-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, QUQHEujMPBiTurBLJGqm2Yf13kYlCgYaRn3dbI424yS5mNY4g2hZcxpJL4W3IYmY oUop59z7SEb0avoaSY17BQ== 0000066025-99-000008.txt : 19990325 0000066025-99-000008.hdr.sgml : 19990325 ACCESSION NUMBER: 0000066025-99-000008 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990323 FILER: COMPANY DATA: COMPANY CONFORMED NAME: MIDLAND CO CENTRAL INDEX KEY: 0000066025 STANDARD INDUSTRIAL CLASSIFICATION: FIRE, MARINE & CASUALTY INSURANCE [6331] IRS NUMBER: 310742526 STATE OF INCORPORATION: OH FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 001-06026 FILM NUMBER: 99570300 BUSINESS ADDRESS: STREET 1: 7000 MIDLAND BLVD STREET 2: P O BOX 125 CITY: AMELIA STATE: OH ZIP: 45102-2607 BUSINESS PHONE: 5139437100 MAIL ADDRESS: STREET 2: P O BOX 1256 CITY: CINCINNATI STATE: OH ZIP: 45201 10-K 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K ANNUAL REPORT Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the Fiscal Year Ended December 31, 1998 Commission File Number - 1-6026 THE MIDLAND COMPANY Incorporated in Ohio I.R.S. Employer Identification No. 31-0742526 7000 Midland Boulevard Amelia, Ohio 45102-2607 Tel. (513) 943-7100 Securities registered pursuant to Section 12(b) of the Act: Common stock - no par value. - American Stock Exchange Securities registered pursuant to Section 12(g) of the Act: None. Indicate by check mark whether the registrant (1) has filed all other 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_____ Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] The aggregate market value of the voting common stock held by nonaffiliates, which includes shares held by executive officers and directors, of the registrant as of March 5, 1999 was $237,966,000. Number of shares of common stock outstanding as of March 5, 1999 - 9,518,639. Documents Incorporated by Reference Annual Report to Shareholders for the year ended December 31, 1998 is incorporated by reference into Parts I, II and IV. Registrant's Proxy Statement dated March 11, 1999 is incorporated by reference into Parts III and IV. 1 THE MIDLAND COMPANY FORM 10-K DECEMBER 31, 1998 Certain statements contained in this report that are not historical facts constitute forward-looking statements, within the meaning of the Private Securities Litigation Reform Act of 1995, and are intended to be covered by the safe harbors created by that Act. Reliance should not be placed on forward- looking statements because they involve known and unknown risks, uncertainties and other factors which may cause actual results, performance or achievements to differ materially from those expressed or implied. Any forward-looking statement speaks only as of the date made. The Midland Company undertakes no obligation to update any forward-looking statements to reflect events or circumstances arising after the date on which they are made. Statements concerning expected financial performance, on-going business strategies and possible future action which The Midland Company intends to pursue to achieve strategic objectives constitute forward-looking information. Implementation of these strategies and the achievement of such financial performance are each subject to numerous conditions, uncertainties and risk factors. Factors which might cause deviations from the forward looking statements include, without limitations, the following: 1) changes in the laws or regulations affecting the operations of the Company or any of its subsidiaries; 2) changes in the business tactics or strategies of the Company or any of its subsidiaries; 3)acquisition(s) of assets or of new or complementary operations, or divestiture of any segment of the existing operations of the Company or any of its subsidiaries; 4) changing market forces or litigation which necessitate, in Management's judgment, changes in plans, strategy or tactics of the Company or its subsidiaries and 5) adverse weather conditions, fluctuations in the investment markets, changes in the retail marketplace, Year 2000 related issues or fluctuations in interest rates, any one of which might materially affect the operations of the Company and/or its subsidiaries. 2 PART I ITEM 1. Business. Incorporated by reference from the inside cover and pages 2 through 13 and 33 and 34 (Note 18) of the Registrant's 1998 Annual Report to Shareholders. The number of persons employed by the Registrant was approximately 890 at December 31, 1998. Property and Casualty Loss Reserves The Company's consolidated financial statements include the estimated liability (reserves) for unpaid losses and loss adjustment expenses (LAE) of its property and casualty insurance subsidiaries. The liability is presented net of amounts recoverable from salvage and subrogation and includes amounts recoverable from reinsurance for which receivables are recognized. The Company establishes reserves for losses that have been reported to the Company and certain legal expenses on the "case basis" method. The Company estimates claims incurred but not reported ("IBNR") and other adjustment expenses using statistical procedures. The Company accrues salvage and subrogation recoveries using the "case basis" method for large claims and statistical procedures for smaller claims. The Company's objective is to set reserves that are adequate; that is, the amounts originally recorded as reserves should at least equal the amounts ultimately expected to be required to settle losses. The Company's reserves aggregate its best estimates of the total ultimate cost of claims that have been incurred but have not yet been paid. The estimates are based on past claims experience and reflect current claims trends as well as social, legal and economic conditions, including inflation. The reserves are not discounted. The Company reviews its loss and loss adjustment expense reserve development on a regular basis to determine whether the reserving assumptions and methods are appropriate. Reserves initially determined are compared to the amounts ultimately paid. The Company regularly makes statistical estimates of the projected amounts necessary to settle outstanding claims, compares these estimates to the recorded reserves and adjusts the reserves as necessary. The adjustments are reflected in current operations. There are no material differences between the loss and LAE liability reported in the accompanying consolidated financial statements in accordance with generally accepted accounting principles ("GAAP") and that reported in the annual statements filed with state insurance departments in accordance with statutory accounting practices ("SAP"). The following table provides an analysis of changes in loss and LAE reserves for 1998, 1997 and 1996 (net of reinsurance amounts) for the Company. Based on the information available during and at the end of 1998, operations were credited $2,120,000 in 1998 as a result of a decrease in the estimated amounts needed to settle prior years' claims. Based on information available during and at the end of 1997 and 1996, operations were charged $5,230,000 in 1997 and $3,771,000 in 1996 as a result of increases in such estimates. Such reserve adjustments, which affected reported results of current operations during each of the years, resulted from developed losses from prior years being different than were anticipated when the liability for losses and loss adjustment expense were originally estimated. These development trends have been considered in establishing the current year liabilities. 3 Changes in Loss and LAE Reserves: (amounts in 000's) 1998 1997 1996 -------------------------------------- Balance at January 1 $108,334 $ 88,992 $ 61,497 Less reinsurance recoverables 26,433 24,208 13,785 -------------------------------------- Net balance at January 1 81,901 64,784 47,712 -------------------------------------- Incurred related to: Current year 208,811 163,035 166,554 Prior years (2,120) 5,230 3,771 -------------------------------------- Total incurred 206,691 168,265 170,325 -------------------------------------- Paid related to: Current year 157,530 113,841 121,782 Prior years 42,795 37,307 31,471 -------------------------------------- Total paid 200,325 151,148 153,253 -------------------------------------- Net balance at December 31 88,267 81,901 64,784 Plus reinsurance recoverables 20,430 26,433 24,208 -------------------------------------- Balance at December 31 $108,697 $108,334 $ 88,992 ====================================== Analysis of Loss and LAE Reserve Development The next table presents the development of the estimated liability for the ten years prior to 1998. The top line of the table illustrates the estimated liability for unpaid losses and LAE recorded at the balance sheet date at the end of each of the indicated years. This liability represents the estimated amount of losses and LAE at the end of claims arising in all prior years that were unpaid at the balance sheet date, including losses that had been incurred but not yet reported to the Company. The upper portion of the table shows the re-estimated amount of the previously recorded liability based on experience as of the end of each succeeding year. The estimate was increased or decreased as more information became known about the frequency and severity of claims for individual years. Conditions and trends that have affected development of the liability in the past may not necessarily occur in the future. Accordingly, it may not be appropriate to extrapolate future redundancies or deficiencies based on this table. The table shows the cumulative redundancy (deficiency) developed with respect to the previously recorded liability for all years as of the end of 1998. For example, the Company's 1990 reserve of $16,570,000 has been re-estimated as of year-end 1998 to be $13,579,000, indicating a redundancy of $2,991,000. The lower section of the table shows the cumulative amount paid with respect to the previously recorded liability as of the end of each succeeding year. For example, as of December 31, 1998, the Company had paid $13,574,000 of the currently estimated $13,579,000 of losses and LAE that have been incurred as of the end of 1990; thus an estimated $5,000 of losses incurred as of the end of 1990 remain unpaid as of the current financial statement date. In using this information, it should be noted that this table does not present accident or policy year development data which readers may be more accustomed to analyzing. Each amount in each column includes amounts applicable to the year over the column and all prior years. For example, the amounts included in the 1993 column include amounts related to 1993 and all prior years. The Company's reserve development is unfavorable for 1995 and 1996 due to the Company's expansion into certain areas of commercial lines insurance. However, reserve development is favorable for 1997 due to a reduction in the aforementioned commercial lines business combined with a strengthening of the commercial lines reserves in 1997. 4 Analysis of Loss and Loss Adjustment Expense Development (Amounts in 000s) Year Ended December 31 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 ------------------------------------------------------------------------------------------------- Reserve for Unpaid Losses, Net of Reinsurance $12,464 $15,732 $16,570 $19,089 $20,405 $27,744 $37,481 $47,712 $64,784 $81,901 $88,267 Net Reserve Re-estimated as of: One Year Later 11,609 15,167 15,492 17,160 18,425 25,668 30,134 51,483 70,014 79,781 Two Years Later 11,534 15,043 14,859 15,699 18,451 22,686 32,074 53,467 67,310 Three Years Later 11,292 14,397 13,841 15,202 16,871 21,154 31,880 52,418 Four Years Later 11,024 13,773 13,929 14,497 16,616 20,966 31,734 Five Years Later 10,886 13,758 13,663 14,393 16,505 20,688 Six Years Later 10,926 13,754 13,598 14,373 16,445 Seven Years Later 10,962 13,722 13,589 14,361 Eight Years Later 10,948 13,741 13,579 Nine Years Later 10,967 13,732 Ten Years Later 10,929 Net Cumulative Redundancy (Deficiency) $ 1,535 $ 2,000 $ 2,991 $ 4,728 $ 3,960 $ 7,056 $ 5,747 $(4,706) $(2,526) $ 2,120 ========================================================================================= Net Cumulative Amount of Reserve Paid Through: One Year Later $ 8,659 $11,210 $11,117 $10,937 $11,730 $ 9,684 $19,040 $31,471 $37,307 $42,795 Two Years Later 9,644 12,902 12,488 12,685 14,397 18,445 26,471 41,785 51,461 Three Years Later 10,461 13,355 12,965 13,588 15,923 19,930 29,237 47,434 Four Years Later 10,668 13,465 13,208 14,171 16,312 20,427 30,425 Five Years Later 10,739 13,595 13,471 14,307 16,381 20,558 Six Years Later 10,825 13,689 13,530 14,331 16,420 Seven Years Later 10,915 13,704 13,550 14,356 Eight Years Later 10,930 13,703 13,574 Nine Years Later 10,929 13,727 Ten Years Later 10,929 Net Reserve - December 31 $20,405 $27,744 $37,481 $47,712 $64,784 $ 81,901 $ 88,267 Reinsurance Recoverables 2,780 6,220 14,597 13,785 24,208 26,433 20,430 ------------------------------------------------------------- Gross Reserve-December 31 $23,185 $33,964 $52,078 $61,497 $88,992 $108,334 $108,697 ============================================================= Net Re-estimated Reserve $16,445 $20,688 $31,734 $52,418 $67,310 $ 79,781 Re-estimated Reinsurance 2,240 4,638 12,359 15,145 25,152 25,742 ----------------------------------------------------- Gross Re-estimated Reserve $18,685 $25,326 $44,093 $67,563 $92,462 $105,523 ===================================================== Gross Cumulative Redundancy (Deficiency) $ 4,500 $ 8,638 $ 7,985 $(6,066) $(3,470)$ 2,811 =====================================================
5 Reinsurance The Company reinsures certain levels of risk with other insurance companies and cedes varying portions of its written premiums to such reinsurers. In addition, the Company pays a percentage of earned premiums to reinsurers in return for coverage against catastrophic losses. To the Company's knowledge, none of its reinsurers are experiencing financial difficulties. Furthermore, the Company monitors concentrations of credit risk arising from similar geographic regions, activities or economic characteristics of the reinsurers to minimize its exposure to significant losses from reinsurer insolvencies. The composition of its reinsurers has not changed significantly in recent years. The Company has not experienced any uncollectible reinsurance amounts or coverage disputes with its reinsurers in over ten years. As indicated in Management's Discussion and Analysis of Financial Condition and Results of Operations, for 1998, the Company decided to cede less business to it reinsurers than in prior years. This was significantly accomplished by a change in a quota share reinsurance contract for manufacturing housing insurance. The related terms were changed, applicable with business written in 1998, from 25% of written premium with a maximum of $50 million to 12.5% with a maximum of $25 million. Significant Customer As indicated in Note 18 to the Company's 1998 consolidated financial statements, in 1998 and 1997, respectively, revenues (including amounts that are ultimately ceded to reinsurers) from one customer amounted to $61,865,000 and $41,011,000. That customer is Greentree Financial Corporation. ITEM 2. Properties. The Company owns its 275,000 square foot principal offices located in Amelia, Ohio. The Company's insurance subsidiaries lease office space in Montgomery, Alabama, St. Louis, Missouri and Clearwater, Florida and the Company's transportation subsidiaries lease offices in Metairie, Louisiana. The Company owns a 292,000 square foot manufacturing, warehouse and office facility which it leases to a non-affiliated third party. ITEM 3. Legal Proceedings. Reference is made to Item 3 of the December 31, 1995 Registrant's Form 10-K concerning criminal litigation against M/G Transport Services, Inc., a subsidiary of the Registrant. Upon Motion, the Court dismissed six of the remaining eight counts against M/G, four of the six remaining counts against one former employee and all of the remaining counts against two former employees. The United States has appealed. The Sixth Circuit Court of Appeals heard oral agreements on the appeal by the United States in January, 1999 and has not yet rendered an opinion. On October 31, 1997, M/G was fined $250,000 and placed on two years' probation on the two remaining counts. The Company does not expect any additional fines unless the United States is successful in its appeal. ITEM 4. Submission of Matters to a Vote of Security Holders. None during the fourth quarter. PART II ITEM 5. Market for the Registrant's Common Stock and Related Security Holder Matters. Incorporated by reference to pages 33 (Note 17) and 36 of the Registrant's 1998 Annual Report to Shareholders. The number of holders of the Company's common stock at December 31, 1998 was approximately 1,350. The Company's common stock is registered on the American Stock Exchange (MLA). ITEM 6. Selected Financial Data. Incorporated by reference to pages 14 and 15 of the Registrant's 1998 Annual Report to Shareholders. ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations. Incorporated by reference to pages 16 through 21 of the Registrant's 1998 Annual Report to Shareholders. 6 PART II (Continued) ITEM 8. Financial Statements and Supplementary Data. Incorporated by reference to pages 22 through 36 of the Registrant's 1998 Annual Report to Shareholders. ITEM 9. Changes In and Disagreements with Accountants on Accounting and Financial Disclosures. None. PART III ITEM 10. Directors and Executive Officers of the Registrant. Incorporated by reference to the Registrant's Proxy Statement dated March 11, 1999. Executive Officers of the Company - J. P. Hayden, Jr. - Age 69 - Chairman of the Executive Committee of the Board Michael J. Conaton - Age 65 - Vice Chairman J. P. Hayden, III - Age 46 - Chairman and Chief Operating Officer John W. Hayden - Age 41 - President and Chief Executive Officer John I. Von Lehman - Age 46 - Executive Vice President, Chief Financial Officer and Secretary Kurt R. Schwamberger - Age 52 - Senior Vice President Paul T. Brizzolara - Age 41 - Senior Vice President and Chief Legal Officer W. Todd Gray - Age 31 - Treasurer The officers listed above have served in the positions indicated for the past five years (except as noted below or in the Company's proxy statement). During 1998, Kurt R. Schwamberger was elected Senior Vice President of The Midland Company. Mr. Schwamberger joined the Company in 1996 as President and Chief Operating Officer of American Modern Insurance Group, Inc. (AMIG) and will continue in that position with AMIG. Before joining AMIG in 1996, Mr. Schwamberger held executive management positions in the insurance industry. Also in 1998, Paul T. Brizzolara was elected Senior Vice President and Chief Legal Officer of The Midland Company. Mr. Brizzolara was previously the Company's Assistant Vice President, Assistant Chief Counsel and Assistant Secretary of The Midland Company and will continue as Assistant Secretary in his new position. The Board of Directors of The Midland Company voted at their regular meeting on March 5, 1998 to elect the following new executive officers effective with the Company's Annual Shareholders' Meeting on April 9, 1998. Mr. J. P. Hayden, III was elected Chairman and Chief Operating Officer of The Midland Company. Mr. John W. Hayden was elected President and Chief Executive Officer of The Midland Company. Mr. J. P. Hayden, Jr. was elected Chairman of the Executive Committee of the Board. Mr. Michael J. Conaton was elected Vice Chairman of the Board and Vice Chairman of the Company. During 1997, W. Todd Gray was elected Treasurer. Mr. Gray joined Midland in 1994 and served as Internal Audit Manager and, more recently, Assistant Treasurer. Prior to that he was employed by a national accounting firm. During 1996, J. P. Hayden, III and John W. Hayden (formerly Vice Presidents) were elected Senior Executive Vice Presidents. Also in 1996, John I. Von Lehman (formerly Vice President, Treasurer and Chief Financial Officer) was elected Executive Vice President and Chief Financial Officer. J. P. Hayden, III and John W. Hayden are brothers and are sons of J. P. Hayden, Jr. 7 PART III (Continued) ITEM 11. Executive Compensation. Incorporated by reference to the Registrant's Proxy Statement dated March 11, 1999. ITEM 12. Security Ownership of Certain Beneficial Owners and Management. Incorporated by reference to the Registrant's Proxy Statement dated March 11, 1999. ITEM 13. Certain Relationships and Related Transactions. Incorporated by reference to the Registrant's Proxy Statement dated March 11, 1999. PART IV ITEM 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K. (a) 1. Financial Statements. Incorporated by reference in Part II of this report: Independent Auditors' Report. Consolidated Balance Sheets, December 31, 1998 and 1997. Consolidated Statements of Income for the Years Ended December 31, 1998, 1997 and 1996. Consolidated Statements of Changes in Shareholders' Equity for the Years Ended December 31, 1998, 1997 and 1996. Consolidated Statements of Cash Flows for the Years Ended December 31, 1998, 1997 and 1996. Notes to Consolidated Financial Statements. (a) 2. Financial Statement Schedules. Included in Part IV of this report: Page Independent Auditors' Consent and Report on Schedules. 