**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C.  20549**

 

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**FORM 10-Q**

 
|                                                                                                                                                          | **(Mark One)** |   |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------|----------------|--------|
| **ý****   QUARTERLY REPORT PURSUANT TO  SECTION 13 OR 15(d)  OF THE SECURITIES EXCHANGE ACT OF 1934**                                     |
|                                                                                                                                                          |
| **For the Quarterly Period Ended June 30, 2003**                                                                                                              |
|                                                                                                                                                          |
| **OR**                                                                                                                                                        |
|                                                                                                                                                          |
| **o****   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 0-23181**                                                                                                                       |

 

**PAULA FINANCIAL**

(Exact name of registrant as specified in its charter)

 

| **Delaware**                                                             |   | **95-4640368**                           |
|--------------------------------------------------------------------------|--------|------------------------------------------|
| (State or other jurisdiction of  incorporation or organization)          |   | (I.R.S. Employer  identification number) |
|                                                                     |   |                                     |
| **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 whetherthe registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.

 

Yes  ý   No  o

 

Indicate the number of sharesoutstanding of each of the issuer’s classes of common stock, as of the latest practicabledate.  Number of shares of Common Stock,$.01 par value, outstanding as of close of business on July 31, 2002: 6,239,879shares.

 

 

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PAULA FINANCIAL

INDEX TO FORM 10-Q

 
| PART I. FINANCIAL INFORMATION                                                                                           |
|-------------------------------------------------------------------------------------------------------------------------|
|                                                                                                                    |
| Item 1.  Financial Statements                                                                                      |
|                                                                                                                    |
| Condensed consolidated balance sheets as of  June 30, 2003 and December 31, 2002 (unaudited)                            |
|                                                                                                                    |
| Condensed consolidated statements of income  for the three and six months ended June 30, 2003 and 2002 (unaudited)      |
|                                                                                                                    |
| Condensed consolidated statements of cash  flows for the six months ended June 30, 2003 and 2002 (unaudited)            |
|                                                                                                                    |
| Notes to condensed consolidated financial  statements for the three and six months ended June 30, 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 Risk                                               |
|                                                                                                                    |
| Item 4.   Controls and Procedures                                                                                  |
|                                                                                                                    |
| PART II. OTHER INFORMATION                                                                                              |
|                                                                                                                    |
| Item  5.  Submission of Matters to a Vote of  Security Holders                                                     |
|                                                                                                                    |
| Item  6.  Exhibits and Reports on Form 8-K                                                                         |
|                                                                                                                    |
| SIGNATURE                                                                                                               |

 

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**PARTI****                  FINANCIALINFORMATION**

Item 1.                    Financial Statements

 

**PAULA FINANCIAL ANDSUBSIDIARIES**

**CondensedConsolidated Balance Sheets**

(In thousands, except share data)

