<PAGE>
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
-------------
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 1999
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 0-23181
PAULA FINANCIAL
(Exact name of registrant as specified in its charter)
DELAWARE 95-4640368
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) identification number)
PAULA FINANCIAL
300 NORTH LAKE AVENUE, SUITE 300
PASADENA, CA 91101
(Address of principle executive offices)
(626) 304-0401
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
--- ---
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date. Number of shares of Common
Stock, $.01 par value, outstanding as of close of business on July 30, 1999:
5,894,467 shares.
- --------------------------------------------------------------------------------
<PAGE>
PAULA FINANCIAL
INDEX TO FORM 10-Q
<TABLE>
<CAPTION>
PART I. FINANCIAL INFORMATION PAGE
Item 1. Financial Statements
<S> <C>
Condensed consolidated balance sheets as of
June 30, 1999 and December 31, 1998 (unaudited) .........................2
Condensed consolidated statements of operations for the three
and six months ended June 30, 1999 and 1998 (unaudited)..................3
Condensed consolidated statements of comprehensive income (loss) for
the three and six months ended June 30, 1999 and 1998
(unaudited)..............................................................4
Condensed consolidated statements of cash flows for the six months
ended June 30, 1999 and 1998 (unaudited).................................5
Notes to condensed consolidated financial statements for the three
and six months ended June 30, 1999 (unaudited) ..........................6
Item 2. Management's Discussion and Analysis of Consolidated Financial
Condition and Results of Operations......................................7
Item 3. Quantitative and Qualitative Disclosures about Market Risk .....................14
PART II. OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders ............................14
Item 5. Other Information.......................................... ....................15
Item 6. Exhibits and Reports on Form 8-K................................................15
SIGNATURE.................................................................................16
</TABLE>
<PAGE>
PART I FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PAULA FINANCIAL AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
<TABLE>
<CAPTION>
June 30, December 31,
ASSETS 1999 1998
------------------ -----------------
(Unaudited) (*)
<S> <C> <C>
Investments:
Fixed maturities, available for sale, at market
(amortized cost: 1999, $148,420; 1998, $171,379) $143,364 $170,792
Equity securities, at market
Preferred stock (cost: 1999, $999; 1998, $999) 960 1,040
Common stock (cost: 1999, $5,151; 1998, $3,252) 4,842 3,219
Invested cash, at cost (approximates market) 1,025 2,572
------------------ -----------------
Total investments 150,191 177,623
------------------ -----------------
Cash (restricted: 1999, $2,104; 1998, $1,398) 907 4,145
Accounts receivable, net of allowance for uncollectible
accounts (1999, $1,051; 1998, $901) 29,248 26,846
Reinsurance recoverable on paid and unpaid losses and
loss adjustment expenses 45,143 25,852
Deferred income taxes 6,938 6,306
Other assets 23,548 14,176
------------------ -----------------
$255,975 $254,948
------------------ -----------------
------------------ -----------------
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Unpaid losses and loss adjustment expenses $136,299 $ 136,316
Unearned premiums 20,841 20,234
Accrued policyholder dividends 679 335
Accounts payable and accrued expenses 14,143 21,360
Notes payable 11,753 2,667
------------------ -----------------
183,715 180,912
------------------ -----------------
STOCKHOLDERS' EQUITY:
Preferred Stock, $0.01 par value. Authorized 4,058,823
shares, none issued and outstanding - -
Common stock, $0.01 par value
(Authorized 15,000,000 shares, issued: 1999,
6,338,767; 1998, 6,338,815) 63 63
Additional paid-in-capital 67,386 67,386
Retained earnings 11,832 10,182
Accumulated other comprehensive income (loss):
Net unrealized gain (loss) on investments (3,567) (382)
------------------ -----------------
75,714 77,249
Treasury stock, at cost (1999, 436,800; 1998, 409,800 shares) (3,454) (3,213)
------------------ -----------------
72,260 74,036
------------------ -----------------
$255,975 $ 254,948
------------------ -----------------
------------------ -----------------
</TABLE>
* Derived from audited financial statements.
See notes to condensed consolidated financial statements.
