ITEM 2. PROPERTIES
The Company's corporate offices are located at 400 Sawgrass Corporate Parkway, Sunrise, Florida. The Company leases approximately 24,980 square feet in a two-story office building for a ten year term, expiring December 31, 2005. The Company currently pays rent of approximately $33,000 per month, including sales tax and maintenance charges. The Company also leases office space for a regional sales and administrative office in Texas, under a lease with a remaining term of three years.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
The Company incurs numerous lawsuits in the ordinary course of its home warranty contract business, typically concerning whether claims under such home warranty contracts are entitled to coverage. The Company does not believe any of these suits are material to the Company's operations or financial results.
In December 1991, suit was brought against HMS and the Company by Acceleration National Insurance Company ("ANIC") for damages related to the E & O insurance program in which ANIC was the policy issuing company. On December 13, 1995, a jury in the Court of Common Pleas of Franklin County, Ohio rendered a verdict against HMS in favor of ANIC, in the amount of $5,156,022, which accrues interest at the rate of 10% per annum. In May, 1996, the Company entered into a definitive merger agreement with Cross Country, pursuant to which Cross Country agreed to purchase all of the outstanding shares of the Company for $2.35 per share in cash and pay the balance due to ANIC under a settlement agreement, upon closing of the Merger. Pursuant to the settlement agreement, on September 4, 1996, the Company paid to ANIC the full amount of its 1995 federal income tax refund, together with interest, which totaled $1,401,485. An affiliate of Cross Country purchased the judgment from ANIC as of October 31, 1996, for approximately $2.75 million, and pursuant to a new settlement agreement ("the Settlement Agreement"), the Cross Country affiliate agreed, under certain conditions, to take no action to collect on the judgment before January 31, 1997. In January 1997, under the Second Amendment to the Merger Agreement, the Cross Country affiliate extended the date until which it agreed to take no action to collect on the judgment to July 1, 1997. The Company guaranteed the obligation of HMS and pledged the shares of HMS and another subsidiary of the Company to secure such guarantee. HMS and the subsidiary granted security interests in their assets as part of the First Amendment to the Merger Agreement. Should the Merger fail to be consummated by July 1, 1997, Cross Country will be entitled to take action to collect on its judgment. In the event the judgment creditor proceeds to execute on its judgment, it is likely that the Company will be without adequate resources to pay the full amount due.
In February 1996, a lawsuit was filed against the Company in the Court of Common Pleas of Bucks County, Pennsylvania, by the former franchisee of the Pennsylvania territory, alleging breach of contact, fraud and misrepresentation. In March 1997, this case was settled for $110,000.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
PART II
ITEM 5.
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
MARKET INFORMATION
The Company's common stock is listed on the Nasdaq National Market under the symbol HOMG. The following table sets forth the high and low transaction prices for each quarterly period during 1996 and 1995. Stock price data reflects inter-dealer prices, without retail mark-up, mark-down or commission, and may not represent actual transactions.
YEAR QUARTER HIGH LOW ---- ------- ---- ---
1996 First $1.75 $ 0.50 Second 2.06 1.50 Third 2.13 1.88 Fourth 2.06 1.50
1995 First $1.75 $ 0.63 Second 2.13 1.13 Third 2.00 1.00 Fourth 1.94 0.50
As of March 15, 1997, there were approximately 140 shareholders of record of the Company's common stock, some of whom are brokerage firms which hold shares in nominee name on behalf of their clients. The Company believes that there are over 690 beneficial owners of its common stock.
DIVIDENDS
The agreements reached with CNA impose certain restrictions on dividends until funds due to CNA are paid in full. The Company declared no dividends in 1996, 1995 or 1994. The Company does not anticipate paying any dividends in the future.
NOTE: CERTAIN AMOUNTS REFLECT RECLASSIFICATIONS FROM AMOUNTS REPORTED PREVIOUSLY TO CONFORM TO CURRENT PRESENTATION.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following table presents certain relationships deemed to be pertinent indicators of the Company's results of operations:
* DIRECT COSTS ARE PRESENTED AS A PERCENTAGE OF THE RELATED REVENUES. - -------------------------------------------------------------------------------
1996 COMPARED TO 1995
HOME WARRANTY OPERATIONS:
Home warranty revenue, totaling $40,136,000 and representing 88% of total operating revenue for 1996, increased 8% from the 1995 figure of $37,181,000, or 83% of total operating revenue, due primarily to increases in home warranty contract sales. The increase in contract sales is due to additional membership and to a strong residential real estate market. Due to the Company's warranty revenue recognition method, which recognizes contract revenue over the one year term of the contract, warranty revenue for any period of time is also impacted by production in the eleven months immediately preceding that period. There have been no major pricing changes which would have significantly affected warranty revenue.
Direct expenses of the warranty product, which consist primarily of claims expense and acquisition costs, as a percentage of related operating revenue, increased to 80% in 1996 from 79% in 1995, primarily due to a 2% increase in average claim severity and a 6% increase in warranty claim frequency. Claim frequency experienced in 1996 returned to the unusually high frequency experienced in 1994, as a result of the severe weather patterns experienced across the country during 1996. Through December, 1996 the winter season has been extremely severe, resulting in negative experience in the last quarter of the year. This trend has continued into the first quarter of 1997, and has had a continued negative impact on the Company's cash position and its results of operations.
The 1996 warranty acquisition cost ratio of 35% is slightly lower than the 1995 ratio, which approximated 36%. As the volume of contract sales shifts between geographic regions, the Company's overall acquisition cost ratio changes, since the Company's acquisition costs vary in different locations. In addition, the increasing proportion of renewal warranty contracts reduces the acquisition cost ratio, as renewal contract acquisition costs are generally lower than acquisition costs for first year contract sales. The acquisition cost ratio is expected to remain relatively stable at its current level, assuming that the warranty product mix and geographic distribution do not change significantly. Management, at this time, does not expect such a change to occur.
The amount of general and administrative ("G&A") expenses of the home warranty operation, which primarily include allocated fixed costs, increased slightly from the prior year period due primarily to increases in overhead costs related to the pending sale of the Company.
MEMBERSHIP AND OTHER OPERATIONS:
Membership and other related revenue of $4,331,000 in 1996 was 31% lower than 1995 revenue of $6,258,000, which is primarily related to the continued change in mix of the Company's membership base. As in the prior year, the portion of the Company's membership which no longer participates in the Company's E&O program and which pays the associated marketing/placement fees has continued to decline. These factors have caused continuing decreases in related revenue and earnings in 1996, a continuing reflection of the effects of the change in the Company's E&O carrier. As a result of this change, and due to continued increased competitive pressures within the E&O market, the Company has continued to experience declines in Members as participants in its current E&O program. Additionally, attraction of new full members continues to be difficult, due to premium quotes which are not competitive for certain brokers.
Throughout 1996, the Company has also continued to focus on attracting new members and retaining as participants in the warranty program former members who are not covered by CNA. This strategy has somewhat reduced the negative impact of the loss of members through increases in warranty production.
Direct expense of the membership operations approximated 75% of related revenue for 1996 and 70% of related revenue for 1995. The disproportionate cost ratio is related primarily to certain fixed costs, which do not decline with decreases in revenues, and to the results of the CORs, which were particularly impacted by the Full E&O membership declines, especially in the states of California and Texas. Also impacting the direct cost ratio is the effect of continued promotional discounting of some of the Company's membership programs, a step the Company has taken to retain some of its top producing members.
As with the home warranty operations, G&A expenses of the Company's membership and other operations increased from 1995 totals, again related to increases in general overhead costs related to the pending acquisition.
E&O OPERATIONS:
E&O related revenue for 1996, totaling $964,000, was 23% lower than the 1995 revenue of $1,253,000. The decrease relates to the decline in the Company's membership base, which has a corresponding effect on the premium volume of the program and, thus, the commissions earned.
Direct expenses of the E&O operations increased from $648,000, or 52% of revenue in 1995 to $657,000 or 68% of revenue in 1996. Under the current E&O program, the Company has agreed to pay a portion of the commission it receives on the E&O premiums collected to the Affiliates generating the premium volume. There are also certain fixed costs related to the Company's risk management programs which result in the cost ratio being disproportionate.
UNUSUAL ITEMS:
In 1996, the Company reported approximately $677,000 in the "Unusual Items" caption in its consolidated statements of operations, related to several infrequently occurring events that occurred in 1996. Specifically, in the third quarter of 1996, the Company terminated its Agency Agreement and Administration Agreement with New Hampshire Insurance Company ("NHIC"), as it determined that it no longer desired to carry the program previously negotiated with NHIC. As part of the termination arrangement, the Company has paid approximately $260,000 to NHIC, and has also agreed to indemnify NHIC for all claims incurred under contracts issued during the time the agreements were in effect by paying for all claims on covered components which may be reported under such contracts, as if the arrangement with NHIC had not taken place. To the extent that claims have been paid or reported on these contracts, such amounts have been included in the "Direct costs" caption in the Company's consolidated statements of operations, and any related accrual for unpaid amounts is included in the "Accounts payable" caption in the consolidated balance sheets. In addition, effective September 15, 1996, in conjunction with its plans for future organization and growth, the Company terminated an employment contract with one of its officers, and has agreed to pay the former officer severance and related benefits totaling approximately $157,000 through the month of July 1997. In the fourth quarter of 1996, in connection with the Company's plan to improve the operating results of its Corporate Owned Regions, the employment of three regional managers of the Company's Corporate Owned Regions was terminated, and the California office was closed. In connection with these changes, the Company agreed to pay amounts totaling approximately $260,000 for severance, related benefits and rents on the California office. Charges for these items are included in the accompanying consolidated statements of operations under the caption "Unusual Items".
OTHER INCOME (EXPENSE):
Investment income approximated $636,000 in 1996, a decrease of approximately 53% from the 1995 level of $1,367,000. Unrealized holding gains/losses on trading securities are included in the Company's earnings for the period, and unrealized gains/losses on securities available for sale are reported as a separate component of stockholders' equity. In 1995, decreasing interest rates caused the Company's investments in debt securities to generate significant income, especially on its trading securities portfolio, which has been included in the Company's consolidated statement of operations. In 1996 this trend slowed, reducing the amount of income recognized. Also, in mid-1996, the Company transferred a portion of its trading portfolio to available for sale, which changed the presentation of market value adjustments from a statement of operations impact to a balance sheet impact. This transfer was made to maximize earnings potential and to consolidate investment balances for one of the Company's regulated subsidiaries. Investment income is generated primarily from the securities currently invested by the Company's regulated home warranty subsidiaries, as well as from additional investment of funds generated through the sales of warranty products. Funds generated through the other operations of the Company's business are generally invested in highly liquid overnight investments, and therefore earn a minimal amount of interest over the course of a year.
Other expenses include interest expense of approximately $351,000, related primarily to the CNA obligation, losses from the Company's share of investment in an Internet access provider joint venture of approximately $220,000, and a loss on disposal of fixed assets of approximately $120,000. In 1995, the Company formed a partnership through which it planned to offer services as an Internet access provider to its members. Due to continued losses, and lower than anticipated sales, in December 1996, the Company stopped funding the partnership, and plans to sell its partnership interest or otherwise dissolve the partnership agreement. The losses on fixed asset disposals resulted from the Company's change in corporate office locations, at which time the Company disposed of certain office furniture and equipment, for which it received only nominal proceeds. In 1995, other expense included interest on the CNA obligation of approximately $275,000 and losses incurred by the Internet access provider joint venture of approximately $80,000.
INCOME TAXES:
The Company's effective tax rate in 1996 was a benefit of 35%, as compared to a provision of 38.4% on income from continuing operations in 1995.
As a result of the losses generated in 1996, and by the 1995 ANIC judgment, the 1994 work-force reduction and termination of its UK operations, combined with the 1993 losses generated by the Company's discontinued reinsurance operations, the Company has recognized significant income tax benefits since 1993. A portion of the Company's 1993 and 1994 pre-tax losses was carried back for income tax purposes, to offset taxable income earned in the prior three years, generating tax refunds for the Company. The remaining pre-tax losses give rise to significant deferred tax benefits, which will be recognized in future years, as the temporary book to tax differences which create the deferred tax benefits become deductible for tax purposes. The total deferred tax benefit which is expected to be realized in future years approximates $9.5 million at December 31, 1996. Based upon management's estimates of future taxable income and of the positive and negative evidence regarding the likelihood of ultimate recognition of this benefit, it has been determined that no valuation allowance is necessary. This determination was based on the Company's taxable earnings history, exclusive of non-recurring charges, and the period anticipated for full recognition, assuming the Company maintains its current level of taxable income, exclusive of the charges incurred for its discontinued operations, the restructuring charges reported in 1994 and 1996, and certain other non-recurring items. The Company is currently undergoing an examination by the Internal Revenue Service of its tax returns for the years of 1993, 1994 and 1995, which could result in the proposal of significant adjustments to its taxes in those years. The Company believes that the returns as originally filed are correct in all material respects.