 
|                                                                                                   |   | **June 30,  2003** |     | **December  31,  2002** |     |
|--------------------------------------------------------------------------------------------------------|--------|--------------------|----------|-------------------------|----------|
|                                                                                                   |   | **(Unaudited)**    |     | **(*)**                 |     |
| ***Assets***                                                                                           |   |               | * * |                    |     |
| *Current Assets:*                                                                                      |   |               | * * |                    |     |
| Cash (restricted: 2003, $1,818; 2002, $851)                                                            |   | $                  | 2,781    |                    | $        | 1,290 | * * |
| Accounts receivable, net of allowance for  uncollectible accounts (2003, $80; 2002, $140)              |   | 2,557              |     | 875                     | * * |
| Commissions receivable                                                                                 |   | 1,030              |     | 1,284                   | * * |
| Income tax receivable                                                                                  |   | —             |     | 141                     | * * |
| Other receivables                                                                                      |   | 15                 |     | 92                      | * * |
| Deferred income taxes                                                                                  |   | 1,369              |     | 1,274                   | * * |
| Other assets                                                                                           |   | 379                |     | 262                     | * * |
|                                                                                                   |   | 8,131              |     | $                       | 5,218    | * * |
| *Non-Current Assets:*                                                                                  |   |               |     |                    | * * |
| Property and equipment, net                                                                            |   | 251                |     | 266                     | * * |
| Investment in related party                                                                            |   | 703                |     | 703                     | * * |
| Goodwill                                                                                               |   | 2,180              |     | 1,452                   | * * |
| Other amortizable intangible assets, net                                                               |   | 2,420              |     | 1,194                   | * * |
| Deferred income taxes                                                                                  |   | 5,047              |     | 5,368                   | * * |
| Other assets                                                                                           |   | 172                |     | 99                      | * * |
|                                                                                                   |   | $                  | 18,904   |                    | $        | 14,300 | * * |
|                                                                                                   |   |               |     |                    | * * |
| ***Liabilities and Stockholders’ Equity***                                                        |   |               |     |                    | * * |
| *Current Liabilities:*                                                                                 |   |               |     |                    | * * |
| Due to underwriters and assureds                                                                       |   | $                  | 4,273    |                    | $        | 1,890 | * * |
| Income taxes payable                                                                                   |   | 36                 |     | —                  | * * |
| Accounts payable and accrued expenses                                                                  |   | 1,905              |     | 1,401                   | * * |
| Note payable to bank                                                                                   |   | 1,300              |     | 1,300                   | * * |
|                                                                                                   |   | 7,514              |     | 4,591                   | * * |
| *Non-Current Liabilities:*                                                                             |   |               |     |                    | * * |
| Accounts payable and accrued expenses                                                                  |   | 2,291              |     | 600                     | * * |
| Note payable to bank                                                                                   |   | 801                |     | 1,450                   | * * |
|                                                                                                   |   | $                  | 10,606   |                    | $        | 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 7,113,379; 2002, 7,023,379) |   | 71                 |     | 70                      | * * |
| Additional paid-in-capital                                                                             |   | 13,958             |     | 68,294                  | * * |
| Accumulated earnings (deficit), after  January 1, 2003, net of $54,405 deficit eliminated              |   | 409                |     | (54,405                 | )        |
| Unearned compensation                                                                                  |   | (43                | )        | (26                     | )        |
| Employee loans for stock purchase                                                                      |   | (220               | )        | (397                    | )        |
|                                                                                                   |   | 14,175             |     | 13,536                  |     |
| Treasury stock, at cost (2003, 873,500;  2002, 873,500 shares)                                         |   | (5,877             | )        | (5,877                  | )        |
|                                                                                                   |   | 8,298              |     | 7,659                   | * * |
|                                                                                                   |   | $                  | 18,904   |                    | $        | 14,300 | * * |

 

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*  Derived from audited financial statements.

 

See notes tocondensed consolidated financial statements.

 

2

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**PAULA FINANCIAL ANDSUBSIDIARIES**

**CondensedConsolidated Statements of Income**

(In thousands, except share and per share data)

