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 SEPTEMBER 30, 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
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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 (954) 845-9100
--------------
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 November 14, 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.
HOMEOWNERS GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, DECEMBER 31,
1997 1996
----------------- ---------------
(UNAUDITED) (AUDITED)
<S> <C> <C>
ASSETS:
Current assets:
Cash and cash equivalents $ 2,923,841 $ 1,833,977
Trading securities 4,218,817 4,927,225
Current portion of securities available for sale 124,220 507,050
Miscellaneous receivables 896,785 990,644
Deferred home warranty acquisition costs 6,602,384 6,137,476
Refundable income taxes 0 28,000
Current portion of deferred income taxes 7,392,790 6,336,602
Prepaid expenses and other current assets 853,746 840,250
----------- -----------
Total current assets 23,012,583 21,601,224
Restricted cash 230,000 660,000
Non-current portion of securities available for sale 8,107,229 7,417,599
Property and equipment-net 4,615,546 4,403,030
Other assets 777,383 432,755
Deferred and refundable income taxes-net of current portion 2,066,891 3,239,965
----------- -----------
TOTAL $38,809,632 $37,754,573
----------- -----------
LIABILITIES AND STOCKHOLDERS' EQUITY:
Current liabilities:
Accounts payable $ 2,079,747 $ 1,122,885
Accrued expenses 5,499,899 7,088,961
Litigation settlement 4,162,386 3,881,567
Current maturities of long term debt 2,210,239 1,191,601
Deferred home warranty revenue 19,338,275 17,768,964
----------- -----------
Total current liabilities 33,240,546 31,053,978
Long term debt-net of current portion 1,424,606 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 September 30, 1997 and December 31, 1996 55,584 55,584
Additional paid-in capital 7,602,243 7,458,288
Retained earnings (3,563,177) (3,799,406)
Unrealized holding gain (loss) on securities
available for sale, net 49,830 45,418
----------- -----------
Total stockholders' equity 4,144,480 3,759,884
----------- -----------
TOTAL $38,809,632 $37,754,573
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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 NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------------------------------------------------------------
1997 1996 1997 1996
------------------------------------- --------------------------------------
<S> <C> <C> <C> <C>
OPERATING REVENUE $12,398,163 $12,040,374 $35,252,253 $33,971,432
OPERATING COSTS AND EXPENSES:
Direct expenses 10,320,932 9,679,526 27,822,074 27,173,289
General and administrative expenses 2,188,623 2,208,928 7,355,863 7,052,270
Unusual Items 417,381 417,381
------------------------------------- --------------------------------------
Total 12,509,555 12,305,835 35,177,937 34,642,940
------------------------------------- --------------------------------------
OPERATING INCOME (LOSS) (111,392) (265,461) 74,316 (671,507)
OTHER INCOME (EXPENSE):
Investment income - net 357,745 294,110 647,555 483,896
Other income (expense) - net (66,909) (180,006) (342,641) (392,169)
------------------------------------- --------------------------------------
Total 290,836 114,103 304,914 91,727
INCOME BEFORE
INCOME TAXES 179,444 (151,357) 379,229 (579,780)
PROVISION FOR INCOME TAXES (66,000) 47,000 (143,000) 206,000
------------------------------------- --------------------------------------
NET INCOME (LOSS) $113,444 ($104,357) $236,229 ($373,780)
===================================== ======================================
PER SHARE AMOUNTS:
Net income (loss) $0.02 ($0.02) $0.04 ($0.07)
===================================== ======================================
WEIGHTED AVERAGE COMMON 5,558,350 5,558,350 5,558,350 5,558,350
SHARES OUTSTANDING
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HOMEOWNERS GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
NINE MONTHS ENDED
SEPTEMBER 30,
1997 1996
----------- -----------
<S> <C> <C>
Cash flows from operating activities:
Net income (loss) $ 236,229 ($ 373,780)
Adjustments:
Depreciation and amortization 949,842 589,286
Provision (benefit) for deferred income taxes 245,000 245,000
Loss on trading securities 188,520 98,326
Other net changes in assets and liabilities
Decrease in receivables 93,859 (78,246)
Increase in deferred home warranty acquisition costs (464,908) (502,825)
(Increase) decrease in deferred income taxes (100,115) 685,879
(Increase) decrease in prepaid expenses and other assets (414,614) 283,380
Increase in accounts payable 956,862 1,025,212
Increase (decrease) in accrued expenses (1,639,062) 308,449
Increase (decrease) in litigation settlement 280,819 (1,369,090)
Increase in deferred home warranty revenue 1,569,311 1,799,634
Purchases of trading securities (1,375,914) (3,791,187)
Proceeds from sales of trading securities 2,011,238 5,716,104
----------- -----------
Net cash provided by operating activities 2,537,067 4,636,142
----------- -----------
Cash flows from investing activities:
Property and equipment expenditures (1,105,869) (1,189,835)
