EX-13 3 l93271aex13.txt EXHIBIT 13 Exhibit 13 BALANCED GROWTH- Key to Long-term Value The Midland Company 2001 Annual Report -------------------------- -------------------------------------------------------------------------------- COMPANY PROFILE The Midland Company is a highly focused provider of specialty insurance products and services through its American Modern Insurance Group subsidiary, which contributes approximately 94 percent of the company's revenues. In addition, Midland has a profitable investment in a niche river transportation business, M/G Transport Services, Inc. (M/G). American Modern is a leader in specialty insurance products and services, marketing through diverse distribution channels. American Modern specializes in physical damage insurance and related coverages for manufactured homes, watercraft, collector automobiles, motorcycles, snowmobiles, and recreational vehicles, among others. The company focuses on four key strategies to create long-term value: organic growth in current markets, strategic acquisitions, strategic alliances and the expansion of low-risk fee-income business. By focusing on a formula of balanced growth, the company achieved strong operating performance in 2001, reporting record revenue despite the myriad of challenges facing the company's largest market segment. Management believes that this emphasis on proven growth strategies, balanced product and distribution channels and core relationships will enable the company to continue to leverage its strong competitive position, thereby achieving its performance objectives and increasing value for shareholders over the long term. 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. TABLE OF CONTENTS ------------------------------------------------------------------------ Financial Highlights 1 Letter to Shareholders-Balancing Premium Growth and Profitability 2-5 Balance-Creating a Strong Mix of Speciality Products 6-7 Balance-Establishing Multiple Channels of Distribution 8-9 Balance-Building Lasting Relationships Through Innovative Services to Customers 10-11 American Modern Insurance Group, Inc. - Investment Portfolio 12 Balance-Profitable Investment in a Niche River Transportation Business, M/G Transport Services, Inc. 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 Independent Auditor's Report 35 Management's Report 35 Quarterly Data and Other Information 36 Officers and Directors 37 This report contains forward-looking statements that involve potential risks and uncertainties. Please see the Management's Discussion and Analysis, Pages 16-21, for factors that could cause results to differ materially from those discussed. --------------------------------------------------------------------------------
------------------------------------------------------------------------------------------ FINANCIAL HIGHLIGHTS THE MIDLAND COMPANY AND SUBSIDIARIES For the Years Ended December 31, (Amounts in thousands, except per share data) 2001 2000 ------------------------------------------------------------------------------------------- OPERATING PERFORMANCE Revenues $ 586,543 $ 534,422 Income Before Federal Income Tax $ 36,704 $ 50,699 Operating Income $ 25,907 $ 31,755 Capital Gains (After-Tax) $ 1,315 $ 3,708 Net Income $ 27,222 $ 35,463 PER SHARE DATA Net Income--Basic $ 3.15 $ 3.91 Average Shares Outstanding--Basic 8,641 9,066 Operating Income--Diluted $ 2.88 $ 3.39 Net Income--Diluted $ 3.03 $ 3.78 Average Shares Outstanding--Diluted 8,995 9,379 Cash Dividends $ .32 $ .30 Book Value $ 33.05 $ 31.46 FINANCIAL POSITION Total Assets $1,053,942 $ 993,850 Shareholders' Equity $ 291,876 $ 283,177 PERFORMANCE RATIOS Combined Ratio (American Modern's Property and Casualty Companies) 99.8% 96.2% Return on Beginning Equity 9.6% 13.7%
REVENUES GROW 9.8% IN 2001 (Continuing Operations) dollars in millions 1997 1998 1999 2000 2001 -------- -------- -------- -------- -------- Revenues $373.768 $442.362 $469.126 $534.422 $586.543 Despite industry challenges and a deepening recession, Midland's revenues grew for the 16th consecutive year. Property and casualty premiums and investment income fueled the growth. -------------------------------------------------------------------------------- NET INCOME AND NET OPERATING INCOME PER SHARE REFLECT STRATEGIC DECISIONS (Continuing Operations) 1997 1998 1999 2000 2001 -------- -------- -------- -------- -------- Net Income Per Share $2.63 $2.86 $3.30 $3.78 $3.03 Net Operating Income Per Share $2.33 $2.42 $3.06 $3.39 $2.88 Midland exited the manufactured housing commercial liability market in 2001 due to profitable concerns. While this action reduced earnings for the short term, it positioned the company for a return to double-digit earnings growth and return on equity objectives for the long term. BOOK VALUE PER SHARE REACHES RECORD $33.05 1997 1998 1999 2000 2001 -------- -------- -------- -------- -------- Book Value Per Share $21.11 $26.61 $27.11 $31.46 $33.05 Midland's Compounded Annual Growth in Book Value 1 Yr. 3 Yr. 5 Yr. 10 Yr. ---- ---- ---- ----- 5.1% 7.5% 13.6% 11.4% Book value per share grew 5.1 percent in 2001. Over the past 10 years, it has grown at a compounded rate of 11.4 percent. -------------------------------------------------------------------------------- The Midland Company/1 -------------------------------------------------------------------------------- LETTER TO SHAREHOLDERS - Balancing Premium Growth and Profitability As we reflect on the events of 2001, we're left with a variety of contrasting images, impressions and memories. The events of September 11 reshaped our personal and business lives in many ways ... some obvious, some more subtle. For many Americans, one result of the tragedies was a renewed quest for balance. Balance in their work. Balance in their lives. As we look back on the year for The Midland Company, and look forward into our future, we are struck by the important role that balance played in our successes and in our challenges. Without our concerted emphasis the past several years on maintaining balance in our business -- balance in our product lines, balance in our distribution channels and balance in our relationships -- the year would have delivered many more challenges and fewer successes. Instead, our strategy led to growth and laid the groundwork for substantial improvements in the company's value. We look ahead to an exciting future, one in which we will continue to rely on balance to help us achieve our double-digit earnings growth and return on equity objectives over the long term. A YEAR OF CHALLENGES The year 2001 began with high hopes. We had just completed our fourth consecutive year of record- breaking performance, and our balanced growth strategies were paying dividends. Our optimism became increasingly tempered, however, as the economic boom of the 1990s eroded... a boom that had served as a catalyst for unparalleled growth. A deepening recession resulted in a predictable deterioration in our fire loss ratio and an uncharacteristic challenge to our combined ratio objective. Since our goal is to consistently produce an underwriting profit, we are directly facing this challenge with heightened discipline in risk selection. A concentration on rate adequacy also is a high priority for our team in 2002, and actions are already in place to ensure that we obtain the rates necessary to maintain our high standards of profitability. Further, in 2000, we saw our largest market undergo its most significant contraction since 1975, and that trend continued in 2001. After declining 28 percent in 2000, manufactured home shipments continued to fall, ultimately down an estimated 23 percent for 2001. Beyond the overall economic conditions, contributing to the decline was tightening of loan requirements for this market, as well as the decision by several key lenders to exit the manufactured home business. In response, manufacturers and dealers continued to redefine the products offered to consumers and attracted conventional mortgage lenders into the market, requiring a shift in our business model to maintain our preeminent position at the point of sale. We firmly believe this industry will recover, and there are many who see signs that the recovery already is under way. When conditions improve in the manufactured housing segment, we will be ready to support and leverage its growth with a full range of specialty products. In reviewing the year, we cannot ignore the impact of September 11, the defining event of 2001. While Midland did not suffer direct business consequences, we continue to feel the emotional and indirect business effects on our industry. Some consequences, such as rising reinsurance rates, will affect American Modern less than many of our peers due to our risk profile. Finally, we decided in late 2001 to exit the manufactured housing commercial liability market because of profitability concerns. The product simply did not fit well into our core competencies, nor did it fit the profile of "high-frequency, low-severity lines of business" that leverage our strengths. As we look to 2002, we see the decision to exit this market as an opportunity for improving profitability. -------------------------------------------------------------------------------- The Midland Company/2 -------------------------------------------------------------------------------- MEASURING THE SUCCESSES The year just passed also was marked by important successes - again, a result of concentrated efforts to maintain balance. The balance we have methodically introduced into our product, distribution and under-writing strategies over the last several years positioned us to take all that 2001 could deliver. We begin 2002 with our optimism intact and with a marketplace that is increasingly knowledgeable and confident in our ability to deliver profitable long-term growth. For example, even with the continuing difficulties confronting the manufactured housing industry, we experienced virtually flat manufactured housing premium results in 2001, a testament to our balanced distribution strategy that allows us to capture new business wherever the opportunity arises. On another front, our decision to add even more balance to our specialty product offerings by underwriting the GuideOne motorcycle business reaped significant benefits for us in 2001 and, along with other motorsports insurance products, was responsible for $38 million in growth for the year. Motorsports represented 7.4 percent of premiums written in 2001, up from 1.2 percent in 2000, while manufactured housing declined to 56.1 percent from 62.6 percent. Further, financial services continued to provide new opportunities for us. In 2001, we integrated these various services and launched a coordinated initiative to expand our reach and impact with banks, credit unions and other financial organizations. Ameritrac Business Solutions, our primary fee-income generating subsidiary, expanded its customer base and services, resulting in a 5 percent increase in insurance writings and a 24 percent increase in fee revenues. Opportunities exist to expand Ameritrac's relationship with key new accounts in 2002, which will continue to add to the company's fee revenues. Also in 2001, we continued our ascent to a leadership position within the credit life insurance market. The life companies' premiums increased 12.5 percent over 2000, with a three-year compounded annual growth rate of 53.8 percent. FINANCIAL PERFORMANCE REFLECTED CHALLENGES AND SUCCESSES Taken in the context of the year, the company achieved credible -- and in some cases stellar -- financial performance. Revenue for the year increased 9.8 percent to a record $586.5 million. While American Modern's manufactured housing direct and assumed written premiums remained essentially flat due to industry challenges, growth in the other property and casualty lines was 34.8 percent, resulting in a total of $555.5 million in direct and assumed property and casualty written premium for 2001. Credit life premiums rose to $44.7 million. For the year, net operating income (which excludes capital gains) was $2.88 per share (diluted) compared with $3.39 per share (diluted) in 2000. Total net income was $3.03 per share (diluted) compared with $3.78 per share (diluted) in 2000. But those results do not tell the whole story. After-tax losses from TOTAL PREMIUMS RISE 11% (DIRECT AND ASSUMED PREMIUMS WRITTEN) dollars in millions [GRAPH]
1997 1998 1999 2000 2001 ---- ---- ---- ---- ---- Premiums $433.978 $457.580 $493.210 $540.720 $600.233
Over the past 5 years, P&C premium growth has been 2 times that of the industry, reflecting the emphasis on balance in the product mix and distribution channels. COMBINED RATIO REFLECTS UNDERLYING STRENGTH AND CONTINUED COMMITMENT TO SOUND UNDERWRITING PRINCIPLES [GRAPH]
1997 1998 1999 2000 2001 ---- ---- ---- ---- ---- AMIG 94.2% 96.6% 93.4% 95.2% 99.3% Industry 101.6% 105.6% 107.8% 110.4% 117.0%
