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, 1996
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.)
400 SAWGRASS CORPORATE PARKWAY, SUNRISE, FLORIDA 33325
- ------------------------------------------------ --------
(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 August 7, 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
JUNE 30, DECEMBER 31,
1996 1995
--------------------------- ------------------------
(UNAUDITED) (AUDITED)
<S> <C> <C>
ASSETS:
Current assets:
Cash and cash equivalents $2,310,841 $997,336
Trading securities 7,138,674 9,250,349
Current portion of securities available for sale 1,623,181 1,811,624
Miscellaneous receivables 1,366,506 1,278,044
Deferred home warranty acquisition costs 5,589,827 5,666,899
Refundable income taxes 1,277,449 1,277,449
Current portion of deferred income taxes 6,807,998 6,769,294
Prepaid expenses and other current assets 1,051,249 1,080,458
--------------------------- ------------------------
Total current assets 27,165,725 28,131,453
Restricted cash 3,160,000 3,160,000
Non-current portion of securities available for sale 2,768,148 1,834,981
Property and equipment - net 4,190,273 3,581,893
Other assets 595,728 432,327
Deferred and refundable income taxes - net of current portion 1,636,630 1,373,608
--------------------------- ------------------------
TOTAL $39,516,504 $38,514,262
=========================== ========================
LIABILITIES AND STOCKHOLDERS' EQUITY:
Current liabilities:
Accounts and accrued expenses payable $13,023,842 $11,584,923
Current maturities of long term debt 1,938,226 1,537,257
Deferred home warranty revenue 16,119,265 16,239,431
--------------------------- ------------------------
Total current liabilities 31,081,333 29,361,611
Long term debt - net of current portion 2,165,132 2,591,929
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, 1996 and December 31, 1995 55,584 55,584
Additional paid-in capital 7,458,288 7,458,288
Retained earnings (1,275,790) (1,006,367)
Unrealized holding gain (loss) on securities available for sale 31,957 53,217
--------------------------- ------------------------
Total stockholders' equity 6,270,039 6,560,722
--------------------------- ------------------------
TOTAL $39,516,504 $38,514,262
=========================== ========================
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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)
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------------------------------------------------------------------------------------
1996 1995 1996 1995
---------------------------------------- ------------------------------------------
<S> <C> <C> <C> <C>
OPERATING REVENUE $11,548,135 $11,217,709 $21,931,058 $22,052,792
OPERATING COSTS AND EXPENSES:
Direct expenses 9,213,870 8,449,450 17,493,762 16,631,558
General and administrative expenses 2,371,840 2,341,404 4,843,342 4,952,707
---------------------------------------- ------------------------------------------
Total 11,585,710 10,790,854 22,337,104 21,584,265
---------------------------------------- ------------------------------------------
OPERATING INCOME (LOSS) (37,575) 426,855 (406,046) 468,527
OTHER INCOME (EXPENSE):
Investment income - net 98,428 335,386 189,788 893,352
Other income (expense) - net (105,435) (86,199) (212,163) (171,898)
---------------------------------------- ------------------------------------------
Total (7,007) 249,187 (22,375) 721,454
INCOME BEFORE
INCOME TAXES (44,582) 676,042 (428,421) 1,189,981
PROVISION FOR INCOME TAXES (20,000) 263,000 (159,000) 461,000
---------------------------------------- ------------------------------------------
NET INCOME (LOSS) ($24,582) $413,042 ($269,421) 728,961
======================================== ==========================================
PER SHARE AMOUNTS:
Net income (loss) ($0.00) $0.07 ($0.05) $0.13
======================================== ==========================================
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.
