<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
- --- EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
- --- EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ________ TO ________.
COMMISSION FILE NUMBER: 0-8678
MCM CORPORATION
-----------------------------------------------------
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
<TABLE>
<S> <C>
NORTH CAROLINA 56-1171691
- -------------------------------------------------------------- ---------------------------------
(STATE OR OTHER JURISDICTION OF INCORPORATION OR ORGANIZATION) (IRS EMPLOYER IDENTIFICATION NO.)
BOX 12317, 702 OBERLIN ROAD, RALEIGH, NORTH CAROLINA 27605
- -------------------------------------------------------------- ---------------------------------
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICE) (ZIP CODE)
</TABLE>
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE (919) 833-1600
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
<TABLE>
<S> <C>
NAME OF EACH EXCHANGE
TITLE OF EACH CLASS ON WHICH REGISTERED
- ------------------- -------------------
NONE
</TABLE>
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
COMMON STOCK, PAR VALUE - $1.00
-------------------------------
(TITLE OF CLASS)
INDICATE BY CHECK MARK WHETHER THE REGISTRANT (1) HAS FILED ALL REPORTS REQUIRED
TO BE FILED BY SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 DURING
THE PRECEDING TWELVE MONTHS, AND (2) HAS BEEN SUBJECT TO SUCH FILING
REQUIREMENTS FOR THE PAST NINETY (90) DAYS.
YES X NO
--- ---
INDICATE BY CHECK MARK IF DISCLOSURE OF DELINQUENT FILERS PURSUANT TO ITEM 405
OF REGULATION S-K IS NOT CONTAINED HEREIN, AND WILL NOT BE CONTAINED, TO THE
BEST OF REGISTRANT'S KNOWLEDGE, IN DEFINITIVE PROXY OR INFORMATION STATEMENTS
INCORPORATED BY REFERENCE IN PART III OF THIS FORM 10-K. [X ]
STATE THE AGGREGATE MARKET VALUE OF THE VOTING STOCK HELD
---------------------------------------------------------
BY NON-AFFILIATES OF THE REGISTRANT AS OF MARCH 30, 1999.
---------------------------------------------------------
COMMON STOCK, $1.00 PAR VALUE -- $8,313,926
AT DECEMBER 31, 1998, 4,706,388 SHARES OF COMMON STOCK OF THE REGISTRANT WERE
OUTSTANDING.
DOCUMENTS INCORPORATED BY REFERENCE
-----------------------------------
NOT APPLICABLE
<PAGE> 2
PART I
Item 1. Business
McM Corporation ("McM" or the "Company") is an insurance holding
company conducting its business through insurance and non-insurance
subsidiaries. The following schedule identifies the subsidiaries of McM and the
abbreviations by which they are identified in this document.
<TABLE>
<CAPTION>
Subsidiary Abbreviation
---------- ------------
<S> <C>
PROPERTY AND CASUALTY
Occidental Fire & Casualty Company
of North Carolina OF&C
Wilshire Insurance Company Wilshire
OTHER:
Equity Holdings, Inc. Equity Holdings
</TABLE>
In connection with and because it desires to take advantage of the
"safe harbor" provisions of the Private Securities Litigation Reform Act of
1995, McM would like to caution readers regarding certain forward- looking
statements in the following discussion and elsewhere in this Form 10-K. While
McM believes in the veracity of all statements made herein, forward-looking
statements are necessarily based upon a number of estimates and assumptions
that, while considered reasonable by McM, are inherently subject to significant
business, economic and competitive uncertainties and contingencies, many of
which are beyond McM's control, and many of which, with respect to future
business decisions, are subject to change. These uncertainties and contingencies
can affect actual results and could cause its actual results to differ
materially from those expressed in any forward-looking statements made by or on
behalf of McM. The forward looking statements are especially difficult for lines
of business that are longer tail in nature such as the Company's commercial
automobile liability line of business which is inherently subject to
considerable variability and volatility.
Item 1. (a) General Development of the Business
McM was organized as a North Carolina corporation on May 27, 1977, and
subsequently acquired or organized a number of insurance corporations and other
subsidiaries. From 1977 to 1991, McM operated as a multi-line holding company
with both life and health and property and casualty insurance operations.
The McMillen Trust, controlling shareholder of McM, currently owns
51.6% of the outstanding stock of McM. A petition was filed on behalf of the
McMillen Trust in the Chancery Court of Delaware on December 2, 1986, seeking
relief from the requirement that the Trust own at least
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65% of the shares of McM. The Court, on December 10, 1987, determined that the
Trust must divest itself of its ownership of the shares of McM and invest the
proceeds in a diversified portfolio for the benefit of present and future
beneficiaries of the Trust.
In 1991, McM decided to discontinue its life and health insurance
segment. On October 24, 1991, Occidental Life Insurance Company and Peninsular
Life Insurance Company were sold to Pennsylvania Life Insurance Company. On June
22, 1992, Atlantic Southern Insurance Company was sold to Global Life Assurance
Company Limited. The sale of Atlantic Southern Insurance Company completed the
disposition of the Company's life and health segment.
In January 1993, McM's Board of Directors announced that it had decided
to discontinue efforts to sell the remaining companies in the McM group,
including OF&C and Wilshire. The Board's decision was prompted by market and
economic conditions as well as other factors which had an adverse effect on the
general sale process being conducted by PaineWebber, Incorporated
("PaineWebber"). However, PaineWebber continued to serve the McM group as its
financial advisor.
In April 1993, the Chancery Court granted the petition of the
Wilmington Trust Company, Trustee of the McMillen Trust, for a clarification of
existing orders to make clear, among other things, that the timing and terms of
any disposition of the Trust's shares shall be determined in the sound
discretion of the Trustee.
In late 1996 the Trust granted an option (the "Option") to purchase all
of its McM shares to McM Acquisition Corporation ("MAC"), a company controlled
by Raleigh private investor M. Roland Britt. In a separate, independent action
McM agreed to provide MAC with exclusive confidential access to McM's records
and information to conduct due diligence reviews and pursue financing for its
proposed purchase of some or all of McM's common shares (the "Standstill
Agreement"). The Standstill Agreement expired September 28, 1997.
On September 22, 1997, two shareholders of McM filed suit against McM
purportedly on behalf of all McM shareholders other than the Trust, complaining
that the Trust controlled McM and its board, that the board should not have
entered into the Standstill Agreement and that the composition of McM's board of
directors was inappropriate, among other allegations. The plaintiffs requested
that the court void the Option.
On December 23, 1997, MAC and the Trust agreed to terminate the Option.
MAC and all remaining parties to the suit executed a mutual release and
dismissal of MAC as a defendant. On February 20, 1998, the suit was settled with
the approval of the court. The settlement provided that the defendants would use
their best efforts to elect one of the plaintiffs, Jesse Greenfield, to the
board of directors of McM. The settlement also contained nominal monetary
concessions by the
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<PAGE> 4
Plaintiffs and McM and mutual releases between all parties. Mr. Greenfield was
elected to the McM Board on May 21, 1998.
On June 15, 1998, IAT Reinsurance Syndicate Ltd.("IAT"), a Bermuda-
based insurance and investment company, provided OF&C with a $5 million cash
infusion supported by five $1 million certificates of contribution. The terms of
the certificates provided, upon the approval of the Commissioner of the North
Carolina Department of Insurance, for quarterly interest payments at the rate of
5% per annum with the principal balance payable no later than December 31, 2000,
upon the approval of the Commissioner of the North Carolina Department of
Insurance.
On July 17, 1998, the Company and IAT jointly announced the signing of
an agreement dated July 16, 1998, (the "Offer and Rights Agreement") pursuant to
which IAT expressed its intention to acquire up to 49% of McM's outstanding
common stock for $3.65 per share. Up to 35% of McM's common stock was to be
acquired in a public tender offer (the "Tender Offer") with the remaining 14% to
be acquired from the McMillen Trust, pursuant to an agreement between IAT and
the Trust executed the same day (the "Trust Purchase Agreement"). The McMillen
Trust owned approximately 65% of McM's outstanding shares at the time the
agreement was signed.
The Offer and Rights Agreement was unanimously approved by McM's Board
of Directors and the Tender Offer commenced on July 23, 1998. The Tender Offer
was made through offering documents filed with the Securities and Exchange
Commission and mailed to McM Shareholders.
On October 1, 1998, IAT successfully completed the Tender Offer and
purchased 1,279,692 shares (or 27.2%) of McM's common stock at the Tender Offer
price of $3.65 per share. On the same day, IAT also purchased 658,900 shares of
McM common stock from the McMillen Trust pursuant to the Trust Purchase
Agreement. In total, IAT purchased 1,938,592 shares (or 41.2%) for an aggregate
price of approximately $7,075,860.
On October 7, 1998, IAT provided a $10 million cash contribution to McM
Corporation. IAT made an additional $1 million cash contribution to McM on
October 28, 1998. In consideration of these contributions, McM issued 11,000
shares of McM Corporation Series B PIK Preferred Stock, $1,000 par value to IAT.
McM also retired the five $1 million certificates of contribution issued to IAT
by McM subsidiary OF&C, replacing these certificates with a permanent $5 million
cash capital contribution to OF&C as additional paid-in capital. McM
simultaneously issued 5,000 shares of Series B PIK Preferred Stock to IAT in
exchange for the retirement of these certificates of contribution.
McM issued 10,000 shares of Series B PIK Preferred Stock to IAT in
consideration of an additional $10 million cash contribution to McM Corporation
on December 29, 1998. On the same day, McM made a permanent
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$5 million cash capital contribution to OF&C as additional paid-in capital and
transferred the remaining $5 million to OF&C in exchange for the issuance of
500,000 shares of OF&C 8% Preferred Stock, $10 par value.
The Series B PIK Preferred Stock accumulates dividends at a rate of 12%
per annum, payable quarterly in arrears on January 7, April 7, July 7, and
October 7 of each year. The dividends are cumulative from the date of issuance
and will be paid in kind with additional fully paid and nonassessable shares of
Series B PIK Preferred Stock. At the discretion of the Board of Directors'
quarterly dividends may be paid in cash.
The OF&C Preferred Stock pays dividends at a rate of 8% per annum, with
the first payment payable March 31 of the first year following date of issuance
and quarterly thereafter.
There were 134 employees of McM and its subsidiaries at December 31,
1998, all of which are directly employed by the property and casualty
subsidiaries.
Item 1. (b) Financial Information About Industry Segments
The Company has determined that it operates in two segments: Commercial
Auto and Private Passenger Auto. Appropriate disclosures about the Company's
segments are included in Note L to the Consolidated Financial Statements.
Item 1. (c) Narrative Description of Business
PROPERTY AND CASUALTY INSURANCE
McM's property and casualty insurance business is conducted through two
insurance companies, OF&C and Wilshire. The business is concentrated in
commercial auto liability, physical damage and cargo coverages for the trucking
transportation industry as well as non-standard private passenger automobile
coverages. These insurance policies are generally marketed through general and
independent agents who have no authority to alter any terms of the policies.
The agents who produce business for OF&C and Wilshire are not exclusive
agents of the companies and generally have affiliations with other insurance
companies which may compete with McM. One agent accounts for approximately 11%
of premium income of the property and casualty business of McM.
OF&C is licensed in the District of Columbia and all states other than
Connecticut and Hawaii. Certain states have placed restrictions on the amount of
premiums that OF&C may write in those states. Wilshire is licensed in nineteen
states comprised of Arizona, California, Colorado, Hawaii, Idaho, Iowa, Kansas,
Minnesota, Montana, Nebraska, Nevada, New
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<PAGE> 6
Mexico, North Carolina, Ohio, Oregon, South Dakota, Utah, Washington and
Wisconsin. Wilshire is also approved, as a non-admitted carrier, to write
coverages in the states of Alabama, Alaska, Florida, Georgia, Illinois, Indiana,
Kentucky, Louisiana, Maryland, North Dakota, Oklahoma, Pennsylvania, Texas and
Wyoming. A non-admitted carrier may write coverages at rates in excess of the
rates approved by the various states, provided that licensed carriers in those
states are unwilling to provide coverages at the approved rates. Wilshire's
premium writings are not restricted by any state. Also see "Geographic
Distribution of Premiums Received."
Competition. The property and casualty insurance business is highly competitive.
In most jurisdictions in which McM's property and casualty insurance
subsidiaries market their policies, there are numerous large standard lines
stock and mutual companies as well as other specialty companies competing for
the same business. Many of the companies have greater financial resources,
larger marketing organizations and broader diversification of risks than the McM
companies. However, McM believes that the policies, rates, commissions and
services of its companies are competitive with other companies writing these
types of business.
Regulation. All insurance companies are subject to regulation and supervision by
the jurisdictions in which the companies are authorized to transact business.
These regulatory bodies have broad administrative powers relating to the
standards of solvency which must be met and maintained by insurance companies,
minimum capital and surplus requirements, limitations on the investments of
capital and surplus, granting and revoking of licenses, licensing of agents,
filing and approval of policy forms and rates, maintenance of required reserves,
unfair discrimination, form and content of financial statements and other
reporting forms, issuance and sale of stock, types of allowable investments, and
numerous other matters pertaining to insurance.
Insurance companies must keep assets equal to the minimum capital
required by law plus the accumulated reserves invested in certain classes of
investments as specified in the statutes applicable to such companies. In
addition, the National Association of Insurance Commissioners ("NAIC") has
adopted Risk-Based Capital ("RBC") requirements for property and casualty
insurance companies. RBC was developed to evaluate the adequacy of statutory
capital and surplus in relation to investment and insurance risks. The RBC
formula serves as an early warning tool for state insurance regulators to help
identify, for the purpose of initiating regulatory action, companies which may
be inadequately capitalized.
At December 31, 1998, the capital and surplus levels of the Company's
property and casualty subsidiaries exceeded all RBC thresholds.
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<PAGE> 7
The reporting practices for McM's property and casualty subsidiaries
are prescribed or permitted by state regulatory authorities ("statutory
accounting") and may differ from generally accepted accounting principles
("GAAP"). OF&C (which includes Wilshire on a statutory equity basis) reported to
insurance regulatory authorities combined statutory capital and surplus of $27.7
million and $11.5 million at December 31, 1998 and 1997, respectively.
There are several reconciling differences between the statutory
accounting and consolidated GAAP capital and surplus balances of McM's property
and casualty subsidiaries. In GAAP accounting, costs which vary with and are
primarily related to the production of property and casualty business are
deferred to the extent recoverable and are amortized over the lives of the
policies in proportion to the recognition of premium earned. Statutory
accounting does not permit this deferral and requires property and casualty
companies to fully recognize these expenses in the period they were incurred. At
December 31, 1998, McM's property and casualty subsidiaries recorded $2.4
million in deferred policy acquisition costs as an asset on the GAAP balance
sheet compared to $2.8 million at December 31, 1997. Under statutory accounting
certain assets of a Company may not be admissible under certain circumstances
such as agents' balances and other balances receivable for a period greater than
ninety days. Such balances are "nonadmitted" and shown as a reduction to
statutory capital and surplus. At December 31, 1998, the capital and surplus of
McM's property and casualty subsidiaries was reduced by approximately $542,000
for nonadmitted assets. Statutory accounting also requires property and casualty
companies to record as a liability and restriction to capital and surplus the
uncollateralized portion of balances receivable from non-admitted reinsurers
("Schedule F Penalty"). The combined Schedule F Penalty recorded by McM's
property and casualty subsidiaries totalled $298,000 and $261,000 at December
31, 1998 and 1997, respectively. Finally, for GAAP accounting purposes the $26
million of outstanding Series B PIK Preferred Stock of McM is not shown as a
component of shareholders' equity but as "mezzanine" debt, whereas $25 million
of this amount which was contributed to the property and casualty subsidiaries
of McM is shown as contributed capital and included in statutory capital and
surplus.
Insurance holding company laws grant additional powers to insurance
regulators with respect to acquisitions and control of insurance companies by
holding companies and the requirements of disclosure relating to transactions
with affiliated companies.
Each company files a detailed annual report with the insurance
department of each state or governmental jurisdiction in which it is licensed to
do business. Insurance companies are also subject to periodic examinations by
these regulatory bodies. Some of the jurisdictions in which OF&C is licensed to
do business have, for various reasons, instituted restrictions or limitations on
the amount of
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business written in that state. These restrictions were imposed years ago when
the property and casualty companies were generating substantial losses and
experiencing financial difficulties. Generally they involved states in which the
Company was not actively writing business nor had intentions to write business.
These restrictions have no current effect on liquidity, capital resources or
results of operations. In the future, should the Company desire to further
expand its market presence into any state with such restrictions, it will then
pursue the lifting of such restrictions by providing current financial and
operational information as required by individual state regulatory authorities.
Reinsurance As with other property and casualty insurance companies, the McM
property and casualty insurance companies reinsure a portion of the insurance
they write in order to control their exposure on large individual risks or in
the event of catastrophic losses. The companies remain contingently liable on
that portion of the risk reinsured should the reinsurer be unable to meet its
obligations under the reinsurance agreements. See Note D of the Notes to
Consolidated Financial Statements.
The largest liability exposure insured for any one risk is $2,000,000.
Reinsurance is in place to reduce the companies' exposure on premiums earned
subsequent to January 1992 to $100,000 of loss per risk. The retention per risk
on premiums earned prior to January 1, 1992, generally is $100,000 with the
exception of 1991 when the loss retention was $250,000. Premiums payable under
certain of the companies' liability reinsurance treaties prior to January 1,
1990, are based in part on actual loss experience. Premiums for the liability
treaties subsequent to 1990 are calculated on a flat rate based on policy
limits. Separate physical damage (excluding theft and collision) and motor cargo
catastrophe reinsurance treaties provide reinsurance on any one catastrophic
occurrence. Coverages under these treaties are limited to a maximum of 95% of
$4,000,000 in excess of the first $500,000 of losses paid.
Quota share reinsurance coverages, by which the companies and their
reinsurers share risk on a proportionate basis, are also in place for both
commercial and private passenger automobile business. During 1998 the companies
ceded 5% of the retained commercial auto liability coverages. The cession rates
for the private passenger auto coverages has ranged from the 40% rate in 1998 to
20% since this arrangement's inception. These quota share arrangements have been
established to help the companies control premium growth.
The principal reinsurers of the companies for current business are
Zurich Reinsurance, Ltd., Unionamerica Insurance Company, CNA International
Reinsurance Company, Ltd., Lloyds of London, AXA Reassurance Company and Sphere
Drake Insurance. Reinsurance agreements cover commercial and private passenger
automobile liability, physical damage (excluding theft and collision), motor
cargo and ancillary coverages. In addition to the reinsurers named above,
principal
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reinsurers of the companies for prior years' reinsurance treaties are Employers
Reinsurance Corporation and National Reinsurance Company.
Loss Reserves and Loss Adjustment Expenses
The consolidated financial statements include the estimated liability
for unpaid losses and loss adjustment expenses ("LAE") of the property and
casualty insurance subsidiaries. The liabilities for losses and LAE are
determined using case basis evaluations and statistical projections and
represent estimates of the ultimate net cost of all unpaid losses and LAE
incurred through December 31 of each year. These estimates give effect to trends
in claims severity and other factors which may vary as the liabilities are
ultimately settled. The estimates are continually reviewed and as adjustments to
these liabilities become necessary such adjustments are reflected in current
operations.
THIS SPACE LEFT BLANK INTENTIONALLY
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The following table provides a reconciliation of beginning and ending
liability balances for 1998, 1997 and 1996.
RECONCILIATION OF LIABILITY FOR LOSSES
AND LOSS ADJUSTMENT EXPENSES
<TABLE>
<CAPTION>
1998 1997 1996
------- ------- -------
(Thousands of dollars)
<S> <C> <C> <C>
GAAP
Reserves for losses and
settlement expenses, net of
reinsurance recoverables, at
beginning of year $29,159 $26,532 $29,997
Provision for insured events of
the current year 37,399 42,243 37,651
Increase in provision for
insured events of prior
years 7,086 5,774 1,559
------- ------- -------
Incurred losses and settlement
expenses during current year,
net of reinsurance 44,485 48,017 39,210
Payments for:
Losses and settlement expenses
attributable to insured events of
the current year 20,905 26,123 22,853
Losses and settlement expenses
attributable to insured events
of prior years 19,434 19,267 19,822
------- ------- -------
40,339 45,390 42,675
------- ------- -------
Reserves for losses and settlement
expenses, net of reinsurance
recoverables, at end of year 33,305 29,159 26,532
Reinsurance recoverable on unpaid
losses and settlement expenses
at end of current year 27,539 28,124 28,768
------- ------- -------
Gross reserves for losses and
settlement expenses at end
of year $60,844 $57,283 $55,300
======= ======= =======
</TABLE>
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The reconciliation shows that a deficiency of $7,086,000 in the prior
year reserve emerged during 1998. The deficiency at December 31, 1998, included
adverse reserve development of approximately $6,885,000 in the commercial auto
liability line of business, and $1,038,000 in discontinued lines of business and
participation in involuntary pools and other residual market mechanisms in which
OF&C and WIC are required to participate by the various states in which the
companies write insurance. Mitigating the above adverse development was $748,000
of favorable development in inland marine, commercial auto physical damage, and
general liability lines of business, and favorable development of $89,000
relating to private passenger liability and physical damage lines of business.
