During 1996, the Company closed its Virginia office upon the termination of business with Central Fidelity, and closed its Tennessee office, moving all customer service for Tennessee and New York to the Company's corporate office. This facility is suitable and adequate to meet the Company's requirements. The Company intends to either renegotiate a new lease for the existing facility or locate alternative suitable space upon expiration of the lease, as market conditions indicate. The following is the lease for the principal facility utilized in the Company's operations as of January 1, 1997:
Corporate Headquarters 9710 Scranton Road Suites 100 and 120 San Diego, CA 92121 Exp. Date: October 1998 Square Footage: 14,169
- -------- * Non-recurring items included in the quarterly net income (loss) figures for 1996 include: (a) expenses related to the proposed merger with USBA of $704,000 ($433,000 after-tax benefit) in the third quarter; and (b) net gain on sale of rights to future asset-based fees of $1,844,000 ($1,189,000 after-tax provision) and the write-off of the remaining unamortized balance of the Marketing Agreement with USBA, net of a settlement with USBA, in the amount of $515,000 ($332,000 after-tax benefit) in the fourth quarter.
** Non-recurring items included in the quarterly net income (loss) figures for 1995 include: (a) other revenues of $1,309,000 ($785,000 after-tax provision) for a third party's right to hire certain personnel in the first quarter; and (b) after-tax net gain on sale of rights to certain future asset-based fees of $1,987,000 in the third quarter and $361,000 in the fourth quarter. See further explanation of these items in "Management's Discussion and Analysis of Financial Condition and Results of Operations-- Results of Operations--1996 Compared to 1995."
The Company reported a net loss for the year ended December 31, 1996 of $503,000 (after providing for income tax benefit of $243,000) compared with net income of $1,741,000 (after providing for income taxes of $1,256,000) in 1995. Included in the 1996 and 1995 results were the following:
. Expenses net of recoveries related to a Marketing Plan and Marketing Agreement as well as a proposed merger with USBA (all included in 1996) as follows:
. Expenses related to the proposed merger including primarily legal, accounting, investment banking and printing expenses of $884,000 ($570,000 or $0.09 per share after estimated tax benefit); and
. 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. The net gain is a result of a purchase price of $4.05 million less costs associated with the loss of the Company's Florida operations of $136,000.
Total revenues for 1996 were $11,845,000 compared to revenues of $20,372,000 in 1995, a decrease of $8,527,000 or 42%. As previously stated, revenues for 1996 and 1995 include net gains on the sale of rights to certain asset-based fee revenues of $1,844,000 and $3,914,000, respectively, and 1995 revenues include a payment of $1,309,000 for the right to hire certain employees and certain other services. In addition to these revenue items, the Company earned transition fee revenue of $250,000 and $538,000 in 1996 and 1995, respectively. These transition fees, which were negotiated by the Company, were intended to cover the cost of operations during a transitional period prior to termination of the Company's relationships with certain financial institution clients. 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 transitions are included in total operating expenses.
. A decrease of approximately $2,161,000 in asset-based fee revenue in 1996 compared to 1995. This decrease is primarily a result of the sale of the rights to certain future asset-based fee revenues for its Florida-based client at the end of August 1995.
Total expenses for 1996 were $12,592,000 compared to $17,375,000 in 1995. Excluding the previously described one-time charges of $884,000 in merger- related expenses and $750,000 net loss on a marketing agreement, total expenses for 1996 would have been $10,958,000, a decrease of $6,417,000 or 37%, when compared to 1995 expenses. This drop in total expenses is primarily attributable to the following:
. An additional $3,661,000 or 36% reduction in base operating expenses as a result of the following:
. The reconfiguration and ultimate termination of the Company's Florida operations in August 1995.
Fixed annuities achieve a higher gross margin rate because the Company receives a higher gross revenue rate on fixed annuities but makes payments to its financial institution clients and sales personnel at a constant rate. Mutual Funds achieve the lowest gross margin rate due to the significantly lower gross revenue rate paid on these products, even though the payout to the Company's financial institution clients is a fixed percentage of the gross revenue rate. During 1996, variable annuity and mutual fund sales comprised 77% of total sales compared to 58% of total sales in 1995, resulting in a decline in the gross margin rate on total product sales in 1996 from 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.
. The reconfiguration and ultimate termination of the Company's Florida operations contributed to $241 million or 81% of the sales volume decline. The Company terminated its relationship with its Florida financial institution client in August, 1995.
. Declining interest rates and increased competition, primarily from Certificates of Deposits during 1995 also contributed to the sales decline.
. 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 $783,000 or 48% reduction in salesperson's commissions also due to lower sales volume; and
. A reduction in legal fees related to the Company's administrative proceeding with the Florida Department of Insurance. The Company incurred significant legal expenses in connection with the five-week administrative hearing which occurred in February and March of 1994.
