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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 8-K
CURRENT REPORT
Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
Date of Report (Date of earliest event reported) October 18, 1996
INTERNATIONAL ALLIANCE SERVICES, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 0-25890 22-2769024
(State or other jurisdiction (Commission (I.R.S. Employer
of incorporation) File Number) Identification No.)
10055 SWEET VALLEY DRIVE
VALLEY VIEW, OHIO 44125
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (216) 447-9000
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With respect to each contract, agreement or other document referred to
herein and filed with the Securities and Exchange Commission as an exhibit to
this report, reference is made to the exhibit for a more complete description
of the matter involved, and each such statement shall be deemed qualified in
its entirety by such reference.
ITEMS 1 AND 2. CHANGES IN CONTROL OF REGISTRANT; ACQUISITION OR DISPOSITION OF
ASSETS
MERGERS. On October 18, 1996, International Alliance Services, Inc.
(formerly known as Republic Environmental Systems, Inc., the "Company"), issued
(i) 14,760,000 shares of common stock, $.01 par value per share ("Common
Stock"), of the Company, (ii) warrants to purchase an additional (a) 1,400,000
shares of Common Stock at $2.625 per share, (b) 1,400,000 shares of Common
Stock at $3.125 per share and (c) 1,400,000 shares of Common Stock at $3.875
per share and (iii) a promissory note in the principal amount of $4,000,000 to
Alliance Holding Corporation in exchange for all of the outstanding shares of
common stock of Century Surety Company ("CSC") and Commercial Surety Agency,
Inc., d/b/a Century Surety Underwriters ("CSU" and, together with CSC, the
"Alliance Companies"), each a Ohio corporation and wholly-owned subsidiary of
Alliance Holding Corporation ("Alliance"), pursuant to an Agreement and Plan of
Merger (as amended to date, the "Merger Agreement") dated as of May 19, 1996
among the Company, two wholly-owned, newly-created subsidiaries of the Company,
CSC, CSU and Alliance (the "Mergers"). Mr. Joseph E. LoConti, a director and
Vice Chairman of the Company, is also the Chairman of the Board, President and
controlling shareholder of Alliance.
STOCK ISSUANCES. On October 18, 1996, the Company issued and sold to
(i) H. Wayne Huizenga, for an aggregate purchase price of $5,250,000 (a) an
aggregate of 2,000,000 shares of Common Stock and (b) warrants to purchase an
additional (1) 2,000,000 shares of Common Stock at $2.625 per share, (2)
2,000,000 shares of Common Stock at $3.125 per share and (3) 2,000,000 shares
of Common Stock at $3.875 per share, pursuant to the terms set forth in a Stock
Purchase Agreement dated as of May 19, 1996 by and between the Company and H.
Wayne Huizenga and (ii) MGD Holdings Ltd., a Bermuda corporation controlled by
Mr. Michael G. DeGroote ("MGD Holdings"), and its permitted assigns, for an
aggregate purchase price of $5,250,000 (a) an aggregate of 2,000,000 shares of
Common Stock and (b) warrants to purchase an additional (1) 2,000,000 shares of
Common Stock at $2.625 per share, (2) 2,000,000 shares of Common Stock at
$3.125 per share and (3) 2,000,000 shares of Common Stock at $3.875 per share,
pursuant to the terms set forth in a Stock Purchase Agreement dated as of May
19, 1996 by and between the Company and MGD Holdings (such transactions are
referred to collectively as the "Stock Issuances" and, together with the
Mergers, the "Combination").
CHANGE OF CONTROL -- CHANGES IN SECURITY OWNERSHIP, BOARD COMPOSITION AND
MANAGEMENT
Upon consummation of the Combination, Alliance became the largest
stockholder of the Company and may effectively control the management and
operations of the Company. The following is a description of certain changes
that occurred with respect to the Company upon consummation of the Combination.
CHANGE IN SECURITY OWNERSHIP OF THE COMPANY. As a result of the
Combination, Alliance may be deemed to beneficially own 26,076,000 shares, or
78.6% of the outstanding shares of Common Stock, calculated in accordance with
Rule 13d-3 under the Securities Exchange Act of 1934, as amended (the "Exchange
Act"). Such shares include 7,116,000 shares owned of record by MGD Holdings
Ltd. ("MGD Holdings"), a Bermuda corporation controlled by Michael G. DeGroote,
the Chairman of the Company and the beneficial owner of 13,136,000 or 36.9% of
the outstanding shares of Common Stock, for which Alliance shares voting power
under a voting agreement, dated October 18, 1996 (the "Voting Agreement"),
between Alliance and MGD Holdings. Pursuant to the Voting Agreement, MGD
Holdings, for a period of two years from the date thereof, has agreed to vote
all shares of Common Stock held by MGD Holdings from time to time in accordance
with the recommendation of the management of Alliance. Accordingly, Alliance
has the ability to determine the outcome of any vote of the Company's
stockholders during this period.
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CHANGE IN THE COMPOSITION OF THE BOARD OF DIRECTORS OF THE COMPANY.
Immediately following the consummation of the Combination, the Board of
Directors was enlarged to seven members and Michael J. Occhionero resigned from
the Board of Directors and Messrs. Edward F. Feighan, Harve A. Ferrill, Richard
C. Rochon and Craig L. Stout were appointed to fill the vacancies on the Board
of Directors. Of the seven members of the Board, four of such members, Messrs.
LoConti, Feighan, Stout and Ferrill, were nominated by, and/or are affiliated
with, Alliance. Accordingly, Alliance has effective control of the Board of
Directors of the Company.
CHANGE IN THE COMPOSITION OF THE MANAGEMENT OF THE COMPANY. Upon
consummation of the Combination, Mr. LoConti was appointed Vice Chairman of the
Company, Mr. Feighan was appointed Chief Executive Officer and President of the
Company and Mr. Stout was appointed Executive Vice President and Chief
Operating Officer of the Company. Mr. DeGroote will continue as Chairman of
the Board of Directors of the Company. This management team will manage the
operations of the Company upon consummation of the Combination.
ITEM 5. OTHER EVENTS.
AMENDMENTS TO THE CERTIFICATE OF INCORPORATION. In connection with
the Combination, on August 23, 1996, by written consent, a majority of the
outstanding shares of Common Stock approved the amendment of the Company's
Certificate of Incorporation to change the name of the Company from Republic
Environmental Systems, Inc. to International Alliance Services, Inc. and
increase the number of authorized shares of Common Stock from 20,000,000 to
100,000,000. Accordingly, on October 18, 1996, the Company filed a Certificate
of Amendment with the Delaware Secretary of State to effect such amendments to
the Company's Certificate of Incorporation.
ITEM 7. FINANCIAL INFORMATION AND EXHIBITS.
(a) The audited financial statements for the Alliance Companies
for the periods specified in Section 210- 3.05(b) under the
Exchange Act were filed with the Company's Definitive Schedule
14C Information Statement dated September 23, 1996 and are
incorporated herein by reference. Such financial statements
are filed herewith as Exhibit 99.8.
(b) The pro forma financial statements for the Company as provided
in Article 11 of Regulation S-X were filed with the Company's
Definitive Schedule 14C Information Statement dated September
23, 1996 and are incorporated herein by reference. Such
financial statements are filed herewith as Exhibit 99.8.
(c) The following exhibits are included herein pursuant to Item 7(c):
99.1 Agreement and Plan of Merger, dated as of May 19, 1996, by
and among the Company, Republic/CSA Acquisition
Corporation, Republic/CSU Acquisition Corporation,
Alliance, CSC and CSU (filed as Appendix I to the Company's
Definitive Schedule 14C Information Statement dated
September 23, 1996 and incorporated herein by reference).
99.2 Amendment No. 1 to Agreement and Plan of Merger, dated as
of July 25, 1996, by and among the Company, Republic/CSA
Acquisition Corporation, Republic/CSU Acquisition
Corporation, Alliance, CSC and CSU (filed as Appendix IV to
the Company's Definitive Schedule 14C Information Statement
dated September 23, 1996 and incorporated herein by
reference).
99.3 Amendment No. 2 to Agreement and Plan of Merger, dated as
of August 23, 1996, by and among the Company, Republic/CSA
Acquisition Corporation, Republic/CSU Acquisition
Corporation, Alliance, CSC and CSU (filed as Appendix V to
the Company's Definitive Schedule 14C Information Statement
dated September 23, 1996 and incorporated herein by
reference).
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99.4 Stock Purchase Agreement, dated as of May 19, 1996, by and
between the Company and H. Wayne Huizenga (filed as
Appendix II to the Company's Definitive Schedule 14C
Information Statement dated September 23, 1996 and
incorporated herein by reference).
99.5 Stock Purchase Agreement, dated as of May 19, 1996, by and
between the Company and MGD Holdings (filed as Appendix III
to the Company's Definitive Schedule 14C Information
Statement dated September 23, 1996 and incorporated herein
by reference).
99.6 Voting Agreement, dated as of October 18, 1996, by and
between MGD Holdings and Alliance.
99.7 Promissory Note, dated October 18, 1996, in the aggregate
principal amount of $4,000,000 issued by the Company
payable to Alliance.
99.8 The following audited financial statements for the Alliance
Companies for the periods specified in Section 210-3.05(b)
under the Exchange Act and the pro forma financial
statements for the Company pursuant to Article 11 of
Regulation S-X:
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REPUBLIC ENVIRONMENTAL SYSTEMS, INC. AND SUBSIDIARIES
UNAUDITED PRO FORMA FINANCIAL INFORMATION
Unaudited Pro Forma Condensed Balance Sheet as of June 30, 1996 . . . . . . . . . . . . . . . . . . . . F-3
Unaudited Pro Forma Condensed Statement of Operations:
Year ended December 31, 1995 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . F-4
Six months ended June 30, 1996 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . F-5
Notes to Unaudited Pro Forma Financial Information . . . . . . . . . . . . . . . . . . . . . . . . . . . F-6
CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS
Report of Independent Public Accountants . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . F-7
Consolidated and Combined Balance Sheets as of December 31, 1995 and 1994 . . . . . . . . . . . . . . . F-8
Consolidated and Combined Statements of Operations for the years ended
December 31, 1995, 1994 and 1993 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . F-9
Consolidated and Combined Statements of Cash Flows for the years ended
December 31, 1995, 1994 and 1993 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . F-10
Consolidated and Combined Statements of Stockholders' Equity for the
years ended December 31, 1995, 1994 and 1993 . . . . . . . . . . . . . . . . . . . . . . . . . . . . F-11
Notes to Consolidated and Combined Financial Statements . . . . . . . . . . . . . . . . . . . . . . . F-12
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Consolidated Balance Sheet as of June 30, 1996 (Unaudited) . . . . . . . . . . . . . . . . . . . . . . F-27
Consolidated Statements of Operations for the six months ended June 30, 1996
and 1995 (Unaudited) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . F-28
Consolidated Statements of Cash Flows for the six months ended June 30, 1996
and 1995 (Unaudited) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . F-29
Notes to Consolidated Financial Statements (Unaudited) . . . . . . . . . . . . . . . . . . . . . . . . F-30
CENTURY SURETY COMPANY AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
Independent Auditors' Report . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . F-32
Consolidated Balance Sheets as of December 31, 1995 and 1994 . . . . . . . . . . . . . . . . . . . . . F-33
Consolidated Statements of Income for the years ended December 31, 1995,
1994 and 1993 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . F-34
Consolidated Statements of Shareholder's Equity for the years ended
December 31, 1995, 1994 and 1993 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . F-35
</TABLE>
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<TABLE>
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Consolidated Statements of Cash Flows for the years ended December 31, 1995,
1994 and 1993 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . F-36
Notes to Consolidated Financial Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . F-37
Schedule I -- Summary of Investments -- Other than Investments in Related
Parties as of December 31, 1995 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . F-53
Schedule IV -- Reinsurance for the years ended December 31, 1995, 1994 and 1993 . . . . . . . . . . . F-54
Schedule VI -- Supplemental Information Concerning Property -- Casualty Insurance
Operation for the years ended December 31, 1995 1994 and 1993 . . . . . . . . . . . . . . . . . . . F-55
CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Consolidated Balance Sheets as of June 30, 1996 (Unaudited) and
December 31, 1995 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . F-56
Consolidated Statements of Income (Unaudited) for the six months
ended June 30, 1996 and 1995 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . F-57
Consolidated Statement of Cash Flows (Unaudited) for the six months ended
June 30, 1996 and 1995 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . F-58
Notes to the Consolidated Financial Statements (Unaudited) . . . . . . . . . . . . . . . . . . . . . . F-59
COMMERCIAL SURETY AGENCY, INC.
FINANCIAL STATEMENTS
Independent Auditors' Report . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . F-60
Balance Sheets as of December 31, 1995 and 1994 . . . . . . . . . . . . . . . . . . . . . . . . . . . F-61
Statements of Income for the years ended December 31, 1995, 1994 and 1993 . . . . . . . . . . . . . . F-62
Statements of Shareholder's Equity (Deficit) for the years ended
December 31, 1995, 1994 and 1993 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . F-63
Statements of Cash Flows for the years ended December 31, 1995, 1994 and 1993 . . . . . . . . . . . . F-64
Notes to the Financial Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . F-65
FINANCIAL STATEMENTS (UNAUDITED)
Balance Sheets as of June 30, 1996 (Unaudited) and December 31, 1995 . . . . . . . . . . . . . . . . . F-69
Statements of Income (Unaudited) for the six months ended June 30, 1996
and 1995 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . F-70
Statements of Cash Flows (Unaudited) for the six months ended June 30, 1996
and 1995 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . F-71
Notes to the Financial Statements (Unaudited) . . . . . . . . . . . . . . . . . . . . . . . . . . . . F-72
</TABLE>
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of
1934, the registrant has duly caused this report to be signed on its behalf by
the undersigned hereunto duly authorized.
INTERNATIONAL ALLIANCE SERVICES, INC.
Date: November 4, 1996 /s/ Edward F. Feighan
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Edward F. Feighan
President and Chief Executive Officer
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INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER
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99.1 Agreement and Plan of Merger, dated as of May 19, 1996, by and
among the Company, Republic/CSA Acquisition Corporation,
Republic/CSU Acquisition Corporation, Alliance, CSC and CSU
(filed as Appendix I to the Company's Definitive Schedule 14C
Information Statement dated September 23, 1996 and
incorporated herein by reference).
99.2 Amendment No. 1 to Agreement and Plan of Merger, dated as of
July 25, 1996, by and among the Company, Republic/CSA
Acquisition Corporation, Republic/CSU Acquisition Corporation,
Alliance, CSC and CSU (filed as Appendix IV to the Company's
Definitive Schedule 14C Information Statement dated September
23, 1996 and incorporated herein by reference).
99.3 Amendment No. 2 to Agreement and Plan of Merger, dated as of
August 23, 1996, by and among the Company, Republic/CSA
Acquisition Corporation, Republic/CSU Acquisition Corporation,
Alliance, CSC and CSU (filed as Appendix V to the Company's
Definitive Schedule 14C Information Statement dated September
23, 1996 and incorporated herein by reference).
99.4 Stock Purchase Agreement, dated as of May 19, 1996, by and
between the Company and H. Wayne Huizenga (filed as Appendix
II to the Company's Definitive Schedule 14C Information
Statement dated September 23, 1996 and incorporated herein by
reference).
99.5 Stock Purchase Agreement, dated as of May 19, 1996, by and
between the Company and MGD Holdings (filed as Appendix III to
the Company's Definitive Schedule 14C Information Statement
dated September 23, 1996 and incorporated herein by
reference).
99.6 Voting Agreement, dated as of October 18, 1996, by and between
MGD Holdings and Alliance.
99.7 Promissory Note, dated October 18, 1996, in the aggregate
principal amount of $4,000,000 issued by the Company payable
to Alliance.
99.8 The audited financial statements for the Alliance Companies
for the periods specified in Section 210-3.05(b) under the
Exchange Act and the pro forma financial statements for the
Company pursuant to Article 11 of Regulation S-X.
</TABLE>
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EXHIBIT 99.6
VOTING AGREEMENT
This VOTING AGREEMENT ("Agreement"), dated as of October 18, 1996, is
entered into by and between MGD Holdings Ltd., a Bermuda corporation
("Stockholder"), and Alliance Holding Corporation, an Ohio corporation ("AHC").
W I T N E S S E T H:
WHEREAS, contemporaneously with the delivery of this Agreement,
Republic Environmental Systems, Inc., a Delaware corporation ("RESI"), AHC,
Republic/CSC Acquisition Corporation, a wholly-owned subsidiary of RESI ("CSC
Merger Sub"), Republic/CSU Acquisition Corporation, a wholly-owned subsidiary
of RESI ("CSU Merger Sub"), Century Surety Company, a wholly-owned subsidiary
of AHC ("CSC"), Commercial Surety Agency, Inc., d/b/a Century Surety
Underwriters, a wholly-owned subsidiary of AHC ("CSU"), are closing the
transactions contemplated by that certain Agreement and Plan of Merger dated as
of even date herewith (the "Merger Agreement"), providing for, among other
items, the merger of CSC Merger Sub with and into CSC with CSC being the
surviving corporation (the "CSC Merger") and the merger of CSU Merger Sub with
and into CSU with CSU being the surviving corporation (the "CSU Merger" and,
together with the CSU Merger, the "Mergers"); and
WHEREAS, in order to induce AHC to enter into the Merger Agreement,
Stockholder agrees to vote all shares of RESI common stock, $.01 par value per
share ("Common Stock"), held by it from time to time (the "Shares") in
accordance with the terms of this Agreement;
NOW, THEREFORE, in consideration of AHC entering into the Merger
Agreement and the mutual covenants and agreements set forth herein, the receipt
and sufficiency of which are hereby acknowledged, the parties hereto hereby
agree as follows:
1. Voting. Stockholder hereby revokes any and all previous
voting agreements and proxies granted with respect to the Shares which are
inconsistent with this Agreement. Stockholder agrees to vote the Shares at any
meeting or action by written consent at which a vote is taken or requested in
accordance with the recommendation of management of AHC.
2. Term and Effect. The obligations of Stockholder under this
Agreement shall terminate two years from the date of this Agreement.
3. No Grant of Other Proxies. Except pursuant to this Agreement
or as permitted or contemplated by the Merger Agreement, Stockholder shall not,
without the prior written consent of AHC, directly or indirectly grant any
proxies or enter into any voting trust or other agreement or arrangement with
respect to the voting of the Shares inconsistent with this Agreement.
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4. Miscellaneous.
(a) Severability. If any term, provision, covenant or restriction
of this Agreement is held by an court of competent jurisdiction to be invalid,
void or unenforceable, the remainder of the terms, provisions, covenants and
restrictions of this Agreement shall remain in full force and effect and shall
in no way be affected, impaired or invalidated.
(b) Binding Effect and Assignment. This Agreement and all of the
provisions hereof shall be binding upon and inure to the benefit of the parties
hereto and their respective successors and permitted assigns, except as
otherwise specifically provided, neither this Agreement nor any of the rights,
interests or obligations of the parties hereto may be assigned by any of the
parties hereto without the prior written consent of the other.
(c) Amendments and Modification. This Agreement may not be
modified, amended, altered or supplemented except upon the execution and
delivery of a written agreement executed by the parties hereto.
(d) Specific Performance. The parties hereto acknowledge that AHC
will be irreparably harmed and that there will be no adequate remedy at law for
a violation of any of the covenants or agreements of Stockholder set forth
herein. Therefore, it is agreed that, in addition to any other remedies which
may be available to AHC upon any such violation, AHC shall have the right to
enforce such covenants and agreements by specific performance, injunctive
relief or by any other means available to AHC at law or in equity.
(e) Notices. All notices, requests, claims, demands and other
communications hereunder shall be in writing and sufficient if delivered in
person, by cable, telecopy, telegram or telex, or sent by mail (registered or
certified mail, postage prepaid, return receipt requested) to the respective
parties as follows:
If to AHC:
Alliance Holding Corporation
10055 Sweet Valley Drive
Valley View, Ohio 44125
Attention: Mr. Joseph E. LoConti
Telecopy: (216) 447-9137
With a copy to:
Anne L. Meyers & Associates Co., L.P.A.
2 Summit Park Drive, Suite 150
Independence, Ohio 44131-2553
Attention: Anne L. Meyers, Esq.
Telecopy: (216) 520-4350
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If to Stockholder:
MGD Holdings
Westbury (Bermuda) Ltd.
Victoria Hall
11 Victoria Street
P.O. Box HM 1065
Hamilton HM EX, Bermuda
Attention: Mr. Michael DeGroote
Fax: (809) 292-8911
With a copy to:
Akin, Gump, Strauss, Hauer & Feld, L.L.P.
711 Louisiana, Suite 1900
Houston, Texas 77002
Attention: Mr. Rick L. Burdick
Fax: (713) 236-0822
or to such other address any party may have furnished to the other in writing
in accordance herewith, except that notices of change of address shall only be
effective upon receipt.
(f) Governing Law. This Agreement shall be governed by, construed
and enforced in accordance with the laws of the State of Delaware as applied to
contracts entered into solely between residents of, and to be performed
entirely in, such state.
(g) Entire Agreement. This Agreement contains the entire
understanding of the parties hereto in respect of the subject matter hereof,
and supersedes all prior negotiations and understandings between the parties
with respect to such subject matters.
(h) Effect of Headings. The section headings herein are for
convenience only and shall not affect the construction or interpretation of
this Agreement.
(i) Definitions. All capitalized terms used herein shall have the
meanings defined in the Merger Agreement, unless otherwise defined herein.
(j) Counterparts. This Agreement shall be executed in one or more
counterparts, each of which shall be deemed an original and all of which
together shall constitute one instrument.
[Remainder of page intentionally left blank.]
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IN WITNESS WHEREOF, the parties hereto have caused this Agreement to
be duly executed as of the date first above written.
ALLIANCE HOLDING CORPORATION
By: /s/ Joseph E. LoConti
---------------------------------------------
Printed Name: Joseph E. LoConti
-----------------------------------
Title: President
------------------------------------------
MGD HOLDINGS LTD.
By:/s/ Michael G. DeGroote
---------------------------------------------
Printed Name: Michael G. DeGroote
-----------------------------------
Title: Chief Executive Officer and President
------------------------------------------
<PAGE> 1
EXHIBIT 99.7
PROMISSORY NOTE
$4,000,000.00 October 18, 1996
FOR VALUE RECEIVED, the undersigned, Republic Environmental Systems,
Inc., a Delaware corporation (the "Maker"), hereby unconditionally promises to
pay to the order of Alliance Holding Corporation (the "Payee"), at 10055 Sweet
Valley Drive, Valley View, Ohio 44125 or such other address as may be given to
the Maker by the Payee, the principal sum of FOUR MILLION AND NO/100 DOLLARS
($4,000,000.00), in lawful money of the United States of America, together with
interest on the unpaid principal balance at the three-month LIBOR rate per
annum compounded daily or, in the event of default of timely payment thereof,
the three-month LIBOR rate plus five percent (5%) per annum compounded daily
from the date thereof or (if less) the highest rate permitted by applicable
law.
Principal shall be due and payable in ten equal quarterly installments
of $400,000.00, together with accrued and unpaid interest, computed as follows:
(1) for the first installment, based on the three-month LIBOR rate per annum in
effect on the Closing Date (as defined in that certain Agreement and Plan of
Merger executed by Maker and Payee dated as of May 19, 1996); and (2) for all
subsequent installments, based on the three-month LIBOR rate per annum in
effect on the date the prior installment was due. The first installment of
principal and interest shall be due and payable on the later of the Closing
Date or September 15, 1996. Each subsequent installment of principal and
interest shall be due and payable on the 15th day of the last month of each
calendar quarter thereafter until December 15, 1999, when the entire
outstanding principal amount of this Promissory Note, together with all accrued
and unpaid interest, shall be due and payable aforesaid.
The Maker shall have the right to prepay, in full or from time to time
in part, the then unpaid principal balance on this Promissory Note (together
with all accrued and unpaid interest then due) at any time without premium or
penalty. All prepayments shall be applied first to unpaid accrued interest,
with the balance being applied to principal. All prepayments made at any time
on the unpaid principal balance on this Promissory Note shall be listed on
Schedule A which is attached hereto and made a part hereof for all purposes.
The Holder of this Promissory Note (the "Holder") is hereby authorized to
record on Schedule A the dates and amounts of any prepayments of principal and
the aggregate amount of principal then outstanding. Such recordation shall
constitute prima facie evidence of the accuracy of the information recorded in
the absence of manifest error; provided, however, that failure by the Holder to
make such recordation shall not effect the Maker's obligations hereunder.
Should the Maker fail to make any payment of principal or interest
hereunder on or before ten days after the date such payment is due and such
failure be continuing, the Holder at its option, and in addition to any other
remedies that may be available, may declare the entire principal balance and
accrued interest hereon to be due and payable by giving written notice
<PAGE> 2
thereof to Maker. Failure to exercise this option shall not constitute a
waiver of the right to exercise the same with respect to any subsequent Event
of Default.
If this Promissory Note shall be collected by legal proceedings or
through a probate or bankruptcy court, or shall be placed in the hands of an
attorney for collection after default or maturity, the Maker agrees to pay all
costs of collection, including, without limitation, reasonable attorneys' fees.
