UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended MARCH 31, 1995
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 0-17338
HOMEOWNERS GROUP, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 65-0033743
State or other jurisdiction of (I.R.S. Employer
incorporation or organization Identification No.)
6365 TAFT STREET, HOLLYWOOD, FLORIDA 33024
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (305) 983-0350
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
YES X NO ___
On May 2, 1995, there were 5,558,350 shares of the registrant's common
stock issued and outstanding.
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PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
HOMEOWNERS GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
1995 1994
----------- -----------
(UNAUDITED) (AUDITED)
<S> <C> <C>
ASSETS:
Current assets:
Cash and cash equivalents $3,486,919 $5,875,844
Trading securities 8,417,898 8,261,915
Miscellaneous receivables 915,323 1,153,188
Deferred home warranty acquisition costs 4,864,442 5,677,322
Refundable income taxes 1,816,149 1,816,149
Current portion of deferred income taxes 4,077,896 4,880,781
Prepaid expenses and other current assets 999,546 1,281,693
----------- -----------
Total current assets 24,578,173 28,946,892
Restricted cash 1,407,851 1,407,851
Non-current securities available for sale 3,969,011 4,078,966
Property and equipment - net 2,167,244 2,009,165
Other assets 1,159,534 1,177,026
Deferred and refundable income taxes - net of current portion 2,189,783 1,579,345
----------- -----------
TOTAL $35,471,596 $39,199,245
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY:
Current liabilities:
Accounts and accrued expenses payable $8,819,585 $10,296,813
Current maturities of long term debt 1,315,394 1,065,487
Deferred home warranty revenue 13,482,233 16,118,752
----------- -----------
Total current liabilities 23,617,212 27,481,052
Long term debt - net of current portion 3,097,054 3,316,845
Commitments and contingencies
Stockholders' equity:
Common stock - $0.01 par value; 45,000,000 shares
authorized; 5,558,350 shares issued and outstanding
at March 31, 1995 and December 31, 1994 55,584 55,584
Additional paid-in capital 7,458,288 7,458,288
Retained earnings 1,218,227 902,289
Unrealized holding gain (loss) on securities
available for sale 25,231 (14,813)
----------- -----------
Total stockholders' equity 8,757,330 8,401,348
----------- -----------
TOTAL $35,471,596 $39,199,245
=========== ===========
</TABLE>
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
2
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HOMEOWNERS GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
<TABLE>
<CAPTION>
QUARTER ENDED QUARTER ENDED
MARCH 31, MARCH 31,
------------- -------------
1995 1994
<S> <C> <C>
OPERATING REVENUE $10,835,083 $12,827,854
OPERATING COSTS AND EXPENSES:
Direct expenses 8,169,430 9,567,850
General and administrative expenses 2,623,981 2,799,042
----------- -----------
Total 10,793,411 12,366,892
----------- -----------
OPERATING INCOME 41,672 460,962
OTHER INCOME (EXPENSE):
Investment income - net 557,185 30,490
Other income (expense) - net (84,918) 127,724
----------- -----------
Total 472,267 158,214
INCOME BEFORE
INCOME TAXES 513,939 619,176
PROVISION FOR INCOME TAXES (198,000) (254,000)
----------- -----------
NET INCOME $315,939 $365,176
=========== ===========
PER SHARE AMOUNTS:
Net income $0.06 $0.07
=========== ===========
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING 5,558,350 5,558,350
</TABLE>
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
3
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HOMEOWNERS GROUP, INC AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
QUARTER ENDED QUARTER ENDED
MARCH 31 MARCH 31
------------- -------------
1995 1994
<S> <C> <C>
Cash flows from operating activities:
Net income $315,938 $365,176
Adjustments:
Depreciation and amortization 142,092 188,780
Provision for deferred income taxes 958,000 2,547,000
Foreign currency translation adjustment 0 (6,114)
(Gain) loss on sales of trading securities (343,539) 103,554
Unrealized holding loss on securities available for sale 40,045 15,603
Other net changes in assets and liabilities:
Decrease in miscellaneous receivables 237,865 353,265
Decrease in deferred home warranty acquisition costs 812,880 359,350
Increase in refundable income taxes 0 (1,646,251)
Increase in deferred income taxes (765,553) (332,655)
