<PAGE>
Washington, D. C. 20549
FORM 10-KSB
(Mark One)
__X__ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE
ACT OF 1934 For the fiscal year ended December 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 0-24638
-------
MOUNTBATTEN, INC.
- --------------------------------------------------------------------------------
(Name of small business issuer as specified in its charter)
Pennsylvania 23-2633708
- ---------------------------- -------------------------------
(State or other jurisdiction IRS Employer Identification No.
of incorporation or organization)
33 Rock Hill Road
Bala Cynwyd, Pennsylvania 19004
- ---------------------------------------- ----------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (610) 664-2259
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.001 par value
-----------------------------
(Title of class)
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15 (d) of the Exchange Act during the past 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____
Check if disclosure of delinquent filers in response to Item 405 of
Regulation S-B, is not contained in this form, and no disclosure will be
contained, to the best of the registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB. [ X ]
State issuer's revenues for the most recent fiscal year: $8,965,600
The aggregate market value of the voting stock held by non-affiliates, as of
March 24, 1998 was approximately $23 million.
As of March 24, 1998 the aggregate number of shares outstanding was 2,528,530.
DOCUMENTS INCORPORATED BY REFERENCE:
None.
Transitional Small Business Disclosure Format (check one) Yes____ No __X__
<PAGE>
Item 1. Description of Business
A. Description of the Business
Mountbatten, Inc. ("Mountbatten") commenced operations in February
1992. Mountbatten acts as a holding company for The Mountbatten Surety Company,
Inc. (the "Surety Company") and HMS Dreadnought, Inc. ("Dreadnought"). The
Surety Company engages in the underwriting of surety bonds, primarily contract
bonds. Contract bonds constitute a specialty market within the property and
casualty insurance industry, and are generally posted by contractors (and/or
subcontractors) to guarantee completion of their work on government and private
construction projects.
Suretyship is an extension of credit in the form of an agreement by the
"surety" for the benefit of the "obligee" to guarantee payment or performance by
the "principal." When a surety bond is issued, the obligee holds the surety
responsible for the obligation of the principal. The surety and the principal
are jointly responsible to the obligee for the debt or obligation, which is the
subject of the surety bond. Surety bonds are often required by law, and a type
of surety bond known as a "contract bond" is often required by a party, whether
private or governmental, entering into a construction, rehabilitation,
remediation or similar contract. In some instances, bonds are furnished in lieu
of cash deposits, but often a bond is required and a cash alternative is not
permitted.
The Surety Company wrote its first bond in October 1992. In May 1994,
the Surety Company received a Treasury Listing (the "T-Listing") to write
federally required bonds anywhere in the United States and its territories.
Prior to July 1994, the Surety Company was licensed to write bonds only in the
Commonwealth of Pennsylvania. The following table sets forth information,
chronologically, with respect to those states in which the Surety Company is
presently licensed to write bonds:
State Date of Admission
- ----- -----------------
Pennsylvania September 11, 1992
Delaware July 13, 1994
Maryland October 7, 1994
New Jersey March 31, 1995
Virginia August 17, 1995
District of Columbia September 1, 1995
New York October 19, 1995
Ohio November 28, 1995
Kentucky April 26, 1996
Tennessee September 23, 1996
Indiana September 30, 1996
Connecticut December 1, 1996
Mississippi December 1, 1996
Illinois December 5, 1996
South Carolina February 3, 1997
West Virginia May 8, 1997
Alabama August 6, 1997
Michigan March 3, 1998
In addition, the Surety Company has applied for a license to underwrite
bonds in Florida, Georgia, Iowa and North Carolina, and anticipates filing
license applications in various other states.
Dreadnought commenced operations in February 1997. It provides escrow,
dispute resolution, claims handling and construction management services to
Mountbatten. (Mountbatten together with the Surety Company and Dreadnought are
referred to below as the "Company".)
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B. Bond Products
The Surety Company writes primarily contract bonds to guarantee the
required performance and payments of contractors and subcontractors engaged in
construction and, to a lesser extent, environmental remediation projects.
Projects bonded by the Surety Company generally have durations that do not
exceed two years; most are completed in one year or less. The Surety Company
also writes a variety of other surety bonds, although it is focusing
increasingly on contract bonds. The Surety Company does not provide financial
guarantee bonds, bail bonds, bonds for remediation of groundwater contamination
or bonds covering a variety of risks deemed inappropriate for the Surety
Company; nor does it underwrite any liability insurance.
The following table sets forth information concerning the nature of the
bonds written by the Surety Company for the years ended December 31, 1997 and
1996:
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------
Years ended December 31,
- --------------------------------------------------------------------------------------------------------
1997 1996
---- ----
% of % of
Gross Gross Gross Gross
% of Written Written % of Written Written
Type of Bond Number Total Premiums Premiums Number Total Premiums Premiums
------------ ------ ----- ----------- -------- ------ ----- - --------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Contract bonds 1,525 82.0% $10,087,891 97.0% 1,112 80.1% $ 7,541,676 96.3%
Non-contract bonds 335 18.0% 308,757 3.0% 277 19.9% 287,495 3.7%
------ ----- ----------- ----- ------ ----- ----------- -----
Total 1,860 100.0% $10,396,648 100.0% 1,389 100.0% $ 7,829,171 100.0%
- --------------------------------------------------------------------------------------------------------
</TABLE>
Prior to November 1997, the reinsurance program required that the
Company not write any bond exceeding $5 million, or bonds on the same work
program in favor of the principal exceeding $7.5 million in the aggregate.
Effective November 1, 1997, the Company secured a new reinsurance treaty that
increased the maximum single bond limit to $6 million, and the work program
aggregate to $12 million. While future increases in the Surety Company's maximum
bond size are anticipated, management believes that the current maximum bond
size of $6 million will allow the Surety Company to continue to penetrate
selected markets for contract bonds.
The following table sets forth information concerning the dollar amount
of bonds written by the Surety Company for the years ended December 31, 1997 and
1996:
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------
Years ended December 31,
- -----------------------------------------------------------------------------------------------------------
1997 1996
---- ----
% of % of
Gross Gross Gross Gross
% of Written Written % of Written Written
Bond Amount Number Total Premiums Premiums Number Total Premiums Premiums
----------- ------ ----- -------- -------- ------ ----- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
$150,000 or less 1,122 60.3% $1,201,098 11.5% 896 64.5% $912,120 11.7%
$150,001 - $250,000 192 10.3% 805,775 7.8% 132 9.5% 565,590 7.2%
$250,001 - $500,000 216 11.6% 1,555,517 15.0% 168 12.1% 1,331,933 17.0%
$500,001 - $750,000 128 6.9% 1,349,774 13.0% 59 4.2% 726,215 9.2%
$750,001 - 48 2.6% 742,798 7.1% 36 2.6% 663,188 8.5%
$1,000,000
$1,000,001 - 59 3.2% 1,152,813 11.1% 36 2.6% 886,583 11.3%
$1,500,000
$1,500,001 - 27 1.4% 680,905 6.5% 23 1.7% 804,420 10.3%
$2,000,000
$2,000,001 - 35 1.9% 1,415,228 13.6% 22 1.6% 945,908 12.1%
$3,000,000
OVER $3,000,000 33 1.8% 1,492,740 14.4% 17 1.2% 993,214 12.7%
---- ----- --------- ------ ---- ----- --------- ------
Total 1,860 100.0% $10,396,648 100.0% 1,389 100.0% $7,829,171 100.0%
===== ====== =========== ====== ===== ====== ========== ======
- -----------------------------------------------------------------------------------------------------------
</TABLE>
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The Surety Company uses bond forms prepared by the American Institute
of Architects ("AIA"), or bond forms specified by the bond obligee, for
performance, payment and bid bonds. The Surety Company also uses an internally
generated indemnity agreement to document its rights with respect to entities or
persons it bonds. Among other things, the indemnity agreement provides the
Surety Company with an assignment of the principal's contract rights and a
confession of judgment against the bond principal in the event of a default
under the indemnity agreement, the principal's obligation, or both.
C. Underwriting
The Surety Company places a high priority on minimizing bond claims and
losses. Accordingly, the Surety Company underwrites each bond submission at its
home office and has granted no binding authority to its independent brokers and
agents. The Surety Company believes that its use of both financial analysis and
technical analysis in the bond underwriting process permits it to achieve better
underwriting results than would otherwise be possible through financial analysis
alone. Technical analysis procedures in the underwriting process using
management's expertise in the construction industry can provide an indication of
substandard construction or record-keeping practices that might increase the
likelihood of a bond claim.
D. Claims and Reserves
The Surety Company attempts to actively manage disputes and claims in
an effort to minimize losses. Depending on the relevant factors, the Surety
Company can pursue its rights at law and, under the general indemnity agreements
associated with a bond, may enforce its rights with respect to collateral
securing the bond; may pay the claim or may complete the project using any
remaining project funds due the bonded contractor as well as, or in addition to,
seeking the remedies referred to previously.
While the Surety Company does not bond projects with durations
exceeding two years, and while it attempts to obtain releases from bond obligees
upon completion of bonded projects, in cases where releases are not obtained,
claims may be asserted following completion of the contract. AIA performance
bonds permit claims for up to two years following the scheduled date of the
final contract payment, and AIA payment bonds permit claims up to one year after
the bond principal ceases work on the project.
The Surety Company maintains incurred but not reported loss ("IBNR")
reserves with respect to claims that have been incurred but not reported.
Because of the Company's limited operating history and claims experience, its
IBNR reserves are primarily based on both data derived from the experience of
industry, as well as the Surety Company's actual experience. The Surety Company
has established case reserves to provide for all anticipated payments and
related expenses on known claims.
Case and IBNR reserves are reviewed and certified at least annually by
the Surety Company's independent actuary. Such certification has been obtained
as of December 31, 1997. The Surety Company believes that aggregate reserves
make reasonable and sufficient provision for payments on reported and unreported
claims.
E. Sales and Marketing
Substantially all the Surety Company's business is produced by its
network of independent brokers and agents. The Surety Company documents its
agent relationships with a broad agency agreement, which relies on
pre-negotiated commission and incentive commission schedules. The Surety Company
has established similar agency arrangements in all of the states in which it is
licensed to write bonds.
3
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F. Regulation
Surety companies are generally regulated as property and casualty
insurance companies even though surety bonds differ in important respects from
traditional forms of property and casualty insurance. Thus, surety companies,
like other types of insurance companies, are subject to supervision and
regulation in the states in which they transact business. Such supervision and
regulation, designed primarily for the protection of policyholders (or bond
obligees) and not shareholders, relate to most aspects of an insurance company's
business and include such matters as authorized lines of business, underwriting
standards, financial condition standards, licensing, investment policies,
premium levels and the filing of quarterly, annual and other reports based on
statutory accounting principles and a variety of other financial and
nonfinancial matters.
Because the Company is domiciled in the Commonwealth of Pennsylvania,
the Pennsylvania Insurance Department (the "Department") has primary authority
over it. The Surety Company is also subject to the supervision and regulation of
the appropriate agency in any state in which the Surety Company obtains a
license to transact business.
In general, the Surety Company must obtain a license in a given state
in order to write bonds covering risks therein. In order to obtain a license,
the Surety Company must submit detailed financial and other information, and
satisfy statutory and regulatory requirements, as well as informal criteria
applied by the state insurance department.
In May 1994, the Surety Company received a certificate of authority, or
"T-Listing," from the United States Department of the Treasury, allowing it to
write bonds required by the United States government. The T-Listing entitles the
Surety Company to write federally required bonds anywhere in the United States
or its territories, currently in amounts up to $798,000 (representing
approximately 10% of the Surety Company's statutory policyholders' surplus at
December 31, 1996). The Surety Company is authorized to write larger bonds so
long as a T-Listed reinsurer with greater bonding authority (such as the Surety
Company's current reinsurer) provides a "Miller Act" endorsement undertaking to
be liable directly to the bond obligee in the event the Surety Company defaults
on its bond. The Surety Company intends to write bonds regularly on this basis.
The Company expects its T-Listing amount to increase in the 1998 Treasury
Circular.
The range of premium rates charged by the Surety Company for its bonds
has been filed with and approved by the Department. The Department's approval is
required to increase or decrease premiums in the future beyond the current
ranges of approved premium rates. The Surety Company would additionally require
rate approvals from other states in which it is licensed in order to change its
premium rates from the ranges currently approved.
Most states, including Pennsylvania, have enacted legislation that
regulates insurance holding company systems. Each insurance holding company
system is required to register with the insurance supervisory agency of its
state of domicile, and furnish information concerning the operations of
companies within the system. Pursuant to these laws, the Department may examine
the Company and the Surety Company, require disclosure of material transactions
by the holding company, and require prior approval of certain transactions, such
as extraordinary dividends from an insurance company to its holding company.
All transactions between the Company and the Surety Company must be
fair and equitable. Approval by the applicable Insurance Commissioner is
required prior to consummation of transactions affecting the control of an
insurer. In Pennsylvania, the acquisition of 10% or more of the outstanding
capital stock of an insurer or its holding company is presumed to be a change in
control.
4
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G. Competition
The surety industry is highly competitive. Many surety companies are
larger than the Surety Company, have considerably greater financial and other
resources, have greater experience in the surety industry and, unlike the Surety
Company, offer a broad line of insurance products. In addition, the Surety
Company is at a competitive disadvantage against companies that have an A.M.
Best "letter" rating and/or licenses to write surety bonds on a broader
geographic basis. A.M. Best has assigned a "number" rating of 5 (Secure) to the
Surety Company, and will assign a "letter" rating to the Surety Company in 1998,
once five full years of operations have been completed. While many of the
largest surety companies have targeted the market for bonds of $6 million or
more, many other surety companies actively target the Surety Company's primary
market niche for bonds up to $6 million. The Surety Company attempts to meet
this competition by providing its brokers, agents and customers with high
quality, timely and innovative services.
H. Employees
The Company employs 23 full time employees at its Bala Cynwyd,
Pennsylvania offices. Management believes that employee relations are generally
good.
Item 2. Description of Property
The Company leases 4,424 square feet of office space at 33 Rock Hill
Road, Bala Cynwyd, Pennsylvania 19004 at an annual cost of approximately
$79,762. The lease term expires September 30, 1999, provided that the Company
may terminate the lease at any time by giving 60 days advance written notice and
paying a specified amount of the landlord's cost to improve the space. The
Company has not purchased or developed real estate for investment purposes or
made real estate loans. Accordingly, it has no properties arising from such
activities.
Item 3. Legal Proceedings
The Company is not involved in any pending or threatened legal or
administrative proceedings other than those undertaken in the ordinary course of
its surety business.
Item 4. Submission of Matters to a Vote of Security Holders
No matter was submitted to a vote of security holders through the
solicitation of proxies or otherwise during the fourth quarter of the year ended
December 31, 1997.