While above historic levels in 2001, American Modern's P&C statutory combined ratio has averaged 97.2 percent over the past 10 years, well below the industry average of 108.6 percent. -------------------------------------------------------------------------------- The Midland Company/3 -------------------------------------------------------------------------------- American Modern's commercial liability programs were 67 cents per share (diluted) for the year versus 44 cents last year and the after-tax impact of higher-than-normal fire losses was $1.05 compared with 40 cents in 2000. Clearly, without those items impacting profitability, 2001 would have been a stronger year. Even so, American Modern's superior underwriting results were evident in our property and casualty operations' combined ratio. The ratio, while substantially better than the estimated industry result of 117 percent (includes the impact of September 11), was outside the range we target. For the year, the combined ratio was 99.8 percent, including 2.3 percentage points from the commercial liability losses and 2.9 from higher-than-normal fire losses. Catastrophe losses, which were still somewhat lower than normal in 2001, but higher than in 2000, further impacted our combined ratio. POSITIVE CONTRIBUTION FROM INVESTMENT INCOME In a year in which many suffered from the vagaries of the stock market and the reduced returns from lower interest rates, our continued emphasis on a disciplined investment approach yielded favorable results. Overall, the market value of Midland's investment portfolio rose to $704.0 million at year-end up from $692.7 million at year-end 2000, while pre-tax investment income increased 9.8 percent for the year. Midland's shareholders' equity closed the year at $291.9 million, or $33.05 per share, up from $283.2 million, or $31.46 per share, at year-end 2000. Our consistent financial strength and performance were acknowledged on a number of fronts during the year. A.M. Best upgraded American Modern's property and casualty operations to A+ (Superior). The Ward Financial Group placed American Modern among its Top 50 property and casualty insurers for the third consecutive year. Forbes Magazine named Midland as one of the top 200 small companies in America. M/G TRANSPORT M/G Transport, Midland's transportation subsidiary, reported 5.2 percent growth in operating revenue for the year. M/G's after-tax contribution to operating earnings was 12 cents for 2001, compared with 18 cents in 2000. M/G experienced a change in the shipping patterns for some of its products, resulting in lower operating profits in the second and third quarters of 2001. Nonetheless, M/G remains a valuable investment for Midland, adding an average of $4.5 million to operating cash flow and averaging a 13.8 percent return on beginning equity over the past five years. LOOKING BEYOND 2001 Of course, challenges remain. But we intend to remain focused on achieving and maintaining balance in all aspects of our business. We will continue to implement our four strategies for growth: organic growth in current markets, strategic acquisitions, strategic alliances and the expansion of low-risk fee-income [Photo] From left, Joseph P. Hayden III, Chairman and Chief Operating Officer, and John W. Hayden, President and Chief Executive Officer -------------------------------------------------------------------------------- The Midland Company/4 -------------------------------------------------------------------------------- business. We will continue to consistently deliver superior products and services by adhering to our seven key operating strategies: - Focus on specialty products - Employ multiple distribution channels - Leverage multiple company structure across distribution channels - Profit from expert claims management - Reduce earnings volatility via risk management - Consistently produce an underwriting profit - Strategically deploy technology While we will remain faithful to all seven strategies, we will pay particularly close attention to the strategic deployment of technology over the next several years, centering on our modernLINK initiative, which is in the process of delivering Web-based, self-servicing capabilities to our producers. Already, we have begun to realize the benefits of more sophisticated automated online processes. At the same time, Web-enabled processing systems allow our business partners to more efficiently serve customer needs and our company to more fully benefit from information distribution efficiencies. EMPHASIS ON CREATING VALUE FOR SHAREHOLDERS Midland's goal always has been to place the highest priority on creating long-term value for our shareholders. To that end, on January 25, 2001, the Board of Directors authorized the repurchase of an additional 500,000 shares of our common stock. During 2001, the company repurchased 197,846 shares of our stock at an average price of $34.44 per share. And, on January 31, 2002, the Board approved an indicated annual dividend of 35 cents per share, the 16th consecutive year of increasing dividends to shareholders. In addition, more and more financial analysts and professional investors have taken notice of the balance we have achieved over the years. They have taken notice of the viability of our long-term strategies to produce profits and growth that outpace the industry, as well as create stability and security that provide a welcome relief from the volatility of technology stocks. This underlying confidence in your company was reflected in the dramatic growth in market value of Midland's common stock during 2001, up 57.8 percent to $43.80 per share from year end 2000. The strong performance of Midland's stock in 2001 should come as no surprise, however, since it continued to out perform the S&P 500 for the 1-, 5-, 10-, 15- and 20-year time frames. In closing, we thank you for your support of Midland. Your company made important strides in 2001 to create long-term value for our shareholders, as well as for our business partners, policyholders and associates. By remaining true to the balance that has characterized our products, distribution and services in the past, we look forward to a strong future. /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 07, 2002 -------------------------------------------------------------------------------- The Midland Company/5 -------------------------------------------------------------------------------- Manufactured housing. Watercraft. Motorcycles. Recreational vehicles. Collector automobiles. Collateral protection. Credit life. Specialty markets served by American Modern's special expertise. In addition to a balanced insurance portfolio, Midland has built a balanced fee-income portfolio-- a suite of products and services that are not subject to the risk-bearing uncertainty associated with the underwriting of insurance. Through loan tracking, compliance research, escrow processing and marketing support, Midland's Ameritrac subsidiary adds value to our business relationships and creates additional balance for our business. Looking ahead, Midland will continue to develop products that complement our strategic mix and expand our strategic reach. BALANCE- CREATING A STRONG MIX OF SPECIALTY PRODUCTS In recent years, balance in American Modern's mix of specialty products has been more than a goal; it has been an evolving reality. In 2001, manufactured housing's contribution to total direct and assumed written premiums was 56.1 percent, a noteworthy decline from the 62.6 percent level it reached in 2000. This balance has earned and will continue to earn American Modern new customers, new relationships and new paths to profits. Midland, through American Modern, has strategically built a product portfolio that serves the varied needs of varied customers. Each product in the portfolio has unique features that speak directly to the policyholder. Each reflects an expertise that is unique to that market. Together, they create a mix that is highly specialized, highly competitive and highly balanced. [Graph] PRODUCT MIX (Percentage of Total Direct and Assumed Written Premiums) 2001 2000 Manufactured Homes 56.1% 62.6% Motor Sport 7.4% 1.2% Credit Life & Related 7.4% 7.3% Site Built Dwelling 6.2% 4.6% Collateral Protection 3.9% 4.2% Mortgage Fire 3.3% 2.6% Watercraft 3.1% 2.8% Long-Haul Truck 2.0% 2.2% Commercial - Proper 1.5% 2.1% All Other 9.1% 10.4% Manufactured housing premiums declined as a percent of the total by more than 6.5 percentage points between 2000 and 2001. Newer product areas increased their contribution, in line with the company's strategic decision to diversity. COMPETITIVE. CONFIDENT -------------------------------------------------------------------------------- The Midland Company/6 [GRAPHICS] AGILE. -------------------------------------------------------------------------------- General agents. Point of sale. Lenders. Strategic alliances. Financial services. Distinct channels served by American Modern's special expertise. American Modern provides customers with convenient access points that satisfy virtually any insurance shopper's needs while enabling American Modern to cross-sell products and develop multi-layer relationships. This diversity has distinguished American Modern for many years. In 2001, distribution balance helped provide a level of insulation against cyclical challenges experienced in the point-of-sale channel, particularly in the manufactured housing market. Due to the expanding strength of American Modern's relationships with key general agents, that distribution channel grew to represent 29.9 percent of total direct and assumed written premiums, up from 21.6 percent in 2000. New relationships--such as those developed with South & Western General Agency in Texas and Graham-Rogers General Agency in Oklahoma--are of growing importance in the balance of American Modern's distribution network. New partnerships with US Bancorp and Fifth channel declined as general agency contributions rose. Third Bancorp--two of our nation's premier financial institutions--provided new opportunities for growth in our life operations and in fee generation...growth that will continue well into 2002. While our relationship with GEICO remained the cornerstone of our strategic alliance distribution channel, in 2001, two new alliances were announced that are likely to expand the role of strategic partners in distribution beyond the current level of 3 percent of total premium. Amica Mutual Insurance Company, the nation's oldest mutual insurer of automobiles, rounded out its product line with manufactured housing policies underwritten by American Modern. American Express Property Casualty sought out American Modern for manufactured home, motor home, travel trailer and nonstandard specialty homeowner products to expand American Express's insurance offerings. Cultivating American Modern's distribution channels as a means of balancing performance through economic and other business cycles will remain a high priority for Midland. BALANCE- ESTABLISHING MULTIPLE CHANNELS OF DISTRIBUTION {Graph] DISTRIBUTION MIX (Percentage of Total Direct and Assumed Written Premiums) 2001 2000 ---- ---- Agency 29.9% 21.6% Lender 27.0% 31.6% Point of Sale 22.4% 26.2% Financial Services 13.9% 12.4% Strategic Alliances 3.0% 2.8% All Other 3.8% 5.4% Expansion of the company's distribution channels between 2000 and 2001 resulted in more balance. For example, contributions from the point-of-sale channel declined as general agency contributions rose. INSTINCTUAL. -------------------------------------------------------------------------------- The Midland Company/8 -------------------------------------------------------------------------------- [Graphics] INTENSE. CONCENTRATED. -------------------------------------------------------------------------------- The Midland Company/9 -------------------------------------------------------------------------------- BALANCE- BUILDING LASTING RELATIONSHIPS THROUGH INNOVATIVE SERVICES TO CUSTOMERS Policyholders. Strategic partners. Agents. Customers. Relationships cultivated by American Modern's special expertise. Building positive relationships that help American Modern connect with its agents, partners and customers is a strategic initiative balanced across all of the company's operations. Looking into the future, relationships will form in the manner best suited to the customer's needs. American Modern continues to invest heavily in that future through the development of Web-based systems that will introduce new capabilities and efficiencies to producers and policyholders in the years ahead. For example, American Modern achieved growth of 59 percent in one of its smaller product lines in 2001, largely as the result of new rating and processing capability through American Modern's Web-based modernLINK systems. In addition to existing capabilities that allow for policy inquiry online, these new functions give agents and American Modern a distinct advantage that will allow the company to compete more successfully for this highly desirable market. When it comes to claims activities, American Modern's representatives continue to balance accuracy, compassion and efficiency in responding to customer needs. In 2001, American Modern continued its strong record of service in this area, closing 84.3 percent of claims within 30 days or less, while handling more than 89.5 percent of the claims through its own staff adjusters. American Modern's customer service representatives respond quickly and efficiently to information requests, seeking to deliver added value in any way possible. From the customer service representative to the claims representative to electronic interactions, American Modern will seek to continue to build positive relationships to achieve higher levels of retention, which serve as the foundation for profitable growth. ACTIVE. -------------------------------------------------------------------------------- The Midland Company/10 [GRAPHICS] RESPONSIVE. CONSISTENT. -------------------------------------------------------------------------------- The Midland Company/11 -------------------------------------------------------------------------------- AMERICAN MODERN INSURANCE GROUP INVESTMENT PORTFOLIO [GRAPH] MARKET VALUES (dollars in millions)
97 98 99 00 01 ------- ------- ------- ------- ------- Government 201.363 177.101 140.496 156.819 141.095 Municipal 88.186 168.401 170.909 178.913 190.470 Corporate 78.958 79.328 121.038 133.878 176.355 Cash Equivalents 34.635 29.337 40.910 66.093 43.690 Equities 92.332 132.808 125.290 145.954 147.259 Other - - 11.757 11.443 8.131
[GRAPH] PRE-TAX INVESTMENT INCOME (dollars in millions)
97 98 99 00 01 ------ ------ ------ ------ ------ Capital Gains 4.200 6.400 3.500 4.600 2.000 Operations 21.300 23.900 25.300 30.800 33.800
American Modern manages its investment portfolio with a focus on both total return and current income. Market value for the portfolio increased to $707.0 million in 2001 from $693.1 million at year end 2000. Pre-tax investment income rose 9.8 percent in 2001 to $33.8 million from $30.8 million in 2000. After-tax capital gains decreased in 2001 to $1.3 million, or 15 cents per diluted share, compared with $3.0 million, or 31 cents per diluted share, in 2000. Net unrealized capital gains decreased in 2001 to $62.2 million from $74.1 million in 2000. 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.)
