10-K405 1 d85500e10-k405.txt FORM 10-K FOR FISCAL YEAR END DECEMBER 31, 2000 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K Annual Report Pursuant to Section 13 or 15 (d) of The Securities Exchange Act of 1934 For the fiscal year ended Commission file number 1-9828 December 31, 2000 GAINSCO, INC. (Exact name of registrant as specified in its charter) TEXAS 75-1617013 (State of Incorporation) (IRS Employer Identification No.) 500 Commerce Street Fort Worth, Texas 76102 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code (817) 336-2500 Securities registered pursuant to Section 12(b) of the Act: Title of each class Name of each exchange on which registered Common Stock ($.10 par value) The New York Stock Exchange Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. X Yes No --- ---- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] The aggregate market value of registrant's Common Stock ($.10) par value), registrant's only class of voting or non-voting common equity stock, held by non-affiliates of the registrant (19,176,363 shares) as of the close of the business on February 28, 2001 was $36,435,090 (based on the closing sale price of $1.90 per share on that date on the New York Stock Exchange). As of February 28, 2001, there were 21,169,736 shares of the registrant's Common Stock ($.10 par value) outstanding. 2 PART I ITEM 1. BUSINESS GENERAL DESCRIPTION GAINSCO, INC. ("GNA") is a holding company that provides administrative and financial services for its wholly owned subsidiaries. The term "Company" as used in this document includes GNA and its subsidiaries unless the context otherwise requires. GNA was incorporated in Texas on October 11, 1978. It completed its initial public offering on November 14, 1986. The Company is a property and casualty insurance company concentrating its efforts on three major nonstandard markets: commercial lines, personal lines and specialty lines. The commercial lines division includes commercial auto, garage, general liability and commercial property products. The personal lines division includes personal auto, umbrella and personal property products. The specialty lines division is focused on developing growth in professional liability products. The Company's insurance operations are conducted through four insurance companies: General Agents Insurance Company of America, Inc. ("General Agents"), an Oklahoma corporation; MGA Insurance Company, Inc.("MGAI"), a Texas corporation; GAINSCO County Mutual Insurance Company ("GCM"), a Texas chartered company: and Midwest Casualty Insurance Company ("MCIC"), a North Dakota insurance corporation acquired January 7, 2000. The Company is approved to write insurance in 48 states and the District of Columbia on a non-admitted basis and in 44 states and the District of Columbia on an admitted basis. The Company markets its commercial lines of insurance through 194 non-affiliated general agency offices and its personal line of insurance through approximately 1,145 non-affiliated retail agencies. Approximately 75% of the Company's gross premiums written during 2000 resulted from risks located in California, Florida, Georgia, Louisiana, Pennsylvania, and Texas. The Company's lines of insurance are written on certain classes and types of risks which are not generally insured by many of the standard companies, although such companies have been competing in this market more frequently in recent years. The strategy of the Company is to identify various types of risks where it can price its coverages profitably and competitively. This strategy results in changes in product mix and product design from time to time. For a description of the product lines presently written by the Company, see "Product Lines." The Company sets its policy premiums by applying its own judgment after consideration of the risks involved and the competition. Part of its analysis includes the review of historical premium rate and loss cost information as compiled and reported by independent rating bureaus. Through GCM, the Company has fronting agreements with two non-affiliated insurance companies. The business written under these agreements is ceded 100% to reinsurers rated "A (Excellent)" or better by A.M. Best Company ("Best's"), and 100% of the liabilities are fully collateralized with pledged investment grade securities or letters of credit. RECENT DEVELOPMENTS Preferred Stock Transactions Transactions with Goff Moore Strategic Partners, L.P. ("GMSP") 1999 GMSP Transaction. On October 4, 1999 GNA sold to GMSP, for an aggregate purchase price of $31,620,000, (i) 31,620 shares of GNA's Series A Convertible Preferred Stock (the "Series A Preferred Stock"), which are convertible into 6,200,000 shares of GNA's Common Stock, par value $0.10 per share ("Common Stock"), at a conversion price of $5.10 per share (subject to adjustment for certain events), (ii) a five year warrant (the "Series A Warrant") to purchase an aggregate of 1,550,000 shares of Common Stock at an exercise price of $6.375 per share and (iii) a seven year warrant (the "Series B Warrant") to purchase an aggregate of 1,550,000 shares of Common Stock at an exercise of $8.50 per share. At closing GNA and its insurance company subsidiaries entered into Investment Management Agreements with GMSP pursuant to which GMSP manages their respective investment portfolios. Completion of this transaction (collectively, the "1999 GMSP Transaction") concluded the strategic alternatives review process that the Company initiated in 1998. See "Investment Strategy" and "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations -- Business Operations." 2001 GMSP Transaction. On March 23, 2001, the Company consummated a transaction (the "2001 GMSP Transaction") with GMSP pursuant to which, among other things, the Company issued shares of its newly created Series C Redeemable Preferred Stock (the "Series C Preferred Stock") to GMSP in exchange for an aggregate purchase price of $3.0 million in cash. In the 2001 GMSP Transaction, the warrants issued to GMSP in the 1999 GMSP Transaction were changed and the Company undertook to redeem the Series A Preferred Stock in 2006, subject to certain conditions. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations -- Business Operations." Transaction with Robert W. Stallings On March 23, 2001, the Company consummated a transaction (the "Stallings Transaction") with Robert W. Stallings pursuant to which, among other things, the Company issued shares of its newly created Series B Redeemable Convertible Preferred Stock (the "Series B Preferred Stock") and a warrant to purchase an aggregate of 1,050,000 shares of GNA common stock at the defined Conversion Price in exchange for an aggregate purchase price of $3.0 million in cash. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations -- Business Operations." Mr. Stallings has entered into a Consulting Agreement with the 2 3 Company and has been elected as non-executive Vice Chairman of the Board and a director of the Company. Change in A.M. Best Rating. On March 27, 2001, A.M. Best Co. downgraded the Company's insurance subsidiaries current rating of "A-" (Excellent) to "B++" (Very Good), and assigned a negative outlook. Reinsurance. Effective December 31, 2000 the Company entered into a quota share reinsurance agreement whereby the Company ceded 100% of its commercial auto liability unearned premiums and 50% of all other commercial business unearned premiums at December 31, 2000 to a non-affiliated reinsurer. For policies with an effective date of January 1, 2001 or subsequent, the Company entered into a quota share reinsurance agreement whereby the Company will cede 20% of its commercial business to a non-affiliated reinsurer. Also effective December 31, 2000, the Company entered into a reserve reinsurance cover agreement with a non-affiliated reinsurer. This agreement reinsures the Company's ultimate net aggregate liability in excess of $32,500,000 up to an aggregate limit of $57,150,000 for net commercial auto liability losses and loss adjustment expense incurred but unpaid as of December 31, 2000. The Company established a reinsurance balance receivable and a liability for funds held under reinsurance agreements for the reserves transferred at December 31, 2000. Exit from Trucking Lines. On November 13, 2000 the Company announced that, due to increases in underlying claims severity trends for the commercial trucking business, the Company decided it would cease writing certain identified non-profitable commercial trucking business that had accounted for approximately $25 million in annual premiums or about 15% of the Company's gross premiums written. See "Product Lines," "Reinsurance, Unpaid Claims and Claim Adjustment Expenses" and "Item 7. Management's Discussion and Analysis of Financial Condition And Results Of Operations." Tri-State Acquisition. On January 7, 2000, the Company acquired Tri-State, Ltd. ("Tri-State"), an insurance operation specializing in underwriting, servicing and claims handling of nonstandard personal auto insurance in Minnesota, North Dakota and South Dakota. Tri-State owns and operates a managing general agency, a motor vehicle driving records service company and an insurance subsidiary, MCIC. Tri-State was incorporated in 1980 and currently markets nonstandard personal auto insurance through over 540 retail agencies in its three key states and commercial automobile insurance in four states. The purchase price consideration consisted of $6,000,000 in cash at closing, plus additional payments of up to $5,500,000 in cash over the next several years, contingent on conversion of business to the Company, meeting specific profitability targets and Tri-State's 1999 year-end book value. Tri-State's insurance subsidiary, MCIC, had approximately $3,000,000 of policyholders' surplus at December 31, 1999. PRODUCT LINES The Company's principal products serve certain nonstandard markets within the commercial lines and personal lines. The following table sets forth, for each product line, gross premiums written (before ceding any amounts to reinsurers), percentage of gross premiums written for the periods indicated and the number of policies in force at the end of each period.
As of and for the years ended December 31 -------------------------------------------------------------------- 2000 1999 1998 -------------------- -------------------- -------------------- (Dollar amounts in thousands) Gross Premiums Written: Commercial Lines $113,354 68% $ 97,139 73% $ 88,188 97% Personal Lines 54,932 32 36,759 27 2,974 3 -------- -------- -------- -------- -------- -------- $168,286 100% $133,898 100% $ 91,162 100% ======== ======== ======== ======== ======== ======== Policies in Force (End of Period) 87,048 68,943 38,939
Commercial Lines The commercial lines of insurance written by the Company include: Commercial Auto The commercial auto coverage underwritten by the Company includes risks associated with local haulers of specialized freight, tradespersons' vehicles and trucking companies. See "Recent Developments - Exit from Trucking Lines." 4 4 Garage The Company's garage product line includes garage liability, garage keepers' legal liability and dealers' open lot coverages. The Company targets its coverage to used car dealers, recreational vehicle dealers, automobile repair shops and wrecker/towing risks. General Liability The Company underwrites general liability insurance for businesses such as car washes, janitorial services, small contractors, apartment buildings, rental dwellings and retail stores. Property The Company underwrites commercial property coverages that include fire, extended coverage and vandalism on commercial establishments packaged with its liability product or on a monoline basis. Specialty Lines The Company underwrites and manages programs in professional liability for lawyers, real estate agents, educators and other general professions, as well as directors and officers liability. Personal Lines The personal lines of insurance written by the Company include: Personal Auto The Company's personal auto product line is in the nonstandard personal auto market and is primarily written with minimum liability limits. Umbrella The Company writes personal umbrella risks which do not have access to the preferred markets. Property The Company writes nonstandard dwelling fire risks and is expanding into nonstandard homeowners coverages. REINSURANCE The Company purchases reinsurance in order to reduce its liability on individual risks and to protect against catastrophe claims. A reinsurance transaction takes place when an insurance company transfers, or "cedes", to another insurer a portion or all of its exposure. The reinsurer assumes the exposure in return for a portion or the entire premium. The ceding of insurance does not legally discharge the insurer from its primary liability for the full amount of the policies, and the ceding company is required to pay the claim if the reinsurer fails to meet its obligations under the reinsurance agreement. Commercial Lines Prior to 1999, the Company wrote commercial casualty policy limits of $1,000,000. For policies with an effective date occurring from 1995 through 1998, the Company has first excess casualty reinsurance for 100% of casualty claims exceeding $500,000 up to the $1,000,000 limits, resulting in a maximum net claim retention per risk of $500,000 for such policies. During 1999 and 2000, the Company wrote commercial casualty policy limits of $5,000,000. For policies with an effective date occurring in 1999 or 2000, the Company has first excess casualty reinsurance for 100% of casualty claims exceeding $500,000 up to $1,000,000 and second excess casualty reinsurance for 100% of casualty claims exceeding $1,000,000 up to the $5,000,000 limits, resulting in a maximum net claim retention per risk of $500,000. The Company uses facultative reinsurance for policy limits written in excess of $5,000,000. Effective December 31, 2000 the Company entered into a quota share reinsurance agreement whereby the Company ceded 100% of its commercial auto liability unearned premiums and 50% of all other commercial business unearned premiums at December 31, 2000 to a non-affiliated reinsurer. For policies with an effective date of January 1, 2001 or subsequent, the Company entered into a quota share reinsurance agreement whereby the Company will cede 20% of its commercial business to a non-affiliated reinsurer. Also effective December 31, 2000, the Company entered into a reserve reinsurance cover agreement with a non-affiliated reinsurer. This agreement reinsures the Company's 5 5 ultimate net aggregate liability in excess of $32,500,000 up to an aggregate limit of $57,150,000 for net commercial auto liability losses and loss adjustment expense incurred but unpaid as of December 31, 2000. The Company established a reinsurance balance receivable and a liability for funds held under reinsurance agreements for the reserves transferred at December 31, 2000. Prior to 2001, the Company had property excess per risk reinsurance that covered property claims exceeding $100,000 up to $5,000,000 net loss each risk. The Company used facultative reinsurance for limits written on individual risks in excess of $5,000,000. For 2001, the Company also carries property excess per risk reinsurance that covers property claims exceeding $150,000 up to $1,500,000 net loss each risk. The Company uses facultative reinsurance for limits written on individual risks in excess of $1,500,000. For 1998 through 2001, the Company also has excess casualty clash reinsurance for $5,000,000 in ultimate net losses on any one accident in excess of $1,000,000 in ultimate net losses arising out of the accident. The Company is operating under excess casualty reinsurance agreements with six reinsurance companies for its commercial lines business, each of which reinsures a given percentage of ceded risks. The Company's excess reinsurance is provided in varying amounts by these reinsurers who are rated "A (Excellent)" or better by Best's. See "Rating." The following table identifies each such reinsurer and sets forth the percentage of the coverage assumed by each of them:
Percentage of Risk Reinsured ---------------------------------------------------------- 2001 2000 1999 ---------- ---------------------- ---------------------- 1st Excess 1st Excess 2nd Excess 1st Excess 2nd Excess ---------- ---------- ---------- ---------- ---------- Excess Reinsurer: American Re-insurance Company --% 35% 40% --% 40% Dorinco Reinsurance Company -- -- -- 35 -- First Excess and Reinsurance Corporation -- -- 40 35 40 Folksamerica Reinsurance Company -- 15 -- -- -- GE Reinsurance Corporation 65 20 -- -- -- GMAC Re/Motors Insurance Corporation 15 -- -- -- -- Liberty Mutual Insurance Company 20 20 20 20 20 Republic Western Insurance Company -- 10 -- 10 -- ------ ------ ------ ------ ------ 100% 100% 100% 100% 100% ====== ====== ====== ====== ======
Specialty Lines For its lawyers professional liability coverages, the Company has quota share reinsurance for 50% of the first $1,000,000 of professional liability claims and excess casualty reinsurance for 100% of professional liability claims exceeding $1,000,000 up to $5,000,000 policy limits resulting in a maximum net claim retention per risk of $500,000. For its real estate agents professional liability coverages, the Company has quota share reinsurance for 25% of the first $1,000,000 of professional liability claims resulting in a maximum net claim retention per risk of $750,000. For its educators professional liability coverages, the Company has quota share reinsurance for 60% of the first $1,000,000 of professional liability claims and excess casualty reinsurance for 100% of professional liability claims exceeding $1,000,000 up to $5,000,000 policy limits resulting in a maximum net claim retention per risk of $400,000. For its directors and officers liability coverages, the Company has quota share reinsurance for 90% of the first $5,000,000 of professional liability claims resulting in a maximum net claim retention per risk of $500,000. For its miscellaneous professional liability coverages, the Company has quota share reinsurance for 50% of the first $1,000,000 of professional liability claims resulting in a maximum net claim retention per risk of $500,000. Personal Lines The Company's personal auto business is produced by NSL and Tri-State or written on a direct basis through MCIC. For business produced by NSL with an effective date of April 1, 2000 through December 31, 2000, the Company has excess of loss reinsurance for 100% of claims in excess of $25,000 up to the $100,000 policy limits and quota share reinsurance for 20% of the first $25,000 of claims resulting in a maximum net claim retention per risk of $20,000. For business produced by NSL with an effective date of January 1, 2001 or after, the Company has excess of loss reinsurance for 100% of claims in excess of $25,000 up to the $100,000 policy limits and quota share reinsurance for 50% of the first $25,000 of claims resulting in a maximum net claim retention per risk of $12,500. 6 6 For business produced by Tri-State or written on a direct basis with MCIC with an effective date prior to January 1, 2001, the Company has excess of loss reinsurance for 100% of claims in excess of $25,000 up to the $100,000 policy limits and quota share reinsurance for 50% of the first $25,000 of claims resulting in a maximum net claim retention per risk of $12,500. For business produced by Tri-State or written on a direct basis with MCIC with an effective date of January 1, 2001 or after, the Company has excess of loss reinsurance for 100% of claims in excess of $25,000 up to the $100,000 policy limits and quota share reinsurance for 75% of the first $25,000 of claims resulting in a maximum net claim retention per risk of $6,250. For its umbrella coverages for 1999 through 2001, the Company has excess casualty reinsurance for 100% of umbrella claims exceeding $1,000,000 up to $10,000,000 policy limits. The Company also has quota share reinsurance for 75% of the first $1,000,000 of umbrella claims resulting in a maximum net claim retention per risk of $250,000. For its personal auto coverages for 1998 through 2001, the Company has excess casualty clash reinsurance for $5,000,000 in ultimate net losses on any one accident in excess of $1,000,000 in ultimate net losses arising out of the accident. Commercial and Personal Lines Excess casualty reinsurance carried by the Company includes "extra-contractual obligations" coverage. This coverage protects the Company against claims arising out of certain legal liability theories not directly based on the terms and conditions of the Company's policies of insurance. Extra-contractual obligation claims are covered 90% under the excess casualty reinsurance treaty up to its respective limits. Prior to 2001, the Company carried catastrophe property reinsurance to protect it against catastrophe occurrences for 95% of the property claims that exceed $500,000 but do not exceed $17,500,000 for a single catastrophe. Beginning in 2001, the Company carries catastrophe property reinsurance to protect it against catastrophe occurrences for 95% of the property claims that exceed $1,500,000 but do not exceed $13,000,000 for a single catastrophe as well as second event catastrophe property reinsurance for 100% of $1,000,000 excess of $500,000 on a second catastrophic event. Since 1995, the Company has had reinsurance fronting arrangements with non-affiliated insurance companies. The Company retains no portion of the business written under these agreements as it is 100% ceded to non-affiliated reinsurers. Although these cessions are made to authorized reinsurers rated "A (Excellent)" or better by Best's, the agreements require that collateral (in the form of trust agreements and/or letters of credit) be maintained to assure payment of the unearned premiums and unpaid claims and claim adjustment expenses relating to the risks insured under these fronting arrangements. See Note (5) of Notes to Consolidated Financial Statements. 7 7 The Company has signed contracts in force for its reinsurance agreements for all years through 2000. The Company has written confirmations from reinsurers for 2001 regarding the basic terms and provisions under which they will assume the Company's risks, but, as of the date hereof, formal reinsurance contracts with these reinsurers have not been executed. It is customary in the industry for insurance companies and reinsurers to operate under such commitments pending the execution of formal reinsurance agreements. No assurance can be given that such reinsurance agreements will be executed or, if executed, that the terms and provisions thereof will not be modified. MARKETING AND DISTRIBUTION Commercial Lines The Company markets its commercial lines insurance products through 194 non-affiliated general agency offices that are compensated on a commission basis that varies by line of business. These general agents each represent several insurance companies, some of which may compete with the Company. The general agents solicit business from independent local agents or brokers, commonly referred to as retail agents, who are in direct contact with insurance buyers. The Company has elected to utilize general agents to market its insurance products in order to avoid the fixed costs of a branch office system. The Company requires that its general agents have a specified level of errors and omissions insurance coverage, which indirectly protects the Company against certain negligence on the part of general agents. The Company reviews its appointed agencies for financial solvency and liquidity levels. The Company has developed underwriting manuals to be used by its general agents. The general agents are authorized to bind the Company to provide insurance if the risks and terms involved in the particular coverage are within the underwriting guidelines set forth in the Company's underwriting manuals. The manuals stipulate minimum rates to be charged for the various classes of coverage offered. Certain coverages, such as auto liability, may only be written in some states by companies with the authority to write insurance on an admitted basis in such states. The Company currently is approved to write insurance on an admitted basis in 44 states and the District of Columbia. The Company has errors and omissions insurance coverage to protect against negligence on the part of its employees. Personal Lines The Company markets its nonstandard personal auto insurance through approximately 1,145 non-affiliated retail agencies that are compensated on a commission basis. The retail agents may represent several insurance companies, some of which may compete with the Company. The Company utilizes the retail agency market because they are in direct contact with the insurance buyers. The Company requires that its retail agents have a specified level of errors and omissions insurance coverage. The Company has developed underwriting manuals to be used by its retail agents. The retail agents are authorized to bind the Company to provide insurance if the risks and terms involved in the particular coverage are within the underwriting guidelines set forth in the Company's underwriting manuals. UNPAID CLAIMS AND CLAIM ADJUSTMENT EXPENSES The Company maintains reserves for the payment of claims and claim adjustment expenses for both reported and unreported claims. Claim reserves are estimates, at a given point in time, of amounts that the Company expects to pay on incurred claims based on facts and circumstances then known. The amount of claim reserves for reported claims is primarily based upon a case-by-case evaluation of the type of claim involved, the circumstances surrounding the claim, and the policy provisions relating to the type of claim. The amount of claim reserves for unreported claims and case reserve development is determined on the basis of historical information and anticipated future conditions by lines of insurance and actuarial review. Reserves for claim adjustment expenses are intended to cover the ultimate costs of settling claims, including investigation and defense of lawsuits resulting from such claims. Inflation is implicitly reflected in the reserving process through analysis of cost trends and review of historical reserve results. 8 8 The process of establishing claim reserves is an imprecise science and reflects significant judgmental factors. In many liability cases, significant periods of time, ranging up to several years or more, may elapse between the occurrence of an insured claim and the settlement of the claim. Some judicial decisions and legislative actions, even after coverage is written and reserves are initially set, broaden liability and policy definitions and increase the severity of claim payments. As a result of this and other societal and economic developments, the uncertainties inherent in estimating ultimate claim costs on the basis of past experience have increased significantly, further complicating the already difficult claim reserving process. Ultimate liability may be greater or lower than current reserves. Reserves are monitored by the Company using new information on reported claims and a variety of statistical techniques. The reserves are reviewed annually by an independent actuarial firm. The Company does not discount to present value that portion of its claim reserves expected to be paid in future periods. The following table sets forth the changes in unpaid claims and claim adjustment expenses, net of reinsurance cessions, as shown in the Company's consolidated financial statements for the periods indicated:
As of and for the years ended December 31 ----------------------------------------- 2000 1999 1998 ------------ ---------- ------------- (Amounts in thousands) Unpaid claims and claim adjustment expenses, beginning of period $ 132,814 136,798 113,227 Less: Ceded unpaid claims and claim adjustment expenses, beginning of period 37,299 35,030 29,524 ---------- ---------- ---------- Net unpaid claims and claim adjustment expenses, beginning of period 95,515 101,768 83,703 ---------- ---------- ---------- Net claims and claim adjustment expense incurred related to: Current period 124,077 75,976 59,635 Prior periods 19,362 373 26,718 ---------- ---------- ---------- Total net claim and claim adjustment expenses incurred 143,439 76,349 86,353 ---------- ---------- ---------- Net claims and claim adjustment expenses paid related to: Current period 58,898 32,651 19,693 Prior periods 54,683 49,951 48,595 ---------- ---------- ---------- Total net claim and claim adjustment expenses paid 113,581 82,602 68,288 ---------- ---------- ---------- Net reserves acquired through purchase of subsidiary 1,084 -- -- ---------- ---------- ---------- Net unpaid claims and claim adjustment expenses, end of period 126,457 95,515 101,768 Plus: Ceded unpaid claims and claim adjustment expenses, end of period 37,703 37,299 35,030 ---------- ---------- ---------- Unpaid claims and claim adjustment expenses, end of period $ 164,160 132,814 136,798 ========== ========== ==========
9 9 For 2000 the development in claims and claim adjustment expenses incurred was primarily the result of unanticipated development of commercial auto claims for the 1999, 1997 and 1996 accident years. At December 31, 2000 the Company believes that the carried reserves and the reinsurance agreements currently in force are sufficient to support the future emergence of prior year claim and claim adjustment expenses. For 1998 the development in claims and claim adjustment expenses incurred was primarily the result of unanticipated development for commercial auto claims for the 1997, 1996 and 1995 accident years. The following table sets forth, as of December 31, 2000, 1999 and 1998, differences between the amount of net unpaid claims and claim adjustment expenses reported in the Company's statements, prepared in accordance with statutory accounting principles ("SAP"), and filed with the various state insurance departments, and those reported in the consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP"):
As of December 31 ------------------------------- 2000 1999 1998 -------- -------- -------- (Amounts in thousands) Net unpaid claims and claim adjustment expenses reported on a SAP basis $126,457 96,472 102,404 Adjustments: Estimated recovery for salvage and subrogation -- (957) (636) -------- -------- -------- Net unpaid claims and claim adjustment expenses reported on a GAAP basis $126,457 95,515 101,768 ======== ======== ========
In January, 2000, the Company elected to take estimated salvage and subrogation into account when determining ultimate incurred losses and unpaid losses for financial statements prepared in accordance with SAP. The effect on prior periods was reflected in the Company's statutory financial statements as an adjustment to policyholders' surplus. The following table represents the development of GAAP balance sheet reserves for the years ended December 31, 1990 through 2000. The top line of the table shows the reserves for unpaid claims and claim adjustment expenses for the current and all prior years as recorded at the balance sheet date for each of the indicated years. The reserves represent the estimated amount of claims and claim adjustment expenses for claims arising in the current and all prior years that are unpaid at the balance sheet date, including claims that have been incurred but not yet reported to the Company. The second portion of the following table shows the net cumulative amount paid with respect to the previously recorded liability as of the end of each succeeding year. The third portion of the table shows the reestimated amount of the previously recorded net unpaid claims and claim adjustment expenses based on experience as of the end of each succeeding year, including net cumulative payments made since the end of the respective year. For example, the 1994 liability for net claims and claim adjustment expenses reestimated six years later (as of December 31, 2000) was $68,660,000 of which $68,438,000 has been paid, leaving a net reserve of $222,000 for claims and claim adjustment expenses in 1994 and prior years remaining unpaid as of December 31, 2000. "Net cumulative deficiency" represents the change in the estimate from the original balance sheet date to the date of the current estimate. For example, the 1994 net unpaid claims and claim adjustment expenses indicates a $7,903,000 net deficiency from December 31, 1994 to December 31, 2000 (six years later). Conditions and trends that 10 10 have affected development of liability in the past may or may not necessarily occur in the future. Accordingly, it may or may not be appropriate to extrapolate future redundancies or deficiencies based on this table.