Purchases of securities classified as available for sale (4,262,227) (3,036,938)
Proceeds from sale of securities classified as available for sale 3,844,404 2,226,004
----------- -----------
Net cash used in investing activities (1,523,692) (2,000,769)
----------- -----------
Cash flows from financing activities:
Repayments of debt (511,139) (1,090,876)
Amortization of discount on long term debt 13,673 148,378
Release of restricted cash 430,000 --
Section 16(b) of the SEC Act of 1934 143,955 --
Borrowings under capital lease obligation 0 536,250
----------- -----------
Net cash used in financing activities 76,488 (406,247)
----------- -----------
Net increase in cash and cash equivalents 1,089,863 2,229,125
Cash and cash equivalents at beginning 1,833,977 997,336
of period
----------- -----------
Cash and cash equivalents at end of period $ 2,923,840 $ 3,226,461
=========== ===========
SUPPLEMENTAL DISCLOSURE:
Cash paid during the period for:
Interest 410,674.00 $ 169,622
Income taxes 70,447.00 137,499
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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
SEPTEMBER 30, 1997
(Unaudited)
1. GENERAL
The consolidated balance sheet as of September 30, 1997 and the consolidated
statements of income and cash flows for the three and nine month periods ended
September 30, 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 September 30, 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, and has received
Notices of Proposed Adjustments from the Internal Revenue Services with respect
to its federal income tax returns for those years. These notices would disallow
losses totaling approximately $20.5 million, which would result in the Company
being liable for approximately $7 million of tax, plus interest and possible
penalties. The Company believes that the returns as originally filed are correct
in all material respects, and intends to vigorously contest the IRS position.
5
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RECENT DEVELOPMENTS
In May, 1996, Homeowners Group, Inc. ("HOMG" or the "Company") entered into a
definitive merger agreement under which, as amended, The Cross Country Group,
Inc. ("Cross Country") agreed to acquire the Company.
On September 17, 1997 the Company and Cross Country signed an amendment to the
merger agreement, which commenced a tender offer to acquire all outstanding
shares, a portion of the consideration to be held in escrow pending resolution
of certain tax liabilities. On October 20, 1997 87% of issued and outstanding
shares were validly tendered to Cross Country. On October 21, 1997 as a result
of closing the tender offer, four members of the Board of Directors resigned,
and three individuals who are founders and owners of Cross Country filled the
vacancies.
BUSINESS ENVIRONMENT
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 /registred trademark/), the
HMS BuyerTrack /registered trademark/ Follow-Up System, It's Your Move, Secret
Shopper and other advertising and public relations products, services and
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. The
Company and the home warranty contract offered are subject to insurance type
regulations in 15 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.
6
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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
NINE MONTHS ENDED SEPTEMBER 30, 1997 AS COMPARED TO SEPTEMBER 30, 1996
- ----------------------------------------------------------------------
HOME WARRANTY OPERATIONS:
Home warranty revenue, totaling $32,098,000 and representing 91% of total
operating revenue for the nine months ended September 30, 1997, increased 7%
from the corresponding 1996 figure of $29,845,000, or 88% 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 nine months of 1997, as compared to the comparable 1996
period is due primarily to the impact of higher warranty production in the last
nine months of 1996, as compared to the corresponding period for 1995. Warranty
contract sales in the first nine months of 1997 were 6% higher than in the 1996
first nine months, as a result of increased sales opportunities corresponding to
increased residential resale transactions during the first three quarters of
1997. This trend is consistent with industry experience. Renewal warranty
contract sales in the first nine months of 1997 were 14% higher than in the 1996
first nine months. There have been no major pricing changes which would have
significantly affected warranty revenue.
Direct expenses of the warranty product, which consist primarily of claims
expenses and acquisition costs, as a percentage of related operating revenue,
decreased to 79% in 1997 from 81% in 1996. This decrease was experienced in
spite of the impact of the harsher winter weather in the first quarter of 1997
as compared to the first quarter of 1996, and the extremely hot summer weather
in May and June of 1997. Average severity decreased by 3% during the current
1997 nine month period, while frequency increased 9% from the corresponding 1996
levels.
The 1997 year to date warranty acquisition cost ratio is approximately 3% lower
than the comparable 1996 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.