Periods Ending December 31, 2001 ---------------------------------------------- 1 Year 3 Year 5 Year ---------------------------------------------------------------------------------------------------- EQUITIES: American Modern-Composite -13.5% -5.9% 12.7% American Modern-Excluding Investment In US Bancorp- -18.6% -1.2% 8.7% American Modern-US Bancorp Only -6.8% -9.7% 18.3% S&P 500 -11.9% -1.0% 10.7% FIXED INCOME TOTAL RETURN: American Modern After-Tax 6.5% 5.1% 5.2% After-Tax Lehman Brothers Intermediate Government/Credit Index 6.7% 4.1% 4.7% FIXED INCOME PRE-TAX EQUIVALENT YIELD AS OF DECEMBER 31, 2001 5.4% AVERAGE MATURITY AS OF DECEMBER 31, 2001 5.0 years DURATION AS OF DECEMBER 31, 2001 3.8 years
-------------------------------------------------------------------------------- The Midland Company/12 BALANCE- Profitable Investment in a Niche River Transportation Business, M/G TRANSPORT SERVICES, INC. M/G Transport and its sales and marketing arm, MGT Services, Inc., continue to fill a profitable niche in the transportation marketplace and today account for 6 percent of Midland's total revenues. Collectively known as M/G, this barge affreightment subsidiary of Midland operates in New Orleans, Louisiana. In 2001 M/G's pre-tax earnings declined 39 percent to $1.7 million from $2.8 million in 2000. The decrease was primarily due to a change in traffic patterns for petroleum coke. M/G remains committed to the transportation of dry bulk commodities, as evidenced in its 30 new open hopper barges scheduled for delivery over the next 15 months. EFFICIENCY CONTINUES TO DEFINE M/G M/G provides superior service to large industrial clients, transporting dry cargo such as petroleum coke, barite, sugar, iron ore, grain, steel pipe and other dry commodities. The operations are concentrated on the Lower Mississippi River and westbound on the Gulf Intercoastal Waterway. As of December 31, 2001, M/G serves its customers with a fleet of 206 jumbo hopper barges, owned or leased by the company. M/G supplements its fleet by chartering equipment or renting space from other operators as necessary to meet customer needs, thus providing operating flexibility. M/G has been and continues to be a sound investment for Midland, in particular because of its efficient operations. M/G generated $34.8 million in revenue and $3.9 million in cash flow in 2001, with an experienced staff of 15 employees. M/G remains attuned to market conditions and will respond with strategies designed to best take advantage of those conditions. [GRAPH] M/G TRANSPORT RETURN ON BEGINNING EQUITY 97 98 99 00 01 20.0% 15.9% 6.1% 16.1% 11.1% M/G is a valuable investment for Midland, adding an average of $4.5 million to operating cash flow and averaging 13.8 percent return on beginning equity over the past five years. -------------------------------------------------------------------------------- The Midland Company/13 ----------------------------------------------------------------------------- SIX YEAR FINANCIAL SUMMARY DATA
THE MIDLAND COMPANY AND SUBSIDIARIES For the Years Ended December 31, (Amounts in thousands, except per share data) 2001 2000 1999 1998 1997 1996 ------------------------------------------------------------------------------------------------------------------------------------ INCOME STATEMENT DATA Revenues: Insurance: Premiums earned $ 508,233 $ 456,120 $ 400,991 $ 375,478 $ 311,159 $ 280,614 Net investment income 33,802 30,774 25,292 23,908 21,332 18,269 Net realized investment gains(a) 2,023 4,646 3,486 6,354 4,170 2,690 Other insurance income 7,175 8,784 6,793 2,508 1,557 1,602 Transportation 34,826 33,119 31,327 33,059 34,933 34,064 Other 484 979 1,237 1,055 617 499 --------- --------- --------- --------- --------- --------- Total 586,543 534,422 469,126 442,362 373,768 337,738 --------- --------- --------- --------- --------- --------- Costs and Expenses: Insurance: Losses and loss adjustment expenses 292,188 240,680 204,365 210,015 171,163 172,426 Commissions and other policy acquisition costs 145,777 137,053 114,212 103,169 79,518 81,533 Operating and administrative expenses 73,322 70,755 66,541 54,309 49,118 41,355 Transportation operating expenses 32,898 28,828 29,255 28,287 30,079 31,163 Interest expense 4,368 4,132 4,067 4,991 4,983 4,829 Other operating and administrative expenses 1,286 2,305 6,973 4,064 4,204 3,115 --------- --------- --------- --------- --------- --------- Total 549,839 483,753 425,413 404,835 339,065 334,421 --------- --------- --------- --------- --------- --------- Income from Continuing Operations Before Federal Income Tax 36,704 50,669 43,713 37,527 34,703 3,317 Provision (Credit) for Federal Income Tax 9,482 15,206 12,534 10,595 10,336 (426) --------- --------- --------- --------- --------- --------- Income from Continuing Operations 27,222 35,463 31,179 26,932 24,367 3,743 Loss from Discontinued Operations(b) -- -- -- -- (6,817) (2,675) --------- --------- --------- --------- --------- --------- Net Income $ 27,222 $ 35,463 $ 31,179 $ 26,932 $ 17,550 $ 1,068 --------- --------- --------- --------- --------- --------- Basic Earnings (Loss) Per Share of Common Stock(d): Continuing operations $ 3.15 $ 3.91 $ 3.42 $ 2.99 $ 2.72 $ .42 Discontinued operations -- -- -- -- (.76) (.30) --------- --------- --------- --------- --------- --------- Total $ 3.15 $ 3.91 $ 3.42 $ 2.99 $ 1.96 $ .12 --------- --------- --------- --------- --------- --------- Diluted Earnings (Loss) Per Share of Common Stock(d): Continuing operations $ 3.03 $ 3.78 $ 3.30 $ 2.86 $ 2.63 $ .41 Discontinued operations -- -- -- -- (.74) (.29) --------- --------- --------- --------- --------- --------- Total $ 3.03 $ 3.78 $ 3.30 $ 2.86 $ 1.89 $ .12 --------- --------- --------- --------- --------- --------- Cash Dividends Per Share of Common Stock(d): $ .32 $ .30 $ .27 $ .25 $ .23 $ .22 --------- --------- --------- --------- --------- ---------
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THE MIDLAND COMPANY AND SUBSIDIARIES For the Years Ended December 31, (Amounts in thousands, except per share data) 2001 2000 1999 1998 1997 1996 ------------------------------------------------------------------------------------------------------------------------------------ BALANCE SHEET DATA Total Cash and Marketable Securities $ 715,295 $ 701,048 $ 620,957 $ 593,857 $ 504,106 $ 403,804 Total Assets 1,053,942 993,850 888,057 837,220 760,463 655,979 Total Debt 84,141 85,045 69,838 76,085 92,309 95,170 Unearned Insurance Premiums 403,855 357,185 312,838 255,115 240,340 208,417 Loss Reserves 148,674 135,887 133,713 125,496 120,134 95,830 Shareholders' Equity 291,876 283,177 258,002 248,832 197,026 159,688 Book Value Per Share(d) $ 33.05 $ 31.46 $ 27.11 $ 26.61 $ 21.11 $ 17.50 Common Shares Outstanding(d) 8,830 9,000 9,516 9,352 9,334 9,126 OTHER DATA Midland Consolidated Operating Income from Continuing Operations(c) $ 25,907 $ 31,755 $ 28,913 $ 22,802 $ 21,657 $ 1,995 --------- --------- --------- --------- --------- --------- Operating Income Per Share from Continuing Operations (Diluted)(c,d) $ 2.88 $ 3.39 $ 3.06 $ 2.42 $ 2.33 $ .22 --------- --------- --------- --------- --------- --------- AMIG's Property and Casualty Operations Direct and Assumed Written Premiums $ 555,548 $ 500,984 $ 472,041 $ 446,248 $ 422,982 $ 387,165 Net Written Premium 523,105 471,336 439,863 391,770 342,310 290,355 Loss and Loss Adjustment Expense Ratio (GAAP) 57.8% 52.9% 51.2% 56.1% 55.1% 61.8% Underwriting Expense Ratio (GAAP) 42.0% 43.3% 43.2% 40.8% 40.7% 42.5% Combined Ratio (GAAP) 99.8% 96.2% 94.4% 96.9% 95.8% 104.3% Statutory Capital and Surplus 222,036 235,521 220,080 217,091 164,128 124,131 Net Written Premium to Statutory Surplus 2.4x 2.0x 2.0x 1.8x 2.1x 2.3x M/G Transport's Transportation Operations Net Revenues $ 34,826 $ 33,119 $ 31,327 $ 33,059 $ 34,933 $ 34,064 Net Income 1,079 1,809 1,169 2,994 3,126 1,938 Total Assets 24,952 27,412 30,564 39,167 42,914 41,458 Shareholders' Equity 10,509 9,728 10,919 18,749 18,783 15,658
Footnotes: (a) Net Realized Investment Gains in 2001 include the effect of SFAS 133 adjustments. (b) 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. (c) Represents income from continuing operations excluding net realized investment gains or losses, net of federal income taxes. (d) Previously reported share information has been adjusted to reflect a three-for-one common stock split effective May 21, 1998. -------------------------------------------------------------------------------- The Midland Company/15 -------------------------------------------------------------------------------- MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS THE MIDLAND COMPANY AND SUBSIDIARIES The Midland Company, through its wholly owned subsidiaries, is primarily a specialty property and casualty insurance company, with approximately 56 percent of its specialty premium volume related to insuring manufactured housing. In addition, Midland owns a barge chartering and freight brokerage operation that accounts for approximately 6 percent of its consolidated revenues. LINES OF BUSINESS AND REPORTABLE SEGMENTS The discussions of Results of Operations and Liquidity and Capital Resources are grouped according to Midland's three reportable segments: manufactured housing insurance, other insurance and transportation. A description of the operations of each of these lines of business is included below. RESULTS OF OPERATIONS INSURANCE (MANUFACTURED HOUSING AND OTHER INSURANCE) Midland's specialty insurance operations are conducted through American Modern Insurance Group, Inc., a wholly-owned subsidiary of Midland and a holding company which controls six property and casualty insurance companies, two credit life insurance companies and five licensed insurance agencies. American Modern is licensed, through its subsidiaries, to write insurance premium in all 50 states and the District of Columbia. More than fifty percent of American Modern'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. A subsidiary of American Modern, Ameritrac, offers proprietary loan and lease tracking service. Other insurance products include watercraft, motorsports, recreational vehicle, homeowners, lower value homes, extended service contract related products, dwelling ore, mortgage ore, collateral protection, specialty automobile, credit life, long-haul truck, commercial and excess and surplus lines. TRANSPORTATION M/G Transport Services, Inc. and MGT Services, Inc. (collectively M/G Transport), Midland's transportation subsidiaries, charter barges and broker freight for the movement of dry bulk commodities such as petroleum coke, ores, barite, fertilizers, sugar and other dry cargoes primarily on the lower Mississippi River and its tributaries. YEAR ENDED DECEMBER 31, 2001 COMPARED TO YEAR ENDED DECEMBER 31, 2000 INSURANCE General Overview of Insurance Operations and Insurance Premiums Direct and assumed written premiums generated from American Modern's property and casualty and life insurance subsidiaries for the year ended December 31, 2001 increased 11.0% to $600.2 million from $540.7 million in 2000. Net earned premiums for the year increased at a similar rate at 11.4% to $508.2 million from $456.1 million in 2000. This growth came despite on-going challenges within the manufactured housing industry, which resulted in a slight decrease in American Modern's manufactured housing premium volume in 2001. Diversification of American Modern's product offering was an important facet of 2001 growth performance, as was the continued diversification of its distribution channels. From a product diversification perspective, manufactured housing direct and assumed written premium represented 56 percent of all specialty insurance premium in 2001 compared to 63 percent in 2000. From a distribution channel perspective in 2001, American Modern experienced a 54 percent increase in direct and assumed written premium though the agency channel, which rose to 30 percent of the total from 22 percent last year. That increase was driven by expanded and new relationships with leaders in the general agent marketplace, as well as significant premium conversion opportunities in the manufactured housing, motorsports and watercraft lines of business. Despite the positive contributions from a top-line perspective, American Modern's contributions to Midland's overall earnings for 2001 were somewhat depressed as a result of losses from commercial liability lines, a product line that American Modern decided to exit in September 2001, and higher-than-normal fire losses. The growth in direct and assumed written premiums was due primarily to volume increases in the motorsports (motorcycle and snowmobile), dwelling fire, mortgage fire, recreational vehicle and credit life books of business. The most significant growth came from the motorsports book that was acquired from GuideOne Insurance Company in 2001 contributing $44.5 million in direct and assumed written premium in 2001 as compared to $6.4 million in the prior year. Mobile home and related direct and assumed written premium in 2001 of $336.5 million was comparable to 2000 levels of $338.6 million. The mobile home and related line of business has traditionally experienced a consistent level of growth. The static level of production from this product line in 2001, however, reflects an overall decline in the level of manufactured housing new home shipments in 2001 compared to 2000. Credit life direct and assumed written premium increased 12.5% to $44.7 million in 2001 from $39.7 million in 2000. This continued growth is primarily the result of an expansion of the credit life business with a large financial institution customer. Premium rate increases also contributed to American Modern's overall direct and assumed premium growth, but to a lesser degree than volume increases. American Modern is also seeking premium rate increases in various states in 2002 as part of its operating strategies. Other Insurance Income (Fee Income) American Modern's other insurance income decreased to $7.2 million in 2001 from $8.8 million in 2000. This decrease is primarily the result of the decline in American Modern's warranty and loan facilitation businesses. Although third-party fee income decreased in 2001, direct and assumed written premium generated by American Modern's loan tracking operations and insurance agencies increased 6.1% to $98.3 million in 2001. -------------------------------------------------------------------------------- The Midland Company/16 THE MIDLAND COMPANY AND SUBSIDIARIES Insurance Investment Income and Realized Capital Gains American Modern's net investment income (before taxes and excluding net realized capital gains and the impact of SFAS No. 133 "Accounting for Derivative Instruments and Hedging Activities") increased 9.8% to $33.8 million in 2001 from $30.8 million in 2000. The increase in investment income was primarily the result of the continued investment of the cash flow generated from underwriting and investment activities. On a cost basis, American Modern's invested asset base (cash and investments) increased $27.7 million from December 31, 2000. Excluding the impact of SFAS No. 133, American Modern's after-tax net realized capital gains decreased to $0.6 million, 7 cents per share (diluted) in 2001, from $3.0 million, 31 cents per share (diluted) in 2000. The impact of accounting for