Increase (decrease) in prepaid expenses and other assets 286,444 (238,889)
Decrease in accounts and accrued expenses payable (1,477,227) (461,539)
Decrease in deferred home warranty revenue (2,636,520) (1,015,623)
Payments on reserve for loss on reinsurance
portfolio transfer 0 (658,797)
Purchases of trading securities (421,900) (305,700)
Proceeds from sales of trading securities 597,193 261,980
---------- ----------
Net cash used in operating activities (2,254,282) (470,860)
---------- ----------
Cash flows from investing activities:
Property and equipment expenditures (286,977) (261,488)
Purchases of securities classified as available for sale (50,833) (2,276,568)
Proceeds from sale of securities classified as
available for sale 173,051 2,231,540
---------- ----------
Net cash used in investing activities (164,759) (306,516)
---------- ----------
Cash flows from financing activities:
Repayments of debt (179,734) (40,475)
Amortization of discount on long term debt 69,850 76,816
Borrowings under capital lease obligation 140,000 210,538
---------- ----------
Net cash provided by financing activities 30,116 246,879
---------- ----------
Net decrease in cash and cash equivalents (2,388,925) (530,497)
Cash and cash equivalents at beginning of period 5,875,844 7,530,452
Cash and cash equivalents at end of period $3,486,919 $6,999,955
========== ==========
SUPPLEMENTAL DISCLOSURE:
Cash paid during the period for:
Interest $71,917 $15,213
Income taxes 8,142 137,200
</TABLE>
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
4
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HOMEOWNERS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 1995
(Unaudited)
1. GENERAL
The consolidated balance sheet as of March 31, 1995 and the consolidated
statements of income and cash flows for the three month periods ended March
31, 1995 and 1994 have been prepared by the Company, without audit. In the
opinion of management, all adjustments, which include only normal recurring
adjustments necessary to present fairly the financial position, results of
operations and cash flows at March 31, 1995, and for the periods presented,
have been made.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted. These consolidated financial
statements should be read in conjunction with the consolidated financial
statements and notes included in the Company's 1994 Annual Report on Form
10-K, filed with the Securities and Exchange Commission.
2. FRANCHISE SALE
In the first quarter of 1995, the Company entered into an agreement to
franchise, effective May 1, 1995, the Corporate Owned Region of New
England, consisting of the states of Maine, Massachusetts, New Hampshire
and Vermont, for a franchise fee of $100,000.
3. CONTINGENCIES
In December 1991, Acceleration National Insurance Company ("Acceleration"),
the insurer of the Company's E&O program through April 1991, brought suit
against the Company for damages related to the 1986-1991 E&O program.
Willis Corroon, the Company's insurance broker at the time, and Meridian,
the reinsurer of the program at the time, are also defendants in this suit.
Meridian is a wholly-owned subsidiary of Willis Corroon. The complaint
alleges breach of contract, unjust enrichment, negligent misrepresentation
and mismanagement of claims operations. Currently, Acceleration's total
claim is in excess of $10,000,000. Under the Acceleration program, the
Company had two letters of credit (`LOC's') totaling $2,059,000 issued to
Acceleration. Actuarial studies indicated that funds available and
anticipated investment income on the Acceleration pool would not be
sufficient to cover related claims and expenses. As a result, the Company,
in December 1991, provided a reserve of $2,059,000 against its investments
to cover their possible loss under the Acceleration agreement. This
provision was included in unusual charges in the 1991 consolidated
statement of income. In October 1992, Acceleration called the LOC's, based
upon its contention that the program pool was depleted. The underlying
investments were liquidated and the required proceeds surrendered to
Acceleration. The transaction was charged against the reserve, thus
eliminating it. The Company disputes all claims of Acceleration, including
its obligation under the LOC's, and believes it is entitled to damages from
Acceleration for mismanagement. The Company has filed both an answer and a
counterclaim. The matter, previously scheduled to go to trial in November
1994, is now expected to be tried in mid 1995.