The anticipated effect of inflation is implicitly considered when
estimating liabilities for losses and settlement expenses. While anticipated
cost increases due to inflation are considered in estimating the ultimate claim
costs, the increase in average severity of claims is caused by a number of
factors that vary with the individual type of policy written. Future average
severity is projected based on historical trends adjusted for anticipated
changes in these trends and general economic conditions. These anticipated
trends are monitored based on actual development and are modified as necessary.
The liability for losses and LAE of $60,844,000 reported in the
accompanying financial statements in accordance with generally accepted
accounting principles (GAAP) is reported on a gross basis, i.e., without
reduction for reinsurance, and differs from that reported in the annual
statements filed with state insurance departments in accordance with statutory
accounting practices (SAP), which are reported net of reinsurance. See Note A of
the accompanying 1998 financial statements.
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ANALYSIS OF LOSS AND LOSS ADJUSTMENT
EXPENSE DEVELOPMENT
NET OF REINSURANCE WITH SUPPLEMENTAL GROSS DATA
<TABLE>
<CAPTION>
(Thousands of dollars)
YEAR ENDED 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998
- ---------------------------- ------- ------- ------- ------- ------- -------- ------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Liability for Unpaid
Claims and Claim
Adjustment Expense $96,308 $78,120 $64,002 $64,304 $59,580 $ 51,625 $38,415 $29,997 $26,532 $29,159 $33,305
Paid (Cumulative) as of:
One year later $48,461 $42,731 $41,726 $29,635 $28,500 $ 27,034 $21,338 $19,822 $19,267 $19,434 $ 0
Two years later 72,353 63,893 47,833 44,905 44,659 39,119 31,096 28,469 28,405
Three years later 84,912 67,649 56,343 54,980 51,326 44,649 35,177 32,181
Four years later 87,368 72,305 61,006 58,364 54,561 46,668 36,891
Five years later 90,495 75,568 62,341 60,459 55,699 47,849
Six years later 93,146 76,350 63,728 61,215 56,801
Seven years later 93,769 77,562 64,459 62,144
Eight years later 94,930 78,084 65,211
Nine years later 95,451 78,862
Ten years later 96,227
Liability Reestimated as of:
One year later $97,562 $77,625 $68,679 $64,175 $60,849 $ 51,643 $38,167 $31,556 $32,306 $36,245 $ 0
Two years later 95,362 78,970 66,266 64,686 59,881 50,184 38,060 34,207 36,935
Three years later 96,354 79,861 67,429 64,167 58,563 49,874 38,966 36,893
Four years later 96,874 80,345 67,540 63,204 58,713 50,131 40,528
Five years later 97,453 80,695 66,357 63,939 59,138 51,062
Six years later 97,619 79,909 67,115 64,278 59,977
Seven years later 97,251 80,698 67,465 65,195
Eight years later 98,054 81,067 68,262
Nine years later 98,428 81,907
Ten years later 99,269
------- ------- ------- ------- ------- -------- ------- ------- ------- ------- -------
Cumulative Deficiency
(Redundancy) $ 2,961 $ 3,787 $ 4,260 $ 891 $ 397 ($ 563) $ 2,113 $ 6,896 $10,403 $ 7,086 $ 0
======= ======= ======= ======= ======= ======== ======= ======= ======= ======= =======
Gross Data at End of Year
Gross Liability $57,283 $60,844
Reinsurance Recoverable 28,124 27,539
======= =======
Net Liability $29,159 $33,305
======= =======
</TABLE>
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The table above presents the development of balance sheet liabilities
for 1988 through 1998. The top line of the table shows the estimated liability
for unpaid losses and LAE recorded at the balance sheet date for each of the
indicated years. This liability represents the estimated amount of losses and
LAE for claims arising in all prior years that are unpaid at the balance sheet
date, including losses that had been incurred but not yet reported to the
Company. The lower portion of the table shows the re-estimated amount of the
previously recorded liability based on experience as of the end of each
succeeding year. The estimate is increased or decreased as more information
becomes known about the frequency and severity of claims for individual years.
The deficiency/(redundancy) totals as set forth in the table represent
the aggregate change in the estimates over all prior years. For example, through
1998, the 1988 liability has developed a $2,961,000 deficiency which has been
recognized in operations over the ten year period. The effects on income of the
past three years of changes in estimates of the liabilities for losses and LAE
is shown in the preceding table, "Reconciliation of Liability for Losses and
Loss Adjustment Expenses".
The upper section of the table, "Analysis of Loss and Loss Adjustment
Expense Development", shows the cumulative amount paid with respect to the
previously recorded liability as of the end of each succeeding year. For
example, as of December 31, 1998, the Company paid $96,227,000 of the current
re-estimated reserve for losses and loss adjustment expenses at December 31,
1988, of $99,269,000. Thus an estimated $3,042,000 of losses incurred through
1988 remain unpaid as of the current financial statement date.
In evaluating this information, it should be noted that each amount
includes the effects of all changes in amounts for prior periods. For example,
the amount of the deficiency related to losses settled in 1991, but incurred in
1989, will be included in cumulative redundancy (deficiency) amount for years
1989 and 1990. This table does not present accident or policy year development
data. Conditions and trends that have affected development of the liability in
the past may not necessarily occur in the future. Accordingly, it may not be
appropriate to extrapolate future deficiencies or redundancies based on this
table.
The information below the table is a reconciliation of the data in the
table, which is reported net of reinsurance, to the reserves in the balance
sheet which are stated gross of reinsurance.
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<PAGE> 14
Geographic Distribution of Direct Written Premiums
The following is a summary of property and casualty direct written
premiums in 1998 by geographic location. States accounting for less than five
percent (5%) of premiums are combined in "Other".
<TABLE>
<CAPTION>
STATE PERCENT
----- -------
<S> <C>
Arizona 6
California 32
Colorado 6
Florida 11
Nevada 9
New Mexico 5
Other 31
---
100%
</TABLE>
Item 1. (d) Financial Information About Foreign and Domestic Operations
and Export Sales
The information called for under this item does not apply.
Item 2. Properties
McM and its subsidiaries lease home office properties in various
locations. The major locations are set forth in the following table:
<TABLE>
<CAPTION>
Square Book Annual
Footage Value Rent
------- ----- ----
<S> <C> <C> <C>
Raleigh, North Carolina
OF&C 27,298 Not Owned $462,101
Wilshire
McM
Lancaster, California
Wilshire 10,578 Not Owned $121,924
Scottsdale, Arizona
OF&C 7,193 Not Owned $131,277
Wilshire
</TABLE>
Item 3. Legal Proceedings
The information called for under this item does not apply.
Item 4. Submission of Matters to a Vote of Security Holders
There were no matters submitted to a vote of security holders during
the fourth quarter of 1998.
13
<PAGE> 15
PART II
Item 5. Market for the Registrant's Common Equity and Related
Stockholder Matters
McM Corporation Common Stock was previously traded on the
over-the-counter securities market, under the NASDAQ symbol, McMc. Effective
with the opening of business on October 19, 1998, McM's common stock was
delisted from the NASDAQ SmallCap Market. The delisting occurred as a result of
McM's no longer meeting the NASDAQ requirement to maintain a minimum of 300
shareholders who each own 100 shares or more. The number of record shareholders
of McM Corporation was 450 as of December 31, 1998.
The table below sets forth by quarters, for the years 1998 and 1997,
the range of high and low bid prices of McM Corporation's Common Stock as
reported in the Wall Street Journal. No dividends were declared or paid during
1998 or 1997. See Management's Discussion and Analysis of Financial Condition
and Results of Operations and Note B to the consolidated financial statements
for information regarding restrictions on the ability of McM's subsidiaries to
transfer funds to McM and discussion regarding nonpayment of dividends.
<TABLE>
<CAPTION>
1998 1997
HIGH LOW HIGH LOW
<S> <C> <C> <C> <C>
First Quarter $2 7/8 $1 3/4 $4 5/8 $3 7/8
Second Quarter 2 1/4 1 7/8 3 7/8 3 1/8
Third Quarter 3 1/2 2 1/8 3 3/8 2 7/8
Fourth Quarter N/A N/A 3 1/4 2 1/8
</TABLE>
14
<PAGE> 16
Item 6. Selected Financial Data
<TABLE>
<CAPTION>
1998 1997 1996 1995 1994
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
Assets $117,135 $104,140 $112,870 $126,568 $137,665
Liabilities 89,278 91,372 91,215 103,328 117,258
Redeemable
Preferred Stock 26,000 -- -- -- --
Retained (deficit)
earnings (8,173) 7,013 15,553 16,623 14,413
Shareholders' equity 2,457 12,768 21,655 23,240 20,407
Net premium earned 47,008 55,707 51,854 45,701 41,126
Net investment income 2,516 2,985 3,159 3,497 3,684
Realized investment
gains 274 196 40 123 122
Total revenue 50,228 59,537 55,698 49,571 45,304
Net (loss)income (15,186) (8,540) (788) 2,210 1,354
Net (loss income available
to common shareholders (15,595) (8,540) (788) 2,210 1,354
Per common share data:
Shareholders' equity
less preferred
dividends in arrears $ .44 $ 2.72 $ 4.63 $ 4.97 $ 4.37
Net (loss)income -
basic (3.32) (1.82) (.17) .47 .29
Net (loss) income -
assuming dilution (3.32) (1.82) (.17) .47 .29
Cash dividends -- -- .06 -- --
</TABLE>
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations
The response to Item 7 is submitted under a separate section of this
report beginning on page 32.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
The Company's invested assets consist of equity and fixed maturity
securities. Fixed maturity securities represent approximately 65% of the
Company's invested assets at December 31, 1998, and the fair value of these
fixed rate securities generally bears an inverse relationship to changes in
prevailing market interest rates. A 10% relative increase or decrease in market
interest rates that affect the Company's financial instruments would not have a
material impact on earnings during the next fiscal year, and would not
materially affect the fair value of the Company's financial instruments.
The Company is exposed to equity price risk on its equity
15
<PAGE> 17
securities. McM holds common stock with a carrying value of approximately $22.0
million. If the market value of the S&P 500 decreased 10% from their December
31, 1998, values, it is estimated that the fair value of the Company's equity
investments would decrease by approximately $2.1 million.
Item 8. Financial Statements and Supplementary Data
The consolidated financial statements of McM Corporation and its
subsidiaries and the report of the Company's independent auditors filed in
response to Item 8 is submitted under a separate section of this report
beginning on page 44.
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure
The information called for under this item does not apply.
THIS SPACE LEFT BLANK INTENTIONALLY
16
<PAGE> 18
PART III
Item 10 Directors and Executive Officers of the Registrant.
The following table sets forth the name and age of each director, the
director's occupation, including positions and offices with the Company, the
period during which he has served as a director, if applicable, together with
the number of shares of common stock beneficially owned, directly or indirectly,
by such director, if any, and the percentage of the outstanding shares that any
such ownership represented at the close of business on March 15, 1999.
<TABLE>
<CAPTION>
Director's
Name, Principal
Occupation (in Period of Amount and Percent of
Addition to Director, Consecutive Nature of Class
if applicable) Service Beneficial Beneficially
and Address** Age From Ownership Owned
- ---------------------- ---- ----------- ---------- ------------
<S> <C> <C> <C> <C>
MICHAEL A. DiGREGORIO 52 1995 0 0
Vice President/Senior
Trust Counsel
Wilmington Trust Company
Wilmington, DE
MARGUERITE R. GORMAN * 68 1998 0 0
Vice President
Spear, Leeds & Kellogg
New York, NY
PETER R. KELLOGG * 56 1998 1,936,592 41.2%
Senior Managing Director
Spear, Leeds & Kellogg
New York, NY
EDWARD A. KERBS * 48 1998 0 0
President
Oceanic Company, Inc.
Fair Haven, NJ
GEORGE E. KING 68 1989 0 0
Chairman/Chief
Executive Officer
McM Corporation
Raleigh, NC
STEPHEN L. STEPHANO 45 1992 0 0
President/Chief
Operating Officer
McM Corporation
Raleigh, NC
Share ownership of
all Directors,
Nominees and Executive
Officers of McM as a
Group (6 persons).......................... 1,938,592 41.2%
</TABLE>
17
<PAGE> 19
* In Section 5.1 of the Offer and Rights Agreement (more particularly described
in Item 1(a) hereof) the Company agreed to take all actions necessary to cause
IAT's designees to be elected as directors of the Company. Likewise, in Section
5(a) of the Tender Agreement (more particularly described in Item 1(a) hereof)
the directors of McM as of July 16, 1998, including Messrs. DiGregorio, King and
Stephano listed above, agreed to appoint IAT designees to fill vacancies on the
Company's Board of Directors. IAT's designees are indicated above by an asterisk
*.
** John A. Amaral and Richard D. Spurling declined to accept their
October 1, 1998, appointments to the McM Board of Directors.
Business Experience of the Directors
Mr. DiGregorio has served as a director of McM since May 1995. He has
also served for more than eight years as Vice President and Senior Trust Counsel
with Wilmington Trust Company in Wilmington, Delaware, where he manages the
Estate and Legal Services Division. A graduate of Temple University, Mr.
DiGregorio was admitted to the Pennsylvania Bar in 1979, and was then employed
as an Investigator for the United States Department of Labor. Prior to joining
Wilmington Trust, Mr. DiGregorio worked as an Employee Benefits Attorney for the
Fidelity Mutual Group in Radnor, Pennsylvania, and later at the law firm of
Stradley, Ronon, Stevens & Young in Philadelphia, Pennsylvania.
Ms. Gorman was appointed to serve as a director of McM on October 1,
1998. Ms. Gorman has worked for over forty years in the stock brokerage business
at Spear, Leeds & Kellogg, a New York brokerage firm. She currently serves as a
Vice President of Spear, Leeds &
18
<PAGE> 20
Kellogg.
Mr. Kellogg was appointed to serve as a director of McM on October 1,
1998. Mr. Kellogg has worked for over thirty years in the stock brokerage
business and has served as Senior Managing Director of Spear, Leeds & Kellogg, a
New York stock brokerage firm, for over 20 years. Mr. Kellogg also serves on the
Boards of Directors of the Ziegler Companies and Interstate Johnson/Lane, both
public companies.
Mr. Kerbs was appointed to serve as a director of McM on October 1,
1998. Mr. Kerbs has worked for over twenty years in the stock brokerage
business. From 1984 - 1996, Mr. Kerbs served as Managing Director with Spear,
Leeds & Kellogg, a New York stock brokerage firm. Since 1996, Mr. Kerbs has
served as President of Oceanic Company, Inc., a private financial consulting
firm.
Mr. King has served as a director of McM since February 1989. Mr. King
has also acted as Chairman of the Board of McM and Chairman of all of its
subsidiaries since February 1989 when he was named President and Chief Executive
Officer. He was elected Chairman Emeritus of McM in August 1996. He served as
President of McM subsidiaries Occidental Life and Peninsular Life Insurance
Companies until McM sold those companies on October 24, 1991. Through December
1988, Mr. King served as Executive Vice President of McM, to which position he
was named in January 1985. Prior to his affiliation with McM, Mr. King was
Deputy Commissioner and Chief Examiner with the North Carolina Department of
Insurance.
Mr. Stephano has served as a director of McM since August 1992. In
August 1996, he was elected President of McM. In March 1995, he was elected
Chief Executive Officer of McM subsidiaries Occidental Fire & Casualty Company
of North Carolina and Wilshire Insurance Company after having been named
President of both companies in July 1994. He was named Chief Operating Officer
of McM and its subsidiaries in September 1992. Previously, Mr. Stephano was
named Executive Vice President of McM in January 1988. He had been named Senior
Vice President/Chief Financial Officer of McM in January 1985. Mr. Stephano's
various other previous positions at McM have been Vice President, Chief
Financial Officer and Treasurer beginning in 1983; Vice President and Controller
beginning in January 1983; Controller beginning in 1982. Prior to his employment
with McM, he served on the professional staff of Ernst & Young, an international
public accounting firm.
Executive Officers of McM Corporation
The table below sets forth the names and ages of all executive officers
of McM, all positions and offices with McM presently held by
19
<PAGE> 21
each such person, and the period of service as an officer with McM and
subsidiaries.
<TABLE>
<CAPTION>
Period of
Service as
Name Age Offices an Officer
---- --- ------- ----------
<S> <C> <C> <C>
George E. King 68 Chairman Emeritus and 12/77
Chief Executive Officer
Stephen L. Stephano 45 President and Chief 1/82
Operating Officer
</TABLE>
Mr. King - See "Business Experience of the Directors."
Mr. Stephano - See "Business Experience of the Directors."
Item 11. Executive Compensation
Directors' Fees
Prior to October 1, 1998, directors of the Board who were not salaried
officers of McM or its subsidiaries were compensated at a rate of $15,000 per
year plus $1,000 per diem for each Board or Board committee meeting attended and
$1,000 per diem for travel associated with such meeting. The directors were also
reimbursed for other expenses incurred in attending the meetings. Similarly,
directors involved in special assignments were compensated at the rate of $1,000
per diem for special assignments and $1,000 per diem for travel associated with
such special assignments. As with regular Board meetings, other expenses
incurred by these directors in attending such special assignments were
reimbursed.
In addition, prior to October 1, 1998, directors of the Board who were
not salaried officers were compensated at a rate of $5,000 per year for each
subsidiary company Board of Directors on which they served. Per diem allowances
were the same as those for serving on the McM Board of Directors except that no
per diem allowances were paid if Board meetings were held concurrently. During
1998, all subsidiary Board meetings were held concurrently with McM Board
meetings. Total fees in the amount of $203,500 were expended for all regular McM
and subsidiary Board meetings, Board committee meetings and special assignments
during 1998.
Effective October 1, 1998, there are no fees paid to directors.
Directors are reimbursed for expenses incurred in attending meetings.
20
<PAGE> 22
EXECUTIVE OFFICERS' SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
Long Term Compensation
---------------------------------------
Annual Compensation Awards Payouts
--------------------------------------------- ---------------------------------------
Other Securities
Name and Annual Restricted Underlying All Other
Principal Compen- Stock Options LTIP Compensa-
Position Year Salary($) Bonus($) sation($)(3) Award(s)($) (#) Payouts($) tion(4)
- -------- ---- --------- -------- ------------ ----------- --- ---------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
George E. King(1) 1998 286,004 -- -- -- -- -- 10,259
Chairman Emeritus/CEO 1997 274,992 19,350 -- -- -- -- 7,120
1996 274,992 90,320 -- -- -- 22,324 7,120
Stephen L. Stephano(2) 1998 234,000 -- -- -- -- -- 1,700
President/COO 1997 225,000 15,850 -- -- -- -- 1,219
1996 225,000 66,863(5) -- -- -- 15,921 1,126
</TABLE>
(1) Effective February 16, 1998, the Company entered into an employment contract
with Mr. King. The contract, as amended effective March 28, 1990, October 18,
1990, December 30, 1991, February 1, 1993, September 1, 1993, March 16, 1995,
August 6, 1996, and March 26, 1998, provided that Mr. King be employed as an
executive officer of McM and provided for base salary and such additional
discretionary bonuses, stock options or other compensation or increases in
compensation, if any, as may be authorized by the Company. The contract also
contained special provisions regarding a change in control or a termination
without cause. See contract and amendments attached hereto as Exhibit 10(c) for
more specific information. This contact was terminated effective January 31,
1998. Effective February 1, 1999, the Company entered into an employment
contract with Mr. King. The contract provides that Mr. King be employed by the
Company and provides for payment of a base salary. In addition, should Mr.
King's employment be terminated without cause, he would receive continuing
installments of his base salary until such time as total payments under the
contract reached $450,000.
(2) Effective February 1, 1993, the Company entered into an employment contract
with Mr. Stephano. The contract, as amended September 1, 1993, March 16, 1995,
August 6, 1996, and March 26, 1998, provided that Mr. Stephano be employed as an
executive
21
<PAGE> 23
officer of McM and provided for base salary and such additional discretionary
bonuses, stock options or other compensation or increases in compensation, if
any, as may be authorized by the Company. The contract also contained special
provisions regarding a termination without cause. See contract and amendments
attached hereto as Exhibit 10(c) for more specific information. This contract
was terminated effective January 31, 1998. Effective February 1, 1999, the
Company entered into an employment contract with Mr. Stephano. The contract
provides that Mr. Stephano be employed by the Company and provides for payment
of a base salary. In addition, should Mr. Stephano's employment be terminated
without cause, he would receive continuing installments of his base salary until
such time as total payments under the contract reached $450,000.
