UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended MARCH 31, 1997
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 May 12, 1997, 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.
<TABLE>
<CAPTION>
HOMEOWNERS GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
MARCH 31, DECEMBER 31,
1997 1996
---------------- ---------------
(UNAUDITED) (AUDITED)
<S> <C> <C>
ASSETS:
Current assets:
Cash and cash equivalents $409,132 $ 1,833,977
Trading securities 4,194,111 4,927,225
Current portion of securities available for sale 1,660,295 507,050
Miscellaneous receivables 963,060 990,644
Deferred home warranty acquisition costs 5,330,838 6,137,476
Refundable income taxes - 28,000
Current portion of deferred income taxes 6,203,979 6,336,602
Prepaid expenses and other current assets 756,600 840,250
---------------- ---------------
Total current assets 19,518,015 21,601,224
Restricted cash (net of allowance of $2,500,000) 660,000 660,000
Non-current portion of securities available for sale 6,244,783 7,417,599
Property and equipment - net 4,311,004 4,403,030
Other assets 480,097 432,755
Deferred and refundable income taxes - net of current portion 3,545,441 3,239,965
---------------- ---------------
TOTAL $34,759,340 $37,754,573
================ ===============
LIABILITIES AND STOCKHOLDERS' EQUITY:
Current liabilities:
Accounts payable $ 1,733,011 $ 1,122,885
Accrued expenses 5,947,771 7,088,961
Litigation settlement 3,974,144 3,881,567
Current maturities of long term debt 1,894,324 1,191,601
Deferred home warranty revenue 15,627,171 17,768,964
---------------- ---------------
Total current liabilities 29,176,421 31,053,978
Long term debt - net of current portion 2,062,774 2,940,711
Commitments and contingencies
Stockholders' equity:
Common stock - $0.01 par value; 45,000,000 shares
authorized; 5,558,350 shares issued and outstanding
at March 31, 1997 and December 31, 1996 55,584 55,584
Additional paid-in capital 7,458,288 7,458,288
Retained earnings (4,005,785) (3,799,406)
Unrealized holding gain on securities available for sale 12,058 45,418
---------------- ---------------
Total stockholders' equity 3,520,145 3,759,884
---------------- ---------------
TOTAL $34,759,340 $37,754,573
================ ===============
</TABLE>
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
2
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<TABLE>
<CAPTION>
HOMEOWNERS GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
THREE MONTHS ENDED
MARCH 31,
------------------------------------------
1997 1996
------------------ ----------------
<S> <C> <C>
OPERATING REVENUE $10,984,498 $10,385,309
OPERATING COSTS AND EXPENSES:
Direct expenses 8,665,469 8,287,752
General and administrative expenses 2,594,340 2,464,269
------------------ ----------------
Total 11,259,809 10,752,021
------------------ ----------------
OPERATING LOSS (275,311) (366,712)
OTHER INCOME (EXPENSE):
Investment income - net 105,561 91,359
Other income (expense) - net (154,629) (108,488)
------------------ ----------------
Total (49,068) (17,129)
LOSS BEFORE INCOME TAXES (324,379) (383,841)
INCOME TAX BENEFIT 118,000 139,000
------------------ ----------------
NET LOSS ($206,379) ($244,841)
================== ================
PER SHARE AMOUNTS:
Net loss ($0.04) ($0.04)
================== ================
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING 5,558,350 5,558,350
</TABLE>
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
3
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<TABLE>
<CAPTION>
HOMEOWNERS GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
THREE MONTHS ENDED
MARCH 31,
-----------------------------------------
1997 1996
-----------------------------------------
<S> <C> <C>
Cash flows from operating activities:
Net income ($206,379) ($244,841)
Adjustments:
Depreciation and amortization 295,539 175,305
Provision for deferred income taxes (226,000) (279,000)
(Gain) loss on trading securities 116,751 84,263
Other net changes in assets and liabilities:
(Increase) decrease in miscellaneous receivables 27,584 (165,281)
Decrease in deferred home warranty acquisition costs 806,638 637,840
Decrease in refundable income taxes 28,000 -
Decrease in deferred income taxes 53,147 5,782
Decrease in prepaid expenses and other assets 17,261 221,813
Increase in accounts payable 610,126 1,310,118
Decrease in accrued expenses (1,141,190) (564,150)
Increase in litigation settlement 92,577 -
Decrease in deferred home warranty revenue (2,141,793) (1,717,525)
Purchases of trading securities (53,580) (104,147)
Proceeds from sales of trading securities 700,000 1,365,512
------------------ ----------------