Executive Officers of the Company
The names of the executive officers of the Company, together with
certain information regarding them, are as follows:
Name Age Position
- ---- --- --------
Kenneth L. Brier 48 President and Chief Executive Officer since 1992
Ted A. Drauschak 37 Executive Vice President since 1992
Joel D. Cooperman 45 Vice President - Finance, Treasurer, and Chief
Financial Officer since 1995; Formerly Vice
President - Finance, Treasurer, and Chief
Financial Officer with O'Brien Environmental
Energy, Inc. from January 1981 through April 1995
5
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Item 5. Market for Common Equity and Related Stockholder Matters
The Registrant's common stock was originally traded in the
over-the-counter market on the Nasdaq SmallCap Market System under the symbol
MTBN. The Company publicly listed its common stock as a result of an initial
public offering that was completed in September 1994. On December 26, 1995 the
Registrant's common stock began trading on the Nasdaq National Market System
under the same symbol. The following table sets forth the high and low trading
prices as reported by Nasdaq:
<TABLE>
<CAPTION>
1997 1996
---- ----
High Low High Low
---- --- ---- ---
<S> <C> <C> <C> <C>
First Quarter 9 5/8 8 6 1/4 5
Second Quarter 11 8 8 1/2 5 1/4
Third Quarter 11 3/4 9 1/2 8 1/2 7
Fourth Quarter 15 1/2 11 8 3/4 7 3/4
</TABLE>
On March 20, 1998 the closing price was $13.75. There were
approximately 44 holders of record of the common stock of the Company. The
Company believes that there are approximately 438 beneficial owners of its
common stock.
The Registrant has paid no dividends in the past, though it may elect
to do so in the future. Dividends are subject to the dividend restrictions
imposed on the Surety Company by the Department. Pennsylvania insurance laws
currently prohibit dividends that would leave the Surety Company with total
capital and surplus in an amount less than the Department requires to conduct a
surety business. These laws also afford the Department 30 days to disapprove the
payment of dividends in excess of "unassigned surplus" (i.e., undistributed
accumulated surplus including net income and realized gains) or "extraordinary
dividends" (i.e., dividends over a twelve-month period that exceed the greater
of 10% of policyholders' surplus as shown on the latest annual statement filed
with the Department, or net income shown on such statement).
6
<PAGE>
Item 6.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Introduction
The Company's principal business activity is to underwrite surety bonds
through its wholly owned subsidiary, the Surety Company. The Surety Company
wrote its first bond in October 1992. In May 1994, the Surety Company received a
Treasury Listing (the "T-Listing") to write federally required bonds anywhere in
the United States and its territories. Prior to July 1994, the Surety Company
was licensed it write bonds only in the Commonwealth of Pennsylvania. The
following table sets forth information, chronologically, with respect to those
states in which the Surety Company is presently licensed to write bonds:
State Date of Admission
- ----- -----------------
Pennsylvania September 11, 1992
Delaware July 13, 1994
Maryland October 7, 1994
New Jersey March 31, 1995
Virginia August 17, 1995
District of Columbia September 1, 1995
New York October 19, 1995
Ohio November 28, 1995
Kentucky April 26, 1996
Tennessee September 23, 1996
Indiana September 30, 1996
Connecticut December 1, 1996
Mississippi December 1, 1996
Illinois December 5, 1996
South Carolina February 3, 1997
West Virginia May 8, 1997
Alabama August 6, 1997
Michigan March 3, 1998
In addition, the Surety Company has applied for a license to underwrite
bonds in Florida, Georgia, Iowa, and North Carolina, and anticipates filing
license applications in various other states.
Results of Operations
Year ended December 31, 1997 compared to year ended December 31, 1996:
During the year ended December 31, 1997, the Surety Company generated
$10,396,648 of gross written premiums, compared to $7,829,171 of gross written
premiums during the year ended December 31, 1996, representing an increase of
$2,567,477, or 33%. Management attributes the increase in gross written premiums
primarily to the Surety Company's increased penetration of the states in which
the Surety Company became licensed in late 1995 and during 1996.
For the year ended December 31, 1997, ceded reinsurance premiums
totaled $1,560,662, representing approximately 15% of gross written premiums.
For the year ended December 31, 1996, ceded reinsurance premiums totaled
$1,287,308, representing approximately 16% of gross written premiums. The
increase in ceded reinsurance premiums from the 1996 period to the 1997 period
was primarily the result of the increase in gross written premiums as well as an
increase in reinsurance coverage limits and reinstatements, offset by a slightly
lower reinsurance rate.
7
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Effective November 1, 1996 through October 31, 1997, the Company's work
program aggregate under its reinsurance treaty increased to $10 million from
$7.5 million. The maximum single bond limit remained at $5 million. However, the
Company's aggregate reinsurance coverage limits and reinstatements increased,
and ceded reinsurance premiums were calculated at approximately 15.26% of gross
written premiums, net of the Company's 5% participation in the first and second
layers.
Effective November 1, 1997, for the twelve-month period ending October
31, 1998, the Company's maximum single bond limit increased to $6 million from
$5 million, and the work program aggregate increased to $12 million from $10
million. In addition, the Company's aggregate reinsurance coverage limits and
reinstatements increased, and ceded reinsurance premiums will represent
approximately 14.11% of gross written premiums, net of the Company's 5%
participation in the first and second layers.
The Company's current reinsurance program provides four layers of
reinsurance. Under the first layer, the Company retains 100% of all losses up to
$150,000 and the reinsurer assumes 95% of the next $850,000, subject to a
maximum annual recovery by the Company of $4,250,000. The second layer provides
$2,000,000 of coverage (95% to be assumed by the reinsurer) on any loss
discovered for any principal in excess of the first $1,000,000 of loss with an
aggregate annual maximum of $6,000,000. The third layer provides $3,000,000 of
coverage on any loss discovered for any principal in excess of the first
$3,000,000 of loss with an aggregate annual maximum of $6,000,000. The fourth
layer provides $4,000,000 of coverage on any loss discovered for any principal
in excess of the first $6,000,000 with an aggregate annual maximum of
$4,000,000.
For the year ended December 31, 1997, claims and claim adjustment
expenses incurred were $921,499, or an incurred loss and loss adjustment expense
ratio of 11.2%, compared to $519,708, or an incurred loss and loss adjustment
expense ratio of 8.4%, for the year ended December 31, 1996. The increase in
claim and claim adjustment expenses in 1997 reflects primarily the increase in
the Company's business volume and claims paid by the Company.
Of the $921,499 of claims and claim adjustment expenses incurred in
1997, $839,190 relates to known claims, most of which are associated with four
bonded principals. $82,309 relates to the increase in IBNR reserves, which is
primarily driven by net earned premiums in force at December 31, 1997.
A limited number of claims have been filed on the Surety Company's
bonds. Accordingly, the Surety Company has established IBNR and case reserves of
$608,819 and $2,749,759, respectively, gross of reinsurance, to provide for
future claims and claim adjustment expense payments.
For the year ended December 31, 1997, commission expenses were
$3,040,013, representing approximately 29% of gross written premiums, compared
to $2,233,048, or approximately 29% of gross written premiums, for the year
ended December 31, 1996. The increase in commission expenses in 1997 relates
primarily to the increase in gross written premiums.
For the years ended December 31, 1997 and 1996, the Company incurred
salary and benefits costs of $1,529,372 and $1,299,702, respectively. The
increase in salary and benefit costs in 1997 reflects an increase in the number
of employees, including additional underwriters and related support personnel, a
controller, increased compensation and merit bonuses for these personnel, as
well as additional compensation awarded to senior management by the Company's
compensation committee.
For the year ended December 31, 1997, the Company incurred
approximately $158,072 for professional services and $938,187 for other
operating expenses, compared to $144,128 and $705,188, respectively, for the
year ended December 31, 1996. This increase reflected legal, accounting,
auditing, and various other expenses incurred to comply with regulatory
reporting obligations, licensure and tax requirements in states in which the
Company is licensed to transact business, licensing of additional agents, and
required infrastructure changes to support the Company's current and expected
future levels of gross written premiums.
8
<PAGE>
For the years ended December 31, 1997 and 1996, the Company generated
$439,265 and $421,810, respectively, of income from its investments, comprised
exclusively of U.S. Government securities. The yield on average invested assets
for 1997 and 1996 was 5.22% and 5.6%, respectively. The slight increase in
interest income in 1997 was due to the investment of additional funds generated
from the Company's operations during most of the year, offset by lower yields.
$4,620,819 of the Company's investment portfolio is invested in a U.S.
government security maturing in November 2000. The balance of the portfolio is
invested in U.S. government securities maturing in less than one year.
For the year ended December 31, 1997, the Company generated $273,048 of
fee income for various services performed by Dreadnought (including escrow,
dispute resolution, claims handling, and construction management). These
services were rendered to third parties in connection with bonds written by the
Surety Company.
The provision for income taxes for 1997 was $815,235 (an effective tax
rate of 34.3%), as compared to $593,831 (an effective tax rate of 34.3%) for
1996.
Net income for the year ended December 31, 1997 was $1,563,222, as
compared to $1,135,370 for the year ended December 31, 1996, an increase of
$427,852, or 38%.
Seasonality
Because most of the Surety Company's premiums are generated on
construction related bonds, and are associated with jobs primarily in
Mid-Atlantic and Mid-Western States, the Surety Company's business has been
seasonal. Accordingly, operating results have varied from quarter to quarter,
with premium levels lowest from November to March. Seasonality is expected to
have less of an effect on premium activity as the Surety Company becomes
licensed and generates business in states having more temperate climates.
Liquidity and Capital Resources
Initial operations of the Surety Company were financed by contributions
from the Company, principally from the sale of common stock by the Company.
Continuing operations have been financed by internally generated cash flow from
operations. Costs incurred by the Company are shared with the Surety Company and
Dreadnought under a services agreement which provides for these subsidiaries to
reimburse the Company for costs paid by the Company which are deemed to benefit
the subsidiaries. The Surety Company may elect to pay dividends in the future,
subject to the dividend restrictions of the Commonwealth of Pennsylvania
insurance laws and regulations. The Company expects to maintain a high level of
liquidity through, among other things, the continued investment in U.S.
government securities and other high-grade investment instruments.
During 1997, approximately $279,000 of the Company's cash and
investment portfolio was converted to U.S. Treasury instruments in conjunction
with the licensure requirements of various states. Management anticipates that
additional "deposit" requirements will be required to be satisfied in those
states in which the Surety Company intends to seek a license to write surety
bonds.
The Company had approximately $8,289,000 of investments and cash
equivalents at December 31, 1997, and approximately $9,248,000 of investments
and cash equivalents at December 31, 1996. The decrease in investments and cash
equivalents is primarily attributed to the increase in reinsurance and
subrogation receivable, offset by the respective loss reserves. These amounts
have increased, over the balances that existed at December 31, 1996, as a result
of timing differences between the Company's payments of claims and its
anticipated recovery of the funds through subrogation efforts and reinsurance
payments.
The Company's anticipated expansion plans will require additional
personnel and financial resources. While certain costs are expected to increase
due to the changes in infrastructure as discussed
9
<PAGE>
above, management believes that the Company and the Surety Company have adequate
liquidity to pay all claims and meet all other obligations for the next twelve
months, at a minimum.
The Surety Company requires capital to support its bond underwriting.
Management believes that the statutory surplus of the Surety Company, which was
approximately $9,048,000 at December 31, 1997, will be sufficient to support the
Surety Company's current and anticipated premiums and losses.
The Year 2000 Issue
Many existing computer programs use only two digits to identify a year
in the date field. These programs were designed and developed without
considering the impact of the upcoming change in the century. If not corrected,
many computer applications could fail or create erroneous results by or at the
Year 2000. The Year 2000 Issue affects virtually all companies and
organizations. Management believes the Year 2000 Issue will not have a material
adverse effect on the Company's financial position or operations.
Cautionary Statement for Forward Looking Statements
Except for historical information provided in the Management's
Discussion and Analysis, statements made throughout this document are
forward-looking and contain information about financial results, economic
conditions, trends and known uncertainties. The Company cautions the reader that
actual results could differ materially from those expected by the Company,
depending on the outcome of certain factors (some of which are described with
the forward-looking statements) including: 1) adverse loss development for
projects bonded by the Company in prior years; 2) heightened competition,
particularly price competition, reducing margins; and 3) significant changes in
interest rates.
10
<PAGE>
Item 7. Financial Statements
<TABLE>
<CAPTION>
Page
----
<S> <C>
Report of Independent Accountants 12
Consolidated Balance Sheets as of December 31, 1997 and 1996 13
Consolidated Statements of Operations for the years ended
December 31, 1997 and 1996 14
Consolidated Statements of Changes in Shareholders' Equity for the years ended
December 31, 1997 and 1996 15
Consolidated Statements of Cash Flows for the years ended
December 31, 1997 and 1996 16
Notes to Consolidated Financial Statements 17
</TABLE>
11
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders
of Mountbatten, Inc.
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, of changes in shareholders' equity and of
cash flows present fairly, in all material respects, the financial position of
Mountbatten, Inc. and its subsidiaries at December 31, 1997 and 1996, and the
results of their operations and their cash flows for each of the two years in
the period ended December 31, 1997, in conformity with generally accepted
accounting principles. These financial statements are the responsibility of the
Company's management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these
statements in accordance with generally accepted auditing standards which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.
/S/ PRICE WATERHOUSE LLP
PRICE WATERHOUSE LLP
Boston, Massachusetts
February 20, 1998
12
<PAGE>
Mountbatten, Inc. and Subsidiaries
Consolidated Balance Sheets
<TABLE>
<CAPTION>
As of As of
December 31, 1997 December 31, 1996
----------------- -----------------
<S> <C> <C>
ASSETS
Fixed maturity securities
Available for sale, at fair value (amortized
cost of $7,715,677 and $8,596,475, respectively) $ 7,687,211 $ 8,487,946
Cash and cash equivalents 601,587 759,749
Premiums receivable 928,301 562,820
Miscellaneous accounts recoverable 30,005 2,200
Reinsurance receivable 2,200,283 294,911
Subrogation receivable 2,539,976 606,476
Accrued investment income 59,466 60,196
Property and equipment, net 112,736 56,838
Deferred policy acquisition costs 653,725 393,447
Prepaid reinsurance premiums 394,887 --
Deferred tax asset -- 32,223
Other assets 83,830 2,015
------------ ------------
TOTAL ASSETS $ 15,292,007 $ 11,258,821
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Unpaid claims and claim adjustment expenses $ 3,358,578 $ 1,153,270
Unearned premiums 1,536,800 954,101
Reinsurance premium payable -- 353,834
Accrued expenses and other liabilities 200,307 254,927
Deferred tax liability 86,491 --
Federal income taxes payable 105,864 161,505
------------ ------------
TOTAL LIABILITIES 5,288,040 2,877,637
------------ ------------
Commitments and contingencies (Notes 4 and 10)
Shareholders' Equity
Common stock, par value $.001 per share;
Authorized 20,000,000 shares; issued and
and outstanding, 2,528,530 shares 2,529 2,529
Additional paid in capital 6,762,934 6,762,934
Net unrealized depreciation, fixed maturities (12,068) (71,629)
Retained earnings 3,250,572 1,687,350
------------ ------------
TOTAL SHAREHOLDERS' EQUITY 10,003,967 8,381,184
------------ ------------
TOTAL LIABILITIES AND SHAREHOLDERS'
EQUITY $ 15,292,007 $ 11,258,821
============ ============
</TABLE>
The accompanying notes are an integral part of these financial statements.
