<PAGE>
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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 1997
Commission File Number 33-83382
FIRST MERCURY FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 38-3164336
(State or other jurisdiction (I.R.S. Employer Identification No.)
of incorporation or organization)
29621 Northwestern Highway, P.O. Box 5096 Southfield, Michigan 48086
(Address of principal executive offices) (zip code)
Registrant's telephone number, including area code: (810) 358-4010
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
--- ---
The number of shares outstanding of the registrant's Common Stock, par
value $.01, as of May 14, 1997 was 6,164.07.
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FIRST MERCURY FINANCIAL CORPORATION
INDEX
-----
PART I. FINANCIAL INFORMATION Page No.
--------
Item 1. Financial Statements
Condensed Consolidated Balance Sheets;
March 31, 1997 (Unaudited) and
December 31, 1996 2
Condensed Consolidated Statements of
Operations (Unaudited); Three
Months Ended March 31, 1997 and 1996 3
Condensed Consolidated Statements of
Stockholders' Equity (Unaudited); Three
Months Ended March 31, 1997 and 1996 4
Condensed Consolidated Statements of
Cash Flows (Unaudited); Three Months
Ended March 31, 1997 and 1996 5
Notes to Condensed Consolidated Financial
Statements (Unaudited) 6
Item 2. Management's Discussion and Analysis
of Financial Condition and Results
of Operations 7
Part II. OTHER INFORMATION 11
<PAGE>
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
FIRST MERCURY FINANCIAL CORPORATION
Condensed Consolidated Balance Sheets
<TABLE>
<CAPTION>
March 31, December 31,
Assets 1997 1996
------ ---- ----
(Unaudited)
<S> <C> <C>
Investments:
Debt securities available for sale, at market value $ 69,859,301 71,871,818
Preferred stocks, at market 2,747,812 2,691,194
Common stocks, at market 52,668 52,200
Short-term investments 2,797,364 1,810,340
------------- -----------
Total investments 75,457,145 76,425,552
Cash and cash equivalents 2,223,337 3,945,289
Premiums and reinsurance balances receivable 2,771,800 2,584,644
Accrued investment income receivable 915,639 1,078,346
Other receivables 300,000 300,000
Reinsurance recoverable on unpaid losses 9,564,115 8,484,364
Prepaid reinsurance premiums 1,416,223 1,799,876
Deferred acquisition costs 759,274 691,319
Deferred federal income taxes 2,468,441 2,288,715
Federal income taxes recoverable 552,306 571,541
Fixed assets, net of accumulated depreciation 1,695,484 1,667,317
Other assets 2,285,693 2,274,410
------------- -----------
Total assets $ 100,409,457 102,111,373
------------- -----------
------------- -----------
Liabilities and Stockholders' Equity
------------------------------------
Loss and loss adjustment expense reserves $ 55,005,349 55,519,174
Unearned premium reserves 5,185,618 5,656,660
Senior subordinated notes payable 9,225,000 9,225,000
Ceded reinsurance payable 66,344 87,373
Funds held under reinsurance contracts 673,097 842,295
Deferred revenue 1,991,451 2,181,975
Accounts payable and accrued expenses 2,074,474 2,080,221
------------- -----------
Total liabilities 74,221,333 75,592,698
Minority interest 3,242 3,278
Stockholders' equity:
Cumulative preferred stock, issued and
outstanding 20,850 shares 209 209
Common stock, issued and
outstanding 6,164.07 shares 62 62
Gross paid-in and contributed capital 3,437,372 3,437,372
Net unrealized gains (losses) on marketable securities (402,723) 183,780
Retained earnings 23,149,962 22,893,974
------------- -----------
Total stockholders' equity 26,184,882 26,515,397
------------- -----------
Total liabilities and stockholders' equity $ 100,409,457 102,111,373
------------- -----------
------------- -----------
</TABLE>
See accompanying notes to condensed consolidated financial statements.