Net cash provided by (used in) operating activities (1,021,319) 725,688
------------------ ----------------
Cash flows from investing activities:
Property and equipment expenditures (184,466) (602,900)
Purchases of securities classified as available for sale (3,606,038) (370,084)
Proceeds from sale of securities classified as available for sale 3,562,191 4,676
Unrealized holding loss on securities available for sale - 9,502
------------------ ----------------
Net cash used in investing activities (228,313) (958,806)
------------------ ----------------
Cash flows from financing activities:
Repayments of debt (253,772) (352,747)
Amortization of discount on long term debt 43,668 62,886
Borrowings under capital lease obligation 34,891 0
------------------ ----------------
Net cash used in financing activities (175,213) (289,861)
------------------ ----------------
Net decrease in cash and cash equivalents (1,424,845) (522,979)
Cash and cash equivalents at beginning of period 1,833,977 997,336
------------------ ----------------
Cash and cash equivalents at end of period $409,132 $474,357
================== ================
SUPPLEMENTAL DISCLOSURE:
Cash paid during the period for:
Interest $24,559 $68,608
Income taxes 65,564 128,515
</TABLE>
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
4
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HOMEOWNERS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 1997
(Unaudited)
1. GENERAL
The consolidated balance sheet as of March 31, 1997 and the consolidated
statements of income and cash flows for the three month periods ended March 31,
1997 and 1996 have been prepared by the Company, without audit. In the opinion
of management, all adjustments, which include only normal recurring adjustments
necessary to present fairly the financial position, results of operations and
cash flows at March 31, 1997, 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 1996 Annual Report on Form 10-K, as amended, filed
with the Securities and Exchange Commission.
2. COMMITMENTS AND CONTINGENCIES
The Company is currently undergoing an examination by the Internal Revenue
Service of its tax returns for the years 1993, 1994 and 1995, which could result
in the proposal of significant adjustments to its taxes in those years. The
Company believes that the returns as originally filed are correct in all
material respects.
The Company is subject to various lawsuits and claims arising in the normal
course of business. In the opinion of management, the resolution of these
matters will not have a material adverse effect on the Company's consolidated
financial position or results of operations.
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 will purchase all of the outstanding shares of the Company
for $2.06 per share in cash. Under the terms of the merger agreement, Cross
Country agreed to pay the balance due to Acceleration National Insurance Company
("ANIC") under a settlement agreement, upon closing of the Merger. Pursuant to
the settlement agreement, on September 4, 1996, the Company paid to ANIC the
full amount of its 1994 federal income tax refund, together with interest, which
totaled $1,401,485. The remaining balance due bears interest at the rate of 10%
per annum from September 1, 1996 until the settlement amount is paid in full. An
affiliate of Cross Country purchased the judgment from ANIC as of October 31,
1996, for approximately $2.75 million. The Cross Country affiliate agreed, under
certain conditions, to take no action to collect on the
5
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judgment before January 31, 1997. In January 1997, under a second amendment to
the merger agreement, the Cross Country affiliate extended the date until which
it agreed to take no action to collect on the judgment to July 1, 1997, or
failure to consummate the merger. The Company guaranteed the obligation of HMS
and pledged the shares of HMS and another subsidiary of the Company to secure
such guarantee. HMS and the subsidiary granted security interests in their
assets as part of the First Amendment to the Merger Agreement. In the event the
judgment creditor proceeds to execute on its judgment, it is likely that the
Company will be without adequate resources to pay the full amount due to Cross
Country, as holder of the judgment, which would become immediately due and
payable. In such event, the Company would be forced to seek alternatives to
paying the remaining unpaid balance of the judgment. No other alternatives are
presently being considered. See further discussion in MANAGEMENT'S DISCUSSION
AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - RECENT
DEVELOPMENTS.
