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 EXCHANGE
ACT OF 1934
For the quarterly period ended September 30, 2002
-------------------------------------------------
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 1-6026
---------------------------------------------------------
The Midland Company
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Ohio 31-0742526
------------------------------- -----------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
7000 Midland Boulevard, Amelia, Ohio 45102-2607
-----------------------------------------------
(Address of principal executive offices)
(Zip Code)
(513) 943-7100
--------------
(Registrant's telephone number, including area code)
N/A
---
(Former name, former address and former fiscal year, if changed
since last report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months, and (2) has been subject to such filing
requirements for the past 90 days.
Yes X . No .
----- -----
The number of common shares outstanding as of October 31, 2002 was
17,560,689.
PART I - ITEM 1. FINANCIAL INFORMATION
THE MIDLAND COMPANY
AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, 2002 AND DECEMBER 31, 2001
Amounts in 000's
(UNAUDITED)
SEPT. 30, DEC. 31,
ASSETS 2002 2001
-------------- --------------
MARKETABLE SECURITIES AVAILABLE FOR SALE:
Fixed income (cost, $557,798 at September 30, 2002 and
$542,563 at December 31, 2001) $ 587,111 $ 555,159
Equity (cost, $93,686 at September 30, 2002 and $91,191
at December 31, 2001) 128,056 148,850
-------------- --------------
Total 715,167 704,009
-------------- --------------
CASH 7,791 11,286
-------------- --------------
ACCOUNTS RECEIVABLE - NET 101,137 88,108
-------------- --------------
REINSURANCE RECOVERABLES AND
PREPAID REINSURANCE PREMIUMS 76,155 69,795
-------------- --------------
PROPERTY, PLANT AND EQUIPMENT - NET 61,618 59,095
-------------- --------------
DEFERRED INSURANCE POLICY ACQUISITION COSTS 102,261 100,785
-------------- --------------
OTHER ASSETS 17,869 20,864
-------------- --------------
TOTAL ASSETS $ 1,081,998 $ 1,053,942
============== ==============
See notes to condensed consolidated financial statements.
THE MIDLAND COMPANY
AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, 2002 AND DECEMBER 31, 2001
Amounts in 000's
(UNAUDITED)
SEPT. 30, DEC. 31,
LIABILITIES & SHAREHOLDERS' EQUITY 2002 2001
-------------------- --------------------
UNEARNED INSURANCE PREMIUMS $ 430,149 $ 403,855
-------------------- --------------------
INSURANCE LOSS RESERVES 160,078 148,674
-------------------- --------------------
INSURANCE COMMISSIONS PAYABLE 30,181 26,887
-------------------- --------------------
FUNDS HELD UNDER REINSURANCE AGREEMENTS
AND REINSURANCE PAYABLES 6,341 6,297
-------------------- --------------------
LONG-TERM DEBT 47,533 48,619
-------------------- --------------------
OTHER NOTES PAYABLE:
Banks 29,000 26,000
Commercial paper 5,327 9,522
-------------------- --------------------
Total 34,327 35,522
-------------------- --------------------
DEFERRED FEDERAL INCOME TAX 28,896 31,803
-------------------- --------------------
OTHER PAYABLES AND ACCRUALS 49,857 60,409
-------------------- --------------------
COMMITMENTS AND CONTINGENCIES - -
-------------------- --------------------
SHAREHOLDERS' EQUITY:
Common stock (issued and outstanding: 17,570 shares at
September 30, 2002 and 17,660 shares at December 31,
2001 after deducting treasury stock of 4,286 shares and
4,196 shares, respectively) 911 911
Additional paid-in capital 22,405 20,386
Retained earnings 272,897 264,057
Accumulated other comprehensive income 40,294 45,875
Treasury stock - at cost (41,465) (38,698)
Unvested restricted stock awards (406) (655)
-------------------- --------------------
Total 294,636 291,876
-------------------- --------------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 1,081,998 $ 1,053,942
==================== ====================
See notes to condensed consolidated financial statements.
THE MIDLAND COMPANY
AND SUBSIDIARIES
STATEMENTS OF CONDENSED CONSOLIDATED INCOME (UNAUDITED)
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2002 AND 2001
Amounts in 000's (except per share information)
NINE-MOS. ENDED SEPT. 30, THREE-MOS. ENDED SEPT. 30,
---------------------------- --------------------------
2002 2001 2002 2001
-------------- ------------ ------------ ------------
REVENUES:
Insurance:
Premiums earned $ 425,794 $ 372,756 $ 148,417 $ 130,459
Net investment income 26,114 25,538 8,706 8,328
Net realized investment gains (losses) (6,968) 1,406 (5,607) (2,115)
Other insurance income 4,660 5,099 1,543 2,090
Transportation 16,815 25,792 5,404 8,238
Other 437 351 96 97
-------------- ------------ ------------- ------------
Total 466,852 430,942 158,559 147,097
-------------- ------------ ------------- ------------
COSTS AND EXPENSES:
Insurance:
Losses and loss adjustment expenses 250,686 218,296 98,473 80,615
Commissions and other policy acquisition costs 124,049 106,571 41,704 37,857
Operating and administrative expenses 56,501 54,597 17,351 18,266
Transportation operating expenses 16,666 24,150 5,118 7,836
Interest expense 2,703 3,502 850 912
Other operating and administrative expenses 1,015 625 417 133
-------------- ------------ ------------- ------------
Total 451,620 407,741 163,913 145,619
-------------- ------------ ------------- ------------
INCOME (LOSS) BEFORE FEDERAL INCOME TAX
AND CUMULATIVE EFFECT OF CHANGE
IN ACCOUNTING PRINCIPLE 15,232 23,201 (5,354) 1,478
PROVISION (CREDIT) FOR FEDERAL INCOME TAX 2,625 5,634 (2,739) (330)
-------------- ------------ ------------- ------------
INCOME (LOSS) BEFORE CUMULATIVE EFFECT OF
CHANGE IN ACCOUNTING PRINCIPLE 12,607 17,567 (2,615) 1,808
CUMULATIVE EFFECT OF CHANGE IN
ACCOUNTING PRINCIPLE - NET (1,463) - - -
-------------- ------------ ------------- ------------
NET INCOME (LOSS) $ 11,144 $ 17,567 $ (2,615) $ 1,808
============== ============ ============= ============
BASIC EARNINGS (LOSSES) PER SHARE
OF COMMON STOCK:
Income before change in accounting principle $ 0.72 $ 1.01 $ (0.15) $ 0.11
Cumulative effect of change in accounting principle (0.08) - - -
-------------- ------------ ------------- ------------
Total $ 0.64 $ 1.01 $ (0.15) $ 0.11
============== ============ ============= ============
DILUTED EARNINGS (LOSSES) PER SHARE
OF COMMON STOCK:
Income before change in accounting principle $ 0.70 $ 0.98 $ (0.15) $ 0.10
Cumulative effect of change in accounting principle (0.08) - - -
-------------- ------------ ------------- ------------
Total $ 0.62 $ 0.98 $ (0.15) $ 0.10
============== ============ ============= ============
CASH DIVIDENDS DECLARED PER SHARE
OF COMMON STOCK $ .13125 $ .1200 $ 0.04375 $ 0.0400
============== ============ ============= ============
See notes to condensed consolidated financial statements. All per share amounts
are adjusted for the two-for-one stock split effective July 17, 2002 (Note 2).