13
<PAGE>
Mountbatten, Inc. and Subsidiaries
Consolidated Statements of Operations
<TABLE>
<CAPTION>
Year ended
December 31,
-------------------------------------
1997 1996
------------ ------------
Underwriting:
<S> <C> <C>
Gross written premiums $ 10,396,648 $ 7,829,171
Premiums ceded (1,560,662) (1,287,308)
------------ ------------
Net written premiums 8,835,986 6,541,863
Change in unearned premium (582,699) (332,698)
------------ ------------
Net earned premiums 8,253,287 6,209,165
------------ ------------
Claims and claims adjustment expenses 921,499 519,708
Commission expense 3,040,013 2,233,048
Salaries and benefits 1,529,372 1,299,702
Professional fees 158,072 144,128
Other operating expenses 938,187 705,188
------------ ------------
6,587,143 4,901,774
------------ ------------
Underwriting income 1,666,144 1,307,391
Other income
Interest income 439,265 421,810
Fee income 273,048 --
------------ ------------
Income before income taxes 2,378,457 1,729,201
Provision for income taxes 815,235 593,831
------------ ------------
Net income $ 1,563,222 $ 1,135,370
============ ============
Shares outstanding - basic 2,528,530 2,528,530
------------ ------------
Earnings per common share - basic $ 0.62 $ 0.45
------------ ------------
Shares outstanding - diluted 2,769,527 2,662,000
------------ ------------
Earnings per share - diluted $ 0.56 $ 0.43
------------ ------------
</TABLE>
The accompanying notes are an integral part of these financial statements.
14
<PAGE>
Mountbatten, Inc. and Subsidiaries
Consolidated Statements of Changes in Shareholders' Equity
<TABLE>
<CAPTION>
Net unrealized
(Depreciation), Total
Common Additional Fixed Retained Shareholders'
Shares Amount Paid-in-capital Maturities Earnings Equity
------ ------ --------------- ---------- -------- ------
<S> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1995 2,528,530 $ 2,529 $ 6,762,934 $ 13,580 $ 551,980 $ 7,331,023
Net income 1,135,370 1,135,370
Change in unrealized depreciation,
Fixed maturities, net of deferred tax (85,209) (85,209)
---------- ----------- ----------- ----------- ----------- -----------
Balance at December 31, 1996 2,528,530 $ 2,529 $ 6,762,934 $ (71,629) $ 1,687,350 $ 8,381,184
========== =========== =========== =========== =========== ===========
Net income 1,563,222 1,563,222
Change in unrealized appreciation,
Fixed maturities, net of deferred tax 59,561 59,561
---------- ----------- ----------- ----------- ----------- -----------
Balance at December 31, 1997 2,528,530 $ 2,529 $ 6,762,934 $ (12,068) $ 3,250,572 $10,003,967
========== =========== =========== =========== =========== ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
15
<PAGE>
Mountbatten, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
<TABLE>
<CAPTION>
Year ended December 31,
----------------------------------
1997 1996
----------- -----------
<S> <C> <C>
Operating activities:
Net income $ 1,563,222 $ 1,135,370
Adjustments to reconcile net income to net cash
Provided by operating activities:
Depreciation and amortization 45,207 26,391
Changes in:
Premiums receivable (365,481) (177,448)
Reinsurance receivable (1,905,372) (89,874)
Subrogation recoverable (1,933,495) (212,477)
Accrued investment income 730 (23,523)
Unearned premiums 582,699 332,698
Unpaid claims and claim adjustment expenses 2,205,308 551,005
Prepaid reinsurance premiums (394,887) 39,166
Reinsurance premium payable (353,834) 353,834
Accrued expenses and other liabilities (54,620) 8,335
Deferred acquisition costs (260,278) (122,760)
Deferred taxes 118,714 81,374
Federal income taxes payable (55,641) (35,119)
Other, net (130,065) 99,059
----------- -----------
Net cash (used in) provided by operating activities (937,793) 1,966,031
----------- -----------
Investing activities:
Purchases of equipment (101,104) (30,710)
Purchases of investments (3,094,491) (3,952,428)
Maturities of investments 3,975,226 2,021,217
----------- -----------
Net cash provide by (used in) investing activities 779,631 (1,961,921)
----------- -----------
Net (decrease) increase in cash and cash equivalents (158,162) 4,110
Cash and cash equivalents at beginning of period 759,749 755,639
----------- -----------
Cash and cash equivalents at end of period $ 601,587 $ 759,749
=========== ===========
Supplemental disclosure of cash flow information:
Federal tax payments $ 775,000 $ 503,680
=========== ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
16
<PAGE>
Mountbatten, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Note 1 - Description of Business:
Mountbatten, Inc. ("Mountbatten") commenced operations on February 1, 1992.
Mountbatten acts as a holding company for The Mountbatten Surety Company, Inc.
(the "Surety Company") and HMS Dreadnought, Inc. ("Dreadnought"). The Surety
Company underwrites performance, payment and other bonds, and is licensed to
conduct business in the Commonwealths of Pennsylvania, Virginia, and Kentucky,
the States of Delaware, Maryland, New Jersey, New York, Ohio, Tennessee,
Indiana, Connecticut, Mississippi, Illinois, South Carolina, West Virginia,
Alabama, Michigan and the District of Columbia. The Surety Company distributes
bonds in these states through independent agents and brokers. Dreadnought
commenced operations in February 1997, and provides escrow and disbursement
services, inspections, subrogation recovery, dispute resolution, claims
handling, construction management and other surety related services.
(Mountbatten together with the Surety Company and Dreadnought are referred to
below as the "Company").
Note 2 - Summary of Significant Accounting Policies:
Basis of presentation:
The consolidated financial statements have been prepared in conformity with
generally accepted accounting principles ("GAAP"). The consolidated financial
statements include the accounts of Mountbatten, Inc. and its subsidiaries. The
preparation of financial statements in conformity with GAAP requires management
to make estimates and assumptions that affect the reported amounts and related
disclosures in the notes to the consolidated financial statements. Significant
estimates used in determining subrogation recoverable, unearned premiums and
unpaid claims and claim expenses are discussed throughout these notes. Actual
results could differ from those estimates. All intercompany amounts are
eliminated in consolidation.
Stock-Based Compensation:
Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based
Compensation ("FASB Statement No. 123") encourages, but does not require,
companies to record compensation cost for stock-based employee compensation
plans at fair value. The Company has chosen to account for stock-based
compensation using the intrinsic value method prescribed in Accounting
Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, ("APB
25") and related interpretations. See Note 9 to the consolidated financial
statements for additional information.
Premium and fee income recognition:
Premiums are recognized as earned over the estimated period of bond performance
or project completion, which is generally less than one year. Ceded reinsurance
premiums are recognized on a similar basis. Unearned premiums represent the
portion of net premiums applicable to the unexpired portion of the bond. The
estimates are based primarily on management's understanding of a bonded
project's stage of completion supplemented by historical completion patterns.
Fee income represents amounts earned by Dreadnought for various services
(including escrow, dispute resolution, claims handling, and construction
management) rendered to third parties in connection with bonds written by the
Surety Company.
17
<PAGE>
Note 2 - Summary of Significant Accounting Policies: - (continued)
Earnings per Share:
Earnings per share are calculated in accordance with the provisions of Statement
of Financial Accounting Standards No. 128, "Earnings per Share" (SFAS No. 128),
effective for 1997, with restatement of prior periods presented. SFAS No. 128
requires the Company to report both basic earnings per share, which is based on
the weighted-average number of common shares outstanding, and diluted earnings
per share, which is based on the weighted-average number of common shares
outstanding and all dilutive potential common shares outstanding.
For the Year Ended December 31, 1997
------------------------------------
Per Share
Income Shares Amount
------ ------ ------
Basic EPS
Net income $1,563,222 2,528,530 $0.62
Effect of dilutive stock options 240,997
----------
Diluted EPS
Net income-assuming dilution $1,563,222 2,769,527 $0.56
---------- ---------
For the Year Ended December 31, 1996
------------------------------------
Per Share
Income Shares Amount
------ ------ ------
Basic EPS
Net income $1,135,370 2,528,530 $0.45
Effect of dilutive stock options 133,470
----------
Diluted EPS
Net income-assuming dilution $1,135,370 2,662,000 $0.43
---------- ---------
Cash equivalents:
Cash equivalents include highly liquid money market instruments with original
maturities of three months or less.
Investments:
The Company accounts for its investments in fixed maturity securities in
accordance with SFAS No. 115, "Accounting for Certain Investments in Debt and
Equity Securities." SFAS No. 115 requires that an enterprise classify debt and
equity securities into either of these categories as applicable:
held-to-maturity, available-for-sale or trading. SFAS No. 115 also requires that
unrealized gains and losses for trading securities be included in earnings,
while unrealized gains and losses for available-for-sale securities be excluded
from earnings and reported as a separate component of shareholders' equity until
realized. At December 31, 1997 and 1996, the Company's investments in fixed
maturity securities were classified as available-for-sale.
18
<PAGE>
Note 2 - Summary of Significant Accounting Policies: - (continued)
Fixed assets:
Fixed assets, which are comprised of furniture and fixtures, computer equipment
and leasehold improvements, are recorded at cost and are depreciated using the
straight line method over their useful lives, which range from three to five
years.
Deferred policy acquisition costs:
Acquisition costs which vary with and are primarily related to the production of
premiums, primarily commissions, premium taxes, and certain underwriting
expenses, are deferred and amortized ratably over the terms of the related
insurance contracts, to the extent such costs are deemed to be recoverable.
Future underwriting and investment income are considered in determining the
recoverability of such acquisition costs. The amortization of the deferred
policy acquisition cost asset is included as an adjustment to commission
expense, salaries and benefits, and other operating expenses.
Reinsurance receivable:
Reinsurance receivable includes an estimate of an amount to be received from its
reinsurer relating to unpaid claims and claims adjustment expenses and includes
amounts receivable for paid losses.
Subrogation receivable:
The Surety Company requires bond applicants to enter into an indemnity agreement
which obligates the insured to reimburse the Surety Company for any claims paid
and costs incurred that are related to the bond. Subrogation receivable
represents amounts estimated to be recovered by the Surety Company from bonded
principals for claim costs incurred by the Surety Company after a failure of a
bonded principal to fulfill a bonded obligation. The Company records subrogation
receivable when a claim is incurred and it is considered highly probable that
the costs will be recovered from available job funds, from assets belonging to
the bonded principal or from assets belonging to other indemnitors on the bond.
Changes in estimates of subrogation receivable are credited or charged to income
in the period in which they are determined and are included in claims and claim
adjustment expenses.
Unpaid claims and claim adjustment expenses:
The reserve for unpaid claims and claim adjustment expenses represents the
estimated indemnity cost and claims adjustment expense to cover the ultimate net
cost of investigating, defending and settling claims, such estimates are based
upon (a) accumulation of case reserves on an individual basis, for claims
reported prior to the close of the accounting period, (b) estimates for incurred
but unreported claims, as well as additional developments on reported claims,
are determined on the basis of industry experience, and (c) expenses directly
associated with specific claims paid or in the process of settlement.
Management believes that its reserves for unpaid and claim adjustment expense at
December 31, 1997 is reasonable and adequate to cover the ultimate cost of
losses on reported and unreported claims, but such reserve is necessarily based
on estimates and such estimates may be more or less than the amounts ultimately
paid when claims are settled. These estimates are periodically reviewed and
adjusted as necessary; such adjustments are reflected in current operations.
Income taxes:
Mountbatten, Inc. files a consolidated federal income tax return with its wholly
owned subsidiaries, the Surety Company and Dreadnought. Current taxes are
allocated among the Companies based upon a written tax sharing agreement.
Deferred federal income taxes are provided based on an asset and liability
19
<PAGE>
Note 2 - Summary of Significant Accounting Policies: - (continued)
approach in accordance with SFAS 109, "Accounting for Income Taxes," which
requires the recognition of deferred income tax assets and liabilities for the
expected future tax consequences of temporary differences between the financial
statement carrying amounts and the tax bases of assets and liabilities.
Note 3 - Investments:
The amortized cost and estimated fair values of fixed maturity investments at
December 31, 1997 and 1996 are as follows:
<TABLE>
<CAPTION>
December 31, 1997 December 31, 1996
---------------------------- --------------------------
Cost Fair Value Cost Fair Value
---- ---------- ---- ----------
<S> <C> <C> <C> <C>
U.S. Treasury Securities $7,715,677 $7,687,211 $8,596,475 $8,487,946
</TABLE>
U.S. Treasury instruments with a fair market value of approximately $2,126,725
and $1,819,000 were held on deposit with various insurance departments as of
December 31, 1997 and 1996, respectively.
The amortized cost and estimated fair value of fixed maturity investments at
December 31, 1997 and 1996 are shown below by the expected maturity period:
December 31, 1997
-------------------------
Cost Fair Value
---------- ----------
Less than one year $3,094,858 $3,095,117
Due after one year through
five years 4,620,819 4,592,094
---------- ----------
Total $7,715,677 $7,687,211
========== ==========
20
<PAGE>
Note 4 - Fixed Assets
Fixed assets consists of:
<TABLE>
<CAPTION>
December 31,
----------------------
1997 1996
--------- --------
<S> <C> <C>
Furniture and fixtures $51,288 $41,733
Office equipment 31,905 9,380
Computer equipment 77,472 48,832
Leasehold Improvements 55,285 14,900
------ ------
215,950 114,845
Less: accumulated depreciation / amortization (103,214) (58,007)
--------- --------
$112,736 $56,838
======== =======
</TABLE>
Depreciation and Amortization expense was $45,207 and $26,391 for the years
ended December 31, 1997 and 1996, respectively.
The Company occupies its office space under operating leases that expire
September 30, 1999, if not terminated by either party by delivering written
notice 60 days prior to the expiration of the current term. Rent expense for
1997 and 1996 was $59,988 and $58,374, respectively.
