UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1998
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from ________ to ____________
Commission File Number: 0-18649
THE NATIONAL SECURITY GROUP, INC.
(Exact name of registrant as specified in its charter)
Delaware 63-1020300
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
661 East Davis Street, Elba, Alabama 36323
(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code (334) 897-2273
Not Applicable
(Former name, 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 (X) No ( )
Number of Shares of Common Stock outstanding as of August 6, 1998: 2,271,018
Exhibit index is located on page 14.
Page 1 of 14 pages
1
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THE NATIONAL SECURITY GROUP, INC.
INDEX
Page No.
PART I FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Statements of Income .............................. 3
Consolidated Balance Sheets .................................... 4
Consolidated Statements of Cash Flows .......................... 5
Notes to Financial Statements .................................. 6
Item 2. Management's Discussion and Analysis
of Financial Condition and Results of Operations ...... 9
PART II OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K ....................... 12
SIGNATURE ............................................................. 13
EXHIBIT INDEX ......................................................... 14
2
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Part I. FINANCIAL INFORMATION
Item 1. Financial Statements
THE NATIONAL SECURITY GROUP, INC.
CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share amounts)
<TABLE>
Three Months Six Months
Ended June 30 Ended June 30
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Revenues
Net insurance premiums earned ............................. $ 7,273 $ 7,881 $ 14,774 $ 15,863
Net investment income ..................................... 917 914 2,082 2,016
Realized investment gains ................................. 937 620 1,417 683
Other income .............................................. 126 171 264 333
-------- -------- -------- --------
Total revenues .......................................... 9,253 9,586 18,537 18,895
-------- -------- -------- --------
Benefits and Expenses
Policyholder benefits and settlement expenses ............. 6,128 5,158 12,009 10,504
Policy acquisition costs .................................. 1,640 1,542 3,311 2,944
General insurance expenses ................................ 2,587 1,153 3,877 2,319
Insurance taxes, licenses and fees ........................ 301 415 698 777
-------- -------- -------- --------
Total benefits and expenses ............................. 10,656 8,268 19,895 16,544
-------- -------- -------- --------
Income Before Income Taxes and Cumulative Effect Adjustment (1,403) 1,318 (1,358) 2,351
Income Taxes (Current and deferred) ....................... 18 308 (257) 719
-------- -------- -------- --------
Net Income (Loss) ......................................... $ (1,421) $ 1,010 $ (1,101) $ 1,632
======== ======== ======== ========
Earnings (loss) per share ................................. $ (0.62) $ 0.43 $ (0.48) $ 0.70
======== ======== ======== ========
Dividends Declared per Share .............................. $ 0.19 $ 0.17 $ 0.38 $ 0.34
======== ======== ======== ========
</TABLE>
The Notes to Financial Statements are an integral part of these statements.
3
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THE NATIONAL SECURITY GROUP, INC.
CONSOLIDATED BALANCE SHEET
(In thousands, except per share amounts)
As of As of
June 30, December 31,
Assets 1998 1997
---- ----
Investments:
Securities held-to-maturity at amortized cost
(estimated fair value: 1998 - $32,468 1997 - 30,807) . $ 31,712 $ 29,995
Securities available-for-sale, at estimated fair value
(cost: 1998 - 33,567; 1997 - 35,257) ................. 52,902 52,819
Receivable for securities .............................. 0 400
Mortgage loans ......................................... 219 320
Investment real estate, at cost ........................ 1,615 1,645
Policy loans ........................................... 648 660
--------- ---------
Total investments .................................... 87,108 85,827
--------- ---------
Cash and cash equivalents ................................. 3,299 3,888
Accrued investment income ................................. 876 833
Reinsurance recoverable ................................... 7,969 8,489
Deferred policy acquisition costs ......................... 4,200 4,216
Current income tax recoverable ............................ 234 0
Prepaid reinsurance premiums .............................. 214 341
Other assets .............................................. 3,626 3,364
--------- --------
Total assets ........................................... $ 107,526 $ 106,958
========= =========
Liabilities
Policy reserves ........................................ $ 18,748 $ 18,667