THE MIDLAND COMPANY AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (UNAUDITED)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2002 AND 2001
Amounts in 000's
ACCUMULATED
ADDITIONAL OTHER COM-
COMMON PAID-IN RETAINED PREHENSIVE TREASURY
STOCK CAPITAL EARNINGS INCOME STOCK
--------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 2000 $ 911 $ 19,838 $239,679 $ 54,396 $(30,404)
Comprehensive income:
Net income 17,567
Decrease in unrealized gain on
marketable securities, net of related
income tax effect of $3,511 (6,582)
Total comprehensive income
Purchase of treasury stock (8,539)
Issuance of treasury stock for options
exercised and employee savings plan (504) 2,429
Cash dividends declared (2,137)
Federal income tax benefit related to the
exercise or granting of stock awards 854
Amortization and cancellation of
unvested restricted stock awards (12) (11)
--------------------------------------------------------------------------------
BALANCE, SEPTEMBER 30, 2001 $ 911 $ 20,176 $255,109 $ 47,814 $(36,525)
================================================================================
BALANCE, DECEMBER 31, 2001 $ 911 $ 20,386 $264,057 $ 45,875 $(38,698)
Comprehensive income:
Net income 11,144
Decrease in unrealized gain on
marketable securities, net of related
income tax effect of $2,253 (4,366)
Other, net of federal income tax of $654 (1,215)
Total comprehensive income
Purchase of treasury stock (3,593)
Issuance of treasury stock for options
exercised and employee savings plan 484 853
Cash dividends declared (2,304)
Federal income tax benefit related to the
exercise or granting of stock awards 1,561
Amortization and cancellation of
unvested restricted stock awards (26) (27)
--------------------------------------------------------------------------------
BALANCE, SEPTEMBER 30, 2002 $ 911 $ 22,405 $272,897 $ 40,294 $(41,465)
================================================================================
UNVESTED
RESTRICTED COMPRE-
STOCK HENSIVE
AWARDS TOTAL INCOME
------------------------------------------
BALANCE, DECEMBER 31, 2000 $ (1,243) $283,177
Comprehensive income:
Net income 17,567 $17,567
Decrease in unrealized gain on
marketable securities, net of related
income tax effect of $3,511 (6,582) (6,582)
-------------
Total comprehensive income $10,985
=============
Purchase of treasury stock (8,539)
Issuance of treasury stock for options
exercised and employee savings plan 1,925
Cash dividends declared (2,137)
Federal income tax benefit related to the
exercise or granting of stock awards 854
Amortization and cancellation of
unvested restricted stock awards 438 415
----------------------------
BALANCE, SEPTEMBER 30, 2001 $ (805) $286,680
============================
BALANCE, DECEMBER 31, 2001 $ (655) $291,876
Comprehensive income:
Net income 11,144 $11,144
Decrease in unrealized gain on
marketable securities, net of related
income tax effect of $2,253 (4,366) (4,366)
Other, net of federal income tax of $654 (1,215) (1,215)
-------------
Total comprehensive income $5,563
=============
Purchase of treasury stock (3,593)
Issuance of treasury stock for options
exercised and employee savings plan 1,337
Cash dividends declared (2,304)
Federal income tax benefit related to the
exercise or granting of stock awards 1,561
Amortization and cancellation of
unvested restricted stock awards 249 196
----------------------------
BALANCE, SEPTEMBER 30, 2002 $ (406) $294,636
============================
See notes to condensed consolidated financial statements.
THE MIDLAND COMPANY AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2002 AND 2001
AMOUNT IN 000'S
2002 2001
------------------- -------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 11,144 $ 17,567
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 6,013 6,216
Cumulative effect of change in accounting for goodwill 2,251 -
Net realized investment losses (gains) 6,386 (1,406)
Increase in unearned insurance premiums 26,294 55,419
Increase in net accounts receivable (13,029) (32,606)
Increase in insurance loss reserves 11,404 11,011
Decrease in other accounts payable and accruals (10,918) (17,488)
Increase in reinsurance recoverables and
prepaid reinsurance premiums (6,360) (13,497)
Increase (decrease) in insurance commissions payable 3,294 (1,230)
Increase in deferred insurance policy acquisition costs (1,476) (12,960)
Decrease in other assets 744 5,624
Increase in funds held under reinsurance
agreements and reinsurance payables 44 634
Other-net 912 487
------------------- -------------------
Net cash provided by operating activities 36,703 17,771
------------------- -------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of marketable securities (209,125) (164,805)
Sale of marketable securities 130,363 131,198
Maturity of marketable securities 42,963 23,051
Decrease in cash equivalent marketable securities 10,721 29,029
Acquisition of property, plant and equipment (8,497) (5,613)
Proceeds from sale of property, plant and equipment 159 220
------------------- -------------------
Net cash provided by (used in) investing activities (33,416) 13,080
------------------- -------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Purchase of treasury stock (3,593) (8,539)
Dividends paid (2,245) (2,110)
Issuance of treasury stock 1,337 1,925
Decrease in net short-term borrowings (1,195) (19,833)
Repayment of long-term debt (1,086) (1,049)
------------------- -------------------
Net cash used in financing activities (6,782) (29,606)
------------------- -------------------
NET INCREASE (DECREASE) IN CASH (3,495) 1,245
CASH AT BEGINNING OF PERIOD 11,286 8,391
------------------- -------------------
CASH AT END OF PERIOD $ 7,791 $ 9,636
=================== ===================
INTEREST PAID $ 2,778 $ 3,384
INCOME TAXES PAID $ 6,000 $ 2,900
See notes to the condensed consolidated financial statements.
THE MIDLAND COMPANY AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
SEPTEMBER 30, 2002
1. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements of The
Midland Company and subsidiaries ("Midland" or the "Company") have been prepared
in accordance with accounting principles generally accepted in the United States
of America for interim financial information and with the instructions to Form
10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of
the information and footnotes required by accounting principles generally
accepted in the United States of America for complete annual financial
statements. In the opinion of management, all adjustments (consisting of normal
recurring accruals) considered necessary for a fair presentation have been
included. Financial information as of December 31, 2001 has been derived from
the audited consolidated financial statements of the Company. Revenue and
operating results for the nine and three-month periods ended September 30, 2002
are not necessarily indicative of the results that may be expected for the year
ending December 31, 2002. For further information, refer to the audited
consolidated financial statements and footnotes thereto for the year ended
December 31, 2001 included in the Company's Annual Report on Form 10-K.
Certain reclassifications (minor in nature) have been made to the 2001 amounts
to conform to 2002 classifications.
2. TWO-FOR-ONE STOCK SPLIT
On June 17, 2002, Midland announced a two-for-one stock split effective July 17,
2002 for holders of record on July 8, 2002. Accordingly, data related to
Midland's common stock (number of shares, average shares outstanding, earnings
per share and dividends per share) have been adjusted for the current and prior
periods to reflect the impact of this stock split.
3. EARNINGS PER SHARE
Earnings per share (EPS) of common stock amounts are computed by dividing net
income by the weighted average number of shares outstanding during the period
for basic EPS, plus the dilutive share equivalents for stock options and
restricted stock awards for diluted EPS. Shares used for EPS calculations were
as follows (000's):
For Basic EPS For Diluted EPS
------------- ---------------
Nine months ended Sept. 30:
2002 17,312 17,868
====== ======
2001 17,314 18,010
====== ======
Three months ended Sept. 30:
2002 17,341 17,341
====== ======
2001 17,254 17,932
====== ======
Potential diluted common shares of 576 were not included in computing
diluted per share amounts for the three months ended September 30, 2002 because
the effects were anti-dilutive.
