e10vq
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
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þ |
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Quarterly report pursuant to section 13 or 15 (d) of the Securities Exchange Act of 1934 |
For the Quarterly period ended March 31, 2009
or
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o |
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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 1-4720
WESCO FINANCIAL CORPORATION
(Exact name of Registrant as Specified in its Charter)
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DELAWARE
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95-2109453 |
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(State or other jurisdiction of
incorporation or organization)
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(I.R.S. Employer Identification No.) |
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301 East Colorado Boulevard, Suite 300, Pasadena, California 91101-1901
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(Address of principal executives
offices) (Zip Code)
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626/585-6700
(Registrants telephone number, including area code)
(Former name, former address and former fiscal year, if changed since last report)
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 þ No o
Indicate by check mark whether the registrant has submitted electronically and posted on its
corporate Web site, if any, every Interactive Data File required to be submitted and posted
pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months
(or for such shorter period that the registrant was required to submit and post such files).
Yes o No o
Indicate by check mark whether registrant is a large accelerated filer, an accelerated filer, a
non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated
filer, accelerated filer and smaller
reporting company in Rule 12b-2 of the Exchange Act.
(Check one):
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Large Accelerated filer o
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Accelerated filer þ
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Non-Accelerated filer o
(Do not check if a smaller reporting company)
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Smaller reporting company o |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of
the Exchange Act).
Yes o No þ
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS
DURING THE PRECEDING FIVE YEARS
Indicate by check mark whether the registrant has filed all documents and reports required to be
filed by Section 12, 13 or 15 (d) of the Securities Exchange Act of 1934 subsequent to the
distribution of securities under a plan confirmed by a court.
Yes o No o
APPLICABLE ONLY TO CORPORATE ISSUERS
Indicate the number of shares outstanding of each of the issuers classes of common stock, as
of the latest practicable date. 7,119,807 as of April 30, 2009
PART I. FINANCIAL INFORMATION
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
Reference is made to Item 7A, Quantitative and Qualitative Disclosures About Market Risk
appearing on pages 37 39 of the Form 10-K Annual Report for the year ended December 31, 2008,
filed by Wesco Financial Corporation (Wesco), for information on equity price risk and interest
rate risk at Wesco. There have been no material changes through March 31, 2009 except as to the
effects on shareholders equity resulting from the decline in fair values of Wescos investments in
marketable equity securities.
Item 4. Controls and Procedures.
An evaluation was performed under the supervision and with the participation of the management
of Wesco, including Charles T. Munger (Chief Executive Officer) and Jeffrey L. Jacobson (Chief
Financial Officer), of the effectiveness of the design and operation of Wescos disclosure controls
and procedures as of March 31, 2009. Based on that evaluation, Messrs. Munger and Jacobson
concluded that the Companys disclosure controls and procedures are effective in ensuring that
information required to be disclosed by the Company in reports it files or submits under the
Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported as
specified in the rules and forms of the Securities Exchange Commission, and are effective to ensure
that information required to be disclosed by Wesco in the reports it files or submits under the
Exchange Act, as amended, is accumulated and communicated to Wescos management, including Mr.
Munger and Mr. Jacobson, as appropriate to allow timely decisions regarding required disclosure.
There have been no changes in Wescos internal control over financial reporting during the quarter
ended March 31, 2009 that have materially affected or are reasonably likely to materially affect
the internal control over financial reporting.
-2-
PART II. OTHER INFORMATION
Item 6. Exhibits
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31 (a)
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Certification Pursuant to Rule 13a-14 under the Securities Exchange Act
of 1934, as amended (Chief Executive Officer) |
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31 (b)
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Certification Pursuant to Rule 13a-14 under the Securities Exchange Act
of 1934, as amended (Chief Financial Officer) |
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32 (a)
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Certification Pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002 (Chief Executive Officer) |
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32 (b)
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Certification Pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002 (Chief Financial Officer) |
-3-
WESCO FINANCIAL CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEET
(Dollar amounts in thousands)
(Unaudited)
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March 31, |
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Dec. 31, |
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2009 |
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2008 |
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ASSETS |
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Cash and cash equivalents |
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$ |
313,716 |
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$ |
297,643 |
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Investments |
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Securities with fixed maturities |
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32,494 |
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28,656 |
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Equity securities |
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1,440,739 |
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1,868,293 |
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Receivable from affiliates |
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206,261 |
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133,396 |
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Rental furniture |
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205,792 |
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217,597 |
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Goodwill of acquired businesses |
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277,795 |
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277,742 |
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Other assets |
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241,889 |
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227,368 |
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$ |
2,718,686 |
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$ |
3,050,695 |
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LIABILITIES AND SHAREHOLDERS EQUITY |
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Insurance losses and loss adjustment expenses |
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Affiliated business |
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$ |
231,683 |
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$ |
164,424 |
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Unaffiliated business |
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15,137 |
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50,844 |
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Unearned insurance premiums |
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Affiliated business |
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150,914 |
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94,544 |
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Unaffiliated business |
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6,043 |
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13,251 |
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Deferred furniture rental income and security deposits |
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16,590 |
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17,674 |
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Notes payable |
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43,200 |
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40,400 |
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Income taxes payable, principally deferred |
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83,640 |
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230,657 |
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Other liabilities |
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53,745 |
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61,145 |
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600,952 |
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672,939 |
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Shareholders equity: |
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Capital stock and additional paid-in capital |
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33,324 |
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33,324 |
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Accumulated other comprehensive income |
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(124,406 |
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152,763 |
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Retained earnings |
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2,208,816 |
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2,191,669 |
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Total shareholders equity |
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2,117,734 |
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2,377,756 |
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$ |
2,718,686 |
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$ |
3,050,695 |
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See notes beginning on page 7.