2
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FIRST MERCURY FINANCIAL CORPORATION
Condensed Consolidated Statements of Operations
(Unaudited)
Three Months Ended
March 31,
---------------------
1997 1996
---- ----
Net earned premiums $ 2,305,692 7,895,647
Net investment income 1,153,657 1,395,713
Realized gains (losses) on the sale of investments 124,294 152,691
Miscellaneous income 269,719 16,255
----------- -----------
Total revenues and other income 3,853,362 9,460,306
----------- -----------
Losses and loss adjustment expenses, net 1,733,503 7,507,634
Amortization of deferred acquisition expenses 457,853 1,817,273
Other underwriting expenses 986,319 959,071
Interest expense 278,120 298,607
----------- -----------
Total expenses 3,455,795 10,582,585
----------- -----------
Income(loss) before federal income taxes 397,567 (1,122,279)
Federal income taxes (benefit) 141,578 (245,725)
Net income $ 255,989 (876,554)
----------- -----------
----------- -----------
Per-share earnings $ 41.53 (142.20)
----------- -----------
----------- -----------
See accompanying notes to condensed consolidated financial statements.
3
<PAGE>
FIRST MERCURY FINANCIAL CORPORATION
Condensed Consolidated Statements of Stockholders' Equity
(Unaudited)
<TABLE>
<CAPTION>
Net Unrealized
Gross Paid-in Gains (Losses),
Preferred Common and Contributed Net of Federal Retained
Stock Stock Capital Income Taxes Earnings Total
----- ----- ------- ------------ -------- -----
<S> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1995 $ 209 62 3,474,872 1,270,614 21,655,479 26,401,236
Net income - - - - (876,554) (876,554)
Change in market values of
marketable investment securities - - - (956,745) - (956,745)
------ ---- --------- --------- ---------- ----------
Balance at March 31, 1996 $ 209 62 3,474,872 313,869 20,778,925 24,567,937
------ ---- --------- --------- ---------- ----------
------ ---- --------- --------- ---------- ----------
Balance at December 31, 1996 $ 209 62 3,437,372 183,780 22,893,973 26,515,396
Net income - - - - 255,989 255,989
Change in market values of
marketable investment securities - - - (586,503) - (586,503)
------ ---- --------- --------- ---------- ----------
Balance at March 31, 1997 $ 209 62 3,437,372 (402,723) 23,149,962 26,184,882
------ ---- --------- --------- ---------- ----------
------ ---- --------- --------- ---------- ----------
</TABLE>
See accompanying notes to condensed consolidated financial statements.
4
<PAGE>
FIRST MERCURY FINANCIAL CORPORATION
Condensed Consolidated Statements of Cash Flows
(Unaudited)
Three Months Ended
March 31,
---------------------
1997 1996
---- ----
Net cash used in operating activities $(1,606,324) 630,675
Cash flows from investing activities:
Cost of short-term investments acquired (9,981,794) (7,120,787)
Proceeds from disposals of short-term investments 8,994,771 8,833,284
Cost of debt securities acquired (5,869,496) (9,832,281)
Proceeds from maturities of debt securities 3,852,675 1,116,267
Proceeds from debt securities sold 3,284,770 6,742,422
Cost of equity securities acquired (305,770) (395,411)
Proceeds from equity securities sold 286,022 1,090,211
Other, net (101,806) (164,178)
----------- -----------
Net cash used in investing activities 159,372 269,527
----------- -----------
Interest payments on senior subordinated notes (275,000) (275,000)
----------- -----------
Net decrease in cash and cash equivalents (1,721,952) 625,202
Cash and cash equivalents at beginning of period 3,945,289 2,336,140
----------- -----------
Cash and cash equivalents at end of period $ 2,223,337 2,961,342
----------- -----------
----------- -----------
5
<PAGE>
FIRST MERCURY FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. The accompanying unaudited condensed consolidated financial statements of
First Mercury Financial Corporation and subsidiaries (the "Company")
have been prepared pursuant to the rules and regulations of the
Securities and Exchange Commission. Certain information and note
disclosures normally included in financial statements prepared in
accordance with generally accepted accounting principles have been
condensed or omitted. In management's opinion, all adjustments,
consisting of normal recurring adjustments, which are necessary for a
fair presentation of financial position and results of operations, have
been made. It is recommended that these condensed consolidated
financial statements be read in conjunction with the consolidated
financial statements and notes related thereto included in the December
31, 1996 annual report on Form 10-K.
