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 JUNE 30, 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 July 31, 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.
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HOMEOWNERS GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
JUNE 30, DECEMBER 31,
1995 1994
----------- ------------
(UNAUDITED) (AUDITED)
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ASSETS:
Current assets:
Cash and cash equivalents $4,243,120 $5,875,844
Trading securities 8,376,921 8,261,915
Miscellaneous receivables 1,049,235 1,153,188
Deferred home warranty acquisition costs 4,977,772 5,677,322
Refundable income taxes 1,277,449 1,816,149
Current portion of deferred income taxes 4,173,743 4,880,781
Prepaid expenses and other current assets 1,208,577 1,281,693
----------- -----------
Total current assets 26,068,973 28,946,892
Restricted cash 1,907,851 1,407,851
Non-current securities available for sale 2,984,092 4,078,966
Property and equipment - net 2,448,154 2,009,165
Other assets 1,217,382 1,177,026
Deferred and refundable income taxes - net of current portion 2,382,847 1,579,345
----------- -----------
TOTAL $37,009,299 $39,199,245
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY:
Current liabilities:
Accounts and accrued expenses payable $9,643,484 $10,296,813
Current maturities of long term debt 1,357,078 1,065,487
Deferred home warranty revenue 13,868,602 16,118,752
----------- -----------
Total current liabilities 24,869,164 27,481,052
Long term debt - net of current portion 2,936,697 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 June 30, 1995 and December 31, 1994 55,584 55,584
Additional paid-in capital 7,458,288 7,458,288
Retained earnings 1,631,270 902,289
Unrealized holding gain (loss) on securities available for sale 58,296 (14,813)
----------- -----------
Total stockholders' equity 9,203,438 8,401,348
----------- -----------
TOTAL $37,009,299 $39,199,245
=========== ===========
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SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
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HOMEOWNERS GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
SIX MONTHS ENDED THREE MONTHS ENDED
JUNE 30, JUNE 30,
------------------------------ ------------------------------
1995 1994 1995 1994
----------- ----------- ----------- -----------
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OPERATING REVENUE $22,052,792 $30,214,605 $11,217,709 $17,386,751
OPERATING COSTS AND EXPENSES:
Direct expenses 16,631,558 20,182,882 8,449,450 10,615,032
General and administrative expenses 4,952,707 6,007,369 2,341,404 3,208,327
----------- ----------- ----------- -----------
Total 21,584,265 26,190,251 10,790,854 13,823,359
----------- ----------- ----------- -----------
OPERATING INCOME 468,527 4,024,354 426,855 3,563,392
OTHER INCOME (EXPENSE):
Investment income - net 893,352 (43,846) 336,168 (74,336)
Other income (expense) - net (171,898) (2,609) (86,980) (130,333)
----------- ----------- ----------- -----------
Total 721,454 (46,455) 249,188 (204,669)
INCOME BEFORE
INCOME TAXES 1,189,981 3,977,899 676,043 3,358,723
PROVISION FOR INCOME TAXES (461,000) (1,619,335) (263,000) (1,365,335)
----------- ----------- ----------- -----------
NET INCOME $728,981 $2,358,564 $413,043 $1,993,388
=========== =========== =========== ===========
PER SHARE AMOUNTS:
Net income $0.13 $0.42 $0.07 $0.36
=========== =========== =========== ===========
WEIGHTED AVERAGE COMMON SHARES
OUTSTANDING 5,558,350 5,558,350 5,558,350 5,558,350
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SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
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HOMEOWNERS GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
SIX MONTHS ENDED
JUNE 30
---------------------------
1995 1994
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Cash flows from operating activities:
Net income $728,981 $2,358,564
Adjustments:
Depreciation and amortization 282,355 382,493
Provision for deferred income taxes 876,000 2,070,000
Foreign currency translation adjustment - (11,054)
(Gain) loss on sale of investments (501,078) 302,255
Unrealized holding gain 78,286 22,931
Other net changes in assets and liabilities:
(Increase) decrease in receivables 103,953 (3,164,130)
Increase) decrease in deferred home warranty acquisition costs 699,550 (2,259)
Increase in prepaid and deferred income taxes (433,764) (159,907)
(Increase) decrease in prepaid expenses and other assets 4,134 (621,647)
Increase (decrease) in accounts and accrued expenses payable (653,329) 2,246,913
Increase (decrease) in deferred home warranty revenue (2,250,150) 198,167
Payments on reserve for loss on reinsurance portfolio transfer - (715,415)
Payments for purchases of trading securities (424,516) (8,205,949)