5
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After taking into consideration the evaluation of outside legal
counsel, the Company has determined, and legal counsel concurs, that the
potential loss in connection with this matter is zero to $2,500,000 and
that no particular estimate within this range is more probable than
another. Accordingly, no additional provision has been made in connection
with this matter.
In connection with the transfer of the net assets of POMG Insurance
Company, Ltd ("POMG") to Continental Casualty Company ("CNA"), the Company
is obligated to pay CNA $5,000,000 (the "CNA Obligation") over a period
estimated to be five years toward the ultimate settlement of the
transferred losses and expenses. CNA will maintain a separate accounting
for the POMG net assets. Additionally, a separate fund, the `Holdback
Fund,' has been established to accumulate the aforementioned $5,000,000
from the Company, additional funds to be contributed by Schinnerer and CNA
over the same period, and investment income earned on these funds, to pay
claims and expenses related to the reinsured policies in excess of the POMG
net assets. If the ultimate reinsured losses and related expense are less
than the transferred net assets of POMG, combined with the assets in the
Holdback Fund, CNA will distribute the remaining assets among the Company,
Schinnerer and itself according to a predetermined formula. However,
management believes that a refund is unlikely. In addition, the Company has
guaranteed the validity of a $5,000,000 reinsurance treaty, one of the POMG
assets transferred to CNA, by posting $3,000,000 in cash collateral, of
which $1,500,000 has been posted. This asset represents amounts recoverable
from a third party reinsurance company under a reinsurance treaty purchased
by POMG to protect it from losses in excess of a predetermined amount. The
Company has agreed, if necessary, to pay the additional $2,000,000 related
to the guarantee from future commissions. As of March 31, 1995, claims had
exceeded the predetermined amount but the reinsurer has not yet honored
the program administrator's request to remit the amounts due CNA under the
reinsurance treaty, and has requested additional information from the program
administrator. The Company has not recorded a provision for this guarantee,
as management, based on the opinion of its special insurance counsel, has
determined that the reinsurance contract is a binding agreement, enforceable
in accordance with its terms and that various objections to coverage voiced
by the reinsurer do not support a material basis for it to successfully deny
coverage.
4. RECLASSIFICATIONS
Certain amounts in the accompanying 1994 consolidated financial statements
have been reclassified from amounts previously reported to conform to the
current presentation.
6
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
RECENT DEVELOPMENTS
The Company has received several inquiries from unaffiliated third parties
relating to various proposed transactions with the Company, including the
purchase of all of the outstanding shares of the Company. Consequently, the
Company has formed a Special Committee of the Board of Directors to
evaluate the alternatives available to the Company.
The Committee is examining all options that may enhance stockholder value,
including an alliance with a financial or strategic investor and/or a
business combination with an entity complementary to existing operations.
The Committee has retained the investment banking firm of Raymond James &
Associates to assist it in evaluating the inquiries and alternatives.
Although the Company is considering the terms of the referenced proposals,
there can be no assurance that any of the same will result in definitive
agreements; or any assurance as to form or timing of such a transaction, if
one should occur.
BUSINESS ENVIRONMENT
HMS MEMBERSHIP NETWORK
The Company, through its Homeowners Marketing Services, Inc. ("HMS")
subsidiary, has developed a national network of real estate brokers
("Members"), enrolled by the Company's franchisees ("Affiliates") and the
field sales force employed in the Corporate Owned Regions ("COR"). The
Company offers various types of memberships including a "full membership,"
under which participating brokers have access to all of the Company's
products and services, and a "limited membership," under which
participating brokers have access to certain of the Company's products and
services.
Members generally pay an initial membership fee and annual renewal fees, in
order to retain the rights of membership. Full members participate in the
Company's Errors & Omissions insurance ("E&O") program and pay marketing or
placement fees to the Company for access to the program. Members also have
the right to use products and services provided by other vendors with which
the Company has made preferred arrangements.
Membership provides access to home warranty contracts and the real estate
brokers E&O insurance, in addition to access to the following programs: a
membership-wide referral networking system (REFNET Registermark), the HMS
BuyerTrack Registermark Follow-Up System, the HMS Consumer Reach Program, a
monthly real estate publication (HMS NETWORKING Registermark Magazine), the HMS
Risk Management System Registermark, and certain advertising and public
relations materials.