2
<PAGE>
PAULA FINANCIAL AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except share and per share data)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
1999 1998 1999 1998
------------ ------------ ----------- -----------
(Unaudited) (Unaudited)
<S> <C> <C> <C> <C>
INCOME:
Premiums earned:
Workers' compensation $17,502 $37,041 $34,004 64,861
Group medical and life 217 194 402 369
Commissions 1,144 913 1,976 1,630
Net investment income 2,401 2,119 5,141 4,173
Net realized investment losses (1,655) (83) (1.554) (53)
Other 138 161 346 360
------------ ------------ ----------- -----------
19,747 40,345 40,315 71,340
------------ ------------ ----------- -----------
EXPENSES:
Losses and loss adjustment
expenses incurred 11,176 42,736 22,414 63,534
Dividends provided for policyholders 276 84 427 507
Operating 6,874 9,922 14,051 18,554
------------ ------------ ----------- -----------
18,326 52,742 36,892 82,595
------------ ------------ ----------- -----------
Equity in net loss of unconsolidated
affiliate (186) - (270) -
------------ ------------ ----------- -----------
Income (loss) before income taxes 1,235 (12,397) 3,153 (11,255)
Income tax expense (benefit) 390 (4,396) 1,029 (4,277)
------------ ------------ ----------- -----------
NET INCOME (LOSS) $845 ($8,001) $2,124 ($6,978)
------------ ------------ ----------- -----------
------------ ------------ ----------- -----------
Earnings (loss) per share $0.14 ($1.26) $0.36 ($1.10)
Weighed average shares outstanding 5,923,846 6,331,285 5,926,406 6,326,894
Earnings (loss) per share - assuming dilution $0.14 ($1.26) $0.36 ($1.10)
Weighted average shares outstanding -
assuming dilution 5,927,524 6,331,285 5,932,303 6,326,894
</TABLE>
See notes to condensed consolidated financial statements.
3
<PAGE>
PAULA FINANCIAL AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(In thousands)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
1999 1998 1999 1998
------------ ------------ ----------- -----------
(Unaudited) (Unaudited)
<S> <C> <C> <C> <C>
Net income (loss) $845 ($8,001) $2,124 ($6,978)
Other comprehensive income, net of tax:
Unrealized gains (losses) on investments:
Unrealized holding gains
arising during period (tax impact:
1999: $1,083 and $1,624; 1998:
$14 and $45) (2,100) 27 (3,151) 86
Reclassifications adjustment for gains
(losses) included in net income
(tax impact: 1999: $113 and
$17; 1998: $0 and $9) 218 - (34) (16)
------------ ------------ ----------- -----------
(1,882) 27 (3,185) 70
------------ ------------ ----------- -----------
COMPREHENSIVE INCOME (LOSS) ($1,037) ($7,974) ($1,061) ($6,908)
------------ ------------ ----------- -----------
------------ ------------ ----------- -----------
</TABLE>
See notes to condensed consolidated financial statements.
4
<PAGE>
PAULA FINANCIAL AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30,
1999 1998
---------------- ----------------
(Unaudited)
<S> <C> <C>
CASH FLOW FROM OPERATING ACTIVITIES:
Net income (loss) $2,124 ($6,978)
ADJUSTMENTS TO RECONCILE NET INCOME (LOSS) TO NET CASH PROVIDED BY (USED IN)
OPERATING ACTIVITIES:
Depreciation and amortization 852 684
Amortization of fixed maturity premium, net 330 440
Equity in net loss of unconsolidated affiliate 270 -
Loss on sale of property and equipment 28 4
Loss on sales and calls of investments 1,554 53
Increase in receivables (23,294) (10,383)
(Increase) decrease in deferred income taxes 1,009 (2,661)
Increase (decrease) in unpaid losses and loss adjustment expenses (17) 32,377
Increase in accrued policyholder dividends 344 165
Increase (decrease) in accounts payable and accrued expenses (7,217) 458
Increase in unearned premiums 607 10,119
Other, net 685 (1,167)
---------------- ----------------
NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES (22,725) 23,111
---------------- ----------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sale of available for sale fixed maturities 20,231 3,787
Proceeds from maturities and calls of available for sale fixed 3,924 2,920
maturities
Proceeds from sale of property and equipment 53 19
Purchase of preferred and common stocks - (4,231)
Purchase of available for sale fixed maturities (4,980) (33,795)
Purchase of property and equipment (1,005) (870)
Purchase of book of business (105) -
Purchase of insurance agency (3,049) -
Investment in unconsolidated affiliate (5,500) -
---------------- ----------------
NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES 9,569 (32,170)
---------------- ----------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Borrowings under line of credit agreement, net 7,470 -
Issuance of notes payable 1,659 -
Payments on notes payable (43) (317)
Dividends paid (474) (507)
Exercise of stock options - 206
Repurchase of common stock (241) -
Retirement of common stock (2) -
Issuance of common stock 2 -
---------------- ----------------
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES 8,371 (618)
---------------- ----------------
NET DECREASE IN CASH AND INVESTED CASH (4,785) (9,677)
Cash and invested cash at beginning of period 6,717 19,452
---------------- ----------------
---------------- ----------------
CASH AND INVESTED CASH AT END OF PERIOD $1,932 $9,775
---------------- ----------------
---------------- ----------------
</TABLE>
See notes to condensed consolidated financial statements.