-4-
WESCO FINANCIAL CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF
INCOME AND RETAINED EARNINGS
(Dollar amounts in thousands except for amounts per share)
(Unaudited)
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Three Months Ended |
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March 31, |
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March 31, |
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2009 |
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2008 |
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Revenues: |
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Furniture rentals |
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$ |
82,699 |
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$ |
80,716 |
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Sales and service revenues |
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28,505 |
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32,748 |
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Insurance premiums earned |
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Affiliated business |
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75,584 |
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21,792 |
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Unaffiliated business |
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3,713 |
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4,588 |
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Dividend and interest income |
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19,304 |
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19,331 |
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Other |
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997 |
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1,021 |
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210,802 |
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160,196 |
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Costs and expenses: |
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Cost of products and services sold |
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35,538 |
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35,767 |
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Insurance losses and loss adjustment expenses |
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Affiliated business |
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45,987 |
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12,269 |
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Unaffiliated business |
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2,323 |
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3,420 |
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Insurance underwriting expenses |
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Affiliated business |
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21,959 |
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5,860 |
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Unaffiliated business |
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1,260 |
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2,198 |
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Selling, general and administrative expenses |
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78,924 |
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72,214 |
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Interest expense |
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255 |
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527 |
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186,246 |
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132,255 |
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Income before income taxes |
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24,556 |
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27,941 |
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Income taxes |
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4,597 |
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7,224 |
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Net income |
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19,959 |
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20,717 |
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Retained earnings beginning of period |
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2,191,669 |
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2,120,518 |
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Cash dividends declared and paid |
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(2,812 |
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(2,742 |
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Retained earnings end of period |
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$ |
2,208,816 $ |
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2,138,493 |
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Amounts per capital share based on 7,119,807 shares
outstanding throughout each period: |
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Net income |
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$ |
2.80 |
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$ |
2.91 |
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Cash dividends |
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$ |
.395 |
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$ |
.385 |
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See notes beginning on page 7.
-5-
WESCO FINANCIAL CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(Dollar amounts in thousands)
(Unaudited)
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Three Months Ended |
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March 31, |
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March 31, |
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2009 |
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2008 |
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Cash flows from operating activities, net |
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$ |
18,778 |
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$ |
30,471 |
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Cash flows from investing activities: |
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Maturities and redemptions of securities
with fixed maturities |
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839 |
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893 |
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Purchases of equity securities |
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(29,396 |
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Purchases of securities with fixed maturities |
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(4,232 |
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Purchases of rental furniture |
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(11,547 |
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(25,009 |
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Sales of rental furniture |
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17,146 |
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15,623 |
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Additions to condominium construction in process |
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(4,282 |
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(8,235 |
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Acquisitions of businesses, net of cash acquired |
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(4,916 |
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Other, net |
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(586 |
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(1,626 |
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Net cash flows from investing activities |
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(2,662 |
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(52,666 |
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Cash flows from financing activities: |
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Net increase in notes payable, principally line of credit |
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2,800 |
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7,600 |
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Payment of cash dividends |
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(2,812 |
) |
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(2,742 |
) |
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Net cash flows from financing activities |
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(12 |
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4,858 |
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Effect of foreign currency exchange rate changes |
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(31 |
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Increase (decrease) in cash and cash equivalents |
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16,073 |
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(17,337 |
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Cash and cash equivalents beginning of period |
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297,643 |
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526,722 |
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Cash and cash equivalents end of period |
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$ |
313,716 |
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$ |
509,385 |
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Supplementary information: |
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Interest paid during period |
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$ |
329 |
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$ |
521 |
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Income taxes paid, net, during period |
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1,584 |
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4,259 |
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See notes beginning on page 7.
-6-
WESCO FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in thousands except for amounts per share)
(Unaudited)
Note 1. General
The unaudited condensed consolidated financial statements of which these notes are an integral
part include the accounts of Wesco Financial Corporation (Wesco) and its subsidiaries. In
managements opinion, such statements reflect all adjustments (all of them of a normal recurring
nature) necessary to a fair statement of interim results in accordance with accounting principles
generally accepted in the United States.
Reference is made to the notes to Wescos consolidated financial statements appearing on pages
48 through 60 of its 2008 Form 10-K Annual Report for other information deemed generally applicable
to the condensed consolidated financial statements. In particular, Wescos significant accounting
policies and practices are set forth in Note 1 on pages 48 through 52.
Consolidated Federal income tax return liabilities have been settled with the Internal Revenue
Service (the IRS) through 1998. The IRS has completed its audit of the Federal tax returns for the years
1999 through 2004. The examination for these years is currently in the IRS appeals process. The
IRS is currently auditing the 2005 and 2006 Federal tax returns. Wesco management believes that the
ultimate outcome of the Federal income tax audits will not materially affect Wescos consolidated
financial statements.
Wescos management does not believe that any accounting pronouncements issued by the Financial
Accounting Standards Board or other applicable authorities that are required to be adopted after
March 31, 2009 are likely to have a material effect on reported shareholders equity.
Note 2. Investments
Following is a summary of investments in equity securities (all common stocks):
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March 31, |
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Dec. 31, |
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2009 |
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2008 |
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Amortized cost |
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$ |
1,632,437 |
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$ |
1,632,437 |
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Gross unrealized gains |
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339,640 |
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399,910 |
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Gross unrealized losses |
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(531,338 |
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(164,054 |
) |
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Fair value |
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$ |
1,440,739 |
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$ |
1,868,293 |
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Following is a summary of investments in securities with fixed maturities:
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March 31, |
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Dec. 31, |
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2009 |
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2008 |
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Amortized cost |
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$ |
30,899 |
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$ |
27,500 |
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Gross unrealized gains |
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1,595 |
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|
1,156 |
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Gross unrealized losses |
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Fair value |
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$ |
32,494 |
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$ |
28,656 |
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-7-
Note 3. Comprehensive income
The following table sets forth Wescos consolidated comprehensive income for the three-month
periods ended March 31, 2009 and 2008:
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Three Months Ended |
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March 31, |
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March 31, |
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2009 |
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2008 |
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Net income |
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$ |
19,959 |
|
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$ |
20,717 |
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Foreign currency translation adjustment, net of tax * |
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(174 |
) |
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37 |
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Decrease in unrealized appreciation of investments, net of income
tax effect of ($150,121) and ($23,539) |
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(276,995 |
) |
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(43,597 |
) |
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Comprehensive income (loss) |
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$ |
(257,210 |
) |
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$ |
(22,843 |
) |
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* |
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Represents gains and losses from translating the financial statements of the furniture rental
segments foreign-based operations, acquired in January of 2008,
from the local currency to U.S. dollars. |
Note 4. Fair value measurements
Following is a summary of Wescos financial instruments measured at fair value as of March 31,
2009 on a recurring basis by the type of inputs applicable to fair value measurement.