4. INCOME TAXES
The federal income tax provisions for the three and nine-month periods ended
September 30, 2002 and 2001 are different from amounts derived by applying the
statutory tax rates to income before federal income tax as follows (000's):
NINE-MOS. ENDED SEPT. 30, THREE-MOS. ENDED SEPT. 30,
------------------------- --------------------------
2002 2001 2002 2001
---- ---- ---- ----
Federal income tax at statutory rate (including
a tax credit of $787 in 2002 on the
cumulative effect of change in accounting
principle) $4,544 $8,120 $(1,873) $517
Add (deduct) the tax effect of:
Tax exempt interest and
excludable dividend income (2,965) (2,721) (954) (923)
Other - net 259 235 88 76
---------- ---------- ----------- ----------
Provision (credit) for federal income tax $1,838 $5,634 $(2,739) $(330)
========== ========== =========== ==========
5. SEGMENT DISCLOSURES
Since Midland's annual report for 2001, there have been no changes in reportable
segments or the manner in which Midland determines reportable segments or
measures segment profit or loss. Summarized segment information for the interim
periods for 2002 and 2001 is as follows (000's):
Nine Months Ended Sept. 30, 2002 Three Months Ended Sept. 30, 2002
-------------------------------- ---------------------------------
Revenues- Pre-Tax Revenues-
Total External Income External Pre-Tax
Assets Customers (Loss) Customers Income (Loss)
------ --------- ------ --------- -------------
Reportable Segments:
Insurance:
Manufactured housing n/a $244,016 $13,689 $81,953 $ (179)
Other n/a 186,438 4,585 68,007 (4,383)
Unallocated $1,034,653 - (1,029) - (351)
Transportation 22,585 16,815 8 5,404 219
Corporate and all other - - (2,021) - (660)
--------- ----------
$15,232 $(5,354)
======== ==========
Nine Months Ended Sept. 30, 2001 Three Months Ended Sept. 30, 2001
-------------------------------- ---------------------------------
Revenues- Pre-tax Revenues-
Total External Income External Pre-tax
Assets Customers (Loss) Customers Income (Loss)
------ --------- ------ --------- -------------
Reportable Segments:
Insurance:
Manufactured housing n/a $238,195 $ 19,693 $79,987 $7,408
Other n/a 139,660 5,380 52,562 (5,502)
Unallocated $970,241 - (756) - (73)
Transportation 26,296 25,792 1,424 8,238 344
Corporate and all other n/a - (2,540) - (699)
--------- --------
$23,201 $1,478
======== ========
Intersegment revenues are insignificant. Revenues reported above, by definition,
exclude investment income and realized gains. Certain amounts are not allocated
to segments ("n/a" above) by the Company.
6. CHANGE IN ACCOUNTING PRINCIPLE
On January 1, 2002 Midland adopted SFAS No. 142, "Goodwill and Other Intangible
Assets." SFAS No. 142 changed the accounting for goodwill from an amortization
method to the impairment approach. Upon the adoption of the statement, Midland
ceased amortizing goodwill, including goodwill recorded from past business
combinations. As a result of the initial impairment test, Midland recorded an
impairment charge of $(1,463,000) (net of tax), or $(0.08) per share (diluted),
in its Other Insurance segment for the quarter ended March 31, 2002. This charge
is reported separately in Midland's income statement as a Cumulative Effect of
Change in Accounting Principle. The fair value of that reporting unit was
estimated using the expected present value of future cash flows. There were no
additional impairment charges incurred in the nine months ended September 30,
2002. At September 30, 2002, Midland's remaining goodwill balance, all of which
is attributable to the Other Insurance segment, was $2,145,000.
The following table illustrates what reported net income would have been
exclusive of amortization expense related to goodwill had Midland adopted the
standard effective January 1, 2001 (amounts in 000's except per share data):
FOR THE NINE-MONTHS FOR THE THREE-MONTHS
ENDED SEPT. 30, ENDED SEPT. 30,
-------------------------- ------------------------
2002 2001 2002 2001
---- ---- ---- ----
Reported net income (loss) $11,144 $17,567 $(2,615) $1,808
Add back: goodwill amortization (net tax) -- 287 -- 95
------- ------- ------- ------
Adjusted net income (loss) $11,144 $17,854 $(2,615) $1,903
======= ======= ======= ======
Basic earnings (loss) per share:
Reported net income $0.64 $1.01 $(0.15) $0.11
Goodwill amortization -- 0.02 -- 0.01
------- ------- ------- ------
Adjusted net income (loss) $0.64 $1.03 $(0.15) $0.12
======= ======= ======= ======
Diluted earnings (loss) per share:
Reported net income $0.62 $0.98 $(0.15) $0.10
Goodwill amortization -- 0.02 -- 0.01
------- ------- ------- ------
Adjusted net income (loss) $0.62 $1.00 $(0.15) $0.11
======= ======= ======= ======
7. NEW ACCOUNTING STANDARDS
The Financial Accounting Standards Board issued Statement of Financial
Accounting Standards ("SFAS") No. 145 "Rescission of FASB Statements No. 4, 44
and 64, Amendment of FASB Statement No. 13, and Technical Corrections" in April
2002, SFAS No. 146 "Accounting for Costs Associated with Exit or Disposal" in
June 2002 and SFAS No. 147 "Accounting for Certain Acquisitions of Banking or
Thrift Institutions - an amendment of FASB Statement No. 72 and 144 and FASB
Interpretations No. 9" in October 2002. The adoption of SFAS No. 145, SFAS No.
146 and SFAS No. 147 will not have a material impact on Midland's consolidated
financial position or results of operations.
8. SUBSEQUENT EVENT
During October 2002, American Modern experienced losses from Hurricane Lili in
Louisiana. Preliminary loss data suggest that the fourth quarter results could
be impacted by approximately $(0.35) to $(0.40) per share (after-tax, diluted)
from this event.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with our
consolidated financial statements and the related footnotes. This discussion
contains forward-looking statements. Forward-looking statements reflect our
current views about future events, are based on assumptions and are subject to
known and unknown risks and uncertainties. Many important factors could cause
actual results or achievements to differ materially from any future results or
achievements expressed or implied by forward-looking statements.
INTRODUCTION
The discussions of "Results of Operations" and "Liquidity, Capital
Resources and Changes in Financial Condition" address our three reportable
segments, which are manufactured housing insurance, all other insurance products
and services and transportation. A summary description of the operations of each
of these segments is included below.
Our specialty insurance operations are conducted through American Modern
which controls six property and casualty insurance companies, two credit life
insurance companies, three licensed insurance agencies and three service
companies. American Modern is licensed, through its subsidiaries, to write
insurance premium in all 50 states and the District of Columbia. More than 50%
of American Modern's property and casualty business relates to physical damage
insurance and related coverages on manufactured homes, generally written for a
term of 12 months with coverages similar to conventional homeowner's insurance
policies. All other insurance products and services include the other specialty
insurance products such as watercraft, motorsports, recreational vehicles,
homeowners, site-built, extended service contracts, dwelling fire, mortgage
fire, collateral protection, credit life, long-haul truck, commercial, excess
and surplus lines and also includes the results of our fee producing
subsidiaries.
M/G Transport charters barges and brokers freight for the movement of dry
bulk commodities such as petroleum coke, ores, barite, fertilizers, sugar and
other dry cargoes primarily on the lower Mississippi River and its tributaries.
OVERVIEW OF RECENT TRENDS
Motorcycle and Homeowners/Site-built Premium Increasing. While manufactured
housing insurance remains American Modern's largest single product, over the
most recent 18 months, motorcycle and homeowners/site-built insurance have
become more significant to the growth in premium volume. In the second half of
2000, American Modern acquired the motorsport book (motorcycle and, to a lesser
extent, snowmobile and watercraft) from GuideOne Insurance Company. Through the
first nine months, motorcycle gross written premium increased 52.5% over 2001
levels. American Modern's future growth in motorcycle premium is expected to be
more consistent with the rate of growth in our total premium volume. Premium
from site-built insurance has increased for American Modern due to a tightening
of underwriting restrictions by standard carriers with respect to
homeowners/site-built risks. Through the first nine months of 2002,
homeowners/site-built written premium increased substantially over 2001 levels.
During the third quarter of 2002, American Modern decided to discontinue certain
unprofitable homeowner programs. American Modern is currently undertaking a
careful review of all of its homeowners programs with the intent of tightening
the product offering to target only those properties that fall outside the
parameters of the standard homeowner's insurance market. As a result of these
actions, American Modern's future growth in the homeowners/site-built product
lines is expected to be significantly reduced from the current growth rate.
Manufactured Housing Premium. Manufactured homes have historically
represented approximately one out of every five new single family housing starts
in the United States. The industry became over built during the period between
1997 and 1999 as credit became readily available. New manufactured home sales
will likely be slower than historical averages during the remainder of 2002.
American Modern has experienced a decrease in its manufactured housing insurance
premium volume due to its focus on placing insurance in connection with the
purchase of new manufacturing housing units. In the first nine months of 2002,
American Modern's manufactured housing insurance premium was approximately 12%
less than in the same period in 2001, although the reduction was primarily as a
result of American Modern's decision to terminate unprofitable business.