HOME WARRANTY CONTRACTS
The Company offers, through its Members, home warranty contracts for a
fixed fee, paid at the time of closing of residential sale transactions
participated in by HMS Members. The home warranty contract provides for the
repair or replacement, at the Company's discretion, of major mechanical
systems and certain appliances of a residence which malfunction as a result
of normal wear and tear during the term of the contract. The Company
7
<PAGE>
currently offers a home warranty contract for sale in every state in which
the Company operates, with the exceptions of Connecticut and New Hampshire.
The Company and the home warranty contract offered are subject to insurance
type regulations in 16 of the states in which contracts are sold.
Funds received for the home warranty contracts are deferred upon receipt
and recognized as revenue over the contract term (generally one year) in
proportion to historical experience of home warranty repair costs incurred.
The direct costs of acquiring the contracts, which are generally a fixed
portion of the related revenue, are recorded in the same manner. Repair
costs under home warranty contracts, which are expensed as mechanical
break-downs are reported to and are authorized by the Company, represent
the direct expense which typically varies most with respect to related
revenue. A significant portion of repair costs generally relates to heating
and air conditioning systems, water heaters and plumbing. The frequency and
severity of such repair costs vary with changing weather patterns.
ERRORS & OMISSIONS AND OTHER INSURANCE PRODUCTS
The Company also markets real estate brokers' E&O liability insurance to
its Members, through its HOMS Insurance Agency, Inc. ("HOMS") subsidiary.
This insurance generally provides limits of between $100,000 and $1,000,000
per loss and from $100,000 to $1,000,000 aggregate per policy year. The
policies generally provide coverage for wrongful acts which occur during
the term of the policy and are reported up to 60 days after expiration of
the policy and all claims after expiration for which notice of wrongful act
is given prior to expiration. The policy provides for a deductible per loss
and covers the real estate brokerage firm and all officers, partners,
stockholders, employees, salespersons and sales associates or independent
contractor brokers of the brokerage firm. The Company is not subject to
reinsurance risk under the current program.
SEASONALITY
Most of the Company's revenue is generated at the time of residential
resale closings. These closings generally follow a seasonal pattern. First
quarter volume is usually the lowest, third quarter the highest, and second
and fourth quarters are about equal. Claims under home warranty contracts
are generally higher in the summer and winter months, while general and
administrative expenses are usually incurred evenly from quarter to
quarter. As a result, the Company's operating results in the second half of
a given year are generally better than the results in the first half.
FOREIGN OPERATIONS
The Company discontinued funding its British operation, Home Guarantee
Corporation ("HGC") effective October, 1994, accruing all expenses related
to the closing of that operation in the third quarter consolidated results
of operations. The liquidation and final settlement of HGC's debt was
completed in May 1995.
RESULTS OF OPERATIONS
THREE MONTHS ENDED MARCH 31, 1995 AS COMPARED TO MARCH 31, 1994
Home Warranty Operations:
Home warranty revenue, totaling $9,071,000 and representing 84% of total
operating revenue for the three months ended March 31, 1995, increased 2%
over the corresponding 1994 figure of $8,924,000, or 70% of
8
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total operating revenue. This revenue increase is due primarily to the
impact of warranty production increases in the preceding eleven months, as
compared to the comparable prior year period because of the Company's
revenue recognition policy, under which warranty revenue is recognized
ratably over the contract term, generally twelve months. Warranty contract
sales in the first quarter of 1995 were 20% lower than in the 1994 first
quarter, which is primarily attributable to the impact on housing sales of
increasing interest rates, and is consistent with industry experience.
Heavy rains and flooding have significantly impacted the California real
estate market in the first quarter, resulting in declines in transactions
and in opportunities for warranty sales. Also negatively impacting warranty
production in the first quarter of 1995 was the decline in the Company's
membership base, which was 14% lower than at March 31, 1994. The impact of
this decrease in warranty contract sales will affect warranty revenue
recognition in future quarters, due to the warranty revenue recognition
method. Partially offsetting these declines, renewal warranty contract
sales in the first quarter of 1995 were 62% higher than in the 1994 first
quarter, which is attributable to management's development of several new
marketing strategies, resulting in an increase in renewal success rates to
approximately 15%, a threefold improvement over 1994 levels. There have
been no major pricing changes which would have significantly affected
warranty revenue.
