-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, BWTo5D0mkHQI+CSKZcYzNd4iqiy+/2pOjHBhVDujn0a++AD4zLfsF8ObU6ZRdFC3 l4REYhtQL9m7AaCXvG7gpA== 0000950152-99-009146.txt : 19991117 0000950152-99-009146.hdr.sgml : 19991117 ACCESSION NUMBER: 0000950152-99-009146 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19990930 FILED AS OF DATE: 19991115 FILER: COMPANY DATA: COMPANY CONFORMED NAME: PROGRESSIVE CORP/OH/ CENTRAL INDEX KEY: 0000080661 STANDARD INDUSTRIAL CLASSIFICATION: FIRE, MARINE & CASUALTY INSURANCE [6331] IRS NUMBER: 340963169 STATE OF INCORPORATION: OH FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 001-09518 FILM NUMBER: 99754737 BUSINESS ADDRESS: STREET 1: 6300 WILSON MILLS RD CITY: MAYFIELD VILLAGE STATE: OH ZIP: 44143 BUSINESS PHONE: 4404615000 MAIL ADDRESS: STREET 1: 6300 WILSON MILLS RD CITY: MAYFIELD VILLAGE STATE: OH ZIP: 44143 10-Q 1 THE PROGRESSIVE CORPORATION 10-Q 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 1O-Q (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 1999 ------------------------------------------ or [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to ------------------- ------------------- Commission File Number 1-9518 ------ THE PROGRESSIVE CORPORATION -------------------------------------------------------------------- (Exact name of registrant as specified in its charter) Ohio 34-0963169 -------------------------------------------------------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 6300 Wilson Mills Road, Mayfield Village, Ohio 44143 --------------------------------------------------------------------- (Address of principal executive offices) (Zip Code) (440) 461-5000 ---------------------------------------------------------------------- (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Common Shares, $1.00 par value: 73,112,244 outstanding at October 29, 1999 2 PART I - FINANCIAL INFORMATION ------------------------------ ITEM 1. Financial Statements. The Progressive Corporation and Subsidiaries CONSOLIDATED STATEMENTS OF INCOME (unaudited)
Three Months Nine Months ----------------------------------------- ------------------------------------ Periods Ended September 30, 1999 1998 % Change 1999 1998 % Change - -------------------------------------------------------------------------------------------- ------------------------------------ (millions - except per share amounts) NET PREMIUMS WRITTEN $1,581.0 $1,359.3 16 $4,743.1 $4,053.7 17 ========================== ====================== REVENUES Premiums earned $1,459.2 $1,281.7 14 $4,185.9 $3,655.1 15 Investment income 88.5 71.3 24 249.2 219.8 13 Net realized gains on security sales 22.2 1.1 NM 40.9 49.2 (17) Service revenues 15.3 9.2 66 38.7 29.2 33 Other income(1) -- -- -- 5.2 -- -- -------------------------- ---------------------- Total revenues 1,585.2 1,363.3 16 4,519.9 3,953.3 14 -------------------------- ---------------------- EXPENSES Losses and loss adjustment expenses 1,110.0 847.4 31 3,028.6 2,481.2 22 Policy acquisition costs 190.3 171.0 11 551.7 488.6 13 Other underwriting expenses 144.6 122.4 18 426.6 355.9 20 Investment expenses 2.5 2.0 25 7.1 6.4 11 Service expenses 13.9 8.2 70 33.9 23.2 46 Interest expense 19.7 14.7 34 56.6 46.0 23 -------------------------- ---------------------- Total expenses 1,481.0 1,165.7 27 4,104.5 3,401.3 21 -------------------------- ---------------------- NET INCOME Income before income taxes 104.2 197.6 (47) 415.4 552.0 (25) Provision for income taxes 30.2 62.5 (52) 124.0 173.8 (29) -------------------------- ---------------------- Net income $74.0 $135.1 (45) $291.4 $378.2 (23) ========================== ====================== COMPUTATION OF EARNINGS PER SHARE Basic: Average shares outstanding 73.0 72.5 1 72.9 72.5 1 ========================== ====================== Per share $1.01 $1.86 (46) $4.00 $5.22 (23) ========================== ====================== Diluted: Average shares outstanding 73.0 72.5 1 72.9 72.5 1 Net effect of dilutive stock options 1.6 2.2 (27) 1.8 2.3 (22) ========================== ====================== Total equivalent shares 74.6 74.7 -- 74.7 74.8 -- ========================== ====================== Per share $.99 $1.81 (45) $3.90 $5.06 (23) ========================== ======================
(1) See Note 7 - Related Party Transaction for discussion. See notes to consolidated financial statements. NM = Not Meaningful 2 3 The Progressive Corporation and Subsidiaries CONSOLIDATED BALANCE SHEETS (unaudited)