 
|                                                                                                             |   | **Three  Months Ended  June 30,** |   | **Six Months  Ended  June 30,** |   |
|------------------------------------------------------------------------------------------------------------------|--------|-----------------------------------|--------|---------------------------------|--------|
|                                                                                                             |   | **2003**                          |   | **2002**                        |   | **2003** |   | **2002** |   |
|                                                                                                             |   | **(Unaudited)**                   |   | **(Unaudited)**                 |   |
| ***Income:***                                                                                                    |   |                              |   |                            |   |   |   |   |   |
| Commissions                                                                                                      |   | $                                 | 4,052  |                            | $      | 2,366 |   | $ | 7,522 |   | $ | 4,932 |   |
| Contingent commissions                                                                                           |   | 117                               |   | 395                             |   | 1,182 |   | 1,091 |   |
| Net investment income                                                                                            |   | 2                                 |   | 4                               |   | 4 |   | 8 |   |
| Service fees                                                                                                     |   | 83                                |   | 25                              |   | 158 |   | 35 |   |
| Other                                                                                                            |   | 45                                |   | 100                             |   | 52 |   | 106 |   |
|                                                                                                             |   | 4,299                             |   | 2,890                           |   | 8,918 |   | 6,172 |   |
|                                                                                                             |   |                              |   |                            |   |   |   |   |   |
| ***Expenses:***                                                                                                  |   |                              |   |                            |   |   |   |   |   |
| Salaries and related expenses                                                                                    |   | 2,456                             |   | 1,504                           |   | 4,802 |   | 3,236 |   |
| Interest expense                                                                                                 |   | 38                                |   | 64                              |   | 81 |   | 132 |   |
| Other expenses                                                                                                   |   | 1,603                             |   | 1,096                           |   | 3,311 |   | 2,131 |   |
|                                                                                                             |   | 4,097                             |   | 2,664                           |   | 8,194 |   | 5,499 |   |
|                                                                                                             |   |                              |   |                            |   |   |   |   |   |
| Income from continuing operations before  income taxes                                                           |   | 202                               |   | 226                             |   | 724 |   | 673 |   |
| Income tax expense                                                                                               |   | 89                                |   | 104                             |   | 315 |   | 291 |   |
| Income from continuing operations                                                                                |   | 113                               |   | 122                             |   | 409 |   | 382 |   |
|                                                                                                             |   |                              |   |                            |   |   |   |   |   |
| Discontinued operations:                                                                                         |   |                              |   |                            |   |   |   |   |   |
| Loss from operations of discontinued  underwriting segment (including loss on disposal in 2002 of $120 and $203) |   | —                            |   | (125                            | )      | — |   | (208 | ) |
| Income tax benefit                                                                                               |   | —                            |   | (53                             | )      | — |   | (88 | ) |
| Loss on discontinued operations                                                                                  |   | —                            |   | (72                             | )      | — |   | (120 | ) |
|                                                                                                             |   |                              |   |                            |   |   |   |   |   |
| ***Net income***                                                                                                 |   | $                                 | 113    |                            | $      | 50 |   | $ | 409 |   | $ | 262 |   |
|                                                                                                             |   |                              |   |                            |   |   |   |   |   |
| Earnings per share:                                                                                              |   |                              |   |                            |   |   |   |   |   |
| Income from continuing operations                                                                                |   | $                                 | 0.02   |                            | $      | 0.02 |   | $ | 0.07 |   | $ | 0.06 |   |
| Loss on discontinued operations                                                                                  |   | —                            |   | $                               | (0.01  | ) | — |   | $ | (0.02 | ) |
| Net income                                                                                                       |   | $                                 | 0.02   |                            | $      | 0.01 |   | $ | 0.07 |   | $ | 0.04 |   |
| Weighed average shares outstanding                                                                               |   | 6,235,264                         |   | 6,091,756                       |   | 6,206,398 |   | 6,092,168 |   |
|                                                                                                             |   |                              |   |                            |   |   |   |   |   |
| Earnings per share - assuming dilution                                                                           |   |                              |   |                            |   |   |   |   |   |
| Income from continuing operations                                                                                |   | $                                 | 0.02   |                            | $      | 0.02 |   | $ | 0.06 |   | $ | 0.06 |   |
| Loss on discontinued operations                                                                                  |   | —                            |   | $                               | (0.01  | ) | — |   | $ | (0.02 | ) |
| Net income                                                                                                       |   | $                                 | 0.02   |                            | $      | 0.01 |   | $ | 0.06 |   | $ | 0.04 |   |
| Weighted average shares outstanding -  assuming dilution                                                         |   | 6,476,860                         |   | 6,118,477                       |   | 6,418,942 |   | 6,107,564 |   |

 

See notes to condensedconsolidated financial statements.