Direct expenses of the warranty product, which consist primarily of claims
expenses and acquisition costs, as a percentage of related operating
revenue, decreased to 77% in 1995 from 82% in 1994, primarily due to a 10%
decrease in average claim severity.
The 1995 warranty acquisition cost ratio is slightly lower than the
comparable 1994 ratio. As the volume of contract sales shifts between
geographic regions, the Company's overall acquisition cost ratio changes,
as the Company's acquisition costs vary in different locations. The
acquisition cost ratio is expected to remain relatively stable at its
current level, assuming that the warranty product mix and geographic
distribution do not change significantly. Management, does not expect a
significant change to occur in the near future.
Franchising Operations:
The Company has entered into an agreement, effective May 1, 1995, to
franchise the New England territory, consisting of the states of Maine,
Massachusetts, New Hampshire and Vermont. The franchise was sold for $100,000.
Membership and Other Operations:
Membership related revenue was 54% lower than in the comparable prior year
period, which is primarily the result of the changing mix of the membership
base retained, as a large portion of the Company's membership no longer
participates in the Company's E&O program and is exempted from paying the
associated marketing fees. The decrease is also partially related to the
14% decline in the Company's membership base from the prior year level. In
spite of the decline in total number of offices from the prior year period,
the Company has seen a positive impact from the recently introduced Agent
membership program. Also indicative of positive results, is the fact that
the membership renewal experience has improved over the prior year levels,
while new membership enrollments have increased by 52% over 1994.
Management believes that this trend is a result of the resolution of the
E&O transition issues encountered throughout 1994.
During the 1995 first quarter the Company introduced, to Members meeting
certain criteria, the Easy E&O application, a user friendly approach which
is utilized in the field as a point of sale presentation. This new point of
sale opportunity will allow the Company national field representatives to
supply potential Members
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with an E&O insurance quote at the point of original contact and
presentation of the Company's' full range of membership benefits. This new
application is anticipated to increase sales in two ways, first by making
it simpler to close a sale, with a single sales call, and second by
allowing the sales force to increase the number of initial sales calls,
instead of making repeat calls to present E&O quotes and repeat sales
presentations.
Direct expenses of the membership operations approximated 71% of related
revenue for the first three months of 1995 and 63% of related revenue for
the comparable prior year period. The increasing cost ratio is related
primarily to the impact of the decline in operating results of the COR's,
primarily in California. As discussed previously, the California region has
been heavily impacted by rains and flooding, which has resulted in
declining transactions and warranty sales.
E&O Brokerage Operations:
E&O brokerage revenue for the three months ended March 31, 1995, totaled
$275,000, a decrease of 60% from the 1994 first quarter revenue of
$690,000. The 1995 revenue includes commissions earned on the current E&O
program of nearly $253,000 and approximately $17,000 of E&O reimbursement
earned on the run-off of the prior E&O program. The 1994 revenue was
comprised primarily of the administrative reimbursement earned on the prior
E&O program, combined with a small amount of commission earned on the
current program, which was only beginning in the 1994 first quarter. The
decrease results from the change in composition of the Company's membership
base, as only 43% of the Company's membership currently participates in the
E&O program compared to 73% at March 31, 1994. The commission rate earned
currently is the same as the reimbursement rate earned under the prior
program. Under the current program, the Company acts as an insurance
broker, and is not exposed to any reinsurance risk.
Direct costs of the E&O brokerage operations increased from $96,000 or 14%
of related revenue in the 1994 three month period to $104,000 or 38% of
related revenue in the comparable 1995 period. Under the current E&O
program, the Company generally pays 50% of the commission it receives on
the E&O premiums collected to the Affiliates generating the premium volume.