September 30, December 31, ----------------------------- ---------------- 1999 1998 1998 - ----------------------------------------------------------------------------------------------------------------------------------- (millions) ASSETS Investments: Available-for-sale: Fixed maturities, at market (amortized cost: $4,876.1, $4,165.3 and $4,171.6) $4,802.4 $4,252.1 $4,219.0 Equity securities, at market Preferred stocks (cost: $351.6, $439.9 and $374.3) 353.4 432.3 376.5 Common stocks (cost: $987.3, $607.1 and $512.2) 1,070.6 605.9 636.9 Short-term investments, at amortized cost (market: $125.0, $273.5 and $441.9) 125.0 273.5 441.9 ----------------------------- ---------------- Total investments 6,351.4 5,563.8 5,674.3 Cash 8.6 32.1 18.6 Accrued investment income 50.1 49.7 53.1 Premiums receivable, net of allowance for doubtful accounts of $39.7, $32.5 and $34.0 1,854.1 1,456.3 1,456.2 Reinsurance recoverables 264.0 287.3 281.0 Prepaid reinsurance premiums 86.6 78.4 77.7 Deferred acquisition costs 365.6 301.4 299.1 Income taxes 250.8 178.9 192.9 Property and equipment, net of accumulated depreciation of $234.9, $180.9 and $194.1 439.7 355.3 376.2 Other assets 73.3 32.9 34.0 ----------------------------- ---------------- Total assets $9,744.2 $8,336.1 $8,463.1 ============================= ================ LIABILITIES AND SHAREHOLDERS' EQUITY Unearned premiums $2,895.7 $2,377.3 $2,329.7 Loss and loss adjustment expense reserves 2,323.6 2,173.8 2,188.6 Policy cancellation reserve 19.7 29.7 29.1 Accounts payable and accrued expenses 701.7 567.2 582.0 Debt 1,040.8 776.4 776.6 ----------------------------- ---------------- Total liabilities 6,981.5 5,924.4 5,906.0 ----------------------------- ---------------- Shareholders' equity: Common Shares, $1.00 par value (treasury shares of 10.0, 10.7 and 10.6) 73.1 72.4 72.5 Paid-in capital 480.0 437.0 448.3 Accumulated comprehensive income: Net unrealized appreciation on investment securities 7.5 50.5 113.3 Other comprehensive income (9.0) (9.0) (9.6) Retained earnings 2,211.1 1,860.8 1,932.6 ----------------------------- ---------------- Total shareholders' equity 2,762.7 2,411.7 2,557.1 ----------------------------- ---------------- Total liabilities and shareholders' equity $9,744.2 $8,336.1 $8,463.1 ============================= ================
See notes to consolidated financial statements. 3 4 The Progressive Corporation and Subsidiaries CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
Nine Months Ended September 30, 1999 1998 - ----------------------------------------------------------------------------------------------------------------- (millions) CASH FLOWS FROM OPERATING ACTIVITIES Net income $291.4 $378.2 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 49.7 41.0 Net realized gains on security sales (40.9) (49.2) Gain on sale of property and equipment (5.2) -- Changes in: Unearned premiums 566.0 397.2 Loss and loss adjustment expense reserves 135.0 27.2 Accounts payable and accrued expenses 154.8 108.9 Policy cancellation reserve (9.4) (5.0) Prepaid reinsurance premiums (8.9) 1.4 Reinsurance recoverables 17.0 30.2 Premiums receivable (397.9) (295.5) Deferred acquisition costs (66.5) (41.8) Income taxes (.3) (23.8) Other, net 15.8 26.2 ----------------------------------------- Net cash provided by operating activities 700.6 595.0 CASH FLOWS FROM INVESTING ACTIVITIES Purchases: Available-for-sale: fixed maturities (5,502.1) (3,383.9) equity securities (698.1) (708.0) Sales: Available-for-sale: fixed maturities 4,468.3 2,713.5 equity securities 289.8 501.8 Maturities, paydowns, calls and other: Available-for-sale: fixed maturities 291.6 332.6 equity securities 12.7 26.2 Net sales of short-term investments 325.0 135.9 Receivable on securities (68.6) (38.8) Purchases of property and equipment (116.4) (136.2) Sale of property and equipment 12.1 -- Purchase of subsidiary, net of cash acquired (5.7) -- ----------------------------------------- Net cash used in investing activities (991.4) (556.9) CASH FLOWS FROM FINANCING ACTIVITIES Proceeds from exercise of stock options 11.8 7.8 Tax benefits from exercise of stock options 19.8 17.9 Proceeds from debt 293.7 -- Payments on debt (30.0) -- Dividends paid to shareholders (14.2) (13.4) Acquisition of treasury shares (.3) (41.6) ----------------------------------------- Net cash provided by (used in) financing activities 280.8 (29.3) ----------------------------------------- Increase (decrease) in cash (10.0) 8.8 Cash, January 1 18.6 23.3 ----------------------------------------- Cash, September 30 $8.6 $32.1 =========================================