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Total Fair |
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Fair Value Measurements Using |
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Value |
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(Level 1) |
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(Level 2) |
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(Level 3) |
Investments in fixed maturity securities |
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$ |
32,494 |
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$ |
|
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$ |
32,494 |
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$ |
$-- |
|
Investments in equity securities |
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1,440,739 |
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|
1,203,162 |
|
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237,577 |
|
Level 1 inputs represent unadjusted quoted prices in active markets for identical assets.
Level 2 inputs represent observable inputs other than Level 1 prices, such as quoted prices for
similar assets or liabilities or quoted prices in markets that are not active. Fair values for
Wescos investments in fixed maturity securities are based primarily on market prices and market
data available for instruments with similar characteristics since there are not active markets for
many of the Companys investments.
Level 3 inputs include unobservable inputs used in the measurement of assets. Measurement of the
fair values of the non-exchange traded investments are based on a standard warrant valuation model
or a discounted cash flow model, as applicable, which are techniques believed to be widely used by
other market participants. Significant assumptions inherent in the warrant valuation model include
an estimated stock price volatility factor, dividend and interest rate assumptions, and the
estimated term of the warrants. Significant assumptions used in a discounted cash flow model
include the discount rate and the estimated duration of the instrument. There have been no
significant changes in the valuation techniques used at the end of the current period from those
used at yearend 2008.
Dollar amounts in thousands, except for amounts per share
-8-
Following is a summary of Wescos assets and liabilities measured at fair value, with the use
of significant unobservable inputs (Level 3):
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|
Investments |
|
|
|
In equity |
|
|
|
securities |
|
Balance as of December 31, 2008 |
|
$ |
209,510 |
|
Unrealized gains included in other comprehensive income |
|
|
28,067 |
|
Purchases |
|
|
|
|
|
|
|
|
Balance as of March 31, 2009 |
|
$ |
237,577 |
|
|
|
|
|
Note 5. Goodwill
Goodwill of acquired businesses represents the excess of the cost of acquired entities over
the fair values assigned to their assets acquired and liabilities assumed. All goodwill acquired is
assigned to the reporting unit that the related assets are employed in and the liabilities relate
to, as it is believed that those reporting units benefit from the acquisition. The Company accounts
for goodwill in accordance with Statement of Financial Accounting Standards (SFAS) No. 142,
Goodwill and Other Intangible Assets, which requires a test for impairment annually or if an
event occurs or circumstances change that would more likely than not reduce the fair value of a
reporting unit below its carrying amount. The impairment test is performed in two phases. The first
step compares the carrying value of the reporting unit, including goodwill, to its estimated fair
value. If the carrying value is greater than the estimated fair value of the unit, a second step is
required, comparing the implied fair value of the reporting units goodwill with the carrying
amount of that goodwill. An impairment loss, charged to earnings, is recorded to the extent that
the carrying amount of goodwill exceeds its implied fair value.
The Company determines the fair value of its furniture rental unit using the income approach.
Under the income approach, the Company estimates the fair value of the reporting unit based on the
present value of its estimated future earnings. This approach incorporates a number of significant
estimates and assumptions that include: a forecast of the reporting units future operating
results, estimated growth rates, future terminal value, and an appropriate discount rate. In
projecting future earnings, the Company considers the current economic environment as well as
historical results of the unit. The Company believes that the income approach is the most
meaningful valuation technique for the furniture rental business, as CORT is the only national
company that operates in the rent-to-rent furniture industry, thus making market-based and
transaction-based valuation techniques less meaningful.
The Company performed its annual impairment tests in the fourth quarter of 2008 and concluded
that there was no impairment for any of its reporting units because the fair values exceeded the
book carrying values. In connection with the preparation of its consolidated financial statements
for the first quarter of 2009, the Company reviewed the conclusions reached in connection with its
impairment testing as of yearend 2008 and noted that no events had occurred, nor had circumstances
changed subsequent to yearend that would more likely than not reduce the fair value of its
reporting units below their carrying amounts.
Dollar amounts in thousands, except for amounts per share
-9-
The economic recession and crises affecting financial institutions which became evident in
2008 continued through the first quarter of 2009. The length and magnitude of the recession and
whether it will have a long-term positive or negative impact on the Companys reporting units
cannot be reasonably predicted. There can be no assurance that the Companys estimates and
assumptions regarding future operating results made for purposes of the goodwill impairment testing
will prove to be accurate predictions of the future. If the current recession has an adverse impact
on the long term economic value of the reporting units, the Company may be required to record goodwill impairment losses in future periods. Currently, it is not possible to
determine if any such future impairment losses would result or if such losses would be material.
Note 6. Environmental matters
Wescos Precision Steel subsidiary and one of its subsidiaries are parties to an environmental
matter in the state of Illinois, the ultimate outcome of which is not expected to be material.
