ITEM 1. BUSINESS
General
ACMAT Corporation ("ACMAT" or the "Company") provides specialized commercial insurance and bonding coverages for contractors, architects, engineers and other professionals in the construction and environmental fields and other specialty insurance. The Company derives its underwriting expertise from its construction and remediation operations. Through United Coastal Insurance Company ("United Coastal Insurance"), the Company provides a broad line of general, professional, environmental and other liability insurance primarily to environmental contractors and specialty trade contractors and architects, engineers and other professionals. Through ACSTAR Insurance Company ("ACSTAR Insurance"), the Company provides surety bonds for general building, specialty trade and environmental contractors and others. Both United Coastal Insurance and ACSTAR Insurance are rated A (excellent) by The A.M. Best Co., Inc. ("A.M. Best"). In 1996, insurance operations accounted for over 70% of the Company's consolidated revenues.
The Company is also engaged in construction contracting which consists of interior contracting services involving the design and furnishing of building interiors and asbestos abatement services for commercial, industrial and institutional buildings.
Effective September 16, 1996, the Company completed the merger of United Coasts Corporation into ACMAT. United Coasts Corporation shareholders received one share of ACMAT Class A stock for each approximately 1.536 shares of United Coasts Corporation stock. As a result of the merger, ACMAT issued approximately 1,100,000 shares of its Class A stock amounting to a purchase price of approximately $14 million for the 16% minority interest in the insurance holding company subsidiary. As a result, United Coastal Insurance Company, formerly a subsidiary of United Coasts, became a wholly-owned subsidiary of ACMAT and its affiliates.
Financial Information about Industry Segments
Financial information relating to the two segments is set forth in Note 16 to the consolidated financial statements on page 39 of this document.
INSURANCE AND SURETY BONDING
General
The Company's insurance subsidiaries primarily provide liability insurance and surety bonding for general, specialty trade, environmental remediation, asbestos and lead abatement contractors and professional liability for architects, engineers, environmental consultants and others. The Company also provides products liability insurance for manufacturers and distributors. This highly specialized insurance market includes general liability, pollution liability, environmental consulting liability, hazardous waste storage and treatment pollution liability and other related liabilities. Fewer property and casualty insurers serve these markets due to the technical skills required in the underwriting process and the high degree and intensive amount of service required to tailor coverages to the special needs of policyholders and to provide timely responses to individual contract requirements.
Liability Insurance
The liability insurance lines of the Company, which consist primarily of contractor policies and professional liability policies, are discussed more fully below:
Contractors
- General Liability - Policies are offered to general contractors and specialty trade contractors involved in plumbing, heating, electrical, framing, roofing, drilling, excavation, demolition, road work, and other contracting activities. Coverage is also offered for other specialized non-contractor general liability risks. Coverage is limited to third-party bodily injury and property damage arising out of covered operations. General liability insurance is offered on either a claims-made or occurrence basis.
- - Contractor Pollution Liability - Policies are offered to contractors involved in hazardous waste remediation or cleanup, installation or removal of storage tanks, or the transportation of hazardous waste. Coverage is provided for third party-bodily injury or property damage liability caused by release of, or exposure to, pollutants as a result of contractors' operations. Contractors pollution liability insurance is offered on a claims-made basis.
- - Asbestos and Lead Abatement Liability - Policies are offered to contractors involved in the removal or encapsulation of asbestos and/or lead containing materials from structures or their containment through appropriate encapsulation or repair. Coverage is provided for third-party bodily injury and property damage liability as a result of a release of asbestos or lead which arises out of the contractors' operations. Asbestos and lead abatement liability insurance is provided on either a claims-made or occurrence basis.
Professionals
- - Architects and Engineers Professional Liability - Policies are offered to architects and engineers and consultants in the fields of architecture; civil, electrical, mechanical, structural and process engineering; construction/property management; design/build services; laboratory testing and surveying. Project professional liability policies are also offered for architect and engineer design teams and owner controlled wrap-ups. All policies are written on a claims-made basis.
- - Environmental Asbestos and/or Lead Consultants Professional Liability - Policies are offered to consultants involved in providing services such as environmental assessments, design/build services, asbestos or lead consulting, remedial investigations and feasibility studies, and storage tank consulting. Coverage is provided for liability arising out of the acts, errors or omissions of a consultant in the performance of professional services. All professional liability coverages are written on a claims-made basis.
Owners and Lenders
- - Hazardous Waste Storage and Treatment Pollution Liability - Policies are offered on a claims-made basis in response to the insurance requirements of the Environmental Protection Agency in connection with facilities subject to the Resource Conservation and Recovery Act of 1976 ("RCRA").
- - Site Specific Pollution Liability - These policies cover pollution claims arising or emanating from a specific site and are provided on a claims-made basis. Comprehensive site evaluations are required prior to providing coverage for any site.
- - Lenders Pollution Liability - Policies are offered to financial institutions for pollution occurring at property owned or controlled by the institution as a result of foreclosure or otherwise. Lender pollution liability coverage is offered on a claims-made basis.
Products Liability
- - Products Liability - Policies are offered on a claims-made or occurrence basis to manufacturers for a variety of products including chemicals, fertilizers, pesticides, pollution control devices and storage tanks and other.
The Company customizes many of its insurance policies to suit the individual needs of its insureds. Combined policies insuring multiple exposures under one policy form and one combined policy limit are available.
Surety Bonding
Surety bonds are written for general, specialty trade, environmental, asbestos and lead abatement contractors. The Company also offers a wide variety of miscellaneous bonds. Most bonds are supported by various levels of collateral based upon the financial condition of the contractor.
The Company generally requires cash, liquid investments or irrevocable letters of credit to collateralize a portion or all of most bonds issued. In addition, the Company will only accept irrevocable letters of credit from financial institutions which have a rating of C "sound credit risk" or higher as determined by Thomson BankWatch, Inc.
However, no assurance can be made that such financial institutions will maintain their financial strength and, thus, that funds guaranteed under letters of credit will be available, if needed, to offset any potential future claims.
The Company provides the following types of bonds:
- - Payment and performance bonds - Bonds are provided for general building and specialty trade contractors, environmental remediation and asbestos abatement contractors and consultants, lead abatement contractors and solid waste disposal contractors. A payment and performance bond guarantees satisfactory performance and completion of the contractor's work and payment of the contractor's debts and obligations relating to the performance of the contract covered by the bond.
- - Closure and post-closure bonds - Bonds are provided for owners of solid and hazardous waste landfills as required to meet certain requirements under RCRA and remediation bonds in connection with the Comprehensive Environmental Response, Compensation and Liability Act of 1980 ("CERCLA"). Closure bonds usually guarantee that a property owner will restore property to a specified level or condition. Post-closure bonds guarantee cultivation and maintenance of a closed site.
- - Supply bonds and other specialty bonds - Bonds are provided for contractors, manufacturers and other owners in their normal course of operations, usually to guaranty the supply of equipment and material.
- - Miscellaneous surety, license, permit, self insurer, supersedeas and other bonds - Miscellaneous bonds are provided for applicants based on those requirements specified in the bond form and the applicant's financial strength.
The underwriting department and management are responsible for the development of new insurance products and enhancements. Underwriting profitability is enhanced by the creation of niche products focused on classes of business which traditionally have provided underwriting profits.
Insurance Performance Ratios
The following table sets forth the combined ratios of the Company, prepared in accordance with generally accepted accounting principles and statutory accounting principles prescribed or permitted by state insurance authorities. The combined ratio is a traditional measure of underwriting profitability. When the combined ratio is under 100%, underwriting results are generally considered profitable. Conversely, when the combined ratio is over 100%, underwriting results are considered unprofitable. The combined ratio does not reflect investment income, federal income taxes or other non-operating income or expense.
The increase in the combined ratio over the past three years results primarily from the decline in premiums. See Item 7 -- "Management's Discussion and Analysis of Financial Condition and Results of Operations".
Underwriting
The Company's underwriting practices rely heavily upon the knowledge base which it has developed in over forty-five years of construction contracting. Accordingly, ACMAT, in addition to its construction contracting operations, provides risk evaluation, loss adjustment, underwriting, claims handling and monitoring services for its insurance subsidiaries, United Coastal Insurance and ACSTAR Insurance. Contractors seeking liability insurance and bonding through the Company are carefully reviewed with respect to their past practices, claims history and records. Other factors considered are the contractors' and professionals' financial conditions, training techniques,
safety procedures, histories of violations, record keeping, supervisory qualifications and experience. Historically, the Company has issued policies and bonds to fewer than twenty-five percent of its applicants. Underwriting procedures for products liability insurance involve conducting an in-depth review of the product that is being manufactured or distributed. Such review involves examining an applicant's past record of recalls, claims history and litigation.
The Company's underwriting and pricing strategy is designed to produce an underwriting profit resulting in a Company-wide combined ratio well below 100%. The Company has a conservative underwriting philosophy which, in the opinion of management, is one of the primary reasons for the favorable loss ratios relative to the property and casualty insurance industry over the last three years.
The Company continually monitors financial stability of contractors with surety bonds outstanding. Work in progress reports and updated financial information are reviewed by the Company to ensure that the contractor continues to meet the underwriting guidelines.
Reinsurance
The Company reinsures the excess limit on each insurance policy above $2 million up to $5 million for liability and reinsures $10 million of $15.8 million of individual bond limits offered by the Company through a treaty with two companies, Transatlantic Reinsurance Company, an affiliate of AIG Insurance, and United States Fidelity & Guaranty Company, each rated "A+" and "A", respectively, by A. M. Best. The Company has additional treaty excess of loss reinsurance which provides limits on a per policy basis of $5,000,000 per occurrence or claim made and in the aggregate excess of $5,000,000 per occurrence or claim made and in the aggregate. To date, the Company's reinsurers have fulfilled their obligations under their reinsurance contracts with the Company. Facultative reinsurance is also used for current insureds seeking project specific excess insurance. In general, a reinsurance transaction takes place when an insurance company cedes all or a portion of its exposure to liability on insurance written or surety bonds issued to another insurer which assumes such exposure, as if the ceding insurer were itself purchasing insurance from the assuming insurer. Reinsurance does not legally discharge an insurance carrier from its primary liability to a policyholder for the face amount of coverage and, accordingly, the financial stability of the Company's reinsurers is an important factor in determining the Company's ultimate exposure to claims.