7
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MEMBERSHIP AND OTHER OPERATIONS:
Membership related revenue was 26% 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 September 30, 1997,
approximately 21% of the Company's membership participated in the Company's E&O
program, as opposed to approximately 29% as of September 30, 1996. These members
generate the bulk of the Company's membership revenue. The remaining 79% 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 membership renewal fee, or these fees may even be waived.
Direct expenses of the membership operations declined by 32% and approximated
59% of related revenue for the first nine months of 1997 and 76% of related
revenue for the comparable prior year period. The decreasing cost ratio results
from the impact of certain fixed cost for programs which were discontinued in
late 1996.
E&O BROKERAGE OPERATIONS:
E&O brokerage revenue for the nine months ended September 30, 1997, totaled
$585,000, a decrease of 21% from $742,000 reported in the first nine months of
1996. This relates to the continuing declines in the Company's Full E&O
membership base discussed above.
Direct costs of the E&O brokerage operations increased from $530,000 or 71% of
related revenue in the 1996 first nine months to $444,000 or 75% 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.
G&A EXPENSE:
General and administrative expenses ("G&A") increased from $7,052,000 in the
first nine months of 1996 to $7,356,000 in the first nine months of 1997,
primarily due to increases in legal fees and other expenses. As a percentage of
revenue, G&A was 21% for the first nine months of 1997 and 22% for the first
nine months of 1996.
OTHER INCOME (NET):
Other income, net is comprised of net investment income in excess of interest
expense. Investment income is generated primarily from the trading securities
currently invested by the Company's regulated home warranty subsidiaries, as
well as from additional investments of funds generated through sales of warranty
products. Net investment income increased by 33%, from $484,000 for the nine
months ended September 30, 1996 to $648,000 in the 1997 equivalent period.
Approximately $142,000 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 gains of $24,000 in the
1997 first nine months. Interest expense of approximately $466,000 in the 1997
first nine month period 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 $135,000 in the 1996 nine
month period. The Company stopped funding this venture in December 1996 and
dissolved this venture in September 1997. Accordingly, there are no expenses
related to this venture included in the 1997 results.
8
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INCOME TAXES:
The Company's effective income tax rate on continuing operations for the current
nine month period was 37.7%, as compared to a benefit of 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.
THREE MONTHS ENDED SEPTEMBER 30, 1997 AS COMPARED TO SEPTEMBER 30, 1996
- -----------------------------------------------------------------------
HOME WARRANTY OPERATIONS:
Home warranty revenue, totaling $11,344,000 and representing 91% of total
operating revenue for the three months ended September 30, 1997, increased 6%
from the corresponding 1996 figure of $10,686,000, or 89% 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 1996 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 third quarter of 1997 were 9% higher than
in the 1996 third quarter. Renewal warranty contract sales in the third quarter
of 1997 were 21% higher than in the 1996 third quarter, and approximated 15% 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 84% in the 1997 third quarter from 83% in the 1996 third quarter.
This increase was primarily due to the impact of a 9.5% decrease in severity and
a 10.5% increase in frequency during the 1997 third quarter, as compared to the
1996 third quarter.
The 1997 third quarter warranty acquisition cost ratio is 4% lower than the
comparable 1996 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 1997 third quarter was 24% 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 by 25% and approximated
60% of related revenue for the third quarter of 1997 and 67% of related revenue
for the comparable prior year period. The decreasing cost ratio results from the
impact of certain fixed cost programs which were discontinued in late 1996.
9
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E&O BROKERAGE OPERATIONS:
E&O brokerage revenue for the three months ended September 30, 1997, totaled
$199,000, a decrease of 26% from the 1996 third quarter revenue of $271,000. 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 to $170,000 or 85% of
related revenue in the 1997 third quarter from $150,000 or 55% of related
revenue in the comparable 1996 period.
G&A EXPENSE:
General and administrative expenses ("G&A") decreased slightly from $2,208,000
in the third quarter of 1996 to $2,189,000 in the 1997 third quarter. As a
percentage of revenue, G&A decreased from 21.8% in the third quarter of 1996
to 18% in the third quarter of 1997.
OTHER INCOME (NET):
Other income (net) is comprised of net investment income in excess of interest
expense. Investment income is generated primarily from the trading securities
currently invested by the Company's regulated home warranty subsidiaries, as
well as from additional investments of funds generated through sales of warranty
products. Net investment income increased from $294,000 for the third quarter of
1996 to $358,000 in the current year third quarter. This increase 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 increase from the 1996 market values. Approximately $14,000 of
realized holding losses were included in the third quarter 1996 investment
income figures, as compared to realized holding gains of $21,000 in the 1997
third quarter. Interest expense of approximately $152,000 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
$120,000 in the 1996 third quarter. The Company stopped funding this venture in
December 1996 and dissolved this venture in September 1997. Accordingly, 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 third
three month period was 36.8% as compared to a benefit of 31% in the comparable
1996 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. As a result
of increases in home warranty production in the first nine months of 1997 as
compared to the first nine months of 1996, cash collected on warranty contracts
in the 1997 first nine months was approximately $230,000 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.