This Promissory Note has not been registered under the Securities Act
of 1933, as amended, or the securities laws of any state. Without such
registration, this Promissory Note may not be sold, pledged, hypothecated, or
otherwise transferred, unless an exemption from registration under the
Securities Act of 1933, as amended, and any applicable state securities laws or
any rule or regulation promulgated thereunder, is available.
THIS PROMISSORY NOTE SHALL BE GOVERNED BY, AND CONSTRUED AND
INTERPRETED IN ACCORDANCE WITH, THE LAWS OF THE STATE OF DELAWARE.
THIS PROMISSORY NOTE, TOGETHER WITH SCHEDULE A HERETO, REPRESENTS THE
FINAL AGREEMENT OF THE PARTIES HERETO AND MAY NOT BE CONTRADICTED BY EVIDENCE
OF PRIOR, CONTEMPORANEOUS OR SUBSEQUENT ORAL AGREEMENTS OF THE PARTIES.
Any notice, demand or other communication to be given under or for the
purposes of this Promissory Note shall be in writing (including telecopy with
prompt written confirmation thereafter, such telecopy notice to be deemed given
upon receipt of such written confirmation) and shall be treated as properly
served or given if hand-delivered or sent by first class prepaid mail (airmail
if appropriate);
If to Payee:
Alliance Holding Corporation
10055 Sweet Valley Drive
Valley View, Ohio 44125
Attention: Mr. Joseph E. LoConti
Telecopy: (216) 447-9137
With a copy to:
Anne L. Meyers & Associates Co., L.P.A.
2 Summit Park Drive, Suite 150
Independence, Ohio 44131-2553
Attention: Anne L. Meyers, Esq.
Telecopy: (216) 520-4350
2
<PAGE> 3
If to Maker:
Republic Environmental Systems, Inc.
16 Sentry Park West
1787 Sentry Parkway West, Suite 400
Blue Bell, Pennsylvania 19422
Attention: Douglas R. Gowland
Telecopy: (215) 283-4809
With a copy to:
Akin, Gump, Strauss, Hauer & Feld, L.L.P.
711 Louisiana, Suite 1900
Houston, Texas 77002
Attention: Mr. Rick L. Burdick
Fax: (713) 236-0822
or to such other address any party may have furnished to the other in writing
in accordance herewith, except that notices of change of address shall only be
effective upon receipt.
All such notices and communications shall, when mailed or telecopied,
be effective upon the earlier of actual receipt (in case of telecopy, of the
written confirmation thereof) or three business days from the date when
deposited in the mails (or in the case of telecopy, of receipt of the written
confirmation thereof).
This Promissory Note has been executed and delivered pursuant to, and
is subject to certain terms and conditions set forth in, that certain Agreement
and Plan of Merger among the Maker, Republic/CSC Acquisition Corporation and
Republic/CSU Acquisition Corporation, each Delaware corporations and
wholly-owned subsidiaries of the Maker, the Payee, and Century Surety Company
and Commercial Surety Agency, Inc., d/b/a Century Surety Underwriters, each
Ohio corporations and wholly-owned subsidiaries of the Payee, dated as of May
19, 1996 (as the same may be amended from time to time, the "Merger
Agreement"), and is the "Note" referred to therein. All capitalized terms used
herein and not otherwise defined herein shall have the meanings given thereto
in the Merger Agreement.
This Promissory Note shall be governed by, and construed in accordance
with, the laws of the State of Delaware.
Maker:
REPUBLIC ENVIRONMENTAL SYSTEMS, INC.
By: /s/ Michael G. DeGroote
------------------------------------------------
Name: Michael G. DeGroote
----------------------------------------------
Title: President & Chief Executive Officer
---------------------------------------------
3
<PAGE> 1
EXHIBIT 99.8
INDEX TO FINANCIAL INFORMATION AND FINANCIAL STATEMENTS
REPUBLIC ENVIRONMENTAL SYSTEMS, INC. AND SUBSIDIARIES
<TABLE>
<S> <C>
UNAUDITED PRO FORMA FINANCIAL INFORMATION
Unaudited Pro Forma Condensed Balance Sheet as of June 30, 1996....................... F-3
Unaudited Pro Forma Condensed Statement of Operations:
Year ended December 31, 1995....................................................... F-4
Six months ended June 30, 1996..................................................... F-5
Notes to Unaudited Pro Forma Financial Information.................................... F-6
CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS
Report of Independent Public Accountants.............................................. F-7
Consolidated and Combined Balance Sheets as of December 31, 1995 and 1994............. F-8
Consolidated and Combined Statements of Operations for the years ended December 31,
1995, 1994 and 1993................................................................. F-9
Consolidated and Combined Statements of Cash Flows for the years ended December 31,
1995, 1994 and 1993................................................................. F-10
Consolidated and Combined Statements of Stockholders' Equity for the years ended
December 31, 1995, 1994 and 1993.................................................... F-11
Notes to Consolidated and Combined Financial Statements............................... F-12
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Consolidated Balance Sheet as of June 30, 1996 (Unaudited)............................ F-27
Consolidated Statements of Operations for the six months ended
June 30, 1996 and 1995 (Unaudited)................................................. F-28
Consolidated Statements of Cash Flows for the six months ended
June 30, 1996 and 1995 (Unaudited)................................................. F-29
Notes to Consolidated Financial Statements (Unaudited)................................ F-30
CENTURY SURETY COMPANY AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
Independent Auditors' Report.......................................................... F-32
Consolidated Balance Sheets as of December 31, 1995 and 1994.......................... F-33
Consolidated Statements of Income for the years ended
December 31, 1995, 1994 and 1993................................................... F-34
Consolidated Statements of Shareholder's Equity for the years ended December 31, 1995,
1994 and 1993....................................................................... F-35
Consolidated Statements of Cash Flows for the years ended
December 31, 1995, 1994 and 1993................................................... F-36
Notes to Consolidated Financial Statements............................................ F-37
Schedule I -- Summary of Investments -- Other than Investments in Related Parties as
of December 31, 1995................................................................ F-53
Schedule IV -- Reinsurance for the years ended December 31, 1995, 1994 and 1993....... F-54
Schedule VI -- Supplemental Information Concerning Property -- Casualty Insurance
Operation for the years ended December 31, 1995, 1994 and 1993...................... F-55
CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Consolidated Balance Sheets as of June 30, 1996 (Unaudited) and December 31, 1995..... F-56
Consolidated Statements of Income (Unaudited) for the six months ended
June 30, 1996 and 1995............................................................. F-57
Consolidated Statement of Cash Flows (Unaudited) for the six months ended
June 30, 1996 and 1995............................................................. F-58
Notes to the Consolidated Financial Statements (Unaudited)............................ F-59
COMMERCIAL SURETY AGENCY, INC.
FINANCIAL STATEMENTS
Independent Auditors' Report.......................................................... F-60
Balance Sheets as of December 31, 1995 and 1994....................................... F-61
Statements of Income for the years ended December 31, 1995, 1994 and 1993............. F-62
Statements of Shareholder's Equity (Deficit) for the years ended December 31,
1995, 1994 and 1993................................................................ F-63
Statements of Cash Flows for the years ended December 31, 1995, 1994 and 1993......... F-64
Notes to the Financial Statements..................................................... F-65
FINANCIAL STATEMENTS (UNAUDITED)
Balance Sheets as of June 30, 1996 (Unaudited) and December 31, 1995.................. F-69
Statements of Income (Unaudited) for the six months ended June 30, 1996 and 1995...... F-70
Statements of Cash Flows (Unaudited) for the six months ended June 30, 1996
and 1995........................................................................... F-71
Notes to the Financial Statements (Unaudited)......................................... F-72
</TABLE>
F-1
<PAGE> 2
REPUBLIC ENVIRONMENTAL SYSTEMS, INC.
PRO FORMA FINANCIAL INFORMATION
The following unaudited pro forma condensed income statements of RESI for
the year ended December 31, 1995 and for the six months ended June 30, 1996 give
effect to the Combination as if it had occurred on January 1, 1995. The
unaudited pro forma condensed balance sheet as of June 30, 1996 gives effect to
the Combination as if it had occurred on June 30, 1996. The pro forma
adjustments are based on currently available information and upon certain
assumptions that management believes are reasonable under the circumstances as
described in the accompanying Notes to Pro Forma Financial Information.
THE PRO FORMA FINANCIAL INFORMATION DOES NOT PURPORT TO REPRESENT WHAT
RESI'S FINANCIAL POSITION OR RESULTS OF OPERATIONS WOULD ACTUALLY HAVE BEEN IF
THE COMBINATION IN FACT HAD OCCURRED AT THE DATES INDICATED OR TO PROJECT RESI'S
FINANCIAL POSITION OR RESULTS OF OPERATIONS FOR ANY FUTURE DATE OR PERIOD.
The following financial information should be read in conjunction with the
"RESI Management's Discussion and Analysis of Results of Operations and
Financial Condition," "Alliance Companies Management's Discussion and Analysis
of Results of Operations and Financial Condition," the consolidated and combined
financial statements of RESI and subsidiaries and the notes thereto, the
consolidated financial statements of CSC and the notes thereto, and the
financial statements of CSU and the notes thereto which are included elsewhere
herein.
F-2
<PAGE> 3
REPUBLIC ENVIRONMENTAL SYSTEMS, INC.
UNAUDITED PRO FORMA CONDENSED BALANCE SHEET
AS OF JUNE 30, 1996
(IN THOUSANDS)
<TABLE>
<CAPTION>
HISTORICAL(A)
------------------------------------------- ACQUISITION
REPUBLIC CENTURY PRO FORMA
ENVIRONMENTAL SURETY ADJUSTMENTS EQUITY
SYSTEMS, INC. COMPANY COMMERCIAL AND TRANSACTIONS PRO
AND AND SURETY INTERCOMPANY COMBINED PRO FORMA FORMA
SUBSIDIARIES SUBSIDIARIES AGENCY, INC. ELIMINATIONS(B) COMPANIES ADJUSTMENTS(C) TOTAL
------------- ------------ ------------ --------------- --------- -------------- --------
<S> <C> <C> <C> <C> <C> <C> <C>
ASSETS
Cash and cash
equivalents........... $ 2,442 $ 2,374 $ 138 $ $ 4,954 $ 10,500 $ 15,454
Investments
Fixed maturities held
to maturity......... 15,240 15,240 15,240
Securities available
for sale, at fair
value:
Fixed maturities.... 33,422 33,422 33,422
Equity securities... 8,098 8,098 8,098
Mortgage loans on real
estate.............. 2,611 2,611 2,611
Other investments..... 2,584 2,584 2,584
Premium balances
receivable............ 6,400 713 (1,020)(3) 6,093 6,093
Deferred policy
acquisition costs..... 3,954 3,954 3,954
Reinsurance
receivables........... 10,282 10,282 10,282
Prepaid insurance
premiums.............. 2,834 2,834 2,834
Accounts receivable,
net................... 6,184 6,184 6,184
Property and equipment,
net................... 20,322 367 172 20,861 20,861
Goodwill................ 8,984 1,285(1) 10,269 10,269
Other assets............ 2,493 2,450 266 5,209 5,209
------- ------- ------ ------- -------- ------- --------
Total assets.... $40,425 $ 90,616 $1,289 $ 265 $132,595 $ 10,500 $143,095
======= ======= ====== ======= ======== ======= ========
LIABILITIES AND
STOCKHOLDERS' EQUITY
Accounts payable........ $ 2,516 $ $ 10 $ $ 2,526 $ $ 2,526
Losses and loss expenses
payable............... 39,265 39,265 39,265
Unearned premiums....... 17,248 (1,020)(3) 16,228 16,228
Reinsurance balances
payable............... 2,392 2,392 2,392
Income taxes payable.... 60 500 560 560
Accrued expenses and
other liabilities..... 2,394 2,681 1,146 6,221 6,221
Note Payable -- Alliance
Holding Company....... 4,000(1) 4,000 4,000
Long-term debt.......... 877 17 894 894
Accrued environmental
costs................. 3,569 3,569 3,569
Deferred income taxes... 2,437 406 2,843 2,843
Minority interest....... 257 257 257
------- ------- ------ ------- -------- ------- --------
Total
liabilities... 12,110 62,492 1,173 2,980 78,755 78,755
------- ------- ------ ------- -------- ------- --------
Stockholders' equity
Common stock.......... 109 2,000 1 (1,853)(1) 257 40 297
Paid-in-capital....... 27,479 17,591 181 (1)(5 45,251 10,460 55,711
Retained earnings..... 531 4,644 115 (847)(1)(5) 4,443 4,443
Net unrealized
appreciation of
investments......... 3,889 3,889 3,889
Cumulative translation
adjustment.......... 196 (196)(1)
------- ------- ------ ------- -------- ------- --------
Total
stockholders'
equity........ 28,315 28,124 116 (2,715) 53,840 10,500 64,340
------- ------- ------ ------- -------- ------- --------
Total
liabilities
and
stockholders'
equity........ $40,425 $ 90,616 $1,289 $ 265 $132,595 $ 10,500 $143,095
======= ======= ====== ======= ======== ======= ========
</TABLE>
F-3
<PAGE> 4
REPUBLIC ENVIRONMENTAL SYSTEMS, INC.
UNAUDITED PRO FORMA CONDENSED STATEMENT OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 1995
(IN THOUSANDS EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
HISTORICAL(A)
-----------------------------------------------
REPUBLIC
ENVIRONMENTAL CENTURY MERGER
SYSTEMS, INC. SURETY COMMERCIAL ADJUSTMENTS PRO
AND COMPANY SURETY AND INTERCOMPANY FORMA
SUBSIDIARIES AND SUBSIDIARIES AGENCY, INC. ELIMINATIONS(B) TOTAL
------------- ---------------- ------------ ---------------- -------
<S> <C> <C> <C> <C> <C>
Revenues........................ $44,537 $ 30,824 $2,602 $ (2,487)(3) $75,476
------- ------- ------ ------- -------
Expenses:
Cost of operations............ 32,702 893 33,595
Selling, general, and
administrative............. 9,768 1,399 32 (2) 11,199
Losses and loss expenses...... 15,117 15,117
Acquisition and other
expenses................... 11,126 (2,487)(3) 8,639
Other, net.................... 26 220 (4) 246
------- ------- ------ ------- -------
42,496 26,243 2,292 (2,235) 68,796
------- ------- ------ ------- -------
Income before income taxes...... 2,041 4,581 310 (252) 6,680
------- ------- ------ ------- -------
Income tax expense (benefit)
Current....................... 369 2,013 108 (88)(4) 2,402
Deferred...................... 386 (699) (313)
------- ------- ------ ------- -------
755 1,314 108 (88) 2,089
------- ------- ------ ------- -------
Net Income............ $ 1,286 $ 3,267 $ 202 $ (164) $ 4,591
======= ======= ====== ======= =======
Earnings per common and common
equivalent share(D)........... $ 0.12 $ 0.15
======= =======
Weighted average shares(D)...... 11,110 29,870
======= =======
</TABLE>
F-4
<PAGE> 5
REPUBLIC ENVIRONMENTAL SYSTEMS, INC.
UNAUDITED PRO FORMA CONDENSED STATEMENT OF OPERATIONS
FOR THE SIX MONTHS ENDED JUNE 30, 1996
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
HISTORICAL(A)
---------------------------------------------
REPUBLIC ACQUISITION
ENVIRONMENTAL CENTURY PRO FORMA
SYSTEMS, INC. SURETY COMMERCIAL ADJUSTMENTS PRO
AND COMPANY AND SURETY AND INTERCOMPANY FORMA
SUBSIDIARIES SUBSIDIARIES AGENCY, INC. ELIMINATIONS TOTAL
------------- ------------ ------------ ---------------- -------
<S> <C> <C> <C> <C> <C>
Revenues...................... 15,796 $ 16,612 $1,425 $ (1,687)(3)(5) $32,146
------ ------ ---- ----- -------
Expenses:
Cost of operations.......... 11,849 599 12,448
Selling, general, and
administrative........... 4,656 687 16 (2) 5,359
Losses and loss expenses.... 8,471 8,471
Acquisition and other
expenses................. 5,978 (1,209)(3) 4,769
Other, net.................. (316) 110 (4) (206)
------ ------ ---- ----- -------
16,189 14,449 1,286 (1,083) 30,841
------ ------ ---- ----- -------
Income (loss) before income
taxes....................... (393) 2,163 139 (604) 1,305
------ ------ ---- ----- -------
Income tax expense (benefit)
Current..................... (146) 797 47 (206)(4)(5) 492
Deferred.................... 32 32
------ ------ ---- ----- -------
(146) 829 47 (206) 524
------ ------ ---- ----- -------
Net Income (Loss)............. $ (247) $ 1,334 $ 92 $ (398) $ 781
====== ====== ==== ===== =======
Earnings (loss) per common and
common equivalent
share(D).................... $ (0.02) $ 0.03
====== =======
Weighted average shares(D).... 10,850 29,610
====== =======
</TABLE>
F-5
<PAGE> 6
REPUBLIC ENVIRONMENTAL SYSTEMS, INC.
NOTES TO PRO FORMA FINANCIAL INFORMATION
A. DESCRIPTION OF THE MERGERS
On May 19, 1996, Alliance and RESI signed a binding letter of intent and
agreed to the terms of mergers (the "Mergers") pursuant to which Alliance would
receive (i) 14,760,000 shares of RESI's common stock, par value $0.01 per share
("RESI Common Stock"), (ii) warrants to acquire an additional 4,200,000 shares
of RESI Common Stock, at prices ranging from $2.625 to $3.875 per share and
exercisable over two to four year periods and (iii) a promissory note in the
principal amount of $4.0 million in consideration for all of the outstanding
common stock of its wholly-owned subsidiaries, Century Surety Company ("CSC")
and Commercial Surety Agency, Inc. ("CSU"). In connection with such transaction,
each of MGD Holdings, Ltd. ("MGD Holdings") and H. Wayne Huizenga ("Huizenga")
will purchase 2,000,000 shares of RESI Common Stock and warrants to purchase
6,000,000 additional shares of RESI Common Stock at exercise prices ranging from
$2.625 to $3.875 per share and exercisable over two to four year periods for an
aggregate purchase price of $5,250,000. After the Mergers, but before the
exercise of the Merger Warrants and Stock Issue Warrants, Alliance and MGD
Holdings will beneficially own approximately % and %, respectively of
the outstanding shares of RESI common stock. As a result of the Mergers,
Alliance will control four of the seven board positions, thereby having the
ability to control the RESI Board of Directors. In addition, contemporaneously
with the consummation of the Mergers, MGD Holdings will enter into a voting
agreement with Alliance whereby MGD Holdings, for a period of two years
commencing as of the completion of the Mergers thereof agrees to vote all shares
of RESI Common Stock in accordance with the recommendation of the management of
Alliance. Accordingly, Alliance will have the ability to control the outcome of
matters submitted to a vote of the RESI Stockholders, including the election of
directors. The Mergers will be accounted for as a purchase business combination
pursuant to which Alliance is acquiring RESI. Consequently, in RESI's
consolidated financial statements, the assets and liabilities of RESI will be
recorded at fair value based upon the closing market price of the outstanding
shares of RESI common stock on May 17, 1996 (10,797,950 shares at 2 5/16 per
share). The historical balances shown in the pro forma statements for RESI, CSC
and CSU are derived from the financial statements of each company included
elsewhere herein.
B. ACQUISITION PRO FORMA ADJUSTMENTS AND INTERCOMPANY ELIMINATIONS
(1) Reflects the adjustments related to the Mergers including (a) a
purchase price of approximately $29.6 million (including transaction costs of
approximately $0.7 million) based on the number of RESI common shares
outstanding at the market price of May 17, 1996 and an additional $4.0 million
note payable to Alliance, (b) elimination of the historical equity balances of
CSC and CSU to reflect the new capital structure of RESI as a result of the
transaction and (c) recognition of $1.285 million of goodwill resulting from the
excess purchase price over the estimated fair value of the net assets of RESI at
June 30, 1996.
(2) Records the amortization over 40 years of the resulting goodwill for
the year ended December 31, 1995 and the six months ended June 30, 1996.
(3) Reflects the elimination of intercompany balances between CSC and CSU.
(4) Reflects the interest expense associated with the $4.0 million note
payable to Alliance at the current LIBOR rate of 5.5% and the related adjustment
to income taxes (using an estimated combined federal and state tax rate of 40%)
for the year ended December 31, 1995 and the six months ended June 30, 1996.
(5) Reflects the elimination of the 1996 CSC sale of RESI stock it owned
prior to the Mergers.
C. EQUITY TRANSACTIONS PRO FORMA ADJUSTMENTS
Reflects the purchase of 2.0 million RESI common shares each and warrants
to purchase an additional 6.0 million RESI common shares each by MGD Holdings
and Huizenga as noted in A. above.
D. EARNINGS PER SHARE
Pro forma earnings per share reflect the issuance of 14,760,000 common
shares to Alliance and the 4,000,000 new shares issued to MGD Holdings and
Huizenga and also reflect the effect of a two-for-one stock split, effected in
the form of a stock dividend in June 1996. Primary and fully diluted pro forma
earnings per share are the same.
F-6
<PAGE> 7
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Republic Environmental Systems, Inc.:
We have audited the accompanying consolidated and combined balance sheets
of Republic Environmental Systems, Inc. (a Delaware corporation) and
subsidiaries, as of December 31, 1995 and 1994, and the related consolidated and
combined statements of operations, cash flows and stockholders equity for the
years then ended, as discussed in Note 2 to the financial statements. 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 in accordance with generally accepted auditing
standards. Those standards 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. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Republic Environmental
Systems, Inc. and subsidiaries as of December 31, 1995 and 1994, and the results
of their operations and their cash flows for the years then ended, in conformity
with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Philadelphia, PA.,
February 13, 1996
(except with respect
to the matters discussed
in Note 12, as to which
the date is June 14, 1996)
F-7
<PAGE> 8
REPUBLIC ENVIRONMENTAL SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED AND COMBINED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
DECEMBER 31
-------------------
1995 1994
------- -------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents.............................................. $ 3,255 $ 1,433
Accounts receivable, less allowance for doubtful accounts of $1,031 and
$1,174, respectively................................................ 7,614 10,870
Other current assets................................................... 1,445 1,292
------- -------
Total current assets........................................... 12,314 13,595
Property and equipment, net.............................................. 19,469 16,844
Goodwill, net of accumulated amortization of $1,187 and $935,
respectively........................................................... 9,109 9,255
Other assets............................................................. 858 248
------- -------
Total assets................................................... $41,750 $39,942
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable....................................................... $ 2,568 $ 4,686
Accrued liabilities.................................................... 2,825 3,127
Notes payable.......................................................... 193 257
Current maturities of long-term debt and capitalized lease
obligations......................................................... 507 2,133
Current portion of accrued environmental costs......................... 1,999 2,677
Income taxes payable................................................... 56 160
------- -------
Total current liabilities...................................... 8,148 13,040
Long-term debt and capitalized lease obligations, net of current
maturities............................................................. 618 1,128
Accrued environmental costs, net of current portion...................... 1,790 2,850
Deferred income taxes.................................................... 2,344 2,375
Minority interest........................................................ 257 257
------- -------
Total liabilities.............................................. 13,157 19,650
------- -------
Commitments and contingencies
Stockholders' equity:
Common stock, par value $.01 per share; 20,000,000 shares authorized,
11,366,432 shares issued............................................ 114 --
Additional paid-in capital............................................. 27,653 --
Retained earnings...................................................... 778 --
Cumulative translation adjustment...................................... 193
Treasury stock, 102,000 shares, at cost................................ (145) --
Investment by Republic Industries, Inc................................. -- 20,292
------- -------
Total stockholders' equity..................................... 28,593 20,292
------- -------
Total liabilities and stockholders' equity..................... $41,750 $39,942
======= =======
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-8
<PAGE> 9
REPUBLIC ENVIRONMENTAL SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED AND COMBINED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
----------------------------------
1995 1994 1993
------- ------- --------
<S> <C> <C> <C>
Revenues................................................... $44,537 $46,599 $ 61,617
Expenses:
Cost of operations....................................... 32,702 33,377 47,028
Selling, general and administrative...................... 9,768 10,349 13,480
Restructuring and unusual charges........................ -- 8,484 14,906
------- ------- --------
Operating income (loss).......................... 2,067 (5,611) (13,797)
------- ------- --------
Other (income) expense:
Interest and other income................................ (193) (120) (161)
Interest expense......................................... 219 473 1,153
------- ------- --------
Income (loss) before income taxes and extraordinary gain... 2,041 (5,964) (14,789)
Income tax provision (benefit)............................. 755 (3,092) (210)
------- ------- --------
Income (loss) before extraordinary gain.................... 1,286 (2,872) (14,579)
Extraordinary gain on conversion of debt, net of income tax
provision of $3,092...................................... -- 5,556 --
------- ------- --------
Net income (loss)................................ $ 1,286 $ 2,684 $(14,579)
======= ======= ========
Earnings (loss) per common and common equivalent share:
Income (loss) before extraordinary gain.................. $ 0.12 $ (0.26) $ (1.32)
Extraordinary gain....................................... -- 0.51 --
------- ------- --------
Net income (loss)................................ $ 0.12 $ 0.25 $ (1.32)
======= ======= ========
Weighted average common and common equivalent shares....... 11,110 10,966 11,004
======= ======= ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-9
<PAGE> 10
REPUBLIC ENVIRONMENTAL SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED AND COMBINED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
--------------------------------
1995 1994 1993
------- ------- --------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income (loss).......................................... $ 1,286 $ 2,684 $(14,579)
Adjustments to reconcile net income (loss) to net cash
provided by operations:
Extraordinary gain on conversion of debt................ -- (5,556) --
Restructuring and unusual charges....................... -- 8,484 14,906
Depreciation and amortization........................... 2,312 2,457 2,803
Provision for doubtful accounts......................... 569 929 469
Provision for accrued environmental costs............... 347 373 267
(Loss) gain on the sale of equipment.................... (74) 6 (1)
Changes in assets and liabilities
Accounts receivable................................... 2,671 (81) 4,714
Prepaid expenses and other assets..................... (986) 227 (187)
Accounts payable and accrued liabilities.............. (2,231) (1,213) (3,383)
Income taxes payable.................................. (105) 20 (395)
Due to Republic Industries, Inc....................... 784 2,515 2,659
Other liabilities..................................... (1,835) (4,682) (1,014)
------- ------- --------
Net cash provided by operations.................... 2,738 6,163 6,259
Cash flows from investing activities:
Business acquisitions, net of cash acquired................ -- -- (317)
Capital additions.......................................... (4,197) (1,837) (3,569)
Proceeds from the sale of equipment........................ 212 112 240
------- ------- --------
Net cash used in investing activities.............. (3,985) (1,725) (3,646)
------- ------- --------
Cash flows from financing activities:
Amounts borrowed from Republic Industries, Inc............. -- 2,788 6,717
Repayment of borrowings from Republic Industries, Inc...... -- (5,495) (5,016)
Cash received from exercise of stock options and
warrants................................................ 1,664 -- --
Purchase of treasury stock................................. (145) -- --
Payments of long-term debt and notes payable............... (3,922) (2,380) (8,832)
Proceeds from long-term debt and notes payable............. 827 395 3,888
Capital contributions and other payments from Republic
Industries, Inc......................................... 2,518 -- --
Cash received from Stout-capital contribution.............. 2,127 -- --
------- ------- --------
Net cash provided by (used in) financing
activities....................................... 3,069 (4,692) (3,243)
------- ------- --------
Increase (decrease) in cash and cash equivalents............. 1,822 (254) (630)
Cash and cash equivalents:
Beginning of year.......................................... 1,433 1,687 2,317
------- ------- --------
End of year................................................ $ 3,255 $ 1,433 $ 1,687
======= ======= ========
Supplemental disclosure of cash paid for:
Interest................................................... $ 216 $ 469 $ 826
Income taxes............................................... $ 128 $ 64 $ 42
Supplemental disclosure of noncash investing and financing
activities:
Equipment purchases of $536, $137 and $232 were financed in
the years ended December 31, 1995, 1994 and 1993,
respectively by borrowings and capitalized lease
obligations.
