SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C.  20549

 

 

FORM 10-Q

 

 

PAULA FINANCIAL

(Exact name of registrant as specified in its charter)

 

 

PAULA FINANCIAL

87 East Green Street, Suite 206

Pasadena, CA 91105

(Address of principal executive offices)

 

(626) 844-7100

(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.

 

Indicate by check mark whether the registrant is an accelerated filer (as defined by Rule 12b-2 of the Exchange Act.

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.  Number of shares of Common Stock, $.01 par value, outstanding as of close of business on April 30, 2003:  6,229,879 shares.

 

 

PAULA FINANCIAL

INDEX TO FORM 10-Q

 

PART I.	FINANCIAL INFORMATION
Item 1.	Financial Statements
	Condensed consolidated balance sheets as of
	March 31, 2003 (unaudited) and December 31, 2002
	Condensed consolidated statements of income for the three
	months ended March 31, 2003 and 2002 (unaudited)
	Condensed consolidated statements of cash flows for the three months
	ended March 31, 2003 and 2002 (unaudited)
	Notes to condensed consolidated financial statements for the three
	months ended March 31, 2003 (unaudited)
Item 2.	Management’s Discussion and Analysis of Consolidated Financial
	Condition and Results of Operations
Item 3.	Quantitative and Qualitative Disclosures About Market Risks
Item 4.	Controls and procedures
PART II.	OTHER INFORMATION
Item 6	Exhibits and Reports on Form 8-K
SIGNATURE

 

 

PART I        FINANCIAL INFORMATION

Item 1.         Financial Statements

 

PAULA FINANCIAL AND SUBSIDIARIES

Condensed Consolidated Balance Sheets

(In thousands, except share data)

 

 

		March 31, 2003			December 31, 2002
		(Unaudited)			(*)
Assets
Current Assets:
Cash (restricted: 2003, $1,229; 2002, $851)		$	2,124		$	1,290
Accounts receivable, net of allowance for uncollectible accounts (2003, $140 and 2002, $140)		1,344			875
Commissions receivable		1,283			1,284
Income tax receivable		—			141
Other receivables		7			92
Deferred income taxes		1,293			1,274
Other assets		385			262
		6,436			5,218
Non-Current Assets:
Property and equipment, net		260			266
Investment in related party		703			703
Goodwill		1,905			1,452
Other amortizable intangible assets, net		1,840			1,194
Deferred income taxes		5,171			5,368
Other assets		198			99
		$	16,513		$	14,300
Liabilities and Stockholders’ Equity
Current Liabilities:
Due to underwriters and assureds		$	2,657		$	1,890
Income taxes payable		16			—
Accounts payable and accrued expenses		2,012			1,401
Notes payable to bank		1,300			1,300
		5,985			4,591
Non-Current Liabilities:
Accounts payable and accrued expenses		1,350			600
Notes payable to bank		1,125			1,450
		$	8,460		$	6,641
Stockholders’ Equity:
Preferred stock, $0.01 par value.  Authorized 4,058,823 shares, none issued and outstanding		$	—		$	—
Common stock, $0.01 par value (Authorized 15,000,000 shares, issued: 2003, 7,103,379; 2002, 7,023,379)		71			70
Additional paid-in-capital		68,360			68,294
Accumulated deficit		(54,109		)	(54,405		)
Unearned compensation		(67		)	(26		)
Employee loans for stock purchase		(325		)	(397		)
		13,930			13,536
Treasury stock, at cost (2003 and 2002, 873,500 shares)		(5,877		)	(5,877		)
		$	8,053		$	7,659
		$	16,513		$	14,300

 

*                          Derived from audited financial statements.

 

                                 See notes to condensed consolidated financial statements.

 

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PAULA FINANCIAL AND SUBSIDIARIES

Condensed Consolidated Statements of Income

(In thousands, except share and per share data)

 

 

		Three Months Ended March 31,
		2003			2002
		(Unaudited )
Income:
Commissions		$	3,470		$	2,566
Contingent commissions		1,065			696
Net investment income		2			4
Service fees		75			10
Other		7			6
		4,619			3,282
Expenses:
Salaries and related expenses		2,346			1,732
Interest expense		43			68
Other expenses		1,708			1,035
		4,097			2,835
Income from continuing operations before income taxes		522			447
Income tax expense		226			187
Income from continuing operations		296			260
Discontinued operations:
Loss from operations of discontinued underwriting segment (including loss on disposal in 2002 of $83)		—			(83		)
Income tax benefit		—			(35		)
Loss on discontinued operations		—			(48		)
Net income		$	296		$	212
Earnings per share:
Income from continuing operations		$	0.05		$	0.04
Loss on discontinued operations		—			(0.01		)
Net income		$	0.05		$	0.03
Weighed average shares outstanding		6,177,212			6,092,585
Earnings per share - assuming dilution
Income from continuing operations		$	0.05		$	0.04
Loss on discontinued operations		—			(0.01		)
Net income		$	0.05		$	0.03
Weighted average shares outstanding - assuming dilution		6,341,936			6,092,585

 

See notes to condensed consolidated financial statements.