As of December 31, 1997, the future minimum rental commitments payable under its
operating lease are as follows:
1998 $ 79,762
1999 59,821
------
$139,583
========
21
<PAGE>
Note 5 - Income Taxes
The tax effect of temporary differences, which give rise to deferred income tax
assets and liabilities as of December 31 were as follows:
<TABLE>
<CAPTION>
1997 1996
--------- ---------
<S> <C> <C>
Deferred tax liabilities:
Deferred acquisition costs ($222,267) ($133,772)
Subrogation receivable discounting (81,318) (30,958)
Other (1,208) --
--------- ---------
Gross deferred tax liabilities (304,793) (164,730)
--------- ---------
Deferred tax assets:
Loss reserve discounting 81,341 30,828
Net unrealized loss, fixed maturities 9,679 36,900
Unearned premium reserve 104,502 64,879
Organizational and startup costs 22,780 62,606
Other - 1,740
--------- ---------
Gross deferred tax asset 218,302 196,953
--------- ---------
Deferred tax (liability) asset, net ($ 86,491) $ 32,223
========= =========
</TABLE>
The components of income tax expense in the Consolidated Statements of
Operations are as follows:
<TABLE>
<CAPTION>
1997 1996
--------- ---------
<S> <C> <C>
Current federal tax expense $ 723,743 $ 468,561
Deferred federal tax expense 91,492 125,270
--------- ---------
Total federal income tax expense $ 815,235 $ 593,831
========= =========
</TABLE>
The provision for income taxes differs from the amount of income tax determined
by applying the applicable statutory federal income tax to pretax income from
operations as a result of the following differences:
<TABLE>
<CAPTION>
1997 1996
--------- ---------
<S> <C> <C>
Tax expense at statutory rate (34%) $ 808,675 $ 587,928
Other, net 6,560 5,903
--------- ---------
Total federal income tax expense $ 815,235 $ 593,831
========= =========
</TABLE>
The tax effect of temporary differences which resulted in the deferred tax
(benefit) were as follows:
<TABLE>
<CAPTION>
1997 1996
--------- ---------
<S> <C> <C>
Deferred acquisition costs $ 88,495 $ 41,738
Accrued salaries and benefits -- 65,960
Organizational and startup costs 39,826 45,508
Loss reserve discounting (50,513) (13,362)
Subrogation receivable discounting 50,360 9,041
Unearned premium reserve (39,624) (22,623)
Other 2,948 (992)
--------- ---------
Deferred tax expense $ 91,492 $ 125,270
========= =========
</TABLE>
22
<PAGE>
Note 6 - Unpaid Claims and Claim Expense Reserves and Reinsurance Receivable:
The process by which reserves are established for insured events and related
litigation requires reliance upon estimates based on the Surety Company's
limited claims experience, supplemented with available industry data. The Surety
Company's limited claims experience creates uncertainty with respect to the
estimation of loss and loss adjustment expense reserves. As information develops
which varies from expected experience, provides additional data or, in some
cases, augments data which previously were not considered sufficient in
determining reserves, adjustments to reserves may be required. Included in loss
reserves at December 31, 1997 and 1996 are case reserves totaling $2,749,759 and
$634,156, respectively, and IBNR reserves of $608,819 and $519,114,
respectively.
Activity in the reserve for unpaid claims and claim adjustment expenses for the
years ended December 31, 1997 and 1996 was as follows:
1997 1996
----------- -----------
Gross Reserves - January 1, $ 1,153,270 $ 602,265
Less subrogation receivable 606,476 393,999
Less reinsurance receivable 324,994 75,838
----------- -----------
Net reserve- January 1, 221,800 132,428
----------- -----------
Incurred losses related to:
Current year 1,036,713 768,722
Prior year (115,214) (249,014)
----------- -----------
921,499 519,708
----------- -----------
Paid related to:
Current Year 1,057,379 409,802
Prior Year 495,780 20,531
----------- -----------
1,553,159 430,333
----------- -----------
Net reserve- December 31, (409,860) 221,800
Plus subrogation receivable 2,539,976 606,476
Plus reinsurance receivable 1,228,462 324,994
----------- -----------
Gross Reserves - December 31, $ 3,358,578 $ 1,153,270
=========== ===========
As part of an ongoing process, the reserves have been re-estimated for all prior
accident years and were decreased by $115,214 and $249,014 in 1997 and 1996,
respectively. Decrease in prior accident year incurred losses is the result of
better than anticipated development of incurred losses than originally
contemplated in prior years' recorded estimate of ultimate losses.
Note 7 - Subrogation receivable:
Subrogation receivable, net of reinsurance, is composed of the following:
December 31,
------------------------
1997 1996
--------- ----------
Subrogation recoverables on paid
loss and loss adjustment expenses $1,513,109 $ 374,828
Subrogation recoverables on unpaid
loss and loss adjustment expenses 1,026,867 231,648
--------- ----------
$2,539,976 $ 606,476
========== ==========
23
<PAGE>
Note 8 - Reinsurance:
In the normal course of business, the Company enters into contracts to cede
reinsurance, primarily to limit losses from large exposures and to permit
recovery of a portion of direct losses. However, such a transfer of risk does
not relieve the Company from contingent liability for these losses.
The following are the reinsurance programs currently limiting the Company's
exposure to losses:
Effective November 1, 1995 to October 31, 1996:
The Company's reinsurance program for losses discovered during this period
provides four layers of reinsurance. Under the first layer, the Company retains
100% of all losses up to $150,000 and the reinsurer assumes the next $350,000,
subject to a maximum annual recovery by the Company of the greater of 250
percent of ceded premiums or $2,250,000. The second layer provides $1,500,000 of
coverage (95% to be assumed by the reinsurer) on any loss discovered for any
principal in excess of the first $500,000 of loss with an aggregate annual
maximum of $4,500,000. The third layer provides $2,500,000 of coverage on any
loss discovered for any principal in excess of the first $2,000,000 with an
aggregate annual maximum of $5,000,000. The fourth layer provides $3,000,000 of
coverage on any loss discovered for any principal in excess of the first
$4,500,000 with an aggregate annual maximum of $3,000,000.
Effective November 1, 1996 to October 31, 1997:
The Company's reinsurance program for losses discovered during this period
provides four layers of reinsurance. Under the first layer, the Company retains
100% of all losses up to $150,000 and the reinsurer assumes 95% of the next
$850,000, subject to a maximum annual recovery by the Company of $3,400,000. The
second layer provides $1,000,000 of coverage (95% to be assumed by the
reinsurer) on any loss discovered for any principal in excess of the first
$1,000,000 of loss with an aggregate annual maximum of $3,000,000. The third
layer provides $2,500,000 of coverage on any loss discovered for any principal
in excess of the first $2,000,000 of loss with an aggregate annual maximum of
$5,000,000. The fourth layer provides $3,000,000 of coverage on any loss
discovered for any principal in excess of the first $4,500,000 with an aggregate
annual maximum of $3,000,000.
Effective November 1, 1997 to October 31, 1998
The Company's reinsurance program for losses discovered during this period
provides four layers of reinsurance. Under the first layer, the Company retains
100% of all losses up to $150,000 and the reinsurer assumes 95% of the next
$850,000, subject to a maximum annual recovery by the Company of $4,250,000. The
second layer provides $2,000,000 of coverage (95% to be assumed by the
reinsurer) on any loss discovered for any principal in excess of the first
$1,000,000 of loss with an aggregate annual maximum of $6,000,000. The third
layer provides $3,000,000 of coverage on any loss discovered for any principal
in excess of the first $3,000,000 of loss with an aggregate annual maximum of
$6,000,000. The fourth layer provides $4,000,000 of coverage on any loss
discovered for any principal in excess of the first $6,000,000 with an aggregate
annual maximum of $4,000,000.
Prior to November 1997, the reinsurance program required that the Company not
write any bond exceeding $5 million or bonds on the same work program in favor
of the principal exceeding $10 million in the aggregate. Under this program, the
maximum bond duration could not exceed 24 months.
Effective November 1997, the reinsurance program required that the Company not
write any bond exceeding $6 million, or bonds on the same work program in favor
of the principal exceeding $12 million in the aggregate.
24
<PAGE>
Note 8 - Reinsurance: - (continued)
The effect of reinsurance on premiums written and earned for 1997 and 1996 is as
follows:
1997 1996
------------------------------- -------------------------------
Written Earned Written Earned
--------------- --------------- --------------- ---------------
Direct $10,396,648 $ 9,711,030 $ 7,829,171 $ 7,431,006
Ceded (1,560,662) (1,457,743) (1,287,308) (1,221,841)
------------ ------------ ------------ ------------
$ 8,835,986 $ 8,253,287 $ 6,541,863 $ 6,209,165
------------ ------------ ------------ ------------
Reinsurance receivable of $2,200,283 at December 31, 1997 includes $992,170
related to paid losses, and $1,228,462 of receivables related to unpaid losses,
offset by $20,349 received from the reinsurer as a prepayment. Reinsurance
receivable of $294,911 at December 31, 1996 includes $324,994 related to unpaid
losses, offset by $30,083 received from the reinsurer as an overpayment.
Note 9 - Shareholders' Equity
Statutory surplus and dividend restrictions:
The Surety Company is subject to the minimum capital and surplus requirements of
the Commonwealth of Pennsylvania insurance laws and regulations. Under
applicable Pennsylvania laws and regulations, the Company is required to
maintain a minimum of $1,125,000 of paid in capital. Generally, the maximum
amount of dividends which can be paid by the Company to shareholders without
prior approval of the domiciling state Insurance Commissioner is the greater of
10% of the Company's total capital and surplus or 100% of the Company's net
income. Subject to these restrictions, dividends may be paid as determined by
the Board of Directors. At December 31, 1997, the maximum dividend that may be
paid to shareholders in 1998 without regulatory approval is approximately
$1,524,000. Statutory surplus at December 31, 1997 and 1996 was $9,048,407 and
$7,975,119, respectively, and statutory net income for the years ended December
31, 1997 and 1996 was $1,524,219 and $1,260,999, respectively.
Stock options and warrants:
In November 1993 the Company granted incentive stock options to selected
individuals to purchase 186,000 shares of common stock (35,000 shares and
151,000 shares at an exercise price of $4.95 and $4.50, respectively). These
options become exercisable over a five-year period commencing one year after the
date of grant. In December 1995, 500 of these incentive stock options were
cancelled. In September and December 1997, 12,500 and 62,500 of these incentive
stock options were cancelled, respectively.
In November 1993 the Company granted non-qualified stock options to selected
individuals to purchase 81,000 shares of common stock at an exercise price of
$4.50 per share. These options vested immediately, and are exercisable for a
ten-year period after the date of grant.
In July 1993, the Company issued a warrant to an underwriter to purchase 4,800
shares of common stock at an exercise price of $4.50 per share of common stock
until July 1996. The exercise price then increases by $.45 per share until July
1999. The warrant expires July 2000.
The Company sold to the underwriter, for nominal consideration in connection
with the initial public offering, warrants to purchase 100,000 shares of common
stock at an exercise price of $6.00 per share. These warrants became exercisable
during a four-year period commencing August 1995, and they expire August 1999.
25
<PAGE>
Note 9 - Shareholders' Equity: - (continued)
In February 1995, the Company granted incentive stock options to selected
individuals to purchase 19,000 shares of common stock at an exercise price of
$5.00 per share. These options vest over a four-year period and are exercisable
for a ten-year period after the date of grant. In September 1995, 2,000 of these
incentive stock options were canceled.
In February 1995, the Company granted incentive stock options to an individual
to purchase 15,000 shares of common stock at an exercise price of $5.50 per
share. These options vest over a two-year period and are exercisable for a
five-year period after the date of grant
In February 1995, the Company granted non-qualified stock options to outside
directors to purchase 8,000 shares of common stock at an exercise price of $5.00
per share. These options vest immediately, and are exercisable for a ten-year
period after the date of grant. In June 1995, 4,000 of these non-qualified stock
options were canceled.
In April 1995, the Company granted non-qualified and incentive stock options to
a selected individual to purchase 10,000 and 30,000 shares, respectively, of
common stock at an exercise price of $5.25 per share. The non-qualified stock
option became exercisable in October 1995, and is exercisable for a ten-year
period after the date of the grant. The incentive stock option vests over a
five-year period, and is exercisable for a ten-year period after the date of the
grant.
On November 3, 1995, the Company adopted the Equity Incentive Plan for Key
Employees and the non-qualified Equity Incentive Plan for Outside Directors,
whereby key employees and outside directors may be granted options to purchase
shares of the Company's common stock at a price not less than the fair market
value of such shares, as determined by the Company's Board of Directors, at the
date on which the options are granted. The options are exercisable during the
period selected by the Board of Directors, but no earlier than six months after
the date of grant and no later than ten years from the date of grant. A total of
250,000 and 50,000 shares of common stock were reserved for issuance under the
Key Employee and Outside Director Plans, respectively.
In January 1996, the Company granted incentive stock options to selected
individuals to purchase 63,750 and 20,000 shares of common stock at an exercise
price of $5.25 and $5.78 per share, respectively. These options all vest over a
five-year period, and are exercisable for a ten-year and five-year period,
respectively, after the date of the grant. In September and December 1995, 250
and 500, respectively, of these incentive stock options were cancelled. In
September and December 1997, 20,000 and 5,000, respectively, of these incentive
stock options were cancelled
In January 1996, the Company granted non-qualified stock options to selected
individuals to purchase 35,000 shares of common stock at an exercise price of
$5.25 per share. These options vest immediately, and are exercisable for a
ten-year period after the date of grant.
In May 1996, the Company granted non-qualified stock options to outside
directors to purchase 8,000 shares of common stock at an exercise price of $5.50
per share. These options became exercisable in November 1996, and are
exercisable for a ten-year period after the date of grant.
In December 1996, the Company granted incentive stock options to selected
individuals to purchase 28,000 shares of common stock at an exercise price of $8
per share. These options vest over a five-year period, and are exercisable for a
ten-year period after the date of grant. In September and October 1997, 20,000
and 1,000, respectively, of these incentive stock options were cancelled.
26
<PAGE>
Note 9 - Shareholders' Equity: - (continued)
In December 1996, the Company granted non-qualified stock options to selected
individuals to purchase 64,000 shares of common stock at an exercise price of $8
per share. These options became exercisable in June 1997, and are exercisable
for a ten-year period after the date of grant.
On March 21, 1997, the Board of Directors approved an amendment to the Equity
Incentive Plan for Key Employees which increased the number of reserved shares
available for award from 250,000 to 500,000.
In May 1997, the Company granted non-qualified stock options to selected outside
directors to purchase 12,000 shares of common stock at an exercise price of
$8.50 per share. These options became exercisable in November 1997, and are
exercisable for a ten-year period after the date of grant.
In June 1997, the Company granted incentive stock options to selected
individuals to purchase 7,500 shares of common stock at an exercise price of
$8.50 per share. These options vest over a five-year period, and are exercisable
for a ten-year period after the date of grant.
In June 1997, the Company granted non-qualified stock options to selected
individuals to purchase 22,000 shares of common stock at an exercise price of
$8.50 per share. These options became exercisable in December 1997, and are
exercisable for a ten-year period after the date of grant.