3
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HOMEOWNERS GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
SIX MONTHS ENDED
JUNE 30,
1996 1995
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<S> <C> <C>
Cash flows from operating activities:
Net income ($269,421) $728,981
Adjustments:
Depreciation and amortization 385,529 282,355
Provision (benefit) for deferred income taxes (64,000) 876,000
(Gain) loss on trading securities 149,601 (501,078)
Other net changes in assets and liabilities:
(Increase) decrease in miscellaneous receivables (88,462) 103,953
Decrease in deferred home warranty acquisition costs 77,072 699,550
Increase in deferred income taxes (237,726) (433,764)
(Increase) decrease in prepaid expenses and other assets (174,151) 4,134
Increase (decrease) in accounts and accrued expenses payable 1,438,919 (653,329)
Decrease in deferred home warranty revenue (120,166) (2,250,150)
Purchases of trading securities (198,633) (424,516)
Proceeds from sales of trading securities 2,173,322 1,146,251
----------------------- ----------------------
Net cash provided by (used in) operating activities 3,071,884 (421,613)
----------------------- ----------------------
Cash flows from investing activities:
Property and equipment expenditures (953,951) (697,893)
Purchases of securities classified as available for sale (2,152,116) (980,104)
Proceeds from sale of securities classified as available for sale 1,373,516 977,159
Unrealized holding loss on securities available for sale 0 78,286
----------------------- ----------------------
Net cash used in investing activities (1,732,551) (622,552)
----------------------- ----------------------
Cash flows from financing activities:
Repayments of debt (663,243) (368,052)
Amortization of discount on long term debt 101,165 139,493
Purchases of restricted cash 0 (500,000)
Borrowings under capital lease obligation 536,250 140,000
----------------------- ----------------------
Net cash used in financing activities (25,828) (588,559)
----------------------- ----------------------
Net increase (decrease) in cash and cash equivalents 1,313,505 (1,632,724)
Cash and cash equivalents at beginning of period 997,336 5,875,844
----------------------- ----------------------
Cash and cash equivalents at end of period $2,310,841 $4,243,120
======================= ======================
SUPPLEMENTAL DISCLOSURE:
Cash paid during the period for:
Interest
Income taxes
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SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
4
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HOMEOWNERS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1996
(Unaudited)
1. GENERAL
The consolidated balance sheet as of June 30, 1996 and the consolidated
statements of income and cash flows for the three and six month periods ended
June 30, 1996 and 1995 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, 1996, 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 1995 Annual Report on Form 10-K, filed with the
Securities and Exchange Commission.
2. COMMITMENTS AND CONTINGENCIES
The Company is subject to various lawsuits and claims arising in the normal
course of business. In the opinion of management, the resolution of these
matters will not have a material adverse effect on the Company's consolidated
financial position or results of operations.
On December 16, 1995, a jury verdict in the amount of $5,156,022 was rendered in
favor of the Plaintiff and against Homeowners Marketing Services, Inc. ("HMS"),
a subsidiary of the Company, in the following matter: ACCELERATION NATIONAL
INSURANCE COMPANY, PLAINTIFF, VS. HOMEOWNERS MARKETING SERVICES, INC., ET AL.,
DEFENDANTS, in the Court of Common Pleas of Franklin County, Ohio. The judgment
is recorded in accrued and other expenses in the accompanying consolidated
balance sheets. In May, 1996, the Company entered into a definitive merger
agreement with The Cross Country Group, Inc. ("Cross Country"), pursuant to
which Cross Country has agreed to purchase all of the outstanding shares of the
Company for $2.35 per share in cash. Under the terms of the merger agreement,
Cross Country will pay the amount due to Acceleration under a settlement
agreement, upon closing of the purchase. See further discussion in MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -
RECENT DEVELOPMENTS.
In February 1996, a lawsuit was filed against the Company in the Court of Common
Pleas of Bucks County, Pennsylvania, by the former franchisee of the
Pennsylvania territory, alleging breach of contact, fraud and misrepresentation,
and seeking damages in the amount of $50,000, trebled, reimbursement of costs
and attorney's fees, and an injunction to prevent the Company from terminating
the franchise agreement. The Company believes this suit is without merit. The
case was transferred to Florida on July 11, 1996. No accrual for this matter has
been reflected in the accompanying consolidated financial statements.