Claim reserves ......................................... 23,301 22,246
Unearned premiums ...................................... 9,547 8,853
Other policyholder funds ............................... 1,588 1,729
Deferred income tax .................................... 4,653 4,078
Current Income tax payable ............................. 0 147
Other liabilities ...................................... 4,862 4,886
--------- ---------
Total liabilities ................................... $ 62,699 $ 60,606
--------- ---------
Shareholders' Equity
Common stock, $1 par value, 2,339,848 shares issued ....... 2,340 2,340
Additional paid in capital ................................ 17 17
Accumulated comprehensive income:
Net unrealized appreciation on investment securities . 13,670 12,497
Retained earnings ......................................... 29,913 31,888
Treasury stock, at cost (68,830 shares) ................... (1,113) (390)
--------- --------
Total shareholders' equity ............................. 44,827 46,352
--------- --------
Total liabilities and shareholder's equity ............. $ 107,526 $ 106,958
========= ========
Shareholders' Equity per Share ............................. 19.74 20.04
========= ========
The Notes to Financial Statements are an integral part of these statements
4
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THE NATIONAL SECURITY GROUP. INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands) Six Months
Ended June 30
1998 1997
----- ----
Cash Flows from Operating Activities
Income from continuing operations ...................... $(1,101) $ 1,632
Adjustments to reconcile income from continuing
operations to net cash provided by (used in)
operating activities:
Accrued investment income ............................ (43) (37)
Reinsurance receivables .............................. 520 1,190
Deferred Policy acquisition costs .................... (190)
Income Taxes ......................................... (147) 1,350
Depreciation expense ................................. 61 59
Policy liabilities and claims ........................ 1,749 1,048
Other, net ........................................... 239 (243)
------- -------
Net cash provided by operating activities .......... 1,294 4,809
------- -------
Cash Flows from Investing Activities
Cost of investments acquired ........................ (4,907) (8,425)
Sale and maturity of investments .................... 4,795 3,002
Purchase of property and equipment .................. (37) (76)
Proceeds from disposal of property and equipment .... 0 0
Other, net .......................................... 0 0
------- -------
Net cash used in investing activities ............. (149) (5,499)
------- -------
Cash Flows from Financing Activities
Decrease in other policyholder funds ................ (141) (39)
Dividends paid ...................................... (871) (788)
Purchase of treasury stock .......................... (722) 0
------- -------
Net cash used in financing activities ............. (1,734) (827)
------- -------
Net increase (decrease) in cash and cash equivalents ..... (589) (1,517)
Cash and cash equivalents, beginning of period ........... 3,888 4,722
------- -------
Cash and cash equivalents, end of period ................. $ 3,299 $ 3,205
======= =======
The Notes to the Financial Statements are an integral part of these statements.
5
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THE NATIONAL SECURITY GROUP, INC.
NOTES TO FINANCIAL STATEMENTS
NOTE 1-Basis of Presentation
The consolidated financial statements have been prepared in conformity with
generally accepted accounting principles. The interim financial statements
include all adjustments necessary, in the opinion of management, for fair
statement of financial position, results of operations and cash flows for the
periods reported. These adjustments are all normal recurring adjustments.
Note 2-Reinsurance
National Security Fire and Casualty Company ("NSFC") and National Security
Insurance Company ("NSIC") wholly owned subsidiaries of the Company, reinsure
certain portions of insurance risk which exceed various retention limits. NSFC
and NSIC are liable for these amounts in the event assuming companies are unable
to meet their obligations.
Note 3-Calculation of Earnings Per Share
Earnings per share were based on net income divided by the weighted average
common shares outstanding. The weighted average number of shares outstanding for
the period ending June 30, 1998 was 2,271,000 and for the period ending June 30,
1997 was 2,320,000.
Note 4-Changes in Shareholder's Equity (in thousands)
During the six months ended June 30, 1998 and 1997, there were no changes in
shareholders' equity except for net (loss) income of $(1,101) and $1,632
respectively; dividends paid of $871 and $789 respectively; unrealized
investment gains, net of applicable taxes, of $1,169 and $2,081 respectively,
and purchase of treasury stock of $722 and $0 respectively.