12 Schedule I - Summary of Investments - Other Than Investments in Related Parties - December 31, 1998 13 Schedule II - Condensed Financial Information of Registrant 14-18 Schedule III - Supplementary Insurance Information for the Years Ended December 31, 1998, 1997 and 1996 19 Schedule IV - Reinsurance for the Years Ended December 31, 1998, 1997 and 1996 20 Schedule V - Valuation and Qualifying Accounts for the Years Ended December 31, 1998, 1997 and 1996 21 Schedule VI - Supplemental Information Concerning Property-Casualty Insurance Operations for the Years Ended December 31, 1998, 1997 and 1996 22 All other schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission have been omitted because such schedules are not required under the related instructions, are inapplicable or the information is included in the financial statements or notes thereto. 8 PART IV (Continued) (a) 3. Exhibits. 3. Articles of Incorporation and Code of Regulations - Filed as Exhibits 3(i) and 3(ii) to the Registrant's Form 10-Q for the quarter ended June 30, 1998 and incorporated herein by reference. 10.1 The Midland Company 1992 Employee Incentive Stock Plan and The Midland Company Stock Option Plan for Non-Employee Directors and The Midland Company 1972 Stock Options Plan - Incorporated by reference to Registrant's Statement 33-48511 on Form S-8. 10.2 A description of the Company's Profit Sharing Plan, Salaried Employees' Non-Qualified Savings Plan and the Supplemental Retirement Plan - Incorporated by reference to the Registrant's Proxy Statement dated March 11, 1999. 13. Annual Report to security holders - Incorporated by reference to the Registrant's 1998 Annual Report to Shareholders. 21. Subsidiaries of the Registrant. 23 22. Published Report Regarding Matters Submitted to Vote of Security Holders - Incorporated by Reference to the Registrant's Proxy Statement dated March 11, 1999. 23. Independent Auditors' Consent - Included in Consent and Report on Schedules referred to under Item 14(a)2 above. 27. Financial Data Schedule. (b) Reports on Form 8-K - None during 1998. 9 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) 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 Signature Title Date S/ J. P. Hayden, III Chairman of the Board and March 5, 1999 (J. P. Hayden, III) Chief Operating Officer S/ John W. Hayden President and March 5, 1999 (John W. Hayden) Chief Executive Officer S/ John I. Von Lehman Executive Vice President, March 5, 1999 (John I. Von Lehman) Chief Financial and Accounting Officer and Secretary 10 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. THE MIDLAND COMPANY Signature Title Date S/ George R. Baker Director March 5, 1999 (George R. Baker) S/ James E. Bushman Director and Member March 5, 1999 (James E. Bushman) of Audit Committee S/ James H. Carey Director and Member March 5, 1999 (James H. Carey) of Audit Committee S/ Michael J. Conaton Vice Chairman March 5, 1999 (Michael J. Conaton) S/ Jerry A. Grundhofer Director March 5, 1999 (Jerry A. Grundhofer) S/ J. P. Hayden, Jr. Chairman of the Executive March 5, 1999 (J. P. Hayden, Jr.) Committee of the Board S/ J. P. Hayden, III Chairman and March 5, 1999 (J. P. Hayden, III) Chief Operating Officer S/ John W. Hayden President and March 5, 1999 (John W. Hayden) Chief Executive Officer S/ Robert W. Hayden Director March 5, 1999 (Robert W. Hayden) S/ William T. Hayden Director March 5, 1999 (William T. Hayden) S/ William J. Keating Director March 5, 1999 (William J. Keating) S/ John R. LaBar Director March 5, 1999 (John R. LaBar) S/ David B. O'Maley Director March 5, 1999 (David B. O'Maley) S/ John M. O'Mara Director and Member March 5, 1999 (John M. O'Mara) of Audit Committee S/ Glenn E. Schembechler Director and Member March 5, 1999 (Glenn E. Schembechler) of Audit Committee S/ John I. Von Lehman Executive Vice President, March 5, 1999 (John I. Von Lehman) Chief Financial and Accounting Officer, Secretary and Director 11 INDEPENDENT AUDITORS' CONSENT AND REPORT ON SCHEDULES - ----------------------------------------------------- To the Shareholders of The Midland Company: We consent to the incorporation by reference in Registration Statements No. 33-64821 on Form S-3 and No. 33-48511 on Form S-8 of The Midland Company of our report dated February 11, 1999, incorporated by reference in this Annual Report on Form 10-K, and our report (appearing below) on the financial statement schedules of The Midland Company for the year ended December 31, 1998. Our audits of the consolidated financial statements referred to in our aforementioned report also included the financial statement schedules of The Midland Company and its subsidiaries, listed in Item 14(a)2. These financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits. In our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly in all material respects the information set forth therein. S/Deloitte & Touche, LLP Deloitte & Touche, LLP Cincinnati, Ohio March 5, 1999 12 THE MIDLAND COMPANY AND SUBSIDIARIES Schedule I - Summary of Investments Other than Investments in Related Parties December 31, 1998 Column A Column B Column C Column D - -------------------------------------------------------------------------------------------------------- Amount at Which Shown in the Balance Type of Investment Cost Value Sheet - -------------------------------------------------------------------------------------------------------- Fixed maturity securities, available-for-sale: Bonds: United States Government and government agencies and authorities $170,035,000 $174,031,000 $174,031,000 States, municipalities and political subdivisions 161,699,000 165,966,000 165,966,000 Mortgage-backed securities 15,422,000 15,570,000 15,570,000 Foreign governments 504,000 508,000 508,000 Public utilities 8,289,000 8,353,000 8,353,000 All other corporate bonds 53,289,000 54,258,000 54,258,000 ------------------------------------------------ Total 409,238,000 418,686,000 418,686,000 ------------------------------------------------ Equity securities, available-for-sale: Common stocks: Public utilities 1,044,000 1,498,000 1,498,000 Banks, trusts and insurance companies 5,817,000 82,243,000 82,243,000 Industrial, miscellaneous and all other 26,584,000 48,801,000 48,801,000 Nonredeemable preferred stocks 4,000,000 3,914,000 3,914,000 ------------------------------------------------ Total 37,445,000 136,456,000 136,456,000 ------------------------------------------------ Accrued interest and dividends 6,434,000 6,434,000 6,434,000 ------------------------------------------------ Short-term investments 28,594,000 28,594,000 28,594,000 ------------------------------------------------ Total Investments $481,711,000 $590,170,000 $590,170,000 ================================================
13 THE MIDLAND COMPANY (Parent Only) Schedule II - Condensed Financial Information of Registrant Condensed Balance Sheet Information December 31, 1998 and 1997 ASSETS 1998 1997 ------------- ------------- Cash $ 96,000 $ 236,000 ------------- ------------- Marketable Securities Available for Sale (at market value): Fixed Income (cost, $497,000 in 1998 and $2,427,000 in 1997) 497,000 2,427,000 Equity (cost, $341,000 in 1998 and $354,000 in 1997) 3,937,000 2,456,000 ------------- ------------- Total 4,434,000 4,883,000 ------------- ------------- Receivables - Net 8,932,000 7,010,000 ------------- ------------- Property, Plant and Equipment (at cost): 37,314,000 35,878,000 Less Accumulated Depreciation 5,439,000 3,552,000 ------------- ------------- Net 31,875,000 32,326,000 ------------- ------------- Other Real Estate - Net 8,700,000 14,779,000 ------------- ------------- Other Assets 4,862,000 3,720,000 ------------- ------------- Investments in Subsidiaries ( at equity) 247,569,000 197,206,000 ------------- ------------- Total Assets $306,468,000 $260,160,000 ============= ============= 14 THE MIDLAND COMPANY (Parent Only) Schedule II - Condensed Financial Information of Registrant Condensed Balance Sheet Information December 31, 1998 and 1997 LIABILITIES AND SHAREHOLDERS' EQUITY 1998 1997 ------------- ------------- Notes Payable Within One year: Banks (including current portion of long-term debt) $ 16,710,000 $ 25,425,000 Commercial Paper 6,522,000 5,791,000 ------------- ------------- Total 23,232,000 31,216,000 ------------- ------------- Other payables and Accruals 4,664,000 3,403,000 ------------- ------------- Intercompany Payables 3,469,000 501,000 ------------- ------------- Long - Term Debt 26,271,000 28,014,000 ------------- ------------- Shareholders' Equity: Common Stock - No Par (issued and outstanding: 9,352,000 shares at December 31, 1998 and 9,334,000 shares at December 31, 1997 after deducting treasury stock of 1,576,000 shares and 1,594,000 shares, respectively) 911,000 911,000 Additional Paid - in Capital 15,947,000 15,359,000 Retained Earnings 178,398,000 153,797,000 Accumulated Other Comprehensive Income 70,507,000 44,123,000 Treasury Stock (at cost) (15,293,000) (14,704,000) Unvested Restricted Stock Awards (1,638,000) (2,460,000) ------------- ------------- Total 248,832,000 197,026,000 ------------- ------------- Total Liabilities and Shareholders' Equity $306,468,000 $260,160,000 ============= ============= 15 THE MIDLAND COMPANY (Parent Only) Schedule II - Condensed Financial Information of Registrant Condensed Statements of Income Information For the Years Ended December 31, 1998, 1997 and 1996 1998 1997 1996 ------------- ------------- ------------- Revenues: Dividends from Subsidiaries $ 3,000,000 $ 8,900,000 $ 20,500,000 All Other Income, Primarily Charges to Subsidiaries 6,934,000 7,746,000 7,876,000 ------------- ------------- ------------- Total Revenues 9,934,000 16,646,000 28,376,000 ------------- ------------- ------------- Expenses: Interest Expense 3,971,000 4,775,000 5,101,000 Depreciation and Amortization 2,701,000 6,195,000 2,548,000 All Other Expenses 2,303,000 833,000 2,033,000 ------------- ------------- ------------- Total Expenses 8,975,000 11,803,000 9,682,000 ------------- ------------- ------------- Income Before Federal Income Tax 959,000 4,843,000 18,694,000 Provision (Credit) for Federal Income Tax (1,023,000) (1,599,000) (654,000) ------------- ------------- ------------- Income Before Change in Undistributed Income of Subsidiaries 1,982,000 6,442,000 19,348,000 Change in Undistributed Income of Subsidiaries: From Continuing operations 24,950,000 17,925,000 (15,605,000) From Discontinued operations - (6,817,000) (2,675,000) ------------- ------------- ------------- Net Income $ 26,932,000 $ 17,550,000 $ 1,068,000 ============= ============= ============= 16 THE MIDLAND COMPANY (Parent Only) Schedule II - Condensed Financial Information of Registrant Condensed Statements of Cash Flows Information For the Years Ended December 31, 1998, 1997 and 1996 1998 1997 1996 ------------- ------------- ------------- Cash Flows from Operating Activities: Net income $ 26,932,000 $ 17,550,000 $ 1,068,000 Loss from discontinued operations - 6,817,000 2,675,000 ------------- ------------- ------------- Income from continuing operations 26,932,000 24,367,000 3,743,000 Adjustments to reconcile net income to net cash provided by operating activities: Decrease (increase) in undistributed income of subsidiaries (24,950,000) (17,925,000) 15,605,000 Depreciation and amortization 2,701,000 6,195,000 2,548,000 Increase in other assets (1,142,000) (1,286,000) (1,359,000) Decrease (increase) in receivables (1,922,000) 134,000 689,000 Increase in other payables and accruals 153,000 1,575,000 90,000 Other - net 301,000 4,000 (592,000) ------------- ------------- ------------- Net Cash Provided by Operating Activities 2,073,000 13,064,000 20,724,000 ------------- ------------- ------------- Cash Flows from Investing Activities: Acquisition of property, plant and equipment (1,657,000) (2,617,000) (1,516,000) Capital contributions to subsidiaries - (12,326,000) - Sale of property, plant and equipment and other real estate - net 5,969,000 535,000 66,000 Change in investments (excluding unrealized appreciation/depreciation) 1,943,000 (1,991,000) 7,690,000 ------------- ------------- ------------- Net Cash Provided by (Used in) Investing Activities 6,255,000 (16,399,000) 6,240,000 ------------- ------------- ------------- Cash Flows from Financing Activities: Net change in intercompany accounts 2,968,000 7,323,000 (21,363,000) Increase (decrease) in long - term debt (1,458,000) 948,000 (767,000) Decrease in short - term borrowings (8,269,000) (2,909,000) (2,920,000) Dividends paid (1,746,000) (2,677,000) (1,962,000) Net issuance (purchase) of treasury stock 37,000 619,000 75,000 ------------- ------------- ------------- Net Cash Provided by (Used in) Financing Activities (8,468,000) 3,304,000 (26,937,000) ------------- ------------- ------------- Net Increase (Decrease) in cash (140,000) (31,000) 27,000 Cash at Beginning of Year 236,000 267,000 240,000 ------------- ------------- ------------- Cash at End of Year $ 96,000 $ 236,000 $ 267,000 ============= ============= ============= 17 THE MIDLAND COMPANY (Parent Only) Schedule II - Condensed Financial Information of Registrant Notes to Condensed Financial Information For the Years Ended December 31, 1998 and 1997 The accompanying condensed financial information should be read in conjunction with the consolidated financial statements and notes included in the Registrant's 1998 Annual Report to Shareholders. Total debt of the Registrant (parent only) consists of the following: DECEMBER 31, 1998 1997 ------------- ------------- Short - Term Bank Borrowings $ 15,000,000 $ 24,000,000 Commercial Paper 6,522,000 5,791,000 Mortgage Notes: 7.10% - Due January 1, 2001 1,227,000 1,773,000 6.83% - Due December 20, 2005 19,195,000 19,768,000 5.40% - Due December 1, 2003 7,559,000 7,898,000 Total Debt $ 49,503,000 $ 59,230,000 See Notes 8 and 9 to the consolidated financial statements included in the 1998 Annual Report to Shareholders for further information on the Company's outstanding debt at December 31, 1998. The Amount of debt that becomes due during each of the next five years is as follows: 1999 - $1,710,000; 2000 - $1,806,000; 2001 - $1,215,000; 2002 - $1,266,000; 2003 - $6,331,000. 18 THE MIDLAND COMPANY AND SUBSIDIARIES Schedule III - Supplementary Insurance Information For the Years Ended December 31, 1998, 1997 and 1996 (Amounts in 000's) Column A Column B Column C Column D Column E Column F Column G Future Policy Deferred Benefits, Other Policy Policy Losses, Claims and Net Acquisition Claims and Unearned Benefits Premium Investment Cost Loss Expenses Premiums Payable Revenue Income (1) ----------------------------------------------------------------------------------------- 1998 Manufactured Housing $ 48,260 $ 48,939 $ 209,171 $ 258,638 $ 14,875 Other Insurance 15,702 76,557 45,944 116,840 9,923 Unallocated Amounts 34 Inter-segment Elimination (924) ----------------------------------------------------------------------------------------- Total $ 63,962 $ 125,496 $ 255,115 $ - $ 375,478 $ 23,908 ========================================================================================= 1997 Manufactured Housing $ 43,366 $ 42,430 $ 195,793 $ 219,394 $ 13,935 Other Insurance 12,224 77,704 44,547 91,765 8,359 Unallocated Amounts 24 Inter-segment Elimination (986) ----------------------------------------------------------------------------------------- Total $ 55,590 $ 120,134 $ 240,340 $ - $ 311,159 $ 21,332 ========================================================================================= 1996 Manufactured Housing $ 34,492 $ 42,547 $ 183,792 $ 182,581 $ 12,303 Other Insurance 10,850 53,283 24,625 98,033 6,756 Unallocated Amounts 14 Inter-segment Elimination (804) ----------------------------------------------------------------------------------------- Total $ 45,342 $ 95,830 $ 208,417 $ - $ 280,614 $ 18,269 ========================================================================================= Column H Column I Column J Column K Benefits, Amortization of Claims, Losses Deferred Policy Other and Settlement Acquisition Operating Premiums Expenses Costs Expenses (1) Written ------------------------------------------------------------------------- 1998 Manufactured Housing $ 137,483 $ 71,288 $ 31,005 $ 283,020 Other Insurance 72,532 31,881 23,304 110,987 (2) Unallocated Amounts Inter-segment Elimination ------------------------------------------------ ---------- Total $ 210,015 $ 103,169 $ 54,309 $ 394,007 ================================================ ========== 1997 Manufactured Housing $ 100,919 $ 64,265 $ 27,763 $ 247,704 Other Insurance 70,244 15,253 21,355 97,745 (2) Unallocated Amounts Inter-segment Elimination ------------------------------------------------ ---------- Total $ 171,163 $ 79,518 $ 49,118 $ 345,449 ================================================ ========== 1996 Manufactured Housing $ 101,223 $ 54,761 $ 20,477 $ 205,933 Other Insurance 71,203 26,772 20,878 86,600 (2) Unallocated Amounts Inter-segment Elimination ------------------------------------------------ ---------- Total $ 172,426 $ 81,533 $ 41,355 $ 292,533 ================================================ ========== Notes to Schedule III: (1) Net investment income is allocated to insurance segments based upon a combination of premium cash flow and equity data. Other operating expenses include expenses directly related to the segments and expenses allocated to the segments based on historical usage factors. (2) Includes other property and casualty insurance and accident and health ($2,237, $2,738 and $2,178 for 1998, 1997 and 1996, respectively) insurance.