In June 1997, the Company granted, under a separate agreement approved by the
Board of Directors, a non-qualified stock option to an outside director of
Dreadnought to purchase 3,000 shares of common stock at an exercise price of
$8.50 per share (fair market value per share of common stock on the date of
grant), which option became exercisable in December 1997 and is exercisable for
a ten-year period after the date of grant.
In December 1997, the Company granted incentive stock options to select
individuals to purchase 42,100 shares of common stock at an exercise price of
$12.125 per share. These options vest over a five-year period, and are
exercisable for a ten-year period after the date of grant.
In December 1997, the Company granted non-qualified stock options to select
individuals to purchase 80,000 shares of common stock at an exercise price of
$12.125 per share. These options become exercisable in June 1998, and are
exercisable for a ten-year period after the date of grant.
In December 1997, the Company granted non-qualified stock options to outside
directors to purchase an aggregate of 10,000 shares of common stock at an
exercise price of $12.125 per share. These options vest immediately, and are
exercisable for a ten-year period after the date of grant. These options were
granted under the Company's Supplemental Non-Qualified Stock Option Plan,
whereby directors and officers of the Company or any subsidiary of the Company
may be granted non-qualified stock options to purchase shares of the Company's
common stock at a price not less than the fair market value of such shares, as
determined by the Company's Board of Directors, at the date the options are
granted. As of December 31, 1997, an aggregate of 25,000 shares were reserved
for issuance under this plan.
In December 1997, the Company granted, under a separate agreement approved by
the Board of Directors, a non-qualified stock option to a consultant to purchase
2,000 shares of common stock at an exercise price of $12.125 per share (fair
market value per share of common stock on the date of grant), which option
became exercisable immediately, and is exercisable for a ten-year period after
the date of grant.
27
<PAGE>
Note 9 - Shareholders' Equity: - (continued)
Information regarding these plans is as follows:
<TABLE>
<CAPTION>
1997 1996
-------------------------- -------------------------------------
Weighted Average Weighted Average
Shares Exercise Price Shares Exercise Price
------ ---------------- ------ ----------------
<S> <C> <C> <C> <C>
Options outstanding-
beginning of year 665,300 $ 5.48 447,300 $5.00
Options granted 178,600 $11.22 218,000 $6.47
Options forfeited (121,000) $ 5.26 - -
------- ------- ------- -----
Options outstanding-
end of year 722,900 $ 6.94 665,300 $5.48
======= ======= ======= =====
Weighted average fair value
of options, granted during the
year $4.81 $3.20
===== =====
</TABLE>
The Company has adopted the disclosure-only provisions of Statement of Financial
Accounting Standards No. 123, "Accounting for Stock-based Compensation."
Accordingly, under SFAS No. 123, no compensation expense has been recognized for
the stock option plans. Had compensation cost been determined based on the fair
value at the grant date for awards in 1997 and 1996 consistent with the
accounting provision of SFAS No. 123, where the fair value of the stock option
grants are recognized on a straight line basis over the vesting period of the
grant, the Company's net earnings and earnings per share would have been reduced
to the pro forma amounts indicated below:
1997 1996
---- ----
Net earnings - as reported $1,563,222 $1,135,370
Net earnings - pro forma $1,336,564 $793,370
Earnings per share (fully diluted) - as reported $0.56 $0.43
Earnings per share (fully diluted) - pro forma $0.48 $0.30
For 1997 and 1996, no compensation expense has been recognized for stock options
under the intrinsic value based method under APB No. 25.
The fair value of each option grant is estimated on the date of grant using the
Black-Scholes option-pricing model with the following weighted average
assumptions used for the respective year of grant:
1997 1996
---- ----
Dividend yield 0% 0%
Expected volatility 53% 50%
Risk-free interest rate 5.4 - 5.9% 5.0 - 5.4%
Expected life of option 3 - 5 years 3 - 5 years
28
<PAGE>
Note 9 - Shareholders' Equity: - (continued)
The following table summarizes information about fixed stock options outstanding
at December 31, 1997:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
--------------------------------------------------- --------------------------------
Range of Number Weighted Average Weighted Number Weighted
Exercise Prices Outstanding Remaining Average Exercisable Average
at 12/31/97 Contractual Life Exercise Price at 12/31/97 Exercise Price
--------------------------------------------------- --------------------------------
<S> <C> <C> <C> <C> <C>
$4.50-$5.50 353,300 6.4 years $4.89 296,050 $4.83
$5.78-$8.00 191,000 4.7 years $6.72 169,400 $6.77
$8.50-$12.125 178,600 10.0 years $11.22 37,000 $8.50
--------------- ------------------ ---------------- --------------- ----------------
722,900 6.8 years $6.94 502,450 $5.76
=============== ================== ================ =============== ================
</TABLE>
Note 10 - Commitments and Contingencies
The Company is a party to a number of legal proceedings arising in the ordinary
course of its business. Management is of the opinion, based in part on the
advice of legal counsel, that the ultimate aggregate liability resulting from
such proceedings, if any, is adequately provided for in the established
reserves.
29
<PAGE>
Item 8. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None
PART III
Item 9. Directors, Executive Officers, Promoters and Control Persons;
Compliance with Section 16(a) of the Exchange Act.
The names of the directors of the Company, together with certain
information regarding them, are as follows:
Director
Name Age Since
---- --- -----
Kenneth L. Brier 48 1992
Ted A. Drauschak 37 1992
J. Michael Adams (1) 50 1994
Thomas P. Garry (1) 49 1994
- -------------
(1) Member of the Company's Audit, Compensation and Nominating Committees.
Mr. Brier has served as Chairman of the Board and President of the
Company since its inception in 1991. From 1984 to 1991, Mr. Brier was active in
commercial real estate development and construction management. Additionally,
from October 1990 until joining the Company, he was employed by Xsirius, Inc., a
publicly held research and development company. Prior to 1990, Mr. Brier was
active in commercial real estate development and construction management. Mr.
Brier is a director of Kleinerts, Inc., and The Civil Affairs Association,
Washington, D.C. He is the Vice President of the Class of 1997 - United States
Army War College, and serves on the Dean's Executive Advisory Committee - Drexel
University - College of Design Arts. Mr. Brier is a Colonel in the United States
Army (Reserve), where he is an Anti - Terrorism and Force Protection Officer at
the Pentagon in the Office of the Secretary of Defense. He is a veteran of
Desert Storm, where he was awarded the Bronze Star for his efforts on behalf of
our country.
Mr. Drauschak has served as Executive Vice President, Secretary and
Director of the Company since its inception in 1991 and, since March 1997, has
served as the President of HMS Dreadnought, Inc. He also served as Executive
Vice President and Director of the Surety Company since its inception until
March 1997. From November 1990 until joining the Company, Mr. Drauschak was
employed by Xsirius, Inc. Prior to November 1990, Mr. Drauschak, a civil
engineer, was Director of Real Estate Development for Tedco Equities, a real
estate development concern, where he managed the development and construction of
commercial real estate throughout the United States. He was also an Associate of
RTKL Associates, Inc., a leading international architectural and engineering
firm, during which time he directed engineering projects throughout Western
Europe in connection with military installations for the U.S. Department of
Defense and NATO. Additionally, Mr. Drauschak was employed as a construction
manager for Bechtel Group, a division of the Bechtel Power Corporation, where he
was a construction manager in the nuclear power industry.
Mr. Adams has been a Director of the Company since 1994 and of the
Surety Company since 1992. He has been the Dean of the College of Design Arts,
Drexel University, Philadelphia, Pennsylvania for more than five years. Mr.
Adams is also a director of R.R. Donnelly International.
Mr. Garry has been a Director of the Company since 1994 and of the
Surety Company since 1992. In 1996, after more than 30 years of service, Mr.
Garry retired from Rohm and Haas, a Fortune 500
30
<PAGE>
chemical and engineering company, where he most recently served as Operations
Manager, Industrial Chemicals.
16(a) REPORTING COMPLIANCE
Section 16 of the Securities Exchange Act of 1934 (the Exchange Act)
requires that the officers and directors of a corporation, such as the Company,
which has a class of equity securities registered under Section 12 of the
Exchange Act, as well as persons who own more than 10% of a class of equity
securities of such a corporation, file reports of their ownership of such
securities, as well as monthly statements of changes in such ownership, with the
corporation and the Securities and Exchange Commission (the "SEC"). Based upon
written representations received by the Company from its officers and directors,
and the Company's review of the monthly statements of changes filed by its
officers and directors during 1997, the Company believes that all such filings
required during 1997 were made on a timely basis.
31
<PAGE>
Item 10. Executive Compensation.
Summary Compensation Table
The following table sets forth the compensation paid by the Company
during each of the three fiscal years ended December 31, 1997, December 31, 1996
and December 31, 1995 to the chief executive officer of the Company and the
three other most highly compensated executive officers of the Company whose
compensation exceeded $100,000 in the fiscal year ended December 31, 1997.
<TABLE>
<CAPTION>
Long-Term
Name and Annual Compensation Compensation
Principal ------------------------ Options All Other
Position Year Salary Bonus Granted Compensation
-------- ---- ------ ----- ------- ------------
<S> <C> <C> <C> <C> <C>
Kenneth L. Brier, Chairman of the 1997 $182,101 $65,209 40,000 $129,133(1)
Board, President, and Chief 1996 $166,000 $39,712 60,000 $124,038
Executive Officer 1995 $147,000 $106,000 15,000 $24,619
Ted A. Drauschak, Executive Vice 1997 $144,555 $47,650 30,000 $21,808(2)
President 1996 $125,700 $43,850 55,000 $12,193
1995 $106,992 $50,900 15,000 $11,315
Stephen C. Fletcher, Vice 1997 $113,333 $ 0 -- $5,600(3)
President of the Company and 1996 $155,000 $41,250 45,000 $8,400
President of the Surety Company's 1995 $136,992 $37,900 -- $12,800
Bond Division (3)
Joel D. Cooperman 1997 $126,500 $52,000 30,000 $14,644(4)
Vice President of Finance, 1996 $110,000 $42,995 39,000 $8,400
Treasurer and Chief Financial 1995 $62,500 $31,000 40,000 $5,250
Officer (4)
</TABLE>
(1) Represents an automobile allowance of $8,400, disability and life insurance
premium payments of $38,839, and premiums for a retirement plan annuity of
$81,894. Mr. Brier's total compensation for 1997 was $376,443.
(2) Represents an automobile allowance of $8,400, loan forgiveness in the
amount of $8,650, and disability and life insurance premiums of $4,758. Mr.
Drauschak's total compensation for 1997 was $214,013.
(3) Mr. Fletcher's employment ceased in September 1997. Represents an
automobile allowance of $5,600. Mr. Fletcher's total compensation for 1997
was $118,933.
32
<PAGE>
(4) Mr. Cooperman began full-time employment at the Company on May 15, 1995.
Represents an automobile allowance of $8,400 and disability insurance
premium payments of $6,244. Mr. Cooperman's total compensation for 1997 was
$193,144.
The following table sets forth information with respect to options
granted to the persons named in the Summary Compensation Table above during the
fiscal year ended December 31, 1997.
Option Grants in Last Fiscal Year
<TABLE>
<CAPTION>
Percent of Total
Number of Securities Options Granted to
Underlying Employees in Fiscal Exercise Price Expiration
Name Options Granted (#) Year ($/sh) Date
- ---- ------------------- -------------------- -------------- ----------
<S> <C> <C> <C> <C>
Kenneth L. Brier 30,000(1) 26.3% $12.125 12/23/07
10,000(2) 8.50 6/2/07
Ted A. Drauschak 25,000(1) 19.8% $12.125 12/23/07
5,000(2) 8.50 6/2/07
Joel D. Cooperman 25,000(1) 19.8% $12.125 12/23/07
5,000(2) 8.50 6/2/07
</TABLE>
- ---------------
(1) This option will become exercisable June 23, 1998.
(2) This option became exercisable commencing on December 1, 1997.
The following table sets forth information with respect to options held
on December 31, 1997 by the persons named in the Summary Compensation Table.
None of these persons exercised any options during the fiscal year ended
December 31, 1997.
Fiscal Year-End Option Values
<TABLE>
<CAPTION>
Value of Unexercised
Number of Unexercised In-the-Money
Options at Options at
December 31, 1997 December 31, 1997
----------------- -----------------
Name Exercisable Unexercisable Exercisable(1) Unexercisable(1)
- ---- ----------- ------------- -------------- ----------------
<S> <C> <C> <C> <C>
Kenneth L. Brier 173,000 42,000 $ 81,390 $1,174,760
Ted A. Drauschak 138,000 37,000 $ 954,750 $ 87,125
Stephen C. Fletcher 0 0 $ 0 $ 0
Joel D. Cooperman 63,000 46,000 $ 358,750 $ 150,125
</TABLE>
(1) Represents the difference between the aggregate exercise price and the
aggregate market value as of December 31, 1997.
33
<PAGE>
Employment Agreements
Kenneth L. Brier has an employment agreement with the Company for a
term that commenced April 6, 1994 and currently ends April 30, 2000, and is
automatically renewed on each April 30th for successive terms of three years
unless either the Company or Mr. Brier gives written notice of non-renewal at
least 90 days prior to a renewal date. As determined by the Board of Directors,
subject to increases under its direction, the agreement currently provides for
annual compensation in the amount of $376,443. If the Company terminates Mr.
Brier's employment other than for just cause, as defined in the agreement, or
Mr. Brier terminates the agreement for good reason, as defined in the agreement,
Mr. Brier will be entitled to an amount equal to the then remaining term of the
agreement times his then current base salary, paid in semi-monthly installments
for the remainder of the term.
Ted A. Drauschak has an employment agreement with the Company, which
can be terminated by either party upon 90 days' written notice. As determined by
the Board of Directors, subject to increases under its direction, the agreement
currently provides for annual compensation in the amount of $214,013.
Joel D. Cooperman has an employment agreement with the Company, which
can be terminated by either party upon five months' written notice. As
determined by the Board of Directors, subject to increases under its direction,
the agreement currently provides for annual compensation in the amount of
$193,144.
Each of the employment agreements described herein provides that, if
during a period of one year immediately subsequent to a change of control of the
Company, as defined in the agreement, the employee's employment is terminated by
the Company without just cause or by the employee for "good reason," the
employee will be entitled to certain payments under the agreement. For this
purpose, termination for "good reason" within one year immediately subsequent to
a change of control of the Company includes an adverse change or reduction, as
the case may be, in the employee's duties, responsibilities, titles, location or
other terms of his salary, bonus or benefits. Under such provision, if the
employee is terminated by the Company without just cause or the employee
terminates his employment for good reason following a change in control, he will
be entitled to receive severance in an amount equal to his average aggregate
annual compensation during the five calendar years preceding the taxable year in
which such termination occurs multiplied by 2.99, which payment must be made on
or before the fifth day following such termination; provided, however, that any
portion of such payment that would result in such payment being subject to an
excise tax under the Internal Revenue Code of 1986, as amended (the "Code"),
will be treated as a loan by the Company to the employee payable in 10 years
with interest fixed at the applicable federal rate for the month in which such
event occurs, subject to his right to prepay such amount in whole or in part
prior to such time without penalty.