Note 5 - Deferred Taxes
The tax effect of significant temporary differences representing deferred tax
assets and liabilities are as follows: (in thousands)
June 30, January 1,
1998 1998
Deferred policy acquisition costs ...................... (1,425) (1,434)
Policy liabilities ..................................... 526 519
Unearned premiums ...................................... 559 442
Claims liabilities ..................................... 653 530
General insurance expenses ............................. 700 931
Unrealized gains on securities available-for-sale ...... (5,610) (5,066)
Other .................................................. (56) 0
------ ------
Net deferred tax liability ............................. (4,653) (4,078)
====== ======
Deferred taxes are determined based on the estimated future tax effects of
differences between the financial statement and tax bases of assets and
liabilities given the provisions of the enacted tax laws.
6
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THE NATIONAL SECURITY GROUP, INC.
NOTES TO FINANCIAL STATEMENTS
(Continued)
Note 6-Contingencies
The Company and its subsidiaries continue to be named as parties to litigation
related to the conduct of their insurance operations. These suits involve
alleged breaches of contracts, torts, including bad faith and fraud claims based
on alleged wrongful or fraudulent acts of agents of the Company's subsidiaries,
and miscellaneous other causes of action. Most of these lawsuits include claims
for punitive damages in addition to other specified relief. The frequency of
these lawsuits has increased significantly over the past 36 months, particularly
in Alabama where the Company conducts the majority of its business. Certain of
these actions are filed in jurisdictions in Alabama where local juries have
returned large punitive damage verdicts against insurance companies and
financial institutions with, in many cases, the punitive damage award bearing
little or no relation to the actual damages. It is not feasible to predict or
determine the ultimate outcome of these matters.
On October 4, 1996, a jury in the Circuit Court of Palm Beach County, Florida
returned a verdict against National Security Fire & Casualty Company, a
subsidiary of the Company, in the amount of $995,252. The plaintiff, Leon B.
King, had alleged that the Company's subsidiary had acted in bad faith in, among
other actions, failing to timely deliver a settlement check in connection with a
1986 automobile accident. This same case was previously tried in 1993 with the
jury returning a verdict in favor of the Company's subsidiary on all counts
alleged. This verdict was subsequently reversed on appeal which resulted in the
subject trial. Various post-trial motions including a motion for a new trial
were denied and the verdict was appealed. The Florida District Court of Appeal
for the Fourth District subsequently affirmed the verdict and concurrently
granted the motion for attorney's fees and costs filed by the attorneys for the
plaintiff, remanding the case to the trial court for a determination of the
amount. The Company's subsidiary subsequently reached a settlement of the
attorney's fee issue and the judgment, including all related issues, was
satisfied on July 8, 1998.
This judgment and the settlement of the attorney's fee award will result in a
combined charge to the Company's 1998 earnings of $2 million. This amount is
reflected in the accompanying financial statements for the quarter ended June
30, 1998. The Company's subsidiary is now pursuing recovery of the amount it has
expended in the resolution of this litigation from the independent adjusting
firm whose actions it believes caused or contributed to the basis for the
subject litigation. No provision has been established for any potential
recovery.
Note 7- Comprehensive Income
Effective January 1, 1998 the Company and its subsidiaries adopted Statement of
Financial Accounting Standards No. 130, "Reporting Comprehensive Income" (SFAS
130). Comprehensive Income is defined as net income and all other changes in
stockholders' equity from transactions and events arising from non-owner
sources. The adoption of SFAS 130 had no impact on the Company's net income or
Shareholders' equity. The primary additional component for The National Security
Group, Inc. is unrealized investment gains and losses. Total comprehensive
income was $72,000 and $3.7 million at June 30, 1998 and 1997, respectively.
7
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THE NATIONAL SECURITY GROUP, INC.