19 THE MIDLAND COMPANY AND SUBSIDIARIES Schedule IV - Reinsurance For the Years Ended December 31, 1998, 1997 and 1996 Column A Column B Column C Column D Column E Column F Ceded to Assumed Percentage of Gross Other from Other Net Amount Assumed Amount Companies Companies Amount to Net ----------------------------------------------------------------------------------- 1998 - ---- Life Insurance in Force $416,892,000 $167,412,000 $ 1,895,000 $251,375,000 0.8% =================================================================================== Insurance Premiums and Other Considerations: Life and Health Insurance $ 9,712,000 $ 3,520,000 $ 235,000 $ 6,427,000 3.7% Property & Liability Insurance 394,166,000 60,573,000 35,458,000 369,051,000 9.6% ----------------------------------------------------------------------------------- Total Premiums $403,878,000 $ 64,093,000 $35,693,000 $375,478,000 9.5% =================================================================================== 1997 - ---- Life Insurance in Force $371,298,000 $170,668,000 $200,630,000 0.0% =================================================================================== Insurance Premiums and Other Considerations: Life and Health Insurance $ 9,761,000 $ 4,371,000 $ 214,000 $ 5,604,000 3.8% Property & Liability Insurance 375,967,000 98,406,000 27,994,000 305,555,000 9.2% ----------------------------------------------------------------------------------- Total Premiums $385,728,000 $102,777,000 $28,208,000 $311,159,000 9.1% =================================================================================== 1996 - ---- Life Insurance in Force $327,473,000 $163,604,000 $ 5,730,000 $169,599,000 3.4% =================================================================================== Insurance Premiums and Other Considerations: Life and Health Insurance $ 7,813,000 $ 4,072,000 $ 1,004,000 $ 4,745,000 21.2% Property & Liability Insurance 347,259,000 92,674,000 21,284,000 275,869,000 7.7% ----------------------------------------------------------------------------------- Total Premiums $355,072,000 $ 96,746,000 $22,288,000 $280,614,000 7.9% ===================================================================================
20 THE MIDLAND COMPANY AND SUBSIDIARIES Schedule V - Valuation and Qualifying Accounts For the Years Ended December 31, 1998, 1997 and 1996 ADDITIONS CHARGED BALANCE AT (CREDITED) TO BALANCE BEGINNING COSTS AND DEDUCTIONS AT END DESCRIPTION OF PERIOD EXPENSES (ADDITIONS) OF PERIOD - -------------------------------------------------------------------------------- YEAR ENDED DECEMBER 31, 1998: Allowance For Losses $ 753,000 $ 176,000 $ 176,000 (1) $ 753,000 YEAR ENDED DECEMBER 31, 1997: Allowance For Losses $ 799,000 $ 184,000 $ 230,000 (1) $ 753,000 YEAR ENDED DECEMBER 31, 1996: Allowance For Losses $ 863,000 $ (50,000) $ 14,000 (1) $ 799,000 NOTES: (1) Accounts written off are net of recoveries. 21 THE MIDLAND COMPANY AND SUBSIDIARIES Schedule VI - Supplemental Information Concerning Property-Casualty Insurance Operations For the Years Ended December 31, 1998, 1997 and 1996 (Amounts in 000's) Column A Column B Column C Column D Column E Column F Column G Reserves for Deferred Unpaid Claims Discount, Affiliation Policy and Claim if any, Net with Acquisition Adjustment Deducted in Unearned Earned Investment Registrant Costs Expenses Column C Premiums Premiums Income - ---------------------------------------------------------------------------------------------------------- Consolidated Property-Casualty Subsidiaries 1998 $ 59,736 $ 121,154 $ - $ 236,171 $ 369,051 $ 22,468 =========== =========== ========== =========== =========== =========== 1997 $ 52,198 $ 116,898 $ - $ 222,530 $ 305,555 $ 20,018 =========== =========== ========== =========== =========== =========== 1996 $ 42,308 $ 92,940 $ - $ 190,071 $ 275,869 $ 17,161 =========== =========== ========== =========== =========== =========== Column H Column I Column J Column K Claims and Claim Adjustment Expenses Amortization Incurred of Deferred Paid Claims Affiliation Related to Policy and Claim with Current Prior Acquisition Adjustment Premiums Registrant Year Years Costs Expenses Written - ------------------------------------------------------------------------------------------- Consolidated Property-Casualty Subsidiaries 1998 $ 208,811 $ (2,120) $ 100,190 $ 200,325 $ 391,770 =========== ========== =========== =========== =========== 1997 $ 163,035 $ 5,230 $ 77,100 $ 151,148 $ 342,711 =========== ========== =========== =========== =========== 1996 $ 166,554 $ 3,771 $ 79,100 $ 153,253 $ 290,355 =========== ========== =========== =========== ===========
22 EX-13 2 THE MIDLAND COMPANY 1998 ANNUAL REPORT Inside Cover COMPANY PROFILE The Midland Company is a highly focused provider of specialty insurance products and services with a profitable investment in a niche transportation business. The company has produced a track record of extraordinary results by building on the entrepreneurial spirit and commitment of its associates. The company's M/G Transport Services Group (M/G) subsidiaries, which contribute the remaining portion of revenue, represent a profitable investment in a niche transportation business. Since the sale of approximately two-thirds of its assets in December 1994, M/G has increased operating income by 10.5% and yielded more than $4.8 million in operating cash flow during 1998. Midland management is focused on a clear, concise, compelling strategic course designed to help it exceed the insurance industry's rates of growth and profitability. Key elements of the company's growth and profit strategies include: - Specialized underwriting expertise - AMIG has unsurpassed knowledge of and experience in the manufactured housing market. - Strong competitive position - A diverse product line, strong customer relationships and underwriting expertise help AMIG maintain its market leadership position. - Risk diversification - Geographic, product and distribution channel diversification aid in limiting AMIG's exposure to catastrophes. - Claims management - Internal claims management contributes to AMIG's strong underwriting results. - Growth opportunities - Introduction of new products, including new fee-based services, into new markets is expected to contribute to a continuation of AMIG's strong growth rate. - Cash flow from transportation business - M/G's healthy return on invested capital makes it a lucrative investment for Midland. - Emphasis on total return investment strategy - A conservative investment strategy is designed to generate long-term capital appreciation with reasonable current income. This page cotains a pie chart: BUSINESS MIX (Revenues) AMIG - $408.2 million M/G - $33.1 million American Modern Insurance Group (AMIG), a highly focused provider of specialty insurance products and services, provides The Midland Company with more than 90% of its revenue. AMIG specializes in writing physical damage insurance and related coverages on manufactured hosing and has expanded into other areas of specialty insurance. The remainder of revenue is contributed by M/G Transport, also a specialty business, which charters barges for the movement of dry cargos on the inland waterways. The Midland Company's Mission To be an indispensable partner to customers within chosen markets by providing value-adding specialty products and services delivered by the best professionals in the industry. FINANCIAL HIGHLIGHTS THE MIDLAND COMPANY AND SUBSIDIARIES For the Years Ended December 31, 1998 1997 % Change - ------------------------------------------------------------------------------ Operating Performance Revenues from Continuing Operations $ 442,362 $ 373,768 18.4% Income from Continuing Operations Before Federal Income Tax $ 37,527 $ 34,703 8.1% Operating Income from Continuing Operations $ 22,802 $ 21,657 5.3% Capital Gains (After-Tax) $ 4,130 $ 2,710 52.4% Net Income (Loss): From Continuing Operations $ 26,932 $ 24,367 10.5% From Discontinued Operations - (6,817) --------------------- Total $ 26,932 $ 17,550 53.5% ===================== Per Share Data Operating Income from Continuing Operations (Diluted) $ 2.42 $ 2.33 3.9% Net Income (Loss) - Basic: From Continuing Operations $ 2.99 $ 2.72 9.9% From Discontinued Operations - (.76) --------------------- Total $ 2.99 $ 1.96 52.6% ===================== Average Shares Outstanding 9,018 8,956 Net Income (Loss) - Diluted: From Continuing Operations $ 2.86 $ 2.63 8.7% From Discontinued Operations - (.74) --------------------- Total $ 2.86 $ 1.89 51.3% ===================== Average Shares Outstanding 9,412 9,292 Cash Dividends $ .25 $ .23 8.7% Book Value $ 26.61 $ 21.11 26.1% Financial Position Total Assets $ 837,220 $ 760,463 10.1% Shareholders' Equity $ 248,832 $ 197,026 26.3% Performance Ratios Combined Ratio (AMIG Property and Casualty Companies) 96.9% 95.8% Return on Beginning Equity - Continuing Operations 13.7% 15.3% Total Return on Beginning Equity Including Net Unrealized Gain and Loss - Continuing Operations 27.1% 28.1% TABLE OF CONTENTS Financial Highlights 1 Letter to Shareholders 2-5 Focus on Specialty Markets 6-7 Focus on Differentiation 8-9 Focus on Lucrative Investment 10-11 Focus on Conservative Investment Strategy 12-13 Six Year Financial Summary Data 14-15 Management's Discussion and Analysis 16-21 Private Securities Reform Act of 1995 - Forward Looking Statements Disclosure 21 Income Statements 22 Balance Sheets 23 Changes in Shareholders' Equity 24 Cash Flows 25 Notes to Financial Statements 26-34 Management's Report 35 Independent Auditors' Report 35 Quarterly Data and Other Information 36 Officers and Directors 37 This page includes a five year bar chart with the following data: NET INCOME AND NET OPERATING INCOME PER SHARE (Continuing Operations) 94 95 96 97 98 Operating Income $1.11 $1.57 $0.22 $2.33 $2.42 Net Income 1.27 1.74 0.41 2.63 2.86 1998 results continued the company's strong record, with net income from continuing operations rising 10.5% to a record $26.9 million or $2.86 per share (diluted). 1 LETTER TO SHAREHOLDERS Nineteen ninety eight was a milestone year for The Midland Company. It celebrated its 60th anniversary, reported record results, passed the torch of leadership to a new generation and implemented plans for future growth. It was an emotional and exciting year filled with appreciation for all that has been accomplished and anticipation of an even brighter future. Early in the year, Midland's Board of Directors placed full responsibility for day-to-day management in our hands. We appreciate their confidence in our ability to lead the business successfully into the future and are eager to prove that their confidence is well-placed. We gratefully acknowledge the continued contributions of our father, J. P. Hayden, Jr., now Chairman of the Executive Committee of the Board, and Michael J. Conaton, now Vice Chairman of the Board. We would also like to acknowledge the retirement of J. R. LaBar and Robert W. Hayden, each of whom served the company in various capacities throughout their 45 and 38 year careers, respectively. We thank them for their many years of loyal service to the company. It is with tremendous enthusiasm that we have assumed our new roles as Chairman and Chief Operating Officer and as President and Chief Executive Officer. We will, in the pages to follow, demonstrate to you that we indeed are focused on a clear, concise and compelling strategic path designed to build on Midland's extraordinary track record. 1998 RESULTS REFLECT BENEFIT OF FOCUSED STRATEGY Results for the company's first year of performance under our care were very satisfying. For the second consecutive year, net income from continuing operations was a record, reaching $26.9 million, up 10.5% from 1997, on an increase in revenues from continuing operations to $442.4 million from $373.8 million. Net income per share from continuing operations reached $2.86 per share (diluted), compared with $2.63 per share (diluted), while return on beginning equity was 13.7% vs. 15.3% a year earlier. Net operating income from continuing operations (net income excluding capital gains) reached a record $22.8 million, or $2.42 per share (diluted), up from $21.7 million, or $2.33 (diluted), while pre-tax investment income, excluding capital gains, rose 12% to $23.9 million. These strong results were driven by solid performance in each of our operating units, as well as from American Modern Insurance Group's (AMIG) investment portfolio. Strong Performance for American Modern Insurance Group - Direct and assumed written premiums generated by AMIG increased 5.4% for 1998 to $458 million, while net earned premiums rose 20.7% to $375 million. The primary driver of growth in written premiums was continued volume This page includes a bar chart with the following data: AMIG PROPERTY & CASUALTY 10-YEAR COMPOUNDED ANNUAL PREMIUM GROWTH AMIG 15.7% Industry 3.4% AMIG has a track record of extraordinary success - consistently outperforming the property and casualty insurance industry by leveraging its unsurpassed knowledge of the specialty markets it serves. Over the past ten years, AMIG's premiums have compounded at a rate more than four times the estimated industry average. 2 increases in manufactured housing and related coverages, where direct and assumed premium written growth was above 13%. As the year progressed, premium growth in key specialty markets, including manufactured housing, watercraft and recreational vehicles, was offset by declines in several less profitable specialty commercial lines markets where we had intentionally reduced our exposure or even exited various portions of the business. The benefits of these decisions were clear as overall premium growth continued and profitability - as measured by the combined ratio (ratio of losses and expenses as a percent of earned premiums) - was substantially better than industry averages. For the year, AMIG's property and casualty combined ratio was 96.9% vs. 95.8% in 1997, with total weather-related catastrophe losses at $34 million on a pre-tax basis compared with an unusually low $14 million in 1997. Excluding catastrophe losses, the combined ratio for the year was 87.7% vs. 91.3% in 1997, reflecting our focus on designing and pricing all AMIG products to yield at least a 5% underwriting margin. Our disciplined approach to underwriting - and to risk management - has allowed us to consistently produce an underwriting profit. Continued Contribution from M/G Transport Services Group (M/G) - For the year, M/G reported revenue of $33.1 million, compared with $34.9 million, and pre-tax operating profits of $4.4 million, essentially unchanged from 1997. The lower revenue and level operating profits were predominantly due to a decline, late in the year, in shipments of barite, a drilling mud used by the oil industry, that was not offset by other types of shipments by year-end 1998. Barite shipments are impacted by the level of oil drilling, which has been declining due to the lower oil prices. M/G's after-tax contribution to net income, however, was down only slightly for the year, at $3.0 million, or 32 cents per share (diluted), compared with $3.1 million, or 34 cents per share (diluted), for the prior year. Cash flow from operations remained strong at $4.8 million and M/G generated a 15.7% return on beginning equity. Investment Income Up 12% - AMIG's investment portfolio continues to be conservatively invested in equity and high quality fixed income securities. The value of the portfolio grew by more than $91 million in 1998, due to the generation of substantial cash flow from operations as well as market appreciation of the portfolio. Pre-tax capital gains for the year were $6.4 million, up from $4.2 million last year. Net unrealized portfolio gains contributed approximately $26 million to the increase in shareholders' equity in 1998. Coupling the net unrealized gains on marketable securities with our strong net income brought total comprehensive income for 1998 to $53.3 million, which equates to a total return on beginning shareholders' equity of 27.1%, up from $38.1 million, or 23.9%, in 1997. Balance Sheet Remains Strong - In part due to the significant gains in our investment portfolio, as well as the strong operating performance, we ended the year with the strongest balance sheet in the company's history. Total assets at year end were $837 million, with shareholders' equity at a record $249 million, or $26.61 per share. BUILDING ON THE TRACK RECORD The results recorded for 1998 were pleasing, but not surprising. They were the result of the vision on which we are focused - to create a sustainable competitive advantage by providing our customers with products, services and relationships they value more than those offered by our competitors and to share that success with shareholders. On the following pages, this report provides details on The Midland Company's operating subsidiaries, their competitive strengths and growth opportunities. Our focus is on a select number of strategies designed to capitalize on those advantages to become an even more indispensable partner to customers in our chosen markets and to achieve This page includes two bar charts with the following data: AMIG 10-YEAR AVERAGE ROE AMIG 14.4% Industry 7.7% Strong growth, combined with a disciplined approach to underwriting and to claims management, has helped AMIG exceed industry returns. Over the past 10 years, AMIG's return on beginning equity has averaged 14.4% compared with an estimated 7.7% average for the industry. M/G TRANSPORT ROE 94 95 96 97 98 M/G TRANSPORT 6.5% 4.8% 5.7% 20.0% 15.9% Since the sale of approximately two-thirds of its assets in December 1994, M/G has proven its value as a lucrative investment for Midland. 3 our long-term financial objectives. Achieve Deeper Penetration of Existing Products Within Existing Markets - Our first opportunity for continued growth is to capture a larger share of the market for our existing products in the niches we presently are serving. While we are widely recognized as a market leader in manufactured housing insurance, we have tremendous growth potential by simply doing more in the markets we are already serving with the products we already have. Our recent track record serves as compelling evidence that we are beginning to realize some of this potential. Take Existing Products and Services Into New Markets - Further, we have the opportunity to move into new markets with our existing assortment of products and services to fill real consumer needs. Clear evidence of this is provided by our recent focus on Arizona with our traditional manufactured housing product/service offering. In less than two years we have been able to more than triple the number of manufactured housing policies written in Arizona. Develop Complementary or Related Products - Our commercial park and dealer package programs in the manufactured housing segment illustrate our ability to identify a market need and develop products specifically designed to address that need. We see a number of similar opportunities on the horizon that will enable us to become an even more indispensable partner to our customers by expanding into complementary or related products. Expand Within Existing Distribution Channels - By continually searching for new ways to bring additional value-adding products and services for our many and varied business partners, we have successfully grown our portfolios with each. We work hard to maximize the performance of all our existing relationships and are endeavoring to truly become their indispensable partner. We are also diligent in our efforts to uncover opportunities to selectively add to our distribution base. Explore New Distribution Methodologies - The people with whom we do business are creative entrepreneurs, each seeking to maximize their business prospects. The pyramiding of these talents affords us numerous opportunities to expand existing business relationships beyond traditional approaches to their respective businesses. Such outside-the-box thinking has allowed us to expand our business horizons beyond those created in a purely linear business environment. Capitalize on Non-Risk, Fee Income/Service Opportunities - In addition, the special expertise that we bring to the table, and our long-standing relationships with important players in each distribution channel, present us with new opportunities. For example, Ameritrac, AMIG's in-house loan and lease tracking service, allows us to meet a vital need of our lending customers. Today we are tracking and servicing approximately 1.5 million loan and lease accounts for more than 40 financial institutions. We continually are evaluating the needs of our customers for additional value-added services. Moving forward, we intend to increase our focus on identifying those opportunities that have the potential to generate This page includes a picture with the following caption: From left, Joseph P. Hayden III, Chairman and Chief Operating Officer and John W. Hayden, President and Chief Executive Officer 4 fee-based revenue, which can be an effective use of capital outside the regulated insurance industry. Lucrative Transportation Operations - While we are constantly evaluating potential expansions of our M/G business, we believe that its focused and efficient staff of 15 can continue to benefit Midland by generating strong cash flow and return on equity. M/G has demonstrated a consistency in its ability to outperform the markets in which it competes, even under the most adverse market conditions. RECOGNIZING IMPORTANT CONTRIBUTIONS Our specialty mindset, combined with the entrepreneurial spirit and genuine commitment of our associates, over time will produce consistently superior results. We strive to recognize the efforts and contributions of our associates on a daily basis, but do not want to miss this opportunity to thank them again for all they do to set us apart from our competitors. With respect to our Board of Directors, we are blessed with a group of talented and devoted individuals who collectively make a real difference in our company. We were most fortunate during the year to welcome two new members to our Board: Jerry A. Grundhofer, president and chief executive officer of Firstar Corporation, and David B. O'Maley, chairman, president and chief executive officer of Ohio National Financial Services. Their experience and insight will be valuable to Midland as we move forward with our strategic plan. EXCITING FUTURE, STRONG BASE We are intent on continuing to differentiate Midland through its people, products and services. We have a deep knowledge and understanding of the markets we serve. We will build on these strengths by giving our talented associates and business partners the tools they need to achieve extraordinary results; results we will share with our shareholders as reward for the confidence they have placed in us. As evidence of our efforts to continue to enhance shareholder value, the board voted in January 1999 to increase the indicated annual dividend to shareholders by 8%, the 13th consecutive year in which The Midland Company has increased its annual dividend. Thank you for your continued confidence and support. We are gratified by the results we are honored to share with you in this report and we are excited by what your company's future holds. We look forward to sharing our story with you in future communications. /S Joseph P. Hayden III /S John W. Hayden Joseph P. Hayden III John W. Hayden Chairman and President and Chief Operating Officer Chief Executive Officer February 11, 1999 This page includes a bar chart with the following data: GROWTH IN ASSETS AND EQUITY (millions) 94 95 96 97 98 Assets $479.5 $600.9 $656.0 $760.5 $837.2 Equity 132.4 156.6 159.7 197.0 248.8 AMIG's disciplined approach to growth and underwriting, as well as a conservative managed investment portfolio and the contribution of M/G, brought Midland's assets and equity to record levels again in 1998. 