There was no such arrangement under previous E&O programs. Thus, the gross
profit earned on the prior program was higher. Consequently, as the revenue
in 1995 will consist almost entirely of commissions earned under the
current program, the direct cost percentage will increase until it at least
approximates the 50% commission paid to Affiliates, in addition to other
direct costs of administering the program. However, certain indirect costs
incurred by the Company in administering the prior program are no longer
incurred in administering the current program, making the operating profit
ratio earned on the two programs more comparable than the gross profit
ratio.
Foreign Operations:
During the third quarter of 1994, the Company ceased funding its UK
subsidiary, HGC. The Company does not expect to incur any further expenses
related to HGC during 1995 or thereafter. Throughout the first three
quarters of 1994, the expenses incurred by HGC approximated $225,000 per
quarter.
G&A Expense:
The amount of general and administrative expenses ("G&A") decreased from
$2,799,000 in the first quarter of 1994 to $2,624,000 in 1995. The decrease
is primarily due to declines in employee related expenses from the
workforce reduction, and to the elimination of UK G&A expenses, which
approximated $225,000 in the 1994 first quarter. Though the total G&A
expenses declined, as a percentage of related revenue, G&A increased
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from 21.8% of revenue in the 1994 first quarter, to 24.2% in the 1995 period.
The proportional increase relates to increased legal fees over the 1994
period, relating to the Acceleration lawsuit, as the Company has been
preparing in the first quarter for the trial. Since many of the components
of G&A are fixed in nature, management monitors these costs to ensure that
they are within acceptable boundaries.
Other Income (net):
Other income, net is comprised of net investment income in excess of
interest expense. Investment income is generated primarily from the trading
securities currently invested by the Company's regulated home warranty
subsidiaries as well as from additional investments of funds generated
through sales of warranty products. Net investment income increased from a
net gain of $30,000 for the three months ended 1994 to a net gain of
$557,000 in the current year equivalent period. This increase is primarily
due to the stabilization and small declines in market interest rates, which
has caused the fair value of the Company's investment portfolio, consisting
mainly of debt instruments, to rebound from the previous lows experienced
in 1994, when the bond market was particularly negatively impacted.
Approximately $238,800 relates to realized holding gains on the Company's
investment portfolio of trading securities, as compared to realized holding
losses of $99,700 in the 1994 first quarter. Interest expense of
approximately $70,000 relates primarily to the CNA obligation.
Income Taxes:
The Company's effective income tax rate on continuing operations for the
current three month period is 39%, decreasing from 41% in the comparable
1994 period. Management does not expect the effective income tax rate to
change substantially during the remainder of 1995.
LIQUIDITY AND CAPITAL RESOURCES
The Company generally receives payment for products and services before
disbursing funds for related direct expenses. Fees from Members and from
sales of home warranty contracts are received before related marketing
commissions are paid out and before claims are made under home warranty
contracts. Consequently, cash flow has historically been more than adequate
to meet current obligations. Due to the impact of seasonality on the
Company's business, cash flow in the first quarter is generally negative.
Cash collected on warranty contracts in the first three months of 1995 was
lower than amounts collected in the comparable 1994 period by approximately
$860,000 as a result of the decline in home warranty contract sales. The
1994 first quarter cash flow was significantly positively impacted by the
large warranty production increases experienced in that period. Based on
preliminary April results and on general improvements in the economy, the
Company anticipates that cash collections on warranty contract sales should
increase in the 1995 second quarter over the first quarter levels, as
second quarter warranty contract sales typically exceed the first quarter
level.
In the first quarter of 1995, net cash used in operating activities totaled
$2,254,000, as compared to $471,000 in the first quarter of 1994. This
increased usage of cash is primarily due to the decline in warranty
production in the 1995 first quarter from the comparable 1994 levels. Also
impacting operating cash flows are various payments for claims payable,
Affiliate and Member commissions and E&O premium remittances. In the 1995
first quarter, the Company used $165,000 in investing activities, as
compared to $307,000 in the first quarter of 1994, primarily due to
decreased trading activity in its investment portfolio. Net cash provided
by financing activities decreased from $247,000 in the first quarter of
1994 to $30,000 in the comparable 1995 period, due to increasing debt
repayments, primarily on the CNA obligation and also to a reduction in
financing
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arrangements under capital lease obligations. The CNA obligation is
repaid through remittance of a portion of the Company's commissions earned
on the E&O premium volume. Consequently, increases in premium volume will
result in increases in debt repayments.