Note 7. Business segment data
Following is condensed consolidated financial information for Wesco, by business segment:
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
March 31, |
|
|
March 31, |
|
|
|
2009 |
|
|
2008 |
|
Insurance segment: |
|
|
|
|
|
|
|
|
Revenues |
|
$ |
98,321 |
|
|
$ |
45,417 |
|
Net income |
|
|
21,265 |
|
|
|
17,032 |
|
Goodwill of acquired businesses |
|
|
26,991 |
|
|
|
26,991 |
|
Assets at end of period |
|
|
2,056,897 |
|
|
|
2,517,766 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Furniture rental segment: |
|
|
|
|
|
|
|
|
Revenues |
|
$ |
101,194 |
|
|
$ |
97,780 |
|
Net income (loss) |
|
|
(956 |
) |
|
|
3,533 |
|
Goodwill of acquired businesses |
|
|
250,804 |
|
|
|
239,616 |
|
Assets at end of period |
|
|
544,423 |
|
|
|
254,214 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Industrial segment: |
|
|
|
|
|
|
|
|
Revenues |
|
$ |
10,010 |
|
|
$ |
15,684 |
|
Net income (loss) |
|
|
(388 |
) |
|
|
296 |
|
Assets at end of period |
|
|
21,817 |
|
|
|
21,020 |
|
|
|
|
|
|
|
|
Dollar amounts in thousands, except for amounts per share
-10-
Other items unrelated to business segments:
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
March 31, |
|
|
March 31, |
|
|
|
2009 |
|
|
2008 |
|
Revenues |
|
$ |
1,277 |
|
|
$ |
1,315 |
|
Net income (loss) |
|
|
38 |
|
|
|
(144 |
) |
Assets at end of period |
|
|
95,549 |
|
|
|
88,601 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consolidated totals: |
|
|
|
|
|
|
|
|
Revenues |
|
$ |
210,802 |
|
|
$ |
160,196 |
|
Net income |
|
|
19,959 |
|
|
|
20,717 |
|
Goodwill of acquired businesses |
|
|
277,795 |
|
|
|
266,607 |
|
Assets at end of period |
|
|
2,718,686 |
|
|
|
3,150,134 |
|
|
|
|
|
|
|
|
Dollar amounts in thousands, except for amounts per share
-11-
WESCO FINANCIAL CORPORATION
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Reference is made to Item 7, Managements Discussion and Analysis of Financial Condition and
Results of Operations appearing on pages 22 through 39 of the Form 10-K Annual Report filed by
Wesco Financial Corporation (Wesco) for the year 2008 (Wescos 2008 10-K) for information deemed
generally appropriate to an understanding of the accompanying condensed consolidated financial
statements. The information set forth in the following paragraphs updates such discussion.
Further, in reviewing the following paragraphs, attention is directed to the accompanying unaudited
condensed consolidated financial statements.
OVERVIEW
Financial Condition
Wescos consolidated balance sheet reflects significant liquidity and a strong capital base,
with relatively little debt. A large amount of liquidity and capital is maintained in the insurance
subsidiaries for strategic purposes and in support of reserves for unpaid losses.
Results of Operations
Wescos consolidated net income for the first quarter of 2009 was $20.0 million, versus $20.7
million for the first quarter of 2008. The decrease in consolidated earnings resulted mainly from
(1) weaknesses in CORTs furniture rental business and Precision Steels business due to
significantly to the recessionary economic environment, and (2) increases in CORTs operating
expenses attributable principally to an acquisition made in the fourth quarter of 2008,
significantly offset by (3) improved underwriting results and investment income of Wesco-Financial
Insurance Companys insurance businesses.
FINANCIAL CONDITION
Wesco continues to have a strong consolidated balance sheet, with high liquidity and
relatively little debt. Consolidated cash and cash equivalents, held principally by Wescos
insurance businesses, amounted to $314 million at March 31, 2009, and $298 million at December 31,
2008.
Wescos liability for unpaid losses and loss adjustment expenses at March 31, 2009 totaled
$246.8 million versus $215.3 million at December 31, 2008. The increase related mainly to the
retrocession agreement with Berkshire Hathaways National Indemnity Company (NICO) subsidiary, to
assume 10% of NICOs quota share reinsurance of Swiss Reinsurance Company and its major
property-casualty affiliates (Swiss Re) described in Item 1, Business, appearing on page 11 of
Wescos Annual Report on Form 10K for the year ended December 31, 2008.
Wescos consolidated borrowings totaled $43.2 million at March 31, 2009 versus $40.4 million
at December 31, 2008. The borrowings relate principally to a revolving credit facility used in the
furniture rental business. In addition to the recorded debt, the liability for unpaid losses and
loss adjustment expenses of Wescos insurance businesses totaled $246.8 million at March 31, 2009,
versus $215.3 million at December 31, 2008. Wesco and its subsidiaries have operating lease and
other contractual obligations which, at March 31, 2009, were essentially unchanged from the $142.2
million included in the table of off-balance sheet arrangements and contractual obligations
appearing on page 32 of Wescos Form 10-K Annual Report for the year ended December 31, 2008.
The declines in global economic activity over the last half of 2008 (and in the fourth quarter
in particular) continued through the first quarter of 2009. Wescos operating results for the first
quarter reflect those declines. Prices for equity securities also experienced significant declines
over the first quarter of 2009, which negatively impacted the fair value of Wescos equity
investments (particularly in financial institutions).
-12-
Wescos shareholders equity at March 31, 2009 was $2.1 billion ($297.44 per share), down $260
million from the $2.4 billion reported at December 31, 2008 ($333.96 per share). Wesco carries its
investments on its consolidated balance sheet at fair value, with net unrealized appreciation or
depreciation included as a component of shareholders equity, net of deferred taxes, without being
reflected in earnings. The decrease in shareholders equity for the period reflected the decline in
fair values of Wescos investments for the quarter, from a position of net unrealized appreciation
of $154.7 million at yearend 2008 to a position of net unrealized depreciation of $122.3 million at
March 31, 2009. Because unrealized appreciation or depreciation is recorded based upon market
quotations and, in some cases, upon other inputs that are affected by economic and market
conditions as of the balance sheet date, gains or losses ultimately realized upon sale of investments could differ substantially from unrealized
appreciation or depreciation recorded at the balance sheet.
In response to the crises in the financial and capital markets and global recession, the U.S.
and other governments around the world are taking measures to stabilize financial institutions,
regulate markets and stimulate economic activity. While management hopes such actions will prove
successful, the potential impact on Wesco is not clear at this time. It is expected that the
current economic conditions will persist at least through 2009 before meaningful improvements
become evident. Wescos subsidiaries have taken and will continue to take cost-reduction actions to
manage through the current economic situation. Management believes that the economic franchises of
Wescos business operations remain intact and that operating results will ultimately return to more
normal historical levels, although it cannot predict the timing of a recovery.