As of and for the years ended December 31 ------------------------------------------------------------------------------------------------------ 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- (Amounts in thousands) Unpaid claims & claim adjustment expenses: Gross 45,214 53,148 66,517 72,656 80,729 95,011 105,691 113,227 136,798 132,814 164,160 Ceded 16,308 15,105 16,594 16,701 19,972 24,650 26,713 29,524 35,030 37,299 37,703 ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- Net 28,906 38,043 49,923 55,955 60,757 70,361 78,978 83,703 101,768 95,515 126,457 Net cumulative paid as of: One year later 10,251 15,037 22,470 24,090 24,730 32,584 39,654 48,595 49,951 54,683 Two years later 18,145 26,819 37,032 39,182 41,874 56,605 70,185 82,950 80,158 Three years later 23,255 33,879 45,884 46,688 55,338 73,349 90,417 103,025 Four years later 26,171 37,292 51,082 54,428 62,389 82,667 101,273 Five years later 26,970 39,999 54,092 57,628 66,573 87,432 Six years later 28,399 41,143 55,828 58,191 68,438 Seven years later 28,734 42,020 56,754 59,733 Eight years later 28,806 42,464 56,941 Nine years later 29,109 42,540 Ten years later 29,031 Net unpaid claims and claim adjustment expenses reestimated as of: One year later 28,354 38,528 54,150 59,573 61,157 75,703 87,095 110,421 102,141 114,877 Two years later 28,479 42,235 57,223 59,922 62,296 80,356 104,588 111,981 111,861 Three years later 30,035 43,217 57,459 59,247 63,871 88,867 105,386 121,024 Four years later 30,129 42,493 56,832 58,414 67,442 89,030 111,314 Five years later 29,022 42,191 56,337 59,735 67,607 91,641 Six years later 29,073 41,984 56,721 59,695 68,660 Seven years later 28,908 42,356 56,938 60,008 Eight years later 28,828 42,527 57,354 Nine years later 29,037 42,955 Ten years later 29,031 Net cumulative deficiency (125) (4,912) (7,431) (4,053) (7,903) (21,280) (32,336) (37,321) (10,093) (19,362)
The deficiencies in the 1995 through 1999 years are primarily related to unanticipated development of commercial auto claims in those years as previously discussed. Net unpaid claims and claim adjustment expenses at December 31, 2000 were approximately $126,457,000, which the Company believes is adequate. 11 11 INSURANCE RATIOS CLAIMS, EXPENSE AND COMBINED RATIOS: Claims and expense ratios are traditionally used to interpret the underwriting experience of property and casualty insurance companies. Statutory Accounting Principles (SAP) Basis - Claims and claim adjustment expenses are stated as a percentage of premiums earned because claims may occur over the life of a particular insurance policy. Underwriting expenses on a SAP basis are stated as a percentage of net premiums written rather than premiums earned because most underwriting expenses are incurred when policies are written and are not spread over the policy period. Underwriting profit margin is achieved when the combined ratio is less than 100%. The Company's claims, expense and combined ratios and the property and casualty industry's claims, expense and combined ratios, both on a SAP basis, are shown in the following table: 12 12
Years ended December 31 ---------------------------------------------- 2000 1999 1998 1997 1996 ------ ------ ------ ------ ------ COMPANY RATIOS Claims Ratio 95.6% 67.9% 95.9% 60.0% 54.3% Expense Ratio 28.6 30.7 37.9 34.4 34.5 ------ ------ ------ ------ ------ Combined Ratio 124.2% 98.6% 133.8% 94.4% 88.8% ====== ====== ====== ====== ====== INDUSTRY RATIOS(1) Claims Ratio 81.5% 78.6% 76.2% 72.8% 78.4% Expense Ratio 27.5 28.0 27.3 27.1 26.3 ------ ------ ------ ------ ------ Combined Ratio 109.0% 106.6% 103.5% 99.9% 104.7% ====== ====== ====== ====== ======
---------- (1) The property and casualty industry as a whole, not companies with comparable lines of coverage, was used in the calculation of these ratios by A.M. Best. Ratios for 2000 are A.M. Best estimates. The unfavorable variance to the industry for 2000 with regard to the claims ratio is primarily the result of unanticipated development of commercial auto claims for the 1999, 1997 and 1996 accident years. The favorable variance to the industry for 1999 with regard to the claims ratio is primarily the result of writing shorter duration business than the industry as a whole. The unfavorable variance to the industry with regard to the claims ratio in 1998 is largely related to unanticipated unfavorable claim development recorded in 1998 on the 1997, 1996 and 1995 accident years for the commercial auto liability line. For 1998, the increase in the unfavorable variance to the industry with regard to the expense ratio is largely because of downward adjustments in reinsurance commission income as a result of the unanticipated unfavorable claim development in 1998. For 1999 and prior years, the unfavorable variance to the industry with regard to the expense ratios is a function of the specific lines that the Company writes. The Company ratios in the table above relate only to insurance operations. GNA as a holding company provides administrative and financial services for its wholly owned subsidiaries. The allocation of GNA's expenses solely to its insurance companies would have an impact on their results of operations and would also affect the ratios presented. As such, expenses related to GNA's strategic alternatives review process conducted in 1999 and 1998 are not included in these ratios. Generally Accepted Accounting Principles (GAAP) Basis - Claims and claim adjustment expenses are stated as a percentage of premiums earned as they are on a SAP basis. However, earned premiums include net policy fees earned whereas on a SAP basis policy fees earned are recorded on a gross basis. The GAAP expense ratio is based on premiums earned and includes the change in policy acquisition costs and underwriting expenses. Other differences include the treatment of the allowance for doubtful accounts. The following table presents the Company's claims, expense and combined ratios on a GAAP basis:
Years ended December 31 ---------------------------------------------- 2000 1999 1998 1997 1996 ------ ------ ------ ------ ------ Claims Ratio 94.7% 67.4% 93.7% 60.7% 54.7% Expense Ratio 31.6 32.0 39.0 33.7 33.8 ------ ------ ------ ------ ------ Combined Ratio 126.3% 99.4% 132.7% 94.4% 88.5% ====== ====== ====== ====== ======
The Company ratios in the table above relate only to insurance operations. The holding company provides administrative and financial services for its wholly owned subsidiaries. The allocation of the holding company's expenses solely to its insurance companies would have an impact on their results of operations and would also affect the ratios presented. 13 13 PREMIUM TO SURPLUS RATIO: The following table shows, for the periods indicated, the Company's statutory ratios of statutory net premiums written to statutory policyholders' surplus. While there is no statutory requirement which establishes a permissible net premiums written to surplus ratio, guidelines established by the National Association of Insurance Commissioners ("NAIC") provide that this ratio should not be greater than 3 to 1.
As of and for the years ended December 31 -------------------------------------------------------------- 2000 1999 1998 1997 1996 ---------- --------- --------- --------- --------- (Dollar amounts in thousands) Net premiums written $ 117,497 130,105 87,040 98,858 109,227 Policyholders' surplus $ 77,532 69,155 71,826 78,496 59,012 Ratio 1.52 to 1 1.88 to 1 1.21 to 1 1.26 to 1 1.85 to 1
INVESTMENT PORTFOLIO HISTORICAL RESULTS AND COMPOSITION The following table sets forth, for the periods indicated, the Company's investment results before income tax effects:
As of and for the years ending December 31 -------------------------------------------------------------------- 2000 1999 1998 1997 1996 ---------- ---------- ---------- ---------- ---------- (Dollar amounts in thousands) Average investments(1) $ 246,091 228,945 212,215 209,121 192,221 Investment income $ 14,093 9,722 9,803 9,731 9,161 Return on average investments(2) 5.7% 4.2% 4.6% 4.7% 4.8% Taxable equivalent return on average investments 6.5% 5.7% 6.2% 6.5% 6.6% Net realized gains (losses) $ (1,907) 606 693 327 472 Net unrealized gains (losses)(3) $ 5,906 (3,456) 2,922 2,422 1,559
---------- (1) Average investments is the average of beginning and ending investments at amortized cost, computed on an annual basis. (2) Includes taxable and tax-exempt securities. (3) Includes net unrealized gains (losses) for total investments. 14 14 The following table sets forth the composition of the investment portfolio of the Company.
As of December 31 --------------------------------------------------------------------------------------- 2000 1999 1998 -------------------------- -------------------------- ----------------------- (Dollar amounts in thousands) Amortized Fair Amortized Fair Amortized Fair Cost Value Cost Value Cost Value ---------- ---------- ---------- ---------- ---------- ---------- Type of Investment Fixed Maturities: Bonds held to maturity: U.S. Government securities $ -- -- -- -- 5,668 5,887 Tax-exempt state and municipal bonds -- -- -- -- 54,120 55,091 Bonds available for sale: U.S. Government securities 21,138 21,317 24,365 24,029 13,734 13,969 Tax-exempt state and municipal 45,284 45,472 148,983 146,204 130,072 131,619 bonds Corporate bonds 121,564 125,553 27,067 26,844 -- -- Certificates of deposit 845 845 455 455 595 595 Common stock 6,027 7,716 -- -- -- -- Other investments 4,581 4,442 1,288 1,170 318 269 ---------- ---------- ---------- ---------- ---------- ---------- 199,439 205,345 202,158 198,702 204,507 207,430 ---------- ---------- ---------- ---------- ---------- ---------- Short-term investments 40,840(1) 40,840(1) 46,478(1) 46,478(1) 4,749 4,749 ---------- ---------- ---------- ---------- ---------- ---------- Total investments $ 240,279 246,185 248,636 245,180 209,256 212,179 ========== ========== ========== ========== ========== ==========
---------- (1) Includes proceeds from 1999 GMSP Transaction and funds accumulated pending assumption of investment management of portfolio by GMSP. As these funds are invested by GMSP in longer term investments, the proportion of the portfolios invested in short-term investments is expected to return closer to historical levels. The maturity distribution of the Company's investments in fixed maturities is as follows:
As of December 31 ---------------------------------------------------- 2000 1999 ------------------------ ------------------------ (Dollar amounts in thousands) Amortized Amortized Cost Percent Cost Percent ---------- ---------- ---------- ---------- Within 1 year $ 22,203 11.8% $ 42,770 21.3% Beyond 1 year but within 5 years 102,822 54.4 113,979 56.7 Beyond 5 years but within 10 years 59,531 31.5 35,123 17.5 Beyond 10 years but within 20 years 4,275 2.3 5,622 2.8 Beyond 20 years -- -- 3,376 1.7 ---------- ---------- ---------- ---------- $ 188,831 100.0% $ 200,870 100.0% ========== ========== ========== ========== Average duration 2.9 yrs 2.6 yrs
As of December 31, 2000 and 1999, the Company did not have any non-performing fixed maturity securities. In the quarter ended December 31, 1999 all bonds classified as held to maturity were transferred to the available for sale classification and adjusted to fair value. The amortized cost at the date of transfer for these bonds was $41,069,988 and the fair value was $41,036,014, resulting in an unrealized loss before Federal income taxes of $33,794. The Company made this change since it no longer invests in bonds with the intent of holding them to maturity. See Note (1) of Notes to Consolidated Financial Statements. 15 15 INVESTMENT STRATEGY Commencing with the closing of the 1999 GMSP Transaction on October 4, 1999, the investment portfolios of GNA and its insurance company subsidiaries are managed by GMSP pursuant to its Investment Management Agreements with the respective companies. The investment policies are subject to the oversight and direction of the Investment Committees of the Boards of Directors of the respective companies. The respective Investment Committees consist entirely of directors not affiliated with GMSP. The investment policies of the insurance subsidiaries, which are also subject to the respective insurance company legal investment laws of the states in which they are organized, are to maximize after-tax yield while maintaining safety of capital together with adequate liquidity for insurance operations. See "Item 7A. Quantitative and Qualitative Disclosures About Market Risk." The insurance company portfolios may also be invested in equity securities within limits prescribed by applicable legal investment laws. Approximately $80.5 million of the bond securities held in the insurance company subsidiaries were redeployed during the year 2000 in an attempt to increase the taxable equivalent yield. This repositioning involved selling both taxable and tax-exempt bonds with a lower effective taxable equivalent interest yields and reinvesting the proceeds in corporate debt with a higher effective taxable equivalent interest yield. This strategy resulted in net realized before tax investment losses of $1,906,911 in 2000. The unrealized gain associated with the investment portfolio was $3,897,371 (net of tax effects) at December 31, 2000. See Note (3) of Notes to Consolidated Financial Statements. RATING A.M. Best Co. has currently assigned to the Company a pooled rating of "B++ (Very Good)", with a negative outlook. Best's ratings are based on an analysis of the financial condition and operation of an insurance company as they relate to the industry in general. GOVERNMENT REGULATION The Company's insurance companies are subject to varied governmental regulation in the states in which they conduct business. Such regulation is vested in state agencies having broad administrative power dealing with all aspects of the Company's business and is concerned primarily with the protection of policyholders rather than shareholders. The Company is also subject to statutes governing insurance holding company systems in the states of Oklahoma, Texas and North Dakota. These statutes require the Company to file periodic information with the state regulatory authorities, including information concerning its capital structure, ownership, financial condition and general business operation. These statutes also limit certain transactions between the Company and its insurance companies, including the amount of dividends which may be declared and paid by the insurance companies, (see Note (7) of Notes to Consolidated Financial Statements). Additionally, the Oklahoma, Texas and North Dakota statutes restrict the ability of any one person to acquire 10% or more of the Company's voting securities without prior regulatory approval. 16 16 COMPETITION The property and casualty insurance industry is highly competitive. The Company underwrites lines of insurance on risks not generally insured by many of the large standard property and casualty insurers. However, few barriers exist to prevent property and casualty insurance companies from entering into the Company's segments of the industry. To the extent this occurs, the Company can be at a competitive disadvantage because many of these companies have substantially greater financial and other resources and can offer a broader variety of specialty risk coverages. The Company believes that its principal competitive advantages are; 1) expertise in its product lines which facilitates underwriting selection and pricing and 2) service in underwriting and claims handling which provides its agents with a competitive advantage and a stable market. EMPLOYEES As of December 31, 2000, the Company employed 339 persons, of whom 23 were officers, 296 were staff and administrative personnel, and 20 were part-time employees. The Company is not a party to any collective bargaining agreement. The Company believes that its relations with its employees are good. 17 17 EXECUTIVE OFFICERS OF THE REGISTRANT Information concerning the executive officers of the Company as of March 30, 2001 is set forth below:
Name Age Position with the Company ---- --- ------------------------- Glenn W. Anderson 48 President, Chief Executive Officer and Director Richard M. Buxton 52 Senior Vice President Daniel J. Coots 49 Senior Vice President and Chief Financial Officer J. Landis Graham 46 Senior Vice President McRae B. Johnston 50 President, National Specialty Lines, Inc. Richard A. Laabs 45 Senior Vice President Joseph W. Pitts 37 Senior Vice President Stephen L. Porcelli 38 Senior Vice President Carolyn E. Ray 48 Senior Vice President Sam Rosen 65 Secretary and Director
Glenn W. Anderson has served as President, Chief Executive Officer and Director of the Company since April 1998. From 1996 to April 1998, Mr. Anderson served as Executive Vice President of USF&G. From 1993 to 1996, Mr. Anderson held the position of Senior Vice President with USF&G. Mr. Anderson has been engaged in the property and casualty insurance business since 1975. Richard M. Buxton has served as Vice President of the Company since December of 1996. In 1999, Mr. Buxton was promoted to Senior Vice President. From 1986 to 1996 Mr. Buxton was with KN Energy, Inc. in the position of Vice President of Strategic Planning and Financial Services. Daniel J. Coots has served as Vice President and Chief Financial Officer of the Company since 1987. In 1991 Mr. Coots was promoted to Senior Vice President. Mr. Coots has been engaged in the property and casualty insurance business since 1983. J. Landis Graham has served as Senior Vice President of the Company since 1998. From 1993 to 1998, Mr. Graham served as Vice President of the Company. Mr. Graham has been engaged in the property and casualty insurance business since 1976. McRae B. Johnston joined the Company in October 1998 when the Company acquired Lalande Group and since that time has served as President of National Speciality Lines, Inc., a subsidiary of the Company. Mr. Johnston is co-founder of National Specialty Lines, Inc. and has served as President since 1989. Mr. Johnston has been engaged in the property and casualty insurance business since 1976. 18 18 Richard A. Laabs has served as Vice President of the Company since June of 1996. Mr. Laabs was promoted to Senior Vice President in 1999. From August of 1995 to May of 1996, Mr. Laabs served as Assistant Vice President of the Company. From 1990 to 1995, Mr. Laabs was with Scottsdale Insurance Company in the position of Senior Information Systems Services Director. Mr. Laabs has been engaged in the property and casualty insurance business since 1978. Joseph W. Pitts has served as Vice President of the Company since August of 1997. Mr. Pitts was promoted to Senior Vice President in 1999. From 1992 to 1997, Mr. Pitts was with USAA in the position of Actuary and Manager. Mr. Pitts has been engaged in the property and casualty insurance business since 1988. Stephen L. Porcelli has served as Senior Vice President of the Company since 1999. From 1994 to 1999 Mr. Porcelli was with TIG Insurance Company in the position of Senior Vice President. Mr. Porcelli has been engaged in the property and casualty insurance business since 1989. Carolyn E. Ray has served as Senior Vice President of the Company since 1998. From 1986 to 1998, Ms. Ray served as Vice President of the Company. From 1984 to 1985, Ms. Ray served as Assistant Vice President of the Company. Ms. Ray has been engaged in the property and casualty insurance business since 1976. Sam Rosen has served as the Secretary and a Director of the Company since 1983. Mr. Rosen is a partner with the law firm of Shannon, Gracey, Ratliff & Miller, L.L.P. He has been a partner in that firm or its predecessors since 1966. That firm, or its predecessors, has provided significant legal services for the Company since 1979. ITEM 2. PROPERTIES The Company owns its corporate offices which provide approximately 35,000 square feet of office space and additional parking. Future expansion could be possible by converting the parking area into office space. The Company owns a 3.28 acre tract of land in Fort Worth, Texas and all improvements located thereon, including a 10,000 square foot office building. The Company currently has this property under lease to an unaffiliated third party. ITEM 3. LEGAL PROCEEDINGS In the normal course of its operations, the Company has been named as defendant in various legal actions seeking payments for claims denied by the Company and other monetary damages. In the opinion of the Company's management the ultimate liability, if any, resulting from the disposition of these claims will not have a material adverse effect on the Company's consolidated financial position or results of operations. The Company's management believes that unpaid claims and claim adjustment expenses are adequate to cover liabilities from claims that arise in the normal course of its insurance business. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. 19 19 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS. GNA's Common Stock is listed on the New York Stock Exchange (Symbol: GNA). The following table sets forth for the fiscal periods indicated the high and low closing sales prices per share of the Common Stock as reported by the New York Stock Exchange. The prices reported reflect actual sales transactions.
