10-Q 1 march10q.txt 03/31/2001 FORM 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (Mark One) [ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended March 31, 2001 -------------- or [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to Commission File Number: 0-18649 THE NATIONAL SECURITY GROUP, INC. (Exact name of registrant as specified in its charter) Delaware 63-1020300 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 661 East Davis Street, Elba, Alabama 36323 -------------------------------------- ---------- (Address of principal executive offices) (Zip code) Registrant's telephone number, including area code (334) 897-2273 -------------- Not Applicable (Former name, address, and former fiscal year, if changed since last report) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes (X) No ( ) Number of Shares of Common Stock outstanding as of May 8, 2001: 2,055,811 Exhibit index is located on page 15. Page 1 of 15 pages THE NATIONAL SECURITY GROUP, INC INDEX Page No. PART I. FINANCIAL INFORMATION Item 1. Financial Statements Consolidated Statements of Income .................................... 3 Consolidated Balance Sheets .......................................... 4 Consolidated Statements of Shareholders Equity ....................... 5 Consolidated Statements of Cash Flow ................................. 6 Notes to Financial Statements ........................................ 7 Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations .............. 10 PART II. OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K ............................ 13 SIGNATURE ............................................................ 14 EXHIBIT INDEX ........................................................ 15 2 Part I. FINANCIAL INFORMATION Item 1. Financial Statements THE NATIONAL SECURITY GROUP, INC. CONSOLIDATED UNAUDITED STATEMENTS OF INCOME (In thousands, except per share amounts) Three Months Ended March 31 2001 2000 ---- ---- Revenues Net insurance premiums earned ........................... $6,162 $5,776 Net investment income ................................... 1,048 1,055 Realized investment gains ............................... 428 949 Other income ............................................ 699 88 ------ ------ Total revenues ........................................ 8,337 7,868 ------ ------ Benefits and Expenses Policyholder benefits and settlement expenses ........... 4,601 3,763 Policy acquisition costs ................................ 1,246 1,138 General insurance expenses .............................. 1,317 1,356 Insurance taxes, licenses and fees ...................... 410 251 ------ ----- Total benefits and expense ............................ 7,574 6,508 ------ ----- Income Before Income Taxes .............................. 763 1,360 Income Taxes (Current and deferred) ..................... 212 249 ------ ------ Net Income .............................................. $ 551 $1,111 ====== ====== Earnings per share ..................................... $ 0.27 $ 0.54 ====== ====== Dividends Declared per Share .......................... $ 0.22 $ 0.21 ====== ====== The Notes to Financial Statements are an integral part of these statements. 3 THE NATIONAL SECURITY GROUP, INC. CONSOLIDATED BALANCE SHEETS (In thousands, except per share amounts)
As of As of March 31, December 31, 2001 2000 ---- ---- (Unaudited) Assets Investments: Debt Securities held-to-maturity at amortized cost (estimated fair value: 2001 - $27,754; 2000 -$29,326) . $ 27,367 $ 28,875 Debt Securities available-for-sale, at estimated fair value (cost: 2001 - $29,251; 2000 - $25,475) ............... 29,550 26,685 Equity Securities, at market (cost: 2001 --$11,389; 2000 -- $12,009) ............... 23,708 24,963 Receivable for securities sold ............................... 0 143 Mortgage loans ............................................... 146 116 Investment real estate, at cost .............................. 1,542 1,569 Policy loans ................................................. 688 692 ------ ----- Total investments ....................................... 83,001 83,043 Cash and cash equivalents .................................... 790 2,629 Accrued investment income .................................... 934 881 Reinsurance recoverable ...................................... 2,972 3,534 Deferred policy acquisition costs ............................ 4,613 4,469 Prepaid reinsurance premiums ................................. 210 293 Other assets ................................................. 2,561 2,714 ------ ----- Total assets .............................................. $ 95,081 $ 97,563 ====== ====== Liabilities Policy reserves ........................................... $ 19,987 $ 19,787 Claim reserves ............................................ 15,252 15,767 Unearned premiums ......................................... 6,521 6,364 Other policyholder funds .................................. 1,442 1,488 Notes payable ............................................. 2,335 2,401 Current income tax payable ................................ 564 336 Deferred income tax ....................................... 3,031 3,419 Other liabilities ......................................... 2,524 4,221 ------ ------ Total liabilities ...................................... $ 51,656 $ 53,783 ------ ------ Shareholders' Equity Common stock, $1 par value, 2,055,811 shares outstanding ..... 2,340 2,340 Additional paid in capital ................................ 17 17 Accumulated comprehensive income: Net unrealized appreciation on investment securities .... 9,323 9,779 Retained earnings ............................................ 35,326 35,225 Treasury stock, at cost (284,037 shares) ..................... (3,581) (3,581) -------- ------- Total shareholders' equity ................................ 43,425 43,780 -------- ------- Total liabilities and shareholder's equity ................ $ 95,081 $ 97,563 ======== ======= Shareholders' Equity per Share 21.13 21.29 ======== =======
