Item 2. Properties
The offices of PHH Vehicle Management Services North American operations are located throughout the US and Canada. Primary office facilities are located in a six-story, 200,000 square foot office building in Hunt Valley, Maryland, leased until September 2003; and offices in Mississauga, Canada, having 59,400 square feet, leased until February 2003.
The offices of HFS Mobility Services North American operations are located throughout the US and Canada. Two primary office facilities are both located in Danbury, Connecticut, one having 92,600 square feet, leased until January 2000 and the other having 30,000 square feet, leased until November 1998. The Company is currently evaluating proposals to consolidate the operations of HFS Mobility Services.
The offices of PHH Mortgage Services are located primarily in a 127,000 square foot building in Mount Laurel, New Jersey, which is owned by the Company.
The offices of Vehicle Management Services and HFS Mobility Services operations located in the United Kingdom and Europe are as follows: a 129,000 square foot building which is owned by the Company located in Swindon, United Kingdom; and field offices having 35,400 square feet located in Swindon and Manchester, United Kingdom; Munich, Germany; and Dublin, Ireland, are leased for various terms to February 2016.
The Company considers that its properties are generally in good condition and well maintained and are generally suitable and adequate to carry on the Company's business.
Item 3.
Item 3. Legal Proceedings
The Company is party to various litigation arising in the ordinary course of business and is plaintiff in several collection matters which are not considered material either individually or in the aggregate.
Item 4.
Item 4. Results of Votes of Security Holders
Not Applicable
PART II
Item 5.
Item 5. Market for the Registrant's Common Stock and Related Security Holder Matters
Prior to the Merger, the Company's common stock was publicly traded on the New York Stock Exchange under the symbol "PHH." The common stock was entitled to dividends when and as declared by the Board of Directors. The dividends and high and low prices for each quarter during the eight-month period ended December 31, 1996 and during the fiscal years ended April 30, 1996 and 1995 were as follows:
Dividend Price Paid High Low -------- ----------------- Eight-month period ended December 31, 1996 First quarter $.19 $28 7/8 $25 5/8 Second quarter $.19 $31 7/8 $26 Two-month period ended December 31, 1996 - $47 7/8 $29 7/8
Fiscal Year 1996 First quarter $.17 $23 3/4 $19 5/8 Second quarter $.17 $23 3/8 $21 Third quarter $.17 $25 3/4 $21 7/8 Fourth quarter $.17 $28 3/8 $24 1/2
Fiscal Year 1995 First quarter $.16 $19 3/8 $17 1/2 Second quarter $.16 $19 $17 3/8 Third quarter $.16 $19 $16 3/4 Fourth quarter $.16 $20 1/4 $17 5/8
In June 1996 the Board of Directors authorized a two-for-one common stock split which was effected in the form of a 100% stock dividend in July 1996. All share, per share and stock price information in this report reflect the two-for-one common stock split.
Item 6.
Item 6. Selected Financial Data
Not Applicable
Item 7.
Item 7. Management's Narrative Analysis of Results of Operations
MERGER WITH HFS INCORPORATED
Pursuant to a merger agreement (the "Merger Agreement") by and among PHH Corporation (the"Company"), HFS Incorporated ("HFS") and Mercury Acquisition Corp. ("Mercury"), a wholly owned subsidiary of HFS, effective April 30, 1997, Mercury was merged into the Company, with the Company being the surviving corporation, and the Company became a wholly owned subsidiary of HFS (the "Merger"). In connection with the Merger, all outstanding shares of the Company's common stock, including shares issued to holders of the Company's employee stock options, were converted into approximately 30.3 million shares of HFS common stock.
In connection with the Merger, the Company's fiscal year was changed from a year ending on April 30, to a year ending December 31. As a result, the transition period financial statements cover the period from May 1, 1996 to December 31, 1996. Accordingly, this discussion covers the transition period compared to the same period in the previous year unless otherwise stated.
RESULTS OF OPERATIONS
This discussion should be read in conjunction with the information contained in the Consolidated Financial Statements and accompanying Notes thereto of the Company appearing elsewhere in this Form 10-K. Unaudited comparable period data is included in the Notes to the Consolidated Financial Statements.
Eight-month Period Ended December 31, 1996 Compared to the Eight-month Period Ended December 31, 1995:
Consolidated net income and net income per share for the eight-month period ended December 31, 1996 increased 12 percent to $55.1 million and 9 percent to $1.53, respectively. The increase for the period was due to an improvement in the vehicle management services segment offset by declines in mortgage banking services and real estate services segments.
Consolidated revenues increased 5 percent to $1.28 billion for the eight-month period ended December 31, 1996. Vehicle management services revenues increased 2 percent to $918.1 million for the same period, primarily from increased leasing revenues as a result of an increased number of and average carrying amount of leased vehicles, partially offset by a decrease in other vehicle revenues primarily due to a decrease in gains on the sale of used vehicles. Real estate services revenues decreased 2 percent to $198.3 million primarily as a result of a decrease in transferee homes sold, partially offset by an increase in revenue due to an increase in the number of fee-based transactions. Mortgage banking revenue increased 40 percent to $167.6 million. The increase was primarily due to an increase in loans closed and to servicing revenues generated from a 23 percent growth in the servicing portfolio from $20.1 billion at December 31, 1995 to $24.8 billion at December 31, 1996.
Consolidated expenses increased 5 percent to $1.19 billion for the eight-month period ended December 31, 1996. Increased depreciation on vehicles under operating leases are primarily due to increases in leased vehicles as discussed above. Costs, including interest, of carrying and reselling homes decreased 14 percent, primarily as a result of the effects of the decrease in homes sold as discussed above. Direct costs of mortgage banking services increased 86 percent to $76.1 million, primarily due to an increase in amortization of servicing rights and fees and costs associated with the increase in the loan portfolio. Interest expense increased 3 percent compared with the same period in the prior year. The effects of increases in liabilities under management programs and other debt were partially offset by the effect of lower interest rates.
Selling, general, and administrative costs increased 4 percent for the eight-month period ended December 31, 1996 compared with the same period in the prior year. Increases in personnel and other operating costs to support the growth in real estate services fee-based transactions and mortgage production and increased US relocation systems costs, were partially offset by decreases in vehicle management services costs as a result of effective cost management, reduction in system spending, reduction in vehicles acquired and by the decrease in the North American truck fuel management subsidiary (NTS, Inc.) expenses as this operation was sold in February 1996.
The Company's effective tax rate was 40.8 percent for the eight-month period ended December 31, 1996 as compared to 41.6 percent for the same period a year ago.
LIQUIDITY AND CAPITAL RESOURCES
The Company manages its funding sources to ensure adequate liquidity. The sources of liquidity fall into three general areas: ongoing liquidation of assets under management, global capital markets, and committed credit agreements with various high-quality domestic and international banks. In the ordinary course of business, the liquidation of assets under management programs, as well as cash flows generated from operating activities, provide the cash flow necessary for the repayment of existing liabilities. For the eight-month period ended December 31, 1996 cash provided by operating activities totaled $300.5 million primarily due to depreciation on vehicles under operating leases, offset by an increase in mortgage loans held for sale at December 31. 1996. Cash used in investing activities totaled $1.0 billion primarily as a result of the growth in investment in leases and leased vehicles under management.