5
<PAGE>
PAULA FINANCIAL AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 1999 (UNAUDITED)
NOTE A - BASIS OF PRESENTATION
PAULA Financial and subsidiaries (the "Company") is an integrated insurance
organization specializing in the production, underwriting and servicing of
workers' compensation and accident and health insurance primarily for
agribusiness clients in California, Arizona, Oregon, Idaho, Alaska, Texas,
Florida, New Mexico and Nevada.
The accompanying unaudited condensed consolidated financial statements of the
Company have been prepared in accordance with generally accepted accounting
principles ("GAAP") for interim financial information and with the instructions
to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include
all of the information and footnotes required by GAAP for complete financial
statements. In the opinion of management, all adjustments, including normally
occurring accruals, considered necessary for a fair presentation have been
included.
Operating results for the three and six months ended June 30, 1999 are not
necessarily indicative of the results to be expected for the year ended December
31, 1999. For further information, refer to the consolidated financial
statements and footnotes thereto included in the Company's Annual Report on Form
10-K for the year ended December 31, 1998.
NOTE B - ADOPTION OF NEW ACCOUNTING STANDARDS
During the fourth quarter of 1997, the American Institute of Certified Public
Accountants issued Statement of Position No. 97-3, "Accounting by Insurance and
Other Enterprises for Insurance-Related Assessments" ("SOP 97-3"). SOP 97-3
addresses the recognition and measurement of assets and liabilities related to
guaranty funds and other assessments. SOP 97-3 is effective for fiscal years
beginning after December 15, 1998. The Company adopted SOP 97-3 effective
January 1, 1999. The impact of adoption was not material.
NOTE C - NEW ACCOUNTING STANDARDS NOT YET ADOPTED
In June 1999, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities" ("SFAS 133"). SFAS 133 is effective for fiscal years
beginning after June 15, 2000 and establishes standards for the reporting for
derivative instruments. It requires changes in the fair value of a derivative
instrument and the changes in fair value of assets or liabilities hedged by that
instrument to be included in income. To the extent that the hedge transaction is
effective, income is equally offset by both investments. Currently changes in
fair value of derivative instruments and hedged items are reported in net
unrealized gain (loss) on securities. The Company has not yet adopted SFAS 133.
However, the effect of adoption on the condensed consolidated financial
statements at June 30, 1999 would not have been material.
6
<PAGE>
PART I FINANCIAL INFORMATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
The Company is a California-based specialty underwriter and distributor of
commercial insurance products which, through its subsidiary PAULA Insurance
Company ("PICO"), is one of the largest underwriters specializing in workers'
compensation insurance products and services for the agribusiness industry. The
Company sells complementary products through the Company's insurance agency
subsidiaries (collectively, "Pan Am"), including group health and life products
provided by the Company's subsidiary PAULA Assurance Company ("PACO").
The Company's revenues consist primarily of premiums earned from workers'
compensation insurance underwriting, premiums earned from group medical
insurance, commission income, net investment income and other income. Premiums
earned during a period represent the portion of direct premiums written for
which all or a portion of the coverage period has expired, net of reinsurance.
Gross premiums written for the three months ended June 30, 1999 and 1998, were
$28.7 million and $38.8 million, respectively. Gross premiums written for the
six months ended June 30, 1999 and 1998, were $58.2 million and $77.8 million,
respectively. Commission income is earned from Pan Am's distribution of
insurance for insurers other than PICO and PACO. Net investment income
represents earnings on the Company's investment portfolio, less investment
expenses. Other income consists of third party administration fees and other
miscellaneous items.
The Company's expenses consist of losses and loss adjustment expenses incurred,
dividends provided for policyholders and operating expenses. Losses include
reserves for future payments for medical care and rehabilitation costs and
indemnity payments for lost wages. Loss adjustment expenses include expenses
incurred in connection with services provided by third parties, including
expenses of independent medical examinations, surveillance costs, and legal
expenses as well as staff and related expenses incurred to administer and settle
claims. Loss and loss adjustment expenses are offset in part by estimated
recoveries from reinsurers under reinsurance treaties. Operating expenses
include commission expenses to third party insurance agencies and other expenses
that vary with premium volume, such as premium taxes, state guaranty fund
assessments and underwriting and marketing expense, as well as general and
administrative expenses, which are less closely related to premium volume.
The Company's revenues are seasonal, and have tended to be highest in the second
and third quarters of each year. This is due primarily to the seasonality of the
size of the workforce employed by the Company's agribusiness clients.
7
<PAGE>
RESULTS OF OPERATIONS FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 1999 COMPARED
TO THE THREE AND SIX MONTHS ENDED JUNE 30, 1998:
GROSS PREMIUMS WRITTEN. The Company's gross premiums written for the three
months ended June 30, 1999 decreased 26.1% to $28.7 million from $38.8 million
for the comparable 1998 period. The Company's gross premiums written for the six
months ended June 30, 1999 decreased 25.2% to $58.2 million from $77.8 million
for the comparable 1998 period. The decrease in gross premiums written relates
primarily to the declines in the Company's large account business in California.