(3) Personal benefits totaled less than $50,000 or 10% of annual salary and
bonus.
(4) The amounts noted represent premiums paid by the Company on behalf of
executive officers for supplemental term life insurance.
(5) Mr. Stephano also received 50,000 shares of phantom stock in 1996.
RETIREMENT PLAN
Officers of McM, including the named executive officers, participate in
the McM Corporation Retirement Plan. A sample retirement benefit table for the
Retirement Plan is outlined below showing the anticipated annual amount of
normal retirement benefits associated with final average earnings and the number
of years of service for the named executive officers.
RETIREMENT PLAN TABLE
<TABLE>
<CAPTION>
Participants'
Final
Average Earnings 15 20 25 30 35
- ---------------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
$125,000 $34,277 $45,702 $57,128 $ 68,553 $ 79,979
150,000 41,777 55,702 69,628 83,553 97,479
175,000 49,277 65,702 82,128 98,553 114,979
200,000 56,777 75,702 94,628 113,553 132,479
225,000 64,277 85,702 107,128 128,553 149,979
250,000 71,777 95,702 119,628 143,553 167,479
</TABLE>
Benefits under the Retirement Plan are determined by
22
<PAGE> 24
multiplying a participant's final average earnings (the best five consecutive
years of the last ten years) by 1.35% times the years of benefit service,
multiplying a participant's final average earnings in excess of Social Security
Average Wages by .65% times the years of benefit service (not in excess of 35
years) and adding the two results together.
Under federal law, the amount of compensation which may be considered
for purposes of calculating benefits is limited. That amount will be adjusted
periodically for inflation in increments of $10,000. The 1998 limit is $160,000
and will not change for 1999 benefit calculations. Benefits paid to participants
are reduced in the event of earlier retirement. The estimated credited years of
service for McM's executive officers are 20 years for Mr. King and 18 years for
Mr. Stephano. Benefits shown in the Retirement Plan Table are not subject to any
deduction for social security or other offset amounts.
AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR
AND FISCAL YEAR-END OPTION VALUES
<TABLE>
<CAPTION>
Number of Securities Value of Unexercised
Underlying Unexercised In-the Money Options at
Options at 12/31/98 ($) 12/31/98 ($)
Shares Acquired Value Exercisable/ Exercisable/
Name on Exercise(#)(1) Realized ($) Unexercisable Unexercisable
- ----------------------- ------------------ ----------------- ---------------------------- ----------------------------
<S> <C> <C> <C> <C>
George E. King 78,981 98,512 -0- -0-
Chairman
Emeritus/CEO
Stephen L. Stephano 78,981 98,512 -0- -0-
President/COO
</TABLE>
(1) No shares were actually acquired by Messrs. King and Stephano, as they
exchanged all of their options for the payment shown above in connection with
IAT's tender offer, as required by the terms of the Tender Agreement (more
particularly described in Item 1(a) hereof).
23
<PAGE> 25
Item 12. Security Ownership of Certain Beneficial Owners
and Management
Set forth below is the ownership of the Company's securities by all
persons or groups known to the Company to be the beneficial owner of more than
five percent of any class of the Company's voting securities as of December 31,
1998:
<TABLE>
<CAPTION>
Title Name and Address Amount and Nature Percent
of Of Beneficial of Beneficial of
Class Owner Ownership Class
- ----- ----- --------- -----
<S> <C> <C> <C>
Common McMillen Trust (1) 2,428,600 shares 51.6%
Wilmington Trust Company, directly owned
Trustee
1100 North Market Street
Wilmington, DE 19890-0001
Common IAT Reinsurance
Syndicate Ltd.(2) 1,938,592 shares 41.2%
Victoria Hall directly owned
11 Victoria Street
Hamilton, HM 12
Bermuda
</TABLE>
- ----------
(1) The McMillen Trust was created in 1925 pursuant to the terms of a deed
of trust from Alonzo B. and Florence O. McMillen. The Trust continues
in existence until the expiration of 21 years after the last to die of
Elizabeth Lee Long, Florence Lee Headley, R. Peyton Woodson III and
Laurence F. Lee, Jr. The McMillen Trust has been directed by the
Chancery Court of the State of Delaware to dispose of its interest in
McM. In April 1993, the Court granted the petition of the Wilmington
Trust Company, Trustee of the McMillen Trust, for a clarification of
existing orders to make clear, among other things, that the timing and
terms of any such disposition or sale shall be determined in the sound
discretion of the Trustee. On October 1, 1998, pursuant to the terms of
a Trust Purchase Agreement dated July 16, 1998, between the McMillen
Trust and IAT Reinsurance Syndicate Ltd., IAT purchased 658,900 shares
from the Trust. (See Item 1(a) for further discussion.)
The Trustee of the McMillen Trust, subject to certain
24
<PAGE> 26
limitations, is required to vote the McM shares owned by the Trust in
the way that a majority in interest of the income beneficiaries may
decide. At present there are six income beneficiaries of the McMillen
Trust. All are lineal descendants of the Trust grantors. The figures
following each name show the relative interests in the Trust of the
income beneficiaries:
a. Mrs. Elizabeth Lee Long (1/9), Denver, Colorado.
b. Mrs. Florence Lee Headley (1/9), Denver, Colorado.
c. Mr. Laurence F. Lee, Jr. (1/9), Jacksonville, Florida.
d. Mrs. Lonnie McMillen Sanchez (1/6), Albuquerque, New Mexico.
e. Mrs. Katherine Faust Roe (1/6), Sante Fe, New Mexico.
f. Mr. R. Peyton Woodson III (1/3), Raleigh, North Carolina.
(2) Amount shown represents 658,900 shares purchased from the McMillen
Trust as noted above and 1,279,692 shares purchased pursuant to a
tender offer completed on October 1, 1998. (See Item 1(a) for further
discussion.)
Note: For security ownership of management and directors, see Item
10.
Item 13. Certain Relationships and Related Transactions
The information called for under this item does not apply.
25
<PAGE> 27
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on
Form 8-K
(a) The following documents are filed as a part of this report.
1. Financial Statements- The following consolidated financial
statements of McM and subsidiaries are filed in response to
Item 8:
<TABLE>
<CAPTION>
Page
----
<S> <C>
Consolidated Balance Sheets - December 31, 1998 44
and 1997
Consolidated Statements of Operations - Years Ended
December 31, 1998, 1997 and 1996 45
Consolidated Statements of Shareholders' Equity
Years Ended December 31, 1998, 1997 and 1996 47
Consolidated Statements of Cash Flows 46
Years Ended December 31, 1998, 1997 and 1996
Notes to Consolidated Financial Statements 48
Report of Independent Auditors 71
2. Financial Statement Schedules--The following
schedules are filed in accordance with the
requirements of Article 7 of Regulation S-X:
Schedule 1 - Summary of Investments - Other than 72
Investments in Related Parties (In
compliance with Schedule I of Rule
7-05):
Schedule 2 - Condensed Financial Information of 73
Registrant (In compliance with
Schedule II of Rule 7-05):
Schedule 3 - Reinsurance (In compliance with 77
Schedule IV of Rule 7-05):
</TABLE>
26
<PAGE> 28
<TABLE>
<CAPTION>
Page
----
<S> <C>
Schedule 4 - Valuation and Qualifying Accounts 78
(In compliance with Schedule V of
Rule 7-05):
Schedule 5 - Supplemental Information for Property 79
& Casualty Insurance Underwriters (In
compliance with Schedule VI of Rule
7-05):
All other schedules to the consolidated
financial statements required by Article 5
or 7 of Regulation S-X are not applicable
and, therefore, have been omitted.
3 The following exhibits are included in
accordance with the requirements of Item 601
of Regulation S-K.
Exhibit (3): a) Articles of Incorporation as
amended are attached 89
b) By-laws of McM Corporation are
incorporated by reference from
Form 10-K, dated December 31, 1995.
Exhibit (9): McMillen Trust Agreement is incorporated
by reference from Form 10, dated
April 24, 1978.
Exhibit (10):Material contracts:
a) The 1986 Employee Incentive Stock Option
Plan (as amended) is incorporated by
reference from the December 31, 1994, Form
10-K. The 1996 Employee Incentive Stock
Option Plan is incorporated by reference
from the 1996 Proxy Statement.
b) The Phantom Stock Plan is incorporated by
reference from the December 31, 1994, Form
10-K. The first amendment to this plan dated
August 6, 1996, is incorporated by reference
from the December 31, 1996, Form 10-K. See
Note J of the Consolidated Financial
Statements regarding the termination of this
plan.
</TABLE>
27
<PAGE> 29
<TABLE>
<CAPTION>
Page
----
<S> <C>
c) Employment and retention bonus contracts for
certain executive officers are incorporated
by reference from the December 31, 1989,
1992, 1993, 1994 and 1996, Forms 10-K. March
26, 1998, amendments are attached. The
employment contracts were terminated
effective January 1, 1999. 81
d) The Key Executive Incentive Compensation
Plan is incorporated by reference from the
December 31, 1994 Form 10-K.
e) The Equity Appreciation Rights Plan is
incorporated by reference from the 1993
Proxy Statement.
f) The 1996 Employee Stock Purchase Plan is
incorporated by reference from the 1996
Proxy Statement. This plan was terminated
effective July 15, 1998.
g) The 1996 Non-Employee Directors' Stock
Purchase Plan is incorporated by reference
from to 1996 Proxy Statement.
h) Contracts of Employment for McM's executive
officers effective February 1, 1999, are
attached. 85
i) The Offers and Rights Agreement dated July
16, 1998, between McM and IAT is
incorporated by reference from the July 23,
1998, McM Form 14d-9.
Exhibit (21): Subsidiaries of the Registrant. 80
Exhibit (23): Consent of Independent Auditors 97
Exhibit (27): Financial Data Schedule
(for SEC use only)
</TABLE>
(b) The Company reported on Form 8-K dated October 1, 1998, the
completion of IAT Reinsurance Syndicate Ltd.'s tender offer
for the purchase of up to 35% of the outstanding common stock
of McM for $3.65 per share. Reference is hereby made to Part
I, Item 1 (a) of this Form 10-K for more detailed information
concerning this transaction.
28
<PAGE> 30
(c) Exhibits--The response to this portion of Item 14 is submitted
as a separate section of this report beginning on page 32.
(d) Financial Statement Schedules--The response to this portion of
Item 14 is submitted as a separate section of this report
beginning on page 31.
THIS SPACE LEFT BLANK INTENTIONALLY
29
<PAGE> 31
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereto duly authorized.
McM CORPORATION
By: /s/STEPHEN L. STEPHANO
-----------------------------------
(Registrant)
Stephen L. Stephano, President and
Chief Operating Officer
Date: 3/30/99
-------------
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.
/s/GEORGE E. KING 3/30/99 /s/MICHAEL DIGREGORIO 3/30/99
- ------------------------------- ------------------------------
George E. King Michael A. DiGregorio
Chairman Emeritus, Director
Chief Executive Officer and
Director
/s/STEPHANO L. STEPHANO 3/30/99 /s/PETER R. KELLOGG 3/30/99
- ------------------------------- ------------------------------
Stephen L. Stephano Peter R. Kellogg
President, Director
Chief Operating Officer
and Director
/s/KEVIN J. HAMM 3/30/99 /s/EDWARD A. KERBS 3/30/99
- ------------------------------- ------------------------------
Kevin J. Hamm Edward A. Kerbs
Vice President and Director
Chief Financial Officer
/s/MARGUERITE R. GORMAN 3/30/99
- -------------------------------
Marguerite R. Gorman
Director
30
<PAGE> 32
ANNUAL REPORT ON FORM 10-K
Item 7(b) - Management's Discussion and Analysis of Financial
Condition and Result's of Operations
Item 8 - Financial Statements and Supplementary Data
Item 14(d) - Financial Statement Schedules
Item 14 (c) - Exhibits
Year Ended December 31, 1998
McM CORPORATION AND SUBSIDIARIES
31
<PAGE> 33
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
McM Corporation and Subsidiaries
This section should be read in conjunction with the financial statements, notes
to the financial statements and related financial data included in this annual
report.
REVIEW OF OPERATIONS
McM Corporation reported a consolidated net loss available for common
shareholders for 1998 of $15,595,000 or a basic net loss per share of $3.32
compared to a net loss of $8,540,000 or a basic net loss per share of $1.82 for
1997 and a net loss of $788,000 or basic net loss per share of $.17 for 1996.
Consolidated results for 1998 were significantly affected by the need to
increase reserves of prior accident years by approximately $7.1 million. This
increase in reserves was necessary as a result of the Company's comprehensive
review of its actuarial loss projections which showed deterioration in the
commercial auto liability line of business for the 1997, 1996 and 1995 accident
years. As a result of these unfavorable loss trends, the Company also
strengthened commercial auto liability loss reserves for the current accident
year by approximately $5.1 million in the fourth quarter of 1998. Higher than
expected claim costs were also experienced by the Company in its commercial auto
property coverages for the 1998 accident year. As a result the Company
strengthened current year reserves for its commercial auto physical damage and
cargo lines of business by approximately $1.7 million in the fourth quarter of
1998.
Consolidated revenues decreased approximately 15.6% in 1998.
Consolidated revenues for 1997 and 1996 showed increases of approximately 6.9%
and 12.4%, respectively. The decline in revenues for 1998 reflects a $12.5
million overall reduction in the Company's gross written premiums when compared
to 1997. Private passenger auto premium writings declined approximately $5.5
million and commercial auto premium writings produced by the Company's general
agency force declined approximately $6.9 million during 1998. The decline in
private passenger business resulted from an overall increase in market
competition and rate increases implemented by the Company in certain markets
during 1998. These rate increases when implemented placed the Company at a
competitive disadvantage until the remainder of the market brought its rates up
to levels more in line with the Company's. Though competition remains high in
this market, premium writings in 1999 are beginning to show some growth.
Market conditions in the Company's commercial auto business continues
to be highly competitive and price sensitive. These conditions coupled with a
reduction in the Company's A.M. Best
32
<PAGE> 34
rating to C for much of 1998 significantly impacted the ability of the Company's
general agents to compete effectively in this marketplace. In addition, the
Company began to remediate a particular general agent's business which was
producing unusually high loss ratios. The effort to improve the profitability of
this agent's business reduced commercial auto premiums by approximately $5
million. In the fourth quarter of 1998 the Company's Best rating was upgraded to
B-. As of December 31, 1998, the impact on this upgrade on the marketing
effectiveness of the Company remained unclear.
Revenue growth in 1997 and 1996 reflected planned growth in overall
property & casualty insurance premiums. Growth in private passenger automobile
premium writings during this period were partially offset by a reduction in net
retained commercial automobile premium writings.
Net earned property and casualty insurance premiums for 1998 were $47.0
million, compared to $55.7 million in 1997 and $51.8 million in 1996. As
mentioned above, the decline in net premium revenue during 1998 reflects highly
competitive conditions in both the commercial and private passenger auto
marketplaces. The Company's property and casualty insurance writings emphasized
liability, cargo and physical damage coverages associated with the
transportation market with a primary emphasis on commercial automobile
insurance. To diversify its premium distribution, the Company entered the
nonstandard personal automobile market in 1989. Gross written premium in the
Company's commercial automobile lines of business totalled $50.7 million and
$57.7 million, and comprised approximately 80.4% and 76.4% of gross written
premiums in 1998 and 1997, respectively. Private passenger automobile premium
writings declined 30.7% to $12.4 million in 1998, from $17.9 million in 1997,
and comprised 19.6% and 23.6% of gross production in 1998, and 1997,
respectively.
Underwriting results for cargo (inland marine) and commercial auto
physical damage coverages historically have been more profitable than commercial
auto liability. These coverages are generally easier to determine and claims
settled more rapidly. Accordingly, the Company sought to increase written
premiums in these lines of business annually and measures progress by reviewing
the ratio of these coverages to total commercial auto written premiums. The
percentage of cargo and commercial auto physical damage premiums to total
commercial auto premiums for 1998 continues the increasing trend of the last
several years showing a slight increase to 30.3% compared to 29.7% in 1997 and
26.6% in 1996
During 1998 the Company had in place quota share reinsurance
arrangements for its commercial auto liability and private passenger auto
coverages to help control unexpected growth and
33
<PAGE> 35
keep its net writings to surplus ratios within regulatory limits. In 1998 the
Company was party to a 40% quota share agreement on its private passenger auto
business compared to 20% and 30% in 1997 and 1996, respectively. The Company
also maintained a 5% quota share arrangement on commercial auto liability
coverages during 1998. The cession rate of this arrangement had remained
unchanged since 1995.
The declining trend in net investment income seen over the last several
years continued into 1998. Net investment income excluding realized investment
gains declined approximately $469,000 in 1998 when compared to 1997 and totalled
$2.5 million. Net investment income was $3.0 million and $3.2 million in 1997
and 1996, respectively. The decline in both 1997 and 1996 related to decreases
in invested assets which totalled $49.9 million in 1997 and $56.9 million in
1996. Invested assets at December 31, 1998, totalled $62.3 million and included
approximately $22 million of new equity investments. (For more detailed
information concerning these new equity investments please see the discussion
under the "Liquidity and Capital Resources" caption.) The declining trend
continued into 1998 and is attributed to the deteriorating loss experience
discussed previously and the associated settlement of claim liabilities. In
addition, net investment income for 1998 was also adversely affected by the
decline in written premium mentioned above. Realized investment gains of
$274,000 are included in 1998 revenues compared to $196,000 and $40,000 in 1997
and 1996, respectively.
The overall ratio of net loss and settlement expenses to net premiums
earned was 94.6% for 1998 compared to 86.2% for 1997 and 75.6% for 1996. As
discussed previously, the increase in the loss ratio in 1998 resulted primarily
from the deterioration in the commercial auto liability line of business,
particularly for the 1997 and 1996 accident years and higher than expected claim
costs in the current underwriting year for commercial auto physical damage and
inland marine(cargo) coverages. A comprehensive actuarial analysis of loss
trends and projections at year end 1998 confirmed this deterioration and the
need to increase prior year loss reserves. The Company determined it was also
necessary to increase loss reserves for the current accident year in the fourth
quarter of 1998.
In 1998 current year loss reserves were increased approximately $7.0
million from management's planned levels and prior year loss reserves were
increased approximately $7.1 million, for a total of $14.1 million, net of
reinsurance. Of the $7.0 million increase to current year reserves,
approximately $5.1 million related to commercial auto liability coverages and
$1.7 million to the physical damage and inland marine lines of business.
The adverse loss development on prior accident years of $7.1
34
<PAGE> 36
million included in net losses and settlement expenses incurred for 1998
includes adverse reserve development of approximately $6.9 million in the
commercial auto liability line of business primarily in the 1997 and 1996
accident years. The commercial auto physical damage and private passenger auto
coverages showed favorable reserve development of approximately $1 million. In
addition, the Company experienced adverse prior year development of
approximately $1 million relating to discontinued lines of business and
participation in involuntary pools and other residual market mechanisms.
Management believes it has taken the appropriate steps to address concerns
raised about the overall adequacy of its reserve levels and that reserves are
now strongly positioned in relation to the overall range of actuarial
indications at year end 1998.
The increase in the 1997 ratio of net loss and settlement expenses to
net premiums earned also reflected deterioration in overall loss and settlement
expense projections. In 1997, the Company strengthened the 1997 accident year
reserves by approximately $4.5 million primarily in commercial auto coverages
and showed adverse reserve development on prior accident year reserves of
approximately $5.7 million. The adverse development on prior year reserves in
1997 included approximately $3.5 million related to commercial auto liability,
$844,000 to private passenger auto liability and $813,000 to commercial and
private passenger auto physical damage coverages. In addition, $586,000 of prior
accident year development in 1997 was related to discontinued lines of business
and involuntary pools.
The ratio of net loss and settlement expenses to net premiums earned
for 1996 reflected an unusually high level of claims severity experienced by the
Company in the fourth quarter of 1996 and increased claim frequency in its other
lines of business.
The Company's ratio of underwriting, acquisition and administrative
expenses (including the provision for bad debts on liquidated reinsurance)to net
earned premium ("the expense ratio") increased 8.5 percentage points to 44.5%
compared to 36.0% and 33.3% for 1997 and 1996, respectively. The increase in the
expense ratio for 1998 can be attributed to the overall decline in written
premiums discussed previously and a $733,000 increase in the provision for
liquidated reinsurance. A $550,000 increase in the provision for liquidated
reinsurance when compared to 1996 was a main factor contributing to the increase
in the expense ratio for 1997. Increased production levels coupled with
budgetary restraint is being emphasized by management entering 1999.