DISCONTINUED OPERATIONS:
In connection with the transfer of the net assets of POMG to CNA and the assumption by CNA of the obligations of POMG under certain Realtor's errors and omissions policies, the Company guaranteed the performance by Sphere Drake Insurance, PLC ("Sphere Drake"), a third party reinsurance company, under a $5 million reinsurance treaty purchased by POMG to protect it from losses in excess of a predetermined amount. Under the terms of the Company's guaranty, CNA, as the transferee of the reinsurance treaty, bears any credit risk under the treaty, including, but not limited to, any risk that Sphere Drake becomes insolvent, is adjudicated as a bankrupt or has liquidation or similar proceedings commenced against it. The Company placed $3 million into a collateral account to secure its guarantee (the "Collateral Account"), and has also agreed, if necessary, to pay the additional $2 million related to the guarantee from future commissions. On April 10, 1996, CNA issued a Notice of Arbitration to the reinsurer with respect to its refusal to honor the reinsurance treaty.
The Company, CNA and Sphere Drake are engaged in settlement discussions with respect to the reinsurance treaty. Although terms are not finalized, it is possible that the Company could pay a substantial portion of the Collateral Account to CNA under the currently proposed settlement agreement. As a result of the settlement negotiations, the Company has recorded a loss provision of $2.5 million for the guaranty in its consolidated statements of operations for 1996. Should the Merger fail to be consummated, the potential settlement agreement will be null and void, and the Company will continue to be contingently liable for the entire $5 million under the conditions described in the preceding paragraph. In such event, the Company will attempt to negotiate a settlement but there can be no assurance that it will be successful in such efforts.
As a result of the settlement negotiations, the Company has recorded a loss provision of $2.5 million for the guarantee, which is reflected in the discontinued operations caption in the accompanying 1996 consolidated statement of operations, and the offsetting reserve is reflected as a reserve against the restricted cash balance in the accompanying 1996 consolidated balance sheet. In its role under this program, the Company bore reinsurance risk through its reinsurance subsidiary. With the change in carriers to CNA, in 1993, the Company removed itself from any risk bearing position in connection with the claims reported under its E&O program, and currently no longer operates in this capacity. The 1995 amount included in the discontinued operations caption was the Acceleration judgment, which was also related to this prior E&O program.
1995 COMPARED TO 1994
HOME WARRANTY OPERATIONS:
Home warranty revenue, totaling $37,181,000 and representing 84% of total operating revenue for 1995, decreased 4% from the 1994 figure of $38,911,000, or 74% of total operating revenue, due primarily to declines in home warranty contract sales. The decrease in contract sales is primarily due to the loss of membership. Due to the Company's warranty revenue recognition method, which recognizes contract revenue over the one year term of the contract, warranty revenue for any period of time is also impacted by production in the eleven months immediately preceding that period. There have been no major pricing changes which would have significantly affected warranty revenue.
Direct expenses of the warranty product, which consist primarily of claims expense and acquisition costs, as a percentage of related operating revenue decreased to 79% in 1995 from 83% in 1994, primarily due to a 2% decrease in average claim severity and a 1% increase in warranty claim frequency. Claim frequency experienced in 1995 returned to the 1993 levels, after the unusually high frequency experienced in 1994, as a result of the severe weather patterns experienced across the country throughout the first eight months of 1994. Through December, 1995 the winter season has been extremely severe, resulting in negative experience in the last quarter of the year. This trend has continued into the first quarter of 1996, and has had a significant negative impact on the Company's cash position and its results of operations.
The 1995 warranty acquisition cost ratio of 36% is slightly lower than the 1994 ratio, which approximated 38%. As the volume of contract sales shifts between geographic regions, the Company's overall acquisition cost ratio changes, since the Company's acquisition costs vary in different locations. The acquisition cost ratio is expected to remain relatively stable at its current level, assuming that the warranty product mix and geographic distribution do not change significantly. Management, at this time, does not expect such a change to occur.
The amount of general and administrative ("G&A") expenses of the home warranty operation, which primarily include allocated fixed costs, decreased significantly from the prior year period, and as a percentage of related revenue. The 1995 expenses were positively impacted by the work-force reduction that took place in September 1994.
MEMBERSHIP AND OTHER OPERATIONS:
Membership and other related revenue of $6,258,000 in 1995 was 45%, lower than 1994 revenue of $11,755,000, which is primarily related to the changing mix of the membership base. A large portion of the Company's membership no longer participates in the Company's E&O program and is exempted from paying the associated marketing/placement fees. Further impacting the membership results is the 6% decline in the Company's membership base from the prior year level. These factors have caused continuing decreases in related revenue and earnings in 1995, and reflect the continuing effects of the change in Company's E&O carriers. As a result of this change and the related increased competitive pressures within the E&O market, the Company has been unable to retain some of its Members as participants in its current E&O program. Additionally, attraction of new full members is more difficult, due to premium quotes which are not competitive for certain brokers and also due to declinations by the Company's primary insurance carrier of certain other brokers.
In 1995, the Company changed its method of recognizing revenue and expenses related to the annual new membership and renewal membership revenues and expenses. Prior to 1995, the Company recognized these items upon collection of the membership fees and upon payment of the associated commission expenses. Currently, these revenue items are deferred as collected and the expense items are deferred when paid, and both items are subsequently recognized in the income statement on a straight line basis over the membership period, generally one year. This change in revenue and expense recognition method was deemed to be a correction of an error, and the accompanying consolidated balance sheets and statements of operations have been restated to reflect the appropriate accounting for these items. The current year effect on revenue and associated direct costs recognized approximates 2% and 1%, respectively, of the current year total membership revenue and expense totals.
Throughout 1995, the Company continued to focus on attracting new members and retaining existing members who have either been declined coverage by CNA or who have obtained their E&O coverage through another entity, as participants in the Company's warranty and Consumer Reach programs. A new membership program targeted at brokers desiring to use the Company's warranty was introduced in mid-1995. This strategy has somewhat reduced the negative impact of the loss of members on other revenues, evidenced by the 1995 fourth quarter improvements in first year warranty contract sales, as compared to prior quarters.
Direct expense of the membership operations approximated 70% of related revenue for 1995 and 62% of related revenue for 1994. The disproportionate cost ratio is related primarily to the results of the CORs, which were particularly impacted by the membership declines, especially in the states of California and Texas. Also impacting the direct cost ratio is the effect of promotional discounting of some of the Company's membership programs, a step the Company has taken to ease the membership transition and retain some of its top producing members.
As with the home warranty operations, G&A expenses of the Company's membership and other operations decreased from 1994 totals, due to the September 1994 work-force reduction, combined with the focus on controlling costs.
E&O OPERATIONS:
E&O related revenue for 1995, totaling $1,253,000 was 50% lower than the 1994 revenue of $2,528,000. The decrease in this revenue relates to the decline in the Company's membership base, which has a corresponding effect on the premium volume of the program and, thus, the commissions earned.
Direct expenses of the E&O operations increased from $512,000 in 1994 to $648,000 in 1995. Under the current E&O program, the Company has agreed to pay a portion of the commission it receives on the E&O premiums collected to the Affiliates generating the premium volume. There was no such arrangement under previous E&O programs, and, as 1994 was a transition year, the 1995 increase was anticipated. As the premium volume under the new program grows, the commission paid to the Affiliates will grow proportionately.
UNITED KINGDOM OPERATIONS:
HGC was liquidated in 1995, and there were no activities of HGC to include in the 1995 financial statements. HGC did not generate any significant revenue and incurred an operating loss of $761,000 in 1994, exclusive of the charges recorded by the parent company in writing off the net assets of this subsidiary.
REDUCTION OF WORK-FORCE:
In early September 1994, the Company underwent an organizational restructuring, reducing its total work-force by approximately 20%. This restructuring resulted in annual cost savings of approximately $1,700,000 in 1995, through reductions in salary, benefits and payroll tax expenses, excluding the effects of any other personnel or staffing changes. The 1994 one time charge for severance pay and related benefits, totaling $1,063,000 is included in "Unusual items" in the accompanying consolidated statements of operations. Approximately $400,000 of this total relates to an agreement to terminate the employment contract between the Company and its former Chairman of the Board of Directors.
OTHER INCOME (EXPENSE):
Investment income approximated $1,367,000 in 1995, an increase of approximately 1000% from the 1994 level of $120,000. Unrealized holding gains/losses on trading securities are included in the Company's earnings for the period, and unrealized gains/losses on securities available for sale are reported as a separate component of stockholders' equity. In 1994, rising interest rates caused the Company's investments in debt securities to generate significant unrealized holding losses, especially on its trading securities portfolio, which have been included in the Company's consolidated income statement. In 1995, this trend reversed, and the Company recognized significant income. Investment income is generated primarily from the securities currently invested by the Company's regulated home warranty subsidiaries, as well as from additional investment of funds
generated through the sales of warranty products. Funds generated through the other operations of the Company's business are generally invested in highly liquid overnight investments, and therefore earn a minimal amount of interest over the course of a year.
INCOME TAXES:
The Company's 1995 effective tax rate on income from continuing operations was 38.4%, as compared to a benefit of 11.3% on income from continuing operations in 1994.
As a result of losses generated by the current year Acceleration judgment (see Discontinued Operations below), the 1994 work-force reduction and termination of its UK operations, combined with the prior year losses generated by the Company's discontinued reinsurance operations, the Company has recognized significant income tax benefits in 1993 and 1994. A portion of the Company's 1993 and 1994 pre-tax losses was carried back for income tax purposes, to offset taxable income earned in the prior three years, generating tax refunds for the Company. The remaining pre-tax losses give rise to significant deferred tax benefits, which will be recognized in future years, as the temporary book to tax differences which create the deferred tax benefits become deductible for tax purposes. The total deferred tax benefit which is expected to be realized in future years approximates $8.2 million at December 31, 1995. Based upon management's estimates of future taxable income and of the positive and negative evidence regarding the likelihood of ultimate recognition of this benefit, it has been determined that no valuation allowance is necessary. This determination was based on the Company's taxable earnings history, exclusive of non-recurring charges, and the period anticipated for full recognition, assuming the Company maintains its current level of taxable income, exclusive of the charges incurred for its discontinued operations, the restructuring charges reported in 1994 and 1996, and certain other non-recurring items.
DISCONTINUED OPERATIONS:
In December 1995, a judgment was awarded against a wholly owned subsidiary of the Company in the amount of $5,156,022. This judgment related to the Company's 1991 and prior E&O program, which was carried by Acceleration National Insurance Companies (Acceleration). Under this program, the Company bore reinsurance risk through the letters of credit that it was required to post as collateral to be drawn upon in the event that the assets in the reinsurance pool, together with investment income earned thereon were insufficient to cover the claims and related expenses incurred. With the change in carriers to CNA, in 1993, the Company removed itself from any risk bearing position in connection with the claims reported under its E&O program, and currently no longer operates in this capacity. Accordingly, the judgment amount was reported in discontinued operations in the accompanying consolidated statements of operations.
LIQUIDITY AND CAPITAL RESOURCES
The Company generally receives payment for products and services before disbursing funds for related direct expenses. Fees from Members and from sales of home warranty contracts are received before related marketing commissions are paid out and before claims are made under home warranty contracts. As a result of increases in home warranty production in 1996 as compared to 1995, cash collected on warranty contracts in 1996 was approximately $4,623,000 higher than 1995. In 1996, membership and related revenues and cash flows were negatively affected by the decrease in members and in the related fees generated by the Company's membership, and the Company continued to provide its Affiliates with various discounted membership options. The Company expects that cash flow generated from its warranty and other operations, in combination with the cost saving measures implemented, will be sufficient to meet its normal operating needs on an ongoing basis. However, should the merger fail to be consummated by July 1, 1997, Cross Country will be entitled to take action to collect on its judgment. In the event the judgment creditor proceeds to execute on its judgment, it is likely that the Company will be without adequate resources to pay the full amount due to Cross Country, as holder of the judgment, which would become immediately due and payable. In such event, the Company would be forced to seek alternatives to paying the remaining unpaid balance of the judgment. No other alternatives are presently being considered.