embedded options under SFAS No. 133, which Midland adopted on January 1, 2001, increased net realized investment gains on an after-tax basis by $0.7 million, 8 cents per share (diluted) in 2001. Insurance Losses and Loss Adjustment Expenses (LAE) Insurance losses and LAE increased 21.4% to $292.2 million in 2001 from $240.7 million in 2000. This increase was due to the continued growth in net earned premium coupled with increases in fire-related losses, discontinued commercial liability losses and catastrophe losses. Higher than normal levels of fire losses added $11.0 million (pre-tax, before any estimated adjustments for contingent commissions) of additional loss costs in 2001 over 2000. Losses stemming from the discontinued commercial liability business were $3.0 million (pre-tax) higher in 2001 than in 2000 and the impact of catastrophes was $9.7 million (pre-tax) higher in 2001 compared to 2000. Insurance Commissions, Other Policy Acquisition Costs and Operating and Administration Expenses Commissions, other policy acquisition costs and operating and administrative expenses increased 5.4% to $219.1 million in 2001 from $207.8 million in 2000. This increase is due primarily to the continued growth in net earned premiums and other insurance income coupled with a decrease in contingent commission expense due to a higher loss ratio in 2001 compared to 2000. Overall Property and Casualty Underwriting Results American Modern's property and casualty operations generated pre-tax underwriting income (property and casualty insurance earned premiums less incurred losses, commissions and operating expenses) of $1.0 million in 2001 compared to $17.0 million in 2000. This resulted in a combined ratio of 99.8% in 2001 compared to 96.2% in 2000. Again, the largest contributors to these weaker results were higher than normal fire losses, discontinued commercial liability losses and higher levels of catastrophe losses. Higher than normal fire-related losses increased the combined ratio by 2.9 percentage points in 2001 compared to only 1.3 percentage points in 2000. Discontinued commercial liability losses contributed 2.3 percentage points to the combined ratio in 2001 compared to 1.9 points a year ago. Catastrophe losses, which were lower than normal in both years, contributed 4.3 points to the combined ratio in 2001 as compared to 2.6 points in 2000. TRANSPORTATION Excluding a one-time pre-tax capital gain of $1.0 million from the sale of transportation equipment in 2000, transportation revenues increased 8.4% to $34.8 million in 2001 from $32.1 million in the prior year. Pre-tax operating profit (excluding capital gains) decreased to $1.7 million in 2001 from $2.8 million in 2000. The fluctuations in both revenue and operating profit are due to a change in shipping patterns to longer duration (but less profitable) affreightment movements in 2001 compared to 2000. YEAR ENDED DECEMBER 31, 2000 COMPARED TO YEAR ENDED DECEMBER 31, 1999 INSURANCE Insurance Premiums Direct and assumed written premiums generated from American Modern's property and casualty and life insurance subsidiaries for the year ended December 31, 2000 increased 9.6% to $540.7 million from $493.2 million in 1999. Net earned premiums for the year increased 13.7% to $456.1 million from $401.0 million in 1999. The difference in growth rates between the direct and assumed written premiums and net earned premiums is due primarily to the impact of multi-year policies generated in prior periods coupled with changes in the levels of premiums ceded under a quota share reinsurance treaty. The growth in direct and assumed written premiums is due to volume increases in manufactured home and related coverages premium, all other property and casualty specialty insurance products and credit life direct and assumed written premium. Manufactured home and related coverages direct and assumed written premium increased 4.4% to $338.6 million in 2000 from $324.4 million in 1999. This increase was achieved in spite of an approximate 30% decrease in manufactured housing shipments in 2000. Direct and assumed written premiums of all other property and casualty specialty insurance products increased 10% to $162.4 million in 2000 from $147.7 million in 1999. Direct and assumed written credit life premium increased 87.7% to $39.7 million in 2000 from $21.2 million in 1999. Premium rate increases also contributed to American Modern's overall direct and assumed premium growth, but to a lesser degree than volume increases. Other Insurance Income (Fee Income) American Modern's other insurance income increased to $8.8 million in 2000 from $6.8 million in 1999. The increase is primarily the result of the growth of American Modern's warranty, loan facilitation and agency fee businesses. -------------------------------------------------------------------------------- The Midland Company/17 -------------------------------------------------------------------------------- MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) THE MIDLAND COMPANY AND SUBSIDIARIES Insurance Investment Income and Realized Capital Gains American Modern's net investment income (before taxes and excluding net realized capital gains) increased 21.7% to $30.8 million in 2000 from $25.3 million in 1999. The increase in investment income was primarily the result of the investment of positive cash flow generated from underwriting and investment activities coupled with a higher interest rate environment in 2000 compared to 1999. American Modern's investment portfolio increased 13.6% to $693.1 million in market value at December 31, 2000. This increase in the market value of the investment portfolio was the result of the investment of positive cash flow from underwriting activities, investment income, net realized capital gains generated from the portfolio and a $7.4 million increase in the unrealized appreciation in the market value of securities held. The increase in unrealized appreciation was primarily the result of the unrealized appreciation in American Modern's fixed income securities of $15.0 million and the increase in the market value of American Modern's investment in the common stock of US Bancorp. The market value of American Modern's investment in US Bancorp increased to $54.3 million at December 31, 2000 from $49.3 million at December 31, 1999. After-tax net realized capital gains increased to $3.0 million, $0.31 per share (diluted) in 2000, from $2.3 million, $0.24 per share (diluted) in 1999. Insurance Losses and Loss Adjustment Expenses (LAE) Insurance losses and LAE increased 17.8% to $240.7 million in 2000 from $204.4 million in 1999. This increase was due to the continued growth in net earned premium plus increases in non-catastrophe weather related losses and fire-related losses. Catastrophe losses decreased in 2000 compared to 1999 with a catastrophe loss ratio of only 2.6% in 2000 compared to 5.6% in 1999. The overall after-tax impact of catastrophes was $7.4 million in 2000 as compared to $12.9 million in 1999. Insurance Commissions, Other Policy Acquisition Costs and Operating and Administration Expenses Commissions, other policy acquisition costs and operating and administrative expenses increased 14.9% to $207.8 million in 2000 from $180.8 million in 1999. This increase is due primarily to the continued growth in net earned premiums and other insurance income coupled with an increase in the commission ratio due to a change in a quota share reinsurance agreement. Overall Property and Casualty Underwriting Results American Modern's property and casualty operations generated pre-tax underwriting income (property and casualty insurance earned premiums less incurred losses, commissions and operating expenses) of $17.0 million in 2000 compared to $22.1 million in 1999. This resulted in a combined ratio of 96.2% in 2000 compared to 94.4% in 1999. The reasons for the change in the combined ratio have been described above. TRANSPORTATION Transportation revenues increased 5.7% to $33.1 million in 2000 from $31.3 million in 1999. The increase was primarily due to increased demand for sugar and barite (a drilling mud used by offshore refineries) and to a one-time capital gain of $1.0 million from the sale of transportation equipment. Transportation's pre-tax profit increased, excluding the capital gain of $1.0 million, from $1.8 million in 1999 to $2.8 million in 2000 due primarily to the increased revenues from the shipment of sugar and barite commodities and changes in the shipping patterns in 2000 when compared to 1999. CORPORATE During 2000, Midland recorded a gain of $7.4 million from the curtailment and settlement of a portion of its pension plan. This gain was offset by excise taxes on the withdrawal of a portion of overfunded pension assets and by one-time expenses related to consulting agreements with retired executives. The net result of these transactions, exclusive of the excise tax, were included in the income statement as other operating and administrative expenses. The excise tax component was included in the Provision for Federal Income Tax. The net impact of these transactions was a net after-tax charge to earnings in 2000 of less than $200,000, or two cents per share on a dilutive basis. LIQUIDITY AND CAPITAL RESOURCES HOLDING COMPANY OPERATIONS Midland and American Modern 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 many of American Modern's insurance subsidiaries is restricted by state regulatory agencies. Such restrictions, however, have not had, and are not expected to have, a significant impact on Midland's or American Modern'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 $48 million of conventional short-term credit lines available at costs 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, 2001 amounted to $52.7 million. The December 31, 2001 balance of outstanding interest bearing debt consisted of $9.5 million in commercial paper, $17.2 million in mortgage obligations and $26.0 million in other short-term borrowings under conventional lines of credit. These short-term borrowings decreased $13 million from $39 million in 2000 due primarily to the receipt of $20.5 million in dividends and loan repayments from its subsidiaries offset by $6.8 million used to repurchase Midland's common stock (discussed below). 18/The Midland Company THE MIDLAND COMPANY AND SUBSIDIARIES Expenditures for the acquisition of businesses and property, plant and equipment amounted to $9.7 million, $6.3 million and $5.8 million for years ended December 31, 2001, 2000 and 1999. The increase in capital expenditures primarily relates to continued investment in proprietary information systems. This is predominately funded from operating cash flows. Midland declared $2.8 million in dividends payable to its shareholders each year during 2001 and 2000. In January 2001, Midland's Board of Directors authorized the repurchase of 500,000 shares of the company's common stock. As of December 31, 2001, 198,000 shares had been repurchased at a total cost of $6.8 million and an average purchase price of $34.44 per share. Under a prior authority by the Board of Directors in 1999, 500,000 shares of common stock were repurchased during 1999 and 2000 at a total cost of $13.9 million and an average purchase price of $27.71 per share. Midland expects to repurchase shares under the remaining January 2001 authorization selectively as price and market conditions warrant. INSURANCE American Modern generates cash inflows primarily from insurance premiums, investment income, proceeds from sale of marketable securities and maturities of debt security investments. The principal cash outflows for the insurance operations relate to the payment of claims, commissions, premium taxes, operating expenses, income taxes, dividends and inter-company borrowings to Midland 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 Midland's insurance subsidiaries are primarily property-related coverages that result in rapid claim payments. The market value of American Modern's investment portfolio increased 2.0% to $707.0 million in market value at December 31, 2001. This increase in the market value of the investment portfolio was the result of the aforementioned $27.7 million investment of cash flow from underwriting activities, investment income and net realized capital gains offset by a $13.1 million decrease in the unrealized appreciation in the market value of securities held. The decrease in the unrealized appreciation was due to the $19.4 million decrease in the market value of equity securities held within the portfolio offset by a $6.3 million increase in market value of the fixed income securities. Included in the decrease in market value of American Modern's equity securities is the decrease in American Modern's largest single holding in its investment portfolio, 2.3 million shares of US Bancorp which decreased to $48.9 million at December 31, 2001 from $54.3 million at December 31, 2000. The average maturity and duration of American Modern's debt security investment portfolio as of December 31, 2001 was approximately 5.0 years and 3.8 years, respectively, which management believes provides adequate asset/liability matching. American Modern also has a $60 million long-term credit facility available on a revolving basis at various rates. American Modern increased its borrowings under this credit facility from $20.0 million in 2000 to $30.0 million at December 31, 2001 and used the additional $10.0 million borrowing to reduce its indebtedness to Midland. Cash flow from the insurance operations is expected to remain sufficiently positive to meet American Modern's future operating requirements and to provide for reasonable dividends to Midland. Accounts receivable is primarily comprised of premiums due from both policyholders and agents. In the case of receivables due directly from policyholders, policies are cancelable in the event of non-payment and thus offer minimal credit exposure. In the case of receivables due from agents, American Modern has extended payment terms that are customary and normal in the insurance industry. Management monitors its credit exposure with its agents and related concentrations on a regular basis. However, as collectibility of such receivables is dependent upon the financial stability of the agent, American Modern cannot assure collections in full. Where management believes appropriate, American Modern has provided a reserve for such exposures. Approximately 56% of American Modern's account receivables relate to premiums due directly from policyholders. Accounts receivable increased in 2001 due primarily to the writing of multi-year insurance policies which are being remitted to American Modern over the term of the policy. Reinsurance recoverables and prepaid reinsurance premiums increased to $69.8 million at December 31, 2001 from $46.0 million in 2000. This increase is primarily due to an $11.3 million increase in ceded unearned premium from the prior year because American Modern experienced large growth in its credit life operation, which cedes a significant portion of its direct and assumed premiums to reinsurers. Additionally, property and casualty's ceded unearned premium increased $6.3 million over the prior year primarily from cessions of several books of business related to certain lines of warranty business which American Modern decided to exit in 2000. The increase in reinsurance recoverables and prepaid reinsurance premiums will have no effect on American Modern's liquidity and capital resources. As of December 31, 2001, American Modern's property and casualty statutory surplus was $222.0 million resulting in a premium to surplus ratio of 2.4 for the year ended December 31, 2001. 