Cumberland leases office space from a company owned by the Chairman of the Board, Mr. Francis M. Williams, at a monthly rate of $7,254 pursuant to a lease that was executed March 1, 1997 and is effective through December 31, 2001.
(1) Pro forma net income (loss) per share (unaudited) for 1994 and 1993 has been calculated based on the 4,039,780 shares of Cumberland Common Stock that were outstanding after the Distribution. The 1997, 1996 and
1995 net income (loss) per share amounts have been computed based on the actual weighted average number of shares outstanding during the respective years.
During the year ended December 31, 1997, net earned premium income increased by 49 percent to $5,684,000 from $3,808,000. Direct premiums earned from nonaffiliates were $5,836,655 and $1,149,377 for 1997 and 1996, respectively, representing an increase of $4,687,278 or 408 percent.
Direct (net) $ 5,202,001$ 1,854,270 181% Assumed (net) 1,032,260 2,513,775 (59% ) -------------- --------------
Total . . . . $ 6,234,261$ 4,368,045 43% ============== ==============
During the year ended December 31, 1997, operating expenses increased to $3,903,476 from $3,255,805 in 1996. The increase is due to expenses incurred in the continuing research and development of Cumberland's Bond Program and additional personnel employed to direct market its insurance products. Management believes that future programming updates to BondPro and other related expenses will remain consistent with 1997 operating expenses.
The Company s effective tax (benefit) rate was -0- percent for 1997 and 1996. The net operating loss carryforward at December 31, 1997 is $841,568. The deviation from statutory rates for 1997 and 1996 primarily relates to the Company s establishment of a valuation allowance on a portion of the net operating loss, the future realization of which is uncertain.
Net reinsurance premiums earned through the Pooling Agreements were $2,693,418 and $4,440,632 for 1996 and 1995, respectively, representing a decrease of $1,747,214, or an overall 39 percent decrease in assumed premiums. Net direct premiums earned were $1,114,901 and $627,683 for 1996 and 1995, respectively, representing an increase of $487,218 or 78 percent.
During 1996, direct premiums written by CCS increased while assumed premiums decreased as a result of the marketing direction of the Company. CCS's direction is to penetrate the direct market while decreasing the volume of reinsurance premiums
Direct, net . $ 1,854,270 $ 881,683 110% Assumed, net 2,513,775 3,899,884 (36%) -------------- --------------
Other revenues for the year ended December 31, 1996 increased to $2,039,331 from $1,198,249 for the year ended December 31, 1995, an increase of 70.1%. The increase is a direct result of an increase of $612,350 in commission income earned by subsidiary surety agencies, and an increase of $228,729 in consulting revenues derived from Qualex Consulting, Inc. a claims consulting company which was formed in November 1994.
The capacity of a surety company to underwrite insurance and reinsurance is based on maintaining liquidity and capital resources sufficient to pay claims and expenses as they become due. Based on standards established by the National Association of Insurance Commissioners (NAIC) and promulgated by the Florida Department of Insurance, the Company is permitted to write premiums up to an amount equal to three times its statutory surplus, or approximately $15,134,000 and $15,104,000 at December 31, 1997 and 1996, respectively. Therefore, based upon statutory guidelines, the Company could increase earned premiums by approximately $9,500,000 in 1998 in addition to the amount earned in 1997.
The primary sources of liquidity for the Company are funds generated from commissions, surety premiums, investment income, and proceeds from sales and maturities of portfolio investments. The principal expenditures are payment of losses and loss adjustment expenses, insurance operating expenses, and commissions.
Net cash (used in) provided by financing activities was $(670,889) $(803,772) and $570,263 for the years ended December 31, 1997, 1996 and 1995, respectively. Financing activities consist of purchases of treasury stock, short-term borrowings and repayment during 1997, 1996 and 1995 on notes payable that are a result of the 1995 purchase of two agencies.
The Company has developed an in-house surety administrative system BondPro . BondPro is an agency surety bond administration system that issues bonds, tracks underwriting, and accounting and reporting from its database. BondPro is a window based program and is year 2000 compliant. The Company is aware of the issues that many computer systems will face as the millennium (year 2000) approaches. The Company, however, believes that its own internal software and hardware is year 2000 compliant. The Company believes that any year 2000 problems encountered by procurement agencies, and other customers and vendors are not likely to have a material adverse effect on the Company s operations. The Company anticipates no other year 2000 problems which are reasonably likely to have a material adverse effect on the Company s operations. There can be no assurance, however, that such problems will not arise.