5 FOCUS ON SPECIALTY MARKETS Midland's specialty insurance operations, American Modern Insurance Group (AMIG), enjoyed another successful year in 1998. Widely recognized as an established leader in the manufactured housing insurance sector, AMIG derives nearly 70% of its premium volume from this unique market segment. Management believes substantial opportunities exist for continued growth in the manufactured housing niche, as well as other specialty markets AMIG has successfully entered over the past ten years. Key to AMIG's success will be its ability to identify niche markets where it can leverage its specialty mindset along with the entrepreneurial energy of its associates. SPECIALTY MARKETS AS DEFINED BY AMIG AMIG prides itself in targeting those specialty markets where frequency of loss, rather than severity of loss, is the norm. AMIG consistently has demonstrated its competency in processing high volumes of lower premium value transactions and has aggressively targeted product and market segments that lend themselves to that characteristic. The manufactured housing segment, in which AMIG has increased premiums at a 20% rate over the past five years, is a classic example. With an average premium of $415 or less per policy, and fairly unique customer cross-sell criteria, the manufactured housing insurer must be able to process high volumes of transactions very efficiently. AMIG has proven itself a very capable player in this regard and is continually refining its processes in its efforts to stay ahead of its customers' constantly changing needs. The growth outlook for the manufactured housing insurance market remains strong, This page contains a bar chart with the following data: AMIG PROPERTY & CASUALTY PREMIUM VOLUME (millions) 94 95 96 97 98 AMIG PROPERTY & CASUALTY $275.5 $376.3 $387.2 $424.0 $446.2 Over the last five years, AMIG's direct and assumed written premiums have grown at a compound annual rate of 15.4% reflecting continued penetration of the manufactured housing sector and growth in other specialty markets. This page also contains two photos of Manufactured Homes with the following caption: Consumer acceptance of manufactured homes is growing, in part due to improvements in their exterior and interior features. Many now offer spacious kitchens, multiple bathrooms, vaulted ceilings, fireplaces, utility rooms and large closets, with floor plans that can measure more than 2,000 square feet. 6 driven by the favorable demographics of the manufactured housing industry in total. According to the U.S. Census Bureau, as of July 1997, manufactured housing accounted for 23.6% of total single-family housing starts and 29.4% of new single-family unit sales. During the past two decades, the typical manufactured home and the lifestyle that accompanies it has been constantly upgraded and the $38,000 average price of a manufactured home compares favorably with the $124,000 average price for a site-built home. In a nutshell, manufactured housing, while still a specialty market, is here to stay. REACHING INTO NEW SPECIALTY MARKETS The manufactured housing market provides AMIG with the financial resources to grow and AMIG has been successful in its efforts to achieve a presence in other specialty markets. For example, since its first foray into the specialty water craft insurance market in 1990, AMIG has clearly established itself as an industry player. Specializing in generally lower-valued, lower-powered watercraft, AMIG has built a highly credible portfolio of marine business, and is recognized widely as an industry expert and leader in the personal watercraft insurance market. AMIG's growing specialty dwelling portfolio is generally targeted at the dwelling business that is around the periphery of the traditional homeowners insurance market. AMIG prefers to avoid the traditional dwelling market segment, as homeowners' insurance is among the least profitable sectors of the property and casualty insurance industry. Instead, AMIG focuses on more limited specialty dwelling market niches where coverages are less comprehensive and price competition is less severe. This group of products is a natural fit for AMIG's core property insurance policy management systems and has proven to be a solid performer since AMIG's first venture into it in 1987. AMIG also is experiencing encouraging results in many of its other product areas, including recreational vehicles, specialty and collectible auto, long-haul truck physical damage, collateral protection, mortgage fire and commercial manufactured housing park and dealer. FEE INCOME OPPORTUNITIES In addition to premium-generating insurance products, AMIG is beginning to see results from its efforts to expand its offering of non-risk related, fee income-generating services. Evidence of this can be found in the results of Ameritrac, AMIG's wholly owned loan and lease portfolio, collateral tracking operation. Ameritrac now services over 1.5 million loan and lease accounts for more than 40 financial institutions. Ameritrac continues to expand its service offerings and now provides flood determinations, agent portfolio conversions, direct mail, marketing and payment processing through electronic fund transfers. LOOKING AHEAD By maintaining its specialty mindset, AMIG has been able to increase its direct and assumed written premiums at a compound annual rate of 16% over the past five years. Management believes that, with its team of motivated associates, AMIG can identify and leverage specialty market opportunities that will result in continued growth in years to come. This page includes a pie chart with the following data (amounts in millions): AMIG PRODUCT MIX (Gross Written Premiums) Manufactured Homes $297.3 Park & Dealer 33.4 Site Built Dwelling 29.1 Collateral Protection 26.8 Watercraft 18.1 Mortgage Fire 9.7 Long Haul Truck 11.8 Credit Life & Related 12.3 All Other 20.2 AMIG is a leader in the manufactured housing insurance market and also offers many other specialty lines. 7 FOCUS ON DIFFERENTIATION AMIG's core business strategy within its targeted specialty markets is differentiation. As a provider of specialty products and services seeking to establish partnerships with its customers, AMIG has built a sustainable competitive advantage by providing its business partners and end-use customers with products, services and relationships they value more than those offered by its competitors. By continuously refining this approach, AMIG believes it can maintain its combined ratio, a measure of overall insurance profitability, well below the property and casualty industry average. SPECIALTY FOCUS CONTRIBUTES TO SUCCESS AMIG is known in the insurance industry as a specialty company, providing highly specialized products and services to unique markets where opportunities exist for reasonable production and profitable returns. Competition in these specialty markets is often less severe and can be more readily predicted. Therefore, while the property and casualty insurance industry as a whole generally is over-capitalized and producing less attractive returns than other industry groups, the specialty insurance companies are growing at a far greater rate than their industry counterparts and producing returns worthy of investor interest. AMIG, for instance, has generated a ten-year compound annual growth rate of 15.7%, while the property and casualty industry in total has averaged just 3.4%. Over the same period, AMIG's statutory combined ratio has averaged 96.3%, well below the property and casualty industry estimated average of 106.3% as reported by A.M. Best Company. Translated into a return on beginning equity benchmark, AMIG has averaged 14.4% over the This page includes a bar chart with the following data: AMIG PROPERTY & CASUALTY UNDERWRITING RESULTS (Statutory Combined Ratio) 94 95 96 97 98 AMIG 96.0% 94.7% 103.0% 94.3% 96.6% Industry 107.0% 104.9% 104.7% 99.9% 103.3% All AMIG products are designed and priced to produce a 5% underwriting margin. This disciplined approach to underwriting - and to risk management - has allowed AMIG to outperform the industry in each of the past five years. This page also includes a photo with the following caption: Classroom training for new adjusters helps guarantee their familiarity with the company's coverages. AMIG utilizes a variety of examples and displays to illustrate key points. 8 past ten years, while the overall industry has struggled to achieve a return on equity estimated in the range of 7.7%. DIFFERENTIATION ENHANCES PROFITABILITY While AMIG will be cost effective in all areas of its business, it does not expect to generate those results and create a competitive advantage by being the total low-cost provider across its array of products and services. Instead, all AMIG products are designed and priced to produce at least a 5% underwriting margin based on AMIG's experience in its specialty markets. AMIG focuses on this pricing level because it targets markets where frequency of loss, rather than severity of loss, is the norm. In particular, in the manufactured housing insurance market, AMIG's history in the industry gives it a unique advantage in distributing, pricing and assessing risk for coverages. SUPERIOR CLAIMS MANAGEMENT AMIG also differentiates itself with superior claims management systems. In the early 1990's, AMIG instituted an in-house staff adjuster training program that is among the best in the industry. Under this program, people are hired out of their local markets and brought to AMIG's headquarters for five weeks of rigorous training in all of the types of coverages, and potential related losses, that it provides. This is followed by extensive in-the-field training and supervision. The benefits of this effort are seen daily by AMIG. With 139 employee field adjusters, AMIG was able to handle 81% of all 1998 claims in-house and settled 86% of property claims within 30 days. Outside adjusters charge a fee for settling claims for insurance companies and lack proper motivation to close the files quickly. By utilizing experienced AMIG staff and by eliminating the fees charged by these outside adjusters, AMIG is able to trim an average of $425 per claim from its handling costs, and has distinguished itself among customers for its high quality service. DISCIPLINED EXPOSURE MANAGEMENT Another element of AMIG's success in generating consistent underwriting profitability is a disciplined process that balances exposure management and reinsurance costs with the potential impact on earnings. AMIG's sophisticated tracking mechanisms regularly compare AMIG's exposure by zip code, by county, by contiguous zip code and county and by state, as well as by distribution channel, to ensure that it has not assumed an unacceptable concentration of risk in any geographic area. Using this information, AMIG evaluates its reinsurance purchases and has distinguished itself as a solid partner in the reinsurance community. SUSTAINABLE COMPETITIVE ADVANTAGE Through differentiation, AMIG has created a sustainable competitive advantage. By continuing to provide its business partners and end-use customers with products, services and relationships they value more than those offered by its competitors, management believes AMIG can continue to outperform the overall insurance industry in terms of growth and profitability. This page contains a pie chart with the following data (amounts in millions): AMIG DISTRIBUTION MIX Wholesale $ 80.0 Retail 63.6 Commercial 32.8 Banks/Credit Unions 40.6 Dealer 105.3 Lender 136.2 AMIG continues to strengthen relationships with its loyal agency base as well as lenders, dealers and others with which it has done business for many years. These multiple distribution outlets provide AMIG with added insight into the needs of its specialty insurance markets. 9 FOCUS ON LUCRATIVE INVESTMENT Midland's transportation services are provided by M/G Transport Services, Inc., which owns 276 jumbo hopper barges, and MGT Services, Inc., which represents the sales and marketing arm of the operation (collectively referred to as M/G). This highly focused specialty player in the customized dry cargo transportation services market represents a lucrative investment for Midland. M/G, with operations in New Orleans, La., is a barge affreightment company. Since the sale of approximately two-thirds of its assets in December 1994, it has seen net income rise 88% to $3.0 million for 1998 from $1.6 million for 1995. Management believes that M/G can continue to provide the company with a positive contribution as evidenced by M/G's operating cash flow of $4.8 million in 1998. CUSTOMIZED DRY CARGO TRANSPORTATION SERVICES M/G provides superior service to large, industrial clients, transporting dry cargos such as petroleum coke, barite, sugar, fertilizer, iron ore, grain and other commodities. The operations are concentrated on the Gulf Coast, but M/G also services the inland river system. Customers appreciate the flexible service that M/G can provide and M/G has become a major player in the movement of both petroleum coke and sugar because of strong customer relationships. The generally favorable economic climate, as well as the dynamics of individual end markets, has driven some volume increases on the Gulf Coast and inland waterways, but, late This page contains a bar chart with the following data: M/G TRANSPORT OPERATING CASH FLOW (millions) 95 96 97 98 M/G TRANSPORT $2.6 $2.9 $5.2 $4.8 A highly efficient organization combined with effective use of invested capital, allows M/G to generate strong operating cash flow and positively contribute to Midland's overall results. This page also contains a photo with the following caption: M/G serves its customers with a fleet of 276 jumbo hopper barges. To hold fixed costs at a low level, M/G does not own any towboats. 10 in 1998, shipments of barite fell below anticipated levels because of lower oil prices. Barite is a drilling mud used by the oil industry to lubricate drilling, which has declined in recent months. M/G experienced a modest decline in revenues because of the barite dip, but because of the flexibility of the company's operations and its relationships across many different industries, M/G can offset shifts in individual markets over the longer term. COMPANY-OWNED AND LEASED EQUIPMENT M/G serves its customers with a fleet of 276 jumbo hopper barges owned, or leased under long-term contracts, by the company. To supplement its owned and leased barges, the company charters equipment or rents space from other operators as necessary to fill customer needs. This provides the company with operating flexibility, allowing it to ramp up capacity when demand rises and trim expenses when business drops off. Looking forward, the company strives to own or lease approximately half of the barges it requires to meet customer needs. In 1999, M/G anticipates purchasing or leasing an additional 20 barges, at a total cost of approximately $6.1 million, to keep its fleet at optimum levels. To hold fixed costs at a low level, M/G does not own any towboats, but orchestrates all required pick-ups with hired towboats. This added flexibility allows the company to focus on its customers' shipping requirements rather than a towboat schedule. EFFICIENT OPERATIONS M/G fills an attractive niche for Midland, in particular because of the efficiency of M/G's operations. Barges do not require human operators, and the company's 15 office-based employees were able to generate $33.1 million in revenue and $3.0 million in net income in 1998. The efficiency extends to M/G's use of long-term debt and equity, which stood at $25.7 million at year-end 1998. Management believes that anticipated capital expenditures for 1999 and beyond can be funded from internally generated cash or bank debt. This page contains a pie chart with the following data (amounts in millions): M/G TRANSPORT MIX OF BUSINESS (Revenues) Petroleum Coke $21.0 Sugar 2.9 Barite 2.1 Barge Charters 1.1 Miscellaneous 5.4 Diverse products such as petroleum coke, barite, sugar, fertilizer, iron ore, grain and other commodities are transported by M/G's fleet of 276 jumbo hopper barges. 11 FOCUS ON CONSERVATIVE INVESTMENT STRATEGY AMIG's investment portfolio continues to be conservatively invested in equity and high quality fixed-income securities. The value of the portfolio grew by more than $91 million in 1998, to $587 million from $495 million, due to the generation of substantial cash flow from operations as well as market appreciation of the portfolio. Pre-tax capital gains for the year were $6.4 million, up from $4.2 million last year. Net unrealized portfolio gains contributed approximately $26 million to the increase in shareholders' equity in 1998. AMIG remains focused on the following three objectives for the portfolio. BALANCE SAFETY AND LIQUIDITY WITH TOTAL RETURN As of year-end 1998, 77% of the portfolio was invested in fixed-income securities with a weighted average quality of AA to AAA, a current average maturity of 5.3 years and a 5.2% one-year after-tax total return. The remaining 23% was invested in a diverse mix of equities, including a large holding in Firstar Corporation, which constitutes the company's largest equity investment. The portfolio has no This page contains three bar charts with the following data: AMERICAN MODERN INSURANCE GROUP, INC. INVESTMENT PORTFOLIO MARKET VALUES (millions) 94 95 96 97 98 Government $101.3 $155.6 $172.2 $201.4 $177.1 Municipal 64.1 94.5 71.5 88.2 168.4 Corporate 31.2 36.0 41.1 79.0 79.3 Cash Equivalents 44.5 33.1 51.7 34.6 29.3 Equities 26.7 40.8 63.4 92.3 132.8 NET INVESTMENT INCOME (millions) 94 95 96 97 98 Capital Gains $ 2.2 $ 2.4 $ 2.7 $ 4.2 $ 6.4 Operations 10.8 17.1 19.1 22.3 24.8 UNREALIZED GAINS (millions) 94 95 96 97 98 Equities $ 6.6 $16.0 $26.0 $51.9 $88.5 Fixed Income (5.1) 8.9 2.4 7.0 9.4 AMIG's investment portfolio is conservatively invested in equity and high-quality fixed income securities. In 1998, the portfolio's value grew by more than $91 million due to substantial cash flow from operations as well as market appreciation of the securities. After-tax capital gains for the year increased by 52% while pretax investment income, excluding those gains, rose 12%. Coupling Midland's 1998 net income with the net unrealized gains on marketable securities produced a total return of $53.3 million in 1998, which equates to a total return on beginning shareholders' equity of 27.1% 12 investments in real estate or high-risk derivative products. The market value of the portfolio at year-end 1998 exceeded the cost by approximately $98.0 million, primarily due to market appreciation of the equity investments. For 1998, AMIG's equity portfolio achieved a one year total return of 44.6% compared with 28.6% for the Standard & Poor's 500 Index and a negative 2.5% for the Russell 2000 Index. TARGET LONG-TERM CAPITAL APPRECIATION The careful selection of a portfolio of high quality securities, combined with continued cash flow from operations, has resulted in overall portfolio compounded annual growth of 21.8% over the past five years and 16.3% over the past 10 years. Management believes that it has created a portfolio with the diversity necessary to continue to achieve long-term capital appreciation, which strengthens the company's financial position and provides it with added flexibility. PRODUCE REASONABLE CURRENT INCOME At the same time, AMIG seeks to generate a consistent flow of current income from investments to help it achieve its overall financial performance objectives. In 1998, pretax investment income, excluding capital gains, rose 11% to $24.8 million, up from $22.3 million in 1997. At year-end, the current pre-tax yield on the fixed income portfolio (which includes 37% in municipal securities) was approximately 5.3%. ANNUALIZED TOTAL RETURN (Total Return is the rate of return on a portfolio that takes into consideration both interest income and dividends plus the change in the market value.) 1 Year 3 Year 5 Year EQUITIES: AMIG 44.6% 42.8% 33.9% S&P 500 Index 28.6% 28.2% 24.1% FIXED INCOME: AMIG Before Tax 7.3% 6.4% 6.3% AMIG After Tax 5.2% 4.5% 4.5% After Tax Lehman Brothers Intermediate Government/Corporate Index 5.4% 4.4% 4.3% The average maturity and duration of AMIG's Fixed Income Portfolio was 5.3 years and 3.8, respectively, at December 31, 1998. 13 SIX YEAR FINANCIAL SUMMARY DATA THE MIDLAND COMPANY AND SUBSIDIARIES For the Periods Ended December 31, (Amounts in thousands, except per share data) 1998 1997 1996 1995 1994 1993 - --------------------------------------------- ------------------------------------------------------------------ Income Statement Data Revenues: Insurance: Premiums earned $375,478 $311,159 $280,614 $263,006 $206,339 $164,363 Net investment income 23,908 21,332 18,269 16,107 10,090 9,240 Net realized investment gains 6,354 4,170 2,690 2,373 2,189 3,735 Other insurance income 2,508 1,557 1,602 618 844 1,066 Transportation(b) 33,059 34,933 34,064 30,371 53,163 53,252 Other 1,055 617 499 752 858 806 ------------------------------------------------------------------- Total 442,362 373,768 337,738 313,227 273,483 232,462 ------------------------------------------------------------------- Costs and Expenses: Insurance: Losses and loss adjustment expenses 210,015 171,163 172,426 136,211 113,096 84,787 Commissions and other policy acquisition costs 103,169 79,518 81,533 80,520 64,557 49,545 Operating and administrative expenses 54,309 49,118 41,355 39,475 26,103 20,919 Transportation operating expenses(b) 28,287 30,079 31,163 28,033 47,820 50,023 Interest expense 4,991 4,983 4,829 3,037 3,800 3,168 Other operating and administrative expenses 4,064 4,204 3,115 3,462 2,807 2,129 ------------------------------------------------------------------- Total 404,835 339,065 334,421 290,738 258,183 210,571 ------------------------------------------------------------------- Income from Continuing Operations Before Federal Income Tax 37,527 34,703 3,317 22,489 15,300 21,891 Provision (Credit) for Federal Income Tax(a) 10,595 10,336 (426) 6,441 3,663 1,554 ------------------------------------------------------------------- Income from Continuing Operations 26,932 24,367 3,743 16,048 11,637 20,337 Loss from Discontinued Operations(c) - (6,817) (2,675) (6,496) (2,218) (2,365) ------------------------------------------------------------------- Net Income $ 26,932 $ 17,550 $ 1,068 $ 9,552 $ 9,419 $ 17,972 =================================================================== Basic Earnings (Loss) Per Share of Common Stock(e): Continuing operations $ 2.99 $ 2.72 $ .42 $ 1.81 $ 1.31 $ 2.28 Discontinued operations - (.76) (.30) (.73) (.25) (.27) ------------------------------------------------------------------- Total $ 2.99 $ 1.96 $ .12 $ 1.08 $ 1.06 $ 2.01 =================================================================== Diluted Earnings (Loss) Per Share of Common Stock(e): Continuing operations $ 2.86 $ 2.63 $ .41 $ 1.74 $ 1.27 $ 2.20 Discontinued operations - (.74) (.29) (.70) (.24) (.25) ------------------------------------------------------------------- Total $ 2.86 $ 1.89 $ .12 $ 1.04 $ 1.03 $ 1.95 =================================================================== Cash Dividends Per Share of Common Stock(e): $ .25 $ .23 $ .22 $ .21 $ .19 $ .18 =================================================================== 14 THE MIDLAND COMPANY AND SUBSIDIARIES For the Periods Ended December 31, (Amounts in thousands, except per share data) 1998 1997 1996 1995 1994 1993 - --------------------------------------------- ------------------------------------------------------------------ Operating Income from Continuing Operations(d) $ 22,802 $ 21,657 $ 1,995 $ 14,506 $ 10,214 $ 17,909 Operating Income Per Share from Continuing Operations (Diluted)(d,e) $ 2.42 $ 2.33 $ .22 $ 1.57 $ 1.12 $ 1.95 Balance Sheet Data Total Cash and Marketable Securities $593,857 $504,106 $403,804 $373,275 $282,116 $228,435 Total Assets 837,220 760,463 655,979 600,905 479,497 433,263 Total Debt 76,085 92,309 95,170 101,076 74,637 92,824 Unearned Premiums 255,115 240,340 208,417 190,948 158,316 118,802 Loss Reserves 125,496 120,134 95,830 68,347 57,715 42,607 Shareholders' Equity 248,832 197,026 159,688 156,595 132,437 113,110 Book Value Per Share(e) $ 26.61 $ 21.11 $ 17.50 $ 17.28 $ 14.73 $ 14.80 Common Shares Outstanding(e) 9,352 9,334 9,126 9,060 8,991 8,997 Other Data AMIG's Property and Casualty Operations Direct and Assumed Written Premiums $446,248 $423,964 $387,165 $376,330 $275,509 $218,022 Net Written Premium 391,770 342,711 290,355 285,306 235,821 180,318 Loss and Loss Adjustment Expense Ratio (GAAP) 56.1% 55.1% 61.8% 52.0% 55.0% 51.7% Underwriting Expense Ratio (GAAP) 40.8% 40.7% 42.5% 45.2% 43.5% 42.3% Combined Ratio (GAAP) 96.9% 95.8% 104.3% 97.2% 98.5% 94.0% Statutory Capital and Surplus 217,091 164,128 124,131 113,189 89,910 70,801 Net Written Premium to Statutory Surplus 1.8x 2.1x 2.3x 2.5x 2.6x 2.5x M/G Transport's Transportation Operations(b) Net Revenues $ 33,059 $ 34,933 $ 34,064 $ 30,371 $ 53,163 $ 53,252 Net Income 2,994 3,126 1,938 1,585 2,000 120 Total Assets 41,576 44,544 41,458 48,375 52,534 87,654 Shareholders' Equity 19,075 19,081 15,658 34,219 32,736 30,735 Footnotes: (a) Included in the 1993 financial results is a credit of $4,867,000 ($0.53 per common share) for the cumulative effect of a change in accounting from the adoption of Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes," effective January 1, 1993. (b) M/G Transport sold approximately 66% of its assets in December 1994. (c) On September 29, 1997, the Company's sportswear subsidiary sold substantially all of its assets to Brazos, Inc., a subsidiary of Brazos Sportswear, Inc. The assets were sold for approximately $13.3 million in cash resulting in an after-tax loss on the disposal of approximately $3.3 million. (d) Represents income from continuing operations excluding net realized investment gains or losses, net of federal income taxes. (e) Previously reported share information has been adjusted to reflect a three-for-one common stock split effective May 21, 1998.