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-10
<PAGE> 11
REPUBLIC ENVIRONMENTAL SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED AND COMBINED STATEMENTS OF STOCKHOLDERS' EQUITY
(IN THOUSANDS)
<TABLE>
<CAPTION>
ADDITIONAL RETAINED CUMULATIVE EQUITY
COMMON PAID-IN EARNINGS TRANSLATION TREASURY INVESTMENT
STOCK CAPITAL (DEFICIT) ADJUSTMENT STOCK BY RII TOTAL
-------- -------- -------- ----------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at December 31,
1992....................... $ $ $ (8,965) $ $ $ 37,498 $ 28,533
Net loss................... (14,579) (14,579)
Net advances from RII...... 1,701 1,701
Return of consideration
held in escrow for an
acquisition.............. (929) (929)
Other transactions with
RII, net(1).............. 2,146 2,146
-------- -------- -------- -------- -------- -------- --------
Balance at December 31,
1993....................... (23,544) 40,416 16,872
Net income................. 2,684 2,684
Net payments to RII........ (2,707) (2,707)
Other transactions with
RII, net(1).............. 3,425 3,425
-------- -------- -------- -------- -------- -------- --------
Balance at December 31,
1994....................... (20,860) 41,152 20,292
Net income through
spin-off................. 508 508
Contributions from RII
prior to spin-off........ 261 261
Spin-off from RII.......... 108 20,802 20,352 151 (41,413) --
Capital contribution from
RII...................... 2,518 2,518
Net income post-spin-off... 778 778
Capital contribution from
Stout.................... 2,127 2,127
Issuance of shares for
stock options............ 6 1,661 1,667
Tax benefit of stock
options and warrants..... 545 545
Purchases of treasury
stock.................... (145) (145)
Currency translation
adjustment............... 42 42
-------- -------- -------- -------- -------- -------- --------
Balance at December 31,
1995....................... $ 114 $ 27,653 $ 778 $ 193 $ (145) $ -- $ 28,593
======== ======== ======== ======== ======== ======== ========
</TABLE>
- ---------------
(1) Includes insurance premiums, self-insured losses and corporate services
expense allocations directly attributable to RESI.
The accompanying notes are an integral part of these financial statements.
F-11
<PAGE> 12
REPUBLIC ENVIRONMENTAL SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS
1. BACKGROUND
In July 1994, Republic Industries, Inc. ("RII"), formerly Republic Waste
Industries, Inc., announced the contemplation of a plan to exit the hazardous
waste services segment of the environmental industry. The plan included the
combination of RII's former hazardous waste services operations in Republic
Environmental Systems, Inc. ("RESI") and the distribution of the stock of RESI
to the stockholders of record of RII (the "Distribution"). In April 1995, the
Board of Directors approved the Distribution to RII stockholders of record as of
April 21, 1995. RII stockholders received one share of RESI's common stock for
every five shares of RII common stock owned on the record date of the
Distribution (the "Distribution Date"). RII currently has no ownership interest
in RESI.
In connection with the Distribution, RESI and RII entered into various
agreements including the Distribution Agreement, Corporate Services Agreement,
Tax Sharing Agreement and various indemnity agreements.
The Distribution Agreement provided for, among other things, the principal
corporate transactions required to effect the Distribution and the contribution
of RII's Canadian hazardous waste services subsidiary to RESI. The Distribution
Agreement also provided for RII to contribute an additional $2.4 million in
capital to RESI to repay indebtedness and to provide working capital in
connection with the Distribution.
The Corporate Services Agreement provides for RII to provide certain
services, including insurance administration, human resources management,
financial reporting and tax, legal and environmental engineering services to
RESI after the Distribution, until the agreement is terminated by either party.
The cost to RESI of such arrangement did not differ significantly from the costs
allocated to RESI in the past, as included in the accompanying statements of
operations. This agreement is expected to terminate at the end of the first
quarter in 1996.
The Tax Sharing Agreement provides for, among other things, the treatment
of tax matters for periods through the date of the Distribution and
responsibility for any adjustments as a result of audit by any taxing authority.
The general terms provide for the indemnification for any tax detriment incurred
by one party which is caused by the other party's actions.
Other agreements include various indemnity agreements which provided for
indemnification by RESI to RII, and vice versa, for potential increases or
decreases in any RESI liabilities which remained with RII as a result of
previously shared arrangements.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The accompanying consolidated financial statements at December 31, 1995
include the accounts of RESI and its subsidiaries, the successor to the business
of Stout Environmental, Inc. ("Stout"), a Delaware corporation, acquired by RII
in March 1992, as well as the accounts of Republic Environmental Systems Ltd.
("RESL") (formerly known as Great Lakes Environmental Group Ltd.), the former
Canadian hazardous waste services subsidiary of RII, which was acquired by RII
in July 1991 and was contributed to RESI as of the Distribution Date
(collectively, the "Company"). One of RESI's subsidiaries, Republic
Environmental Systems (Cleveland) (RES (Cleveland)), Inc. (formerly known as
Evergreen Environmental Group, Inc.), was acquired by RII in September 1991, in
a transaction separate from the Stout acquisition and was contributed to RESI in
May 1993. The accounts of RESI and all its majority owned subsidiaries are
included in the accompanying consolidated financial statements. All significant
intercompany transactions have been eliminated.
F-12
<PAGE> 13
REPUBLIC ENVIRONMENTAL SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
The combined financial statements for all periods presented prior to the
Distribution Date include the historical accounts and operations of the former
RII businesses that now comprise the Company. Material transactions between
entities included herein have also been eliminated.
RII has in the past provided certain corporate general and administrative
services to the Company as described previously. The expenses for these
services, which amounted to $391,000, $851,000, and $839,000 during 1995, 1994
and 1993, respectively, were charged or allocated to the Company on a basis that
approximated the cost of actual services provided. Management believes that the
allocation of expenses was made on a reasonable basis and that expenses to be
incurred as a stand-alone entity will not differ significantly from the amount
of expenses allocated to the Company by RII.
Revenue Recognition
The Company provides a full range of hazardous waste services including
collection, disposal, treatment, storage and recycling services to a broad base
of industrial and commercial waste generators in the Eastern United States and
Canada. Consistent with industry practice, the Company recognizes revenue upon
the receipt and acceptance of waste material at its waste treatment, storage and
disposal facilities ("TSD Facilities"). Appropriate disposal costs are accrued
upon acceptance at its TSD Facilities.
Earnings Per Share
Primary earnings per share computations are based on the weighted average
number of outstanding common and common share equivalents with dilutive effects.
Primary and fully diluted income (loss) per share are the same in each period.
Income (loss) per share for periods prior to the Distribution, have been
determined based on the assumed weighted average number of shares of common
stock outstanding which was considered to be equal to one-fifth of the weighted
average number of shares of RESI common stock for the respective periods.
Property and Equipment
Property and equipment are recorded at cost. Expenditures for major
additions and improvements are capitalized, while minor replacements,
maintenance and repairs are charged to expense as incurred. When property is
retired or otherwise disposed of, the cost and accumulated depreciation are
removed from the accounts and any resulting gain or loss is reflected in current
operations.
Depreciation is provided over the estimated useful lives of the assets
involved using the straight-line method. The estimated useful lives are: twenty
years for buildings and improvements, five to fifteen years for vehicles and
equipment and five years for furniture and fixtures.
A summary of property and equipment is shown below (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31
----------------------
1995 1994
-------- --------
<S> <C> <C>
Vehicles and equipment............................... $ 16,624 $ 16,093
Land, buildings and improvements..................... 14,655 11,063
Furniture and fixtures............................... 2,212 2,407
-------- --------
33,491 29,563
Less- Accumulated depreciation....................... (14,022) (12,719)
-------- --------
$ 19,469 $ 16,844
======== ========
</TABLE>
F-13
<PAGE> 14
REPUBLIC ENVIRONMENTAL SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
Accrued Liabilities
The Company provides accruals for the disposal of hazardous and
nonhazardous waste which has been accepted at its TSD Facilities. At December
31, 1995 and 1994, disposal accruals of $948,000 and $1,107,000, respectively,
were included in accrued liabilities.
Also reflected in accrued liabilities are insurance reserves. Since 1991,
the Company has participated in RII's combined risk management programs for
property and casualty insurance. The Company has agreed to indemnify RII against
increases in current losses and any future losses incurred in connection with
the Company's participation in these programs. The Company continued to
participate in RII's combined risk management programs until the expiration of
these policies in June 1995. The Company has its own insurance program after
that date. At December 31, 1995 and 1994, the insurance accrual was $488,000 and
$72,000, respectively.
Accrued Environmental Costs
Accruals for investigatory and remediation costs are recorded when it is
probable that a liability has been incurred and the amount of loss can be
reasonably estimated. Accrued costs include investigative, administrative, legal
and remediation costs associated with site clean-up. Environmental compliance
costs including maintenance, monitoring and similar costs are expensed as
incurred.
The measurement of environmental liabilities is based on an evaluation of
currently available facts with respect to each individual site and considers
factors such as existing technology, presently enacted laws and regulations, and
prior experience in remediation of contaminated sites. While the current law
potentially imposes joint and several liability upon each party at any Superfund
site, the Company's contribution to clean up these sites is expected to be
limited, given the number of other companies which have also been named as
potentially responsible parties, the volumes of waste involved, and that most of
these matters are indemnified by the former shareholders of Stout (see Note 4).
A reasonable basis for apportionment of costs among responsible parties is
determined and the likelihood of contribution by other parties is established.
If it is considered probable that the Company will only have to pay its expected
share of the total site cleanup, the liability reflects the Company's expected
share. In determining the probability of contribution, the Company considers the
solvency of the parties, whether responsibility is being disputed, the terms of
any existing agreements, and experience to date regarding similar matters. These
liabilities do not take into account any claims for recoveries from insurance or
third parties and are not discounted. As assessments and remediation progress at
individual sites, these liabilities are reviewed periodically and adjusted to
reflect additional technical and legal information which becomes available.
Actual costs to be incurred at identified sites in future periods may vary from
the estimates, given inherent uncertainties in evaluating environmental
exposures.
Anticipated cash expenditures for 1996 are expected to be approximately
$2.0 million ($1.1 million expected to be indemnified). The exact timing of cash
payments from beyond this period are impacted by various governmental and
non-governmental agencies and therefore difficult to predict with any certainty.
Income Taxes
The U.S. operations of the Company are included in the combined federal
income tax return of RII through the Distribution date and on a stand alone
basis thereafter, whereas the Company's Canadian operations file a separate
Canadian tax return. The Company's income tax provision in the accompanying
statements of operations is calculated as if it filed separate tax returns in
both the United States and Canada for all periods.
The Company uses the liability method of accounting for income taxes in
accordance with Statement of Financial Accounting Standards ("SFAS") No. 109.
Under this method, deferred tax assets and liabilities are
F-14
<PAGE> 15
REPUBLIC ENVIRONMENTAL SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
recognized for the tax effects of temporary differences between the financial
reporting and tax basis of assets and liabilities using enacted rates.
Goodwill
Goodwill is amortized on a straight-line basis over forty years.
Amortization expense related to goodwill and other intangible assets was
$255,000, $460,000, and $734,000 in 1995, 1994 and 1993, respectively.
It is the Company's policy to review goodwill for possible impairment
whenever events or changes in circumstances indicate that the carrying amount of
such assets may not be recoverable. The realizability of goodwill is evaluated
periodically as events and circumstances dictate. Such evaluation is based on
various analyses, including cash flow and profitability projections. Generally,
the unamortized goodwill from each acquisition is measured against undiscounted
cash flows from such entity. If such an evaluation indicates an impairment has
occurred, an appropriate writedown would be made based upon a discounted cash
flow analysis or similar determination of fair value. Such adjustment would be
recorded in the period when such events occur and analyses are completed. If
such review indicates that the carrying amount of goodwill is not recoverable,
it is the Company's policy to reduce the carrying amount of such assets to fair
value (see Note 3).
Statements of Cash Flows
The Company considers all highly liquid investments with purchased
maturities of three months or less to be cash equivalents. The effect of noncash
transactions are excluded from the statements of cash flows.
Foreign Currency Translation
All asset and liability accounts of foreign subsidiaries are translated to
U.S. dollars at the rate of exchange in effect at the balance sheet date. All
income statement accounts of foreign subsidiaries are translated at average
exchange rates during the year. Resulting translation adjustments arising from
these translations are charged or credited directly to equity. Gain or loss on
foreign currency transactions is included in income as incurred. Such amounts
were not material in any year presented.
Fair Value of Financial Instruments
The book values of cash, trade accounts receivable, accounts payable and
financial instruments included in other current assets and other assets
approximate their fair values principally because of the short-term maturities
of these instruments. The fair value of the Company's long-term debt is
estimated based on the current rates offered to the Company for debt of similar
terms and maturities. Under this method the Company's fair value of long-term
debt was not significantly different than the stated value at December 31, 1995
and 1994.
In the normal course of business, the Company has letters of credit,
performance bonds and other guarantees which are not reflected in the
accompanying balance sheets. Management believes that the likelihood of
nonperformance under these financial instruments is minimal and expects no
material losses to occur in connection with these financial instruments.
Concentrations of Credit Risk
Concentrations of credit risk with respect to trade receivables are limited
due to the wide variety of customers and markets into which the Company's
services are provided, as well as their dispersion across different geographic
areas. As a result, as of December 31, 1995, the Company does not consider
itself to have any significant concentrations of credit risk. For the years
ended 1995, 1994 and 1993, bad debt expense was $119,000, $929,000 and $914,000
and bad debt write-offs were $262,000, $635,000 and $632,000, respectively.
F-15
<PAGE> 16
REPUBLIC ENVIRONMENTAL SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
Estimates and Assumptions
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets, liabilities, disclosure
of contingent assets and liabilities and the reported amounts of revenues and
expenses. Actual results could differ from those estimates.
Accounting Pronouncements
In March 1995, the Financial Accounting Standards Board issued Statement
No. 121 (the "Statement") on accounting for the impairment of long-lived assets,
certain identifiable intangibles and goodwill related to assets to be held and
used. The Statement also establishes accounting standards for long-lived assets
and certain identifiable intangibles to be disposed of. The Company is required
to adopt the Statement in 1996, and based on a preliminary review, no material
impact is anticipated.
3. RESTRUCTURING AND UNUSUAL CHARGES
Recapitalization of RESL in 1994
In connection with the decision by RII to distribute the hazardous waste
services segment to its existing shareholders, which included the contribution
of the Canadian hazardous waste services subsidiary, RESL, to RESI at the
Distribution Date, RII recapitalized RESL. As such the Company evaluated each of
the individual TSD Facility operations of RESL considering the continued weak
Canadian economy and the amount of capital RESI could devote to RESL's
operations in the future. The results of this evaluation indicated that the
undiscounted cash flows of certain of the individual Canadian TSD Facilities did
not support the recorded amounts of goodwill without a substantial improvement
in the Canadian economy or the investment of substantial amounts of capital.
Additionally, the amount of goodwill recorded as a result of the acquisition of
RESL by RII in 1991 could not be supported by the expected changes in operations
after the planned contribution of RESL to RESI. As a result, the Company wrote
off approximately $6,380,000 of goodwill at RESL in the fourth quarter of 1994.
The Company also wrote off $1,194,000 in abandoned or to-be-abandoned property
and accrued approximately $910,000 of costs associated with the Distribution.
Reorganization of hazardous waste operations in 1993
In order to counteract severe market conditions in the hazardous waste
industry, the Company decided to reorganize its operations in the fourth quarter
of 1993. As a result, the Company consolidated certain TSD operations,
terminated certain contracts, closed or decided to close certain facilities,
reduced its workforce by over 135 people (or 30%) and wrote off goodwill and
other intangibles associated with the closed and abandoned facilities. In
accordance with industry standards, the Company provides for closure costs over
the life of a facility. Accordingly, the Company has fully provided for these
costs on the closed and to-be-closed facilities. In addition to the
reorganization of operations, the Company also reevaluated its exposure related
to litigation and environmental matters and provided additional accruals for the
costs to defend or settle certain
F-16
<PAGE> 17
REPUBLIC ENVIRONMENTAL SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
litigation and environmental matters. A summary of these charges for the closed,
abandoned and to-be-closed facilities is as follows (in thousands):
<TABLE>
<S> <C>
Property and equipment............................. $ 3,427
Goodwill and other intangibles..................... 4,476
Accumulated permitting costs....................... 1,492
Cost of terminating contracts and employees and
office relocation costs.......................... 2,705
Closure and environmental accruals................. 1,756
Accruals for cost of settlement of defense and
existing litigation and environmental matters.... 1,050
-------
$14,906
=======
</TABLE>
4. ACCRUED ENVIRONMENTAL COSTS
The Company's waste services activities are conducted in the context of a
developing and changing statutory and regulatory framework, aggressive
government enforcement and a highly visible political environment. Governmental
regulation of the waste management industry requires the Company to obtain and
retain numerous governmental permits to conduct various aspects of its
operations. These permits are subject to revocation, modification or denial. The
costs and other capital expenditures which may be required to obtain or retain
the applicable permits or comply with applicable regulations could be
significant.
Certain of the Company's facilities are contaminated from past spills of
potentially hazardous material. The amount and severity of contamination are
currently under investigation. The Company believes that remedial action will be
required, including continued investigation, monitoring and treatment of
groundwater and/or possible soil removal. As part of the acquisition of Stout in
1992 by RII, certain of the former stockholders of Stout agreed to indemnify RII
and the Company for certain litigation matters and environmental matters
identified as of the closing date of the merger. The obligation under this
indemnity is secured by amounts held in an escrow fund. The Company accrues for
known exposures in regards to these indemnified matters. Reimbursements from the
escrow account are reflected as capital contributions as cash is received. In
1995, the Company received reimbursement of $2.1 million with respect to these
indemnified matters.
The following is a description of proceedings whose claims are covered by
the indemnity obligations of the former Stout stockholders.
Adams Oil, Inc.
Adams Oil, Inc.("Adams Oil"), a wholly-owned subsidiary of RESI,
previously operated an oil terminal located in Camden, New Jersey. RESI is
aware that there is evidence of contamination on the property which may
have been caused by past spills of possible hazardous materials (i.e.,
petroleum hydrocarbons, gasoline, diesel fuel). The amount and the sources
of the contamination are currently under investigation by Adams Oil. The
New Jersey Department of Environmental Protection and Energy (the "NJDEPE")
has knowledge of the problem and has requested more information from Adams
Oil. Management believes that remedial action may be required and a
clean-up plan has been submitted to NJDEPE for approval.
Republic Environmental Systems (Pennsylvania), Inc.
Republic Environmental Systems (Pennsylvania), Inc. ("RES
(Pennsylvania)") has been named as a PRP in the North Penn Area No. 2
regional ground water problem involving 56 square miles
F-17
<PAGE> 18
REPUBLIC ENVIRONMENTAL SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
occupied by hundreds of industrial companies. The EPA has requested that
RES (Pennsylvania) enter into an administrative consent order to
investigate and determine its contribution, if any, to the regional
groundwater problem. RES (Pennsylvania) believes that it should not agree
to a consent order under CERCLA, but instead should be regulated under its
RCRA corrective action permit. The EPA is looking at the septic system and
the contamination of groundwater, as well as considering adding other PRP
companies. RES (Pennsylvania) is assisting the EPA by conducting testing.
RES (Pennsylvania) is not aware of any evidence that it contributed to a
regional groundwater problem.
In addition, RES (Pennsylvania) (formerly known as Waste Conversion,
Inc.) also has been named as a PRP along with 13 other primary defendants
for the recovery costs to remediate the Moyers Landfill Site in eastern
Pennsylvania. A company previously known as Waste Conversion of Delaware,
Inc. disposed of materials at Moyers Landfill from 1979 to 1981. This
company then sold its assets to Waste Conversion, Inc., which was owned by
Stout. RES (Pennsylvania) is currently in settlement negotiations with the
EPA to limit its exposure in this matter.
Also, RES (New York) and RES (Pennsylvania) are parties in a PRP
action with respect to the Aqua-Tech TSD facility in South Carolina. There
are 180 parties to date. In April 1993, an agreement was reached whereby
RESI paid $360,060 for proposed settlement of certain issues at the
facility, pending the final allocation to the PRP's.
The Company is involved in various matters of litigation and is subject to
ongoing environmental investigations by certain regulatory agencies involving
environmental matters, as well as other claims and disputes that could result in
additional litigation. The environmental investigations include notifications
that the Company is a Potentially Responsible Party, as defined under the
Comprehensive Environmental Response, Compensation and Liability Act of 1980, as
amended, in several site cleanups. With regard to certain of these matters, the
Company has been assessed penalties which it has appealed or has ongoing
negotiations to reduce the level of the assessments. The more significant items
include:
RES (Cleveland), Inc.
In June 1993, RES (Cleveland) received a Complaint and Compliance
Order from the Enforcement Division of Region 5 of the EPA alleging that
the former owners of RES (Cleveland)'s TSD Facility failed to submit a
proper RCRA Facility Investigation ("RFI") Workplan to the EPA on a timely
basis and fined RES (Cleveland). This RFI Workplan included any remedial
action plan necessary for the remediation of sub-surface soil at the TSD
Facility. In September 1993, Region 5 of the EPA approved for
implementation the RFI Workplan submitted by RES (Cleveland).
Republic Environmental Systems (New York), Inc.
In late June 1993, the Company voluntarily ceased operating at its TSD
Facility in Nassau County, New York, due to ongoing disputes and
negotiations with various regulatory agencies including the New York
Department of Environmental Conservation, the town of Oyster Bay and Nassau
County. In addition, RES (New York) received from the New York DEC a
proposed Summary Order in an Administrative Action commenced by the New
York DEC against the RES (New York) facility, whereby the New York DEC
sought revocation of RES (New York)'s permit to operate as a TSD Facility.
The New York DEC withdrew a previous consent order against RES (New York),
under which RES (New York) had agreed to pay $100,000, and subsequently
fined RES (New York) for alleged violations at the facility.