In connection with the transfer of the net assets of POMG to CNA and the
assumption by CNA of the obligations of POMG under certain Realtor's errors and
omissions policies, the Company guaranteed the performance by Sphere Drake
Insurance, PLC ("Sphere Drake"), a third party reinsurance company, under a
$5,000,000 reinsurance treaty purchased by POMG to protect it from losses in
excess of a predetermined amount. Under the terms of the Company's guaranty,
CNA, as the transferee of the reinsurance treaty, bears any credit risk under
the treaty, including, but not limited to, any risk that Sphere Drake becomes
insolvent, is adjudicated as a bankrupt or has liquidation or similar
proceedings commenced against it. This guarantee is secured by $3,000,000 cash
collateral posted by the Company. This amount is reported as restricted cash in
the accompanying consolidated balance sheet. The Company has agreed, if
necessary, to pay an additional $2,000,000, related to the guarantee, out of
future commissions. On April 10, 1996, CNA issued a Notice of Arbitration to the
reinsurer with respect to its refusal to honor the reinsurance treaty. The
Company, CNA and Sphere Drake are engaged in settlement discussions with respect
to the reinsurance treaty. Although terms are not finalized, it is possible that
the Company could pay a substantial portion of the Collateral Account to CNA
under the currently proposed settlement agreement. As a result of the settlement
negotiations, the Company recorded a loss provision of $2.5 million for the
guaranty in its consolidated statements of operations for 1996. Should the
Merger fail to be consummated, the potential settlement agreement will be null
and void, and the Company will continue to be contingently liable for the entire
$5 million under the conditions described above. In such event, the Company will
attempt to negotiate a settlement but there can be no assurance that it will be
successful in such efforts. The restricted cash amount is presented net of the
$2.5 million reserve in the accompanying consolidated balance sheets.
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:
6
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<TABLE>
<CAPTION>
OPTION PRICE AVAILABLE
STOCK OPTIONS PER SHARE OUTSTANDING EXERCISABLE FOR GRANT
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<S> <C> <C> <C> <C> <C>
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 30,500
Canceled 2.00 (1,900) (500) 1,900
At December 31, 1996 $2.00 433,800 246,700 163,200
---------- --------- --------- -----------
Became exercisable 2.00 143,850
Canceled 2.00 (4,150) (1,400) 4,150
---------- --------- --------- -----------
At March 31, 1997 $2.00 429,650 389,150 167,350
---------- --------- --------- -----------
</TABLE>
In May 1992, effective September 1991, the Company adopted a non-employee
directors' stock option plan authorizing issuance of up to 300,000 shares of
common stock. Options under this plan become exercisable annually over the five
years following the date of grant and expire no later than ten years after the
date of grant. Options for 75,000 shares were granted at $6.50 per share on
September 26, 1991, 67,500 of which remain outstanding at March 31, 1997;
options for 25,000 shares were granted at $5.50 per share on January 28, 1993,
all of which remain outstanding at March 31, 1997; options for 25,000 shares
were granted at $3.375 per share on September 23, 1993, which have since been
canceled; and options for 25,000 shares were granted at $0.75 per share on
December 22, 1995, all of which remain outstanding at March 31, 1997. Options
for 87,500 shares are exercisable at March 31, 1997.