5
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In connection with the transfer of the net assets of POMG Insurance Company, Ltd
("POMG") to Continental Casualty Company ("CNA"), the Company guaranteed the
validity of a $5,000,000 reinsurance recoverable, one of the POMG assets
transferred to CNA. 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. The Company has not recorded a provision for this guarantee, based
on the opinion of its special insurance counsel, that the cover note relating to
the reinsurance contract is a binding agreement, enforceable in accordance with
its terms, and that various the objections voiced by the reinsurer do not
support a material basis for it to successfully deny coverage. On April 10,
1996, CNA issued a Notice of Arbitration to the reinsurer with respect to its
refusal to honor the reinsurance treaty.
3. STOCK OPTIONS, WARRANTS AND PURCHASE RIGHTS
The Company adopted stock option plans in 1988 authorizing issuance of up to
600,000 shares of common stock to officers and other employees. Of the
authorized shares, 300,000 may be issued as 'incentive stock options' within the
meaning of Section 422 of the Internal Revenue Code, and 300,000 may be issued
as non-qualified options. The options issued through 1992 generally become
exercisable two years after the date of grant and expire no later than ten years
after the date of grant. The options issued in 1993 generally become exercisable
over a five year period, beginning on the date of grant. All options become
immediately exercisable upon a change in control of the Company. Information
with respect to options under the above plans follows:
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OPTION PRICE AVAILABLE
STOCK OPTIONS PER SHARE OUTSTANDING EXERCISABLE FOR GRANT
- -------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
At December 31, 1993 4.00 - 9.75 558,550 206,050 38,450
----------- ------- ------- ----------
Granted 2.00 80,000 (80,000)
Became exercisable 5.75 75,900
Canceled 4.00 - 9.75 (156,250) (43,650) 156,250
----------- ------- ------- ----------
At December 31, 1994 2.00 - 9.00 482,300 238,300 114,700
Granted 2.00 240,000 (240,000)
Became exercisable 2.00 203,000
Canceled 2.00 (286,600) (224,600) 286,600
----------- ------- ------- ----------
At December 31, 1995 $2.00 435,700 216,700 161,300
Became exercisable 2.00 147,000
Canceled 2.00 (4,150) (4,150) 4,150
----------- ------- ------- ----------
At June 30, 1996 $2.00 431,550 359,550 165,450
----------- ------- ------- ----------
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In May 1992, effective September 1991, the Company adopted a non-employee
directors' stock option plan authorizing issuance of up to 300,000 shares of
common stock. Options under this plan become exercisable annually over the five
years following the date of grant and expire no later than ten years after the
date of grant. Options for 75,000 shares were granted at $6.50 per share on
September 26, 1991; options for 25,000 shares were granted at $5.50 per share on
January 28, 1993; options for 25,000 shares were granted at $3.375 per share on
September 23, 1993; and options for 25,000 shares were granted at $0.75 per
share on December 22, 1995. As of June 30, 1996, options for 117,500 remain
outstanding, and options for 62,500 shares were exercisable.
6
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In 1991, the Company issued a five year stock purchase warrant for 25,000 shares
to an outside director. The warrant, which was exercisable at $10.80 per share,
expired on April 11, 1996.
In December 1994, the Company repriced all outstanding employee options to $2.00
per share, with the exception of the options granted to the current Chairman and
the former Chairman of the Board of Directors and the Chief Financial Officer.
The options granted to the Chief Financial Officer were repriced to $3.00 per
share. The options granted to the former Chairman were canceled effective
January 1995. Upon such cancellation, 100,000 options were granted to the
current Chairman of the Board, at $3.00 per share. In December 1995, all of the
options granted to the Chief Financial Officer were repriced to $2.00 per share,
Also in December 1995, 140,000 options granted to the Chairman from 1988 through
1992 were canceled and replaced by a new grant of 140,000 options, exercisable
for a ten year period at $2.00 per share. At the same time, an additional grant
of 120,000 options was issued to the Chairman of the Board, effective January 2,
1996. The options became fully exercisable as of the effective date.
7
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
RECENT DEVELOPMENTS
A Special Committee of the Board of Directors was formed in January 1995 to
examine alternatives to enhance stockholder value, and on April 12, 1996, the
Company announced that it was engaged in discussions with a number of parties
relating to the possible acquisition of the Company. As a result of these
discussions, the Company announced on May 15, 1996 that it entered into a
definitive merger agreement (the "Merger Agreement") with The Cross Country
Group, Inc. ("Cross Country"), pursuant to which Cross Country has agreed to
acquire all of the outstanding shares of the Company for $2.35 per share in
cash. The merger is subject to a number of conditions, including approval of the
transaction by the stockholders of the Company and by regulatory authorities.