The Notes to Financial Statements are an integral part of these statements 4 THE NATIONAL SECURITY GROUP, INC. CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (In thousands, except per share amounts)
Accumulated Other Retained Comprehensive Common Paid-in Treasury Total Earnings Income Stock Capital Stock Balance at December 31, 1999 $ 41,888 $ 33,197 $ 9,915 $ 2,340 $ 17 $ (3,581) Comprehensive Income Net Income for 2000 3,776 3,776 Other comprehensive income (net of tax) Unrealized loss on securities, net of reclassification adjustment (136) (136) -------- Total Comprehensive Income 3,640 -------- Cash dividends ($.85 per share) ( 1,748) ( 1,748) ------- ------- ------- ------ ----- ------ Balance at December 31, 2000 $ 43,780 $35,225 $ 9,779 $ 2,340 $ 17 $(3,581) Comprehensive Income Net Income three months ended 3/31/2001 551 551 Other comprehensive income (net of tax) Unrealized loss on securities, net of reclassification adjustment (456) (456) ------ Total Comprehensive Income 95 ----- Cash dividends ($.22 per share) ( 450) ( 450) ------- ------- ------- ------ ------ --------- Balance at March 31, 2001 (Unaudited) $ 43,425 $35,326 $ 9,323 $ 2,340 $ 17 $( 3,581) ======== ======= ======== ======= ===== ========
The Notes to the Financial Statements are an integral part of these statements. 5 THE NATIONAL SECURITY GROUP. INC. CONSOLIDATED UNAUDITED STATEMENTS OF CASH FLOWS (In thousands) Three Months Ended March 31 2001 2000 ----- ---- Cash Flows from Operating Activities Income from continuing operations ...................... $ 551 $ 1,111 Adjustments to reconcile income from continuing operations to net cash provided by (used in) operating activities: Accrued investment income ............................ (53) 18 Reinsurance receivables .............................. 562 (121) Deferred Policy acquisition costs .................... (144) (11) Income Taxes ......................................... (160) (249) Depreciation expense ................................. (36) 33 Policy liabilities and claims ........................ (158) (638) Other, net ...........................................(1,357) (1,563) ----- ----- Net cash used in operating activities (795) (1,420) ----- ----- Cash Flows from Investing Activities Cost of investments acquired ....................... (4,483) (3,224) Sale and maturity of investments ................... 4,071 2,512 Purchase of property and equipment ................ (68) (88) ----- ----- Net cash used in investing activities .............. (480) (800) ----- ----- Cash Flows from Financing Activities Change in other policyholder funds ................ (46) (24) Change in notes payable ........................... (66) (62) Dividends paid .................................... (452) (432) ----- ----- Net cash used in financing activities ........... (564) (518) ----- ----- Net decrease in cash and cash equivalents .............. (1,839) (2,738) Cash and cash equivalents, beginning of period ........ 2,629 3,512 ----- ----- Cash and cash equivalents, end of period .............. $ 790 $ 774 ====== ===== The Notes to the Financial Statements are an integral part of these statements. 6 THE NATIONAL SECURITY GROUP, INC. NOTES TO FINANCIAL STATEMENTS NOTE 1-Basis of Presentation The consolidated unaudited financial statements have been prepared in conformity with generally accepted accounting principles. The interim financial statements include all adjustments necessary, in the opinion of management, for fair statement of financial position, results of operations and cash flows for the periods reported. These adjustments are all normal recurring adjustments. A summary of the more significant accounting policies are set forth in the notes to the audited consolidated financial statements for the year ended December 31, 2000. The accompanying consolidated unaudited financial statements include the accounts of The National Security Group, Inc. (the Company) and its wholly owned subsidiaries: National Security Insurance Company (NSIC), National Security Fire and Casualty Company (NSFC) and Natsco, Inc. (Natsco). NSFC includes a wholly owned subsidiary, Omega One Insurance Company, and Liberty Southern Insurance Company, which is wholly owned by Omega. Note 2-Reinsurance National Security Fire and Casualty Company ("NSFC"), Omega One Insurance Company ("OMEGA"), and National Security Insurance Company ("NSIC") wholly owned subsidiaries of the Company, reinsure certain portions of insurance risk, which exceed various retention limits. NSFC, OMEGA, and NSIC are liable for these amounts in the event assuming companies are unable to meet their obligations. Note 3-Calculation of Earnings Per Share Earnings per share were based on net income divided by the weighted average common shares outstanding. The weighted average number of shares outstanding for the period ending March 31, 2001 was 2,056,000 and for the period ending March 31, 2000 was 2,056,000. Note 4-Changes in Shareholder's Equity (in thousands) During the three months ended March 31, 2001 and 2000, there were no changes in