The consolidated financial statements include the estimated liability for unpaid losses and loss adjustment expenses (LAE) of CCS. The liabilities for losses and LAE are determined using case-basis evaluations and statistical projections and represent estimates of the ultimate net cost of all unpaid losses and LAE incurred through the end of the period. These estimates are subject to the effect of trends in future claim severity and frequency. These estimates are continually reviewed and, as experience develops and new information becomes known, the liability is adjusted as necessary; such adjustments, if any, are included in current operations.
Reconciliation of Liability for Losses and Loss Adjustment Expenses ----------------------------------------------------------------- The following table provides a reconciliation of the beginning and ending liability balances, net of reinsurance recoverable, for 1997, 1996 and 1995 to the gross amounts reported in Cumberland s balance sheets:
Liability for losses and LAE, net of reinsurance recoverable on unpaid losses, at beginning $ 594,922 $ 1,052,547 $1,625,703 of year . . . . . . . . . . ----------- ----------- ---------- Provision for losses and LAE for claims occurring in the current year, net of reinsurance . . . . . . . . 1,743,117 1,008,640 1,486,546
Losses and LAE payments for claims, net of reinsurance, occurring during: The current year . . . . 553,629 422,544 161,279 Prior years . . . . . . 440,479 1,705,721 1,657,423 ----------- ----------- ---------- 994,108 2,128,265 1,818,702 ----------- ----------- ----------
Reinsurance recoverables on unpaid losses at end of year 1,157,369 1,396,874 1,299,257 ----------- ----------- ----------
Cumberland experienced a $49,000 and $662,000 a deficiency for losses and loss adjustment expenses in 1997 and 1996, respectively, and experienced a redundancy of $241,000 in 1995, for losses incurred in prior years. The deficiency in 1997 principally resulted from settling case basis reserves established in prior years for amounts that were more than expected. The deficiency in 1996 is a result of additional claims expense on a 1993/94 pooling agreement. The redundancy in 1995 principally resulted from settling case basis reserves established in prior years for amount less than expected.
Reinsurance recoverables on unpaid losses and LAE . . . . . . . . . . . . . . . . . . 1,157,369 --------------
Year ended December 31 ---------------------------------- 1997 1996 1995 ----------- ----------- ---------- Operating activities: Net income loss . . . . . . $ 170,520 $ (582,744) $ (228,210) Adjustments to reconcile net loss to net cash (used in) provided by operating activities: Amortization/accretion of investment premiums and discounts . . . . . (2,788) (6,052) (10,137) Policy acquisition costs amortized . . . . . . 1,778,808 1,532,355 2,380,140 Policy acquisition costs deferred . . . . . . . (1,956,364) (1,732,272) (2,234,669) Depreciation and amortization . . . . . 370,553 378,447 278,008 Net realized (gain) on sales of investments (201,863) (117,824) (124,004) Provision for bad debts 113,120 - 67,209 Accrued interest on term notes, net . . . . . . - 404,337 454,772 (Increase) decrease in: Accrued investment income . . . . . . 6,831 (2,421) (40,629) Reinsurance recoverable (425,900) 709,464 51,126 Trade receivables . . (852,285) (139,675) 1,644,946 Other assets . . . . . 57,079 (232,148) (89,891) Increase (decrease) in: Policy liabilities and accruals . . . . . 1,325,672 319,801 (1,235,291) Ceded reinsurance payable . . . . . . 1,690,766 165,504 (1,930,993) Accounts payable and other liabilities (148,246) (713,730) 641,933 ----------- ----------- ---------- Net cash (used in) provided by operating activities 1,925,903 (16,958) (375,690)
Amounts recoverable from reinsurers for unpaid losses are presented as an asset in the accompanying consolidated financial statements.
Commissions related to agency activity are generally recognized at the later of the effective date of the policy or the date billed.
The Company s provision for income taxes is computed under the provisions of Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes. Under the method required by Statement No. 109, 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. Under Statement No. 109, the effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
The Company files a consolidated tax return that includes all of its subsidiaries. See Note 9.
Affiliate accounts receivable represents funds advanced and joint expenses that have not yet been reimbursed from KC and its affiliates. These receivables are paid periodically and no interest is charged on the outstanding balances which are payable on demand. Also included in affiliate accounts receivable at December 31, 1997 and 1996 is a $135,000 note receivable from the Company s Chairman of the Board of Directors. No interest is charged on the note which is payable on demand.
At December 31, 1996, the Company was a guarantor for $2.25 million of borrowings made under the terms of a loan agreement entered into on December 8, 1995 between KC and a bank. During
At December 31, 1997 and 1996, the Company had $5.3 million and $5.0 million, respectively, in restricted investments (fixed maturity securities and short-term investments). Restricted investments primarily represent funds held as collateral in connection with reinsurance trust agreements and funds held as required under statutory regulations by state insurance departments.