In 1996, net cash provided by operating activities totaled $4,347,000, as compared to cash used in operations of $667,000 in 1995. This increase in cash is primarily due to liquidation of some of the Company's investment portfolio, relating to a transfer of investments from trading to available for sale in mid-1996, paired with increases in warranty production in 1996 as compared to the 1995 levels. In the first quarter of 1996, the Company modified its payment terms to its claims service contractors to move from 20 to 30 day terms, consistent with industry standards, which further positively impacted cash flows. Also impacting operating cash flows are various payments for claims payable, Affiliate and Member commissions and E&O premium
remittances. In 1996, the Company used $3,513,000 in investing activities, as compared to $2,207,000 in 1995, primarily due to the transfer of investments previously noted, offset by decreases in purchases of property and equipment. Net cash provided by financing activities totaled $3,000 in 1996, as compared to cash used in financing activities of $2,005,000 in the comparable 1995 period. The 1995 financing activities reflect the collateral fund contributions related to the Sphere Drake reinsurance recoverable.
In consideration for CNA's assumption of POMG's reinsurance obligations, which is more fully discussed in the BUSINESS ERRORS & OMISSIONS INSURANCE section herein, the Company has agreed to pay CNA $5 million by December 1999 toward the ultimate settlement of the transferred losses and expenses. The agreements with CNA impose certain restrictive covenants until the $5 million CNA obligation is satisfied, including limits on dividends and on future borrowings. The funds due to CNA are a senior obligation of the Company, secured by an interest in the common stock of the Company's HOMS subsidiary and in the Company's Member list. Through December 31, 1999, the Company and its Affiliates must provide CNA/Schinnerer with right of first refusal on E&O insurance offered to its membership. The Company forwards half of its commissions earned under the CNA E&O program to CNA, to be applied as debt repayments on the obligation until its satisfaction. The Company is currently in default with the terms of this agreement, as it has failed to achieve the minimum premium volume quotas as defined in the agreements, and the Company could be required by CNA to make a payment against its obligation to the Holdback Fund in the amount of approximately $200,000. However, the Company and CNA have entered into an amendment to the Holdback Agreement which would delete the premium volume quotas and release the Company from its current obligation to pay the remaining $3.1 million. Following the effective date of this amendment, the Company's obligation will be limited to the payment of 50% of actual commissions to CNA. The proposed amendment becomes effective if the Merger is consummated prior to July 1, 1997, and the dispute with Sphere Drake (as described below) is settled within 14 days of the consummation of the Merger.
During 1996 the Company made principal repayments of approximately $725,000 against the CNA obligation. As of December 31, 1996, the net present value of the balance due to CNA under this obligation was $3,075,000. In addition, in connection with the transfer of the net assets of POMG to CNA and the assumption by CNA of the obligations of POMG under certain Realtor's errors and omissions policies, the Company guaranteed the performance by Sphere Drake Insurance, PLC ("Sphere Drake"), a third party reinsurance company, under a $5 million reinsurance treaty purchased by POMG to protect it from losses in excess of a predetermined amount. Under the terms of the Company's guaranty, CNA, as the transferee of the reinsurance treaty, bears any credit risk under the treaty, including, but not limited to, any risk that Sphere Drake becomes insolvent, is adjudicated as a bankrupt or has liquidation or similar proceedings commenced against it. The Company has agreed, if necessary, to pay an additional $2 million out of future commissions related to the guarantee. Should this occur, the repayments on the $5 million obligation will be delayed until the $2 million is paid. The Company will not be required to further reduce its collected commission by more than 50% under these agreements. On April 10, 1996, CNA issued a Notice of Arbitration to Sphere Drake, with respect to its refusal to honor the reinsurance treaty. Accordingly, the Company, CNA and Sphere Drake have engaged in settlement negotiations with respect to the reinsurance treaty. Although terms are not yet finalized, its is possible that the Company could pay a substantial portion of the Collateral Account to CNA under the terms of the currently proposed settlement agreement. As a result of the settlement negotiations between CNA and Sphere Drake, the Company has recorded a loss provision of $2.5 million for the guarantee.
In December 1991, ANIC, the insurer of the Company's E&O program through April 1991, brought suit against the Company and HMS. On December 13, 1995, a jury verdict in the amount of $5,156,022 was rendered in favor of the Plaintiff and against HMS. Under the terms of the Merger Agreement with Cross Country, Cross Country agreed to pay the balance due to ANIC under a settlement agreement, upon closing of the Merger. Pursuant to the settlement agreement, on September 4, 1996, the Company paid to ANIC the full amount of its 1995 federal income tax refund, together with interest, which totaled $1,401,485. The remaining balance due bears interest at the rate of 10% per annum from September 1, 1996 until the settlement amount is paid in full. An affiliate of Cross Country purchased the judgment from ANIC as of October 31, 1996, for approximately $2.75 million. The Cross Country affiliate agreed, under certain conditions, to take no action to collect on the judgment before January 31, 1997. In January 1997, under the Second Amendment to the Merger Agreement, the Cross Country affiliate extended the date until which it agreed to take no action to collect on the judgment to July 1, 1997. The Company has guaranteed the obligation of HMS and pledged the shares of HMS and another subsidiary of the Company to secure such guarantee. HMS and the subsidiary granted security interests in their assets as part of the First Amendment to the merger agreement. Should the merger fail to be consummated by July 1, 1997, Cross Country will be entitled to take action to collect on its judgment. In the event the judgment creditor proceeds to execute on its judgment, it is likely that the Company will be without adequate resources to pay the full amount due to Cross Country, as holder of the judgment, which would become immediately due and payable. In such event, the Company would be forced to seek alternatives to paying the remaining unpaid balance of the judgment. No other alternatives are presently being considered. The Company's efforts in 1996 to contest the
domestication of the judgment in Florida, appeal the judgment and otherwise prevent the judgment creditor from executing on its judgment have resulted in substantial fees to professionals and other advisors, which further negatively impacted the Company's liquidity during 1996.
Seventeen of the states in which the Company's subsidiaries operate regulate the home warranty business. Certain of these states require that reserves be maintained to cover future repairs for the remaining terms of warranty contracts (generally one year). As of December 31, 1996, approximately $10,800,000 of cash and investments are needed to maintain the regulated subsidiaries' required minimum reserve and surplus levels. Of this amount, approximately $1,200,000 of cash and investments are held by the regulated states to assure the Company's fulfillment of its obligations to contract holders. Increases in warranty production, as seen thus far in the first quarter of 1996, result in increases in the Company's required reserve and surplus levels in the regulated states. In addition, state regulators generally seek reserve balances in excess of the minimum standards. In certain states, withdrawal of any reserves in excess of statutory minimums requires approval from the regulatory authorities. The Company has been advised by certain authorities that such approval will not be granted. Accordingly, the Company maintained reserves of approximately $13,500,000 as of December 31, 1996. The Company is currently in compliance with all applicable surplus and reserve requirements.
The Company is continuing its efforts to upgrade its current computer and processing environments over the next two years, in an attempt to increase operational efficiency, improve management information, and allow for future growth in the Company's business. This plan is currently expected to have an incremental cost of approximately $750,000 in excess of the cost of maintaining, servicing and improving the existing system, over the life of the project. Management expects that sufficient funds will be available to cover the cost of the upgrade. If such funds are not available, this project will be deferred.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
FINANCIAL STATEMENTS PAGE - -------------------------------------------------------------------------------
Independent Auditors' Report 21
Consolidated Balance Sheets - December 31, 1996 and 1995 22
Consolidated Statements of Operations - Years Ended December 31, 1996, 1995 and 1994 23
Consolidated Statements of Cash Flows - Years Ended December 31, 1996, 1995 and 1994 24
Consolidated Statements of Stockholders' Equity - Years Ended December 31, 1996, 1995 and 1994 25
Notes to Consolidated Financial Statements 26
INDEPENDENT AUDITORS' REPORT
To the Board of Directors of Homeowners Group, Inc. Sunrise, Florida:
We have audited the accompanying consolidated balance sheets of Homeowners Group, Inc. and its subsidiaries (the "Company") as of December 31, 1996 and 1995 and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1996. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. These standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a resonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 1996 and 1995 and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1996 in conformity with generally accepted accounting principles.
The accompanying financial statements for the year ended December 31, 1996 have been prepared assuming the Company will continue as a going concern. As discussed in Notes 1, 2 and 10, the Company could be obligated to pay on an outstanding judgement. In the event the judgement creditor proceeds to execute on its judgement, it is likely the Company will be without adequate resources to pay the full amount due, which raises substantial doubt about its ability to continue as a going concern. Management's plans in regard to this matter are also described in Note 1. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.
As discussed in Note 10 to the consolidated financial statements the Company is currently undergoing an examination by the Internal Revenue Service of its tax returns for the years 1993, 1994 and 1995.
DELOITTE & TOUCHE LLP Certified Public Accountants Miami, Florida
April 8, 1997
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------
1. THE COMPANY - ------------------------------------------------------------------------------- Homeowners Group, Inc. ('HOMG') and its subsidiaries (collectively the 'Company') provide home warranty contracts, access to real estate errors and omissions liability insurance ('E&O') and other products and services primarily to residential real estate brokerage firms and agents. The Company enters into agreements with real estate brokerage firms and agents ('Members') which grant Members the right to use the products and services provided by the Company. The Company generally markets its products and services through franchise agreements whereby the third party operators ('Affiliates') have exclusive geographic territories in which to enroll real estate brokerage firms as Members. Through December 31, 1996, the Company had entered into agreements with Affiliates for territories encompassing 35 states and the District of Columbia. In 1996, the Company marketed directly in California, Florida, except Northwest Florida which territory has been granted to an Affiliate, Colorado, Hawaii, Idaho, Indiana, Iowa, Nebraska, North Dakota, Pennsylvania, South Dakota, Oregon, and Washington, ('Corporate-Owned Regions'), and is a 45% partner in a partnership which directly enrolls Members in Texas. In 1994 and part of 1995, the Company also directly enrolled Members in Maine, Massachusetts, New Hampshire and Vermont, however, in May 1995, the Company franchised this New England territory. Under management agreements executed in 1995, the Company continued in 1996 to manage the operations and administration of the Kansas, Missouri, Oklahoma, Arizona and New Mexico territories.
In October 1991, the Company acquired an 80% interest in a British subsidiary which began marketing home warranty contracts in the United Kingdom in February 1992. The home warranty contract program and other insurance products offered by this subsidiary were completely underwritten by Lloyd's of London, thereby eliminating any underwriting risk to the Company. In the third quarter of 1994, the Company ceased funding the UK operation, effectively closing down the subsidiary. Accordingly, there was no foreign operations activity in 1995. See further discussion of this transaction in Note 9.
Although the Company's home warranty contracts are generally not considered to be insurance products, the Company is subject to insurance-type regulations in many of the states in which the home warranty contracts are sold. Certain of these states require that reserves be maintained to cover future repairs for the remaining terms of the warranty contracts (generally one year). As of December 31, 1996, approximately $10,800,000 of cash and securities were needed to maintain the regulated subsidiaries' minimum reserve and surplus levels. Increases in warranty production, as seen thus far in the first quarter of 1997, result in increases in the Company's required reserve and surplus levels in the regulated states. In addition, state regulators generally seek reserve balances in excess of the minimum standards. In certain states, withdrawal of any reserves in excess of statutory minimums requires approval from the regulatory authorities. The Company has been advised by certain authorities that such approval will not be granted. Accordingly, the Company maintained reserves of approximately $13,500,000 as of December 31, 1996. The Company is currently in compliance with all applicable surplus and reserve requirements.
As warranty production increases, the Company's required reserve and surplus levels increase, which reduces the cash available to the Company to fund its operations. During 1996 the fees generated by the Company's membership continued to decline, and the Company continued to provide its Affiliates with various discounted membership options to maintain competitiveness in the marketplace. As a result of these factors, the Company's cash flow from membership operations has been significantly impacted. The Company expects that cash flow generated from its warranty and other operations, in combination with the cost saving measures implemented, will be sufficient to meet its normal operating needs on an ongoing basis. However, should the merger fail to be consummated by July 1, 1997, Cross Country will be entitled to take action to collect on its judgment. In the event the judgment creditor proceeds to execute on its judgment, it is likely that the Company will be without adequate resources to pay the full amount due to Cross Country, as holder of the judgment, which would become immediately due and payable. In such event, the Company would be forced to seek alternatives to paying the remaining unpaid balance of the judgment. No other alternatives are presently being considered.
See also Note 2, for discussion of the Company's cash collateral requirements relative to the 1993 transfer of its discontinued reinsurance operations and Note 10 for discussion of other commitments and contingencies impacting cash flow.