NOTES TO FINANCIAL STATEMENTS
(Continued)
Note 8-Year 2000 Issue
The Year 2000 issue relates to computer system programs which may not properly
recognize the change in date years from 1999 to 2000. As a result of this time
sensitivity of existing software, any business entity is at risk of possible
system failure or miscalculations causing disruption of operations, including,
among other things, a temporary inability to process transactions, send
billings, or engage in similar normal business activities.
The Company is currently modifying significant portions of its computer programs
so that its computer systems will function properly with respect to the year
2000 date recognition. The Company presently believes that with modifications to
existing software, the year 2000 issue will not pose a significant operational
problem. However, if such modifications are not made, or not completed timely,
the year 2000 issue could have a material impact on the operations of the
Company.
The Company is utilizing internal resources to reprogram and test software for
year 2000 modifications. The Company anticipates completing the year 2000
project no later than June 30, 1999. The total cost of the year 2000 project is
not expected to be material to the financial results of the Company.
8
<PAGE>
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
INTRODUCTION
The following discussion addresses the financial condition of The National
Security Group, Inc. as of June 30, 1998, compared with December 31, 1997 and
its results of operations and cash flows for the quarter ending June 30, 1998,
compared with the same period last year.
The reader is assumed to have access to the Company's 1997 Annual Report. This
discussion should be read in conjunction with the Annual Report and with
consolidated financial statements on pages 3 through 6 of this form 10-Q.
Information is presented in whole dollars.
CONSOLIDATED RESULTS OF OPERATIONS
Premium revenues:
Earned premium for the six month period ending June 30, 1998 was $14.7 million
versus $15.8 million for the same period last year. This reduction in premium is
primarily due to a subsidiary eliminating a private passenger automobile program
in Louisiana. To help replace premium lost from this program the
property/casualty subsidiaries have begun new programs in Louisiana and Florida.
The Louisiana program is a mobile homeowners program which began in late 1997.
The Florida program is an automobile program which also began in late 1997.
Net investment income:
Net investment income is up slightly, primarily due to an increase in
investments in debt securities over the last year.
Realized capital gains and losses:
Investment gains of $1.4 million were realized in the first half of 1998. In
light of the record highs achieved by many of the equity investments held by the
Company, the investment committee elected to sale a portion of certain holdings
to increase the diversity of the portfolio.
Other income:
Other income is down slightly due to a decrease in policy fees from the
Louisiana private passenger auto program which was discontinued in 1997.
Policyholder benefits and settlement expenses:
Policyholder benefits as a percent of net insurance premiums earned is up
considerably from last year, 81.2% versus 66.1%. The increase in policy holder
benefits is primarily due to losses incurred from the discontinuation of the
previously mentioned Louisiana automobile program, and from second quarter
tornado losses incurred in a property/casualty subsidiary's low value dwelling
and homeowners programs. Tornado losses incurred in April from a single tornado
which hit Jefferson County Alabama exceeded $500,000.
9
<PAGE>
Policy acquisition costs:
Policy acquisition costs as a percent of premiums earned are up due to increased
cost associated with the startup of the new homeowners program in Louisiana and
the new automobile program in Florida. Both programs are run by managing general
agents which underwrite policies and pay claims. The Company, in order to
compensate the agent for these added responsibilities, pays a higher commission
rate to the agent. These increased commissions are partly offset by decreased
general and administrative expenses on the program.
General insurance expenses:
General insurance expenses are up 67% from last year due to expenses associated
with the settlement of the litigation discussed in Note 7 of the financial
statements.
Insurance taxes, licenses, and fees:
Insurance taxes, licenses and fees are down due to a decrease in written
premium. As previously discussed, the decrease in written premium is primarily
due to the cancellation of a private passenger auto program in the State of
Louisiana.
Income taxes:
The Company has an income tax benefit for the current year due to a net loss
caused primarily by the settlement of previous years litigation expenses in
1998. Previous year's litigation accruals are deferred tax assets representing
future deductible amounts until the litigation is actually settled. The
settlement of previous year's litigation in 1998 will be current tax assets
deductible on the Company's 1998 income tax.