The Board of Directors has approved the transaction and will recommend
ratification of the agreement at the Special Stockholders' meeting called to
consider the merger. The meeting and the closing are anticipated in late
October.
In connection with the Merger Agreement, the Company has reached a settlement
with Acceleration National Insurance Company, pursuant to which Cross Country
has agreed to satisfy the Acceleration judgment at the time of the closing of
the merger.
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
8
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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 exceptions of Connecticut
and New Hampshire. The Company and the home warranty contract offered are
subject to insurance type regulations in 17 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.
RESULTS OF OPERATIONS
SIX MONTHS ENDED JUNE 30, 1996 AS COMPARED TO JUNE 30, 1995
Home Warranty Operations:
Home warranty revenue, totaling $19,159,000 and representing 87% of total
operating revenue for the six months ended June 30, 1996, increased 5% from the
corresponding 1995 figure of $18,193,000, or 82% of total operating revenue.
Because of the Company's warranty revenue recognition policy under which
warranty revenue is recognized over the contract term, generally twelve months,
the revenue earned is impacted by warranty production in the preceding eleven
months, as well as current period production. Consequently, revenue recognition
generally lags behind production, and the revenue increase experienced in the
first six
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months of 1996, as compared to the comparable 1995 period is due primarily to
the impact of higher warranty production in the last six months of 1995, as
compared to the corresponding period for 1994. Warranty contract sales in the
first six months of 1996 were 19% higher than in the 1995 first six months, as a
result of increased sales opportunities corresponding to increased residential
resale transactions during the first half of 1996. This trend is consistent with
industry experience. The impact of this increase in warranty contract sales will
continue to affect warranty revenue recognition in future quarters, due to the
warranty revenue recognition method, as discussed above. Renewal warranty
contract sales in the first six months of 1996 were 41% higher than in the 1995
first six months. The renewal success rate has improved to approximately 20% as
opposed to approximately 15% during the comparable period in 1995. 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,
increased to 80% in 1996 from 78% in 1995. This increase is primarily due to the
impact of the harsher winter weather in the first quarter of 1996 as compared to
the first quarter of 1995, combined with the extremely hot summer weather in May
and June of 1996. Changing weather patterns, particularly when severe, have a
negative impact on the Company's claims expense incurred. Average severity
increased by 4% during the 1996 first quarter, while frequency increased 6% over
the 1995 levels.
The 1996 warranty acquisition cost ratio is approximately 1% lower than the
comparable 1995 ratio. The Company's acquisition costs vary in different
locations, and as the volume of contract sales shifts between geographic
regions, the Company's overall acquisition cost ratio changes. . 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.
Membership and Other Operations:
Membership related revenue was 28% lower than in the comparable prior year
period, which reflects the continuing impact of the reduction in Full E&O
membership on the Company's membership revenue stream. As of June 30, 1996, only
approximately 31% of the Company's membership participated in the Company's E&O
program, as opposed to approximately 38% as of June 30, 1995. These members
generate the bulk of the Company's membership revenue. The remaining 69% of the
Company's membership does not pay the marketing/placement fees associated with
Full E&O membership. Additionally, non E&O members often pay a reduced annual
membership or renewal fee, or these fees may even be waived.
Direct expenses of the membership operations declined only 12% and approximated
67% of related revenue for the first six months of 1996 and 59% of related
revenue for the comparable prior year period. The increasing cost ratio results
from the impact of certain fixed costs which do not decline with decreases in
revenue. Also, the Company currently operates six more territories as corporate
owned regions in 1996 than it did in 1995.