The Company utilizes a reinsurance intermediary with which it has a
long-term relationship to assist in the development, placement and maintenance
of the Company's reinsurance program. The Company's current reinsurance program
has been placed with high
35
<PAGE> 37
quality and financially sound reinsurers specializing in personal and commercial
auto business. The creditworthiness of the Company's reinsurers is continually
reviewed by the Company and the intermediary. The majority of the Company's
reinsurance is placed through the London reinsurance market. The reinsurers
participating in the Company's reinsurance program are generally very large
international reinsurers with capital and surplus in excess of $100 million and
hold A.M. Best ratings of B++ or better. Participating Lloyds syndicates are
well regarded syndicates which have been approved by the National Association of
Insurance Commissioners ("NAIC"). The Company's U.S. reinsurers are all rated A-
or higher by A.M. Best. For those reinsurers not admitted by the Company's state
of domicile, collateral is secured for the exposure ceded to them in the form of
letters of credit or other reinsurer funds held by the Company. This collateral
would minimize the impact of a potential reinsurer insolvency on the Company's
operations. A schedule of the Company's reinsurers whose balances are
approximately 10% or more of McM's shareholders' equity is provided below:
<TABLE>
<CAPTION>
Ceded
Reinsurer Balances Receivable
--------- -------------------
(Thousands of dollars)
<S> <C>
Lloyds of London $ 8,430
CNA International 4,542
Unionamerica 4,446
AXA Reassurance 3,321
Zurich Re 3,039
Sphere Drake Insurance, PLC 1,976
Hannover Ruckersicherungs 922
Terra Nova Insurance Co. 704
National Reinsurance Corp 692
Chartwell Reinsurance Co. 567
National Workers Comp. Pool 549
Folksamerica Reinsurance Co. 505
Great Lakes American
Reinsurance Company 489
Employers Reinsurance Corp. 433
Focus Insurance Company
in Liquidation 375
Trenwick America Reinsurance Co. 310
All other 2,386
-------
Total $33,686
</TABLE>
The provision for (recovery of) bad debts of liquidated reinsurers
relating to discontinued property and casualty programs was increased by
$1,134,000 and $401,000 and decreased by $150,000 in 1998, 1997 and 1996,
respectively. The increase in the provision for 1998 was primarily related to
adverse development in the workers compensation line of business.
36
<PAGE> 38
Amortization of deferred policy acquisition costs exceeded policy
acquisition costs deferred by approximately $395,000 in 1998 compared to $1.2
million in 1997 reflecting the overall declines in written premiums discussed
previously. Policy acquisition costs deferred exceeded those amortized in 1996
by $649,000 reflecting overall premium growth in that year.
INCOME TAXES
McM Corporation files a consolidated tax return. The Company had
cumulative net operating loss tax carryforwards of approximately $103.0 million
as of December 31, 1998 (See Note E to the consolidated financial statements).
Subject to certain limitations and alternative minimum tax considerations,
future operations can earn up to the amount of these loss carryforwards without
being subject to federal income taxation.
IMPACT OF YEAR 2000 ISSUE
The Year 2000 Issue, also known as the Y2K problem, is a worldwide
problem relating to computer programs and imbedded chips that use two digits
rather than four to define the applicable year. Computer programs that have
time-sensitive software may recognize a date using "00" as the year 1900 rather
than the year 2000. Failure to address the Y2K problem could have had a material
adverse effect on the Company's operations and financial condition and result in
systems failures or miscalculations causing disruptions of operations,
including, among other things, a temporary inability to process premium
transactions, pay claims or engage in similar normal business activities.
In addition to uncertainties related to the functioning of systems
subsequent to December 31, 1999, property and casualty insurance companies may
have an underwriting exposure related to the Year 2000. Although McM has not
received any claims for coverage from its policyholders based on losses
resulting from Year 2000 issues, there can be no assurance that policyholders
will not suffer losses of this type and seek compensation under insurance
policies issued by its property and casualty subsidiaries. If any claims are
made, coverage, if any, will depend on the facts and circumstances of the claim
and the provisions of the policy. At this time, McM is unable to determine
whether the adverse effect, if any, in connection with the foregoing
circumstances would be material to its operations.
The Company completed an assessment of its computerized information
systems to determine the impact of the year 2000 on the ability of those systems
to accurately process information that may be date sensitive. It was found that
the system managing the Company's specialized monthly commercial automobile
direct bill program would have to be modified so that it would function
37
<PAGE> 39
properly with respect to dates in the year 2000 and thereafter. This
modification was successfully completed in 1997 at an approximate cost of
$96,000. Other Company computer applications, most of which are licensed from
third party computer program vendors, were determined to be Year 2000 compliant
or, based upon communication with these vendors, would be compliant before any
anticipated impact resulting from the year 2000.
The project, as it relates to all of the Company's computer platforms,
was completed and fully operational on July 1, 1998. The Company continues to
replace peripheral hardware and software such as personal computers,
telecommunications and spreadsheet software with Year 2000 compliant products.
The Company remains on target to correct all remaining year 2000 related problem
products well ahead December 31, 1999. The Company will devote all resources
necessary to resolve any remaining year 2000 issues in a timely manner and
believes the year 2000 will pose no significant threat to its operations.
NEW ACCOUNTING STANDARDS
In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standard No. 130, "Reporting Comprehensive
Income" ("SFAS 130") for years beginning after December 15, 1997. Comprehensive
Income is defined as essentially all changes in shareholders' equity exclusive
of transactions with owners, such as capital investments and includes net income
(loss) plus changes in certain assets and liabilities that are reported directly
in equity. The unrealized gain or loss on available-for-sale securities is the
Company's only component of other comprehensive income and is presented in the
Consolidated Statement of Changes in Shareholders' Equity.
Also in June 1997, the FASB issued the Statement of Financial
Accounting Standards No. 131 "Disclosure about Segments of an Enterprise and
Related Information" ("SFAS 131"). SFAS 131 requires companies to use the
"management approach" in disclosing segment information. The management approach
requires disclosure based on the types of financial information top management
uses in the decision-making process and in evaluating segment operations.
Management views the Company as operating in two segments: commercial automobile
and private passenger automobile. Appropriate disclosures about the Company's
segments are included in Note L to the Consolidated Financial Statements.
In February 1998, the FASB issued the Statement of Financial Accounting
Standards No. 132 "Employers' Disclosures about Pensions and Other
Postretirement Benefits" ("SFAS 132") for years beginning after December 15,
1997. The objective of SFAS 132 is to improve and standardize disclosures about
pensions and other postretirement benefits and to make the required information
easier to prepare and
38
<PAGE> 40
more understandable. Information disclosed in Note F "Pension Plan" to the
Company's financial statements is presented in accordance with the requirements
of SFAS 132.
LIQUIDITY AND CAPITAL RESOURCES
On July 17, 1998, the Company and IAT Reinsurance Syndicate Ltd.
("IAT"), a Bermuda-based insurance and investment company, announced the signing
of an agreement dated July 16, 1998, (the "Offer and Rights Agreement") pursuant
to which IAT expressed its intention to acquire up to 49% of McM's outstanding
common stock for $3.65 per share. Up to 35% of McM's common stock was to be
acquired in a public tender offer (the "Tender Offer") with the remaining 14% to
be acquired from the McMillen Trust pursuant to an agreement between IAT and the
Trust executed the same day (the "Trust Purchase Agreement"). The McMillen Trust
owned approximately 65% of McM's outstanding shares at the time the agreement
was signed.
Contained in the Offer and Rights Agreement is a provision whereby McM
issued to IAT rights (the "Rights" or "Poison Pill") to purchase 60,000 shares
of McM Series A Preferred Stock, par value $1,000, at an exercise price of $.01
per share. The Rights become exercisable in whole or in part at any time after
issuance and prior to June 1, 2008, if (i) the McMillen Trust sells any of its
retained McM shares to any third party other than IAT (or IAT's assignees) or
(ii) if any person or entity other than IAT causes IAT's McM Board designees
(see Item 10 hereof) to cease to constitute a majority of the members of the McM
Board of Directors. However, death, resignation or removal by IAT of IAT's Board
designees shall not trigger the Rights' exercisability unless, while IAT's
designees do not constitute a majority of the McM Board, the Board takes any
action opposed by a majority of the remaining IAT designees or, if no IAT
designees remain, then the current chief executive officer of IAT. The Offer and
Rights Agreement further describes the procedure by which the Rights are
exercised should any of the above-described triggering events take place.
The Series A Preferred Stock that would be obtained by IAT if the
Rights were exercised has no conversion, dividend or voting rights (except those
required by law), but carries a senior liquidation preference and immediate
right to redemption upon 10 business days' written notice to the Company.
The Offer and Rights Agreement was unanimously approved by McM's Board
of Directors and the Tender Offer commenced on July 23, 1998. The Tender Offer
was made through offering documents filed with the Securities and Exchange
Commission and mailed to McM shareholders.
39
<PAGE> 41
On October 1, 1998, IAT successfully completed the Tender Offer and
purchased 1,279,692 shares (or 27.2%) of McM's common stock at the Tender Offer
price of $3.65 per share. On the same day IAT also purchased an additional
658,900 shares of McM common stock from the McMillen Trust pursuant to the Trust
Purchase Agreement. In total, IAT purchased 1,938,592 shares or (41.2%) for an
aggregate price of approximately $7,075,860.
On October 7, 1998, IAT provided a $10 million cash contribution to McM
Corporation. IAT made an additional $1 million cash contribution to McM on
October 28, 1998. In consideration of these contributions, McM issued 11,000
shares of McM Corporation Series B PIK Preferred Stock, $1000 par value to IAT.
The Series B PIK Preferred Stock accumulate dividends at a rate of 12% per
annum, payable quarterly in arrears on January 7, April 7, July 7, and October 7
of each year. The dividends are cumulative from the date of issuance and will be
paid in kind with additional fully paid and nonassessable shares of Series B PIK
Preferred Stock. At the Board of Directors' discretion quarterly dividends may
be paid in cash. McM also retired five $1 million certificates of contribution
issued to IAT by McM subsidiary OF&C (see later discussion under this caption),
replacing these certificates with a permanent $5 million cash capital
contribution to OF&C as additional paid-in capital. McM simultaneously issued
5,000 shares of Series B PIK Preferred Stock to IAT in exchange for the
retirement of these certificates of contribution.
On December 29, 1998, IAT made an additional $10 million cash
contribution to McM for consideration of 10,000 shares of McM Series B PIK
Preferred Stock. On the same day, McM made a permanent $5 million cash capital
contribution to OF&C as additional paid-in capital and transferred the remaining
$5 million to OF&C in exchange for the issuance of 500,000 shares of OF&C 8%
Preferred Stock, $10 par value.
By statute, the majority of the Company's investments are required to
be held in investment grade securities which provide ample protection for both
the policyholder and the shareholder. Significant amounts of short-term
investments are held to meet the liquidity needs of the property and casualty
insurance operations.
As shown in the Consolidated Statements of Cash Flows, the Company
experienced negative cash flows from operations on a consolidated basis of $12.1
million in 1998 compared to $5.5 million in 1997 and $4.4 million in 1996.
The main source of the Company's cash flows is derived from its
property and casualty subsidiaries. The Company's property and casualty
subsidiaries experienced consolidated negative cash flows from operations of
$11.1 million, $5.4 million and $4.2 million in 1998, 1997 and 1996,
respectively. The negative cash flows for the
40
<PAGE> 42
property and casualty operations can be attributed primarily to the reduction in
written premiums and the increase in the settlement of claim liabilities related
to the deteriorated loss experience discussed previously. Short-term investments
were utilized to handle the liquidity needs of the Company during 1998.
Short-term investments held at December 31, 1998, were $11.6 million compared to
$21.5 million at December 31, 1997.
Total cash and invested assets at December 31, 1998, were approximately
$70.4 million compared to $51.6 million at December 31, 1997. The increase in
cash and invested assets is directly related to the cash contributions from IAT
discussed above. Approximately $18.1 million of the cash received from IAT was
invested in an equity investment portfolio in the property and casualty
subsidiaries.
The Company maintains a mix of high-quality investments which provides
adequate returns, while limiting credit risk and providing necessary levels of
liquidity to meet projected expenditures. At December 31, 1998, approximately
36.4% or $25.6 million of cash and invested assets were comprised of
fixed-maturity securities available-for-sale, 31.2% or $22.0 million were
recorded as equity securities available-for-sale and 4.5% of fixed-maturity
securities held-to-maturity. Cash and short-term investments comprised the
remaining 27.9% of cash and invested assets. Of the total cash and invested
assets at December 31, 1997, approximately 49.0% or $25.3 million were comprised
of fixed-maturity securities available-for- sale and 6.1% or $3.1 million were
classified as fixed-maturity securities held-to-maturity. Cash and short-term
investments totalling $23.2 million comprised the remaining 44.9% of the
investment portfolio. The fixed-maturity security portfolio has a range of
expected maturities which, as mentioned previously, management believes are
adequate to meet long and short-term liquidity needs.
At December 31, 1998, the market value of the Company's long-term
fixed-maturity securities portfolio was $645,000 greater than amortized cost and
$137,000 greater than its carrying value. The unrealized gain of $137,000
relates to those investments the Company intends to hold to maturity. The par
value of these securities will be realized as they mature (see Note G to the
consolidated financial statements). At December 31, 1998, the market value of
the Company's equity securities portfolio was approximately $3.9 million greater
than its cost. As mentioned above the equity security portfolio is classified as
available-for- sale. At December 31, 1997, the market value of the
fixed-maturity securities portfolio was $370,000 less than its amortized cost
and $100,000 greater than its carrying value.
Statutory capital positions of the property and casualty insurance
companies are closely monitored by the Company. In
41
<PAGE> 43
addition, the NAIC has adopted Risk-Based Capital ("RBC") requirements. Annual
statutory financial statements are filed with state insurance regulators on or
before March 1 following each year end.
RBC was developed to evaluate the adequacy of statutory capital and
surplus in relation to investment and insurance risks such as asset quality,
asset and liability matching, loss reserve adequacy and other business
environmental factors. The RBC formula is used by state insurance regulators as
an early warning tool to identify, for the purpose of initiating regulatory
action, insurance companies that may be inadequately capitalized. Regulatory
compliance is determined by a ratio of the enterprise's regulatory total
adjusted capital, as defined by the NAIC, to its authorized control level RBC,
as defined by the NAIC. Enterprises below specific ratios are classified within
certain levels, each of which requires specific corrective action.
As discussed in the Company's 1997 Annual Report, OF&C, triggered the
first regulatory threshold, Company Action Level, of the Risk-Based Capital
framework established by the NAIC. Breaching this threshold required the Company
to submit an action plan to the North Carolina Department of Insurance ("NCDOI")
explaining the Company's intended course of action to eliminate this RBC
condition. The plan, submitted to the NCDOI by the Company on April 15, 1998,
included a proposed capital infusion of $5 million. On June 15, 1998, IAT
provided OF&C with a $5 million cash infusion supported by five $1 million
certificates of contribution. The terms of the certificates provided for
quarterly interest payments at the rate of 5% per annum with the principal
payable no later than December 31, 2000, upon the approval of the Commissioner
of the NCDOI. As discussed previously, the certificates of contribution were
retired upon the completion of IAT's successful cash tender purchase of McM
common stock.
At December 31, 1998, the Company's property and casualty insurance
subsidiaries exceeded all RBC thresholds. Combined statutory capital and surplus
of the property and casualty subsidiaries increased by $16.2 million to $27.7
million at December 31, 1998, compared to $11.5 million at December 31, 1997.
At December 31, 1998, the Company had consolidated shareholders' equity
of $2.5 million compared to $12.8 million at December 31, 1997. The Company's
main source of funds from which dividends are paid to its shareholders is its
insurance subsidiaries which are subject to certain restrictions as to the
amount of dividends that can be paid in a given year. These restrictions are
discussed in Note B to the consolidated financial statements. No dividends were
declared or paid during 1998 or 1997. The Board will continue to consider
carefully the Company's earnings, capital requirements, financial condition and
other
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<PAGE> 44
relevant factors with regard to payment of dividends.
THIS SPACE LEFT BLANK INTENTIONALLY
43
<PAGE> 45
CONSOLIDATED BALANCE SHEETS
McM CORPORATION AND SUBSIDIARIES
(Thousands of dollars)
<TABLE>
<CAPTION>
December 31
ASSETS 1998 1997
-------------------------
<S> <C> <C>
Invested assets:
Securities available-for-sale, at fair value:
Fixed maturities (amortized cost: 1998 - $25,152; 1997 - $25,755) $ 25,660 $ 25,284
Equity securities (cost: 1998 - $18,093; 1997 - $0) 21,969 0
Fixed maturities held-to-maturity, at amortized cost
(fair value: 1998 - $3,275; 1997 - $3,235) 3,138 3,134
Short-term investments 11,572 21,522
------------------------
62,339 49,940
Cash 8,120 1,698
Accrued investment income 579 531
Premiums receivable 6,660 8,552
Reinsurance balances recoverable on:
Paid losses and settlement expenses 3,090 1,476
Reserves for losses and settlement expenses 27,539 28,124
Unearned premiums 2,847 6,313
Deferred policy acquisition costs 2,407 2,802
Equipment, at cost less accumulated depreciation
(1998 - $2,153; 1997 - $1,954) 1,639 1,833
Other assets 2,515 2,871
------------------------
TOTAL ASSETS $ 117,735 $ 104,140
========================
LIABILITIES AND SHAREHOLDERS' EQUITY
Reserves for losses and settlement expenses $ 60,844 $ 57,283
Unearned premiums 10,793 15,676
Other policyholder funds 5,881 6,380
Amounts payable to reinsurers 3,233 4,461
Accrued expenses 8,527 7,572
------------------------
89,278 91,372
Redeemable Preferred Stock - Series B PIK 26,000 0
Shareholders' equity:
Common Stock, par value $1 per share - authorized: 1998 and 1997 - 10,000,000 shares;
issued and outstanding: 1998 - 4,706,388 and 1997 - 4,695,621 shares 4,706 4,696
Additional paid-in capital 1,540 1,530
Accumulated other comprehensive income 4,384 (471)
Retained (deficit) earnings (8,173) 7,013
------------------------
TOTAL SHAREHOLDERS' EQUITY 2,457 12,768
------------------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 117,735 $ 104,140
========================
</TABLE>
See notes to consolidated financial statements.
44
<PAGE> 46
CONSOLIDATED STATEMENTS OF INCOME
McM CORPORATION AND SUBSIDIARIES
(Thousands of dollars, except per share data)
<TABLE>
<CAPTION>
Year Ended
December 31
------------------------------------
1998 1997 1996
------------------------------------
<S> <C> <C> <C>
REVENUES
Premiums earned $ 67,135 $ 75,778 $ 73,568
Premiums ceded (20,127) (20,071) (21,714)
------------------------------------
Net premiums earned 47,008 55,707 51,854
Investment income, less investment expenses:
(1998 - $362; 1997 - $413; 1996 - $457) 2,516 2,985 3,159
Realized investment gains 274 196 40
Other income 430 649 645
------------------------------------
TOTAL REVENUES 50,228 59,537 55,698
LOSSES AND EXPENSES
Losses and settlement expenses 59,834 62,882 51,781
Losses and settlement expenses ceded (15,349) (14,865) (12,571)
------------------------------------
Net losses and settlement expenses 44,485 48,017 39,210
Underwriting, acquisition and administrative
expenses 19,795 19,659 17,426
Provision for bad debts on liquidated reinsurers 1,134 401 (150)
------------------------------------
TOTAL LOSSES AND EXPENSES 65,414 68,077 56,486
------------------------------------
NET LOSS (15,186) (8,540) (788)
Preferred stock dividends (409) 0 0
------------------------------------
NET LOSS AVAILABLE TO COMMON SHAREHOLDERS ($15,595) ($8,540) ($ 788)
====================================
PER SHARE DATA:
Net loss per common share - basic ($ 3.32) ($ 1.82) ($ 0.17)
Net loss per common share - assuming dilution ($ 3.32) ($ 1.82) ($ 0.17)
Dividends per common share declared by McM $ 0.00 $ 0.00 $ 0.06
====================================
</TABLE>
See notes to consolidated financial statements.