Proceeds from sales of trading securities 1,146,251 6,004,760
---------- ----------
Net cash provided by (used in) operating activities (343,327) 705,722
---------- ----------
Cash flows from investing activities:
Property and equipment expenditures (697,893) (408,618)
Payments for investments classified as available for sale (980,104) (3,554,519)
Proceeds from sale of investments classified as available for sale 977,159 3,628,191
---------- ----------
Net cash used in investing activities (700,838) (334,946)
---------- ----------
Cash flows from financing activities:
Repayments of debt (368,052) (134,399)
Amortization of discount on long term debt 139,493 147,643
Purchases of restricted cash (500,000) -
Borrowings under capital lease obligation 140,000 210,538
---------- ----------
Net cash provided by (used in) financing activities (588,559) 223,782
---------- ----------
Net increase (decrease) in cash and cash equivalents (1,632,724) 594,558
Cash and cash equivalents at beginning of period 5,875,844 7,530,452
---------- ----------
Cash and cash equivalents at end of period $4,243,120 $8,125,010
========== ==========
SUPPLEMENTAL DISCLOSURE:
Cash paid during the period for:
Interest $145,908 $86,659
Income taxes 16,336 158,810
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HOMEOWNERS GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
THREE MONTHS ENDED
JUNE 30
----------------------------------
1995 1994
---------- ----------
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Cash flows from operating activities:
Net income $413,043 $1,993,388
Adjustments:
Depreciation and amortization 140,263 193,713
Benefit for deferred income taxes (81,000) (477,000)
Foreign currency translation adjustment - (4,940)
(Gain) loss on sale of investments (157,539) 198,701
Loss on sale of property and equipment 9,082 -
Unrealized holding gains 33,066 7,328
Other net changes in assets and liabilities:
Increase in receivables (133,912) (3,517,395)
Increase in deferred home warranty acquisition costs (113,330) (361,609)
Decrease in prepaid and deferred income taxes 330,789 1,818,999
Increase in prepaid expenses and other assets (277,139) (382,758)
Increase in accounts and accrued expenses payable 823,092 2,714,702
Increase in deferred home warranty revenue 386,370 1,213,790
Payments on reserve for loss on reinsurance portfolio transfer - (56,618)
Payments for purchases of trading securities (2,616) (7,900,249)
Proceeds from sales of trading securities 549,058 5,742,780
---------- ----------
Net cash provided by operating activities 1,920,037 1,182,832
---------- ----------
Cash flows from investing activities:
Property and equipment expenditures (419,998) (147,130)
Payments for investments classified as available for sale (929,271) (1,277,951)
Proceeds from sale of investments classified as available for sale 804,108 1,396,651
---------- ----------
Net cash used in investing activities (545,161) (28,430)
---------- ----------
Cash flows from financing activities:
Repayments of debt (188,318) (100,174)
Amortization of discount on long term debt 69,643 70,827
Payments for restricted cash (500,000) -
---------- ----------
Net cash used in financing activities (618,675) (29,347)
---------- ----------
Net increase in cash and cash equivalents 756,201 1,125,055
Cash and cash equivalents at beginning of period 3,486,919 6,999,955
---------- ----------
Cash and cash equivalents at end of period $4,243,120 $8,125,010
========== ==========
SUPPLEMENTAL DISCLOSURE:
Cash paid during the period for:
Interest $73,991 $71,446
Income taxes 8,142 21,610
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HOMEOWNERS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1995
(Unaudited)
1. GENERAL
The consolidated balance sheet as of June 30, 1995 and the consolidated
statements of income and cash flows for the six and three month periods ended
June 30, 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 June 30, 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 OPERATIONS
The Company 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. Effective July 14, 1995, the Company terminated the
Colorado franchise agreement, thus making Colorado a Corporate Owned Region. The
Company also entered into agreements to manage the Kansas, Oklahoma, Missouri
territory and the Arizona, New Mexico territory. Additionally, effective July
14, 1995, the Company purchased a nominal interest in the Arizona, New Mexico
territory. The Company believes that the changes in Franchise/Corporate Owned
Regions will enable the Company to combine the administrative functions of these
regions into the Texas and California regions, thereby generating savings in
overhead expenses. Additionally, the Company believes that the above changes
could result in production increases, once improved market presence is
established.