The availability and price of reinsurance fluctuates according to market conditions. In recent years, many reinsurers have withdrawn from the market or become insolvent. Depending on the availability and cost of reinsurance, the Company may, from time to time, elect to cede greater or lesser portions of its underwriting risk.
Claims
The Company directly handles substantially all claims of its insureds, except that independent claims adjusters and/or counsel selected for their experience and reputation in the locality of the claim are retained to conduct initial fact-finding investigations. All decisions respecting payment of claims are made by experienced employees of the Company.
Reserves for Losses and Loss Adjustment Expenses
Reserves for losses and loss adjustment expenses are estimates at any given point in time of what the Company may have to ultimately pay on incurred losses, including related settlement costs, based on facts and circumstances then known. The Company also reviews its claims reporting patterns, past loss experience, risk factors and current trends and considers their effect in the determination of estimates of incurred but not reported losses. Ultimate losses and loss adjustment expenses are affected by many factors which are difficult to predict, such as claim severity and frequency, inflation levels and unexpected and unfavorable judicial rulings. Reserves for surety claims also consider the amount of collateral held as well as the financial strength of the contractor and its indemnitors. Management believes that the reserves for losses and loss adjustment expenses at December 31, 1996 are adequate to cover the unpaid portion of the ultimate net cost of losses incurred through that date and related adjustment expenses incurred, including losses incurred but not reported.
Reserves for losses and loss adjustment expenses are established with respect to both reported and incurred but not reported claims for insured risks. The amount of loss reserves for reported claims is primarily based upon a case-by-case evaluation of the type of risk involved, knowledge of the circumstances surrounding each claim and the policy provisions relating to the type of claim. In determining appropriate adjustments to reserves historical
data is reviewed and consideration is given to the anticipated impact of various factors such as legal developments and economic conditions, including the effects of inflation. Reserves are monitored and recomputed periodically using new information on reported claims.
The following table sets forth a reconciliation of beginning and ending reserves for losses and loss adjustment expenses for the periods indicated on a GAAP basis for the business of the Company.
The decrease in 1996 and 1995 of incurred losses and loss adjustment expenses of prior years represents a reallocation of reserves among accident years. The continued increase in claim payments are primarily the result of payments relating to settlement of losses reserved in prior periods and are expected based on the continued development of the Company's insurance operations. There can be no assurance, however, that the Company's reserves will be sufficient to cover ultimate losses and loss adjustment expenses or that future adjustments to losses and loss adjustment expense reserves will not be required.
The Company has no exposure to any asbestos or environmental claims associated with general liability policies issued with the pre-1986 pollution exclusion. Policies written with the exclusion are typically associated with mass tort environmental and asbestos claims. The Company has never issued a policy with the pre-1986 pollution exclusion. The Company's exposure to asbestos and environmental liability claims is primarily limited to asbestos and environmental liability insurance for contractors and consultants involved in the remediation, removal, storage, treatment and/or disposal of environmental and asbestos hazards.
As of December 31, 1996, 1995 and 1994 reserves for the combined losses and loss adjustment expenses of the Company's insurance operations as determined in accordance with accounting principles and practices prescribed or permitted by insurance regulatory authorities ("Statutory basis reserves") were $59,968,945, $58,835,913 and $53,642,609, respectively. As of December 31, 1996, 1995 and 1994 reserves determined in accordance with generally accepted accounting principles ("GAAP basis reserves") were $47,960,084, $45,235,311 and $40,954,783, respectively. The difference between the Statutory basis reserves and the GAAP basis reserves result from the minimum statutory, or "Schedule P", loss reserves required to be maintained by the Company's insurance subsidiaries, partially offset by the netting of reinsurance recoverable against losses and loss adjustment expense reserves for statutory purposes.
The following losses and loss adjustment expense reserve runoff table is for the combined insurance operations of the Company's insurance subsidiaries. ACSTAR Insurance operations began in 1988. The run-off table presents the reserve activity since the inception of United Coastal Insurance in 1985. The data for 1992 and prior periods are presented on a net basis in the reserve run-off table. Restatement of prior periods is not practicable.
Each column shows the reserve held at the indicated calendar year-end and cumulative data on payments and reestimated liabilities for that accident year and all prior accident years making up that calendar year-end reserve. Therefore, the redundancy (deficiency) is also a cumulative number for that year and all prior years. It would not be appropriate to use this cumulative history to project future performance.
In 1995, the Company changed its method of reporting estimated liabilities for claims-made policies which is reflected in the reserve run-off table. For calendar years 1994 and prior, reserves associated with claims-made policies were reported based on accident year basis consistent with the Company's treatment in Schedule P to the Company's Statutory Annual Statement. At the request of the Arizona Insurance Department, ("Department") the Company was required to change its method of reporting in Schedule P to the Annual Statement, reserve and payment data associated with claims-made policies to a report year basis versus an accident year basis in order to comply with the National Association of Insurance Commissioners ("NAIC") guidelines. The Company's prior treatment of claims- made loss data on an accident basis was approved by the Department during years prior to 1995. For its 1995 statutory filing, the Company restated loss data reported in Schedule P to comply with the Department's request. As a result of the change to Schedule P for claims-made policies, the Company has also changed the method for reporting claims-made loss payment data in the reserve run-off table to conform to a report year basis for claims- made policies. Occurrence policies were and continue to be reported on an accident year basis. The 1995 reestimated liabilities for each calendar year have been restated to reflect the new method of reporting.
Because of the change in reporting loss data for claims-made policies from an accident year basis to a report year basis, prior accident year reserves have been moved forward to fall within the report year resulting in no change to total reserve amounts or estimates. Management believes that the aggregate reserves for losses and loss adjustment expenses for all accident years are adequate.
IRIS Ratios
The National Association of Insurance Commissioners ("NAIC") has developed the Insurance Regulatory Information System ("IRIS"), intended to assist state insurance departments in executing their statutory mandates to oversee the financial condition of insurance companies operating in their respective states. IRIS identifies eleven industry ratios and specifies "usual values" for each ratio. When an insurance company's ratio falls outside the "usual value," it is
designated an "unusual value," which event alerts state insurance departments to potential problems. For the year ended December 31, 1996, none of the Company's insurance subsidiaries' IRIS ratios were designated an "unusual value," except for the investment yield ratio for ACSTAR Insurance Company. The calculated investment yield was below the NAIC standard of 4.5% because of the Company's policy of investing in relatively short-term tax-exempt securities and ACSTAR Insurance Company's ownership of United Coastal Insurance Company which is not an income producing security.
A.M. Best Ratings
A.M. Best ratings are indications of the solvency of an insurer based on an analysis of the financial condition and operations of a company relative to the industry in general. Occasionally, the requirement for A.M. Best's-rated insurer is a condition imposed upon the contractor by the party engaging the contractor. Certain insurance brokers also restrict the business they will place with insurers which are not A.M. Best's-rated. The 1996 Best letter ratings range from A++ (superior) to F (in liquidation).
Since 1994, United Coastal Insurance and ACSTAR Insurance each have an A.M. Best's rating of A (excellent).
Risk-Based Capital
Risk-based capital requirements are used as early warning tools by the National Association of Insurance Commissioners and the states to identify companies that require further regulatory action. The ratio for each of the Company's insurance subsidiaries as of December 31, 1996 was significantly above the level which might require regulatory action.
CONSTRUCTION CONTRACTING
General
The Company provides a broad range of coordinated interior contracting services. The Company began to offer asbestos abatement services in the 1970's and the Company continues to be active in the asbestos abatement field. The Company installs interiors in office buildings, retail establishments, schools, colleges, churches, hospitals and other buildings. The Company's interior contracting is provided both in connection with new buildings and in connection with the remodeling and renovation of interiors of existing buildings usually under contracts with building owners and building occupants.
The interior design, construction and asbestos abatement industries are highly fragmented. Many interior contractors, in contrast to the Company, specialize in a particular interior component such as ceilings or partitions. The Company provides a broad range of coordinated interior contracting services, many of which are performed by subcontractors. Both the interior construction and asbestos abatement markets have, in recent years, reflected the economic recession in the Northeast. The asbestos abatement market has also declined as many of the intensive abatement programs mandated in recent years with respect to public buildings have been completed.
Backlog
The following table sets forth the Company's backlog of unbilled contract amounts, the total number of contracts and the number of contracts with unbilled amounts in excess of $400,000 as of December 31, 1996 and 1995:
The Company estimates that approximately $6,000,000 of the December 31, 1996 backlog will be completed prior to December 31, 1997.
Materials
The Company purchases the materials it installs in the course of its construction contracting operations from a number of suppliers. Most of the Company's materials are standard building components which historically have been readily available from several suppliers. Some components are manufactured to the Company's specifications. Most of the materials used by the Company are shipped directly to the job site by the manufacturer.
Contract Acquisition
The Company's work projects are obtained by lump sum fixed price bids, unit prices or are negotiated. Contract prices are usually determined by competition with other contractors.
Warranty
Each project usually contains a one-year warranty or guaranty period, wherein the Company and its subcontractors warrant that the work is free from defects and was performed in accordance with the plans and specifications. Occasionally, the Company is required to make minor corrections or adjustments, but has never incurred any significant costs in connection with any such work.
Asbestos Abatement Operations
Both the Company's insurance and construction contracting operations have involved risks associated with asbestos. The Company has in the past insured and continues to insure risks associated with asbestos abatement or containment operations on both a claims-made and occurrence basis. Since harm from exposure to asbestos fibers may not be detectable in humans for as much as thirty years, losses under insurance contracts written on an occurrence basis may not be known for some time.