This was partially offset by rate increases in California and a 5% growth in
gross premiums written in other states.
NET PREMIUMS EARNED. The Company's net premiums earned for the three months
ended June 30, 1999 decreased 52.4% to $17.7 million from $37.2 million for
comparable 1998 period and decreased 47.3% to $34.4 million for the six months
ended June 30, 1999 from $65.2 million for the comparable 1998 period. The
decline in net premiums earned is due principally to the impact of $11.2 million
in premiums ceded during the three months ended June 30, 1999 and $21.7 million
in premiums ceded during the six months ended June 30, 1999 under a reinsurance
arrangement which became effective October 1, 1998.
COMMISSION INCOME. For the three months ended June 30, 1999 commission income
was $1.1 million compared to $0.9 million for the comparable 1998 period, a
25.3% increase. For the six months ended June 30, 1999 commission income was
$2.0 million compared to $1.6 million for the comparable 1998 period, a 21.2%
increase. The increase is due to the acquisition by Pan Am of two new California
offices which was effective April 30, 1999, as well as increased premiums placed
with insurance carriers other than PICO and PACO, which generates non-risk fee
income for the Company. Commissions paid to Pan Am on PICO and PACO business are
eliminated in the Company's consolidated financial statements.
NET INVESTMENT INCOME. Net investment income increased 13.3% to $2.4 million for
the three months ended June 30, 1999 from $2.1 million for the comparable 1998
period. Net investment income increased 23.2% to $5.1 million for the six months
ended June 30, 1999 from $4.2 million for the comparable 1998 period. The
increase was the result of cash flow increases from PICO's underwriting activity
in 1998. Average invested assets increased to $166.7 million for the six months
ended June 30, 1999 from $147.6 million for the comparable period in 1998. The
Company's average yield on its portfolio was 6.2% for the six month period in
1999 and 5.7% for the six month period in 1998. The average yield on the
Company's investment portfolio increased over the related 1998 period due to a
repositioning of the investment portfolio from tax-exempt securities to taxable
securities in the third quarter of 1998.
NET REALIZED INVESTMENT LOSSES. Net realized investment losses were $1.7 million
for the three months ended June 30, 1999 compared to $0.1 million for the
comparable 1998 period. Net realized investment losses were $1.6 million for the
six months ended June 30, 1999 compared to $0.1 million for the comparable 1998
period. The increase in net realized investment losses in 1999 is due to the
realization of an "other than temporary" decline of $1.6 million on a
non-performing investment in the second quarter.
8
<PAGE>
LOSSES AND LOSS ADJUSTMENT EXPENSES INCURRED. The Company's net loss ratio for
the three months ended June 30, 1999 decreased to 63.1% from 114.8% for the
comparable 1998 period. The 1999 loss ratio includes the benefit of 3.5% in
favorable development on prior accident years. The Company's net loss ratio for
the six months ended June 30, 1999 decreased to 65.1% from 97.4% for the
comparable 1998 period. The 1999 loss ratio includes the benefit of 2.4% in
favorable development on prior accident years. The 1999 loss ratios are also
significantly impacted by the reinsurance treaty entered into in the fourth
quarter of 1998. The loss ratios for the 1998 periods include the impact of
actions taken by the Company to increase loss reserves on the 1997 and 1998
accident years by a total of $14.8 million in the second quarter of 1998.
DIVIDENDS PROVIDED FOR POLICYHOLDERS. Dividends provided for policyholders as a
percentage of premiums earned for the three months ended June 30, 1999 was 1.6%
compared to 0.2% for the comparable 1998 period. Dividends provided for
policyholders as a percentage of premiums earned for the six months ended June
30, 1999 was 1.2% compared to 0.8% for the comparable 1998 period.
OPERATING EXPENSES. Operating expenses decreased 30.7% to $6.9 million for the
three months ended June 30, 1999 from $9.9 million for the comparable 1998
period. Variable expenses include the benefit of $2.4 million in ceding
commissions received in the second quarter of 1999 in conjunction with the
reinsurance arrangement which was effective in the fourth quarter of 1998.
Excluding the benefit of the ceding commissions, operating expenses for the
three months ended June 30, 1999 would have decreased $0.7 million or 7.1% over
the 1998 period. Operating expenses decreased 24.3% to $14.1 million for the six
months ended June 30, 1999 from $18.6 million for the comparable 1998 period.
Variable expenses include the benefit of $4.6 million in ceding commissions
received in the first six months of 1999 in conjunction with the reinsurance
arrangement which was effective in the fourth quarter of 1998. Excluding the
benefit of the ceding commissions, operating expenses for the six months ended
June 30, 1999 would have been consistent with the 1998 period.