Franchising fee revenue earned in the 1994 second quarter was related to the
franchising of the California territory to Independent Brokers Services
Corporation. An allowance for this transaction was provided in the third quarter
of 1994 as a result of the franchisee's default on the promissory note, deferred
payment obligation and the franchise agreement.
See legal proceedings.
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
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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 is expected to be tried in September 1995. 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
$1,750,000 was posted as of June 30, 1995. The remaining balance of $1,250,000
was posted in July 1995. 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. Claims have 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.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
RECENT DEVELOPMENTS
In early 1995, the Company 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 formed a Special Committee of the Board of Directors to evaluate the
alternatives available to the Company.
The Committee retained the investment banking firm of Raymond James & Associates
to assist it in evaluating the inquiries and alternatives available to the
Company. The Committee has been 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. 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 the 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(R)), the HMS BuyerTrack(R)
Follow-Up System, the HMS Consumer Reach Program, a monthly real estate
publication (HMS NETWORKING(R) Magazine), the HMS Risk Management System(R), 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 currently offers a home
warranty contract for sale in every state in which the Company operates, with
the
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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.
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 outstanding
liabilities was completed in May 1995.
RESULTS OF OPERATIONS
SIX MONTHS ENDED JUNE 30, 1995 AS COMPARED TO JUNE 30, 1994
Home Warranty Operations:
Home warranty revenue, totaling $18,193,000 and representing 82% of total
operating revenue for the six months ended June 30, 1995, decreased 3.8% from
the corresponding 1994 figure of $18,781,000, or 62% of total operating revenue.
This revenue decrease is due primarily to the impact of warranty production
decreases in the preceding eleven months, as compared to the comparable prior
year period because of the Company's
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revenue recognition policy, under which warranty revenue is recognized
over the contract terms, generally twelve months. Warranty contract sales in the
first six months of 1995 were 17% lower than in the 1994 period. Although the
number of members selling the Company's home warranties has improved over 1994
levels, during the first six months of 1995, there have been fewer sales
opportunities, due to the impact on housing sales of increasing interest rates,
particularly in the first five months of the year. Also, heavy rains and
flooding significantly impacted the California real estate market throughout the
first quarter and into the second quarter, resulting in further industry wide
reported declines in transactions and in opportunities for warranty sales, as
compared to 1994. The impact of this decrease in warranty contract sales will
continue to impact warranty revenue in future quarters. Renewal warranty
contract sales, which approximated 12% of total warranty production in the first
six months of 1995, were 75% higher than in the first six months of 1994
partially offsetting these declines. This increase is attributable to
management's development of several new marketing strategies. These strategies
have increased renewal success rates to approximately 23%. 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 78% in the first six months of 1995, from 84% in the comparable
1994 period. This decrease is primarily due to the impact of a 5.8% decrease in
average claim severity, as a result of improved claims management, improved
systems and favorable weather. Claims costs generally vary with weather
patterns, and as a result of the unprecedented heat wave experienced across the
nation, July 1995 claims cost exceeded June 1995 and July 1994 levels, as a
percentage of related revenue.
The warranty acquisition cost ratio for the first six months of 1995
approximated the 1994 ratio. The acquisition costs 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 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. Effective July 14, 1995, the Company terminated the
Colorado franchise agreement, thus making Colorado a Corporate Owned Region. The
Company also entered into agreements to manage the Kansas, Oklahoma, Missouri
territory and the Arizona, New Mexico territory. Additionally, effective July
14, 1995, the Company purchased a nominal interest in the Arizona, New Mexico
territory. These changes in Franchise/Corporate Owned Regions will enable the
Company to combine the administrative functions of these regions into the Texas
and California regions, thereby creating savings in overhead expenses.