The Company's construction contracting operations involve the removal of asbestos. As asbestos containing materials deteriorate or become disturbed by incidental or intentional contact, asbestos fibers may enter the air and can circulate into the breathing zone of building occupants. Exposure to asbestos is thought by some to be a cause of cancer. In the mid 1970's, the Company became engaged in the removal of asbestos in addition to its other contracting operations. Since that time, it has been engaged in hundreds of contracts involving the removal of asbestos. Claims by non-employees related to asbestos have been made against the Company from time to time and are pending and there can be no assurance that claims will not be made in the future.
While the Company currently has claims pending against it by employees, the Company believes that it is fully covered by workers' compensation insurance with respect to any claims by current and former employees relating to asbestos operations. The Company currently obtains its workers' compensation insurance in those states in which it performs work either from state insurance funds or one of several insurance companies designated in accordance with the Assigned Risk Pool. The amount of workers' compensation insurance maintained varies from state to state but is generally greater than the maximum recovery limits established by law and is not subject to any aggregate policy limits. In the past, the Company has received a number of asbestos-related claims from employees, all of which have been fully covered by its workers' compensation insurance. The Company believes, although no assurances can be given, that workers' compensation insurance sufficient to cover all future claims will remain available in accordance with applicable state laws.
MARKETING
Insurance and Surety Bonding
As an excess and surplus lines carrier, United Coastal Insurance markets its policies through excess and surplus lines brokers only in those states in which it is permitted to write coverage. Currently, United Coastal Insurance is permitted to write excess and surplus lines insurance as a nonadmitted insurer in forty-six states, the District of Columbia, Puerto Rico and the Virgin Islands.
ACSTAR Insurance offers payment and performance bonds through carefully selected insurance agents which specialize in the needs of contractors. All underwriting approvals and issuance of policies and bonds are performed directly by the Company's insurance subsidiaries.
The Company's insurance products are marketed in all 50 states primarily through several of the largest insurance brokers, including Johnson & Higgins, Marsh & McLennan, Willis Corroon, AON, Inc. and Sedgwick.
Construction Contracting
The Company markets its construction contracting services directly to building owners and building occupants. Project opportunities are brought to the attention of the Company through various sources such as F. W. Dodge Company, which publishes lists of projects available for bid, architects, owners, general contractors, or engineers who are familiar with the Company. The Company also depends upon repeat business and responses to the Company's advertising program which is intended to emphasize ACMAT's packaged interior renovation capability. ACMAT's sales force consists of its senior management and project managers, all of whom function as construction consultants and work closely with owners, tenants and architects.
COMPETITION
Insurance and Surety Bonding
The property and casualty insurance industry is highly competitive. The Company competes with large national and smaller regional insurers in each state in which it operates, as well as monoline specialty insurers. The Company's principal competitors include certain insurance subsidiaries of American International Group, Inc. ("AIG"), Reliance Insurance Group, Zurich Insurance Group, Design Professionals Insurance Company, CNA Insurance Companies and Lloyd's of London. Many of its competitors are larger and have greater financial resources than the Company. Among other things, competition may take the form of lower prices, broader coverage, greater product flexibility, higher quality services or the insurer's rating by independent rating agencies. The Company competes with admitted insurers, surplus line insurers, new forms of insurance organizations such as risk retention groups, and alternative self-insurance mechanisms.
Competition in the field of surety bonding is intense and many of the Company's competitors are larger and have greater surplus than the Company, thereby allowing them to provide bonds with higher limits than those which the Company is able to provide. The Company's principal competitors include the St. Paul Companies, Inc., Reliance Insurance Group, AIG and CNA. The Company's insurance subsidiaries hold primary and reinsurance certificates of authority as acceptable sureties on Federal bonds as do approximately 250 to 300 other surety companies. The certificates give the Company an advantage over companies which are not certified by the United States Treasury Department with respect to surety bonding on Federal projects in that such certification has become a standard with respect to both Federal and other bonds. Approximately one-half of the surety bonds written by the Company's subsidiaries are required to be provided by a Treasury listed company. With respect to other bonds, the Company faces competition from as many as 1,000 additional non-certified surety companies.
Construction Contracting
Competition in the interior construction business serviced by ACMAT generally is intense. Historically, a majority of the Company's construction business was performed on projects on which the Company had been in competition with other contractors. The Company currently focuses its efforts on privately negotiated contracts obtained through advertising and its reputation. Quality of service and pricing are the Company's principal methods of competition.
The economic climate of the Northeast has increased the competitive pressure on all aspects of the Company's contracting operations. The Company has responded with marketing efforts seeking to obtain business when the Company's reputation and experience allow it to privately negotiate contracts at prices which are sufficiently profitable.
REGULATION
The business of ACMAT's insurance subsidiaries is subject to comprehensive and detailed regulation and supervision throughout the United States. The laws of the various jurisdictions establish supervisory agencies with broad administrative authority which includes, but is not limited to, the power to regulate licenses, to transact business, trade practices, agent licensing, policy forms, claim practices, underwriting practices, reserve requirements, the form and content of required financial statements and the type and amounts of investments permitted. The insurance companies are required to file detailed annual reports with supervisory agencies in each of the jurisdictions in which they do business, and their operations and accounts are subject to examination by such agencies at regular intervals.
As a nonadmitted excess and surplus lines insurer, United Coastal Insurance is not subject to the comparatively more extensive state regulations to which ACSTAR Insurance is subject. The regulations and restrictions to which ACSTAR Insurance and United Coastal Insurance are subject include provisions intended to assure the solvency of ACSTAR Insurance and United Coastal Insurance and are primarily for the protection of policyholders and loss claimants rather than for the benefit of investors.
State insurance regulations impose certain restrictions upon the types of investments that the Company's insurance subsidiaries can acquire and the percentage of their capital or assets that may be placed in any particular investment or type of investment. Certain states also require insurance companies to furnish evidence of financial security by means of a deposit of marketable securities with the state insurance regulatory authority. On December 31, 1996, the Company's insurance subsidiaries had securities with an aggregate book value of approximately $9.8 million on deposit with various state regulatory authorities.
The insurance subsidiaries of ACMAT are restricted as to the amount of cash dividends they may pay. United Coastal Insurance is restricted by the Arizona Insurance Holding Company Systems Act as to the amount of dividends it may pay without the prior approval of the Arizona Department. During 1996, United Coastal Insurance paid $6,047,900 in dividends. At January 1, 1997, $4,301,000 is available for the payment of dividends by United Coastal Insurance in 1997 without the prior approval of the Arizona Insurance Department.
Under applicable insurance regulations in its domicile state of Illinois, ACSTAR Insurance is also restricted as to the amount of dividends it may pay. ACSTAR may pay or declare a dividend only up to the amount of any available surplus funds derived from realized net profits on its business, as determined in accordance with statutory accounting principles. During 1996, ACSTAR paid $2,000,000 in dividends to ACSTAR Holdings. At January 1, 1997, approximately $2,710,000 is available for the payment of dividends by ACSTAR Insurance in 1997 without the prior approval of the Illinois Insurance Department.
New regulations and legislation are being proposed to limit damage awards, to control plaintiffs' counsel fees, to bring the industry under regulation by the federal government and to control premiums, policy terminations and other policy terms. It is not possible to predict whether these proposals will be adopted or their likely effect, if any, on the Company.
INVESTMENTS
The Company's investment strategy is to maintain a conservative investment policy by generally acquiring high quality tax-exempt securities, primarily bonds, with fixed effective maturities of approximately three years or less. The investment portfolio is well diversified and is in compliance with regulatory requirements. The Company's bond portfolio is composed primarily of investments rated AA or better by Standard and Poor's. Management has also decided to avoid long-term investing at what management believes to be low long-term interest rates.
The Company's investment portfolio is subject to several risks including interest rate and reinvestment risk. Fixed maturity security values generally fluctuate inversely with movements in interest rates. The Company's corporate and municipal bond investments may contain call and sinking fund features which may result in early redemptions and the Company's mortgage-backed securities investments held by the Company are subject to prepayment risk. Declines in interest rates could cause early redemptions or prepayments which would require the Company to reinvest at lower rates.
Investment securities are classified as held to maturity, availablefor sale or trading. The Company currently classifies all investment securities as available for sale. Investment securities available for sale, are carried at fair value and unrealized gains and losses are excluded from earnings and recorded as a separate component of stockholders' equity, net of estimated income taxes.
The Company invests primarily in tax-exempt securities as part of its strategy to maximize after-tax income. Such strategy considers, among other factors, the impact of the alternative minimum tax. The following table summaries the fixed maturity investments portfolio at December 31, 1996 and 1995 (dollars in thousands):
- ------------------ (1) Fixed maturities available for sale are carried at fair value. Total cost of fixed maturities was approximately $93,398,000 at December 31, 1996 and $121,613,000 at December 31, 1995.
(2) Equity securities are carried at fair value. Total cost of equity securities was approximately $5,000 at December 31,1996 and $20,000 at December 31, 1995.
(3) Limited partnership investments are carried at fair value. Total cost of the limited partnership investments was approximately $1,087,000 at December 31, 1996 and $1,120,000 at December 31, 1995.
The following table sets forth the maturities in the fixed maturity investment portfolio at December 31, 1996 and 1995 (dollars in thousands):
- ---------------------
(1) Based on stated maturity dates with no prepayment assumptions. Actual maturities may differ because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
The Company's insurance subsidiaries are subject to state laws and regulations that require diversification of its investment portfolio and limit the amount of investments in certain investment categories. Failure to comply with these laws and regulations would cause non-conforming investments to be treated as non-admitted assets for purposes of measuring statutory surplus and, in some instances, would require divestiture. As of December 31, 1996, the Company's investments complied with such laws and regulations.
Investment results for the years ended December 31, 1996, 1995 and 1994 are shown in the following table (dollars in thousands):
(1) Average of the aggregate invested amounts at the beginning and end of the period including cash and cash equivalents.
(2) Investment income is net of investment expenses and does not include realized investment gains or losses or provision for income taxes.