45
<PAGE> 47
CONSOLIDATED STATEMENTS OF CASH FLOWS
McM CORPORATION AND SUBSIDIARIES
(Thousands of dollars)
<TABLE>
<CAPTION>
Year Ended
December 31
----------------------------------
1998 1997 1996
----------------------------------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net loss $(15,186) $(8,540) $ (788)
Adjustments to reconcile net loss to net cash used by operating
activities:
Policy liabilities (1,821) (466) (10,828)
Premiums receivable 1,892 828 555
Accrued investment income (48) 272 37
Net receivable from reinsurers 1,209 1,971 6,128
Amortization of deferred policy acquisition costs 11,401 10,332 9,116
Policy acquisition costs deferred (11,006) (9,142) (9,765)
Other 1,437 (720) 1,150
----------------------------------
CASH USED BY OPERATING ACTIVITIES (12,122) (5,465) (4,395)
INVESTING ACTIVITIES
Securities available-for-sale:
Purchases (31,370) (10,499) (18,447)
Sales 14,286 19,506 0
Maturities 86 2,050 12,974
Securities held-to-maturity:
Purchases 0 0 (1,118)
Maturities 0 2,777 11,362
Purchases of property and equipment (428) (1,045) (757)
Decrease/(increase) in short-term investments 9,950 (7,461) 787
----------------------------------
CASH (USED) PROVIDED BY INVESTING ACTIVITIES (7,476) 5,328 4,801
FINANCING ACTIVITIES
Employee Stock Purchases 20 59 15
Cash Dividends Paid 0 0 (282)
Issuance of Series B Preferred Stock 26,000 0 0
----------------------------------
CASH PROVIDED (USED) BY FINANCING ACTIVITIES 26,020 59 (267)
----------------------------------
NET INCREASE (DECREASE) IN CASH $ 6,422 $ (78) $ 139
==================================
</TABLE>
See notes to consolidated financial statements.
46
<PAGE> 48
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
McM CORPORATION AND SUBSIDIARIES
(Thousands of dollars)
<TABLE>
<CAPTION>
Accumulated
Other Retained
Common Paid-in Comprehensive (Deficit)
Stock Capital Income Earnings Total
--------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
BALANCES AT JANUARY 1, 1996 $ 4,675 $ 1,477 $ 465 $ 16,623 $23,240
Activity for 1996
Comprehensive Income:
Net loss (788) (788)
Unrealized losses on securities (530) (530)
-------
Comprehensive income (1,318)
Dividends declared and paid (282) (282)
Employee stock purchases 3 12 15
--------------------------------------------------------------
BALANCES AT DECEMBER 31, 1996 $ 4,678 $ 1,489 $ (65) $ 15,553 $21,655
Activity for 1997
Comprehensive Income:
Net loss (8,540) (8,540)
Unrealized losses on securities (406) (406)
-------
Comprehensive income (8,946)
Employee stock purchases 18 41 59
--------------------------------------------------------------
BALANCES AT DECEMBER 31, 1997 $ 4,696 $ 1,530 $ (471) $ 7,013 $12,768
Activity for 1998
Comprehensive Income:
Net loss (15,186) (15,186)
Unrealized gains on securities 4,855 4,855
-------
Comprehensive income (10,331)
Employee stock purchases 10 10 20
--------------------------------------------------------------
BALANCES AT DECEMBER 31, 1998 $ 4,706 $ 1,540 $ 4,384 $ (8,173) $ 2,457
===============================================================
</TABLE>
See notes to consolidated financial statements.
47
<PAGE> 49
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
McM CORPORATION AND SUBSIDIARIES
NOTE A Significant Accounting Policies
Basis of Presentation: The consolidated financial statements have been prepared
in accordance with generally accepted accounting principles (GAAP) which, as to
the insurance subsidiaries, vary in some respects from statutory accounting
practices which are prescribed or permitted by the various state insurance
departments.
The consolidated financial statements include the accounts and
operations of McM and its wholly-owned subsidiaries. McM is actively engaged
through certain of its subsidiaries in the property and casualty insurance
business. All significant intercompany accounts and transactions have been
eliminated. The Company's subsidiaries are as follows:
<TABLE>
<CAPTION>
Subsidiary Abbreviation
- -------------------------------------------------------------------------
<S> <C>
Property and Casualty:
Occidental Fire & Casualty Company
of North Carolina OF&C
Wilshire Insurance Company Wilshire
Other:
Equity Holdings, Inc. Equity
- -------------------------------------------------------------------------
</TABLE>
The property and casualty insurance subsidiaries are primarily
involved in the sale of commercial automobile and private passenger automobile
insurance. The commercial automobile insurance consists primarily of liability,
physical damage and inland marine coverages. The commercial automobile lines of
business represented between 77% and 80% of gross written premium for all
periods presented. Private passenger automobile insurance, which represents the
remainder of gross written premiums, consists primarily of liability and
physical damage coverages. The Company's products are generally marketed through
general and independent agents. In 1998, premiums were written in 28 states
throughout the U.S. Direct premiums written in California, all of which were for
commercial automobile insurance products, represented between 32% and 34% of
direct written premiums for all periods presented.
Investments: Fixed maturity securities are classified as either held-to-maturity
or available-for-sale. Management determines the appropriate classification of
fixed maturity securities at the time of purchase. The Company has identified
and accounted for its investments as follows:
48
<PAGE> 50
Securities held-to-maturity and available-for-sale: Securities are classified as
held-to-maturity when the Company has the positive intent and ability to hold
the securities to maturity. Held-to-maturity securities are stated at amortized
cost. Securities not classified as held-to-maturity are classified as
available-for-sale. Available-for-sale securities are stated at fair value, with
the unrealized gains and losses reported as a separate component of
shareholders' equity. The amortized cost of securities classified as
held-to-maturity or available-for-sale is adjusted for amortization of premiums
and accretion of discounts to maturity, or in the case of mortgage-backed
securities, over the estimated life of the security. Such amortization is
included in investment income. Realized gains and losses include any declines in
value judged to be other-than-temporary. The cost of securities sold is based on
the specific identification method. Short-term investments are comprised of
corporate master notes and United States Treasury Notes and Bills maturing in
twelve months or less. These investments are carried at fair value.
The Company had fixed maturity securities with a face value of
approximately $12.2 million and $12.0 million on deposit with various state
insurance departments at December 31, 1998, and 1997, respectively. The Company
also had $3.4 million in short-term investments held in a security trust as
collateral for assumed reinsurance balances at December 31, 1998 and 1997.
Cash: Cash represents cash balances deposited in banking institutions. Balances
invested in corporate master notes and other interest bearing cash equivalents
are included in short-term investments.
Equipment: Equipment is stated at cost less allowances for accumulated
depreciation which are computed principally on the straight-line method.
Recognition of Insurance Revenues: Premiums for property and casualty insurance
policies are recognized as revenues on a monthly pro rata basis over the terms
of the policies.
The Company utilizes a general agency force to market its annual
commercial automobile business and a portion of its private passenger automobile
business. As of December 31, 1998, agents' balances receivable of approximately
$850,000 were associated with one general agent.
49
<PAGE> 51
Deferred Policy Acquisition Costs: Costs which vary with and are primarily
related to the production of property and casualty policies are deferred to the
extent recoverable and are amortized over the lives of the policies in
proportion to the recognition of premiums earned. Anticipated investment yield
is considered in the evaluation of recoverability of unamortized deferred
acquisition costs.
Reserves for Losses and Settlement Expenses: Reserves for estimated losses are
determined on a case basis for reported claims and on estimates based on Company
experience for loss settlement expenses and incurred but not reported claims.
These liabilities give effect to trends in claims severity and other factors
which may vary as the losses are ultimately settled. Although considerable
variability is inherent in such estimates for losses and loss settlement
expenses, management believes that these liabilities are adequate. The estimates
are continually reviewed and, as adjustments to these liabilities become
necessary, such adjustments are reflected in current operations.
The reserves for losses include amounts assumed from involuntary pools
and other residual market mechanisms of the various states in which the Company
has written policies. The estimated liability for the assumed pools is recorded
based on information provided to the Company by the pools.
Reinsurance: McM assumes and cedes reinsurance and participates in various pools
and associations. The reinsurance arrangements allow management to control
exposure to potential losses arising from large risks, and provide additional
capacity for growth. The reinsurance is effected under quota-share contracts and
by excess-of-loss contracts. Amounts recoverable from reinsurers for unpaid
losses and settlement expenses are estimated in a manner consistent with the
related liabilities associated with reinsured policies.
Income Taxes: The Company accounts for income taxes using the liability method.
Deferred tax assets, net of a valuation allowance, and liabilities are
recognized for the future tax consequences attributable to differences between
the financial statement carrying amounts of existing assets and liabilities and
their respective tax bases. Deferred tax assets and liabilities are measured
using enacted tax rates expected to apply to taxable income in the years in
which those temporary differences are expected to be recovered or settled. The
effect on deferred tax assets and liabilities of a change in tax rates is
recognized in income in the period that includes the enactment date.
Leases: The Company and its subsidiaries rent office space and equipment under
various operating lease agreements. The aggregate rental expense charged to
operations was approximately $865,000 in
50
<PAGE> 52
1998, $826,000 in 1997, and $802,000 in 1996. Future minimum lease commitments
require payments of approximately $735,000, $681,000 and $342,000 in 1999, 2000
and 2001, respectively.
Use of Estimates: The preparation of financial statements requires management to
make estimates and assumptions that affect amounts reported in the financial
statements and accompanying notes. Such estimates and assumptions could change
in the future as more information becomes known which could impact the amounts
reported and disclosed herein.
Earnings per Share: Basic earnings per share are based on the weighted-average
number of common shares outstanding during the year. The weighted-average number
of common shares outstanding was 4,702,805, 4,688,364 and 4,675,701 at December
31, 1998, 1997 and 1996, respectively. Diluted earnings per share are computed
assuming that the weighted-average number of shares increases by the conversion
of fixed awards (employee stock options). The diluted per share computations
reflect a change in the number of common shares outstanding (the "denominator")
to include the number of additional shares that would have been outstanding if
the potentially dilutive shares had been issued. The Company had no potentially
dilutive employee stock options outstanding for the periods presented.
Therefore, the denominator was the same for both basic and dilutive per share
calculations. The numerator (net loss) was also constant for both computation
methods.
New Accounting Standards: In June 1997, The Financial Accounting Standards Board
("FASB") issued Financial Accounting Standard No. 130, "Reporting Comprehensive
Income" ("SFAS 130") for years beginning after December 15, 1997. Comprehensive
income is defined as essentially all changes in shareholders' equity exclusive
of transactions with owners, such as capital investments, and includes net
income (loss) plus changes in certain assets and liabilities that are reported
directly in equity. The unrealized gain or loss on available-for-sale securities
is the Company's only component of other comprehensive income and is presented
on the Consolidated Statement of Changes in Shareholders' Equity.
Also during June 1997, the FASB issued Statement of Financial
Accounting Standard No. 131 "Disclosures about Segments of an Enterprise and
Related Information" ("SFAS 131") for years beginning after December 15, 1997.
SFAS 131 requires companies to use the "management approach" in disclosing
segment information based on what type of financial information top management
uses in the decision-making process. This approach is intended to allow users to
better understand the Company's performance. Management has reviewed the
requirements of SFAS 131 and, in accordance with the standard, has determined
that the Company has two operating segments: property and casualty insurance for
commercial automobile and private passenger automobile. See Note L.
51
<PAGE> 53
In February 1998, the FASB issued Statement of Financial Accounting
Standards No. 132 "Employers' Disclosures about Pensions and Other
Postretirement Benefits" ("SFAS 132") for years beginning after December 15,
1997. The overall objective of SFAS 132 is to improve and standardize
disclosures about pensions and other postretirement benefits and to make the
required information easier to prepare and more understandable. Information
disclosed in Note F regarding the Company's Pension Plan is presented in
accordance with the requirements of SFAS 132.
NOTE B Statutory Results and Dividend Restrictions
The reporting practices for McM's insurance subsidiaries prescribed or
permitted by state regulatory authorities ("statutory accounting") differ from
generally accepted accounting principles. OF&C (which includes Wilshire on a
statutory equity basis) reported to insurance regulatory authorities a net loss
of $7.1 million and $2.8 million in 1998 and 1997 respectively, and net income
of $49,000 in 1996. Combined capital and surplus reported to insurance
regulatory authorities totalled $27.7 million and $11.5 million at December 31,
1998 and 1997, respectively.
McM's insurance subsidiaries are subject to regulation and supervision
by regulatory authorities in the states in which they operate. The regulatory
bodies have broad administrative powers relating to standards of solvency,
minimum capital and surplus requirements, maintenance of required reserves,
payments of dividends, statutory accounting and reporting practices, and other
financial and operational matters. Generally, the net assets of the insurance
subsidiaries available for transfer to the parent company are limited to the
amounts by which the insurance subsidiaries' net assets, as determined in
accordance with statutory accounting practices, exceed the minimum statutory
capital requirement of $2,250,000. Also, by statute, dividends exceeding the
lesser of 10% of statutory-basis capital and surplus or the previous year's net
income, excluding net realized capital gains, require the prior approval of the
Commissioner of the North Carolina Department of Insurance.
OF&C and Wilshire are domiciled in the State of North Carolina
and prepare their statutory-basis financial statements in
accordance with accounting practices and procedures prescribed or permitted by
the North Carolina Department of Insurance. "Prescribed" statutory accounting
practices include state laws, regulations, and general administrative rules, as
well as a variety of publications of the National Association of Insurance
Commissioners ("NAIC"). "Permitted" statutory accounting practices may differ
from state to state, may differ from company to company within a state, and may
change in the future. In 1998, the NAIC adopted codified statutory accounting
practices, which constitutes the only source of comprehensive "prescribed"
statutory accounting
52
<PAGE> 54
practices. The codified practices and principles, which are effective January 1,
2001, will result in changes to the accounting methodology that insurance
enterprises use to prepare their statutory financial statements. The full impact
of the codified practices and principles on McM's insurance subsidiaries'
statutory financial statements is not known at this time.
The North Carolina Department of Insurance imposes minimum risk-based
capital requirements on insurance enterprises that were developed by the NAIC.
The formulas for determining the amount of risk-based capital ("RBC") specify
various weighting factors that are applied to financial balances or various
levels of activity based on the perceived degree of risk. Regulatory compliance
is determined by a ratio ("the Ratio") of the enterprise's regulatory total
adjusted capital, as defined by the NAIC, to its authorized control level RBC as
defined by the NAIC. Enterprises below specific trigger points or ratios are
classified within certain levels, each of which requires corrective action.
The capital and surplus levels at December 31, 1998, for both insurance
subsidiaries exceeded all RBC requirements.
NOTE C Redeemable Preferred Stock
Redeemable Series A: On October 1, 1998 McM authorized 60,000 shares of Series A
Preferred Stock, $1,000 par value per share ("Series A Preferred Stock"). Series
A Preferred Stock has no dividend or voting rights and are nonconvertible. Upon
voluntary or involuntary liquidation, dissolution or winding up of the Company,
holders of shares of Series A Preferred Stock shall be entitled to receive out
of net assets of the Company before any payment or distribution shall be made or
set apart for payment on the common stock or any other class or series of stock
of the Company, the amount of $1,000 per share of Series A Preferred Stock.
After payment to the holders of Series A Preferred Stock of $1,000 per share,
the holders of shares of Series A Preferred Stock, as such, shall have no right
or claim to any of the remaining net assets of the Company.
The shares of Series A Preferred Stock shall at all times be redeemable
at the option of the holder thereof in cash for $1,000 per share payable by the
Company immediately from available funds. Holders of Series A Preferred Stock do
not have any rights to convert such share into to exchange such share for shares
of Common Stock of the Company or any other class or series of stock of the
Corporation. Holders of Series A Preferred Stock do not have a right to vote on
any matter pertaining to the Company. Series A Preferred Stock shall rank senior
to any other class or series of preferred stock of the Company upon liquidation
of the Company.
As a condition to the Offer and Rights Agreement between the
53
<PAGE> 55
Company and two shareholders, McM has agreed to issue all 60,000 Series A
Redeemable Preferred Shares to one shareholder at an exercise price of $.01 per
share upon the occurrence of certain events. The events that could cause an
exercise of theses rights involve the purchase/sale of shares between the two
shareholders and certain changes in the Board of Directors.
As of December 31, 1998, there were no shares of Series A Preferred
issued or outstanding.
Cumulative, Redeemable PIK Series B: On October 28, 1998, McM authorized 50,000
shares of Series B PIK Preferred Stock, $1,000 par value per share. The Series B
PIK Preferred Stock are nonconvertible and have no voting rights. Series B PIK
Preferred Stock accumulate dividends at a rate of 12.0% per annum, payable
quarterly in arrears to such holders of Series B PIK Preferred Stock on January
7, April 7, July 7 and October 7. Dividends are cumulative from the date of
issuance and shall be paid in kind with additional fully paid and nonassessable
shares of Series B PIK Preferred Stock and having an aggregate liquidation
preference equal to the amount of such dividends. However, the Board of
Directors of McM, at its option, may pay any dividend in cash. No dividends were
declared or paid in 1998. Cumulative dividends in arrears at December 31, 1998,
were $408,658.
Upon the voluntary or involuntary liquidation of the Company, the
holders of shares of Series B PIK Preferred Stock shall be entitled to receive
out of the net assets of the Company before any payment or distribution shall be
made or set apart for payment on the Common Stock or any other class or series
of stock of the Company other than Series A Redeemable Preferred Stock, $1,000
per share of Series B PIK Preferred Stock. After payment to holders of shares of
Series B PIK Preferred Stock, the amount of $1,000 per share, the holders of
shares of Series B PIK Preferred Stock shall have no right or claim to any of
the remaining assets of the Company.
Effective on the date that is seven years from the date of issuance,
outstanding shares of Series B PIK Preferred Stock shall be redeemed by the
Company in cash for $1,000 per share plus an amount equal to all accumulated and
unpaid dividends. Holders of Series B PIK Preferred Stock have no rights to
convert such share into or to exchange such share for shares of Common Stock or
any other class or series of stock of the Company. Holders of Series B PIK
Preferred Stock do not have any right to vote on any matter of the Company.
Series B PIK Preferred Stock shall rank, as to the distribution of assets upon
liquidation of the Company senior to any other class or series of preferred
stock of the Company except Series A Redeemable Preferred Stock.
As of December 31, 1998, there were 26,000 shares of Series B PIK
Preferred Stock issued and outstanding.
54
<PAGE> 56
NOTE D Reinsurance
The property and casualty insurance subsidiaries have entered into
reinsurance agreements with various reinsurers in order to reduce their ultimate
claim risk. Current reinsurance agreements provide for premium rates based on
the amount of coverage in excess of the defined retention level.
Generally, the Company's retention level for all accident years was
$100,000 with the exception of the 1991 accident year which was $250,000. These
retention levels are effected under the Company's casualty excess of loss
reinsurance treaties.
The Company is also party to quota share reinsurance arrangements on
its private passenger automobile and commercial auto liability coverages. A
quota share reinsurance treaty is maintained on the Company's private passenger
automobile business which became effective in April 1993. The rates pertaining
to this treaty have ranged between 20% and 40% since its inception. An addendum
to the private passenger quota share treaty provided for the ceding of 100% of
the unearned premium to the reinsurers as of December 31, 1997. A 5% quota share
is also maintained for commercial auto liability coverages. These quota share
treaties were placed to help control the Company's statutory net writings to
surplus ratios as well as future premium growth in related markets.
The effect of reinsurance on premiums written and earned in 1998, 1997
and 1996 was as follows:
<TABLE>
<CAPTION>
For the Year Ended December 31
----------------------------------------------------------------------
1998 1997 1996
Premiums Premiums Premiums
Written Earned Written Earned Written Earned
-------- -------- -------- -------- -------- ---------
(Thousands of dollars)
<S> <C> <C> <C> <C> <C> <C>
Direct $56,494 $ 59,335 $ 63,699 $ 65,205 $ 62,698 63,163
Assumed 5,759 7,800 9,830 10,573 11,561 10,405
Ceded (16,662) (20,127) (22,315) (20,071) (20,839) (21,714)
------- -------- -------- -------- -------- --------
Net $45,591 $ 47,008 $ 51,214 $ 55,707 $ 53,420 $ 51,854
======= ======== ======== ======== ======== ========
</TABLE>
To minimize its exposure to losses from reinsurance insolvencies, OF&C
and Wilshire evaluate the financial condition of their reinsurers and monitor
concentration of credit risk arising from similar geographic regions, activities
or economic characteristics of the reinsurers. A schedule of the Company's
reinsurers whose balances are approximately 10% or more of McM's shareholders'
equity at December 31, 1998 is provided below:
55
<PAGE> 57
<TABLE>
<CAPTION>
Ceded
Reinsurer Balances Receivable
------------ --------------------
(Thousands of dollars)
<S> <C>
Lloyds of London $ 8,430
CNA International 4,542
Unionamerica 4,446
AXA Reassurance 3,321
Zurich Re 3,039
Sphere Drake Insurance, PLC 1,976
Hannover Ruckersicherungs 922
Terra Nova Insurance Co. 704
National Reinsurance Corp 692
Chartwell Reinsurance Co. 567
National Workers Comp. Pool 549
Folksamerica Reinsurance Co. 505
Great Lakes American
Reinsurance Company 489
Employers Reinsurance Corp. 433
Focus Insurance Company
in Liquidation 375
Trenwick America Reinsurance Co. 310
All other 2,386
-------
Total $33,686
</TABLE>
OF&C and Wilshire's policy is to hold collateral under related
reinsurance agreements in the form of letters of credit for all reinsurers not
licensed to do business in North Carolina.