The Company provides for deferred income taxes on the excess of deferred
warranty revenue over the related deferred acquisition cost. As a result,
the Company generally pays taxes on the revenue collected, not on the
revenue recognized, which gives rise to the deferred tax asset of
approximately $6.3 million at March 31, 1995. Cash paid for income taxes is
generally expected to approximate the current income tax provision in a
given year. However, due to the losses incurred in 1993 and 1994, the
Company has currently refundable income tax benefits approximating $1.8
million. Consequently, the Company is not expected to be required to pay
any Federal income taxes in the near future. The Company intends to file
for further refunds of taxes paid in prior years, and expects to receive
its refundable income taxes in the second or third quarter of 1995.
The agreements with CNA in connection with the transfer of POMG's net
assets include several restrictive covenants on both dividends and
borrowings, until the $5,000,000 obligation to CNA is satisfied. In
addition to the assets transferred to CNA, the Company has guaranteed the
validity of a $5,000,000 reinsurance recoverable, one of the assets
transferred. This guarantee is to be secured by $3,000,000 cash collateral
to be posted by the Company. Approximately $1,250,000 was posted in
November, 1994, and an additional $250,000 was posted in April. The
remaining balance of $1,500,000 will be posted in two installments of
$250,000 and $1,250,000, due in June and July, respectively. The Company
has agreed, if necessary, to pay an additional $2,000,000 out of future
commissions related to the guarantee. Should this occur, the repayments on
the $5,000,000 obligation will be delayed until the $2,000,000 is paid. The
Company will not be required to reduce its collected commission by more
than 50% under these agreements. The Company has not recorded a provision
for this guarantee, based upon the advice of its special insurance counsel,
that the reinsurance contract is a binding agreement, enforceable in
accordance with its terms, and the objections voiced by the reinsurer do
not support a material basis for it to successfully deny coverage.
The liquidation of the UK subsidiary was finalized in May 1995, with a lump
sum payment of $150,000, which will be used by the liquidator to satisfy
all outstanding debts of the UK corporation.
The Company is engaged in settlement discussions with Independent Broker
Services Corporation ("IBSC"), with respect to the lawsuit brought in
December 1994.
In December 1991, Acceleration National Insurance Companies
("Acceleration"), the insurer of the Company's E&O program through April
1991, brought suit against the Company and one of its subsidiaries,
alleging, under alternative theories which include breach of contract,
negligent misrepresentation and unjust enrichment, that the release of
certain funds to the Company in connection with the E&O program, when
combined with allegations relating to the Company's handling of E&O claims,
resulted in the funds currently available to Acceleration being
insufficient to satisfy the expected claims and expenses under the
Acceleration program. Acceleration's total claim is currently in excess of
$10 million. Under the Acceleration program, the Company had pledged assets
to secure letters of credit ("LOC's") in favor of Acceleration. In October
1992, Acceleration called the LOC's and received cash proceeds from the
liquidation of the collateral investments. The Company disputes all claims
of Acceleration and has filed an answer and counterclaim. The Company's
position is that the funds were released unconditionally with
Acceleration's consent, and the Company is therefore under no obligation to
return the funds. The Company also denies the balance of Acceleration's
claims, and is seeking damages for claims mismanagement by Acceleration
during the period Acceleration undertook that responsibility. This matter
is anticipated to go to trial in mid 1995. After taking into
12
<PAGE>
consideration the evaluation of outside legal counsel, management has
determined, and legal counsel concurs, that the potential range of loss in
connection with this matter is zero to $2.5 million, that no particular
estimate within this range is more likely than another and that the
likelihood of any verdict in excess of this range is remote. Consequently,
no additional reserve has been provided for this matter.