Year ended December 31 ---------------------------------- 1997 1996 1995 ----------- ----------- ---------- Fixed maturity and equity securities . . . . . . . . $ 344,459 $ 388,700 $ 387,859 Mortgage loans on real estate 4,105 4,613 4,658 Short-term investments, including cash and cash equivalents . . . . . . . . 70,857 50,684 74,601 ----------- ----------- ---------- 419,421 443,997 467,118 Less investment expenses . . (11,371) (40,078) (69,738) ----------- ----------- ---------- Net investment income . . . . $ 408,050 $ 403,919 $ 397,380 =========== =========== ==========
The carrying amounts and fair values of the Company's financial instruments at December 31, 1997 are as follows:
December 31, 1997 ----------------------------- Carrying Amount Fair Value -------------- -------------- Assets: Cash and cash equivalents, including short-term $ 2,127,523 $ 2,127,523 investments . . . . . . . . Investments . . . . . . . . . 6,145,083 6,164,835 Accounts receivable . . . . . 2,210,397 2,210,397
1997 1996 -------------- ------------- Purchased customer accounts $ 1,084,041 $ 1,084,041 Noncompete agreements . . . . 234,000 234,000 Goodwill . . . . . . . . . . 926,661 926,661 Deferred state admission costs and other . . . . . . 489,365 489,365 -------------- -------------- 2,734,067 2,734,067 Less accumulated amortization (1,053,434) (777,343) -------------- -------------- $ 1,680,633 $ 1,956,724 ============== ==============
During 1995, the Company entered into a margin loan agreement with an investment firm which enabled the Company to borrow funds up to a percentage of the Company s invested funds ($518,000 at December 31, 1995). As of December 31, 1995, the Company had $406,607 outstanding under the agreement. As of December 31, 1995, the Company had preferred and common stocks with an estimated fair value of $1,160,500 on account with the investment firm. The loan bears interest at .75% to 2.50% above the investment firm's base rate (8.75% at December 31, 1996). For the year ended December 31, 1995 and 1996, the Company incurred interest expense of $28,612 and $27,389 respectively, under the terms of the agreement. During 1996, the Company paid off this margin loan.
1997 1996 ---------------------------- Note payable due March 1, 2002 $377,077 $ 423,265 Note payable due June 30, 2010 1,041,443 1,110,000 ---------------------------- $1,418,520 $ 1,533,265 ============================
In connection with the acquisition of certain agencies during 1995 (see Note 16), the Company entered into two notes payable with the agencies previous owners. One note is due March 1, 2002 and bears interest at 8% through February 28, 2001 and 10% thereafter. Principal payments of $150,000 are due annually beginning March 1, 2000. The other is due June 30, 2010 and bears interest at 8% through March 31, 1999 and 9% thereafter. Principal payments of $40,000 are due annually for three years beginning January 5, 1996. Principal payments of $11,104 are payable monthly beginning April 1, 1997.
In 1992, CTI entered into a term note agreement with KC for the outstanding amount of a debenture, including interest arrearage of $4,291,049. The term note was pari passi with the other debts of CCS, bearing interest at 10 percent of the unpaid principal and interest and was due on October 1, 2002. Interest and principal were due quarterly with minimum payments equal to one half of net earnings before interest and federal income taxes.
Effective October 1, 1996, CTI issued 1,723,290 shares at the fair value of $3.00 per share of its common stock to Kimmins Corp. (f/k/a Kimmins Environmental Service, Corp.) in exchange for surrender of the term note payable in the amount of $5,169,870 (including accrued interest).
There was no income tax expense or benefit recognized in 1997, 1996 or 1995.