To the extent that reinsuring companies may later be unable to meet
obligations under the reinsurance agreements, the insurance subsidiaries would
remain liable.
The Companies have administrative and reinsurance agreements whereby
the Companies administer the business written by a Texas county mutual insurance
company and the Companies assume $100,000 of risk per policy. At December 31,
1998 and 1997, the Companies had receivable balances related to these agreements
of $1,720,240 and $833,460, respectively, which are included in other assets.
NOTE E Income Taxes
The Revenue Reconciliation Act of 1993 increased the U.S. Federal
income tax rate to 35% for taxable income in excess of $10 million. Because of
the large tax return net operating loss carryforwards of the Company and Company
estimates that annual taxable income in the near future, before utilization of
the carryforwards, will not exceed $10 million, a U.S. Federal income tax rate
of 34% has been used to compute deferred tax assets and liabilities for the
Company.
There was no income tax expense attributable to income from
56
<PAGE> 58
continuing operations for the years ended December 31, 1998, 1997 and 1996.
These amounts differed from the amounts computed by applying the U.S. federal
income tax rate of 34 percent to pretax income from continuing operations as
follows:
<TABLE>
<CAPTION>
Year Ended December 31
1998 1997 1996
(Thousands of dollars)
<S> <C> <C> <C>
Pretax income (loss) from
continuing operations $(15,186) $(8,540) $(788)
- ------------------------------------------------------------------------------
Computed "expected" tax
expense (benefit) (5,163) (2,904) (268)
Increase (decrease) in
taxes resulting from:
Change in valuation
allowance 2,323 2,356 (77)
Other 29 256 191
Net operating and
capital losses not
utilized 2,811 292 -
- ------------------------------------------------------------------------------
Income Tax Expense $ 0 $ 0 $ 0
- ------------------------------------------------------------------------------
</TABLE>
THIS SPACE LEFT BLANK INTENTIONALLY
57
<PAGE> 59
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities as of December
31, 1998 and December 31, 1997, are presented below.
<TABLE>
<CAPTION>
December 31
----------------------
1998 1997
(Thousands of dollars)
<S> <C> <C>
Deferred tax asset:
Unearned premium reserves $ 540 $ 637
Claim reserves 1,367 1,270
Tax return net operating
and capital loss
carryforwards 35,074 33,028
Unrealized losses on fixed
maturity securities 0 160
Other 286 232
-------- --------
Total gross deferred tax
assets 37,267 35,327
Less: Valuation allowance (34,789) (34,117)
-------- --------
Net deferred tax assets $ 2,478 $ 1,210
Deferred tax liabilities:
Deferred policy acquisition
costs $ 818 $ 953
Agent balances 20 57
Unrealized gains on fixed
maturity securities 1,491 -
Other 149 200
-------- --------
Total liabilities $ 2,478 $ 1,210
-------- --------
Net deferred tax account $ 0 $ 0
======== ========
</TABLE>
The valuation allowance for deferred tax assets as of January 1, 1998,
was $34,789,000. The net change in the total valuation allowance for the year
ended December 31, 1998, was an increase of $671,000, which includes a
$1,651,000 decrease related to unrealized gains.
McM and its subsidiaries file a consolidated income tax return. The
Company had cumulative tax operating loss carryforwards of approximately $103
million as of December 31, 1998, with expiration dates of 1999 through 2018. No
income taxes were paid in 1998, 1997, or 1996.
58
<PAGE> 60
NOTE F Pension Plan
McM and its subsidiaries have a non-contributory defined benefit
pension plan covering substantially all their employees. The plan provides for
payments to qualified employees based on compensation and years of service. The
Company and its subsidiaries make contributions to the plan, if necessary, equal
to the amounts required by ERISA.
The following table sets forth the plan's funded status and amounts
recognized in the Company's balance sheets at December 31:
<TABLE>
<CAPTION>
December 31
----------------------
1998 1997
- ------------------------------------------------------
(Thousands of dollars)
<S> <C> <C>
CHANGE IN BENEFIT OBLIGATION
Benefit obligation at
beginning of year $ 3,356 $ 2,816
Service cost 288 255
Interest cost 248 227
Actuarial loss 120 161
Benefits paid (85) (103)
------- -------
Benefit obligation at
end of year $ 3,927 $ 3,356
CHANGE IN PLAN ASSETS
Fair value of plan
assets at beginning
of year $ 2,476 $ 1,819
Actual return on
plan assets 211 369
Company contributions 443 391
Benefits paid (86) (103)
------- -------
Fair value of plan
assets at end of year $ 3,044 $ 2,476
Funded status of the
plan (underfunded) (882) (880)
Unrecognized net
actuarial loss 297 100
Unrecognized prior service
cost (91) (47)
------- -------
Accrued benefit cost $ (676) (827)
======= =======
WEIGHTED-AVERAGE ASSUMPTIONS
Discount rate 6.75% 7.25%
Expected return on plan
assets 9.00% 9.00%
Rate of compensation increase 4.75% 4.75%
</TABLE>
59
<PAGE> 61
Net periodic pension expense included the following components:
<TABLE>
<CAPTION>
Year Ended December 31
1998 1997 1996
- ----------------------------------------------------------
(Thousands of dollars)
<S> <C> <C> <C>
Service cost $ 289 $ 255 $ 257
Interest cost 248 227 206
Expected return on plan
assets (226) (171) (120)
Amortization of prior
service cost (20) (20) (20)
Recognized net actuarial
loss - - 20
- ---------------------------------------------------------
Benefit cost 291 291 343
=========================================================
</TABLE>
NOTE G Investment Operations
The sources of investment income are summarized as follows:
<TABLE>
<CAPTION>
Year Ended December 31
-----------------------------
1998 1997 1996
-----------------------------
(Thousands of dollars)
<S> <C> <C> <C>
Fixed maturities $1,962 $2,694 $2,490
Equity securities 20 0 0
Other long-term investments 49 44 48
Short-term investments 847 660 1,078
-----------------------------
2,878 3,398 3,616
Investment expenses (362) (413) (457)
-----------------------------
NET INVESTMENT INCOME $2,516 $2,985 $3,159
=============================
</TABLE>
60
<PAGE> 62
The amortized cost and estimated market values of investments in fixed
maturities at December 31, 1998 and 1997, are as follows:
<TABLE>
<CAPTION>
Gross Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
-------------------------------------------
(Thousands of dollars)
<S> <C> <C> <C> <C>
Securities Available-for-Sale:
- ------------------------------
December 31, 1998:
Fixed maturities:
U.S. Treasury
securities
and obligations of
U.S. governmental
corporations and
agencies $22,756 $ 512 $ - $23,268
Public utilities
and other 383 4 - 387
Mortgage-backed
securities 2,013 - (8) 2,005
- ----------------------------------------------------------------------------
Total fixed maturities: 25,152 516 (8) $25,660
Equity securities:
Industrial, miscellaneous
and other 18,093 3,963 (87) 21,969
- ----------------------------------------------------------------------------
Total equity securities: 18,093 3,963 (87) 21,969
- ----------------------------------------------------------------------------
Total $43,245 $4,479 $(95) $47,629
============================================================================
Securities Held-to-Maturity:
- ----------------------------
December 31, 1998:
Fixed maturities:
U.S. Treasury securities
and obligations of
U.S. governmental
corporations and
agencies $ 2,943 $ 112 $ - $ 3,055
Obligations of states
and political
subdivisions 195 25 - 220
- ----------------------------------------------------------------------------
Total $ 3,138 $ 137 $ (0) $ 3,275
============================================================================
</TABLE>
61
<PAGE> 63
<TABLE>
<CAPTION>
Gross Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
---------------------------------------------
(Thousands of dollars)
<S> <C> <C> <C> <C>
Fixed Maturity Securities Available-for-Sale:
- ---------------------------------------------
December 31, 1997:
U. S. Treasury securities
and obligations of U.S.
governmental
corporations and
agencies $22,714 $178 $ (18) $22,874
Public utilities 469 2 (6) 465
Mortgage-backed
securities 2,572 3 (630) 1,945
- ---------------------------------------------------------------------------------------------
Total $25,755 $183 $(654) $25,284
=============================================================================================
Fixed Maturity Securities Held-to-Maturity:
- -------------------------------------------
December 31, 1997:
U.S. Treasury securities
and obligations of
U.S. governmental
corporations and
agencies $ 2,940 $ 74 $ (1) $ 3,013
Obligations of states
and political
subdivisions 194 28 - 222
- ---------------------------------------------------------------------------------------------
Total $ 3,134 $102 $ (1) $ 3,235
=============================================================================================
</TABLE>
The amortized cost and estimated market value of fixed maturities at
December 31, 1998, by contractual maturity, are shown below. Expected maturities
may differ from contractual maturities as certain borrowers have the right to
call or prepay obligations without penalty.
62
<PAGE> 64
<TABLE>
<CAPTION>
Estimated
Amortized Market
Cost Value
----------------------
(Thousands of dollars)
<S> <C> <C>
Fixed Maturity Securities Available-for-Sale:
- ---------------------------------------------
Due in one year or less $ 587 $ 590
Due after one year through
five years 10,059 10,184
Due after five years through
ten years 3,452 3,788
Due after ten years 9,041 9,093
- -----------------------------------------------------------------------
23,139 23,655
Mortgage backed securities 2,013 2,005
- -----------------------------------------------------------------------
$25,152 $25,660
=======================================================================
Fixed Maturity Securities Held-to-Maturity:
- -------------------------------------------
Due in one year or less $ 1,705 $ 1,710
Due after one year through
five years 1,015 1,084
Due after five years through
ten years 418 481
Due after ten years -- --
- -----------------------------------------------------------------------
$ 3,138 $ 3,275
=======================================================================
</TABLE>
Realized gains and losses from sales of investments in fixed maturities
were as follows:
<TABLE>
<CAPTION>
Year Ended December 31
1998 1997 1996
------------------------
(Thousands of dollars)
<S> <C> <C> <C>
Realized gains and losses:
Securities available-for-sale:
Fixed maturities:
Gross realized gains $ 1 $ 367 $ 40
Gross realized losses 20 171 -
Equity securities:
Gross realized gains 558 - -
Gross realized losses 265 - -
</TABLE>
The carrying value of investments in persons (other than the U.S.
Government or a Government Agency or Authority, State, Municipality, or
Political Subdivision) exceeding 10% of total shareholders' equity is as
follows:
63
<PAGE> 65
<TABLE>
<CAPTION>
December 31
---------------------
1998 1997
---------------------
(Thousands of dollars)
<S> <C> <C>
Southern Capital Corporation $ 1,117 $ 3,431
General Electric Capital Corporation 9,686 17,520
AIM Short Term 759 -
American Safety Razor Company 1,200 -
Bankers Trust Corporation 3,417 -
Elxsi Corporation 1,856 -
ESS Technology Incorporated 480 -
Helmerich & Payne Incorporated 969 -
Keycorp Incorporated 1,357 -
Lehman Brothers Holdings Incorporated 2,423 -
MFC Bancorp Limited 913 -
Mercer International Incorporated 2,003 -
Merrill Lynch Pierce
Fenner & Smith Incorporated 334 -
Stolt Comex Seaway Incorporated 550 -
TRC Companies Incorporated 1,669 -
Thoratec Labs Corporation 1,843 -
Thousand Trails Incorporated 1,182 -
Varco International Incorporated 295 -
Ziegler Company Incorporated 1,125 -
</TABLE>
NOTE H Reserves for Losses and Settlement Expenses
The consolidated financial statements include the estimated reserve for
losses and settlement expenses of the property and casualty insurance
subsidiaries. The subsidiaries primarily write commercial auto liability,
physical damage and cargo coverages and non-standard private passenger
automobile coverages. The liabilities for losses and settlement expenses are
determined using case basis evaluations and statistical projections and
represent estimates of the ultimate net cost of all unpaid losses and settlement
expenses incurred through December 31 of each year. These estimates give effect
to trends in claims severity and other factors which may vary as the liabilities
are ultimately settled. The estimates are continually reviewed and, as
adjustments to these liabilities become necessary, such adjustments are
reflected in current operations.
The following table provides a reconciliation of the beginning and
ending reserve balances for losses and settlement expenses, on a
gross-of-reinsurance basis, for 1998, 1997 and 1996, to the gross amounts
reported in McM's balance sheet.
64
<PAGE> 66
<TABLE>
<CAPTION>
Year Ended December 31
------------------------------
1998 1997 1996
- ---------------------------------------------------------------
(Thousands of dollars)
<S> <C> <C> <C>
Reserves for losses
and settlement expenses,
net of reinsurance
recoverables, at
beginning of year $29,159 $26,532 $29,997
Provision for insured
events of the current
year 37,399 42,243 37,651
Increase in provision
for insured events
of prior years 7,086 5,774 1,559
-----------------------------
Incurred losses and
settlement expenses
during current year, net
of reinsurance 44,485 48,017 39,210
Payments for:
Losses and settlement
expenses attributable to
insured events of the
current year 20,905 26,123 22,853
Losses and settlement
expenses attributable to
insured events of prior
years 19,434 19,267 19,822
-----------------------------
40,339 45,390 42,675
-----------------------------
Reserves for losses and
settlement expenses, net
of reinsurance recoverables,
at end of year 33,305 29,159 26,532
Reinsurance recoverable on
unpaid losses and settlement
expenses at end of year 27,539 28,124 28,768
-----------------------------
Gross reserves for losses and
settlement expenses at end
of year $60,844 $57,283 $55,300
=============================
</TABLE>
The reconciliation above shows that a deficiency of $7,086,000 in the
prior year reserve emerged during 1998. The deficiency at December 31, 1998,
included adverse reserve development of approximately $6,885,000 in the
commercial auto liability line of business, and $1,038,000 in discontinued lines
of business and participation in involuntary pools and other residual market
mechanisms in which OF&C and WIC are required to participate by the various
states in which the companies write insurance. Mitigating
65
<PAGE> 67
the above adverse development was $748,000 of favorable development in inland
marine, commercial auto physical damage, and general liability lines of
business, and favorable development of $89,000 relating to private passenger
liability and physical damage lines of business.
The $5,774,000 deficiency included for 1997 included adverse reserve
development of approximately $844,000 in private passenger automobile liability
reserves, $813,000 in private passenger and commercial automobile physical
damage and inland marine reserves and $3,531,000 relating to the commercial
automobile liability line of business. In addition, approximately $586,000 of
this deficiency relates to discontinued lines of business and participation in
involuntary pools and other residual market mechanisms in which OF&C and
Wilshire are required to participate by the various states in which the
companies write insurance. The increase in overall reserves levels for 1997
resulted from prior year reserve deficiencies, particularly for the 1996 and
1995 accident years and increased claim costs in the current underwriting year
for commercial and private passenger automobile physical damage coverages.
The anticipated effect of inflation is implicitly considered when
estimating liabilities for losses and settlement expenses. While anticipated
cost increases due to inflation are considered in estimating the ultimate claim
costs, the increase in average severity of claims is caused by a number of
factors that vary with the individual type of policy written. Future average
severity is projected based on historical trends adjusted for anticipated
changes in these trends and general economic conditions. These anticipated
trends are monitored based on actual development and are modified as necessary.
NOTE I Contingencies
Litigation: In the normal course of operations, certain subsidiaries of the
Company have been named as parties to various pending and threatened litigation.
While the outcome of some of these matters cannot be estimated with certainty,
it is the opinion of management that the resolution of these matters will not
have a material adverse affect on the Company's consolidated financial position
or results of operations.
Guaranty Associations: The insurance subsidiaries are required to be members of
various state insurance guaranty associations in order to conduct business in
those states. These associations have the authority to assess member companies
in the event that an insurance company conducting business in that state is
unable to meet its policyholder obligations. The Company recognizes the expense
for these assessments in the year they are assessed. The Company incurred
expenses of $13,000 and $25,000 in 1998 and 1997,
66
<PAGE> 68
respectively, and received a net refund of $26,000 in 1996 related to these
assessments.
NOTE J Stock Option Plan and Earnings Per Share
At December 31, 1996, the Company adopted Statement of Financial
Accounting Standards No. 123 "Accounting for Stock-Based Compensation" ("SFAS
123"). SFAS 123 introduces a fair-value based method of accounting for
stock-based compensation and encourages, but does not require, compensation
expense recognition for grants of stock, stock options and other equity
instruments to employees. In accordance with SFAS 123, the Company has elected
to continue to follow Accounting Principles Board Opinion No. 25, "Accounting
for Stock Issued to Employees" (APB 25) and related interpretations in
accounting for its employee stock options.
The Company had an Employee Incentive Stock Option Plan, the 1986
Employee Incentive Stock Option Plan ("1986 Plan"), which expired by its terms,
May 16, 1996. The 1986 Plan provided that options could be granted to selected
key employees at exercise prices equal to market value on the date the option is
granted. Options were granted for a period not exceeding ten years and were
exercisable at a rate of 20% per year starting one year from the date of grant.
Depending upon the circumstances of an optionee's termination of employment, the
optionee's options either a) remain exercisable for three or six months after
termination to the extent they were exercisable at termination unless vesting is
accelerated by the Compensation Committee, b) remain exercisable until a change
in control of the Company, as defined in the 1986 Plan, c) remain exercisable
for five years and one day from the date of the optionee's termination or d)
terminate as of the termination of the optionee's employment.
In 1996 the Company adopted the 1996 Employee Incentive Stock Option
Plan ("1996 Plan"). The terms of the 1996 Plan are generally the same as the
1986 plan.
The Company had reserved 250,000 shares of common stock for
distribution under the 1986 Plan, and 300,000 shares have been reserved for
distribution under the 1996 Plan. The following options to purchase the
Company's common shares were outstanding under the 1986 and 1996 Plans as of
December 31, 1998 and 1997:
67
<PAGE> 69
<TABLE>
<CAPTION>
NUMBER OF SHARES
UNDERLYING
OUTSTANDING
OPTIONS
OPTION
PRICE
DATE OF GRANT 1998 1997 PER SHARE
- ----------------------------------------------------------------
<S> <C> <C> <C>
January 15, 1988 -0- 1,000 $ 8.50
October 6, 1988 -0- 2,000 $10.00
January 15, 1993 -0- 42,962 $ 1.38
July 25, 1994 -0- 19,000 $ 2.25
August 17, 1994 -0- 81,000 $ 2.75
March 26, 1997 20,000 35,000 $ 3.94
- ----------------------------------------------------------------
20,000 180,962
================================================================
</TABLE>
At December 31, 1998, 4,000 options were exercisable. In accordance
with the terms of the 1986 Plan, the options granted January 15, and October 6,
1988 expired during 1998, ten years after their date of grant. The options
granted January 15, 1993, July 25, 1994, and August 17, 1994 were forfeited in
1998. The remaining contractual life for the options outstanding at December 31,
1998 is 8.24 years.
The Company previously had a phantom stock plan under which shares of
"phantom stock" were awarded to certain employees. A maximum of 250,000 shares
of phantom stock could be awarded under the plan. Upon maturity of an award,
shares of phantom stock would be settled in cash equal to the market value of
common shares at the maturity date plus the amount of cash dividends paid on an
equal number of common shares over the life of the award. The awards generally
vested over a five year period beginning five years after the award date and
matured on the two year anniversary of the termination of the employee, or upon
a change in control (as defined in the plan) of the Company. There were no
shares of phantom stock granted in 1998 or 1997. In 1996 and 1995, 50,000 shares
of phantom stock were granted under the plan. Related expenses of $80,000,
$10,000, $44,000 and $26,000 were accrued at December 31, 1998, 1997, 1996, and
1995, respectively. The phantom stock plan and all awards thereunder were
terminated effective December 16, 1998. The Company paid a total of $160,000 to
award recipients in exchange for an agreement to terminate the outstanding
awards.