E&O Brokerage Operations:
E&O brokerage revenue for the six months ended June 30, 1996, totaled $471,000,
a decrease of 20% from $587,000 in the first six months of 1995. The decrease
relates to the continuing declines in the Company's Full E&O membership base
discussed above.
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Direct costs of the E&O brokerage operations increased from $227,000 or 39% of
related revenue in the 1995 first six months to $380,000 or 81% of related
revenue in the comparable 1996 period. The Company pays 25% of the commission it
earns on the E&O premiums collected to the Affiliates generating the premium
volume. Also, certain policy costs were incurred in the first six months of 1996
relative to the Seller's E&O program which were not incurred in each of the
first six months of 1995, due to the change in funding the policy and change in
insurers which took place in June 1995.
G&A Expense:
General and administrative expenses ("G&A") decreased from $4,952,000 in the
first six months of 1995 to $4,843,000 in the first six months of 1996,
primarily due to decreases in legal fees, rent and insurance expenses. As a
percentage of revenue, G&A was 22.1% for the first six months of 1996, compared
to 22.5% in the first six months of 1995.
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 and available
for sale 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 decreased from a net gain of
$893,000 for the six months ended June 30, 1995 to a net gain of $190,000 in the
current year six month period. This decrease is primarily due to market interest
rate fluctuations, which have caused the fair value of the Company's investment
portfolio, consisting mainly of mutual funds and debt instruments, to decline
from the 1995 market values. Approximately $501,000 of the 1995 income related
to realized holding gains on the Company's investment portfolio of trading
securities. In the 1996 six month period, the Company realized holding losses of
$128,000. Interest expense of approximately $112,000 relates primarily to the
CNA obligation described in LIQUIDITY AND CAPITAL RESOURCES below. The Company's
investment in a joint venture in an Internet access provider generated losses of
approximately $90,000 in the first six months of 1996.
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Income Taxes:
The Company's effective income tax rate on continuing operations for the current
six month period was a benefit of 37%, as compared to 39% provision in the
comparable 1995 period. Management does not expect the effective income tax rate
to change substantially during the remainder of 1996, as there are no
significant permanent differences which would generate such a change.
THREE MONTHS ENDED JUNE 30, 1996 AS COMPARED TO JUNE 30, 1995
Home Warranty Operations:
Home warranty revenue, totaling $10,124,000 and representing 88% of total
operating revenue for the three months ended June 30, 1996, increased 11% from
the corresponding 1995 figure of $9,122,000, or 81% of total operating revenue.
This revenue increase is due primarily to the impact of warranty production
increases in the preceding eleven month period, and the current period
production, as compared to the comparable 1995 and prior periods. This impact
results from the Company's warranty revenue recognition policy under which
warranty revenue is recognized over the contract term, generally twelve months.
Warranty contract sales in the second quarter of 1996 were 23% higher than in
the 1995 second quarter. This trend is consistent with industry experience.
Renewal warranty contract sales in the second quarter of 1996 were 35% higher
than in the 1995 second quarter, and approximated 14% of total contract sales.
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,
increased to 80% in the 1996 second quarter from 79% in the 1995 second quarter.
This increase was primarily due to the impact of a 5% increase in severity and a
7% increase in frequency during the 1996 second quarter, as compared to the 1995
second quarter. As a result of the heat wave experienced across the nation, May
1996 claims costs exceeded May 1995 levels as a percentage of related revenue.
The 1996 warranty acquisition cost ratio is 1% lower than the comparable 1995
ratio. The Company's acquisition costs vary in different locations, and as the
volume of contract sales shifts between geographic regions, the Company's
overall acquisition cost ratio changes.. 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.
Membership and Other Operations:
Membership related revenue for the 1996 second quarter was 29% lower than in the
comparable prior year period, which reflects the continuing impact of the
reduction in Full E&O membership on the Company's membership revenue stream,
consistent with recent experience.
Direct expenses of the membership operations declined only 18% and approximated
66% of related revenue for the second quarter of 1996 and 57% of related revenue
for the comparable prior year period. The increasing cost ratio results from the
impact of certain fixed costs which do not decline with decreases in revenue.