HIGH LOW 1998 First Quarter 8 11/16 7 7/8 1998 Second Quarter 9 7/8 6 1998 Third Quarter 7 15/16 5 15/16 1998 Fourth Quarter 7 1/8 5 15/16 1999 First Quarter 6 7/16 4 13/16 1999 Second Quarter 5 7/8 3 15/16 1999 Third Quarter 6 13/16 5 3/16 1999 Fourth Quarter 6 5/16 5 3/8 2000 First Quarter 6 5/16 5 1/2 2000 Second Quarter 6 4 9/16 2000 Third Quarter 4 15/16 3 11/16 2000 Fourth Quarter 4 1/4 2 3/8
Cash dividends of $.0175 per share were paid to shareholders of record on March 31, June 30, September 30 and December 31, 1998, March 31, June 30, September 30 and December 31, 1999 and March 31, June 30, September 30 and December 31, 2000. In February 2001, the Company discontinued quarterly dividends on the common stock. As of February 28, 2001, there were 279 shareholders of record of GNA's Common Stock. 20 20 ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA The selected consolidated financial data presented below for, and as of the end of each of the years ended December 31, have been derived from the consolidated financial statements of the Company which have been audited by KPMG LLP, independent certified public accountants. The consolidated balance sheets as of December 31, 2000 and 1999, and the consolidated statements of operations, shareholders' equity and comprehensive income and cash flows for each of the years in the three-year period ended December 31, 2000, and the independent auditors report thereon are included elsewhere in this document. The information presented below should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations," consolidated financial statements and the notes thereto, and the other financial information included herein.
Years ended December 31 --------------------------------------------------------------------- 2000 1999 1998 1997 1996 ---------- ---------- ---------- ---------- ---------- (Dollar amounts in thousands, except per share data) Income Data: Gross premiums written (1) $ 168,286 133,898 91,162 99,776 110,000 Ceded premiums written 49,463 2,761 2,603 1,637 1,749 ---------- ---------- ---------- ---------- ---------- Net premiums written 118,823 131,137 88,559 98,139 108,251 Decrease (increase) in unearned premiums 32,633 (17,857) 3,644 4,117 (1,458) ---------- ---------- ---------- ---------- ---------- Net premiums earned 151,456 113,280 92,203 102,256 106,793 Net investment income 14,093 9,722 9,803 9,731 9,161 Net realized gains (losses) (1,907) 606 693 327 472 Insurance services 1,054 1,849 2,927 2,631 2,379 ---------- ---------- ---------- ---------- ---------- Total revenues 164,696 125,457 105,626 114,945 118,805 ---------- ---------- ---------- ---------- ---------- Claims and claim adjustment expenses 143,439 76,349 86,353 62,086 58,379 Policy acquisition costs 33,326 24,288 23,619 22,552 23,828 Underwriting and operating expense 18,880 16,479 16,934 15,545 15,499 ---------- ---------- ---------- ---------- ---------- Total expenses 195,645 117,116 126,906 100,183 97,706 ---------- ---------- ---------- ---------- ---------- Income (loss) before taxes (30,949) 8,341 (21,280) 14,762 21,099 Income tax expense (benefit) (11,398) 1,214 (9,617) 2,838 5,079 ---------- ---------- ---------- ---------- ---------- Net income (loss) (2) $ (19,551) 7,127 (11,663) 11,924 16,020 ========== ========== ========== ========== ========== Earnings (loss) per share: Basic $ (.97) .34 (.56) .57 .75 ========== ========== ========== ========== ========== Diluted $ (.97) .32 (.56) .56 .74 ========== ========== ========== ========== ========== GAAP insurance ratios: Claims ratio 94.7% 67.4% 93.7% 60.7% 54.7% Expense ratio 31.6 32.0 39.0 33.7 33.8 ---------- ---------- ---------- ---------- ---------- Combined ratio 126.3% 99.4% 132.7% 94.4% 88.5% ========== ========== ========== ========== ==========
21 21
As of December 31 -------------------------------------------------------------- 2000 1999 1998 1997 1996 ---------- ---------- ---------- ---------- ---------- (Dollar amounts in thousands, except per share data) Balance Sheet Data: Investments $ 246,185 245,180 210,989 216,802 203,831 Premiums receivable $ 25,471 25,432 14,885 14,250 15,825 Ceded unpaid claims and claim adjustment expense $ 37,703 37,299 35,030 29,524 26,713 Ceded unearned premiums $ 45,995 23,149 22,388 19,146 16,280 Deferred policy acquisition costs $ 2,302 14,928 11,320 11,618 12,634 Property and equipment $ 7,944 6,855 6,717 6,941 6,981 Goodwill $ 22,797 18,351 17,058 -- -- Total assets $ 475,043 395,648 345,590 313,685 296,846 Unpaid claims and claim adjustment expenses $ 164,160 132,814 136,798 113,227 105,692 Unearned premiums $ 72,578 82,220 63,602 64,005 65,255 Note payable $ 16,000 18,000 18,000 -- -- Total liabilities $ 351,938 257,949 240,106 195,123 187,493 Shareholders' equity $ 123,104 137,699 105,484 118,562 109,353 Shareholders' equity per share (3) $ 4.50 5.08 5.05 5.68 5.19
---------- (1) Excludes premiums of $26,973,000 in 2000, $58,137,000 in 1999, $47,588,000 in 1998, $40,136,000 in 1997 and $31,603,000 in 1996 from the Company's fronting arrangements, the commercial automobile plans of Arkansas, California, Louisiana, Mississippi, and Pennsylvania under which the Company was a servicing carrier and the reinsurance arrangement in Florida whereby MGAI premiums are ceded to a non-affiliated reinsurer and assumed by General Agents. (2) Includes after tax net realized gains (losses) from securities transactions of $(1,258,000), $400,000, $457,000, $212,000, and $307,000 for 2000, 1999, 1998, 1997, and 1996, respectively. (3) Based on shares of Common Stock outstanding of 27,369,736, 27,119,833, 20,896,563, 20,874,224 and 21,087,407 at the end of 2000, 1999, 1998, 1997 and 1996, respectively. Common Stock outstanding at December 31, 2000 and 1999 assumes conversion of the Series A Convertible Preferred stock that was issued in the 1999 GMSP transaction. 22 22 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS BUSINESS OPERATIONS In 2000, the Company recorded a net loss of $19,551,365, or $.97 per share (basic), primarily as a result of significant unfavorable claims experience in the commercial auto liability line of business. The Company is no longer writing certain identified nonprofitable coverages that had accounted for approximately $25 million in annual premiums in the commercial trucking portion of this line of business. The Company materially increased the ultimate estimated liabilities for the line and entered into a reinsurance agreement, effective December 31, 2000, that provides significant additional protection in the event of further adverse reserve development. Additionally, the Company has reinsured the run-off of this business in 2001. In 1999, net income was $7,127,137, or $.32 per share (diluted), compared to a net loss in 1998 of $11,662,564, or $.56 per share (basic). The Company recorded GAAP combined ratios of 126.3% in 2000, 99.4% in 1999 and 132.7% in 1998. On October 23, 1998, the Company completed the acquisition of the Lalande Financial Group, Inc. ("Lalande Group"). The Lalande Group includes National Specialty Lines, Inc. ("NSL") and DLT Insurance Adjusters, Inc. ("DLT"). NSL is a managing general agency that markets nonstandard personal auto insurance through approximately 605 retail agencies in Florida. DLT is an automobile claims adjusting firm that provides claim services on NSL produced business and to outside parties. The purchase price was for $18,000,000 in cash paid at closing plus up to an additional $22,000,000 in cash to be paid over approximately five years contingent upon the operating performance of the Lalande Group. The Company paid $2,000,000 of the operating performance contingency in April of 2000. In April 1999, the Company completed the sale of the assets of Agents Processing Systems, Inc. ("APS"), which marketed a computer software package related to general agency operations. The purchaser acquired all rights to the APS software products, assignment of the APS customer contracts and other miscellaneous assets for a nominal amount of cash, assumption of contract obligations, a fixed number of software use licenses and development work on an electronic data interchange project. The Company recorded a small write-off as a result of this transaction. On January 7, 2000, the Company acquired Tri-State, Ltd. ("Tri-State"), an insurance operation specializing in underwriting, servicing and claims handling of nonstandard personal auto insurance in Minnesota, North Dakota and South Dakota. Tri-State owns and operates a managing general agency, a motor vehicle driving records service company and an insurance subsidiary, MCIC. Tri-State was incorporated in 1980 and currently markets nonstandard personal auto insurance through over 540 retail agencies in its three key states and commercial automobile insurance in four states. The purchase price consideration consisted of $6,000,000 in cash at closing, plus additional payments of up to $5,500,000 in cash over the next several years, contingent on conversion of business to the Company, meeting specific profitability targets and Tri-State's 1999 year-end book value. Tri-State's insurance subsidiary, MCIC, had approximately $3,000,000 of policyholders' surplus at December 31, 1999. Transactions with Goff Moore Strategic Partners, L.P. ("GMSP") 1999 GMSP Transaction. On October 4, 1999, GNA sold to GMSP, for an aggregate purchase price of $31,620,000, (i) 31,620 shares of Series A Preferred Stock, which are convertible into 6,200,000 shares of Common Stock at a conversion price of $5.10 per share (subject to adjustment for certain events), (ii) the Series A Warrant to purchase an aggregate of 1,550,000 shares of Common Stock at an exercise price of $6.375 per share and (iii) the Series B Warrant to purchase an aggregate of 1,550,000 shares of Common Stock at an exercise of $8.50 per share. At closing GNA and its insurance company subsidiaries entered into Investment Management Agreements with GMSP, pursuant to which GMSP manages their respective investment portfolios. Completion of the 1999 GMSP Transaction concluded the strategic alternatives review process that the Company initiated in 1998. Proceeds from the 1999 GMSP Transaction were available for acquisitions, investments and other corporate purposes. See "Investment Strategy" and "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Business Operations." 2001 GMSP Transaction. On March 23, 2001, the Company consummated the 2001 GMSP Transaction with GMSP pursuant to which, among other things, the Company issued shares of its newly created Series C Preferred Stock to GMSP in exchange for an aggregate purchase price of $3.0 million in cash. The annual dividend rate on the Series C Preferred Stock is 10% during the first three years and 20% thereafter. Unpaid dividends are cumulative and compounded. The Series C Preferred Stock is redeemable at the Company's option after five years and at the option of the majority holders after six years. The Series C Preferred Stock is not convertible into Common Stock. The agreement with GMSP was conditioned upon the following changes in the securities currently held by GMSP. The exercise prices of the Series A Warrant and the Series B Warrant held by GMSP were amended to equal a defined Conversion Price (see below) and 115% of the defined Conversion Price, respectively. Each of these warrants provides for the purchase of 1,550,000 million shares of Common stock, subject to adjustment. Further, GNA is required to redeem the outstanding shares of its Series A Preferred Stock on January 1, 2006, subject to certain conditions. Any Series A Preferred Stock unredeemed for any reason after that date would accrue interest, payable quarterly at a rate equal to eight percent per year with any unpaid interest compounded annually. The agreement with GMSP provides an opportunity to convert GNA holding company illiquid investments with a cost of $4.2 million to cash as of November 2002, as follows: GNA could at its option require GMSP to purchase the illiquid investments for $2.1 million, less any future cash received prior to November 2002 from the investments. GMSP could at its option require GNA to sell the illiquid investments to GMSP for $4.2 million, less any future cash received prior to November 2002 from the investments. Transactions with Robert W. Stallings 23 23 On March 23, 2001, the Company consummated the Stallings Transaction pursuant to which, among other things, the Company issued shares of its newly created Series B Preferred Stock and a warrant to purchase an aggregate of 1,050,000 shares of Common Stock at the defined Conversion Price in exchange for an aggregate purchase price of $3.0 million in cash. The annual dividend provisions and the redemption provisions of the Series B Preferred Stock are the same as those for the Series C Preferred Stock. The Series B Preferred Stock is convertible into Common Stock at the defined Conversion Price. Subject to adjustment for certain events, the Series B Preferred Stock is convertible into a maximum of 1,333,333 shares of Common Stock. The term of the warrant is five years. Mr. Stallings was elected non-executive Vice Chairman of the Board and a director of the Company. A defined Conversion Price formula, subject to standard adjustments, will be used to determine the conversion price for the Series B Preferred Stock and to determine the exercise prices for the Stallings warrant and as the base for the amended exercise prices of the GMSP warrants. The Conversion Price will be equal to the lesser of tangible book value per share of GNA Common Stock as of June 30, 2001, or 110% of the average closing price per share of GNA common stock for the 30 trading days immediately prior to April 30, 2001. Under no circumstance may the Conversion Price be less than $2.25. The discussion below primarily relates to the Company's insurance operations, although the selected consolidated financial data appearing elsewhere is on a consolidated basis. The expense item "Underwriting and operating expenses" includes the operating expenses of the computer software, plan servicing and premium finance operations. 24 24 RESULTS OF OPERATIONS Gross premiums written in 2000 of $168,285,832 were 26% above the $133,898,001 recorded in 1999 primarily because of increases in commercial specialty lines, personal auto business written in Florida and personal umbrella business written in 2000. The 47% increase recorded in 1999 from 1998 was primarily due to the personal auto business written in Florida beginning in late 1998. The following table compares the major product lines between the years for gross premiums written:
Years ended December 31 --------------------------------------------------------------------- 2000 1999 1998 --------------------- --------------------- ------------------- (Dollar amounts in thousands) Gross Premiums Written: Commercial Lines $ 113,354 67% $ 97,139 73% $ 88,188 97% Personal Lines 54,932 33 36,759 27 2,974 3 ---------- ------- ---------- ------- ---------- ----- $ 168,286 100% $ 133,898 100% $ 91,162 100% ========== ======= ========== ======= ========== ===== Policies in Force (End of Period) 87,048 68,943 38,939
COMMERCIAL LINES grew 17% in 2000 and 10% in 1999. Commercial auto contributed 2 points to the increase in 2000. Commercial auto contributed 7 points to the increase in 1999. The garage product increased slightly in 2000 but decreased in 1999 and accounted for 3 points of decrease in 1999. Pricing pressure and new entrants to the garage market are the primary reasons for the results in both years. The general liability line contributed 10 points to the increase in 2000 and 3 points to the increase in 1999. The large increase in 2000 is primarily attributable to specialty lines of business in professional liability and directors and officers liability. PERSONAL LINES increased 49% in 2000 primarily as a result of nonstandard auto and umbrella business. The large increase in personal lines in 1999 was the result of the Florida nonstandard auto business the Company began writing in late 1998. For 2000 gross premiums written percentages by significant product line are as follows: commercial auto (34%), personal auto (28%), general liability (19%) and garage (11%), with no other product line comprising 5% or more. Premiums earned increased 34% in 2000 and 23% in 1999 primarily as a result of the level of premiums written. Net investment income increased 45% in 2000 from 1999 after a decrease of 1% in 1999 from 1998. During 2000, approximately $80.5 million in bond securities were sold for a pre-tax loss of $1,906,911 and a large portion of the proceeds were reinvested in bond securities with an average taxable equivalent yield of more than 150 basis points over the bond securities that were sold. The increase in investments and the increase in yield on the proceeds reinvested from the sales of bonds account for the increase in investment income in 2000. The decrease in 1999 was the result of reinvesting maturities through the first nine months in shorter durations that had lower yields. In the fourth quarter of 1999 GMSP invested approximately $30 million in the Company and took over management of the Company's investments. Investment income in the fourth quarter of 1999 increased over the comparable 1998 period and offset a large portion of the decrease in investment income recorded during the first nine months of 1999 when compared to the first nine months of 1998. At December 31, 2000, 94% of the Company's investments were investment grade with an average duration of approximately 2.9 years. On a taxable equivalent basis the return on average investments was 6.5% in 2000, 5.7% in 1999, and 6.2% in 1998. The Company classifies its bond securities as available for sale. The Company does not have any non-performing fixed maturity securities. The unrealized gain associated with the investment portfolio was $3,897,371 (net of tax effects) at December 31, 2000. The Company recorded net realized capital losses of $1,906,911 in 2000 versus net realized capital gains of $605,606 in 1999 and $692,510 in 1998. All of these gains and losses were generated from the bonds available for sale category of the fixed maturity portfolio. 25 25 Insurance service revenues decreased $794,453 in 2000 from 1999 and $1,078,997 in 1999 from 1998. The decrease in 2000 was primarily a result of the decrease in claim adjusting service revenues. The decrease in 1999 was primarily a result of the run-off of the plan servicing business and the sale of the computer software operation. Claims and claim adjustment expenses ("C & CAE") increased $67,090,034 in 2000 from 1999 and decreased $10,003,936 in 1999 from 1998. The C & CAE ratio was 94.7% in 2000, 67.4% in 1999 and 93.7% in 1998. The ratio in 2000 is above the 1999 level primarily because of significant unfavorable claims experience in the commercial auto liability line of business for the current and prior accident years. As mentioned previously, the Company is ceasing to write new policies in the trucking portion in this line of business and has reinsurance agreements in place that are expected to minimize future adverse results from this line of business. The C & CAE ratio of 93.7% in 1998 was primarily related to unanticipated unfavorable development from the 1997, 1996 and 1995 accident years for commercial auto liability. With regard to environmental and product liability claims, the Company has an immaterial amount of exposure. The Company does not provide environmental impairment coverage and excludes pollution and asbestos related coverages in its policies. The Company's premium writings for product liability coverages are immaterial. Inflation impacts the Company by causing higher claim settlements than may have originally been estimated. Inflation is implicitly reflected in the reserving process through analysis of cost trends and review of historical reserve results. The ratio of commissions and the change in deferred policy acquisition costs and deferred ceding commission income to net premiums earned is 22% in 2000, 21% in 1999 and 26% in 1998. The decrease in 1999 from 1998 is primarily due to a reduction in reinsurance commission income of approximately $3,318,000 that was recorded in 1998. This was a result of unfavorable development in C & CAE incurred in 1998. Interest expense from the note payable increased in 2000 as a result of higher interest rates. Amortization expense increased in 2000 as a result of the amortization of goodwill related to the Tri-State acquisition. Interest and amortization expense increased in 1999 from 1998 primarily as a result of recording a full year of expenses in 1999 versus approximately three months of expenses in 1998. Underwriting and operating expenses were up 14% in 2000 from 1999, but were down 13% in 1999 from 1998. The increase for 2000 was primarily due to salary increases, personnel additions and bad debt reserve increases. The decrease for 1999 was primarily due to approximately $2 million in non-recurring expenses associated with a reduction in the number of employees, legal fees and consulting fees that were incurred in 1998. The effective tax rate of 15% for 1999 was primarily the result of tax-exempt income comprising a major portion of income before taxes. For 2000 and 1998 the Company generated a current tax benefit as a result of a net loss from operations. The effective tax benefit rate for 2000 was 37%. The effective tax benefit rate for 1998 of 45% is above the Federal statutory rate largely because of tax-exempt interest income. A reconciliation between income taxes computed at the Federal statutory rates and the provision for income taxes is included in Note (6) of Notes to Consolidated Financial Statements. 26 26 LIQUIDITY AND CAPITAL RESOURCES Parent Company GAINSCO, INC. (GNA) is a holding company that provides administrative and financial services for its wholly owned subsidiaries. GNA needs cash for: (1) principal and interest on the note payable, (2) dividends on common and preferred stock, (3) administrative expenses, (4) income taxes, and (5) investments. In February, 2001, GNA discontinued its policy of paying dividends to common shareholders. The primary sources of cash to meet these obligations included statutory permitted payments from certain insurance subsidiaries including: (1) dividend payments, (2) surplus debenture interest payments, and (3) tax sharing payments. Subject to credit agreement restrictions, GNA may also obtain cash through the sale of subsidiaries or assets and through the issuance of common or preferred stock. The Company believes sufficient cash dividends are available from the insurance subsidiaries to meet its obligations for 2001. Subsidiaries, Principally Insurance Operations The primary sources of the insurance subsidiaries' liquidity are funds generated from insurance premiums, net investment income and maturing investments. The short-term investments and cash are intended to provide adequate funds to pay claims without selling fixed maturity investments. At December 31, 2000, the insurance subsidiaries held short-term investments and cash that the insurance subsidiaries believe are adequate liquidity for the payment of claims and other short-term commitments. With regard to long term liquidity, the average duration of the investment portfolio is approximately 2.9 years. The fair value of the fixed maturity portfolio at December 31, 2000 was $4,356,723 above amortized cost. With regard to the availability of funds to the holding company, see Note (7) of Notes to Consolidated Financial Statements for restrictions on the payment of dividends by the insurance companies. Various insurance departments of states in which the Company operates require the deposit of funds to protect policyholders within those states. At December 31, 2000 and 1999, the balance on deposit for the benefit of such policyholders totaled $16,507,427 and $14,832,735, respectively. Effective December 31, 2000, the insurance subsidiaries entered into a quota share reinsurance agreement whereby the Company ceded 100% of its commercial auto liability unearned premiums and 50% of all other commercial business unearned premiums at December 31, 2000 to a non-affiliated reinsurer. For policies with an effective date of January 1, 2001 or subsequent, the Company entered into a quota share reinsurance agreement whereby the Company will cede 20% of its commercial business to a non-affiliated reinsurer. Also effective December 31, 2000, the Company entered into a reserve reinsurance cover agreement with a non-affiliated reinsurer. This agreement reinsures the Company's ultimate net aggregate liability in excess of $32,500,000 up to an aggregate limit of $57,150,000 for net commercial auto liability losses and loss adjustment expense incurred but unpaid as of December 31, 2000. The Company established a reinsurance balance receivable and a liability for funds held under reinsurance agreements for the reserves transferred at December 31, 2000. These reinsurance agreements significantly impact many of the balance sheet items at December 31, 2000. Reinsurance balances receivable increased primarily as a result of the reserve reinsurance cover agreement the insurance subsidiaries entered into effective December 31, 2000, mentioned previously. Ceded unearned premiums increased primarily as a result of the quota share reinsurance agreement the insurance subsidiaries entered into effective December 31, 2000. Deferred policy acquisition costs (DAC) decreased primarily because of an increase in deferred commission income as a result of the quota share reinsurance agreement effective December 31, 2000. Deferred Federal income taxes recoverable increased due to the net loss recorded for the period. The increase in goodwill is primarily related to the Tri-State acquisition discussed previously. Unpaid claims and claim adjustment expenses increased primarily due to the significant unfavorable claims experience in the commercial auto liability line of business, as mentioned previously. Unearned premiums decreased primarily because of a decrease in fronting premiums written during 2000. Reinsurance balances payable increased primarily because of the ceded unearned premiums, net of ceding commission income due to the reinsurer under the quota share reinsurance agreement effective December 31, 2000. Drafts payable increased primarily as a result of an increase in paid claims during the fourth quarter of 2000 versus the fourth quarter of 1999. 