Pro forma information regarding net (loss) income and earnings per
share is required by SFAS 123, which also requires that the information be
determined as if the Company has accounted for its employee stock options and
awards granted subsequent to December 31, 1994, under the fair value method
prescribed by SFAS 123. The estimated fair value of the options was calculated
under the Black-Scholes valuation model using the following assumptions as of
December 31, 1997 (the period of the last option grant:
68
<PAGE> 70
<TABLE>
<CAPTION>
1997
-----
<S> <C>
Risk-free interest rate 6.96%
Dividend yield 0.00%
Volatility factor 63.5%
Expected life (years) 10
</TABLE>
The pro forma basic and diluted net(loss) income per share did not
change from that which has been reported, for all periods presented, as a result
of SFAS 123. Further, because SFAS 123 is applicable only to stock-based awards
granted after December 31, 1994, the pro forma effect of the amortization of the
estimated fair value of the Company's outstanding stock is not likely to be
representative of the effects on the reported net (loss) income for future
years.
NOTE K Summary of Fair Values
The method of determining fair values for investments in fixed maturity
securities is discussed in Note F. For all other financial instruments, carrying
value approximates fair value.
The following table summarizes the carrying value and fair value of
financial instruments:
<TABLE>
<CAPTION>
December 31
1998 1997
----------------------------------------
Carrying Fair Carrying Fair
Value Value Value Value
-----------------------------------------
(Thousands of dollars)
<S> <C> <C> <C> <C>
Financial Assets:
Cash $ 8,120 $ 8,120 $ 1,698 $ 1,698
Short-term investments $11,572 $11,572 $21,522 $21,522
Fixed maturity securities
available-for-sale
(Note G) $25,660 $25,660 $25,284 $25,284
Equity securities
available-for-sale
(Note G) $21,969 $21,969 - -
Fixed maturity securities
held-to-maturity
(Note G) $ 3,138 $ 3,275 $ 3,134 $ 3,235
</TABLE>
NOTE L Segment Information
The major focus of McM Corporation and its property and casualty
insurance subsidiaries is providing commercial insurance to the trucking
industry including cargo, liability and physical damage coverages and to the
personal automobile market providing liability and physical damage coverages.
The Company, therefore, has two reportable segments: commercial automobile and
private passenger automobile.
69
<PAGE> 71
The Company's reportable segments are business units that offer
insurance coverage to different market segments. The reportable segments are
each managed separately because their insurance products are tailored to meet
the specific needs of their respective clientele. The Company does not account
for assets on a segment basis.
<TABLE>
<CAPTION>
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
Net premiums earned:
Private passenger $ 6,099 $ 14,155 $ 9,703
Commercial auto 40,909 41,552 42,151
Other - - -
-------- -------- --------
Total 47,008 55,707 51,854
Net investment income
(including realized
investment gains):
Private passenger 297 381 418
Commercial auto 2,574 2,587 3,377
Other (81) 213 (596)
-------- -------- --------
Total 2,790 3,181 3,199
Net (loss) income:
Private passenger (2,986) (3,862) 2,759
Commercial auto (10,715) (4,600) (2,182)
Other (1,485) (78) 211
-------- -------- --------
Total $(15,186) $ (8,540) $ 788
======== ======== ========
</TABLE>
70
<PAGE> 72
Report of Independent Auditors
ERNST & YOUNG LLP
Board of Directors and Shareholders
McM Corporation
We have audited the accompanying consolidated balance sheets of McM
Corporation and subsidiaries as of December 31, 1998 and 1997, and the
related consolidated statements of operations, shareholders equity and
cash flows for each of the three years in the period ended December
31, 1998. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on
these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the
consolidated financial statements. An audit also includes assessing
the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the consolidated financial position
of McM Corporation and subsidiaries at December 31, 1998 and 1997, and
the consolidated results of their operations and their cash flows for
each of the three years in the period ended December 31, 1998, in
conformity with generally accepted accounting principles. Also, in our
opinion, the related financial statement schedules, when considered in
relation to the basic financial statements taken as a whole, present
fairly, in all material respects, the information set forth therein.
Raleigh, North Carolina ERNST & YOUNG LLP
February 26, 1999
71
<PAGE> 73
SCHEDULE 1 -- SUMMARY OF INVESTMENTS
McM CORPORATION AND SUBSIDIARIES
December 31, 1998
<TABLE>
<CAPTION>
AMOUNT
SHOWN ON
MARKET BALANCE
TYPE OF INVESTMENT COST VALUE SHEET
------------------ ------- ------- -------
(Thousands of dollars)
<S> <C> <C> <C>
Securities Available-for-Sale
- -----------------------------
Fixed Maturities:
Bonds
Mortgage-backed securities $ 2,013 $ 2,005 $ 2,005
U.S. Government, government
agencies and authorities 22,756 23,268 23,268
Public utilities and other bonds 383 387 387
------- ------- -------
Total Fixed Maturities 25,152 25,660 25,660
Equity Securities:
Industrial, miscellaneous and other 18,093 21,969 21,969
------- ------- -------
Total Equity Securities 18,093 21,969 21,969
Short-term investments 11,572 11,572 11,572
------- ------- -------
Total Securities Available-for-Sale 54,817 59,201 59,201
Held-to-Maturity
- ----------------
U.S. Government, government
agencies and authorities 2,943 3,055 2,943
States, municipalities and political
subdivisions 195 220 195
------- ------- -------
Total Securities Held-to-Maturity 3,138 3,275 3,138
------- ------- -------
Total Investments $57,955 $62,476 $62,339
======= ======= =======
</TABLE>
72
<PAGE> 74
SCHEDULE 2 - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
BALANCE SHEETS
McM CORPORATION (PARENT COMPANY)
(Thousands of dollars)
<TABLE>
<CAPTION>
December 31
1998 1997
------- -------
<S> <C> <C>
ASSETS
Fixed maturities available for sale $ 37 $ 0
Short term investments 10 35
Cash 125 108
Other assets 33 99
------- -------
205 242
Investments in wholly-owned subsidiaries
at equity * 31,176 15,331
------- -------
TOTAL ASSETS $31,381 $15,573
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Accrued expenses $ 1,623 $ 1,619
Income taxes payable to wholly-owned subsidiaries * 387 387
Payable to wholly-owned subsidiaries * 914 799
------- -------
2,924 2,805
Redeemable Preferred Stock - Series B PIK 26,000 0
Shareholders' Equity:
Common stock 4,706 4,696
Additional paid-in capital 1,540 1,530
Unrealized gain (loss) on securities available-for-sale,
including unrealized gain (loss) on securities
held by subsidiaries: 1998 - $4,384 ; 1997 - ($471) 4,384 (471)
Retained (deficit) earnings (8,173) 7,013
------- -------
TOTAL SHAREHOLDERS' EQUITY 2,457 12,768
------- -------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $31,381 $15,573
======= =======
</TABLE>
* Eliminated in consolidation
See notes to condensed financial information.
73
<PAGE> 75
SCHEDULE 2 - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
STATEMENTS OF OPERATIONS
McM CORPORATON (PARENT COMPANY)
(Thousands of dollars)
<TABLE>
<CAPTION>
Year Ended December 31
1998 1997 1996
-------- ------- -----
<S> <C> <C> <C>
INCOME
Administrative charges to subsidiaries * - Note B $ 500 $ 650 $ 650
Realized investment income 45 (135) 8
-------- ------- -----
545 515 658
General and administrative expenses 1,723 932 893
-------- ------- -----
LOSS BEFORE TAXES
AND EQUITY IN UNDISTRIBUTED
LOSS OF SUBSIDIARIES (1,178) (416) (235)
Income taxes (benefits) 0 0 (140)
-------- ------- -----
LOSS BEFORE EQUITY IN UNDISTRIBUTED
LOSS OF SUBSIDIARIES (1,178) (416) (95)
Equity in undistributed loss of subsidiaries (14,008) (8,124) (693)
-------- ------- -----
NET LOSS $(15,186) $(8,540) $(788)
======== ======= =====
</TABLE>
* Eliminated in consolidation.
See notes to condensed financial information.
74
<PAGE> 76
SCHEDULE 2 - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
STATEMENTS OF CASH FLOWS
McM CORPORATON (PARENT COMPANY)
(Thousands of dollars)
<TABLE>
<CAPTION>
Year Ended December 31
1998 1997 1996
-------- ------- -----
<S> <C> <C> <C>
OERATING ACTIVITIES
Net Loss $(15,186) $(8,540) $(788)
Adjustments to reconcile net loss to net cash (used) provided by operating
activities:
Depreciation 2 1 4
Equity in loss of subsidiaries 14,008 8,124 693
Other assets 66 (19) 33
Other liabilities 4 57 53
Income taxes payable to wholly-owned subsidiaries 0 0 182
Payables to wholly-owned subsidiaries 115 181 69
Adjustment to market value of fixed maturity (37) 143 0
-------- ------- -----
CASH (USED) PROVIDED BY OPERATING ACTIVITIES (1,028) (53) 246
INVESTING ACTIVITIES
Disposals of fixed maturities 0 0 57
Decrease (increase) in short-term investments 25 (5) (30)
-------- ------- -----
CASH PROVIDED (USED) BY INVESTING ACTIVITIES 25 (5) 27
FINANCING ACTIVITIES
Employee stock purchases 20 59 15
Cash dividends paid 0 0 (282)
Preferred stock issuance 26,000 0 0
Purchase of wholly-owned subsidiaries' preferred stock (5,000) 0 0
Capital contributed to wholly-owned subsidiaries (20,000) 0 0
-------- ------- -----
CASH PROVIDED (USED) BY FINANCNG ACTIVITIES 1,020 59 (267)
-------- ------- -----
INCREASE IN CASH $ 17 $ 1 $ 6
======== ======= =====
</TABLE>
See notes to condensed financial information.
75
<PAGE> 77
SCHEDULE 2 -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT
NOTES TO CONDENSED FINANCIAL INFORMATION
McM CORPORATION (PARENT COMPANY)
The accompanying condensed financial information should be read in conjunction
with the consolidated financial statements and notes thereto of McM Corporation
and Subsidiaries.
NOTE A -- Significant Accounting Policies
In the parent company financial statements, the Company's investments
in wholly-owned subsidiaries are stated at cost plus equity in undistributed
earnings of the subsidiaries. McM is actively engaged through certain of its
subsidiaries in the property and casualty insurance business.
NOTE B -- Administrative Charges
During 1998 McM was compensated by its subsidiaries in the form of
management fees for providing management support, planning assistance,
financial reporting and investment services.
76
<PAGE> 78
SCHEDULE 3 - REINSURANCE
McM CORPORATION AND SUBSIDIARIES
Year Ended December 31, 1998, 1997, and 1996
<TABLE>
<CAPTION>
Premiums Earned
----------------------------------------------
Percentage
Ceded to Assumed of Amount
Direct Other From Other Net Assumed
(Thousands of dollars) Amount Companies Parties Amount to Net
------- --------- --------- ------- ----------
<S> <C> <C> <C> <C> <C>
YEAR ENDED DECEMBER 31, 1998 $59,335 $20,127 $ 7,800 $47,008 16.59%
======= ======= ======= =======
YEAR ENDED DECEMBER 31, 1997 $65,205 $20,071 $10,573 $55,707 18.98%
======= ======= ======= =======
YEAR ENDED DECEMBER 31, 1996 $63,163 $21,714 $10,405 $51,854 20.07%
======= ======= ======= =======
</TABLE>
77
<PAGE> 79
SCHEDULE 4 - VALUATION AND QUALIFYING ACCOUNTS
McM CORPORATION AND SUBSIDIARIES
(Thousands of dollars)
<TABLE>
<CAPTION>
ADDITIONS
-------------------------------------------
(1) (2)
Charged to Charged to
Balance at (Recovery of) (Recovery of) Other
DESCRIPTION Beginning of Period Costs and Expenses Accounts-Describe
------------------- ------------------ -------------------
<S> <C> <C> <C>
YEAR ENDED DECEMBER 31, 1998
Deducted from asset account:
Allowance for uncollectible accounts $ 345 $( 316) $ 0
Deferred tax valuation allowance 34,117 0 2,323 (2)
Included as liability account:
Allowance for bad debts on liquidated reinsurers (242) 1,415 0
YEAR ENDED DECEMBER 31, 1997
Deducted from asset account:
Allowance for uncollectible accounts $ 345 $ 0 $ 0
Deferred tax valuation allowance 31,623 0 2,356 (2)
Included as liability account:
Allowance for bad debts on liquidated reinsurers 158 402 0
YEAR ENDED DECEMBER 31, 1996
Deducted from asset accounts:
Allowance for uncollectible accounts $ 345 $ 0 $ 0
Deferred tax valuation allowance 31,520 0 (77)(2)
Included as liability account:
Allowance for bad debts on liquidated reinsurers 1,060 (150) 0
<CAPTION>
Balance at End
of Period
Deductions-Describe (Debit) Credit
- ------------------- --------------
<C> <C>
$ 0 $ 29
1,651 34,789
444 729
$ 0 $ 345
(138)(3) 34,117
802 (242)
$ 0 $ 345
180 31,263
752 158
</TABLE>
(1) Write-off of paid recoverable balances for insolvent/liquidated reinsurers
against provision established
(2) Increase (decrease) in deferred tax valuation account
(3) Change in deferred tax valuation account related to net appreciation
(depreciation) in securities available-for-sale
78
<PAGE> 80
SCHEDULE 5 - SUPPLEMENTAL INSURANCE INFORMATION
PROPERTY/CASUALTY INSURANCE SUBSIDIARIES
YEAR ENDED DECEMBER 31, 1998, 1997 AND 1996
(Thousands of dollars)
<TABLE>
<CAPTION>
CLAIMS AND CLAIM
ADJUSTMENT EXPENSES
RESERVES FOR INCURRED RELATED TO
DEFERRED UNPAID CLAIMS DISCOUNT --------------------
POLICY AND CLAIM IF ANY (1) (2)
ACQUISITION ADJUSTMENT DEDUCTED IN UNEARNED EARNED INVESTMENT CURRENT PRIOR
COSTS EXPENSES RESERVES PREMIUMS PREMIUMS INCOME YEAR YEAR
----------- ------------- ----------- -------- -------- ---------- ------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
YEAR ENDED DECEMBER 31:
Net of Reinsurance
1998 $2,407 $33,305 -- $ 7,946 $47,008 $2,516 $37,399 $ 7,086
1997 2,802 29,159 -- 9,363 55,707 2,985 42,243 5,774
1996 3,992 26,532 -- 13,857 51,854 3,159 37,651 1,559
Gross of Reinsurance
1998 $2,407 $60,844 -- $10,793 $67,135 $2,516 $53,187 $ 6,649
1997 2,802 57,283 -- 15,676 75,778 2,985 54,266 8,616
1996 3,992 55,300 -- 17,925 73,568 3,159 52,711 (930)
<CAPTION>
AMORTIZATION
OF DEFERRED PAID CLAIMS
POLICY AND CLAIM
ACQUISITION ADJUSTMENT PREMIUMS
COSTS EXPENSES WRITTEN
------------ ----------- --------
<C> <C> <C>
$11,401 $40,339 $45,591
10,332 45,390 51,214
9,116 42,675 53,420
$11,401 $56,275 $62,253
10,332 60,898 73,529
9,116 62,633 74,259
</TABLE>
79
<PAGE> 1
RESTATED
ARTICLES OF INCORPORATION
OF
McM CORPORATION
1. The name of the corporation is McM Corporation.
2. The period of duration of the corporation is perpetual.
3. The purposes of which the corporation is organized are to
perform management and other services to insurance companies; to enter into
contracts with insurance companies; to perform all activities which may be
useful and helpful to insurance companies; and to engage in any other lawful
act or activity for which corporations may be organized under Chapter 55 of the
General Statutes of North Carolina, including, but not limited to:
constructing, manufacturing or producing; repairing, servicing, processing,
buying, selling, dealing, brokering, factoring, owning, leasing, distributing,
lending, borrowing, investing, transporting, or advertising; performing
personal services; and entering into any type of management, advisory,
promotional, insurance, guarantyship, fiduciary or representative capacity or
relationship with or for any persons or corporation whatsoever.
4. Shares.
(a) AUTHORIZED SHARES. The aggregate number of shares
which the Corporation shall have authority to issue is 11,000,000, of which
10,000,000 shares shall be designated "Common Shares," with a par value of
$1.00, of which 1,000,000 shares shall be designated "Preferred Shares" with
such par value as the Board of Directors may hereafter determine.
(b) RELATIVE RIGHTS AND PREFERENCE. The relative rights,
privileges and limitations of the Common Shares and Preferred Shares shall be
as follows:
89
<PAGE> 2
1) COMMON SHARES. The holders of Common Shares
issued and outstanding, except where otherwise provided by law, these Articles
of Incorporation or the Board of Directors, shall have and possess the right to
notice of shareholders' meetings and voting rights and powers. Subject to any
and all of the rights of the Preferred Shares, as such are determined by the
Board of Directors, dividends may be paid on the Common Shares, as and when
declared by the Board of Directors, out of any funds of the Corporation legally
available for the payment of such dividends.
In the event of dissolution of the Corporation, whether voluntary or
involuntary, any distribution to holders of Common Shares shall be subject to
the rights and preferences of the holders of the Preferred Shares, as such
rights and preferences are determined by the Board of Directors, but all of the
shares together shall be entitled to receive the net assets of the Corporation.
2) PREFERRED SHARES. Authority is expressly granted to the Board
of Directors at any time and from time to time to issue the Preferred Shares in
one or more series and for such consideration as may be fixed from time to time
by the Board of Directors, and to fix, subject to the provisions herein, before
the issuance of any shares of a particular series, the designation of such
series, the number of shares to comprise such series, the dividend rate per
annum payable on the shares of such series, the redemption price or prices of
the shares in such series, the conversion features of such series, the voting
rights of such series, the liquidation preference of such series, and any other
rights, preferences and limitations pertaining to such series. Such rights,
preferences and limitations shall be recorded in Articles of Amendment to the
Corporation's Articles of Incorporation and filed with the Secretary of State
before the issuance of any shares of such series. All shares of any one series
of Preferred Shares shall be identical, except that the dates from which
dividends shall be cumulative may vary.
90
<PAGE> 3
3) The rights, preferences, limitations and characteristics of
the Corporation's Series A Preferred Stock are set forth in Appendix A hereto
and are incorporated herein by reference.
4) The rights, preferences, limitations and characteristics of
the Corporation's Series B PIK Preferred Stock are set forth in Appendix B
hereto and are incorporated herein by reference.
5. The minimum amount of consideration to be received by the
corporation for its shares before it shall commence business is $100 in cash or
property of equivalent value.
6. The address of the current registered office of the
corporation is 702 Oberlin Road, Raleigh, North Carolina 27605, Post Office Box
12317, Raleigh, North Carolina 27605; and the name of its current registered
agent at such address is George E. King.
7. The number of directors constituting the initial Board of
Directors shall be one; and the name and address of the person who is to serve
as director until the first meeting of shareholders, or until his successors be
elected and qualified, is:
<TABLE>
<CAPTION>
Name Address
---- -------
<S> <C> <C>
R. Peyton Woodson III 601 Oberlin Road
Raleigh, North Carolina 27605
8. The name and address of the incorporator is:
Frank R. Liggett III 333 Fayetteville Street
Raleigh, North Carolina 27602
</TABLE>
9. No person who is serving or who has served as Director of the
corporation shall be personally liable in any action for monetary damages for
breach of his or her duty as a Director, whether such action is brought by or
in the right of the corporation or otherwise, except for breach of
91
<PAGE> 4
duty for which personal liability cannot be limited or eliminated under the
North Carolina Business Corporation Act ("NCBCA") or other applicable law. If
the NCBCA or other applicable law is amended after approval by the shareholders
of this Article to authorize corporate action further eliminating or limiting
the personal liability of Directors, then the liability of a Director of the
corporation shall be eliminated or limited to the fullest extent permitted by
the NCBCA or other applicable law as so amended. Any repeal or modification of
this Article by the shareholders of the corporation shall not adversely affect
any right or protection of a Director of the corporation existing at the time
of such repeal or modification.
92
<PAGE> 5
APPENDIX A
McM CORPORATION
SERIES A PREFERRED STOCK
RIGHTS, PREFERENCES, LIMITATIONS AND CHARACTERISTICS
1. Designation and Amount. The shares of this series shall be
designated as "Series A Preferred Stock, $1,000 par value per share"
(hereinafter called this "Series"). Each share of this Series shall be
identical in all respects with the other shares of this Series.
The number of shares in this Series shall initially be 60,000, which
number may from time to time be increased or decreased (but not below the
number then outstanding) by the Board of Directors of the Corporation. Shares
of this Series purchased or otherwise acquired by the Corporation shall be
cancelled and shall thereupon be restored to the status of authorized but
unissued shares.
2. Dividends. The holders of shares of this Series shall not be
entitled to receive any dividends.