The yields reflect the Company's investment strategy of acquiring high quality tax-exempt securities with fixed effective maturities of approximately three years or less. The increase in investment income in 1996 over 1995 was due substantially to an increase in total invested assets. The increase in investment income in 1995 over 1994 was due substantially to higher yields on the portfolio as the result of higher interest rates as well as an increase in total invested assets. The increase in invested assets is attributable to the net cash flow generated by written premiums, cash collateral and the reinvestment of investment income offset in part by cash used to repay debt and repurchase stock.
ENVIRONMENTAL COMPLIANCE
The Company does not expect that its compliance with federal, state or local environmental laws or regulations will have any material effect upon its capital expenditures, earnings or competitive position.
EMPLOYEES
As of December 31, 1996, the Company employed approximately 30 persons, all in the United States. None of its current employees are employed subject to collective bargaining agreements. The Company believes that its relations with all of its employees are excellent.
ITEM 2.

ITEM 2. PROPERTIES
The Company and its subsidiaries occupy a 7 story office building located at 233 Main Street, in New Britain, Connecticut. ACMAT leases approximately 40% of the building to unaffiliated tenants. The office building is suitable and adequate for ACMAT's current and future requirements.
ITEM 3.

ITEM 3. LEGAL PROCEEDINGS
The Company is a party to a few legal actions arising in the ordinary course of its business. In management's opinion, the Company has adequate legal defenses or insurance coverages respecting those actions where the Company is a defendant and does not believe their settlement will materially affect the Company's operations or financial position.
The Company has, together with many other defendants, been named as a defendant in approximately 152 actions brought in Connecticut state courts by injured or deceased individuals or their representatives based on product liability claims relating to materials containing asbestos. No specific claims for monetary damages are asserted in these actions. Although it is early in the litigation process, the Company does not believe that its exposure in connection with these cases is significant.
ITEM 4.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth quarter of 1996.
PART II
ITEM 5.

ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
ACMAT's Class A Stock trades on the Nasdaq National Market under the symbol ACMTA. As of September 5, 1995, the Common Stock no longer qualified for continued listing on the Nasdaq National Market and is now traded in the over-the-counter market. The following table sets forth the quarterly high and low closing prices of the Company's Common Stock and Class A Stock as reported by Nasdaq.
No dividends have been paid in the past five years and there is no intention of paying dividends in the near future. As of March 24, 1997, there were 310 Common Stock shareholders of record and 926 Class A Stock shareholders of record.
ITEM 6.

ITEM 6. SELECTED FINANCIAL DATA
Note: No cash dividends were paid during any of the periods above.
*Including cumulative effect of a change in accounting principle of $1,127,943 (26(cent) per share) in 1992.
ITEM 7.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS: YEARS ENDED DECEMBER 31, 1996 AND 1995:
Earned Premiums
Earned premiums in 1996 were $19,899,936 compared to $23,492,905 in 1995. Net written premiums were $18,041,488 in 1996 compared to $22,856,791 in 1995. The decrease in earned premiums in 1996 reflects the 21% decrease in 1996 net written premiums over 1995 net written premiums. The Company has written fewer new accounts as a result of what is believed to be an inadequate pricing environment in the market. Variances in net written premiums have historically occurred due to the fluctuations in size, number and timing of bonds and policies bound by the Company.
Contract Revenues
Contract revenues were $9,415,734 in 1996 compared to $11,614,632 in 1995. During the past several years, the Company has focused on fewer, more profitable projects. Construction revenue is difficult to predict in 1997 and depends greatly on the successful securement of contracts bid.
Investment Income, Net
Net investment income was $6,535,572 in 1996 compared to $6,062,883 in 1995, representing effective yields of 4.64% and 4.58%, respectively. The increase in investment income in 1996 over 1995 was due substantially to an increase in total invested assets. Invested assets, including cash and cash equivalents, were $144,117,159 and $137,528,676 at December 31, 1996 and 1995, respectively. The increase in invested assets is attributable to the net cash flow generated by written premiums, cash collateral and the reinvestment of investment income offset by the purchase of stock and the repayment of debt.
Net Realized Capital Gains
Realized capital gains from the sale of investments during 1996 were $257,774 compared to realized capital gains of $7,897 in 1995. In December, 1996, the Company sold fixed maturity securities with a book value of approximately $34,000,000 resulting in a realized gain of approximately $204,000.
Cost of Contract Revenues
Cost of contract revenues were $8,396,344 in 1996 compared to $10,774,758 in 1995. The decrease in cost of contract revenues during 1996 compared to 1995 reflects the decrease in contract revenues. Cost of contract revenues vary from period to period as a function of contract revenues (See Contract Revenues). The Company's construction backlog at December 31, 1996 was approximately $8,700,000 compared to $3,600,000 at December 31, 1995.
Losses and Loss Adjustment Expenses
Losses and loss adjustment expenses were $5,969,980 in 1996 compared to $7,115,371 in 1995. The decreases in the losses and loss adjustment expenses are attributable to the decline in earned premiums from 1995 to 1996 without any fluctuations in the loss ratios. Loss and loss adjustment expense reserves represent management's estimate of the ultimate cost of unpaid losses incurred for these periods relative to premiums earned.
Amortization of Policy Acquisition Costs
Amortization of policy acquisition costs was $3,617,308 in 1996 as compared to $3,939,008 in 1995. The decrease in amortization of policy acquisition costs is primarily attributable to the decrease in premiums earned. Policy acquisition costs, primarily commissions, are deferred and amortized over the policy or bond term.
Selling, General and Administrative Expenses
Selling, general and administrative expenses were $5,610,176 in 1996 compared to $6,097,322 in 1995. The decrease in selling, general and administrative expenses from 1996 to 1995 reflects a decrease in salary expense.
19 Interest Expense
Interest expense has increased to $4,946,418 in 1996 from $4,810,578 in 1995. The increase in interest expense in 1996 is due primarily to the increase in short term borrowings offset, in part, by a decrease in long-term debt.
Income Taxes
Income tax expense was $2,313,828 in 1996 compared to $2,414,400 in 1995, representing effective Federal tax rates of 26.5% and 25.1%, respectively. The Federal effective tax rate fluctuates according to the mix of tax exempt and taxable securities held by the Company.
YEARS ENDED DECEMBER 31, 1995 AND 1994:
Earned Premiums
Earned premiums in 1995 were $23,492,905 compared to $27,141,639 in 1994. Net written premiums were $22,856,791 in 1995 compared to $27,216,453 in 1994. The decrease in earned premiums in 1995 reflects the 16% decrease in 1995 net written premiums over 1994 net written premiums. The Company has written fewer new accounts as a result of what is believed to be an inadequate pricing environment in the market. Variances in net written premiums have historically occurred due to the fluctuations in size, number and timing of bonds and policies bound by the Company.
Contract Revenues
Contract revenues were $11,614,632 in 1995 compared to $8,160,758 in 1994. During the past several years, the Company has focused on fewer projects and devoted more resources to the Insurance Group. Increases for the 1995 period are believed to be temporary and are related to more backlog on hand. Construction revenue is difficult to predict in 1996 and depends greatly on the successful securement of contracts bid.
Investment Income, Net
Net investment income was $6,062,883 in 1995 compared to $4,637,158 in 1994, representing effective yields of 4.58% and 3.72%, respectively. The increase in investment income in 1995 over 1994 was due substantially to higher yields on the portfolio as the result of higher interest rates obtained on reinvested assets as well as an increase in total invested assets. Invested assets, including cash and cash equivalents, were $137,528,676 and $124,757,438 at December 31, 1995 and 1994, respectively. The increase in invested assets is attributable to the net cash flow generated by written premiums, cash collateral and the reinvestment of investment income offset by the purchase of stock and the repayment of debt.
Net Realized Capital Gains (Losses)
Realized capital gains from the sale of investments during 1995 were $7,897 compared to realized capital losses of $34,238 in 1994.
Cost of Contract Revenues
Cost of contract revenues were $10,774,758 in 1995 compared to $7,793,535 in 1994. The increase in cost of contract revenues during 1995 compared to 1994 reflects the increase in contract revenues and the elimination of the gross losses on the construction operations. Costs of contract revenues vary from period to period as a function of contract revenues (See Contract Revenues). The Company's construction backlog at December 31, 1995 was approximately $3,600,000 compared to $9,100,000 at December 31, 1994.
Losses and Loss Adjustment Expenses
Losses and loss adjustment expenses were $7,115,371 in 1995 compared to $8,209,992 in 1994. The decreases in the losses and loss adjustment expenses are attributable to the decline in earned premiums from 1994 to 1995 without any fluctuations in the loss ratios. Loss and loss adjustment expense reserves represent management's estimate of the ultimate cost of unpaid losses incurred for these periods relative to premiums earned.
Amortization of Policy Acquisition Costs
Amortization of policy acquisition costs was $3,939,008 in 1995 as compared to $4,260,759 in 1994. Policy acquisition costs, primarily commissions, are deferred and amortized over the policy or bond term.
Selling, General and Administrative Expenses
Selling, general and administrative expenses were $6,097,322 in 1995 compared to $6,964,686 in 1994. The decrease in selling, general and administrative expenses from 1995 to 1994 reflects a decrease in the bad debts expense and a decrease in the amortization of intangible assets. Amortization of intangible assets amounted to approximately $399,000 in 1995 and $747,000 in 1994 due to the expiration, in 1994, of certain covenants not to compete.
Interest Expense
Interest expense has decreased to $4,810,578 in 1995 from $4,940,014 in 1994. The decrease in interest expense in 1995 is due primarily to the repayment of notes totaling $11,690,000 on March 31, 1994 offset in part by the issuance on June 30, 1994 of the $8,000,000 term loan.
Income Taxes
Income tax expense was $2,414,400 in 1995 compared to $2,245,300 in 1994, representing effective Federal tax rates of 25.1% and 24.6%, respectively. The Federal effective tax rate fluctuates according to the mix of tax exempt and taxable securities held by the Company.