Rate Increases. Over the past 12 months, we have been approved for and are
implementing nationwide rate increases in our manufactured housing products. The
majority of these increases, which have averaged in excess of 10%, were approved
as of September 30, 2002. Also over the past 12 months, we have been approved
for, and are implementing rate increases in other major product lines.
Throughout the past 10 years, American Modern has been able to implement
periodic rate increases. We do not have any assurance or expectation that we
will be able to experience double digit rate increases beyond 2002.
Fire Loss Ratio. American Modern experienced higher than normal levels of
losses caused by fire in mobile home and site-built units during the second half
of 2000 and continuing through most of 2001. It is our belief that the fire loss
ratio will tend to increase during economic downturns. While American Modern's
fire loss ratio remains higher than normal, it has improved considerably during
the first six months of 2002. However, in July and August of 2002 American
Modern experienced an upward spike in its fire loss ratio. This negative trend
reversed in September 2002. It is our belief that the increase in fire losses in
July and August was an anomaly. As discussed, in response to this trend,
American Modern has been aggressively pursuing rate increases in its mobile home
products and discontinued some unprofitable homeowners/site-built programs.
Changing Mix of American Modern's Distribution Channels. American Modern
has experienced a significant increase in the percentage of its gross written
premium generated through its agency channel. American Modern's agency channel
growth was driven by its growth in motorsport premium from the acquisition of
business of GuideOne and was also due to American Modern's successful conversion
of agency books of business to American Modern from other insurance companies.
American Modern's premium volume generated by its lender and point of sale
channels decreased from 2000 to 2001 and during the first nine months of 2002 as
a result of the slowdown in new manufactured housing sales and the decision to
terminate certain unprofitable books of business.
Discontinued Commercial Liability. In September 2001, American Modern
announced that it was exiting the commercial liability line of coverages that
had been provided to manufactured home parks and dealerships. Through the first
nine months of 2002, American Modern continued to write related commercial lines
coverages in those states that had required longer notices of terminations.
Related premium volume was less than $3.3 million in the first nine months of
2002 and is expected to be minimal the remainder of 2002. In the first nine
months of 2002, our earnings per share included losses of $0.02 per share
compared to losses of $0.31 per share in the first nine months of 2001 related
to this line of business.
Credit Life Changes. Several states have enacted laws designed to prohibit
or limit the ability to sell single premium credit life insurance in connection
with residential real estate financings. Changes in federal regulations,
effective in October, 2002, will have the result of imposing additional
disclosure requirements in connection with single credit life insurance
products. Due to this regulation, lenders will most likely change to either
monthly credit life insurance or other debt protection type products payable on
a monthly basis. As a result, American Modern will most likely experience a
decrease in its total credit life insurance premium volume written in the fourth
quarter of 2002 and in 2003, although it should not have significant impact on
earned premium for the life business.
Shift Away from Chattel Financing. Manufactured housing sales have
traditionally been financed as personal property through a financing transaction
referred to as chattel financing. Several large chattel lenders over the past 18
months have ceased, or substantially reduced, lending for manufactured housing.
As a result, manufactured housing sales have slowed and there has been a shift
to more traditional mortgage loan financing on manufactured homes. American
Modern has or had relationships with several of the chattel lenders who reduced
their lending or exited this market. This, coupled with American Modern's
decision to terminate certain unprofitable business in the lender channel, has
resulted in a decrease in the amount of premium volume American Modern has
generated through its lender channel.
RESULTS OF OPERATIONS
INSURANCE
Insurance Premium
Property and casualty and life insurance gross written premium increased
7.0% in the third quarter to $172.1 million from $160.9 million for the same
quarter in 2001. Net earned premium for the third quarter of 2002 increased
13.8% to $148.4 million from $130.5 million for the comparable quarter in 2001.
On a year-to-date basis, gross written premium generated by American Modern's
insurance operations increased 6.7% to $492.3 million from $461.6 million for
the same nine-month period in 2001. The growth in gross written premium is
attributable to both premium rate and volume increases. The volume increases
resulted from the continued growth of American Modern's other specialty products
such as motorcycle, site-built and credit life. Year-to-date earned premium
increased 14.2% to $425.8 million from $372.8 million in 2001.
The growth in gross written premium is primarily due to the growth in
non-manufactured housing (which we refer to as other specialty property and
casualty products) and credit life insurance products. Gross written premium
related to other specialty property and casualty products collectively increased
37.8% to $78.6 million in the third quarter of 2002 from $57.0 million in the
third quarter of 2001. On a year-to-date basis, the gross written premium for
other specialty property and casualty products increased 30.8% to $220.7 million
in the first nine months of 2002 from $168.7 million in the comparable period in
2001. This growth is primarily the result of concentrated efforts over the past
several years to add balance and diversity to American Modern's product lines
and is largely attributable to the continued growth in motorcycle and
homeowners/site-built lines.
Manufactured housing gross written premium decreased 10.7% to $82.2 million
during the third quarter of 2002 from $92.0 million in the comparable period in
2001. On a year-to-date basis, manufactured housing gross written premium has
decreased 11.7% to $230.8 million during the first nine months of 2002 from
$261.3 million during the comparable period in 2001. The decline in gross
written premium is due to the adverse market conditions which currently exist in
the manufactured housing sector, coupled with American Modern's decision to
terminate certain unprofitable business in the lender channel.
Credit life gross written premium increased 3.6% to $11.3 million in the
third quarter of 2002 from $10.9 million during the prior year's quarter. On a
year-to-date basis, credit life gross written premium increased 33.6% to $40.8
million from $30.5 million during the comparable period in 2001. This growth in
credit life premium is due primarily to the expansion of our relationship with
U.S. Bancorp.
American Modern's largest producer, Conseco Agency, a subsidiary of Conseco
Inc. (CNCE.OB), accounted for less than 10 percent of American Modern's total
direct and assumed written premiums in the first nine months of 2002 as compared
to more than 16 percent of total premium for the first nine months of the prior
year. Of the premiums that will be written through Conseco in 2002, American
Modern expects more than 90 percent of the volume would result from the renewal
of policies from existing Conseco Agency policyholders.
Other Insurance Income (Fee Income)
American Modern's other insurance income decreased 26.2% to $1.5 million in
the third quarter of 2002 compared to the same quarter in 2001. On a
year-to-date basis, American Modern's Other Insurance Income decreased 8.6% to
$4.7 million in 2002 compared to 2001. These decreases are the result of the
discontinuance of an unprofitable agency operation. AMIG is committed to
increasing its fee income and Ameritrac(R), AMIG's portfolio tracking operation,
continues to expand its client base and grow its loan-tracking portfolio.
Insurance Investment Income and Realized Capital Gains
American Modern's net investment income (before taxes and excluding net
realized capital gains) increased 4.5% to $8.7 million in the third quarter of
2002 from $8.3 million in the third quarter of 2001. On a year-to-date basis,
net investment income increased 2.3% to $26.1 million from $25.5 million during
the same period in the prior year. Net investment income increased due to the
growth in American Modern's investment portfolio which increased due to cash
flow from operations over the last twelve months. Reinvestment rates relative to
American Modern's fixed income portfolio continue to be depressed. The
annualized pre-tax equivalent investment yield on American Modern's fixed income
investments, which is net interest income divided by the average amount of fixed
income assets, was 5.7% during the first nine months 2002 and 6.1% during the
first nine months of 2001.
After-tax losses from embedded derivatives which are included in net
realized capital losses, amounted to $(0.6) million, $(0.03) per share
(diluted), during the third quarter of 2002 and $(0.7) million, $(0.04) per
share (diluted), during the third quarter of 2001. On a year-to-date basis,
after-tax losses from embedded derivatives amounted to $(0.4) million, $(0.02)
per share (diluted), during the first nine months of 2002 as compared to $(0.2)
million, $(0.01) per share (diluted), during the comparable period in 2001.
These embedded derivatives relate to the equity conversion features attributable
to the convertible preferred stocks and convertible debentures held in American
Modern's convertible security portfolio. American Modern's investment portfolio
does not currently include any other types of derivative investments.