15 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS THE MIDLAND COMPANY AND SUBSIDIARIES LINES OF BUSINESS AND REPORTABLE SEGMENTS The discussions of Results of Operations and Liquidity and Capital Resources are grouped according to Midland's (the company) two primary lines of business (insurance and transportation) and three reportable segments (manufactured housing insurance, other insurance and transportation). A description of the operations of each of these lines, along with a brief discussion of Discontinued Operations, is included below. Insurance The company's specialty insurance operations are conducted through American Modern Insurance Group, Inc. (AMIG), a wholly owned subsidiary of the company and a holding company for six property and casualty insurance companies, two credit life insurance companies and two licensed insurance agencies. Other subsidiaries of AMIG offer warranty products and operate Ameritrac, AMIG's proprietary loan and lease tracking service. AMIG is licensed, through its subsidiaries, to write insurance in all 50 states and the District of Columbia. The majority of AMIG's 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. Other insurance products include Lower Valued Homes, Dwelling Fire, Homeowners, Mortgage Fire, Collateral Protection, Watercraft, Long-Haul Truck, Commercial Park and Dealer, Excess and Surplus Lines, Specialty Auto and Extended Service Contracts. Transportation M/G Transport Services, Inc. and MGT Services, Inc. (collectively M/G Transport), the company's transportation subsidiaries, operate a barge chartering and freight brokerage business. M/G Transport arranges for the movement of dry bulk commodities such as petroleum coke, ores, barite, fertilizers, sugar and other dry cargos primarily on the Gulf Coast and the lower Mississippi River and its tributaries. 1997 Discontinued Operations On September 29, 1997, the company's sportswear subsidiary sold substantially all of its assets to Brazos, Inc., a subsidiary of Brazos Sportswear, Inc. The assets were sold for approximately $13.3 million in cash resulting in an after-tax loss on the disposal of approximately $(3.3 million). The cash proceeds from this transaction were primarily used to reduce the company's short-term bank borrowings. The results of operations and the related loss on disposal for these operations are categorized in the consolidated financial statements as "Discontinued Operations" and are reported separately from continuing operations. Management does not expect any future activity in regard to this subsidiary to have a material impact on the consolidated financial results of the company and there have been no financial results reported from this discontinued subsidiary since the date of sale. YEAR ENDED DECEMBER 31, 1998 COMPARED TO YEAR ENDED DECEMBER 31, 1997 Insurance Insurance Premiums Direct and assumed written premiums generated from AMIG's property and casualty and life insurance subsidiaries for the year ended December 31, 1998 increased 5.4% to $458.5 million from $435.0 million in 1997. Net earned premiums for the year increased 20.7% to $375.5 million from $311.2 million in 1997. The difference in growth rates between the direct and assumed written premiums and net earned premiums was due primarily to AMIG's decision to cede less written business to its reinsurers in 1998 compared to 1997. The growth in direct and assumed written premiums is primarily the result of volume increases in manufactured home and related coverages. Manufactured home and related coverages direct and assumed written premium increased 13.2% to $297.3 million in 1998 from $262.7 million in 1997. Direct and assumed written premiums of all other specialty insurance products collectively decreased by 6.4% to $161.2 million in 1998 from $172.3 million in 1997 due, in part, to AMIG's strategy to exit certain commercial lines programs. Premium rate increases also contributed to AMIG's overall direct and assumed premium growth, but to a lesser degree than the aforementioned volume increases. Investment Income and Realized Capital Gains AMIG's net investment income (before taxes and excluding net realized capital gains) increased 12.2% to $23.9 million in 1998 from $21.3 million in 1997. The increase in investment income was primarily the result of the positive cash flow generated by underwriting activities coupled with the continued growth of AMIG's investment portfolio. AMIG's investment portfolio increased by $91.5 million to $587 million in market value at December 31, 1998. The portfolio increase was due primarily to three factors: 1) cash flow from underwriting activities, 2) investment income and net realized capital gains generated from the portfolio and 3) unrealized appreciation in the market value of the securities held. This increase was driven by the relatively strong stock market in 16 1998 which caused a significant increase in the value of AMIG's equity investments, including its investment in the common stock of Firstar Corporation that increased in market value from $44.6 million at December 31, 1997 to approximately $72.4 million at December 31, 1998. After-tax net realized capital gains increased to $4.1 million, $0.44 per share (diluted), in 1998 from $2.7 million, $0.30 per share (diluted), in 1997. Losses and Loss Adjustment Expenses (LAE) Insurance losses and LAE increased 22.7% to $210.0 million in 1998 from $171.2 million in 1997. This increase was due primarily to an increase in the level of weather-related catastrophe losses compared to the prior year and AMIG's decision to cede less written business to its reinsurers in 1998. Weather-related catastrophe losses amounted to $33.9 million, on a pre-tax basis, representing approximately 9.2 percentage points of the 96.9% combined ratio (ratio of losses and expenses as a percent of earned premiums) for the property and casualty operations in 1998. This compares to weather-related catastrophe losses in 1997 totaling $13.8 million, on a pre-tax basis, representing approximately 4.5 percentage points of the 95.8% combined ratio for the property and casualty operations. Commissions, Other Policy Acquisition Costs and Other Operating and Administration Expenses Commissions, other policy acquisition costs and other operating and administrative expenses increased 22.5% to $157.5 million in 1998 from $128.6 million in 1997. This increase is due primarily to the continued growth in net earned premiums. Overall Underwriting Results AMIG's property and casualty operations generated pre-tax underwriting income of $11.4 million in 1998 compared to $12.9 million in 1997. This equates to a combined ratio of 96.9% in 1998 compared to 95.8% in 1997. Transportation Transportation revenues decreased 5.2% to $33.1 million in 1998 from $34.9 million in 1997. This fluctuation was due primarily to decreases in the loadings of barite, a drilling mud used by the oil industry to lubricate drilling. Transportation's pre-tax profits amounted to $4.4 million in both 1998 and 1997. The transportation operations in 1998 generated a 15.7% return on beginning equity. This compares to a return on beginning equity in 1997 of 19.8%. Discontinued Operations As previously reported, on September 29, 1997, the company's sportswear subsidiary sold substantially all of its assets to Brazos, Inc., a subsidiary of Brazos Sportswear, Inc. The after-tax operating losses and loss on disposal from the discontinued operations for 1997 amounted to $(6.8 million), $(0.74) per share (diluted). There have been no financial results reported from this discontinued subsidiary since the date of sale. YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED DECEMBER 31, 1996 Insurance Insurance Premium Direct and assumed written premium generated from AMIG's property and casualty and life insurance operations for the year ended December 31, 1997 increased 9.0% to $435.0 million from $399.1 million in 1996. Net earned premiums for the year increased by 10.9% to $311.2 million from $280.6 million in 1996. This premium growth was primarily the result of a volume increase in the premiums for manufactured homes and related coverages. Manufactured home and related coverages direct and assumed written premium increased 20.6% to $262.7 million in 1997 from $217.8 million in 1996. Direct and assumed written premium of all other specialty insurance products collectively decreased by 5.0% to $172.3 million in 1997 from $181.3 million in 1996 due, in part, to the implementation of AMIG's strategy to exit certain commercial lines programs. Premium rate increases also contributed to AMIG's overall direct and assumed premium growth, but to a lesser degree than the aforementioned volume increases. Investment Income and Realized Capital Gains AMIG's net investment income (before taxes and excluding net realized capital gains) increased by approximately 16.4% to $21.3 million in 1997 from $18.3 million in 1996. This increase was primarily the result of the growth in AMIG's investment portfolio. AMIG's investment portfolio increased by $95.6 million to $495.5 million in market value at December 31, 1997. After-tax net realized capital gains increased to $2.7 million, $0.30 per share (diluted), in 1997 from $1.7 million, $0.19 per share (diluted), in 1996. Losses and Loss Adjustment Expenses (LAE) AMIG's losses and LAE decreased 0.7% to $171.2 million in 1997 from $172.4 million in 1996. Losses decreased (even though net earned premiums 17 increased by nearly 11%) due to the existence of more favorable weather patterns throughout the United States in 1997 compared to 1996. Weather related catastrophe losses represented 4.5 percentage points of the 95.8% property and casualty combined ratio in 1997 compared to 8.4 percentage points of the 104.3% property and casualty combined ratio in 1996. The 1996 losses and LAE were negatively impacted by numerous catastrophic weather related losses ranging from severe winter storm systems and flooding during the first part of the year to Hurricanes Fran and Bertha which caused heavy damage along the eastern United States during the third quarter of 1996. The decrease in weather related catastrophe losses, however, was partially offset by loss and LAE reserve strengthening by AMIG in 1997. This strengthening included $5.2 million in loss reserve provisions related to prior years' reserve development and was in addition to reserves established for losses in the normal course of business. Such loss reserve strengthening was deemed necessary as a result of an unfavorable loss development trend attributable to the commercial lines business. The commercial lines operation (including both continuing and discontinued programs) incurred approximately $17.7 million in underwriting losses in 1997 compared to $10.3 million of underwriting losses in 1996. Based on the underwriting results generated by the commercial products, AMIG made the decision to refocus the Commercial Lines Division in 1997. As a result, AMIG discontinued numerous commercial programs and the remaining programs were redesigned in an effort to improve underwriting profitability and build on synergies between the commercial and personal lines operations. Commissions, Other Policy Acquisition Costs and Other Operating and Administration Expenses While the growth in AMIG's written premium resulted in a $5.7 million increase in underwriting expenses (commission, other policy acquisition and operating and administrative expenses), the property and casualty underwriting expense ratio (ratio of underwriting expenses to earned premium) actually decreased to 40.7% in 1997 from 42.5% in 1996. This improvement was due, in part, to a decrease in litigation related expenses resulting from the settlement of a class action lawsuit in Alabama and Mississippi. Also contributing to the decrease in the property and casualty underwriting expense ratio was the fact that commission expenses remained flat in 1997 compared to 1996, despite the increase in earned premium. This was due to increases in ceding commissions received by AMIG in 1997 (which are included in the consolidated financial statements as offsets to commission expenses). Overall Underwriting Results AMIG's property and casualty operations generated pre-tax underwriting income of $12.9 million in 1997 compared to a pre-tax loss of $(11.8 million) in 1996. The property and casualty companies' combined ratio improved to 95.8% in 1997 from 104.3% in 1996. As discussed in "Losses and Loss Adjustment Expenses (LAE)" above, the improved underwriting results were primarily the result of favorable weather patterns in 1997 compared to 1996. Transportation M/G Transport's revenues increased 2.3% to $34.9 million in 1997 from $34.1 million in 1996. Transportation operating expenses decreased in 1997 compared to 1996 due primarily to a $3.6 million decrease in litigation related expenses. M/G Transport's net profits improved 63.2% to $3.1 million in 1997 from $1.9 million in 1996. LIQUIDITY AND CAPITAL RESOURCES Holding Company Operations Midland and AMIG are holding companies which rely primarily on dividends and management fees from their subsidiaries to assist in servicing their debt, paying their operating expenses and paying dividends to their respective stockholders. The payment of dividends to these holding companies from AMIG's insurance subsidiaries is restricted by state regulatory agencies and/or covenants contained in debt agreements. Such restrictions, however, have not had, and are not expected to have, a significant impact on the company's or AMIG's liquidity or their ability to meet their long or short-term operating, financing or capital obligations. Midland issues commercial paper, generally below the bank prime borrowing rates and has $50 million of conventional short-term credit lines available at costs generally not exceeding prime borrowing rates. Additional short-term borrowing lines are available at the discretion of various lending institutions with comparable rates. Outstanding interest bearing debt, not allocable to either the insurance or transportation operations, as of December 31, 1998 amounted to approximately $49.5 million. The December 31, 1998 balance of outstanding interest bearing debt consisted of short-term borrowings on conventional lines of credit of $15.0 million, $6.5 million in commercial paper payable to external investors, $1.2 million related to a collateralized equipment obligation and $26.8 million in mortgage obligations. Any intercompany investment in parent company commercial paper is eliminated in consolidation. 18 Capital expenditures, other than for barge acquisitions discussed below, amounted to $4.9 million, $7.6 million and $4.4 million for years ended December 31, 1998, 1997 and 1996, respectively. The company currently estimates that the level of capital expenditures for 1999 will be in the range of prior years. Insurance AMIG generates cash inflows primarily from insurance premiums, investment income and proceeds from sales of marketable securities and maturities of fixed income investment securities. The principal cash outflows for the insurance operations relate to the payment of claims, commissions, premium taxes, operating expenses, income taxes and the purchase of marketable securities. In each of the years 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 insurance products written by the company's insurance subsidiaries are primarily property-related coverages that result in relatively rapid claim payments. The average maturity and duration of AMIG's fixed income investment portfolio are approximately 5.3 and 3.8 years, respectively, which management believes provide adequate asset/liability matching. The gross unrealized appreciation on AMIG's marketable securities increased by 66.4% to $98.0 million at December 31, 1998 from $58.9 million at December 31, 1997. AMIG also has a $40 million long-term credit facility available on a revolving basis at various rates. As of December 31, 1998, $20 million was outstanding on this credit facility. Cash flow from the insurance operations is expected to remain sufficient to meet AMIG's future operating requirements and to provide for reasonable dividends to the company. As of December 31, 1998, AMIG's property and casualty statutory surplus was $217.1 million resulting in a premium to surplus ratio of 1.8 for the year ended December 31, 1998. Transportation M/G Transport generates its cash inflows primarily from affreightment revenue. The primary outflows of cash relate to the payment of barge charter costs, debt service obligations, operating expenses, income taxes and the acquisition of capital equipment. Like the insurance operations, cash flow from the transportation operations is expected to remain sufficient to meet future operating requirements while providing for reasonable dividends to Midland. The transportation subsidiaries acquired 41 barges in 1997 and 25 barges in 1996. The total collective cost of these 66 barges was approximately $18.1 million. As consideration for these acquisitions, M/G Transport exchanged four of its towboats in 1996 and paid $11.9 million in 1997. These acquisitions were financed primarily with internally generated capital and short-term bank borrowings. There were no barge acquisitions during 1998. M/G Transport has committed to acquiring 20 new steel roll-top barges to be delivered in the third quarter of 1999. The total cost of these barges will be approximately $6.1 million. This acquisition, along with any additional acquisitions, will likely be accomplished through a combination of internally financed funds, external borrowings or lease transactions. As of December 31, 1998, the transportation subsidiaries had $6.6 million of collateralized equipment obligations outstanding. OTHER MATTERS Market Risk Market risk is the risk that the company will incur losses due to adverse changes in market rates and prices. The company's market risk exposures are substantially related to AMIG's investment portfolio and changes in interest rates and equity prices. Each risk is defined in more detail below. Interest rate risk is the risk that AMIG will incur economic losses due to adverse changes in interest rates. The risk arises from AMIG's investment activities, as AMIG invests substantial funds in interest-sensitive assets. AMIG manages the interest rate risk inherent in its investment assets relative to the interest rate risk inherent in its liabilities. One of the measures AMIG uses to quantify this exposure is duration. By definition, duration is a measure of the sensitivity of the fair value of assets to changes in interest rates. Based upon the 3.8 year average duration of AMIG's fixed income portfolio at December 31, 1998, management estimates that a 100 basis point increase in interest rates ("rate shock") would decrease the net fair value of its fixed income portfolio by 3.8% or $17.3 million. Equity price risk is the risk that AMIG will incur economic losses due to adverse changes in a particular stock or its stock portfolio. AMIG's equity exposure consists primarily of the risk of declines in the value of its equity security holdings, including the common stock of Firstar Corporation. At December 31, 1998, AMIG had approximately $131.2 million in equity holdings, including $72.4 million of Firstar Corporation common stock. A 10% decrease in the market value of Firstar Corporation's common stock would decrease the fair value of AMIG's equity portfolio by approximately $7.2 million. AMIG's portfolio of equity securities has a beta coefficient (a measure of stock price volatility) of approximately .97. This means that, in general, if the S&P Index decreases by 10%, management estimates that the fair value of its equity portfolio will decrease by approximately 9.7%. 