See notes to consolidated financial statements. 4 5 The Progressive Corporation and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) NOTE 1 Basis of Presentation -- These financial statements and the notes thereto should be read in conjunction with the Company's audited financial statements included in its Annual Report on Form 10-K for the year ended December 31, 1998. The consolidated financial statements reflect all normal recurring adjustments which were, in the opinion of management, necessary to present a fair statement of the results for the interim periods. The results of operations for the period ended September 30, 1999, are not necessarily indicative of the results expected for the full year. NOTE 2 Supplemental Cash Flow Information -- The Company paid income taxes of $105.7 million and $174.6 million for the nine months ended September 30, 1999 and 1998, respectively. Total interest paid was $48.4 million and $38.5 million for the nine months ended September 30, 1999 and 1998, respectively. NOTE 3 Debt -- On March 1, 1999, the Company issued $300 million of 6 5/8% Senior Notes due March 1, 2029. Debt at September 30 consisted of:
1999 1998 -------------------------------- -------------------------------- Market Market Cost Value Cost Value ------------- -------------- -------------- --------------- 6 5/8% Senior Notes $ 293.7 $ 264.8 $ -- $ -- 7.30% Notes 99.7 100.1 99.7 110.1 6.60% Notes 199.2 196.9 199.0 208.2 7% Notes 148.5 144.8 148.4 162.8 8 3/4% Notes -- -- 29.9 30.6 10% Notes 149.9 156.5 149.7 165.1 10 1/8% Subordinated Notes 149.8 156.7 149.7 165.1 ------------- -------------- -------------- --------------- $1,040.8 $1,019.8 $776.4 $841.9 ============= ============== ============== ===============
NOTE 4 Comprehensive Income -- Total comprehensive income (loss) was ($5.7) million and $33.7 million for the quarters ended September 30, 1999 and 1998, respectively, and $186.2 million and $303.7 million for the nine months ended September 30, 1999 and 1998, respectively. NOTE 5 Dividends -- On September 30, 1999, the Company paid a quarterly dividend of $.065 per Common Share to shareholders of record as of the close of business on September 10, 1999. The dividend was declared by the Board of Directors on August 27, 1999. On October 22, 1999, the Board of Directors declared a quarterly dividend of $.065 per Common Share. The dividend is payable December 31, 1999, to shareholders of record as of the close of business on December 10, 1999. 5 6 NOTE 6 Segment Information -- The Company's Personal Lines business units write insurance for private passenger automobiles and recreation vehicles. The other lines of business include writing insurance for small fleets of commercial vehicles, lenders' collateral protection and directors' and officers' liability, and providing related services. All revenues are generated from external customers. Periods ended September 30, (millions)
Three Months Nine Months -------------------------------------------- ------------------------------------------------ 1999 1998 1999 1998 --------------------- --------------------- ------------------------ ---------------------- Pretax Pretax Pretax Pretax Profit Profit Profit Profit Revenues (Loss) Revenues (Loss) Revenues (Loss) Revenues (Loss) --------- ---------- --------- ---------- ----------- ----------- ---------- ---------- Personal Lines $1,361.0 $ (3.6) $1,187.1 $119.5 $3,898.8 $138.0 $3,381.0 $288.7 Other 113.5 19.3 103.8 22.4 331.0 51.0 303.3 46.7 Investments(1) 110.7 108.2 72.4 70.4 290.1 283.0 269.0 262.6 Interest Expense -- (19.7) -- (14.7) -- (56.6) -- (46.0) --------- ---------- --------- ---------- ----------- ----------- ---------- ---------- $1,585.2 $104.2 $1,363.3 $197.6 $4,519.9 $415.4 $3,953.3 $552.0 ========= ========== ========= ========== =========== =========== ========== ==========
(1) Revenues represent recurring investment income and net realized gains on security sales; pretax profit is net of investment expenses. NOTE 7 Related Party Transaction -- On April 23, 1999, the Company sold its corporate aircraft to a company independently owned by Peter B. Lewis, the Company's Chairman of the Board, President and Chief Executive Officer-Insurance Operations. The airplane had a net book value of $6.9 million and was sold to Mr. Lewis for $12.1 million, the fair market value of the airplane as determined by an independent appraiser. NOTE 8 Litigation --The Company is named as defendant in various lawsuits generally relating to its insurance operations. All legal actions relating to claims made under insurance policies or in connection with previous reinsurance agreements are considered by the Company in establishing its loss and loss adjustment expense reserves. Various other legal and regulatory actions are currently pending that involve the Company and specific aspects of its conduct of business. Except as discussed below, the Company believes that the ultimate disposition of these lawsuits in excess of amounts currently reserved will