The following table summarizes information about stock options outstanding as of
March 31, 1997:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
---------------------------------------- -------------------------------------
WTD AVERAGE WEIGHTED
RANGE OF NUMBER REMAINING AVERAGE NUMBER WTD AVG
EXERCISE OUTSTANDING CONTRACTUAL EXERCISE EXERCISABLE EXERCISE
PRICE AT 3/31/97 LIFE PRICE AT 3/31/97 PRICE
---------- ----------- ----------- --------- ----------- --------
<S> <C> <C> <C> <C> <C> <C>
$2.00 429,650 5.0 $2.00 389,150 $2.00
$0.75-6.50 117,500 6.2 5.06 87,500 6.14
</TABLE>
In connection with the amendment to the definitive merger agreement with Cross
Country, the Company's stock rights plan was modified to permit Cross Country
and its affiliates to buy an unlimited number of shares in privately negotiated
transactions. This stock rights plan amendment was not effective until three
business days after the information was released, or November 7, 1996, provided
that no other bid for the Company was received within such three day period. The
three day period passed with no other bids submitted to purchase the Company.
7
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RECENT DEVELOPMENTS
Homeowners Group, Inc. ("HOMG" or the "Company") announced on May 15, 1996 that
it had entered into a definitive merger agreement under which The Cross Country
Group, Inc. ("Cross Country") agreed to acquire the Company for $2.35 per share
in cash. The merger agreement stated that the merger was subject to a number of
conditions including approval of the transaction by the Company's stockholders
and regulatory authorities. The Company also announced on May 15, 1996 that it
had reached an agreement to settle the judgment obtained by Acceleration
National Insurance Company ("Acceleration" or "ANIC") by paying to Acceleration
a reduced amount of approximately $4.4 million in cash at the closing of the
merger, which Cross Country had agreed, as a condition to the merger, to
satisfy.
On November 7, 1996, the Company, announced that it had entered into an
amendment to the merger agreement with Cross Country, which, among other things,
reduced the price at which Cross Country will acquire HOMG stock to $2.06 per
share in cash. The amendment also extended the anticipated closing date to no
later than March 1, 1997. In addition, the amendment modified the Company's
stock rights plan to permit Cross Country and its affiliates to buy an unlimited
number of shares in privately negotiated transactions. This stock rights plan
amendment was not effective until three business days after the information was
released, provided that no other bid for the Company was received within such
three day period. The three day period passed with no other bids submitted to
purchase the Company.
An affiliate of Cross Country purchased, for approximately $2.75 million, the
$5.2 million judgment obtained by Acceleration (the "Judgment"). The purchase
price of the judgment reflected a $1.4 million payment previously made by the
Company. The Cross Country affiliate also agreed, under certain conditions, to
take no action to collect on the Judgment before January 31, 1997.
On February 10, 1997, the Company entered into a second amendment to the merger
agreement with Cross Country, which extended the anticipated closing date to the
earlier of July 1, 1997 or termination of the merger agreement. The Company also
entered into an amendment to the agreement with the affiliate of Cross Country
which holds the Judgment, extending the date through which the Cross Country
affiliate agreed, under certain conditions, to take no action to collect on the
Judgment until the earlier of July 1, 1997 or termination of the merger
agreement. The Company guaranteed the obligation of HMS and pledged the shares
of HMS and another subsidiary of the Company to secure such guarantee. HMS and
the subsidiary granted security interests in their assets as part of the First
Amendment to the Merger Agreement. Should the Merger fail to be consummated by
July 1, 1997, Cross Country will be entitled to take action to collect on its
judgment. In the event the judgment creditor proceeds to execute on its
judgment, it is likely that the Company will be without adequate resources to
pay the full amount due.
A Special Meeting of stockholders has been scheduled for June 19, 1997, where
the stockholders will be asked to consider and approve the Merger Agreement.
Stockholders of record at the close of business on April 21, 1997 have received
notice of and are entitled to vote at the Special Meeting. The Company has
obtained regulatory approval for the merger in all states. The only material
condition to the closing of the merger is the approval of the stockholders at
the Special Meeting.
In May, 1997, an affiliate of Cross Country purchased 1.027 million shares of
the Company's common stock in a single privately negotiated transaction. Cross
Country and its affiliates now hold approximately 29.7% of
8
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the Company's outstanding common stock, and pursuant to a Voting Agreement with
certain officers and directors of the Company, hold proxies representing an
additional 12.3% of the outstanding common shares. Cross Country and its
affiliates intend to vote all such shares in favor 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 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.