INCOME TAXES. Income tax expense for the three months ended June 30, 1999 was
$0.4 million compared to an income tax benefit of $4.4 million for the
comparable 1998 period. Income tax expense for the six months ended June 30,
1999 was $1.0 million compared to an income tax benefit of $4.3 million for the
comparable 1998 period. The effective combined income tax rates for the six
months ended June 30, 1999 and 1998 were 32.6% and (38.0%), respectively. The
difference in the effective tax rates is due to a repositioning of the
investment portfolio from tax-exempt securities to taxable securities in the
third quarter of 1998.
EQUITY IN NET LOSS OF UNCONSOLIDATED AFFILIATE. The equity in net loss of
unconsolidated affiliate in 1999 represents the Company's share of the net loss
of Montlake Insurance Holdings, LLC. The Company is accounting for this
investment using the equity method.
LIQUIDITY AND CAPITAL RESOURCES:
As a holding company, PAULA Financial's principal sources of funds are dividends
and expense reimbursements from its operating subsidiaries, proceeds from the
sale of its capital stock and income from its investment portfolio. PAULA
Financial's principal uses of funds are capital contributions to its
subsidiaries, payment of operating expenses, investments in new ventures,
dividends to its stockholders and repurchase of Company common stock.
9
<PAGE>
California law places significant restrictions on the ability of the insurance
subsidiaries to pay dividends to PAULA Financial. Based on these restrictions
and the Company's results for the year ended December 31, 1998, PAULA Financial
would be able to receive $5.4 million in dividends in 1999 from its insurance
subsidiaries without obtaining prior regulatory approval from the California
Department of Insurance ("DOI"). No dividends were paid by the insurance
subsidiaries to PAULA Financial during the six months ended June 30, 1999.
Management believes that the remaining proceeds from the Company's initial
public offering held at the parent company level, funds available under the
Credit Agreement described below, and expense reimbursements and dividends from
its operating subsidiaries will be sufficient to meet the parent company's
operating cash needs for at least twelve months.
In March 1997, PAULA Financial entered into the Credit Agreement with a
commercial bank providing PAULA Financial with a revolving credit facility of
$15.0 million until December 31, 1999. At such time PAULA Financial may elect to
convert all or a portion of the borrowings then outstanding under such facility
into a term loan payable in quarterly installments and maturing on December 31,
2001. Each of PAULA Financial's non-insurance subsidiaries has guaranteed all
obligations of PAULA Financial under the Credit Agreement. As of July 30, 1999,
$10.1 million was outstanding under this facility. This use of the Credit
Agreement was for repurchase of the Company's common stock and investments in
new ventures.
The Company's investments consist primarily of taxable and tax-exempt United
States government and other investment grade securities and investment grade
fixed maturity commercial paper and, to a lesser extent, equity securities. The
Company does not generally invest in below investment grade fixed maturity
securities, mortgage loans or real estate.
As of June 30, 1999, the carrying value of the Company's fixed maturity
securities portfolio was $143.4 million of which $143.1 million was rated. Of
the rated fixed maturities portfolio 93.9% was rated "A" or better by S&P,
Moody's or Fitch. In December 1998, the issuer of a $2.0 million par value bond
held by PICO declared Chapter 11 bankruptcy. At that time, the Company ceased
accruing investment income and realized an "other than temporary" decline of
$0.1 million on this bond. The carrying value of this bond at the end of 1998
was $1.6 million based on market values obtained from the Company's investment
advisor. The Parent purchased the bond from PICO in March 1999 in exchange for
cash and marketable securities held by the Parent. In the second quarter of
1999, based on information received from its investment advisor, the Company
realized an additional "other than temporary" decline of $1.6 million. As of
June 30, 1999, this bond had a carrying value of $0.3 million based on market
values obtained from the Company's investment advisor.
California workers' compensation insurance companies are required to maintain
some of their investments on deposit with the California DOI for the protection
of policyholders. Other states in which PICO is licensed have also required PICO
to post deposits for the protection of those states' policyholders. Pursuant to
applicable state laws, PICO had, as of June 30, 1999, securities with a par
value of $120.6 million held by authorized depositories pursuant to these
deposit requirements. In addition to the deposits, the Company's insurance
company operating subsidiaries must maintain regulated levels of capital and
surplus in relation to premiums written and the risks retained by the
subsidiaries.
10
<PAGE>
In early 1999, the Company made an investment in the recently formed Montlake
Insurance Holdings, LLC, formerly known as Altus Insurance Holdings, LLC, the
parent company of Montlake Casualty Company Ltd. ("Montlake"), formerly known as
Altus Casualty Company Ltd., a specialty workers' compensation insurance
company. The Company invested $5.5 million and has the option to acquire
additional equity and provide quota-share reinsurance to Montlake through PICO.
The Company is accounting for its investment in Montlake using the equity
method.