RESULTS OF OPERATIONS
Wescos reportable business segments are organized in a manner that reflects how Wescos
senior management views those business activities. Wescos management views insurance businesses as
possessing two distinct operations underwriting and investing, and believes that underwriting
gain or loss is an important measure of their financial performance. Underwriting gain or loss
represents the simple arithmetic difference between the following line items appearing on the
consolidated statement of income: (1) insurance premiums earned, less (2) insurance losses and loss
adjustment expenses, and insurance underwriting expenses. Managements goal is to generate
underwriting gains over the long term. Underwriting results are evaluated without allocation of
investment income.
The condensed consolidated income statement appearing on page 5 has been prepared in
accordance with generally accepted accounting principles in the United States of America (GAAP).
Revenues, including realized net investment gains, if any, are followed by costs and expenses, and
a provision for income taxes, to arrive at net income. The following summary sets forth the
after-tax contribution to GAAP net income of each business segment insurance, furniture rental
and industrial as well as activities not considered related to such segments. Realized net
investment gains, if any, are excluded from segment activities, consistent with the way Wescos
management views the business operations. (Amounts are in thousands, all after income tax effect.)
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
March 31, |
|
|
March 31, |
|
|
|
2009 |
|
|
2008 |
|
Insurance segment: |
|
|
|
|
|
|
|
|
Underwriting |
|
$ |
5,049 |
|
|
$ |
1,711 |
|
Investment income |
|
|
16,216 |
|
|
|
15,321 |
|
Furniture rental segment |
|
|
(956 |
) |
|
|
3,533 |
|
Industrial segment |
|
|
(388 |
) |
|
|
296 |
|
Other |
|
|
38 |
|
|
|
(144 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consolidated net income |
|
$ |
19,959 |
|
|
$ |
20,717 |
|
|
|
|
|
|
|
|
-13-
Insurance Segment
The insurance segment comprises Wesco-Financial Insurance Company (Wes-FIC) and The Kansas
Bankers Surety Company (KBS). Their operations are conducted or supervised by wholly owned
subsidiaries of Berkshire Hathaway Inc. (Berkshire), Wescos ultimate parent company. Following
is a summary of the results of segment operations, which represents the combination of underwriting
results with dividend and interest income. (Amounts are in thousands.)
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
March 31, |
|
|
March 31, |
|
|
|
2009 |
|
|
2008 |
|
Insurance premiums written: |
|
|
|
|
|
|
|
|
Reinsurance |
|
$ |
124,950 |
|
|
$ |
81,179 |
|
Primary |
|
|
2,812 |
|
|
|
5,926 |
|
|
|
|
|
|
|
|
Total |
|
$ |
127,762 |
|
|
$ |
87,105 |
|
|
|
|
|
|
|
|
Insurance premiums earned: |
|
|
|
|
|
|
|
|
Reinsurance |
|
$ |
75,584 |
|
|
$ |
21,409 |
|
Primary |
|
|
3,713 |
|
|
|
4,971 |
|
|
|
|
|
|
|
|
Total |
|
|
79,297 |
|
|
|
26,380 |
|
|
|
|
|
|
|
|
Insurance losses, loss adjustment expenses and underwriting
expenses |
|
|
71,530 |
|
|
|
23,747 |
|
Underwriting gain, before income taxes: |
|
|
|
|
|
|
|
|
Reinsurance |
|
|
7,638 |
|
|
|
52 |
|
Primary |
|
|
129 |
|
|
|
2,581 |
|
|
|
|
|
|
|
|
Total |
|
|
7,767 |
|
|
|
2,633 |
|
Income taxes |
|
|
2,718 |
|
|
|
922 |
|
|
|
|
|
|
|
|
Underwriting gain, after taxes |
|
$ |
5,049 |
|
|
$ |
1,711 |
|
|
|
|
|
|
|
|
At March 31, 2009, in-force reinsurance business consisted of the participation in two
distinctive arrangements with wholly owned subsidiaries of Berkshire. The first is a quota-share
retrocession agreement with NICO to assume 2% part of NICOs 20% quota share reinsurance of Swiss
Re incepting over the five-year period which began January 1, 2008, on the same terms as NICOs
agreement with Swiss Re (the Swiss Re contract). The second is Wes-FICs participation, since
2001, in aviation-related risks (hull, liability and workers compensation) through aviation
insurance pools, whose underwriting and claims are managed by United States Aviation Underwriters,
Inc. (the aviation business).
Contractual delays in reporting, and limitations in details reported, by the ceding companies
necessitate that estimates be made of reinsurance premiums written and earned, as well as
reinsurance losses and expenses. Under the Swiss Re contract, for example, estimates of premiums,
claims and expenses are generally reported 45 days after the end of each quarterly period.
Estimates are therefore made each reporting period by management for the activity not yet reported.
Such estimates are developed by NICO based on information publicly available and adjusted for the
impact of its, as well as Wes-FICs managements, assessments of prevailing market conditions and
other factors with respect to the underlying reinsured business. The relative importance of the
Swiss Re contract to Wescos results of operations causes those results to be particularly
sensitive to this estimation process. However, increases or decreases
in premiums earned as a result of the estimation process related to the reporting lag will
typically be substantially offset by related increases or decreases in claim and expense estimates.
Periodic underwriting results can also be affected significantly by changes in estimates for unpaid
losses and loss adjustment expenses, including amounts established for occurrences in prior years.