The Company announced on May 15, 1996 that it had entered into a definitive merger agreement (the "Merger") under which The Cross Country Group, Inc. ("Cross Country") agreed to acquire the Company for $2.35 per share in cash. The merger agreement stated that the merger was subject to a number of conditions including approval of the transaction by the Company's stockholders and regulatory authorities. The Company also announced on May 15, 1996 that it had reached an agreement to settle the judgment obtained by Acceleration National Insurance Company ("Acceleration" or "ANIC") by paying to Acceleration a reduced amount of approximately $4.4 million in cash at the closing of the merger, which Cross Country had agreed, as a condition to the merger, to satisfy.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- 1. THE COMPANY (Continued) - ------------------------------------------------------------------------------- On November 7, 1996, the Company, announced that it had entered into an amendment to the merger agreement with Cross Country, which, among other things, reduced the price at which Cross Country will acquire HOMG stock to $2.06 per share in cash. The amendment also extended the anticipated closing date to no later than March 1, 1997. In addition, the amendment modified the Company's stock rights plan to permit Cross Country and its affiliates to buy an unlimited number of shares in privately negotiated transactions. This stock rights plan amendment was not effective until three business days after the information was released, provided that no other bid for the Company was received within such three day period. The three day period passed with no other bids submitted to purchase the Company.
An affiliate of Cross Country purchased, for approximately $2.75 million, the $5.2 million judgment obtained by Acceleration (the "Judgment"). The purchase price of the judgment reflected a $1.4 million payment previously made by the Company. The Cross Country affiliate also agreed, under certain conditions, to take no action to collect on the Judgment before January 31, 1997.
On February 10, 1997, the Company entered into a second amendment to the merger agreement with Cross Country, which extended the anticipated closing date to the earlier of July 1, 1997 or termination of the merger agreement. The Company also entered into an amendment to the agreement with the affiliate of Cross Country which holds the Judgment, extending the date through which the Cross Country affiliate agreed, under certain conditions, to take no action to collect on the Judgment until the earlier of July 1, 1997 or termination of the merger agreement. The Company guaranteed the obligation of HMS and pledged the shares of HMS and another subsidiary to secure such guarantee. HMS and the subsidiary granted security interests in their assets as part of the First Amendment to the Merger Agreement.
As of the date of this filing, the Company has obtained regulatory approval for the merger in all states.
Management anticipates that the Merger will be approved by the majority of its stockholders at the special meeting to vote on the Merger, and that the various issues related to the judgment held by the Cross Country affiliate will be resolved by the consummation of the Merger.
2. DISCONTINUED REINSURANCE OPERATIONS - -------------------------------------------------------------------------------
In December 1992, the Company formed its own reinsurance subsidiary, POMG Insurance Company, Ltd. ('POMG'), which acquired certain net assets from Meridian Insurance Company, Ltd. ('Meridian'), the previous reinsurer of the Company's E&O program. In December 1992, the subsidiary purchased a $5,000,000 aggregate stop loss reinsurance policy to further protect it from the risk of loss in excess of a predetermined amount on the first two E&O policy years.
In the second and third quarters of 1993, the E&O program experienced significant losses. Effective December 1, 1993, Continental Casualty Company, ("CNA") replaced POMG as the reinsurer of the E&O policies issued through November 30, 1993 to the Company's Members by certain subsidiaries of American International Group, Inc. ("AIG"). This transaction took place through a novation of previous reinsurance agreements in effect. For policies issued from December 1, 1993 forward, CNA became the insurer, and the Company began marketing CNA policies to its Members through Victor O. Schinnerer and Company, Inc. ("Schinnerer"), CNA's exclusive program and underwriting manager. Pursuant to the agreement with CNA, the Company discontinued POMG's operations. The Company, through its HOMS Insurance Agency, Inc. ("HOMS") subsidiary acts solely in the capacity of an insurance broker. Under the terms of the agreements, the Company receives a fixed percentage of the E&O premiums collected as a commission. The Company pays a portion of these commissions to the Affiliates generating the premium volume. In February 1994, the Company, CNA and AIG entered into definitive agreements, effective as of December 1, 1993, setting forth the terms described above.
The Company is further obligated to pay CNA $5,000,000 (the 'CNA Obligation') over a period originally estimated to be three years and subsequently revised to be five years, toward the ultimate settlement of the transferred losses and expenses. CNA is maintaining a separate accounting for the POMG net assets. Additionally, a separate fund, the 'Holdback Fund,' has been established to accumulate the aforementioned $5,000,000 from the Company, additional funds to be contributed by Schinnerer and CNA over the same period, and investment income earned on these funds, to pay claims and expenses related to the reinsured policies in excess of the POMG net assets.
In connection with the transfer of the net assets of POMG to CNA and the assumption by CNA of the obligations of POMG under certain Realtor's errors and omissions policies, the Company guaranteed the performance by Sphere Drake Insurance, PLC ("Sphere Drake"), a third party reinsurance company, under a $5,000,000 reinsurance treaty purchased by POMG to protect it from losses in excess of a predetermined amount. Under the terms of the Company's guaranty, CNA, as the transferee of the reinsurance treaty, bears any credit risk under the treaty, including, but not limited to, any risk that Sphere Drake becomes insolvent, is adjudicated as a bankrupt or has liquidation or similar proceedings commenced against it. The reinsurance treaty represents amounts recoverable from a third party insurance company under the reinsurance treaty purchased by POMG. This guarantee is secured by $3,000,000 cash collateral posted by the Company. This amount is reported as restricted cash in the accompanying consolidated balance sheet. The Company has agreed, if necessary, to pay an additional $2,000,000, related to the guarantee, out of future commissions. On April 10,
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------
2. DISCONTINUED REINSURANCE OPERATIONS (Continued) - -------------------------------------------------------------------------------
1996, CNA issued a Notice of Arbitration to the reinsurer with respect to its refusal to honor the reinsurance treaty. The Company, CNA and Sphere Drake are engaged in settlement discussion with respect to the reinsurance treaty. Although terms are not finalized, it is possible that the Company could pay a substantial portion of the Collateral Account to CNA under the currently proposed settlement agreement. The potential settlement agreement is contingent upon the closing of the Merger. Should the Merger fail to be consummated, the potential settlement agreement will not be consummated and the Company and Sphere Drake will either continue arbitration or seek some other resolution of this issue. If the Merger is not consummated, the Company will continue to be contingently liable for the entire $5 million under the conditions described in the preceding paragraph. As a result of the settlement negotiations, the Company has recorded a loss provision of $2.5 million for the guarantee, which is included in the Discontinued Operations caption in the accompanying 1996 consolidated statements of operations. The restricted cash amount is presented net of the $2.5 million reserve in the 1996 consolidated balance sheets.
The agreements with CNA impose certain restrictive covenants until the $5,000,000 CNA Obligation is satisfied. These covenants include limits on dividends and on future borrowings. The funds due to CNA are a senior obligation of the Company, secured by an interest in the common stock of the Company's HOMS subsidiary and in the Company's Member list. For a five year period ending November 30, 1999, the Company and its Affiliates must provide CNA/Schinnerer with right of first refusal on E&O insurance offered to its membership. In addition to the restrictive covenants, the Company has agreed to meet certain production quotas with respect to annual premium volume. Based on the 1996 premium volume achieved, the Company is currently in default of the terms of the agreements as modified, and could be required by CNA to make a payment against its obligation to the Holdback Fund in the amount of approximately $200,000. However, the Company and CNA have entered into an amendment to the Holdback Agreement which would delete the premium volume quotas and release the Company from its current obligation to pay the remaining $3.1 million. Following the effective date of this amendment, the Company's obligation will be limited to the payment of 50% of actual commissions to CNA. The proposed amendment becomes effective if the Merger is consummated prior to July 1, 1997, and the dispute with Sphere Drake (as described above) is settled within 14 days of the consummation of the Merger.
On December 13, 1995, a jury verdict in the amount of $5,156,022 was rendered in favor of the Plaintiff and against Homeowners Marketing Services, Inc. ("HMS"), a subsidiary of the Company, in the following matter: Acceleration National Insurance Company, Plaintiff, vs. Homeowners Marketing Services, Inc., et al., Defendants, in the Court of Common Pleas of Franklin County, Ohio. This amount has been accrued as an adjustment to the Company's loss from discontinued reinsurance operation, and reported net of taxes in the amount of $2,036,629 in the accompanying consolidated income statements. See also note 10 regarding contingencies and anticipated resolution of this matter.
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - -------------------------------------------------------------------------------
PRINCIPLES OF CONSOLIDATION -- The accompanying consolidated financial statements include the accounts of HOMG and all of its majority owned subsidiaries. All significant intercompany transactions have been eliminated in consolidation. The Company's 45% interest in the partnership enrolling and servicing Members in Texas is accounted for by the equity method. The earnings from the partnership are included in operating revenue in the accompanying consolidated statements of operations.
ACCOUNTING ESTIMATES -- The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
REVENUE AND EXPENSE RECOGNITION -- Home warranty contract revenue is recognized over the life of the contract (generally one year) in proportion to historical experience of repair costs. Direct costs incurred in acquiring the contracts are recognized in the same manner. Direct acquisition costs include certain additional expenses, such as incentive bonuses paid to the Company's Members and Affiliates, costs of personnel directly involved in acquiring the contracts, and premium taxes. Repair costs under home warranty contracts are expensed as mechanical breakdowns are reported to and repairs are authorized by the Company. Initial and renewal membership fees and associated commission expenses are deferred upon collection of the fees and are recognized over the life of the membership period, generally one year. E&O premium commissions are recognized upon collection of the related premiums. All other revenues and expenses are recognized upon delivery or receipt of the related products or services.
PROPERTY AND EQUIPMENT -- Property and equipment is carried at cost and depreciated on the straight-line method over their estimated useful lives, which range from three to seven years. Leasehold improvements are amortized over the shorter of the lease term or the estimated useful lives of the improvements.
INVESTMENTS -- The Company accounts for its investments according to Statement of Financial Accounting Standards ('SFAS') No. 115, 'Accounting for Certain Investments in
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) - -------------------------------------------------------------------------------
Debt and Equity Securities.' This standard requires that the Company report at fair value the securities which are held for trading purposes, or which are available for sale. Unrealized holding gains and losses on trading securities are determined based upon the change in fair value and are included in investment income in the accompanying consolidated statements of operations. Unrealized holding gains on securities available for sale are also determined based upon the changes in fair values, and are reported net of tax as a separate component in the stockholders equity section of the balance sheet. Gains and losses on securities are determined based upon specific identification of the securities sold. The Company does not currently have any securities which are classified as held to maturity.
INCOME TAXES -- Income taxes are provided in accordance with SFAS No. 109, 'Accounting for Income Taxes.' Under this standard, deferred tax assets and liabilities represent the tax effects, based on current tax law, of future deductible or taxable amounts attributable to events that have been recognized in the financial statements.
FOREIGN CURRENCY TRANSLATION -- The financial statements of the Company's previous 80% owned British subsidiary are translated into US dollars in accordance with SFAS No. 52, 'Foreign Currency Translation.' Net assets of the subsidiary, whose functional currency is the British Pound Sterling, are translated at current exchange rates, while results of operations are translated at average exchange rates in effect for the year.
NET INCOME PER COMMON SHARE -- Net income per common share is based upon the weighted average number of common shares outstanding during each year. Dilutive stock options and warrants are included in the calculation of weighted average shares utilizing the Treasury Stock Method. Primary and fully diluted earnings per share are essentially the same in all years presented in the accompanying consolidated statements of operations.
DISCONTINUED OPERATIONS -- The Company reviews the liabilities recorded in association with its 1993 discontinued reinsurance operations annually, and adjusts the balances as necessary. In 1995 and 1994, the Company revised its estimate of the net present value of the CNA obligation, based upon the actual payments remitted during each year, and in 1994, to reflect an estimated repayment term of five years, as opposed to the original estimated term of three years. This change in estimate resulted in an increase in the discount on the obligation, which will be amortized to interest expense over the life of the obligation. Further, in both years, the Company revised its estimate of expenses incurred relative to the reinsurance portfolio transfer, and recorded an adjustment for the additional balances due. The net effect of these two adjustments had no impact on the Company's consolidated results of operations. In 1996, this evaluation did not result in any adjustment.
FRANCHISING FEE REVENUE -- The Company records franchising fee revenue in accordance with SFAS No. 45, 'Accounting for Franchise Fee Revenue.' Under this standard, franchising revenue is recorded when all material services or conditions related to the sale are complete, substantially all of the initial services of the franchisor required by the franchise agreement are complete, and no other material conditions or obligations related to the determination of substantial performance exist.
STOCK-BASED COMPENSATION -- SFAS No. 123 'Accounting for Stock-Based Compensation', encourages, but does not require companies to record compensation cost for stock-based employees and non-employee members of the Board compensation plans at fair value. The Company has chosen to continue to account for stock-based compensation to employees and non-employee members of the Board using the intrinsic value method as prescribed by Accounting Principles Board Opinion ("APB") No. 25, 'Accounting for Stock Issued to Employees', and related interpretations. Accordingly, compensation cost for stock options issued to employees and non-employee members of the Board are measured as the excess, if any, of the fair value of the Company's stock at the date of grant over the amount an employee or non-employee member of the Board must pay for the stock.