19 The active management of market risk is integral to AMIG's operations. AMIG has investment guidelines that define the overall framework for managing market and other investment risks, including accountability and control over these activities. Comprehensive Income For the company, the only difference between net income and comprehensive income is the net change in unrealized gain on marketable securities. As discussed above, the primary component of the net change in unrealized gains on marketable securities during 1998 and 1997 was the appreciation in the company's equity investments. For the year ended December 31, 1998 and 1997, such net unrealized gains increased (net of income tax effects) by $26.4 million and $20.5 million, respectively. The company's 1998 net income, coupled with the appreciation of the net unrealized gains on marketable securities, produced a total comprehensive income of $53.3 million, which equates to a return on beginning shareholders' equity of 27.1%. This follows a total comprehensive income from continuing operations in 1997 of $44.9 million, a 28.1% return on beginning equity. Year 2000 Compliance The Year 2000 Issue The Year 2000 Issue arises from the common computer programming convention of using a two digit shorthand to represent a calendar year (i.e., "99" means 1999). Some computer systems and embedded chips may not recognize the entry "00" as the two digit shorthand for calendar year 2000. This could lead to erroneous results or, in the worst case, to system shutdowns. Status of the Company's Response to the Year 2000 Issue The company's information systems professional staff began preparing for the Year 2000 Issue as early as 1992. Since that time, the company has been upgrading and replacing its computer hardware and software. These upgrades and replacements have been driven by non-Year 2000 related business requirements. However, all hardware and software that have been upgraded and replaced since 1992 have been certified by their suppliers as Year 2000 compliant. The company has developed a comprehensive Year 2000 Work Plan to deal with the Year 2000 Issue. The company's Year 2000 Work Plan called for all mission-critical internal computer hardware and software to be Year 2000 compliant by the end of 1998. As of December 31, 1998, the company, with minor exceptions, had met the schedule established in its Year 2000 Work Plan. The company's Year 2000 Work Plan consists of five phases: 1) awareness, 2) assessment, 3) remediation, 4) testing and 5) implementation. The awareness and assessment phases of its Year 2000 Work Plan are ongoing, but have been substantially completed. Remediation, testing and implementation have been completed for nearly all of the company's internal hardware and software. Remediation, testing and implementation for the remaining internal hardware and software are currently scheduled for completion by the end of the first quarter of 1999. During the awareness phase, the company formed a multi-disciplinary task force to address the Year 2000 Issue, defined the Year 2000 Issue, obtained executive level support, and educated company personnel, customers, suppliers and policyholders concerning the Year 2000 Issue and its potential effects on the company. Education efforts are ongoing. During the assessment phase, the company collected a comprehensive list of internal items that might be affected by Year 2000 Issues. The company also identified critical business relationships that might be affected by the Year 2000 Issue. The company then evaluated these items and business relationships to determine whether they faced Year 2000 Issues and what effect they would have on the company if they failed due to Year 2000 Issues. The company continues to try to identify potential Year 2000 Issues. The remediation phase included an analysis of the items that are affected by Year 2000 Issues, identification of problem areas, recommendations concerning repair of critical non-Year 2000 compliant items and remediation of those items. Similarly, during the remediation phase, the company has been and is communicating and working with its critical business relationships to help them understand and remediate their Year 2000 Issues. The testing phase followed the remediation phase and included a thorough testing of all recommended remediation. Testing included present and forward date testing which simulated critical dates in the Year 2000. The company has tested, or will test, all of its critical internal systems and has or will attempt to verify Year 2000 compliance of its critical business relationships. The implementation phase consisted of placing all internal items that have been remediated and successfully tested into production. Successful completion of the company's Year 2000 Work Plan is expected to significantly reduce the company's level of uncertainty about Year 2000 Issues, and, in particular, about the Year 2000 compliance and readiness of its material business relationships. The company believes that with the implementation of its new computer hardware and software and completion of its Year 2000 Work Plan as scheduled, the possibility of significant interruptions of normal operations should be reduced. 20 Risks The company expects that its internal mission critical computer hardware and software and other mission critical equipment already is, or will be, Year 2000 compliant before December 31, 1999. The company believes, based on responses it has received to date, that its significant business partners, including vendors, suppliers (including suppliers of utilities) and customers, will be Year 2000 compliant before December 31, 1999. If the company's Year 2000 Work Plan fails to identify or correct Year 2000 Issues in the company's mission critical computer hardware and software or other equipment, the company might not be able to communicate with and/or provide services to suppliers, customers and policyholders until corrective measures have been taken. Under such a worst case scenario, the company might not be able to process policy applications and collect premium revenue for some period of time. If corrective actions cannot be taken in a timely fashion, this could have a material adverse affect on the company's financial condition or results of operations. Sustained Year 2000 failures by certain of the company's vendors and suppliers (especially suppliers of utility services such as electric and telephone) could have similar consequences for the company. The company cannot currently predict the impact of the Year 2000 Issue on its customers. However, sustained Year 2000 failures by customers which, in the aggregate, provide a material portion of the company's revenues could materially reduce cash flow available to the company. This, in turn, could have a material adverse affect on the company's financial condition or results of operations. Contingency Plans The company is preparing a Year 2000 specific contingency plan to deal with business failures brought about by Year 2000 Issues. Contingency planning will include plans for alternative processing of business from customers who experience disruptions due to the Year 2000 Issue. The company's Year 2000 contingency plans will involve invoking existing disaster recovery plans where appropriate. During the first few months of 1999, the company will continue to document its Year 2000 specific contingency plan. The company anticipates that the contingency planning process will be substantially completed by the end of April, 1999. Cost of the Year 2000 Issue Based upon currently available information, the company estimates that the total cost of implementing its Year 2000 Work Plan will be less than $1 million. This estimate does not include costs associated with converting the company's mainframe. As discussed above, the migration to the company's new mainframe was made, primarily, to address specific business needs rather than to address the Year 2000 Issue. The cost estimate, however, does include all internal costs related to activities undertaken on Year 2000 related matters across the company including activities pursued as part of all five phases of the company's Year 2000 Work Plan. Through December 31, 1998, the company had expended approximately $650,000 on the Year 2000 Work Plan. The majority of the remaining costs are expected to be directed primarily towards testing, remediation and implementation activities. These costs have been, and will continue to be, funded through operating cash flow and are expensed in the period in which they are incurred. Impact of Inflation Management does not consider the impact of the change in prices due to inflation to be material in the analysis of the company's overall operations. PRIVATE SECURITIES REFORM ACT OF 1995-FORWARD LOOKING STATEMENTS DISCLOSURE This Report contains forward looking statements. For purposes of this Report, a "Forward Looking Statement", within the meaning of the Securities Reform Act of 1995, is any statement concerning the year 1999 and beyond. The actions and performance of the company and its subsidiaries could deviate materially from what is contemplated by the forward looking statements contained in this Report. Factors which might cause deviations from the forward looking statements include, without limitations, the following: 1) changes in the laws or regulations affecting the operations of the company or any of its subsidiaries, 2) changes in the business tactics or strategies of the company or any of its subsidiaries, 3) acquisition(s) of assets or of new or complementary operations, or divestiture of any segment of the existing operations of the company or any of its subsidiaries, 4) changing market forces or litigation which necessitate, in management's judgment, changes in plans, strategy or tactics of the company or its subsidiaries and 5) adverse weather conditions, fluctuations in the investment markets, changes in the retail marketplace, Year 2000 related issues or fluctuations in interest rates, any one of which might materially affect the operations of the company and/or its subsidiaries. Any forward-looking statement speaks only as of the date made. We undertake no obligation to update any forward-looking statements to reflect events or circumstances arising after the date on which they are made. 21 CONSOLIDATED STATEMENTS OF INCOME THE MIDLAND COMPANY AND SUBSIDIARIES Years Ended December 31, (Amounts in thousands, except per share data) 1998 1997 1996 - ---------------------------------------- ------------------------------------ Revenues: Insurance: Premiums earned $375,478 $311,159 $280,614 Net investment income 23,908 21,332 18,269 Net realized investment gains 6,354 4,170 2,690 Other insurance income 2,508 1,557 1,602 Transportation 33,059 34,933 34,064 Other 1,055 617 499 ------------------------------------ Total 442,362 373,768 337,738 ------------------------------------ Costs and Expenses: Insurance: Losses and loss adjustment expenses 210,015 171,163 172,426 Commissions and other policy acquisition costs 103,169 79,518 81,533 Operating and administrative expenses 54,309 49,118 41,355 Transportation operating expenses 28,287 30,079 31,163 Interest expense 4,991 4,983 4,829 Other operating and administrative expenses 4,064 4,204 3,115 ------------------------------------ Total 404,835 339,065 334,421 ------------------------------------ Income from Continuing Operations Before Federal Income Tax 37,527 34,703 3,317 Provision (Credit) for Federal Income Tax 10,595 10,336 (426) ------------------------------------ Income from Continuing Operations 26,932 24,367 3,743 ------------------------------------ Discontinued Operations: Loss from discontinued operations less related income tax credits of $1,881, and $1,411 in 1997 and 1996, respectively - (3,492) (2,675) Loss on disposal of assets less related income tax credit of $1,790 - (3,325) - ------------------------------------ Loss from Discontinued Operations - (6,817) (2,675) ------------------------------------ Net Income $ 26,932 $ 17,550 $ 1,068 ==================================== Basic Earnings (Loss) Per Share of Common Stock: Continuing operations $ 2.99 $ 2.72 $ .42 Discontinued operations - (.76) (.30) ------------------------------------ Total $ 2.99 $ 1.96 $ .12 ==================================== Diluted Earnings (Loss) Per Share of Common Stock: Continuing operations $ 2.86 $ 2.63 $ .41 Discontinued operations - (.74) (.29) ------------------------------------ Total $ 2.86 $ 1.89 $ .12 ==================================== Cash Dividends Per Share of Common Stock-Declared $ .25 $ .23 $ .22 ==================================== See notes to consolidated financial statements. 22 CONSOLIDATED BALANCE SHEETS THE MIDLAND COMPANY AND SUBSIDIARIES December 31, (Amounts in thousands) 1998 1997 - -------------------------------------------------- ---------------------- ASSETS Marketable Securities Available for Sale: Fixed income (cost, $443,975 in 1998 and $397,033 in 1997) $453,422 $404,038 Equity (cost, $37,736 in 1998 and $33,928 in 1997) 136,748 94,791 ---------------------- Total 590,170 498,829 ---------------------- Cash 3,687 5,277 ---------------------- Receivables: Accounts receivable 60,094 59,492 Less allowance for losses 753 753 ---------------------- Net 59,341 58,739 ---------------------- Reinsurance Recoverables and Prepaid Reinsurance Premiums 33,955 49,016 ---------------------- Property, Plant and Equipment: Original cost 114,466 111,418 Less accumulated depreciation and amortization 46,629 39,806 ---------------------- Net 67,837 71,612 ---------------------- Other Real Estate-Net 8,700 14,779 ---------------------- Deferred Insurance Policy Acquisition Costs 63,962 55,590 ---------------------- Other Assets 9,568 6,621 ---------------------- Total Assets $837,220 $760,463 ====================== LIABILITIES AND SHAREHOLDERS' EQUITY Unearned Insurance Premiums $255,115 $240,340 ---------------------- Insurance Loss Reserves 125,496 120,134 ---------------------- Insurance Commissions Payable 20,272 19,033 ---------------------- Funds Held Under Reinsurance Agreements and Reinsurance Payables 14,624 15,443 ---------------------- Long-Term Debt 54,563 62,518 ---------------------- Other Notes Payable: Banks 15,000 24,000 Commercial paper 6,522 5,791 ---------------------- Total 21,522 29,791 ---------------------- Deferred Federal Income Tax 39,305 26,180 ---------------------- Other Payables and Accruals 57,491 49,998 ---------------------- Commitments and Contingencies - - ---------------------- Shareholders' Equity: Common stock (issued and outstanding: 9,352 shares at December 31, 1998 and 9,334 shares at December 31, 1997 after deducting treasury stock of 1,576 shares and 1,594 shares, respectively) 911 911 Additional paid-in capital 15,947 15,359 Retained earnings 178,398 153,797 Accumulated other comprehensive income 70,507 44,123 Treasury stock (at cost) (15,293) (14,704) Unvested restricted stock awards (1,638) (2,460) ---------------------- Total 248,832 197,026 ---------------------- Total Liabilities and Shareholders' Equity $837,220 $760,463 ====================== See notes to consolidated financial statements. 23 CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY THE MIDLAND COMPANY AND SUBSIDIARIES (Amounts in thousands) Years Ended December 31, 1998, 1997, and 1996 - ----------------------------------------------------------------------------------------------------------------------- Accumulated Unvested Additional Other Compre- Restricted Compre- Common Paid-In Retained hensive Treasury Stock hensive Stock Capital Earnings Income Stock Awards Total Income - ----------------------------------------------------------------------------------------------------------------------- Balance, January 1, 1996 $911 $15,362 $139,350 $19,716 $(16,575) $(2,169) $156,595 Comprehensive income: Net income 1,068 1,068 $ 1,068 Increase in unrealized gain on marketable securities, net of related income tax effect of $2,083 3,871 3,871 3,871 -------- Total comprehensive income $ 4,939 ======== Purchase of treasury stock, net 111 (1,810) (1,699) Cash dividends declared (1,995) (1,995) Exercise of stock options (620) 1,774 1,154 Amortization and cancellation of unvested restricted stock awards (7) (10) 711 694 ---------------------------------------------------------------------------- Balance, December 31, 1996 911 14,846 138,423 23,587 (16,621) (1,458) 159,688 Comprehensive income: Net income 17,550 17,550 $17,550 Increase in unrealized gain on marketable securities, net of related income tax effect of $11,060 20,536 20,536 20,536 -------- Total comprehensive income $38,086 ======== Issuance of treasury stock, net 124 160 284 Cash dividends declared (2,176) (2,176) Exercise of stock options (32) 335 303 Restricted stock awards 626 1,808 (2,434) Amortization and cancellation of unvested restricted stock awards (205) (386) 1,432 841 ---------------------------------------------------------------------------- Balance, December 31, 1997 911 15,359 153,797 44,123 (14,704) (2,460) 197,026 Comprehensive income: Net income 26,932 26,932 $26,932 Increase in unrealized gain on marketable securities, net of related income tax effect of $14,207 26,384 26,384 26,384 -------- Total comprehensive income $53,316 ======== Purchase of treasury stock, net 570 (906) (336) Cash dividends declared (2,331) (2,331) Exercise of stock options 50 373 423 Amortization and cancellation of unvested restricted stock awards (32) (56) 822 734 ---------------------------------------------------------------------------- Balance, December 31, 1998 $911 $15,947 $178,398 $70,507 $(15,293) $(1,638) $248,832 ============================================================================ See notes to consolidated financial statements.