-14-
Written reinsurance premiums for the first quarter of 2009 increased by $43.8 million (53.9%)
over the corresponding 2008 figure. $42.8 million of that increase related to the Swiss Re contract
and was attributable to the following factors: Wes-FICs managements estimate of written premium
volume under the contract for the first quarter of 2008 was based entirely on published, publicly
available, data for Swiss Re for periods prior to 2008. When Swiss Re reported its actual first
quarter data at a later date, Wes-FIC learned that a disproportionately large amount of Swiss Res
annual premiums are written in the first quarter. Thus, by 2009, management had gained a years
worth of knowledge under the Swiss Re contract, causing it to increase its estimate to a higher
amount of written premium volume for the first quarter of 2009. The increase in written premiums
under the Swiss Re contract also reflects the emergence of a pattern of growth in Swiss Re
premiums, to which has been added a factor reflecting Swiss Res published projection of additional
premium growth for the first quarter of 2009, offset to the extent of 6% in recognition of the
strengthening of the U.S. Dollar relative to the foreign currencies in which Swiss Re does a
significant portion of its business. Written aviation-related premiums increased by $0.9 million
(12.9%) for the first quarter of 2009 as compared with premiums written for the corresponding 2008
quarter. At the direction of the pool members, including Wes-FIC, the aviation pool manager
purchased less hull and liability reinsurance in the first quarter of 2009 than in 2008, and
workers compensation premium volume increased by $0.3 million for the current quarter over volume
for the 2008 quarter.
Earned premiums under the Swiss Re contract were $66.5 million for the first quarter of 2009,
versus $13.9 million for the first quarter of 2008, representing an increase of $52.6 million
(379.3%) for the 2009 quarter. Earned premiums for a fiscal quarter typically include two
components: (1) amortization of the portion of that quarters written premiums relating to the
insurance coverages provided customers during the period, and (2) amortization of unearned premiums
on the balance sheet at the beginning of that quarter, relating to the coverages provided during
the quarter. Because the contract incepted as of the beginning of 2008, there were no unearned
premiums at inception to be amortized into earned revenues for first quarter of 2008. By yearend,
however, Wes-FIC had accumulated $82.1 million of unearned premiums, a portion of which were
amortized into earned revenues during the 2009 quarter. Earned premiums under the aviation-related
contracts for the first quarter of 2009 increased by $1.6 million (20.6%), over those of the 2008
quarter. The principal factors involved were the purchase of less hull and liability reinsurance
and the increase in workers compensation premium volume noted above.
Written primary insurance premiums for the first quarter of 2009 decreased by $3.1 million
(52.6%) from those of the first quarter of 2008. Earned primary insurance premiums decreased by
$1.3 million (25.3%). The decreases were attributable principally to KBSs decision late in 2008 to
discontinue its line of bank deposit guarantee bonds, which insure deposits above FDIC limits for
specific customers of mainly Midwestern banks, and which represented approximately half of its
premium volume for 2008. Wesco reported in its Quarterly Report on Form 10-Q for the quarter ended
September 30, 2008, that recent events in the banking industry, including a number of bank
failures, had caused management to become less confident in the long-term profitability of this
line of business. In September 2008, KBS notified its customers of its decision to exit this line
of insurance as rapidly as feasible and stopped renewing bond coverages. In mid-November 2008, it
began to issue 90-day notices of non-voluntary bond cancellation. As a result, the aggregate face
amount of outstanding bonds has been reduced, from $9.7 billion at September 30, 2008, when 1,671
separate institutions were insured, to $2.3 billion, insuring 576 institutions, at March
31, 2009. KBS anticipates that outstanding deposit guaranty bonds will decline to $1.1 billion,
insuring 282 banks, by June 30, 2009; $100 million, insuring 34 banks, by September 30, 2009; $50
million, insuring 21 banks by December 31, 2009; $11 million deposited in 3 banks, by June 30,
2010; and zero, in July 2011.
-15-
KBS management maintains familiarity with its customers and endeavors to avoid insuring
deposits of banks deemed to present unacceptable risks. In order to limit exposure to loss from
deposit guarantee bonds, KBS management regularly updates its list ranking the banks it believes to
be the 250 weakest based on data obtained from quarterly financial Call reports filed by all
domestic banks with their banking regulators. Data by which banks are rated includes, capital to
asset ratio, brokered deposits, loan to deposit ratio, loans to insiders, loan delinquencies and
non-accruing loans. Procedures followed by KBS management with respect to customer banks whose
names are on the list might include the issuance of 90-day notices of non-voluntary cancellation.
As of March 31, 2009, of the 576 banks for which deposit guarantee bonds were outstanding, six
banks, whose outstanding deposit guarantee bonds aggregated $8.2 million, were included on KBSs
list. Two of those banks were believed to have adequate capital and liquidity to pose little danger
of failure before their $1.6 million of outstanding deposit guarantee bonds expire in July and
August, 2009. With regard to each of the other four weak banks, KBS had issued 90-day notices of
non-voluntary cancellation prior to March 31, 2009; however, one of those banks, with respect to
which KBS had $3.0 million of outstanding deposit guarantee bonds, failed early in April. The loss,
which amounted to $2.0 million, after taxes, will be reflected in underwriting results for the
second quarter of 2009. KBS management believes that few of the institutions for which deposit
guarantee bonds are outstanding, whose names are not included on its list of the weaker banks, are
facing a significant risk of failure, and through policy limits and reinsurance, KBS has
effectively limited its exposure per bank (or group of affiliated banks) to $7.6 million, after
taxes.
In previous reports on Forms 10-K and 10-Q that some portion of deposit guarantee losses KBS
has incurred may eventually be recovered as the FDIC liquidates each failed banks assets and
distributes funds to the banks creditors and owners of deposits in excess of FDIC insurance
limits, including KBS (by right of subrogation). Early in the second quarter of 2009 KBS received
$0.5 million in partial recovery of the loss of $4.7 million sustained in the third quarter of
2008. Additional recoveries, if any, with regard to that loss or others, will be recorded when
received. As noted above, KBS has stopped writing coverage for excess bank deposits and is taking
steps to lessen its exposure to losses from bank failures as rapidly as feasible.