The results of operations for the three month period ended March 31, 1997,
are not necessarily indicative of the results to be expected for the full
year.
2. Per share earnings are computed by dividing net income by the weighted
average number of shares of common stock outstanding during the period.
6
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
First Mercury Financial Corporation ("Mercury") is an insurance holding
company incorporated in Delaware in December 1993 and engaged, through its
subsidiaries, in the underwriting of specialty commercial lines and
non-standard automobile insurance for individuals. Mercury's subsidiaries
are First Mercury Insurance Company ("FMIC"), an Illinois property and
casualty insurance company and successor to First Mercury Syndicate, Inc.
(the "Syndicate"), All Nation Insurance Company ("All Nation") and its
wholly owned subsidiary, National Family Insurance Corporation, in Liquidation
("National Family"), both Minnesota property and casualty insurance companies.
Mercury and its subsidiaries are referred to herein as the "Company."
National Family has been in liquidation under the oversight of the Ramsey
County District Court in Minnesota since December 1996. Prior to the
liquidation order, National Family was in rehabilitation for over 30 years.
The Company became affiliated with National Family upon its purchase of All
Nation in 1992. Under generally accepted accounting principles, because All
Nation lacks voting control over National Family, the financial statements
of National Family are not consolidated with the financial statements of the
Company.
Prior to its withdrawal from the Illinois Insurance Exchange ("IIE") in
December 1996, the Syndicate operated as an underwriting member of the IIE.
Under the eligibility of the IIE, the Syndicate wrote general liability
insurance, allied property and auto physical damage coverage in 44 states,
the District of Columbia, and the U.S. Virgin Islands. On June 28, 1996, the
Syndicate formed FMIC as an Illinois property and casualty insurance
subsidiary with an initial capitalization of $5 million and a subsequent $15
million contribution to surplus. The formation of FMIC, a licensed Illinois
insurer, provided the Syndicate with an affiliated company in which to
potentially place coverages offered by the Syndicate and in which to reinsure
certain of the Syndicate's outstanding liabilities. Under a loss portfolio
transfer, on June 28, 1996, the Syndicate transferred approximately $35
million in loss and loss adjustment expense reserves and corresponding assets
to FMIC. In conjunction with the formation of FMIC and the loss portfolio
transfer, on July 8, 1996, the Syndicate notified the IIE of its intention to
withdraw from the IIE. On November 7, 1996, the Syndicate and the IIE
executed a withdrawal agreement. Subsequent to the Syndicate's withdrawal,
the Syndicate was merged into FMIC on December 16, 1996. As of March 31, 1997,
FMIC was an admitted carrier only in the state of Illinois. As a result, FMIC
and Empire Indemnity Insurance Company ("Empire") entered into a quota share
reinsurance arrangement effective July 18, 1996 whereby Empire writes on a
direct basis the coverages previously offered by the Syndicate and cedes
50 percent of such business to FMIC.
On May 1, 1996, an agreement was entered into between Mercury, All
Nation, Allstate Insurance Company ("Allstate") and its wholly owned
subsidiary, Deerbrook Insurance Company ("Deerbrook"), for the assignment of
All Nation's independent agent contracts to Deerbrook and the ceding of
associated prospective premium to Allstate on the agency-produced
non-standard automobile business of All Nation. The agreement also included a
three year non-compete clause and various financial guarantees by Mercury.