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, dividends to Midland and the acquisition of capital equipment. Like the insurance operations, cash flow from the transportation operations is expected to remain sufficiently positive to meet future operating requirements while providing for reasonable dividends to Midland. THE MIDLAND COMPANY/19 -------------------------------------------------------------------------------- MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) THE MIDLAND COMPANY AND SUBSIDIARIES The transportation subsidiaries entered into a seven-year lease in 2000 and a fifteen-year lease in 1999 for transportation equipment. Aggregate rental payments under these two leases over the next thirteen years will approximate $8.1 million. There were no other barge acquisitions during 2001 and 2000. M/G Transport has committed to acquire 30 new barges over the next 15 months at an approximate total cost of $6.8 million. This acquisition and any future acquisitions would likely be financed through a combination of internally generated funds, external borrowings or lease transactions. As of December 31, 2001, the transportation subsidiaries had $1.4 million of collateralized equipment obligations outstanding. CONSOLIDATED OPERATIONS As disclosed in the footnote to the consolidated financial statements, Midland has certain obligations and commitments to make future payments under contracts. At December 31, 2001, the aggregate obligations (excluding the $6.8 million of future commitments relating to barge acquisitions as discussed above), on a consolidated basis, are (amounts in thousands): Thousands of Dollars Payments Due By Period --------------------------------------- Less Than 2-5 After Total 1 Year Years 5 Years ----------------------------------------------------------- Long-term Debt: $48,619 $ 1,456 $47,163 $ -- Other Notes Payable 35,522 35,522 -- -- Annual Commitments Under Non- Cancelable Leases 11,390 2,424 3,576 5,390 -------------------------------------- Total $95,531 $39,402 $50,739 $5,390 ====================================== OTHER MATTERS CRITICAL ACCOUNTING POLICIES The accounting policies of Midland conform to those generally accepted in the United States of America and are summarized in the footnotes to the company's consolidated financial statements. Certain of Midland's accounting policies require management to use estimations and assumptions that affect the amounts reported in the financial statements and Midland acknowledges that actual results could differ from those estimates. For instance, Midland's reserve for insurance losses is based on past experience of settling known claims as well as estimating those not yet reported, and while management believes the amounts are fairly stated, the ultimate liability, once fully developed, may be more than or less than that provided. Management and its actuaries, both internal and external, continually review these liabilities and adjustments are made as necessary in the current period. These reserves are subject to unpredictable events such as weather patterns and other catastrophic losses. Midland attempts to mitigate its risk to such events by diversifying the geographic areas covered and by reinsuring certain levels of risk with other insurance companies. Management does not foresee any significant change in the manner in which it records its reserve for insurance losses. By reinsuring certain levels and types of insurable risk with other insurance companies, Midland limits its exposure to losses to that portion of the insurable risk it retains. However, failure of the reinsurer to honor their obligation could result in losses to Midland, as the reinsurance contracts do not relieve Midland of its obligations to policyholders. Midland continually evaluates the financial condition of its reinsurers to minimize its exposure to losses from reinsurer insolvencies and does not believe it holds any significant concentration of credit risk arising from any single reinsurer or any similar geographic region, activity or economic characteristic associated with its reinsurers. Midland fully expects it reinsurers to honor their obligations. As of December 31, 2001 Midland is owed $3.9 million from reinsurers for claims that have been paid and for which a contractual obligation to collect from a reinsurer exists. Midland does not utilize any special purpose financing vehicles and does not have any undisclosed off-balance sheet arrangements that would materially affect Midland's assets, liabilities or reported income. Similarly, Midland holds no fair value contracts for which a lack of marketplace quotations would necessitate the use of fair value techniques. MARKET RISK Market risk is the risk that Midland will incur losses due to adverse changes in market rates and prices. Midland's market risk exposures are substantially related to American Modern's investment portfolio and changes in interest rates and equity prices. Each risk is defined in more detail as follows: Interest rate risk is the risk that American Modern will incur economic losses due to adverse changes in interest rates. The risk arises from many of American Modern's investment activities, as American Modern invests substantial funds in interest-sensitive assets. American Modern manages the interest rate risk inherent in its investment assets relative to the interest rate risk inherent in its liabilities. One of the measures American Modern uses to quantify this exposure is duration. By definition, duration is a measure of the sensitivity of the fair value of a fixed income portfolio to changes in interest rates. Based upon the 3.8 year duration of American Modern's fixed income portfolio at December 31, 2001, management estimates that a 100 basis point increase in interest rates would decrease the market value of its $560.9 million debt security portfolio by approximately 3.8% or $21.3 million. Equity price risk is the risk that American Modern will incur economic losses due to adverse changes in a particular stock or stock index. American Modern's equity exposure consists primarily of declines in the value of its equity security holdings. At December 31, 2001, American Modern had approximately $146.2 million in equity holdings, including $48.9 million of US Bancorp common stock. A 10% decrease in the market value of US Bancorp's common stock would decrease the fair 20/THE MIDLAND COMPANY THE MIDLAND COMPANY AND SUBSIDIARIES value of its equity portfolio by approximately $4.9 million. At December 31, 2001, the remainder of American Modern's portfolio of equity securities had a beta coefficient (a measure of stock price volatility) of approximately 1.10. This means that, in general, if the S&P Index decreases by 10%, management estimates that the fair value of the remaining equity portfolio will decrease by approximately 11.0%. The active management of market risk is integral to American Modern's operations. American Modern has investment guidelines that define the overall framework for managing market and other investment risks, including the accountabilities and controls over these activities. IMPACT OF SEPTEMBER 11, 2001 In 2001, Midland did not suffer significant adverse financial effects from the tragic events of September 11, 2001. The insurance products offered by American Modern are not the kind associated with that type of event. It is possible that a portion of the increase in American Modern's reinsurance costs in 2002 would be related to the events of September 11, 2001. OTHER COMPREHENSIVE INCOME For Midland, the primary difference between net income and comprehensive income is the net change in unrealized gain on marketable securities. For the years ended December 31, 2001, 2000 and 1999, such net unrealized gains in equity securities decreased (net of income tax effects) by $12.6 million, $4.8 million and $9.3 million, respectively. For fixed income securities, the net unrealized gains increased by $4.1 million and $9.8 million for the years ended December 31, 2001 and 2000, respectively, and decreased $11.8 million in the year 1999. 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. NEW ACCOUNTING STANDARDS The Financial Accounting Standards Board (FASB) issued Statement of Financial Account Standards (SFAS) No. 133 "Accounting for Derivative Instruments and Hedging Activities" during 1998. SFAS No. 133, as amended by SFAS Nos. 137 and 138, is effective January 1, 2001. The American Modern's investment portfolio includes $35.8 million of convertible securities, some of which contain embedded derivatives. The embedded conversion options are valued separately, and the change in market value of the embedded conversion options is reported in net realized investment gains. For the year 2001, the American Modern recorded pre-tax gains on these securities of $1.1 million in accordance with the SFAS statements. Midland did not hold any other derivative instruments at December 31, 2001. On June 29, 2001, SFAS No. 141, "Business Combinations" was approved by the FASB. SFAS No. 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001. Goodwill and certain intangible assets will remain on the balance sheet and will not be amortized. On an annual basis, and when there is reason to suspect that goodwill values have been diminished or impaired, these assets must be tested for impairment, and write-downs may be necessary. Midland was required to implement SFAS No. 141 on July 1, 2001 and this statement had no impact on its consolidated financial position, results of operations or cash flows as Midland made no business acquisitions since the implementation of SFAS 141. On June 29, 2001, SFAS No. 142, "Goodwill and Other Intangible Assets" was approved by the FASB. SFAS No. 142 changes the accounting for goodwill from an amortization method to an impairment-only approach. Amortization of goodwill, including goodwill recorded in past business combinations, will cease upon adoption of this statement. Midland is required to implement SFAS No. 142 by June 30, 2002. Midland's after-tax amortization of goodwill was approximately 4 cents per share (diluted) each year for 2001 and 2000. In June and August 2001, respectively, the FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations", and SFAS No. 144, "Accounting for the Impairment on Disposal of Long-Lived Assets". Midland does not expect these standards to have a material effect on its consolidated financial position, results of operations or cash flows. PRIVATE SECURITIES REFORM ACT OF 1995-- FORWARD LOOKING STATEMENTS DISCLOSURE Certain statements made in this report are forward-looking and are made pursuant to the safe harbor provisions of the Securities Litigation Reform Act of 1995. These statements include certain discussions relating to underwriting, premium and investment income volume, business strategies, profitability and business relationships, as well as any other statements concerning the year 2002 and beyond. The forward-looking statements involve risks and uncertainties that may cause results to differ materially from those anticipated in those statements. Factors that might cause results to differ from those anticipated include, without limitation, adverse weather conditions, changes in underwriting results affected by adverse economic conditions, fluctuations in the investment markets, changes in the retail marketplace, changes in the laws or regulations affecting the operations of Midland or its subsidiaries, changes in the business tactics or strategies of Midland, its subsidiaries or its current or anticipated business partners, the financial condition of Midland's business partners, acquisitions or divestitures, changes in market forces, litigation and the other risk factors that have been identified in Midland's filings with the SEC, any one of which might materially affect the operations of Midland or its subsidiaries. Any forward-looking statements speak 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. THE MIDLAND COMPANY /21 -------------------------------------------------------------------------------- CONSOLIDATED STATEMENTS OF INCOME
THE MIDLAND COMPANY AND SUBSIDIARIES Years Ended December 31, (Amounts in thousands, except per share data) 2001 2000 1999 -------------------------------------------------------------------------------------------------- REVENUES: Insurance: Premiums earned $508,233 $456,120 $400,991 Net investment income 33,802 30,774 25,292 Net realized investment gains 2,023 4,646 3,486 Other insurance income 7,175 8,784 6,793 Transportation 34,826 33,119 31,327 Other 484 979 1,237 ------------------------------------------ Total 586,543 534,422 469,126 ------------------------------------------ COSTS AND EXPENSES: Insurance: Losses and loss adjustment expenses 292,188 240,680 204,365 Commissions and other policy acquisition costs 145,777 137,053 114,212 Operating and administrative expenses 73,322 70,755 66,541 Transportation operating expenses 32,898 28,828 29,255 Interest expense 4,368 4,132 4,067 Other operating and administrative expenses 1,286 2,305 6,973 ------------------------------------------ Total 549,839 483,753 425,413 ------------------------------------------ INCOME BEFORE FEDERAL INCOME TAX 36,704 50,669 43,713 PROVISION FOR FEDERAL INCOME TAX 9,482 15,206 12,534 ------------------------------------------ NET INCOME $ 27,222 $ 35,463 $ 31,179 ------------------------------------------ BASIC EARNINGS PER SHARE OF COMMON STOCK: $ 3.15 $ 3.91 $ 3.42 ------------------------------------------ DILUTED EARNINGS PER SHARE OF COMMON STOCK: $ 3.03 $ 3.78 $ 3.30 ------------------------------------------ CASH DIVIDENDS PER SHARE OF COMMON STOCK $ .32 $ .30 $ .27 ------------------------------------------
See notes to consolidated financial statements. 22/ The Midland Company ------------------------------------------------------------------------------ CONSOLIDATED BALANCE SHEETS