24 CONSOLIDATED STATEMENTS OF CASH FLOWS THE MIDLAND COMPANY AND SUBSIDIARIES Years Ended December 31, (Amounts in thousands) 1998 1997 1996 - ------------------------------------------ ------------------------------------ Cash Flows from Operating Activities: Net income $ 26,932 $ 17,550 $ 1,068 Loss from discontinued operations - 6,817 2,675 Income from continuing operations 26,932 24,367 3,743 Adjustments to reconcile to net cash provided by operating activities: Depreciation and amortization 8,798 10,269 7,939 Net realized investment gains (6,354) (4,170) (2,690) Decrease (increase) in reinsurance recoverables and prepaid reinsurance premiums 15,061 3,789 (14,000) Increase in unearned insurance premiums 14,775 31,923 17,469 Increase in deferred insurance policy acquisition costs (8,372) (10,248) (2,196) Increase in other accounts payable and accruals 7,417 11,240 5,905 Increase in insurance loss reserves 5,362 24,304 27,483 Increase in other assets (2,947) (2,308) (2,335) Increase (decrease) in insurance commissions payable 1,239 5,212 (1,935) Increase (decrease) in deferred federal income tax (1,082) (1,725) 519 Increase (decrease) in funds held under reinsurance agreements and reinsurance payables (819) (11,506) 6,330 Increase in net accounts receivable (602) (4,865) (3,474) Other-net 748 (459) 392 ------------------------------------ Net cash provided by continuing operations 60,156 75,823 43,150 Net cash used in discontinued operations - (2,104) (8,973) ------------------------------------ Net cash provided by operating activities 60,156 73,719 34,177 ------------------------------------ Cash Flows from Investing Activities: Purchase of marketable securities (277,853) (207,474) (138,486) Proceeds from sale of marketable securities 191,014 88,687 87,577 Maturity of marketable securities 35,034 41,165 42,041 Decrease (increase) in cash equivalent marketable securities 6,937 15,404 (17,445) Proceeds from sale of property, plant and equipment 6,003 1,561 1,453 Acquisition of property, plant and equipment (4,948) (19,538) (4,403) Proceeds from sale of discontinued operations - 13,330 - ------------------------------------ Net cash used in investing activities (43,813) (66,865) (29,263) ------------------------------------ Cash Flows from Financing Activities: Decrease in net short-term borrowings (8,269) (2,909) (2,920) Repayment of long-term debt (7,944) (3,289) (2,647) Dividends paid (1,746) (2,677) (1,962) Payment of capitalized lease obligations (414) (375) (339) Issuance of long-term debt 403 3,712 - Net treasury stock transactions 37 619 75 ------------------------------------ Net cash used in financing activities (17,933) (4,919) (7,793) ------------------------------------ Net Increase(Decrease) in Cash (1,590) 1,935 (2,879) Cash at Beginning of Period 5,277 3,342 6,221 ------------------------------------ Cash at End of Period $ 3,687 $ 5,277 $ 3,342 ==================================== Supplemental Disclosures: The Company paid interest of $4,946, $6,148 and $5,820 and income taxes of $10,690, $4,655 and $930 in 1998, 1997 and 1996, respectively. See notes to consolidated financial statements. 25 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS THE MIDLAND COMPANY AND SUBSIDIARIES Years Ended December 31, 1998, 1997 and 1996 1. GENERAL INFORMATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The company operates generally in two industries-insurance and transportation with the most significant business activities being in insurance. The accounting policies of the company and its subsidiaries conform to generally accepted accounting principles (GAAP). The preparation of financial statements in conformity with generally accepted accounting principles requires management to use numerous estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. The accompanying consolidated financial statements include estimates for items such as insurance loss reserves, income taxes, various other liability accounts and deferred insurance policy acquisition costs. Actual results could differ from those estimates. Policies that affect the more significant elements of the consolidated financial statements are summarized below. Principles of Consolidation-The consolidated financial statements include the accounts of the company and all subsidiary companies. Material intercompany balances and transactions have been eliminated. Marketable Securities-Marketable securities are categorized as debt securities (cash equivalents, debt instruments and preferred stocks having scheduled redemption provisions) and equity securities (common and preferred stocks which do not have redemption provisions). The company classifies all debt and equity securities as available-for-sale and carries such investments at market value. Unrealized gains or losses on investments, net of related income taxes, are included in shareholders' equity as an item of accumulated other comprehensive income. Realized gains and losses on sales of investments are recognized in income on a specific identification basis. Property and Depreciation-Property, plant and equipment are recorded at cost. Depreciation and amortization are generally calculated using accelerated methods over the estimated useful lives of the respective properties (buildings and equipment - 15 to 35 years, furniture and equipment - 5 to 7 years and vessels and barges - 20 to 30 years). Federal Income Tax-Deferred federal income taxes are recognized to reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for federal income tax purposes. Investment tax credits previously allowed on property and equipment additions were deferred in the year of tax benefit and are being amortized against future operations over the estimated useful lives of the related properties. The company continually reviews deferred tax assets to determine the necessity of a valuation allowance. The company files a consolidated federal income tax return which includes all subsidiaries. Insurance Income-Premiums for physical damage and credit accident and health insurance, net of premiums ceded to reinsurers, are recognized as income on a pro-rata basis over the lives of the policies. Credit life premiums are recognized as income over the lives of the policies using a sum-of-the-digits method. The company 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 premiums are earned. Selling and administrative expenses which are not primarily related to premiums written are expensed as incurred. Insurance Loss Reserves-Unpaid insurance losses and loss adjustment expenses include an amount determined from reports on individual cases and an amount, based on past experience, for losses incurred but not reported. Such liabilities are necessarily based on estimates and, while management believes that the amounts are fairly stated, the ultimate liability may be in excess of or less than the amounts provided. The methods of making such estimates and for establishing the resulting liabilities are continually reviewed and any adjustments resulting therefrom are included in earnings currently. Insurance loss reserves also include an amount for claim drafts issued but not yet paid. Allowance for Losses-Provisions for losses on receivables are made in amounts deemed necessary to maintain adequate reserves to cover probable losses incurred at the balance sheet date. Reinsurance-The company reinsures certain levels of risk with other insurance companies and cedes varying portions of its written premiums to such reinsurers. Failure of reinsurers to honor their obligations could result in losses to the company as reinsurance contracts do not relieve the company from its obligations to policyholders. The company evaluates the financial condition of its reinsurers and monitors concentrations of credit risk arising from similar geographic regions, activities or economic characteristics of the reinsurers to minimize its exposure to significant losses 26 from reinsurer insolvencies. In addition, the company pays a percentage of earned premiums to reinsurers in return for coverage against catastrophic losses. The company also assumes a limited amount of business on certain reinsurance contracts. Related premiums and loss reserves are recorded based on records supplied by the ceding companies. Transportation Revenues-Revenues for river transportation activities are recognized when earned based on contractual rates and the stage of transportation on inland waterways. Statements of Cash Flows-For purposes of the statements of cash flows, the company defines cash as cash held in operating accounts at financial institutions. The amounts reported in the statements of cash flows for the purchase, sale or maturity of marketable securities do not include cash equivalents. Fair Value of Financial Instruments-The book values of cash, receivables, other notes payable, trade accounts payable and any financial instruments included in other assets and accrued liabilities approximate their fair values principally because of the short-term maturities of these instruments. The fair value of investments is considered to be the market value which is based on quoted market prices. The fair value of long-term debt is estimated using interest rates that are currently available to the company for issuance of debt with similar terms and maturities. Stock Option and Award Plans-The company has various plans which provide for granting options and common stock to certain employees and independent directors of the company and its subsidiaries. As permitted by Statements of Financial Accounting Standards (SFAS) No. 123, "Accounting for Stock Based Compensation", the company accounts for compensation expense related to such transactions using the "intrinsic value" based method under the provisions of Accounting Principles Board Opinion No. 25. New Accounting Standards-For the year ended December 31, 1998, the company adopted SFAS Nos. 130 and 131 "Reporting Comprehensive Income" and "Disclosures about Segments of an Enterprise and Related Information", respectively. Adoption of Statement No. 130 resulted in the company reporting comprehensive income, which for the company consists of net income and the after-tax effect of changes in the unrealized appreciation of marketable securities. Also, the company decided to present changes in shareholders' equity in a financial statement; such changes had previously been reported in the notes to the financial statements. Adoption of Statement No. 131 resulted in certain changes to segment information discussed in Note 18 and had no effect on the company's reported results of operations or financial position. For the year ended December 31, 1998, the company also adopted SFAS No. 132, "Employers Disclosures about Pensions and Other Postretirement Benefits", which resulted in certain additional disclosures included in Note 13, but had no effect on the company's reported results of operations or financial position. The Financial Accounting Standards Board issued SFAS No. 133 "Accounting for Derivative Instruments and Hedging Activities" during 1998. SFAS No. 133 is effective for fiscal years beginning after June 15, 1999. The company is currently evaluating the impact of adoption of SFAS 133 on the results of operations or financial position. In March 1998, the AICPA issued Statement of Position (SOP) 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use", SOP 98-1 revises the accounting for software development costs which the company has historically expensed. The company is currently analyzing the impact of this statement, which is required to be adopted in 1999, and does not expect the statement to have a material impact on the reported results of operations or financial position of the company. In October 1998, the AICPA issued SOP 98-7 "Deposit Accounting for Insurance and Reinsurance Contracts that Transfer Risk". SOP 98-7 is effective for fiscal years beginning after June 15, 1999. Adoption of SOP 98-7 is not expected to have a material impact on the reported results of operations or financial position of the company. Reclassifications-Certain previously reported amounts in the accompanying consolidated financial statements have been reclassified to conform to the current year's classifications. 2. DISCONTINUED OPERATIONS On September 29, 1997, the company's sportswear subsidiary, CS Crable Sportswear, Inc., sold substantially all of its assets to Brazos, Inc., a subsidiary of Brazos Sportswear, Inc. The assets were sold for approximately $13.3 million in cash resulting in an after-tax loss on the disposal of approximately $3.3 million. The results of operations and the related loss on disposal for these operations are categorized in the consolidated financial statements as "Discontinued Operations" and reported separately from continuing operations. There have been no material financial results from this discontinued unit since the aforementioned date of sale. Revenues related to the discontinued operations amounted to $22.8 million and $32.8 million for 1997 and 1996, respectively. 27 3. MARKETABLE SECURITIES Thousands of Dollars -------------------------------------------- Gross Unrealized Market 1998 Cost Gains Losses Value - ------------------------------------------------------------------------ Fixed Income Securities: Governments $170,539 $ 4,320 $ 320 $174,539 Municipals 161,699 4,366 99 165,966 Corporates 77,000 1,496 315 78,181 Cash Equivalents 28,594 - - 28,594 -------------------------------------------- Total 437,832 10,182 734 447,280 Equity Securities 37,445 99,537 526 136,456 Accrued Interest and Dividends 6,434 - - 6,434 -------------------------------------------- Total Marketable Securities $481,711 $109,719 $1,260 $590,170 ============================================ Thousands of Dollars -------------------------------------------- Gross Unrealized Market 1997 Cost Gains Losses Value - ------------------------------------------------------------------------ Fixed Income Securities: Governments $195,577 $ 2,965 $ 168 $198,374 Municipals 83,997 2,890 10 86,877 Corporates 76,459 1,418 90 77,787 Cash Equivalents 35,532 - - 35,532 -------------------------------------------- Total 391,565 7,273 268 398,570 Equity Securities 33,711 61,672 809 94,574 Accrued Interest and Dividends 5,685 - - 5,685 -------------------------------------------- Total Marketable Securities $430,961 $ 68,945 $1,077 $498,829 ============================================ At December 31, 1998 and 1997, the market value of the company's investment in the common stock of Firstar Corporation (Star Banc Corporation prior to recent merger), which exceeded 10% of the company's shareholders' equity, was $76.3 million and $47.1 million, respectively. The following is investment information summarized by investment category (net investment income includes amounts classified as insurance, transportation or other revenues) (amounts in 000's): 1998 1997 1996 --------------------------- Investment Income: Interest on Fixed Income Securities $23,344 $20,895 $18,410 Dividends on Equity Securities 1,624 1,493 1,259 --------------------------- Total 24,968 22,388 19,399 Less Investment Expenses (884) (837) (891) --------------------------- Net Investment Income $24,084 $21,551 $18,508 =========================== Realized Gains on Marketable Securities: Fixed Income Securities: Gross Realized Gains $ 4,420 $ 306 $ 1,061 Gross Realized Losses (371) (169) (690) Equity Securities: Gross Realized Gains 5,683 5,859 3,964 Gross Realized Losses (3,378) (1,826) (1,645) --------------------------- Total $ 6,354 $ 4,170 $ 2,690 =========================== Change in Unrealized Gains on Marketable Securities: Fixed Income Securities $ 2,443 $ 4,590 $(6,507) Equity Securities 38,148 27,006 12,460 --------------------------- Total $40,591 $31,596 $ 5,953 =========================== The cost and approximate market value of debt securities held at December 31, 1998, summarized by contractual maturities, are shown below. Actual maturities may differ from contractual maturities when there exists a right to call or prepay obligations with or without call or prepayment penalties (amounts in 000's). Market Cost Value --------------------- Under 1 year $ 50,917 $ 51,085 1-5 years 205,799 209,980 6-10 years 142,197 146,474 Over 10 years 38,919 39,741 --------------------- Total $437,832 $447,280 ===================== 28 4. RECEIVABLES Accounts receivable at December 31, 1998 and 1997 are generally due within one year and consist of the following (amounts in 000's): 1998 1997 --------------------- Insurance $ 53,764 $ 49,975 Transportation 4,687 5,912 Other 1,643 3,605 --------------------- Total $ 60,094 $ 59,492 ===================== 5. PROPERTY, PLANT AND EQUIPMENT At December 31, 1998 and 1997, property, plant and equipment stated at original cost consist of the following (amounts in 000's): 1998 1997 ------------------------ Land $ 1,366 $ 1,241 Buildings, Improvements, Fixtures, etc. 56,944 52,860 Transportation Equipment 56,156 57,317 ------------------------ Total $114,466 $111,418 ======================== Total rent expense related to the rental of equipment included in the accompanying consolidated statements of income is (amounts in 000's): $5,496 in 1998, $4,582 in 1997 and $4,867 in 1996. Future rentals under non-cancelable operating leases are approximately (amounts in 000's): $3,425 - 1999; $2,639 - 2000; $2,160 - 2001; $1,942 - 2002 and $586 - 2003. The company has committed to acquire 20 new barges with a total cost of approximately $6.1 million with delivery during the third quarter of 1999. 6. OTHER REAL ESTATE-NET Other real estate-net at December 31, 1998 includes the former manufacturing facility of CS Crable Sportswear, Inc., the company's discontinued operations. This facility is currently subject to a leasing arrangement with an option to purchase; however, the lessee has declared bankruptcy subsequent to year-end. The facility is carried at estimated net realized value. At December 31, 1997, other real estate-net included the aforementioned manufacturing facility as well as the former corporate headquarters of the company which was sold in 1998 with a small capital gain. These properties are carried at their estimated net realizable value. After-tax impairment provisions of $975,000 (former corporate headquarters) and $991,000 (manufacturing facility) were recognized (based on estimated current market values) in the 1997 consolidated income statement and were included in "Other Operating and Administrative Expenses" and "Discontinued Operations-Loss on Disposal of Assets...", respectively. 7. DEFERRED INSURANCE POLICY ACQUISITION COSTS Acquisition costs incurred and capitalized during 1998, 1997 and 1996 amounted to $111.5 million, $89.8 million and $83.7 million, respectively. Amortization of deferred acquisition costs was $103.2 million, $79.5 million and $81.5 million for 1998, 1997 and 1996, respectively. 8. NOTES PAYABLE TO BANKS At December 31, 1998 and 1997, the company had conventional lines of credit with commercial banks of $50 million. The lines of credit in use under these agreements at December 31, 1998 and 1997 amounted to $11 million and $21 million, respectively. Borrowings under these lines of credit constitute senior debt. Annual commitment fees of $89,000 are currently paid to the lending institutions to maintain these credit agreements. Additionally, at December 31, 1998 and 1997, the company had other short-term bank borrowings outstanding of $4 million and $3 million, respectively. These borrowings also constitute senior debt. The aforementioned notes payable, together with outstanding commercial paper, had weighted average interest rates of 6.06% and 5.73% at December 31, 1998 and 1997, respectively. 9. LONG-TERM DEBT Long-term debt at December 31, 1998 and 1997 is summarized as follows (amounts in 000's): 1998 1997 ------------------------- Equipment Obligations, Due Through- 6.45% July 1, 2000 $ 1,710 $ 2,090 7.10% January 1, 2001 1,227 1,773 *6.79% September 30, 2003 1,149 1,355 6.50% October 31, 2003 3,500 3,717 6.35% December 31, 1998 - 5,280 Mortgage Notes, Due Through- 5.40% December 1, 2003 7,559 7,898 6.83% December 20, 2005 19,195 19,768 Unsecured Notes Under a $40 million Credit Facility, Payments Beginning 2002- *6.32% November 1, 2005 20,000 20,000 Capitalized Lease Obligations 223 637 ------------------------- Total Obligations 54,563 62,518 Current Maturities 3,225 11,420 ------------------------- Non Current Portion $51,338 $51,098 ========================= *Rates in effect on December 31, 1998. The interest rates on the borrowings are adjusted quarterly to the LIBOR rate plus a margin ranging from 1% to 1.2%. 29 Equipment and real estate obligations are collateralized by transportation equipment and real estate with a net book value of $44,860,000 at December 31, 1998. The aggregate amount of repayment requirements on long-term debt and capitalized leases for the five years subsequent to 1998 are (amounts in 000's): 1999 - $3,225; 2000 - $4,064; 2001 - $2,159; 2002 - $7,226; 2003 - $12,237. Certain long-term debt agreement covenants limit the payment of dividends as discussed in Note 17. At December 31, 1998 and 1997, the carrying value approximated the fair value of the company's long-term debt. 10. FEDERAL INCOME TAX The provision for federal income tax is summarized as follows (amounts in 000's): 1998 1997 1996 ----------------------------- Current provision (credit) $11,677 $12,061 $ (945) Deferred provision (credit) (1,082) (1,725) 519 Total continuing operations 10,595 10,336 (426) Discontinued operations - (3,671) (1,411) ----------------------------- Total $10,595 $ 6,665 $(1,837) ============================= The federal income tax provision related to income from continuing operations for the years ended December 31, 1998, 1997 and 1996 is different from amounts derived by applying the statutory tax rates to income before federal income tax as follows (amounts in 000's): 1998 1997 1996 ----------------------------- Federal income tax at statutory rate $13,134 $12,146 $ 1,161 Tax effect of: Tax exempt interest and excludable dividend income (2,330) (1,793) (1,574) Investment tax credits (167) (366) (169) Business meals and entertainment expenses 91 106 151 Other-net (133) 243 5 ----------------------------- Provision (credit) for federal income tax $10,595 $10,336 $ (426) ============================= Significant components of the company's net deferred federal income tax liability are summarized as follows (amounts in 000's): 1998 1997 ------------------- Deferred tax liabilities: Deferred insurance policy acquisition costs $21,123 $18,450 Unrealized gain on marketable securities 37,952 23,745 Accelerated depreciation 6,968 7,585 Other 407 861 ------------------- Sub-total 66,450 50,641 ------------------- Deferred tax assets: Unearned insurance premiums 16,402 14,808 Pension expense 4,197 3,383 Insurance loss reserves 3,465 3,136 Other 3,081 3,134 ------------------- Sub-total 27,145 24,461 ------------------- Deferred federal income tax $39,305 $26,180 =================== 11. REINSURANCE A reconciliation of direct to net premiums, on both a written and an earned basis for the property and casualty companies, is as follows (amounts in 000's): Direct Assumed Ceded Net ------------------------------------------- 1998 - ---- Written $409,812 $36,436 $(54,478) $391,770 Earned 394,166 35,458 (60,573) 369,051 1997 - ---- Written $389,467 $34,497 $(81,253) $342,711 Earned 375,967 27,994 (98,406) 305,555 1996 - ---- Written $358,418 $28,747 $(96,810) $290,355 Earned 347,259 21,284 (92,674) 275,869 The amounts of recoveries pertaining to reinsurance contracts that were deducted from losses incurred during 1998, 1997 and 1996 were (amounts in 000's): $28,674, $52,182 and $71,133, respectively. 