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 September 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 November 6, 1998: 2,051,311
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)
Three Months Nine Months
Ended September 30 Ended September 30
1998 1997 1998 1997
---- ---- ---- ----
Revenues
Net insurance premiums earned ..... $ 6,942 $ 7,894 $ 21,716 $ 23,757
Net investment income ............. 1,135 1,173 3,217 3,189
Realized investment gains ......... 1,094 1,414 2,511 2,097
Other income ...................... 147 155 411 488
-------- -------- -------- --------
Total revenues .................. 9,318 10,636 27,855 29,531
-------- -------- -------- --------
Benefits and Expenses
Policyholder benefits and
settlement expenses ........... 6,273 6,365 18,282 16,869
Policy acquisition costs .......... 1,094 1,299 4,405 4,243
General insurance expenses ........ 887 1,536 4,764 3,855
Insurance taxes, licenses and fees 453 363 1,151 1,140
-------- -------- -------- --------
Total benefits and expenses ..... 8,707 9,563 28,602 26,107
-------- -------- -------- --------
Income Before Income Taxes and
Cumulative Effect Adjustment .. 611 1,073 (747) 3,424
Income Taxes (Current and deferred) 219 440 (38) 1,159
-------- -------- -------- --------
Net Income (Loss) ................. $ 392 $ 633 $ ( 709) $ 2,265
======== ======== ======== ========
Earnings (loss) per share ......... $ 0.17 $ 0.28 $ (0.31) $ 0.98
======== ======== ======== ========
Dividends Declared per Share ...... $ 0.19 $ 0.17 $ 0.57 $ 0.51
======== ======== ======== ========
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
Sept 30, Dec 31,
Assets 1998 1997
---- ----
Investments:
Debt Securities held-to-maturity at amortized cost
(estimated fair value: 1998 - $31,779; 1997 - 30,807) ..... $30,494 $29,995
Debt Securities available-for-sale, at estimated fair value
(cost: 1998 - 20,192; 1997 - 21,131) ..................... 20,295 21,104
Equity Securities, at market
(cost: 1998 - $14,489; 1997 - $14,126) .................... 29,002 31,715
Receivable for securities .................................. 0 400
Mortgage loans .......................................... 154 320
Investment real estate, at cost ......................... 1,599 1,645
Policy loans ............................................ 652 648
------- -------
Total investments ..................................... 82,196 85,827
------- -------
Cash and cash equivalents ...................... 3,382 3,888
Accrued investment income ...................... 921 833
Reinsurance recoverable ........................ 7,504 8,489
Deferred policy acquisition costs .............. 4,355 4,216
Current income tax recoverable ................. 516 0
Prepaid reinsurance premiums ................... 329 341
Other assets ................................... 3,426 3,364
-------- --------
Total assets ................................ $102,629 $106,958
======== ========
Liabilities
Policy reserves ............................. $18,817 $18,667
Claim reserves .............................. 23,575 22,246
Unearned premiums ........................... 9,724 8,853
Other policyholder funds .................... 1,693 1,729
Deferred income tax ......................... 3,383 4,078
Current Income tax payable .................. 0 147
Other liabilities ........................... 4,006 4,886
------- -------
Total liabilities ........................ $61,198 $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 10,314 12,497
Retained earnings .................................... 29,873 31,888
Treasury stock, at cost (68,830 shares) .............. (1,113) (390)
--------- --------
Total shareholders' equity ........................ 41,431 46,352
--------- --------
Total liabilities and shareholder's equity ........ $ 102,629 $106,958
========= ========
Shareholders' Equity per Share ....................... 18.25 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) Nine Months
Ended September 30
1998 1997
----- ----
Cash Flows from Operating Activities
Income from continuing operations ................. $ (709) $ 2,265
Adjustments to reconcile income from continuing
operations to net cash provided by (used in)
operating activities:
Accrued investment income ....................... (88) (178)
Reinsurance receivables ......................... 985 (88)
Deferred Policy acquisition costs ............... (139) (315)
Income Taxes .................................... (842) 1,951
Depreciation expense ............................ 92 89
Policy liabilities and claims ................... 2,350 3,626
Other, net ...................................... (3,356) 491
-------- --------
Net cash (used in) provided by operating activities . (1,707) 7,841
-------- --------
Cash Flows from Investing Activities
Cost of investments acquired ................... (6,786) (17,043)
Sale and maturity of investments ............... 8,229 8,223
Purchase of property and equipment ............. (69) (95)
Proceeds from disposal of property and equipment 0 0