 

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PAULA FINANCIAL AND SUBSIDIARIES

Condensed Consolidated Statements of Cash Flows

(In thousands)

 

 

		Three Months Ended March 31,
		2003			2002
		(Unaudited )
Cash flow from operating activities:
Net income		$	296		$	212
Loss from discontinued operations		—			48
Income from continuing operations		296			260
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		118			122
Loss on sale of property and equipment		—			3
Increase in receivables		(242		)	(54		)
Decrease in deferred income taxes		178			153
Increase in accounts payable and accrued expenses		1,205			274
Other, net		(146		)	231
Net cash provided by operating activities		1,409			989
Cash flows from investing activities:
Purchase of book of business		(247		)	—
Purchase of property and equipment		(25		)	(39		)
Net cash used in  investing activities		(272		)	(39		)
Cash flows from financing activities:
Payments on note payable to bank		(325		)	(325		)
Repayment of employee loans for stock purchase		22			65
Funding of discontinued operations		—			(83		)
Net cash used in financing activities		(303		)	(343		)
Net increase in cash and invested cash		834			607
Cash and invested cash at beginning of period		1,290			1,997
Cash and invested cash at end of period		$	2,124		$	2,604

 

See notes to condensed consolidated financial statements.

 

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PAULA FINANCIAL AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

For the Three Months Ended March 31, 2003 (Unaudited)

 

Note A - Basis of Presentation

 

PAULA Financial and subsidiaries (the “Company”) is a California-based specialty distributor of commercial insurance products.   The Company’s agency operations place a full array of commercial insurance products for their customers.  In addition, the Company owns a third party administration operation which has minimal operations.

 

The accompanying unaudited condensed consolidated financial statements of the Company have been prepared in accordance with generally accepted accounting principles (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X.  Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements.  In the opinion of management, all adjustments, including normally occurring accruals, considered necessary for a fair presentation have been included.

 

Operating results for the three months ended March 31, 2003 are not necessarily indicative of the results to be expected for the year ended December 31, 2003.  For further information, refer to the consolidated financial statements and footnotes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2002.

 

Note B – Change in Stockholders’ Equity

 

In the first quarter of 2003, the Company issued 80,000 shares of restricted stock.  As of March 31, 2003, 50,000 shares were unvested.  Of the 80,000 shares issued, 60,000 shares related to the addition to the Company’s crop insurance platform of Roudebush & Avina Insurance Agency, Inc. (“R&A”).  R&A is based in Modesto, California and specializes in providing crop insurance to commercial wine grape growers.  Since 2002, the Company has made efforts to dramatically expand crop insurance sales, primarily through producer recruitment.  As part of the agreement, the Company will purchase R&A’s existing book of business.  Balances owing under the arrangement will be paid over a five year period.  As of March 31, 2003, the obligation related to this transaction was $826,000 with $126,000 of the balance due in the next twelve months.  Of the total purchase price, $503,000 has been allocated to other amortizable intangible assets, with the remaining $323,000 allocated to goodwill.  Other amortizable intangible assets relate to expiration lists and covenants not to compete.

 

Additionally, in the first quarter of 2003, the Company received payments on employee loans for stock purchase totaling $22,000 and increased the valuation allowance on these loans by $50,000.

 

Note C – Comprehensive Income

 

The Company has not included a statement of comprehensive income in the accompanying consolidated financial statements as the Company does not have any other comprehensive income adjustments.

 

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Note D – Discontinued Operations

 

Historically, the Company also operated a workers’ compensation underwriting facility, PAULA Insurance Company (“PICO”).  As of December 31, 2001, PICO’s Risk Based Capital fell into the “Mandatory Control Level.”  Consequently, on March 12, 2002, PICO and the California DOI entered into an Oversight Agreement which effectively gave the California DOI control over PICO’s operations.  As a result of these events, in the fourth quarter of 2001, the Company began accounting for its investment in PICO using the equity method.  In the fourth quarter of 2001, the Company wrote its investment in PICO down to $-0-.  Consequently, no direct PICO operating activity is included in the consolidated financial statements for the 2002 period.

 

On April 26, 2002, the California DOI obtained a conservation order for PICO which was followed on June 21, 2002 by a liquidation order.  Subsequent to the liquation order, the Company provided limited operation support to PICO.  Given the continued activity with PICO through the third quarter of 2002, the Company was precluded from treating PICO as a discontinued operation for accounting purposes.