RESERVES FOR LOSSES AND LOSS ADJUSTMENT EXPENSES:
Reserves for losses and loss adjustment expenses are established with respect to both reported and incurred but not reported claims for insured risks. The amount of loss reserves for reported claims is primarily based upon a case-by-case evaluation of the type of risk involved, knowledge of the circumstances surrounding each claim and the policy provisions relating to the type of claim. As part of the reserving process, historical data is reviewed and consideration is given to the anticipated impact of various factors such as legal developments and economic conditions, including the effects of inflation. Reserves are monitored and evaluated periodically using current information on reported claims.
Management believes that the reserves for losses and loss adjustment expenses at December 31, 1996 are adequate to cover the unpaid portion of the ultimate net cost of losses and lost adjustment expenses, including losses incurred but not reported. Reserves for losses and loss adjustment expenses are estimates at any given point in time of what the Company may have to pay ultimately on incurred losses, including related settlement costs based on facts and circumstances then known. The Company also reviews its claims reporting patterns, past loss experience, risk factors and current trends and considers their effect in the determination of estimates of incurred but not reported reserves. Ultimate losses and loss adjustment expenses are affected by many factors which are difficult to predict, such as claim severity and frequency, inflation levels and unexpected and unfavorable judicial rulings. Reserves for surety claims also consider the amount of collateral held as well as the financial strength of the contractor and its indemnitors.
The combined ratio is one means of measuring the underwriting experience of a property and casualty insurer. The combined ratio, consisting of the ratio of losses and loss adjustment expenses to premiums earned (the "loss ratio") plus the ratio of underwriting expenses to premiums written (the "expense ratio") reflects relative underwriting profit or loss. The Company's insurance subsidiaries' loss ratios under generally accepted accounting principles ("GAAP") were 30.0% for each of the years ended December 31, 1996, 1995 and 1994. These loss ratios are below industry averages and are believed to be the result of conservative underwriting. There can be no assurance that such loss ratios can continue. The Company's insurance subsidiaries' expense ratios under GAAP were 43.5%, 41.4% and 39.6% for the years ended December 31, 1996, 1995 and 1994, respectively. The Company's insurance subsidiaries' combined ratios under GAAP were 73.5%, 71.4% and 69.6% for the years ended December 31, 1996, 1995 and 1994, respectively. The increase in the 1996 combined ratio results primarily from the decline in premiums.
LIQUIDITY AND CAPITAL RESOURCES:
The Company internally generates sufficient funds for its current operations and maintains a relatively high degree of liquidity in its investment portfolio. The primary sources of funds to meet the demands of claim settlements and operating expenses are premium collections, investment earnings and maturing investments. The Company has no material commitments for capital expenditures and, in the opinion of management, has adequate sources of liquidity to fund its operations over the next 12 months.
ACMAT, exclusive of its subsidiaries, has incurred negative cash flows from operating activities primarily because of interest expense related to notes payable and long-term debt incurred by ACMAT to acquire and capitalize its insurance subsidiaries and to repurchase Company stock. ACMAT has also incurred negative working capital as a result of holding short-term debt related to its operations.
ACMAT's principal sources of funds are dividends from its wholly-owned subsidiaries, intercompany and short-term borrowings, insurance underwriting fees from its subsidiaries, construction contracting operations and rental income. Management believes that these sources of funds are adequate to service its indebtedness. ACMAT has recently utilized short-term borrowings to repurchase its stock. On a long-term basis, ACMAT could rely, if necessary, on dividends from its insurance subsidiaries to improve its working capital.
The Company realized cash flow from operations of $14,226,539 in 1996 compared to $19,312,412 in 1995 and $9,629,444 in 1994. Net cash flows provided by operations in 1996 were derived principally from premium collections and collateral held. Substantially all of the Company's cash flow was used to repay long-term debt, repurchase stock and purchase investments. Purchases of investments are made based upon excess cash available after the payment of losses and loss adjustment expenses and other operating and non-operating expenses. The Company's short term investment strategy coincides with the relatively short maturity of its liabilities which are comprised primarily of reserves for losses covered by claims-made insurance policies, reserves related to surety bonds and collateral held for surety obligations.
Net cash used for investing activities amounted to $11,358,672 in 1996, $11,454,974 in 1995 and $4,535,375 in 1994. In December 1996, the Company sold fixed maturity securities with a book value of approximately $34,000,000 resulting in a realized gain of approximately $204,000.
The terms of the Company's note agreements contain limitations on payment of cash dividends, re-acquisition of shares, borrowings and investments and require maintenance of specified ratios and minimum net worth levels, including cross default provisions. The Company is prohibited from paying any dividends prior to July 1, 1997. The payment of future cash dividends and the re-acquisition of shares are restricted each to amounts of an available fund ("Available Fund"). The Available Fund is a cumulative fund which is increased each year by 20% of the Consolidated Net Earnings (as defined). The Company is in compliance with all covenants at December 31, 1996, except for the limitation on the reacquisition of shares which exceeded the Available Fund at December 31, 1996. The Company has received a waiver to exceed this limitation at December 31, 1996.
The Company maintains a short-term unsecured bank credit line of $10 million to fund interim cash requirements. There was $8,000,000 outstanding under this line of credit as of December 31, 1996. Effective June 30, 1994, this credit line was renewed and modified to include an additional $8,000,000, six-year, term loan which is repayable in quarterly installments commencing September 30, 1994. Portions of the proceeds of such term loan were applied to the repayment of intercompany debt and to the reduction of the Company's short-term credit line.
On November 7, 1995, the Company obtained a $7,500,000 Demand Discretionary Line of Credit with The Bank of Boston Connecticut which expires on November 6, 1997. Under the terms of the line of credit, interest on the outstanding balance is calculated based upon the LIBOR plus 160 basis points in effect during the borrowing period. There was $5,200,000 outstanding under this line of credit at December 31, 1996.
During 1996, the Company purchased, in the open market and privately negotiated transactions, 42,207 shares of its Common Stock at an average price of $18.81. The Company also repurchased, in open market and privately negotiated transactions, 872,975 shares of its Class A Stock at an average price of $13.24 per share.
The Company's principal source of cash for repayment of long-term debt is dividends from its two insurance companies. Under applicable insurance regulations, ACMAT's insurance subsidiaries are restricted as to the amount of dividends they may pay to their respective holding companies, without the prior approval of their domestic state insurance department. For 1997, the amount of dividends ACMAT's insurance subsidiaries may pay, without prior approval of their domestic state insurance departments, is limited to approximately $7,011,000.
In 1997, the Company anticipates that internally generated funds and short-term borrowings will be utilized for repayment of long-term debt. Principal repayments on long-term debt is scheduled to be approximately $6,300,000 in 1997.
REGULATORY ENVIRONMENT
Risk-based capital requirements are used as early warning tools by the National Association of Insurance Commissioners and the states to identify companies that require further regulatory action. The ratio for each of the Company's insurance subsidiaries as of December 31, 1996 was significantly above the level which might require regulatory action.
ITEM 8.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Index to Consolidated Financial Statements and Schedules
ACMAT Corporation and Subsidiaries:
The following Consolidated Financial Statements of the Company, related notes and Independent Auditors' Report are included herein:
Independent Auditors' Report
Consolidated Statements of Earnings for the years ended December 31, 1996, 1995 and 1994
Consolidated Balance Sheets as of December 31, 1996 and 1995
Consolidated Statements of Stockholders' Equity for the years ended December 31, 1996, 1995 and 1994
Consolidated Statements of Cash Flows for the years ended December 31, 1996, 1995 and 1994
Notes to Consolidated Financial Statements - December 31, 1996, 1995 and 1994
Consolidated Schedules included in Part II of this Report - Years ended December 31, 1996, 1995 and 1994:
I - Condensed Financial Information of Registrant II - Valuation and Qualifying Accounts and Reserves V - Supplemental Information Concerning Property-Casualty Insurance Operations
INDEPENDENT AUDITORS' REPORT
The Board of Directors ACMAT Corporation:
We have audited the consolidated financial statements of ACMAT Corporation and subsidiaries as listed in the accompanying index. In connection with our audits of the consolidated financial statements, we also have audited the financial statement schedules as listed in the accompanying index. 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 ACMAT Corporation and subsidiaries as of December 31, 1996 and 1995, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1996 in conformity with generally accepted accounting principles. Also in our opinion, the related 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.
Hartford, Connecticut KPMG Peat Marwick LLP February 24, 1997
ACMAT CORPORATION AND SUBSIDIARIES
Consolidated Statements of Earnings Years Ended December 31, 1996, 1995 and 1994
See Notes to Consolidated Financial Statements.
ACMAT CORPORATION AND SUBSIDIARIES
See Notes to Consolidated Financial Statements.
ACMAT CORPORATION AND SUBSIDIARIES
Consolidated Statements of Stockholders' Equity December 31, 1996, 1995 and 1994
See Notes to Consolidated Financial Statements.
ACMAT CORPORATION AND SUBSIDIARIES
Consolidated Statements of Cash Flows Years ended December 31, 1996, 1995, 1994
See Notes to Consolidated Financial Statements.
ACMAT CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1996, 1995 AND 1994
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) Principles of Consolidation
The consolidated financial statements include ACMAT Corporation ("ACMAT" or the "Company"), its subsidiaries, AMINS, Inc., Geremia Electric Co., ACMAT of Texas, Inc., ACSTAR Holdings, Inc. ("ACSTAR Holdings") and ACSTAR Holdings' wholly-owned subsidiary, ACSTAR Insurance Company ("ACSTAR"); and United Coastal Insurance Company ("United Coastal Insurance").
These consolidated financial statements have been prepared in conformity with generally accepted accounting principles ("GAAP"). All significant intercompany accounts and transactions have been eliminated in consolidation. Certain reclassifications have been made to the 1995 and 1994 financial statements to conform with the classifications in 1996.
(b) Business
ACMAT operates as an insurance holding company and as an interior contractor; designing, supplying, renovating and installing interiors for commercial, industrial and institutional buildings, including asbestos abatement contracting.