 

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**PAULA FINANCIAL ANDSUBSIDIARIES**

**CondensedConsolidated Statements of Cash Flows**

(In thousands)

 
|                                                                                 |   | **Six Months  Ended  June 30,** |   |
|--------------------------------------------------------------------------------------|--------|---------------------------------|--------|
|                                                                                 |   | **2003**                        |   | **2002** |   |
|                                                                                 |   | **(Unaudited)**                 |   |
| ***Cash flow from  operating activities:***                                          |   |                            |   |   |   |
| Net income                                                                           |   | $                               | 409    |   | $ | 262 |   |
| Loss from discontinued operations                                                    |   | —                          |   | 120 |   |
| Income from continuing operations                                                    |   | 409                             |   | 382 |   |
| *Adjustments to reconcile net income to net cash provided by operating  activities:* |   |                            |   |   |   |
| Depreciation and amortization                                                        |   | 284                             |   | 249 |   |
| Loss on sale of property and equipment                                               |   | —                          |   | 3 |   |
| Increase in receivables                                                              |   | (1,210                          | )      | (662 | ) |
| Decrease in deferred income taxes                                                    |   | 226                             |   | 247 |   |
| Increase (decrease) in accounts payable and  accrued expenses                        |   | 2,683                           |   | (129 | ) |
| Other, net                                                                           |   | 2                               |   | 317 |   |
| ***Net cash provided  by operating activities***                                     |   | 2,394                           |   | 407 |   |
|                                                                                 |   |                            |   |   |   |
| ***Cash flows from  investing activities:***                                         |   |                            |   |   |   |
| Purchase of book of business                                                         |   | (247                            | )      | — |   |
| Purchase of property and equipment                                                   |   | (41                             | )      | (119 | ) |
| ***Net cash used in  investing activities***                                         |   | (288                            | )      | (119 | ) |
|                                                                                 |   |                            |   |   |   |
| ***Cash flows from  financing activities:***                                         |   |                            |   |   |   |
| Payments on notes payable                                                            |   | (650                            | )      | (650 | ) |
| Payments received on employee loans for  stock purchase                              |   | 35                              |   | 81 |   |
| Retirement of common stock                                                           |   | —                          |   | (4 | ) |
| Issuance of common stock                                                             |   | —                          |   | — |   |
| Funding of discontinued operations                                                   |   | —                          |   | (207 | ) |
| ***Net cash used in  financing activities***                                         |   | (615                            | )      | (780 | ) |
|                                                                                 |   |                            |   |   |   |
| ***Net increase  (decrease) in cash and invested cash***                             |   | 1,491                           |   | (492 | ) |
| Cash and invested cash at beginning of  period                                       |   | 1,290                           |   | 1,997 |   |
| ***Cash and invested  cash at end of period***                                       |   | $                               | 2,781  |   | $ | 1,505 |   |

 

See notes to condensedconsolidated financial statements.

 

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**PAULA FINANCIAL ANDSUBSIDIARIES**

**Notes to Condensed ConsolidatedFinancial Statements**

**For the Three and SixMonths Ended June 30, 2003 (Unaudited)**

 

**Note A - Basis of Presentation**

 

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

 

The accompanying unauditedcondensed consolidated financial statements of the Company have been preparedin accordance with generally accepted accounting principles (“GAAP”) forinterim financial information and with the instructions to Form 10-Q andArticle 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotesrequired by GAAP for complete financial statements.  In the opinion of management, all adjustments, including normallyoccurring accruals, considered necessary for a fair presentation have beenincluded.

 

Operating results for the threeand six months ended June 30, 2003 are not necessarily indicative of theresults to be expected for the year ended December 31, 2003.  For further information, refer to theconsolidated financial statements and footnotes thereto included in theCompany’s Annual Report on Form 10-K for the year ended December 31, 2002.

 

In December 2002, the FinancialAccounting Standards Board issued Statement of Financial Accounting Standard(“SFAS”) No. 148, “Accounting for Stock Based Compensation – Transition andDisclosure, an amendment of SFAS 123”. Among other provisions, SFAS 148 amends the disclosure requirements ofSFAS 123 to require prominent disclosures in both annual and interim financialstatements.  For the three and sixmonths ended June 30, 2003, the differences between the as reported net incomeand income per share amounts and the related pro forma amounts are not materialto the consolidated financial statements.