9
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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
THREE MONTHS ENDED MARCH 31, 1997 AS COMPARED TO MARCH 31, 1996
HOME WARRANTY OPERATIONS:
Home warranty revenue, totaling $10,016,000 and representing 91% of total
operating revenue for the three months ended March 31, 1997, increased 11% from
the corresponding 1996 figure of $9,035,000, or 87% 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. Thus, the revenue increase experienced in the
first quarter of 1997, as compared to the comparable 1996 period is due
primarily to the impact of the combined increase in warranty production in the
last three quarters of 1996, as compared to the corresponding period for 1995
and the first quarter of 1997, as compared to the corresponding period of 1996.
Warranty contract sales in the first quarter of 1997 were 6% higher than in the
1996 first quarter, as a result of increased sales opportunities resulting from
increased residential resale transactions during the first quarter of 1997. This
trend is consistent with industry experience. The impact of this increase in
warranty contract sales will affect warranty revenue recognition in future
quarters, due to the warranty revenue recognition method, as discussed
previously. Renewal warranty contract sales in the first quarter of 1997 were
12% higher than in the 1996 first quarter. 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 1997 from 79% in 1996, primarily due to increased claims
expense incurred. Average severity decreased by 5% during the 1997 first
quarter, while frequency increased 7% over the 1996 levels.
10
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The 1997 warranty acquisition cost ratio is 2% higher than the comparable 1996
ratio. As the volume of contract sales shifts between geographic regions, the
Company's overall acquisition cost ratio changes, as the Company's acquisition
costs vary in different locations. The acquisition cost ratio is expected to
remain relatively stable at its current level, assuming that the warranty
product mix and geographic distribution do not change significantly. Management,
does not expect a significant change to occur in the near future.
MEMBERSHIP AND OTHER OPERATIONS:
Membership related revenue was 31% 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. Currently, only
approximately 26% of the Company's membership participates in the Company's E&O
program, as opposed to approximately 34% for the comparable period in 1996, and
these members generate the bulk of the Company's membership revenue. The
remaining 74% of the Company's membership does not pay the marketing/placement
fees associated with Full E&O membership. Additionally, these 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 70% and approximated 70%
of related revenue for the first three months of 1997 and 84% of related revenue
for the comparable prior year period. The decreasing cost ratio results from the
impact of the elimination of certain programs in late 1996, and also, due to
savings in the operation of the Company's corporate owned regions, through
management agreements, where the managers receive compensation only on sales
made.
E&O BROKERAGE OPERATIONS:
E&O brokerage revenue for the three months ended March 31, 1997, totaled
$178,000, a decrease of 17% from the 1996 first quarter revenue of $215,000. The
decrease relates to the continuing declines in the Company's Full E&O membership
base.
Direct costs of the E&O brokerage operations decreased from $197,000 or 92% of
related revenue in the 1996 first quarter to $84,000 or 47% of related revenue
in the comparable 1997 period. The Company pays 25% of the commission it earns
on the E&O premiums collected to the Affiliates generating the premium volume.
Also, there are certain related programs which are supported by components of
the E&O programs, such as the Company's Seller's E&O product. Certain policy
costs were incurred in the first quarter of 1996 relative to the Seller's E&O
program which were not incurred in the first quarter of 1997.
G&A EXPENSE:
General and administrative expenses ("G&A") increased from $2,472,000 in the
first quarter of 1996 to $2,594,000 in 1997, primarily due to increases in
professional fees, primarily related to the merger. As a percentage of revenue,
G&A increased slightly from 22.2% in the 1996 first quarter, to 22.8% in the
1997 first 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
11
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investment income was relatively flat for the two periods, at a net gain of
$91,000 for the three months ended March 31, 1996 and a net gain of $106,000 in
the current year equivalent period. Approximately $85,000 of realized holding
losses are included in the 1996 figure related to realized holding losses on the
Company's investment portfolio of trading securities, as compared to realized
holding losses of $90,000 in the 1997 first quarter. Interest expense of
approximately $154,000 in the 1997 first quarter relates primarily to the
Acceleration judgment and 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 first quarter. The Company stopped funding this venture in
December, 1996, and thus there are no expenses related to this venture included
in the 1997 results.