not materially impact the Company's financial position, cash flows or results of operations. One of the Company's subsidiaries was named as a defendant in a lawsuit claiming fraud and bad faith action arising out of the issuance of a blanket vendor single interest and a loan deficiency balance policy. The suit challenges our ability to cancel the policies and limit losses, and is scheduled to go to a jury trial in November 1999. No amount for damages was specified in the complaint and the Company is unable to estimate the potential exposure. The Company plans to vigorously contest this lawsuit. The Company is also named as defendant in five class action lawsuits alleging damages as a result of the Company's use of after-market parts and for breach of contract relating to such use. Numerous other insurance companies face similar suits. There is the potential that similar lawsuits could be filed against the Company. The Company plans to vigorously contest these suits and is currently unable to estimate the potential exposure. 6 7 ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. RESULTS OF OPERATIONS For the third quarter 1999, operating income, which excludes net realized gains on security sales, was $59.5 million, or $.80 per share, compared to $134.4 million, or $1.80 per share, last year. The combined ratio was 99.0, compared to 89.0 for the third quarter 1998. For the nine months ended September 30, 1999, operating income was $262.0 million, or $3.51 per share, compared to $346.2 million, or $4.63 per share, in 1998. The year-to-date combined ratio was 95.7, compared to 91.0 last year. Net premiums written increased 16% over the third quarter 1998 and 17% over the first nine months of 1998, primarily reflecting an increase in unit sales driven by the Company's competitive rates and its effort to increase brand awareness through its advertising campaign. Premiums earned, which are a function of the amount of premiums written in the current and prior periods, increased 14% for the quarter and 15% for the first nine months of 1999. The Personal Lines business units write insurance for private passenger automobiles and recreation vehicles and generate 93% of the Company's net premiums written. The Personal Lines business is generated either by an agent or written directly by the Company. The Agent channel includes business written by our network of 30,000 Independent Insurance Agents and through Strategic Alliance business relationships (other insurance companies, financial institutions, employers and national brokerage agencies). Total net premiums written through the Agent channel increased 9% to $1,199.5 million for the third quarter 1999, compared to $1,102.6 million for the same period last year, and increased 10% to $3,720.8 million for the nine months ended September 30, 1999, compared to $3,386.0 million for the same period last year. Direct business includes business written through 1 800 AUTO PRO(R), the Internet and the Strategic Alliances business unit on behalf of affinity groups. Net premiums written on a Direct basis increased 74% to $277.2 million for the third quarter 1999, compared to $159.4 million for the same period last year, and increased 85% to $703.8 million for the nine months ended September 30, 1999, compared to $379.5 million for the same period last year. The sales generated via the Internet represented approximately 8% and 7% of the Direct business net premiums written in the third quarter and first nine months of 1999, respectively. Four factors contributed to the Company's inability to meet its traditional goals in 1999. The first factor was during the first nine months of 1999, the company reduced loss reserves relating to prior accident years $41 million, compared to $122 million and $36 million for the first nine months of 1998 and 1997, respectively. The second was continued strong growth in the Direct business in 1999. In periods of rapid growth in the direct business, the Company's earnings may be lower as a result of higher up-front costs and higher loss costs traditionally associated with new business. In response, the Company decided to return to profit targets based on a calendar year measure rather than over the entire retention period of a policyholder, with the intent to bring the combined ratio back to the historic goal of 96. The Company's profit and growth opportunities change from year to year; however, over every consecutive 5-year period, the Company strives to produce a four percent underwriting profit and to grow at 15 percentage points greater than the rate of inflation. The third factor was that the Company lowered rates during the last 12 months in an attempt to raise its combined