On April 30, 1999, the Company closed the transaction to purchase the insurance
agency assets of the Sacramento and Stockton, California offices of CAPAX. The
transaction was previously announced in March 1999. The assets were purchased
for approximately $2.9 million and the Company funded the transaction with $1.3
million in cash and $1.1 million in CAPAX securities, which were owned by the
Company. The balance of $0.5 million is due on May 1, 2001 and is subject to a
downward earnout adjustment.
YEAR 2000 CONSIDERATIONS
THE FOLLOWING IS A YEAR 2000 READINESS DISCLOSURE STATEMENT.
OVERVIEW. The Company's Year 2000 Project (the "Project") is steadily
proceeding. The Company believes that it has identified and corrected
substantially all of its own information technology systems ("IT Systems")
and non-information technology (embedded technology) systems ("Non-IT
Systems") which require modification in order to become Year 2000 compliant.
The Company is currently in the final testing phase of the project. In
addition, the Company believes that it has identified those third parties
whose inability to handle date-sensitive processing could materially and
adversely impact the Company if corrective action is not taken in a timely
manner.
The Company has identified five major internal IT Systems which require
attention as part of the Project: General Ledger ("GL"), Agency Operations
("Agency"), Underwriting, which includes policy issuance, maintenance of policy
records, billing and auditing ("Underwriting"), Claims Adjudication ("Claims")
and Third Party Administration, which includes life insurance and accident and
health insurance policy issuance, maintenance and billing operations ("TPA").
GL SYSTEM. The Company has completed in-house construction and testing of a new
GL system which is Year 2000 compliant.
AGENCY SYSTEM. The Company has completed the process of out-sourcing its Agency
System needs to James G. Parker Insurance Associates ("Parker"), one of the
founders of the PAULA Trading Company. Parker utilizes an agency software system
provided by a third party vendor which is Year 2000 compliant according to a
written statement received from the vendor.
UNDERWRITING SYSTEM. The Company chose to make its existing Underwriting system
Year 2000 compliant using a technique known as "windowing," which is a solution
that will work for many years, but not permanently. The Company believes
permanent solutions are not necessary in light of the new underwriting system
under development.
The windowing project is proceeding on its revised schedule. The Company has
completed the correction phase of the project and is currently in the final
phase of testing, which is expected to be completed by the middle of the third
quarter of 1999, 60 days later than previously reported.
11
<PAGE>
The Company is currently constructing a new in-house Underwriting system that
will be Year 2000 compliant, but this new system is not expected to address the
Company's Year 2000 issues in a timely fashion.
CLAIMS SYSTEM. The Company's Claims system is licensed from a third party
vendor. The Claims system uses two distinct products, one for claims
adjudication and one for claims telephonic reporting.
The Company has installed and completed the final testing of the customized
version of the Year 2000 compliant Claims adjudication system. The installation
and testing was completed on schedule.
The Company's prior Claims telephonic reporting system was not made Year 2000
compliant by the vendor. The Company therefore chose to move to a
vendor-maintained, Year 2000 compliant, mainframe-based telephonic reporting
system. The conversion was completed on schedule in the second quarter of 1999.
TPA SYSTEM. The Company has licensed a third party claims administration
software product that the Company uses for all TPA functions. The Company has
completed the installation and testing of the vendor provided Year 2000 upgrade
to this software.
NON-IT SYSTEMS. The Company has addressed its primary Year 2000 issues relating
to Non-IT Systems by purchasing a new IBM mainframe computer to run its IT
Systems. The Company intends to extend the capacity of this new mainframe as
necessary. The Company's old IBM mainframe will be relegated to a back-up role
as more functions are moved to the new mainframe during 1999. The Company has
received, installed and tested an upgrade to both mainframes' operating systems
and has obtained satisfactory evidence that these upgraded operating systems are
Year 2000 compliant from IBM's Internet website.
The Company has substantially completed its inventory of other Non-IT Systems
and most of the issues raised in the inventory process have been addressed.
Non-IT Systems include the Company's personal computer network, telephone
switching equipment and other office equipment. The Company expects the
remaining corrective action to be completed by the end of the third quarter of
1999, a delay of approximately 45 days from previous disclosures.
The Company does not believe that it is materially exposed to any
Company-specific Non-IT System Year 2000 issues other than those addressed by
purchasing a new mainframe computer due to the nature of the Company's business.
The Company has no material property, plant or equipment.
THIRD PARTY YEAR 2000 ISSUES. The Company has made good progress in obtaining
Year 2000 compliance assurances from third parties with whom the Company has
material trading arrangements, or upon whom the Company relies to a material
extent in its normal operations. The Company will continue working to satisfy
itself that each third party performing important functions for the Company has
taken necessary measures to ensure that their IT and Non-IT Systems will be Year
2000 compliant in a timely manner. The Company believes it will suffer no
material disruption of its operations from its trading partners' Year 2000
issues. The Company has not, and will not,
12
<PAGE>
attempt to assess the Year 2000 compliance of regulatory authorities,
statistical rating bureaus or public utilities as the Company cannot cause such
entities to increase their efforts to become Year 2000 compliant.