shareholders' equity except for net income of $551 and $1,111 respectively; dividends paid of $452 and $432 respectively; and unrealized investment losses, net of applicable taxes, of $(456) and $(668) respectively. Note 5 - Deferred Taxes The tax effect of significant temporary differences representing deferred tax assets and liabilities are as follows: (in thousands) March 31, January 1, 2001 2001 ------ ------- Deferred policy acquisition costs (1,568) (1,519) Policy liabilities 401 419 Unearned premiums 429 383 Claims liabilities 418 432 General insurance expenses 678 694 Alternative minimum tax credit carry forward 244 67 Unrealized gains on securities available-for-sale (3,633) (3,895) ------ ------ Net deferred tax liability (3,031) (3,419) ======= ======= Deferred taxes are determined based on the estimated future tax effects of differences between the financial statement and tax bases of assets and liabilities given the provisions of the enacted tax laws. 7 THE NATIONAL SECURITY GROUP, INC. NOTES TO FINANCIAL STATEMENTS (Continued) Note 6-Contingencies The Company and its subsidiaries continue to be named as parties to litigation related to the conduct of their insurance operations. These suits involve alleged breaches of contracts, torts, including bad faith and fraud claims based on alleged wrongful or fraudulent acts of agents of the Company's subsidiaries, and miscellaneous other causes of action. Most of these lawsuits include claims for punitive damages in addition to other specified relief. In recently filed actions, NSIC is named as a defendant in purported class actions relating to the past sale of industrial burial insurance. The actions address whether the premiums charged were "excessive" relative to the benefit provided and whether the premiums charged were in any manner discriminatory relative to the race of the person insured. These actions are in the initial phases and no discovery has been undertaken and no class has been certified. The issues raised in these actions are similar to the issues pending in numerous other actions currently pending nationwide against numerous insurers. While NSIC did at one time sell industrial burial insurance, no such plans have been sold for several decades. The company establishes and maintains reserves on contingent liabilities. In many instances, however, it is not feasible to predict the ultimate outcome with any degree of accuracy. While a resolution of these matters may significantly impact consolidated earnings and the Company's consolidated financial position, it remains management's opinion, based on information presently available, that the ultimate resolution of these matters will not have a material impact on the Company's consolidated financial position. However, it should be noted that instances of class action lawsuits against insurance companies appear to be increasing in several states in which insurance subsidiaries of the company operate. The Company and its subsidiaries continue to be named as parties to litigation related to the conduct of their insurance operations. These suits involve alleged breaches of contracts, torts, including bad faith and fraud claims based on alleged wrongful or fraudulent acts of agents of the Company's subsidiaries, and miscellaneous other causes of action. Most of these lawsuits include claims for punitive damages in addition to other specified relief. Note 7-Accounting for certain investments in debt and equity securities The Company's investment securities are classified in two categories and accounted for as follows: Securities Held-to-Maturity - Bonds, notes and redeemable preferred stock for which the Company has the positive intent and ability to hold to maturity are reported at cost, adjusted for amoritization of premiums and accretion of discounts which are recognized in interest using methods which approximate level yields over the period to maturity. Securities Available-for-Sale - Bonds, notes, common stock and non-redeemable preferred stock not classified as either held-to-maturity, or trading are reported at fair value, adjusted for other-than-temporary declines in fair value. The Company and its subsidiaries have no trading securities. 8 THE NATIONAL SECURITY GROUP, INC. NOTES TO FINANCIAL STATEMENTS (Continued) Unrealized holding gains and losses, net of tax, on securities available-for-sale are reported as a net amount in a separate component of shareholders' equity until realized. Realized gains and losses on the sale of securities available-for-sale are determined using the specific identification method. Mortgage loans and policy loans are stated at the unpaid principle balance of such loans. Investment real estate is reported at cost, less allowances for depreciation computed on the straight-line basis. Short-term investments are carried at cost, which approximate market value. Investments with other than temporary impairments in value are written down to estimated realizable values. 