 

##### **Note B – Change inStockholders’ Equity**

 

Effective January 1, 2003, theCompany implemented a quasi-reorganization of its capital accounts.  At December 31, 2002, the Company had anaccumulated deficit of $54.4 million which was primarily generated by theCompany’s underwriting operations, PAULA Insurance Company (“PICO”).  PICO was disposed of in 2002 (see Note D –Discontinued Operations).  Afterapproval by the stockholders on May 21, 2003, the Company effected thequasi-reorganization pursuant to which the Company eliminated its accumulateddeficit and charged the corresponding amount to additional paid-in-capital.

 

In the first quarter of 2003,the Company issued 80,000 shares of restricted stock.  As of June 30, 2003, 50,000 shares were unvested.  Of the 80,000 shares issued, 60,000 sharesrelated 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 inproviding crop insurance to commercial wine grape growers.  Since 2002, the Company has made efforts todramatically expand

 

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crop insurance sales, primarilythrough producer recruitment.  As partof the agreement, the Company purchased R&A’s existing book ofbusiness.  Balances owing under the arrangementwill be paid over a five year period. As of June 30, 2003, the obligation related to this transaction was$626,000 with $120,000 of the balance due in the next twelve months.  Of the total purchase price, $503,000 hasbeen allocated to other amortizable intangible assets, with the remaining$323,000 allocated to goodwill.  Otheramortizable intangible assets relate to expiration lists and covenants not tocompete.

 

Additionally, in the first sixmonths of 2003, the Company received payments on employee loans for stockpurchase totaling $35,000 and increased the valuation allowance on these loansby $242,000.

 

##### **Note C – Comprehensive Income**

 

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

 

##### **Note D – Discontinued Operations**

 

Historically, the Company also operated a workers’ compensationunderwriting facility, PICO.  As ofDecember 31, 2001, PICO’s Risk Based Capital fell into the “Mandatory ControlLevel.”  Consequently, on March 12, 2002PICO and the California Department of Insurance (“California DOI”) entered intoan Oversight Agreement which effectively gave the California DOI control overPICO’s operations.  As a result of theseevents, in the fourth quarter of 2001, the Company began accounting for itsinvestment in PICO using the equity method. In the fourth quarter of 2001, the Company wrote its investment in PICOdown to $-0-.  Consequently, no directPICO operating activity is included in the consolidated financial statementsfor the 2002 period.

 

On April 26, 2002, theCalifornia DOI obtained a conservation order for which was followed on June 21,2002 by a liquidation order.  Subsequentto the liquidation order, the Company provided limited operational support toPICO.  Given the continued activity withPICO through the third quarter of 2002, the Company was precluded from treatingPICO as a discontinued operation for accounting purposes.

 

In the fourth quarter of 2002the 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 toworkers’ compensation underwriting has been reclassified as discontinuedoperations.  As a result, certainfinancial information previously issued has been adjusted to give effect to theclassification of the PICO business as discontinued operations in accordancewith SFAS 144.

 

Amounts related to discontinuedoperations in the 2002 period primarily relate to employee severance costsassociated with the discontinuance of PICO operations.

 

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**NoteE – Goodwill**

 

The increase in goodwill in thefirst six months of 2003 is related to the previously discussed purchase ofR&A’s book of business as well as the purchase of a large accountagribusiness book of business.  In July2002, the Company successfully recruited an experienced, large accountagribusiness producer.  As part of theagreement, the Company agreed to purchase his business.  As structured, the Company acquires thebusiness as the related accounts are renewed.

 

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**PART I****                                                       FINANCIALINFORMATION**

Item 2.                                          Management’sDiscussion and Analysis of Consolidated Financial Condition and Results ofOperations

 

**Overview**

 

The Company’s revenues consistprimarily of agency commission, contingent commission income, and servicefees.  Commission income is earned fromPan Am’s insurance sales activity. Associated premiums are primarily billed directly by the insurancecarrier.  However, in certain instances,Pan Am will invoice the customer and remit the premium, less commission, to theinsurance carrier.  The Company focusesits sales efforts on agribusiness and rural markets in California andArizona.  Contingent commission isrelated to volume and profit sharing arrangements with insurance carriers.  Service fees are primarily received for theperformance of services related to loss control and claims advocacy.