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E&O Brokerage Operations:
E&O brokerage revenue for the three months ended June 30, 1996, totaled
$255,000, a decrease of 18% from the 1995 second quarter revenue of $312,000.
The decrease relates to the continuing declines in the Company's Full E&O
membership base.
Direct costs of the E&O brokerage operations increased from $123,000 or 39% of
related revenue in the 1995 second quarter to $182,000 or 71% of related revenue
in the comparable 1996 period. The increase is due to the inclusion in 1996 of
certain policy costs relative to the Seller's E&O program which were incurred in
only one month in the 1995 second quarter.
G&A Expense:
Although general and administrative expenses ("G&A") increased from $2,341,000
in the second quarter of 1995 to $2,371,000 in 1996, the 1995 second quarter
included a credit of $275,000 as a result of the liquidation and final
settlement of the outstanding liabilities of the Company's former UK subsidiary.
Excluding the impact of this 1995 credit, G&A expenses for the 1996 second
quarter were $245,000 lower than in 1995, due to decreases in rent and insurance
expenses. As a percentage of revenue, G&A fell from 20.9% in the 1995 second
quarter, to 20.5% in the 1996 second quarter.
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 decreased from a net gain of $335,000 for the
second quarter of 1995 to a net gain of $98,000 in the current year second
quarter. This decrease is primarily due to market interest rate fluctuations,
which have caused the fair value of the Company's investment portfolio,
consisting mainly of mutual funds and debt instruments, to decline from the 1995
market values. Approximately $158,000 of the second quarter 1995 income related
to realized holding gains on the Company's investment portfolio of trading
securities, as compared to realized holding losses of $43,000 in the 1996 second
quarter. Interest expense of approximately $44,000 relates primarily to the CNA
obligation. The Company's investment in a joint venture in an Internet access
provider generated losses of approximately $45,000 in the 1996 second quarter.
Income Taxes:
The Company's effective income tax rate on continuing operations for the second
three month period was a benefit of 45%, as compared to 39% in the comparable
1995 period.
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 been adequate to meet current obligations. As a result of
increases in home warranty production growth in 1996 as compared to 1995, cash
collected on warranty contracts in the first six months of 1996 was
approximately $3,121,000 higher than in 1995. However, the Company incurred
heavy
13
<PAGE>
claims in the first half of 1996, and also experienced significant decreases in
the membership and E&O revenue as compared to the 1995 first six months, which
partially offset the increased cash receipts from production growth.
As discussed above, the Company's membership and related revenues continue to be
negatively affected by decreases in new and renewal Full E&O members, and in the
related fees generated by this type of membership. In 1996, the Company has and
will continue to provide various discounted membership options. The Company's
Warranty Sales Only memberships do not result in the collection of any
membership related fees, but the Company believes this membership has
contributed to the growth in warranty production over 1995 levels. While the
Company anticipates that its cash flow from membership and E&O operations will
continue to be significantly negatively impacted by the discounted membership
options and the shift in membership composition, the Company believes that cash
flow generated from its warranty operations will be sufficient to meet its
operating needs on an ongoing basis.
In the first six months of 1996, net cash provided by operating activities
totaled $3,072,000, as compared to net cash used in operations of $422,000 in
the corresponding 1995 period. This increase in net cash provided by operating
activities is primarily due to liquidation of certain investment balances, which
was necessary to meet the high claims demands resulting from the severe winter
weather during December 1995, January and February 1996, and again in May 1996,
and also to offset the effects of decreasing membership revenues. In early 1996,
the Company changed its vendor payment terms to more appropriately match its
operating cycle. This change moved the Company's payment cycle from
approximately 20 days to approximately 30 days. Also impacting cash flows from
operating activities are various payments for Affiliate and Member commissions,
which increase as production increases. In the first six months of 1996, the
Company used $1,733,000 in investing activities, as compared to $623,000 in the
1995 six months, primarily due to increased expenditures for property and
equipment. Also, in an effort to maximize investment earnings potential, the
Company transferred certain securities from its trading portfolio to its
available for sale portfolio, pursuant to a consolidation of investment balances
for one of its regulated subsidiaries,. The increases in property and equipment
expenditures relate to investments in the Company's processing environment
technology, and also to leasehold improvements made in the Company's new leased
office building. Net cash used in financing activities totaled $26,000 in the
first six months of 1996, as compared to $589,000 in the comparable 1995 period.
The 1996 financing activities relate primarily to financing of certain equipment
purchases and other obligations, offset by increasing debt repayments, primarily
on the Company's obligation to Continental Casualty Company ("CNA").
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 $1,277,000. A portion of the prior year losses, and the current
year loss have generated NOL carryforwards that will be used to offset future
taxable income. Despite these NOL carry forwards, the Company will be required
to make estimated tax payments until certain of the losses generated for
financial statement purposes become deductible for tax purposes. The Company
intends to file for further refunds of taxes paid in prior years. The
application for refund filed by the Company in 1995, approximating $1,277,000 is
still pending. The refund has been pledged to Acceleration National Insurance
Company (" Acceleration") as security for the judgment rendered against one of
the Company's subsidiaries in December 1995. If the refund is received prior to
the closing of the merger with Cross Country, the amount will be paid to
Acceleration in reduction of the amount payable at closing, under the terms of
the settlement agreement. In the first six months of 1996, the Company made
estimated state and federal tax payments of approximately $129,000 relating to
the 1995 and 1996 tax years.
14
<PAGE>
In consideration for CNA's assumption of certain reinsurance obligations of POMG
Insurance Company, Ltd ("POMG"), a wholly owned subsidiary of the Company prior
to its May 1995 liquidation, the Company has agreed to pay CNA $5,000,000 out of
certain revenue sources, over a period estimated to be five years from the
commencement of the CNA E&O program in 1993 toward the ultimate settlement of
the transferred losses and expenses. The agreements with CNA impose certain
restrictive covenants until the $5,000,000 CNA Obligation is satisfied. These
covenants include limits on dividends and on future borrowings. The funds due to
CNA are a senior obligation of the Company, secured by an interest in the common
stock of the Company's HOMS Insurance Agency, Inc. subsidiary and in the
Company's Member list. Through December 31, 1999, the Company and its Affiliates
must provide CNA/Schinnerer with right of first refusal on E&O insurance offered
to its membership. The Company forwards half of its commissions earned under the
CNA E&O program to CNA, to be applied as debt repayments on the obligation until
its satisfaction. In March 1996, the Company revised its repayment schedule for
the CNA obligation, due to the 1995 premium quota shortfalls. Accordingly,
through the remainder of 1996, a portion of the repayments made to CNA will be
at fixed amount, to make up for the repayment shortfall caused by the premium
volume shortfall in 1995. In addition to this fixed monthly repayment, the
Company will continue to remit 50% of the commission generated on premium volume
collections.
As of June 30, 1996, the net present value of the balance due to CNA under this
obligation was $3,463,000. During the first six months of 1996 the Company made
principal repayments of approximately $139,000 against the obligation. In
addition to the assets transferred to CNA, the Company has guaranteed the
validity of a $5,000,000 reinsurance recoverable, one of the POMG assets
transferred. This guarantee is secured by $3,000,000 cash collateral posted by
the Company. 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 further 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 cover note relating to 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. OnApril 10, 1996 CNA issued a Notice of Arbitration
to the reinsurer with respect to its refusal to honor ithe reinsurance treaty.
Under the terms of the Company's agreement with CNA, the Company must pay the
cost of arbitration, which totaled $40,000 through June 30, 1996.
On December 16, 1995, a jury verdict in the amount of $5,156,022 was rendered in
favor of the Plaintiff and against Homeowners Marketing Services, Inc. ("HMS"),
a subsidiary of the Company, in the following matter: ACCELERATION NATIONAL
INSURANCE COMPANY, PLAINTIFF, VS. HOMEOWNERS MARKETING SERVICES, INC., ET AL.,
DEFENDANTS, in the Court of Common Pleas of Franklin County, Ohio. The judgment
is recorded in accrued and other expenses in the accompanying consolidated
balance sheets. Under the terms of the Merger Agreement, Cross Country has
agreed to satisfy the obligation of the Company to Acceleration, pursuant to the
terms of a settlement agreement, at the closing of the merger.