 

In the fourth quarter of 2002 the requirements of Statement of Financial Accounting Standards No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS 144”) for treating a segment as a discontinued operation were met.  Consequently, operating activity related to workers’ compensation underwriting has been reclassified as discontinued operations.  As a result, certain financial information previously issued has been adjusted to give effect to the classification of the PICO business as discontinued operations in accordance with SFAS 144.

 

Amounts related to discontinued operations in the 2002 period primarily relate to employee severance costs associated with the discontinuance of PICO operations.

 

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PART I        FINANCIAL INFORMATION

Item 2.         Management’s Discussion and Analysis of Consolidated Financial Condition and Results of Operations

 

Overview

 

The Company’s revenues consist of agency commission income, contingent commission income, and service fees. Commission income is earned from Pan Am’s insurance sales activity.  Associated premiums are primarily billed directly by the insurance carrier.  However, in certain instances, Pan Am will invoice the customer and remit the premiums, less commission, to the insurance carrier.  The Company focuses its sales efforts on agribusiness and rural markets in California and Arizona.  Contingent commission is related to volume and profit sharing arrangements with insurance carriers.  Service fees are primarily received for the performance of services related to loss control and claims advocacy.

 

The Company’s expenses consist of salaries and related expenses, interest expense and other general and administrative expenses.

 

Results of Operations for the Three Months Ended March 31, 2003 Compared to the Three Months Ended March 31, 2002:

 

Commission income. For the three months ended March 31, 2003 commission income increased 35.2% to $3.5 million compared to $2.6 million for the comparable 2002 period.  Of the $0.9 million increase 50% is due to increases in the placement of crop insurance while another 34% is due to increases in the workers compensation line of business.

 

Since 2002, the Company has made efforts to dramatically expand crop insurance sales, primarily through producer recruitment.  In March 2003, R&A joined the Company.  R&A is based in Modesto, California and specializes in providing crop insurance to commercial wine grape growers.  The Company believes that its efforts to expand crop insurance production will help absorb some of the changes recently announced by the California State Compensation Insurance Fund (“SCIF”).  California Insurance Commissioner Garamendi and SCIF management have recently announced a plan to reduce commission rates to all approved agents beginning in August 2003.

 

Contingent commission income. For the three months ended March 31, 2003 contingent commission income increased 53.0% to $1.1 million compared to $0.7 million for the comparable 2002 period.    Contingent commission fluctuates from year to year based on the profitability of the underlying business.

 

Service fees.  Service fee income increased to $75,000 for the three months ended March 31, 2003 from $10,000 for the comparable 2002 period.  The increase in service fees is due to new service arrangements where the Company is paid for providing loss control and other field support services to selected accounts.

 

Salaries and related expenses.  Salaries and employee benefits increased 35.5% to $2.3 million for the three months ended March 31, 2003 from $1.7 million for the comparable 2002 period.  The increase is due to three primary factors:  the transfer of selected employees from PICO’s payroll to Pan Am in early to mid-2002, the addition of new employees beginning in July 2002 and the elimination of previous cost sharing arrangements that were in effect with PICO through mid-2002.

 

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Interest expenses.  Interest expense decreased 36.8% to $43,000 for the three months ended March 31, 2003 from $68,000 for the comparable 2002 period due to the decline in the outstanding balance of the related note payable.

 

Other expenses.  Other expenses increased 65.0% to $1.7 million for the three months ended March 31, 2003 from $1.0 million for the comparable 2002 period.   The increase is primarily due to the elimination of previous cost sharing arrangements that were in effect with PICO until mid-2002 as well as the costs associated with an increased number of employees, including insurance and facilities expenses.

 

Income taxes on continuing operations.  Income tax expense for the three months ended March 31, 2003 was $226,000 compared to $187,000 for the comparable 2002 period.  The effective combined income tax rates for the three months ended March 31, 2003 and 2002 were 43.3% and 41.8%, respectively.

 

Loss from discontinued operations before taxes.  In 2002, these costs primarily included employee severance costs associated with the discontinuance of PICO operations.

 

Income taxes on discontinued operations.  Income tax benefit on discontinued operations for the three months ended March 31, 2002 was $35,000 for the comparable 2002 period.  The effective combined income tax rates for the three months ended March 31, 2002 was 42.2%.

 

Liquidity and Capital Resources:

 

As a holding company, PAULA Financial’s principal sources of funds are dividends and expense reimbursements from its operating subsidiaries and proceeds from the sale of its capital stock.  PAULA Financial’s principal uses of funds are capital contributions to its subsidiaries and payment of operating expense.