Other, net ..................................... 0 0
-------- --------
Net cash provided by (used in) investing activities 1,374 (8,915)
-------- --------
Cash Flows from Financing Activities
Decrease in other policyholder funds ........... (36) 77
Loan proceeds .................................. 1,887 0
Dividends paid ................................. (1,302) (1,182)
Purchase of treasury stock ..................... (722) (98)
-------- --------
Net cash used in financing activities ............... (173) (1,203)
-------- --------
Net decrease in cash and cash equivalents .......... (506) (2,277)
Cash and cash equivalents, beginning of period ...... 3,888 4,722
-------- --------
Cash and cash equivalents, end of period ............ $ 3,382 $ 2,445
======== ========
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 Omega One Insurance
Company ("Omega") are wholly owned property and casualty insurance subsidiaries
of The National Security Group, Inc ("The Company"). National Security Insurance
Company ("NSIC") is a wholly owned life insurance subsidiary of the Company. The
insurance subsidiaries reinsure certain portions of insurance risk which exceed
various retention limits. NSFC, Omega 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 September 30, 1998 was 2,279,000 and for the period ending
September 30, 1997 was 2,313,000.
Note 4-Changes in Shareholder's Equity (in thousands)
During the nine months ended September 30, 1998 and 1997, there were no changes
in shareholders' equity except for net (loss) income of $(709) and $2,265
respectively; dividends paid of $1,302 and $1,183 respectively; changes in
unrealized investment gains, net of applicable taxes, of $(2,182) and $3,223
respectively, and purchase of treasury stock of $722 and $70 respectively.
Note 5 - Deferred Taxes
The tax effect of significant temporary differences representing deferred tax
assets and liabilities are as follows:
(in thousands)
September 30, January 1,
1998 1998
------- -------
Deferred policy acquisition costs ...................... (1,514) (1,434)
Policy liabilities ..................................... 526 519
Unearned premiums ...................................... 549 442
Claims liabilities ..................................... 643 530
General insurance expenses ............................. 700 931
Unrealized gains on securities available-for-sale ...... (4,231) (5,066)
Other .................................................. (56) 0
------ ------
Net deferred tax liability ............................. (3,383) (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. 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 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
(loss) income was $(2.9 million) and $5.4 million at September 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.
Note 9-Subsequent Events
On October 7, 1998 the Company repurchased 219,707 shares of its common stock,
representing 9.7% of the total shares outstanding. The shares were repurchased
at the market price of $11.51 per share. The repurchase was partially funded by
an unsecured short term 7.8% loan from a local bank in the amount of $2,350,000.
Management intends to secure long term financing of this debt before maturity,
and repay the loan from dividends of subsidiaries.
8
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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 September 30, 1998, compared with December 31, 1997
and its results of operations and cash flows for the quarter ending September
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 nine month period ending September 30, 1998 was $21.7
million versus $23.8 million for the same period last year. This reduction in
premium is primarily due to a property/casualty subsidiary eliminating a private
passenger automobile program in Louisiana. The subsidiary has also reduced
automobile premium writings in Georgia during 1998. To help replace premium lost
from these programs 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 comparable to last year.
Realized capital gains and losses:
Investment gains of $2.5 million were realized in the first nine months of 1998.
Investment gains of $2.1 million were realized in the first nine months of 1997.
With many of the Company's equity investment holdings rapidly increasing in
value over the last three years, 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.
9
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Policyholder benefits and settlement expenses:
Policyholder benefits as a percent of net insurance premiums earned are up
considerably from last year, 85% versus 72%. There are several factors which
have contributed to the large increase in policyholder benefits and settlement
expenses during 1998. Late in the third quarter of 1998 Hurricane Georges made
landfall on the coast of Mississippi causing widespread, mostly moderate, damage
to property insured by the Company in south Mississippi and southwest Alabama.