In early 1994, RES (New York) also permanently closed its hazardous
waste treatment, storage and disposal facility in Nassau County, New York
due to ongoing disputes and negotiations with the New York DEC, the town of
Oyster Bay and Nassau County. In addition, RES (New York) entered into a
F-18
<PAGE> 19
REPUBLIC ENVIRONMENTAL SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
consent decree with the New York DEC which provided for payment by RES (New
York) of $150,000 and the manner in which RESI was required to close the
facility. The parties are currently negotiating the technical aspects of
the requirements relating to facility closure.
Additionally, due to the reorganization of operations in 1993 as discussed
in Note 3, the Company evaluated its exposure related to certain environmental
matters and litigation related to its closed or to-be-closed TSD Facilities. As
a result, the Company provided additional accruals of $2,806,000 for the costs
to defend or settle these matters in 1993, of which approximately $468,000
remains as of December 31, 1995.
Although it is possible that a loss exceeding amounts already recorded may
be incurred upon the resolution of the litigation and environmental matters
described above, management believes that such losses, if realized, will not
have a material adverse effect on the Company's cash flows, consolidated results
of operations or combined financial position.
5. SHORT-TERM BORROWINGS, NOTES PAYABLE, LONG-TERM DEBT AND CAPITALIZED LEASES
Short-Term Borrowings and Notes Payable
In May 1995, the Company secured a $6 million credit facility with
CoreStates Bank, N.A., to be used for additional working capital and other
funding needs. Up to $4.5 million of the credit facility is available for the
issuance of standby letters of credit. At December 31, 1995, the Company had
issued $2.6 million in standby letters of credit. The unused portion of the
facility is available for cash borrowings. There were no cash borrowings under
the credit facility during 1995.
The credit facility provides for the maintenance of certain restrictive
covenants including, among others, minimum working capital levels, maintaining
current and fixed charges ratios and a predetermined level of interest coverage.
The Company is also restricted from making any dividend payments and incurring
additional debt. This facility is collateralized by substantially all of the
Company's U.S. assets. During 1995, the Company was in full compliance with all
covenants.
F-19
<PAGE> 20
REPUBLIC ENVIRONMENTAL SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
Notes payable consisted primarily of borrowings to fund the Company's
insurance premiums at December 31, 1995 and in 1994, amounts reflect borrowings
from lines of credit for working capital purposes. Long-Term Debt and
Capitalized Leases
Long-term debt, including obligations under capitalized leases, consists of
the following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31
-----------------
1995 1994
------ ------
<S> <C> <C>
Notes payable and capitalized lease obligations to banks
and financial institutions, secured by equipment and
other assets, interest ranging from 7.3% to 9.54%
(weighted average interest rate of 8.0% as of December
31, 1995), payable monthly through 2000.................. $ 854 $1,418
Note payable for an acquisition, secured by a letter of
credit, interest at Canadian prime, (7.50% as of December
31, 1994), payable monthly through April 1995............ -- 1,367
Other notes payable, secured by equipment and other assets,
interest ranging from 8.0% to 9.25% (weighted average
interest rate of 7.9% as of December 31, 1995) payable
monthly through 1998..................................... 271 476
------ ------
1,125 3,261
Less -- Current maturities................................. (507) (2,133)
------ ------
$ 618 $1,128
====== ======
</TABLE>
At December 31, 1995, aggregate maturities of long-term debt, including
obligations under capitalized leases, were as follows (in thousands):
<TABLE>
<S> <C>
1996................................................ $ 507
1997................................................ 361
1998................................................ 151
1999................................................ 104
2000................................................ 2
------
$1,125
======
</TABLE>
In connection with the decision by RII to distribute the hazardous waste
services segment to its existing shareholders, as discussed in Note 2, RII
recapitalized RESL. In December 1994, the Company's Canadian subsidiary
converted its U.S. subordinated term loan payable by RESL to 360,000 shares of
redeemable convertible participating preferred stock of RESL. The preferred
stock, with a face amount of Canadian $9.0 million ($6.6 million U.S. as of
December 31, 1995), is redeemable at the option of the Company and is
convertible into 15% of the common stock of RESL at the option of the holder.
The holders of the preferred stock are eligible to receive dividends based on
the future profitability of RESL in excess of specified target earnings levels.
The Company recorded an extraordinary gain on the conversion to preferred stock
of approximately U.S. $5.6 million, net of income taxes, based on the preferred
stock's fair market value.
The fair market value of the preferred stock was estimated by management
based on the current financial condition of the Canadian subsidiary, projected
undiscounted net income of that subsidiary and the current estimated fair market
value of the Canadian subsidiary.
F-20
<PAGE> 21
REPUBLIC ENVIRONMENTAL SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
6. STOCK OPTIONS AND WARRANTS
Stock Options
On the Distribution Date, holders of options to acquire RII Common Stock,
previously granted to employees, directors and affiliates of RII, received
options to acquire RESI Common Stock at the ratio of one RESI option for each
five RII options. These options have substantially similar terms to the RII
options. The outstanding options of RII at the Distribution Date and the RESI
options granted with respect thereto are stapled (i.e., RII options and RESI
options granted with respect thereto are only exercisable if exercised
together). The per share exercise prices of RII and RESI options at the
Distribution Date were appropriately adjusted to reflect the effect of the
Distribution on the market prices of RII and RESI Common Stock. The combined
exercise price of an option to purchase shares of RII Common Stock and the
option to purchase shares of RESI Common Stock granted with respect thereto was
equal to the exercise price of the RII option prior to the Distribution Date.
Unvested RII options held by any optionee and the unvested RESI options granted
to such optionee with respect to such RII options, vests in accordance with the
vesting schedule of the RII options held by such optionee as long as the
optionee is employed by RII or RESI or their affiliates. Options granted under
this plan expire ten years from the date of grant and vest over varying periods.
In April 1995, the RESI Board of Directors approved the RESI Adjustment Plan
("Adjustment Plan") and approved the issuance, on the Distribution Date, of
options to purchase up to 450,000 shares of RESI Common Stock. The purpose of
the Adjustment Plan is to provide for the issuance of RESI options to certain
optionees who have been granted options to purchase RII Common Stock which were
outstanding as of the Distribution Date. The option price of these plans is
based on the fair market value of the common shares on the date that the stock
options are granted.
In May 1995, the RESI Board of Directors approved the RESI 1995 Employee
Stock Option Plan for certain key employees of the Company. A maximum of 500,000
options may be awarded to purchase the Company's Common Stock. The option price
under this plan shall not be less than the fair market value of the Common Stock
on the date the stock option is granted. In the event of a change of control, as
defined in the plan, all outstanding employee options shall become immediately
exercisable and the prescribed time limits for exercise will run from such
vesting.
Certain information for 1995 relative to these stock option plans is
summarized below:
<TABLE>
<S> <C>
Number of Shares
Granted at Distribution Date.................... 420,400
Granted subsequent to distribution.............. 31,000
Exercised (a)................................... (257,800)
Expired or canceled............................. (3,400)
--------
Outstanding at end of year (b).................. 190,200
========
Exercisable at end of year...................... 70,000
========
Participants at end of year..................... 40
========
Available for future grant at the end of year... 502,000
========
</TABLE>
- ---------------
(a) Options were exercised at prices ranging from $1.08 to $5.80.
(b) For outstanding shares under option at December 31, 1995, option prices
ranged from $1.08 to $5.80 (and averaged $2.25). The expiration dates for
these options from May 1996 to May 2004.
F-21
<PAGE> 22
REPUBLIC ENVIRONMENTAL SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
Warrants
As of the Distribution Date, there were outstanding unexercised warrants
(the "RII Warrants") to acquire 4,361,500 shares of RII Common Stock. On the
Distribution Date, the holders of unexpired RII Warrants received additional
warrants (the "RESI Warrants") to acquire a number of shares equal to one-fifth
the number of shares of RII Common Stock (or 872,300 of RESI Common Stock) which
they may acquire upon exercise of their outstanding RII options. The outstanding
RII and RESI options are stapled and contain substantially similar terms. The
per share exercise price of the RESI warrants has been appropriately adjusted to
reflect the effect of the Distribution on the market prices of the RII and RESI
Common Stock. There were 250,000 RESI warrants exercised at prices ranging from
$1.08 to $5.10 with no cancellations occurring during the year. These warrants
expire beginning July 1996 to May 2003.
7. COMMITMENTS AND CONTINGENCIES
Operating Lease Commitments
The Company leases certain of its premises and certain equipment under
various operating lease agreements. At December 31, 1995, future minimum rental
commitments becoming payable under all operating leases are as follows (in
thousands):
<TABLE>
<S> <C>
1996.................................................. $412
1997.................................................. 370
1998.................................................. 316
1999.................................................. 302
2000.................................................. 233
Thereafter............................................ 222
</TABLE>
Total rental expense incurred under operating leases was $709,000,
$848,000, and $1,058,000 in 1995, 1994 and 1993, respectively.
Employee Benefits
Effective January 1, 1994, RESI instituted a defined contribution 401(k)
savings plan ("the Plan") for employees meeting certain employment requirements
which covered the Company's eligible employees. Under the Plan, RESI may, at its
discretion, match a portion of employee contributions based on the profitability
and growth of RESI. There have been no contributions to the Plan.
Other Matters
In May 1994, RESI decided to terminate its operations at a TSD Facility in
Farmingdale, New York. RESI's Dayton, Ohio TSD facility terminated operations in
October, 1995. RESI has ceased its efforts to relocate the Dayton, Ohio TSD
facility, but will continue to provide services in Ohio through its Bedford,
Ohio facility. With respect to the closing of each of these TSD facilities, RESI
has accrued the appropriate costs.
At December 31, 1995, RESI had placed in escrow accounts approximately
$873,000 in connection with TSD Facility closure and certain other obligations,
of which $813,000 was included in cash and cash equivalents and $60,000 was
included in other current assets. Additionally, RESI has used its bonding
facilities for the issuance of payment, performance and bid bonds, of which $1.9
million in bonds were outstanding at December 31, 1995.
F-22
<PAGE> 23
REPUBLIC ENVIRONMENTAL SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
8. CAPITAL STOCK
At the Distribution Date, RII stockholders of record as of April 21, 1995
received one share of RESI's common stock for each five shares of RII common
stock held. If the Distribution had taken place on December 31, 1994,
approximately 10,800,000 million shares of RESI's common stock would have been
issued.
During the current year, the Board of Directors adopted resolutions
authorizing, but not requiring, RESI to purchase up to a total of 500,000 shares
from time to time. As of December 31, 1995, 102,000 shares had been acquired at
a cost of $145,000. Subsequent to year-end, the Board of Directors authorized an
additional 500,000 shares to be purchased. and 594,000 shares were repurchased
at a cost of $896,000.
9. INCOME TAXES
The components of the income tax provision are shown below (in thousands):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
-------------------------------
1995 1994 1993
----- ------- -------
<S> <C> <C> <C>
Current:
Federal..................................... $ 227 $ (11) $ --
Foreign..................................... 43 -- (729)
State....................................... 99 155 121
----- ------- -------
369 144 (608)
Deferred:
Federal..................................... 749 910 (3,110)
Foreign..................................... (363) (638) --
----- ------- -------
386 272 (3,110)
Change in valuation allowance................. -- (3,508) 3,508
----- ------- -------
Income tax provision (benefit)................ $ 755 $(3,092) $ (210)
===== ======= =======
</TABLE>
In addition to the above, RESI recorded a deferred income tax provision of
$3,092,000 in 1994 related to the extraordinary gain on conversion of debt.
Deferred tax assets are recognized under SFAS No. 109 unless it is "more
likely than not" that they will not be realized. In 1993, RESI recorded a
$3,508,000 valuation allowance related to the realization of deferred tax assets
generated as a result of the restructuring and unusual charges. This valuation
allowance was recorded due to the uncertainty surrounding the future utilization
of such deferred tax assets. In 1994, the valuation allowance was eliminated
based on the expected realization of such deferred tax assets primarily as a
result of the deferred tax gain generated from the conversion of the Canadian
debt to redeemable convertible participating preferred stock (see Note 5).
F-23
<PAGE> 24
REPUBLIC ENVIRONMENTAL SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
A reconciliation of the statutory federal income tax rate to the Company's
effective tax rate as reported is shown below:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
-------------------------------
1995 1994 1993
----- ------- -------
<S> <C> <C> <C>
Statutory federal income tax rate............. 34.0% (34.0)% (34.0)%
Goodwill and other permanent items............ 9.3 27.6 11.4
State income taxes, net of federal benefit.... 3.2 1.4 0.7
Foreign income tax (benefit) provision at
other than U.S. rates....................... (4.2) 2.8 (3.2)
Nondeductible expenses related to the
distribution................................ -- 5.2 --
Change in valuation allowance................. -- (58.8) 23.7
Reduction of previously accrued taxes......... (5.3) -- --
Other, net.................................... -- 4.0 --
----- ------- -------
Effective tax rate............................ 37.0% (51.8)% (1.4)%
===== ======= =======
</TABLE>
Components of the net deferred income tax liability are shown below (in
thousands):
<TABLE>
<CAPTION>
DECEMBER 31
-------------------
1995 1994
------- -------
<S> <C> <C>
Deferred tax liabilities:
Book basis in property over tax basis................. $ 5,855 $ 5,532
Deferred gain on the conversion of Canadian debt...... 2,617 2,617
------- -------
8,472 8,149
Deferred tax assets:
Net operating losses.................................. (4,727) (3,405)
Accrued environmental costs........................... (1,191) (2,100)
Accruals not currently deductible..................... (210) (269)
------- -------
(6,128) (5,774)
------- -------
Net deferred income tax liability....................... $ 2,344 $ 2,375
======= =======
</TABLE>
At December 31, 1995 the Company had available U.S. net operating loss
carryforwards of approximately $8.9 million which begin to expire in the year
2006. The Company also has approximately $3.8 million of Canadian net operating
loss carryforwards, the majority of which will begin to expire in 1999.
The U.S. operations of RESI are included in the consolidated federal income
tax return of RII through the date of the Distribution. All tax amounts above as
well as tax amounts included in the accompanying combined financial statements
have been reflected as if RESI filed a separate federal tax return.
The Company and RII have entered into a tax sharing agreement which
reflects each party's rights and obligations with respect to deficiencies and
refunds, if any, of federal, state or other taxes related to RESI, or RII's
hazardous waste services subsidiaries prior to their distribution to RESI, for
tax periods prior to the Distribution. RESI has agreed to indemnify RII for
positions taken in tax periods prior to the Distribution.
The tax sharing agreement provides for adjustments to the Company's net
deferred tax liability based on the completion of federal tax returns, in which
RESI will be included in the RII consolidated return. Adjustments might be
necessary due to the timing of certain deductions and the calculation of interim
period taxable income in 1995. Per the tax sharing agreement, any adjustments
necessary would affect the Company's equity as if such adjustments had been made
at the Distribution Date.
F-24
<PAGE> 25
REPUBLIC ENVIRONMENTAL SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
10. RELATED PARTY TRANSACTIONS
The Company has entered into several agreements to lease office space and
obtain other services for certain subsidiaries with the former owners of these
subsidiaries, primarily Stout, who were formerly officers of the Company.
Aggregate payments for such leases and other services were $814,000, $647,000
and $1,202,000 in 1995, 1994, and 1993, respectively.
11. OPERATIONS BY GEOGRAPHIC AREA
The Company's only line of business is providing environmental services to
hazardous and non-hazardous waste generators.
The following tables present information regarding the Company's different
geographic regions based on the historical operations of the Company (in
thousands):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
----------------------------------
1995 1994 1993
-------- -------- --------
<S> <C> <C> <C>
Revenue
United States............................................ $ 38,815 $ 41,539 $ 54,047
Canada................................................... 5,722 5,060 7,570
-------- -------- --------
$ 44,537 $ 46,599 $ 61,617
======== ======== ========
Operating income (loss):
United States............................................ $ 2,760 $ 1,061 $(10,164)
Canada................................................... (693) (6,672) (3,633)
Interest, net.............................................. (26) (353) (992)
-------- -------- --------
Income (loss) before income taxes and extraordinary gain... $ 2,041 $ (5,964) $(14,789)
======== ======== ========
Depreciation and amortization:
United States............................................ $ 1,894 $ 1,910 $ 2,000
Canada................................................... 418 547 803
-------- -------- --------
$ 2,312 $ 2,457 $ 2,803
======== ======== ========
Capital expenditures:
United States............................................ $ 3,600 $ 1,707 $ 1,870
Canada................................................... 1,133 267 1,931
-------- -------- --------
$ 4,733 $ 1,974 $ 3,801
======== ======== ========
Identifiable assets:
United States............................................ $ 32,155 $ 31,494 $ 33,662
Canada................................................... 9,595 8,448 15,856
-------- -------- --------
$ 41,750 $ 39,942 $ 49,518
======== ======== ========
</TABLE>
12. SUBSEQUENT EVENTS
On May 19, 1996, RESI and Alliance Holding Company ("Alliance") signed a
binding letter of intent and agreed to the terms of mergers (the "Mergers")
pursuant to which RESI would issue to Alliance (i) 14,760,000 shares of RESI
Common Stock, (ii) warrants to acquire an additional 4,200,000 shares of RESI
Common Stock at exercise prices ranging from $2.625 to $3.875 per share and
exercisable over two to four year periods and (iii) a promissory note in the
principal amount of $4.0 million, in consideration for all of the outstanding
common stock of Alliance's wholly-owned subsidiaries, Century Surety Company and
Commercial Surety Agency, Inc. As part of the same transaction, MGD Holdings
Ltd. and Mr. H. Wayne Huizenga will each purchase 2,000,000 shares of RESI
common stock for $2.625 per share and will each
F-25
<PAGE> 26
REPUBLIC ENVIRONMENTAL SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
receive warrants to purchase an additional 6,000,000 shares of RESI Common Stock
at exercise prices ranging from $2.625 to $3.875 per share and exercisable over
two to four year periods.
As a result of the Mergers, there will be a change in control of RESI to
Alliance and utilization of the RESI net operating losses of approximately $8.9
million (at December 31, 1995) will be subject to certain limitations imposed by
the Internal Revenue Code.
Additionally, on June 7, 1996, RESI announced a two for one stock split,
effected in the form of a stock dividend effective June 14, 1996. These
consolidated and combined financial statements have been adjusted to reflect the
effect of the stock split.
Also, in May 1996, the Board of Directors approved a resolution to retire
all of the common shares held in the Company's treasury.
F-26
<PAGE> 27
REPUBLIC ENVIRONMENTAL SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1996 1995
------- -------
(UNAUDITED)
<S> <C> <C>
ASSETS
CURRENT ASSETS
Cash and cash equivalents........................................... $ 2,442 $ 3,255
Accounts receivable, less allowance for doubtful accounts of $1,036
and $1,031, respectively......................................... 6,184 7,614
Other current assets................................................ 1,625 1,445
------- -------
TOTAL CURRENT ASSETS........................................... 10,251 12,314
Property and equipment, net........................................... 20,322 19,469
Goodwill, net of accumulated amortization of $1,326 and $1,187,
respectively........................................................ 8,984 9,109
Other assets.......................................................... 868 858
------- -------
TOTAL ASSETS................................................... $40,425 $41,750
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable.................................................... $ 2,516 $ 2,568
Accrued liabilities................................................. 1,991 2,825
Notes payable....................................................... 403 193
Current maturities of long-term debt and capitalized lease
obligations...................................................... 423 507
Current portion of accrued environmental costs...................... 1,759 1,999
Income taxes payable................................................ 60 56
------- -------
TOTAL CURRENT LIABILITIES...................................... 7,152 8,148
Long-term debt and capitalized lease obligations, net of current
maturities.......................................................... 454 618
Accrued environmental costs, net of current portion................... 1,810 1,790
Deferred income taxes................................................. 2,437 2,344
Minority interest..................................................... 257 257
------- -------
TOTAL LIABILITIES.............................................. 12,110 13,157
------- -------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY
Common stock, par value $0.01 per share; 20,000,000 shares
authorized, 10,855,238 and 11,366,432 shares issued,
respectively..................................................... 109 57
Additional paid-in capital.......................................... 27,479 27,710
Retained earnings................................................... 531 778
Cumulative translation adjustment................................... 196 193
Treasury stock, 102,000 shares, at cost............................. -- (145)
------- -------
TOTAL STOCKHOLDERS' EQUITY..................................... 28,315 28,593
------- -------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY..................... $40,425 $41,750
======= =======
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-27
<PAGE> 28
REPUBLIC ENVIRONMENTAL SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30,
-------------------
1996 1995
------- -------
<S> <C> <C>
Revenues................................................................ $15,796 $25,165
Expenses:
Cost of operations.................................................... 11,849 18,123
Selling, general and administrative................................... 4,656 5,092
------- -------
Operating income (loss).......................................... (709) 1,950
Other (income) expense:
Interest and other income............................................. (426) (118)
Interest expense...................................................... 110 154
------- -------
Income (loss) before income taxes....................................... (393) 1,914
Income tax (benefit) provision.......................................... (146) 708
------- -------
Net (loss) income................................................ $ (247) $ 1,206
======= =======
(Loss) earnings per common and common equivalent share.................. $ (0.02) $ 0.11
======= =======
Weighted average common and common equivalent shares.................... 11,150 10,850
======= =======
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-28
<PAGE> 29
REPUBLIC ENVIRONMENTAL SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30,
--------------------
1996 1995
------- -------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net (loss) income..................................................... $ (247) $ 1,206
Adjustments to reconcile net (loss) income to net cash provided by
operations:
Depreciation and amortization.................................... 1,078 1,184
Provision for doubtful accounts.................................. 98 424
Provision for accrued environmental costs........................ 148 204
Loss (gain) on the sale of equipment............................. (64) (20)
Changes in assets and liabilities --
Accounts receivable........................................... 1,337 1,404
Prepaid expenses and other assets............................. (354) (537)
Accounts payable and accrued liabilities...................... (1,015) (378)
Income taxes payable.......................................... 4 144
Due to Republic Industries, Inc............................... -- 762
Other liabilities............................................. (192) (1,367)
------- -------
Net cash provided by operations............................. 793 3,026
------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital additions..................................................... (1,704) (2,201)
Proceeds from the sale of equipment................................... 119 41
------- -------
Net cash used in investing activities....................... (1,585) (2,160)
------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from stock options........................................... 872 --
Capital contributions from Republic Industries, Inc................... -- 2,191
Repayment of borrowings from Republic Industries, Inc................. -- (501)
Cash received from Stout -- capital contribution...................... 74 2,454
Purchase of treasury stock............................................ (895) (141)
Payments of long-term debt and notes payable.......................... (440) (3,044)
Proceeds from long-term debt and notes payable........................ 368 319
------- -------
Net cash (used) provided in financing activities............ (21) 1,278
------- -------
DECREASE IN CASH AND CASH EQUIVALENTS................................... (813) 2,144
CASH AND CASH EQUIVALENTS:
Beginning of period................................................... 3,255 1,433
------- -------
End of period......................................................... $ 2,442 $ 3,577
======= =======
SUPPLEMENTAL DISCLOSURE OF CASH PAID FOR:
Interest.............................................................. $ 110 $ 152
Income taxes.......................................................... $ 89 $ 65
</TABLE>
SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES:
Equipment purchases of $0 and $536 were financed in the six months ended June
30, 1996 and 1995, respectively by borrowings and capitalized lease obligations.
The accompanying notes are an integral part of these financial statements.
F-29
<PAGE> 30
REPUBLIC ENVIRONMENTAL SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION AND PRINCIPLES OF CONSOLIDATION
The accompanying unaudited consolidated and combined financial statements
at June 30, 1996 include the accounts of Republic Environmental Systems, Inc.
and its subsidiaries ("RESI"), the successor to the business of Stout
Environmental, Inc. ("Stout"), a Delaware corporation, acquired by Republic
Industries, Inc. ("RII"), formerly Republic Waste Industries, Inc., in March
1992, as well as the accounts of Republic Environmental Systems Ltd. ("RESL")
(formerly known as Great Lakes Environmental Group Ltd.), the former Canadian
hazardous waste services subsidiary of RII, which was acquired by RII in July
1991 and was contributed to RESI as of the Distribution Date (collectively, the
"Company"). One of RESI's subsidiaries, Republic Environmental Systems
(Cleveland) (RES (Cleveland)), Inc. (formerly known as Evergreen Environmental
Group, Inc.), was acquired by RII in September 1991, in a transaction separate
from the Stout acquisition and was contributed to RESI in May 1993. The accounts
of RESI and all its majority owned subsidiaries are included in the accompanying
consolidated financial statements. All significant intercompany transactions
have been eliminated.
The consolidated and combined financial statements of RESI and its
subsidiaries included herein have been prepared by RESI, without audit, pursuant
to the rules and regulations of the Securities and Exchange Commission. Certain
information and footnote disclosures normally included in financial statements
prepared in accordance with generally accepted accounting principles have been
condensed or omitted pursuant to such rules and regulations. In the opinion of
RESI, the accompanying statements reflect all adjustments necessary to present
fairly the financial position, results of operations and cash flows for those
periods indicated, and contain adequate disclosure to make the information
presented not misleading. Such adjustments are of a normal, recurring nature
unless otherwise disclosed in the notes to consolidated and combined financial
statements. It is suggested that these condensed consolidated and combined
financial statements be read in conjunction with the financial statements and
notes thereto included elsewhere herein.
Results of operations for any six month period are not necessarily
indicative of the results of operations for a full year.