27 27 The note payable decreased as a result of quarterly principal repayments made by the Company during 2000. Funds held under reinsurance agreements represent claim funds held in conjunction with the reserve reinsurance cover agreement from which the insurance subsidiaries will pay future claims covered under this reinsurance agreement. Accumulated other comprehensive income of $3,897,371 was recorded at December 31, 2000 as a result of the unrealized gains on bonds available for sale and common stocks. The decrease in retained earnings is primarily attributable to the net loss of $19,551,365 for the 2000 year. The Company is not aware of any current recommendations by regulatory authorities, which if implemented, would have a material effect on the Company's liquidity, capital resources or results of operations. The Company's statutory capital exceeds the benchmark capital level under the Risk Based Capital formula for its major insurance companies. Risk Based Capital is a method for establishing the minimum amount of capital appropriate for an insurance company to support its overall business operations in consideration of its size and risk profile. FORWARD LOOKING STATEMENTS Statements made in this report that are not strictly historical may be forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Investors are cautioned that important factors, representing certain risks and uncertainties, could cause actual results to differ materially from those contained in the forward-looking statements. These factors include, but are not limited to, (a) the Company's ability to operate successfully and maintain its A.M. Best rating, and meet its obligations under its new capital and amended debt arrangements, (b) the Company's ability to effect the successful exit from unprofitable trucking lines while maintaining and growing other profitable lines, (c) heightened competition from existing competitors and new competitor entrants into the Company's markets, (d) the extent to which market conditions firm up, the acceptance of higher prices in the market place and the Company's ability to realize and sustain higher rates, (e) contraction of the markets for the Company's various lines of business, (f) development and performance of new specialty programs, (g) the ongoing level of claims and claims-related expenses and the adequacy of claim reserves, (h) the ability to complete value-adding acquisitions and fully integrate newly acquired companies and their customers and managers into the Company, as well as the ability to implement growth strategies which can achieve incremental value, (i) the effectiveness of the redeployment of the Company's bond portfolio and other investment strategies implemented by the Company's investment manager, and (j) general economic conditions including fluctuations in interest rates. A forward-looking statement is relevant as of the date the statement is made. The Company undertakes no obligation to update any forward-looking statements to reflect events or circumstances arising after the date on which the statements are made. 28 28 ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Market risk is the risk of economic losses due to adverse changes in the estimated fair value of a financial instrument as the result of changes in equity prices, interest rates, foreign exchange rates and commodity prices. The Company's consolidated balance sheets include assets whose estimated fair values are subject to market risk. The primary market risk to the Company is interest rate risk associated with investments in fixed maturities. The Company has no foreign exchange or commodity risk, and its exposure to equity risk is immaterial. INTEREST RATE RISK The Company's fixed maturity investments are subject to interest rate risk. Increases and decreases in interest rates typically result in decreases and increases in the fair value of these investments. Most of the Company's investable assets are in the portfolios of the insurance company subsidiaries and come from premiums paid by policyholders. These funds are invested predominately in high quality bonds with relatively short durations. The fixed maturity portfolio had an average duration of 2.9 years at December 31, 2000. The fixed maturity portfolio is exposed to interest rate fluctuations; as interest rates rise, fair values decline and as interest rates fall, fair values rise. The changes in the fair value of the fixed maturity portfolio are presented as a component of shareholders' equity in accumulated other comprehensive income, net of taxes. The effective duration of the fixed maturity portfolio is managed with consideration given to the estimated duration of the Company's liabilities. The Company has investment policies that limit the maximum duration and maturity of the fixed maturity portfolio. The Company utilizes the modified duration method to estimate the effect of interest rate risk on the fair values of its fixed maturity portfolio. The usefulness of this method is to a degree limited, as it is unable to accurately incorporate the full complexity of market interactions. 29 29 The table below summarizes the Company's interest rate risk and shows the effect of a hypothetical change in interest rates as of December 31, 2000. The selected hypothetical changes do not indicate what could be the potential best or worst case scenarios (dollars in thousands):
Estimated Estimated Hypothetical Estimated Fair Change in Fair Value After Percentage Increase Value at Interest Rates Hypothetical Change (Decrease) in December 31, 2000 (BP=basis points) in Interest Rates Shareholders' Equity ----------------- ----------------- ------------------- -------------------- U.S. Treasury securities $ 62,157 200 BP Decrease $ 62,704 .88 (including short-term 100 BP Decrease $ 62,431 .44 Investments) 100 BP Increase $ 61,884 (.44) 200 BP Increase $ 61,610 (.88) Obligation of states, $ 45,472 200 BP Decrease $ 47,582 4.64 municipalities and 100 BP Decrease $ 46,527 2.32 Political subdivisions 100 BP Increase $ 44,417 (2.32) 200 BP Increase $ 43,362 (4.64) Corporate bonds and $ 126,398 200 BP Decrease $137,268 8.60 Certificates of Deposit 100 BP Decrease $131,833 4.30 100 BP Increase $120,963 (4.30) 200 BP Increase $115,528 (8.60) Total fixed maturity investments $ 234,027 200 BP Decrease $247,507 5.76 (including short-term 100 BP Decrease $240,767 2.88 Investments) 100 BP Increase $227,287 (2.88) 200 BP Increase $220,547 (5.76)
30 30 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The following consolidated Financial Statements are on pages 43 through 76
Page ---- Report of Management 43 Independent Auditors' Report 44 Consolidated Balance Sheets as of December 31, 2000 and 1999 45-46 Consolidated Statements of Operations for the Years Ended December 31, 2000, 1999, and 1998 47 Consolidated Statements of Shareholders' Equity and Comprehensive Income for the Years Ended December 31, 2000, 1999, and 1998 48-49 Consolidated Statements of Cash Flows for the Years Ended December 31, 2000, 1999, and 1998 50-51 Notes to Consolidated Financial Statements December 31, 2000, 1999, and 1998 52-75
The following Consolidated Financial Statements Schedules are on pages 77 through 88:
Schedule Page -------- ---- Independent Auditors' Report on Supplementary Information 76 I Summary of Investments 77 II Condensed Financial Information of the Registrant 78-84 III Supplementary Insurance Information 85 IV Reinsurance 86 VI Supplemental Information 87
ITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURES None. 31 31 PART III The information required by this Part III will be supplied by a Schedule 14A filing or an amendment to this Report. 32 32 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORMS 8-K (a) Documents filed as part of the report: 1. The following financial statements filed under Part II, Item 8: Independent Auditors' Report Consolidated Balance Sheets as of December 31, 2000 and 1999 Consolidated Statements of Operations for the Years Ended December 31, 2000, 1999 and 1998 Consolidated Statements of Shareholders' Equity and Comprehensive Income for the Years Ended December 31, 2000, 1999 and 1998 Consolidated Statements of Cash Flows for the Years Ended December 31, 2000, 1999 and 1998 Notes to Consolidated Financial Statements, December 31, 2000, 1999 and 1998 2. The following Consolidated Financial Statement Schedules are filed under Part II, Item 8: Schedule Description -------- ----------- I Summary of Investments II Condensed Financial Information of the Registrant III Supplementary Insurance Information IV Reinsurance VI Supplemental Information 3. The following Exhibits: Exhibit No. ----------- *3.1 Restated Articles of Incorporation of Registrant as filed with the Secretary of State of Texas on July 24, 1986 [Exhibit 3.1, filed in Registration Statement No. 33-7846 on Form S-1, effective November 6, 1986]. *3.2 Articles of Amendment to the Articles of Incorporation as filed with the Secretary of State of Texas on June 10, 1988 [Exhibit 3.2, filed in Registration Statement No. 33-25226 on Form S-1, effective November 14, 1988]. 38 33 *3.3 Articles of Amendment to Articles of Incorporation as filed with the Secretary of State of Texas on August 13, 1993 [Exhibit 3.6, Form 10-K dated March 25, 1994]. *3.4 Statement of Resolution Establishing and Designating Series A Convertible Preferred Stock of Registrant as filed with the Secretary of State of the State of Texas on October 1, 1999 [Exhibit 99.18, Form 8-K dated June 29, 1999]. +3.5 Bylaws of Registrant as amended through February 21, 2001. *3.6 Statement of Resolution Establishing and Designating Series B Convertible Redeemable Preferred Stock of Registrant as filed with the Secretary of State of the State of Texas on March 22, 2001. [Exhibit 99.19, Form 8-K/A dated March 30, 2001] *3.7 Statement of Resolution Establishing and Designating Series C Redeemable Preferred Stock of Registrant as filed with the Secretary of State of the State of Texas on March 22, 2001. [Exhibit 99.20, Form 8-K/A dated March 30, 2001] *4.1 Rights Agreement, dated as of March 3, 1988, between the Registrant and Team Bank/Fort Worth, N.A. [Exhibit 1, Form 8-K dated March 14, 1988]. *4.2 Amendment No. 1 dated as of March 5, 1990 to Rights Agreement dated as of March 3, 1988 between Registrant and Team Bank as Rights Agent [Exhibit 4.2, Form 10-K dated March 27, 1992]. *4.3 Amendment No. 2 dated as of May 25, 1993 to Rights Agreement between Registrant and Society National Bank (successor to Team Bank (formerly Texas American Bank/Fort Worth, N.A.)), as Rights Agent [Exhibit 4.4, Form 10-K dated March 25, 1994]. *4.4 Amendment No. 3 to Rights Agreement and appointment of Continental Stock Transfer & Trust Company as Successor Rights Agent, dated September 30, 1994 [Exhibit 10.29, Form 10-K dated March 30, 1995]. *4.5 Amendment No. 4 dated June 29, 1999 to Rights Agreement between Registrant and Continental Stock Transfer & Trust Company [Exhibit 99.21, Form 8-K dated June 29, 1999]. *4.6 Form of Common Stock Certificate [Exhibit 4.6, Form 10-K dated March 28, 1997]. *4.7 Agreement dated August 26, 1994 appointing Continental Stock Transfer & Trust Company transfer agent and registrar [Exhibit 10.28, Form 10-K dated March 30, 1995]. *10.1 1990 Stock Option Plan of the Registrant [Exhibit 10.16, Form 10-K dated March 22, 1991]. *10.2 1995 Stock Option Plan of the Registrant [Exhibit 10.31, Form 10-K dated March 28, 1996]. *10.3 1998 Long Term Incentive Plan of the Registrant [Exhibit 99.8, Form 10-Q Report dated August 10, 1998]. *10.4 Forms of Change of Control Agreements [Exhibit 10.36, Form 10-K dated March 29, 1993; Exhibit 10.36 Form 10-K dated March 30, 1998]. *10.5 Employment Agreement dated April 25, 1998 between Glenn W. Anderson and the Registrant [Exhibit 99.5, Form 10-Q/A dated June 16, 1998]. 39 34 *10.6 Change of Control Agreement for Glenn W. Anderson [Exhibit 99.7, Form 10-Q/A dated June 16, 1998]. *10.7 Replacement Non-Qualified Stock Option Agreement dated July 24, 1998 between Glenn W. Anderson and the Registrant [Exhibit 99.6, Form 10-Q Report dated August 10, 1998]. *10.8 Management Contract between GAINSCO County Mutual Insurance Company and GAINSCO Service Corp. and related Surplus Debenture, Amendment to Surplus Debenture, Certificate of Authority and accompanying Commissioner's Order granting Certificate Authority, allowing for charter amendments and extension of charter [Exhibits 10.23, 10.24 and 10.25, Form 10-K dated March 29, 1993; Exhibit 10.27, Form 10-K dated March 25, 1994]. *10.9 Revolving Credit Agreement dated November 13, 1998 among Registrant, GAINSCO Service Corp. and Bank One, Texas, N.A., First Amendment thereto dated October 4, 1999 and related Promissory Note, Security Agreement and Pledge Agreement, and Amendment No. 2 thereto dated March 23, 2001 [Exhibits 10.50 to 10.53, Form 10-K/A dated March 30, 1999; Exhibit 99.22, Form 8-K dated October 4, 1999, Exhibit 99.24, Form 8-K/A dated March 30, 2001]. *10.10 Securities Purchase Agreement dated as of June 29, 1999 between Registrant and Goff Moore Strategic Partners, L.P. ("GMSP") and related Series A Common Stock Purchase Warrant and Series B Common Stock Purchase Warrant [Exhibit 2.1, Form 8-K dated June 29, 1999; Exhibits 99.19 and 99.20, Form 8-K dated October 4, 1999]. *10.11 Investment Management Agreements dated October 4, 1999 between GMSP and each of Registrant, General Agents Insurance Company of America, Inc., MGA Insurance Company, Inc. and GAINSCO County Mutual Insurance Company; and Investment Management Agreement dated January 6, 2000 between GMSP and Midwest Casualty Insurance Company.[Exhibit 10.11, Form 10-K dated March 30, 2000] *10.12 Stock Purchase Agreements dated August 17, 1998 with Carlos de la Torre, McRae B. Johnston, Michael S. Johnston and Ralph Mayoral relating to acquisition by Registrant of Lalande Group and related employment agreements with them [Exhibits 99.6 to 99.13, Form 8-K dated August 26, 1998]. *10.13 Asset Purchase Agreement dated March 9, 1999 between the Registrant, Agents Processing Systems, Inc. and Insurance Business Solutions Incorporated [Exhibit 10.49, Form 10-K dated March 30, 1999]. *10.14 Stock Purchase Agreement dated as of November 17, 1999 among Registrant, Tri-State, Ltd., Herbert A. Hill and Alan E. Heidt and related Pledge Agreement dated as of January 7, 2000 executed by the Registrant in favor of Bank One, NA and Unlimited Guaranty dated as of January 7, 2000 executed by Tri-State, Ltd. in favor of Bank One, NA.[Exhibit 10.14, Form 10-K dated March 30, 2000] 40 35 *10.15 Agreement of Limited Partnership of GNA Investments I, L.P. dated as of November 30, 1999 between Registrant and Goff Moore Strategic Partners, L.P. [Exhibit 10.15, Form 10-K dated March 30, 2000] *10.16 Professional Service Agreement dated as of October 22, 1999 between Registrant and ClientSoft, Inc. [Exhibit 10.16, Form 10-K dated March 30, 2000] *10.17 First Amendment to Stock Purchase Agreement dated May 16, 2000 among Registrant, Tri-State, Ltd., Herbert A. Hill and Alan E. Heidt [Exhibit 10.14, Form 10-Q Report dated August 11, 2000] *10.18 GAINSCO, INC. 401 (k) Plan and related Adoption Agreement [Exhibit 99.1 to Registration Statement on Form S-8, effective April 12, 2000] *10.19 Securities Purchase Agreement dated as of February 26, 2001 between Registrant and GMSP (including exhibits) and related First Amendment to Securities Purchase Agreement, letter regarding redemption of Registrant's outstanding Series A Convertible Preferred Stock, First Amendment to Series A Common Stock Purchase Warrant, and First Amendment to Series B Common Stock Purchase Warrant. [Exhibit 2.1, Form 8-K dated March 2, 2001; Exhibits 2.2, 2.8, 99.21 and 99.22, Form 8-K/A dated March 30, 2001] *10.20 Securities Purchase Agreement dated as of February 26, 2001 between Registrant and Robert W. Stallings ("Stallings") (including exhibits) and related First Amendment to Securities Purchase Agreement, Assignment and Assumption Agreement between Stallings and ING Pilgrim Capital Corporation, LLC, Amendment to Assignment and Assumption Agreement, letter dated March 23, 2001 from Stallings to Registrant, and Common Stock Purchase Warrant. [Exhibit 2.2, Form 8-K dated March 2, 2001; Exhibits 2.4 to 2.7 and 99.23, Form 8-K/A dated March 30, 2001] *10.21 Consulting Agreement dated as of February 26, 2001 between Registrant and Stallings. [Exhibit 99.15, Form 8-K dated March 2, 2001] *10.22 Agreement dated March 23, 2001 among Registrant, GAINSCO SERVICE CORP., GMSP, Stallings and Bank One, N.A. [Exhibit 99.25, Form 8-K/A dated March 30, 2001] 11 Statement regarding Computation of Per Share Earnings (the required information is included in Note 1(m) of Notes to Consolidated Financial Statements included in this Report and no separate statement is, or is required to be, filed as an exhibit). +21 Subsidiaries of Registrant. +23 Consent of KPMG LLP to incorporation by reference. +24 Powers of Attorney. ---------- * Exhibit has previously been filed with the Commission as an exhibit in the filing designated in brackets and is incorporated herein by this reference. Registrant's file number for reports filed under the Securities Exchange Act of 1934 is 1-9828. + Filed herewith (see Exhibit Index). ---------- (b) Reports on Form 8-K No Current Reports on Form 8K were filed by Registrant during the quarter ended December 31, 2000. (c) Exhibits required by Item 601 of Regulation S-K. The exhibits listed in Item 14(a) 3 of this Report, and not incorporated by reference to a separate file, are filed herewith. 41 36 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) 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. GAINSCO, INC. (Registrant) /s/ Glenn W. Anderson -------------------------------- By: Glenn W. Anderson, President Date: 03/30/01 -------------------- Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. Name Title Date ---- ----- ---- Joel C. Puckett* Chairman of the Board 3/30/01 --------------------------- Joel C. Puckett /s/ Glenn W. Anderson President, Chief Executive 3/30/01 --------------------------- Officer and Director Glenn W. Anderson /s/ Daniel J. Coots Senior Vice President and 3/30/01 ---------------------------- Chief Financial Officer Daniel J. Coots Sam Rosen* Secretary and Director 3/30/01 ---------------------------- Sam Rosen J. Randall Chappel* Director 3/30/01 ---------------------------- J. Randall Chappel John C. Goff* Director 3/30/01 ---------------------------- John C. Goff Harden H. Wiedemann* Director 3/30/01 ---------------------------- Harden H. Wiedemann John H. Williams* Director 3/30/01 ---------------------------- John H. Williams Robert W. Stallings* Director 3/30/01 ---------------------------- Robert W. Stallings *By: /s/ Glenn W. Anderson ----------------------- Glenn W. Anderson, Attorney in-fact under Power of Attorney 42 37 REPORT OF MANAGEMENT The accompanying consolidated financial statements were prepared by the Company, which is responsible for their integrity and objectivity. The statements have been prepared in conformity with accounting principles generally accepted in the United States of America and include some amounts that are based upon the Company's best estimates and judgement. Financial information presented elsewhere in this report is consistent with the accompanying consolidated financial statements. The accounting systems and controls of the Company are designed to provide reasonable assurance that transactions are executed in accordance with management's criteria, that the financial records are reliable for preparing financial statements and maintaining accountability for assets, and that assets are safeguarded against claims from unauthorized use or disposition. The Company's consolidated financial statements have been audited by KPMG LLP, independent auditors. The auditors have full access to each member of management in conducting their audits. The Audit Committee of the Board of Directors, comprised solely of directors from outside of the Company, meets regularly with management and the independent auditors to review the work and procedures of each. The auditors have free access to the Audit Committee, without management being present, to discuss the results of their work as well as the adequacy of the Company's accounting controls and the quality of the Company's financial reporting. The Board of Directors, upon recommendation of the Audit Committee, appoints the independent auditors, subject to shareholder approval. /s/ Glenn W. Anderson ------------------------------------------------- Glenn W. Anderson President and Chief Executive Officer /s/ Daniel J. Coots ------------------------------------------------- Daniel J. Coots Senior Vice President and Chief Financial Officer 43 38 INDEPENDENT AUDITORS' REPORT The Board of Directors and Shareholders GAINSCO, INC.: We have audited the accompanying consolidated balance sheets of GAINSCO, INC. and subsidiaries as of December 31, 2000 and 1999, and the related consolidated statements of operations, shareholders' equity and comprehensive income and cash flows for each of the years in the three-year period ended December 31, 2000. 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 auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the 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 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 financial position of GAINSCO, INC. and subsidiaries at December 31, 2000 and 1999, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2000, in conformity with accounting principles generally accepted in the United States of America. We have also previously audited, in accordance with auditing standards generally accepted in the United States of America, the consolidated balance sheets of GAINSCO, INC. and subsidiaries as of December 31, 1998, 1997 and 1996, and the related consolidated statements of operations, shareholders' equity and cash flows for the years ended December 31, 1997 and 1996, and we expressed unqualified opinions on those consolidated financial statements. In our opinion, the information set forth in the selected consolidated financial data for each of the years in the five-year period ended December 31, 2000, appearing on pages 21 and 22, is fairly presented, in all material respects, in relation to the consolidated financial statements from which it has been derived. KPMG LLP Dallas, Texas February 27, 2001, except for notes (8) and (12), as to which the date is March 23, 2001. 44 39 GAINSCO, INC. AND SUBSIDIARIES Consolidated Balance Sheets December 31, 2000 and 1999