ratio to 96 while achieving its growth target. Lastly, during the last two quarters, loss trend accelerated 7 8 at a pace not anticipated; consequently, loss costs rose faster than expected. As a result of a combination of reduced rates, higher loss trends and the success of writing direct business, the Company believes that meeting both historic growth and profit margin targets will be particularly difficult over the next several quarters. Furthermore, if trend continues to accelerate given that a significant percentage of the Company's policies are annual, the Company may not make an underwriting profit over the next quarter or two. The Company also continues to pursue multichannel distribution, allowing customers to purchase its products from Independent Agents, via the Internet or by calling the Company directly at 1 800 AUTO PRO(R). The Company plans to balance its efforts among these different channels in order to produce the best outcome for profit and growth on a companywide basis. The Company is winding down its Canadian operations and reducing the volume of nonstandard auto premiums written by the Midland Financial Group, which was acquired in 1997. Each of these groups contribute less than 1% of the Company's consolidated net premiums written. Claim costs, which represent actual and estimated future payments to or for our policyholders, as well as loss estimates for future assignments and assessments under state-mandated assigned risk programs, were 76% of premiums earned for the quarter, compared to 66% the same period last year. Year-to-date claim costs were 72%, compared to 68% last year. The increase in claim costs was primarily driven by increases in loss cost trends and the effects of the Company taking rate decreases over the last year. The Company expects adverse changes in severity trends to continue and has begun raising prices. Policy acquisition costs and other underwriting expenses were 23% of premiums earned for both the third quarter 1999 and 1998, and 23% for both the first nine months of 1999 and 1998. Recurring investment income (interest and dividends) increased 24% for the quarter and 13% for the first nine months, reflecting an increase in the average investment portfolio and a shift in the portfolio from tax free to taxable securities during the third quarter. The weighted average annualized fully taxable equivalent book yield of the portfolio was 6.3% for both the quarter and first nine months ended September 30, 1999, compared to 6.1% and 6.4% for the third quarter and first nine months of 1998, respectively. The Company had net realized gains on security sales of $22.2 million and $40.9 million for the third quarter and first nine months of 1999, respectively, compared to $1.1 million and $49.2 million in 1998. On September 30, 1999, the Company's portfolio had $11.4 million in total unrealized gains, compared to $174.3 million at December 31, 1998; the decrease was driven by rising interest rates and the overall decline in the equity market. During the nine months ended September 30, 1999, the yield on the 5-year Treasuries rose 121 basis points over which time the total return was (1.59)%. During the same period, the Company's fixed-income portfolio had a total return of 2.31%. The Company continues to invest in fixed maturity, equity and short-term securities. The majority of the portfolio was in short-term and intermediate-term, investment-grade fixed-maturity securities ($4,485.8 million, or 70.6%, at September 30, 1999, and $3,987.6 million, or 71.7%, at September 30, 1998). Long-term investment-grade fixed-maturity securities represented $229.3 million, or 3.6%, and $411.9 million, or 7.4%, of the total investment portfolio at September 30, 1999 and 1998, respectively. Non-investment-grade 8 9 fixed-maturity securities were $212.3 million, or 3.3%, in 1999, and $126.1 million, or 2.2%, in 1998, and offer the Company higher returns and added diversification without a significant adverse effect on the stability and quality of the investment portfolio as a whole. A portion of the investment portfolio is invested in marketable equity securities. Common stocks represented $1,070.6 million, or 16.9%, in 1999, compared to $605.9 million, or 10.9%, in 1998. The majority of the common stock portfolio is invested in domestic equities traded on nationally recognized securities exchanges. The Company also invests in foreign equities (1.3% in 1999, compared to 2.0% in 1998), partnership investments (1.4% in 1999, compared to 1.0% in 1998) and equity investments in closed-end unit investment trusts (3.6% in 1999, compared to .4% in 1998). Preferred stocks represented $353.4 million, or 5.6% of the portfolio