Seventeen of the states in which the Company's subsidiaries operate regulate the
home warranty business. As of June 30, 1996, approximately $9,300,000 of cash
and investments are needed to maintain the regulated subsidiaries' required
minimum reserve and surplus levels. Of this amount, approximately $1,200,000 of
cash and investments are held by the regulated states to assure the Company's
fulfillment of its obligations to contract holders. Increases in warranty
production, as seen thus far in the first quarter of 1996, result in increases
in the Company's required reserve and surplus levels in the regulated states. In
addition, state
15
<PAGE>
regulators generally seek reserve balances in excess of the minimum standards.
In certain states, withdrawal of any reserves in excess of statutory minimums
requires approval from the regulatory authorities. The Company has been advised
by certain authorities that such approval will not be granted. Accordingly, the
Company maintained reserves of approximately $11,700,000 as of June 30, 1996.
The Company is currently in compliance with all applicable surplus requirements.
The Company is continuing its efforts to upgrade 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
approximately $750,000 in excess of the costs incurred to date and the costs of
maintaining, servicing and improving the existing system. Management expects
that sufficient funds will be available to cover the cost of the upgrade. If
such funds are not available, or, as in the past, parts of this project will be
deferred.
16
<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.
17
<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, 1996 and 1995.
(b) Reports on Form 8-K
On June 9, 1996, the Company filed an Agreement and
Plan of Merger, dated as of May 14, 1996, between the
Company and the Cross Country Group ("Cross
Country"), pursuant to which Cross Country has agreed
to acquire all of the outstanding shares of the
Company for $2.35 per share in cash.
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 12, 1996 By: /S/ C. GREGORY MORRIS
----------------------
C. Gregory Morris
Vice President, Treasurer and
Chief Financial Officer
18
<TABLE>
<CAPTION>
EXHIBIT 11
HOMEOWNERS GROUP, INC. AND SUBSIDIARIES
COMPUTATION OF NET INCOME (LOSS) PER COMMON SHARE
FOR THE THREE AND SIX MONTHS ENDED
JUNE 30, JUNE 30,
1996 1995 1996 1995
--------------------------- --------------------------
<S> <C> <C> <C> <C>
Net income (loss) ($24,582) $413,042 ($269,421) $728,981
CALCULATION OF PRIMARY NET INCOME (LOSS) 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) - - - -
--------------------------- --------------------------
Weighted average primary common shares outstanding 5,558,350 5,558,350 5,558,350 5,558,350
--------------------------- --------------------------
Primary net income (loss) per common share ($0.00) $0.07 ($0.05) $0.13
======= ===== ======= =====
CALCULATION OF AVERAGE FULLY DILUTED NET INCOME (LOSS) 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) - - - -
--------------------------- --------------------------
Weighted average fully diluted common shares outstanding 5,558,350 5,558,350 5,558,350 5,558,350
--------------------------- --------------------------
Fully diluted net income (loss) per common share ($0.00) $0.07 ($0.05) $0.13
======= ===== ======= =====
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1995
<PERIOD-END> JUN-30-1996
<CASH> 5,470,841
<SECURITIES> 7,138,674
<RECEIVABLES> 1,366,506
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 27,165,725
<PP&E> 4,190,273
<DEPRECIATION> 0
<TOTAL-ASSETS> 39,516,504
<CURRENT-LIABILITIES> 31,081,333
<BONDS> 0
0
0
<COMMON> 55,584
<OTHER-SE> 6,214,455
<TOTAL-LIABILITY-AND-EQUITY> 39,516,504
<SALES> 0
<TOTAL-REVENUES> 11,548,135
<CGS> 0
<TOTAL-COSTS> 11,585,710
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (44,582)
<INCOME-TAX> (20,000)
<INCOME-CONTINUING> (24,582)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (24,582)
<EPS-PRIMARY> (0.00)
<EPS-DILUTED> (0.00)
</TABLE>