Additionally, the Company believes that the above changes could result in
production increases, once improved market presence is established.
Franchising fee revenue earned in the 1994 second quarter was related to the
franchising of the California territory to Independent Brokers Services
Corporation. An allowance for this transaction was provided in the third quarter
of 1994, as a result of the franchisee's default on the promissory note,
deferred payment obligation and the franchise agreement.
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Membership and Other Operations:
Membership related revenue for the first six months of 1995 totaled $3,161,000,
53% lower than the $6,742,000 reported in the comparable prior year period. This
decline is primarily the result of the changing mix of the Company's membership
base. A large portion of the Company's membership no longer participates in the
Company's E&O program, and is exempted from paying the associated marketing
fees. As of June 30, 1995, approximately 39% of the Company's membership
participated in the E&O program, as compared to 60% as of June 30, 1994. In
spite of this decline from the prior year period, the Company has seen positive
impact from its Agent membership program. Membership renewal experience has also
improved over the prior year levels, and new membership enrollments have
increased by 46% over 1994 levels. Management believes that these trends relate
to the resolution of the E&O transition issues encountered throughout 1994.
During the first six months of 1995, the Company introduced 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 allows the Company
national field representatives to supply potential members, which meet certain
underwriting criteria, with an E&O insurance quote at the point of original
contact and presentation of the Company's full range of membership benefits.
This application has increased new member enrollments 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 to repeat sales presentations.
Direct expenses of the membership operations approximated 69% of related revenue
for the first six months of 1995 versus 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. As discussed
previously, the California region was heavily impacted by rains and flooding
during the early part of 1995, which has resulted in declining transactions and
warranty sales.
E&O Brokerage Operations:
E&O brokerage revenue for the six months ended June 30, 1995, totaled $587,000,
a decrease of 59% from the comparable 1994 period revenue of $1,442,000. The
1995 revenue includes commissions earned on the current E&O program of
approximately $554,000 and $20,000 of administrative reimbursement earned on the
run-off of the prior E&O program. The 1994 revenue included $1,072,000 in
administrative reimbursement earned on the prior E&O program, combined with
$347,000 in commissions earned on the current program. The decrease in total E&O
brokerage revenue results from the change in composition of the Company's
membership base, as only 39% of the Company's membership currently participates
in the E&O program, compared to 60% at June 30, 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 $225,000 or 16% of
related revenue in the 1994 six month period, to $227,000 or 39% of related
revenue in the comparable 1995 period. Under the current E&O program, the
Company generally pays a portion of the commission it receives on the E&O
premiums collected to Affiliates generating the premium volume. There was no
such arrangement under previous E&O program, resulting in a higher gross profit
on the prior program. Consequently, as the revenue in 1995 will
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consist almost entirely of commissions earned under the current program, the
direct cost percentage will increase until it at least approximates the
commission rate paid to Affiliates, in addition to other direct costs of
administering the program. However, certain indirect costs incurred in
administering the prior program are no longer incurred, resulting in a
comparable operating profit ratio for the new program.
Foreign Operation:
During the third quarter of 1994, the Company discontinued 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
$6,007,000 in the first six months of 1994 to $4,946,000 in the comparable 1995
period. The decrease is primarily due to declines in employee related expenses
from the September 1994 workforce reduction, and to the elimination of UK G&A
expenses, which approximated $500,000 in the 1994 six month period. Certain
non-recurring G&A expenses incurred in the first six months of 1995, primarily
increased legal fees for lawsuit preparation and settlements and expenses
related to the activities of the Special Committee of the Board of Directors,
have been offset by credits taken into income on the liquidation and final
settlement of the outstanding liabilities of the UK subsidiary. Although total
G&A expenses for the current six month period are lower than the 1994 period, as
a percentage of related revenue, exclusive of the franchising fees earned, G&A
increased from 22.3% in the 1994 first six months to 25.4% in the 1995 period.
Certain of the Company's expenses are fixed in nature, and the increasing G&A
ratio is heavily impacted by the decline in revenue, net of 1994 franchising
fees.