The combined financial statements for all periods presented prior to the
Distribution Date include the historical accounts and operations of the former
RII businesses that now comprise the Company. Material transactions between
entities included herein have also been eliminated.
2. EARNINGS PER COMMON AND COMMON EQUIVALENT SHARE
The computation of weighted average common and common equivalent shares
used in the calculation of earnings per share for the six months ended June 30,
1996 is shown below (in thousands):
<TABLE>
<CAPTION>
SIX
MONTHS
ENDED
JUNE 30,
1996
------
<S> <C>
Common shares outstanding, net of treasury shares................... 10,855
Effect of stock options and warrants assumed exercisable............ 299
Effect of using weighted average common shares outstanding during
the period........................................................ (4)
-----
Weighted average common and common equivalent shares................ 11,150
=====
</TABLE>
On June 7, 1996 the Board of Directors declared a two-for-one split of
RESI's common stock, $.01 par value per share ("Common Stock"), in the form of a
100% stock dividend, payable June 30, 1996, to holders of record on June 14,
1996. Accordingly, all prior year share and per share information contained
herein reflects the stock split.
F-30
<PAGE> 31
REPUBLIC ENVIRONMENTAL SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The difference between shares for primary and fully diluted earnings per
common and common equivalent share was not dilutive for the periods presented.
3. TREASURY STOCK
In April 1995 the RESI Board of Directors adopted resolutions authorizing,
but not requiring, RESI to repurchase up to a total of 500,000 shares (or 4.6%
of the then outstanding RESI Common Stock) from time to time. The repurchasing
of shares was intended to achieve a more favorable balance between the market
supply of the shares and expected market demand, as well as establish stability
in the trading market for RESI shares. Repurchases were effected at prevailing
market prices from time to time on the open market prior to the negotiation of
the Combination (see: Note 4). The last repurchase was effected by RESI on March
4, 1996 and as of such date RESI had repurchased approximately 695,842 shares of
RESI Common Stock for an aggregate cost of approximately $1,040,000. On May 9,
1996, the RESI Board of Directors authorized the retirement of the 695,842
shares of RESI Common Stock.
4. PROPOSED MERGER AND SUBSEQUENT EVENTS
On May 19, 1996, RESI and Alliance Holding Company ("Alliance") signed a
binding letter of intent and agreed to the terms of mergers (the "Mergers")
pursuant to which RESI would issue to Alliance (i) 14,760,000 shares of RESI
Common Stock, (ii) warrants to acquire an additional 4,200,000 shares of RESI
Common Stock at exercise prices ranging from $2.625 to $3.875 per share and
exercisable over two to four year periods and (iii) a promissory note in the
principal amount of $4.0 million, in consideration for all of the outstanding
common stock of Alliance's wholly-owned subsidiaries, Century Surety Company and
Commercial Surety Agency, Inc. As part of the same transaction, MGD Holdings
Ltd. and Mr. H. Wayne Huizenga will each purchase 2,000,000 shares of RESI
common stock for $2.625 per share and will each receive warrants to purchase an
additional 6,000,000 shares of RESI Common Stock at exercise prices ranging from
$2.625 to $3.875 per share and exercisable over two to four year periods.
As a result of the Mergers, there will be a change in control of RESI to
Alliance and utilization of the RESI net operating losses of approximately $8.9
million (at December 31, 1995) will be subject to certain limitations imposed by
the Internal Revenue Code.
On June 7, 1996, RESI announced a two for one stock split, effected in the
form of a stock dividend effective June 14, 1996. These consolidated and
combined financial statements have been adjusted to reflect the effect of the
stock split.
In May 1996, the Board of Directors approved a resolution to retire all of
the common shares held in the Company's treasury.
During July 1996, the Alliance Companies entered into an agreement to
acquire Environmental & Commercial Insurance Agency, Inc.; an agreement with
Gulf Insurance Company and Midwest Indemnity Corporation ("Midwest") for the
production, underwriting and reinsurance of contract surety and surety bond
business primarily to environmental businesses; and an option to purchase assets
of Midwest. These transactions are subject to the consummation of the Mergers.
F-31
<PAGE> 32
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Century Surety Company:
We have audited the consolidated financial statements of Century Surety
Company (a wholly owned subsidiary of Alliance Holding Corporation) and
subsidiaries (collectively, the Company), as listed in the accompanying index on
page F-1. In connection with our audits of the consolidated financial
statements, we have also audited the financial statement schedules as listed in
the accompanying index on page F-1. These consolidated financial statements and
financial statement schedules are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements and financial statement schedules based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards 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. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Century
Surety Company and subsidiaries as of December 31, 1995 and 1994, and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 1995, in conformity with generally accepted
accounting principles. Also, in our opinion, the financial statement schedules,
when considered in relation to the basic consolidated financial statements taken
as a whole, present fairly, in all material respects, the information set forth
therein.
As discussed in note 1 to the consolidated financial statements, in 1994
the Company adopted the provisions of the Financial Accounting Standards Board's
Statement of Financial Accounting Standards No. 115, Accounting for Certain
Investments in Debt and Equity Securities.
KPMG Peat Marwick LLP
Columbus, Ohio
April 9, 1996
except as to Note 12,
which is as of June 14, 1996
F-32
<PAGE> 33
CENTURY SURETY COMPANY AND SUBSIDIARIES
(A WHOLLY OWNED SUBSIDIARY OF ALLIANCE HOLDING CORPORATION)
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1995 AND 1994
<TABLE>
<CAPTION>
1995 1994
----------- -----------
<S> <C> <C>
ASSETS
Investments (note 2):
Fixed maturities held to maturity, at amortized cost............ $15,308,405 $20,129,353
Securities available for sale, at fair value:
Fixed maturities............................................. 33,153,196 24,884,791
Equity securities (cost $1,999,419 and $2,468,337,
respectively)............................................... 5,425,813 1,764,521
Mortgage loans on real estate (note 7).......................... 3,393,205 2,960,723
Other investments............................................... 90,267 139,283
Short-term investments, at cost................................. 843,095 870,242
----------- -----------
Total investments....................................... 58,213,981 50,748,913
Cash (note 2)..................................................... 2,691,746 6,577,481
Premium balances receivable, net of allowance for bad debts of
$137,736 and $56,396, respectively (note 7)..................... 4,357,298 4,623,574
Deferred policy acquisition costs (note 7)........................ 3,427,551 3,725,611
Reinsurance receivables (note 5).................................. 12,646,960 10,887,657
Prepaid reinsurance premiums...................................... 2,881,174 2,413,623
Accrued investment income......................................... 870,245 784,969
Deferred federal income taxes (note 6)............................ -- 467,680
Furniture and equipment at cost, net of accumulated depreciation
of $527,254 and $355,857, respectively.......................... 329,435 349,914
Other assets...................................................... 579,784 59,757
----------- -----------
Total assets............................................ $85,998,174 $80,639,179
=========== ===========
LIABILITIES AND SHAREHOLDER'S EQUITY
Losses and loss expenses payable (note 4)......................... 37,001,841 34,661,007
Unearned premiums................................................. 15,636,442 15,453,487
Reinsurance balances payable...................................... 2,259,400 2,055,562
Current federal income taxes payable (note 7)..................... 1,322,280 597,465
Deferred federal income taxes (note 6)............................ 53,337 --
Accrued expenses and other liabilities............................ 2,660,005 2,865,364
Collateral held................................................... 321,115 1,248,662
----------- -----------
Total liabilities....................................... 59,254,420 56,881,547
----------- -----------
Shareholder's equity (notes 8 and 11):
Capital stock, $10,000 par value per share. Authorized 500
shares; issued and outstanding 200 shares.................... 2,000,000 2,000,000
Additional paid-in capital...................................... 17,293,158 16,698,158
Net unrealized appreciation (depreciation) of investments....... 3,265,550 (1,208,641)
Retained earnings............................................... 4,185,046 6,268,115
----------- -----------
Total shareholder's equity.............................. 26,743,754 23,757,632
----------- -----------
Commitments and contingencies (notes 5 and 10)
Total liabilities and shareholder's equity.............. $85,998,174 $80,639,179
=========== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
F-33
<PAGE> 34
CENTURY SURETY COMPANY AND SUBSIDIARIES
(A WHOLLY OWNED SUBSIDIARY OF ALLIANCE HOLDING CORPORATION)
CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993
<TABLE>
<CAPTION>
1995 1994 1993
----------- ----------- -----------
<S> <C> <C> <C>
Revenue:
Premiums earned (note 5)........................... $26,961,397 $23,367,623 $17,372,598
Net investment income (note 2)..................... 3,340,956 2,477,428 1,376,916
Income on American Sentinel transaction (note 9)... -- 807,306 --
Net realized gains on investments (note 2)......... 166,286 79,955 (91,450)
Other income....................................... 355,035 222,682 511,561
----------- ----------- -----------
Total revenue.............................. 30,823,674 26,954,994 19,169,625
----------- ----------- -----------
Expenses:
Losses and loss expenses (notes 4, 5 and 7)........ 15,116,726 12,494,170 8,612,664
Acquisition expenses (note 7)...................... 6,612,518 5,268,596 4,996,403
Other expenses (note 7)............................ 4,513,096 5,126,694 2,417,389
----------- ----------- -----------
Total expenses............................. 26,242,340 22,889,460 16,026,456
----------- ----------- -----------
Amortization of negative goodwill.................... -- -- 219,194
----------- ----------- -----------
Income before federal income taxes......... 4,581,334 4,065,534 3,362,363
----------- ----------- -----------
Federal income tax expense (benefit) (notes 6 and 7):
Current............................................ 2,013,192 1,022,647 1,234,483
Deferred........................................... (698,789) 55,621 (90,333)
----------- ----------- -----------
Total federal income tax expense........... 1,314,403 1,078,268 1,144,150
----------- ----------- -----------
Net income................................. $ 3,266,931 $ 2,987,266 $ 2,218,213
=========== =========== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
F-34
<PAGE> 35
CENTURY SURETY COMPANY AND SUBSIDIARIES
(A WHOLLY OWNED SUBSIDIARY OF ALLIANCE HOLDING CORPORATION)
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993
<TABLE>
<CAPTION>
1995 1994 1993
----------- ----------- -----------
<S> <C> <C> <C>
Capital stock:
Beginning and end of year......................... $ 2,000,000 $ 2,000,000 $ 2,000,000
----------- ----------- -----------
Additional paid-in capital:
Beginning of year................................. 16,698,158 12,891,158 8,745,722
Capital contributed by parent (notes 7 and 9)..... 595,000 3,807,000 4,145,436
----------- ----------- -----------
End of year....................................... 17,293,158 16,698,158 12,891,158
----------- ----------- -----------
Net unrealized appreciation (depreciation) of
investments:
Beginning of year................................. (1,208,641) (80,139) (16,938)
Cumulative effect of change in accounting for
investments (note 1[c])........................ -- 36,215 --
Change in net unrealized appreciation
(depreciation)................................. 4,474,191 (1,164,717) (63,201)
----------- ----------- -----------
End of year....................................... 3,265,550 (1,208,641) (80,139)
----------- ----------- -----------
Retained earnings:
Beginning of year................................. 6,268,115 4,280,849 2,902,636
Net income........................................ 3,266,931 2,987,266 2,218,213
Cash dividend..................................... (5,350,000) (1,000,000) (840,000)
----------- ----------- -----------
End of year....................................... 4,185,046 6,268,115 4,280,849
----------- ----------- -----------
Total shareholder's equity................ $26,743,754 $23,757,632 $19,091,868
=========== =========== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
F-35
<PAGE> 36
CENTURY SURETY COMPANY AND SUBSIDIARIES
(A WHOLLY OWNED SUBSIDIARY OF ALLIANCE HOLDING CORPORATION)
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993
<TABLE>
<CAPTION>
1995 1994 1993
----------- ----------- ------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income............................................... $ 3,266,931 $ 2,987,266 $ 2,218,213
----------- ----------- ------------
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization.......................... 312,311 384,540 (158,784)
Deferred federal income taxes.......................... (698,789) 55,621 (90,333)
Income on American Sentinel transaction................ -- (807,306) --
Writedown of investments............................... -- -- 139,218
(Increase) decrease in premium balances receivable..... 266,276 (514,868) (1,582,913)
(Increase) decrease in deferred policy acquisition
costs................................................ 298,060 (1,319,776) (728,628)
Increase in reinsurance receivables.................... (1,759,303) (379,762) (7,944,199)
(Increase) decrease in prepaid reinsurance premiums.... (467,551) 557,860 (2,945,035)
Increase in accrued investment income.................. (85,276) (272,818) (191,550)
(Increase) decrease in other assets.................... (520,027) 54,169 384,727
Increase in losses and loss expenses payable........... 2,340,834 5,133,202 9,773,009
Increase in unearned premiums.......................... 182,955 3,287,024 6,733,798
Decrease in contract funds on deposit.................. -- (350,000) (350,000)
Increase (decrease) in reinsurance balances payable.... 203,838 (870,845) 500,721
Increase in current federal income taxes payable....... 724,815 170,149 318,816
Increase (decrease) in accrued expenses and other
liabilities.......................................... (205,359) 376,014 665,240
Increase (decrease) in collateral held................. (927,547) 174,116 877,404
Other, net............................................. -- -- (108,504)
----------- ----------- ------------
Net adjustments................................... (334,763) 5,677,320 5,292,987
----------- ----------- ------------
Net cash provided by operating activities......... 2,932,168 8,664,586 7,511,200
----------- ----------- ------------
Cash flows from investing activities:
Purchase of fixed maturities available for sale.......... (9,552,437) (8,857,940) --
Purchase of fixed maturities held to maturity............ (269,070) (1,804,698) --
Purchase of fixed maturities............................. -- -- (21,440,472)
Purchase of equity securities............................ (228,185) (223,084) (614,858)
Maturity of fixed maturities held to maturity............ 1,280,816 2,009,186 1,654,502
Sale of fixed maturities available for sale.............. 7,088,543 1,155,282 --
Sale of fixed maturities................................. -- -- 202,000
Sale of equity securities................................ 149,505 201,620 1,128,332
(Increase) decrease in limited partnership............... 21,631 (34,348) --
Increase in mortgage loans on real estate................ (1,341,000) (1,893,000) (1,258,000)
Principal receipts on mortgage loans on real estate...... 908,518 780,100 1,285,560
Sales of real estate owned............................... -- -- 296,666
Purchase of subsidiaries, net of cash acquired........... -- 538,217 (1,515,060)
Decrease in short-term investments....................... 27,147 5,967,491 9,897,577
Net additions to furniture and equipment................. (148,371) (235,113) (69,553)
Other, net............................................... -- 200,000 (200,000)
----------- ----------- ------------
Net cash used in investing activities............. (2,062,903) (2,196,287) (10,633,306)
----------- ----------- ------------
Cash flows from financing activities:
Dividends to parent...................................... (5,350,000) (1,000,000) (840,000)
Capital contributed by parent............................ 595,000 340,000 285,600
----------- ----------- ------------
Net cash used in financing activities............. (4,755,000) (660,000) (554,400)
----------- ----------- ------------
Net increase (decrease) in cash................... (3,885,735) 5,808,299 (3,676,506)
Cash at the beginning of year.............................. 6,577,481 769,182 4,445,688
----------- ----------- ------------
Cash at the end of year.................................... $ 2,691,746 $ 6,577,481 $ 769,182
=========== =========== ============
SUPPLEMENTAL DISCLOSURE:
Federal income taxes paid................................ $ 693,377 $ 409,781 $ 627,500
=========== =========== ============
</TABLE>
See note 9 for supplemental disclosure of noncash financing activities.
See accompanying notes to consolidated financial statements.
F-36
<PAGE> 37
CENTURY SURETY COMPANY AND SUBSIDIARIES
(A WHOLLY OWNED SUBSIDIARY OF ALLIANCE HOLDING CORPORATION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1995 AND 1994
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) Consolidation Policy
Century Surety Company ("CSC"), a wholly owned subsidiary of Alliance
Holding Corporation ("Alliance"), was incorporated in 1978 as an Ohio property
and casualty insurance company and was acquired by Alliance in 1988. The
accompanying consolidated financial statements include the accounts of CSC and
its wholly owned subsidiaries: CSC Insurance Agency, Incorporated ("CSCI"),
Continental Heritage Insurance Company ("CHIC"), Evergreen National Indemnity
Company ("Evergreen"), American Inspection & Audit Service, Inc. ("AIAS"),
Continental Heritage Life Insurance Company ("CHLIC") (through May 22, 1995) and
Latitude Premium Finance Company ("Latitude") (through March 3, 1993)
(collectively, the "CSC Group").
CSC acquired Evergreen on December 31, 1993 through a capital contribution
from its parent and $1.61 million paid by CSC. On April 14, 1994, CSC paid
$16,400 for 100% of the outstanding common stock of AIAS. These transactions
were accounted for as purchases by CSC in accordance with the provisions of
Accounting Principles Board Opinion No. 16 with the acquired assets and assumed
liabilities recorded at their estimated fair values. The acquisitions of AIAS
and Evergreen did not have a material impact on the accompanying consolidated
statements of income. See notes 7 and 9. In addition, on March 3, 1993, CSC sold
Latitude to an unrelated party, and on May 22, 1995, CSC liquidated CHLIC. These
transactions did not have a material impact on the CSC Group's consolidated
financial position or results of operations.
All significant intercompany accounts and transactions have been eliminated
in consolidation.
(b) Business Description
The CSC Group primarily writes "non-standard" or specialty coverages,
including bonding, property and casualty insurance coverages to individual and
commercial customers through independent agents and affiliated agents primarily
throughout Ohio and over 40 other states. The CSC Group's coverages primarily
insure risks regarded as higher than standard, or normal, risks and to risk
groups regarded as too small or too rare to permit profitable underwriting by
larger, "standard market" insurance companies. In general, non-standard
insurance and bonds are more expensive, and coverage more limited, because of
perceived additional risk associated with this type of business. The CSC Group
attempts to identify and exploit those niches in the non-standard market where
the actual risk is significantly less than the perceived risk at which the
coverage is defined and priced, or where the CSC Group, because of its smaller
size and lower overhead, is able to underwrite coverages more economically than
larger carriers can. The CSC Group is subject to competition from other property
and casualty insurance companies and to the regulations of certain state and
federal agencies and undergoes periodic financial examinations by those
regulatory authorities.
Following is a description of additional significant risks facing
property/casualty insurers and how the CSC Group mitigates those risks:
Inadequate Pricing Risk is the risk that the premium charged for
insurance and insurance related products is insufficient to cover the costs
associated with the distribution of such products which include: claim and
loss costs, loss adjustment expense, acquisition expense, and other
corporate expenses. The CSC group utilizes a variety of actuarial and/or
other qualitative methods to set such levels.
Adverse Loss Development and IBNR Risk is the risk inherent in the
handling and settling of claims whose ultimate costs, which include loss
costs, loss adjustment expenses, and other related expenses, are unknown at
the time the claim is presented. An associated risk relates to claims which
have been incurred, but for which the company has no knowledge. The CSC
Group makes judgments as to the
F-37
<PAGE> 38
CENTURY SURETY COMPANY AND SUBSIDIARIES
(A WHOLLY OWNED SUBSIDIARY OF ALLIANCE HOLDING CORPORATION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
ultimate costs of presented claims and makes provision for their future
payment by establishing reserves for existing claims (case reserves) and
for incurred but not reported claims (IBNR); however, there can be no
assurance that the amounts reserved will be adequate to ultimately make all
required payments.
Legal/Regulatory Risk is the risk that changes in the legal or
regulatory environment in which an insurer operates will occur and create
additional loss costs or expenses not anticipated by the insurer in pricing
its products. That is, regulatory initiatives designed to reduce insurer
profits or new legal theories may create costs for the insurer beyond those
recorded in the financial statements. The CSC Group is exposed to this risk
by writing approximately 40% of its business in Ohio and surrounding
states, thus increasing its exposure to a particular region. This risk is
reduced by underwriting and loss adjusting practices that identify and
minimize the adverse impact of this risk.
Credit Risk is the risk that issuers of securities and mortgagors of
the mortgages owned by the CSC Group will default, or other parties,
including reinsurers that owe the CSC Group money will not pay. The CSC
Group minimize this risk by adhering to a conservative investment strategy,
by maintaining sound reinsurance and credit and collection policies, and by
providing for any amounts deemed uncollectible.
Interest Rate Risk is the risk that interest rates will change and
cause a decrease in the value of an insurer's investments. The CSC Group
mitigates this risk by attempting to match the maturity schedule of its
assets with the expected payouts of its liabilities. To the extent that
liabilities come due more quickly than assets mature, an insurer would have
to sell assets prior to maturity and recognize a gain or loss. Management
believes that the CSC Group's positive cash flow from investment income and
operations will enable the CSC Group to operate without having to recognize
significant losses from the sale of investments that have an unrealized
holding loss as of December 31, 1995.
(c) Basis of Presentation
The consolidated financial statements have been prepared on the basis of
generally accepted accounting principles ("GAAP"). Purchase accounting
adjustments and subsequent amortization of such adjustments (reflecting the
basis in acquired companies and earnings since acquisition) have been recorded
in the accompanying consolidated financial statements. GAAP differs from
statutory accounting practices used by insurance companies in reporting to state
regulatory authorities.
In preparing the consolidated financial statements, management is required
to make certain estimates and assumptions that affect the reported amounts of
assets and liabilities and the disclosures of contingent assets and liabilities
as of the date of the consolidated financial statements and the reported amounts
of revenues and expenses for the reporting period. Actual results could differ
significantly from those estimates.
Material estimates that are particularly susceptible to significant change
in the near-term relate to the determination of losses and loss expenses payable
and the recoverability of deferred policy acquisition costs. In connection with
the determination of losses and loss expenses payable, management uses the
methodology discussed in note 1(h) to estimate the liability. In evaluating the
recoverability of deferred policy acquisition costs, management uses the
methodology discussed in note 1(f).
Management believes that the recorded liability for losses and loss
expenses is adequate. While management uses available information to estimate
losses and loss expenses payable, future changes to the liability may be
necessary based on claims experience and changing claims frequency and severity
conditions. Management also believes that deferred policy acquisition costs are
recoverable; however, future costs that are associated with the business in the
unearned premium liability could exceed management's estimates, causing the
recorded asset to be unrecoverable in whole or in part.
F-38
<PAGE> 39
CENTURY SURETY COMPANY AND SUBSIDIARIES
(A WHOLLY OWNED SUBSIDIARY OF ALLIANCE HOLDING CORPORATION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(d) Investments
The CSC Group account for their investment securities in accordance with
Statement of Financial Accounting Standards No. 115, Accounting for Certain
Investments in Debt and Equity Securities ("SFAS No. 115"). Fixed maturity
securities that the CSC Group have the positive intent and ability to hold to
maturity are classified as held-to-maturity and are stated at amortized cost;
other fixed maturity securities and all equity securities are classified as
available-for-sale and are stated at fair value, with the unrealized gains and
losses, net of deferred income tax, reported as a separate component of
shareholder's equity. The CSC Group has no investment securities classified as
trading. Pursuant to a Financial Accounting Standards Board ("FASB") Special
Report, A Guide to Implementation of Statement 115 on Accounting for Certain
Investments in Debt and Equity Securities, the CSC Group reassessed the
classification of all its investment securities. Effective December 20, 1995,
the CSC Group reclassified some of its held-to-maturity securities to
available-for-sale (see note 2). The CSC Group adopted SFAS No. 115 as of
January 1, 1994, with no effect on net income and an increase to shareholder's
equity of $36,215.
Mortgage loans on real estate are stated at the unpaid principal balance of
such loans. Other investments consist primarily of investments in joint ventures
and are recorded using the equity method. Short-term investments have original
maturities less than one year and are carried at cost which approximates market.
Realized gains and losses on the sale of investments are determined on the
basis of specific security identification and also includes other than temporary
declines. Interest income is recognized on the accrual basis and dividend income
is recognized on the ex-dividend date.
(e) Premium Balances Receivable
Premium balances receivable include amounts due relating to assumed
reinsurance and are stated net of certain commission payable amounts.
(f) Deferred Policy Acquisition Costs
Acquisition costs, consisting of commissions, premium taxes and certain
underwriting expenses that vary with and are primarily related to the production
of business are deferred and amortized ratably over the policy term. The method
followed in computing deferred policy acquisition costs limits the amount of
such deferred costs to their estimated realizable value. In determining
estimated realizable value, the computation gives effect to the premium to be
earned, losses and loss expenses to be incurred, and certain other costs
expected to be incurred as premium is earned. Deferred policy acquisition costs
amortized to expense during the year was $6,612,518, $5,268,596 and $4,996,403
in 1995, 1994 and 1993, respectively.
(g) Furniture and Equipment
Furniture and equipment are recorded at cost, net of accumulated
depreciation. The CSC Group uses an accelerated method of depreciation using the
estimated useful lives of the assets.
(h) Losses and Loss Expenses Payable
The liability for losses is provided based upon: (1) case basis estimates
for losses reported in respect to direct business; (2) estimates of unreported
losses based on estimated loss experience; (3) estimates received and
supplemental amounts provided relating to assumed reinsurance; and (4) deduction
for estimated salvage and subrogation recoverable.