3. Liquidation. Upon the voluntary or involuntary liquidation,
dissolution or winding up of the Corporation, the holders of shares of this
Series shall be entitled to receive out of the net assets of the Corporation,
before any payment or distribution shall be made or set apart for payment on
the Common Stock or any other class or series of stock of the Corporation, the
amount of $1,000 per share of this Series. After the payment to the holders of
the shares of this Series of $1,000 per share, the holders of shares of this
Series, as such, shall have no right or claim to any of the remaining net
assets of the Corporation. Neither the sale, lease or conveyance of all or
substantially all of the property or business of the Corporation, nor the
merger or consolidation of the Corporation into or with any other corporation
or the merger or consolidation of any other corporation into or with the
Corporation, shall be deemed to be a liquidation, dissolution or winding up,
voluntary or involuntary, for purposes of this paragraph.
4. Redemption. Subject to the North Carolina Business
Corporation Act and required regulatory approvals, the shares of this Series
shall at all times be redeemable at the option of the holder thereof in cash
for $1,000 per share payable by the Corporation by official bank or certified
check or wire transfer of immediately available funds. Such redemption shall
occur within ten business days after receiving a written notice of redemption
from the holder of shares of this Series accompanied by a certificate or
certificates for such shares duly endorsed by the holder thereof with the
signature guaranteed by a financial institution.
5. Conversion and Exchange. The holders of shares of this Series
shall not have any rights to convert such shares into or to exchange such
shares for shares of Common Stock of the Corporation or any other class or
series of stock (or any other security) of the Corporation.
93
<PAGE> 6
6. Voting Rights. The holders of shares of this Series shall not
have a vote on any matter except as provided to the contrary by the North
Carolina Business Corporation Act.
7. Rank. The shares of this Series shall rank, as to
distribution of assets upon liquidation, dissolution or winding up, senior ro
any other class or series of preferred stock of the Corporation.
94
<PAGE> 7
APPENDIX B
McM CORPORATION
SERIES B PIK PREFERRED STOCK
RIGHTS, PREFERENCES, LIMITATIONS AND CHARACTERISTICS
1. Designation and Amount. The shares of this series shall be
designated as "Series B PIK Preferred Stock, $1,000 par value per share:
(hereinafter called this "Series"). Each share of this Series shall be
identical in all respects with the other shares of this Series.
The number of shares in this Series shall initially be 50,000, which
number may from time to time be increased or decreased (but not below the
number then outstanding) by the Board of Directors of the Corporation. Shares
of this Series purchased or otherwise acquired by the Corporation shall be
canceled and shall thereupon be restored to the status of authorized but
unissued shares.
2. Dividends. The Corporation shall pay and the holders of
shares of this Series shall receive dividends at a rate of 12.0% per annum,
payable quarterly in arrears to such holders on January 7, April 7, July 7 and
October 7. The dividends shall be cumulative from the date of issuance and
shall be paid in kind (PIK) with additional fully paid and nonassessable shares
of Series B PIK Preferred Stock having an aggregate liquidation preference
equal to the amount of such dividends. However, notwithstanding anything else
provided herein, the Board of Directors of the Corporation may, at its option,
pay any dividend in cash. All dividends paid with respect to shares of Series B
PIK Preferred Stock shall be paid pro rata to the holders entitled thereto.
3. Liquidation Preference. Upon the voluntary or involuntary
liquidation, dissolution or winding up of the Corporation, the holders of
shares of this Series shall be entitled to receive out of the net assets of the
Corporation, before any payment or distribution shall be made or set apart for
payment on the Common Stock or any other class or series of stock of the
Corporation other than Series A Preferred Stock, but after any payment due and
payable to holders of Series A Preferred Stock, the amount of $1,000 per share
of this Series B. After the payment to the holders of the shares of this Series
B of $1,000 per share, the holders of share of this Series, as such, shall have
no right or claim to any of the remaining net assets of the Corporation.
Neither the sale, lease or conveyance of all or substantially all of the
property or business of the Corporation, nor the merger or consolidation of the
Corporation into or with any other corporation or the merger or consolidation
of any other corporation into or with the Corporation, shall be deemed to be a
liquidation, dissolution or winding up, voluntary or involuntary, for purposes
of this paragraph.
4. Mandatory Redemption. Subject to the North Carolina Business
Corporation Act and required regulatory approvals, effective on the date that
is seven years from the date of issuance, outstanding shares of this Series B
shall be redeemed by the Corporation in cash for $1,000 per share plus an
amount equal to all accumulated and unpaid dividends per share payable by the
Corporation by official bank or certified check or wire transfer of immediately
available funds.
95
<PAGE> 8
5. Conversion and Exchange. The holders of shares of this Series
shall not have any rights to convert such shares into or to exchange such
shares for shares of Common Stock of the Corporation or any other class or
series of stock (or any other security) of the Corporation.
6. Voting Rights. The holders of shares of this Series shall not
have the right to vote on any matter except as provided to the contrary by the
North Carolina Business Corporation Act.
7. Rank. The shares of this Series shall rank, as to
distribution of assets upon liquidation, dissolution or winding up, senior to
any other class or series of preferred stock of the Corporation except Series A
Preferred Stock.
96
<PAGE> 1
EIGHTH AMENDMENT TO EMPLOYMENT AGREEMENT
THIS EIGHTH AMENDMENT TO EMPLOYMENT AGREEMENT (the "Amendment") is
made effective the 26th day of March, 1998, between GEORGE E. KING
("Employee"), and McM CORPORATION ("McM"), OCCIDENTAL FIRE & CASUALTY COMPANY
OF NORTH CAROLINA, and WILSHIRE INSURANCE COMPANY (the three companies
collectively being the "Employer" or the "McM Group").
W I T N E S S E T H:
WHEREAS, the Employee and the Employer have entered an Employment
Agreement dated as of February 16, 1989, and amended March 28, 1990, October
18, 1990, December 30, 1991, February 1, 1993, September 1, 1993, March 16,
1995, and August 6, 1996 (collectively, the "Agreement"); and
WHEREAS, the Employee and Employer wish to amend the Agreement in
certain respects and agree that the mutual promises set forth in this Amendment
are full and valid consideration therefor.
NOW THEREFORE, the parties hereto agree as follows:
1. Term of Employment. Paragraph 3 of the Agreement is hereby
deleted in its entirety and in its place is inserted the following:
3. Term. The term of this Agreement shall automatically
renew on a daily rolling basis and continue until
two years from the date the Employer delivers to the
Employee written notice of non-renewal.
2. Relocation of Employer. In the event Employer shall require
Employee to relocate his office more than fifty (50) miles from its present
location at 702 Oberlin Road, Raleigh, North Carolina, and Employee terminates
his employment hereunder as a result of such required relocation, Employee
shall receive the lump sum provided for in paragraph 9 hereof (Termination By
Employer Without Cause), the lump sum to be calculated in the manner provided
for in such paragraph.
3. Ratification. Except as modified in this Amendment, the
Agreement, as amended, is ratified and confirmed in all respects.
81
<PAGE> 2
IN WITNESS WHEREOF, Employer, by action approved and directed by its
Boards of Directors and Employee, on his own behalf, have executed this
Amendment as of the day and year first above written.
EMPLOYEE:
/s/ George E. King (Seal)
--------------------------------------
George E. King
EMPLOYER:
Attest: McM CORPORATION, a North Carolina
corporation
/s/ Michael D. Blinson
- ----------------------------
Corporate Secretary By: /s/ Stephen L. Stephano
- --------- ---------------------------------------
Its: President and CEO
---------------------------------------
[Corporate Seal]
OCCIDENTAL FIRE & CASUALTY
COMPANY OF NORTH CAROLINA, a North
Attest: Carolina corporation
/s/ Michael D. Blinson By: /s/ Stephen L. Stephano
- ---------------------------- ---------------------------------------
Corporate Secretary Its: President and CEO
- --------- ---------------------------------------
[Corporate Seal]
WILSHIRE INSURANCE COMPANY, a North
Attest: Carolina corporation
/s/ Michael D. Blinson
- ----------------------------
Corporate Secretary By: /s/ Stephen L. Stephano
- --------- ---------------------------------------
Its: President and CEO
---------------------------------------
[Corporate Seal]
82
<PAGE> 3
FOURTH AMENDMENT TO EMPLOYMENT AGREEMENT
THIS FOURTH AMENDMENT TO EMPLOYMENT AGREEMENT (the "Amendment") is
made effective the 26th day of March, 1998, between STEPHEN L. STEPHANO
("Employee"), and McM CORPORATION ("McM"), OCCIDENTAL FIRE & CASUALTY COMPANY
OF NORTH CAROLINA, and WILSHIRE INSURANCE COMPANY (the three companies
collectively being the "Employer" or the "McM Group").
W I T N E S S E T H:
WHEREAS, the Employee and the Employer have entered an Employment
Agreement dated as of February 1, 1993, and amended September 1, 1993, March
16, 1995, and August 6, 1996 (collectively, the "Agreement"); and
WHEREAS, the Employee and Employer wish to amend the Agreement in
certain respects and agree that the mutual promises set forth in this Amendment
are full and valid consideration therefor.
NOW THEREFORE, the parties hereto agree as follows:
1. Term of Employment. Paragraph 2 of the Agreement is hereby
deleted in its entirety and in its place is inserted the following:
2. Term. The term of this Agreement shall automatically
renew on a daily rolling basis and continue until
two years from the date the Employer delivers to the
Employee written notice of non-renewal.
2. Relocation of Employer. In the event Employer shall require
Employee to relocate his office more than fifty (50) miles from its present
location at 702 Oberlin Road, Raleigh, North Carolina, and Employee terminates
his employment hereunder as a result of such required relocation, Employee
shall receive the lump sum provided for in paragraph 8 hereof (Termination By
Employer Without Cause), the lump sum to be calculated in the manner provided
for in such paragraph.
3. Ratification. Except as modified in this Amendment, the
Agreement, as amended, is ratified and confirmed in all respects.
83
<PAGE> 4
IN WITNESS WHEREOF, Employer, by action approved and directed by its
Boards of Directors and Employee, on his own behalf, have executed this
Amendment as of the day and year first above written.
EMPLOYEE:
/s/ Stephen L. Stephano (Seal)
--------------------------------------
Stephen L. Stephano
EMPLOYER:
Attest: McM CORPORATION, a North Carolina
corporation
/s/ Michael D. Blinson
- ----------------------------
Corporate Secretary By: /s/ George E. King
- --------- ---------------------------------------
Its: Chairman
---------------------------------------
[Corporate Seal]
OCCIDENTAL FIRE & CASUALTY
COMPANY OF NORTH CAROLINA, a North
Attest: Carolina corporation
/s/ Michael D. Blinson By: /s/ George E. King
- ---------------------------- ---------------------------------------
Corporate Secretary Its: Chairman
- --------- ---------------------------------------
[Corporate Seal]
WILSHIRE INSURANCE COMPANY, a North
Attest: Carolina corporation
/s/ Michael D. Blinson
- ----------------------------
Corporate Secretary By: /s/ George E. King
- --------- ---------------------------------------
Its: Chairman
---------------------------------------
[Corporate Seal]
84
<PAGE> 1
CONTRACT OF EMPLOYMENT
THIS AGREEMENT is entered into as of the 1st day of February 1999, between
George E. King (the "Employee"), and McM Corporation, Occidental Fire &
Casualty Company of North Carolina, and Wilshire Insurance Company (the three
companies collectively being the "Employer").
WHEREAS the Employee is currently employed by the Employer, the Employer wishes
to continue to employ the Employee and the Employee wishes to remain employed.
NOW THEREFORE in consideration of the covenants and agreements set forth
hereinafter which are acknowledged to be good and valuable consideration, the
Employer and the Employee agree as follows:
1. The Employer agrees to continue to employ the employee at will and the
Employee agrees to continue to be so employed at will.
2. For all services rendered by the Employee, the Employer shall pay a
salary to the Employee of $200,000 (the "Salary") per annum, such
amount to be pro rated and paid in equal semi-monthly amounts.
3. The Employee's accrued vacation as established in accordance with the
written policy of the Employer as of December 31, 1998, shall be fixed
as of December 31, 1998, and such fixed amount shall be payable to the
Employee at such time as he may cease to be employed by the Employer.
The Employee agrees that further accrual of vacation shall cease at
December 31, 1998.
4. The Employer may terminate the Employee at any time. Should the
Employee be terminated, the Employee would be entitled to
Post-Termination Payments (referred to hereinafter as "PTP's"). PTP's
are defined as continuing installments of the Salary to be made
subsequent to termination of the Employee if, and only if, the
cumulative sum of the Salary measured from the date of this Agreement,
shall be less than the sum of $450,000 (the "Cumulative Compensation
Amount"). Neither the Employer nor the Board of Directors of the
Employer may take any unilateral action, other than for Cause, that
would preclude the Employee from receiving the Cumulative Compensation
Amount.
5. Termination of the Employee for cause shall immediately terminate the
Employer's obligation to pay the Salary or pay PTP's. "Cause" is
defined as the Employee's commission of any act constituting a felony,
willful misconduct or material non-performance of those duties
bestowed upon him after 30 days written notice setting out the
specific deficiencies in performance of those duties.
6. The Employee shall have the right to terminate his employment
hereunder at any time by giving notice in writing to the Employer, the
date of such notice to be considered the effective
85
<PAGE> 2
date of termination. The obligation of the Employer under this
Agreement to pay Salary or PTP's shall be terminated upon the Employee
giving written notice that he is terminating his employment.
7. If the Employee dies prior to the Salary accumulating to the level of
the Cumulative Compensation Amount, the Employer shall pay to the
Employee's estate the Salary that would otherwise be payable to the
Employee under the terms of this Agreement.
8. If the Employee becomes incapacitated by reason of mental or physical
disability during the term of this Agreement, the Employer shall
provide short term and long term disability benefits to the Employee
as are in effect under the Employer's group benefits plan as they
exist from time to time.
9. No waiver of any provision of this Agreement or any change to this
Agreement shall be valid unless the Board of Directors of McM
Corporation approves it in writing.
10. This Agreement contains the entire understanding of the parties. This
Agreement supersedes in full any prior employment agreements, written
or oral, that may have existed between the Employer and any of its
subsidiaries and the Employee.
AGREED TO AND ACCEPTED BY: /s/ GEORGE E. KING
-----------------------------------------------
George E. King
Employee
/s/ PETER R. KELLOGG
-----------------------------------------------
Peter R. Kellogg
Chairman - Compensation Comm.
/s/ STEPHEN L. STEPHANO
-----------------------------------------------
Stephen L. Stephano, for the Employer
President/COO - McM Corporation
President/CEO - Occidental Fire & Casualty
Co. of NC
President/CEO - Wilshire Insurance Company
86
<PAGE> 3
CONTRACT OF EMPLOYMENT
THIS AGREEMENT is entered into as of the 1st day of February 1999, between
Stephen L. Stephano (the "Employee"), and McM Corporation, Occidental Fire &
Casualty Company of North Carolina, and Wilshire Insurance Company (the three
companies collectively being the "Employer").
WHEREAS the Employee is currently employed by the Employer, the Employer wishes
to continue to employ the Employee and the Employee wishes to remain employed.
NOW THEREFORE in consideration of the covenants and agreements set forth
hereinafter which are acknowledged to be good and valuable consideration, the
Employer and the Employee agree as follows:
1. The Employer agrees to continue to employ the employee at will and the
Employee agrees to continue to be so employed at will.
2. For all services rendered by the Employee, the Employer shall pay a
salary to the Employee of $200,000 (the "Salary") per annum, such
amount to be pro rated and paid in equal semi-monthly amounts.
3. The Employee's accrued vacation as established in accordance with the
written policy of the Employer as of December 31, 1998, shall be fixed
as of December 31, 1998, and such fixed amount shall be payable to the
Employee at such time as he may cease to be employed by the Employer.
The Employee agrees that further accrual of vacation shall cease at
December 31, 1998.
4. The Employer may terminate the Employee at any time. Should the
Employee be terminated, the Employee would be entitled to
Post-Termination Payments (referred to hereinafter as "PTP's"). PTP's
are defined as continuing installments of the Salary to be made
subsequent to termination of the Employee if, and only if, the
cumulative sum of the Salary measured from the date of this Agreement,
shall be less than the sum of $450,000 (the "Cumulative Compensation
Amount"). Neither the Employer nor the Board of Directors of the
Employer may take any unilateral action, other than for Cause, that
would preclude the Employee from receiving the Cumulative Compensation
Amount.
5. Termination of the Employee for cause shall immediately terminate the
Employer's obligation to pay the Salary or pay PTP's. "Cause" is
defined as the Employee's commission of any act constituting a felony,
willful misconduct or material non-performance of those duties
bestowed upon him after 30 days written notice setting out the
specific deficiencies in performance of those duties.
6. The Employee shall have the right to terminate his employment hereunder
at any time by giving
87
<PAGE> 4
notice in writing to the Employer, the date of such notice to be
considered the effective date of termination. The obligation of the
Employer under this Agreement to pay Salary or PTP's shall be
terminated upon the Employee giving written notice that he is
terminating his employment.
7. If the Employee dies prior to the Salary accumulating to the level of
the Cumulative Compensation Amount, the Employer shall pay to the
Employee's estate the Salary that would otherwise be payable to the
Employee under the terms of this Agreement.
8. If the Employee becomes incapacitated by reason of mental or physical
disability during the term of this Agreement, the Employer shall
provide short term and long term disability benefits to the Employee
as are in effect under the Employer's group benefits plan as they
exist from time to time.
9. No waiver of any provision of this Agreement or any change to this
Agreement shall be valid unless the Board of Directors of McM
Corporation approves it in writing.
10. This Agreement contains the entire understanding of the parties. This
Agreement supersedes in full any prior employment agreements, written
or oral, that may have existed between the Employer and any of its
subsidiaries and the Employee.
AGREED TO AND ACCEPTED BY: /s/ STEPHEN L. STEPHANO
------------------------------------------
Stephen L. Stephano
Employee
/s/ PETER R. KELLOGG
------------------------------------------
Peter R. Kellogg
Chairman - Compensation Comm.
/s/ MICHAEL D. BLINSON
------------------------------------------
Michael D. Blinson, for the Employer
SVP - McM Corporation
SVP - Occidental Fire & Casualty Co. of NC
SVP - Wilshire Insurance Company
88
<PAGE> 1
CORPORATE ORGANIZATION CHART
As of December 31, 1998, the organization chart of corporate structure and
ownership is shown below. Percent figures show percent ownership of shares by
parent. Jurisdiction of organization is shown in parentheses.
McM CORPORATION (NC) 56-1171691
- - 100% - - Equity Holdings, Inc. (DE) 56-1651565
- - 100% - - Occidental Fire & Casualty Company of North
Carolina (NC) 84-0513811
- - 100% - - Wilshire Insurance Company (NC) 56-1507441
Note: Two entities, Equity American Financial Service, Inc. and
Equity American General Agency, Inc., have been formed as North
Carolina corporations. Although neither company has been fully
activated or capitalized, it is anticipated that they might be
utilized in additional marketing programs in the future.
80
<PAGE> 1
EXHIBIT 23
CONSENT OF INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration Statements
(Forms S-8 No. 333-05991 and 333-05989) pertaining to the 1996 Non-Employee
Directors' Stock Purchase Plan and the 1996 Employee Incentive Stock Option
Plan, respectively, of McM Corporation of our report dated February 26, 1999,
with respect to the consolidated financial statements and the financial
statement and schedules included in this Annual Report (Form 10-K) of McM
Corporation and subsidiaries.
ERNST & YOUNG LLP
Raleigh, North Carolina
March 29, 1999
97
<TABLE> <S> <C>
<ARTICLE> 7
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
FINANCIAL STATEMENTS OF MCM CORPORATION FOR THE TWELVE MONTHS ENDED DECEMBER 31,
1998, AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL
STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<DEBT-HELD-FOR-SALE> 25,660
<DEBT-CARRYING-VALUE> 3,138
<DEBT-MARKET-VALUE> 3,275
<EQUITIES> 21,969
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 62,339
<CASH> 8,120
<RECOVER-REINSURE> 33,476
<DEFERRED-ACQUISITION> 2,407
<TOTAL-ASSETS> 117,735
<POLICY-LOSSES> 60,844
<UNEARNED-PREMIUMS> 10,793
<POLICY-OTHER> 0
<POLICY-HOLDER-FUNDS> 5,881
<NOTES-PAYABLE> 0
0
26,000
<COMMON> 4,706
<OTHER-SE> (2,249)
<TOTAL-LIABILITY-AND-EQUITY> 117,735
47,008
<INVESTMENT-INCOME> 2,516
<INVESTMENT-GAINS> 274
<OTHER-INCOME> 430
<BENEFITS> 44,485
<UNDERWRITING-AMORTIZATION> 0
<UNDERWRITING-OTHER> 20,929
<INCOME-PRETAX> (15,186)
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