Assets 2000 1999 ------ ------------ ------------ Investments (note 2): Fixed maturities: Bonds available for sale, at fair value (amortized cost: $187,985,651 - 2000, $200,415,218 - 1999) $192,342,374 197,077,075 Certificates of deposit, at cost (which approximates fair value) 845,000 455,000 Common stock, at fair value (cost: $6,027,392 - 2000, $0 - 1999) 7,716,250 -- Other investments, at fair value (cost: $4,580,690 - 2000, $1,288,457 - 1999) 4,441,240 1,170,329 Short-term investments, at cost (which approximates fair value) 40,839,852 46,477,728 ------------ ------------ Total investments 246,184,716 245,180,132 Cash 3,111,311 1,205,364 Accrued investment income 3,539,804 3,797,286 Premiums receivable (net of allowance for doubtful accounts: $200,000 - 2000, $42,000 - 1999) (note 1) 25,471,377 25,431,714 Reinsurance balances receivable (note 5) 54,494,967 3,254,930 Ceded unpaid claims and claim adjustment expenses (notes 1 and 5) 37,703,034 37,299,327 Ceded unearned premiums (note 5) 45,994,658 23,148,581 Deferred policy acquisition costs (note 1) 2,301,944 14,927,673 Property and equipment (net of accumulated depreciation and amortization: $9,745,505 - 2000, $8,605,454 - 1999) (note 1) 7,944,404 6,855,250 Current Federal income taxes (note 1) 1,242,801 144,628 Deferred Federal income taxes (notes 1 and 6) 15,671,326 8,401,714 Management contract 1,587,571 1,637,571 Other assets 6,997,501 6,012,424 Goodwill (note 1) 22,797,358 18,351,117 ------------ ------------ Total assets $475,042,772 395,647,711 ============ ============
See accompanying notes to consolidated financial statements. 45 40 GAINSCO, INC. AND SUBSIDIARIES Consolidated Balance Sheets December 31, 2000 and 1999
Liabilities and Shareholders' Equity 2000 1999 ------------------------------------ -------------- -------------- Liabilities: Unpaid claims and claim adjustment expenses (notes 1 and 5) $ 164,159,519 132,813,583 Unearned premiums (notes 1 and 5) 72,578,157 82,219,785 Commissions payable 2,077,771 1,629,787 Accounts payable 10,899,280 9,198,827 Reinsurance balances payable (note 5) 27,154,389 7,899,550 Deferred revenue 1,632,174 1,227,863 Drafts payable 8,862,849 4,206,314 Note payable (note 4) 16,000,000 18,000,000 Dividends payable (note 7) 478,971 474,598 Funds held under reinsurance agreements (note 5) 47,850,000 -- Other liabilities 245,383 278,829 -------------- -------------- Total liabilities 351,938,493 257,949,136 -------------- -------------- Shareholders' Equity (notes 7 and 8): Preferred stock ($100 par value, 10,000,000 shares authorized, 31,620 issued at December 31, 2000 and December 31, 1999) 3,162,000 3,162,000 Common stock ($.10 par value, 250,000,000 shares authorized, 22,013,830 issued at December 31, 2000 and 21,763,927 issued at December 31, 1999) 2,201,383 2,176,393 Common stock warrants 2,040,000 2,040,000 Additional paid-in capital 113,540,252 112,674,842 Accumulated other comprehensive income (loss) (notes 2 and 3) 3,897,371 (2,246,575) Retained earnings 5,957,798 27,586,440 Treasury stock, at cost (844,094 shares at December 31, 2000 and December 31, 1999) (note 1) (7,694,525) (7,694,525) -------------- -------------- Total shareholders' equity 123,104,279 137,698,575 -------------- -------------- Commitments and contingencies (notes 5, 8, 9 and 11) Total liabilities and shareholders' equity $ 475,042,772 395,647,711 ============== ==============
See accompanying notes to consolidated financial statements. 46 41 GAINSCO, INC. AND SUBSIDIARIES Consolidated Statements of Operations Years ended December 31, 2000, 1999 and 1998
2000 1999 1998 -------------- -------------- -------------- Revenues: Net premiums earned (note 5) $ 151,455,505 113,280,292 92,203,393 Net investment income (note 2) 14,092,914 9,722,213 9,802,702 Net realized gains (losses) (note 1) (1,906,911) 605,606 692,510 Insurance services 1,054,137 1,848,590 2,927,587 -------------- -------------- -------------- 164,695,645 125,456,701 105,626,192 -------------- -------------- -------------- Expenses: Claims and claims adjustment expenses (notes 1 and 5) 143,439,078 76,349,044 86,352,980 Commissions 20,687,486 27,895,646 23,321,414 Change in deferred policy acquisition costs and deferred ceding commission income (note 1) 12,638,482 (3,607,531) 297,994 Interest expense 1,409,378 1,265,529 101,763 Amortization of goodwill 963,700 688,645 171,502 Underwriting and operating expenses 16,506,906 14,524,068 16,660,628 -------------- -------------- -------------- 195,645,030 117,115,401 126,906,281 -------------- -------------- -------------- Income (loss) before Federal income taxes (30,949,385) 8,341,300 (21,280,089) Federal income taxes (note 6): Current expense (benefit) (1,110,714) 1,113,399 (5,571,134) Deferred expense (benefit) (10,287,306) 100,764 (4,046,391) -------------- -------------- -------------- (11,398,020) 1,214,163 (9,617,525) -------------- -------------- -------------- Net income (loss) $ (19,551,365) 7,127,137 (11,662,564) ============== ============== ============== Earnings (loss) per share (notes 1 and 7): Basic $ (.97) .34 (.56) ============== ============== ============== Diluted $ (.97) .32 (.56) ============== ============== ==============
See accompanying notes to consolidated financial statements. 47 42 GAINSCO, INC. AND SUBSIDIARIES Consolidated Statements of Shareholders' Equity and Comprehensive Income Years ended December 31, 2000, 1999 and 1998
2000 1999 1998 ------------ ------------ ------------ Preferred stock: Balance at beginning of year $ 3,162,000 -- -- Issuance of shares (31,620 in 1999) -- 3,162,000 -- ------------ ------------ ------------ Balance at end of year 3,162,000 3,162,000 -- ------------ ------------ ------------ Common stock: Balance at beginning of year 2,176,393 2,174,066 2,170,112 Exercise of options to purchase shares (249,903 in 2000, 23,270 in 1999 and 39,539 in 1998) 24,990 2,327 3,954 ------------ ------------ ------------ Balance at end of year 2,201,383 2,176,393 2,174,066 ------------ ------------ ------------ Common stock warrants: Balance at beginning of year 2,040,000 -- -- Issuance of warrants in connection with Preferred stock -- 2,040,000 -- ------------ ------------ ------------ Balance at end of year 2,040,000 2,040,000 -- ------------ ------------ ------------ Additional paid-in capital Balance at beginning of year 112,674,842 87,778,548 87,697,754 Exercise of options to purchase shares (249,903 in 2000, 23,270 in 1999 and 39,539 in 1998) 519,246 47,551 80,794 Issuance of preferred shares (31,620 in 1999) -- 24,762,929 -- Accretion of discount on preferred shares 346,164 85,814 -- ------------ ------------ ------------ Balance at end of year $113,540,252 112,674,842 87,778,548 ------------ ------------ ------------
(continued) 48 43 GAINSCO, INC. AND SUBSIDIARIES Consolidated Statements of Shareholders' Equity and Comprehensive Income Years ended December 31, 2000, 1999 and 1998
2000 1999 1998 ---------------------------- ---------------------------- ---------------------------- Retained earnings: Balance at beginning of year $ 27,586,440 22,086,868 35,188,460 Net income (loss) for year (19,551,365) (19,551,365) 7,127,137 7,127,137 (11,662,564) (11,662,564) Cash dividend -- common (note 7) (1,474,206) (1,463,227) (1,462,070) Cash dividend -- preferred (note 7) (434,000) (108,500) -- Accretion of discount on preferred shares (346,164) (85,814) -- Tax benefit on non-qualified stock options exercised 177,093 29,976 23,042 ------------- ------------- ------------- Balance at end of year 5,957,798 27,586,440 22,086,868 ------------- ------------- ------------- Accumulated other comprehensive income (loss): Balance at beginning of year (2,246,575) 1,138,941 1,058,268 Unrealized gains (losses) on securities, net of reclassification adjustment, net of tax (note 3) 6,143,946 6,143,946 (3,385,516) (3,385,516) 80,673 80,673 ------------- ------------ ------------- ------------ ------------- ------------ Comprehensive income (loss) (13,407,419) 3,741,621 (11,581,891) ============ ============ ============ Balance at end of year 3,897,371 (2,246,575) 1,138,941 ------------- ------------- ------------- Treasury stock: Balance at beginning of year (7,694,525) (7,694,525) (7,552,334) Purchases during year -- -- (142,191) ------------- ------------- ------------- Balance at end of year (7,694,525) (7,694,525) (7,694,525) ------------- ------------- ------------- Total shareholders' equity at end of year $ 123,104,279 137,698,575 105,483,898 ============= ============= =============
See accompanying notes to consolidated financial statements. 49 44 GAINSCO, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows Years ended December 31, 2000, 1999 and 1998
2000 1999 1998 ------------ ------------ ------------ Cash flows from operating activities: Net income (loss) $(19,551,365) 7,127,137 (11,662,564) Adjustments to reconcile net income (loss) to cash provided by/(used for) operating activities: Depreciation and amortization 2,734,855 4,312,400 4,794,084 Change in deferred Federal income taxes (10,287,306) 100,764 (4,046,391) Change in accrued investment income 307,007 426,944 490,598 Change in premiums receivable 558,442 (10,546,651) 187,021 Change in reinsurance balances receivable (50,365,554) (862,354) 211,935 Change in ceded unpaid claims and claim adjustment expenses 21,819 (2,269,326) (5,505,975) Change in ceded unearned premiums (22,846,077) (760,982) (3,241,327) Change in deferred policy acquisition costs and deferred ceding commission income 12,638,482 (3,607,531) 297,994 Change in other assets (734,871) (2,795,813) (440,620) Change in unpaid claims and claim adjustment expenses 29,836,469 (3,984,566) 23,571,140 Change in unearned premiums (9,786,141) 18,618,108 (402,830) Change in commissions payable 355,072 (2,649,644) 2,072,010 Change in accounts payable 1,158,081 1,886,907 (2,140,412) Change in reinsurance balances payable 19,254,839 6,571,553 582,192 Change in deferred revenue 404,311 (707,427) (369,872) Change in drafts payable 4,656,535 (1,628,532) (3,558,529) Change in funds held under reinsurance agreements 47,850,000 -- -- Change in other liabilities (33,446) (372,535) (371,359) Change in current Federal income taxes (1,521,613) 4,917,298 (4,212,277) ------------ ------------ ------------ Net cash provided by/(used for) operating activities $ 4,649,539 13,775,750 (3,745,182) ------------ ------------ ------------
(continued) 50 45 GAINSCO, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows Years ended December 31, 2000, 1999 and 1998
2000 1999 1998 ------------ ------------ ------------ Cash flows from investing activities: Bonds held to maturity: Matured $ -- 17,833,400 30,636,243 Purchased -- -- (2,253,813) Bonds available for sale: Sold 80,469,659 32,934,481 46,326,098 Matured 32,030,354 11,177,942 1,520,000 Purchased (98,744,876) (61,910,875) (71,425,415) Common stock purchased (6,027,392) -- -- Other investments sold 690,016 3,148 28,191 Other investments purchased (3,959,136) (973,169) -- Certificates of deposit matured 740,000 510,000 595,000 Certificates of deposit purchased (545,000) (370,000) (595,000) Net change in short-term investments 5,792,476 (41,728,589) (1,312,442) Property and equipment purchased (1,341,872) (568,270) (504,229) Net assets acquired through purchase of subsidiary (net of cash acquired: 2000 -- $662,422, 1999 -- $0, 1998 -- $5,865,515) (8,488,225) (2,012,500) (12,464,783) ------------ ------------ ------------ Net cash provided by/(used for) investing activities 616,004 (45,104,432) (9,450,150) ------------ ------------ ------------ Cash flows from financing activities: Proceeds from (payments on) note payable (2,000,000) -- 18,000,000 Cash dividends paid (1,903,832) (1,462,820) (1,461,679) Preferred stock and warrants issued (net of transaction fees) -- 29,964,929 -- Proceeds from exercise of common stock options 544,236 49,878 84,748 Treasury stock acquired -- -- (142,191) ------------ ------------ ------------ Net cash provided by/(used for) financing activities (3,359,596) 28,551,987 16,480,878 ------------ ------------ ------------ Net increase (decrease) in cash 1,905,947 (2,776,695) 3,285,546 Cash at beginning of year 1,205,364 3,982,059 696,513 ------------ ------------ ------------ Cash at end of year $ 3,111,311 1,205,364 3,982,059 ============ ============ ============
See accompanying notes to consolidated financial statements. 51 46 GAINSCO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2000, 1999 and 1998 (1) SUMMARY OF ACCOUNTING POLICIES (a) Basis of Consolidation The accompanying consolidated financial statements include the accounts of GAINSCO, INC. ("GNA") and its wholly-owned subsidiaries (collectively, the "Company"), General Agents Insurance Company of America, Inc. ("General Agents"), General Agents Premium Finance Company, Agents Processing Systems, Inc., Risk Retention Administrators, Inc., GAINSCO Service Corp. ("GSC"), Lalande Financial Group, Inc. ("Lalande Group"), National Specialty Lines, Inc. ("NSL"), DLT Insurance Adjusters, Inc. ("DLT") and Tri-State, Ltd. ("Tri-State"). General Agents has one wholly owned subsidiary, MGA Insurance Company, Inc. ("MGAI") which, in turn, owns 100% of MGA Agency, Inc. Tri-State has three wholly owned subsidiaries, Midwest Casualty Insurance Company ("MCIC"), Herb Hill Insurance, Inc. and MDR/Motor Vehicle Driving Records. GSC has one wholly owned subsidiary, MGA Premium Finance Company. GSC controls the management contract and charter of GAINSCO County Mutual Insurance Company ("GCM") and its accounts have been included in the accompanying consolidated financial statements All significant intercompany accounts have been eliminated in consolidation. The accompanying consolidated financial statements are prepared in conformity with accounting principles generally accepted in the United States of America. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. (b) Nature of Operations The Company is predominantly a property and casualty insurance company concentrating its efforts on nonstandard markets within the commercial, personal and specialty insurance lines. The Company is approved to write insurance in 48 states and the District of Columbia on a non-admitted basis and in 44 states and the District of Columbia on an admitted basis. The Company markets its commercial lines of insurance through 194 non-affiliated general agents' offices and its nonstandard personal auto line is marketed through approximately 1,145 non-affiliated retail agencies. Approximately 75% of the Company's gross premiums written during 2000 resulted from risks located in California, Florida, Georgia, Louisiana Pennsylvania, and Texas. 52 47 GAINSCO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2000, 1999 and 1998 (c) Investments Bonds held to maturity were stated at amortized cost. Bonds available for sale, common stock and other investments are stated at fair value with changes in fair value recorded as a component of comprehensive income. Short-term investments are stated at cost. The following schedule summarizes the components of other investments:
As of December 31 --------------------------------------------------------------- 2000 1999 ----------------------------- ----------------------------- Fair value Cost Fair Value Cost ------------ ------------ ------------ ------------ Equity investments $ 2,117,226 2,117,226 916,278 916,278 Marketable securities 266,530 405,980 254,051 372,179 Note receivable 2,057,484 2,057,484 -- -- ------------ ------------ ------------ ------------ Total other investments $ 4,441,240 4,580,690 1,170,329 1,288,457 ============ ============ ============ ============
The equity investments are predominately private equity investments that are not traded in public markets and cost is considered to approximate fair value. Cost is considered to approximate fair value for the note receivable due to its short duration and market rate of interest. The Company holds an embedded derivative financial instrument in common stock warrants attached to the note receivable. As of December 31, 2000, the exercise price of the warrants was not determinable and, therefore, the warrants were not recorded at fair value in these financial statements. The agreement with GMSP, disclosed in note (8), provides an opportunity to convert the equity investments and the note receivable with a cost of $4.2 million to cash as of November 2002, as follows: the Company could at its option require GMSP to purchase these investments for $2.1 million, less any future cash received prior to November 2002 from the investments. GMSP could at its option require the Company to sell the equity investments and the note receivable to GMSP for $4.2 million, less any future cash received prior to November 2002 from the investments. In the fourth quarter of 1999 all bonds classified as held to maturity were transferred to the available for sale classification and adjusted to fair value. The amortized cost at the date of transfer for these bonds was $41,069,988 and the fair value was $41,036,014 resulting in an unrealized loss before Federal income taxes of $33,974. The Company made this change since it no longer invests in bonds with the intent of holding them to maturity. The "specific identification" method is used to determine costs of investments sold. Provisions for possible losses are recorded only when the values have experienced impairment considered "other than temporary" by a charge to realized losses resulting in a new cost basis of the investment. Proceeds from the sale of bond securities totaled $80,469,659, $32,934,481, and $46,326,098 in 2000, 1999 and 1998, respectively. Proceeds from the sale of other investments totaled $690,016, $3,148 and $28,191 in 2000, 1999 and 1998, respectively. 53 48 GAINSCO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2000, 1999 and 1998 Realized gains and losses on investments for the years ended December 31, 2000, 1999 and 1998 are presented in the following table:
Years ended December 31 ----------------------------------------------- 2000 1999 1998 ------------ ------------ ------------ Realized gains: Bonds $ 17,554 684,029 721,404 Other investments 33,602 -- -- ------------ ------------ ------------ Total realized gains 51,156 684,029 721,404 ------------ ------------ ------------ Realized losses: Bonds 1,958,067 78,423 28,894 ------------ ------------ ------------ Total realized losses 1,958,067 78,423 28,894 ------------ ------------ ------------ Net realized gains (losses) $ (1,906,911) 605,606 692,510 ============ ============ ============
During 2000, approximately $80.5 million in bond securities were sold for a pre-tax loss of $1,906,911 and a large portion of the proceeds were reinvested in bond securities with an average taxable equivalent yield of more than 150 basis points over the bond securities that were sold. (d) Financial Instruments For premiums receivable, which include premium finance notes receivable, and all other accounts (except investments) defined as financial instruments in Statement of Financial Accounting Standards No.107, "Disclosures About Fair Values of Financial Instruments," the carrying amount approximates fair value due to the short-term nature of these instruments. The carrying amount of notes payable approximates fair value due to the variable interest rate on the note. These balances are disclosed on the face of the balance sheets. Fair values for investments, disclosed in note 2, were obtained from independent brokers and published valuation guides. (e) Deferred Policy Acquisition Costs and Deferred Ceding Commission Income Policy acquisition costs, principally commissions, premium taxes and certain marketing and underwriting expenses, are deferred and charged to operations over periods in which the related premiums are earned. Ceding commission income, which is realized on a written basis, is deferred and recognized over periods in which the related premiums are earned. Deferred ceding commission income is netted against deferred policy acquisition costs. The marketing expenses are predominately salaries, salary related expenses and travel expenses of the Company's marketing representatives who actively solicit business from the independent general agents. The Company utilizes investment income when assessing recoverability of deferred policy acquisition costs. The Company recorded an impairment of $501,930 on its deferred policy acquisition costs related to the property and nonstandard personal auto lines of business at December 31, 2000. The change in the resulting deferred asset is charged (credited) to operations. Information relating to these net deferred amounts, as of and for the years ended December 31, 2000, 1999 and 1998 is summarized as follows: 54 49 GAINSCO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2000, 1999 and 1998
2000 1999 1998 ------------ ------------ ------------ Asset balance, beginning of period $ 14,927,673 11,320,142 11,618,136 ------------ ---------- ---------- Asset balance acquired through purchase of subsidiary 12,753 -- -- Deferred commissions 34,050,455 27,149,110 19,709,462 Deferred premium taxes, boards & bureaus and fees 2,792,869 3,129,942 1,552,028 Deferred marketing and underwriting expenses 2,968,031 3,078,115 3,199,524 Deferred ceding commission income (12,623,698) (212,127) (373,435) Amortization (39,324,209) (29,537,509) (24,385,573) Impairment (501,930) -- -- ------------ ------------ ------------ Net change (12,625,729) 3,607,531 (297,994) ------------ ------------ ------------ Asset balance, end of period $ 2,301,944 14,927,673 11,320,142 ============ ============ ============
The increase in the deferred ceding commission income is a result of the quota share reinsurance agreement effective December 31, 2000, whereby the Company ceded 100% of its commercial auto liability unearned premiums and 50% of all other commercial business unearned premiums. (f) Property and Equipment Property and equipment are stated at cost. Depreciation is calculated using the straight-line method over the estimated useful lives of the respective assets (30 years for buildings and primarily 5 years for furniture and software and 3 years for equipment). The following schedule summarizes the components of property and equipment:
As of December 31 ------------------------------ 2000 1999 ------------ ------------ Land $ 865,383 865,383 Buildings 6,332,850 6,295,850 Furniture and equipment 5,709,400 5,196,044 Software 4,782,276 3,103,427 Accumulated depreciation and amortization (9,745,505) (8,605,454) ------------ ------------ $ 7,944,404 6,855,250 ============ ============
(g) Software Costs Computer software costs relating to programs for internal use are recorded in property and equipment and are amortized using the straight-line method over five years or the estimated useful life, whichever is shorter. (h) Goodwill Goodwill, which represents the excess of purchase price over fair value of net assets acquired, is amortized on a straight-line basis over 25 years, which is the expected period to be benefited. The 55 50 GAINSCO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2000, 1999 and 1998 Company periodically reviews the recoverability of goodwill based on an assessment of undiscounted cash flows of future operations to ensure it is appropriately valued. On January 7, 2000, the Company completed the acquisition of Tri-State, an insurance operation specializing primarily in underwriting, servicing and claims handling of nonstandard personal auto insurance in Minnesota, North Dakota and South Dakota. The purchase price was approximately $6,000,000 with an additional payment of $1,148,454 made in July, 2000 and additional payments up to approximately $4,350,000 in cash possible over the next several years based on a conversion goal and specific profitability targets. The Company paid $1,566,081 in January of 2001 for the conversion goal. (i) Treasury Stock The Company records treasury stock in accordance with the "cost method" described in Accounting Principles Board Opinion (APB) 6. The Company held 844,094 shares as treasury stock at December 31, 2000 and 1999 with a cost basis of $9.12 per share. (j) Revenue Recognition Premiums are recognized as earned on a pro rata basis over the period the Company is at risk under the related policy. Unearned premiums represent the portion of premiums written which are applicable to the unexpired terms of policies in force. NSL charges policy fees to recoup the cost of processing and issuing policies. These fees are non-refundable and are recognized as earned when the policy is written. NSL's net commission revenues are recognized as earned on a pro rata basis over the policy period. (k) Claims and Claim Adjustment Expenses Claims and claim adjustment expenses, less related reinsurance, are provided for as claims are incurred. The provision for unpaid claims and claim adjustment expenses includes: (1) the accumulation of individual case estimates for claims and claim adjustment expenses reported prior to the close of the accounting period; (2) estimates for unreported claims based on past experience modified for current trends; and (3) estimates of expenses for investigating and adjusting claims based on past experience. Liabilities for unpaid claims and claim adjustment expenses are based on estimates of the ultimate cost of settlement. Changes in claim estimates resulting from the review process and differences between estimates and ultimate payments are reflected in expense for the year in which the revision of these estimates first become known. The process of establishing claim reserves is an imprecise science and reflects significant judgmental factors. In many liability cases, significant periods of time, ranging up to several years or more, may elapse between the occurrence of an insured claim and the settlement of the claim. Some judicial decisions and legislative actions, even after coverage is written and reserves are initially set, broaden 56 51 GAINSCO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2000, 1999 and 1998 liability and policy definitions and increase the severity of claim payments. As a result of this and other societal and economic developments, the uncertainties inherent in estimating ultimate claim costs on the basis of past experience have increased significantly, further complicating the already difficult claim reserving process. Ultimate liability may be greater or lower than current reserves. Reserves are monitored by the Company using new information on reported claims and a variety of statistical techniques. The reserves are reviewed annually by an independent actuarial firm. The Company does not discount to present value that portion of its claim reserves expected to be paid in future periods. The following table sets forth the changes in unpaid claims and claim adjustment expenses, net of reinsurance cessions, as shown in the Company's consolidated financial statements for the periods indicated:
As of and for the years ended December 31 ---------------------------------------- 2000 1999 1998 ---------- ---------- ---------- (Amounts in thousands) Unpaid claims and claim adjustment expenses, beginning of period $ 132,814 136,798 113,227 Less: Ceded unpaid claims and claim adjustment expenses, beginning of period 37,299 35,030 29,524 ---------- ---------- ---------- Net unpaid claims and claim adjustment expenses, beginning of period 95,515 101,768 83,703 ---------- ---------- ---------- Net claims and claim adjustment expense incurred related to: Current period 124,077 75,976 59,635 Prior periods 19,362 373 26,718 ---------- ---------- ---------- Total net claim and claim adjustment expenses incurred 143,439 76,349 86,353 ---------- ---------- ---------- Net claims and claim adjustment expenses paid related to: Current period 58,898 32,651 19,693 Prior periods 54,683 49,951 48,595 ---------- ---------- ---------- Total net claim and claim adjustment expenses paid 113,581 82,602 68,288 ---------- ---------- ---------- Net reserves acquired through purchase of subsidiary 1,084 -- -- ---------- ---------- ---------- Net unpaid claims and claim adjustment expenses, end of period 126,457 95,515 101,768 Plus: Ceded unpaid claims and claim adjustment expenses, end of period 37,703 37,299 35,030 ---------- ---------- ---------- Unpaid claims and claim adjustment expenses, end of period $ 164,160 132,814 136,798 ========== ========== ==========
For 2000 the development in claims and claim adjustment expenses incurred was primarily the result of unanticipated development of commercial auto claims for the 1999, 1997 and 1996 accident years. At December 31, 2000 the Company believes that the carried reserves and the reinsurance agreements currently in force are sufficient to support the future emergence of prior year claim and claim adjustment expenses. For 1998 the development in claims and claim adjustment expenses incurred was primarily the result of unanticipated development for commercial auto claims for the 1997, 1996 and 1995 accident years. 57 52 GAINSCO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2000, 1999 and 1998 (l) Income Taxes The Company and its subsidiaries file a consolidated Federal income tax return. Deferred income tax items are accounted for under the "asset and liability" method which provides for temporary differences between the reporting of earnings for financial statement purposes and for tax purposes, primarily deferred policy acquisition costs, the discount on unpaid claims and claim adjustment expenses and the nondeductible portion of the change in unearned premiums. The Company paid income taxes of $280,000, $1,340,161, and $0 during 2000, 1999 and 1998, respectively. The Company received Federal income tax refunds totaling $251,644 and $5,144,060 during 2000 and 1999, respectively. (m) Earnings Per Share The following table sets forth the computation of basic and diluted earnings per share:
Years ended December 31 ----------------------------------------------- 2000 1999 1998 ------------ ------------ ------------ Basic earnings (loss) per share: Numerator: Net income (loss) $(19,551,365) 7,127,137 (11,662,564) Less: Preferred stock dividends 434,000 108,500 -- Less: Accretion of discount on preferred stock 346,164 -- -- ------------ ------------ ------------ Net income (loss) available to common shareholders $(20,331,529) 7,018,637 (11,662,564) ------------ ------------ ------------ Denominator: Weighted average shares outstanding 21,027,699 20,903,723 20,881,357 ------------ ------------ ------------ Basic earnings (loss) per share $ (.97) .34 (.56) ============ ============ ============ Diluted earnings (loss) per share: Numerator: Net income (loss) $(19,551,365) 7,127,137 (11,662,564) ------------ ------------ ------------ Denominator: Weighted average shares outstanding 21,027,699 20,903,723 20,881,357 Effect of dilutive securities: Employee stock options -- 157,536 355,329 Convertible preferred stock 6,200,000 1,430,769 -- ------------ ------------ ------------ Weighted average shares and assumed conversions 27,227,699 22,492,028 21,236,686 ------------ ------------ ------------ Diluted earnings (loss) per share (1) $ (.97) .32 (.56) ============ ============ ============
(1) The effects of common stock equivalents and convertible preferred stock are antidilutive for the 2000 and 1998 periods; therefore, diluted earnings (loss) per share is reported the same as basic earnings (loss) per share. (n) Stock-Based Compensation In October 1995, the FASB issued Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("Statement 123"). Statement 123 defines a fair value based method of accounting for an employee stock option or similar equity instrument. Under Statement 123, the Company elects to measure compensation costs using the intrinsic value based 58 53 GAINSCO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2000, 1999 and 1998 method of accounting prescribed by APB 25 "Accounting for Stock Issued to Employees". (o) Accounting Pronouncements Effective January 1, 2001, the Company adopted Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("Statement 133"), as amended. Statement 133 establishes accounting and reporting standards for derivative instruments and requires that an entity recognize all derivatives as either assets or liabilities in the financial statements and measure those instruments at fair value with changes in fair value recorded through the income statement. The Company anticipates that the adoption of Statement 133 will not have a material impact on the consolidated financial statements. (2) INVESTMENTS The following schedule summarizes the components of net investment income:
Years ended December 31 ------------------------------------------------ 2000 1999 1998 ------------ ------------ ------------ Investment income on: Fixed maturities $ 12,137,120 9,086,506 9,109,856 Common stocks 602,300 -- -- Other investments 109,307 -- -- Short-term investments 2,266,657 1,019,238 896,940 ------------ ------------ ------------ 15,115,384 10,105,744 10,006,796 Investment expenses (1,022,470) (383,531) (204,094) ------------ ------------ ------------ Net investment income $ 14,092,914 9,722,213 9,802,702 ============ ============ ============
59 54 GAINSCO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2000, 1999 and 1998 The following schedule summarizes the amortized cost and estimated fair values of investments in debt securities:
Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains Losses Value ------------ ------------ ------------ ------------ (Amounts in thousands) Fixed maturities: Bonds available for sale: U.S. Government securities - 2000 $ 21,138 205 (26) 21,317 U.S. Government securities - 1999 24,365 -- (336) 24,029 Tax-exempt state & municipal bonds - 2000 45,284 330 (142) 45,472 Tax-exempt state & municipal bonds - 1999 148,983 178 (2,957) 146,204 Corporate bonds - 2000 121,564 4,857 (868) 125,553 Corporate bonds - 1999 27,067 22 (245) 26,844 Certificates of deposit - 2000 845 -- -- 845 Certificates of deposit - 1999 455 -- -- 455 Total Fixed maturities - 2000 188,831 5,392 (1,036) 193,187 Total Fixed maturities - 1999 $ 200,870 200 (3,538) 197,532
The amortized cost and estimated fair value of debt securities at December 31, 2000 and 1999, by maturity, are shown below.
2000 1999 ----------------------------- ----------------------------- Estimated Estimated Amortized Fair Amortized Fair Cost Value Cost Value ------------ ------------ ------------ ------------ (Amounts in thousands) Due in one year or less $ 22,203 22,274 42,770 42,821 Due after one year but within five years 102,822 103,944 113,979 112,151 Due after five years but within ten years 59,531 62,601 35,123 33,755 Due after ten years but within twenty years 4,275 4,368 5,622 5,432 Due beyond twenty years -- -- 3,376 3,373 ------------ ------------ ------------ ------------ $ 188,831 193,187 200,870 197,532 ============ ============ ============ ============
Investments of $16,507,427 and $14,832,735, at December 31, 2000 and 1999, respectively, were on deposit with various regulatory bodies as required by law. 60 55 GAINSCO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2000, 1999 and 1998 (3) ACCUMULATED OTHER COMPREHENSIVE INCOME The following schedule presents the components of other comprehensive income:
Years ended December 31 ------------------------------------------------ 2000 1999 1998 ------------ ------------ ------------ Unrealized gains (losses) on securities: Unrealized holding gains (losses) during period $ 7,455,491 (4,613,296) 827,036 Reclassification adjustment for amounts included in net income for realized gains (losses) (1,906,911) 605,606 692,510 ------------ ------------ ------------ Other comprehensive income (loss) before Federal income taxes 9,362,402 (5,218,902) 134,526 Federal income tax expense (benefit) 3,218,456 (1,833,386) 53,853 ------------ ------------ ------------ Other comprehensive income (loss) $ 6,143,946 (3,385,516) 80,673 ============ ============ ============
(4) NOTE PAYABLE In November of 1998, the Company entered into a credit agreement with a commercial bank pursuant to which it borrowed $18,000,000. Interest was due monthly at an interest rate that approximated the 30-day London Interbank Offered Rate (LIBOR) plus 175 basis points (8.3125% at December 31, 2000). Principal payments of $500,000 were due each quarter with the balance of $10,500,000 due at maturity of the note on October 1, 2003. The Company recorded interest expense of $1,409,378, $1,265,529 and $101,763 during 2000, 1999 and 1998, respectively. The Company paid interest of $1,286,438, $1,367,292 and $0 during 2000, 1999 and 1998, respectively. The Company made principal payments of $500,000 in January, April, July and October of 2000 and in January, 2001. In March 2001, the credit agreement was amended, specific breaches of covenants were waived, $2,500,000 in principal was prepaid and certain terms were amended. Interest is due monthly at an interest rate that approximates the 30-day LIBOR plus 250 basis points with an increase of 25 basis points each quarter beginning October 1, 2001. Principal payments of $500,000 are due each quarter and increase to $750,000 beginning April 1, 2002, with the balance of $6,500,000 due at maturity of the note on October 1, 2003. (5) REINSURANCE Ceded Commercial Lines Prior to 1999, the Company wrote commercial casualty policy limits of $1,000,000. For policies with an effective date occurring from 1995 through 1998, the Company has first excess casualty reinsurance for 100% of casualty claims exceeding $500,000 up to the $1,000,000 limits, resulting in a maximum net claim retention per risk of $500,000 for such policies. During 1999 and 2000, the Company wrote commercial casualty policy limits of $5,000,000. For policies with an effective date occurring in 1999 or 2000, the Company has first excess casualty reinsurance for 100% of casualty claims exceeding $500,000 up to $1,000,000 and second excess casualty reinsurance for 100% of casualty claims exceeding $1,000,000 up to the $5,000,000 limits, resulting in a maximum net claim retention per risk of $500,000. The Company uses facultative reinsurance for policy limits written in excess of $5,000,000. Effective December 31, 2000 the Company entered into a quota share reinsurance agreement whereby the Company ceded 100% of its commercial auto liability unearned premiums and 50% of all other commercial business unearned premiums at December 31, 2000 to a non-affiliated reinsurer. For policies with an effective date of January 1, 2001 or subsequent, the Company entered into a quota share reinsurance agreement whereby the Company will cede 20% of its commercial business to a non-affiliated reinsurer. Also effective December 31, 2000, the Company entered into a reserve reinsurance cover agreement with a non-affiliated reinsurer. This agreement reinsures the Company's ultimate net aggregate liability in excess of $32,500,000 up to an aggregate limit of $57,150,000 for net commercial auto liability losses and loss adjustment expense incurred but unpaid as of December 31, 2000. The Company established a reinsurance 61 56 GAINSCO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2000, 1999 and 1998 balance receivable and a liability for funds held under reinsurance agreements for the reserves transferred at December 31, 2000. The Company also has excess casualty clash reinsurance for $5,000,000 in ultimate net losses on any one accident in excess of $1,000,000 in ultimate net losses arising out of each accident. Specialty Lines For its lawyers professional liability coverages, the Company has quota share reinsurance for 50% of the first $1,000,000 of professional liability claims and excess casualty reinsurance for 100% of professional liability claims exceeding $1,000,000 up to $5,000,000 policy limits resulting in a maximum net claim retention per risk of $500,000. For its real estate agents professional liability coverages, the Company has quota share reinsurance for 25% of the first $1,000,000 of professional liability claims resulting in a maximum net claim retention per risk of $750,000. For its educators professional liability coverages, the Company has quota share reinsurance for 60% of the first $1,000,000 of professional liability claims and excess casualty reinsurance for 100% of professional liability claims exceeding $1,000,000 up to $5,000,000 policy limits resulting in a maximum net claim retention per risk of $400,000. For its directors and officers liability coverages, the Company has quota share reinsurance for 90% of the first $5,000,000 of professional liability claims resulting in a maximum net claim retention per risk of $500,000. For its miscellaneous professional liability coverages, the Company has quota share reinsurance for 50% of the first $1,000,000 of professional liability claims resulting in a maximum net claim retention per risk of $500,000. Personal Lines For its umbrella coverages, the Company has excess casualty reinsurance for 100% of umbrella claims exceeding $1,000,000 up to $10,000,000 policy limits. The Company also has quota share reinsurance for 75% of the first $1,000,000 of umbrella claims resulting in a maximum net claim retention per risk of $250,000. For its personal auto coverages, the Company has excess casualty clash reinsurance for $5,000,000 in ultimate net losses on any one accident in excess of $1,000,000 in ultimate net losses arising out of each accident. The Company's personal auto business is produced by NSL and Tri-State or written on a direct basis through MCIC. For business produced by NSL with an effective date of April 1, 2000 through December 31, 2000, the Company has excess of loss reinsurance for 100% of claims in excess of $25,000 up to the $100,000 policy limits and quota share reinsurance for 20% of the first $25,000 of claims resulting in a maximum net claim retention per risk of $20,000. For business produced by NSL with an effective date of January 1, 2001 or after, the Company has excess of loss reinsurance for 100% of claims in excess of $25,000 up to the 62 57 GAINSCO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2000, 1999 and 1998 $100,000 policy limits and quota share reinsurance for 50% of the first $25,000 of claims resulting in a maximum net claim retention per risk of $12,500. For business produced by Tri-State or written on a direct basis with MCIC with an effective date prior to January 1, 2001, the Company has excess of loss reinsurance for 100% of claims in excess of $25,000 up to the $100,000 policy limits and quota share reinsurance for 50% of the first $25,000 of claims resulting in a maximum net claim retention per risk of $12,500. For business produced by Tri-State or written on a direct basis with MCIC with an effective date of January 1, 2001 or after, the Company has excess of loss reinsurance for 100% of claims in excess of $25,000 up to the $100,000 policy limits and quota share reinsurance for 75% of the first $25,000 of claims resulting in a maximum net claim retention per risk of $6,250. For 2000, the Company carried catastrophe property reinsurance to protect against catastrophe occurrences for 95% of the property claims that exceed $500,000 but do not exceed $13,000,000 for a single catastrophe. The Company also carried property excess per risk reinsurance which covers property claims exceeding $100,000 up to $5,000,000 net loss each risk. From time to time the Company makes use of facultative reinsurance to cede unusual risks on a negotiated basis. Beginning in 2001, the Company carries catastrophe property reinsurance to protect it against catastrophe occurrences for 95% of the property claims that exceed $1,500,000 but do not exceed $13,000,000 for a single catastrophe as well as second event catastrophe property reinsurance for 100% of $1,000,000 excess of $500,000 on a second catastrophic event. The Company also carries property excess per risk reinsurance that covers property claims exceeding $150,000 up to $1,500,000 net loss each risk. The Company uses facultative reinsurance for limits written on individual risks in excess of $1,500,000. MGAI utilized a reinsurance arrangement in Florida whereby premiums were ceded to a non-affiliated authorized reinsurer and the reinsurer ceded the premiums to General Agents. This was necessary because General Agents was not an authorized reinsurer in Florida until the fourth quarter of 2000. This program is currently in run off. GCM has entered into fronting arrangements with non-affiliated insurance companies. GCM retains no portion as the business written under these agreements is 100% ceded. Although these cessions are made to authorized reinsurers rated "A (Excellent)" or better by Best's, the agreements require that collateral (in the form of trust agreements and/or letters of credit) be maintained to assure payment of the unearned premiums and unpaid claims and claim adjustment expenses relating to the risks insured under these fronting arrangements. The balances in such accounts as of December 31, 2000 and 1999 total $24,148,000, and $30,687,000, respectively. 63 58 GAINSCO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2000, 1999 and 1998 The amounts deducted in the consolidated financial statements for reinsurance ceded as of and for the years ended December 31, 2000, 1999 and 1998 respectively, are set forth in the following table.
2000 1999 1998 ------------ ------------ ------------ Premiums earned $ 11,796,216 2,745,843 1,982,459 Premiums earned - Florida business $ 13,928,709 9,360,816 38,937 Premiums earned - plan servicing $ -- 977,684 3,767,180 Premiums earned - fronting arrangements $ 27,864,491 47,415,305 41,199,644 Claims and claim adjustment expenses $ 15,824,110 5,867,896 5,332,551 Claims and claim adjustment expenses - Florida business $ 13,215,687 6,998,999 26,267 Claims and claim adjustment expenses - plan servicing $ 1,094,163 3,456,779 4,429,624 Claims and claims adjustment expenses - fronting arrangements $ 20,315,134 35,075,008 34,992,635
Premiums and claims ceded to the commercial automobile plans of Arkansas, California, Louisiana, Mississippi and Pennsylvania are designated as "plan servicing". The amounts included in the Consolidated Balance Sheets for reinsurance ceded under fronting arrangements and reinsurance ceded to the commercial automobile plans of Arkansas, California, Louisiana, Mississippi, and Pennsylvania were as follows:
2000 1999 1998 ------------ ------------ ------------ Unearned premiums - Florida business $ 617,477 7,817,052 362,402 Unearned premiums - plan servicing $ -- -- 1,139,560 Unearned premiums - fronting arrangements $ 6,642,887 14,263,564 20,194,814 Unpaid claims and claim adjustment expenses - Florida business $ 4,253,582 2,651,273 24,386 Unpaid claims and claim adjustment expenses - plan servicing $ 4,700,008 8,094,763 9,380,484 Unpaid claims and claim adjustment expenses fronting arrangements $ 9,481,175 13,575,089 13,927,694
The Company remains directly liable to its policyholders for all policy obligations and the reinsuring companies are obligated to the Company to the extent of the reinsured portion of the risks. Assumed The Company, from time to time, utilizes reinsurance arrangements with various non-affiliated admitted insurance companies, whereby the Company underwrites the coverage and assumes the policies 100% from the companies. These arrangements require that the Company maintain escrow accounts to assure payment of the unearned premiums and unpaid claims and claim adjustment expenses relating to risks insured through such arrangements and assumed by the Company. As of December 31, 2000, 1999 and 1998, the balance in such escrow accounts totaled $15,059,497, $13,200,000, and $0, respectively. For 2000, 1999 and 1998 the premiums earned by assumption were $18,243,710, $5,396,727 and $1,883,349, respectively. The assumed unpaid claims and claim adjustment expenses were $5,142,488, $3,148,901 and $603,833, respectively. 64 59 GAINSCO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2000, 1999 and 1998 (6) FEDERAL INCOME TAXES In the accompanying consolidated statements of operations, the provisions for Federal income tax as a percent of related pretax income differ from the Federal statutory income tax rate. A reconciliation of income tax expense using the Federal statutory rates to actual income tax expense follows:
2000 1999 1998 ------------ ------------ ------------ Income tax expense (benefit) at 34% - 2000, 35% - 1999 and 1998 $(10,522,791) 2,919,455 (7,448,031) Tax-exempt interest income (988,145) (2,137,175) (2,182,650) Dividends received deduction (144,767) (1,620) -- Amortization of goodwill 327,658 241,026 -- Other, net (69,975) 192,477 13,156 ------------ ------------ ------------ Income tax expense (benefit) $(11,398,020) 1,214,163 (9,617,525) ============ ============ ============
Under Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes" ("Statement 109"), the primary objective is to establish deferred tax assets and liabilities for the temporary differences between the financial reporting basis and the tax basis of the Company's assets and liabilities at enacted tax rates expected to be in effect when such amounts are realized or settled. As a consequence, the portion of the tax expense which is a result of the change in the deferred tax asset or liability may not always be consistent with the income reported on the statement of operations. The following table represents the tax effect of temporary differences giving rise to the net deferred tax asset established under Statement 109.