9 Item 2. MANAGEMENTS' DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS INTRODUCTION The following discussion addresses the financial condition of The National Security Group, Inc. as of March 31, 2001, compared with December 31, 2000 and its results of operations and cash flows for the quarter ending March 31, 2001, compared with the same period last year. The reader is assumed to have access to the Company's 2000 Annual Report. This discussion should be read in conjunction with the Annual Report and with consolidated financial statements on pages 3 through 6 of this form 10-Q. Information is presented in whole dollars. CONSOLIDATED RESULTS OF OPERATIONS ---------------------------------- Premium revenues: Premium revenue in the life insurance subsidiary, National Security Insurance Company (NSIC), accounts for 20% of total premium income of the Company. Life insurance premium revenue was up 16.5% compared to the first three months of 2000. Life insurance sales through independent agents are the primary area of increased premium production for NSIC. Insurance sales in NSIC's traditional home service market, which is sold through employee agents, are down about 3.5% compared to last year. Premium revenue in the property/casualty insurance subsidiaries, National Security Fire & Casualty Company (NSFC) and Omega One Insurance Company (Omega), is up 4.6% over last year. The homeowners and private passenger auto insurance lines of business are the areas of growth in the property/casualty insurance subsidiaries. Total premium revenue is up 6.7% over the first quarter of last year. Management will continue to explore ways to enhance and improve existing marketing and product distribution methods in order to continue to increase premium revenue. Net investment income: Net investment income is virtually unchanged compared to last year. Realized capital gains and losses: Realized capital gains are generated primarily by the sale of common stock investments from the insurance subsidiaries investment portfolio. The Company's investment committee will sell positions in the portfolio when market conditions warrant, producing realized capital gains and/or losses. This periodic selling of securities can produce significant fluctuations in realized capital gains from period to period. Realized capital gains are down $521,000 from last year. Other income: Other income is up significantly for the quarter due to a one-time gain on a recovery from a third party of $580,000 in connection with a previously settled lawsuit in an insurance subsidiary. Policyholder benefits and settlement expenses: 10 Policyholder benefits and settlement expenses as a percent of earned premium increased significantly compared to last year, 74.7% versus 65.1%, an increase of $838,000 compared to last year. The property/casualty subsidiaries incurred numerous tornado and windstorm related losses in the first quarter of 2001. Insured losses from a single storm on February 16, 2001 totaled over $400,000. Policy acquisition costs: Policy acquisition costs are up $108,000 compared to last year, and increase of 9.5%. An increase in sales of both life and property/casualty insurance, which produced an increase in agents commission expense, contributed to the increase. General insurance expenses: General insurance expenses are down marginally for the quarter. However, general insurance expenses for the year are expected to increase approximately 5 to 10% compared to last year as the company makes improvements to working facilities, including the corporate headquarters and existing computer systems. Insurance taxes, licenses, and fees: Insurance taxes, licenses and fees are up due to an increase in written premium. Summary: The Company has a year to date net income of $551,000 versus net income of $1.1 million in 2000. The primary reason for the decrease in earnings compared to last year is a $521,000 decrease in realized capital gains and an increase in property/casualty subsidiary related storm losses. Investments: Investments at March 31, 2001 are down $42,000 to December 31, 2000, virtually unchanged. Capital resources: At March 31, 2001, the Company had aggregate equity capital, unrealized investment gains (net of income taxes) and retained earnings of $43.4 million, down $355,000 compared to December 31, 2000. The decrease reflects net income of $551,000, a decrease in accumulated unrealized investment gains of $456,000, and dividends paid of $452,000. The Company has $2.3 million in notes from local banks which management intends to repay in full over the next three years. Liquidity: The liquidity requirements of the Company are primarily met by funds provided from operations of the life insurance and property/casualty subsidiaries. Premium and investment income, as well as maturities, calls, and sales of invested assets, provide the primary sources of cash for both subsidiaries. Cash is used by subsidiaries for payments of policy benefits, the acquisition of new business (principally commissions), operating expenses, and purchases of new investments. 11 The Company had $790,000 in cash and cash equivalents at March 31, 2001. Net cash used in operating activities was $795,000 for the current period, compared to net cash used of $1,420,000 for the period ended March 31, 2000. Cash used in investing activities was $480,000. Cash dividends paid to stockholders' of $452,000 and payments on notes payable of $66,000 were the primary uses of cash used in financing activities. 12 Part II. OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K See Exhibit Index SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed by the undersigned duly authorized officer, on its behalf and in the capacity indicated. The National Security Group, Inc. By /s/ M.L. Murdock ------------------ M.L. Murdock Senior Vice President and Chief Financial Officer Dated: May 15, 2001 14 EXHIBIT INDEX Exhibit Description Page (a)11 Statement Regarding Computation of Per Share Earnings Filed Herewith; See Note 3 to Financial (b) Form 8-K Incorporated by reference to the Registrant's Current Report on Form 8-K filed on April 20, 2001. 15