Three of the Company's subsidiaries operate in 16 states that regulate the
home warranty business. Certain of these states require that reserves be
maintained to cover future repairs for the remaining terms of warranty
contracts (generally one year). As of March 31, 1995, approximately $9.7
million of cash and investments are needed to maintain the regulated
subsidiaries' required reserve and surplus levels. Of this amount,
approximately $1,200,000 of investments are held by the regulated states to
assure the Company's fulfillment of its obligations to contract holders.
Deferred home warranty contract revenue at March 31, 1995 exceeds the
reserve requirements which would be applicable if such requirements were in
effect in all states in which the Company operates. The Company is
currently in compliance with all applicable surplus and reserve
requirements.
The Company is in the design and development phase of upgrading its current
computer and processing environments, in an attempt to increase operational
efficiency, improve management information, and allow for future growth in
the Company's business. This plan is currently expected to have an
incremental cost of $1,000,000 in excess of the cost of maintaining,
servicing and improving the existing system, over the life of the project.
Management expects that sufficient funds will be available to cover the
costs of the upgrade. If such funds are not available, a portion of this
project may be deferred.
13
<PAGE>
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company incurs numerous lawsuits in the ordinary course of its home
warranty contract business, typically concerning whether claims under such
home warranty contracts are entitled to coverage. The Company does not
believe any of these suits are material to the Company's operations or
financial results.
The Company is engaged in settlement discussions with Independent Broker
Services Corporation ("IBSC"), with respect to the lawsuit brought in
December 1994.
On May 8, 1995, the Seventeenth Judicial Circuit in and for Broward
County Florida dismissed without prejudice all of the counterclaim filed by
Richard L. Abedon and Robert S. Catanzaro in HOMEOWNERS GROUP, INC. v.
RICHARD L. ABEDON AND ROBERT S. CATANZARO, case number 94-12840(05).
14
<PAGE>
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits and Index to Exhibits
11. Computation of Net Income per Common Share for
the three and three month periods ended March 31,
1995 and 1994.
(b) Reports on Form 8-K
None.
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934,
the registrant has caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
HOMEOWNERS GROUP, INC.
May 10, 1995 By: /s/ C. GREGORY MORRIS
----------------------
C. Gregory Morris
Vice President, Treasurer and
Chief Financial Officer
15
EXHIBIT 11
HOMEOWNERS GROUP, INC. AND SUBSIDIARIES
COMPUTATION OF NET INCOME PER COMMON SHARE
FOR THE THREE MONTH PERIODS ENDED MARCH 31,
<TABLE>
<CAPTION>
1995 1994
---------------------------------
<S> <C> <C>
Net income $ 315,938 $ 365,176
---------- ----------
CALCULATION OF PRIMARY NET INCOME PER COMMON SHARE:
Weighted average common shares outstanding during the period 5,558,350 5,558,350
Weighted average additional common shares (options) 0 0
---------- ----------
Weighted average primary common shares outstanding 5,558,350 5,558,350
---------- ----------
Primary net income per common share $ 0.06 $ 0.07
========== ==========
CALCULATION OF FULLY DILUTED NET INCOME PER COMMON SHARE:
Weighted average common shares outstanding during the year 5,558,350 5,558,350
Weighted average additional common shares (options) 0 0
---------- ----------
Weighted average fully diluted common shares outstanding 5,558,350 5,558,350
---------- ----------
Fully diluted net income per common share $ 0.06 $ 0.07
========== ==========
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1995
<PERIOD-END> MAR-31-1995
<CASH> 4,894,770
<SECURITIES> 8,417,898
<RECEIVABLES> 915,323
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 24,578,173
<PP&E> 2,167,244
<DEPRECIATION> 0
<TOTAL-ASSETS> 35,471,596
<CURRENT-LIABILITIES> 23,617,212
<BONDS> 0
<COMMON> 55,584
0
0
<OTHER-SE> 8,701,746
<TOTAL-LIABILITY-AND-EQUITY> 35,471,596
<SALES> 0
<TOTAL-REVENUES> 10,835,083
<CGS> 0
<TOTAL-COSTS> 8,169,430
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 513,939
<INCOME-TAX> 198,000
<INCOME-CONTINUING> 315,939
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 315,939
<EPS-PRIMARY> 0.06
<EPS-DILUTED> 0.06
</TABLE>