 

As of December 31, 2002, the Company had an outstanding balance on its bank term loan of $2.8 million. Under the terms of the amended credit agreement, the loan balance will be paid over the next 21 months with the final principal payment due January 1, 2005.  As of March 31, 2003, the outstanding balance was $2.4 million. Management believes that funds currently available and expected to be generated by the agency operations will be sufficient to meet the required principal and interest payments on the term loan.

 

Each of PAULA Financial’s non-insurance subsidiaries has guaranteed all obligations of PAULA Financial under the credit agreement.

 

The Company’s Board of Directors had previously approved a 1,000,000 share repurchase program.  As of March 31, 2003, the Company held 873,500 shares in treasury stock.  On February 20, 2003, the Board of Directors authorized an additional 2,000,000 shares for the share repurchase program.   The Company’s current credit agreement restricts its ability to repurchase capital stock.

 

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Forward-Looking Statements

 

In connection with, and because it desires to take advantage of the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995, the Company cautions readers to recognize the existence of certain forward-looking statements in this Form 10-Q and in any other statement made by, or on behalf of, the Company, whether or not in future filings with the Securities and Exchange Commission.  Forward-looking statements are statements not based on historical information and which relate to future operations, strategies, financial results or other developments.  Some forward-looking statements may be identified by the use of terms such as “expects,” “believes,” “anticipates,” “intends,” or “judgment.” Forward-looking statements are necessarily based upon estimates and assumptions that are inherently subject to significant business, economic and competitive uncertainties, many of which are beyond the Company’s control and many of which, with respect to future business decisions, are subject to change.  Examples of such uncertainties and contingencies include, among other important factors, those affecting the insurance industry in general, such as the economic and interest rate environment, legislative and regulatory developments and market pricing and competitive trends, and those relating specifically to the Company and its businesses, such as the level of its commission and fee income, and acquisitions of companies or blocks of business.  These uncertainties and contingencies can affect actual results and could cause actual results to differ materially from those expressed in any forward-looking statements made by, or on behalf of, the Company. The Company disclaims any obligation to update forward-looking information.

 

Item 3:          Quantitative and Qualitative Disclosures About Market Risk.

 

There have been no significant changes since the annual report Form 10-K filed for the year ended December 31, 2002.

 

Item 4:          Controls and Procedures

 

Controls and Procedures

 

The Company’s Chief Executive Officer and Vice President Finance have evaluated the effectiveness of the Company’s disclosure controls and procedures (as such term is defined in Rules 13a-14(c) and 15d-14(c) under the Securities and Exchange Act of 1934, as amended (the “Exchange Act”)) as of a date 90 days prior to the filing date of this quarterly report (the “Evaluation Date”).  Based on such evaluation, such officers have concluded that, as of the Evaluation Date, the Company’s disclosure controls and procedures are effective in alerting them on a timely basis to material information relating to the Company (including its consolidated subsidiaries) required to be included in the Company’s periodic filings under the Exchange Act.

 

Changes in Internal Controls

 

Since the Evaluation Date, there have not been any significant changes in the Company’s internal controls or in other factors that could significantly affect such controls.

 

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PART II.                OTHER INFORMATION

 

Item 6:	Exhibits and Reports on Form 8-K:
	(a)	Exhibits.
		11.			Computation of Earnings Per Share.
		99.1			Certification by the Chief Executive Officer and Chief Financial Officer Relating to a Period Report Containing Financial Statements.
	(b)		Reports on Form 8-K.
				There were no reports filed on Form 8-K during the three months ended March 31, 2003.

 

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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this Quarterly Report on Form 10-Q to be signed on its behalf by the undersigned thereunto duly authorized.

 

Date:  May 15, 2003		PAULA FINANCIAL
		By:	/s/ Deborah S. Maddocks
		Vice President - Finance

 

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CERTIFICATION

 

I, Jeffrey A. Snider, certify that:

 

1.                     I have reviewed this quarterly report on Form 10-Q of PAULA Financial;

 

2.                     Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

 

3.                     Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

 

4.                     The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

 

a)                    designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

 

b)                   evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

 

c)                    presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

 

5.                     The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

 

a)                    all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record,  process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and

 

b)                 any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

 

6.                     The registrant’s other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

 

 

Date:  May 15, 2003	By:	/s/ Jeffrey A. Snider
	Chief Executive Officer

 

 

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CERTIFICATION

 

I, Deborah S. Maddocks, certify that:

 

1.                     I have reviewed this quarterly report on Form 10-Q of PAULA Financial;

 

2.                     Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

 

3.                     Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

 

4.                     The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

 

a)                    designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

 

b)                   evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

 

c)                    presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

 

5.                     The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

 

a)                    all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record,  process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and

 

b)                 any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

 

6.                     The registrant’s other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

 

 

Date:  May 15, 2003	By:	/s/ Deborah S. Maddocks
	Vice President - Finance

 

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