INCOME TAXES:
The Company's effective income tax rate on continuing operations for the current
three month period was a benefit of 37%, as compared to 36% in the comparable
1996 period. Management does not expect the effective income tax rate to change
substantially during the remainder of 1997, as there are no significant
permanent differences which would generate such a change.
LIQUIDITY AND CAPITAL RESOURCES
The Company generally receives payment for products and services before
disbursing funds for related direct expenses. Fees from Members and from sales
of home warranty contracts are received before related marketing commissions are
paid out and before claims are made under home warranty contracts. As a result
of increases in home warranty production in the first quarter of 1997 as
compared to the first quarter of 1996, cash collected on warranty contracts in
the 1997 first quarter was approximately $276,000 higher than in the comparable
1996 period. In 1997, membership and related revenues and cash flows continue to
be negatively affected by the decrease in members and in the related fees
generated by the Company's membership, and the Company continued to provide its
Affiliates with various discounted membership options. The Company expects that
cash flow generated from its warranty and other operations, in combination with
certain cost saving measures implemented, will be sufficient to meet its normal
operating needs on an ongoing basis. However, should the merger fail to be
consummated by July 1, 1997, Cross Country will be entitled to take action to
collect on its judgment. In the event the judgment creditor proceeds to execute
on its judgment, it is likely that the Company will be without adequate
resources to pay the full amount due to Cross Country, as holder of the
judgment, which would become immediately due and payable. In such event, the
Company would be forced to seek alternatives to paying the remaining unpaid
balance of the judgment. No other alternatives are presently being considered.
In the 1997 first quarter, net cash used in operating activities totaled
$1,021,000, as compared to cash provided by operations of $725,000 in the 1996
first quarter. This decrease in cash generated from operations is primarily due
to payments on certain accrued expenses, and to recognition of previously
deferred amounts of home warranty revenue. In the first quarter of 1996, the
Company modified its payment terms to its claims service contractors to move
from 20 to 30 day terms, consistent with industry standards, which significantly
positively impacted cash flows in the 1996 first quarter Also impacting
operating cash flows are various payments for claims payable, Affiliate and
Member commissions and E&O premium remittances. In the 1997 first quarter, the
Company used $228,000 in investing activities, as compared to $958,000 in the
1996 first quarter, primarily due to the decreases in purchases of property and
equipment. In the 1996 first quarter, certain furniture and equipment purchases
were made, related to the Company's 1996 move of its corporate
12
<PAGE>
headquarters. Net cash used in financing activities totaled $175,000 in the 1997
first quarter, as compared to cash used in financing activities of $290,000 in
the comparable 1996 period.
In consideration for CNA's assumption of POMG's reinsurance obligations, the
Company has agreed to pay CNA $5 million by December 1999 toward the ultimate
settlement of the transferred losses and expenses. The agreements with CNA
impose certain restrictive covenants until the $5 million CNA obligation is
satisfied, including limits on dividends and on future borrowings. The funds due
to CNA are a senior obligation of the Company, secured by an interest in the
common stock of the Company's HOMS subsidiary and in the Company's Member list.
Through December 31, 1999, the Company and its Affiliates must provide
CNA/Schinnerer with right of first refusal on E&O insurance offered to its
membership. The Company forwards half of its commissions earned under the CNA
E&O program to CNA, to be applied as debt repayments on the obligation until its
satisfaction. The Company is currently in default with the terms of this
agreement, as it has failed to achieve the minimum premium volume quotas as
defined in the agreements, and the Company could be required by CNA to make a
payment against its obligation to the Holdback Fund in the amount of
approximately $200,000. However, the Company and CNA have entered into an
amendment to the Holdback Agreement which would delete the premium volume quotas
and release the Company from its current obligation to pay the remaining $3.0
million. Following the effective date of this amendment, the Company's
obligation will be limited to the payment of 50% of actual commissions to CNA.