Current estimates of losses incurred from Hurricane Georges are $1.2 million.
The second major factor contributing to the increase in policy holder benefits
is losses incurred from the previously mentioned Louisiana private passenger
automobile program. This program was canceled earlier this year due to the poor
underwriting results and unfavorable legal and regulatory climate in Louisiana.
The third major factor contributing to the poor underwriting results was 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.
The unpredictability of hurricane and tornado losses is inherent in the dwelling
property insurance business. The Company maintains catastrophe reinsurance
coverage to prevent catastrophic natural disaster related losses from having a
material impact on the Company's financial condition, but such losses will have
a material impact on the Company's results of operations(current net income) in
the period incurred.
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 24% 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 up slightly due to an increase in written
premium in the State of Florida and an increase in guaranty fund assessments.
Income taxes:
The Company has an income tax benefit due to the current years net operating
loss.
Summary:
The Company has a year to date net loss of $700,000 versus net income of $2.3
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, windstorm, and hurricane losses incurred in
low value dwelling and homeowners property insurance programs.
10
<PAGE>
Investments:
Investments decreased during the third quarter of 1998. The Company's equity
portfolio had a decrease in unrealized gains during the third quarter as the
overall stock market suffered a decline. Also, several of the Company's bonds
were called during the third quarter as interest rates continued to decline. The
cash from these investments were used to pay the litigation settlement discussed
in the notes to the financial statements.
Capital resources:
At September 30, 1998, the Company had aggregate equity capital, unrealized
investment gains (net of income taxes) and retained earnings of $41.4 million,
down $4.9 million from December 31, 1997. The decrease reflects a net loss of
$709,000, a decrease in unrealized investment gains of $2.1 million, dividends
paid of $1.3 million, 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.
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 $3.4 million in cash and cash equivalents at September 30, 1998.
Net cash used in operating activities was $1.7 million for the current period,
compared to net cash provided of $7.8 million for the period ended September 30,
1997. Cash provided by investing activities was $1.4 million. Cash dividends
paid to stockholders' of $1.3 million and treasury stock purchased of $722,000
are the primary uses of cash used in financing activities.
11
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Part II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
See Exhibit Index
12
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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: November 13, 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 Incorporated by
reference; dated
October 12, 1998
14
<TABLE> <S> <C>
<ARTICLE> 7
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<DEBT-HELD-FOR-SALE> 20,295
<DEBT-CARRYING-VALUE> 30,494
<DEBT-MARKET-VALUE> 31,779
<EQUITIES> 29,002
<MORTGAGE> 154
<REAL-ESTATE> 1,599
<TOTAL-INVEST> 82,196
<CASH> 3,382
<RECOVER-REINSURE> 7,504
<DEFERRED-ACQUISITION> 4,355
<TOTAL-ASSETS> 102,629
<POLICY-LOSSES> 18,817
<UNEARNED-PREMIUMS> 9,724
<POLICY-OTHER> 23,575
<POLICY-HOLDER-FUNDS> 1,693
<NOTES-PAYABLE> 687
0
0
<COMMON> 2,340
<OTHER-SE> 39,091
<TOTAL-LIABILITY-AND-EQUITY> 102,629
21,716
<INVESTMENT-INCOME> 3,217
<INVESTMENT-GAINS> 2,511
<OTHER-INCOME> 411
<BENEFITS> 18,282
<UNDERWRITING-AMORTIZATION> 4,405
<UNDERWRITING-OTHER> 5,915
<INCOME-PRETAX> (747)
<INCOME-TAX> (38)
<INCOME-CONTINUING> (709)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (709)
<EPS-PRIMARY> (.31)
<EPS-DILUTED> (.31)
<RESERVE-OPEN> 0
<PROVISION-CURRENT> 0
<PROVISION-PRIOR> 0
<PAYMENTS-CURRENT> 0
<PAYMENTS-PRIOR> 0
<RESERVE-CLOSE> 0
<CUMULATIVE-DEFICIENCY> 0
</TABLE>