Using historical information, the Company projects the time period that a client's vehicle will be in service or the length of time that a home will be held in inventory before being sold on behalf of a client. Once the relevant asset characteristics are projected, the Company generally matches the projected dollar amount, interest rate and maturity characteristics of the assets within the overall funding program. This is accomplished through stated debt terms or effectively modifying such terms through other instruments, primarily interest rate swap agreements and revolving credit agreements. (See Liabilities Under Management Programs in Notes to Consolidated Financial Statements.) Within mortgage banking services, the Company funds the mortgage loans on a short-term basis until sale to unrelated investors, which generally occurs within sixty days. Interest rate risk on mortgages originated for sale is managed through the use of forward delivery contracts, financial futures and options.
The Company has maintained broad access to global capital markets by maintaining the quality of its assets under management. This is achieved by establishing credit standards to minimize credit risk and the potential for losses. Depending upon asset growth and financial market conditions, the Company utilizes the United States, Euro and Canadian commercial paper markets, as well as other cost-effective short-term instruments. In addition, the Company utilizes public and private debt markets to issue unsecured senior corporate debt. Augmenting these sources, the Company has reduced outstanding debt by the sale or transfer of managed assets to third parties while retaining fee-related servicing responsibility. The Company's aggregate commercial paper outstanding totaled $3.1 billion at December 31, 1996. At December 31, 1996, $1.7 billion in medium-term notes and $337 million in other debt securities were outstanding.
Cash provided by financing activities was $727.3 million for the eight-month period ended December 31, 1996 largely due to an increase in borrowings with terms of less than 90 days due to increase in mortgage loans held for sale as discussed above. From a risk management standpoint, borrowings not in the local currency of the business unit are converted to the local currency through the use of foreign currency forward contracts. The Company maintains a leverage ratio between 7 to 1 and 8 to 1.
To provide additional financial flexibility, the Company's current policy is to ensure that minimum committed bank facilities aggregate 80 percent of the average amount of outstanding commercial paper. The Company has a $2.5 billion syndicated unsecured credit facility. The facility is backed by 22 domestic and foreign banks and is comprised of $1.25 billion of lines maturing in 364 days and $1.25 billion maturing in five years. In addition, the Company has approximately $300 million of uncommitted lines of credit with various financial institutions. Management closely evaluates not only the credit quality of the banks but the terms of the various agreements to ensure ongoing availability. The full amount of the Company's committed facilities at December 31, 1996, was undrawn and available. Management believes that its current policy provides adequate protection should volatility in the financial markets limit the Company's access to commercial paper or medium-term note funding.
Management believes that these established means of effectively matching floating and fixed interest rate and maturity characteristics of funding to related assets, the variety of short- and long-term domestic and international funding sources, and the committed banking facilities minimize the Company's exposure to interest rate and liquidity risk.
IMPACT OF NEW ACCOUNTING PRONOUNCEMENTS
In 1996, the FASB issued SFAS No. 125 "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities." The statement provides accounting and reporting standards for transfers and servicing of financial assets and, among other things, SFAS No. 125 also requires that previously recognized servicing receivables that exceed contractually specified servicing fees shall be reclassified as interest-only strips receivable, and subsequently measured under the provisions of SFAS No. 115 "Accounting for Certain Investments in Debt and Equity Securities." The Company will adopt the provisions of SFAS No. 125 on January 1, 1997 and will reclassify a portion of its excess servicing fees to interest-only strips. The effect of adopting SFAS No. 125 is not expected to be material to the Company's operations or financial condition.
Item 8.
Item 8. Financial Statements and Supplementary Data
See Financial Statement and Financial Statement Schedule Index commencing on page hereof.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
(a) As reported in the Company's Report on Form 8-K filed on May 14, 1997, the Board of Directors of the Company engaged the accounting firm of Deloitte and Touche LLP, as independent accountants for the Company, effective as of May 12, 1997 and, accordingly, dismissed KPMG Peat Marwick LLP in such capacity effective with the completion of their report on the financial statements of PHH Corporation included in this transition report on Form 10-K for the period ended December 31, 1996.
(b) During the eight-month transition period ended December 31, 1996 and the two most recent fiscal years ended April 30, 1996 and 1995, and the subsequent interim period through May 12, 1997, there have been no disagreements with KPMG Peat Marwick LLP on any matter of accounting principles or practices, financial statement disclosure or auditing scope or procedure or any reportable events.
(c) The reports of KPMG Peat Marwick LLP on the financial statements for the transition period and past the two fiscal years contained no adverse opinion or disclaimer of opinion and were not qualified or modified as to uncertainty, audit scope or accounting principles.
PART III
Item 10.
Item 10. Directors and Executive Officers of the Registrant
Not applicable.
Item 11.
Item 11. Executive Compensation
Not applicable.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management
Not applicable.
Item 13.
Item 13. Certain Relationships and Related Transactions
Not applicable.
PART IV
Item 14.
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
Item 14(a)(1) Financial Statements
See Index to Financial Statements and Financial Statement Schedules
Item 14(a)(2) Financial Statement Schedules
See Index to Financial Statements and Financial Statement Schedules
Item 14(a)(3) Exhibits
The exhibits identified by an asterisk (*) are on file with the Commission and such exhibits are incorporated by reference from the respective previous filings. The exhibits identified by a double asterisk (**) are being filed with this report.
Exhibit No.
2-1 Agreement and Plan of Merger dated as of November 10, 1996, by and among HFS Incorporated, PHH Corporation and Mercury Acquisition Corp., filed as Annex I in the Joint Proxy Statement/Prospectus included as part of Registration No. 333-24031(*).
3-1 Charter of PHH Corporation, as amended August 23, 1996(**).
3-2 By-Laws of PHH Corporation, as amended October 1990(*).
4-1 Indenture between the Company and Bank of New York, Trustee, dated as of May 1, 1992, filed as Exhibit 4(a)(iii) to Registration Statement 33-48125(*).
4-2 Indenture between the Company and First National Bank of Chicago, Trustee, dated as of March 1, 1993, filed as Exhibit 4(a)(i) to Registration Statement 33-59376(*).
4-3 Indenture between the Company and First National Bank of Chicago, Trustee, Dated as of June 5, 1997(**).
4-4 Indenture between the Company and the Bank of New York, Trustee Dated as of June 5, 1997,(**).
4-5 364-Day Credit Agreement Among the Company, PHH Vehicle Management Services, Inc., the Lenders, the Chase Manhattan Bank, as Administrative Agent and the Chase Manhattan Bank of Canada, as Canadian Agent, Dated March 4, 1997, filed as Exhibit 10.1 to Registration Statement 333-27715(*).
4-6 Five-year Credit Agreement among the Company, the Lenders, and Chase Manhattan Bank, as Administrative Agent, dated March 4, 1997 filed as Exhibit 10.2 to Registration Statement 333-27715(*).
10-17 Distribution Agreement between the Company and Credit Suisse; First Boston Corporation; Goldman Sachs & Co. and Merrill Lynch & Co., dated June 5, 1997(**).
11 Schedule containing information used in the computation of net income per share(**).
12 Schedule containing information used in the computation of the ratio of earnings to fixed charges(**).
23 Consent of KPMG Peat Marwick LLP(**).
27 Financial Data Schedule (filed electronically only)(**).
The registrant hereby agrees to furnish to the Commission upon request a copy of all constituent instruments defining the rights of holders of long-term debt of the registrant and all its subsidiaries for which consolidated or unconsolidated financial statements are required to be filed under which instruments the total amount of securities authorized does not exceed 10% of the total assets of the registrant and its subsidiaries on a consolidated basis.