Management believes that underwriting gain or loss is an important measure of the financial
performance of an insurance company. Underwriting results of Wescos insurance segment fluctuate
from period to period and have generally been favorable. Underwriting results, before taxes,
benefited by $6.0 million under the Swiss Re contract for the first quarter of 2009. For the first
quarter of 2008 there was a pre-tax underwriting loss of $0.3 million under the contract. The
improvement for the 2009 period was attributable to an adjustment recorded during the quarter to
reflect more favorable 2008 underwriting results reported by Swiss Re than the figure Wes-FIC
management had previously estimated. Underwriting gains under the aviation-related contracts were
$1.7 million and $0.4 million for the first quarters of 2009 and 2008. The frequency and severity
of aviation-related losses tend to be volatile, especially with respect to incurred losses during a
single quarterly reporting period.
The profitability of any reinsurance or insurance arrangement is best assessed after all
losses and expenses have been realized, perhaps many years after the coverage period, rather than
for any given reporting period.
-16-
Following is a summary of investment income produced by Wescos insurance segment (in
thousands of dollars).
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
March 31, |
|
|
March 31, |
|
|
|
2009 |
|
|
2008 |
|
Investment income, before taxes |
|
$ |
19,024 |
|
|
$ |
19,034 |
|
Income taxes |
|
|
2,808 |
|
|
|
3,713 |
|
|
|
|
|
|
|
|
Investment income, after taxes |
|
$ |
16,216 |
|
|
$ |
15,321 |
|
|
|
|
|
|
|
|
Investment income of the insurance segment comprises dividends and interest earned principally
from the investment of shareholder capital (including reinvested earnings) as well as float
(principally, premiums received before payment of related claims and expenses). In 2008 Wesco
invested $205 million, at cost, in shares of newly issued 10% cumulative perpetual preferred stock
of The Goldman Sachs Group, Inc. The amount had previously been invested principally in
cash-equivalent investments with respect to which interest rates have been declining for more than
one year. For the first quarter of 2009, dividend income increased by $4.3 million, and interest
income decreased, as compared with the corresponding amounts earned for the first quarter of 2008.
The income tax provisions, expressed as percentages of pre-tax investment income, shown in the
foregoing table, amounted to 14.8% and 19.5% for the first quarters of 2009 and 2008. These
fluctuations reflect the relation of dividend income, which is substantially exempt from income
taxes, to interest income, which is fully taxable.
Management continues to seek to invest in the purchase of businesses and in long-term equity
holdings.
Furniture Rental Segment
The furniture rental segment consists of CORT Business Services Corporation (CORT).
Following is a summary of segment operating results. (Amounts are in thousands.)
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
March 31, |
|
|
March 31, |
|
|
|
2009 |
|
|
2008 |
|
Revenues: |
|
|
|
|
|
|
|
|
Furniture rentals |
|
$ |
82,699 |
|
|
$ |
80,716 |
|
Furniture sales |
|
|
17,146 |
|
|
|
15,623 |
|
Service fees |
|
|
1,349 |
|
|
|
1,441 |
|
|
|
|
|
|
|
|
Total revenues |
|
|
101,194 |
|
|
|
97,780 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of rentals, sales and fees |
|
|
26,759 |
|
|
|
22,644 |
|
Selling, general and administrative expenses |
|
|
75,881 |
|
|
|
68,835 |
|
Interest expense |
|
|
255 |
|
|
|
527 |
|
|
|
|
|
|
|
|
|
|
|
102,895 |
|
|
|
92,006 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before income taxes |
|
|
(1,701 |
) |
|
|
5,774 |
|
Income taxes |
|
|
(745 |
) |
|
|
2,241 |
|
|
|
|
|
|
|
|
Segment net income (loss) |
|
$ |
(956 |
) |
|
$ |
3,533 |
|
|
|
|
|
|
|
|
-17-
Furniture rental revenues for the first quarter of 2009 increased $2.0 million (2.5%) from
those of the first quarter of 2008. Excluding $20.8 million and $13.4 million of rental revenues
from trade shows and locations not in operation throughout each quarter, rental revenues for the
first quarter of 2009 decreased 9.8% from those of the 2008 quarter. The number of furniture leases
outstanding at the end of the first quarter of 2009, excluding leases acquired from Aaron Rents,
Inc., in November 2008, declined 12.1% from the number outstanding at the end of the first quarter
of 2008. This downward trend that started late in 2006 has been exacerbated by the current
economic recession. Traditionally, growth in furniture rental revenues is closely tied to periods
of economic expansion, but in this prolonged period of economic contraction, CORTs furniture
rental revenue growth has resulted principally from strategic acquisitions and price increases.
Furniture sales revenues increased 9.8% for the first quarter of 2009 from those reported for
the year ago period. The increase in sales revenues is primarily due to the addition of twenty new
retail showrooms over the year ago period, due mainly for the Aaron Rents acquisition. The sales
revenues increase represents a higher volume of furniture sold at lower average prices in an effort
to control inventory. In the current recessionary period, management expects that gross profit
margins on furniture sales will be somewhat lower than in periods of economic growth due to the
necessity to aggressively manage rental inventory levels in the face of lower customer demand.
Service fees for the first quarter of 2009 were essentially unchanged from those reported for
the first quarter of 2008. Despite the significant investment made by CORT in recent years, towards
the expansion and marketing of its relocation services, initially marketed to individual
residential customers and more recently to corporate relocation customers, service fee revenues
remain disappointing. In light of the current economic environment, management is focusing its
efforts on leveraging CORTs existing investment in rental relocation services to drive
higher-margin furniture rental revenues.
Cost of rentals, sales and fees amounted to 26.4% of revenues for the first quarter of 2009
versus 23.2% for the comparable 2008 period. The increase in costs as a percentage of revenue was
primarily due to an increase in depreciation expense on rental furniture acquired from Aaron Rents
in November 2008 and a significant decrease in profit margin on furniture sales.
Selling, general, administrative and interest expenses (operating expenses) for the segment
were $76.1 million for the first quarter of 2009, up $6.8 million (9.8%) from the $69.4 million
incurred in the first quarter of 2008. The increase in operating expenses was due principally to
the incremental costs associated with the November 2008 business acquisition, primarily
employee-related costs and $3.5 million in non-recurring amortization expense relating to the value
assigned to rental contracts acquired. Management is aggressively seeking to reduce operating
expenses.