Summary:
The Company has a year to date net loss of $1.1 million dollars versus net
income of $1.6 million in 1997. The net loss in 1998 is primarily a result of
the previously discussed litigation settlement reached in July of 1998 and
accrued in the second quarter, and from tornado and windstorm losses incurred in
low value dwelling and homeowners property insurance programs.
Investments:
Investments increased slightly during the first half of 1998 primarily due to
increases in market value of available-for-sale equity securities. Proceeds from
the sale of select available-for-sale securities were reinvested primarily in
debt securities classified in the hold-to-maturity portfolio.
Capital resources:
At June 30, 1998, the Company had aggregate equity capital, unrealized
investment gains (net of income taxes) and retained earnings of $44.8 million,
down $1.5 million from December 31, 1997. The decrease reflects a net loss of
$(1.1 million), an increase in unrealized investment gains of $1.1 million,
dividends paid of $871,000, and the purchase of treasury stock of $722,000.
A subsidiary has a note from a local bank which management intends to repay in
full within the next year.
10
<PAGE>
Liquidity:
The liquidity requirements of the Company are primarily met by funds provided
from operations of the life insurance and property/casualty subsidiaries.
Premium and investment income, as well as maturities, calls, and sales of
invested assets, provide the primary sources of cash for both subsidiaries. Cash
is used by subsidiaries for payments of policy benefits, the acquisition of new
business (principally commissions), operating expenses, and purchases of new
investments.
The Company had $3.3 million in cash and cash equivalents at June 30, 1998. Net
cash provided by operating activities was $1.2 million for the current period,
compared to net cash provided of $4.8 million for the period ended June 30,
1997. Cash used in investing activities was $149,000. Cash dividends paid to
stockholders' of $871,000 and treasury stock purchased of $722,000 are the
primary uses of cash used in financing activities.
11
<PAGE>
Part II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
See Exhibit Index
12
<PAGE>
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed by the undersigned duly
authorized officer, on its behalf and in the capacity indicated.
The National Security Group, Inc.
By /S/ M.L. Murdock
------------------------------
M.L. Murdock
Senior Vice President and
Chief Financial Officer
Dated: August 14, 1998
13
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EXHIBIT INDEX
Exhibit Description Page
(a) 11 Statement Regarding Computation of Per Share Earnings Filed Herewith;
See Note 3 to
Financial
(b) Form 8-K None
14
<PAGE>
<TABLE> <S> <C>
<ARTICLE> 7
<MULTIPLIER> 1000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> JUN-30-1998
<DEBT-HELD-FOR-SALE> 19,708
<DEBT-CARRYING-VALUE> 31,712
<DEBT-MARKET-VALUE> 32,468
<EQUITIES> 33,194
<MORTGAGE> 219
<REAL-ESTATE> 1,615
<TOTAL-INVEST> 87,108
<CASH> 3,299
<RECOVER-REINSURE> 7,969
<DEFERRED-ACQUISITION> 4,200
<TOTAL-ASSETS> 107,526
<POLICY-LOSSES> 18,748
<UNEARNED-PREMIUMS> 9,547
<POLICY-OTHER> 23,301
<POLICY-HOLDER-FUNDS> 1,588
<NOTES-PAYABLE> 750
0
0
<COMMON> 2,340
<OTHER-SE> 42,487
<TOTAL-LIABILITY-AND-EQUITY> 107,526
14,774
<INVESTMENT-INCOME> 2,082
<INVESTMENT-GAINS> 1,417
<OTHER-INCOME> 264
<BENEFITS> 12,009
<UNDERWRITING-AMORTIZATION> 3,311
<UNDERWRITING-OTHER> 4,575
<INCOME-PRETAX> (1,358)
<INCOME-TAX> (257)
<INCOME-CONTINUING> (1,101)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (1,101)
<EPS-PRIMARY> (.48)
<EPS-DILUTED> (.48)
<RESERVE-OPEN> 0
<PROVISION-CURRENT> 0
<PROVISION-PRIOR> 0
<PAYMENTS-CURRENT> 0
<PAYMENTS-PRIOR> 0
<RESERVE-CLOSE> 0
<CUMULATIVE-DEFICIENCY> 0
</TABLE>