 

The Company’s expenses consistof salaries and related expenses, interest expense and other general andadministrative expenses.

 

**Results of Operations for the Three and SixMonths Ended June 30, 2003 Compared to the Three and Six Months Ended June 30,2002:**

 

**Commission income.**For the three months ended June 30, 2003 commission income increased 71% to$4.1 million compared to $2.4 million for the comparable 2002 period.  For the six months ended June 30, 2003commission income increased 53% to $7.5 million compared to $4.9 million forthe comparable 2002 period.  For the sixmonth period, 28% of the $2.6 million increase is due to increases in theworkers compensation line of business while 42% of the increase is due toincreases in the placement of crop insurance.

 

Currently the California StateCompensation Insurance Fund (“SCIF”) is the largest single market for workers’compensation insurance in the state.  Consequently,the Company places a significant portion of its related business withSCIF.  California Insurance CommissionerGaramendi and SCIF management have announced a plan to reduce commission ratesto all approved agents beginning in August 2003.  Prior to August 2003, the maximum commission rate was 8.0%.  Effective August 2003, the maximumcommission rate is 5.5%.  Sincecommission rates are only adjusted at renewal, the full impact of this changewill not be reflected in the Company’s consolidated financial statements untilthe last half of 2004.  Partiallyoffsetting the reduced commission rate, SCIF has announced another round ofrate increases effective July 1, 2003.

 

The Company is attempting tomitigate the impact of the SCIF commission adjustment in a number ofsignificant ways.  First, the Company isactively engaged in offering alternative risk structures, including proprietaryaccess to a Bermuda captive.  Second,the Company is diversifying its revenue base by expanding its property and casualtycommissions and developing a significant crop insurance platform. Since 2002,the Company has made efforts to dramatically expand crop insurance sales,primarily through producer recruitment. In March 2003, R&A’s joined the Company.  R&A is based in Modesto, California and specializes inproviding crop insurance to commercial wine grape growers.

 

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The Company is now beginning tosee the impact of its diversification efforts. For the six months ended June 30, 2003, workers’ compensation accountedfor 41% of commission income as compared to 48% for the comparable 2002 period.

 

**Contingent commission income.**For the three months ended June 30, 2003 contingent commission income decreased70% to $117,000 compared to $395,000 for the comparable 2002 period. For thesix months ended June 30, 2003 contingent commission income increased 8% to$1.2 million compared to $1.1 million for the comparable 2002 period.Contingent commission fluctuates from year to year based on the profitabilityof the underlying business and external market conditions which can result inchanges to contingency programs offered by insurance carriers.

 

**Service fees.**  Service fee income increased to $83,000 forthe three months ended June 30, 2003 from $25,000 for the comparable 2002period.  For the six months ended June30, 2003 service fee income increased to $158,000 compared to $35,000 for thecomparable 2002 period.  The increase inservice fees is due to new service arrangements where the Company is paid forproviding loss control and other field support services to selected accounts.

 

**Salaries and related expenses.**  Salaries and employee benefits increased 63%to $2.5 million for the three months ended June 30, 2003 from $1.5 million forthe comparable 2002 period. For the six months ended June 30, 2003 salaries andemployee benefits increased 48% to $4.8 million compared to $3.2 million forthe comparable 2002 period.  Theincrease is due to three primary factors: the transfer of selected employeesfrom PICO’s payroll to Pan Am in early to mid-2002, the addition of newemployees beginning in July 2002 and the elimination of previous cost sharingarrangements that were in effect with PICO through mid-2002.  For the six months ended June 30, 2003,salaries and related expenses was 64% of total revenues as compared to 66% forthe comparable 2002 period.

 

**Interest expenses.**  Interest expense decreased 41% to $38,000for the three months ended June 30, 2003 from $64,000 for the comparable 2002period. For the six months ended June 30, 2003 interest expense decreased 39%to $81,000 compared to $132,000 for the comparable 2002 period.  The decrease is due to the decline in theoutstanding balance of the related note payable.

 

**Operating expenses.**  Operating expenses increased 46% to $1.6million for the three months ended June 30, 2003 from $1.1 million for thecomparable 2002 period. For the six months ended June 30, 2003 operatingexpenses increased 55% to $3.3 million compared to $2.1 million for thecomparable 2002 period.  The increase isprimarily due to the elimination of previous cost sharing arrangements thatwere in effect with PICO until mid-2002 as well as the costs associated with anincreased number of employees, including insurance and facilities expense.

 

**Income taxes on continuing operations.**  Income tax expense for the three monthsended June 30, 2003 was $89,000 compared to $104,000 for the comparable 2002period.  Income tax expense for the sixmonths ended June 30, 2003 was $315,000 compared to $291,000 for the comparable2002 period.  The effective combinedincome tax rates for the six months ended June 30, 2003 and 2002 were 44% and43%, respectively.

 

**Loss from discontinued operations beforetaxes.**  In2002, these costs primarily included employee severance costs associated withthe discontinuance of PICO operations.

 

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**Income taxes on discontinued operations.**  Income tax benefit on discontinuedoperations for the three months ended June 30, 2002 was $53,000.  Income tax benefit on discontinuedoperations for the six months ended June 30, 2002 was $88,000.  The effective combined income tax rate forthe six months ended June 30, 2002 was 42%.

 

**Liquidity and Capital Resources:**

 

As a holding company, PAULAFinancial’s principal sources of funds are dividends and expense reimbursementsfrom its operating subsidiaries and proceeds from the sale of its capitalstock.  PAULA Financial’s principal usesof funds are capital contributions to its subsidiaries and payment of operatingexpenses.

 

As of December 31, 2002, theCompany had an outstanding balance on its bank term loan of $2.8 million. Underthe terms of the amended credit agreement, the loan balance will be paid overthe next eighteen months with the final principal payment due January 1,2005.  As of June 30, 2003, theoutstanding balance was $2.1 million. Management believes that funds currentlyavailable and expected to be generated by the agency operations will besufficient to meet the required principal and interest payments on the termloan.

 

Each of PAULA Financial’ssubsidiaries has guaranteed all obligations of PAULA Financial under the CreditAgreement.

 

The Company’s Board ofDirectors had previously approved a 1,000,000 share repurchase program.  As of June 30, 2003, the Company held873,500 shares in treasury stock.  OnFebruary 20, 2003, the Board of Directors authorized an additional 2,000,000shares for the share repurchase program. The Company’s current credit agreement restricts its ability torepurchase capital stock.

 

FASB Interpretation No. 46,“Consolidation of Variable Interest Entities” is not applicable to the Company.

 

**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 of1995, the Company cautions readers to recognize the existence of certainforward-looking statements in this Form 10-Q and in any other statement madeby, or on behalf of, the Company, whether or not in future filings with theSecurities and Exchange Commission. Forward-looking statements are statements not based on historicalinformation and which relate to future operations, strategies, financialresults or other developments.  Someforward-looking statements may be identified by the use of terms such as“expects,” “believes,” “anticipates,” “intends,” or “judgment.” Forward-lookingstatements are necessarily based upon estimates and assumptions that areinherently subject to significant business, economic and competitiveuncertainties, many of which are beyond the Company’s control and many ofwhich, with respect to future business decisions, are subject to change.  Examples of such uncertainties andcontingencies include, among other important factors, those affecting theinsurance industry in general, such as the economic and interest rateenvironment, legislative and regulatory developments and market pricing andcompetitive trends, and those relating specifically to the Company and itsbusinesses, such as the level of its commission and fee income and acquisitionsof companies or blocks of business. These uncertainties and contingencies can affect actual results andcould cause actual results to differ

 

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materially from those expressed in any forward-looking statements madeby, or on behalf of, the Company. The Company disclaims any obligation toupdate forward-looking information.