ACMAT's Insurance Group includes United Coastal Insurance, ACSTAR and AMINS, Inc. United Coastal Insurance is an excess and surplus lines property and casualty insurer providing specialty general and environmental liability insurance to specialty trade and environmental contractors, property owners, storage and treatment facilities and allied professionals, as well as professional liability insurance to architects, engineers and consultants. ACSTAR is licensed as an admitted insurer in 49 states and the District of Columbia and provides surety bonding for specialty trade, environmental remediation and asbestos abatement contractors. AMINS, Inc. is an insurance agency which acts primarily as a general agent for ACSTAR and United Coastal Insurance. United Coastal Insurance participates in a number of reinsurance arrangements with other companies on a quota share basis. These arrangements primarily cover marine and other property catastrophic risks.
During 1996, 1995 and 1994, customers who individually accounted for more than 10% of consolidated construction contracting revenue for the respective years are as follows: 1996 - four customers provided 18%, 15%, 14% and 10%, respectively; in 1995 - three customers provided 28%, 24% and 18%, respectively; in 1994 - three customers provided 17%, 13% and 11%, respectively. No customers accounted for more than 10% of the consolidated insurance revenues in any year.
(c) Investments
Investment securities are classified as held to maturity, available for sale or trading. The Company classifies all investment securities as available for sale. Investment securities available for sale are carried at fair value and unrealized gains and losses are excluded from earnings and recorded as a separate component of stockholders' equity, net of estimated income taxes. Adjustments to minority interests are made as a result of unrealized gains and losses.
Investment in limited partnership, which represents participation in a joint venture which invests primarily in small capitalization stocks traded on national market exchanges, is carried at fair value.
Short-term investments, consisting primarily of money market instruments maturing within one year are carried at cost which, along with accrued interest, approximates fair value. Cash and cash equivalents include cash on hand and short-term highly liquid investments of maturities of three months or less when purchased. These investments are carried at cost plus accrued interest which approximates fair value.
Realized gains and losses are determined on a specific identification basis. The fair values of investment securities were based on quoted market prices.
The Company continually evaluates its investment portfolio and establishes reserves for impairment in value deemed to be other than temporary.
ACMAT CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(d) Policy Acquisition Costs
Policy acquisition costs, representing commissions and certain underwriting costs, are deferred and amortized on a straight-line basis over the policy term. During the years ended December 31, 1996, 1995 and 1994, deferrable costs capitalized were $3,063,875, $3,736,895 and 4,216,421, respectively. The amortization of deferred policy acquisition costs charged to operations for the years ended December 31, 1996, 1995 and 1994 was $3,617,308, $3,939,008 and $4,260,759, respectively.
(e) Property and Equipment
Property and equipment are reported at depreciated cost. Depreciation is computed using the straight-line method at rates based upon the respective estimated useful lives of the assets. Maintenance and repairs are expensed as incurred.
(f) Intangibles
All intangibles are stated at amortized cost and are being amortized using the straight-line method. Intangibles include insurance operating licenses and goodwill, which represents the excess of cost over the fair market value of net assets acquired. These intangible assets are amortized over periods ranging from 15 to 25 years.
(g) Insurance Reserve Liabilities
Reserves for losses and loss adjustment expenses are established with respect to both reported and incurred but not reported claims for insured risks. The amount of loss reserves for reported claims is primarily based upon a case-by-case evaluation of the type of risk involved, knowledge of the circumstances surrounding the claim and the policy provisions relating to the type of claim. As part of the reserving process, historical data are reviewed and consideration is given to the anticipated impact of various factors such as legal developments and economic conditions, including the effects of inflation. Reserves are monitored and recomputed periodically using new information on reported claims.
Reserves for losses and loss adjustment expenses are estimates at any given point in time of what the Company may have to pay ultimately on incurred losses, including related settlement costs, based on facts and circumstances then known. The Company also reviews its claims reporting patterns, past loss experience, risk factors and current trends and considers their effect in the determination of estimates of incurred but not reported losses. Ultimate losses and loss adjustment expenses are affected by many factors which are difficult to predict, such as claim severity and frequency, inflation levels and unexpected and unfavorable judicial rulings. Reserves for surety claims also consider the amount of collateral held as well as the financial strength of the contractor and its indemnitors. Management believes that the reserves for losses and loss adjustment expenses are adequate to cover the unpaid portion of the ultimate net cost of losses and loss adjustment expenses incurred, including losses incurred but not reported.
(h) Collateral Held
The carrying amount of collateral held approximates its fair value because of the short maturity of these instruments. Collateral held represents cash and investments retained by the Company for surety bonds issued by the Company.
(i) Reinsurance
In the normal course of business, the Company assumes and cedes reinsurance with other companies. Reinsurance ceded primarily represents excess of loss reinsurance with companies with "A" ratings from the insurance rating organization, A.M. Best Company, Inc. Such reinsurance is applicable on a per policy basis generally to those policies with per occurrence limits in excess of $2 million up to $5 million for liability and in excess of $1.5 million up to $15.8 million for surety bonds. Effective April 1, 1995, the Company secured additional treaty excess of loss reinsurance which provides limits on a per policy basis of $5,000,000 per occurrence or claim made and in the aggregate excess of $5,000,000 per occurrence or claim made and in the aggregate. Reinsurance ceded also includes a facultative reinsurance treaty which is applicable to excess policies written over a primary policy issued by the Company for specific projects. Reinsurance is ceded to limit losses from large exposures and to permit recovery of a portion of direct losses; however, such a transfer does not relieve the originating insurer of its liability. The Company participates in assumed quota share reinsurance arrangements covering marine and property catastrophe risks with one ot its excess of loss reinsurers.
ACMAT CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Reinsurance recoverables include ceded reserves for losses and loss adjustment expenses. Ceded unearned premiums of $1,083,877 and $1,186,401 at December 31, 1996 and 1995, respectively, are included in other assets. All reinsurance contracts maintained by the Company qualify as short-duration prospective contracts under the provisions of FAS No. 113. A summary of reinsurance premiums written and earned is provided below:
Reinsurance recoveries on ceded paid losses and loss adjustment expenses totaled approximately $98,000 and $30,000 for the years ended December 31, 1996 and 1995, respectively. There were no reinsurance recoveries on ceded paid losses and loss adjustment expenses for the year ended December 31, 1994. Ceded incurred losses and loss adjustment expenses totaled $421,408 and $378,254 for the years ended December 31, 1996 and 1995, respectively.
(j) Revenue Recognition
Revenue on construction contracts is recorded using the percentage of completion method. Under this method revenues with respect to individual contracts are recognized in the proportion that costs incurred to date relate to total estimated costs. Revenues and cost estimates are subject to revision during the terms of the contracts, and any required adjustments are made in the periods in which the revisions become known. Provisions are made, where applicable, for the entire amount of anticipated future losses on contracts in progress. Claims are recorded as revenue at the time of settlement and profit incentives and change orders are included in revenues when their realization is reasonably assured. Selling, general and administrative expenses are not allocated to contracts.
Insurance premiums are recognized over the terms of the respective policy contracts. Unearned premiums represent the portion of premiums written that is applicable to the unexpired terms of policies in force, calculated on a prorata basis.
(k) Income Taxes
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. 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.
(l) Use of Estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from reported results using those estimates.
(m) Application of New Accounting Standards
Effective January 1, 1996, the Company adopted Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed of" (FAS 121). This statement establishes accounting standards for the impairment of long-lived assets and certain identifiable intangibles to be disposed of. This statement requires a write down to fair value when long-lived assets to be held and used are impaired. The adoption of this statement did not have any effect on results of operations, financial condition or liquidity as no adjustments were required.
Also effective January 1, 1996, the Company adopted Statement of Financial Accounting Standards No. 123", "Accounting for Stock-Based Compensation" (FAS 123). This statement addresses alternative accounting treatments for stock-based compensation, such as stock options and restricted stock. FAS 123 permits disclosing in the financial statement footnotes the pro forma impact to net income as if the value of stock-based compensation awards had been expensed. The value of awards are measured at the grant date based upon estimated fair value, using option pricing models. The Company has selected the alternative which provides for pro forma disclosure in the footnotes to the consolidated financial statements (See Note 13).
ACMAT CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(2) ACQUISITIONS
Effective September 16, 1996, the Company completed the merger of United Coasts Corporation into ACMAT. United Coasts Corporation shareholders received one share of ACMAT Class A stock for each approximately 1.536 shares of United Coasts Corporation stock. As a result of the merger, ACMAT issued approximately 1,100,000 shares of its Class A stock amounting to a purchase price of approximately $14 million for the 16% minority interest in the insurance holding company subsidiary. As a result, United Coastal Insurance, formerly a subsidiary of United Coasts Corporation, has become a wholly-owned subsidiary of ACMAT and its affiliates. The merger is a non-cash transaction that is not reflected in the Statements of Cash Flow.
The merger of United Coasts Corporation into ACMAT has been accounted for by the purchase method and, accordingly, the purchase price was allocated to the net assets of United Coasts Corporation based on the fair value of the assets purchased and liabilities assumed on September 16, 1996.
The following table presents the unaudited pro forma results of operations as if the merger of United Coasts Corporation had been consummated at the beginning of the periods presented. These unaudited pro forma results have been prepared for comparative purposes only and are not necessarily indicative of the actual results of operations that would have occurred had the merger actually been made at the beginning of the periods presented, or of results which may occur in the future.
On September 21, 1994, ACMAT purchased from The Environmental Venture Fund, a Delaware limited partnership ("EVF"), The Apex Investment Fund, an Illinois limited partnership ("Apex") and The Productivity Fund, a Delaware limited partnership ("PF"), 15, 10 and 5 shares, respectively, of the common stock of ACSTAR Holdings, a subsidiary of the Company, for an aggregate consideration of $3,000,000. As a result of these transactions, the amount of the outstanding common stock of ACSTAR Holdings owned by the Company has increased from 91% to 100%, thereby making ACSTAR Holdings a wholly-owned subsidiary of the Company.
In a separate transaction, EVF, Apex and PF exercised warrants to purchase 189,750, 126,500 and 63,250 shares, respectively, of Class A Stock of the Company for an aggregate consideration of $3,000,000.
ACMAT CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(3) INVESTMENTS
Investments at December 31, 1996 and 1995 follows:
Fair value estimates are made at a specific point in time, based on quoted market prices and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company's entire holdings of a particular financial instrument. In addition, the tax ramifications related to the realization of the unrealized gains and losses have not been considered in any of the estimates. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and, therefore, cannot be determined with precision. Changes in assumptions could significantly affect the estimates.
On December 31, 1996, the Company's insurance subsidiaries had securities with an aggregate book value of approximately $9.8 million on deposit with various state regulatory authorities.
The amortized cost and fair value of fixed maturities at December 31, 1996 and 1995, by effective maturity, follows:
The Company's portfolio is comprised primarily of fixed maturity securities rated AA or better by Standard and Poor's and includes mostly U.S. Treasuries and tax-free municipal securities.
ACMAT CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A summary of gross unrealized gains and losses at December 31, 1996 and 1995 follows:
(4) INVESTMENT INCOME AND REALIZED CAPITAL GAINS AND LOSSES
A summary of net investment income for the years ended December 31, 1996, 1995 and 1994 follows:
Realized capital gains (losses) for the years ended December 31, 1996, 1995 and 1994 follows:
Gross gains of $237,726, $25,235 and $17,076 and gross losses of $27,808, $24,425 and $89,866 were realized on fixed maturity sales for the years ended December 31, 1996, 1995, and 1994, respectively. Gross gains of $48,568, $56,926 and $41,247 and gross losses of $0, $49,839 and $0 were realized on sale of equity securities for the years ended December 31, 1996, 1995 and 1994, respectively.
ACMAT CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(5) RECEIVABLES
A summary of receivables at December 31, 1996 and 1995 follows:
The balances billed but not paid by customers pursuant to retainage provisions in construction contracts will be due upon completion of the contracts and acceptance by the owner. In management's opinion, the majority of contract retainage is expected to be collected in 1997.
Recoverable costs in excess of billings on uncompleted contracts are comprised principally of amounts of revenue recognized on contracts for which billings had not been presented to the contract owners as of the balance sheet date. These amounts will be billed in accordance with the contract terms.
(6) PROPERTY AND EQUIPMENT
A summary of property and equipment at December 31, 1996 and 1995 follows:
Future minimum rental income to be generated by leasing a portion of the building under noncancelable operating leases as of December 31, 1996 are estimated to be $528,548 for 1997, $528,548 for 1998, $465,845 for 1999, $444,944 for 2000, and $444,944 for 2001. Rental income earned in 1996, 1995 and 1994 was $504,063, $543,507 and $561,825, respectively.
(7) INTANGIBLES
A summary of intangibles, acquired primarily in connection with purchases of the Company's insurance subsidiaries, at December 31, 1996 and 1995 follows:
Intangible assets are written off when they become fully amortized.
ACMAT CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(8) RESERVES FOR LOSSES AND LOSS ADJUSTMENT EXPENSES
The following table sets forth a reconciliation of beginning and ending reserves for unpaid losses and loss adjustment expenses for the periods indicated on a GAAP basis for the business of the Company.
The decrease in 1996 and 1995 of incurred losses and loss adjustment expenses of prior years represents a reallocation of reserves among accident years. The increases in claim payments are also attributable to an increase in earned premiums during the development of the Company's insurance operations and the conversion of related loss reserves to loss payments in the normal course of business. Management believes that the reserves for losses and loss adjustment expenses are adequate to cover the unpaid portion of the ultimate net cost of losses and loss adjustment expenses, including losses incurred but not reported.
The Company has no exposure to any asbestos or environmental claims associated with general liability policies issued with the pre-1986 pollution exclusion. Policies written with the exclusion are typically associated with mass tort environmental and asbestos claims. The Company has never issued a policy with the pre-1986 pollution exclusion. The Company's exposure to asbestos and environmental liability claims is primarily limited to asbestos and environmental liability insurance for contractors and consultants involved in the remediation, removal, storage, treatment and/or disposal of environmental and asbestos hazards.
(9) NOTES PAYABLE TO BANKS
The Company has available a $10,000,000 bank line of credit with Fleet Bank, N.A. which expires in June 1997. The line of credit requires the Company to maintain, on deposit with the bank, a compensating balance equal to 5% of the line of credit. Borrowings outstanding under this line were $8,000,000 at December 31, 1996 and $7,500,000 at December 31, 1995.
Under the terms of the line of credit, interest on the outstanding balance is calculated based upon the London Inter-Bank Offering Rate (LIBOR) plus 180 basis points in effect during the borrowing period (7.4% and 7.7% at December 31, 1996 and 1995, respectively).
The Company has available a $7,500,000 Demand Discretionary Line of Credit with The Bank of Boston Connecticut which expires on November 6, 1997. Under the terms of the line of credit, interest on the outstanding balance is calculated based upon the LIBOR plus 160 basis points in effect during the borrowing period (7.4% at December 31, 1996). Borrowings outstanding under this line was $5,200,000 at December 31, 1996. There were no borrowings outstanding under this line of credit at December 31, 1995.
The fair value of notes payable to banks approximates cost.
(10) LONG-TERM DEBT
A summary of long-term debt at December 31, 1996 and 1995 follows:
ACMAT CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
On April 1, 1996, the Company obtained a $2,500,000, seven-year, term loan, which is repayable in quarterly installments of $89,286 commencing June 30, 1996. The proceeds were used to repay the line of credit.
On June 30, 1994, the Company obtained an $8,000,000, six-year, term loan, which is repayable in quarterly installments of $333,333 commencing September 30, 1994. Portions of the proceeds of such term loan were applied to the repayment of intercompany debt and to the reduction of the Company's short-term credit line.
On July 1, 1992, the Company issued a 30-year unsecured $16,500,000, 11.5% subordinated debenture to the Sheet Metal Workers' National Pension Fund ("Fund") to purchase 3,000,000 shares of United Coasts Corporation's outstanding common stock held by the Fund. Annual principal payments of $1,650,000 per year for ten years are due beginning on July 1, 2012. The note is convertible into ACMAT Class A stock at $11 per share. The conversion price of $11 per share would be adjusted at the time of conversion to reflect any stock dividends, recapitalizations or additional stock issuances. At December 31, 1995, the Company had reserved 1,500,000 shares of Class A Stock for issuance pursuant to such conversion option.
On April 18, 1990, the Company obtained a permanent mortgage loan from The Manufacturer's Life Insurance Company. The $8,350,000 mortgage note, with interest at 9.69%, is payable in monthly installments over 10 years based on a thirty year amortization schedule. The remaining outstanding principal balance is payable on April 1, 2000. The proceeds were used to repay an existing construction loan and to fund completion of the Company's headquarters.
On July 18, 1989, the Company issued $15,000,000, 10.5% Convertible Senior Notes due June 30, 1999 to AIG Life Insurance Company and American International Life Assurance Company of New York. Quarterly principal repayments of $500,000 began on June 30, 1993. The notes are convertible, at any time prior to their payment date, into shares of ACMAT Class A Stock at $10 per share. The conversion price of $10 per share would be adjusted at the time of conversion to reflect any stock dividends, recapitalizations or additional stock issuances. At December 31, 1996, the Company had reserved 450,000 shares of Class A Stock for issuance pursuant to such conversion option.
During 1996 and 1995, the Company issued 499,999 and 149,997 shares, respectively of Class A Stock at $10 per share pursuant to the conversion options of the Convertible Senior Notes to AIG Life Insurance Company and American International Life Assurance Company of New York. The issuance of stock pursuant to the conversion option of the Convertible Senior Notes is a non-cash transaction that is not reflected in the Consolidated Statement of Cash Flows.
The terms of the note agreements contain limitations on payment of cash dividends, re-acquisition of shares, borrowings and investments and require maintenance of specified ratios and a minimum tangible net worth of $12,000,000. ACMAT may also require its insurance subsidiaries to pay dividends to the extent of funds legally available therefor, in order to enable ACMAT to have funds to pay on a timely basis all amounts due with respect to the notes. The Company is in compliance with all but one of these covenants at December 31, 1996 and the Company has received a waiver relative to the covenant with which the Company was not in compliance.
Principal payments on long-term debt are $6,284,692, $1,794,238, $1,804,751, $8,620,250 and $357,144 for the years 1997 through 2001, respectively. Interest expense paid in 1996, 1995 and 1994 amounted to $4,980,833, $4,791,005 and $4,911,392, respectively.
It is not practicable to estimate the fair value of long-term debt at December 31, 1996 because of the complex and unique terms associated with these debt instruments.
(11) INCOME TAXES
The components of income tax expense for each year follows:
ACMAT CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The effective Federal income tax rate, as a percentage of earnings before income taxes and minority interest follows:
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 1996 and 1995 are presented below:
There was no valuation allowance for deferred income tax assets as of December 31, 1996 and 1995. In assessing the realization of deferred tax assets, management considers whether it is more likely than not that the deferred tax assets will be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, tax planning strategies and anticipated future taxable income in making this assessment and believes it is more likely than not the Company will realize the benefits of its deductible differences at December 31, 1996.
Taxes paid in 1996, 1995 and 1994 were $1,556,471, $3,045,627 and $1,685,362, respectively.
(12) PENSION AND PROFIT SHARING PLANS
The Company and its subsidiaries maintain, for the benefit of non-union employees, a qualified thrift, profit sharing and retirement plan. Participants are required to contribute three percent of their compensation to the plan annually. The Company's contributions, established by the Board of Directors, were $100,000, $100,000 and $90,600, for 1996, 1995 and 1994, respectively.