Also included in net realized capital losses for the three and nine months
ended September 30, 2002 were after-tax losses of $(2.4) million, $(0.13) per
share (diluted), resulting from the write-down (other than temporary impairment)
of several lower rated bonds/convertible securities in American Modern's
investment portfolio.
Excluding the impact of losses from derivatives and other than temporary
impairments referred to above, American Modern's net realized after-tax capital
gains (losses) were $(0.7) million, $(0.04) per share (diluted), in the third
quarter of 2002 and 2001. On a year-to-date basis, net realized after-tax
capital gains (losses), excluding the impact of embedded derivatives and
impairments, decreased to a loss of $(1.8) million, $(0.10) per share (diluted),
in 2002 from a gain of $1.1 million, $0.06 per share (diluted), in 2001.
Insurance Losses and Loss Adjustment Expenses (LAE)
American Modern's loss and loss adjustment expenses in the third quarter of
2002 increased 22.2% to $98.5 million from $80.6 million for the third quarter
of 2001 due to the continued growth in net earned premium, increases in
weather-related catastrophe losses, higher than normal fire losses and the
anticipated seasonal upswing in losses related to our motorcycle and watercraft
products. Other events contributing to our third quarter of 2002 losses were
Texas floods in July and Tropical Storm Isidore in September. American Modern's
total weather-related catastrophe losses (net of reinsurance recoveries) for the
third quarter of 2002 amounted to $4.4 million on a pre-tax basis compared with
$1.2 million for the same quarter of 2001. These losses had an after-tax impact
of approximately $0.16 per share (diluted), in the third quarter of 2002
compared to $0.04 per share (diluted), in the third quarter of 2001.
On a year-to-date basis, American Modern's loss and loss adjustment
expenses increased 14.8% to $250.7 million from $218.3 million for the same
nine-month period in 2001 due primarily to the continued growth in net earned
premium. American Modern's weather-related catastrophe losses for the first nine
months of 2002 amounted to $15.8 million on a pre-tax basis compared with $17.6
million for the same period in 2001. These losses had an after-tax impact of
approximately $0.58 per share (diluted), in the first nine months of 2002
compared to $0.63 per share (diluted), in the same period of 2001.
During October 2002, American Modern experienced losses from Hurricane Lili
in Louisiana. Our preliminary loss data suggested that the fourth quarter
results could be impacted by approximately $(0.25) to $(0.30) per share
(diluted). Our loss data, while not yet final, currently suggests that our
fourth quarter results could be impacted by approximately $(0.35) to $(0.40) per
share (diluted). The increase in the impact of Hurricane Lili has been offset by
favorable operating results in the month of October, primarily due to a decrease
in the fire loss ratio on our mobile home product line.
Insurance Commissions, Other Policy Acquisition Costs and Operating and
Administration Expenses
American Modern's commissions and other policy acquisition costs and
operating and administrative expenses for the third quarter of 2002 increased
5.2% to $59.1 million from $56.1 million in the third quarter of 2001. On a
year-to-date basis, American Modern's commissions and other policy acquisition
costs and operating and administrative expenses for the first nine months of
2002 increased 12.0% to $180.6 million from $161.2 million for the same
nine-month period in 2001. These increases are due primarily to continued growth
in earned premium. This increase was partially offset by a decrease in
contingent commission expense in the third quarter of 2002 as a result of higher
than normal losses in that quarter.
Property and Casualty Underwriting Results
American Modern's property and casualty operations generated pre-tax
underwriting losses (property and casualty insurance earned premium less
incurred losses, commissions and operating expenses) of $(8.6) million for the
third quarter of 2002 compared to pre-tax underwriting losses of $(5.2) million
in the same quarter in 2001. For the third quarter 2002, American Modern's
combined ratio (ratio of losses and expenses as a percentage of earned premium)
for its property and casualty business was 106.0% compared to 104.1% in the
third quarter of 2001. Higher than normal fire losses in the manufactured home
and homeowners/site-built programs added 3.5 percentage points to the third
quarter 2002 combined ratio compared to 1.8 percentage points for the same
quarter in 2001. Additionally, the discontinued commercial liability business
added 1.0 percentage points to the combined ratio in the third quarter of 2002
compared to 5.0 percentage points for the same quarter in 2001. Excluding
catastrophe losses, American Modern's property and casualty combined ratio for
the third quarter was 102.9% compared to 103.2% for the same quarter in 2001.
On a year-to-date basis, American Modern's property and casualty pre-tax
underwriting losses decreased to $3.2 million in the first nine months of 2002
from $4.0 million in the first nine months of 2001. American Modern's combined
ratio for its property and casualty business was 100.8% for the first nine
months of 2002 compared to 101.1% for the same period in 2001. Higher than
normal fire losses added 2.4 percentage points to the combined ratio in the
first nine months of 2002 compared to 2.5 percentage points for the same period
for the first nine months of 2001. The discontinued commercial liability
business added 0.5 percentage points to the combined ratio for the first nine
months of 2002 compared to 2.8 percentage points for the same period in 2001.
Excluding catastrophe losses, American Modern's property and casualty combined
ratio for the first nine months of 2002 was 97.0% compared to 96.3% for the same
period in 2001.
TRANSPORTATION
M/G Transport reported revenues for the third quarter of 2002 of $5.4
million compared to $8.2 million during the third quarter of 2001, a decrease of
34.4%. Pre-tax operating profits were $0.2 million during the current quarter
compared to $0.3 million in the same quarter a year ago. On a year-to-date
basis, revenues were $16.8 million compared to $25.8 million during the first
nine months of 2001, a decrease of 34.8%. Pre-tax operating profits were
break-even during the first nine months of 2002 compared to an operating profit
of $1.4 million during the comparable period in 2001. The declines in revenues
and operating profits during the nine-month period of 2002 were due primarily to
a significant reduction in shipments from its largest revenue source. M/G
Transport is in the process of evaluating its revenue sources and believes its
profits, if any, will be negligible for the remainder of 2002.
LIQUIDITY, CAPITAL RESOURCES AND CHANGES IN FINANCIAL CONDITION
CONSOLIDATED OPERATIONS
We have certain obligations and commitments to make future payments under
contracts. As of September 30, 2002 the aggregate obligations (excluding the
$7.5 million of future commitments relating to barge acquisitions as discussed
below) on a consolidated basis were (amounts in 000's):
PAYMENTS DUE BY PERIOD
----------------------
LESS THAN 2-5 AFTER 5
TOTAL 1 YEAR YEARS YEARS
----- ------ ----- -----
Long-term debt.............................. $47,533 $ 1,496 $46,037 $ --
Other notes payable......................... 34,327 34,327 -- --
Annual commitments under
non-cancelable leases................... 8,981 1,718 3,003 4,260
------- ------- ------- ------
Total............................. $90,841 $37,541 $49,040 $4,260
======= ======= ======= ======
Other than the annual commitments under non-cancelable leases noted above,
there are no other material off-balance sheet obligations or guarantees.
Expenditures for acquisition of property plant and equipment amounted to
$8.5 million for the nine months ended September 30, 2002 and $5.6 million for
the nine months ended September 30, 2001. The amounts expended for the
development costs capitalized in connection with the development of
modernLINK(R), our proprietary information systems and web enablement
initiative, amounted to $4.8 million for the first nine months of 2002. The
initiative is being designed, developed and implemented in periodic phases to
ensure its cost effectiveness and functionality. We are approximately 24 months
into the process, which we expect to be completed over the next 24 to 36 months.
The current budget for this project calls for expenditures of $6.0 to $7.0
million annually over the next 2 to 3 years. However, actual costs may be more
or less than what we estimate. The cost of the development and implementation is
expected to be funded out of operating cash flow. This system is in development
and its effectiveness has not been proven. Further, significant changes to the
technology interface between American Modern and its distribution channel
participants and policyholders, while unlikely, could significantly disrupt or
alter its distribution channel relationships. If the new information systems are
ultimately deemed ineffective, it could result in an impairment charge to our
capitalized costs.