Compensation of Directors
A director of the Company who is not an employee is paid $300 for each
meeting attended of the Board of Directors and of each committee on which he
serves. If a director serves on the Board of Directors of both the Company and
the Surety Company, and the Boards of Directors of both companies meet on the
same day, the director receives only one meeting fee. In such event, meeting
fees are allocated 50% to the Company and 50% to the Surety Company. In
addition, the Company's outside directors, Messrs. Adams and Garry, each
received directors' fees of $8,500 for 1997. Under the Company's 1995 Equity
Incentive Plan for Outside Directors, each outside director of the Company or
any of the Company's subsidiaries is entitled to receive an annual grant of
options to purchase 2,000 shares of the Company's Common Stock at an exercise
price equal to the fair market value of the shares on the grant date. In 1997,
Messrs. Adams and Garry each also received stock options to purchase 5,000
shares of the Company at an exercise price equal to the fair market value of the
shares on the grant date under the Company's Supplemental Non-Qualified Stock
Option Plan.
34
<PAGE>
Item 11. Security Ownership of Certain Beneficial Owners and Management.
The following table sets forth as of March 23, 1998 the amount and
percentage of the Company's outstanding Common Stock beneficially owned by (i)
each person who is known by the Company to own beneficially more than 5% of its
Common Stock, (ii) each director and nominee for director, (iii) each executive
officer named in the Summary Compensation Table and (iv) all executive officers
and directors of the Company as a group.
<TABLE>
<CAPTION>
Shares Percent of
Name of Individual Beneficially Outstanding
or Identity of Group Owned(1) Common Stock
-------------------- -------- ------------
<S> <C> <C>
Executive Officers
Kenneth L. Brier................................... 475,794 (2) 17.6%
Ted A. Drauschak................................... 182,500 (3) 6.8%
Stephen C. Fletcher................................ -- (4) --
Joel D. Cooperman.................................. 63,000 (5) 2.4%
Directors
J. Michael Adams................................... 9,650 (6) *%
Thomas P. Garry.................................... 9,000 (7) *%
5% Holders
Jack Brier (8)..................................... 293,375 (9) 11.6%
ESQF Advisors, Inc. and
Martin J. Whitman .............................. 293,000(10) 11.6%
All directors and executive
officers as a group (6 persons).................... 739,944(11) 25.4%
</TABLE>
- --------------------------
* Represents less than 1%.
(1) Information furnished by each individual named. This table includes
shares that are owned jointly, in whole or in part, with the persons
spouse or children, or individually by such spouse or children.
(2) Includes 17,918 shares owned by Kenneth L. Brier's wife and 7,500
shares owned by his children as to which Kenneth L. Brier disclaims
beneficial ownership. Also includes 173,000 shares subject to
currently exercisable options. Kenneth L. Brier's address is 33 Rock
Hill Road, Bala Cynwyd, PA 19004.
(3) Includes 138,000 shares subject to currently exercisable options and
2,000 shares owned by Mr. Drauschak's children as to which he
disclaims beneficial ownership. Mr. Drauschak's address is 33 Rock
Hill Road, Bala Cynwyd, PA 19004.
(4) Mr. Fletcher's emploment and service as an officer of the Company
terminated on September 2, 1997.
(5) Includes 63,000 shares subject to currently exercisable options.
35
<PAGE>
(6) Includes 400 shares owned by Mr. Adams' wife, for which he disclaims
beneficial ownership, and 8,000 shares subject to currently
exercisable options.
(7) Includes 8,000 shares subject to currently exercisable options.
(8) Jack Brier is Kenneth L. Brier's father. Jack Brier's address is
Kleinerts, Inc., Suite 100, 120 West Germantown Pike, Plymouth
Meeting, PA 19462.
(9) Includes 416 shares owned by Jack Brier's wife, as to which he
disclaims beneficial ownership.
(10) Based upon the Schedule 13G of ESQF Advisors, Inc. ("ESQF") and Martin
J. Whitman filed July 7, 1996, ESQF is a registered investment
adviser, of which Mr. Whitman is chief executive officer and
controlling person. The address of ESQF and Mr. Whitman is 767 Third
Avenue, New York, NY 10017.
(11) Includes 390,000 shares subject to currently exercisable options.
Item 12. Certain Relationships and Related Transactions.
Gary L. Bragg, Esquire, Secretary and a Director of the Surety Company,
is also a shareholder in the law firm of O'Neill, Bragg and Staffin, P.C., which
has served as general counsel to the Company and the Surety Company since 1992,
principally in connection with corporate and regulatory matters. Such firm is
paid its customary fees for such services.
36
<PAGE>
Item 13. Exhibits and Reports on Form 8-K.
(a) Financial Statements and exhibits filed:
(1) Financial Statements included in Item 7 of this Form 10-KSB
Report.
Page
----
Report of Independent Accountants 12
Consolidated Balance Sheets as of December 31, 1997 and 1996 13
Consolidated Statements of Operations for the two years ended
December 31, 1997 and 1996 14
Consolidated Statements of Changes in Shareholders' Equity for
the years ended December 31, 1997 and 1996 15
Consolidated Statements of Cash Flows for the
years ended December 31, 1997 and 1996 16
Notes to the Consolidated Financial Statements 17
(2) Exhibits
Exhibit No. Description of Exhibit
- ----------- ----------------------
(3.2)* Amended and Restated Articles of Incorporation of the
Registrant
(3.3)** By-laws of Registrant
(10.1)*** Reinsurance Treaty with Transatlantic Reinsurance Company
dated March 1, 1995
Management Contracts and Compensatory Plans or Arrangements
(10.2)*** Amended and Restated Employment Agreement between the Company
and Kenneth L. Brier dated March 8, 1996
(10.3)*** Amended and Restated Employment Agreement between the Company
and Ted A. Drauschak dated March 8, 1996
(10.5)**** Amended and Restated Employment Agreement between the Company
and Joel D. Cooperman dated June 14, 1996
(10.6)** 1993 Non-Qualified Stock Option Plan and Form of 1993
Non-Qualified Stock Option Agreement
37
<PAGE>
Item 13. (continued) Exhibits and Reports on Form 8-k
(10.7)** 1993 Incentive Stock Option Plan and Form of 1993 Incentive
Stock Option Agreement
(10.8)***** 1995 Equity Incentive Plan for Key Employees, as amended
(10.9)****** 1995 Equity Incentive Plan for Outside Directors
(10.10) Supplemental Non-Qualified Stock Option Plan
Other Material Contracts
(10.11)*** Amended and Restated Services Agreement dated December 31,
1995 between the Company and The Surety Company
(10.12)*** Summary of First, Second, Third, and Fourth Surety Excess of
Loss Reinsurance Agreement dated November 1, 1995
(10.13)**** Summary of First, Second, Third, and Fourth Surety Excess of
Loss Reinsurance Agreement dated November 1, 1996
(10.14) Summary of First, Second, Third, and Fourth Surety Excess of
Loss Reinsurance Agreement dated November 1, 1997
(21)**** Subsidiaries of the Company
(23) Consent of Independent Public Accountants
(27) Financial Data Schedule
(b) Reports on Form 8-K:
During the quarter ended December 31, 1996, the Registrant did not file
any reports on Form 8-K.
- --------------------------------------------------------------------------------
* Such exhibit is hereby incorporated by reference to the like-described
exhibit in the Registrant's Form 10-QSB quarterly report for the period
ended March 31, 1996.
** Such exhibit is hereby incorporated by reference to the like-described
exhibit in the Registrant's SB-2 Registration Statement No. 33-78336
declared effective September 1, 1994.
*** Such exhibit is hereby incorporated by reference to the like-described
exhibit in the Registrant's Form 10-KSB Annual Report for the year
ended December 31, 1995.
**** Such exhibit is hereby incorporated by reference to the like-described
exhibit in the Registrant's Form 10-KSB Annual Report for the year
ended December 31, 1996
***** Such exhibit is hereby incorporated by reference to the like-described
exhibit in the Registrant's Form 10-QSB Quarterly Report for the
quarter ended June 30, 1997
****** Such exhibit is hereby incorporated by reference to the like-described
exhibit in the Registrant's Form S-8 Registration Statement No.
333-23055 filed on March 10, 1997.
38
<PAGE>
SIGNATURES
In accordance with Section 13 or 15(d) of Exchange Act, the Registrant has duly
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
March 27,1998 MOUNTBATTEN, INC.
By /s/ Kenneth L. Brier
---------------------------------------
Kenneth L. Brier
President and Chief Executive Officer
(principal executive officer)
By /s/ Joel D. Cooperman
---------------------------------------
Joel D. Cooperman
Vice President, Finance, Treasurer, and
Chief Financial Officer
(principal financial and
accounting officer)
In accordance with the Exchange Act, this report has been signed below by the
following persons on behalf of the Registrant and in the capacities and on the
dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<S> <C> <C>
/s/ Kenneth L. Brier President, Chief March 27, 1998
- ------------------------------------ Executive Officer,
Kenneth L. Brier and Director (principal
executive officer)
/s/ Ted Drauschak Executive Vice President, March 27, 1998
- ------------------------------------ Secretary, and Director
Ted Drauschak
/s/ Joel D. Cooperman Vice President, Finance, March 27, 1998
- ------------------------------------ Treasurer, and Chief Financial
Joel D. Cooperman Officer (principal financial and
accounting officer)
/s/ J. Michael Adams Director March 27, 1998
- ------------------------------------
J. Michael Adams
/s/ Thomas P. Garry Director March 27, 1998
- ------------------------------------
Thomas P. Garry
</TABLE>
39
<PAGE>
Exhibit Index
(3.2)* Amended and Restated Articles of Incorporation of the
Registrant
(3.3)** By-laws of Registrant
(10.1)*** Reinsurance Treaty with Transatlantic Reinsurance Company
dated March 1, 1995
Management Contracts and Compensatory Plans or Arrangements
(10.2)*** Amended and Restated Employment Agreement between the Company
and Kenneth L. Brier dated March 8, 1996
(10.3)*** Amended and Restated Employment Agreement between the Company
and Ted A. Drauschak dated March 8, 1996
(10.5)**** Amended and Restated Employment Agreement between the Company
and Joel D. Cooperman dated June 14, 1996
(10.6)** 1993 Non-Qualified Stock Option Plan and Form of 1993
Non-Qualified Stock Option Agreement
(10.7)** 1993 Incentive Stock Option Plan and Form of 1993 Incentive
Stock Option Agreement
(10.8)***** 1995 Equity Incentive Plan for Key Employees, as amended
(10.9)****** 1995 Equity Incentive Plan for Outside Directors
(10.10) Supplemental Non-Qualified Stock Option Plan
Other Material Contracts
(10.11)*** Amended and Restated Services Agreement dated December 31,
1995 between the Company and The Surety Company
(10.12)*** Summary of First, Second, Third, and Fourth Surety Excess of
Loss Reinsurance Agreement dated November 1, 1995
(10.13)**** Summary of First, Second, Third, and Fourth Surety Excess of
Loss Reinsurance Agreement dated November 1, 1996
(10.14) Summary of First, Second, Third, and Fourth Surety Excess of
Loss Reinsurance Agreement dated November 1, 1997
(21)**** Subsidiaries of the Company
(23) Consent of Independent Public Accountants
(27) Financial Data Schedule
<PAGE>
Exhibit Index (continued)
* Such exhibit is hereby incorporated by reference to the like-described
exhibit in the Registrant's Form 10-QSB quarterly report for the period
ended March 31, 1996.
** Such exhibit is hereby incorporated by reference to the like-described
exhibit in the Registrant's SB-2 Registration Statement No. 33-78336
declared effective September 1, 1994.
*** Such exhibit is hereby incorporated by reference to the like-described
exhibit in the Registrant's Form 10-KSB Annual Report for the year
ended December 31, 1995.
**** Such exhibit is hereby incorporated by reference to the like-described
exhibit in the Registrant's Form 10-KSB Annual Report for the year
ended December 31, 1996.
***** Such exhibit is hereby incorporated by reference to the like-described
exhibit in the Registrant's Form 10-QSB Quarterly Report for the
quarter ended June 30, 1997.
****** Such exhibit is hereby incorporated by reference to the like-described
exhibit in the Registrant's Form S-8 Registration Statement No.
333-23055 filed on March 10, 1997.
<PAGE>
Exhibit 10.10
MOUNTBATTEN, INC.
SUPPLEMENTAL NONQUALIFIED STOCK OPTION PLAN
1. Purpose. The purpose of the Mountbatten, Inc. Supplemental
Nonqualified Stock Option Plan (the "Plan") is to further the growth,
development and financial success of Mountbatten, Inc. (the "Company") and the
subsidiaries of the Company by providing additional incentives to directors and
those officers who are responsible for the management of the business affairs of
the Company and/or subsidiaries of the Company, which will enable them to
participate directly in the growth of the capital stock of the Company. To
accomplish these purposes, the Plan provides a means whereby directors and
officers may receive stock options ("Options") to purchase the Company's Common
Stock, $.01 par value (the "Common Stock"), which Options are intended to
supplement awards made under the Company's existing equity incentive plans.
2. Administration.
(a) Administration by the Board. The Plan shall be administered by the
Company's Board of Directors (the "Board").
(b) Authority of the Board. The Board shall have full and final
authority, in its sole discretion, to interpret the provisions of the Plan and
to decide all questions of fact arising in its application; to determine the
directors and officers to whom Options shall be granted and the type, amount,
size and terms of each such grant; to determine the time when Options shall be
granted; and to make all other determinations necessary or advisable for the
administration of the Plan. All decisions, determinations and interpretations of
the Board shall be final and binding on all optionees and all other holders of
Options granted under the Plan.
3. Stock Subject to the Plan. Subject to Section 16 hereof, the shares
that may be issued under the Plan shall not exceed in the aggregate 25,000
shares of Common Stock. Such shares may be authorized and unissued shares or
shares issued and subsequently reacquired by the Company. Except as otherwise
provided herein, any shares subject to an Option that for any reason expires or
is terminated unexercised as to such shares shall again be available under the
Plan.
4. Eligibility To Receive Options. Persons eligible to receive Options
under the Plan shall be limited to directors and those officers and key
employees of the Company and any subsid iary of the Company (as defined in
Section 425 of the Code or any amendment or substitute thereto) who are in
positions in which their decisions, actions and counsel significantly impact
upon the profitability and success of the Company or any subsidiary of the
Company.