(b) Reports on Form 8-K
There was one report on Form 8-K filed during the two-month period ended December 31, 1996 as follows:
The Company filed a Current Report on Form 8-K on November 15, 1996, describing that the Company entered into an Agreement and Plan of Merger (the "Merger Agreement") with HFS Incorporated ("HFS"), and Mercury Acquisition Corp., a wholly-owned subsidiary of HFS.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
PHH CORPORATION
By /s/ Robert D. Kunich Robert D. Kunisch Chief Executive Officer and President July 29, 1997
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated:
Principal Executive Officer:
/s/ Robert D. Kunisch July 29, 1997 Robert D. Kunisch Chief Executive Officer and President
Principal Financial Officer:
/s/ Michael P. Monaco July 29, 1997 Michael P. Monaco Executive Vice President, Chief Financial Officer and Assistant Treasurer
Principal Accounting Officer:
/s/ Nan A. Kreamer July 29, 1997 Nan A. Kreamer Corporate Controller
Board of Directors:
/s/ James E. Buckman July 29, 1997 James E. Buckman Director
/s/ Stephen P. Holmes July 29, 1997 Stephen P. Holmes Director
and Financial Statement Schedules
Consolidated Financial Statements of the Company:
Independent Auditors' Report
Consolidated Statement of Income for the eight-month period ended December 31, 1996. Consolidated Balance Sheet at December 31, 1996. Consolidated Statement of Cash Flows for the eight-month period ended December 31, 1996. Consolidated Statement of Stockholders' Equity for the eight-month period ended December 31, 1996. Notes to Consolidated Financial Statements
Financial Statement Schedule:
Schedule II--Valuation and Qualifying Accounts
INDEPENDENT AUDITORS' REPORT
The Stockholders and Board of Directors PHH Corporation:
We have audited the consolidated financial statements of PHH Corporation and subsidiaries as listed in the accompanying index on page. In connection with our audit of the consolidated financial statements, we have also audited the financial statement schedule as listed in the accompanying index. These consolidated financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and schedule based on our audit.
We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of PHH Corporation and subsidiaries at December 31, 1996, and the results of their operations and their cash flows for the eight-month period ended December 31, 1996, in conformity with generally accepted accounting principles. Also in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
/s/ KPMG Peat Marwick LLP KPMG Peat Marwick LLP Baltimore, Maryland April 30, 1997
PHH CORPORATION AND SUBSIDIARIES Consolidated Statement of Income For the eight-month period ended December 31, 1996
(In thousands except per share data) - -------------------------------------------------------------------------------- Revenues: Vehicle management services ................................... $ 918,088 Real estate services .......................................... 198,324 Mortgage banking services ..................................... 167,581 ---------- 1,283,993 ---------- Expenses: Depreciation on vehicles under operating leases ............... 645,143 Costs, including interest, of carrying and reselling homes .... 98,934 Direct costs of mortgage banking services ..................... 76,100 Interest ...................................................... 151,129 Selling, general and administrative .......................... 219,599 ---------- 1,190,905 ---------- Income before income taxes ........................................ 93,088 Income taxes ...................................................... 37,981 ---------- Net income ........................................................ $ 55,107 ---------- Net income per share ............................................... $ 1.53 ----------
See Notes to Consolidated Financial Statements
PHH CORPORATION AND SUBSIDIARIES Consolidated Balance Sheet December 31, 1996 (Dollars in thousands) - -------------------------------------------------------------------------------- Assets: Cash ............................................................. $ 13,779 Restricted cash .................................................. 89,849 Accounts receivable, less allowance for doubtful accounts of $6,319 ............. 540,569 Carrying costs on homes under management ......................... 49,000 Mortgage loans held for sale ..................................... 1,248,299 Mortgage servicing rights and fees ............................... 288,943 Property and equipment, net ...................................... 92,145 Goodwill, net .................................................... 47,279 Other assets .................................................... 138,453 ----------- 2,508,316 ----------- Assets Under Management Programs: Net investment in leases and leased vehicles ................. 3,418,666 Equity advances on homes ....................................... 647,664 ----------- 4,066,330 ----------- $6,574,646 -----------
Liabilities: Accounts payable and accrued expenses ...............................$ 460,294 Advances from clients and deferred revenue .......................... 116,649 Other debt .......................................................... 1,185,647 Deferred income taxes ............................................. 237,200 ----------- 1,999,790 -----------
Liabilities Under Management Programs ............................. 3,904,296 ----------- Commitments and Contingencies
Stockholders' Equity: Preferred stock, authorized 3,000,000 shares ................. -- Common stock, no par value, authorized 75,000,000 shares; issued and outstanding shares of 34,956,835 ............... 101,155 Cumulative foreign currency translation adjustment .......... (8,364) Retained earnings ................................................ 577,769 ----------- 670,560 ----------- $ 6,574,646 -----------
See Notes to Consolidated Financial Statements.
PHH CORPORATION AND SUBSIDIARIES Consolidated Statement of Cash Flows For the eight-month period ended December 31, 1996
(In thousands) - -------------------------------------------------------------------------------- Operating Activities: Net income .................................................. $ 55,107 Adjustments to reconcile net income to cash provided by operating activities: Depreciation on vehicles under operating leases .......... 645,143 Other depreciation and amortization ...................... 22,650 Amortization and write-down of servicing rights and fees . 35,272 Additions to originated mortgage servicing rights ........ (56,583) Additions to excess mortgage servicing fees .............. (38,277) Gain on sales of mortgage servicing rights ............... (1,449) Deferred income taxes .................................... 28,700 Gain on sale of subsidiary ............................... (2,944) Changes in: Accounts receivable .................................... (64,128) Carrying costs on homes under management ............... (2,083) Mortgage loans held for sale ........................... (373,505) Accounts payable and accrued expenses .................. 23,911 Advances from clients and deferred revenue ............. 19,294 All other operating activity ........................... 9,417 ----------- Cash provided by operating activities ....................... 300,525 ----------- Investing Activities: Investment in leases and leased vehicles .................... (1,207,150) Repayment of investment in leases and leased vehicles ....... 392,758 Equity advances on homes under management ................... (2,220,660) Repayment of advances on homes under management ............. 2,138,595 Proceeds from sales of mortgage servicing rights ............ 2,303 Additions to property and equipment ......................... (16,950) Proceeds from sale of subsidiary ............................ 4,400 Funding of grantor trusts ................................... (89,849) All other investing activities .............................. (2,678) ----------- Cash used in investing activities ............................ (999,231) ----------- Financing Activities: Net change in borrowings with terms of less than 90 days ..... 875,775 Proceeds from issuance of other borrowings .................. 1,243,241 Principal payment on other borrowings ....................... (1,383,565) Stock option plan transactions .............................. 5,074 Payment of dividends ........................................ (13,236) ----------- Cash provided by financing activities ....................... 727,289 -----------
Effect of exchange rate changes on cash ......................... (24,092) -----------
Increase in cash ................................................ 4,491 Cash at beginning of period ..................................... 9,288 ----------- Cash at end of period ........................................... $ 13,779 -----------
See Notes to Consolidated Financial Statements
PHH CORPORATION AND SUBSIDIARIES Consolidated Statement of Stockholders' Equity For the eight-month period ended December 31, 1996
See Notes to Consolidated Financial Statements.
PHH CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements
(In thousands except per share data)
Merger with HFS Incorporated Pursuant to a merger agreement (the "Merger Agreement") by and among PHH Corporation (the "Company"), HFS Incorporated ("HFS") and Mercury Acquisition Corp. ("Mercury"), a wholly owned subsidiary of HFS, effective April 30, 1997, Mercury was merged into the Company, with the Company being the surviving corporation, and the Company became a wholly owned subsidiary of HFS (the "Merger"). In connection with the Merger, all outstanding shares of the Company's common stock, including shares issued to holders of the Company's employee stock options, were converted into approximately 30.3 million shares of HFS common stock. Pursuant to the Merger Agreement, the number of HFS shares issued to complete the Merger was determined by multiplying the outstanding shares of the Company as of April 30, 1997 by the conversion number of 0.825, calculated in accordance with the terms of the Merger Agreement plus 0.7 million shares of HFS common stock issued in exchange for outstanding options to purchase shares of the Company's common stock. The 30.3 million shares of HFS common stock issued to shareholders and option holders of the company represent 19.2% of the total outstanding shares of HFS at April 30, 1997.
Under the change in control provisions of certain grantor trusts established in connection with the Company's Senior Executive Severance Plan, Supplemental Executive Retirement Plan and the PHH Excess Benefits Plan, the Company was required to fund the trusts for the present value of amounts expected to be paid under the Plans. At December 31, 1996, the funded amounts of the grantor trusts are shown as restricted cash in the Consolidated Balance Sheets.
Change in Fiscal Year On April 30, 1997, the Compan's fiscal year was changed from a year ending on April 30, to a year ending on December 31. As a result, these consolidated financial statements cover the transition period from May 1, 1996 to December 31, 1996. The Company's next full year will be for the period January 1, 1997 to December 31, 1997.
Accounting Policies The accounting policies of the Company conform to generally accepted accounting principles. The consolidated financial statements include the accounts of the Company and its wholly owned domestic and foreign subsidiaries (the Company). Policies outlined below include all policies considered significant. All significant intercompany balances and transactions have been eliminated.
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and judgments that affect the reported amounts of assets and liabilities and disclosures of contingencies at the date of the financial statements, and revenues and expenses recognized during the reporting period. Actual results could differ from those estimates.
Vehicle Management Services Vehicle management services primarily consist of the management, purchase, leasing, and resale of vehicles for corporate clients and government agencies. These services also include fuel, maintenance, safety and accident management programs and other fee-based services for clients' vehicle fleets. Revenues from these services other than leasing are taken into income over the periods in which the services are provided and the related expenses are incurred.
The Company leases vehicles primarily to corporate fleet users under operating and direct financing lease arrangements. Open-end operating leases and direct financing leases generally have a minimum lease term of 12 months with monthly renewal options thereafter. Closed-end operating leases typically have a longer term, usually 30 months or more, but are cancelable under certain conditions. The Company records the cost of leased vehicles as an "investment in leases and leased vehicles." Amounts charged to lessees for interest on the unrecovered investment are credited to income on a level yield method which approximates the contractual terms. Vehicles under operating leases are amortized using the straight-line method over the expected lease term.
PHH CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements
Real Estate Services The relocation services provided by the Company include facilitating the purchase and resale of the transferee's residence, providing equity advances on the transferee's residence and home management services. The home is purchased under a contract of sale and the Company obtains a deed to the property; however, it does not generally record the deed or transfer of title. Transferring employees are provided equity on their home based on an appraised value determined by independent appraisers, after deducting any outstanding mortgages. The mortgage is generally retired concurrently with the advance of the equity and the purchase of the home. Based on its client agreements, the Company is given parameters under which it negotiates for the ultimate sale of the home. The gain or loss on resale is generally borne by the client corporation.
While homes are held for resale, the amount funded for such homes carry an interest charge computed at the floating rate based on various indices. Direct costs of managing the home during the period the home is held for resale, including property taxes and repairs and maintenance are generally borne by the client. All such advances are generally guaranteed by the client corporation. The client normally advances funds to cover a portion of such carrying costs. When the home is sold, a settlement is made with the client corporation netting actual costs with any advanced billing.
Revenues and the related "costs, including interest, of carrying and reselling homes" are recognized at closing on the resale of a home. Real estate services revenue is shown net of costs reimbursed by client corporations. Under the terms of contracts with clients, the Company is generally protected against losses from changes in real estate market conditions.
The Company also offers fee-based programs such as home marketing assistance, household goods moves, destination services, and property dispositions for financial institutions and government agencies. Revenues from these fee-based services are taken into income over the periods in which the services are provided and the related expenses are incurred.
Mortgage Banking Services Mortgage banking services primarily include the origination, sale and servicing of residential first mortgage loans. The Company markets a variety of first mortgage products to consumers through relationships with corporations, affinity groups, financial institutions, real estate brokerage firms and other mortgage banks. Loan origination fees, commitment fees paid in connection with the sale of loans, and direct loan origination costs associated with loans held for resale, are deferred until the loan is sold. Fees received for servicing loans owned by investors are based on the difference between the weighted average yield received on the mortgages and the amount paid to the investor, or on a stipulated percentage of the outstanding monthly principal balance on such loans. Servicing fees are credited to income when received. Costs associated with loan servicing are charged to expense as incurred.
Sales of mortgage loans are generally recorded on the date a loan is delivered to an investor. Sales of mortgage securities are recorded on the settlement date. Gains or losses on sales of mortgage loans are recognized based upon the difference between the selling price and the carrying value of the related mortgage loans sold. The carrying value of the loans excludes the cost assigned to originated servicing rights (see note for Mortgage Servicing Rights and Fees). Such gains and losses are also increased or decreased by the amount of deferred mortgage servicing fees recorded.
The Company acquires mortgage servicing rights and excess servicing fees by originating or purchasing mortgage loans and selling those loans with servicing retained, or it may purchase mortgage servicing rights separately. The carrying value of mortgage servicing rights and excess servicing fees is amortized over the estimated life of the related loan portfolio.
Gains or losses on the sale of mortgage servicing rights are recognized when title and all risks and rewards have irrevocably passed to the buyer and there are no significant unresolved contingencies.
The Company reviews the recoverability of excess servicing fees by discounting anticipated future excess servicing cash flows at original discount rates utilizing externally published prepayment rates.
PHH CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements
If the discounted value is less than the recorded balance, due to higher than expected prepayments, the difference is recognized as a write-down in the consolidated statement of income.
Property and Equipment Property and equipment are carried at cost less accumulated depreciation and amortization. Depreciation of property and equipment is provided by charges to income over the estimated useful lives of such assets. Buildings are depreciated using the straight-line method (25 to 50 years); building improvements, using the straight-line method (10 to 20 years); equipment and leasehold improvements, using either the double-declining balance or straight-line method (3 to 10 years); and externally developed software is capitalized and amortized using the straight-line method (5 years). Expenditures for improvements that increase value or that extend the life of the assets are capitalized; maintenance and repairs are charged to operations. Gains or losses from retirements and disposals of property and equipment are included in selling, general and administrative expense.
Goodwill, Net Goodwill, net represents the excess of cost over the net tangible and intangible assets of businesses acquired net of accumulated amortization. It is being amortized by the straight-line method over various periods up to 40 years and such amortization is included in selling, general and administrative expense.
Assets Under Management Programs Assets under management programs are held subject to leases or other client contracts. The effective interest rates and maturity characteristics of the leases and other contracts are generally matched with the characteristics of the overall funding program.
Translation of Foreign Currencies Assets and liabilities of the foreign subsidiaries are translated at the exchange rates as of the balance sheet dates; equity accounts are translated at historical exchange rates and revenues, expenses and cash flows are translated at the average exchange rates for the period presented. Translation gains and losses are included in stockholders' equity including, for years prior to 1991, transaction gains and losses resulting from forward exchange contracts on foreign equity amounts net of income tax effects. Gains and losses resulting from the change in exchange rates realized upon settlement of foreign currency transactions are substantially offset by gains and losses realized upon settlement of forward exchange contracts. Therefore, the resulting net income effect of transaction gains and losses for the eight-month period ended December 31, 1996 was not significant.
Interest Interest expense consists of interest on debt incurred to fund working capital requirements and to finance vehicle leasing activities, real estate services and mortgage banking operations. Interest on borrowings used to finance equity advances on homes is included in "costs, including interest, of carrying and reselling homes" and was $23,127 for the eight-month period ended December 31, 1996. Total interest paid, including amounts within "costs, including interest, of carrying and reselling homes," was $183,256 for the eight-month period ended December 31, 1996.
Income Taxes The provision for income taxes includes deferred income taxes resulting from items reported in different periods for income tax and financial statement purposes. Deferred tax assets and liabilities represent the expected future tax consequences of the differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. The effects of changes in tax rates on deferred tax assets and liabilities are recognized in the period that includes the enactment date. No provision has been made for US income taxes on cumulative undistributed earnings of foreign subsidiaries since it is the present intention of management to reinvest the undistributed earnings indefinitely in foreign operations. Undistributed earnings of the foreign subsidiaries at December 31, 1996, were approximately $115,000. The determination of unrecognized deferred US tax liability for unremitted earnings is not practicable. However, it is estimated that foreign withholding taxes of approximately $5,700 may be payable if such earnings were remitted.
PHH CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements
Net Income Per Share Net income per share is based on the weighted average number of shares of common stock outstanding during the period and common stock equivalents arising from the assumed exercise of outstanding stock options under the treasury stock method. The number of shares used in the calculations, adjusted to reflect the two-for-one common stock split (See note for Capital Stock) were 36,082 for the eight-month period ended December 31, 1996.
Derivative Financial Instruments As a matter of policy, the Company does not engage in derivatives trading or market-making activities. Rather, derivative financial instruments such as interest rate swaps are used by the Company principally in the management of its interest rate exposures and foreign currency exposures on intercompany borrowings. Additionally, the Company enters into forward delivery contracts, financial futures programs and options to reduce the risks of adverse price fluctuation with respect to both mortgage loans held for sale and anticipated mortgage loan closings arising from commitments issued.
Amounts to be paid or received under interest rate swap agreements are accrued as interest rates change and are recognized over the life of the swap agreements as an adjustment to interest expense. The fair value of the swap agreements is not recognized in the consolidated financial statements since they are accounted for as hedges. Market value gains and losses on the Company's foreign currency transaction hedges are recognized in income and substantially offset the foreign exchange gains and losses on the underlying transactions. Market value gains and losses on positions used as hedges in the mortgage banking services operations are deferred and considered in the valuation of lower of cost or market value of mortgage loans held for sale.
New Accounting Pronouncements The Company adopted the provisions of the Financial Accounting Standards Board's (FASB) statement of Financial Accounting Standards (SFAS) No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," effective in 1996. Application of this statement requires the Company to review long-lived assets and certain intangibles for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Adoption of this statement had no impact on the consolidated financial statements of the Company.
The Company uses the intrinsic value method to account for stock-based employee compensation plans. Under this method, compensation cost is recognized for awards of shares of common stock to employees under compensatory plans only if the quoted market price of the stock at the grant date (or other measurement date, if later) is greater than the amount the employee must pay to acquire the stock. In October 1995, the FASB issued SFAS No. 123, "Accounting for Stock-Based Compensation." This statement permits companies to adopt a new fair value-based method to account for stock-based employee compensation plans or to continue using the intrinsic value method. If the intrinsic value method is used, information concerning the pro forma effects on net income and net income per share of adopting the fair value-based method is required to be presented in the notes to the financial statements. Pursuant to the Merger Agreement, options granted under employee compensation plans were converted to HFS stock on April 30, 1997. Accordingly, the Company has not provided disclosures about its stock-based employee compensation plans.
In 1996, the FASB issued SFAS No. 125 "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities." The statement provides accounting and reporting standards for transfers and servicing of financial assets and, among other things, SFAS No. 125 also requires that previously recognized servicing receivables that exceed contractually specified servicing fees shall be reclassified as interest-only strips receivable, and subsequently measured under the provisions of SFAS No. 115 "Accounting for Certain Investments in Debt and Equity Securities." The Company will adopt the provisions of SFAS No. 125 on January 1, 1997 and will reclassify a portion of its excess servicing fees to interest-only strips. The effect of adopting SFAS No. 125 is not expected to be material to the Company's operations or financial condition.
PHH CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements
Mortgage Loans Held for Sale Mortgage loans held for sale represent mortgage loans originated by the Company and held pending sale to permanent investors. Such mortgage loans are recorded at the lower of cost or market value as determined by outstanding commitments from investors or current investor yield requirements calculated on the aggregate loan basis. The valuation reserve was $10,141 at December 31, 1996.
The Company issues mortgage-backed certificates insured or guaranteed by the Federal National Mortgage Association (FNMA), Federal Home Loan Mortgage Corporation (FHLMC), Government National Mortgage Association (GNMA) and other private insurance agencies. The insurance provided by FNMA and FHLMC and other private insurance agencies are on a non-recourse basis to the Company. However, the guarantee provided by GNMA is only to the extent recoverable from insurance programs of the Federal Housing Administration and the Veterans Administration. The outstanding principal balance of mortgages backing GNMA certificates issued by the Company aggregated approximately $3.4 billion at December 31, 1996. Additionally, the Company sells mortgage loans as part of various mortgage-backed security programs sponsored by FNMA, FHLMC and GNMA. Certain of these sales are subject to recourse or indemnification provisions in the event of default by the borrower. As of December 31, 1996, mortgage loans sold with recourse amounted to $83,034. The Company believes adequate reserves are maintained to cover all potential losses.
Mortgage Servicing Rights and Fees
Mortgage servicing rights and fees activity was as follows for the for the eight - -month period ended December 31, 1996:
Excess servicing fees represent the present value of the differential between the actual servicing fees and normal servicing fees which are capitalized at the time loans are sold with servicing rights retained. Purchased servicing rights represent the cost of acquiring the rights to service mortgage loans for others.
In May 1995, the FASB issued Statement of Financial Accounting Standards No. 122 "Accounting for Mortgage Servicing Rights" (SFAS No. 122). This Statement requires that mortgage servicing rights be recognized when a mortgage loan is sold and servicing rights are retained. The Company adopted SFAS No. 122 effective May 1, 1995, and, accordingly, capitalized originated servicing rights, net of amortization and valuation allowances, of $45,827 for the eight-month period ended December 31, 1996.
PHH CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements
SFAS No. 122 requires that a portion of the cost of originating a mortgage loan be allocated to the mortgage servicing rights based on the servicing rights' fair value relative to the loan as a whole. To determine the fair value of mortgage servicing rights, the Company uses market prices for comparable mortgage servicing, when available, or alternatively uses a valuation model that calculates the present value of future net servicing income using assumptions that market participants would use in estimating future net servicing income.
SFAS No. 122 also requires the impairment of originated and purchased servicing rights to be measured based on the difference between the carrying amount and current fair value of the servicing rights. In determining impairment, the Company aggregates all mortgage servicing rights, excluding those capitalized prior to the adoption of SFAS No. 122, and stratifies them based on the predominant risk characteristic of interest rate band. For each risk stratification, a valuation allowance is maintained for any excess of amortized book value over the current fair value by a charge or credit to income.
Property and Equipment Property and equipment at December 31, 1996 consisted of the following: - -------------------------------------------------------------------------------- Land .............................................................. $ 9,122 Buildings and leasehold improvements .............................. 61,359 Equipment ......................................................... 109,198 accumulated depreciation and amortization ......................... (93,588) --------- 86,091 Capitalized software costs, net .................................... 6,054 --------- $ 92,145 ---------
Other Assets Other assets at December 31, 1996 consisted of the following: - -------------------------------------------------------------------------------- Mortgage-related notes receivable ................................. $ 66,053 Residential properties held for resale ............................ 7,788 Income taxes receivable ........................................... 19,165 Other.............................................................. 45,447 --------- $ 138,453 ---------
Mortgage-related notes receivable are loans secured by residential real estate. Residential properties held for resale are located primarily in the US and are carried at the lower of cost or net realizable value.
PHH CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements
Assets Under Management Programs
Net Investment in Leases and Leased Vehicles The net investment in leases and leased vehicles at December 31, 1996 consisted of the following: - -------------------------------------------------------------------------------- Vehicles under open-end operating leases .......................... $2,617,263 Vehicles under closed-end operating leases ........................ 443,853 Direct financing leases ........................................... 356,699 Accrued interest on leases ......................................... 851 ---------- $3,418,666 ----------
The Company leases vehicles for initial periods of twelve months or more under either operating or direct financing lease agreements. The Company's experience indicates that the full term of the leases may vary considerably due to extensions beyond the minimum lease term. Lessee repayments of investments in leases and leased vehicles for the eight-month period ended December 31, 1996 were $1,026,826 and the ratio of such repayments to the average net investment in leases and leased vehicles was 47.74%.
The Company has two types of operating leases. Under one type, open-end operating leases, resale of the vehicles upon termination of the lease is generally for the account of the lessee except for a minimum residual value which the Company has guaranteed. The Company's experience has been that vehicles under this type of lease agreement have consistently been sold for amounts exceeding the residual value guarantees. Maintenance and repairs of vehicles under these agreements are the responsibility of the lessee. The original cost and accumulated depreciation of vehicles under this type of operating lease was $4,604,552 and $1,987,289 respectively, at December 31, 1996.
Under the other type of operating lease, closed-end operating leases, resale of the vehicles on termination of the lease is for the account of the Company. The lessee generally pays for or provides maintenance, vehicle licenses and servicing. The original cost and accumulated depreciation of vehicles under these agreements was $600,560 and $156,707 respectively, at December 31, 1996. The Company believes adequate reserves are maintained in the event of loss on vehicle disposition.
Under the direct financing lease agreements, resale of the vehicles upon termination of the lease is generally for the account of the lessee. Maintenance and repairs of these vehicles are the responsibility of the lessee.
Leasing revenues are included in revenues from vehicle management services. Following is a summary of leasing revenues for the eight-month period ended December 31, 1996: - -------------------------------------------------------------------------------- Operating leases $ 767,823 Direct financing leases, primary interest 25,172 - -------------------------------------------------------------------------------- $ 792,995 - --------------------------------------------------------------------------------
Other managed vehicles are subject to leases serviced by the Company for others, and neither the vehicles nor the leases are included as assets of the Company. The Company receives a fee under such agreements which covers or exceeds its cost of servicing.
PHH CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements
The Company has transferred existing managed vehicles and related leases to unrelated investors and has retained servicing responsibility. Credit risk for such agreements is retained by the Company to a maximum extent in one of two forms: excess assets transferred, which were $7,109 at December 31, 1996; or guarantees which was $0 at December 31, 1996. All such credit risk has been included in the Company's consideration of related reserves. The outstanding balances under such agreements aggregated $158,481 at December 31, 1996.
Other managed vehicles with balances aggregating $93,901 at December 31, 1996 are included in a special purpose entity which is not owned by the Company. This entity does not require consolidation as it is not controlled by the Company and all risks and rewards rest with the owners. Additionally, managed vehicles totaling $47,418 at December 31, 1996 are owned by special purpose entities which are owned by the Company. However such assets and related liabilities have been netted in the balance sheet since there is a two-party agreement with determinable accounts, a legal right of offset exists and the Company expercises its right of offset in settlement with client corporations.
Equity Advances on Homes Equity advances on homes represent advances paid to transferring employees of clients for their equity based on appraised values of their homes.
Other Debt Other debt at December 31, 1996 consisted of the following:
- -------------------------------------------------------------------------------- Commercial paper $ 1,085,647 Medium-term note 100,000 - -------------------------------------------------------------------------------- $ 1,185,647 - --------------------------------------------------------------------------------
Commercial paper programs are more fully described in the note for Liabilities Under Management Programs. The medium-term notes represented an unsecured obligation having a fixed interest rate of 6.5% with interest payable semi-annually and a term of seven years payable in full in fiscal 2000.
Income Taxes Provisions for income taxes were comprised as follows for the eight-month period ended December 31, 1996: - -------------------------------------------------------------------------------- Current income taxes: Federal $ 1,196 State and local 2,177 Foreign 5,908 - -------------------------------------------------------------------------------- 9,281 - -------------------------------------------------------------------------------- Deferred income taxes: Federal 25,400 State and local 3,200 Foreign 100 - -------------------------------------------------------------------------------- 28,700 - -------------------------------------------------------------------------------- $ 37,981 - --------------------------------------------------------------------------------
PHH CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements
Deferred income taxes are recorded based upon differences between the financial statement and the tax bases of assets and liabilities and available tax credit carryforwards. There was no valuation allowance relating to deferred tax assets. Net deferred tax liabilities as of December 31, 1996 were comprised as follows:
- -------------------------------------------------------------------------------- Depreciation $ (245,146) Accrued liabilities and deferred income 46,107 Unamortized mortgage servicing rights (51,239) Alternative minimium tax and net operating loss carryforwards 13,078 - -------------------------------------------------------------------------------- $ (237,200) - --------------------------------------------------------------------------------
The portions of the income tax liability and provision classified as current and deferred are subject to final determination based on the actual income tax returns to be filed for the twelve-month period ended April 30, 1997.
The Company paid income taxes of $8,126 for the eight-month period ended December 31, 1996.
A summary of the differences between the statutory federal income tax rate and the Company's effective income tax rate follows for the eight-month period ended December 31, 1996: - -------------------------------------------------------------------------------- Federal income tax statutory rate 35.0% State income taxes, net of federal benefit 3.9% Amortization of goodwill 0.5% Foreign tax in excess of domestic rate 1.0% Other 0.4% - -------------------------------------------------------------------------------- Effective tax rate 40.8% - --------------------------------------------------------------------------------
The Company's US federal income tax returns have been examined by the Internal Revenue Service through April 30, 1993.
Liabilities Under Management Programs Borrowings to fund assets under management programs are classified as "liabilities under management programs" and, at December 31, 1996 consisted of the following: - -------------------------------------------------------------------------------- Commercial paper $ 2,005,196 Medium-term note 1,562,200 Limited recourse debt 9,653 Secured notes payable on vehicles under lease 16,147 Other unsecured debt 311,100 - -------------------------------------------------------------------------------- $ 3,904,296 - --------------------------------------------------------------------------------
PHH CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements
Commercial paper, all of which matures within 90 days, is supported by committed revolving credit agreements described below and short-term lines of credit. The weighted average interest rate on the Company's outstanding commercial paper was 5.4% at December 31, 1996.
Medium-term notes represent unsecured loans which mature in 1997. The weighted average interest rate on medium-term notes was 5.7% at December 31, 1996.
Limited recourse debt and secured notes payable on vehicles under lease primarily consist of secured loans arranged for certain clients for their convenience. The lenders hold a security interest in the lease payments and the clients' leased vehicles. The debt and notes payable mature concurrently with the related lease payments. The aggregate lease payments due from the lessees exceed the loan repayment requirements. The weighted average interest rate on secured debt was 5.3% at December 31, 1996.
The Company has a $2.5 billion syndicated unsecured credit facility backed by 22 domestic and foreign banks. The facility is comprised of $1.25 billion of lines maturing in 364 days and $1.25 billion maturing in five years. Under the credit facilities, the Company is obligated to pay annual commitment fees of approximately 7 basis points. The Company has other unused lines of credit of $301,468 at December 31, 1996 with various banks.
Other unsecured debt, all of which matures in 1997, includes other borrowings under short-term lines of credit and other bank facilities. The weighted average interest rate on unsecured debt was 5.8% at December 31, 1996.
Although the period of service for a vehicle is at the lessee's option, and the period a home is held for resale varies, management estimates, by using historical information, the rate at which vehicles will be disposed and the rate at which homes will be resold. These projections of estimated liquidations of assets under management programs and the related estimated repayment of liabilities under management programs as of December 31, 1996, as set forth in the table below, indicate that the actual repayments of liabilities under management programs will be different than required by contractual maturities.
Assets Under Liabilities Under Management Programs Management Programs ------------------- -------------------
1997 $2,163,260 $2,070,029 1998 1,135,667 1,089,109 1999 513,964 496,119 2000 163,695 160,041 2001 53,843 51,617 2002-2006 35,901 37,381 ---------- ---------- $4,066,330 $3,904,296 - --------------------------------------------------------------------------------
PHH CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements
Stock Option Plans Prior to the Merger, the Company had stock option plans for key employees and outside Directors of the Company. On April 30, 1997 all unexercised options were canceled and converted to shares of HFS as provided by the Merger Agreement. The plans allowed for the purchase of common stock at prices not less than fair market value on the date of grant. Either incentive stock options or non-statutory stock options were granted under the plans. Options became exercisable after one year from date of grant on a vesting schedule provided by the plans, and expired ten years after the date of the grant. Option transactions are summarized as follows for the eight-month period ended December 31, 1996:
Number of Option Price Shares per Share - --------------------------------------------------------------------------------
Outstanding April 30, 1996 2,615,970 $ 9.94 to $26.56 Granted 1,098,100 $27.00 to $30.75 Exercised (306,192) $12.25 to $19.94 Canceled (25,200) $19.94 to $28.44
Outstanding December 31, 1996 3,382,678 $ 9.94 to $30.75
- -------------------------------------------------------------------------------- Exercisable December 31, 1996 2,291,578 $ 9.94 to $21.00 - --------------------------------------------------------------------------------
Capital Stock On June 24, 1996, the Board of Directors authorized a two-for-one common stock split, effected in the form of a 100% stock dividend which was paid on July 31, 1996. All share amounts and per share amounts herein, have been adjusted for the common stock split.
Pension and Other Employee Benefit Plans
Pension and Supplemental Retirement Plans The Company has a non-contributory defined benefit pension plan covering substantially all US employees of the Company and its subsidiaries. The Company's subsidiary located in the UK has a contributory defined benefit pension plan, with participation at the employee's option. Under both the US and UK plans, benefits are based on an employee's years of credited service and a percentage of final average compensation. The Company's policy for both plans is to contribute amounts sufficient to meet the minimum requirements plus other amounts as the Company deems appropriate from time to time. The Company also sponsors two unfunded supplemental retirement plans to provide certain key executives with benefits in excess of limits under the federal tax law and to include annual incentive payments in benefit calculations.
PHH CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements
Net costs included the following components for the eight-month period ended December 31, 1996:
- -------------------------------------------------------------------------------- Service cost $ 3,919 Interest cost 5,732 Actual return on assets (6,652) Net amortization and deferral 2,067 - -------------------------------------------------------------------------------- Net cost $ 5,066 - --------------------------------------------------------------------------------
A summary of the plans' status and the Company's recorded liability recognized in the Consolidated Balance Sheet at December 31, 1996 follows:
Funded Plans - -------------------------------------------------------------------------------- Accumulated benefit obligation: Vested $ 69,743 Unvested 7,058 - ------------------------------------------------------------------------------- $ 76,801 - -------------------------------------------------------------------------------- Projected benefit obligation $ 97,145 Funded assets, at fair value (primarily common stock and bond mutual funds) (88,416) Unrecognized net loss from past experience different from that assumed and effects of changes in assumptions (4,544) Unrecognized prior service cost (761) Unrecognized net obligation (356) - -------------------------------------------------------------------------------- Recorded liability $ 3,068 - --------------------------------------------------------------------------------
Unfunded Plans - -------------------------------------------------------------------------------- Accumulated benefit obligation: Vested $ 13,031 Unvested 601 - ------------------------------------------------------------------------------- $ 13,632 - -------------------------------------------------------------------------------- Projected benefit obligation $ 17,977 Unrecognized net loss from past experience different from that assumed and effects of changes in assumptions (3,087) Unrecognized prior service cost (2,641) Unrecognized net obligation (1,237) Minimum liability adjustment 2,620 - -------------------------------------------------------------------------------- Recorded liability $ 13,632 - --------------------------------------------------------------------------------
PHH CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements
Significant percentage assumptions used in determining the cost and related obligations under the US pension and unfunded supplemental retirement plans are as follows for the eight-month period ended December 31, 1996: - -------------------------------------------------------------------------------- Discount rate 8.00% Rate of increase in compensation 5.00% Long-term rate of return on assets 10.00% - --------------------------------------------------------------------------------
Postretirement Benefits Other Than Pensions The Company provides healthcare and life insurance benefits for certain retired employees up to the age of 65. A summary of the plan's status and the Company's recorded liability recognized in the consolidated balance sheet at December 31, 1996 follows:
- -------------------------------------------------------------------------------- Accumulated postretirement benefit obligation: Active employees $ 5,811 Current retirees 1,670 - -------------------------------------------------------------------------------- 7,481
Unrecognized transition obligation (4,799) Unrecognized net gain 1,832 - -------------------------------------------------------------------------------- Recorded liability $ 4,514 - --------------------------------------------------------------------------------
Net periodic postretirement benefit costs included the following components for the eight-month period ended December 31, 1996. - -------------------------------------------------------------------------------- Service costs $ 568 Interest cost 353 Net amortization and deferral 126 - -------------------------------------------------------------------------------- $ 1,047 - --------------------------------------------------------------------------------
Significant percentage assumptions used in determining the cost and obligations under the postretirement benefit plan are as follows for the eight-month period ended December 31, 1996: - -------------------------------------------------------------------------------- Discount rate 8.00% Health care costs trend rate for subsequent year 10.00% - --------------------------------------------------------------------------------
The health care cost trend rate is assumed to decrease gradually through 2004 when the ultimate trend rate of 4.75% is reached. At December 31, 1996, a one-percentage-point increase in the assumed health care cost trends rate for each future year would increase the annual service and interest cost by approximately $126 and the accumulated postretirement benefit obligation by approximately $582.
PHH CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements
Investment Plan Under provisions of the Company's employee investment plan, a qualified retirement plan, eligible employees may generally have up to 10% of their base salaries withheld and placed with an independent custodian and elect to invest in common stock of the Company, an index equity fund, a growth equity fund, an international equity fund, a fixed income fund, an asset allocation fund and/or a money market fund. The Company's contributions vest proportionately in accordance with an employee's years of vesting service, with an employee being 100% vested after three years of vesting service. The Company matches, in common stock of the Company, employee contributions to 3% of their base salaries, with up to an additional 3% match available at the end of the year based on the Company's operating results for the twelve month period beginning May 1 and ending April 30. The Company's additional matches of employee contributions greater than 3% up to 6%, were 75% in 1996. The additional match, initially invested in a money market fund, can be redirected by the employee into any of the investment elections noted above. The Company recorded contribution expense of $3,412 for the eight-month period ended December 31, 1996.
Lease Commitments Total rental expenses relating to office facilities and equipment were $16,407, for the eight-month period ended December 31, 1996. Minimum rental commitments under non-cancelable leases with remaining terms in excess of one year are as follows: - --------------------------------------------------------------------------------
1997............... $16,797 2001...................... $5,567 1998............... 15,245 2002-2006............. 9,094 1999............... 10,222 2007 and thereafter.. 4,568 2000............... 7,555 - --------------------------------------------------------------------------------
These leases provide for additional rentals based on the lessors' increased property taxes, maintenance and operating expenses.
Contingent Liabilities The Company and its subsidiaries are involved in pending litigation of the usual character incidental to the business transacted by them. In the opinion of management, such litigation will not have a material effect on the Company's consolidated financial statements.
The Company is contingently liable under the terms of an agreement involving its discontinued aviation services segment for payment of Industrial Revenue Bonds issued by local governmental authorities operating at two airports, one of which comes due in the year 2013 and the other which comes due in the year 2014, each of which is in the amount of $3,500. The Company believes its allowance for disposition loss is sufficient to cover all potential liability.
Fair Value of Financial Instruments and Servicing Rights The following methods and assumptions were used by the Company in estimating fair value disclosures for financial instruments:
- - Cash, accounts receivable, certain other assets and commercial paper borrowings. Due to the short-term nature of these financial instruments, the carrying value equals or approximates fair value.
PHH CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements
- - Mortgage loans held for sale. Fair value is estimated using the quoted market prices for securities backed by similar types of loans and current dealer commitments to purchase loans. These loans are priced to be sold with servicing rights retained. Gains (losses) on mortgage-related positions, used to reduce the risk of adverse price fluctuations, for both mortgage loans held for sale and anticipated mortgage loan closings arising from commitments issued, are included in the carrying amount of mortgage loans held for sale.
- - Mortgage servicing rights and fees. Fair value is estimated by discounting the expected net cash flow of servicing rights and deferred mortgage servicing fees using discount rates that approximate market rates and externally published prepayment rates, adjusted, if appropriate, for individual portfolio characteristics.
- - Borrowings. Fair value of borrowings, other than commercial paper, is estimated based on quoted market prices or market comparables.
- - Interest rate swaps, foreign exchange contracts, forward delivery commitments, futures contracts and options. The fair value of interest rate swaps, foreign exchange contracts, forward delivery commitments, futures contracts and options is estimated, using dealer quotes, as the amount that the Company would receive or pay to execute a new agreement with terms identical to those remaining on the current agreement, considering interest rates at the reporting date.
- - The following table sets forth information about financial instruments, except for those noted above for which the carrying value approximates fair value, at December 31, 1996:
* Gains (losses) on mortgage-related positions are already included in the determination of market value of mortgage loans held for sale.
PHH CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements
Derivative Financial Instruments The Company employs interest rate swap agreements to match effectively the fixed or floating rate nature of liabilities to the assets funded. A key assumption in the following information is that rates remain constant at December 31, 1996 levels. To the extent that rates change, both the maturity and variable interest rate information will change. However, the net rate the Company pays remains matched with the assets funded.
The following table summarizes the maturity and weighted average rates of the Company's interest rate swaps employed at December 31, 1996. These characteristics are effectively offset within the portfolio of assets funded by the Company.
PHH CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements
For the eight-month period ended December 31, 1996, the Company's hedging activities increased interest expense $3,653 and had no effect on its weighted average borrowing rate.
The Company enters into foreign exchange contracts as hedges against currency fluctuation on certain intercompany loans. Such contracts effectively offset the currency risk applicable to approximately $329,088 of obligations at December 31, 1996.
The Company is exposed to credit-related losses in the event of non-performance by counterparties to certain derivative financial instruments. The Company manages such risk by periodically evaluating the financial condition of counterparties and spreading its positions among multiple counterparties. The Company presently does not expect non-performance by any of the counterparties.
Comparable Prior Year Income Statement (unaudited) As described in the note on Change in Fiscal Year, the Company changed its fiscal year. Comparable results of operations for the eight-month period ended December 31, 1995 are as follows:
Revenues ............................................ $1,217,647 Operating expenses .................................. 1,133,631 ---------- Operating income .................................... 84,016 Income Taxes ....................................... 34,934 ---------- Net Income .......................................... $ 49,082 ==========
Quarterly Financial Data (Unaudited)
(In thousands except per share data) Eight-month period ended December 31, 1996 ------------------------------------------------- First Second Third Eight-Month Quarter Quarter Quarter* Period ---------- ---------- ---------- ----------- Revenues ......................$ 475,761 $ 473,002 $ 335,230 $1,283,993 Income before income taxes .... 37,113 39,963 16,012 93,088 Net income .................... 21,772 23,966 9,369 55,107 ---------- ---------- ---------- ---------- Net income per share...........$ 0.61 $ 0.68 $ 0.26 $ 1.53 ---------- ---------- ---------- ----------
* Comprised of the two-month period ended December 31, 1996.
Business Segments The Company's operations are classified into three business segments: vehicle management services, real estate services and mortgage banking services. Vehicle management services and real estate services are provided in North America and Europe. Mortgage banking services are provided in the US. Selected information by business segment and geographic area for the eight-month period ended December 31, 1996 are as follows:
PHH CORPORATION AND SUBSIDIARIES
Business Segments (In thousands) - ------------------------------------------------------------------------------- Revenues: Vehicle management services .... $ 918,088 Real estate services ........... 198,324 Mortgage banking services .......... 167,581 ---------- Consolidated ................... $1,283,993 ----------
Income Before Income Taxes: Vehicle management services .... $ 45,706 Real estate services ........... 23,529 Mortgage banking services ...... 23,853 ----------
Consolidated ................... $ 93,088 ----------
Identifiable Assets: Vehicle management services .... $3,866,907 Real estate services ........... 965,330 Mortgage banking services ...... 1,742,409 ----------
Consolidated ................... $6,574,646 ----------
Capital Expenditures: Vehicle management services .... $ 6,369 Real estate services ........... 1,982 Mortgage banking services ...... 8,599 ----------
Consolidated ................... $ 16,950 ----------
Depreciation and Amortization: Vehicle management services .... $ 657,541 Real estate services ........... 7,016 Mortgage banking services ...... 38,508 ----------
Consolidated .................. $ 703,065 ----------
Geographic Areas (In thousands) ---------- Revenues: North America (principally U.S.) $1,129,831 Europe ......................... 154,162 ---------- Consolidated ................... $1,283,993 ----------
Income Before Income Taxes: North America (principally U.S.) $ 79,458 Europe ......................... 13,630 ----------
Consolidated ................... $ 93,088 ----------
Identifiable Assets: North America (principally U.S.) $5,854,657 Europe ......................... 719,989 ----------
Consolidated ................... $6,574,646 ----------
PHH Corporation and Subsidiaries
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS FOR THE EIGHT-MONTH PERIOD ENDED DECEMBER 31, 1996
Note: (a) Amounts relate to acquisitions, divestitures and reclassifications of prior year amounts. (b) Deductions from reserves represent accounts charged off, less recoveries, and foreign translation gains and losses.