Other Income:
Other income, net is comprised primarily 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 loss of
$44,000 for the six months ended June 30,1994 to a net gain of $893,000 in the
current year equivalent period. This increase is due to the stabilization and
small declines in market interest rates, causing the fair value of the Company's
trading investment portfolio, consisting mainly of debt instruments, to rebound
from the previous lows 1994. Approximately $395,000 of the current year
investment earnings relates to realized holding gains on the Company's trading
investment portfolio of trading securities as of June 30, 1995, as compared to
realized holding losses of $70,000 in the 1994 first six months. Interest
expense of approximately $146,000 relates primarily to the CNA obligation.
Income Taxes:
The Company's effective income tax rate for the six month period ended June 30,
1995, was 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.
12
<PAGE>
THREE MONTHS ENDED JUNE 30, 1995 AS COMPARED TO JUNE 30, 1994
Home Warranty Operations
Home warranty revenue, totaling $9,122,000 and representing 81% of total
operating revenue for the three months ended June 30, 1995, was 7.5% lower than
the corresponding 1994 figure of $9,857,000, or 57% of total operating revenue.
This revenue decrease is due primarily to the impact of warranty production
decreases 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 over the contract term, generally twelve months.
Warranty contract sales in the second quarter of 1995 were 16% lower than in the
1994 period. Housing sales have lagged behind falling interest rates in the
second quarter. Also, the heavy rains and flooding continued to impact the
California real estate market in the beginning of the second quarter. Both of
these factors have caused declines in transactions and in opportunities for
warranty sales. The impact of this decrease in warranty contract sales will
affect warranty revenue in future quarters, due to the warranty revenue
recognition method. Partially offsetting these declines, renewal warranty
contract sales in the second quarter of 1995 were 85% higher than in the 1994
second quarter. This increase is attributable to management's development of
several new marketing strategies, resulting in an increase in renewal success
rates to approximately 23%. Renewal warranty contract sales currently
approximate 12% of total contract sales, and this improvement may have a more
significant impact on warranty revenue on the future, should the renewal rate
continue to improve. 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 79% in the 1995 second quarter from 85% in the 1994 second quarter,
primarily due to the impact of a 5.8% decrease in average claim severity. Claims
costs generally vary with weather patterns. As a result of the unprecedented
heat wave experienced across the nation, July 1995 claims costs exceeded June,
1995 and July, 1994 levels as a percentage of related revenue.
The second quarter 1995 warranty acquisition cost ratio was slightly lower than
the 1994 second quarter ratio. As the volume of contract sales shifts between
geographic regions, the Company's overall acquisition cost ratio may change, 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:
In the second and third quarter of 1995, the Company negotiated several purchase
and management agreements with some of its franchisees, in an effort to generate
cost savings and improve production. For a complete discussion of franchising
operations, refer to the SIX MONTHS ENDED JUNE 30, 1995 AS COMPARED TO JUNE 30,
1994 "Franchising Operations."
13
<PAGE>
Membership and Other Operations:
Membership related revenue for the 1995 second quarter totaled $1,687,000, 52%
lower than the $3,528,000 reported in the comparable prior year quarter, which
is primarily the result of the changing mix of the Company's membership base. A
large portion of the Company's membership no longer participates in the
Company's E&O program, and is exempted from paying the associated marketing
fees. In spite of this decline, the Company has seen a positive impact from its
Agent membership program. Membership renewal experience continues to improve
over the prior year levels, and new membership enrollments have increased by 42%
over 1994 levels. Management believes that these trends result from the
resolution of the E&O transition issues encountered throughout 1994.
Direct expenses of the membership operations approximated 66% of related revenue
for the second quarter of 1995, versus 59% 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. As discussed previously, the
California region was 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 June 30, 1995, totaled
$312,000, a decrease of 58% from the 1994 second quarter revenue of $752,000.
The 1995 revenue includes commissions earned on the current E&O program of
nearly $301,000 and approximately $3,000 of E&O reimbursement earned on the
run-off of the prior E&O program. The 1994 revenue was comprised of
administrative reimbursement earned on the prior E&O program totaling $492,000,
and $245,000 of commissions earned under the current program. The decrease in
total E&O related revenue results from the change in composition of the
Company's membership base, as only 39% of the Company's membership currently
participates in the E&O program compared to 60% as of June 30, 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 decreased from $129,000, or 17% of
related revenue in the 1994 second quarter to $123,000 and 39% of related
revenue in the comparable 1995 period. Under the current E&O program, the
Company generally pays a portion of the commission it receives on the E&O
premiums collected to the Affiliates generating the premium volume. There was no
such arrangement under previous E&O programs. 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 commission rate 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.