On June 17, 2002, we announced a two-for-one stock split effective July 17,
2002. This stock split increased our common stock shares outstanding to 17.6
million shares as of September 30, 2002.
In August 2002, we withdrew the registration statement related to a
proposed secondary offering of our common stock. The proposed offering of
2,450,000 shares of common stock, covered by a registration statement filed with
the Securities and Exchange Commission on July 17, included 2,000,000 shares to
be offered by the Company and 450,000 shares to be offered by selling
stockholders. The withdrawal of the registration statement will not have a
material impact on our liquidity as we believe our current capital resources are
sufficient to support our business model.
On January 25, 2001 our Board of Directors approved an increase in the
number of shares authorized under our share repurchase program from 1,000,000
shares to 2,000,000 shares on a post split basis. No shares were repurchased in
the open market under our share repurchase program during the first nine months
of 2002 and a total of 604,000 shares remain authorized for repurchase under
terms of this authority. There were, however, certain stock repurchase
transactions consummated in connection with our associate stock incentive
programs during the first nine months of 2002. On April 25, 2002, our Board of
Directors approved a two-year extension to the share repurchase program that
will run through the date of the Board's second quarterly meeting in 2004. The
resolution does not require us to repurchase our shares, but rather gives
management discretion to make purchases based on market conditions and our
capital requirements.
We paid dividends to our shareholders of $2.3 million during the first nine
months of 2002, and $2.1 million during the first nine months of 2001.
We expect that cash and other liquid investments, coupled with future
operating cash flows and our short-term borrowing capacity, will be readily
available to meet our operating cash requirements for the next 12 months.
HOLDING COMPANY OPERATIONS
Midland and American Modern are holding companies which rely primarily on
dividends and management fees from subsidiaries to assist in servicing debt,
paying operating expenses and paying dividends to the respective shareholders.
The payment of dividends to these holding companies from American Modern's
insurance subsidiaries is restricted by state regulatory agencies. Such
restrictions, however, have not had, and are not expected to have, a significant
impact on our, or American Modern's, liquidity or our and American Modern's
ability to meet our respective long or short-term operating, financing or
capital obligations.
Midland has a commercial paper program under which qualified purchasers may
invest in the short-term unsecured notes of Midland. As of September 30, 2002,
we had $5.3 million of commercial paper debt outstanding, $4.3 million of which
represented notes held either directly or indirectly by our executive officers
and directors. The effective yield paid to all participants in this program was
1.7% as of September 30, 2002, a rate that is considered to be competitive with
the market rates offered for similar instruments. As of September 30, 2002,
Midland also had $67.0 million of conventional short-term credit lines available
at costs not exceeding prime borrowing rates, of which $29.0 million was
outstanding. These lines of credit contain minimal covenants and are typically
drawn and repaid over periods ranging from two weeks to three months. Additional
short-term borrowing lines are available at the discretion of various lending
institutions with comparable rates and terms. These short-term borrowings
increased $3.0 million from $26.0 million since December 31, 2001 due primarily
to transactions related to associate incentive and awards programs, the payment
of dividends to our shareholders and the payment of other operating and
administrative expenses. We also have a mortgage obligation related to the
financing of our corporate headquarters building. As of September 30, 2002, the
outstanding balance of this mortgage was $16.7 million. This mortgage obligation
includes normal and customary debt covenants for instruments of this type.
Monthly principal and interest payments are required until maturity in December,
2005. The effective interest rate on this obligation is 6.9%.
INSURANCE
American Modern generates cash inflows primarily from insurance premium,
investment income, proceeds from the sale of marketable securities and
maturities of debt security investments. The principal cash outflows for the
insurance operations relate to the payment of claims, commissions, premium
taxes, operating expenses, capital expenditures, income taxes, dividends and
inter-company borrowings to us and the purchase of marketable securities. In
each of the periods presented, funds generated from the insurance operating
activities were used primarily to purchase investment grade marketable
securities, accounting for the majority of the cash used in investing
activities.
The market value of American Modern's investment portfolio increased 3.7%
from December 31, 2001, to $732.9 million at September 30, 2002. This increase
in the market value of the investment portfolio was the result of the investment
of cash flow from underwriting activities and the reinvestment of investment
income offset by a $(6.3) million decrease in the unrealized appreciation in the
market value of securities held. The decrease in the unrealized appreciation was
due to a $16.7 million increase in unrealized appreciation related to the fixed
income portfolio offset by a $(23.0) million decrease in the unrealized
appreciation related to the equity portfolio. American Modern's largest equity
holding, 2.3 million shares of U.S. Bancorp, decreased to $43.4 million as of
September 30, 2002 from $48.9 million as of December 31, 2001.
The average maturity and duration of American Modern's debt security
investment portfolio as of September 30, 2002 was 5.2 years and 3.8 years,
respectively, which management believes provides adequate asset/liability
matching.
American Modern has a $60.0 million long-term credit facility available on
a revolving basis at various rates. As of September 30, 2002, there was $30.0
million outstanding under these facilities.
During the first quarter of 2002, American Modern entered into an interest
rate swap agreement with a consortium of three banks. Under the terms of this
agreement, the floating interest rate related to $30.0 million outstanding under
American Modern's long-term credit facility has been effectively fixed at 5.6%
until December 1, 2005, the maturity date. The fair value of this agreement as
of September 30, 2002 was $(1.9) million and is included in Other payables and
accruals.
Accounts receivable is primarily comprised of premium due from both
policyholders and agents. In the case of receivables due directly from
policyholders, policies are cancelable in the event of non-payment and thus
offer minimal credit exposure. Approximately 78% of American Modern's accounts
receivables relate to premium due directly from policyholders as of September
30, 2002. In the case of receivables due from agents, American Modern has
extended payment terms that are customary and normal in the insurance industry.
Management monitors its credit exposure with its agents and related
concentrations on a regular basis. However, as collectibility of such
receivables is dependent upon the financial stability of the agent, American
Modern cannot assure collections in full. Where management believes appropriate,
American Modern has provided a reserve for such exposures. Since December 31,
2001, American Modern's accounts receivable has increased $10.2 million to $92.9
million as of September 30, 2002 due to the continued growth in insurance
premiums written. American Modern's receivable balance from its largest
customer, Conseco Agency, Inc., decreased from $20.7 million as of December 31,
2001 to $14.9 million as of September 30, 2002. It has been reported that
Conseco and certain of its subsidiaries have experienced significant financial
problems. If American Modern were unable to collect the amounts due to it from
Conseco, our financial condition and results would be negatively impacted.
Reinsurance recoverables and prepaid reinsurance premium increased to $76.2
million at September 30, 2002 from $69.8 million at December 31, 2001. This
increase was primarily due to a $12.2 million increase in ceded unearned
premium offset by decreases in paid loss recoverables and ceded loss reserves
since December 31, 2001. This fluctuation was due, in part, to the fact that
American Modern experienced significant growth in its credit life operation,
which cedes a significant portion of its gross premium to reinsurers. The
increase in reinsurance recoverables and prepaid reinsurance premium is not
expected to have an impact on American Modern's liquidity and capital resources.
The increase in unearned insurance premium and insurance commissions
payable since December 31, 2001 reflects the continued growth in insurance
premiums written. The decrease in other payables and accruals since December 31,
2001 reflects the timing of annual incentive payments and other operating costs.
Cash flow from the insurance operations is expected to remain sufficiently
positive to meet American Modern's future operating requirements and to provide
for reasonable dividends to Midland.
TRANSPORTATION
M/G Transport generates its cash inflows primarily from affreightment
revenue. Its primary outflows of cash relate to the payment of barge charter
costs, debt service obligations, operating expenses, income taxes, dividends to
Midland and the acquisition of capital equipment. Like the insurance operations,
cash flow from the transportation subsidiaries is expected to remain
sufficiently positive to meet future operating requirements.