30 12. INSURANCE LOSS RESERVES Activity in the liability for unpaid insurance losses and loss adjustment expenses (excluding claim checks issued but not yet paid) for the property and casualty companies is summarized as follows (amounts in 000's): 1998 1997 1996 ------------------------------------------ Balance at January 1 $108,334 $ 88,992 $ 61,497 Less reinsurance recoverables 26,433 24,208 13,785 ------------------------------------------ Net balance at January 1 81,901 64,784 47,712 ------------------------------------------ Incurred related to: Current year 208,811 163,035 166,554 Prior years (2,120) 5,230 3,771 ------------------------------------------ Total incurred 206,691 168,265 170,325 ------------------------------------------ Paid related to: Current year 157,530 113,841 121,782 Prior years 42,795 37,307 31,471 ------------------------------------------ Total paid 200,325 151,148 153,253 ------------------------------------------ Net balance at December 31 88,267 81,901 64,784 Plus reinsurance recoverables 20,430 26,433 24,208 ------------------------------------------ Balance at December 31 $108,697 $108,334 $ 88,992 ========================================== 13. BENEFIT PLANS The company has a qualified pension plan which provides for the payment of annual benefits to substantially all employees upon retirement. Such benefits are based on years of service and the employee's highest compensation during five consecutive years of employment. The company's funding policy is to contribute annually an amount sufficient to satisfy ERISA funding standards. Contributions are intended to provide not only for benefits attributed to service to date but also for benefits expected to be earned in the future. The company also has a supplemental, unfunded pension plan. The following tables, which include amounts related to both the qualified and supplemental pension plans, illustrate 1) a reconciliation of the plans' benefit obligation and assets, 2) the weighted average assumptions used and 3) the components of the net periodic benefit cost (amounts in 000's except for percentages): 1998 1997 ------------------------- Qualified Plan Change in benefit obligation: Benefit obligation at beginning of year $ 22,460 $ 20,849 Service cost 1,159 1,124 Interest cost 1,734 1,587 Actuarial (gain)/loss 1,777 393 Curtailments - (645) Benefits paid (1,266) (848) ------------------------- Benefit obligation at end of year $ 25,864 $ 22,460 ========================= Change in plan assets: Fair value of plan assets at beginning of year $ 22,587 $ 19,774 Actual return on plan assets 4,616 3,628 Employer contributions - 33 Benefits paid (1,266) (848) ------------------------- Fair value of plan assets at end of year $ 25,937 $ 22,587 ========================= Funded status: Funded status at end of year $ 73 $ 127 Unrecognized net actuarial (gain)/loss (5,317) (3,988) Unrecognized prior service cost 379 408 Unrecognized net transition asset (948) (1,113) ------------------------- Accrued benefit cost $ (5,813) $ (4,566) ========================= Supplemental Plan Change in benefit obligation: Benefit obligation at beginning of year $ 6,268 $ 7,238 Service cost 210 100 Interest cost 600 397 Actuarial (gain)/loss 3,917 (1,416) Benefits paid (63) (51) ------------------------- Benefit obligation at end of year (accumulated benefit obligation of $6,999 and $4,905, respectively) $ 10,932 $ 6,268 ========================= Funded status: Funded status at end of year $(10,932) $ (6,268) Unrecognized actuarial (gain)/loss 5,490 1,725 Unrecognized prior service cost 1,102 1,180 ------------------------- Accrued benefit cost $ (4,340) $ (3,363) ========================= 31 1998 1997 1996 ----------------------------- Qualified and Supplemental Plans Weighted-average assumptions as of December 31: Discount rate 7.00% 7.25% 7.50% Expected return on plan assets 8.00% 8.00% 8.00% Rate of compensation increase 5.50% 5.50% 5.50% Components of net periodic benefit cost: Service cost $ 1,369 $ 1,224 $ 1,160 Interest cost 2,334 1,984 1,969 Expected return on assets (1,510) (1,367) (1,271) Amortization of: Transition asset (165) (165) (165) Prior service cost 106 112 112 Actuarial loss 152 34 151 ----------------------------- Net periodic benefit cost 2,286 1,822 1,956 Curtailment credit - (559) - ----------------------------- Total net periodic benefit cost $ 2,286 $ 1,263 $ 1,956 ============================= 14. STOCK OPTION AND AWARD PLANS Under the company's stock option plans, all of the outstanding stock options at December 31, 1998 were exercisable non-qualified options and had an exercise price of not less than 100% of the fair market value of the common stock on the date of grant. A summary of stock option transactions follows: 1998 1997 1996 -------------------------------------------------------------- Wtd. Avg. Wtd. Avg. Wtd. Avg. (000's) Option (000's) Option (000's) Option Shares Price Shares Price Shares Price -------------------------------------------------------------- Outstanding, beginning of year 420 $10.13 456 $ 9.77 657 $ 8.59 Exercised (40) 10.65 (36) 8.34 (201) 5.91 Expired - - (27) 8.93 - - Granted - - 27 12.63 - - --------- --------- --------- Outstanding, end of year 380 $10.07 420 $10.13 456 $ 9.77 ============================================================== Weighted avg. fair value of options granted $ - $ 4.74 $ - ======= ======= ======= Information regarding such outstanding options at December 31, 1998 follows: Weighted Average Outstanding Weighted Range of Remaining Options Average Exercise Life (000's) Price Price - ---------------------------------------------------------------- One year 314 $ 8.94 $ 8.83 to $ 9.00 Three years 45 16.81 $16.71 to $16.92 Seven years 21 12.63 $12.63 to $12.63 ----------------------- Total 380 $10.07 ======================= The company implemented a restricted stock award program during 1993. Under this program, grants of the company's common stock will vest after an incentive period, conditioned upon the recipient's employment throughout the period. During the vesting period, shares issued are nontransferable, but the shares are entitled to all of the rights of outstanding shares. In 1993, 96,000 shares were initially awarded under the program and 71,000 shares were eventually distributed by 1998. In 1995 and 1997, 147,000 and 195,000 shares, respectively, were also awarded and 124,000 and 172,000 shares, respectively, remain outstanding at December 31, 1998. The value of the awards is being amortized as compensation expense over a five year vesting period. The company applies APB Opinion 25 and related interpretations in accounting for the stock option plans. Accordingly, no compensation cost has been recognized for the stock option plans. Had compensation cost for the company's stock option plans been determined based on the fair value at the grant dates for awards under these plans consistent with the method of SFAS No. 123, the company's 1997 net income and earnings per share would have been reduced to the pro forma amounts indicated below (1998 and 1996 would not have been affected)(amounts in 000's, except per share data): 1997 ------- Net Income As reported $17,550 Pro forma $17,467 Net Income per Common Share-basic As reported 1.96 Pro forma 1.95 Net Income per Common Share-diluted As reported 1.89 Pro forma 1.88 32 The fair value of the 1997 option grant was estimated on the date of the grant using the Black-Scholes option-pricing model with the following (weighted average) assumptions: dividend yield of 1.3%, expected volatility of 26.7%, risk-free interest rates of 6.4% and expected lives of 7 years. At December 31, 1998, 1,278,000 common shares are authorized for future option awards or stock grants. 15. EARNINGS PER SHARE The following table is a reconciliation of the number of shares used to compute Basic and Diluted earnings per share. There was no adjustment necessary to the income used in the Basic or Diluted calculations for the years ended December 31, 1998, 1997 or 1996. Shares in 000's ----------------------------- 1998 1997 1996 ----------------------------- Shares used in basic EPS calculation (shares outstanding) 9,018 8,956 8,844 Effect of dilutive stock options 228 164 159 Effect of dilutive restricted stock grants 166 172 96 ----------------------------- Shares used in diluted EPS calculation 9,412 9,292 9,099 ============================= On April 9, 1998, the company approved a three-for-one stock split effective May 21, 1998 for holders of record on April 30, 1998. Accordingly, the number of shares have been adjusted for the prior periods to reflect the impact of this stock split and previously reported per share amounts have been restated. All outstanding stock options at December 31, 1998 had exercise prices that were less than the average market price of the company's common stock and, therefore, were included in the computation of diluted earnings per share. Options to purchase 54,000 shares of common stock at prices ranging from $16.71 to $16.92 per share were outstanding as of December 31, 1997 and 1996 and were not included in the computation of diluted earnings per share because the options' exercise prices were greater than the average market price of the common stock. 16. CONTINGENCIES Various litigation and claims against the company and its subsidiaries are in process and pending. Based upon a review of open matters with legal counsel, Management believes that the outcome of such matters will not have a material effect upon the company's consolidated financial position or results of operations. 17. SHAREHOLDERS' EQUITY In 1998, The Midland Company effected a three-for-one stock split and increased its number of shares of common stock authorized without par value (stated value of $.083 a share) to 20,000,000 shares from 5,000,000 shares. The company also has 500,000 shares of preferred stock authorized, without par value, none of which have been issued. Covenants included in the borrowing agreements of M/G Transport Services, Inc. (the company's transportation subsidiary) limit its payment of dividends to The Midland Company. Under the most restrictive of such covenants, $12,642,000 of its $19,877,000 of shareholder's equity was not available for distribution to the company at December 31, 1998. The insurance subsidiaries are subject to state regulations which limit by reference to statutory investment income and policyholders' surplus the dividends that can be paid to their parent company without prior regulatory approval. Dividend restrictions vary between the companies as determined by the laws of the domiciliary states. Under these restrictions, the maximum dividends that may be paid by the insurance subsidiaries in 1999 without regulatory approval total approximately $21,087,000; such subsidiaries paid cash dividends of $4,725,000 in 1998, $1,240,000 in 1997 and $4,375,000 in 1996. Net income as determined in accordance with statutory accounting practices, which differ in certain respects from generally accepted accounting principles, for the company's insurance subsidiaries was $22,583,000, $17,538,000 and $5,396,000 for 1998, 1997 and 1996, respectively. Shareholders' equity on the same basis was $227,647,000 and $173,181,000 at December 31, 1998 and 1997. 18. INDUSTRY SEGMENTS The company operates in several industries and company management reviews operating results by several different classifications (e.g., product line, legal entity, distribution channel). Reportable segments are determined based upon revenues and/or operating profits and include manufactured housing insurance, all other insurance and transportation. Manufactured housing insurance includes primarily insurance similar to homeowners insurance for manufactured houses. All other insurance includes various personal lines such as site-built dwelling, collateral protection and watercraft insurance, as well as commercial lines such as manufactured housing park and dealer insurance. The company writes insurance throughout the United States with larger concentrations in the southern and southeastern states. Transportation is a barge affreightment operation primarily on the Gulf Coast and the lower Mississippi River and its tributaries. 33 THE MIDLAND COMPANY AND SUBSIDIARIES Listed below is financial information required to be reported for each industry segment. Certain amounts are allocated and certain amounts are not allocated (n/a below) (e.g., assets and investment gains) to each segment for management review. Operating segment information based upon how it is reviewed by the Company is as follows for the years ended December 31, 1998, 1997 and 1996 (amounts in 000's): Insurance ---------------------------------- Corporate Manufactured Unallocated and All Inter-segment Housing Other Amounts Transportation Other Elimination Total - --------------------------------------------------------------------------------------------------------------------- 1998 - ---- Revenues-External customers $258,638 $119,348 $33,059 $ 879 $411,924 Net investment income 14,875 9,923 $ 34 323 262 $(1,333) 24,084 Net realized investment gains n/a n/a 6,354 6,354 Interest expense n/a n/a 1,461 795 4,097 (1,362) 4,991 Depreciation and amortization 1,989 918 3,190 2,701 8,798 Income-Continuing operations before taxes 31,609 11,207 (2,598) 4,389 (7,080) 37,527 Income tax expense 10,039 2,774 (909) 1,395 (2,704) 10,595 Acquisition of fixed assets n/a n/a 2,805 561 1,582 4,948 Identifiable assets n/a n/a 747,451 41,576 57,165 (8,972) 837,220 1997 - ---- Revenues-External customers 219,394 93,322 34,933 398 348,047 Net investment income 13,935 8,359 24 286 318 (1,371) 21,551 Net realized investment gains n/a n/a 4,170 4,170 Interest expense n/a n/a 1,417 849 5,084 (2,367) 4,983 Depreciation and amortization 1,704 738 3,157 4,670 10,269 Income-Continuing operations before taxes 36,764 3,819 (2,590) 4,399 (7,689) 34,703 Income tax expense 12,100 629 (906) 1,300 (2,787) 10,336 Acquisition of fixed assets n/a n/a 3,555 13,366 2,617 19,538 Identifiable assets n/a n/a 660,464 44,544 62,055 (6,600) 760,463 1996 - ---- Revenues-External customers 182,581 99,635 34,064 260 316,540 Net investment income 12,303 6,756 14 845 391 (1,801) 18,508 Net realized investment gains n/a n/a 2,690 2,690 Interest expense n/a n/a 1,391 984 5,895 (3,441) 4,829 Depreciation and amortization 1,878 1,025 2,488 2,548 7,939 Income-Continuing operations before taxes 14,936 (5,342) (2,336) 2,763 (6,704) 3,317 Income tax expense 4,362 (2,549) (818) 825 (2,246) (426) Acquisition of fixed assets n/a n/a 2,440 6,326 1,603 10,369 Identifiable assets n/a n/a 551,498 41,458 94,924 (31,901) 655,979 The amounts shown for manufactured housing insurance, other insurance and unallocated insurance comprise the consolidated amounts for Midland's insurance operations subsidiary, American Modern Insurance Group, Inc. Except for $16,518,000 of assets of discontinued operations included in corporate and all other assets at the end of 1996, amounts above for 1997 and 1996 do not include amounts related to discontinued sportswear operations (a separate segment that, as discussed elsewhere herein, was sold in 1997). Inter-segment revenues were not significant for 1998, 1997 or 1996. In 1998 and 1997, revenues from one customer amounted to $61,865,000 and $41,011,000, respectively. No single customer accounted for 10% or more of consolidated revenues in 1996.
34 MANAGEMENT'S REPORT THE MIDLAND COMPANY AND SUBSIDIARIES The consolidated financial statements and accompanying notes of The Midland Company and its subsidiaries are the responsibility of the company's management, and have been prepared in conformity with generally accepted accounting principles. They necessarily include amounts that are based on management's best estimates and judgments. Other financial information contained in this annual report is presented on a basis consistent with the financial statements. In order to maintain the integrity, objectivity and fairness of data in these financial statements, the company has developed and maintains comprehensive internal controls which are supplemented by a program of internal audits. Management believes that the company's internal controls are adequate to provide reasonable, but not absolute, assurance that assets are safeguarded and the objectives of accuracy and fair presentation of financial data are met in all material respects. Deloitte & Touche LLP, independent auditors, have audited and reported on the company's consolidated financial statements in accordance with generally accepted auditing standards. Deloitte & Touche LLP reviews the results of its audits both with management and with the Audit Committee. The Audit Committee, comprised entirely of outside Directors, meets periodically with management, internal auditors and independent auditors ( separately and jointly) to assure that each is fulfilling its responsibilities. INDEPENDENT AUDITORS' REPORT THE MIDLAND COMPANY AND SUBSIDIARIES To the Shareholders of The Midland Company: We have audited the accompanying consolidated balance sheets of The Midland Company and its subsidiaries as of December 31, 1998 and 1997, and the related consolidated statements of income, of changes in shareholders' equity and of cash flows for each of the three years in the period ended December 31, 1998. These financial statements are the responsibility of the company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of The Midland Company and its subsidiaries at December 31, 1998 and 1997 and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1998 in conformity with generally accepted accounting principles. S/DELOITTE & TOUCHE LLP DELOITTE & TOUCHE LLP Cincinnati, Ohio February 11, 1999 35 QUARTERLY DATA THE MIDLAND COMPANY AND SUBSIDIARIES THE MIDLAND COMPANY AND SUBSIDIARIES 1998 1997 - ----------------------------------------------------------------------------- --------------------------------------- (Amounts in thousands, First Second Third Fourth First Second Third Fourth except per share data) Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter - ----------------------------------------------------------------------------- --------------------------------------- Revenues from continuing operations $107,237 $110,431 $112,538 $112,156 $ 89,753 $ 92,369 $ 92,425 $ 99,221 ======================================= ======================================= Income from continuing operations $ 6,040 $ 3,638 $ 7,299 $ 9,955 $ 4,265 $ 5,047 $ 6,112 $ 8,943 Loss from discontinued operations - - - - (1,175) (1,067) (4,575) - --------------------------------------- --------------------------------------- Net income $ 6,040 $ 3,638 $ 7,299 $ 9,955 $ 3,090 $ 3,980 $ 1,537 $ 8,943 ======================================= ======================================= Basic earnings (loss) per common share: Continuing operations $ .67 $ .40 $ .81 $ 1.11 $ .48 $ .56 $ .68 $ 1.00 Discontinued operations - - - - (.13) (.12) (.51) - --------------------------------------- --------------------------------------- Total $ .67 $ .40 $ .81 $ 1.11 $ .35 $ .44 $ .17 $ 1.00 ======================================= ======================================= Diluted earnings (loss) per common share: Continuing operations $ .64 $ .39 $ .77 $ 1.06 $ .46 $ .55 $ .66 $ .96 Discontinued operations - - - - (.12) (.12) (.50) - --------------------------------------- --------------------------------------- Total $ .64 $ .39 $ .77 $ 1.06 $ .34 $ .43 $ .16 $ .96 ======================================= ======================================= Cash dividends per common share $ .0625 $ .0625 $ .0625 $ .0625 $ .0583 $ .0583 $ .0583 $ .0583 ======================================= ======================================= Price range of common stock (AMEX): High $ 27.13 $ 31.67 $ 30.75 $ 22.50 $ 14.75 $ 16.67 $ 19.17 $ 21.50 ======================================= ======================================= Low $ 19.42 $ 22.88 $ 22.50 $ 20.00 $ 12.42 $ 12.67 $ 16.42 $ 19.04 ======================================= =======================================
Note: The sum of the quarterly reported diluted earnings per share may not equal the full year as each is computed independently. Certain reclassifications have been made to 1997 revenues from continuing operations to conform with 1998 classifications. Previously reported share information has been adjusted to reflect a three-for-one common stock split effective May 21, 1998. OTHER INFORMATION TRANSFER AGENT AND REGISTRAR INDEPENDENT AUDITORS GENERAL AND TAX COUNSEL Fifth Third Bank Deloitte & Touche LLP Cohen, Todd, Kite & 38 Fountain Square, 250 East Fifth Street Stanford, LLC Mail Drop #10AT66 Cincinnati, Ohio 45202 525 Vine Building Cincinnati, Ohio 45263 Cincinnati, Ohio 45202 SHAREHOLDERS' MEETING The next meeting of the shareholders will be held at 10:00 a.m. on Thursday, April 8, 1999 at the company's offices, 7000 Midland Boulevard, Amelia, Ohio 45102. DIVIDEND REINVESTMENT PLAN The Plan provides for the acquisition of additional shares of the company without brokerage fees through automatic dividend reinvestment. Enrollment forms and information about the Plan are available from Fifth Third Bank (1-800-837-2755). FORM 10-K A copy of the company's 1998 Annual Report to the Securities and Exchange Commission on Form 10-K may be obtained by writing to the company - Attention: Chief Financial Officer. 36 INSIDE BACK COVER OFFICERS AND DIRECTORS THE MIDLAND COMPANY AND SUBSIDIARIES BOARD OF DIRECTORS George R. Baker Corporate Director / Advisor James E. Bushman + President and Chief Executive Officer Cast-Fab Technologies, Inc. James H. Carey * + Corporate Director/Advisor Michael J. Conaton Vice Chairman Jerry A. Grundhofer * President and Chief Executive Officer Firstar Corporation J. P. Hayden, Jr. Chairman of the Executive Committee of the Board J. P. Hayden, III Chairman and Chief Operating Officer John W. Hayden President and Chief Executive Officer Robert W. Hayden Formerly Vice President of the Company William T. Hayden Attorney William J. Keating * Formerly Chairman, Chief Executive Officer and Publisher-Cincinnati Enquirer and Formerly Chairman of the Board-Associated Press John R. LaBar Formerly Vice President and Secretary of the Company David B. O'Maley * Chairman, President and CEO Ohio National Financial Services John M. O'Mara + Corporate Director/Financial Consultant Glenn E. Schembechler + Professor Emeritus University of Michigan John I. Von Lehman Executive Vice President, Chief Financial Officer and Secretary OFFICERS J. P. Hayden, III Chairman and Chief Operating Officer John W. Hayden President and Chief Executive Officer J. P. Hayden, Jr. Chairman of the Executive Committee of the Board Michael J. Conaton Vice Chairman John I. Von Lehman Executive Vice President, Chief Financial Officer and Secretary Kurt R. Schwamberger Senior Vice President Paul T. Brizzolara Senior Vice President and Chief Legal Officer W. Todd Gray Treasurer Charles J. Jenkins Vice President-Management Information Systems Michael L. Flowers Vice President and Assistant Secretary Henry N. Thoman Assistant Vice President and Assistant Secretary Brenda D. Gumbs Vice President - Human Resources Mark E. Burke Director of Taxation Ronald L. Gramke Assistant Treasurer Edward J. Heskamp Assistant Treasurer Mary Ann C. Pettit Assistant Secretary Geraldine M. Stigall Assistant Secretary + Member of Audit Committee * Member of Compensation Committee EX-21 3 THE MIDLAND COMPANY AND SUBSIDIARIES Exhibit (21) - Subsidiaries of the Registrant December 31, 1998 The subsidiaries of the Registrant as of December 31, 1998, all of which are included in the consolidated financial statements, are as follows: Percentage State of of Voting Incorporation Stock Owned ------------- ----------- M/G Transport Services, Inc. Ohio 100 Midland - Guardian Co. Ohio 100 MGT Services, Inc. Ohio 100 M/G Sportswear, Inc. Ohio 100 SUBSIDIARIES OF MIDLAND - GUARDIAN CO.: American Modern Insurance Group, Inc. Ohio 100 Marbury Agency, Inc. Ohio 100 SUBSIDIARIES OF AMERICAN MODERN INSURANCE GROUP, INC.: American Modern Home Insurance Company Ohio 100 American Family Home Insurance Company Florida 100 The Atlas Insurance Agency, Inc. Ohio 100 American Modern Life Insurance Company Ohio 100 Midwest Enterprises, Inc. Florida 100 Lloyds Modern Corporation Texas 100 American Modern Home Service Company Ohio 100 SUBSIDIARIES OF AMERICAN MODERN HOME INSURANCE CO.: American Modern Lloyds Insurance Company Texas 100 American Southern Home Insurance Company Florida 100 American Western Home Insurance Company Oklahoma 100 G.U.I.C. Insurance Company Pennsylvania 100 SUBSIDIARY OF AMERICAN WESTERN HOME INSURANCE CO.: Modern Life Insurance Company of Arizona, Inc. Arizona 100 SUBSIDIARY OF MIDWEST ENTERPRISES, INC.: Sunbelt General Agency, Inc. Alabama 100 The names of two wholly - owned subsidiaries of The Midland Company are not shown above as such individual listing is not required. EX-27 4
7 12-MOS DEC-31-1998 DEC-31-1998 453,422,000 0 0 136,748,000 0 0 590,170,000 3,687,000 20,430,000 63,962,000 837,220,000 125,496,000 255,115,000 0 34,896,000 76,085,000 0 0 911,000 247,921,000 837,220,000 375,478,000 23,908,000 6,354,000 36,622,000 210,015,000 103,169,000 54,309,000 37,527,000 10,595,000 26,932,000 0 0 0 26,932,000 2.99 2.86 81,901,000 208,811,000 (2,120,000) 157,530,000 42,795,000 88,267,000 (2,120,000)
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