A reconciliation of the federal statutory income tax rate applied to pre-tax income (loss) and the effective income tax benefit rate is as follows:
1997 1996 1995 ----------- ----------- ---------- Federal statutory tax rate 34.0% (34.0)% (34.0)% State income taxes, net of federal income tax benefit . . . . . . . . 3.9 (3.7)% (4.4) Income exempt from taxation and dividend exclusions . . . . . . . (7.2) (10.1) (8.5) Differences between income statement and tax return 69.3 - 10.7 Utilization of NOL carryforwards . . . . . (110.1) 44.4 34.6 Nondeductible expenses . 10.1 3.4 1.6 ----------- ----------- ---------- Effective tax rate . . . - - - =========== =========== ==========
1997 1996 ---------------------------- Deferred tax liabilities: Deferred policy acquisition costs . . . . . . . . . . . $ 305,836 $ 239,022 Losses and loss adjustment expenses . . . . . . . . . - 31,269 -------------- -------------- Total deferred tax liabilities 305,836 270,291 ============================ Deferred tax assets: Outside basis difference in investments . . . . . . . . 40,620 - Amortization of intangibles 90,857 63,341 Unearned premiums . . . . . . 321,557 140,143 Losses and loss adjustment expenses . . . . . . . . . 19,050 - Net operating loss carryforward . . . . . . . 316,682 746,174 Alternative minimum credit carryforward . . . . . . . 15,555 15,555 Other, net . . . . . . . . . 8,931 347 ---------------------------- 813,252 965,560 Less valuation allowance . . (507,416) (695,269) ---------------------------- Net deferred tax assets . . . . $ 305,836 $ 270,291 ============================
Statutory capital and surplus $ 5,044,527 $ 5,034,662 $ 5,134,923 Net income (loss) . . . . . . $ 959,304 $ (293,204)$ 897,955
Under applicable state insurance statues, CCS must maintain minimum capital and surplus of $2,100,000 (as of December 31, 1997). In addition, under applicable state laws and regulations, CCS is restricted from paying dividends to the extent of surplus profits less any dividends that have been paid in the preceding twelve months or net investment income for the year, whichever is less, unless the Company obtains prior approval from the Florida Department of Insurance. As of December 31, 1997, no dividends from CCS are available for payment to the Company without the prior approval of the Department of Insurance.
CCS assumes reinsurance primarily from a pooling agreement for which CCS assumes 10 percent of the risk with a maximum exposure to CCS of $125,000 per bond. CCS is still receiving residual revenues from a pooling agreement for which CCS assumes 25 percent and 20 percent of the risk with a maximum exposure to CCS of $125,000 and $600,000 per bond, respectively.
CCS also cedes reinsurance to other insurance companies. Reinsurance does not relieve an insurer of its liability to the policyholder for the full amount of the policy, however, the reinsurer is obligated to the insurer for the portion assumed by such reinsurer. The Company cedes on an excess of loss treaty 95% of the risk insured with a maximum exposure to the Company of $195,000 per principal. The Company continues to have exposure to risk for reinsurance ceded in the event that the reinsurer is unable to meet its obligation under the reinsurance agreement in force.
During April 1994, CCS amended one of its reinsurance agreements to be retroactive for policies effective October 1, 1993. The agreement was previously effective beginning January 1, 1994. Under this agreement, CCS assumes 10% (effective April 1, 1996), 12.5% (effective April 1, 1995); 25% prior to that date)
Loss and loss adjustment expenses in 1997, 1996, and 1995 are summarized as follows:
One of the Company's subsidiaries is a claimant in a proceeding against the United States Navy before the Armed Services Board of Appeals seeking reimbursement of approximately $1 million related to the subsidiary's performance under a performance and payment bond related to the construction of a building for the United States Navy. Management believes, based on advice from its counsel, that it will be successful in this claim and, accordingly, has recorded a reinsurance recoverable. The Company is currently awaiting a decision in this case.
Effective May 22, 1996, the Company granted options to purchase 20,000 shares to the President of "CCS" at a price of $.75 per share. As of December 31, 1997, 8,000 of the options were exercisable. The Company granted options on July 26, 1996 to purchase 2,500 shares to an employee at a price of $1.00 per share. As of December 31, 1997, 1,000 of the options were exercisable.
On April 1, 1996, CTI adopted a defined contribution 401(k) plan covering substantially all employees. Under the plan, the Company makes contributions equal to one percent of the participant's compensation, not to exceed six percent of the participant's annual compensation. The Company's contributions to the plan totaled $9,367 and $7,288 in 1997 and 1996, respectively.
Effective February 28, 1995, the Company acquired substantially all of the assets of The Surety Group, a Georgia insurance agency specializing in the sales of surety bond policies. The purchase price of $850,000 is comprised of $325,000 paid at closing, the assumption of $25,000 of capital lease obligations and a $500,000 note payable to the seller. The purchase agreement provides that the purchase price may be reduced, but not increased, based on the agency s operating results during the three-year period ending February 28, 1998.