THE MIDLAND COMPANY AND SUBSIDIARIES December 31, (Amounts in thousands) 2001 2000 -------------------------------------------------------------------------------------------------------------- ASSETS Marketable Securities: Fixed income (cost, $542,563 in 2001 and $534,038 in 2000) $ 555,159 $ 540,337 Equity (cost, $91,191 in 2001 and $74,983 in 2000) 148,850 152,320 ------------------------------- Total 704,009 692,657 ------------------------------- Cash 11,286 8,391 ------------------------------- Accounts Receivable--Net 88,108 70,396 ------------------------------- Reinsurance Recoverables and Prepaid Reinsurance Premiums 69,795 46,030 ------------------------------- Property, Plant and Equipment--Net 59,095 56,976 ------------------------------- Deferred Insurance Policy Acquisition Costs 100,785 91,574 ------------------------------- Other Assets 20,864 27,826 ------------------------------- Total Assets $ 1,053,942 $ 993,850 =============================== LIABILITIES AND SHAREHOLDERS' EQUITY Unearned Insurance Premiums $ 403,855 $ 357,185 ------------------------------- Insurance Loss Reserves 148,674 135,887 ------------------------------- Insurance Commissions Payable 26,887 22,181 ------------------------------- Funds Held Under Reinsurance Agreements and Reinsurance Payables 6,297 2,803 ------------------------------- Long-Term Debt 48,619 40,025 ------------------------------- Other Notes Payable: Banks 26,000 39,000 Commercial paper 9,522 6,020 ------------------------------- Total 35,522 45,020 ------------------------------- Deferred Federal Income Tax 31,803 32,938 ------------------------------- Other Payables and Accruals 60,409 74,634 ------------------------------- Commitments and Contingencies -- -- ------------------------------- Shareholders' Equity: Common stock (issued and outstanding: 8,830 shares at December 31, 2001 and 9,000 shares at December 31, 2000 after deducting treasury stock of 2,098 shares and 1,928 shares, respectively) 911 911 Additional paid-in capital 20,386 19,838 Retained earnings 264,057 239,679 Accumulated other comprehensive income 45,875 54,396 Treasury stock (at cost) (38,698) (30,404) Unvested restricted stock awards (655) (1,243) ------------------------------- Total 291,876 283,177 ------------------------------- Total Liabilities and Shareholders' Equity $ 1,053,942 $ 993,850 ===============================
See notes to consolidated financial statements. The Midland Company /23 -------------------------------------------------------------------------------- CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
THE MIDLAND COMPANY AND SUBSIDIARIES (Amounts in thousands) Years Ended December 31, 2001, 2000 and 1999 ----------------------------------------------------------------------------------------------------------------------------------- ACCUMULATED UNVESTED ADDITIONAL OTHER COMPRE- RESTRICTED COMMON PAID-IN RETAINED HENSIVE TREASURY STOCK STOCK CAPITAL EARNINGS INCOME STOCK AWARDS TOTAL ----------------------------------------------------------------------------------------------------------------------------------- BALANCE, JANUARY 1, 1999 $911 $15,947 $178,398 $70,507 $(15,293) $(1,638) $248,832 Comprehensive income: Net income 31,179 31,179 Decrease in unrealized gain on marketable securities, net of related income tax effect of $11,373 (21,119) (21,119) Total comprehensive income Purchase of treasury stock (3,709) (3,709) Issuance of treasury stock for options exercised and other employee benefit plans 315 1,985 2,300 Cash dividends declared (2,572) (2,572) Federal income tax benefit related to the exercise or granting of stock awards 940 940 Restricted stock awards 1,411 1,266 (2,677) Amortization and cancellation of unvested restricted stock awards (30) (35) 2,216 2,151 -------------------------------------------------------------------------------- BALANCE, DECEMBER 31, 1999 911 18,583 207,005 49,388 (15,786) (2,099) 258,002 Comprehensive income: Net income 35,463 35,463 Increase in unrealized gain on marketable securities, net of related income tax effect of $2,661 5,008 5,008 Total comprehensive income Purchase of treasury stock (15,432) (15,432) Issuance of treasury stock for options exercised and other employee benefit plans 109 959 1,068 Cash dividends declared (2,789) (2,789) Federal income tax benefit related to the exercise or granting of stock awards 479 479 Revaluation of stock options relating to a plan amendment 776 776 Amortization and cancellation of unvested restricted stock awards (109) (145) 856 602 -------------------------------------------------------------------------------- BALANCE, DECEMBER 31, 2000 911 19,838 239,679 54,396 (30,404) (1,243) 283,177 COMPREHENSIVE INCOME: NET INCOME 27,222 27,222 DECREASE IN UNREALIZED GAIN ON MARKETABLE SECURITIES, NET OF RELATED INCOME TAX EFFECT OF $4,860 (8,521) (8,521) TOTAL COMPREHENSIVE INCOME PURCHASE OF TREASURY STOCK (10,900) (10,900) ISSUANCE OF TREASURY STOCK FOR OPTIONS EXERCISED AND OTHER EMPLOYEE BENEFIT PLANS (292) 2,625 2,333 CASH DIVIDENDS DECLARED (2,844) (2,844) FEDERAL INCOME TAX BENEFIT RELATED TO THE EXERCISE OR GRANTING OF STOCK AWARDS 861 861 AMORTIZATION AND CANCELLATION OF UNVESTED RESTRICTED STOCK AWARDS (21) (19) 588 548 -------------------------------------------------------------------------------- BALANCE, DECEMBER 31, 2001 $911 $20,386 $264,057 $45,875 $(38,698) $(655) $291,876 ================================================================================ --------------------------------------------------------------- COMPRE- HENSIVE INCOME --------------------------------------------------------------- BALANCE, JANUARY 1, 1999 Comprehensive income: Net income $31,179 Decrease in unrealized gain on marketable securities, net of related income tax effect of $11,373 (21,119) ------- Total comprehensive income $10,060 ======= Purchase of treasury stock Issuance of treasury stock for options exercised and other employee benefit plans Cash dividends declared Federal income tax benefit related to the exercise or granting of stock awards Restricted stock awards Amortization and cancellation of unvested restricted stock awards BALANCE, DECEMBER 31, 1999 Comprehensive income: Net income $35,463 Increase in unrealized gain on marketable securities, net of related income tax effect of $2,661 5,008 ----- Total comprehensive income $40,471 ======= Purchase of treasury stock Issuance of treasury stock for options exercised and other employee benefit plans Cash dividends declared Federal income tax benefit related to the exercise or granting of stock awards Revaluation of stock options relating to a plan amendment Amortization and cancellation of unvested restricted stock awards BALANCE, DECEMBER 31, 2000 COMPREHENSIVE INCOME: NET INCOME $27,222 DECREASE IN UNREALIZED GAIN ON MARKETABLE SECURITIES, NET OF RELATED INCOME TAX EFFECT OF $4,860 (8,521) ------ TOTAL COMPREHENSIVE INCOME $18,701 ======= PURCHASE OF TREASURY STOCK ISSUANCE OF TREASURY STOCK FOR OPTIONS EXERCISED AND OTHER EMPLOYEE BENEFIT PLANS CASH DIVIDENDS DECLARED FEDERAL INCOME TAX BENEFIT RELATED TO THE EXERCISE OR GRANTING OF STOCK AWARDS AMORTIZATION AND CANCELLATION OF UNVESTED RESTRICTED STOCK AWARDS BALANCE, DECEMBER 31, 2001
See notes to consolidated financial statements 24 / The Midland Company -------------------------------------------------------------------------------- CONSOLIDATED STATEMENTS OF CASH FLOWS
THE MIDLAND COMPANY AND SUBSIDIARIES Years Ended December 31, (Amounts in thousands) 2001 2000 1999 -------------------------------------------------------------------------------------------------------------------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 27,222 $ 35,463 $ 31,179 Adjustments to reconcile to net cash provided by operating activities: Depreciation and amortization 8,324 9,151 10,287 Net gains from sale of investments (915) (4,646) (3,486) Increase in unearned insurance premiums 46,670 44,347 57,723 Increase in reinsurance recoverables and prepaid reinsurance premiums (23,765) (2,879) (9,196) Increase in net accounts receivable (17,712) (9,861) (632) Increase (decrease) in other accounts payable and accruals (13,391) 13,375 4,002 Increase in insurance loss reserves 12,787 2,174 8,217 Increase in deferred insurance policy acquisition costs (9,211) (6,406) (21,206) Decrease (increase) in other assets 6,372 (9,919) 5,402 Increase in insurance commissions payable 4,706 1,890 19 Increase in deferred federal income tax 3,526 2,105 239 Increase (decrease) in funds held under reinsurance agreements and reinsurance payables 3,494 (294) (11,527) Other--net 166 (1,626) 1,725 ------------------------------------------ Net cash provided by operating activities 48,273 72,874 72,746 ------------------------------------------ CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of marketable securities (268,283) (258,485) (207,321) Sale of marketable securities 181,999 167,923 130,296 Maturity of marketable securities 38,549 45,316 35,913 Decrease (increase) in cash equivalent marketable securities 24,091 (24,051) (9,588) Acquisition of property, plant and equipment (9,735) (3,833) (3,173) Proceeds from sale of property, plant and equipment 290 2,924 345 Net cash used in business acquisitions -- (2,471) (2,636) ------------------------------------------ Net cash used in investing activities (33,089) (72,677) (56,164) ------------------------------------------ CASH FLOWS FROM FINANCING ACTIVITIES: Purchase of treasury stock (10,900) (15,432) (3,709) Issuance of long-term debt 10,000 -- -- Increase (decrease) in net short-term borrowings (9,498) 19,470 4,028 Dividends paid (2,818) (2,747) (2,515) Issuance of treasury stock 2,333 1,068 2,300 Repayment of long-term debt (1,406) (4,263) (10,275) ------------------------------------------ Net cash used in financing activities (12,289) (1,904) (10,171) ------------------------------------------ NET INCREASE (DECREASE) IN CASH 2,895 (1,707) 6,411 CASH AT BEGINNING OF PERIOD 8,391 10,098 3,687 ------------------------------------------ CASH AT END OF PERIOD $ 11,286 $ 8,391 $ 10,098 ========================================== INTEREST PAID $ 4,178 $ 4,200 $ 4,008 INCOME TAXES PAID $ 4,000 $ 12,457 $ 11,500
See notes to consolidated financial statements. The Midland Company /25 -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS THE MIDLAND COMPANY AND SUBSIDIARIES Years Ended December 31, 2001, 2000 and 1999 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 accounting principles generally accepted in the United States of America. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to use numerous estimates and assumptions that affect the reported amounts of assets, 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 fixed income securities (cash equivalents, debt instruments and preferred stocks having scheduled redemption provisions) and equity securities (common, convertible and preferred stocks which do not have redemption provisions). The Company classifies all fixed income 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. At December 31, 2001, the market value of the Company's investment portfolio includes approximately $35.8 million of convertible securities, some of which contain embedded derivatives. The embedded derivatives are valued separately and the change in market value of the embedded derivatives is included in net realized investment gains and losses on the Consolidated Statements of Income beginning in 2001. 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 - 3 to 7 years, and barges - 20 years). Depreciation expense recorded in 2001, 2000 and 1999 was (amounts in 000's): $7,223, $7,996 and $7,890, respectively. INTANGIBLE ASSETS--Goodwill is amortized on a straight-line basis over a 10 year period. Goodwill, net of accumulated amortization, included in Other Assets at December 31, 2001 and 2000 was (amounts in 000's): $4,395 and $4,985, respectively. 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. 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 other property and casualty related coverages, net of premiums ceded to reinsurers, are recognized as income on a pro-rata basis over the lives of the policies. Credit accident and health and credit life premiums are recognized as income over the lives of the policies using the mean method and the sum-of-the- digits method, respectively. The Company generally does not consider anticipated investment income in determining premium deficiencies (if any) on short-term contracts. Policy acquisition costs, primarily commission expenses and premium taxes, are capitalized and expensed over the terms of the related policies on the same basis as the related premiums are earned. Selling and administrative expenses that 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 future losses. 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 26 / The Midland Company THE MIDLAND COMPANY AND SUBSIDIARIES exposure to significant losses 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 waterway. 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 carrying values of cash, receivables, short-term 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, including embedded derivatives, 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. 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 and its related interpretations. NEW ACCOUNTING STANDARDS--The Financial Accounting Standards Board issued Statements of Financial Accounting Standards "SFAS" Nos. 141 "Business Combinations", SFAS 142 "Goodwill and Other Intangible Assets", SFAS 143 "Accounting for Asset Retirement Obligations" and SFAS 144 "Accounting for the Impairment on Disposal of Long-Lived Assets" in 2001. SFAS 141 had no impact on the Company's consolidated financial position, results of operations or cash flows. Although the Company has not fully completed its analysis of the impact of SFAS 142, which is required to be completed by June 30, 2002, the Company does not expect SFAS 142, SFAS 143 or SFAS 144 to have a material impact on its consolidated financial position, results of operations or cash flows. On January 1, 2001, the Company adopted SFAS 133 "Accounting for Derivative Investments and Hedging Activities". The Company now accounts for the fair value of embedded derivatives separately on its Consolidated Balance Sheets. SFAS 133 did not have a material impact on the results of operations or cash flows at the time of adoption (January 1, 2001). 