The liability for loss expenses is established by estimating future
expenses to be incurred in settlement of the claims provided for in the
liability for losses.
F-39
<PAGE> 40
CENTURY SURETY COMPANY AND SUBSIDIARIES
(A WHOLLY OWNED SUBSIDIARY OF ALLIANCE HOLDING CORPORATION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The liability for losses and loss expenses is not discounted.
(i) Premium Recognition
Premiums are recognized as revenue in proportion to the insurance coverage
provided, which is generally ratable over the terms of the policies. Unearned
premiums are generally computed on the daily pro rata basis and include amounts
relating to assumed reinsurance.
(j) Reinsurance Ceded
Reinsurance balances are accounted for and reported in the accompanying
consolidated financial statements in accordance with SFAS No. 113, Accounting
and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts.
Reinsurance receivables and prepaid reinsurance premiums are accounted for and
reported separately as assets, net of valuation allowance, rather than being
deducted from the liability for losses and loss expenses payable and unearned
premiums. Amounts recoverable from reinsurers are estimated in a manner
consistent with the claim liability. Contracts not resulting in the reasonable
possibility that the reinsurer may realize a significant loss from the insurance
risk assumed generally do not meet the conditions for reinsurance accounting and
are to be accounted for as deposits.
Reinsurance premiums ceded and reinsurance recoveries on claims incurred
are deducted from the respective revenue and expense accounts.
(k) Federal Income Taxes
CSC and its subsidiaries are members of a consolidated federal income tax
return filed with Alliance and other affiliates. Pursuant to written agreements,
CSC pays to or recovers from the parent the amount of federal income tax
calculated primarily on a separate return basis for itself and its wholly owned
subsidiaries. See note 7(a).
The CSC Group utilizes the asset and liability method of accounting for
income tax. Under the asset and liability method, deferred tax assets and
liabilities are recognized for the future tax consequences attributable to
differences between the financial statement carrying amounts of existing assets
and liabilities and their respective tax bases. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to taxable
income in the years in which those temporary differences are expected to be
recovered or settled.
(l) Negative Goodwill
CSC was acquired by Alliance in July 1988 for $3.8 million. The fair value
of CSC's net assets in excess of the purchase price was recorded as negative
goodwill upon acquisition. During 1992, based on the ongoing favorable
evaluation of pre-1988 accident year loss development, which was the basis for
establishing negative goodwill as a result of the acquisition of CSC by Alliance
in 1988, CSC began amortizing negative goodwill over five years. Previously, it
was amortized over seven years. The balance of negative goodwill was fully
amortized in 1993.
(m) Statements of Cash Flows
For purposes of the consolidated statements of cash flows, cash includes
only funds on deposit.
(n) Reclassifications
Certain 1994 and 1993 amounts have been reclassified in the accompanying
consolidated financial statements to conform to 1995 presentation.
F-40
<PAGE> 41
CENTURY SURETY COMPANY AND SUBSIDIARIES
(A WHOLLY OWNED SUBSIDIARY OF ALLIANCE HOLDING CORPORATION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
2. INVESTMENTS
The amortized cost and estimated fair value of fixed maturities held to
maturity at December 31, 1995 were as follows:
<TABLE>
<CAPTION>
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED ESTIMATED
COST GAINS LOSSES FAIR VALUE
----------- -------- -------- -----------
<S> <C> <C> <C> <C>
U.S. Treasury securities and
obligations of U.S. government
corporations and agencies....... $ 6,158,571 $ 81,613 $ (9,220) $ 6,230,964
Obligations of states and
political subdivisions.......... -- -- -- --
Corporate securities.............. 8,654,067 27,177 (61,971) 8,619,273
Mortgage-backed securities........ 495,767 18,374 -- 514,141
----------- -------- -------- -----------
Totals.................. $15,308,405 $127,164 $(71,191) $15,364,378
=========== ======== ======== ===========
</TABLE>
The amortized cost and estimated fair value of securities available for
sale at December 31, 1995 were as follows:
<TABLE>
<CAPTION>
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED ESTIMATED
COST GAINS LOSSES FAIR VALUE
----------- ---------- --------- -----------
<S> <C> <C> <C> <C>
Fixed Maturities:
U.S. Treasury securities and
obligations of U.S.
government corporations and
agencies................... $ 6,521,211 $ 303,462 $ (7,259) $ 6,817,414
Obligations of states and
political subdivisions..... 8,338,751 167,418 (2,622) 8,503,547
Corporate securities.......... 14,990,440 438,598 (14,706) 15,414,332
Mortgage-backed securities.... 2,243,832 174,071 -- 2,417,903
----------- ---------- --------- -----------
32,094,234 1,083,549 (24,587) 33,153,196
Equity securities............... 1,999,419 3,588,843 (162,449) 5,425,813
----------- ---------- --------- -----------
$34,093,653 $4,672,392 $(187,036) $38,579,009
=========== ========== ========= ===========
</TABLE>
As discussed in note 1, on December 20, 1995, the CSC Group reclassified a
portion of their held-to-maturity securities to available-for-sale. The
amortized cost and estimated fair value of the securities reclassified were
$5,732,555 and $5,896,586, respectively, as of the date of reclassification.
F-41
<PAGE> 42
CENTURY SURETY COMPANY AND SUBSIDIARIES
(A WHOLLY OWNED SUBSIDIARY OF ALLIANCE HOLDING CORPORATION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The amortized cost and estimated fair value of fixed maturities held to
maturity at December 31, 1994 were as follows:
<TABLE>
<CAPTION>
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED ESTIMATED
COST GAINS LOSSES FAIR VALUE
----------- ---------- ----------- -----------
<S> <C> <C> <C> <C>
U.S. Treasury securities and
obligations of U.S. government
corporations and agencies..... $ 7,224,706 $ 102 $ (529,219) $ 6,695,589
Obligations of states and
political subdivisions........ 428,042 1,563 (18,870) 410,735
Corporate securities............ 11,331,932 67 (968,126) 10,363,873
Mortgage-backed securities...... 1,144,673 378 (32,454) 1,112,597
----------- ------ ----------- -----------
Totals................ $20,129,353 $2,110 $(1,548,669) $18,582,794
=========== ====== =========== ===========
</TABLE>
The amortized cost and estimated fair value of securities available for
sale at December 31, 1994 were as follows:
<TABLE>
<CAPTION>
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED ESTIMATED
COST GAINS LOSSES FAIR VALUE
----------- ---------- ----------- -----------
<S> <C> <C> <C> <C>
Fixed maturities:
U.S. Treasury securities and
obligations of U.S.
government corporations and
agencies................... $ 5,130,375 $ -- $ (301,201) $ 4,829,174
Obligations of states and
political subdivisions..... 11,832,402 -- (613,214) 11,219,188
Corporate securities.......... 4,513,507 65,917 (245,972) 4,333,452
Mortgage-backed securities.... 4,496,953 175,794 (169,770) 4,502,977
----------- -------- ----------- -----------
25,973,237 241,711 (1,330,157) 24,884,791
Equity securities............... 1,920,745 71,248 (227,472) 1,764,521
----------- -------- ----------- -----------
$27,893,982 $ 312,959 $(1,557,629) $26,649,312
=========== ======== =========== ===========
</TABLE>
Expected maturities will differ from contractual maturities because the
issuers may have the right to call or prepay obligations with or without call or
prepayment penalties. The amortized cost and estimated fair value of fixed
maturities held to maturity at December 31, 1995, by contractual maturity, are
as follows:
<TABLE>
<CAPTION>
ESTIMATED
AMORTIZED FAIR
COST VALUE
----------- -----------
<S> <C> <C>
Due in one year or less................................... $ 998,570 $ 992,660
Due after one year through five years..................... 13,381,257 13,401,253
Due after five years through ten years.................... 356,904 362,023
Due after ten years....................................... 75,907 94,301
----------- -----------
14,812,638 14,850,237
Mortgage-backed securities................................ 495,767 514,141
----------- -----------
$15,308,405 $15,364,378
=========== ===========
</TABLE>
F-42
<PAGE> 43
CENTURY SURETY COMPANY AND SUBSIDIARIES
(A WHOLLY OWNED SUBSIDIARY OF ALLIANCE HOLDING CORPORATION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The amortized cost and estimated fair value of fixed maturities available
for sale at December 31, 1995, by contractual maturity, are as follows:
<TABLE>
<CAPTION>
AMORTIZED ESTIMATED
COST FAIR VALUE
----------- -----------
<S> <C> <C>
Due in one year or less................................... $ 594,403 $ 600,126
Due after one year through five years..................... 20,419,624 20,859,785
Due after five years through ten years.................... 8,737,162 9,152,241
Due after ten years....................................... 99,213 123,141
----------- -----------
29,850,402 30,735,293
Mortgage-backed securities................................ 2,243,832 2,417,903
----------- -----------
$32,094,234 $33,153,196
=========== ===========
</TABLE>
Net investment income was comprised of the following for the years ended
December 31:
<TABLE>
<CAPTION>
1995 1994 1993
---------- ---------- ----------
<S> <C> <C> <C>
Interest....................................... $3,454,757 $2,588,580 $1,415,610
Dividends...................................... 96,457 95,753 59,005
---------- ---------- ----------
Total investment income.............. 3,551,214 2,684,333 1,474,615
Less investment expenses....................... 210,258 206,905 97,699
---------- ---------- ----------
Net investment income................ $3,340,956 $2,477,428 $1,376,916
========== ========== ==========
</TABLE>
Realized gains and losses on investments are as follows for the years ended
December 31:
<TABLE>
<CAPTION>
1995 1994 1993
-------- -------- --------
<S> <C> <C> <C>
Realized gains:
Fixed maturities:
Held to maturity................................ $ -- $ -- $ 24,926
Available for sale.............................. 114,227 -- --
Equity securities.................................. 8,676 145,815 144,556
Other.............................................. 72,989 -- --
-------- -------- --------
Total realized gains....................... 195,892 145,815 169,482
-------- -------- --------
Realized losses:
Fixed maturities:
Held to maturity................................ -- -- --
Available for sale.............................. 27,037 42,166 --
Equity securities.................................. 2,569 23,694 260,654
Other.............................................. -- -- 278
-------- -------- --------
Total realized losses...................... 29,606 65,860 260,932
-------- -------- --------
Net realized gains (losses) on
investments.............................. $166,286 $ 79,955 $(91,450)
======== ======== ========
</TABLE>
F-43
<PAGE> 44
CENTURY SURETY COMPANY AND SUBSIDIARIES
(A WHOLLY OWNED SUBSIDIARY OF ALLIANCE HOLDING CORPORATION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The change in net unrealized appreciation (depreciation) of investments is
summarized as follows:
<TABLE>
<CAPTION>
1995 1994 1993
---------- ----------- --------
<S> <C> <C> <C>
Available for sale:
Fixed maturities............................... $1,788,673 $(1,088,446) $ --
Equity securities.............................. 3,582,618 (76,085) (63,201)
--------- ----------- --------
$5,371,291 $(1,164,531) $(63,201)
========== =========== ========
Held to maturity -- fixed maturities............. $1,602,532 $(1,808,104) $ 44,555
========== =========== ========
</TABLE>
The components of unrealized appreciation (depreciation) on securities
available for sale, net, were as follows at December 31:
<TABLE>
<CAPTION>
1995 1994 1993
----------- ----------- --------
<S> <C> <C> <C>
Gross unrealized appreciation (depreciation).... $ 4,485,356 $(1,208,641) $(80,139)
Deferred federal income tax..................... (1,219,806) -- --
----------- ----------- --------
Net unrealized appreciation (depreciation).... $ 3,265,550 $(1,208,641) $(80,139)
=========== =========== ========
</TABLE>
Fixed maturities held to maturity and certificates of deposit with a
carrying value of approximately $8,909,000 and $8,068,000 at December 31, 1995
and 1994, respectively, were on deposit with regulatory authorities as required
by law.
Approximately $21,173 and $60,282 of fixed maturities and short-term
investments at December 31, 1995 and 1994, respectively, were held in trust
accounts under provisions of various reinsurance contracts.
At December 31, 1995 and 1994, all mortgage loans were secured by
properties in the states of California, Michigan and Ohio.
3. DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used by the CSC Group in
estimating its fair value disclosures for financial instruments:
Cash, short-term investments, premium balances receivable, reinsurance
receivables, reinsurance balances payable and collateral held: The carrying
amounts reported in the consolidated balance sheets for these instruments
approximate their fair value.
Investment securities: Fair values for investments in fixed maturities
are based on quoted market prices, where available. For fixed maturities
not actively traded, fair values are estimated using values obtained from
independent pricing services. The fair values for equity securities are
based on quoted market prices. Fair values for fixed maturities available
for sale and equity securities are recognized in the consolidated balance
sheets.
Mortgage loans: The carrying amounts reported in the consolidated
balance sheets are the aggregate unpaid balance of the loans and
approximate their fair value.
See note 2 for additional disclosure of fair value of investment
securities.
F-44
<PAGE> 45
CENTURY SURETY COMPANY AND SUBSIDIARIES
(A WHOLLY OWNED SUBSIDIARY OF ALLIANCE HOLDING CORPORATION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
4. LIABILITY FOR UNPAID LOSSES AND LOSS EXPENSES
Activity in the liability for unpaid losses and loss expenses is summarized
as follows (in thousands):
<TABLE>
<CAPTION>
1995 1994 1993
------- ------- -------
<S> <C> <C> <C>
Balance at January 1.................................. $34,661 $29,528 $18,908
Less reinsurance recoverables....................... 9,383 8,505 4,801
------- ------- -------
Net balance at January 1.............................. 25,278 21,023 14,107
------- ------- -------
Incurred related to:
Current year........................................ 17,297 14,753 10,060
Prior years......................................... (2,180) (2,259) (1,447)
------- ------- -------
Total incurred.............................. 15,117 12,494 8,613
------- ------- -------
Paid related to:
Current year........................................ 5,963 4,269 2,823
Prior years......................................... 6,344 3,970 3,054
------- ------- -------
Total paid.................................. 12,307 8,239 5,877
------- ------- -------
Reserves assumed through purchase of Evergreen (notes
7 and 9)............................................ -- -- 4,180
------- ------- -------
Net balance at December 31............................ 28,088 25,278 21,023
Plus reinsurance recoverables....................... 8,914 9,383 8,505
------- ------- -------
Balance at December 31................................ $37,002 $34,661 $29,528
======= ======= =======
</TABLE>
The CSC Group has experienced lower-than-anticipated ultimate losses on
prior years due primarily to a reduction in claims severity from that assumed in
establishing the liability for losses and loss expenses payable. The CSC Group's
environmental exposure relates primarily to its coverage of remediation related
risks (i.e., those firms correcting environmental problems as opposed to those
entities causing such damage); thus, management believes the CSC Group's
exposure to historic pollution situations is minimal.
5. REINSURANCE
In the ordinary course of business, the CSC Group assumes and cedes
reinsurance with other insurers and reinsurers. These arrangements provide the
CSC Group with a greater diversification of business and generally limit the
maximum net loss potential on large risks. Excess of loss reinsurance contracts
in effect at December 31, 1995, generally protect against individual property
and casualty losses over $200,000 and contract surety and miscellaneous bond
losses over $300,000. In addition to the excess of loss contract in effect for
contract surety business, a 50% quota share contract on the first $300,000 in
losses is in effect. Asbestos abatement, lead abatement, and environmental
consultants professional liability and remedial action contractors business is
75% ceded on a quota share basis to reinsurers. Catastrophe coverage is also
maintained.
F-45
<PAGE> 46
CENTURY SURETY COMPANY AND SUBSIDIARIES
(A WHOLLY OWNED SUBSIDIARY OF ALLIANCE HOLDING CORPORATION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The impact of reinsurance on the accompanying consolidated statements of
income is as follows (in thousands):
<TABLE>
<CAPTION>
1995 1994 1993
-------- -------- --------
<S> <C> <C> <C>
Written premiums:
Direct................................. $ 36,278 $ 37,127 $ 29,817
Assumed................................ 1,417 742 175
Ceded.................................. (11,018) (10,650) (8,819)
-------- -------- --------
Net............................ $ 26,677 $ 27,219 $ 21,173
======== ======== ========
Earned premiums:
Direct................................. $ 35,750 $ 34,255 $ 25,019
Assumed................................ 1,754 416 184
Ceded.................................. (10,543) (11,303) (7,830)
-------- -------- --------
Net............................ $ 26,961 $ 23,368 $ 17,373
======== ======== ========
Losses and loss expenses incurred:
Direct................................. $ 15,959 $ 15,088 11,932
Assumed................................ -- (65) 62
Ceded.................................. (842) (2,529) (3,381)
-------- -------- --------
Net............................ $ 15,117 $ 12,494 $ 8,613
======== ======== ========
</TABLE>
In the accompanying consolidated balance sheets, ceded premium balances
receivable are recorded as reinsurance balances payable, ceded losses and loss
expenses payable are recorded as reinsurance receivables and ceded unearned
premiums are recorded as prepaid reinsurance premiums.
Reinsurance receivables were comprised of the following as of December 31:
<TABLE>
<CAPTION>
1995 1994
----------- -----------
<S> <C> <C>
Receivables on unpaid losses and loss expenses... $ 8,914,440 $ 9,383,119
Receivables on ceding commissions and other...... 2,892,344 1,026,471
Receivables on paid losses and loss expenses..... 840,176 478,067
----------- -----------
$12,646,960 $10,887,657
=========== ===========
</TABLE>
The CSC Group evaluates the financial condition of its reinsurers and
monitors concentrations of credit risk arising from similar geographic regions,
activities, or economic characteristics of the reinsurers to minimize its
exposure to significant losses from reinsurer insolvencies. The CSC Group
establishes a valuation allowance as reinsurance receivables are deemed
uncollectible. During 1995, the majority of ceded amounts were ceded to Reliance
Insurance Company, Republic Western Insurance Company ("Republic Western") and
Transatlantic Insurance Company, all of which are rated A- or better by A.M.
Best.
6. FEDERAL INCOME TAXES
The CSC Group adopted SFAS No. 109 as of January 1, 1993. The cumulative
effect of this change in accounting for federal income taxes as of January 1,
1993 was not material to the 1993 consolidated statement of income.
F-46
<PAGE> 47
CENTURY SURETY COMPANY AND SUBSIDIARIES
(A WHOLLY OWNED SUBSIDIARY OF ALLIANCE HOLDING CORPORATION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The federal income tax expense is different from the amount computed by
applying the normal tax rate of 34% to income before federal income taxes as
follows:
<TABLE>
<CAPTION>
1995 1994 1993
---------- ---------- ----------
<S> <C> <C> <C>
Expected tax........................... $1,557,654 $1,382,282 $1,143,203
Increase (decrease) in income taxes
resulting from:
Tax exempt interest and dividends
received deduction................ (106,197) (122,921) (30,891)
Nontaxable income on American
Sentinel transaction.............. -- (274,484) --
Amortization of negative goodwill.... -- -- (74,526)
Other, net........................... (137,054) 93,391 106,364
---------- ---------- ----------
$1,314,403 $1,078,268 $1,144,150
========== ========== ==========
</TABLE>
Several provisions of the Internal Revenue Code affect only property and
casualty insurers. The major provisions are discounting of losses and loss
expenses payable and a reduction in the allowable deduction for unearned
premiums.
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and liabilities at December 31, 1995 and
1994 are presented below:
<TABLE>
<CAPTION>
1995 1994
----------- -----------
<S> <C> <C>
Deferred tax assets:
Unearned premiums not deductible.............. $ 1,063,278 $ 855,933
Losses and loss expenses payable
discounting................................ 1,957,482 1,477,385
Unrealized depreciation on investments........ -- 410,938
Deferred compensation......................... 96,244 87,075
Other deferred tax assets..................... 46,830 33,231
----------- -----------
Gross deferred tax assets............. 3,163,834 2,864,562
Less valuation allowance...................... (733,441) (902,124)
----------- -----------
Deferred tax assets................... 2,430,393 1,962,438
----------- -----------
Deferred tax liabilities:
Deferred policy acquisition costs............. (1,165,367) (1,235,566)
Unrealized appreciation on investments........ (1,219,806) --
Ceding commissions receivable................. -- (206,060)
Salvage and subrogation recoverable........... (98,557) (53,132)
----------- -----------
Gross deferred tax liabilities........ (2,483,730) (1,494,758)
----------- -----------
Net deferred tax (liability) asset.... $ (53,337) $ 467,680
=========== ===========
</TABLE>
The CSC Group determines a valuation allowance based on their analysis of
amounts available in the statutory carryback period and consideration of future
deductible amounts. The valuation allowance for deferred tax assets as of
January 1, 1994 was $467,549. The net change in the total valuation allowance
for the years ended December 31, 1995 and 1994 was a decrease of $168,683 and an
increase of $434,575, respectively. Although the CSC Group has had a taxable
income over the last several years, significant income in some instances has
been attributable to non-recurring transactions and thus there is no assurance
that the CSC Group will remain profitable in future years. Therefore, the CSC
Group maintains a policy of
F-47
<PAGE> 48
CENTURY SURETY COMPANY AND SUBSIDIARIES
(A WHOLLY OWNED SUBSIDIARY OF ALLIANCE HOLDING CORPORATION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
recognizing deferred tax assets recoverable in the carryback period and does not
consider future income. Management believes it is more likely than not that as
of December 31, 1995, future deductible amounts in excess of the valuation
allowance can be offset by recovery of federal income taxes paid within the
statutory carryback period.
7. TRANSACTIONS WITH AFFILIATED COMPANIES
(a) Alliance
CSC received a tax benefit of $595,000 and $340,000 in 1995 and 1994,
respectively, from a tax allocation agreement with Alliance for dividends paid
to Alliance. The resultant reduction in CSC's tax payable is recorded as
additional paid-in capital in the accompanying consolidated financial
statements.
In December 1994, CSC received a noncash capital contribution of $3,167,000
from Alliance in connection with the American Sentinel Insurance Company
("American Sentinel") transaction. See notes 9 and 10.
In 1994, Alliance contributed to CSC a $300,000 participation in a mortgage
loan to an affiliate.
As discussed in note 9, CSC acquired all of the outstanding shares of
Evergreen on December 31, 1993, the majority of which was through a capital
contribution from Alliance. Evergreen was formerly known as Summit Fidelity and
Surety Company. Evergreen is an Ohio domiciled property and casualty insurance
company.
CSC has issued six $500,000 bonds covering certain loans obtained by My
Lawyer Plan, Inc., an unrelated party, from the Detroit Fireman and Policeman's
Pension Fund maturing from 1996 and 2002. Collateral for these bonds includes
the personal indemnification of an indirect shareholder of Alliance.
(b) Commercial Surety Agency, Incorporated ("CSU")
CSU does business under the tradename Century Surety Underwriters. CSC paid
CSU $1,815,229, $2,606,719 and $1,854,000 in commission through an agency
agreement in 1995, 1994 and 1993, respectively. That agreement generally
provides CSU a provisional commission of 42%, with certain potential profit
commissions as defined in the agreement. CSU is a wholly owned subsidiary of
Alliance.
At December 31, 1995 and 1994, CSC had outstanding premium balances
receivable from CSU of $613,402 and $496,341, respectively.
Effective April 1, 1994, Evergreen entered into an underwriting service
agreement with CSU, through which CSU is authorized to act on behalf of
Evergreen in performing various financial underwriting services. Evergreen paid
CSU $600,000 and $337,500 in fees under this agreement in 1995 and 1994,
respectively.
(c) COP, Incorporated ("COP")
COP handles the majority of surety claims and provides certain underwriting
services. An officer of COP serves as a director and officer of CSC.
CSC is charged by COP on a claim services performed basis. CSC paid COP
$180,839, $171,886 and $121,892 in fees during 1995, 1994 and 1993,
respectively.
(d) Mortgage Loans
Loans secured by a first mortgage on real estate with interest rates
ranging from 9% to 10% aggregating $1,616,000 were outstanding to related and
affiliated parties at December 31, 1995 and 1994. The mortgage
F-48
<PAGE> 49
CENTURY SURETY COMPANY AND SUBSIDIARIES
(A WHOLLY OWNED SUBSIDIARY OF ALLIANCE HOLDING CORPORATION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
loans are structured as interest only paid quarterly until May 1 and June 30,
1997 at which time the principal balance will be paid in full.
(e) Environmental and Commercial Insurance Agency, Inc. ("ECI")
CSC paid ECI $942,150, $1,337,267 and $1,127,140 in commission through an
agency agreement in 1995, 1994 and 1993, respectively. That agreement provides
ECI a provisional commission of 21% to 22%, with certain potential profit
commissions as defined in the agreement. ECI is owned by immediate family
members of certain directors and an officer of CSC.
At December 31, 1995 and 1994, CSC had outstanding premium balances
receivable from ECI in the amount of $441,231 and $559,477, respectively.
8. STATUTORY SHAREHOLDER'S EQUITY AND DIVIDEND RESTRICTION
Ohio law limits the payment of dividends to the parent. The maximum
dividend that may be paid without prior approval of the Director of Insurance is
limited to the greater of the statutory net income of the preceding calendar
year or 10% of total statutory shareholder's equity as of the prior December 31.
As a result, the maximum dividend CSC may pay to Alliance in 1996 without prior
approval is approximately $2,200,000.