5. Type of Options. Grants may be made at any time and from time to
time by the Board in the form of stock options to purchase shares of Common
Stock. Options granted hereunder shall be Options that are not intended to
qualify as incentive stock options within the
<PAGE>
meaning of Section 422 of the Code or any amendment or substitute thereto
("Nonqualified Stock Options").
6. Option Agreements. Options for the purchase of Common Stock shall be
evidenced by written agreements in such form not inconsistent with the Plan as
the Board shall approve from time to time. The Options granted hereunder may be
evidenced by a single agreement or by multiple agreements, as determined by the
Board in its sole discretion. Each option agreement shall contain in substance
the following terms and conditions:
(a) Type of Option. Each option agreement shall identify the Options
represented thereby either as Nonqualified Stock Options.
(b) Option Price. Each option agreement shall set forth the purchase
price of the Common Stock purchasable upon the exercise of the Option evidenced
thereby. The purchase price of the Common Stock subject to an Option shall be
not less than 100% of the fair market value of such stock on the date the Option
is granted, as determined by the Board, but in no event less than the par value
of such stock. For this purpose, fair market value on any date shall mean the
closing price of the Common Stock, as reported by the Nasdaq National Market, or
if the Common Stock is not reported by the Nasdaq National Market, the fair
market value shall be as determined by the Board.
(c) Exercise Term. Each option agreement shall state the period or
periods of time within which the Option may be exercised, in whole or in part,
as determined by the Board, provided that no Option shall be exercisable after
ten years from the date of grant thereof. The Board shall have the power to
permit an acceleration of previously established exercise terms, subject to the
requirements set forth herein, upon such circumstances and subject to such terms
and conditions as the Board deems appropriate.
(d) Substitution of Options. Options may be granted under the Plan from
time to time in substitution for stock options held by employees of other
corporations who are about to become, and who do concurrently with the grant of
such options become, directors or officers of the Company or a subsidiary of the
Company as a result of a merger or consolidation of the employing corporation
with the Company or a subsidiary of the Company, or the acquisition by the
Company or a subsidiary of the Company of the assets or capital stock of the
employing cor poration. The terms and conditions of the substitute options so
granted may vary from the terms and conditions set forth in this Section 6 to
such extent as the Board at the time of grant may deem appropriate to conform,
in whole or in part, to the provisions of the stock options in substitution for
which they are granted.
7. Date of Grant. The date on which an Option shall be deemed to have
been granted under the Plan shall be the date of the Board's authorization of
the Option or such later date as may be determined by the Board at the time the
Option is authorized. Notice of the determination shall be given to each
individual to whom an Option is so granted within a reasonable time after the
date of such grant.
8. Exercise and Payment for Shares. Options may be exercised in whole
or in part, from time to time, by giving written notice of exercise to the
Secretary of the Company, specify ing the number of shares to be purchased. The
purchase price of the shares with respect to which an Option is exercised shall
be payable in full with the notice of exercise in cash, Common Stock at fair
-2-
<PAGE>
market value, or a combination thereof, as the Board may determine from time to
time and subject to such terms and conditions as may be prescribed by the Board
for such purpose. The Board may also, in its discretion and subject to prior
notification to the Company by an optionee, permit an optionee to enter into an
agreement with the Company's transfer agent or a brokerage firm of national
standing whereby the optionee will simultaneously exercise the Option and sell
the shares acquired thereby through the Company's transfer agent or such a
brokerage firm and either the Company's transfer agent or the brokerage firm
executing the sale will remit to the Company from the proceeds of sale the
exercise price of the shares as to which the Option has been exercised.
9. Rights upon Termination of Service. In the event that an optionee
ceases to be a director or an employee of the Company or any subsidiary of the
Company for any reason other than death or disability (within the meaning of
Section 22 of the Code or any substitute therefor), the optionee shall have the
right to exercise the Option during its term within a period of three months
after such termination to the extent that the Option was exercisable at the time
of termination, or within such other period, and subject to such terms and
conditions, as may be specified by the Board. In the event that an optionee dies
or becomes disabled prior to the expi ration of his Option and without having
fully exercised his Option, the optionee or his successor shall have the right
to exercise the Option during its term within a period of one year after
termination of service as a director or employment due to death or disability to
the extent that the Option was exercisable at the time of termination, or within
such other period, and subject to such terms and conditions, as may be specified
by the Board.
10. General Restrictions. Each Option granted under the Plan shall be
subject to the requirement that, if at any time the Board shall determine that
(i) the listing, registration or qualification of the shares of Common Stock
subject or related thereto upon any securities exchange or under any state or
federal law, or (ii) the consent or approval of any government regulatory body,
or (iii) the satisfaction of any tax payment or withholding obligation, or (iv)
an agreement by the recipient of an Option with respect to the disposition of
shares of Common Stock, is necessary or desirable as a condition of or in
connection with the granting of such Option or the issuance or purchase of
shares of Common Stock thereunder, such Option shall not be consummated in whole
or in part unless such listing, registration, qualification, consent, approval
or agreement shall have been effected or obtained free of any conditions not
acceptable to the Board.
11. Rights of a Shareholder. The recipient of any Option under the
Plan, unless other wise provided by the Plan, shall have no rights as a
shareholder unless and until certificates for shares of Common Stock are issued
and delivered to him.
12. Right to Terminate Employment. If an Option is granted to an
employee of the Company or any subsidiary of the Company, nothing contained in
the Plan or in any option agree ment entered into pursuant to the Plan shall
confer upon any optionee the right to continue in the employment of the Company
or any subsidiary of the Company or affect any right that the Com pany or any
subsidiary of the Company may have to terminate the employment of such optionee.
13. Withholding. Whenever the Company proposes or is required to issue
or transfer shares of Common Stock under the Plan, the Company shall have the
right to require the recipient
-3-
<PAGE>
to remit to the Company an amount sufficient to satisfy any federal, state or
local withholding tax requirements prior to the delivery of any certificate or
certificates for such shares. If and to the extent authorized by the Board, in
its sole discretion, an optionee may make an election, by means of a form of
election to be prescribed by the Board, to have shares of Common Stock that are
acquired upon exercise of an Option withheld by the Company or to tender other
shares of Common Stock or other securities of the Company owned by the optionee
to the Company at the time of exercise of an Option to pay the amount of tax
that would otherwise be required by law to be withheld by the Company as a
result of any exercise of an Option. Any such election shall be irrevocable and
shall be subject to termination by the Board, in its sole discretion, at any
time. Any securities so withheld or tendered will be valued by the Board as of
the date of exercise.
14. Non-Assignability. No Option under the Plan shall be assignable or
transferable by the recipient thereof except by will or by the laws of descent
and distribution or by such other means as the Baord may approve. During the
life of the recipient, such Option shall be exercis able only by such person or
by such person's guardian or legal representative.
15. Non-Uniform Determinations. The Board's determinations under the
Plan (including without limitation determinations of the persons to receive
Options, the form, amount and timing of such grants, the terms and provisions of
Options, and the agreements evidencing same) need not be uniform and may be made
selectively among persons who receive, or are eligible to receive, grants of
Options under the Plan whether or not such persons are similarly situated.
16. Adjustments.
(a) Changes in Capitalization. Subject to any required action by the
shareholders of the Company, the number of shares of Common Stock covered by
each outstanding Option and the number of shares of Common Stock that have been
authorized for issuance under the Plan but as to which no Options have yet been
granted or which have been returned to the Plan upon cancellation or expiration
of an Option, as well as the price per share of Common Stock covered by each
such outstanding Option, shall be proportionately adjusted for any increase or
decrease in the number of issued shares of Common Stock resulting from a stock
split, reverse stock split, stock dividend, combination or reclassification of
the Common Stock, or any other increase or decrease in the number of issued
shares of Common Stock effected without receipt of consider ation by the
Company; provided, however, that conversion of any convertible securities of the
Company shall not be deemed to have been "effected without receipt of
consideration." Such adjustment shall be made by the Board, whose determination
in that respect shall be final, binding and conclusive. Except as expressly
provided herein, no issuance by the Company of shares of stock of any class, or
securities convertible into shares of stock of any class, shall affect, and no
adjustment by reason thereof shall be made with respect to, the number or price
of shares of Common Stock subject to an Option.
(b) Dissolution or Liquidation. In the event of the proposed
dissolution or liquidation of the Company, all outstanding Options will
terminate immediately prior to the consummation of such proposed action, unless
otherwise provided by the Board. The Board may, in the exercise of its
discretion in such instances, declare that any Option shall terminate as of a
date fixed by the Board and give each Option holder the right to exercise his
Option as to all or any part of the shares of
-4-
<PAGE>
Common Stock covered by the Option, including shares as to which the Option
would not otherwise be exercisable.
(c) Sale or Merger. In the event of a proposed sale of all or
substantially all of the assets of the Company, or the merger of the Company
with or into another corporation, the Board, in the exercise of its sole
discretion, may take such action as it deems desirable, including, but not
limited to: (i) causing an Option to be assumed or an equivalent option to be
substituted by the successor corporation or a parent or subsidiary of such
successor corporation, (ii) providing that each Option holder shall have the
right to exercise his Option as to all of the shares of Common Stock covered by
the Option, including shares as to which the Option would not otherwise be
exercisable, or (iii) declaring that an Option shall terminate at a date fixed
by the Board provided that the Option holder is given notice and opportunity to
exercise the then exercisable portion of his Option prior to such date.
17. Amendment. The Board may terminate or amend the Plan at any time,
with respect to shares as to which Options have not been granted, subject to any
required shareholder approval or any shareholder approval that the Board may
deem to be advisable for any reason, such as for the purpose of obtaining or
retaining any statutory or regulatory benefits under tax, securities or other
laws or satisfying any applicable stock exchange listing requirements. The Board
may not, without the consent of the holder of an Option, alter or impair any
Option previously granted under the Plan, except as specifically authorized
herein.
18. Reservation of Shares. The Company, during the term of the Plan,
will at all times reserve and keep available such number of shares as shall be
sufficient to satisfy the require ments of the Plan. Inability of the Company to
obtain authority from any regulatory body having jurisdiction, which authority
is deemed by the Company's counsel to be necessary to the lawful issuance and
sale of any shares hereunder, shall relieve the Company of any liability for the
failure to issue or sell such shares as to which such requisite authority shall
not have been obtained.
19. Effect on Other Plans. Participation in the Plan shall not affect a
director's or an employee's eligibility to participate in any other benefit or
incentive plan of the Company or any subsidiary of the Company. Any Options
granted pursuant to the Plan shall not be used in determining the benefits
provided under any other plan of the Company or any subsidiary of the Company
unless specifically provided.
20. Duration of the Plan. The Plan shall remain in effect until all
Options granted under the Plan have been satisfied by the issuance of shares,
but no Option shall be granted more than ten years after the earlier of the date
the Plan is adopted by the Company or is approved by the Company's shareholders.
21. Forfeiture for Dishonesty. Notwithstanding anything to the contrary
in the Plan, if the Board finds, by a majority vote, after full consideration of
the facts presented on behalf of both the Company and any optionee, that the
optionee has been engaged in fraud, embezzlement, theft, commission of a felony
or dishonest conduct in the course of his service, employment or retention by
the Company or any subsidiary of the Company that damaged the Company or any
subsidiary of the Company
-5-
<PAGE>
or that the optionee has disclosed confidential information of the Company or
any subsidiary of the Company, the optionee shall forfeit all unexercised
Options and all exercised Options under which the Company has not yet delivered
the certificates. The decision of the Board in interpreting and applying the
provisions of this Section 21 shall be final. No decision of the Board, however,
shall affect the finality of the discharge or termination of such optionee by
the Company or any subsidiary of the Company in any manner.
22. No Prohibition on Corporate Action. No provision of the Plan shall
be construed to prevent the Company or any officer or director thereof from
taking any action deemed by the Company or such officer or director to be
appropriate or in the Company's best interest, whether or not such action could
have an adverse effect on the Plan or any Options granted hereunder, and no
optionee or optionee's estate, personal representative or beneficiary shall have
any claim against the Company or any officer or director thereof as a result of
the taking of such action.
23. Indemnification. With respect to the administration of the Plan,
the Company shall indemnify each present and future member of the Board against,
and each member of the Board shall be entitled without further action on his
part to indemnity from the Company for, all expenses (including the amount of
judgments and the amount of approved settlements made with a view to the
curtailment of costs of litigation, other than amounts paid to the Company
itself) reasonably incurred by him in connection with or arising out of, any
action, suit or proceeding in which he may be involved by reason of his being or
having been a member of the Board, whether or not he continues to be such member
at the time of incurring such expenses; provided, however, that such indemnity
shall not include any expenses incurred by any such member of the Board (i) in
respect of matters as to which he shall be finally adjudged in any such action,
suit or proceeding to have been guilty of gross negligence or willful misconduct
in the perfor mance of his duty as such member of the Board; or (ii) in respect
of any matter in which any settlement is effected for an amount in excess of the
amount approved by the Company on the advice of its legal counsel; and provided
further that no right of indemnification under the pro visions set forth herein
shall be available to or enforceable by any such member of the Board unless,
within 60 days after institution of any such action, suit or proceeding, he
shall have offered the Company in writing the opportunity to handle and defend
same at its own expense. The foregoing right of indemnification shall inure to
the benefit of the heirs, executors or administra tors of each such member of
the Board and shall be in addition to all other rights to which such member may
be entitled as a matter of law, contract or otherwise.
24. Miscellaneous Provisions.
(a) Compliance with Plan Provisions. No optionee or other person shall
have any right with respect to the Plan, the Common Stock reserved for issuance
under the Plan or in any Option until a written option agreement shall have been
executed by the Company and the optionee and all the terms, conditions and
provisions of the Plan and the Option applicable to such optionee (and each
person claiming under or through him) have been met.
(b) Approval of Counsel. In the discretion of the Board, no shares of
Common Stock, other securities or property of the Company or other forms of
payment shall be issued hereunder with respect to any Option unless counsel for
the Company shall be satisfied that such issuance will be
-6-
<PAGE>
in compliance with applicable federal, state, local and foreign legal,
securities exchange and other applicable requirements.
(c) Compliance with Rule 16b-3. To the extent that Rule 16b-3 under the
Securities Exchange Act of 1934, as amended, applies to the Plan or to Options
granted under the Plan, it is the intention of the Company that the Plan comply
in all respects with the requirements of Rule 16b-3, that any ambiguities or
inconsistencies in construction of the Plan be interpreted to give effect to
such intention and that, if the Plan shall not so comply, whether on the date of
adoption or by reason of any later amendment to or interpretation of Rule 16b-3,
the provisions of the Plan shall be deemed to be automatically amended so as to
bring them into full compliance with such rule.
(d) Effects of Acceptance of Option. By accepting any Option or other
benefit under the Plan, each optionee and each person claiming under or through
him shall be conclusively deemed to have indicated his acceptance and
ratification of, and consent to, any action taken under the Plan by the Company
and/or the Board or its delegates.