in 1999, compared to $432.3 million, or 7.8%, in 1998. Derivative instruments are primarily used to manage the risks and enhance the returns of the available-for-sale portfolio and may be used for trading purposes. Derivative instruments classified as held or issued for other than trading had a net market value of $(2.3) million at September 30, 1999, compared to $(2.7) million at September 30, 1998. Trading positions had a net market value of $.2 million at September 30, 1999, compared to $(.1) million at September 30, 1998. As of September 30, 1999, the Company had open investment funding commitments of $36.0 million. FINANCIAL CONDITION Progressive's insurance operations create liquidity by collecting and investing premiums written from new and renewal business in advance of paying claims. For the nine months ended September 30, 1999, operations generated a positive cash flow of $700.6 million. In October 1999, the Company entered into a Contribution Agreement with Netrex LLC (Netrex) pursuant to which the Company contributed United Financial Adjusting Company (UFAC), a wholly-owned subsidiary of the Company, and UFAC's subsidiaries along with the Company's 50.1% interest in Progressive Vehicle Inspection Services, Inc. (PVIS) to Netrex Holdings L.L.C. (Holdings), a newly formed limited liability company. In return for this contribution, the Company received a 51% interest in Holdings. The Company's interest will decrease to 19% when Netrex makes an additional capital contribution to Holdings, which is scheduled to occur no later than October 31, 2000. In addition, the Company has two put agreements, under which the Company has the option to cause Netrex to purchase all of its interest in Holdings. The first put is exercisable in December 2004 or January 2005, or earlier upon the occurrence of certain events, and is for $50 million, plus an amount equal to any additional capital contributions made by Progressive to Netrex up to $7.6 million, to be paid in full on December 31, 2011. The second put is exercisable any time on or prior to December 31, 2001, and is for $15 million, plus the additional capital contributions discussed above; if exercised, this put would be paid on January 2, 2002. UFAC and its subsidiaries and PVIS provide claims services to fleet owners and other insurance companies, vehicle inspection services, as well as software development, and represented less than .5% of the Company's year-to-date consolidated revenues. The transaction closed on November 5, 1999. 9 10 In April 1999, UFAC purchased a 58.7% interest in Frontier Adjusters of America, Inc. for $6.8 million. Frontier licenses and franchises independent claims adjusters throughout the United States and Canada, with 650 advertised locations. Frontier also owns and operates independent insurance adjusting businesses in 2 states. On March 1, 1999, the Company issued $300 million of 6 5/8% Senior Notes due March 1, 2029, under a shelf registration statement filed with the Securities and Exchange Commission in 1998. The Company may redeem all or part of the Notes at any time, subject to a "make whole" provision. There are no sinking fund requirements. The Notes were priced at 98.768% to yield 6.721% to maturity. Interest is payable semiannually on March 1 and September 1, beginning September 1, 1999. Net proceeds to the Company of $293.7 million (after discount and underwriting fees) are intended to be used, together with other available funds, to retire certain of the Company's current outstanding debt upon its maturity, including $30 million of 8 3/4% Notes, which were due and paid on June 1, 1999, and $150 million each of 10% Notes and 10 1/8% Subordinated Notes, both of which are due December 15, 2000. The Company is currently constructing a corporate office complex in Mayfield Village, Ohio at an estimated cost of $105.5 million, of which $56.3 million has been paid through September 30, 1999, including $14.1 million paid in the third quarter 1999. The first of four buildings was completed in May 1999, with the second building to be completed by the end of 1999. The third building, parking garage and fourth building are scheduled to be completed in February 2000, October 2000 and February 2001, respectively. The Company has substantial capital resources and believes it has sufficient borrowing capacity and other capital resources to support current and anticipated growth. YEAR 2000 COMPLIANCE The year 2000 problem exists because many computer programs only use the last two digits to refer to a year and could recognize "00" as 1900 instead of 2000. If not corrected, many computer and other microchip supported applications could fail or create erroneous