As of December 31 ----------------------------- 2000 1999 ------------ ------------ Deferred tax assets: Unpaid claims and claims adjustment expenses $ 5,692,474 4,580,133 Unearned premiums 1,807,709 4,135,577 Deferred service fee income 81,654 126,467 Unrealized losses on investments -- 1,209,695 Alternative minimum tax credit 3,514,715 3,821,354 Net operating loss 7,710,640 378,200 Capital losses 648,350 -- Stock options exercised 177,093 -- Other 74,663 21,910 ------------ ------------ Total deferred tax assets 19,707,298 14,273,336 ------------ ------------ Deferred tax liabilities: Deferred policy acquisition costs and deferred ceding commission income 782,661 5,224,686 Unrealized gains on investments 2,008,760 -- Depreciation and amortization 1,068,177 637,924 Accrual of discount on bonds 173,290 7,416 Other 3,084 1,596 ------------ ------------ Total deferred tax liabilities 4,035,972 5,871,622 ------------ ------------ Net deferred tax assets $ 15,671,326 8,401,714 ============ ============
65 60 GAINSCO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2000, 1999 and 1998 In assessing the realization of its deferred tax assets, management considers whether it is more likely than not that a portion or all of the deferred tax assets will be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Based upon management's consideration of expected reversal of deferred tax liabilities and projected future taxable income, management believes it is more likely than not that the Company will realize the benefits of these deferred tax assets. As of December 31, 2000, the Company has net operating loss carry forwards of approximately $24,585,266 for tax return purposes which, if not utilized, will expire in 2020. As of December 31, 2000 the Company has capital loss carry forwards of $1,906,911 for tax purposes which, if not utilized, will expire in 2005. (7) SHAREHOLDERS' EQUITY The Company has 250,000,000 shares of authorized $.10 par value Common Stock (the "Common Stock"). Of the authorized shares, 22,013,830 and 21,763,927 were issued as of December 31, 2000 and 1999, respectively, and 21,169,736 and 20,919,833 were outstanding as of December 31, 2000 and 1999, respectively. The Company also has 10,000,000 shares of Preferred Stock with $100 par value authorized of which 31,620 shares of Series A Convertible Preferred Stock (the "Series A Preferred Stock") were issued and outstanding as of December 31, 2000 and 1999. As a result of the value attributable to Common Stock purchase warrants issued with the Series A Preferred Stock, the Series A Preferred Stock effectively was issued at a discount which is being amortized over a five year period using the effective interest method. The Series A Preferred Stock is convertible into 6,200,000 shares of Common Stock at a conversion price of $5.10 per share. On or after June 30, 2005, the Series A Preferred Stock is redeemable, in whole or in part, at the option of the Company at a redemption price equal to $1,000 per share plus any declared but unpaid dividends and distributions on the Series A Preferred Stock. The Company also has outstanding a five year warrant to purchase an aggregate of 1,550,000 shares of Common Stock at an exercise price of $6.375 per share (the "Series A Warrant") and a seven year warrant to purchase an aggregate of 1,550,000 shares of Common Stock at an exercise price of $8.50 per share (the "Series B Warrant"). Proceeds were allocated based upon the relative fair values of the Series A Preferred Stock, the Series A Warrant and the Series B Warrant. The Warrants are anti-dilutive. See note (12) for subsequent changes. In 2000, 1999 and 1998, the Company paid quarterly cash dividends of $.0175 per share on its Common Stock for every quarter. The Board of Directors discontinued quarterly dividends on the Common Stock in February 2001. 66 61 GAINSCO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2000, 1999 and 1998 The following table presents the statutory policyholders' surplus and statutory net income (loss) as of and for the years ended December 31, 2000, 1999, and 1998:
As of and for the years ended December 31 ------------------------------------------------ 2000 1999 1998 ------------ ------------ ------------ Statutory shareholder's equity/policyholders' surplus: General Agents and MGAI $ 72,383,234 67,155,036 69,825,964 MCIC 3,149,255 -- -- GCM 2,000,000 2,000,000 2,000,000 ------------ ------------ ------------ Consolidated shareholders' equity/policyholders' surplus $ 77,532,489 69,155,036 71,825,964 ============ ============ ============ Statutory net income (loss): General Agents and MGAI $(13,173,203) 5,703,199 (13,682,598) MCIC 144,869 -- -- GCM (331,520) (186,918) (340,460) ------------ ------------ ------------ Consolidated statutory net income (loss) $(13,359,854) 5,516,281 (14,023,058) ============ ============ ============
The Company's statutory capital exceeds the benchmark capital level under the Risk Based Capital formula for its major insurance companies. The Company will adopt the NAIC Accounting Practices and Procedures (Codification of Statutory Accounting) effective January 1, 2001. The Company does not anticipate a significant impact on statutory policyholders' surplus for 2001. Statutes in Texas, Oklahoma and North Dakota restrict the payment of dividends by the insurance company subsidiaries to the available surplus funds derived from their realized net profits. The maximum amount of cash dividends that each subsidiary may declare without regulatory approval in any 12-month period is the greater of net income for the 12-month period ended the previous December 31 or ten percent (10%) of policyholders' surplus as of the previous December 31. In 2001, General Agents (the Oklahoma subsidiary) may declare dividends to GNA of up to $7,238,323 without regulatory approval; MGAI (the Texas subsidiary) may declare dividends to General Agents of up to $1,966,799 without regulatory approval; and MCIC (the North Dakota subsidiary) may declare dividends to Tri-State of $314,925 without regulatory approval. In 1988, the Board of Directors declared, pursuant to a Rights Plan, a dividend distribution of one common share purchase right on each outstanding share of $.10 par value Common Stock. The dividend distribution was made on March 18, 1988, payable to shareholders of record on that date. In 1993, the Board of Directors amended the Rights Plan and extended the expiration date of these rights from March 18, 1998 to May 25, 2003. Each right, as amended during 1993, has an exercise price of $70. The rights are not exercisable until the Distribution Date (as defined in the Rights Plan). The Rights Plan provides, among other things, that if any person or group (other than the Company, one of its subsidiaries or an employee benefit plan of the Company or a subsidiary) acquires 20% or more of the Company's Common Stock (except pursuant to an offer for all outstanding Common Stock which the Continuing Directors (as defined in the Rights Plan) have determined to be in the best interests of the Company and its shareholders), if a 20% holder engages in certain self-dealing transactions or if a holder of 15% or more of the Company's Common Stock is declared an Adverse Person (as defined in the Rights Plan) by the Board of Directors, each holder of a right (other than the 20% holder or the Adverse Person, whose rights would become null and void) would have the right to receive, upon exercise of the right, Common Stock having a market value of two times the exercise price of the right. The Company is able to redeem rights under certain conditions set forth in the Rights Plan. If, following a public announcement that a person has acquired 20% or more of the Common Stock, the Company is acquired in a merger (other than a merger which follows an offer approved by the Continuing Directors as defined in the Rights Plan) or other business combination transaction or if 50% of the assets or earning power of the Company is sold, each right (except rights which have previously become null and void as described above), will entitle its holder to purchase, at the right's then-current exercise price, shares of the acquiring Company's Common Stock having a market value of two times the exercise price of the right. 67 62 GAINSCO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2000, 1999 and 1998 (8) BUSINESS TRANSACTIONS 68 63 GAINSCO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2000, 1999 and 1998 On October 4, 1999 GNA sold to GMSP, for an aggregate purchase price of $31,620,000 (i) 31,620 shares of Series A Preferred Stock, which are convertible into 6,200,000 shares of Common Stock at a conversion price of $5.10 per share, (ii) the Series A Warrant to purchase an aggregate of 1,550,000 shares of Common Stock at an exercise price of $6.375 per share and (iii) the Series B Warrant to purchase an aggregate of 1,550,000 shares of Common Stock at an exercise of $8.50 per share (the "1999 GMSP Transaction"). At closing GNA and its insurance company subsidiaries entered into Investment Management Agreements with GMSP pursuant to which GMSP manages their respective investment portfolios. Completion of the 1999 GMSP Transaction concluded the strategic alternatives review process that the Company initiated in 1998. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations -- Business Operations." On March 23, 2001, the Company consummated a transaction with GMSP pursuant to which, among other things, the Company issued shares of its newly created Series C Preferred Stock to GMSP in exchange for an aggregate purchase price of $3.0 million in cash (the "2001 GMSP Transaction"). In the 2001 GMSP Transaction, the Company and GMSP changed certain terms of certain of the securities issued to GMSP pursuant to the 1999 GMSP Transaction and the Company undertook to redeem the Series A Preferred Stock in 2006, subject to certain conditions. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations -- Business Operations." On March 23, 2001, the Company consummated a transaction with Robert W. Stallings pursuant to which, among other things, the Company issued shares of its newly created Series B Preferred Stock and a warrant to purchase an aggregate of 1,050,000 shares of GNA Common Stock at the defined Conversion Price in exchange for an aggregate purchase price of $3.0 million in cash (the "Stallings Transaction"). See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations -- Business Operations." On January 7, 2000, the Company completed the acquisition of Tri-State, Ltd. (Tri-State), an insurance operation specializing primarily in underwriting, servicing and claims handling of nonstandard personal auto insurance in Minnesota, North Dakota and South Dakota. Tri-State operates a managing general agency, a motor vehicle driving records service company and an insurance subsidiary, Midwest Casualty Insurance Company (MCIC). Tri-State was incorporated in 1980 and currently markets nonstandard personal auto insurance through over 540 retail agencies in its three key states and commercial automobile insurance in four states. Tri-State continues to operate at its current locations to develop personal and commercial lines of business The purchase price was approximately $6 million with an additional payment of approximately $1.2 million made in July, 2000 and $1.6 million made in January 2001 for the conversion goal. Additional payments up to approximately $3.0 million in cash are possible over the next several years based on specific profitability targets. The transaction has resulted in goodwill of approximately $5.4 million which is being amortized on a straight line basis over 25 years. The pro forma unaudited results of operations for the years ended December 31, 1999 and 1998, assuming the purchase of Tri-State had consummated on January 1, 1998 are presented below:
1999 1998 ------------ ------------ (Amounts in thousands, except per share data) Revenues $ 132,998 111,622 Net income (loss) $ 8,310 (10,770) Basic earnings (loss) per share $ .40 (.52) Diluted earnings (loss) per share $ .37 (.52)
In April 1999, the Company completed the sale of the assets of Agents Processing Systems, Inc. ("APS"), which marketed a computer software package related to general agency operations. The purchaser acquired all rights to the APS software products, assignment of the APS customer contracts and other miscellaneous assets for a nominal amount of cash, assumption of contract obligations, a fixed number of software use licenses and development work on an electronic data interchange project. The Company recorded a small write-off as a result of this transaction. On October 23, 1998, the Company completed the acquisition of the Lalande Financial Group, Inc. ("Lalande Group"). The Lalande Group includes National Specialty Lines, Inc. ("NSL") and DLT Insurance Adjusters, Inc. ("DLT"). NSL is a managing general agency that markets nonstandard personal auto insurance through approximately 800 retail agencies in Florida. DLT is an automobile claims adjusting firm that provides claim services on NSL produced business and to outside parties. The purchase price was for $18 million in cash 69 64 GAINSCO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2000, 1999 and 1998 paid at closing plus up to an additional $22 million in cash to be paid over approximately five years contingent upon the operating performance of the Lalande Group. The purchase was financed with a commercial bank borrowing of $18 million (note 4). The transaction resulted in goodwill of approximately $17.2 million which is being amortized on a straight line basis over 25 years. The acquisition was accounted for as a purchase and the results of operations since the acquisition date have been consolidated. The Company paid $2 million of the operating performance contingency in April of 2000. The pro forma unaudited results of operations for the year ended December 31, 1998, assuming the purchase of the Lalande Group had consummated on January 1, 1998, are presented below.
1998 ------------ (Amounts in thousands, except per share data) Revenues $ 112,039 Net loss $ (12,285) Basic loss per share $ (0.59) Diluted loss per share $ (0.59)
(9) BENEFIT PLANS At December 31, 2000, the Company had two plans under which options to purchase shares of GNA's common stock could be granted: the 1995 Stock Option Plan (95 Plan) and the 1998 Long-Term Incentive Plan (98 Plan). The 1990 Stock Option Plan and all unexercised options thereunder expired during 2000. The 95 Plan was approved by the shareholders on May 10, 1996 and 1,071,000 shares are reserved for issuance under this plan. Options granted under the 95 Plan have a maximum ten year term and are exercisable at the rate of 20% immediately upon grant and 20% on each of the first four anniversaries of the grant date. The 98 Plan was approved by the shareholders on July 17, 1998, and the aggregate number of shares of common stock that may be issued under the 98 Plan is limited to 1,000,000. Under the 98 Plan, stock options (including incentive stock options and non-qualified stock options), stock appreciation rights and restricted stock awards may be made. In 2000 options for 521,925 shares were granted to officers, directors and employees of the Company under the 98 Plan at an average exercise price of $5.56 per share. In 1998 options for 579,710 shares were granted to Glenn W. Anderson under an employment agreement at an exercise price of $5.75 per share. The exercise price of each outstanding option equals the market price of the GNA's common stock on the date of grant. A summary of the status of the Company's outstanding options as of December 31, 2000 and 1999, and changes during the years ended December 31, 2000 and 1999 is presented below:
2000 1999 -------------------------------- -------------------------------- Underlying Weighted Average Underlying Weighted Average Shares Exercise Price Shares Exercise Price ------------ ---------------- ------------ ---------------- Options outstanding, beginning of period: 1,565,147 $ 6.49 1,540,640 $ 6.42 Options granted 531,925 $ 5.57 67,000 $ 5.78 Options exercised (249,903) $ 2.18 (23,270) $ 2.14 Options forfeited (31,539) $ 7.35 (19,223) $ 6.34 ------------ ------------ Options outstanding, end of period 1,815,630 $ 6.79 1,565,147 $ 6.49 ============ ============ Options exercisable at end of period 1,287,601 1,353,775 Weighted average fair value of options granted during period 2.71 2.66
70 65 GAINSCO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2000, 1999 and 1998 The following table summarizes information for the stock options outstanding at December 31, 2000:
Options Outstanding Options Exercisable ------------------------------------------------ ------------------------------ Number Weighted Average Weighted Number Weighted Range of Outstanding Remaining Average Exercisable Average Exercise Prices at 12/31/00 Contractual Life Exercise Price at 12/31/00 Exercise Price --------------- ------------ ---------------- -------------- ------------ -------------- $ 2 to 5 15,000 8.25 years $ 4.88 6,000 $ 4.88 $ 5 to 8 1,448,791 5.75 years $ 5.88 929,762 $ 5.99 $ 8 to 11 351,839 5.36 years $ 10.63 351,839 $ 10.63 ------------ ------------ $ 2 to 11 1,815,630 5.70 years $ 6.79 1,287,601 $ 7.25 ============ ============
The Company applies APB 25 and related Interpretations in accounting for its plans. Accordingly, no compensation cost has been recognized for its stock option plans. Had compensation cost been determined consistent with Statement 123 for the options granted, the Company's net income and earnings per share would have been the pro forma amounts indicated below:
Years ended December 31 ---------------------------------------------------------------------------------------------- 2000 1999 1998 ----------------------------- ---------------------------- ----------------------------- As reported Pro forma As reported Pro forma As reported Pro forma ------------ ------------ ------------ ------------ ------------ ------------ Net income (loss) $(19,551,365) (20,098,914) 7,127,137 6,615,014 (11,662,564) (12,139,335) Less: Preferred stock dividends 434,000 434,000 108,500 108,500 -- -- Less: Accretion of discount on preferred stock 346,164 346,164 -- -- -- -- ------------ ------------ ------------ ------------ ------------ ------------ Net income available to common shareholders $(20,331,529) (20,879,078) 7,018,637 6,506,514 (11,662,564) (12,139,335) ============ ============ ============ ============ ============ ============ Basic earnings (loss) per share $ (.97) (.99) .34 .31 (.56) (.58) Diluted earnings (loss) per share $ (.97) (.99) .32 .29 (.56) (.58)
The fair value of each option grant was estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions: expected volatility of 31.81 to 32.00% for 2000, 25.3 to 28.4% for 1999 and 32.6% for 1998, risk free interest rates of 6.31 to 6.66% for 2000, 6.58% for 1999 and 5.04% for 1998, expected dividend yields of 1.23 to 1.27% for 2000, 1.2% for 1999 and 1998, and an expected life of 7.5 years for all periods presented. 71 66 GAINSCO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2000, 1999 and 1998 The Company has a 401(k) plan for the benefit of its eligible employees. The Company made quarterly contributions to the plan during 2000 which totaled $265,836. The Company did not make any annual contributions to the plan during 1999 or 1998. In 1998, the Company implemented an incentive compensation plan under which all full time employees with at least six months of service participate. Factors applicable to the incentive compensation plan are: Company's net income level, individual performance, employee's salary and position with the Company. The amounts expensed for 2000, 1999 and 1998 were $0, $934,659 and $540,666, respectively. (10) SEGMENT REPORTING The Company makes operating decisions and assesses performance for the commercial lines segment and the personal lines segment. The commercial lines segment writes primarily commercial auto, garage, general liability and property. The personal lines segment writes primarily nonstandard personal auto coverages. The Company considers many factors including the nature of the insurance product and distribution strategies in determining how to aggregate operating segments. The following tables represent a summary of segment data as of and for the years ended December 31, 2000, 1999 and 1998:
2000 -------------------------------------------------------------------- Commercial Personal Lines Lines Other Total ------------ ------------ ------------ ------------ (Dollar amounts in thousands) Gross premiums written $ 113,354 54,932 -- 168,286 ============ ============ ============ ============ Premiums earned 107,922 43,534 -- 151,456 Net investment income 8,671 4,301 1,121 14,093 Insurance services -- 354 700 1,054 Expenses (141,454) (49,847) (1,971) (193,272) ------------ ------------ ------------ ------------ Operating income (loss) (24,861) (1,658) (150) (26,669) Net realized gains (losses) -- -- (1,907) (1,907) Interest expense -- (1,409) -- (1,409) Amortization expense -- (964) -- (964) ------------ ------------ ------------ ------------ Income (loss) before Federal income taxes $ (24,861) (4,031) (2,057) (30,949) ============ ============ ============ ============ Combined ratio (GAAP) basis 131.1% 114.5% 126.3% ============ ============ ============ Total assets $ 308,148 84,599 82,296 475,043 ============ ============ ============ ============
72 67 GAINSCO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2000, 1999 and 1998
1999 -------------------------------------------------------------------- Commercial Personal Lines Lines Other Total ------------ ------------ ------------ ------------ (Dollar amounts in thousands) Gross premiums written $ 97,139 36,759 -- 133,898 ============ ============ ============ ============ Premiums earned 91,928 21,352 -- 113,280 Net investment income 7,607 2,115 -- 9,722 Insurance services -- 992 857 1,849 Expenses (91,091) (21,537) (2,533) (115,161) ------------ ------------ ------------ ------------ Operating income (loss) 8,444 2,922 (1,676) 9,690 Net realized gains -- -- 606 606 Interest expense -- (1,266) -- (1,266) Amortization expense -- (689) -- (689) ------------ ------------ ------------ ------------ Income (loss) before Federal income taxes $ 8,444 967 (1,070) 8,341 ============ ============ ============ ============ Combined ratio (GAAP) basis 99.1% 100.9% 99.4% ============ ============ ============ Total assets $ 253,576 73,786 68,286 395,648 ============ ============ ============ ============
1998 -------------------------------------------------------------------- Commercial Personal Lines Lines Other Total ------------ ------------ ------------ ------------ (Dollar amounts in thousands) Gross premiums written $ 88,188 2,974 -- 91,162 ============ ============ ============ ============ Premiums earned 91,697 506 -- 92,203 Net investment income 9,648 155 -- 9,803 Insurance services -- 460 2,468 2,928 Expenses (121,491) (553) (4,589) (126,633) ------------ ------------ ------------ ------------ Operating income (loss) (20,146) 568 (2,121) (21,699) Net realized gains -- -- 693 693 Interest expense -- (102) -- (102) Amortization expense -- (172) -- (172) ------------ ------------ ------------ ------------ Income (loss) before Federal income taxes $ (20,146) 294 (1,428) (21,280) ============ ============ ============ ============ Combined ratio (GAAP) basis 132.5% 109.3% 132.7% ============ ============ ============ Total assets $ 295,699 12,194 37,697 345,590 ============ ============ ============ ============