The proposed amendment becomes effective if the Merger is consummated prior to
July 1, 1997, and the dispute with Sphere Drake (as described below) is settled
within 14 days of the consummation of the Merger.
As of March 31, 1997, the net present value of the balance due to CNA under this
obligation was $3,000,000. In addition, in connection with the transfer of the
net assets of POMG to CNA and the assumption by CNA of the obligations of POMG
under certain Realtor's errors and omissions policies, the Company guaranteed
the performance by Sphere Drake Insurance, PLC ("Sphere Drake"), a third party
reinsurance company, under a $5 million reinsurance treaty purchased by POMG to
protect it from losses in excess of a predetermined amount. Under the terms of
the Company's guaranty, CNA, as the transferee of the reinsurance treaty, bears
any credit risk under the treaty, including, but not limited to, any risk that
Sphere Drake becomes insolvent, is adjudicated as a bankrupt or has liquidation
or similar proceedings commenced against it. The Company has agreed, if
necessary, to pay an additional $2 million out of future commissions related to
the guarantee. Should this occur, the repayments on the $5 million obligation
will be delayed until the $2 million is paid. The Company will not be required
to further reduce its collected commission by more than 50% under these
agreements. On April 10, 1996, CNA issued a Notice of Arbitration to Sphere
Drake, with respect to its refusal to honor the reinsurance treaty. Accordingly,
the Company, CNA and Sphere Drake have engaged in settlement negotiations with
respect to the reinsurance treaty. Although terms are not yet finalized, its is
possible that the Company could pay a substantial portion of the Collateral
Account to CNA under the terms of the currently proposed settlement agreement.
As a result of the settlement negotiations between CNA and Sphere Drake, in
December 1996, the Company recorded a loss provision of $2.5 million for the
guarantee.
In December 1991, ANIC, the insurer of the Company's E&O program through April
1991, brought suit against the Company and HMS. On December 13, 1995, a jury
verdict in the amount of $5,156,022 was rendered in favor of the Plaintiff and
against HMS. Under the terms of the Merger Agreement with Cross Country, Cross
Country agreed to pay the balance due to ANIC under a settlement agreement, upon
closing of the Merger. Pursuant to the settlement agreement, on September 4,
1996, the Company paid to ANIC the full amount of its 1994 federal income tax
refund, together with interest, which totaled $1,401,485. The remaining balance
due bears interest at the rate of 10% per annum from September 1, 1996 until the
settlement amount is paid in full. An affiliate of Cross Country purchased the
judgment from ANIC as of October 31, 1996, for
13
<PAGE>
approximately $2.75 million. The Cross Country affiliate agreed, under certain
conditions, to take no action to collect on the judgment before January 31,
1997. In January 1997, under the Second Amendment to the Merger Agreement, the
Cross Country affiliate extended the date until which it agreed to take no
action to collect on the judgment to July 1, 1997. The Company has guaranteed
the obligation of HMS and pledged the shares of HMS and another subsidiary of
the Company to secure such guarantee. HMS and the subsidiary granted security
interests in their assets as part of the First Amendment to the merger
agreement. Should the merger fail to be consummated by July 1, 1997, Cross
Country will be entitled to take action to collect on its judgment. In the event
the judgment creditor proceeds to execute on its judgment, it is likely that the
Company will be without adequate resources to pay the full amount due to Cross
Country, as holder of the judgment, which would become immediately due and
payable. In such event, the Company would be forced to seek alternatives to
paying the remaining unpaid balance of the judgment. No other alternatives are
presently being considered. The Company's efforts in 1996 to contest the
domestication of the judgment in Florida, appeal the judgment and otherwise
prevent the judgment creditor from executing on its judgment have resulted in
substantial fees to professionals and other advisors, which further negatively
impacted the Company's liquidity during 1996.