Under the agreement, All Nation continues to write agency non-standard
automobile coverages and cedes 100 percent of the written business to
Allstate under a quota share reinsurance agreement for a period of up to two
years, as Deerbrook is taking over the direct writing and servicing
responsibility from All Nation on a state-by-state basis over the two-year
period. In addition, All Nation provides underwriting and administrative
services for the ceded business on a percentage of premiums basis for an
initial period of up to
7
<PAGE>
two years. The agreements do not include All Nation's direct response
non-standard automobile business or agency-produced non-standard automobile
business written prior to May 1, 1996.
RESULTS OF OPERATIONS
The following table reflects revenues of the Company for the three month
periods ended March 31, 1997 and 1996:
Quarter ended March 31,
--------------------------------------
1997 1996
------------------ ----------------
Amount Percent Amount Percent
------- ------- ------ -------
(Dollars in thousands)
NET PREMIUMS EARNED:
Specialty commercial lines:
Security, fire and alarm......... $1,617 70.2% $2,098 26.6%
Police........................... 19 0.8 292 3.7
Public officials................. 93 4.0 186 2.4
Other............................ 369 16.0 307 3.9
Non-standard automobile lines:
Agency personal auto liability... 0 0.0 3,567 45.2
Direct personal auto liability... 134 5.8 212 2.7
Agency personal auto physical
damage.......................... 0 0.0 1,083 13.7
Direct personal auto physical
damage.......................... 74 3.2 151 1.8
------ ----- ------ -----
Total net premiums earned........... $2,306 100.0% $7,896 100.0%
------ ----- ------ -----
------ ----- ------ -----
NET PREMIUMS EARNED
Net premiums earned for the three months ended March 31, 1997 declined
70.8% to $2.3 million from $7.9 million for the year earlier period. The
Company's specialty commercial lines, security, fire, alarm, police, public
official and miscellaneous commercial coverages, experienced a decline in net
premiums earned of 27.2% to $2.1 million for the three months ended March 31,
1997 as compared to $2.9 million for the three months ended March 31, 1996.
This decrease occurred principally due to the quota share reinsurance
arrangement entered into with Empire and the Company's decision to non-renew
a substantial amount of the police business in the first quarter of 1996.
Due to the sale of All Nation's independent agent contracts to Deerbrook
effective May 1, 1996, net premiums earned for private passenger non-standard
automobile coverages decreased 95.9% in the first quarter of 1997 to $208,000
from $5.0 million for the three months ended March 31, 1996.
NET INVESTMENT INCOME AND REALIZED INVESTMENT GAINS (LOSSES)
Net investment income decreased approximately $242,000 to $1.2 million
for the three months ended March 31, 1997 as compared to $1.4 million for
the three months ended March 31, 1996.
8
<PAGE>
The decrease resulted from a decline in the Company's average invested assets
due to the reduction in premium revenues at All Nation under the quota share
reinsurance agreement with Allstate.
For the three months ended March 31, 1997, the Company realized a net
gain on the sale of investments of $124,000 versus a net gain of $153,000 for
the same period in the prior year.
At March 31, 1997, the unrealized loss on investments available for sale,
net of tax, was $403,000 in comparison to a $184,000 unrealized gain as of
December 31, 1996. The market value of the Company's portfolio has been
adversely affected by the increase in interest rates during the first quarter
of 1997.
LOSS AND LOSS ADJUSTMENT EXPENSES
Loss and loss adjustment expenses incurred decreased 76.9% to $1.7
million for the quarter ended March 31, 1997 from $7.5 million for the year
earlier period. The loss and loss adjustment expense ratio for private
passenger automobile coverages decreased to 50.2% for the three months ended
March 31, 1997 as compared to 103.3% for the three months ended March 31,
1996. The decrease resulted primarily from favorable development in the
runoff of the agent-produced non-standard automobile reserves. Within the
specialty commercial lines, the loss and loss adjustment expense ratio
increased marginally to 77.4% for the three months ended March 31, 1997
versus 76.7% for the comparable period in the preceding year. The increase
resulted from severity experienced in the Company's commercial multi-peril
business during the first quarter of 1997.
AMORTIZATION OF DEFERRED ACQUISITION COSTS AND OTHER UNDERWRITING EXPENSES,
INTEREST EXPENSE AND MISCELLANEOUS INCOME (EXPENSE)
Amortization of deferred acquisition costs and other underwriting
expenses represent the Company's costs to generate premium volume. For the
first quarter of 1997, acquisition costs and other underwriting expenses
declined approximately 48.0% to $1.4 million for the three months ended
March 31, 1997 as compared to $2.8 million for the same period in the
preceding year. The Company's underwriting expense ratio increased to 52.9%
for the quarter ended March 31, 1997 in comparison to 36.0% for the quarter
ended March 31, 1996. The increase in the expense ratio principally occurred
due to the decline in net premiums written in the first quarter of 1997 in
comparison to the Company's fixed costs of its insurance operations.
The Company incurred $278,000 and $299,000 of interest expense related to
the $10 million senior subordinated notes during the three months ended March
31, 1997 and 1996, respectively. The decrease in interest expense resulted
from the Company's repurchase of $775,000 of its own senior subordinated
notes during 1996.
The Company realized $270,000 of miscellaneous income in the first quarter
of 1997 as compared to $16,000 in the first quarter of 1996 primarily due to
the recognition of approximately $241,000 of revenue under the non-compete
and service contract agreements with Allstate. No revenue was recognized
under these agreements in the three months ended March 31, 1996.
FEDERAL INCOME TAXES
The effective tax rate for the three months ended March 31, 1997 of 35.6%
differs from the
9
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federal tax rate of 34% primarily due to non-deductible expenses such as
officers' life insurance.
NET INCOME (LOSS)
The Company recognized pre-tax net income of $398,000 for the three
months ended March 31, 1997 as compared to a pre-tax net loss of $1.1 million
for the three months ended March 31, 1996. The 1997 income includes
approximately $241,000 recognized under the non-compete clause and the
service contract of the agreement with Allstate. Excluding these amounts,
the Company would have recognized pre-tax net income of $157,000. The
improvement in results from the first quarter of 1996 in comparison to the
first quarter of 1997 occurred due to the sale of the Company's unprofitable
agent-produced non-standard automobile book to Deerbrook.
LIQUIDITY AND CAPITAL RESOURCES
Mercury is a holding company whose principal assets are its investment in
the capital stock of FMIC and All Nation. Generally, Mercury is dependent
upon the receipt of dividends from FMIC and All Nation to fund any necessary
cash requirements, including debt service requirements. FMIC and All Nation
are restricted by regulation as to the amount of dividends they may pay
without regulatory approval. No dividends were paid by FMIC or All Nation
to Mercury in the first quarter of 1997. Mercury also anticipates cash
payments from Deerbrook of $1.2 million in 1997 for the non-compete
agreement. In addition, Mercury receives annual payments from its
subsidiaries when appropriate pursuant to a tax allocation agreement between
Mercury and its subsidiaries. The Company believes these amounts are
sufficient to meet Mercury's current cash flow requirements.
The Company's subsidiaries' primary sources of cash are from premiums
collected and amounts earned from the investment of this cash flow. The
principal uses of funds are the payment of claims and related expenses, other
operating expenses and interest expense. The Company's insurance operations
utilized cash in operations of $1,606,000 during the three months ended
March 31, 1997 as compared to cash generated from operations of $631,000 in
the first quarter of 1996. The decreased cash flow resulted primarily from a
decline in premium revenues at All Nation under the quota share reinsurance
agreement with Allstate.
At March 31, 1997, the insurance subsidiaries maintained cash and cash
equivalents and short-term investments of $5.0 million to meet short-term
payment obligations. In addition, the Company's investment portfolio is
heavily weighted toward short-term fixed maturities and a portion of the
portfolio could be liquidated without material adverse financial impact
should further liquidity be necessary.
As part of its investment strategy, and as required by debt covenants,
the Company establishes a level of cash and highly liquid short- and
intermediate-term securities which, combined with expected cash flow, is
believed adequate to meet foreseeable payment obligations. As part of this
strategy, the Company attempts to maintain an appropriate relationship
between the average duration of the investment portfolio and the approximate
duration of its liabilities. The weighted average maturity of the Company's
fixed income portfolio as of March 31, 1997 was approximately three years.
Under IIE regulations, the Syndicate maintained a $1,000,000 deposit in a
Guaranty Fund Trust Account prior to its withdrawal from the IIE which required
at least 50 percent of the deposit to be in cash and/or marketable
securities. Under the terms of the Syndicate's withdrawal agreement with the
IIE, a $1,000,000 deposit must be maintained in the Guaranty Fund Trust
Account of the IIE for a period of three years from November 7, 1996.
The Syndicate's withdrawal agreement also required FMIC to establish a
trust fund for the payment of claims under insurance policies issued and
reinsurance agreements entered into by the Syndicate. Investments held in
trust for payment of Syndicate claims approximated $32.6 million at March 31,
1997.
10
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FIRST MERCURY FINANCIAL CORPORATION
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company's subsidiaries are subject to routine legal proceedings in
connection with their property and casualty insurance business. Neither
Mercury nor any of its subsidiaries are involved in any pending or threatened
legal proceedings which reasonably could be expected to have a material
adverse impact on the Company's financial condition or results of operations.
ITEM 2. CHANGES IN SECURITIES
Not applicable.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the first
quarter of 1997.
ITEM 5. OTHER INFORMATION
Not applicable.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a. EXHIBITS
Exhibit 27. Financial Data Schedule
b. REPORTS ON FORM 8-K
No report on Form 8-K was filed by the Registrant during the quarter ended
March 31, 1997.
11
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
FIRST MERCURY FINANCIAL CORPORATION
Date: May 14, 1997 By: /S/ William S. Weaver
-----------------------------
William S. Weaver
Chief Financial Officer
(Principal Financial Officer
and duly authorized to sign on
behalf of the Registrant)
12
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 7
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-END> MAR-31-1997
<DEBT-HELD-FOR-SALE> 69859
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 2527
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 75457
<CASH> 2223
<RECOVER-REINSURE> 379
<DEFERRED-ACQUISITION> 759
<TOTAL-ASSETS> 100409
<POLICY-LOSSES> 0
<UNEARNED-PREMIUMS> 5186
<POLICY-OTHER> 55005
<POLICY-HOLDER-FUNDS> 0
<NOTES-PAYABLE> 9225
0
0
<COMMON> 0
<OTHER-SE> 3438
<TOTAL-LIABILITY-AND-EQUITY> 100409
2306
<INVESTMENT-INCOME> 1154
<INVESTMENT-GAINS> 124
<OTHER-INCOME> 270
<BENEFITS> 1733
<UNDERWRITING-AMORTIZATION> 458
<UNDERWRITING-OTHER> 986
<INCOME-PRETAX> 398
<INCOME-TAX> 142
<INCOME-CONTINUING> 256
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 256
<EPS-PRIMARY> 41.53
<EPS-DILUTED> 41.53
<RESERVE-OPEN> 47035
<PROVISION-CURRENT> 2680
<PROVISION-PRIOR> (946)
<PAYMENTS-CURRENT> 309
<PAYMENTS-PRIOR> 3019
<RESERVE-CLOSE> 45441
<CUMULATIVE-DEFICIENCY> 0
</TABLE>