results. The extent of the potential impact is still unknown but could affect the global economy. In response to this issue, the Company has evaluated its applications and operating software (including its claims reporting, financial reporting, policy issuance, policy maintenance and other internal production systems), hardware and software products, and third-party data exchanges and business relationships and continues to evaluate its end user computing activities and facilities implications (including public utility services). The Company has established a dedicated, tenured project team responsible for overseeing progress on the Company's compliance program and periodically reporting to management. The Company began converting its applications software to be year 2000 compliant in July 1995 and, as a result, has been able to avoid redeploying significant resources or deferring other important projects to specifically address the year 2000 issues. During the first quarter 1998, the Company retained independent consultants to determine its state of readiness. Although some additional areas of focus were identified, the consultants noted that the Company was adequately 10 11 addressing its critical internal systems and issues. As of September 30, 1999, the Company has substantially completed its efforts to bring its applications software in compliance. Testing of critical applications is being accomplished through the use of a special systems environment known as a "Time Warp Lab," which mimics the Company's production environment. As a final test of year 2000 readiness, after conversion and year 2000 certification, critical applications are run in the Time Warp Lab while systems clocks turn over from 1999 to 2000 and beyond. The total cost to modify these existing production systems, which includes both internal and external costs of programming, coding and testing, is estimated to be $9.0 million, of which $8.9 million had been expensed through September 30, 1999. The Company also replaced some of its systems during 1998. In addition to being year 2000 compliant, these new systems added increased functionality to the Company. The majority of the projects were completed in 1998, with remaining parallel testing completed during the first half of 1999. As of September 30, 1999, $5.5 million, which include both internal and external costs, had been paid for these systems. All costs are being funded through operating cash flows. In addition, the Company has identified approximately 380 third parties with which data is exchanged. The majority of scheduled critical data exchanges with our business partners were successfully tested for compliance. The Company continually evaluates computer hardware and software upgrades for enhancements and, therefore, many of the costs to replace these items to be year 2000 compliant were not incremental costs to the Company. The Company's remediation of its mainframe hardware and operating software is over 99% complete and the remediation of its servers and client server operating software is 98% complete. The Company estimates that all mainframe and client server hardware and operating software will be year 2000 compliant before the end of the year. In addition, during 1998, the Company secured software which will assist in the discovery of noncompliant desktop hardware and software. The evaluation of software compliance is complete, with all standard software certified as compliant at the current versions. The Company also completed the inventory and remediation of SAS code user libraries; all user SAS code was either remediated by the customers or archived to prevent its usage. The Company is currently unable to determine the impact that year 2000 noncompliance may have on its financial condition, cash flows and results of operations. The Company believes that it is taking the necessary measures to address issues that may arise relating to the year 2000 and that its production systems will be compliant. The Company realizes, however, that noncompliance by third parties could impact its business. The possibility exists that a portion of the Company's distribution channel may not be compliant, that communication with agents could be disrupted, that underwriting data, such as motor vehicle reports, could be unobtainable, that the claim settling process could be delayed or that frequency and severity of losses may increase due to external factors. The Company continues to contact its key independent insurance agents, vendors and suppliers (e.g. banks, credit bureaus, motor vehicle departments, rating agencies, etc.) to determine their status of compliance and to assess the impact of noncompliance to the Company. The