Seventeen of the states in which the Company's subsidiaries operate regulate the
home warranty business. Certain of these states require that reserves be
maintained to cover future repairs for the remaining terms of warranty contracts
(generally one year). As of March 31, 1997, approximately $10,000,000 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 1997, result in increases
in the Company's required reserve and surplus levels in the regulated states. In
addition, state regulators generally seek reserve balances in excess of the
minimum standards. In certain states, withdrawal of any reserves in excess of
statutory minimums requires approval from the regulatory authorities. The
Company has been advised by certain authorities that such approval will not be
granted. Accordingly, the Company maintained reserves of approximately
$12,100,000 as of March 31, 1997. The Company is currently in compliance with
all applicable surplus and reserve requirements.
The Company is currently undergoing an examination by the Internal Revenue
Service of its tax returns for the years 1993, 1994 and 1995, which could result
in the proposal of significant adjustments to its taxes in those years. The
Company believes that the returns as originally filed are correct in all
material respects.
The Company is continuing its efforts to upgrade its current computer and
processing environments over the next two years, in an attempt to increase
operational efficiency, improve management information, and allow for future
growth in the Company's business. This plan is currently expected to have an
incremental cost of approximately $750,000 in excess of the cost of maintaining,
servicing and improving the existing system, over the life of the project.
Management expects that sufficient funds will be available to cover the cost of
the upgrade. If such funds are not available, this project will be deferred.
14
<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.
15
<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 month periods ended March 31,
1997 and 1996.
27. Financial Data Schedule
(b) Reports on Form 8-K
None
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934, the
registrant has caused this report to be signed on its behalf by the undersigned
thereunto duly authorized.
HOMEOWNERS GROUP, INC.
May 14, 1997 By: /S/ C. GREGORY MORRIS
----------------------
C. Gregory Morris
Vice President, Treasurer and
Chief Financial Officer
16
<PAGE>
INDEX TO EXHIBITS
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
11. Computation of Net Income per Common Share for the three month
periods ended March 31, 1997 and 1996.
27. Financial Data Schedule
17
<TABLE>
<CAPTION>
EXHIBIT 11
HOMEOWNERS GROUP, INC. AND SUBSIDIARIES
COMPUTATION OF NET INCOME (LOSS) PER COMMON SHARE
FOR THE THREE MONTHS ENDED MARCH 31,
1997 1996
------------------ -----------------
<S> <C> <C>
Net income (loss) ($206,379) ($244,841)
CALCULATION OF PRIMARY NET INCOME (LOSS) PER COMMON SHARE:
Weighted average common shares outstanding during the year 5,558,350 5,558,350
Weighted average additional common shares (options) - -
------------------ -----------------
Weighted average primary common shares outstanding 5,558,350 5,558,350
------------------ -----------------
Primary net income (loss) per common share ($0.04) ($0.04)
======= =======
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
Weighted average additional common shares (options) - -
------------------ -----------------
Weighted average fully diluted common shares outstanding 5,558,350 5,558,350
------------------ -----------------
Fully diluted net income (loss) per common share ($0.04) ($0.04)
======= =======
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-END> MAR-31-1997
<CASH> 1,069,132
<SECURITIES> 4,194,111
<RECEIVABLES> 963,060
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 19,518,015
<PP&E> 4,311,004
<DEPRECIATION> 0
<TOTAL-ASSETS> 34,759,340
<CURRENT-LIABILITIES> 29,176,421
<BONDS> 0
0
0
<COMMON> 55,584
<OTHER-SE> 3,464,561
<TOTAL-LIABILITY-AND-EQUITY> 34,759,340
<SALES> 0
<TOTAL-REVENUES> 10,984,498
<CGS> 0
<TOTAL-COSTS> 11,259,808
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (324,379)
<INCOME-TAX> 118,000
<INCOME-CONTINUING> (206,379)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (206,379)
<EPS-PRIMARY> (0.04)
<EPS-DILUTED> (0.04)
</TABLE>