10
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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.
In the first nine months of 1997, net cash provided by operating activities
totaled $2,537,000, as compared to cash provided by operations of $4,636,000 in
the 1996 first nine months. This decrease in cash generated from operations is
primarily due to payments on certain accrued expenses, and the recognition of
previously deferred amounts of home warranty revenue. In the first nine months
of 1997, warranty production is up only 6%, as compared to an increase of 14% in
the 1996 first nine months over the 1995 levels. Also impacting operating cash
flows are various payments for claims payable, Affiliate and Member commissions
and E&O premium remittances. In the 1997 first nine months, the Company used
$1,524,000 in investing activities, as compared to $2,001,000 in the 1996 first
nine months, primarily due to the decreases in purchases of property and
equipment. In early 1996, certain furniture and equipment purchases were made,
related to the Company's 1996 move of its corporate headquarters. Net cash used
in financing activities totaled $76,488 in the 1997 first nine months, as
compared to cash used in financing activities of $406,000 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 $450,000. However, the Company and CNA have entered into an
amendment to the Holdback Agreement which will allow the Company to pay the
shortfall at a later date. As of September 30, 1997, the net present value of
the balance due to CNA under this obligation was $2,900,000.
Fifteen 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 September 30, 1997, approximately $11,501,000 of
cash and investments is 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 nine months 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
$13,277,000 as of September 30, 1997. The Company is currently in compliance
with all applicable surplus and reserve requirements.
In September 1997 The Company received Notices of Proposed Adjustments from the
Internal Revenue Services with respect to its federal income tax returns for the
years ended December 31, 1993, 1994 and 1995. These notices proposed to disallow
losses totaling approximately $20.5 million, which would result in the
11
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Company being liable for approximately $7 million of tax, plus interest and
possible penalties. The Company believes that the returns as originally filed
are correct in all material respects, and intends to vigorously contest the IRS
position.
12
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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.
13
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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 nine month periods ended September 30,
1997 and 1996.
(b) Reports on Form 8-K
On July 2, 1997, the Company filed a Third Amendment to
the Agreement and Plan of Merger, dated as of May 14,
1997, between the Company and the Cross Country Group
("Cross Country"), pursuant to which the expiration date
of the Merger Agreement was extended to July 31, 1997. In
addition, the Company and Cross Country also entered into
an amendment to the Agreement for Satisfaction of
Judgment, further 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 31, 1997 or termination of the merger
agreement.
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.
November 14, 1997 By: /s/ C. GREGORY MORRIS
-------------------------------------
C. Gregory Morris
Vice President, Treasurer and
Chief Financial Officer
14
<PAGE>
EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
11. Computation of Net Income per Common Share for the three and
nine month periods ended September 30, 1997 and 1996.
27. Financial Data Schedule (EDGAR version only)
<TABLE>
<CAPTION>
EXHIBIT 11
HOMEOWNERS GROUP, INC. AND SUBSIDIARIES
COMPUTATION OF NET INCOME (LOSS) PER COMMON SHARE
FOR THE THREE AND NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
1997 1996 1997 1996
------------------------- -------------------------
<S> <C> <C> <C> <C>
Net income (loss) $ 113,444 $ 104,357 $ 236,229 ($ 373,780)
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 (option) -- -- -- --
------------------------- -------------------------
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 $ 0.02 $ 0.02 $ 0.04 ($ 0.07)
========================= =========================
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 $ 0.02 $ 0.02 $ 0.04 ($ 0.07)
========================= =========================
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-END> SEP-30-1997
<CASH> 2,923,841
<SECURITIES> 4,343,037
<RECEIVABLES> 896,785
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 23,012,583
<PP&E> 4,615,546
<DEPRECIATION> 0
<TOTAL-ASSETS> 38,809,632
<CURRENT-LIABILITIES> 33,240,546
<BONDS> 0
<COMMON> 55,584
0
0
<OTHER-SE> 4,088,896
<TOTAL-LIABILITY-AND-EQUITY> 38,809,632
<SALES> 0
<TOTAL-REVENUES> 12,398,163
<CGS> 0
<TOTAL-COSTS> 12,509,555
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 179,444
<INCOME-TAX> (66,000)
<INCOME-CONTINUING> 113,444
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 113,444
<EPS-PRIMARY> 0.02
<EPS-DILUTED> 0.02
</TABLE>