COSTS. The total cost associated with required program modifications, software
upgrades and equipment purchases to become Year 2000 compliant is not expected
to be material to the Company's financial position, results of operations or
cash flows. The Company's total budget for its Year 2000 compliance program,
which began in 1997, is $1,025,000, an increase of $150,000 from previous
disclosures. This estimate does not include the Company's potential share of
Year 2000 costs that may be incurred by the Company's trading partners which the
Company may choose to bear to increase the likelihood of their timely Year 2000
compliance.
Of the total budget amount, $80,000 was spent in 1997, $300,000 was spent in
1998, $502,000 was spent in the first six months of 1999 and $143,000 will be
spent during the remaining six months of 1999. The costs associated with the
Company's new Underwriting System are not included in the Year 2000 budget. The
Company is utilizing cash flow from operations to fund its Year 2000 budget
requirements.
CONTINGENCIES. The Company continues to review its alternatives in the event
that it is not able to complete its Year 2000 compliance plans in a timely
manner. The alternatives are less advantageous to the Company than its current
Year 2000 compliance plan and, if required, could have an adverse effect on the
Company's financial position, results of operations or cash flows.
RISKS. The failure to correct a material Year 2000 problem could result in an
interruption in, or a failure of, certain normal business activities or
operations. Such failures could materially and adversely affect the Company's
results of operations, financial condition and cash flow. Due to the general
uncertainty inherent in the Year 2000 problem, resulting in part from the
uncertainty of the Year 2000 readiness of regulatory authorities, statistical
rating bureaus and public utilities, the Company is unable to determine at this
time whether the consequences of Year 2000 failures will have a material impact
on the Company's results of operations, financial condition or cash flows. The
Company believes the Project will significantly reduce the Company's level of
uncertainty about the Year 2000 problem.
CONSULTANTS. The Company has not used the services of independent Year 2000
consultants to assess its IT System and Non-IT System needs, although the
Company is utilizing the services of independent consultants in its Underwriting
System windowing project and in constructing its new Underwriting system.
FORWARD-LOOKING STATEMENTS
In connection with, and because it desires to take advantage of the "safe
harbor" provisions of the Private Securities Litigation Reform Act of 1995, the
Company cautions readers to recognize the existence of certain forward-looking
statements in this Form 10-Q and in any other statement made by, or on behalf
of, the Company, whether or not in future filings with the Securities and
Exchange Commission. Forward-looking statements are statements not based on
historical information and which relate to future operations, strategies,
financial results or other developments. Some forward-looking statements may be
identified by the use of terms such as "expects," "believes," "anticipates,"
"intends," or "judgment." Forward-looking statements are necessarily based upon
estimates and
13
<PAGE>
assumptions that are inherently subject to significant business, economic and
competitive uncertainties, many of which are beyond the Company's control and
many of which, with respect to future business decisions, are subject to change.
Examples of such uncertainties and contingencies include, among other important
factors, those affecting the insurance industry in general, such as the economic
and interest rate environment, legislative and regulatory developments and
market pricing and competitive trends, and those relating specifically to the
Company and its businesses, such as the level of its insurance premiums and fee
income, the claims experience of its insurance products, the performance of its
investment portfolio, the successful completion by the Company of its Year 2000
compliance program, acquisitions of companies or blocks of business, and the
ratings by major rating organizations of its insurance subsidiaries. These
uncertainties and contingencies can affect actual results and could cause actual
results to differ materially from those expressed in any forward-looking
statements made by, or on behalf of, the Company. The Company disclaims any
obligation to update forward-looking information.
Item 3: Quantitative and Qualitative Disclosures About Market Risk.
There have been no significant changes since the annual report Form
10-K filed for the year ended December 31, 1998.
PART II. OTHER INFORMATION
Item 4: Submission of Matters to a Vote of Security Holders.
The Company held its 1999 Annual Meeting of Stockholders on Wednesday,
May 26, 1999 for the purpose of electing three directors. At the Meeting, the
Company's stockholders re-elected Messrs. Jerry M. Miller, James A. Nicholson
and Robert A. Puccinelli to the Company's Board of Directors for three year
terms.
The election of directors was the only matter before the Meeting. The
following table shows the number of shares voted for each nominee for director
and the number of shares withheld for each director:
<TABLE>
<CAPTION>
NOMINEE SHARES VOTED FOR ELECTION SHARES WITHHELD
- ------- ------------------------- ---------------
<S> <C> <C>
Jerry M. Miller 4,797,081 530,909
James A. Nicholson 4,756,158 571,832
Robert A. Puccinelli 4,761,816 566,174
</TABLE>
The term of office of each of the following directors continued after
the meeting held May 26, 1999. They are Jeffrey A. Snider, Andrew M. Slavitt,
Bradley K. Serwin, John B. Clinton, Gerard Vecchio and Ronald W. Waisner.