The transportation subsidiaries entered into a seven-year lease in 2000 and
a fifteen-year lease in 1999 for transportation equipment. Aggregate rental
payments under these two operating leases over the next thirteen years will
approximate $7.6 million. No other barges were leased or purchased during the
first nine months of 2002. M/G Transport has committed to acquire or lease 30
new barges, which are scheduled for delivery during the second quarter of 2003
at an approximate total cost of $7.5 million. This acquisition and any future
acquisitions would likely be financed through a combination of internally
generated funds, external borrowings or lease transactions. As of September 30,
2002, the transportation subsidiaries had $0.9 million of collateralized
equipment obligations outstanding.
OTHER MATTERS
COMPREHENSIVE INCOME
The only differences between our net income and comprehensive income is the
net after-tax change in unrealized gains on marketable securities and the
after-tax change in the fair value of the interest rate swap agreement. For the
three- and nine-month periods ended September 30, 2002 and 2001 such changes
increased or (decreased), net of related income tax effects, by the following
amounts (amounts in 000's):
FOR THE NINE FOR THE THREE
MONTHS MONTHS
ENDED SEPT. 30, ENDED SEPT. 30,
----------------------- -----------------------
2002 2001 2002 2001
---- ---- ---- ----
Changes in:
Net unrealized capital gains...................... $(4,366) $(6,582) $(5,854) $(2,085)
Fair value of interest rate swap hedge............ (1,215) - (823) -
--------- --------- --------- ---------
Total......................................... $(5,581) $(6,582) $(6,677) $(2,085)
========= ========== ========== =========
For the nine months ended September 30, 2002 and 2001, net unrealized gains
in equity securities decreased (net of income tax effects) by $(15.1) million
and $(14.4) million, respectively. For fixed income securities, the net
unrealized gains increased by $10.9 million and $7.9 million, respectively, for
the same time periods.
Changes in net unrealized gains on marketable securities result from both
market conditions and realized gains recognized in a reporting period. Changes
in the after-tax fair value of the interest rate swap agreement are predicated
on the current interest rate environment relative to the fixed rate of the swap
agreement.
CRITICAL ACCOUNTING POLICIES
Our discussion and analysis of our financial condition and results of
operations are based upon our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States of America. The preparation of these financial statements requires
us to make estimates, assumptions and judgments that affect the reported amounts
of assets, revenues and expenses and related disclosures of contingent assets
and liabilities. We regularly evaluate our critical accounting policies,
assumptions and estimates, including those related to insurance revenue and
expense recognition, loss reserves, reinsurance levels and valuation and
impairment of intangible assets such as goodwill. We base our estimates on
historical experience and on various assumptions that we believe to be
reasonable under the circumstances. This process forms the basis for making
judgments about the carrying values of assets and liabilities that are not
readily apparent from other sources. Actual results may differ from these
estimates under different assumptions or conditions.
We believe the following critical accounting policies require significant
judgments and estimates in the preparation of our consolidated financial
statements.
Insurance Revenue and Expense Recognition
Premium for physical damage and other property and casualty related
coverages, net of premium ceded to reinsurers, are recognized as income on a
pro-rata basis over the lives of the policies. Credit accident and health and
credit life premium are recognized as income over the lives of the policies
using the mean method and the sum-of-the-digits method, respectively. American
Modern generally does not consider anticipated investment income in determining
premium deficiencies (if any) on short-term contracts. Policy acquisition costs,
primarily commission expenses and premium taxes, are capitalized and expensed
over the terms of the related policies on the same basis as the related premium
are earned. Selling and administrative expenses that are not primarily related
to premium written are expensed as incurred.
Reserves for Insurance Losses
American Modern's reserve for insurance losses is based on past experience
of settling known claims as well as estimating those not yet reported. While
management believes the amounts are fairly stated, the ultimate liability, once
fully developed, may be more than or less than that provided. Management and its
actuaries, both internal and external, regularly review these liabilities and
adjustments are made as necessary in the current period. Management does not
foresee any significant change in the manner in which it records its reserve for
insurance losses.
Reinsurance Risks
By reinsuring certain levels and types of insurable risk with other
insurance companies, American Modern limits its exposure to losses to that
portion of the insurable risk it retains. However, if the reinsurer fails to
honor its obligations, American Modern could suffer additional losses as the
reinsurance contracts do not relieve American Modern of its obligations to
policyholders. American Modern regularly evaluates the financial condition of
its reinsurers to minimize its exposure to losses from reinsurer insolvencies.
We do not believe there is any significant concentration of credit risk arising
from any single reinsurer. We expect that American Modern's reinsurers will
satisfy their obligations. As of September 30, 2002, American Modern was owed
$2.1 million from reinsurers for claims that have been paid and for which a
contractual obligation to collect from a reinsurer exists.
Asset Impairment
Our management team and Disclosure Committee meet at regular intervals and
continually monitor investments and other assets that have fair values that are
less than carrying amounts for signs of other-than-temporary impairment. Factors
such as the amount and timing of declines in fair values, the significance of
the declines, the length of time of the declines, duration of fixed-maturity
securities, interest payment defaults, nature of the issuers' operations,
financial condition and industry factors, among others, are considered when
determining investment impairment. Invested assets and property and equipment
are monitored for signs of impairment such as significant decreases in market
value of assets, changes in legal factors or in the business climate, an
accumulation of costs in excess of the amount originally expected to acquire or
construct an asset, or other such factors indicating that the carrying amount
may not be recoverable.
Intangible Assets (Goodwill)
As required by SFAS No. 142, we ceased amortizing goodwill effective
January 1, 2002. Based on the impairment test required by SFAS No. 142 in the
quarter ended March 31, 2002, a non-recurring charge of $(1.5) million after-tax
was taken against income and is reported as cumulative effect of change in
accounting principle in the income statement. Prior to January 1, 2002, goodwill
was amortized on a straight-line basis over a 10-year period. The year-to-date
income statement through September 30, 2001 includes an after-tax expense of
$(0.3) million relating to goodwill amortization. As of September 30, 2002, our
remaining goodwill balance was $2.1 million and is included in Other assets.
Special Purpose Vehicles or Off Balance Sheet Business Arrangements
We do not utilize any special purpose financing vehicles or have any
undisclosed off-balance sheet arrangements. Similarly, we hold no fair value
contracts for which a lack of marketplace quotations would necessitate the use
of fair value techniques.
NEW ACCOUNTING STANDARDS AND CHANGE IN ACCOUNTING PRINCIPLE
The Financial Accounting Standards Board (FASB) issued SFAS No. 133
"Accounting for Derivative Instruments and Hedging Activities" during 1998. SFAS
No. 133, as amended by SFAS Nos. 137 and 138, became effective January 1, 2001.
American Modern's investment portfolio includes $38.5 million of convertible
securities, some of which contain embedded derivatives, as of September 30,
2002. The embedded conversion options are valued separately, and the change in
market value of the embedded conversion options is reported in net realized
investment gains (losses). For the nine months ended September 30, 2002 and
2001, American Modern recorded pre-tax losses on these securities of $(0.6)
million and $(0.3) million, respectively.
On September 29, 2001, SFAS No. 141, "Business Combinations" was approved
by the FASB. SFAS No. 141 requires that the purchase method of accounting be
used for all business combinations initiated after September 30, 2001. We were
required to implement SFAS No. 141 on July 1, 2001 and this statement had no
impact on our consolidated financial position, results of operations or cash
flows as we have made no business acquisitions since the implementation of SFAS
No. 141. We have historically accounted for business combinations under the
purchase method.
On January 1, 2002, we adopted SFAS No. 142, "Goodwill and Other Intangible
Assets." As required by SFAS No. 142, we ceased amortizing goodwill effective
January 1, 2002, however, based on the impairment test required by SFAS No. 142,
a non-recurring charge of $1.5 million (after-tax) was taken against income in
the quarter ended March 31, 2002, and is reported as cumulative effect of change
in accounting principle in the income statement. The September 30, 2001 income
statement includes an after-tax expense of $(0.3) million regarding goodwill
amortization while the after-tax expense for the years 2001 and 2000 was $(0.01)
per share (diluted). As of September 30, 2002, our remaining goodwill balance
was $2.1 million and is included in Other assets.