14
<PAGE>
Foreign Operations:
During the third quarter of 1994, the Company discontinued 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
$3,208,000 in the second quarter of 1994 to $2,335,000 in the second quarter of
1995. The decrease is primarily due to declines in employee related expenses
from the September, 1994 workforce reduction, and to the elimination of UK G&A
expenses, which approximated $225,000 in the 1994 second quarter. As a
percentage of related revenue, G&A decreased from 22.7% of revenue, excluding
franchising fees earned, in the 1994 second quarter, to 20.8% in the comparable
1995 period. The proportional decline in G&A results from cost savings related
to the September 1994 workforce reduction, and the elimination of UK expenses.
Certain non-recurring G&A expenses incurred in the first six months of 1995,
primarily increased legal fees for lawsuit preparation and settlements and
expenses related to the activities of the Special Committee of the Board of
Directors, have been offset by credits taken into income on the liquidation and
final settlement of the outstanding liabilities of the UK subsidiary.
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 loss of $74,000 for the
three months ended June 30, 1994 to a net gain of $334,000 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 $155,000 relates to realized
holding gains on the Company's investment portfolio of trading securities, as
compared to realized holding losses of $29,000 in the 1994 second quarter.
Interest expense of approximately $74,000 relates primarily to the CNA
obligation.
Income Taxes:
The Company's effective income tax rate on continuing operations for the three
month period ended June 30, 1995 was 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 and before claims are made under home warranty contracts. Consequently,
cash flow has historically been more than adequate to meet current obligations.
Cash collected on warranty
15
<PAGE>
contracts in the first six months of 1995 was lower than amounts collected in
the comparable 1994 period by approximately $1,500,000, as a result of the
decline in home warranty contract sales.
In the first six months of 1995, net cash used in operating activities totaled
$337,000, as compared to cash provided by operations of $706,000 in the first
six months of 1994. This decline in cash provided by operations is primarily due
to the decline in warranty production in the 1995 six month period, as compared
to 1994 levels. Also impacting operating cash flows are various payments for
claims payable, Affiliate and Member commissions and E&O premium remittances. In
the first six months 1995, the Company used $701,000 in investing activities, as
compared to $335,000 in the first six months of 1994, primarily due to increased
trading activity in its investment portfolio. Net cash used in financing
activities totaled $595,000 in the first six months of 1995, compared to cash
provided by financing activities of $224,000 in the first six months of 1994,
due to increasing debt repayments, primarily on the CNA obligation, and also to
transfers of collateral amounts due under the CNA agreements to a pledged
account. 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, which gives rise to
the deferred tax asset of approximately $6.5 million at June 30, 1995. As a
result, the Company generally pays taxes on the revenue collected, not on the
revenue recognized, and cash paid for income taxes generally approximates 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 $1.3 million and alternative minimum tax credits of
approximately $600,000. Consequently, the Company is not expected to be required
to pay any Federal income taxes in the near future. The Company has filed for
the refund of taxes paid in prior years, and expects to receive its refundable
income taxes in the 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 of which
approximately $1,750,000 was posted as of June 30, 1995. The remaining balance
of $1,250,000 was posted in July 1995. 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 was used by the liquidator to satisfy all outstanding
liabilities of the UK corporation.
In the 1995 second quarter, the Company reached a settlement with Independent
Broker Services Corporation ("IBSC"), with respect to the lawsuit brought by
IBSC in December 1994. Under the terms of the settlement agreement, the Company
will return to IBSC over the remainder of 1995 a portion of the original
franchise fees collected by the Company. As of June 30, 1995, $50,000 had been
paid, in accordance with the terms of
16
<PAGE>
the settlement agreement. The settlement will not impact the Company's 1995
earnings, as an allowance for this amount was provided in the third quarter of
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 September
1995. After taking into 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. In the second quarter of 1995, the Company restructured the
organization of its warranty company subsidiaries, in order to become more
efficient with respect to servicing warranty contract holders, and more flexible
in its cash investment alternatives. Subsequent to this restructuring, as of
June 30, 1995, approximately $7.2 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 June 30, 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
technology, computer and processing environments, to increase operational
efficiency, improve management information, and allow for future growth in the
Company's business. Implementation of certain operational functions is
anticipated to begin in the third quarter of 1995. This upgrade is currently
expected to have an incremental cost of $1,000,000 in 1995, in excess of the day
to day costs of maintaining, servicing and improving the existing technology.
Management believes 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.
17
<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.
During the second quarter of 1995, the Company reached a settlement of the
lawsuit filed by Independent Broker Service Corporation ("IBSC") in the Superior
Court of California. Under the terms of the settlement agreement, the Company
will return to IBSC a portion of the payments made by IBSC to the Company under
the since-terminated franchise and related agreements, pursuant to which IBSC
had obtained franchise rights to the Company's California and Hawaii regions.
The settlements agreement calls for full payment of the settlement amount by the
end of 1995, and will have no impact on the Company's 1995 earnings, as an
allowance for this amount was provided in the third quarter of 1994.
The Company also settled the litigation between it and Richard L. Abedon and
Robert S. Catanzaro. The terms of the agreement will have no material impact on
the Company's 1995 earnings. As part of the settlement agreement, Richard L.
Abedon resigned from the Company's Board of Directors.
18
<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 six month periods ended June 30, 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.
August 8, 1995 By: /S/ C. GREGORY MORRIS
----------------------
C. Gregory Morris
Vice President, Treasurer and
Chief Financial Officer
19
EXHIBIT 11
<TABLE>
<CAPTION>
HOMEOWNERS GROUP, INC. AND SUBSIDIARIES
COMPUTATION OF NET INCOME PER COMMON SHARE
FOR THE THREE AND SIX MONTH PERIODS ENDED JUNE 30, 1995 AND 1994
SIX MONTHS ENDED THREE MONTHS ENDED
JUNE 30, JUNE 30,
----------------------- -----------------------
1995 1994 1995 1994
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Net income $ 728,981 $2,358,564 $ 413,043 $1,993,388
---------- ---------- ---------- ----------
Calculation of primary net income per common share:
Weighted average common shares outstanding during the period 5,558,350 5,558,350 5,558,350 5,558,350
Weighted average additional common shares (options) 0 0 0 0
---------- ---------- ---------- ----------
Weighted average primary common shares outstanding 5,558,350 5,558,350 5,558,350 5,558,350
Primary net income per common share $ 0.13 $ 0.42 $ 0.07 $ 0.36
========== ========== ========== ==========
Calculation of fully diluted net income per common share:
Weighted average common shares outstanding during the year . 5,558,350 5,558,350 5,558,350 5,558,350
Weighted average additional common shares (options) 0 0 0 0
---------- ---------- ---------- ----------
Weighted average fully diluted common shares outstanding 5,558,350 5,558,350 5,558,350 5,558,350
---------- ---------- ---------- ----------
Fully diluted net income per common share $ 0.13 $ 0.42 $ 0.07 $ 0.36
========== ========== ========== ==========
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1995
<PERIOD-START> JAN-01-1995
<PERIOD-END> JUN-30-1995
<CASH> 4,243,120
<SECURITIES> 8,376,921
<RECEIVABLES> 1,049,235
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 26,068,973
<PP&E> 2,448,154
<DEPRECIATION> 0
<TOTAL-ASSETS> 37,009,299
<CURRENT-LIABILITIES> 24,869,164
<BONDS> 0
<COMMON> 55,584
0
0
<OTHER-SE> 9,147,854
<TOTAL-LIABILITY-AND-EQUITY> 37,009,299
<SALES> 0
<TOTAL-REVENUES> 22,052,792
<CGS> 0
<TOTAL-COSTS> 16,631,558
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 1,189,981
<INCOME-TAX> 461,000
<INCOME-CONTINUING> 728,981
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 728,981
<EPS-PRIMARY> 0.13
<EPS-DILUTED> 0.13
</TABLE>