Revenues . . . . . . . . . $ 6,960,343 Net loss . . . . . . . . . $ (341,347) Net loss per share . . . . $ (.09)
SCHEDULE I - SUMMARY OF INVESTMENTS - OTHER THAN INVESTMENTS IN RELATED PARTIES CUMBERLAND TECHNOLOGIES, INC. DECEMBER 31, 1997 Column A Column B Column C Column D ----------------------------- ----------- ----------- ----------
Amount at Which Shown in the Balance Type of Investment Cost Value Sheet ----------------------------- ----------- ----------- ----------
Total . . . . . . . . . . . . 3,551,313 3,590,459 3,590,459
Industrial and miscellaneous . . . . 1,401,727 1,498,783 1,498,783 ----------- ----------- ----------
Total . . . . . . . . . . . . 982,528 1,002,280 982,528 Residential mortgage loan on real estate . . . . . . . . 45,314 45,314 45,314
Total investments . . . . . . $ 6,334,875 $ 6,488,829 $6,469,077 =========== =========== ==========
Management fees from wholly-owned subsidiaries . . . $ 88,378 $ 62,557 $ - Interest income from subsidiary . . . . 271,875 300,000 300,000 ------------- ------------- -------------
Selling and administrative expenses . . . . 294,901 133,834 151,189 Interest expense to affiliates . . . - 372,066 454,772 ------------- ------------- -------------
Income (loss) before income taxes and equity in net income (loss) of subsidiaries . . . 65,352 (143,343) (305,961)
Federal and state income tax benefits - - - Equity in net income (loss) of subsidiaries . . . 105,168 439,401 77,751 ------------- ------------- -------------
Net income (loss) . . $ 170,520 $ (582,744)$ (228,210) ============= ============= =============
Condensed Statements of Cash Flows 1997 1996 1995 ---------------------- ------------- ------------- -------------
Net cash provided by operating activities - - - ------------- ------------- ------------- Cash and cash equivalents, beginning of year - - - ------------- ------------- -------------
Organization - Cumberland Technologies, Inc. ("CTI" or "Cumberland"), (f/k/a Cumberland Holdings, Inc.) a Florida corporation, was formed on November 18, 1991, to be a holding company and a wholly-owned subsidiary of Kimmins Corp. ("KC"). Effective October 1, 1992, KC contributed all of the outstanding common stock of two of its wholly-owned subsidiaries, Cumberland Casualty & Surety Company ("CCS") and Surety Specialists, Inc. ("SSI") to CTI. KC then distributed to its stockholders CTI's common stock on the basis of one share of common stock of CTI for each five shares of KC common stock and Class B common stock owned (the "Distribution"). CTI conducts its business through its subsidiaries, CCS, SSI, Surety Group, Inc. ( SG ), Surety Associates ( SA ), Official Notary Service of Texas, Inc. ("ONS") and Qualex Consulting Group, Inc. ("Qualex") (collectively together with Cumberland, the "Company." ) CCS, a Florida corporation formed in May 1988, provides performance and payment bonds for contractors and miscellaneous surety bonds to federal and local government agencies. The surety services provided include direct surety and, to a lesser extent, reinsurance. SSI, a Florida corporation formed in August 1988, is a general lines agency which operates as an independent agent. SG, a Georgia corporation, and Associates Acquisition Corp. d/b/a Surety Associates, a South Carolina corporation, purchased by Cumberland in February and July 1995, respectively, are general lines insurance agencies which operate as independent agencies. Qualex, a Florida corporation formed in November 1995, provides claim and contracting consulting services.
For the years ended December 31, 1997 and 1996, CTI charged its subsidiaries excluding CCS, a management fee. No fee was charged for the year ended December 31, 1995.
In 1988, CCS issued a surplus debenture to KC in exchange for $3,000,000 which bears interest at 10 percent per annum. In 1992, the debenture due to KC from CCS was assigned to CTI. Interest and principal payments are subject to approval by the Florida Department of Insurance. On April 1, 1997, CTI forgave $375,000 of its $3,000,000 surplus debenture due to CCS. As a result, CCS increased paid-in-capital by $375,000. As of December 31, 1997, no payments could be made under the terms of the debenture.
Allowance for doubtful accounts 67,209 0 0 67,209 0 ========== ========== ========== ========== ==========
Deferred income tax valuation allowance . . . . 374,149 321,120 0 0 695,269 ========== ========== ========== ========== ========== For the year ended December 31, 1997:
Totals . . . . . . . . . . . 5,449,518 4,026,655 3,824,494 =========== =========== ==========
Net gain (loss) . . . . . . . $ 170,520 $ (582,744)$ (228,210) =========== =========== ==========
Earnings (loss) per share amount . . . . . . . . . . $ .03 $ (.14)$ (.06) =========== =========== ==========
As of December 31, 1997, the subsidiaries of Cumberland Technologies, Inc. were as follows: