During 1995, the Company closed its Florida office upon the termination of business with Barnett, and closed its Tennessee office on February 2, 1996, moving all customer service for Tennessee to the Company's corporate office. All facilities are suitable and adequate to meet the Company's requirements. The Company intends to either renegotiate new leases for the existing facilities or locate alternative suitable space upon expiration of these leases, as market conditions indicate. The following is a list of the leases for the principal facilities utilized in the Company's operations as of January 1, 1996.
JMC VIRGINIA 6800 Paragon Place Suite 526 Richmond, VA 23230 Exp. Date: July 1997 Square Footage: 3,171
1995 Compared to 1994 --------------------- General. Revenues and expenses include the accounts of the Company's subsidiaries, JMC and Priority.
The Company reported net income for the year ended December 31, 1995 of $1,741,000 (after providing for income taxes of $1,256,000) compared with a net loss of $2,370,000 (after providing for income taxes of $492,000) in 1994. Included in the 1995 and 1994 results were the following:
1995: ----- . A net gain of $3,914,000 ($2,349,000 or $0.38 per share after estimated tax provision) on the sale of the rights to certain future asset-based fee revenues to a client financial institution.
. Other revenue in the amount of approximately $1,309,000 ($785,000 or $0.13 per share after estimated tax provision) related to the final portion of that same client financial institution's payment for the right to hire certain employees and certain other services.
. The transition fees were intended to cover the cost of operating the Florida operations during a transitional period prior to termination of the Company's relationship with its Florida financial institution client. For purposes of analyzing revenues from operations, these transition fees have been included as they relate to services performed. As such, all expenses related to the same operational transition are included in total operating expenses.
1994 revenues include the previously mentioned $1,000,000. Excluding the one-time payments for the right to hire certain JMC employees in 1994 and 1995 and the net gain on the sale of the rights to certain asset-based fee revenues in 1995, but including $538,000 for transition fees, revenues for 1995 would have been $15,149,000 compared to $32,357,000 in 1994 (a decrease of $17,208,000 or 53%). This reduction in revenues is primarily attributable to the following:
* The termination of another client relationship in the fourth quarter of 1994 due to that client being acquired by First Interstate Bank contributed to $18 million or 6% of the total gross sales decline in 1995 compared to 1994.
. A decrease of approximately $654,000 in asset-based fee revenue in 1995 compared to 1994. This decrease is a result of the sale of the rights to certain future asset-based fee revenues at the end of August for which the Company recognized a pre-tax net gain of approximately $3,914,000 during 1995. Because of the timing of this sale, the Company did not receive asset-based fee revenues for the last four months of 1995 which would have generated approximately $1.1 million in additional asset-based fee revenue for 1995.
. A $6,744,000 or 51% reduction in fees to financial institutions due to lower sales volume.
. A $783,000 or 48% reduction in salesperson's commissions also due to lower sales volume, and
The percentage decrease in fees to financial institutions in 1995 compared to 1994 is less than the percentage decrease in sales volume primarily due to the following:
these products, even though the payout to the Company's financial institution clients is a fixed percentage of the gross revenue rate. During 1995, variable annuity and mutual fund sales comprised 58% of total sales compared to 33% of total sales in 1994, resulting in a decline in the gross margin rate on total product sales in 1995 from 1994.
The Company reported a net loss for the year ended December 31, 1994 of $2,370,000 (after providing for income taxes of $492,000) compared with after- tax income from continuing operations of $4,368,000 (after providing for income taxes of $3,256,000) and net income of $4,883,000 (after providing for income taxes of $3,599,000) in 1993. Included in the 1994 results were the following:
. One-time pre-tax charges totaling $3,074,000. As explained in detail below, the charges consisted of a restructuring charge of $557,000 (or $345,000 after estimated tax benefit of $212,000) and a write-off of goodwill which amounted to $2,517,000 with no corresponding tax benefit.
. Revenue in the amount of approximately $1,000,000 (or $600,000 after estimated tax provision of $400,000) resulting from a payment from a financial institution client for the right to hire certain JMC employees.
Included in 1993 after-tax income from continuing operations was a one-time pre-tax charge of $575,000 (or $352,000 after estimated tax benefit of $223,000) recorded in the third quarter arising out of an arbitration proceeding with a former bank client. Net income for 1993 included an after- tax gain from disposal of the Company's specialist and securities brokerage businesses of $515,000 (net of applicable income taxes of $343,000). Excluding the above-mentioned items and amortization of goodwill for both periods, the after-tax income from continuing operations would have been $407,000 (after providing for income taxes of $304,000) in 1994 compared to $5,406,000 (after providing for income taxes of $3,479,000) in 1993.
Total revenues for 1994 were $33,357,000 compared to revenues of $49,318,000 from continuing operations in 1993, a decrease of $15,961,000 or 32%. Included in 1994 revenues was the previously mentioned one-time payment from a client financial institution. Without this one-time payment, 1994 revenues would have been $32,357,000, a reduction of $16,961,000 or 34% from 1993. This reduction in revenues is primarily attributable to the following:
. A $1,593,000 increase in asset-based fee revenues due to an increase over 1993 in the average accumulated value of assets generating fees.
. A $2,149,000, or 57%, reduction in salespersons' commissions also due to lower sales volume; and
. An additional $1,333,000 or 8% reduction in base operating expenses (excluding Florida legal fees) due to management of base operating expenses and the initial impact from the Company's restructuring. See "Restructuring".
. Offset, in part, by an increase of approximately $813,000 in legal fees primarily related to the Florida Department of Insurance administrative proceedings.
The Company's gross revenue rate is sensitive to changes in product mix which is impacted by fluctuations in interest rates. Fluctuations in gross revenue rates are not followed by a change in production-based expenses due to contractual obligations with financial institutions. Thus, changes in gross revenue rate will impact the Company's gross margin rate. As interest rates declined in 1993, the product mix moved toward a higher percentage of variable annuities and mutual funds with lower gross revenue rates. This resulted in a decrease in the gross revenue rate. Conversely, during 1994 interest rates increased and during the second half of the year, the amount of fixed annuities as a percentage of annuity sales also increased. As a result, the Company's gross revenue rate increased. If interest rates stabilize or increase further, management believes that the product mix will stabilize and potentially move towards an even higher percentage of fixed rate annuity products, but management is unable to predict interest rate movement and there can be no assurance that product mix will react as management anticipates. During 1994, management negotiated a change in the structure of commission payments it receives on variable annuities. As a result, beginning in the second quarter of 1994, the total compensation rate paid on variable annuities increased.
Restructuring. During the third quarter of 1994, the Company's Board of Directors approved a restructuring plan which was developed by management to enhance operating efficiencies by streamlining the Company's administrative and sales management functions. The primary reason for the restructuring plan was to bring costs in line with the decline in sales volumes by taking advantage of operating efficiencies. See "Trends and Uncertainties--Declining Revenues". The restructuring, which was completed in the fourth quarter of 1994, involved the consolidation of five service centers in Florida into a single center in Tampa, the consolidation of the Company's northern California operations into its corporate offices in San Diego, the centralization of mutual fund processing in San Diego and a reduction in the number of sales managers in relation to active sales people. Approximately 31 administrative employees were terminated as a result of the restructuring.
During the third quarter of 1994, management was notified that JMC's contract with Sacramento Savings would be terminated in the fourth quarter. This contract was in fact terminated effective October 31, 1994. Sacramento Savings was the last significant JMC client remaining from those existing at the time of the 1988 acquisition. This event caused management to conclude that the original amortization period was too long. Accordingly, the Company accelerated its amortization and wrote off $2,517,000 representing the remaining unamortized book value of the goodwill.
DECLINING REVENUES. During 1995, the Company experienced a continued decline in sales volume which generated a corresponding decrease in revenues. The primary reason for this decline was the transition and ultimate termination of the Company's relationship with Barnett. This accounted for 81% of the decrease in sales volume. See further explanation of revenue decline in "Management's Discussion and Analysis of Financial Condition and Results of Operations--Results of Operations--1995 Compared to 1994".
Management believes that interest rate competition also impacted sales volumes and revenues adversely. As long term interest rates declined, the Company's financial institution clients began aggressively pursuing deposit growth to meet loan demand by offering attractive interest rates on bank deposits which compete with the Company's products. Management believes that many conservative investors were attracted to the higher rates on FDIC insured deposits. In addition, as interest rates on fixed annuities came under increasing competition and the stock market rose, the product mix shifted to mutual funds and variable annuity products which provide the opportunity for customers to realize higher returns but pay lower commission rates to the Company. During the first quarter of 1995 the product mix was 65% fixed annuities, 15% variable annuities and 20% mutual funds compared to 17%, 31%, and 52%, respectively, for the fourth quarter of 1995.
We have audited the accompanying consolidated balance sheets of JMC Group, Inc. and subsidiaries as of December 31, 1995 and 1994 and the related consolidated statements of operations, changes in stockholders' equity, and cash flows for each of the three years in the 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.
The consolidated financial statements include the accounts of JMC Group, Inc. ("JMCG" or the "Company"), its wholly-owned subsidiaries, James Mitchell & Co. ("JMC"), and Priority Investment Services, Inc. ("Priority") (formerly known as Spear Rees & Co.). The Company is engaged in the business of selling annuities, insurance products, and mutual funds to the customers of banks, savings and loan associations and thrifts. Effective January 25, 1994, Spear Rees & Co. changed its name to Priority. Priority is registered with the Securities and Exchange Commission as a broker-dealer and during 1995 exclusively served customers of First Tennessee Bank National Association and its affiliates and correspondent banks. All significant intercompany transactions and balances have been eliminated in the consolidated financial statements.
The Company reflects a liability on its balance sheet identified as "Allowance for Contract Cancellations". This allowance is a recognition that certain commissions earned by the Company on the sale of annuities and insurance products must be returned to the provider companies when policies are surrendered within the first year after purchase. A formula is used to calculate the returned commission exposure. This formula was developed based on the Company's policy surrender patterns, actual commissions received by month, "known" unprocessed surrenders, and the availability of recoveries of client fees and sales personnel commissions.
Certain reclassifications have been made to the 1994 and 1993 financial statements in order for them to conform to the presentation for 1995.
As of December 31, 1994, the Company had available a $500,000 bank line of credit for short-term working capital requirements, which permitted borrowing at the bank's prime rate plus .5%. The line of credit required the Company to maintain a collateral account of $536,000 which was recorded as short-term investments as of December 31, 1994. The line of credit was terminated in December 1995.
During 1993, the Company entered into two separate agreements for the disposition of its specialist and securities brokerage businesses. One agreement was for the sale of TCW, Inc., Spear Investment Services, Inc. and Spear Insurance Services, Inc. to a former officer/stockholder of the Company for $1,554,017. An outstanding severance liability of $1,193,226 due to the former officer/stockholder was offset against the sales price of these entities at the time of the disposition. The second agreement was for the sale of the customer accounts of Spear Rees & Co. to a major discount brokerage firm for $3,500,000.
Amounts related to the dispositions, initially established as of December 31, 1992, were revised and a gain on disposal of securities businesses of $514,904, net of applicable taxes, was recorded during the year ended December 31, 1993.
The above schedule of minimum aggregate rentals represents lease payments on all of the Company's offices as if rents were paid on all offices through their respective lease terms less amounts to be received by the Company for offices which have been subleased.
On July 7, 1995, the Florida Department of Insurance (the "Department") issued a Final Order in its administrative proceeding against the Company's wholly-owned subsidiary, JMC, which was commenced on March 11, 1993. The enforcement of the majority of the Final Order has been stayed pending the outcome of its appeal and JMC has complied with all other aspects of the Final Order.
The Final Order is similar in many respects to the Recommended Order which was issued by an administrative hearing officer in August 1994. The Department found that JMC was not involved in an unlawful association with its Florida financial institution client with regard to the sale of annuities. JMC was ordered to cease and desist from certain advertising and sales practices which the Department found to be in violation of Florida insurance laws regarding deceptive advertising and sales practices. The Final Order also requires JMC to obtain an insurance agency license prior to engaging in any activity which by state law may be performed only by a licensed agent and revokes the Florida insurance license of James K. Mitchell, Chairman and Chief Executive Officer of the Company. No monetary damages or penalties were assessed against JMC or Mr. Mitchell.
The Company's broker-dealer subsidiary, Priority (formerly Spear Rees & Co.), has been named as a defendant in lawsuits arising out of the sale of real estate limited partnerships to customers of Spear Rees & Co. and Rees Financial Group, Inc. and Rees Capital Group, Inc. ("Rees") prior to 1992. Spear Rees & Co. was a full service brokerage firm which acquired the assets of Rees in September 1991. Subsequent to year-end, the Company reached a settlement with certain of the Plaintiffs in this case, while other claims remain the subject of NASD arbitration. The amounts to be paid subject to Bankruptcy Court approval in the settlement were accrued in the Company's financial statements and are included in accrued expenses and other liabilities as of December 31, 1995. Management does not believe that resolution of the NASD arbitration will have a material adverse effect on the Company.
In 1994, the Board of Directors authorized the purchase of up to 500,000 shares of the Company's common stock. During 1994, the Company repurchased 326,000 shares of common stock at a total cost of $643,310.
Of the 218,000, 243,000 and 128,000 options granted in 1995, 1994 and 1993 respectively, options granted under the Executive Plan amounted to 152,000 for 1995, 170,000 for 1994 and 37,000 for 1993. Options granted under the Employee Plan amounted to 66,000 in 1995 and 73,000 in 1994. The remaining shares in each of these years were granted under the 1983 Plan. The 512,000 options outstanding at December 31, 1995 became or will become exercisable as follows: 207,500 shares in 1995 and prior; 193,166 in 1996; 82,666 in 1997 and 28,668 in 1998. As of December 31, 1995, options to purchase 546,834 shares had been exercised under the 1983 Plan and options for 101,000 shares were outstanding. As of December 31, 1995, 436,000 shares were available for future grants under the Executive Plan and 653,000 shares were available for future grants under the Employee Plan. As of December 31, 1995, a total of 1,601,000 shares were reserved for issuance under the Plans.
Earnings per share was computed based upon the weighted average number of shares of common stock and common stock equivalents outstanding during the periods. The weighted average number of shares outstanding was adjusted to reflect the dilutive effect of the assumed exercise of stock options using the treasury stock method.
At December 31, 1995 and 1994, the components of the deferred income tax asset are as follows:
As described in Note 5, the Company terminated its relationship with Barnett Banks, Inc. effective October 31, 1995.
The Company's current contract with Central Fidelity expires on December 31, 1996, but is subject to termination or may be renewed upon written notice prior to that time.
The Board of Directors may effect the redemption of the rights at any time before the rights become exercisable at a nominal price payable in cash and/or shares of common stock.
Effective February 1 1996, the Company entered into an agreement with First Tennessee Bank pursuant to which such client has internalized the distribution of annuities and mutual funds. Although the Company will no longer provide a fully-managed alternative investment program to this client, effective with the new agreement, the Company will provide this financial institution administrative support for which it will receive fees based on the number of customers serviced and the amount of transactions processed on a monthly basis. Regardless of the volume administered, the Company will receive a minimum monthly fee of $25,000 through December 31, 1997. For the period from February 1, 1996 through December 31, 1996 the Company and the client bank will share asset-based fees on the block of annuities and mutual funds generated as of January 31,1996 in the same proportion as before the new agreement. Subsequent to that date, the Company will earn a larger portion of the shared fees. Based on this new agreement, no material liabilities were created which would have required an accrual as of December 31, 1995.
The Company entered into an agreement with USBA Holdings, LTD ("USBA") on January 28, 1996. This agreement was established to provide JMC with access to financial institutions through the consulting and other relationships established by USBA and its subsidiaries. In connection with this transaction, the Company paid USBA $1.25 million on January 28, 1996 to assist in the preparation and implementation of a five year marketing plan focusing on the establishment of relationships with new financial institution clients. The Company has the right to recover $1 million of the amount paid under certain circumstances. In addition, USBA was given warrants to purchase up to 1 million shares of the Company's common stock at $2.50 per share which may be adjusted to approximately $1.44 per share under certain circumstances. The warrants, which are exercisable after January 29, 1997, have an estimated value of $315,000. Amounts associated with this transaction will be deferred and amortized over future benefit periods.