RECLASSIFICATIONS -- Certain amounts in the accompanying 1995 and 1994 consolidated financial statements have been reclassified from amounts previously reported to conform to the current presentation.
4. UNITED KINGDOM OPERATIONS - -------------------------------------------------------------------------------
The 1994 general and administrative expenses incurred by the Company's previous 80% owned British subsidiary approximated $777,000, and are included in the accompanying 1994 consolidated statements of operations. Operating revenue generated by the subsidiary in 1994 approximated $16,000. During the third quarter of 1994, the Company ceased funding this operation, effectively closing down the subsidiary. See further discussion of this transaction at Note 10.
5. PROPERTY AND EQUIPMENT - -------------------------------------------------------------------------------
Property and equipment consists of the following at December 31: 1996 1995 ---- ---- Office furnishings and equipment $1,130,428 $1,497,939 Leasehold improvements 529,600 713,970 Computer equipment and software 4,608,420 3,985,487 Automobiles 47,533 47,533 Assets held under capital lease 1,204,804 499,032 ---------- ---------- Total 7,520,785 6,743,961 Accumulated depreciation and amortization (3,117,755) (3,162,068) ----------- ----------- Property & equipment--net $4,403,030 $3,581,893 =========== ===========
Depreciation and amortization expense on property and equipment for the years ended December 31, 1996, 1995 and 1994 approximated $959,000, $602,000 and $749,000, respectively, and is included in general and administrative expenses in the accompanying consolidated statements of operations. In 1996, in connection with the Company's
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------
5. PROPERTY AND EQUIPMENT (Continued) - -------------------------------------------------------------------------------
change in corporate office locations, the Company disposed of office furniture and equipment having a net book value of approximately $120,000, for which it received only nominal proceeds. A charge for the net book value of the disposed assets is included in other income (expense) in the accompanying consolidated statements of operations.
6. INVESTMENTS - -------------------------------------------------------------------------------
Investments consist of the following at December 31:
1996 1995 ---- ---- Trading securities, at fair value $4,927,225 $9,250,349 Current securities available for sale, at fair value 507,050 1,811,624
Non-current securities available for sale, consisting primarily of debt securities, at fair value 7,417,599 1,834,981 ----------- ----------- Total carrying value of investments $12,851,874 $12,896,954 =========== ===========
Information with respect to unrealized holding gains and losses and securities classified as available for sale, as of December 31, 1996 and 1995 is as follows:
GROSS AMORTIZED UNREALIZED HOLDING FAIR COST GAINS LOSSES VALUE ---------- ---------- -------- ---------- Money markets $ 221,560 $ - $ - $ 221,560 US Gov't obligations 6,331,527 69,185 5,567 6,395,145 Corporate bonds 403,122 6,308 1,659 407,771 Municipal bonds 895,000 5,173 - 900,173 ---------- ---------- -------- ---------- Total $7,851,209 $ 80,666 $7,226 $7,924,649 ========== ========== ======== ========== Money markets $ 651,014 $ - $ - $ 651,014 US Gov't obligations 1,051,167 37,555 - 1,088,722 Corporate bonds 961,462 50,958 1,464 1,010,956 Municipal bonds 895,000 913 - 895,913 ---------- ---------- -------- ---------- Total $3,558,643 $ 89,426 $1,464 $3,646,605 ========== ========== ======== ==========
Information with respect to unrealized holding gains and losses and trading securities, as of December 31, 1996 and 1995 is as follows:
GROSS AMORTIZED UNREALIZED HOLDING FAIR COST GAINS LOSSES VALUE ---------- ---------- -------- ---------- Mutual funds $4,423,627 $ 54,336 $155,564 $4,322,399 Partnership holding 570,070 34,756 - 604,826 ---------- ---------- -------- ---------- Total $4,993,697 $ 89,092 $155,564 $4,927,225 ========== ========== ======== ========== Mutual funds $8,419,962 $ 234,985 $ 22,404 $8,632,543 Partnership holding 550,000 67,806 - 617,806 ---------- ---------- -------- ---------- Total $8,969,962 $ 302,791 $ 22,404 $9,250,349 ========== ========== ======== ========== Mutual funds $8,011,093 $ - $371,509 $7,639,584 Partnership holding 550,000 51,825 - 604,825 ---------- ---------- -------- ---------- $8,561,093 $ 51,825 $371,509 $8,244,409 ========== ========== ======== ==========
Gross realized gains and losses from sales of securities available for sale totaled $19,717 and $5,497, respectively for the year ended December 31, 1996. Gross realized gains from sales of securities available for sale totaled $106,139 for the year ended December 31, 1995. Gross unrealized holding gains and losses from sales of securities available for sales totaled $1,744 and $143,774, respectively, for the year ended December 31, 1994. Gains and losses on securities are determined based upon specific identification of the securities sold.
Contractual maturities of securities classified as available for sale as of December 31, 1996 are as follows:
AMORTIZED FAIR COST VALUE --------- ---------- Due in one year or less $508,262 $507,050 Due after one year through five years 7,112,926 7,187,353 Due after five years 230,021 230,246 ---------- ---------- Total securities classified as available for sale $7,851,209 $7,924,649 ========== ==========
At December 31, 1996, treasury bonds, municipal bonds and cash deposits in the amount of $1.2 million were held by various state regulatory agencies to assure performance of the Company's obligations under home warranty contracts.
7. INCOME TAXES - -------------------------------------------------------------------------------
Income (loss) from continuing operations before income taxes consists of the following for the years ended December 31:
1996 1995 1994 ---- ---- ---- Domestic ($1,597,002) $2,207,689 $18,735 Foreign - - (760,957) ----------- ---------- ---------- Total ($1,597,002) $2,207,689 ($742,222) ------------ ---------- ----------
The provision (benefit) for income taxes consists of the following for the years ended December 31:
1996 1995 1994 ---- ---- ---- Continuing Operations: Current: Federal ($70,000) $501,776 ($1,678,495) State (130,125) 53,000 19,031 ---------- ------- ---------- Total (200,125) 554,776 (1,659,464) Deferred (358,566) 292,323 1,575,345 ---------- -------- ---------- Total provision (benefit) on income from continuing operations (558,691) 847,099 (84,119) Discontinued Operation: Tax benefit from loss on operation of discontinued reinsurance segment (940,750) (1,940,211) - ---------- ----------- ---------- Total provision (benefit) for income taxes ($1,499,441) ($1,093,112) ($84,119) =========== ============ ==========
Tax benefits resulting from the 1993 operations of the Company's discontinued reinsurance subsidiary have been carried back to the prior three years for refunds of taxes paid in those years. The remaining tax benefits from the 1993 losses generated by the discontinued operation and the 1994 unusual charges will be carried forward for realization in future years. Based upon management's analysis of the positive and negative evidence regarding the likelihood of realization of this asset, a valuation allowance was deemed to be unnecessary.
The Company historically has provided deferred income taxes primarily on deferred home warranty contract revenues and acquisition costs, which are recognized for tax purposes before recognition in the financial statements. The Company also provides deferred income taxes on deferred marketing fee revenue and expenses under the annually funded E&O
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------
7. INCOME TAXES (Continued) - -------------------------------------------------------------------------------
programs. The major portion of these benefits reverse within one year. The components of the net deferred income tax assets are as follows:
1996 1995 ---------- ---------- Deferred home warranty revenue $6,686,461 $6,414,575 Deferred home warranty acquisition costs (2,309,536) (2,238,425) Litigation accrual 1,460,634 2,036,628 Deferred member fee revenue 312,457 487,601 Deferred member fee commissions (124,077) (191,052) Current portion of provision for loss on disposal of reinsurance operation 273,213 493,750 Miscellaneous 37,450 (106,157) ---------- ---------- Current portion of deferred income tax asset 6,336,602 6,896,920 Non-current portion of provision for loss on disposal of reinsurance operation 884,060 991,855 Provision for reinsurance recoverable 940,750 - NOL tax carryforward 1,528,737 342,292 Capitalized software (812,597) (659,554) AMT credit 699,015 699,015 ---------- ---------- Total deferred income tax asset $9,576,567 $8,270,528 ========== ==========
Realization of the deferred tax asset is dependent on generating sufficient taxable income during the carryforward periods. Although realization is not assured, management believes it is more likely than not that all of the deferred tax asset will be realized. The amount of the deferred tax asset considered realizable, however, could be reduced in the near term, if estimates of future taxable income during the carryforward period are reduced. In reaching this determination, management reviewed the Company's historical performance, and projections of future results, should the Company's performance continue at the current level, exclusive of non-recurring events and transactions. These projections provided positive evidence of future probable realization of the full tax asset within the prescribed carryforward time frame. The projected realization also considered the negative impact of charges which could result from adverse resolution of certain outstanding contingencies; most notably the Company's guarantee to CNA of a $5 million reinsurance recoverable, related to the transfer of the POMG net assets. Negative evidence reviewed consisted of several non-recurring charges incurred by the Company over the past three years. As each of these charges was deemed to be unusual in nature, each of them different from the other, and there was no expectation of future recurrences of such items, the positive evidence was determined to outweigh the negative evidence.
The provision (benefit) for income taxes on income from continuing operations included in the accompanying consolidated statements of operations differs from the provision (benefit) computed using the statutory federal income tax rate (34%), due to the effects of the following items:
- ------------------------------------------------------------------------------- 8. LONG TERM DEBT - -------------------------------------------------------------------------------
Long term debt consists of the following at December 31:
1996 1995 ---- ---- Net present value of obligation to CNA, discounted at 6% $3,075,397 $3,601,513 Obligations under capital leases 966,637 319,166 Other notes payable, due in monthly installments of $3,472 plus interest 90,278 208,507 ------ ------- Total 4,132,312 4,129,186
Less current portion 1,191,601 (1,537,257) ----------- ----------- Long term debt, net of current portion $2,940,711 $2,591,929 ========== ==========
Estimated aggregate annual maturities of long term debt are as follows:
YEAR MATURITIES ---- ---------- 1997 1,191,601 1998 2,668,720 1999 271,991
In connection with the CNA program, the Company is obligated to pay CNA $5 million. The Company makes payments against this obligation through reductions in the commission it earns on the premiums generated under the program (see Note 2). Accordingly, the Company has agreed to meet certain premium volume quotas (the "Quotas"), on an annualized basis, which will ensure that the obligation is paid in full over the term of the agreement, with scheduled minimum repayments. If, on an annualized basis, premium volume falls below the Quotas, a cash payment equal to 5% of the difference between actual premium volume and the Quotas must be made to CNA to be applied against the obligation to CNA. Additionally, there are specified minimum premium volume levels (the "Levels") which must be attained. If E&O premiums fall below the Levels, CNA may review the program, give the Company an opportunity to address the issue and then, at its option, may stop the program and take ownership of the Company's expiration list, and the Company may still be required to make a cash payment equal to 5% of the difference in the actual premium volume and the Quotas, to be applied against the obligation to CNA. As a result of the Company's failure in 1995 to meet the minimum Levels, in March 1996, the Company and CNA amended the agreement, waiving the minimum Levels. In
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------
8. LONG TERM DEBT (Continued) - -------------------------------------------------------------------------------
addition, the Quotas were modified to $17 million in 1995, $18 million in 1996, and $20 million for each year thereafter. The agreement to market CNA insurance exclusively to its membership was extended through December 31, 1999. As of December 31, 1996, the balance due CNA totaled approximately $3.1 million. The Company is currently in default, as it has failed to achieve the minimum Quotas, and the Company could be required by CNA to make a payment against its obligation to the Holdback Fund in the amount of approximately $200,000. However, the Company and CNA have entered into a further amendment to the Holdback Agreement which would delete the Quotas and the Levels, and release the Company from its current obligation to pay the remaining $3.1 million. Following the effective date of this amendment, the Company's obligation will be limited to payment of 50% of actual commissions to CNA. The proposed amendment becomes effective if the Merger is consummated prior to July 1, 1997, and the dispute with Sphere Drake (See Note 2) is settled within 14 days of the consummation of the Merger.
Estimated annual repayments of the CNA obligation are based on anticipated premium volume. In 1995 and 1994, the Company revised its estimate of the net present value of the CNA obligation, based upon the actual payments remitted in each year, and in 1994, to reflect an estimated repayment term of five years, as opposed to the original estimate of three years. This change in estimate resulted in an increase in the discount on the obligation, which will be amortized to interest expense over the life of the obligation. The funds due to CNA, which are recorded at net present value, are a senior obligation of the Company, secured by an interest in the common stock of the Company's HOMS subsidiary and in the Company's Member list.