The furniture rental segment generated a loss of $1.7 million, before taxes ($1.0 million,
after taxes), in the first quarter of 2009, versus income of $5.8 million, before taxes ($3.5
million, after taxes), in the first quarter of 2008, as explained above.
-18-
Industrial Segment
Following is a summary of the results of operations of the industrial segment, which consists
of the businesses of Precision Steel Warehouse, Inc. and its subsidiaries. (Amounts are in
thousands.)
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
March 31, |
|
|
March 31, |
|
|
|
2009 |
|
|
2008 |
|
Revenues |
|
$ |
10,010 |
|
|
$ |
15,684 |
|
|
|
|
|
|
|
|
Cost of sales and services |
|
|
8,779 |
|
|
|
13,123 |
|
Selling, general and administrative expenses |
|
|
1,873 |
|
|
|
2,067 |
|
|
|
|
|
|
|
|
|
|
|
10,652 |
|
|
|
15,190 |
|
|
|
|
|
|
|
|
Income (loss) before income taxes |
|
|
(642 |
) |
|
|
494 |
|
Income taxes |
|
|
(254 |
) |
|
|
198 |
|
|
|
|
|
|
|
|
Segment net income (loss) |
|
$ |
(388 |
) |
|
$ |
296 |
|
|
|
|
|
|
|
|
Reference is made to pages 30 and 31 of Wescos 2008 Annual Report on Form 10-K for
information about Wescos industrial segment, including the challenges affecting the domestic steel
service industry for a number of years, exacerbated in 2008 by the deepening recession.
Industrial segment has been affected by the ongoing recession since the latter half of 2008,
and by the periods of heightened competitive pressures. Revenues for the first quarter of 2009
decreased $5.7 million (36.2%) from those of the first quarter of 2008. Sales, in terms of pounds,
fell by 4.9 million pounds (45.4%) from the volume of the corresponding 2008 period.
The industrial segment operates on a low gross profit margin (revenues, less cost of products
and services). The segments business activities also require a base of operations supported by
significant fixed operating costs. The period-to-period decreases in the industrial segments
pre-tax and net income resulted from the decline in gross profit, despite managements ongoing
efforts to trim expenses aggressively during this recessionary period.
* * * * *
OFF-BALANCE SHEET ARRANGEMENTS AND CONTRACTUAL OBLIGATIONS
Reference is made to page 32, in Item 7, Managements Discussion and Analysis of Financial
Condition and Results of Operations, of the Form 10-K Annual Report filed by Wesco for the year
ended December 31, 2008, for a table summarizing the contractual obligations associated with
ongoing business activities of Wesco and its subsidiaries, some of which are off-balance sheet, and
involve cash payments in periods after year end 2008. At March 31, 2009, there have been no
material changes in contractual obligations, including off-balance sheet arrangements, of Wesco or
its subsidiaries from those reported as of December 31, 2008.
CRITICAL ACCOUNTING POLICIES AND PRACTICES
Reference is made to pages 32 to 36, in Item 7, Managements Discussion and Analysis of
Financial Condition and Results of Operations, of the Form 10-K Annual Report filed by Wesco for
the year ended December 31, 2008 for the accounting policies and practices considered by Wescos
management to be critical to its determination of consolidated financial position and results of
operations, as well as to Note 1 to Wescos consolidated financial statements appearing on pages 48
through 52 thereof for a description of the significant policies and practices followed by Wesco
(including those deemed critical) in preparing its consolidated financial statements. There have
been no changes in significant policies and practices through
-19-
March 31, 2009, except as described
in Note 1 to the accompanying condensed consolidated financial statements.
In applying certain accounting policies, Wescos management is required to make estimates and
judgments regarding transactions that have occurred and ultimately will be settled several years in
the future. Amounts recognized in the consolidated financial statements from such estimates are
necessarily based on assumptions about numerous factors involving varying, and possibly
significant, degrees of judgment and uncertainty. Accordingly, the amounts currently recorded in
the financial statements may prove, with the benefit of hindsight, to be inaccurate.
Information concerning recently issued accounting pronouncements which are not yet effective
is included in Note 1 to the accompanying condensed consolidated financial statements. Wesco does
not currently expect any of the recently issued accounting pronouncements to have a material effect
on its financial condition.
FORWARD-LOOKING STATEMENTS
Certain written or oral representations of management stated in this annual report or
elsewhere constitute forward-looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995, as contrasted with statements of historical fact. Forward-looking
statements include statements which are predictive in nature, or which depend upon or refer to
future events or conditions, or which include words such as expects, anticipates, intends, plans,
believes, estimates, may, or could, or which involve hypothetical events. Forward-looking
statements are based on information currently available and are subject to various risks and
uncertainties that could cause actual events or results to differ materially from those
characterized as being likely or possible to occur. Such statements should be considered judgments
only, not guarantees, and Wescos management assumes no duty, nor has it any specific intention, to
update them.
Actual events and results may differ materially from those expressed or forecasted in
forward-looking statements due to a number of factors. The principal important risk factors that
could cause Wescos actual performance and future events and actions to differ materially from
those expressed in or implied by such forward-looking statements include, but are not limited to
those risks reported in Item 1A, Risk Factors of the Form 10-K Annual Report filed by Wesco for the
year ended December 31, 2008, but also to the occurrence of one or more catastrophic events such as
acts of terrorism, hurricanes, or other events that cause losses insured by Wescos insurance
subsidiaries, changes in insurance laws or regulations, changes in income tax laws or regulations,
and changes in general economic and market factors that affect the prices of investment securities
or the industries in which Wesco and its affiliates do business.
-20-
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.
|
|
|
|
|
|
WESCO FINANCIAL CORPORATION
|
|
Date: May 7, 2009 |
By: |
/s/ Jeffrey L. Jacobson
|
|
|
|
Jeffrey L. Jacobson |
|
|
|
Vice President and
Chief Financial Officer
(principal financial officer) |
|
-21-