or any member of Optionee's
family has a beneficial interest, upon the sale of any such shares equal
to the difference between the option exercise price and the value
received.
Notwithstanding the foregoing, the maximum value of the right to
repurchase under clause (b) above and the gain under clause (c) above
which the Company may recover shall be $1,000,000. The foregoing
limitation shall be applied first against the recovery of gain on the
sale of shares under clause (c) and then from the repurchase of any
shares under clause (b) based on the amount by which the closing bid
price on the date of notice exceeds the option exercise price. The
Company agrees that the $1,000,000 limit will be reduced to the extent
that the Optionee does not derive a federal income tax benefit from the
payments under this paragraph equal to the tax cost of the exercise of
the options and/or the sale of the shares.
11. OPTION PLAN. This Option is subject to certain additional terms and
conditions set forth in the Amended 1994 Stock Plan pursuant to which this
Option has been issued. A copy of the Plan is on file with the Secretary of
the Company and by acceptance hereof Optionee agrees to and accepts this Option
subject to the terms of the Plan. Any capitalized terms in this Agreement that
are not defined herein shall have the meaning set forth in the Plan.
12. DISPUTES. As a condition of the granting of the Option herein
granted, the Optionee agrees, for the Optionee and the Optionee's personal
representatives, that any dispute or disagreement which may arise under or as a
result of or pursuant to this Agreement, shall be determined by the Company, in
its sole discretion, and that any interpretation by the Company of the terms of
this Agreement shall be final, binding and conclusive.
13. BINDING EFFECT. This Agreement shall be binding upon the heirs,
executors, administrators and successors of the parties hereto.
IN WITNESS WHEREOF, the Company and the Optionee have executed this
Agreement as of the date and year first above written.
RTW, INC.
/s/ Carl B. Lehmann By: /s/ Alfred L. LaTendresse
- ------------------------ ----------------------------------------
Optionee Its: Chief Financial Officer
----------------------------------------
4
<PAGE>
1998 GAIN SHARING BONUS PLAN
All employees of the company are eligible to receive annual cash bonuses
based on annual results. The components used to determine the ultimate bonus
payment are as follows:
IN FORCE PREMIUM In force premium is the annualized total premiums in
effect at any one point in time.
NET INCOME Pre-tax, pre-bonus operating profit.
Targets were established for each of the identified components above based on
the 1998 business plan goals. The amount of the bonus payment is determined
based on actual performance compared to the established Gain Sharing Bonus
Plan targets.
<PAGE>
EXHIBIT 11
RTW, INC. AND SUBSIDIARY
STATEMENT REGARDING COMPUTATION OF BASIC AND DILUTED INCOME PER SHARE
<TABLE>
<CAPTION>
1995 1996 1997
------------ ----------- ------------
<S> <C> <C> <C>
BASIC WEIGHTED AVERAGE SHARES OUTSTANDING 10,607,307 11,774,147 11,832,720
STOCK WARRANTS 54,944 4,325 -
STOCK OPTIONS
Options at $25.00 - 57 -
Options at $19.33 - 7,013 -
Options at $16.67 393 1,446 -
Options at $12.50 684 3,424 -
Options at $10.75 - - 919
Options at $ 8.67 19,401 44,254 4,955
Options at $ 7.13 - - 95
Options at $ 6.75 - - 357
Options at $ 2.67 61,119 69,619 54,065
Options at $ 2.00 214,521 232,333 186,018
Options at $ 0.53 750 - -
------------- ------------ ------------
WEIGHTED AVERAGE COMMON AND COMMON
SHARE EQUIVALENTS OUTSTANDING 10,959,119 12,136,618 12,079,129
------------- ------------ ------------
------------- ------------ ------------
NET INCOME ($000'S) $7,058 $8,982 $5,799
------------- ------------ ------------
------------- ------------ ------------
INCOME PER SHARE:
BASIC INCOME PER SHARE $0.67 $0.76 $0.49
------------- ------------ ------------
------------- ------------ ------------
DILUTED INCOME PER SHARE $0.64 $0.74 $0.48
------------- ------------ ------------
------------- ------------ ------------
</TABLE>
<PAGE>
INDEPENDENT AUDITORS' REPORT
We consent to the incorporation by reference in Registration Statement
No. 33-91368 of RTW, Inc. on Form S-8/S-3, Registration Statement No.
33-91372 of RTW, Inc. on Form S-8, Registration Statement No.
33-98966 of RTW, Inc. on Form S-8, and Registration Statement No.
333-28585 of RTW, Inc. on Form S-8 of our reports dated January 23, 1998,
appearing in this Annual Report on Form 10-K of RTW, Inc. for the year
ended December 31, 1997.
/s/ Deloitte & Touche LLP
Minneapolis, Minnesota
March 18, 1998
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 7
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<DEBT-HELD-FOR-SALE> 112,294
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 0
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 112,294
<CASH> 5,798
<RECOVER-REINSURE> 5,374
<DEFERRED-ACQUISITION> 1,559
<TOTAL-ASSETS> 141,986
<POLICY-LOSSES> 61,069
<UNEARNED-PREMIUMS> 13,580
<POLICY-OTHER> 4,105
<POLICY-HOLDER-FUNDS> 0
<NOTES-PAYABLE> 4,875
0
0
<COMMON> 28,976
<OTHER-SE> 29,381
<TOTAL-LIABILITY-AND-EQUITY> 141,986
81,043
<INVESTMENT-INCOME> 6,821
<INVESTMENT-GAINS> 399
<OTHER-INCOME> 0
<BENEFITS> 55,543
<UNDERWRITING-AMORTIZATION> 11,658
<UNDERWRITING-OTHER> 11,616
<INCOME-PRETAX> 8,669
<INCOME-TAX> 2,870
<INCOME-CONTINUING> 5,799
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 5,799
<EPS-PRIMARY> 0.49
<EPS-DILUTED> 0.48
<RESERVE-OPEN> 49,256
<PROVISION-CURRENT> 60,265
<PROVISION-PRIOR> (4,394)
<PAYMENTS-CURRENT> 23,529
<PAYMENTS-PRIOR> 20,529
<RESERVE-CLOSE> 61,069
<CUMULATIVE-DEFICIENCY> 3,085
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 7
<RESTATED>
<MULTIPLIER> 1,000
<S> <C> <C> <C>
<PERIOD-TYPE> 3-MOS 6-MOS 9-MOS
<FISCAL-YEAR-END> DEC-31-1997 DEC-31-1997 DEC-31-1997
<PERIOD-START> JAN-01-1997 JAN-01-1997 JAN-01-1997
<PERIOD-END> MAR-31-1997 JUN-30-1997 SEP-30-1997
<DEBT-HELD-FOR-SALE> 35,306 44,650 50,175
<DEBT-CARRYING-VALUE> 53,936 53,893 53,851
<DEBT-MARKET-VALUE> 53,607 54,107 54,533
<EQUITIES> 0 0 0
<MORTGAGE> 0 0 0
<REAL-ESTATE> 0 0 0
<TOTAL-INVEST> 89,242 98,543 104,026
<CASH> 15,847 10,469 10,613
<RECOVER-REINSURE> 5,856 5,710 5,406
<DEFERRED-ACQUISITION> 1,856 1,782 1,722
<TOTAL-ASSETS> 131,280 136,830 141,191
<POLICY-LOSSES> 51,840 55,062 57,681
<UNEARNED-PREMIUMS> 15,903 16,037 15,809
<POLICY-OTHER> 0 0 0
<POLICY-HOLDER-FUNDS> 0 0 0
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