9. UNUSUAL ITEMS - -------------------------------------------------------------------------------
In 1996, the Company reported approximately $677,000 in the "Unusual Items" caption in its consolidated statements of operations, related to several infrequently occurring events that occurred in 1996. Specifically, in the third quarter of 1996, the Company terminated its Agency Agreement and Administration contract with New Hampshire Insurance Company ("NHIC"), as it determined that it no longer desired to carry the program previously negotiated with NHIC. As part of the termination arrangement, the Company has paid approximately $260,000 to NHIC, and has also agreed to indemnify NHIC for all claims incurred under contracts issued during the time the agreements were in effect by paying for all claims on covered components which may be reported under such contracts, as if the arrangement with NHIC had not taken place. To the extent that claims have been paid or reported on these contracts, such amounts have been included in the "Direct costs" caption in the Company's consolidated statements of operations, and any related accrual for unpaid amounts is included in the "Accounts payable" caption in the consolidated balance sheets. In addition, effective September 15, 1996, in conjunction with its plans for future organization and growth, the Company terminated an employment contract with one of its officers, and has agreed to pay the former officer severance and related benefits totaling approximately $157,000 through the month of July 1997. In the fourth quarter of 1996, in connection with the Company's plan to improve the operating results of its Corporate Owned Regions, the employment of three regional managers of the Company's Corporate Owned Regions was terminated, and the California office was closed. In connection with these changes, the Company agreed to pay amounts totaling approximately $190,000 for severance and related benefits and $70,000 for rent on the California office. Charges for these items are included in the accompanying consolidated statements of operations under the caption "Unusual Items". At December 31, 1996, approximately $283,000 of the charges for unusual items remained accrued and unpaid. There were no adjustments to the liability other than to reflect payments made under the terms of the agreements.
During September 1994, the Company recorded unusual charges totaling $1,787,355. These charges represent expenses related to a reduction in the Company's workforce and the closing of its UK operations.
In early September 1994, the Company underwent an organizational restructuring, reducing its total work force by approximately 20%, or 40 employees, including clerical staff, supervisors, managers and executives. This restructuring is expected to result in annual cost savings of approximately $1,700,000, through reductions in salary, benefits and payroll tax expenses. The charge, consisting of payroll, related taxes and benefits of the terminated employees, and included in the `Unusual items' caption in the accompanying consolidated statements of operations, totaled approximately $1,063,000. Approximately $400,000 of this total related to an agreement to terminate the employment contract between the Company and its former Chairman of the Board of Directors. The plan to terminate employees was approved and carried out prior to September 30, 1994. The benefit arrangement awarded to the terminated employees was within the Company policy, or according to employment contracts with certain employees. As of December 31, 1994, approximately $923,000 had been paid against the liability, and $140,000 remained accrued and unpaid. There were no adjustments to the liability other than to reflect payments to terminated employees.
The Company, in the third quarter of 1994 ceased funding HGC. One time charges for severance pay of $80,000, the balance due under the subsidiary's lease agreements and other obligations of $371,000 and write-off of the subsidiary's net assets of $273,000, for a total of approximately $724,000, is included in the 'Unusual items' caption in the accompanying consolidated statements of operations. In 1995, the Company
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- 9. UNUSUAL ITEMS (Continued) - -------------------------------------------------------------------------------
liquidated the subsidiary and negotiated reduced payments in full settlement of the balances owed, resulting in payment of approximately $175,000. The remaining accrued balance of $276,000 was reversed, and reflected in net income in the year ended December 31, 1995.
- ------------------------------------------------------------------------------- 10. COMMITMENTS AND CONTINGENCIES - -------------------------------------------------------------------------------
The Company is currently undergoing an examination by the Internal Revenue Service of its tax returns for the years 1993, 1994 and 1995, which could result in the proposal of significant adjustments to its taxes in those years. The Company believes that the returns as originally filed are correct in all material respects.
The Company is subject to various lawsuits and claims arising in the normal course of business. In the opinion of management, the resolution of these matters will not have a material adverse effect on the Company's consolidated financial position or results of operations.
The Company currently rents office space in Sunrise, Florida, under a lease which expires on December 31, 2005. The lease requires annual increases of 3% of the base rent per square foot through the end of the lease term plus actual maintenance expenses and property tax increases. The Company also leases office space in one of the Corporate-Owned Regions for a remaining term of three years. Future minimum annual rental payments approximate $353,241 in 1997, $347,481 in 1998, $345,191 in 1999, $330,316 in 2000, $311,306 in 2001, and $1,702,347 thereafter. Rental expense for 1996, 1995 and 1994 approximated $593,000, $563,000 and $601,000, respectively, and is included in general and administrative expenses in the accompanying consolidated statements of operations.
On December 13, 1995, a jury verdict in the amount of $5,156,022 was rendered in favor of the Plaintiff and against Homeowners Marketing Services, Inc. ("HMS"), a subsidiary of the Company, in the following matter: Acceleration National Insurance Company, Plaintiff, vs. Homeowners Marketing Services, Inc., et al., Defendants, in the Court of Common Pleas of Franklin County, Ohio. The causes of action included breach of contract, unjust enrichment, and negligent misrepresentation. Under the Acceleration program, the Company bore reinsurance risk through the letters of credit that it was required to post as collateral to be drawn upon in the event that the assets in the reinsurance pool, together with investment income earned thereon were insufficient to cover the claims and related expenses incurred. With the change in carriers to CNA in 1993, the Company removed itself from any risk bearing position in connection with the claims reported under its E&O program, and currently no longer operates in this capacity. Accordingly, the judgment amount was reported in discontinued operations in the accompanying consolidated statements of operations.
Under the terms of the Merger Agreement, Cross Country agreed to pay the balance due to Acceleration National Insurance Company ("ANIC") under a settlement agreement, upon closing of the Merger. Pursuant to the settlement agreement, on September 4, 1996, the Company paid to ANIC the full amount of its 1994 federal income tax refund, together with interest, which totaled $1,401,485. The remaining balance due bears interest at the rate of 10% per annum from September 1, 1996 until the settlement amount is paid in full. An affiliate of Cross Country purchased the judgment from ANIC as of October 31, 1996, for approximately $2.75 million. The Cross Country affiliate agreed, under certain conditions, to take no action to collect on the judgment before January 31, 1997. In January 1997, under a second amendment to the merger agreement, the Cross Country affiliate extended the date until which it agreed to take no action to collect on the judgment to July 1, 1997, or failure to consummate the merger. The Company guaranteed the obligation of HMS and pledged the shares of HMS and another subsidiary of the Company to secure such guarantee. HMS and the subsidiary granted security interests in their assets as part of the First Amendment to the Merger Agreement.In the event the judgment creditor proceeds to execute on its judgment, it is likely that the Company will be without adequate resources to pay the full amount due to Cross Country, as holder of the judgment, which would become immediately due and payable. In such event, the Company would be forced to seek alternatives to paying the remaining unpaid balance of the judgment. No other alternatives are presently being considered. The judgment, which accrues interest at the rate of 10% per annum, is recorded in discontinued operations in the accompanying consolidated statements of operations, and is separately stated in the accompanying consolidated balance sheets.
In February 1996, a lawsuit was filed against the Company in the Court of Common Pleas of Bucks County, Pennsylvania, by the former franchisee of the Pennsylvania territory, alleging breach of contact, fraud and misrepresentation, and seeking damages in the amount of $50,000, trebled, reimbursement of costs and attorney's fees, and an injunction to prevent the Company from terminating the franchise agreement. In March, 1997, this suit was settled for $110,000, the charge for which is reflected in other income (expense) in the accompanying consolidated statements of operations.
The Company has entered into various employment contracts with certain of its executive officers and management personnel, which provide for salary continuation of a minimum of six months in the event of termination without cause. In addition, the Company entered into an agreement with an officer in December 1995, which provides for annual compensation of $377,211, adjusted for changes in the Consumer Price Index, through December 31, 2000, with an automatic three year extension, unless notice of termination is given by either party six months prior to the termination of the initial term. The agreement also contains a change in control provision that would entitle the officer to receive a minimum of 2.99 times the annual compensation. The agreement also calls for certain other fringe benefits during the term of the agreement.
The Company also entered into an engagement agreement with a director, to provide legal services to the Company for a one year period. The agreement calls for a minimum payment of a non-refundable $100,000 retainer.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- 10. COMMITMENTS AND CONTINGENCIES (Continued) - ------------------------------------------------------------------------------- In connection with the transfer of the net assets of POMG to CNA and the assumption by CNA of the obligations of POMG under certain Realtor's errors and omissions policies, the Company guaranteed the performance by Sphere Drake Insurance, PLC ("Sphere Drake"), a third party reinsurance company, under a $5,000,000 reinsurance treaty purchased by POMG to protect it from losses in excess of a predetermined amount. Under the terms of the Company's guaranty, CNA, as the transferee of the reinsurance treaty, bears any credit risk under the treaty, including, but not limited to, any risk that Sphere Drake becomes insolvent, is adjudicated as a bankrupt or has liquidation or similar proceedings commenced against it. This guarantee is secured by $3,000,000 cash collateral posted by the Company. This amount is reported as restricted cash in the accompanying consolidated balance sheet. The Company has agreed, if necessary, to pay an additional $2,000,000, related to the guarantee, out of future commissions. On April 10, 1996, CNA issued a Notice of Arbitration to the reinsurer with respect to its refusal to honor the reinsurance treaty. The Company, CNA and Sphere Drake are engaged in settlement discussions with respect to the reinsurance treaty. Although terms are not finalized, it is possible that the Company could pay a substantial portion of the Collateral Account to CNA under the currently proposed settlement agreement. As a result of the settlement negotiations, the Company has recorded a loss provision of $2.5 million for the guaranty in its consolidated statements of operations for 1996. Should the Merger fail to be consummated, the potential settlement agreement will be null and void, and the Company will continue to be contingently liable for the entire $5 million under the conditions described in the preceding paragraph. In such event, the Company will attempt to negotiate a settlement but there can be no assurance that it will be successful in such efforts. As a result of the settlement negotiations, the Company has recorded a loss provision of $2.5 million against the guarantee, which is included in the Discontinued Operations caption in the accompanying 1996 consolidated statements of operations. The restricted cash amount is presented net of the $2.5 million reserve in the 1996 consolidated balance sheets. See also Note 2.
11. STOCK OPTIONS, WARRANTS AND PURCHASE RIGHTS - ------------------------------------------------------------------------------- The Company adopted stock option plans in 1988 authorizing issuance of up to 600,000 shares of common stock to officers and other employees. Of the authorized shares, 300,000 may be issued as 'incentive stock options' within the meaning of Section 422 of the Internal Revenue Code, and 300,000 may be issued as non-qualified options. The options issued through 1992 generally become exercisable two years after the date of grant and expire no later than ten years after the date of grant. The options issued in 1993 generally become exercisable over a five year period, beginning on the date of grant. Information with respect to options under the above plans follows:
OPTION PRICE AVAILABLE STOCK OPTIONS PER SHARE OUTSTANDING EXERCISABLE FOR GRANT - ------------------------------------------------------------------------------- At December 31, 1993 4.00 - 9.75 558,550 206,050 38,450
Granted 2.00 80,000 (80,000) Became exercisable 5.75 75,900 Canceled 4.00 - 9.75 (156,250) (43,650) 156,250 ----------- -------- -------- -------
At December 31, 1994 2.00 - 9.00 482,300 238,300 114,700
Granted 2.00 240,000 (240,000) Became exercisable 2.00 203,000 Canceled 2.00 - 3.00 (286,600) (224,600) 286,600 ----------- -------- -------- -------
At December 31, 1995 $2.00 435,700 216,700 161,300 =========== ======== ======== =======
Became exercisable 2.00 30,500 Canceled 2.00 (1,900) (500) 1,900 ----------- -------- -------- -------
At December 31, 1996 $2.00 433,800 246,700 163,200 =========== ======== ======== =======
The Company applies APB No. 25 and related interpretations in accounting for its stock option plan to employees and non-employee members of the Board as described in Note 3. Accordingly, no compensation expense has been recognized in the year ended December 31, 1996 related to this plan. Had compensation costs for the Company's stock option plans been determined based upon the fair value at the grant date for awards under these plans consistent with the methodology prescribed under SFAS 123, 'Accounting for Stock-Based Compensation,' the Company's pro forma net loss for 1995 would have been $2,660,340. Pro forma primary and fully diluted loss per share for 1995 would have been $0.48. There were no options granted in 1996. The weighted average fair value of options granted during 1995 was estimated at $2.38, based upon the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions; no dividend yield, expected volatility of 47.7%, tax free interest rate of 5.78% and expected lives of five years.
In May 1992, effective September 1991, the Company adopted a non-employee directors' stock option plan authorizing issuance of up to 300,000 shares of common stock. Options under this plan become exercisable annually over the five years following the date of grant and expire no later than ten years after the date of grant. Options for 75,000 shares were granted at $6.50 per share on September 26, 1991, 67,500 of which remain outstanding at December 31, 1996; options for 25,000 shares were granted at $5.50 per share on January 28, 1993, all of which remain outstanding at December 31, 1996; options for 25,000 shares were granted at $3.375 per share on September 23, 1993, which have since been canceled; and options for 25,000 shares were granted at $0.75 per share on December 22, 1995, all of which remain outstanding at December 31, 1996. Options for 87,500 shares are exercisable at December 31, 1996.
The following table summarizes information about stock options outstanding as of December 31, 1996:
In 1991, the Company issued five-year stock purchase warrants for 25,000 shares to an outside director. These warrants were for $10.80 per share, expired April 11, 1996; none had been exercised. In 1990, the Company declared a dividend of one right for each share of common stock outstanding as of November 12, 1990. The rights will be distributed and become immediately exercisable upon the earlier of 10 days following a public announcement that a person or group of affiliated persons has acquired the rights to acquire beneficial ownership of 20% or more of the Company's outstanding shares or 10 days following the commencement of a tender offer or exchange offer that would result in a person or affiliated group beneficially owning 30% or more of the outstanding shares. Each right permits the holder to acquire one share of common stock for a price of $30 per share. The rights may be redeemed by the Company at any time prior to the tenth day after the acquisition of 20% of the outstanding shares or the announcement of an offer for 30% of the outstanding shares. Upon the occurrence of certain events after the rights become exercisable, each right
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------
11. STOCK OPTIONS WARRANTS AND PURCHASE RIGHTS (Continued) - -------------------------------------------------------------------------------
would, subject to certain adjustments and alternatives, entitle the holder to purchase common stock of the Company or the acquiring entity having a market value of twice the $30 exercise price of the right (except that acquiring persons would not be able to exercise the rights).
In connection with the amendment to the definitive merger agreement with Cross Country, the Company's stock rights plan was modified to permit Cross Country and its affiliates to buy an unlimited number of shares in privately negotiated transactions. This stock rights plan amendment was not effective until three business days after the information was released, or November 7, 1996, provided that no other bid for the Company was received within such three day period. The three day period passed with no other bids submitted to purchase the Company.
The rights are intended to enable all of the Company's stockholders to realize the long term value of their investment in HOMG. They will not prevent a takeover, but should encourage anyone seeking to acquire the Company to negotiate with the Board of Directors prior to attempting the takeover. The rights will expire at the close of business November 1, 2000.
In December 1994, the Company repriced all outstanding options to $2.00 per share, with the exception of the options granted to the current Chairman and the former Chairman of the Board of Directors and the Chief Financial Officer. The options granted to the Chief Financial Officer were repriced to $3.00 per share. The options granted to the former Chairman were canceled effective January 1995. Upon such cancellation, 100,000 options were granted to the current Chairman of the Board, at $3.00 per share. In December 1995, all of the options granted to the Chief Financial Officer were repriced to $2.00 per share. Also in December 1995, 140,000 options granted to the Chairman from 1988 through 1992 were canceled, and replaced by a new grant of 140,000 options, exercisable for a ten year period at $2.00 per share.
- ------------------------------------------------------------------------------- 12. QUARTERLY FINANCIAL RESULTS (UNAUDITED) - -------------------------------------------------------------------------------
FIRST SECOND THIRD FOURTH QUARTER QUARTER QUARTER QUARTER ------- ------- ------- ------- (In thousands except per share amounts)
Operating revenue $10,415 $11,575 $12,054 $11,387 Loss from continuing operations before income taxes (360) (25) (140) (1,072) Net (loss) from continuing operations (230) (13) (97) (699) Loss from discontinued operation -- -- -- (1,559) Net loss ($230) ($13) ($97) ($2,258) Per share data: Net income (loss) from continuing operations ($0.04) $0.00 ($0.02) ($0.13) Loss from discontinued operation -- -- -- (0.28) Net loss ($0.04) ($0.00) ($0.02) ($0.41)
In the fourth quarter of 1996, the Company recorded unusual charges for certain employee contract terminations and for its California office closing, in the approximate amount of $260,000. Also, in the fourth quarter, the Company charged to expense the balance due from its 50% Internet access provider joint venture in the amount of $150,000, and accrued $110,000 related to a lawsuit settlement with a former franchisee. The fourth quarter 1996 loss from discontinued operation consists of a provision of $2,500,000, related to the Sphere Drake reinsurance recoverable, for which the Company has guaranteed to CNA the validity of the reinsurance treaty. See also Note 10.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The names, ages and positions of all directors and executive officers of the Company as of March 25, 1997 are listed below, followed by a brief account of their business experience during the past five years. Directors are elected at the Company's Annual Meeting of Stockholders and serve three years or until their successors are elected and qualified. All of the Company's five directors listed below are currently serving three-year terms. There are no family relationships among directors or executive officers of the Company. All non-employee directors are currently compensated at the rate of $3,500 for each Board meeting attended. The Board met four times in 1996 and all Directors in office at the time of such meetings attended all of the meetings. The directors of the Company are as follows:
Mr. Lipson has been an attorney in the South Florida area for more than 19 years. From May 1993 to December 1996, he served as Chairman of the Board of KMG Fiber Optics, Inc., a manufacturer and distributor of fiber optic cable. From January, 1988 through March 1996, he served as Chairman of the Board of Spring Water, Ltd., a distributor of bottled water in South Florida. From November, 1988 to September, 1991, he served as a Vice President of Montenay International Corp., which is primarily engaged in the design, construction and operation of waste-to-energy facilities.
Mr. Buccellato has been President and Chief Executive Officer of the Company since May, 1992 and Chairman of the Company since September, 1994. Prior to May, 1992, he served as Chief Operating Officer. Mr. Buccellato currently serves as President and Chief Executive Officer of Homeowners Marketing Services, Inc. ("HMS"), a wholly owned subsidiary of the Company. Mr. Buccellato holds various executive positions in other subsidiaries of the Company and was Secretary of the Company until January, 1993.
Dr. Nocero is a practicing cardiologist with the Central Florida Cardiology Group in Orlando, Florida and is a Diplomate of the American Board of Internal Medicine and Cardiovascular Diseases. Dr. Nocero is on the Board of Trustees of The American College of Cardiology and formerly served as the Chairman of the Board of the American College of Cardiology.
Ms. Gruber has been in the real estate and insurance industries for more than thirty years. She is a licensed life, health and property and casualty insurance broker. Ms. Gruber, along with her spouse, owns 100% of the stock of the firm that is the Company's franchisee for Rhode Island and Connecticut, and 50% of the stock of the firm that is the Company's franchisee for
Maine, Vermont, New Hampshire and Massachusetts. She is Executive Vice President of the Company's franchisee for New Jersey/New York.
Mr. Stewart served as the Chairman of the Company from June, 1988 to September, 1994. Mr. Stewart served as President and Chief Executive Officer from incorporation until May, 1992. He has served as a Director of HMS since its formation in 1980. The Company was organized to become the holding company for HMS and its subsidiaries in 1988. Mr. Stewart has also held various executive positions in HMS and other subsidiaries of the Company.
EXECUTIVE OFFICERS
C. Gregory Morris, 42, has been the Vice President, Treasurer and Chief Financial Officer of the Company since October, 1992. Prior to that he was Vice President of Finance and Administration of Arby's, Inc.
COMPLIANCE WITH SECTION 16(A) OF THE SECURITIES EXCHANGE ACT OF 1934
Section 16(a) of the Securities Exchange Act of 1934 requires the Company's directors and officers and any persons who own more than ten percent of a registered class of the Company's equity securities, to file with the Securities and Exchange commission initial reports of ownership and reports of changes in ownership of Common Stock and other equity securities of the Company. Officers, directors and greater than ten percent shareholders are required by SEC regulation to furnish the Company with copies of all forms they file pursuant to Section 16(a). To the Company's knowledge, based solely on review of the copies of such reports furnished to the Company and written representations that no other reports were required during the year ended December 31, 1996, all Section 16(a) filing requirements applicable to its officers, directors and greater than ten percent beneficial owners were complied with.
COMMITTEES
The Company has a Stock Option and Compensation Committee, an Audit and Investment Committee, a Nominating Committee and an Executive Committee. The Stock Option and Compensation Committee is comprised of Messrs. Stewart and Lipson, Ms. Gruber and Dr. Nocero; the Audit and Investment Committee is comprised of Dr. Nocero and Mr. Stewart; the Nominating Committee is comprised of Dr. Nocero, Mr. Lipson and Mrs. Gruber; and the Executive Committee is comprised of Messrs. Buccellato and Lipson and Mrs. Gruber. In 1996, the Executive Committee met four times. The other committees did not meet. All Directors in office at the time of such meetings attended their respective committee meetings. Non-employee directors are compensated at the rate of $500 for each committee meeting attended and are entitled to reimbursement for travel expenses incurred in connection with attending meetings. However, Mr. Lipson, the non-employee director on the Executive Committee, was paid $3,500 for each of the four Executive Committee meetings he attended.
The function of the Audit and Investment Committee is to review the investment strategy and performance of the investment portfolio, to recommend the firm to be appointed as independent certified public accountants to audit the Company's financial statements, to review the scope and results of the audit with the independent certified public accountants, to receive reports from the independent auditors and to review the adequacy of the internal controls and accounting procedures of the Company.
The function of the Stock Option and Compensation Committee is to administer the stock option plans (including making awards and determining the terms and conditions upon which they are granted) and to review and establish the compensation of the executive officers.
The function of the Nominating Committee is to assist management with respect to matters of succession, to review the qualifications of candidates for the position of Director and to recommend candidates to the Board as nominees for election at the Annual Meeting of Stockholders or to fill such Board vacancies as may occur during the year. The Nominating Committee will consider nominees recommended by security holders. Recommendations may be forwarded to the Nominating Committee at the Company.
The function of the Executive Committee is to review Company activity and make recommendations to the full Board of Directors.
In January, 1995, in response to several inquiries from unaffiliated third parties relating to various proposed transactions with the Company, including the purchase of all of the outstanding shares of the Company, the Board formed a Special Committee to
evaluate the alternatives available to the Company. Mr. Lipson is Chair of the Special Committee on which Ms. Gruber, Dr. Nocero and Mr. Stewart also serve. The Special Committee met ten times in 1996.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The following table discloses compensation received by the Company's Chief Executive Officer and the only other executive officer receiving in excess of $100,000 per year (the "Named Executive Officers") for the three fiscal years ended December 31, 1996.
_____________________
(1) Totals in this column reflect the aggregate value of perquisites, including personal use of Company automobiles, outside financial counseling, executive health benefits, relocation expenses and payments made on life insurance policies for their benefit. During 1996, Mr. Buccellato received health benefits of $6,069, financial counseling of $5,500 and life insurance payments of $5,007; and Mr. Morris received $4,239 of health benefit payments and $9,000 auto allowance.
(2) These amount represent the Company's matching contributions to the Company's 401(k) plan.
EMPLOYMENT AGREEMENTS
The Company entered into an employment agreement, commencing on January 1, 1996 and expiring on December 31, 2000, with Carl Buccellato. Under the terms of his employment agreement, Mr. Buccellato is currently entitled to a base salary of $407,610, subject to an annual cost of living increase based on the Consumer Price Index and a performance bonus as determined by the Board of Directors. The Company provides Mr. Buccellato with the use of a Company car and reimbursement of medical expenses in addition to annual salary. The Company also provides Mr. Buccellato with life insurance in the amount of $1,000,000 and a lump sum death or permanent disability benefit equal to his annual salary and bonus for the immediately preceding year.
Mr. Buccellato's employment agreement provides that, in the event of termination of employment due to a change in control of the Company, he shall be entitled to a lump sum distribution of compensation in an amount equal to 2.99 times the sum of the annual base salary currently provided for in the employment agreement. Upon a change of control and termination, all stock options then held by him immediately become exercisable to the extent otherwise permitted by the Company's Option Plans, and the non-competition provisions contained in the employment agreement terminate. The agreement provides that the lump sum distributions will be limited to the maximum amount which may be deducted by the Company pursuant to Section 280G of the Internal Revenue Code of 1986.
OPTIONS GRANTED DURING 1996
No options were granted to the named executive officers in 1996.
AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION/SAR VALUES
The following table sets forth certain information concerning exercises of stock options by the Named Executive Officers during the 1996 fiscal year and the fiscal year-end value of the unexercised stock options held by the Named Executive Officers.
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(1) The market value of the shares of Common Stock underlying the options held by the Named Executive Officers was less than the exercise price of the options at December 31, 1996.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
The following directors serve on the Stock Option and Compensation Committee ("Compensation Committee") of the Company's Board of Directors: Gary D. Lipson (Chairman), Diane M. Gruber and Michael A. Nocero, Jr., M.D.