Company is working closely with all critical business relationships to minimize its exposure to year 2000 issues, including on-site visits to identify their state of readiness. The Company's process teams and business groups are identifying potential year 2000 scenarios. For those scenarios deemed to be both probable and with a potentially significant business 11 12 impact, the Company is developing contingency plans. The majority of the contingency plans are drafted and were reviewed by the Company's chief financial and technology officers during 1998. Contingency plans include such items as hardening facilities with back-up generators, prioritizing resources, securing alternative vendors, developing alternative processes, pre-ordering policyholder information and other measures. The contingency plans were substantially completed for all material relationships during the first quarter 1999, and were reviewed in detail in the third quarter 1999. The Company will continue to review these plans throughout 1999. SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995: EXCEPT FOR HISTORICAL INFORMATION, THE MATTERS DISCUSSED IN THIS QUARTERLY REPORT ON FORM 10-Q ARE FORWARD-LOOKING STATEMENTS THAT ARE SUBJECT TO CERTAIN RISKS AND UNCERTAINTIES THAT COULD CAUSE THE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE PROJECTED. THESE RISKS AND UNCERTAINTIES INCLUDE, WITHOUT LIMITATION, PRICING COMPETITION AND OTHER INITIATIVES BY COMPETITORS, LEGISLATIVE AND REGULATORY DEVELOPMENTS, WEATHER CONDITIONS (INCLUDING THE SEVERITY AND FREQUENCY OF STORMS, HURRICANES, SNOWFALLS, HAIL AND WINTER CONDITIONS), DRIVING PATTERNS, COURT DECISIONS AND TRENDS IN LITIGATION AND HEALTH CARE COSTS, INTEREST RATE LEVELS AND OTHER CONDITIONS IN THE FINANCIAL AND SECURITIES MARKETS, UNFORESEEN TECHNOLOGICAL ISSUES ASSOCIATED WITH THE YEAR 2000 COMPLIANCE EFFORTS AND THE EXTENT TO WHICH VENDORS, PUBLIC UTILITIES, GOVERNMENTAL ENTITIES AND OTHER THIRD PARTIES THAT INTERFACE WITH THE COMPANY MAY FAIL TO ACHIEVE YEAR 2000 COMPLIANCE, AND OTHER RISKS DETAILED FROM TIME TO TIME IN THE COMPANY'S SEC REPORTS. THE COMPANY ASSUMES NO OBLIGATION TO UPDATE THE INFORMATION IN THIS QUARTERLY REPORT. ITEM 3. Quantitative and Qualitative Disclosures About Market Risk. Investments in the Company's portfolio have varying degrees of risk. The primary market risk exposure to the fixed-income portfolio is interest rate risk, which is limited by managing duration to a defined range of 1.8 to 5 years. The distribution of maturities and convexity are monitored on a regular basis. The duration of the fixed-income portfolio was 3.0 years at September 30, 1999, compared to 2.9 years at September 30, 1998. Based on a hypothetical 100 basis point rise in market rates, exposure to risk in terms of a change in market value is $155 million, or 3.2% of the fixed-income portfolio, at September 30, 1999, compared to $136 million, or 3.2% of the fixed-income portfolio, at December 31, 1998. Derivative financial instruments held or issued for purposes of managing interest rate exposure on the anticipated debt issuance were closed on March 1, 1999, upon the issuance of the $300 million 6 5/8% Senior Notes. The net market value of these instruments at closing was $3.3 million. No other material changes have occurred in market risk since reported in the Annual Report on Form 10-K for the year ended December 31, 1998. 12 13 PART II - OTHER INFORMATION --------------------------- ITEM 6. Exhibits and Reports on Form 8-K. (a) Exhibits: See exhibit index on page 15. (b) Reports on Form 8-K during the quarter ended September 30, 1999: None 13 14 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. THE PROGRESSIVE CORPORATION --------------------------- (Registrant) Date: November 15, 1999 BY: /s/ W. Thomas Forrester ------------------------------------- W. Thomas Forrester Treasurer and Chief Financial Officer 14 15 EXHIBIT INDEX ------------- Exhibit No. Form 10-Q Under Reg. Exhibit S-K Item 601 No. Description of Exhibit - ------------ --------- ---------------------- (27) 27 Financial Data Schedule for the nine months ended September 30, 1999 15 EX-27 2 EXHIBIT 27
7 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CONSOLIDATED BALANCE SHEETS AND STATEMENTS OF INCOME AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMEMENTS. 1,000 U.S. DOLLARS 9-MOS DEC-31-1999 JAN-01-1999 SEP-30-1999 1 4,802,400 0 0 1,424,000 0 0 6,351,400 8,600 264,000 365,600 9,744,200 2,323,600 2,895,700 0 0 1,040,800 0 0 73,100 2,689,600 9,744,200 4,185,900 242,100 40,900 43,900 3,028,600 551,700 426,600 415,400 124,000 291,400 0 0 0 291,400 4.00 3.90 0 0 0 0 0 0 0
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