(e) Construction. The masculine pronoun shall include the feminine and
neuter, and the singular shall include the plural, where the context so
indicates.
December 23, 1997
-7-
<PAGE>
Exhibit 10.14
THE MOUNTBATTEN SURETY COMPANY, INC.
FIRST THROUGH FOURTH SURETY EXCESS OF LOSS
REINSURANCE AGREEMENTS
TERMS EFFECTIVE: NOVEMBER 1, 1997
<TABLE>
<CAPTION>
<S> <C> <C>
REINSURED COMPANY: The Mountbatten Surety Company, Inc. (PREAMBLE)
Bala Cynwyd, Pennsylvania
BUSINESS REINSURED: In force, new and renewal business classified by the Company as Surety ARTICLE 1
Business.
ACCOUNT BASIS: Losses Discovered.
COVER: $ (See Attached Schedule A) each and every Loss Discovered, each and ARTICLE 2
every Principal, in excess of $ (See Attached Schedule A) each and (definition
every Loss Discovered, each and every Principal. attached)
COMMENCEMENT AND Continuous from November 1, 1997 on a losses discovered basis. Either ARTICLE 3
TERMINATION: party may terminate as of any November 1 by giving 90 days written
notice. Runoff at termination not to exceed 24 months (36 months with
respect to Service and Supply Business). Cut-off with a return of
unearned premium to be mutually agreed.
In the event the Company enters into any arrangement either by way of
shareholding or management or otherwise, under which effective
legal or presumptive control is assumed by any other individual or
organization than that which pertained at the time this agreement became
effective, the Company or Reinsurer(s) may terminate this agreement
with 30 days written notice. If Company terminates, they may do so on
either a run-off or cut-off basis as above. If Reinsurer(s) terminate,
termination shall be on run off unless otherwise agreed.
TERRITORY: Applies to Bonds issued to insureds domiciled in the United States of ARTICLE 4
America, its territories and possessions and the District of Columbia;
but this limitation shall not apply to losses if the Company's Bonds
provide coverage outside the aforesaid territorial limits.
WARRANTY: It is warranted for purposes of this Agreement that: ARTICLE 5
Maximum Any One Bond $6,000,000
Maximum Any One Bonded Work Program $12,000,000
Maximum Bond Duration (Service & Supply) 36 Months
Maximum Bond Duration 24 months
(Contract: Exclusive of Maintenance:
Maintenance not to exceed 24 months).
EXCLUSIONS: Attached. ARTICLE 6
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C>
PREMIUM: Deposit Premium of $ (See attached Schedule A) payable in quarterly ARTICLE 7
installments on November 1, 1997, February 1, 1998, May 1, 1998 and
August 1, 1998, adjusted annually at a rate of (See attached Schedule
A)% of GNWPI, subject to a minimum of $ (See attached Schedule A).
REINSTATEMENT: (See attached Schedule A). ARTICLE 8
CONTINGENT PROFIT: (See attached Schedule A). ARTICLE 9
REPORTS: Annually within 60 days. ARTICLE 10
DEFINITIONS: Surety Business ARTICLE 11
Ultimate Net Loss (expenses included; 90% ECO; 100% XPL) - Attached
Bond - Attached
Principal - Attached
Work Program - Attached
Losses Discovered - Attached
Gross Net Written Premium Income
Agreement Year - Attached
CLAUSES: Net Retained Lines ARTICLE 12
Currency ARTICLE 13
Loss/Unearned Premium Reserve Funding (including IBNR) ARTICLE 14
Taxes (Reinsurers pay FET as applicable) ARTICLE 15
Notice of Loss and Loss Settlements ARTICLE 16
Offset ARTICLE 17
Extra Contractual Obligations ARTICLE 18
Delay, Omission or Error ARTICLE 19
Inspection ARTICLE 20
Arbitration ARTICLE 21
Service of Suit ARTICLE 22
Insolvency ARTICLE 23
Entire Agreement ARTICLE 24
Sedgwick Re Intermediary Clause ARTICLE 25
PARTICIPATION: ARTICLE 26
REGULATION 98: Premium and loss payments made to Sedgwick Re shall be deposited in a
Premium and Loss Account in accordance with Section 32.3(a)(1) of
Regulation 98 of the New York Insurance Department. The parties
hereto consent to withdrawals from said Account in accordance with
Section 32.3(a)(3) of the Regulation, including interest and Federal
Excise Tax.
</TABLE>
<PAGE>
Mountbatten Surety Company, Inc.
Surety Excess of Loss Reinsurance Program
Terms Effective: November 1, 1997
Definitions
Loss Discovered
For the purpose of this Agreement, the Loss shall have been deemed to be "Loss
Discovered" on the date that the Company in the normal course of business,
establishes an incurred loss through the actual payment of all, or a portion of
a claim, or the creation of an outstanding loss reserve, or a combination
thereof which exceeds $75,000.
Work Program
The term "bonded work program" as used in this Agreement shall mean, the greater
of (a) the aggregate line of credit for bonded construction or supply contracts
issued by the Company and outstanding at the time a bond is executed, or (b) the
uncompleted portion of bonded construction or supply contracts (including the
principal's share of bonded joint ventures, outstanding bids, and the contract
being bonded and excluding bonded cost plus work not subject to a guaranteed
maximum price) as known to the Company and outstanding at the time any bond is
executed.
Bond
The term "Bond" as used in this Agreement shall mean any bond, undertaking,
guarantee, indemnity, binder, or other obligation, including riders and
endorsements and letters and agreements in connection therewith, at any time
issued, assumed or accepted by the Company and classified by any Federal or
State body as Surety Business at the effective date of such business.
Principal
The term "Principal" as used in this Agreement shall mean any legal entities
under common management and control, or one or more legal entities for which
bonds are executed relying upon the indemnity of the same person, firm or
corporation, or relying upon the indemnity of a related group of persons, firms
or corporations, or the Company is furnished and named in a supporting indemnity
agreement.
Agreement Year
The term "Agreement Year" as used in this Agreement shall mean those Bonds with
inception, renewal or anniversary date during each 12-month period commencing on
each November 1, and all premium attributable to, and all loss arising out of
such Bonds from such inception, renewal or anniversary date until expiration,
cancellation, or next anniversary, whichever occurs first, will be ascribed to
the Agreement Year.
Article 2 - COVER
The Reinsurer shall pay to the Company the amount of Ultimate Net Loss on the
bond business of each Principal in excess of the Company retention, but not
exceeding the limit of liability of the reinsurer for each Principal, as set
forth in Schedule A attached.
<PAGE>
The Mountbatten Surety Company, Inc.
Surety Excess of Loss Reinsurance
Effective: November 1, 1997
Definitions continued
Ultimate Net Loss
The term Ultimate Net Loss shall mean the actual loss or losses paid or payable
by the Company under its bonds in the investigating, defense, settlement or
mitigation of claims or potential claims plus 90% of Extra Contractual
Obligations as defined in the Agreement; such loss or losses to include all
expenses of litigation, if any, and all other loss expenses of the Company,
including expenses incurred by the Company in the recovery of such losses but
excluding salaries of employees and office expenses of the Company, less
deductions of all recoveries and salvage recoveries actually made by the
Company.
<PAGE>
The Mountbatten Surety Company, Inc.
Surety Excess of Loss Reinsurance
Terms Effective: November 1, 1997
This Agreement does not cover:
1. Bank Depository Bonds.
2. Note Guarantee Bonds.
3. Mortgage Deficiency Bonds.
4. Guarantees of Installment Paper.
5. Insurance Company Qualifying Bonds.
6. Securities Exchange Commission Liability Bonds.
7. Insurance Patent Infringement Bonds.
8. Bail Bonds.
9. Lease Bonds.
10. Mortgage Guarantee Insurance.
11. Defeasance Bonds.
12. Small Business Administration Guarantees.
13. Financial Guarantees which shall mean any bonds of coverage which
guarantee to any beneficiaries of the bonds or coverage against or
indemnify such beneficiaries for financial loss or the incurrence of
additional costs or expenses by reason of 1) non-payment of any sums
required to be paid to the beneficiaries of the bonds or coverage
pursuant to any financial obligations, 2) any fluctuations in financial
markets or commodity prices, 3) any changes in law, 4) the failure to
receive any anticipated payments of monies or money equivalents, 5) the
inaccuracy of any valuations and 6) overpayments of any financial
obligations for any reasons, including, but not limited to, Accounts
Receivable Coverage, Change-in-Law Coverage, Commercial Mortgage
Guarantees, Commercial Paper Coverage, Coupon Over-Redemption Coverage,
Cram Down bonds, Excess Federal Deposit Insurance Corporation Coverage,
Excess Federal Savings and Loan Insurance Corporation Coverage, Excess
Securities Investment Protection Corporation Coverage, Golden Parachute
Coverage, Guarantees of Bank Letters Credit, Guarantees of Mortgaged
Backed Securities, Housing Bonds, Industrial bond Insurance Coverage,
Interest Rate Cap Coverage, Lease Bonds or Guarantees, Limited
Partnership Investor Note Bonds or Guarantees, Mobile Home Loan
Guarantees, Money Market Coverage, Mortgage Backed Securities,
Guarantees, Mortgage Services Performance bonds, Movie Completion bonds
or Insurance Municipal Bond Insurance, Repurchase Agreement Guarantees,
Residual Value Insurance or Guarantees, Retroactive Liability
Insurance, Student Loan Guarantees, Systems Performance Insurance,
<PAGE>
Weather-Related Coverage, and Bonds used in Lieu of Letters of Credit
(except where such bonds are allowed to be substituted for Letter of
Credit for Contract Bid, Performance, or Labor and Material payment
obligations outside the United States).
14. Bonds written on an excess of loss basis.
15. Appeal bonds unless 100% collateralized.
16. No coverage for fraudulent or misuse of powers of attorney or granted
authority by producing agents.
17. Nuclear Incident liability reinsurance.
18. War Risks exclusion clause.
19. Pools, Associations and Syndicates.
20. Insolvency Funds.
21. Third Party Liability cover of all types, including strict liability.
In respect of a bond or bonds issued, to guarantee the performance of a
contract, this Agreement does not cover loss or loss expenses which
arise from liability, for bodily injury (including sickness, disease or
death), property damage (including cleanup or remediation costs),
damage to the environment, diminution in value of property), or
economic loss of any kind (including loss of use of property).
Under no circumstances shall the Reinsurer follow the fortunes of the
Company where the Company is found legally liable to pay such loss or
loss expense under a bond or bonds.
22. Reinsurance assumed, except business underwritten by the Company and
otherwise subject to this Agreement, but issued on another Company's
policy due to license or other considerations.
23. Strip Mining Bonds.
24. Co-Surety Bond business.
25. Super - Fund Clean-Up or similar exposures.
26. Ground water contamination exposures.
<PAGE>
The Mountbatten Surety Company Inc.
Surety Excess of Loss Reinsurance
Schedule A
Terms Effective November 1, 1997
Basis: Losses Discovered, Each Principal
<TABLE>
<CAPTION>
First Excess Second Excess Third Excess Fourth Excess
------------ ------------- ------------ -------------
<S> <C> <C> <C> <C>
Limit: $850,000 $2,000,000 $3,000,000 $4,000,000
Excess of
Retention: $150,000 $1,000,000 $3,000,000 $6,000,000
Reinstatements/ 1st two reinstatements 2 with additional 1 with additional premium Nil
Limitations: free, 3rd @ 50%, 4th @ premium pro rata as to pro rata as to amount and
100% amount and 50% as to 100% as to time.
time.
Premium:
Rate applicable to SWP
1998 est SWP: $11,500,000 7.65% 4.70% 1.45% 0.93%
Profit Sharing: 20% of profits after 20%
Reinsurer Expense
Annual Deposit: $850,000 $522,000 $161,000 $103,000
Annual Minimum Premium: $765,000 $467,000 $144,000 $92,000
Payable: Quarterly Quarterly Quarterly Quarterly
Other: Company to retain 5% of the First and Second Excess of Loss Layers
</TABLE>
<PAGE>
The Mountbatten Surety Company Inc.
Bala Cynwyd, Pennsylvania
Surety Excess of Loss Reinsurance
<TABLE>
<CAPTION>
Reinsurers Effective November 1, 1997
First Second Third Fourth
Reinsurer Excess Excess Excess Excess
--------- ------ ------ ------ ------
<S> <C> <C> <C> <C>
Transatlantic Reinsurance Co. 19.0% 19.0% 20.0% 20.0%
Underwriters at Lloyds
London through Ballantyne,
McKean & Sullivan, Ltd. 19.0% 19.0% 20.0% 20.0%
NAC Re Company 14.25% 14.25% 15.0% 15.0%
Hartford Fire Insurance Company 42.75% 42.75% 45.0% 45.0%
------ ------ ----- -----
95.00% 95.00% 100.0% 100.0%
</TABLE>
<PAGE>
EXHIBIT 23
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the incorporation by reference in the Registration
Statements on Form S-8 (No. 333-23055, No. 333-23057, No. 333-36625 and No.
333-36627) of Mountbatten, Inc. of our report dated February 20, 1998, which
appears in this Annual Report on Form 10-KSB.
/S/ PRICE WATERHOUSE LLP
PRICE WATERHOUSE LLP
Boston, Massachusetts
March 27, 1998
<TABLE> <S> <C>
<ARTICLE> 7
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> DEC-31-1998
<DEBT-HELD-FOR-SALE> 7,687,211
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 0
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 7,687,211
<CASH> 601,587
<RECOVER-REINSURE> 971,778
<DEFERRED-ACQUISITION> 653,725
<TOTAL-ASSETS> 15,292,004
<POLICY-LOSSES> 3,358,578
<UNEARNED-PREMIUMS> 1,536,800
<POLICY-OTHER> 0
<POLICY-HOLDER-FUNDS> 0
<NOTES-PAYABLE> 0
0
0
<COMMON> 2,529
<OTHER-SE> 0
<TOTAL-LIABILITY-AND-EQUITY> 15,292,004
10,396,648
<INVESTMENT-INCOME> 439,265
<INVESTMENT-GAINS> 0
<OTHER-INCOME> 273,048
<BENEFITS> 921,461
<UNDERWRITING-AMORTIZATION> (260,278)
<UNDERWRITING-OTHER> 5,925,960
<INCOME-PRETAX> 2,378,457
<INCOME-TAX> 815,235
<INCOME-CONTINUING> 1,563,222
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,563,222
<EPS-PRIMARY> 0.56
<EPS-DILUTED> 43
<RESERVE-OPEN> 1,153,270
<PROVISION-CURRENT> 1,036,713
<PROVISION-PRIOR> (115,214)
<PAYMENTS-CURRENT> 1,057,379
<PAYMENTS-PRIOR> 495,780
<RESERVE-CLOSE> 3,358,578
<CUMULATIVE-DEFICIENCY> 0
</TABLE>