. The Company pays out to its financial institution clients a higher percentage of its asset-based fee revenue than it does on front commission revenue. Thus, as asset-based fee revenue becomes a larger percentage of total revenue (32% in 1995 vs. 17% in 1994) the total payout percentage to the financial institution will increase. The increased percentage of revenues paid out offset the decrease due to decreased revenues generated.
Fixed annuities achieve a higher gross margin rate because the Company receives a higher gross revenue rate on fixed annuities but makes payments to its financial institution clients and sales personnel at a constant. Mutual Funds achieve the lowest gross margin rate due to the significantly lower gross revenue rate paid on 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.
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. During 1995 the Company realized the benefits from this restructuring in terms of a reduced base operating overhead at the beginning of the year. In addition, with the centralization of support functions the Company was able to react quickly to effect further cost reductions as sales volumes continued to decline, primarily as a result of the reconfiguration and ultimate termination of its Florida operations.
As of December 31, 1996, the Company had cash and cash equivalents of approximately $4,683,000, a decrease of $1,150,000 from $5,833,000 in cash and cash equivalents at December 31, 1995.
. The Company generated approximately $1,800,000 related to the net gain on sale of rights to future asset fees. This amount was generated by a sales price of $2.1 million less $300,000 of such sale which was received in the first quarter of 1997. The approximately $250,000 in accrued costs associated with this transaction will impact cash flow primarily in 1997.
The Company is actively pursuing new client financial institutions. Management believes that, as new client financial institutions are acquired, the Company will benefit from spreading its base operating expenses over a larger revenue base. However, the exact amount and nature of this benefit cannot be ascertained with any certainty and will depend, in large part, upon the nature of the services provided to new client financial institutions and sales volume generated. Depending upon the nature of these services and sales volume produced, the Company may need to increase base operating expenses from their current levels. In any event, under the new consolidated structure, the Company believes it has the ability to add new clients with significantly reduced start-up costs compared to historical amounts. In addition, the Company will service these new relationships on a more centralized basis to take full advantage of operating efficiencies. Management does not anticipate opening a new distribution center for each new client financial institution in the future.
The Company sells financial products, primarily annuities and mutual funds. Under its arrangements with the provider companies, the Company earns commissions on each sale and is entitled to ongoing asset-based
fees and 12b-1 fees on the average accumulated value of assets. Under arrangements with most of its client financial institutions, the Company is also required to pay an asset-based fee which, although varying by product, amounts to approximately 50-55% of the fee earned from its provider companies for as long as the marketing relationship with the financial institution continues. The provisions for payment of asset-based fees to client financial institutions after the termination of the marketing relationship varies from institution to institution and depends upon the manner in which the relationship is terminated. At December 31,1996, the accumulated value of assets on which the Company will receive asset-based fee revenue was approximately $580 million (including mutual funds paying 12b-1 fees). Asset- based fee revenue and asset-based fee expense to financial institutions amounted to approximately $2,705,000 and $1,558,000, respectively, in 1996. The reduction in these amounts as compared to 1995 is primarily the result of the sale of the rights to asset-based fees generated by the Florida operation. Due to the sale of rights to future asset-based fees to Central Fidelity at the end of 1996, future asset fee revenues and asset fees expensed to financial institutions will be lower in 1997. During 1996, the Central Fidelity assets, for which the right to future asset-based fees was sold to the bank on December 31, 1996, generated $849,000 in asset fee revenues but also required $631,000 in fees to the bank for a net to JMC of $218,000.
Future fees, both those due from the provider company and those due to financial institution clients, are not reflected as an asset or a liability in the Consolidated Balance Sheets. However, management does believe a value exists related to the present value of the projected future net asset fees to be retained by the Company. Such projected future net asset fees are a function of the projected accumulated value of assets in-force multiplied by the net asset fee rate (gross asset fee rate less amount committed to the financial institution). The current value to the Company would then be the discounted present value of such projected future asset fees less the present value of an estimated cost to service the customers making up such in-force assets. Management's belief that a present value for such future asset-based fees exists and the estimates used to calculate the range of such value are supported by the sale of the right to these types of future fees in 1996 and prior years. The projected value of the future asset-based fees on the remaining block of business at December 31, 1996 is based on assumptions as to growth, persistency and risk adjusted discount rates. The assumptions as to persistency and growth of the business are based on historical data maintained by the Company since its inception. The discount rate used of between 8% and 10% is based on a risk-free rate of return plus a nominal additional factor for risk (taking into account that risk factors are materially covered by the estimated persistency and growth rates). Management believes the value of these net future revenues is appropriately estimated at $6 million to $8 million, pre-tax, based on the Company's valuation calculations. Such estimated value is based on realization of the estimates on the variables used in the calculation (which are consistent with estimates used in prior sales of future rights) and the actual realization, if any, could be higher or lower than this range.
Regulatory Environment. The Company and its financial institution clients operate in a highly regulated environment. Both state and federal laws govern the manner in which insurance agencies, broker-dealers and financial institutions may make annuities, insurance products and mutual funds available to customers of financial institutions. Recently, federal banking regulators, the Securities and Exchange Commission and the National Association of Securities Dealers, Inc. have focused attention in this area. Changes in, or interpretations of, the laws and regulations governing these activities or changes in the implementation or enforcement of such laws and regulations could affect the ability of, and the means by which, the Company and its financial institution clients make annuities, insurance products and mutual funds available to customers of banks, savings and loan associations and thrifts.
Based on a continuing trend of the larger financial institutions internalizing their alternative investment product distribution and not utilizing services of third-party marketing firms like the Company and the exposure to low production volumes at the smaller financial institutions, the Company has taken a strategic approach which includes the following:
. Target the small to medium sized financial institutions with the Company's dual employee program. This offers the bank all of the benefits of the fully managed program but requires the bank to employ the sales force and pay salaries and benefits of such sales force.
. Offer services which are logically outsourced by financial institutions to assist their alternative product distribution programs. Utilizing the Company's reduced cost structure, these services can be offered to financial institutions with competitive pricing while still allowing the Company to realize adequate profit margins.
In general, these new type of services offered by the Company generate less gross revenue than the traditional fully managed program. However, with a significantly reduced cost commitment, management believes the Company can generate comparable pre-tax contributions and not be subject to the same production break-even risk as was the case in the past.
The Company's certificate of incorporation also authorizes 5,000,000 shares of no par value preferred stock, none of which has been issued.
The consolidated financial statements include the accounts of JMC Group, Inc. ("JMCG" or the "Company"), its wholly owned subsidiaries, JMC Investment Services, Inc. ("JMCI") (formerly Priority Investment Services, Inc. which was formerly Spear Rees & Co.) and James Mitchell & Co. and its subsidiaries ("JMC"). The Company is engaged in the business of selling and providing support services for the sales of 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 Investment Services, Inc. Effective July 23, 1996, Priority Investment Services, Inc. changed its name to JMCI. JMCI is registered with the Securities and Exchange Commission and the National Association of Securities Dealers (NASD) as a broker-dealer.
In 1988, JMCG acquired all of the outstanding stock of JMC in a business combination accounted for by the purchase method of accounting. The total cost of the acquisition exceeded the fair value of the net assets acquired and the excess was allocated to the cost of goodwill which was originally being amortized over ten years. This amortization period was derived from the terms of the contracts that JMC had with its remaining financial institution clients at the time of the acquisition. During the third quarter of 1994, the Company was notified of the termination of its contract with the last significant client remaining from those existing at the time of the 1988 acquisition. Accordingly, the Company accelerated its amortization and wrote-off $2,516,683 representing the remaining unamortized book value of goodwill during 1994.
JMC Financial Corporation, James Mitchell & Co.'s broker-dealer subsidiary ("JMC Financial"), began self-clearing mutual fund transactions for itself and JMCI at the end of 1994. As such, JMC Financial carries customer funds for transactions which have been initiated but not settled as of the balance sheet date. Cash of $1,247,231 has been segregated in a special bank account for the benefit of customers under Rule 15c3-3 of the Securities and Exchange Commission.
Statement of Accounting Standards No. 121 "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," was adopted by the Company in 1996. The standard requires that impairment losses be recognized when the carrying value of an asset exceeds its fair value.
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 and liabilities and
disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
The Company recognizes and records commission revenue when a sale has been consummated. Annuity and insurance sales are deemed to be consummated when proof of premium payment, the completed application and supporting documentation have been received in the Company's distribution/service center. Mutual fund sales are recorded on the trade date of such sale. Front commission revenues for 1996, 1995, and 1994 were $6,470,807, $9,447,074, and $26,628,216, respectively. Annuity and insurance sales commission revenue is reported net of chargebacks. The Company recognizes and records asset-based fee revenues as they become due from the provider companies, based upon the average accumulated value of assets in force. Asset-based fee revenues for 1996, 1995 and 1994 were $2,705,055, $4,865,633, and $5,519,339, respectively. Beginning in 1996, the Company began providing support services related to the sale of annuities and mutual funds with its Tennessee client. Revenue is recognized when services have been performed. Service related fees for 1996 were $365,866 and are included in commission revenue for the year.
During the third quarter of 1995, the Company signed an agreement to terminate its Florida operations. As part of the termination agreement, the Florida-based financial institution exercised its right to purchase certain future asset-based fee revenues from the Company. The Company recorded a net gain of $3,914,350 from the sale.
For 1995 and 1994, other income includes revenue received from the Company's Florida-based financial institution client, for the right to hire certain JMC employees of $1,308,500 and $1,000,000, respectively. In addition, 1995 other income includes fees of $538,200 paid to the Company by the same financial institution to transition the sales operation to the financial institution. In 1996, other income includes fees of $250,000 paid to the Company by the Company's Virginia-based financial institution client to transition the sales operations to the financial institution. Costs incurred by the Company to facilitate such transactions are included in expenses for each respective year.
Restructuring expenses represent costs specifically associated with the Company's restructuring, which was approved in the third quarter of 1994, including employee severance, asset write-downs and lease write-offs for closed offices.
The entire $1.25 million payment and recovery of $500,000 are included in the line "Marketing plan payment--net of recovery" and thus, amortization of the plan payment included in depreciation and amortization for the first three quarters of 1996 has been reclassified to this line for more appropriate presentation of material operating transactions.
The Company has incurred most of the anticipated costs of the appeal and management believes that amounts accrued as of December 31, 1996 will be sufficient to cover any additional costs. Effective October 1995, JMC concluded its relationship with its Florida financial institution client, Barnett Banks, Inc., and is not presently doing business in the State of Florida. As described in Note 8, Barnett Bank accounted for revenues of $10,239,630 and $20,176,680 during 1995 and 1994, respectively.
The assumption regarding the stock options issued in 1995 and 1996 was that 100% of such options vested in the respective year rather than the actual vesting schedules which range from one year to three years.
The impact of outstanding non-vested stock options granted prior to 1995 has been excluded from the pro forma calculation; accordingly, the 1996 and 1995 pro forma adjustments are not indicative of future period pro
forma adjustments, when the calculation will apply to all applicable stock. The estimated fair value of options granted is subject to the assumptions illustrated below and if the assumptions changed, the estimated fair value amounts could be significantly different.
The fair value of options granted during 1996 and 1995 was estimated at $11,000 and $82,000, respectively, on the date of grant using the Black- Scholes option-pricing model with the following weighted average assumptions by respective year:
In 1983, the Company adopted a Stock Option Plan (the "1983 Plan") pursuant to which options to purchase an aggregate of 1,000,000 shares of common stock could be granted to directors, officers and key employees. The 1983 Plan expired by its terms in November 1993, although there are still options outstanding under the 1983 Plan. In 1993, the Company adopted the 1993 Executive Stock Option Plan (the "Executive Plan") pursuant to which options to purchase an aggregate of 750,000 shares of common stock may be granted to officers and directors of the Company and its subsidiaries and the 1993 Employee Stock Option Plan (the "Employee Plan") pursuant to which options to purchase an aggregate of 750,000 shares of common stock may be granted to employees of the Company and its subsidiaries (collectively, the "1993 Plans" and, together with the 1983 Plan, the "Plans"). Under the Plans, incentive stock options, as defined in section 422A of the Internal Revenue Code, or non-qualified stock options may be granted. Non-employee directors receive formula grants of options pursuant to the Executive Plan.
Earnings per share for 1996 and 1994 were computed based upon the weighted average number of shares of common stock during such periods. Earnings per share for 1995 was computed based upon the weighted average number of shares of common stock and common stock equivalents outstanding during the period. The weighted average number of shares outstanding for 1995 was adjusted to reflect the dilutive effect of the assumed exercise of stock options using the treasury stock method.
In February of 1997, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 128, Earnings Per Share (EPS). This statement requires the presentation of earnings per share to reflect both "Basic EPS" as well as "Diluted EPS" on the face of the income statement. In general, Basic EPS excludes dilution created by stock equivalents and is a function of the weighted average number of common shares outstanding for the period. Diluted EPS does reflect the potential dilution created by stock equivalents if such equivalents are converted into common stock and is calculated in the same manner as fully Diluted EPS illustrated in Accounting Principals Board Opinion No. 15 "Earnings Per Share" ("APB No. 15").
The Company will be required to adopt the new method of reporting EPS for the year ending December 31, 1997. The Company's EPS as reflected in this document includes Basic EPS for 1996 and 1994 and Diluted EPS for 1995 due to the rules of APB No. 15 and the use of stock equivalents only when they are dilutive.
Based on the Company's capital structure, the anticipated results of implementing SFAS No. 128 would reflect EPS materially in the same manner as currently reported.
Effective February 1, 1996, the Company's level of service provided to First Tennessee Bank was reduced from a fully managed alternative investments program to an administrative support program.
Generally, each right may be exercised ten days after any person or group ("Acquirer") acquires beneficial ownership of 20% of the outstanding shares of common stock, or ten days after an Acquirer announces a tender offer or other business combination, which would result in the Acquirer obtaining beneficial ownership of 20% or more of the voting power of the Company, unless such tender offer or acquisition is made with approval of the Board of Directors.