2. MARKETABLE SECURITIES Thousands of Dollars -------------------------------------------- Gross Unrealized ---------------------- Market 2001 Cost Gains Losses Value ---------------------------------------------------------------------------- Debt Securities: Governments $134,219 $ 5,154 $ 231 $139,142 Municipals 183,645 4,712 524 187,833 Corporates 170,429 6,327 2,842 173,914 Cash Equivalents 38,569 -- -- 38,569 Other--Notes Receivable 8,131 -- -- 8,131 Accrued Interest 7,570 -- -- 7,570 ----------------------------------------------- Total 542,563 16,193 3,597 555,159 =============================================== Equity Securities 89,483 61,193 3,534 147,142 Embedded Derivatives 1,108 -- -- 1,108 Accrued Dividends 600 -- -- 600 ----------------------------------------------- Total 91,191 61,193 3,534 148,850 ----------------------------------------------- Total Marketable Securities $633,754 $ 77,386 $ 7,131 $704,009 =============================================== Thousands of Dollars ----------------------------------------------- Gross Unrealized ---------------------- Market 2000 Cost Gains Losses Value ---------------------------------------------------------------------------- Debt Securities: Governments $150,852 $ 3,923 $ 405 $154,370 Municipals 172,824 3,639 342 176,121 Corporates 132,304 1,962 2,478 131,788 Cash Equivalents 62,737 -- -- 62,737 Other--Notes Receivable 8,016 -- -- 8,016 Accrued Interest 7,305 -- -- 7,305 ----------------------------------------------- Total 534,038 9,524 3,225 540,337 =============================================== Equity Securities 74,465 82,945 5,608 151,802 Accrued Dividends 518 -- -- 518 ----------------------------------------------- Total 74,983 82,945 5,608 152,320 ----------------------------------------------- Total Marketable Securities $609,021 $ 92,469 $ 8,833 $692,657 =============================================== At December 31, 2001 and 2000, the market value of the Company's investment in the common stock of US Bancorp, which exceeded 10% of the Company's shareholders' equity, was $51.5 million and $57.2 million, respectively. THE MIDLAND COMPANY / 27 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) THE MIDLAND COMPANY AND SUBSIDIARIES The following is investment information summarized by investment category (amounts in 000's): 2001 2000 1999 ----------------------------------------- Investment Income: Insurance: Interest on Fixed Income Securities $ 30,782 $ 28,513 $ 24,336 Dividends on Equity Securities 4,564 3,383 2,073 Investment Expense (1,544) (1,122) (1,117) ----------------------------------------- Net Insurance Investment Income 33,802 30,774 25,292 Other Investment Income 193 231 156 ----------------------------------------- Total Investment Income $ 33,995 $ 31,005 $ 25,448 ========================================= Net Realized Investment Gains: Fixed Income: Gross Realized Gains $ 2,358 $ 539 $ 404 Gross Realized Losses (1,687) (3,800) (1,956) Equity Securities: Gross Realized Gains 15,083 16,197 7,290 Gross Realized Losses (13,731) (8,290) (2,252) ----------------------------------------- Net Realized Investment Gains $ 2,023 $ 4,646 $ 3,486 ========================================= Change in Unrealized Investment Gains: Fixed Income $ 6,297 $ 15,019 $(18,167) Equity Securities (19,678) (7,350) (14,325) ----------------------------------------- Change in Unrealized Investment Gains $(13,381) $ 7,669 $(32,492) ========================================= Other Investment Income is included in Other on the Company's Consolidated Statements of Income. Included in Net Realized Investment Gains for 2001 is the change in the fair value of embedded derivative options of $1,108. The cost and approximate market value of debt securities held at December 31, 2001, 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 -------------------------- One year or less $ 50,401 $ 50,604 After one year through five years 261,415 268,470 After five years through ten years 220,274 225,061 After 10 years 10,473 11,024 -------------------------- Total $542,563 $555,159 ========================== 3. ACCOUNTS RECEIVABLE--NET Accounts receivable at December 31, 2001 and 2000 are generally due within one year and consist of the following (amounts in 000's): 2001 2000 -------------------------- Insurance $ 82,682 $ 61,143 Transportation 3,965 4,319 Other 2,287 5,760 -------------------------- Total 88,934 71,222 Less Allowance for Losses 826 826 -------------------------- Accounts Receivable--Net $ 88,108 $ 70,396 ========================== At December 31, 2001 and 2000, the Company had outstanding receivables from its largest customer, Conseco, Inc., of $20.7 million and $6.9 million, respectively. 4. PROPERTY, PLANT AND EQUIPMENT--NET At December 31, 2001 and 2000, property, plant and equipment stated at original cost consist of the following (amounts in 000's): 2001 2000 --------------------------- Land $ 1,341 $ 1,341 Buildings, Improvements, Fixtures, etc 72,051 63,339 Transportation Equipment 42,281 44,301 -------------------------- Total 115,673 108,981 Less Accumulated Depreciation and Amortization 56,578 52,005 -------------------------- Property, Plant and Equipment--Net $ 59,095 $ 56,976 ========================== Total rent expense related to the rental of equipment included in the accompanying Consolidated Statements of Income is (amounts in 000's) $6,589 in 2001, $7,219 in 2000 and $6,566 in 1999. Future rentals under non-cancelable operating leases are approximately (amounts in 000's): $2,424-2002; $1,291-2003; $849-2004; $718-2005; $718-2006 and $5,390-thereafter. The Company has committed to acquire 30 new barges over the next 15 months at an approximate total cost of $6.8 million. 28 / The Midland Company THE MIDLAND COMPANY AND SUBSIDIARIES 5. DEFERRED INSURANCE POLICY ACQUISITION COSTS Acquisition costs incurred and capitalized during 2001, 2000 and 1999 amounted to $155.0 million, $143.5 million and $135.4 million, respectively. Amortization of deferred acquisition costs was $145.8 million, $137.1 million and $114.2 million for 2001, 2000 and 1999, respectively. 6. NOTES PAYABLE TO BANKS At December 31, 2001 and 2000, the Company had conventional lines of credit with commercial banks of $48 million and $52 million, respectively. The lines of credit in use under these agreements at December 31, 2001 and 2000 amounted to $26 million and $31 million, respectively. Borrowings under these lines of credit constitute senior debt. Annual commitment fees of $71,000 are currently paid to the lending institutions to maintain these credit agreements. Additionally, at December 31, 2000, the Company had other short-term bank borrowings outstanding of $8 million. These borrowings also constitute senior debt. The aforementioned notes payable, together with outstanding commercial paper, had weighted average interest rates of 2.35% and 6.86% at December 31, 2001 and 2000, respectively. 7. LONG-TERM DEBT Long-term debt at December 31, 2001 and 2000 is summarized as follows (amounts in 000's): 2001 2000 --------------------------- Equipment Obligations, Due Through-- 6.50% October 31, 2003 $ 1,400 $ 2,100 Mortgage Notes, Due Through-- 6.83% December 20, 2005 17,219 17,925 Unsecured Notes Under a $60 million Credit Facility-- *3.26% December 1, 2005 30,000 20,000 --------------------------- Total Obligations 48,619 40,025 Current Maturities 1,456 1,406 --------------------------- Non Current Portion $ 47,163 $ 38,619 =========================== *Rate in effect on December 31, 2001. The interest rate on this borrowing is adjusted quarterly to the LIBOR rate plus a margin of 1%. The terms of this facility were amended in December, 2001. The amount of the facility was increased from $40 million to $60 million and the maturity was changed to the date indicated above. Equipment and real estate obligations are collateralized by transportation equipment and real estate with a net book value of $28,520,000 at December 31, 2001. The aggregate amount of repayment requirements on long-term debt for the five years subsequent to 2001 are (amounts in 000's): 2002-$1,456; 2003-$1,510; 2004-$865; 2005-remainder of $44,788. At December 31, 2001 and 2000, the carrying value approximated the fair value of the Company's long-term debt. 8. FEDERAL INCOME TAX The provision for federal income tax is summarized as follows (amounts in 000's): 2001 2000 1999 --------------------------------------- Current provision $ 5,956 $13,101 $12,295 Deferred provision 3,526 2,105 239 --------------------------------------- Total $ 9,482 $15,206 $12,534 ======================================= The federal income tax provision for the years ended December 31, 2001, 2000 and 1999 is different from amounts derived by applying the statutory tax rates to income before federal income tax as follows (amounts in 000's): 2001 2000 1999 --------------------------------------- Federal income tax at statutory rate $ 12,846 $ 17,734 $ 15,300 Tax effect of: Tax exempt interest and excludable dividend income (3,672) (3,397) (3,131) Excise tax on reversion of pension assets -- 529 -- Other--net 308 340 365 --------------------------------------- Provision for federal income tax $ 9,482 $ 15,206 $ 12,534 ======================================= The Midland Company /29 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) THE MIDLAND COMPANY AND SUBSIDIARIES Significant components of the Company's net deferred federal income tax liability are summarized as follows (amounts in 000's): 2001 2000 ------------------------- Deferred tax liabilities: Deferred insurance policy acquisition costs $31,923 $28,945 Unrealized gain on marketable securities 24,579 29,240 Accelerated depreciation 7,543 7,281 Other 2,376 1,284 ------------------------- Sub-total 66,421 66,750 ========================= Deferred tax assets: Unearned insurance premiums 24,519 21,467 Pension expense 1,618 3,915 Insurance loss reserves 3,326 3,125 Other 5,155 5,305 ------------------------- Sub-total 34,618 33,812 ------------------------- Deferred federal income tax $31,803 $32,938 ========================= For 2001 and 2000, $861,000 and $479,000, respectively, of income tax benefits applicable to deductible compensation related to stock options exercised were credited to shareholders' equity. 9. 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 (amount in 000's): Direct Assumed Ceded Net -------------------------------------------------------- 2001 ---- Written $472,989 $ 84,864 $(34,748) $523,105 Earned 455,253 70,428 (28,462) 497,219 2000 ---- Written $455,951 $ 47,154 $(31,769) $471,336 Earned 434,565 41,700 (30,766) 445,499 1999 ---- Written $432,263 $ 39,778 $(32,178) $439,863 Earned 409,506 38,803 (55,620) 392,689 The amounts of recoveries pertaining to reinsurance contracts that were deducted from losses incurred during 2001, 2000 and 1999 were (amounts in 000's): $16,146, $14,286 and $62,003, respectively. 10. 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): 2001 2000 1999 -------------------------------------------- Balance at January 1 $ 111,742 $ 113,439 $ 108,697 Less reinsurance recoverables 16,720 24,114 20,430 -------------------------------------------- Net balance at January 1 95,022 89,325 88,267 -------------------------------------------- Incurred related to: Current year 291,502 242,689 211,066 Prior years (4,179) (6,952) (10,178) -------------------------------------------- Total incurred 287,323 235,737 200,888 ============================================ Paid related to: Current year 226,853 186,498 159,045 Prior years 52,634 43,542 40,785 -------------------------------------------- Total paid 279,487 230,040 199,830 -------------------------------------------- Net balance at December 31 102,858 95,022 89,325 Plus reinsurance recoverables 19,309 16,720 24,114 -------------------------------------------- Balance at December 31 $ 122,167 $ 111,742 $ 113,439 ============================================ 11. BENEFIT PLANS The Company has a qualified pension plan which provides for the payment of annual benefits to participants upon retirement. Such benefits are based on years of service and the participant'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. During 2000, the participants of the qualified pension plan were given a one-time election to opt out of the qualified pension plan and enroll in a qualified self-directed defined contribution retirement plan. As a result, the Company recorded a curtailment/settlement gain of approximately $7.4 million, which is included in Other Operating and Administrative Expenses. All new employees are automatically enrolled in the qualified self-directed defined contribution retirement plan. The Company contributed $1.6 million and $1.2 million to the qualified self-directed retirement plan for the years 2001 and 2000, respectively. 30 / The Midland Company THE MIDLAND COMPANY AND SUBSIDIARIES The Company has a qualified 401(k) savings plan and a funded non-qualified savings plan. The Company contributed $876,000, $821,000 and $669,000 to the qualified 401(k) savings plan and $225,000, $293,000 and $329,000 to the non-qualified savings plan for the years 2001, 2000 and 1999, respectively. The Company also has a unfunded non-qualified defined benefit pension plan. The following tables, which include amounts related to both the qualified and non-qualified pension plans, illustrate (1)a reconciliation of the plans' benefit obligation, assets and funded status, (2)the weighted average assumptions used and (3)the components of the net periodic benefit cost (amounts in 000's except for percentages): 2001 2000 ------------------------- QUALIFIED PLAN Change in benefit obligation: Benefit obligation at beginning of year $ 15,608 $ 26,448 Service cost 591 884 Interest cost 1,216 1,853 Actuarial (gain)/loss 991 2,381 Curtailments -- (4,229) Settlements -- (11,068) Benefits paid (705) (661) ------------------------- Benefit obligation at end of year $ 17,701 $ 15,608 ========================= Change in plan assets: Fair value of plan assets at beginning of year $ 16,703 $ 32,368 Actual return on plan assets (753) (371) Employer contributions (reversion) -- (3,565) Settlements -- (11,068) Benefits paid (705) (661) ========================= Fair value of plan assets at end of year $ 15,245 $ 16,703 ------------------------- Funded status: Funded status at end of year $ (2,456) $ 1,095 Unrecognized net actuarial (gain)/loss (396) (3,384) Unrecognized prior service cost 334 358 Unrecognized net transition obligation (asset) (263) (358) ------------------------- Accrued benefit cost $ (2,781) $ (2,289) ========================= 2001 2000 NON-QUALIFIED PLAN Benefit obligation at beginning of year $ 1,078 $ 7,095 Service cost 18 88 Interest cost 13 213 Actuarial (gain)/loss (71) 1,343 Curtailments -- (1,486) Transfer of obligation to successor plan -- (6,120) Settlements (813) -- Gross benefits paid (37) (55) ------------------------- Benefit obligation at end of year (accumulated benefit obligation of $133 and $986, respectively) $ 188 $ 1,078 ========================= Funded status $ (188) $(1,078) Unrecognized actuarial (gain)/loss (40) 31 Unrecognized prior service cost 92 100 ------------------------- Accrued benefit cost $ (136) $ (947) ========================= 2001 2000 1999 -------------------------------------- QUALIFIED AND NON-QUALIFIED PLANS Weighted-average assumptions as of December 31: Discount rate 7.25% 7.75% 7.75% Expected return on plan assets 9.40% 9.00% 8.00% Rate of compensation increase 4.25% 4.25% 5.50% Components of net periodic benefit cost: Service cost $ 609 $ 972 $ 1,614 Interest cost 1,229 2,066 2,527 Expected return on assets (1,244) (2,266) (1,663) Amortization of: Transition asset (95) (113) (165) Prior service cost 32 55 114 Actuarial (gain)/loss -- (107) 133 ====================================== Net periodic benefit cost 531 607 2,560 Curtailment credit -- (4,333) -- Settlement credit (813) (3,063) -- -------------------------------------- Total net periodic benefit cost (credit) $ (282) $(6,789) $ 2,560 ====================================== The Midland Company /31 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) THE MIDLAND COMPANY AND SUBSIDIARIES 12. STOCK OPTION AND AWARD PLANS Under the Company's stock option plans, all of the outstanding stock options at December 31, 2001 were 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. 