(11) CONTINGENCIES In the normal course of its operations, the Company has been named as defendant in various legal actions seeking payments for claims denied by the Company and other monetary damages. The Company's management believes that unpaid claims and claim adjustment expenses are adequate to cover possible liability from lawsuits which arise in the normal course of its insurance business. In the opinion of the Company's management the ultimate liability, if any, resulting from the disposition of all claims will not have a material adverse effect on the Company's consolidated financial position or results of operations. 73 68 GAINSCO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2000, 1999 and 1998 The Company does not have any financial instruments where there is off-balance-sheet-risk of accounting loss due to credit or market risk. There is credit risk in the premiums receivable and reinsurance balances receivable of the Company. At December 31, 2000 and 1999 the Company did not have a premiums receivable balance nor a reinsurance balance receivable from any one entity that was material with regard to shareholders' equity. (12) SUBSEQUENT EVENT Note Payable On March 23, 2001, the Company amended its credit agreement with its bank, which included waivers for specific breaches of covenants. The Company made a $2.5 million prepayment of the note payable from the proceeds of the 2001 GMSP Transaction and the Stallings Transaction. GMSP and Stallings Transactions On October 4, 1999, in the 1999 GMSP Transaction GNA sold to GMSP, for an aggregate purchase price of $31,620,000, (i) 31,620 shares of Series A Preferred Stock, which are convertible into 6,200,000 shares of Common Stock at a conversion price of $5.10 per share, (ii) the Series A Warrant to purchase an aggregate of 1,550,000 shares of Common Stock at an exercise price of $6.375 per share and (iii) the Series B Warrant to purchase an aggregate of 1,550,000 shares of Common Stock at an exercise of $8.50 per share. At closing GNA and its insurance company subsidiaries entered into Investment Management Agreements with GMSP, pursuant to which GMSP manages their respective investment portfolios. Completion of the 1999 GMSP Transaction concluded the strategic alternatives review process that the Company initiated in 1998. Proceeds from the 1999 GMSP Transaction were available for acquisitions, investments and other corporate purposes. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations -- Business Operations." On March 23, 2001, the Company consummated the 2001 GMSP Transaction with GMSP pursuant to which, among other things, the Company issued shares of its newly created Series C Preferred Stock to GMSP in exchange for an aggregate purchase price of $3.0 million in cash. The annual dividend rate on the Series C Preferred Stock is 10% during the first three years and 20% thereafter. Unpaid dividends are cumulative and compounded. The Series C Preferred Stock is redeemable at the Company's option after five years and at the option of the majority holders after six years. The Series C Preferred Stock is not convertible into Common Stock. The agreement with GMSP was conditioned upon the following changes in the securities currently held by GMSP. The exercise prices of the Series A Warrant and the Series B Warrant held by GMSP were amended to equal a defined Conversion Price (see below) and 115% of the defined Conversion Price, respectively. Each of these warrants provides for the purchase of 1,550,000 million shares of Common Stock, subject to adjustment. Further, GNA is required to redeem the outstanding shares of its Series A Preferred Stock on January 1, 2006, subject to certain conditions. Any Series A Preferred Stock unredeemed for any reason after that date would accrue interest, payable quarterly at a rate equal to eight percent per year with any unpaid interest compounded annually. The agreement with GMSP provides an opportunity to convert GNA holding company illiquid investments with a cost of $4.2 million to cash as of November 2002, as follows: GNA could at its option require GMSP to purchase the illiquid investments for $2.1 million, less any future cash received prior to November 2002 from the investments. GMSP could at its option require GNA to sell the illiquid investments to GMSP for $4.2 million, less any future cash received prior to November 2002 from the investments. On March 23, 2001, the Company consummated the Stallings Transaction pursuant to which, among other things, the Company issued shares of its newly created Series B Preferred Stock and a warrant to purchase an aggregate of 1,050,000 shares of Common Stock at the defined Conversion Price in exchange for an aggregate purchase price of $3.0 million in cash. The annual dividend provisions and the redemption provisions of the Series B Preferred Stock are the same as those for the Series C Preferred Stock. The Series B Preferred Stock is convertible into Common Stock 74 69 GAINSCO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2000, 1999 and 1998 at the defined Conversion Price. Subject to adjustment for certain events, the Series B Preferred Stock is convertible into a maximum of 1,333,333 shares of Common Stock. The term of the warrant is five years. Robert W. Stallings was elected non-executive Vice Chairman of the Board and a director of the Company. A defined Conversion Price formula, subject to standard adjustments, will be used to determine the conversion price for the Series B Preferred Stock and to determine the exercise prices for the Stallings warrant and as the basis for the amended exercise prices of the GMSP warrants. The Conversion Price will be equal to the lesser of tangible book value per share of GNA Common Stock as of June 30, 2001, or 110% of the average closing price per share of GNA common stock for the 30 trading days immediately prior to April 30, 2001. Under no circumstance may the Conversion Price be less than $2.25. The transaction dated March 23, 2001 results in all preferred stock being redeemable, which will require mezzanine equity presentation for the March 31, 2001 balance sheet. The discount on the preferred stock will be amortized over the period until redemption using the effective interest method. Rating. On March 27, 2001, A.M. Best Co. downgraded the Company's insurance subsidiaries' current rating of "A-" (Excellent) to "B++" (Very Good), and assigned a negative outlook. (13) QUARTERLY FINANCIAL DATA (UNAUDITED) The following table contains selected unaudited consolidated financial data for each quarter (in thousands, except per share data):
2000 Quarter 1999 Quarter ------------------------------------------------ --------------------------------------------- Fourth Third Second First Fourth Third Second First --------- --------- --------- --------- --------- --------- --------- --------- Gross premiums written $ 39,706 40,274 44,552 43.754 35,530 35,400 35,850 27,119 Total revenues $ 40,818 42,541 42,279 39,057 36,803 33,097 29,231 26,327 Total expenses $ 57,340 54,375 44,205 39,724 34,673 31,664 26,886 23,895 Net income (loss) $ (10,752) (7,561) (1,104) (134) 1,751 1,411 1,828 2,137 Earnings (loss) per share: Basic $ (.52) (.37) (.06) (.02) .08 .07 .09 .10 Diluted $ (.52) (.37) (.06) (.02) .07 .07 .09 .10 Common share prices(a) High 4 1/4 5 1/16 6 1/8 6 3/8 6 1/2 6 15/16 6 3/8 6 9/16 Low 2 3/16 3 11/16 4 1/2 5 3/8 5 1/4 5 3 15/16 4 3/4
(a) As reported by the New York Stock Exchange 75 70 INDEPENDENT AUDITORS' REPORT ON SUPPLEMENTARY INFORMATION The Board of Directors and Shareholders GAINSCO, INC: Under date of February 27, 2001, except for notes (8) and (12), as to which the date is March 23, 2001 we reported on the consolidated balance sheets of GAINSCO, INC. and subsidiaries as of December 31, 2000 and 1999 and the related consolidated statements of operations, shareholders' equity and comprehensive income and cash flows for each of the years in the three-year period ended December 31, 2000. In connection with our audits of the aforementioned consolidated financial statements, we also audited the related financial statement schedules as listed in the accompanying index. These financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statement schedules based on our audits. In our opinion, such 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. KPMG LLP Dallas, Texas February 27, 2001, except for notes (8) and (12), as to which the date is March 23, 2001 76 71 Schedule I GAINSCO, INC. AND SUBSIDIARIES Summary of Investments - Other Than Investments in Related Parties (Amounts in thousands)
As of December 31 ------------------------------------------------------- 2000 1999 ------------------------- ------------------------- (Amounts in thousands) Amortized Fair Amortized Fair Cost Value Cost Value ---------- ---------- ---------- ---------- Type of Investment Fixed Maturities: Bonds available for sale: U.S. Government securities $ 21,138 21,317 24,365 24,029 Tax-exempt state and municipal bonds 45,284 45,472 148,983 146,204 Corporate bonds 121,564 125,553 27,067 26,844 Certificates of deposit 845 845 455 455 Common stock 6,027 7,716 -- -- Marketable securities 4,581 4,442 1,288 1,170 ---------- ---------- ---------- ---------- 199,439 205,345 202,158 198,702 ---------- ---------- ---------- ---------- Short-term investments 40,840 40,840 46,478 46,478 ---------- ---------- ---------- ---------- Total investments $ 240,279 246,185 $ 248,636 245,180 ========== ========== ========== ==========
See accompanying independent auditors' report on supplementary information. 77 72 Schedule II CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT GAINSCO, INC. (PARENT COMPANY) Balance Sheets December 31, 2000 and 1999
2000 1999 -------------- -------------- Assets Investments in subsidiaries $ 107,044,187 103,732,992 Common stock, at fair value (cost: $448,097 - 2000, $0 - 1999) 710,000 -- Other investments, at cost (which approximates fair value) 4,174,710 916,278 Short term investments 11,839,744 31,034,925 Cash 46,743 501,725 Accrued investment income 88,876 75,392 Net receivables from subsidiaries -- 3,446,779 Deferred Federal income taxes 1,660,781 -- Other assets 457,147 142,178 Goodwill 22,797,358 18,351,117 -------------- -------------- Total assets $ 148,819,546 158,201,386 ============== ============== Liabilities and Shareholders' Equity Liabilities: Accounts payable $ 2,073,733 2,028,213 Net payables to subsidiaries 6,405,987 -- Note payable 16,000,000 18,000,000 Dividends payable 478,971 474,598 Current Federal income taxes 756,576 -- -------------- -------------- Total liabilities 25,715,267 20,502,811 -------------- -------------- Shareholders' equity: Preferred stock ($100 par value, 10,000,000 shares authorized, 31,620 issued at December 31, 2000 and December 31, 1999) 3,162,000 3,162,000 Common stock ($.10 par value, 250,000,000 shares authorized, 22,013,830 issued at December 31, 2000 and 21,763,927 issued at December 31, 1999) 2,201,383 2,176,393 Common stock warrants 2,040,000 2,040,000 Additional paid-in capital 113,540,252 112,674,842 Accumulated other comprehensive income (loss) 3,897,371 (2,246,575) Retained earnings 5,957,798 27,586,440 Treasury stock, at cost (844,094 shares at December 31, 2000 and December 31, 1999) (7,694,525) (7,694,525) -------------- -------------- Total shareholders' equity 123,104,279 137,698,575 -------------- -------------- Total liabilities and shareholders' equity $ 148,819,546 158,201,386 ============== ==============
See accompanying notes to condensed financial statements. See accompanying independent auditors' report on supplementary information. 78 73 Schedule II CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT GAINSCO, INC. (PARENT COMPANY) Statements of Operations Years ended December 31, 2000, 1999 and 1998
2000 1999 1998 ------------ ------------ ------------ Revenues - dividend income $ 1,930,000 6,980,000 3,900,000 Investment income 1,121,049 371,928 2,255 Realized capital gains 26,676 -- -- Expenses: Interest expense (1,409,378) (1,265,529) (101,763) Amortization of goodwill (963,700) (688,645) (171,502) Operating expense (2,118,502) (1,720,440) (2,069,139) ------------ ------------ ------------ Operating income (loss) before Federal income taxes (1,413,855) 3,677,314 1,559,851 Federal income taxes: Current expense (benefit) 756,576 (872,941) (354,324) Deferred expense (benefit) (1,572,735) 44,545 (439,874) ------------ ------------ ------------ (816,159) (828,396) (794,198) ------------ ------------ ------------ Income (loss) before equity in undistributed income (loss) of subsidiaries (597,696) 4,505,710 2,354,049 Equity in undistributed income (loss) of subsidiaries (18,953,669) 2,621,427 (14,016,613) ------------ ------------ ------------ Net income (loss) $(19,551,365) 7,127,137 (11,662,564) ============ ============ ============ Earnings (loss) per share: Basic $ (.97) .34 (.56) ============ ============ ============ Diluted $ (.97) .32 (.56) ============ ============ ============
See accompanying notes to condensed financial statements. See accompanying independent auditors' report on supplementary information. 79 74 Schedule II CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT GAINSCO, INC. (PARENT COMPANY) Statements of Shareholders' Equity and Comprehensive Income Years ended December 31, 2000, 1999 and 1998
2000 1999 1998 ------------ ------------ ------------ Preferred stock: Balance at beginning of year $ 3,162,000 -- -- Issuance of shares (31,620 in 1999) -- 3,162,000 -- ------------ ------------ ------------ Balance at end of year 3,162,000 3,162,000 -- ------------ ------------ ------------ Common stock: Balance at beginning of year 2,176,393 2,174,066 2,170,112 Exercise of options to purchase shares (249,903 in 2000, 23,270 in 1999 and 39,539 in 1998) 24,990 2,327 3,954 ------------ ------------ ------------ Balance at end of year 2,201,383 2,176,393 2,174,066 ------------ ------------ ------------ Common stock warrants: Balance at beginning of year 2,040,000 -- -- Issuance of warrants in connection with Preferred stock -- 2,040,000 -- ------------ ------------ ------------ Balance at end of year 2,040,000 2,040,000 -- ------------ ------------ ------------ Additional paid-in capital Balance at beginning of year 112,674,842 87,778,548 87,697,754 Exercise of options to purchase shares (249,903 in 2000, 23,270 in 1999 and 39,539 in 1998) 519,246 47,551 80,794 Issuance of preferred shares (31,620 in 1999) -- 24,762,929 -- Accretion of discount on preferred shares 346,164 85,814 -- ------------ ------------ ------------ Balance at end of year $113,540,252 112,674,842 87,778,548 ------------ ------------ ------------
(continued) 80 75 Schedule II CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT GAINSCO, INC. (PARENT COMPANY) Statements of Shareholders' Equity and Comprehensive Income Years ended December 31, 2000, 1999 and 1998
2000 1999 1998 ----------------------------- ----------------------------- ----------------------------- Retained earnings: Balance at beginning of year $ 27,586,440 22,086,868 35,188,460 Net income (loss) for year (19,551,365) (19,551,365) 7,127,137 7,127,137 (11,662,564) (11,662,564) Cash dividend - common (1,474,206) (1,463,227) (1,462,070) Cash dividend - preferred (434,000) (108,500) -- Accretion of discount on Preferred shares (346,164) (85,814) -- Tax benefit on non-qualified stock options exercised 177,093 29,976 23,042 ------------- ------------- ------------- Balance at end of year 5,957,798 27,586,440 22,086,868 ------------- ------------- ------------- Accumulated other comprehensive income (loss): Balance at beginning of year (2,246,575) 1,138,941 1,058,268 Unrealized gains (losses) on securities, net of reclassification adjustment, net of tax 6,143,946 6,143,946 (3,385,516) (3,385,516) 80,673 80,673 ------------- ------------ ------------- ------------ ------------- ------------ Comprehensive income (loss) (13,407,419) 3,741,621 (11,581,891) ============ ============= ============ Balance at end of year 3,897,371 (2,246,575) 1,138,941 ------------- ------------- ------------- Treasury stock: Balance at beginning of year (7,694,525) (7,694,525) (7,552,334) Change during year -- -- (142,191) ------------- ------------- ------------- Balance at end of year (7,694,525) (7,694,525) (7,694,525) ------------- ------------- ------------- Total shareholders' equity at end of year $ 123,104,279 137,698,575 105,483,898 ============ ============= ============
See accompanying notes to condensed financial statements. See accompanying independent auditors' report on supplementary information. 81 76 Schedule II CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT GAINSCO, INC. (PARENT COMPANY) Statements of Cash Flows Years ended December 31, 2000, 1999 and 1998
2000 1999 1998 ------------ ------------ ------------ Cash flows from operating activities: Net income (loss) $(19,551,365) 7,127,137 (11,662,564) Adjustments to reconcile net income (loss) to cash provided by operating activities: Depreciation and amortization 963,700 688,645 171,502 Change in deferred Federal income taxes (1,572,735) -- -- Change in accrued investment income (13,484) (75,392) -- Change in net receivables from/payables to subsidiaries 9,852,766 (1,214,283) (813,276) Change in other assets (314,969) (16,960) 66,498 Change in accounts payable 45,520 1,981,005 30,275 Equity in (income) loss of subsidiaries 18,953,669 (2,621,427) 14,016,612 Change in current Federal income taxes 756,576 -- -- ------------ ------------ ------------ Net cash provided by operating activities 9,119,678 5,868,725 1,809,047 ------------ ------------ ------------ Cash flows from investing activities: Common stock purchased (448,097) -- -- Other investments sold 247,500 -- -- Other investments purchased (3,505,932) (916,278) -- Change in short term investments 19,195,181 (30,991,387) 39,937 Capital contributions to subsidiaries (12,553,071) -- -- Net assets acquired through purchase of subsidiary (9,150,647) (2,012,500) (18,330,298) ------------ ------------ ------------ Net cash used for investing activities $ (6,215,066) (33,920,165) (18,290,361) ------------ ------------ ------------
(continued) 82 77 Schedule II CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT GAINSCO, INC. (PARENT COMPANY) Statements of Cash Flows Years ended December 31, 2000, 1999 and 1998
2000 1999 1998 ------------ ------------ ------------ Cash flows from financing activities: Proceeds from note payable $ -- -- 18,000,000 Payments on note payable (2,000,000) Cash dividends paid (1,903,830) (1,462,820) (1,461,679) Preferred stock issued -- 29,964,929 -- Proceeds from exercise of common stock options 544,236 49,878 84,748 Treasury stock acquired -- -- (142,191) ------------ ------------ ------------ Net cash provided by/(used for) financing activities (3,359,594) 28,551,987 16,480,878 ------------ ------------ ------------ Net increase (decrease) in cash (454,982) 500,547 (436) Cash at beginning of year 501,725 1,178 1,614 ------------ ------------ ------------ Cash at end of year $ 46,743 501,725 1,178 ============ ============ ============
See accompanying notes to condensed financial statements. See accompanying independent auditors' report on supplementary information. 83 78 Schedule II CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT GAINSCO, INC. (PARENT COMPANY) Notes to Condensed Financial Statements December 31, 2000, 1999 and 1998 (1) GENERAL The accompanying condensed financial statements should be read in conjunction with the notes to the consolidated financial statements for the years ended December 31, 2000, 1999 and 1998 included elsewhere in this Annual Report. (2) RELATED PARTIES The Company made a cash capital contribution of $2,500,000 to General Agents in June of 2000. Also during 2000, the Company made capital contributions to GAINSCO Service Corp by forgiving intercompany debt in the amount of $2,061,066. Included in the payable to General Agents at December 31, 2000 was an accrued capital contribution of $8,000,000. The cash was paid to General Agents in February, 2001. The Company acquired the net assets of Tri-State of $3,732,708 in January 2000 through a 100% purchase. The following table presents the components of the Net receivables from and payables to subsidiaries at December 31, 2000 and 1999:
2000 1999 ------------ ------------ Name of subsidiary ------------------ Agents Processing Systems, Inc. $ 887,775 883,224 GAINSCO Service Corp (902) 1,168,749 General Agents Insurance Company of America, Inc. (7,292,860) 1,394,806 ------------ ------------ Net receivables from/(payables to) subsidiaries $ (6,405,987) 3,446,779 ============ ============
See accompanying independent auditors' report on supplementary information. 84 79 Schedule III GAINSCO, INC. AND SUBSIDIARIES Supplementary Insurance Information Years ended December, 2000, 1999 and 1998 (Amounts in thousands)
Other Deferred Reserves policy policy for claims claims and Net acquisition and claim Unearned benefits premiums Segment costs(1) expenses premiums payable earned ------- ----------- ---------- ---------- ---------- ---------- Year ended December 31, 2000: Commercial lines $ (375) 150,807 49,286 7,121 107,923 Personal lines 2,677 13,353 23,292 1,742 43,533 Other -- -- -- -- -- ---------- ---------- ---------- ---------- ---------- Total $ 2,302 164,160 72,578 8,863 151,456 ========== ========== ========== ========== ========== Year ended December 31, 1999: Commercial lines $ 11,019 127,460 65,350 4,206 91,928 Personal lines 3,909 5,354 16,870 -- 21,352 Other -- -- -- -- -- ---------- ---------- ---------- ---------- ---------- Total $ 14,928 132,814 82,220 4,206 113,280 ========== ========== ========== ========== ========== Year ended December 31, 1998: Commercial lines $ 10,789 136,400 61,430 5,835 91,697 Personal lines 531 398 2,172 -- 506 Other -- -- -- -- -- ---------- ---------- ---------- ---------- ---------- Total $ 11,320 136,798 63,602 5,835 92,203 ========== ========== ========== ========== ========== Amortization of deferred Other Net Claims policy operating Net Investment and claim acquisition costs and premiums Segment Income expenses costs(2) expenses written ------- ---------- ---------- ------------ ---------- ---------- Year ended December 31, 2000: Commercial lines 8,671 103,475 (28,883) 26,543 75,516 Personal lines 4,301 39,964 (10,441) 11,053 43,307 Other 1,121 -- -- 1,971 -- ---------- ---------- ---------- ---------- ---------- Total 14,093 143,439 (39,324) 39,567 118,823 ========== ========== ========== ========== ========== Year ended December 31, 1999: Commercial lines 7,607 60,083 (24,399) 32,161 94,607 Personal lines 2,115 16,266 (5,139) 7,624 36,530 Other -- -- -- 4,589 -- ---------- ---------- ---------- ---------- ---------- Total 9,722 76,349 (29,538) 44,374 131,137 ========== ========== ========== ========== ========== Year ended December 31, 1998: Commercial lines 9,648 85,996 (23,680) 34,938 86,362 Personal lines 155 357 (197) 728 2,197 Other -- -- -- 4,589 -- ---------- ---------- ---------- ---------- ---------- Total 9,803 86,353 (24,386) 40,255 88,559 ========== ========== ========== ========== ==========
(1) Net of deferred ceding commission income. (2) Net of the amortization of deferred ceding commission income. See accompanying independent auditors' report on supplementary information. 85 80 Schedule IV GAINSCO, INC. AND SUBSIDIARIES Reinsurance Years ended December 31, 2000, 1999 and 1998 (Amounts in thousands, except percentages)
Percentage Ceded to Assumed of amount Direct other from other Net Assumed amount Companies Companies amount to net ---------- ---------- ---------- ---------- ----------- Year ended December 31, 2000: Premiums earned: Property and casualty $ 158,937 -- -- 158,937 Reinsurance -- (25,725) 18,244 (7,481) ---------- ---------- ---------- ---------- Total $ 158,937 (25,725) 18,244 151,456 12.0% ========== ========== ========== ========== ========== Year ended December 31, 1999 Premiums earned: Property and casualty $ 113,375 -- -- 113,375 Reinsurance -- (12,107) 12,012 (95) ---------- ---------- ---------- ---------- Total $ 113,375 (12,107) 12,012 113,280 10.6% ========== ========== ========== ========== ========== Year ended December 31, 1998 Premiums earned: Property and casualty $ 93,632 -- -- 93,632 Reinsurance -- (2,120) 691 (1,429) ---------- ---------- ---------- ---------- Total $ 93,632 (2,120) 691 92,203 0.7% ========== ========== ========== ========== ==========
See accompanying independent auditors' report on supplementary information. 86 81 Schedule VI GAINSCO, INC. AND SUBSIDIARIES Supplemental Information Years ended December 31, 2000, 1999 and 1998 (Amounts in thousands)
Column A Column B Column C Column D Column E Column F ----------- ----------- ---------- ---------- ---------- ---------- Reserves for unpaid Discount Deferred claims if any, Affiliation policy and claim deducted with acquisition adjustment in Unearned Net earned Segment registrant costs(1) expenses Column C premiums premiums ------- ----------- ----------- ---------- ---------- ---------- ---------- Year ended December 31, 2000: Commercial lines $ -- (375) 150,807 -- 49,286 107,923 Personal lines -- 2,677 13,353 -- 23,292 43,533 Other -- -- -- -- -- -- ---------- ---------- ---------- ---------- ---------- ---------- Total $ -- 2,302 164,160 -- 72,578 151,456 ========== ========== ========== ========== ========== ========== Year ended December 31, 1999: Commercial lines $ -- 11,019 127,460 -- 65,350 91,928 Personal lines -- 3,909 5,354 -- 16,870 21,352 Other -- -- -- -- -- -- ---------- ---------- ---------- ---------- ---------- ---------- Total $ -- 14,928 132,814 -- 82,220 113,280 ========== ========== ========== ========== ========== ========== Year ended December 31, 1998: Commercial lines $ -- 10,789 136,400 -- 61,430 91,697 Personal lines -- 531 398 -- 2,172 506 Other -- -- -- -- -- -- ---------- ---------- ---------- ---------- ---------- ---------- Total $ -- 11,320 136,798 -- 63,602 92,203 ========== ========== ========== ========== ========== ========== Column H Column I Column J Column K Column L ---------- ---------- ------------ ---------- ---------- Claims and claim adjustment expenses incurred Amortization Paid related to of deferred claims and Net ------------------------- policy claim Net Investment Current Prior acquisition adjustment premiums Segment Income year year costs(2) expenses written ------- ---------- ---------- ---------- ------------ ---------- ---------- Year ended December 31, 2000: Commercial lines 8,671 86,339 17,136 (28,883) 78,342 75.516 Personal lines 4,301 37,738 2,226 (10,441) 35,239 43.307 Other 1,121 -- -- -- -- -- ---------- ---------- ---------- ---------- ---------- ---------- Total 14,093 124,077 19,362 (39,324) 113,581 118,823 ========== ========== ========== ========== ========== ========== Year ended December 31, 1999: Commercial lines 7,607 59,894 189 (24,399) 71,422 94,607 Personal lines 2,115 16,082 184 (5,139) 11,180 36,530 Other -- -- -- -- -- -- ---------- ---------- ---------- ---------- ---------- ---------- Total 9,722 75,976 373 (29,538) 82,602 131,137 ========== ========== ========== ========== ========== ========== Year ended December 31, 1998: Commercial lines 9,648 59,278 26,718 (24,162) 68,183 86,362 Personal lines 155 357 -- (224) 105 2,197 Other -- -- -- -- -- -- ---------- ---------- ---------- ---------- ---------- ---------- Total 9,803 59,635 26,718 (24,386) 68,288 88,559 ========== ========== ========== ========== ========== ==========
(1) Net of deferred ceding commission income. (2) Net of the amortization of deferred ceding commission income. See accompanying independent auditors' report on supplementary information. 87 82 INDEX TO EXHIBITS
EXHIBIT NUMBER DESCRIPTION ------- ----------- 3.5 Bylaws of Registrant as amended through February 21, 2001. 21 Subsidiaries of Registrant. 23 Consent of KPMG LLP to incorporation by reference. 24 Powers of Attorney.