Dividends paid in 1995, 1994 and 1993 totaled $5,350,000 ($26,750 per
share), $1,000,000 ($5,000 per share) and $840,000 ($4,200 per share),
respectively. CSC obtained the approval of the Ohio Director of Insurance for
extraordinary dividends paid in 1995.
Reconciliations of CSC's statutory net income and capital and surplus, as
determined in accordance with statutory accounting principles, to the amounts
included in the accompanying consolidated financial statements are as follows:
The consolidated financial statements have been prepared in accordance with
GAAP. Annual statements for CSC and Evergreen, and CHIC, filed with the Ohio
Department of Insurance and the Utah Department of Insurance, respectively, are
prepared on the basis of accounting practices prescribed or permitted by such
regulatory authorities. Prescribed statutory accounting practices include a
variety of publications of the National Association of Insurance Commissioners
("NAIC"), as well as state laws, regulations and general administrative rules.
Permitted statutory accounting practices encompass all accounting practices not
prescribed.
F-49
<PAGE> 50
CENTURY SURETY COMPANY AND SUBSIDIARIES
(A WHOLLY OWNED SUBSIDIARY OF ALLIANCE HOLDING CORPORATION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following reconciles the statutory net income of CSC as reported to
regulatory authorities to the net income as shown in the accompanying
consolidated financial statements:
<TABLE>
<CAPTION>
1995 1994 1993
---------- ---------- ----------
<S> <C> <C> <C>
Statutory net income........................... $3,681,236 $1,804,052 $1,230,102
Adjustments to restate to the basis of GAAP:
Statutory net income of subsidiaries......... 445,627 (881,070) (4,381)
Increase (decrease) in deferred policy
acquisition costs......................... (298,060) 1,319,776 728,628
Deferred federal income tax (expense)
benefit................................... 698,789 (55,621) 90,333
Income on American Sentinel transaction...... -- 807,306 --
Amortization of negative goodwill............ -- -- 219,194
Current federal income tax expense........... (595,000) (350,000) (285,600)
Ceding commissions receivable................ (606,060) 212,121 325,757
Other, net................................... (59,601) 130,702 (85,820)
---------- ---------- ----------
Net income per accompanying consolidated
statements of income......................... $3,266,931 $2,987,266 $2,218,213
========== ========== ==========
</TABLE>
The following reconciles the statutory capital shares and surplus of CSC as
reported to regulatory authorities to the shareholder's equity as shown in the
accompanying consolidated financial statements:
<TABLE>
<CAPTION>
1995 1994 1993
----------- ----------- -----------
<S> <C> <C> <C>
Statutory capital and surplus............... $22,033,530 $20,122,740 $15,398,670
Add (deduct) cumulative effect of
adjustments:
Deferred policy acquisition costs......... 3,427,551 3,725,611 2,405,835
Deferred federal income tax............... (53,337) 467,680 523,301
Difference between amortized cost and fair
value of fixed maturity securities
available-for-sale, gross.............. 1,058,962 (1,088,446) (80,139)
Ceding commissions receivable............. -- 400,000 260,000
Nonadmitted assets........................ 431,158 345,121 239,363
Other, net................................ (154,110) (215,074) 344,838
----------- ----------- -----------
Shareholder's equity per accompanying
consolidated financial statements......... $26,743,754 $23,757,632 $19,091,868
=========== =========== ===========
</TABLE>
9. SUPPLEMENTAL CASH FLOW DISCLOSURES
On December 9, 1994, Evergreen, along with Alliance, entered into a
transaction with Sentinel Holdings, Inc. ("SHI") (a wholly owned subsidiary of
Pace American Group, Inc. ["Pace"]), American Sentinel (a wholly owned
subsidiary of SHI) and Republic Western, all unrelated parties. The result of
this transaction was the sale of all of American Sentinel's insurance operations
to Republic Western, settlement of Pace debt collateralized by American Sentinel
common stock, and Evergreen obtaining an agreed-upon amount of net assets of
American Sentinel. Evergreen recognized income of $807,306 related to their
participation in the transaction in the 1994 consolidated statement of income.
In conjunction with the American Sentinel transaction, Evergreen
participated in structuring the agreements and received fair value net assets of
American Sentinel totaling $6,091,306, comprised of highly liquid assets of
$6,227,201 and nonpolicy liabilities (not assumed by Republic Western) of
$185,895.
F-50
<PAGE> 51
CENTURY SURETY COMPANY AND SUBSIDIARIES
(A WHOLLY OWNED SUBSIDIARY OF ALLIANCE HOLDING CORPORATION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Additionally, Evergreen paid $5,284,000, primarily in settlement of Pace debt
collateralized by American Sentinel common stock, comprised of cash payments of
$1,550,000, Pace common stock previously owned by Evergreen of $500,000, and
debt incurred by Alliance of $3,167,000, plus $67,000 of acquisition costs. The
debt incurred by Alliance was recorded as a noncash capital contribution to
Evergreen in 1994 and was satisfied by Alliance as of December 31, 1995. As of
December 31, 1994, American Sentinel no longer exists as a separate corporate
entity. As discussed further in note 10, neither Evergreen nor other members of
the Alliance Companies have any future obligations with respect to the American
Sentinel insurance operations under the terms of the American Sentinel
transaction agreements.
On December 31, 1993, CSC acquired all of the outstanding shares of
Evergreen (see notes 1[b] and 7[a]) for a cash payment of $1,515,060
($1,610,000, net of $94,940 acquired from Evergreen). As part of this
transaction, CSC also received a noncash capital contribution from Alliance in
1993 of $3,859,836 as a result of Alliance's acquiring, in connection with CSC's
acquisition of Evergreen, certain Hampton Court Holdings, Inc. (Evergreen's
former parent) debt for which Evergreen shares had been pledged as collateral.
However, CSC and its subsidiaries are not a party to that debt or obligated to
service that debt, nor is the common stock of CSC or any of its subsidiaries
pledged as collateral for that debt.
10. COMMITMENTS AND CONTINGENCIES
In 1993, CSC entered into various agreements to lease office space from
unrelated parties. The minimum future rental payments under these leases at
December 31, 1995 were as follows:
<TABLE>
<S> <C>
1996.............................................. $264,398
1997.............................................. 264,398
1998.............................................. 220,330
--------
$749,126
========
</TABLE>
United States Warranty Corporation ("USWC"), CHIC's former parent, enters
into agreements with various automobile and recreational vehicle dealers
("Dealers") whereby USWC agrees to administer the service contract agreements
issued by the Dealers to consumers. Prior to October 9, 1994, CHIC was
contingently liable should the Dealers and USWC become unable to meet their
obligations to the consumers under the service agreements. During 1994,
Evergreen replaced CHIC as the contingently liable party for Dealer service
contract agreements issued on or prior to October 9, 1994. The CSC Group's
management has estimated the Dealers' liability to range from $310,000 to
$510,000 at December 31, 1995. In the opinion of the CSC Group's management, the
effect to the CSC Group, if any, of ultimate settlement of such Dealers' service
contract agreements are not expected to be material to the CSC Group's
consolidated results of operations or financial position.
Various companies of the CSC Group are defendants in various lawsuits. In
the opinion of management, the effects, if any, of such lawsuits are not
expected to be material to the CSC Group's consolidated results of operations or
financial position.
The terms of the American Sentinel transaction agreements (see note 9)
include a contingent receivable by Evergreen from Republic Western of up to $2.9
million and a contingent note payable by Alliance to SHI, not to exceed $1.45
million. Each of these contingencies relate to the future development of
American Sentinel business acquired by Republic Western as part of the
transaction agreements and are to be settled in December 1996. The amount of the
$2.9 million receivable by Evergreen may be adjusted downward according to the
terms of the agreement, primarily in reference to development of losses of the
American Sentinel block of business acquired by Republic Western. The contingent
note payable is reduced dollar for dollar to the extent that less than $2.9
million is ultimately received by Evergreen from Republic Western. As
F-51
<PAGE> 52
CENTURY SURETY COMPANY AND SUBSIDIARIES
(A WHOLLY OWNED SUBSIDIARY OF ALLIANCE HOLDING CORPORATION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
of December 31, 1995, CSC has not accrued any amounts related to these
contingent items in the accompanying consolidated financial statements due to
the uncertainty related to the future development of losses of the American
Sentinel block of business by Republic Western.
11. RISK-BASED CAPITAL
In December 1993, the NAIC adopted the property and casualty Risk-Based
Capital ("RBC") formula. This model act requires every property and casualty
insurer to calculate its total adjusted capital and RBC requirement, and
provides for an insurance commissioner to intervene if the insurer experiences
financial difficulty. The model act became law in Ohio, Century's and
Evergreen's state of domicile, in March 1996, and in Utah, CHIC's state of
domicile, in April 1996. The formula includes components for asset risk,
liability risk, interest rate exposure and other factors. Based on their
December 31, 1995 and 1994 statutory financial statements, CSC, Evergreen and
CHIC exceed all required RBC levels.
12. SUBSEQUENT EVENT
On May 19, 1996 Alliance and Republic Environmental Systems, Inc. ("RESI")
signed a binding letter of intent and agreed to the terms of mergers (the
"Mergers") pursuant to which Alliance would receive (i) 14,760,000 shares of
RESI's common stock, par value $0.01 per share ("RESI Common Stock"), (ii)
warrants to acquire an additional 4,200,000 shares of RESI Common Stock at
exercise prices ranging from $2.625 to $3.875 per share and exercisable over two
to four year periods, and (iii) a promissory note in the principal amount of
$4.0 million in consideration for all of the outstanding common stock of
Alliance's wholly-owned subsidiaries, CSC and CSU.
F-52
<PAGE> 53
CENTURY SURETY COMPANY AND SUBSIDIARIES
SCHEDULE I -- SUMMARY OF INVESTMENTS -- OTHER THAN
INVESTMENTS IN RELATED PARTIES
DECEMBER 31, 1995
<TABLE>
<CAPTION>
COLUMN B COLUMN C COLUMN D
---------- ----------- -------------
AMOUNT AT
COLUMN A WHICH SHOWN
- ------------------------------------------------------ IN THE
TYPE OF INVESTMENT COST VALUE BALANCE SHEET
- ------------------------------------------------------ ----------- ----------- -------------
<S> <C> <C> <C>
Fixed maturities -- held to maturity:
Bonds:
U.S. government and government agencies and
authorities.................................... $ 6,158,571 $ 6,230,964 $ 6,158,571
States, municipalities and political
subdivisions................................... -- -- --
Corporate securities............................. 8,654,067 8,619,273 8,654,067
Mortgage-backed securities....................... 495,767 514,141 495,767
Fixed maturities -- available for sale:
Bonds:
U.S. government and government agencies and
authorities.................................... 6,521,211 6,817,414 6,817,414
States, municipalities and political
subdivisions................................... 8,338,751 8,503,547 8,503,547
Corporate securities............................. 14,990,440 15,414,332 15,414,332
Mortgage-backed securities....................... 2,243,832 2,417,903 2,417,903
----------- ----------- -----------
Total fixed maturities...................... 47,402,639 48,517,574 48,461,601
----------- ----------- -----------
Equity securities:
Common stock:
Public utilities................................. 322,085 339,812 339,812
Banks, trust and insurance companies............. 430,036 3,917,827 3,917,827
Industrial, miscellaneous and all other.......... 465,185 375,177 375,177
Nonredeemable preferred stocks...................... 782,113 792,997 792,997
----------- ----------- -----------
Total equity securities..................... 1,999,419 5,425,813 5,425,813
----------- ----------- -----------
Mortgage loans on real estate......................... 3,393,205 3,393,205
Other investments..................................... 90,267 90,267
Short-term investments................................ 843,095 843,095
----------- -----------
Total investments........................... $53,728,625 $ 58,213,981
=========== ===========
</TABLE>
F-53
<PAGE> 54
CENTURY SURETY COMPANY AND SUBSIDIARIES
SCHEDULE IV -- REINSURANCE
YEARS ENDED DECEMBER 31, 1995, 1994, AND 1993
(IN THOUSANDS)
<TABLE>
<CAPTION>
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E COLUMN F
- ------------------------------------- ----------------------- ----------------------- -------- ----------
CEDED TO ASSUMED FROM PERCENTAGE
----------------------- ----------------------- OF AMOUNT
GROUP OUTSIDE AFFILIATED OUTSIDE AFFILIATED NET ASSUMED
AMOUNT COMPANIES COMPANIES(1) COMPANIES COMPANIES(1) AMOUNT TO NET
-------- --------- ------------ --------- ------------ -------- ----------
<S> <C> <C> <C> <C> <C> <C> <C>
Year ended December 31, 1995
Property -- Casualty Earned
Premiums................. $35,750 $10,543 -- $ 1,754 -- $26,961 6.51%
Year ended December 31, 1994
Property -- Casualty Earned
Premiums................. $34,255 $11,303 -- $ 416 -- $23,368 1.78%
Year ended December 31, 1993
Property -- Casualty Earned
Premiums................. $25,019 $ 7,830 -- $ 184 -- $17,373 1.06%
</TABLE>
- ---------------
(1) Information is presented in a consolidated basis, therefore, effects of
intercompany pooling are eliminated.
F-54
<PAGE> 55
CENTURY SURETY COMPANY AND SUBSIDIARIES
SCHEDULE VI -- SUPPLEMENTAL INFORMATION CONCERNING
PROPERTY-CASUALTY INSURANCE OPERATIONS
YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993
<TABLE>
<CAPTION>
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E COLUMN F COLUMN G
- ---------- ----------- ----------- ----------- --------- --------- ----------
DEFERRED LOSSES DISCOUNT,
POLICY AND LOSS IF ANY, NET
ACQUISITION ADJUSTMENT DEDUCTED IN UNEARNED EARNED INVESTMENT
SEGMENT COST PAYABLE COLUMN C PREMIUMS PREMIUMS INCOME
- ---------- ----------- ---------- ----------- -------- -------- ----------
<S> <C> <C> <C> <C> <C> <C>
Year
Ended:
December 31, 1995.............. $3,427,551 $37,001,841 N/A $15,636,442 $26,961,397 $3,340,956
December 31, 1994.............. $3,725,611 $34,661,007 N/A $15,453,487 $23,367,623 $2,477,428
December 31, 1993.............. $2,405,835 $29,527,805 N/A $12,166,463 $17,372,598 $1,376,916
</TABLE>
<TABLE>
<CAPTION>
COLUMN H COLUMN I COLUMN J COLUMN K
-------------------------------- ----------------- -------------- --------------
LOSSES AND LOSS
EXPENSES INCURRED
RELATED TO AMORTIZATION PAID LOSSES DIRECT
-------------------------------- OF AND LOSS PREMIUMS
CURRENT YEAR PRIOR YEAR ACQUISITION COSTS EXPENSES WRITTEN
-------------- -------------- ----------------- -------------- --------------
(IN THOUSANDS) (IN THOUSANDS) (IN THOUSANDS) (IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Year Ended:
December 31, 1995............... $ 17,297 $ (2,180) $6,612,518 $ 12,307 $ 36,278
December 31, 1994............... $ 14,753 $ (2,259) $5,268,596 $ 8,239 $ 37,127
December 31, 1993............... $ 10,060 $ (1,447) $4,996,403 $ 5,877 $ 29,817
</TABLE>
F-55
<PAGE> 56
CENTURY SURETY COMPANY AND SUBSIDIARIES
(A WHOLLY OWNED SUBSIDIARY OF ALLIANCE HOLDING CORPORATION)
CONSOLIDATED BALANCE SHEETS
JUNE 30, 1996 AND DECEMBER 31, 1995
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1996 1995
----------- ------------
(UNAUDITED)
<S> <C> <C>
ASSETS
Investments:
Fixed maturities held to maturity, at amortized cost............. $15,240,015 $15,308,405
Securities available for sale, at fair value:
Fixed maturities................................................. 33,422,309 33,153,196
Equity securities................................................ 8,098,330 5,425,813
Mortgage loans on real estate.................................... 2,611,218 3,393,205
Other investments................................................ 90,267
Short-term investments, at cost.................................. 2,583,733 843,095
----------- -----------
Total investments........................................ 61,955,605 58,213,981
Cash............................................................... 2,374,076 2,691,746
Premium balances receivable, net................................... 6,399,504 4,357,298
Deferred policy acquisition costs.................................. 3,954,029 3,427,551
Reinsurance receivables............................................ 10,282,413 12,646,960
Prepaid reinsurance premiums....................................... 2,833,898 2,881,174
Accrued investment income.......................................... 842,634 870,245
Furniture and equipment, at cost, net.............................. 367,346 329,435
Other assets....................................................... 1,606,612 579,784
----------- -----------
Total assets............................................. $90,616,117 $85,998,174
=========== ===========
LIABILITIES AND SHAREHOLDER'S EQUITY
Losses and loss expenses payable................................... 39,264,593 37,001,841
Unearned premiums.................................................. 17,248,372 15,636,442
Reinsurance balances payable....................................... 2,392,312 2,259,400
Current federal income taxes payable............................... 499,792 1,322,280
Deferred federal income taxes...................................... 406,185 53,337
Accrued expenses and other liabilities............................. 2,380,042 2,660,005
Collateral held.................................................... 301,133 321,115
----------- -----------
Total liabilities........................................ 62,492,429 59,254,420
----------- -----------
Shareholder's equity:
Common stock, $10,000 par value. Authorized 500 shares; issued
and outstanding 200 shares.................................... 2,000,000 2,000,000
Additional paid-in-capital....................................... 17,590,658 17,293,158
Net unrealized appreciation of investments....................... 3,888,993 3,265,550
Retained earnings................................................ 4,644,037 4,185,046
----------- -----------
Total shareholder's equity............................... 28,123,688 26,743,754
----------- -----------
Total liabilities and shareholder's equity............... $90,616,117 $85,998,174
=========== ===========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-56
<PAGE> 57
CENTURY SURETY COMPANY AND SUBSIDIARIES
(A WHOLLY OWNED SUBSIDIARY OF ALLIANCE HOLDING CORPORATION)
CONSOLIDATED STATEMENTS OF INCOME
SIX MONTHS ENDED JUNE 30, 1996 AND 1995
(UNAUDITED)
<TABLE>
<CAPTION>
1996 1995
----------- -----------
<S> <C> <C>
Revenues:
Premiums earned.......................................................... $13,062,477 $13,290,317
Net investment income.................................................... 1,629,393 1,657,180
Net realized gains on investments........................................ 598,781 32,839
Income on American Sentinel transaction.................................. 1,150,000 0
Other income............................................................. 171,702 158,899
---------- ----------
Total revenues................................................... 16,612,353 15,139,235
---------- ----------
Expenses:
Losses and loss expenses................................................. 8,471,053 7,812,015
Acquisition expenses..................................................... 2,972,796 3,196,885
Other expenses........................................................... 3,005,540 3,923,863
---------- ----------
Total expenses................................................... 14,449,389 14,932,763
---------- ----------
Income before federal income taxes............................... 2,162,964 206,472
---------- ----------
Federal income tax expense (benefit):
Current.................................................................. 797,292 351,139
Deferred................................................................. 31,681 (398,912)
---------- ----------
Total federal income tax expense (benefit)....................... 828,973 (47,773)
---------- ----------
Net income....................................................... $ 1,333,991 $ 254,245
========== ==========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-57
<PAGE> 58
CENTURY SURETY COMPANY AND SUBSIDIARIES
(A WHOLLY OWNED SUBSIDIARY OF ALLIANCE HOLDING CORPORATION)
CONSOLIDATED STATEMENTS OF CASH FLOWS
SIX MONTHS ENDED JUNE 30, 1996 AND 1995
(UNAUDITED)
<TABLE>
<CAPTION>
1996 1995
----------- -----------
<S> <C> <C>
Cash flows from operating activities:
Net income....................................................... $ 1,333,991 $ 254,245
----------- -----------
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization................................. 189,654 110,367
Deferred federal income taxes................................. 31,681 (398,912)
Increase in premium balances receivable....................... (2,042,206) (817,415)
(Increase) decrease in deferred policy acquisition costs...... (526,478) 221,169
(Increase) decrease in reinsurance receivables................ 2,364,547 (846,997)
(Increase) decrease in prepaid reinsurance premiums........... 47,276 (718,511)
(Increase) decrease in accrued investment income.............. 27,611 (43,070)
Increase in other assets...................................... (1,026,828) (243,564)
Increase in losses and loss expenses payable.................. 2,262,752 3,385,192
Increase in unearned premiums................................. 1,611,930 999,963
Increase in reinsurance balances payable...................... 132,912 435,831
Decrease in reinsurance payable on paid losses................ 0 (1,331)
Decrease in current federal income taxes payable.............. (822,488) (546,025)
Decrease in loss portfolio transfer........................... (10,832) 0
Decrease in accrued expenses and other liabilities............ (269,131) (691,979)
Decrease in collateral held................................... (19,982) (882,640)
----------- -----------
Net adjustments.......................................... 1,950,418 (37,922)
----------- -----------
Net cash provided by operating activities................ 3,284,409 216,323
----------- -----------
Cash flows from investing activities:
Purchase of fixed maturities available for sale.................. (8,548,696) (2,370,603)
Purchase of equity securities.................................... (959,707) (17,137)
Sale of fixed maturities available for sale...................... 7,194,881 58,424
Sale of equity securities........................................ 269,910 393,090
Decrease in mortgage loans on real estate........................ 781,987 291,243
Net decrease in short-term investments........................... (1,740,638) (1,167,149)
Increase (decrease) in limited partnership....................... 90,267 (29,762)
Acquisition of furniture and equipment, net...................... (112,583) (87,098)
----------- -----------
Net cash used in investing activities.................... (3,024,579) (2,928,992)
----------- -----------
Cash flows from financing activities:
Dividends to Parent.............................................. (875,000) (750,000)
Capital contributed by Parent.................................... 297,500 255,000
----------- -----------
Net cash used in financing activities.................... (577,500) (495,000)
----------- -----------
Net decrease in cash............................................... (317,670) (3,207,669)
Cash at the beginning of period.................................. 2,691,746 6,577,481
----------- -----------
Cash at the end of period........................................ $ 2,374,076 $ 3,369,812
=========== ===========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-58
<PAGE> 59
CENTURY SURETY COMPANY AND SUBSIDIARIES
(A WHOLLY OWNED SUBSIDIARY OF ALLIANCE HOLDING CORPORATION)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1996 AND DECEMBER 31, 1995
(UNAUDITED)
1. BASIS OF PRESENTATION AND PRINCIPLES OF CONSOLIDATION
The accompanying unaudited consolidated financial statements as of June 30,
1996, include the accounts of Century Surety Company ("CSC") and subsidiaries
(the "CSC Group"). All significant intercompany transactions have been
eliminated.
The consolidated financial statements of the CSC Group included herein have
been prepared by the management of the CSC Group, without audit, pursuant to the
rules and regulations of the Securities and Exchange Commission. Certain
information and footnote disclosures normally included in the financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted pursuant to such rules and regulations. In the
opinion of the management of the CSC Group, the accompanying statements reflect
all adjustments necessary to present fairly the financial position, results of
operations and cash flows for those periods indicated, and contain adequate
disclosure to make the information presented not misleading. Such adjustments
are of a normal, recurring nature unless otherwise disclosed in the notes to
consolidated financial statements. It is suggested that these consolidated
financial statements be read in conjunction with the consolidated financial
statements and notes thereto included in the CSC Group's latest audited
financial statements.
Results of operations for any three month period are not necessarily
indicative of the results of operations for a full year.
2. PROPOSED MERGER AND SUBSEQUENT EVENTS
On May 19, 1996 Alliance and Republic Environmental Systems, Inc. ("RESI")
signed a binding letter of intent and agreed to the terms of mergers (the
"Mergers") pursuant to which Alliance would receive (i) 14,760,000 shares of
RESI's common stock, par value $0.01 per share ("RESI Common Stock"), (ii)
warrants to acquire an additional 4,200,000 shares of RESI Common Stock at
exercise prices ranging from $2.625 to $3.875 per share and exercisable over two
to four year periods, and (iii) a promissory note in the principal amount of
$4.0 million in consideration for all of the outstanding common stock of
Alliances' wholly-owned subsidiaries, CSC and CSU.
During July 1996, the Alliance Companies entered into an agreement to
acquire Environmental & Commercial Insurance Agency, Inc.; an agreement with
Gulf Insurance Company and Midwest Indemnity Corporation ("Midwest") for the
production, underwriting and reinsurance of contract surety and surety bond
business primarily to environmental businesses; and an option to purchase assets
of Midwest. These transactions are subject to the consummation of the Mergers.
3. INCOME ON AMERICAN SENTINEL TRANSACTION
In 1994, CSC entered into a transaction concerning the sale of the
insurance operations of American Sentinel to Republic Western. Republic Western
contracted to pay CSC's subsidiary, Evergreen, an amount in 1996 which was
indeterminable at that time and was based upon future loss development. The
transaction included a contingent receivable ranging from $0 to $2,900,000 due
Evergreen from Republic Western by December 1996. Based upon performance of the
insurance operations sold, it was determined that $1,150,000 should be
recognized as revenue during the first quarter of 1996. The income is reflected
in these statements. The balance of the receivable in the amount of $1,750,000
has not been included in income because it is subject to a reduction in its
entirety based on the performance, including loss development of the sold
operations, through December 1996.