Bradley K. Serwin resigned his position as Director effective May 31, 1999. (See
Part II, Item 5: Other Information).
14
<PAGE>
Item 5: Other Information.
Effective May 31, 1999, Mr. Bradley K. Serwin resigned his position
as a director and as General Counsel, Senior Vice President and Secretary of
the Company. Mr. Serwin accepted the position of General Counsel, Vice
President and Corporate Secretary with the internet company Ticketmaster
Online-CitySearch, Inc., located in Pasadena, California.
Item 6: Exhibits and Reports on Form 8-K:
(a) Exhibits.
11. Computation of Earnings Per Share.
27. Financial Data Schedule.
(b) Reports on Form 8-K.
There were no reports filed on Form 8-K during the three
months ended June 30, 1999.
15
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended,
the Registrant has duly caused this Quarterly Report on Form 10-Q to be signed
on its behalf by the undersigned thereunto duly authorized.
Date: August 13, 1999 PAULA FINANCIAL
By: s/ James A. Nicholson
-----------------------
Senior Vice President and Chief Financial
Officer
16
<PAGE>
Exhibit 11
PAULA FINANCIAL AND SUBSIDIARIES
COMPUTATION OF BASIC AND DILUTED EARNINGS PER SHARE
(In thousands, except per share data)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
1999 1998 1999 1998
------------- -------------- ------------- --------------
<S> <C> <C> <C> <C>
Net income (loss) $845 ($8,001) $2,124 ($6,978)
------------- -------------- -------------- -------------
------------- -------------- -------------- -------------
Weighted average shares outstanding for calculating
basic earnings per share 5,923,846 6,331,285 5,926,406 6,326,894
Options 3,678 - 5,897 -
------------- -------------- -------------- -------------
Total shares for calculating diluted earnings
per share 5,927,524 6,331,285 5,932,303 6,326,894
------------- -------------- -------------- -------------
------------- -------------- -------------- -------------
Basic earnings (loss) per share $0.14 ($1.26) $0.36 ($1.10)
------------- -------------- -------------- -------------
------------- -------------- -------------- -------------
Diluted earnings (loss) per share $0.14 ($1.26) $0.36 ($1.10)
------------- -------------- -------------- -------------
------------- -------------- -------------- -------------
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 7
<MULTIPLIER> 1,000
<S> <C> <C>
<PERIOD-TYPE> 3-MOS 6-MOS
<FISCAL-YEAR-END> DEC-31-1999 DEC-31-1999
<PERIOD-START> APR-01-1999 JAN-01-1999
<PERIOD-END> JUN-30-1999 JUN-30-1999
<DEBT-HELD-FOR-SALE> 143,364 143,364
<DEBT-CARRYING-VALUE> 0 0
<DEBT-MARKET-VALUE> 0 0
<EQUITIES> 5,802 5,802
<MORTGAGE> 0 0
<REAL-ESTATE> 0 0
<TOTAL-INVEST> 150,191 150,191
<CASH> 907 907
<RECOVER-REINSURE> 45,143 45,143
<DEFERRED-ACQUISITION> 2,628 2,628
<TOTAL-ASSETS> 255,975 255,975
<POLICY-LOSSES> 136,299 136,299
<UNEARNED-PREMIUMS> 20,841 20,841
<POLICY-OTHER> 0 0
<POLICY-HOLDER-FUNDS> 679 679
<NOTES-PAYABLE> 11,753 11,753
0 0
0 0
<COMMON> 63 63
<OTHER-SE> 72,197 72,197
<TOTAL-LIABILITY-AND-EQUITY> 255,975 255,975
17,719 34,406
<INVESTMENT-INCOME> 2,401 5,141
<INVESTMENT-GAINS> (1,655) (1,554)
<OTHER-INCOME> 1,282 2,322
<BENEFITS> 11,176 22,414
<UNDERWRITING-AMORTIZATION> 6,874 14,051
<UNDERWRITING-OTHER> 276 427
<INCOME-PRETAX> 1,235 3,153
<INCOME-TAX> 390 1,029
<INCOME-CONTINUING> 845 2,124
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> 845 2,124
<EPS-BASIC> 0.14 0.36
<EPS-DILUTED> 0.14 0.36
<RESERVE-OPEN> 101,731 111,179
<PROVISION-CURRENT> 11,798 23,246
<PROVISION-PRIOR> (622) (832)
<PAYMENTS-CURRENT> 5,953 9,506
<PAYMENTS-PRIOR> 15,798 32,931
<RESERVE-CLOSE> 91,156 91,156
<CUMULATIVE-DEFICIENCY> 0 0
</TABLE>