Subsequent to the 1994 termination by mutual agreement of Mr. Stewart's prior employment contract with the Company, Mr. Stewart provided consulting services upon the request of the Company through November 30, 1996, for a consulting fee of $15,922 per month. Mr. Stewart also received medical benefits as previously provided under his employment contract. He further agreed not to compete with the Company through January, 1998 and relinquished all stock options granted to him during his employment with the Company.
Homeowners Marketing Services International, Inc. ("HMSI"), a wholly-owned subsidiary of the Company, is party to a franchise agreement with Southwest Marketing Services, Inc. ("SMS"), a corporation owned 25% by Michael A. Nocero, Jr., M.D., granting such corporation the exclusive right to market HMS products and services and enroll Member-Brokers in Arizona and New Mexico. In 1996, the Company paid $390,286 to SMS. The terms and provisions of this franchise agreement are comparable to those entered into with non-affiliated third parties.
Broker Marketing Services of Texas, Inc. ("BMST"), a corporation owned 100% by Dr. Nocero and HMS Texas, Inc., a wholly-owned subsidiary of the Company, have entered into a partnership agreement for the operation of the Texas territory. Pursuant to the terms of this partnership agreement, HMS Texas, Inc. and BMST are each entitled to 45% of the profits and cash distributions from the partnership, with a third-party manager entitled to the remaining 10%. The partnership agreement names HMS Texas, Inc. as managing partner with sole authority to make all major operational decisions and provides for restrictions on transferability and rights of first refusal with respect to interests in the partnership. In 1996, distributions of $31,957 were paid to BMST.
HMSI is also party to a franchise agreement with O & A Marketing Services of the West, Inc. ("O&A"), a corporation owned 20% by Dr. Nocero, granting such corporation the exclusive right to market HMS products and services and enroll Member-Brokers in Kansas, Missouri and Oklahoma. In 1996, the Company paid $691,942 to O&A. The terms and provisions of this franchise agreement are comparable to those entered into with non-affiliated third parties.
Homeowners Marketing Services, Inc. ("HMS"), a wholly owned subsidiary of the Company, has entered into a partnership agreement with Professional Forum Enterprises, Inc. ("PFE"), a corporation 80% owned by Michael A. Nocero, Jr., M.D., to market Internet access and related products and services to real estate professionals. Pursuant to the partnership agreement,
HMS and PFE share in the partnership profits or losses at the rate of 50% each, and both HMS and PFE are obligated to make joint contributions to fund the partnership operations. During 1996, HMS contributed $222,500 toward the joint funding of the partnership and purchased $37,961 in computer equipment and materials on behalf of the partnership.
In 1996, the Company paid approximately $157,308 in fees and reimbursable expenses for consulting services rendered by Gary D. Lipson, which fees and expenses the Company believes are more favorable to the Company than those which would have been paid to an unrelated party. On December 22, 1995, the Company and Mr. Lipson entered into an Engagement Agreement pursuant to which Mr. Lipson agreed to make himself available to provide legal services on behalf of the Company and its subsidiaries for a minimum of 500 hours per year at an hourly rate of $200. Upon his execution of the Engagement Agreement, Mr. Lipson became entitled to a non-refundable retainer of $100,000. The Company has the right to terminate the Engagement Agreement at any time. If the Company terminated the Engagement Agreement without cause (as such term is defined in the Agreement), then the Company is obligated to immediately pay the non-refundable retainer to Mr. Lipson.
HMSI is also party to a franchise agreement with HMS New Jersey/New York ("HMSNJNY") of which Diane M. Gruber is Executive Vice President. HMSNJNY has the exclusive right to market HMS products and services and enroll Member-Brokers in New Jersey and New York. In 1996, the Company paid $528,384 to HMSNJNY. HMSI has also entered into an agreement with a firm that is the Company's franchisee for Rhode Island and Connecticut of which Diane Gruber, with her spouse, owns 100% of the stock. This firm has the exclusive right to market HMS products and services and enroll Member-Brokers in Rhode Island and Connecticut. In connection with the purchase of this territory, as of December 31, 1996, the franchisee firm owes HMSI $12,399, under a promissory note issued at the time of purchase. In 1996, the Company paid $23,874 to this firm. The terms and provisions of the franchise agreements with HMSNJNY and HMSRIC are comparable to those entered into with non-affiliated third parties. In connection with the franchise operations, these two firms have purchased computer equipment through HMS and currently owe $714 and $535 under promissory notes issued to HMS.
HMSI has also entered into an agreement with a firm that is the Company's franchisee for the Massachusetts, Maine, New Hampshire and Vermont of which Diane Gruber, with her spouse, owns 50% of the stock. This firm has the exclusive right to market HMS products and services and enroll Member-Brokers in Massachusetts, Maine, New Hampshire and Vermont. In connection with this arrangement, the franchisee firm owes HMSI $51,443 under a promissory note issued at the time of the purchase of the franchised territory. In 1996, the Company paid $125,204 to this firm. The terms and provisions of the franchise agreements with this firm are comparable to those entered into with non-affiliated third parties. This firm also has the first right of refusal to the franchise rights to the states of Pennsylvania and Florida should the Company decide to sell the franchise rights to those territories.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth information concerning beneficial ownership, as of March 23, 1997, by persons known to the Company (based upon filings on Schedules 13D and 13G filed pursuant to the Securities Exchange Act of 1934) to own more than 5% of the Company's outstanding voting securities. The table also shows information concerning beneficial ownership by all directors, by each of the executive officers named in the Summary Compensation Table and by all directors and executive officers as a group. The number of shares beneficially owned by each director or executive officer is determined under rules of the Commission, and the information is not necessarily indicative of beneficial ownership for any other purpose. Under such rules, beneficial ownership includes any shares as to which the individual has the sole or shared voting power or investment power and also any shares which the individual has the right to acquire within 60 days of March 23, 1997 through the exercise of any stock option or other right. Unless otherwise indicated, each person has sole investment and voting power (or shares such powers with his or her spouse) with respect to the shares set forth in the following table.
BENEFIICIAL OWNERSHIP ----------------------------
NAME AND ADDRESS OF BENEFICIAL OWNER (1) SHARES PERCENT ---------- ------- Carl Buccellato....................... 523,453(2) 8.8%
Diane M. Gruber....................... 27,550(3) 0.5%
Gary D. Lipson........................ 45,000(4) 0.8%
Michael A. Nocero, Jr., M.D........... 140,000(5) 2.5%
Melvin Stewart........................ 307,875(6) 5.2%
C. Gregory Morris..................... 60,000(7) 1.0%
Sandra Stewart Bernstein.............. 406,862(8) 7.3% 2810 North 46th Avenue Hollywood, Florida 33021
Dimensional Fund Advisors, Inc........ 293,500(8) 4.9% 1299 Ocean Avenue Santa Monica, California 90401
NAPAQ Corporation, et al ............. 611,500(9) 10.3% 4040 Mystic Valley Parkway Boston, MA 02155
DC Investment Partners ............... 989,500(10) 16.6% Opportunity Fund, L.P. 2200 Abbott Martin Road, Suite 201 Nashville, TN
All Directors and Executive Officers as a Group (6 persons).............. 1,103,878(11) 18.6%
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(1) The address of all executive officers and directors is 400 Sawgrass Corporate Parkway, Sunrise, Florida 33325.
(2) Includes 14,397 shares of Common Stock held by Carl Buccellato as Trustee of the Renee Buccellato Trust, the Lori Ann Buccellato Trust and the Matthew Buccellato Trust. Includes presently exercisable options to purchase 260,000 shares of Common Stock.
(3) Includes presently exercisable options to purchase 17,500 shares of Common Stock at $5.50 per share. The total does not include 1,000 shares owned by Gayle N. Gruber, Mrs. Gruber's daughter, as to which beneficial ownership is disclaimed by Mrs. Gruber.
(4) Includes presently exercisable options to purchase 25,000 shares of common stock at $6.50 per share.
(5) Includes 78,500 shares of Common Stock owned under a retirement plan for the benefit of Michael A. Nocero, Jr., M.D. and indirect ownership of 33,000 shares owned by his daughters. Includes presently exercisable options to purchase 25,000 shares of Common Stock at $6.50 per share.
(6) Includes presently exercisable options to purchase 2,500 shares of Common Stock at $0.75 per share. Includes 243,701 shares of Common Stock held by Melvin Stewart as Trustee of the Melvin Stewart Trust. Also includes 15,788 shares of Common Stock held by Mitchell Stewart as Trustee of the Bari Udell Trust, as to which trusts Melvin Stewart has the power to direct the voting and investment of such shares as trust advisor and as to which beneficial ownership is disclaimed by Mr. Stewart.
(7) Consists of presently exercisable options to purchase 60,000 shares of Common Stock at $2.00 per share.
(8) Ownership shares and percentage based upon Schedules 13G as provided to the Company.
(9) Ownership shares and percentages based on Schedules 13D, as amended, as provided to the Company. Consists of four related persons that own positions: NAPAQ Corporation, HAC. Inc., Cross Country Motor Club, Inc. and Jeffrey C. Wolk. Each of these persons is affiliated with The Cross Country Group, Inc.
(10) Ownership shares and percentages based on Schedule 13D, as amended, as provided to the Company. Consists of four related parties that own positions: D. Robert Crants, Michael W. Devlin, Lucius E. Burch and the Stephens Group, Inc.
(11) Includes (i) an aggregate of 285,000 shares of common stock which the officers and directors have the right to acquire through the exercise of presently exercisable options and (ii) an additional 50,000 shares of common stock which the officers and directors will have the right to acquire through the exercise of options that will become exercisable contemporaneously with the consummation of the merger.
Ms. Gruber, Messrs. Buccellato, Lipson, Morris and Dr. Nocero have advised the Company that they have granted proxies to Cross Country with respect to the right to vote the Shares held by them, currently 698,481 Shares (12.56% of the outstanding Shares), with respect to all matters relating to the merger.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
See Item 11 "Executive Compensation - Compensation Committee Interlocks and Insider Participation."
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
FINANCIAL STATEMENTS
The following consolidated financial statements of Homeowners Group, Inc. and subsidiaries are included in Part II, Item 8 of this annual report.
Independent Auditors' Report
Consolidated Balance Sheets - December 31, 1996 and 1995
Consolidated Statements of Operations - Years Ended December 31, 1996, 1995 and
Consolidated Statements of Cash Flows - Years Ended December 31, 1996, 1995 and
Consolidated Statements of Stockholders' - Equity Years Ended December 31, 1996, 1995 and 1994
Notes to Consolidated Financial Statements
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*AMENDMENT NO. 2 TO FORM S-1 OF HOMEOWNERS GROUP, INC. FILED WITH THE SEC ON JULY 13, 1988
REPORTS ON FORM 8-K
The Company filed a report on Form 8-K on November 14, 1996, reporting the execution of the amendment to the merger agreement with The Cross Country Group, Inc.
SIGNATURES
Pursuant to the requirements of Section 13 of the Securities Exchange Act of 1934, the Registrant has duly caused this Annual Report to be signed on its behalf by the undersigned, thereunto duly authorized.
HOMEOWNERS GROUP, INC.
Date: April 15, 1997 /S/ CARL BUCCELLATO ------------------- Carl Buccellato, Chairman of the Board President and Chief Executive Officer
Date: April 15, 1997 /S/ C. GREGORY MORRIS --------------------- C. Gregory Morris, Vice-President, Treasurer and Chief Financial Officer
Date: April 15, 1997 /S/ KAREN CHILDRESS ------------------- Karen Childress, Controller, Secretary and Principal Accounting Officer
Pursuant to the requirements of the Securities Exchange Act of 1934 this Annual Report has also been signed by the following persons on behalf of the Registrant in the capacities indicated:
MEMBERS OF THE BOARD OF DIRECTORS
Date: April 15, 1997 /S/ CARL BUCCELLATO ------------------- Carl Buccellato, President and Chief Executive Officer
Date: April 15, 1997 /S/ DIANE M. GRUBER ------------------- Diane M. Gruber, Director
Date: April 15, 1997 /S/ GARY D. LIPSON ------------------ Gary D. Lipson, Director
Date: April 15, 1997 /S/ MICHAEL A. NOCERO, JR. MD. ------------------------------------- Michael A. Nocero, Jr. M.D., Director
Date: April 15, 1997 /S/ MELVIN STEWART ------------------ Melvin Stewart, Chairman
INDEX TO EXHIBITS
EXHIBIT NUMBER DESCRIPTION - ------- -----------
11 Computation of Net Loss Per Common Share
27.1 Financial Data Schedule