156,000 of these stock options were exercisable at December 31,2001, 64,000 options become exercisable each year in 2002 through 2004 and 27,000 options become exercisable in 2005. A summary of stock option transactions follows: 2001 2000 1999 ----------------------------------------------------- Wtd. Wtd. Wtd. Avg. Avg. Avg. (000's) Option (000's) Option (000's) Option Shares Price Shares Price Shares Price ----------------------------------------------------- Outstanding, beginning of year 383 $17.55 246 $12.49 380 $10.07 Exercised (131) 9.43 (39) 9.00 (164) 9.38 Forfeited (11) 27.70 (7) 22.75 -- -- Granted 133 33.19 183 22.75 30 26.09 --- ----- --- ----- -- ----- Outstanding, end of year 374 $25.65 383 $17.55 246 $12.49 =================================================== Exercisable, end of year 156 $22.47 229 $14.06 216 $10.60 =================================================== Fair value of options granted $11.37 $ 8.72 $ 8.64 ============================================= Information regarding such outstanding options at December 31, 2001 follows: Outstanding Remaining Options Life (000's) Price --------------------------------------------------------------- One year 15 $ 16.71 Three years 18 16.92 Five years 15 12.63 Seven years 30 26.09 Eight years 168 22.75 Nine years 128 33.19 --- Total outstanding 374 === Weighted average price $ 25.65 ========= At December 31, 2001, options exercisable have exercise prices between $12.63 and $33.19 and an average contractual life of approximately 6 years. The Company implemented a restricted stock award program during 1993. Under this program, grants of the Company's common stock will vest after a five-year 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 other rights of outstanding shares. In 1995, 147,000 shares were awarded and 124,000 shares were eventually distributed in 2000. In 1997 and 1999, 195,000 and 119,500 shares, respectively, were also awarded and 163,000 and 107,000 shares, respectively, remain outstanding at December 31,2001. The value of the awards is being charged to compensation expense over a five-year vesting period. In 2000, the Company established a performance stock award program. Under this program, shares vest after a three-year performance measurement period and will only be awarded if pre-established performance levels have been achieved. Shares are awarded at no cost and the recipient must have been employed throughout the entire three-year performance period. A maximum of 48,000 of these shares could potentially be issued each year in 2003 (for 2000) and 2004 (for 2001). The expected value of these awards is charged to compensation expense over the performance period. The Company applies APB Opinion No. 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 2001, 2000 and 1999 net income and earnings per share would have been reduced to the pro forma amounts indicated below (amounts in 000's, except per share data): 2001 2000 1999 ------------------------------------ Net Income As reported $ 27,222 $ 35,463 $ 31,179 Pro forma $ 26,707 $ 35,157 $ 31,011 Net Income per Common Share--basic As reported $ 3.15 $ 3.91 $ 3.42 Pro forma $ 3.09 $ 3.88 $ 3.40 Net Income per Common Share--diluted As reported $ 3.03 $ 3.78 $ 3.30 Pro forma $ 2.97 $ 3.75 $ 3.28 The fair values of the 2001, 2000 and 1999 option grants were estimated on the date of the grant using the Black-Scholes option-pricing model with the following (weighted average) assumptions: dividend yields of 1.3%, expected volatility of 27.6%, 27.1% and 26.6%, risk-free interest rates of 4.8%, 6.7% and 4.7% and expected lives of 7 years, respectively. At December 31, 2001, 713,000 common shares are authorized for future option award or stock grants. 32 / The Midland Company THE MIDLAND COMPANY AND SUBSIDIARIES 13. EARNINGS PER SHARE The following table is a reconciliation of the number of shares used to compute Basic and Diluted earnings per share. No adjustments are necessary to the income used in the Basic or Diluted calculations for the years ended December 31, 2001, 2000 or 1999. Shares in 000's ---------------------------------- 2001 2000 1999 ---------------------------------- Shares used in basic EPS calculation (shares outstanding) 8,641 9,066 9,111 Effect of dilutive stock options 114 114 122 Effect of dilutive restricted stock grants 192 174 230 Effect of dilutive performance stock awards 48 25 -- ---------------------------------- Shares used in diluted EPS calculation 8,995 9,379 9,463 ================================== All outstanding stock options at December 31, 2001 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. At December 31, 2000 and 1999, 30,000 stock options at a price of $26.09 were outstanding and were not comprehended in the computation of diluted earnings per share because their price was greater than the average market value of the common stock. 14. 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. The Company also has credit exposure with customers, generally in the form of premiums receivable. Management monitors these exposures on a regular basis. However, as collectibility of such receivables is dependent upon the financial stability of the customers, the Company cannot assure collections in full. Where appropriate, the Company has provided a reserve for such exposures. 15. SHAREHOLDER'S EQUITY The Company has 20,000,000 shares of common stock authorized for issuance without par value (stated value of $.083 a share). The Company also has 500,000 shares of preferred stock authorized, without par value, none of which have been issued. In January 2001, the Company's Board of Directors authorized the repurchase of up to 500,000 shares of the Company's common stock and 198,000 of these shares had been repurchased as of December 31, 2001. In October 1999, 500,000 common shares were authorized for repurchase by the Board of Directors, all of which were repurchased by the end of 2000. 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 2002 without regulatory approval total approximately $24,076,000; such subsidiaries paid cash dividends of $15,000,000 in 2001, $5,350,000 in 2000 and $5,900,000 in 1999. Net income as determined in accordance with statutory accounting practices, which differ in certain respects from accounting principles generally accepted in the United States of America, for the Company's insurance subsidiaries was $18,231,000, $30,854,000 and $21,652,000 for 2001, 2000 and 1999, respectively. Shareholders' equity on the same basis was $235,417,000 and $245,904,000 at December 31, 2001 and 2000, respectively. 16. 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, motorsport 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 includes barge chartering and freight brokerage operations primarily on the lower Mississippi River and its tributaries. The Midland Company /33 -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 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 (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, 2001, 2000 and 1999 (amounts in 000's):
Manufactured Unallocated Corporate Housing Other Insurance Trans- and All Intersegment Insurance Insurance Amounts portation Other Elimination Total ----------------------------------------------------------------------------------------------------------------------------------- 2001 ---- Revenues--External customers $ 318,298 $ 197,110 $ 34,826 $ 291 $ 550,525 Net investment income 20,562 14,042 $ 7 5 193 $ (814) 33,995 Net realized investment gains n/a n/a 2,023 2,023 Interest expense n/a n/a 2,081 260 3,580 (1,553) 4,368 Depreciation and amortization 2,274 1,409 590 2,304 1,747 8,324 Income before taxes 29,758 10,033 (1,113) 1,673 (3,647) 36,704 Income tax expense 7,548 3,006 (349) 594 (1,317) 9,482 Acquisition of fixed assets n/a n/a 9,515 12 208 9,735 Identifiable assets n/a n/a 987,149 24,952 56,670 (14,829) 1,053,942 2000 ---- Revenues--External customers $ 309,943 $ 154,961 $ 33,119 $ 748 $ 498,771 Net investment income 20,787 11,272 $ 25 231 $ (1,310) 31,005 Net realized investment gains n/a n/a 4,646 4,646 Interest expense n/a n/a 1,841 440 3,897 (2,046) 4,132 Depreciation and amortization 2,251 1,125 590 2,690 2,495 9,151 Income before taxes 37,589 15,364 (2,044) 2,793 (3,033) 50,669 Income tax expense 11,390 3,796 (392) 984 (572) 15,206 Acquisition of fixed assets and businesses n/a n/a 5,987 58 259 6,304 Identifiable assets n/a n/a 912,008 27,412 72,009 (17,579) 993,850 1999 ---- Revenues--External customers $ 283,332 $ 124,452 $ 31,327 $ 1,081 $ 440,192 Net investment income 15,526 10,631 $ 19 177 156 $ (1,061) 25,448 Net realized investment gains n/a n/a 3,486 3,486 Interest expense n/a n/a 1,406 359 3,648 (1,346) 4,067 Depreciation and amortization 2,120 931 321 2,860 4,055 10,287 Income before taxes 45,370 6,678 (1,122) 1,806 (9,019) 43,713 Income tax expense 14,219 1,169 (304) 637 (3,187) 12,534 Acquisition of fixed assets and businesses n/a n/a 5,452 84 273 5,809 Identifiable assets n/a n/a 812,791 30,564 59,140 (14,438) 888,057
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. Intersegment revenues were not significant for 2001, 2000 or 1999. In 2001, 2000 and 1999, revenues from one customer, Conseco, Inc., which exceeded 10% of consolidated revenues, amounted to $80,674,000, $77,395,000 and $64,621,000, respectively. 34 / The Midland Company -------------------------------------------------------------------------------- INDEPENDENT AUDITOR'S REPORT THE MIDLAND COMPANY AND SUBSIDIARIES [Deloitte & Touche Logo] Cincinnati, Ohio 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, 2001 and 2000, and the related consolidated statements of income, changes in shareholders' equity and cash flows for each of the three years in the period ended December 31, 2001. 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 auditing standards generally accepted in the United States of America. 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, 2001 and 2000 and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2001 in conformity with accounting principles generally accepted in the United States of America. February 7, 2002 /s/ Deloitte & Touche LLP -------------------------------------------------------------------------------- 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 accounting principles generally accepted in the United States of America. 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 control which is supplemented by a program of internal audits. Management believes that the Company's internal control is 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. The financial statements have been audited by Deloitte & Touche LLP, Certified Public Accountants, in accordance with accounting principles generally accepted in the United States of America, including sufficient tests of the accounting records to enable them to express an informed opinion as to whether the financial statements, considered in their entirety, present fairly the Company's financial position and results of operations in conformity with generally accepted accounting principles. Deloitte & Touche LLP reviews the results of its audit 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. The Midland Company /35
QUARTERLY DATA (UNAUDITED) THE MIDLAND COMPANY AND SUBSIDIARIES 2001 ------------------------------------------------------------------------------------------------- (Amounts in thousands, First Second Third Fourth except per share data) Quarter Quarter Quarter Quarter ------------------------------------------------------------------------------------------------- Revenues $ 139,982 $ 143,863 $ 147,097 $ 155,601 --------------------------- --------------------------- Net income $ 9,692 $ 6,067 $ 1,808 $ 9,655 --------------------------- --------------------------- Basic earnings per common share $ 1.11 $ .71 $ .21 $ 1.12 --------------------------- --------------------------- Diluted earnings per common share $ 1.07 $ .68 $ .20 $ 1.08 --------------------------- --------------------------- Dividends per common share $ .080 $ .080 $ .080 $ .080 --------------------------- --------------------------- Price range of common stock (Nasdaq): High $ 33.63 $ 44.50 $ 45.19 $ 48.27 --------------------------- --------------------------- Low $ 26.13 $ 30.00 $ 25.00 $ 35.41 --------------------------- --------------------------- QUARTERLY DATA (UNAUDITED) THE MIDLAND COMPANY AND SUBSIDIARIES 2000 ------------------------------------------------------------------------------------------------- (Amounts in thousands, First Second Third Fourth except per share data) Quarter Quarter Quarter Quarter ------------------------------------------------------------------------------------------------- Revenues $ 128,741 $ 132,443 $ 135,793 $ 137,445 --------------------------- --------------------------- Net income $ 9,183 $ 7,330 $ 7,925 $ 11,025 --------------------------- --------------------------- Basic earnings per common share $ 1.00 $ .80 $ .88 $ 1.23 --------------------------- --------------------------- Diluted earnings per common share $ .97 $ .78 $ .83 $ 1.20 --------------------------- --------------------------- Dividends per common share $ .075 $ .075 $ .075 $ .075 --------------------------- --------------------------- Price range of common stock (Nasdaq): High $ 23.97 $ 27.25 $ 27.44 $ 30.50 --------------------------- --------------------------- Low $ 18.50 $ 20.52 $ 24.25 $ 25.13 --------------------------- ---------------------------
-------------------------------------------------------------------------------- OTHER INFORMATION TRANSFER AGENT AND REGISTRAR INDEPENDENT AUDITORS Fifth Third Bank Deloitte & Touche LLP 38 Fountain Square, Mail Drop #10AT66-3212 250 East Fifth Street 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 11, 2002 at the Company's offices, 7000 Midland Boulevard, Amelia, Ohio 45102. MARKET FOR REGISTRANT'S COMMON STOCK The Midland Company Common Stock is traded on the NASDAQ National Market System. The symbol is MLAN. 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 2001 Annual Report to the Securities and Exchange Commission on Form 10-K may be obtained by writing to the Company - Attention: Chief Financial Officer or from the Company's website www.midlandcompany.com. FINANCIAL INFORMATION For financial information visit us on the internet at www.nasdaq.com or www.midlandcompany.com 36 / The Midland Company OFFICERS AND DIRECTORS THE MIDLAND COMPANY AND SUBSIDIARIES BOARD OF DIRECTORS JAMES E. BUSHMAN (a) (b) (c) President and Chief Executive Officer Cast-Fab Technologies, Inc. JAMES H. CAREY (a) (b) Corporate Director/Advisor MICHAEL J. CONATON (c) Formerly President and Vice Chairman of the Company JERRY A. GRUNDHOFER (d) President and Chief Executive Officer US Bancorp J. P. HAYDEN, JR. (c) Chairman of the Executive Committee of the Board, Formerly Chairman and Chief Executive Officer of the Company J. P. HAYDEN III (c) Chairman and Chief Operating Officer JOHN W. HAYDEN (c) President and Chief Executive Officer ROBERT W. HAYDEN Formerly Vice President of the Company WILLIAM T. HAYDEN (d) Partner-Katz, Teller, Brant & Hild WILLIAM J. KEATING , JR. (b) Partner-Keating, Muething & Klekamp, P.L.L. JOHN R. LABAR Formerly Vice President and Secretary of the Company DAVID B. O'MALEY (b) (d) Chairman, President and Chief Executive Officer Ohio National Financial Services JOHN M. O'MARA (a) (c) Corporate Director/Financial Consultant GLENN E. SCHEMBECHLER (a) Professor Emeritus University of Michigan FRANCIS MARIE THRAILKILL, OSU ED.D. (d) President-College of Mount St. Joseph 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 JOHN I. VON LEHMAN Executive Vice President, Chief Financial Officer and Secretary PAUL T. BRIZZOLARA Executive Vice President, Chief Legal Officer and Assistant Secretary ELISABETH E. BALDOCK Vice President-Human Resources/ Learning and Development W. TODD GRAY Treasurer MICHAEL L. FLOWERS Vice President and Assistant Secretary 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 (a) Member of Audit Committee (b) Member of Compensation Committee (c) Member of Executive Committee (d) Member of Governance Committee [MIDLAND LOGO] The Midland Company 7000 Midland Boulevard P.O. Box 1256 Cincinnati, Ohio 45201-1256 Phone (513) 943-7100 www.midlandcompany.com