 

Item 3:  Quantitative and Qualitative DisclosuresAbout Market Risk.

 

There have been no significant changes since the Company’s AnnualReport on Form 10-K filed for the year ended December 31, 2002.

 

Item 4:  Controls and Procedures

 

**Controls andProcedures**

 

The Company’s Chief Executive Officer and Vice President Finance haveevaluated 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 Securitiesand Exchange Act of 1934, as amended (the “Exchange Act”)) as of a date 90 daysprior to the filing date of this quarterly report (the “Evaluation Date”).  Based on such evaluation, such officers haveconcluded that, as of the Evaluation Date, the Company’s disclosure controlsand procedures are effective in alerting them on a timely basis to materialinformation relating to the Company (including its consolidated subsidiaries)required to be included in the Company’s periodic filings under the ExchangeAct.

 

**Changes in InternalControls**

 

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

 

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## **PARTII**.  OTHER INFORMATION

 

Item 5:  Submission of Matters to a Vote of Security Holders.

 

The Company held its 2003Annual Meeting of Stockholders on Wednesday, May 21, 2003 for the purposeof electing three directors and deciding on a proposal to implement aquasi-reorganization.

 

At the Meeting, the Company’sstockholders re-elected Messrs. Robert M. Anderson, James G. Parker IIIand Jeffrey A. Snider to the Company’s Board of Directors for threeyear terms.

 

The following table shows thenumber of shares voted for each nominee for director and the number of shareswithheld for each nominee:

 
| **Nominee**         |   | **Shares  Voted for Election** |   | **Shares  Withheld** |   |
|---------------------|--------|--------------------------------|--------|----------------------|--------|
|                |   |                           |   |                 |   |
| Robert M. Anderson  |   | 4,652,067                      |   | 68,400               |   |
|                |   |                           |   |                 |   |
| James G. Parker III |   | 4,596,073                      |   | 124,394              |   |
|                |   |                           |   |                 |   |
| Jeffrey A. Snider   |   | 4,338,940                      |   | 381,527              |   |

 

The term of office of each ofthe following directors continued after the meeting held May 21, 2003:Messrs. Joel W. Geddes, Jr., Karl T. Hansen, andJerry M. Miller.

 

Additionally, the stockholdersvoted to pass the proposal to implement a quasi-reorganization effectiveJanuary 1, 2003.  The following tableshows the voting numbers and percentages:

 
|            |   | **Number of  shares** |   | **Percentage** |   |
|-----------------|--------|-----------------------|--------|----------------|--------|
|            |   |                  |   |           |   |
| For             |   | 3,295,307             |   | 69.81          | %      |
|            |   |                  |   |           |   |
| Against         |   | 168,424               |   | 3.57           | %      |
|            |   |                  |   |           |   |
| Abstain         |   | 17,671                |   | .37            | %      |
|            |   |                  |   |           |   |
| Broker non vote |   | 1,239,067             |   |           |   |

 

Item 6:  Exhibits and Reports on Form 8-K:

 

(a)  Exhibits.

 
| 11.    | Computation  of Earnings Per Share.                                |
|--------|--------------------------------------------------------------------|
|   |                                                               |
| 31.1   | Rule 13a  -14a /15d -14a Certification of Chief Executive Officer. |
|   |                                                               |
| 31.2   | Rule 13a  -14a /15d -14a Certification of Chief Financial Officer. |
|   |                                                               |
| 32     | Section 1350  Certifications.                                      |

 

(b)  Reports on Form 8-K.

 
|   | There were  no reports filed on Form 8-K during the three months ended June 30, 2003. |
|--------|---------------------------------------------------------------------------------------|

 

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SIGNATURES

 

 

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

 
| Date:  August 8 ,2003 | PAULA  FINANCIAL          |
|----------------------------|---------------------------|
|                       |                      |
|                       |                      |
|                       | By:                       | /s/ Deborah  S. Maddocks |   |
|                       | Vice  President - Finance |

 

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