4. DIVIDEND
CSC paid a $437,500 dividend to Alliance in the six-month period ended June
30, 1996.
F-59
<PAGE> 60
INDEPENDENT AUDITORS' REPORT
Board of Directors and Shareholder
Commercial Surety Agency, Inc.:
We have audited the accompanying balance sheets of Commercial Surety
Agency, Inc. (a wholly owned subsidiary of Alliance Holding Corporation) as of
December 31, 1995 and 1994, and the related statements of income, shareholder's
equity (deficit), and cash flows for each of the years in the three-year period
ended December 31, 1995. 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 in accordance with generally accepted auditing
standards. Those standards 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. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Commercial Surety Agency,
Inc. as of December 31, 1995 and 1994, and the results of its operations and its
cash flows for each of the years in the three-year period ended December 31,
1995, in conformity with generally accepted accounting principles.
KPMG PEAT MARWICK LLP
Cleveland, Ohio
June 7, 1996
F-60
<PAGE> 61
COMMERCIAL SURETY AGENCY, INC.
(A WHOLLY OWNED SUBSIDIARY OF ALLIANCE HOLDING CORPORATION)
BALANCE SHEETS
DECEMBER 31, 1995 AND 1994
ASSETS
<TABLE>
<CAPTION>
1995 1994
---------- ----------
<S> <C> <C>
Cash........................................................ $ 2,363 $ 316,028
Premiums receivable......................................... 646,757 318,444
Commissions receivable from affiliates...................... 252,266 603,957
Note receivable-related party (note 2)...................... 19,900 19,900
Other receivables........................................... 45,454 48,429
Other receivables from affiliates........................... 0 80,223
Deferred financing costs, net of accumulated amortization of
$1,170,792 and $1,150,793................................. 0 19,999
Prepaid expenses............................................ 13,605 8,819
Federal income tax recoverable from Parent (note 2)......... 209,464 39,542
---------- ----------
Total current assets.............................. 1,189,809 1,455,341
---------- ----------
Furniture, equipment and leasehold improvements at cost, net
of accumulated depreciation and amortization of $132,555
and $107,694 (note 3)..................................... 178,781 142,288
Advances to Parent (note 2)................................. 156,441 186,035
Deposits.................................................... 1,879 2,587
---------- ----------
Total assets...................................... $1,526,910 $1,786,251
========== ==========
LIABILITIES AND SHAREHOLDER'S EQUITY
Current maturities of long-term debt (note 3)............... 35,897 160,186
Accounts payable............................................ 9,981 188,572
Bonuses payable............................................. 156,000 271,300
Commissions payable (note 2)................................ 139,175 146,391
Premiums payable to affiliates.............................. 788,894 493,928
Accrued payroll............................................. 11,679 11,927
Note payable -- related party (note 2)...................... 0 12,514
Funds held (note 4)......................................... 0 300,000
---------- ----------
Total current liabilities......................... 1,141,626 1,584,818
Long-term debt (note 3)..................................... 11,634 29,661
---------- ----------
Total liabilities................................. 1,153,260 1,614,479
---------- ----------
Shareholder's equity:
Common stock, no par value, $5 stated value. Authorized
750 shares; issued and outstanding 100 shares.......... 500 500
Retained earnings......................................... 373,150 171,272
---------- ----------
Total shareholder's equity........................ 373,650 171,772
---------- ----------
Commitments and contingencies (note 6)
Total liabilities and shareholder's equity........ $1,526,910 $1,786,251
========== ==========
</TABLE>
See accompanying notes to financial statements.
F-61
<PAGE> 62
COMMERCIAL SURETY AGENCY, INC.
(A WHOLLY OWNED SUBSIDIARY OF ALLIANCE HOLDING CORPORATION)
STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993
<TABLE>
<CAPTION>
1995 1994 1993
---------- ---------- ----------
<S> <C> <C> <C>
Revenues:
Commissions (note 2)................................... $2,000,140 $2,686,106 $2,310,024
Management fees from affiliate (note 2)................ 600,000 337,500 0
Interest income........................................ 1,931 1,063 12,190
---------- ---------- ----------
Total revenues................................. 2,602,071 3,024,669 2,322,214
---------- ---------- ----------
Expenses:
Commissions (note 2)................................... 892,897 1,132,049 1,110,396
---------- ---------- ----------
Operating expenses:
Salaries............................................ 983,332 743,119 562,409
Amortization........................................ 19,999 26,450 127,473
Depreciation........................................ 37,118 26,544 38,818
General and administrative.......................... 216,613 201,432 212,527
Interest............................................ 9,908 22,050 47,111
Payroll taxes....................................... 69,511 45,752 41,001
Rent................................................ 63,055 49,079 59,422
---------- ---------- ----------
1,399,536 1,114,426 1,088,761
---------- ---------- ----------
Total expenses................................. 2,292,433 2,246,475 2,199,157
---------- ---------- ----------
Income before Federal income tax expense....... 309,638 778,194 123,057
Federal income tax expense (note 5).................... 107,760 265,952 44,911
---------- ---------- ----------
Net income..................................... $ 201,878 $ 512,242 $ 78,146
========== ========== ==========
</TABLE>
See accompanying notes to financial statements.
F-62
<PAGE> 63
COMMERCIAL SURETY AGENCY, INC.
(A WHOLLY OWNED SUBSIDIARY OF ALLIANCE HOLDING CORPORATION)
STATEMENTS OF SHAREHOLDER'S EQUITY (DEFICIT)
YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993
<TABLE>
<CAPTION>
TOTAL
COMMON STOCK RETAINED SHAREHOLDER'S
---------------- EARNINGS EQUITY
SHARES AMOUNT (DEFICIT) (DEFICIT)
------ ------ --------- -------------
<S> <C> <C> <C> <C>
Balance as of December 31, 1992 (unaudited).......... 100 $500 $(419,116) $(418,616)
Net income -- 1993................................. 0 0 78,146 78,146
--- ---- --------- ---------
Balance as of December 31, 1993...................... 100 500 (340,970) (340,470)
Net income -- 1994................................. 0 0 512,242 512,242
--- ---- --------- ---------
Balance as of December 31, 1994...................... 100 500 171,272 171,772
Net income -- 1995................................. 0 0 201,878 201,878
--- ---- --------- ---------
Balance as of December 31, 1995...................... 100 $500 $ 373,150 $ 373,650
=== ==== ========= =========
</TABLE>
See accompanying notes to financial statements.
F-63
<PAGE> 64
COMMERCIAL SURETY AGENCY, INC.
(A WHOLLY OWNED SUBSIDIARY OF ALLIANCE HOLDING CORPORATION)
STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993
<TABLE>
<CAPTION>
1995 1994 1993
--------- --------- ---------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income.............................................. $ 201,878 $ 512,242 $ 78,146
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization........................ 57,117 52,994 166,291
Loss on sale of property and equipment............... 1,404 3,582 15,252
Changes in operating assets and liabilities:
(Increase) decrease in premiums receivable........... (328,313) 167,276 66,881
(Increase) decrease in commissions receivable........ 351,691 (456,916) (59,330)
(Increase) decrease in other receivables............. 2,975 (15,301) (31,006)
(Increase) decrease in other receivables from
affiliates......................................... 80,223 (80,223) 0
Increase in prepaid expenses......................... (4,786) (487) (8,333)
(Increase) decrease in deposits...................... 708 (135) (1,123)
Increase (decrease) in accounts payable.............. (178,591) 183,797 1,841
Increase (decrease) in bonuses payable............... (115,300) 157,300 71,000
Increase (decrease) in commissions payable........... (7,216) 11,839 (89,603)
Increase (decrease) in premiums payable to
affiliates......................................... 294,966 (14,258) (29,138)
Decrease in accrued payroll.......................... (248) (2,948) (585)
Decrease in funds held............................... (300,000) 0 0
--------- --------- ---------
Net cash provided by operating activities....... 56,508 518,762 180,293
--------- --------- ---------
Cash flows from investing activities:
Proceeds from sale of property and equipment............ 0 325 450
Acquisition of property and equipment................... (75,015) (104,994) (62,657)
--------- --------- ---------
Net cash used in investing activities........... (75,015) (104,669) (62,207)
--------- --------- ---------
Cash flows from financing activities:
Proceeds from long-term debt............................ 0 15,319 0
Repayment of long-term debt principal................... (142,316) (153,667) (120,554)
Advances to Parent...................................... (722,328) (549,421) (687,949)
Repayment of advances................................... 582,000 315,000 811,600
Repayment of note payable -- related party.............. (12,514) (7,077) (6,561)
--------- --------- ---------
Net cash used in financing activities........... (295,158) (379,846) (3,464)
--------- --------- ---------
Net increase (decrease) in cash................. (313,665) 34,247 114,622
Cash -- beginning of year................................. 316,028 281,781 167,159
--------- --------- ---------
Cash -- end of year....................................... $ 2,363 $ 316,028 $ 281,781
========= ========= =========
SUPPLEMENTAL DISCLOSURE:
Interest paid........................................... $ 11,166 $ 24,069 $ 33,179
========= ========= =========
Federal income taxes paid............................... $ 277,682 $ 305,494 $ 44,911
========= ========= =========
</TABLE>
See accompanying notes to financial statements.
F-64
<PAGE> 65
COMMERCIAL SURETY AGENCY, INC.
(A WHOLLY OWNED SUBSIDIARY OF ALLIANCE HOLDING CORPORATION)
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1995 AND 1994
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Business
Commercial Surety Agency, Inc. ("CSU") is a wholly owned subsidiary of
Alliance Holding Corporation ("Alliance"). CSU is an insurance agency operating
in the Northeastern Ohio area doing business under the tradename Century Surety
Underwriters. Substantially all commissions are received from CSU's placement of
surety bonds with Century Surety Company ("CSC"), a wholly owned subsidiary of
Alliance, and its subsidiaries (collectively, the "CSC Group").
Basis of Presentation
The financial statements have been prepared on the basis of generally
accepted accounting principles ("GAAP").
Use of Estimates
In preparing the financial statements in conformity with GAAP, management
is required to make certain estimates and assumptions that affect the reported
amounts of assets and liabilities and the disclosures of contingent assets and
liabilities as of the date of the financial statements and the reported amounts
of revenues and expenses for the reporting period. Actual results could differ
significantly from those estimates.
Commission Revenue and Expense Recognition
Commission revenue is recognized in full as the CSC Group's surety bonds
are placed. CSU also may earn additional commissions dependent upon the
profitability of the business CSU places. The profitability commissions are
based upon the loss ratios of the bond placements, and are recorded as revenues
when notified by the CSC Group, which is approximately 12 months subsequent to
the calendar year-end in which the bond was placed.
Return commissions are recorded when the underlying insurance policy is
cancelled.
Commission expense is recognized in full as the CSC Group's surety bonds
are placed, and is paid to the sub-agent when the premiums from the insured are
collected. Commissions payable represents commissions due to the sub-agent on
premiums that have not been collected.
Property and Equipment
Property and equipment are recorded at cost, net of accumulated
depreciation and amortization. CSU uses the straight-line and accelerated
methods of depreciation and amortization over the estimated useful lives of the
assets.
Management Fees from Affiliate
CSU recognizes management fees from affiliate income as the services are
performed.
Deferred Financing Costs
Deferred financing costs represent costs capitalized related to the
original financing of CSU that are being amortized over the life of the loan.
F-65
<PAGE> 66
COMMERCIAL SURETY AGENCY, INC.
(A WHOLLY OWNED SUBSIDIARY OF ALLIANCE HOLDING CORPORATION)
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Federal Income Taxes
CSU files as part of a consolidated Federal income tax return of Alliance
and its subsidiaries. Pursuant to written agreements, CSU pays to or recovers
from Alliance the amount of Federal income tax calculated primarily on a
separate basis for itself.
CSU utilizes the asset and liability method of accounting for income tax.
Under the asset and liability method, deferred tax assets and liabilities are
recognized for the future tax consequences attributable to differences between
the financial statement carrying amounts of existing assets and liabilities and
their respective tax bases. Deferred tax assets and liabilities are measured
using enacted tax rates expected to apply to taxable income in the years in
which those temporary differences are expected to be recovered or settled.
Differences between the financial reporting and tax bases of assets and
liabilities are not significant and no deferred tax assets or liabilities have
been recorded.
Statement of Cash Flows
For the purpose of the statement of cash flows, cash includes only funds
held on deposit with banks.
2. RELATED PARTY TRANSACTIONS
Advances to Parent and Federal income tax recoverable from Parent represent
cash advanced to Alliance for working capital and income tax purposes. CSU has
not received any interest on these advances.
Note receivable -- related party consists of an unsecured demand note
receivable from the son of a former shareholder of Alliance bearing interest at
12%.
Note payable -- related party represents a 7.5% note, payable to a
shareholder of Alliance, in monthly installments of $694, including interest.
The note was repaid in 1995.
Commission revenues of $1,815,229, $2,606,719, and $1,854,000 for the years
ended December 31, 1995, 1994 and 1993, respectively, were earned from the CSC
Group.
Management fees from affiliate represents fees for performing various
financial underwriting services for a wholly-owned subsidiary of the CSC Group.
The management fee, in accordance with the terms of a written agreement, was
$50,000 per month in 1995, and $37,500 per month beginning April 1, 1994.
F-66
<PAGE> 67
COMMERCIAL SURETY AGENCY, INC.
(A WHOLLY OWNED SUBSIDIARY OF ALLIANCE HOLDING CORPORATION)
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
3. LONG-TERM DEBT
At December 31, 1995 and 1994, long-term debt consisted of the following:
<TABLE>
<CAPTION>
1995 1994
------- --------
<S> <C> <C>
7.5% secured notes, payable to Independence Bank, Independence,
Ohio, in monthly installments of $13,950, including interest,
guaranteed by individuals who are shareholders of an
affiliated company, paid off in 1995......................... $ 0 $162,063
7.5% unsecured note payable to Independence Bank, Independence,
Ohio; in monthly installments of $3,068, including interest,
through October 1996......................................... 26,746 0
14% - 20% capital leases, payable to AT&T in monthly
installments of $1,007, including interest, through January
1998; secured by telephone equipment......................... 20,785 27,784
-------- ---------
47,531 189,847
Less: current portion.......................................... (35,897) (160,186)
-------- ---------
$11,634 $ 29,661
======== =========
</TABLE>
Future maturities of long-term debt are as follows:
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
------------
<S> <C>
1996..................................................................... $35,897
1997..................................................................... 10,669
1998..................................................................... 965
-------
$47,531
=======
</TABLE>
4. FUNDS HELD
Funds held represent cash received as collateral for commissions receivable
from one customer. The cash was returned to the customer during 1995 as the
commissions receivable was settled.
5. FEDERAL INCOME TAXES
A reconciliation between actual Federal income tax expense and the amount
computed at the statutory rate follows:
<TABLE>
<CAPTION>
1995 1994 1993
-------- -------- -------
<S> <C> <C> <C>
Amount at statutory rate............................ $105,277 $264,586 $41,839
Other............................................... 2,483 1,366 3,072
-------- -------- -------
$107,760 $265,952 $44,911
======== ======== =======
</TABLE>
6. COMMITMENTS
CSU leases its facilities from an indirect shareholder of Alliance under an
operating lease expiring in July 1997 with a five year right to renew. Lease
payments over the prior three years ended December 31, 1995, 1994 and 1993 were
$63,100, $49,100 and $59,400, respectively. The minimum future lease payments
under this operating lease at December 31, 1995 are approximately $81,000 in
1996 and $43,000 in 1997.
F-67
<PAGE> 68
COMMERCIAL SURETY AGENCY, INC.
(A WHOLLY OWNED SUBSIDIARY OF ALLIANCE HOLDING CORPORATION)
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
7. SUBSEQUENT EVENT
On May 19, 1996 Alliance and Republic Environmental Systems, Inc. ("RESI")
signed a binding letter of intent and agreed to the terms of mergers (the
"Mergers") pursuant to which Alliance would receive (i) 14,760,000 shares of
RESI's common stock, par value $0.01 per share ("RESI Common Stock"), (ii)
warrants to acquire an additional 4,200,000 shares of RESI Common Stock at
exercise prices ranging from $2.625 to $3.875 per share and exercisable over two
to four year periods, and (iii) a promissory note in the principal amount of
$4.0 million in consideration for all of the outstanding common stock of
Alliances' wholly-owned subsidiaries, CSC and CSU.
F-68
<PAGE> 69
COMMERCIAL SURETY AGENCY, INC.
(A WHOLLY OWNED SUBSIDIARY OF ALLIANCE HOLDING CORPORATION)
BALANCE SHEETS
JUNE 30, 1996 AND DECEMBER 31, 1995
ASSETS
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1996 1995
----------- ------------
(UNAUDITED)
<S> <C> <C>
Cash............................................................... $ 138,435 $ 2,363
Premiums receivable................................................ 713,423 646,757
Commissions receivable from affiliates............................. 13,127 252,266
Note receivable-related party...................................... 19,801 19,900
Other receivables.................................................. 5,714 45,454
Prepaid expenses................................................... 2,654 13,605
Federal income tax recoverable from Parent......................... 0 209,464
---------- ----------
Total current assets..................................... 893,154 1,189,809
---------- ----------
Furniture, equipment and leasehold improvements at cost, net of
accumulated depreciation and amortization........................ 171,601 178,781
Advances to Parent................................................. 224,016 156,441
Deposits........................................................... 690 1,879
---------- ----------
1,289,461 $1,526,910
========== ==========
LIABILITIES AND SHAREHOLDER'S EQUITY
Current maturities of long-term debt............................... 10,091 35,897
Accounts payable................................................... 10,785 9,981
Bonuses payable.................................................... 2,300 156,000
Commissions payable................................................ 83,921 139,175
Premiums payable to affiliates..................................... 1,046,566 788,894
Accrued payroll.................................................... 13,631 11,679
---------- ----------
Total current liabilities................................ 1,167,294 1,141,626
Long-term debt..................................................... 6,505 11,634
---------- ----------
Total liabilities........................................ 1,173,799 1,153,260
---------- ----------
Shareholder's equity:
Common stock, no par value, $5 stated value. Authorized 750
shares; issued and outstanding 100 shares..................... 500 500
Retained earnings................................................ 115,162 373,150
---------- ----------
Total shareholder's equity............................... 115,662 373,650
---------- ----------
Commitments and contingencies
Total liabilities and shareholder's equity............... $ 1,289,461 $1,526,910
========== ==========
</TABLE>
See accompanying notes to financial statements.
F-69
<PAGE> 70
COMMERCIAL SURETY AGENCY, INC.
(A WHOLLY OWNED SUBSIDIARY OF ALLIANCE HOLDING CORPORATION)
STATEMENTS OF INCOME
SIX MONTHS ENDED JUNE 30, 1996 AND 1995
(UNAUDITED)
<TABLE>
<CAPTION>
JUNE 30
-------------------------
1996 1995
---------- ----------
<S> <C> <C>
Revenues:
Commissions....................................................... $1,024,660 $ 841,716
Management fees from affiliate.................................... 300,000 300,000
Other............................................................. 98,670 0
Interest income................................................... 1,868 107
---------- ----------
Total revenues............................................ 1,425,198 1,141,823
---------- ----------
Expenses:
Commissions....................................................... 598,722 413,103
---------- ----------
Operating expenses:
Salaries....................................................... 452,567 411,837
Amortization................................................... 533 14,291
Depreciation................................................... 19,385 16,074
General and administrative..................................... 133,619 92,927
Interest....................................................... 1,755 7,937
Loss on disposal of asset...................................... 0 1,845
Payroll taxes.................................................. 51,449 47,395
Rent........................................................... 27,756 27,487
---------- ----------
687,064 619,973
---------- ----------
Total expenses............................................ 1,285,786 1,032,896
---------- ----------
Income before Federal income tax expense.................. 139,412 108,927
Federal income tax expense........................................ 47,400 37,035
---------- ----------
Net income................................................ $ 92,012 $ 71,892
========= =========
</TABLE>
See accompanying notes to financial statements.
F-70
<PAGE> 71
COMMERCIAL SURETY AGENCY, INC.
(A WHOLLY OWNED SUBSIDIARY OF ALLIANCE HOLDING CORPORATION)
STATEMENTS OF CASH FLOWS
SIX MONTHS ENDED JUNE 30, 1996 AND 1995
(UNAUDITED)
<TABLE>
<CAPTION>
1996 1995
--------- ---------
<S> <C> <C>
Cash flows from operating activities:
Net income......................................................... $ 92,012 $ 71,892
Adjustments to reconcile net income to net cash provided by (use
in) operating activities:
Depreciation and amortization................................... 20,451 4,935
Loss on sale of property and equipment.......................... 0 1,845
Changes in operating assets and liabilities:
(Increase) decrease in premiums receivable...................... (66,666) (210,339)
Decrease in commissions receivable.............................. 239,139 589,948
Decrease in note receivable-related party....................... 0 80,223
Decrease in other receivables................................... 39,740 12,891
Decrease in other receivables from affiliates................... 99 99
Decrease in prepaid expenses.................................... 10,951 6,798
(Increase) decrease in federal income tax receivable from
parent......................................................... 209,464 (159,902)
Decrease in deposits............................................ 1,189 1,897
Decrease in deferred financial cost............................. 0 19,999
Increase (decrease) in accounts payable......................... 804 (177,520)
Decrease in bonuses payable..................................... (153,700) (213,150)
Decrease in commissions payable................................. (55,254) (38,591)
Increase in premiums payable to affiliates...................... 257,672 448,921
Increase in accrued payroll..................................... 1,952 1,495
Increase in accrued interest.................................... 0 5,485
--------- ---------
Net cash provided by (used in) operating activities........ 597,853 446,246
--------- ---------
Cash flows from investing activities:
Acquisition of property and equipment.............................. (13,271) (41,980)
--------- ---------
Net cash (used in) investing activities.................... (13,271) (41,980)
--------- ---------
Cash flows from financing activities:
Advances to Parent................................................. (67,575) (56,706)
Repayment of long-term debt principal.............................. (30,935) (73,005)
Repayment of note payable-related party............................ 0 (12,514)
Dividend distribution to Parent.................................... (350,000) 0
--------- ---------
Net cash (used in) financing activities.................... (448,510) (142,225)
--------- ---------
Net increase in cash................................................. 136,072 262,221
Cash -- beginning of period.......................................... 2,363 316,028
--------- ---------
Cash -- end of period................................................ $ 138,435 $ 579,249
========= =========
SUPPLEMENTAL DISCLOSURE:
Interest paid:..................................................... $ 1,755 $ 7,937
========= =========
Federal income taxes paid.......................................... $ 29,823 $ 149,816
========= =========
</TABLE>
See accompanying notes to financial statements.
F-71
<PAGE> 72
COMMERCIAL SURETY AGENCY, INC.
(A WHOLLY OWNED SUBSIDIARY OF ALLIANCE HOLDING CORPORATION)
NOTES TO FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION
The accompanying unaudited financial statements as of June 30, 1996 and
1995, include the accounts of Commercial Surety Agency, Inc. ("CSU"), a
wholly-owned subsidiary of Alliance Holding Corporation ("Alliance").
The financial statements of CSU included herein have been prepared by the
management of CSU, without audit, pursuant to the rules and regulations of the
Securities and Exchange Commission. Certain information and footnote disclosures
normally included in the financial statements prepared in accordance with
generally accepted accounting principles have been condensed or omitted pursuant
to such rules and regulations. In the opinion of CSU, the accompanying
statements reflect all adjustments necessary to present fairly the financial
position results of operations and cash flows for those periods indicated, and
contain adequate disclosure to make the information presented not misleading.
Such adjustments are of a normal, recurring nature unless otherwise disclosed in
the notes to the financial statements. It is suggested that these condensed
financial statements be read in conjunction with the financial statements and
notes thereto included in CSU's latest audited financial statements.
Results of operations for any six month period are not necessarily
indicative of the results of operations for a full year.
2. DIVIDEND
CSU paid a $350,000 dividend to Alliance in the six-month period ended June
30, 1996.
3. PROPOSED MERGER AND SUBSEQUENT EVENTS
On May 19, 1996 Alliance and Republic Environmental Systems, Inc. ("RESI")
signed a binding letter of intent and agreed to the terms of mergers (the
"Mergers") pursuant to which Alliance would receive (i) 14,760,000 shares of
RESI's common stock, par value $0.01 per share ("RESI Common Stock"), (ii)
warrants to acquire an additional 4,200,000 shares of RESI Common Stock at
exercise prices ranging from $2.625 to $3.875 per share and exercisable over two
to four year periods, and (iii) a promissory note in the principal amount of
$4.0 million in consideration for all of the outstanding common stock of
Alliances' wholly-owned subsidiaries, CSC and CSU.
During July 1996, the Alliance Companies entered into an agreement to
acquire Environmental & Commercial Insurance Agency, Inc.; an agreement with
Gulf Insurance Company and Midwest Indemnity Corporation ("Midwest") for the
production, underwriting and reinsurance of contract surety and surety bond
business primarily to environmental businesses; and an option to purchase assets
of Midwest. These transactions are subject to the consummation of the Mergers.
F-72