In September 2001 the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations," and issued in August 2001 SFAS No. 144, "Accounting for
the Impairment or Disposal of Long-Lived Assets." We do not expect these
standards to have a material effect on our consolidated financial position,
results of operations or cash flows.
The Financial Accounting Standards Board issued Statement of Financial
Accounting Standards ("SFAS") No. 145 "Rescission of FASB Statements No. 4, 44
and 64, Amendment of FASB Statement No. 13, and Technical Corrections" in April
2002, SFAS No. 146 "Accounting for Costs Associated with Exit or Disposal" in
June 2002 and SFAS No. 147 "Accounting for Certain Acquisitions of Banking or
Thrift Institutions - an amendment of FASB Statement No. 72 and 144 and FASB
Interpretations No. 9" in October 2002. The adoption of SFAS No. 145, SFAS No.
146 and SFAS No. 147 will not have a material impact on Midland's consolidated
financial position or results of operations.
IMPACT OF INFLATION
We do not consider the impact of the change in prices due to inflation to
be material in the analysis of our overall operations.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is the risk that we will incur investment losses due to adverse
changes in market rates and prices. Our market risk exposures are substantially
related to American Modern's investment portfolio and changes in interest rates
and equity prices. Each risk is defined in more detail as follows.
Interest rate risk is the risk that American Modern will incur economic
losses due to adverse changes in interest rates. The risk arises from many of
American Modern's investment activities, as American Modern invests substantial
funds in interest-sensitive assets. American Modern manages the interest rate
risk inherent in its investment assets relative to the interest rate risk
inherent in its liabilities. One of the measures American Modern uses to
quantify this exposure is duration. By definition, duration is a measure of the
sensitivity of the fair value of a fixed income portfolio to changes in interest
rates. Based upon the 3.8 year duration of American Modern's fixed income
portfolio as of September 30, 2002, management estimates that a 100 basis point
increase in interest rates would decrease the market value of its $607.2 million
debt security portfolio by 3.8%, or $23.1 million.
Equity price risk is the risk that American Modern will incur economic
losses due to adverse changes in a particular stock or stock index. American
Modern's equity exposure consists primarily of declines in the value of its
equity security holdings. As of September 30, 2002, American Modern had $125.7
million in equity holdings, including $43.4 million of U.S. Bancorp common
stock. A 10% decrease in the market value of U.S. Bancorp's common stock would
decrease the fair value of its equity portfolio by approximately $4.3 million.
As of September 30, 2002, the remainder of American Modern's portfolio of equity
securities had a beta coefficient (a measure of stock price volatility) of 1.04.
This means that, in general, if the S&P 500 Index decreases by 10%, management
estimates that the fair value of the remaining equity portfolio will decrease by
10.4%.
The active management of market risk is integral to American Modern's
operations. American Modern has investment guidelines that define the overall
framework for managing market and other investment risks, including the
accountabilities and controls over these activities.
During the first quarter of 2002, American Modern entered into an interest
rate swap agreement with a consortium of three banks. Under the terms of this
agreement, the floating interest rate related to $30 million outstanding under
American Modern's long-term credit facility has been effectively fixed at 5.6%
until December 1, 2005, the maturity date. The fair value of this agreement as
of September 30, 2002 was a negative $(1.9) million and is included in Other
payables and accruals.
ITEM 4. CONTROLS AND PROCEDURES
As of a date within 90 days of the date of this report (the "Evaluation
Date"), we carried out an evaluation, under the supervision and with the
participation of our management, including our President and Chief Executive
Officer and our Executive Vice President and Chief Financial Officer, of the
effectiveness of the design and operation of our disclosure controls and
procedures pursuant to Rule 13a-14 under the Securities Exchange Act of 1934, as
amended (the "Exchange Act"). Based upon this evaluation, our President and
Chief Executive Officer and our Executive Vice President and Chief Financial
Officer concluded that, as of the Evaluation Date, our disclosure controls and
procedures were adequate to ensure that information required to be disclosed by
us in the reports filed or submitted by us under the Exchange Act is recorded,
processed, summarized and reported within the time periods specified in the
SEC's rules and forms.
Additionally, our President and Chief Executive Officer and Executive Vice
President and Chief Financial Officer determined, as of the evaluation date,
that there were no significant changes in our internal controls or in other
factors that could significantly affect our internal controls subsequent to the
date of their evaluation.
INDEPENDENT ACCOUNTANTS' REPORT
The Midland Company:
We have reviewed the accompanying condensed consolidated balance sheet of The
Midland Company and subsidiaries as of September 30, 2002, and the related
condensed consolidated statements of income for the three-month and nine-month
periods ended September 30, 2002 and 2001 and of changes in shareholders' equity
and cash flows for the nine-month periods ended September 30, 2002 and 2001.
These financial statements are the responsibility of the Company's management.
We conducted our review in accordance with standards established by the American
Institute of Certified Public Accountants. A review of interim financial
information consists principally of applying analytical procedures to financial
data and of making inquiries of persons responsible for financial and accounting
matters. It is substantially less in scope than an audit conducted in accordance
with auditing standards generally accepted in the United States of America, the
objective of which is the expression of an opinion regarding the financial
statements taken as a whole. Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that should
be made to such condensed consolidated financial statements for them to be in
conformity with accounting principles generally accepted in the United States of
America.
We have previously audited, in accordance with auditing standards generally
accepted in the United States of America, the consolidated balance sheet of The
Midland Company and subsidiaries as of December 31, 2001, and the related
consolidated statements of income, changes in shareholders' equity and cash
flows for the year then ended (not presented herein); and in our report dated
February 7, 2002, we expressed an unqualified opinion on those consolidated
financial statements. In our opinion, the information set forth in the
accompanying condensed consolidated balance sheet as of December 31, 2001 is
fairly stated, in all material respects, in relation to the consolidated
financial statements from which it has been derived.
/s/ Deloitte & Touche LLP
Deloitte & Touche LLP
Cincinnati, Ohio
November 8, 2002
PART II. OTHER INFORMATION
THE MIDLAND COMPANY AND SUBSIDIARIES
SEPTEMBER 30, 2002
Item 1. LEGAL PROCEEDINGS
None.
Item 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
None.
Item 3. DEFAULTS UPON SENIOR SECURITIES
None.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
Item 5. OTHER INFORMATION
None.
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
a) Exhibit 15 - Letter re: Unaudited Interim Financial Information.
b) Exhibit 99.1 - Chief Executive Officer's Certification.
c) Exhibit 99.2 - Chief Financial Officer's Certification.
d) Reports on Form 8-K - None.
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
THE MIDLAND COMPANY
Date November 8, 2002 /s/John I. Von Lehman
------------------------- ---------------------------------------------
John I. Von Lehman, Executive Vice President,
Chief Financial Officer and Secretary
CERTIFICATION OF PRINCIPAL EXECUTIVE OFFICER
PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
AND SECURITIES AND EXCHANGE COMMISSION RELEASE 34-46427
I, John W. Hayden, the principal executive officer of The Midland Company,
certify that:
1. I have reviewed this quarterly report on Form 10-Q of The Midland
Company;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by the report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
(a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this quarterly report is being
prepared;
(b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the filing
date of this quarterly report (the "Evaluation Date"); and
(c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):
(a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have identified
for the registrant's auditors any material weaknesses in internal controls;
and
(b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: November 8, 2002
/s/John W. Hayden
-----------------------------------
Principal Executive Officer
CERTIFICATION OF PRINCIPAL FINANCIAL OFFICER
PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
AND SECURITIES AND EXCHANGE COMMISSION RELEASE 34-46427
I, John I. Von Lehman, the principal financial officer of The Midland
Company, certify that:
1. I have reviewed this quarterly report on Form 10-Q of The Midland
Company;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by the report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
(a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this quarterly report is being
prepared;
(b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the filing
date of this quarterly report (the "Evaluation Date"); and
(c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):
(a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have identified
for the registrant's auditors any material weaknesses in internal controls;
and
(b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: November 8, 2002
/s/ John I. Von Lehman
-----------------------------------------
Principal Financial Officer