The Company participates in various multi-employer defined contribution plans for its union employees. Charges to expense with respect to the Company's contributions to the various plans were approximately $13,593 in 1996, $42,000 in 1995 and $19,000 in 1994. Upon withdrawal from these plans, the Company may be liable for its share of the unfunded vested liabilities of the plans. Such obligations, if any, of the Company are not determinable at December 31, 1996.
ACMAT CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(13) STOCKHOLDERS' EQUITY
The Class A Stock has one-tenth voting privilege but has all the other rights and privileges pertaining to the Common Stock.
During 1996, 1995 and 1994, ACMAT repurchased, in open market and privately negotiated transactions 42,207, 10,456, and 40,413, respectively, shares of its Common Stock at an average price of $18.81, $15.52 and $12.07 per share, respectively. The Company also repurchased during 1996, 1995 and 1994, in open market and privately negotiated transactions 872,975, 797,228 and 478,484, respectively, of its Class A Stock at an average price of $13.18, $11.83 and $8.81 per share, respectively.
During 1996 and 1995, the Company issued 449,999 and 149,997, respectively, shares of Class A Stock at $10 per share pursuant to the conversion options of the Convertible Senior Notes to AIG Life Insurance Company and American International Life Assurance Company of New York. The issuance of stock pursuant to the conversion option of the Convertible Senior Notes is a non-cash transaction that is not reflected in the Consolidated Statement of Cash Flows.
On September 21, 1994, EVF, Apex and PF exercised warrants to purchase 189,750, 126,500 and 63,250 shares, respectively, of Class A Stock of the Company for an aggregate consideration of $3,000,000.
The stockholders have periodically approved the distribution of nonstatutory stock options to certain officers and directors giving such individuals the right to purchase restricted shares of the Company's Common and Class A Stock. Transactions regarding these stock options are summarized below:
The exercise price of each option equals the market price of the Company's stock on the date of grant and the option's term is ten years. The options vest six months after the date of grant.
The Company applies APB Opinion No. 25 and related interpretations in accounting for its stock options. Accordingly, no compensation cost has been recognized for its stock options. Had compensation cost for the Company's stock options issued in 1996 been determined consistent with FASB Statement No. 123, the Company's net earnings and earnings per share would have been reduced to the pro forma amounts indicated below. There were no stock options granted in 1995.
The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions used for the options granted in 1996: no dividend yield; expected volatility of 20%; risk free interest rate of 6.7%; and expected life of ten years for the options. The weighted average of fair value of options granted in 1996 was $5.99 per share.
Under applicable insurance regulations, ACMAT's insurance subsidiaries are restricted as to the amount of dividends they may pay, without the prior approval of any insurance department, and are limited to approximately $7,011,000 in 1997.
ACMAT CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Company's insurance subsidiaries, United Coastal Insurance and ACSTAR, are domiciled in the States of Arizona and Illinois, respectively. The statutory financial statements of United Coastal Insurance and ACSTAR are prepared in accordance with accounting practices prescribed by the Arizona Department of Insurance and the Illinois Department of Insurance, respectively. Prescribed statutory accounting practices include a variety of publications of the National Association of Insurance Commissioners (NAIC), as well as the state laws, regulations, and general administrative rules. As of December 31, 1996, the Company does not utilize any statutory accounting practices which are not prescribed by insurance regulators that individually or in the aggregate materially affect statutory shareholders' equity.
In accordance with statutory accounting principles, ACMAT's insurance subsidiaries' statutory capital and surplus was $70,109,199 and $66,382,683 at December 31, 1996 and 1995, respectively, and their statutory net income for the years ended December 31, 1996, 1995 and 1994 was $8,778,843, $9,072,104 and $ 8,860,484, respectively.
Pursuant to various debt covenants, previously described, ACMAT is restricted from purchasing treasury stock and paying dividends greater than 20% of consolidated net earnings.
(14) EARNINGS PER SHARE AND SHARE EQUIVALENT
The earnings per share and share equivalent were computed by dividing net earnings by the weighted average number of Common and Class A shares outstanding of 3,559,367, 3,661,577 and 4,134,110 for 1996, 1995 and 1994, respectively, and includes the common stock equivalency of outstanding options, if dilutive. The number of shares was also increased by the number of shares issuable on the exercise of options when the market price of the stock exceeded the exercise price of the option. This increase in the number of shares was reduced by the number of shares which are assumed to have been purchased with the proceeds from the exercise of the option; these purchases were assumed to have been made at the average price of the common stock during that part of the year when the market price of the common stock exceeded the exercise price of the option.
Earnings per share - assuming full dilution for 1996 and 1995 were determined on the assumptions that the convertible notes were converted and the options were exercised at the beginning of the year. As to the debentures, net earnings were adjusted for the interest expense, net of its tax effect. As to the options, outstanding shares were increased as described above, except that purchases were assumed to have been made at the year-end price of the shares. Earnings per share - assuming full dilution was not presented for 1994 because the effects are not material.
(15) COMMITMENTS AND CONTINGENCIES
The Company is a party to a number of legal actions arising in the ordinary course of its business. In management's opinion, the Company has adequate legal defenses respecting those actions where the Company is a defendant, has appropriate insurance reserves recorded, and does not believe that their settlement will materially affect the Company's operations or financial position.
Many construction projects in which the Company has been engaged have included asbestos exposures which the Company believes to involve a particularly high degree of risk because of the hazardous nature of asbestos. The Company believes it has reduced the risks associated with asbestos through proper training of its employees and by maintaining general liability and workers' compensation insurance. Since 1986, the Company has obtained its general liability insurance and surety bonds from its insurance subsidiaries.
ACMAT CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(16) SEGMENT REPORTING
The Company operates in two industry segments: Construction contracting and insurance. Information relating to the two segments is summarized as follows:
Operating earnings for construction contracting is operating revenues less cost of contract revenues and identifiable selling, general and administrative expenses. Operating earnings for the insurance segment is operating revenues less losses and loss adjustment expenses, amortization of policy acquisition costs and identifiable selling, general and administrative expenses. Interest expense has not been included in the computation of operating earnings. The adjustments and eliminations required to arrive at consolidated amounts shown above consist principally of the elimination of the intersegment revenues related to the performance of certain services and rental charges. Identifiable assets are those assets that are used by each segment's operations.
(17) SUBSEQUENT EVENT
On February 5, 1997, ACMAT Corporation purchased 1,099,996 shares of its own Class A Stock from AIG Life Insurance Company (366,663 shares) and American International Life Assurance Company of New York, (733,333). The shares were purchased at an average price of $14.70 per share for a total purchase price of $16,174,942.
The purchase price of $16,174,942 consisted of $4,174,942 in cash and promissory notes totaling $12,000,000. The promissory notes are with AIG Life Insurance Company and American International Life Assurance Company of New York and are payable over eight years with interest at prime rate (8-1/4%). The interest rate is equal to the prime rate, however, it shall not exceed 9-1/4% and it shall not be less than 7-1/4%.
The 1,099,996 shares of Class A Stock were acquired throughout the past two years by AIG Life Insurance Company and American International Life Assurance Company of New York pursuant to the conversion options of the Convertible Senior Notes.
(18) QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
A summary of the unaudited quarterly results of operations for 1996 and 1995 follows:
Note: Earnings per common share are based on the weighted average number of Common and Class A Stock and equivalent shares outstanding during each of the quarters and at year end. Annual earnings per share for 1996 does not equate to the sum of the quarters due to the timing of stock purchases during the year.
Operating earnings represent operating revenues less the cost of contract revenues, losses and loss adjustment expenses and amortization of policy acquisition costs and selling, general and administrative expenses.
Schedule I
ACMAT CORPORATION AND SUBSIDIARIES
Condensed Financial Information of Registrant
As of December 31, 1996 and 1995 and for the
years ended December 31, 1996, 1995 and 1994
The following presents the condensed financial position of ACMAT Corporation (parent company only) as of December 31, 1996 and 1995 and its condensed statements of earnings and cash flows for the years ended December 31, 1996, 1995 and 1994.
See Notes to Condensed Financial Statements.
Schedule I, continued
ACMAT CORPORATION AND SUBSIDIARIES
Condensed Financial Information of Registrant, Continued
STATEMENT OF EARNINGS
(Continued)
See Notes to Condensed Financial Statements.
Schedule I, Continued
ACMAT CORPORATION AND SUBSIDIARIES
Condensed Financial Information of Registrant, Continued
STATEMENTS OF CASH FLOWS
See Notes to Condensed Financial Statements.
Schedule I, Continued
ACMAT CORPORATION AND SUBSIDIARIES Condensed Financial Information Notes to Condensed Financial Statements
The accompanying condensed financial statements should be read in conjunction with the Consolidated Financial Statements and Notes thereto in the Company's 1996 Annual Report.
(1) SUPPLEMENTAL CASH FLOW INFORMATION
Income taxes received from subsidiaries during the years ended December 31, 1996, 1995 and 1994 were $1,990,201, $2,214,656 and $1,962,126, respectively. Interest paid during the years ended December 31, 1996, 1995 and 1994 was $6,099,379 $5,769,404 and $5,566,037, respectively. Interest paid in 1996 and 1995 included $1,118,546 and $978,399, respectively, paid to subsidiaries for intercompany loans.
During 1996 and 1995, the Company issued 499,999 and 149,997 shares of Class A Stock respectively at $10 per share pursuant to the conversion options of the Convertible Senior Notes to AIG Life Insurance Company and American International Life Assurance Company of New York. The issuance of stock pursuant to the conversion option of the Convertible Senior Notes is a non-cash transaction that is not reflected in the Consolidated Statement of Cash Flows.
(2) LONG-TERM DEBT
A summary of long-term debt at December 31, 1996 and 1995 follows:
See Note 10 to the Consolidated Financial Statements in the Annual Report for a description of the long-term debt and aggregate maturities for 1997 to 2001 and thereafter.
(3) INCOME TAXES
See Note 11 to the Consolidated Financial Statements in the Annual Report for a description of income taxes.
(4) COMMITMENTS AND CONTINGENCIES
See Note 15 to the Consolidated Financial Statements in the Annual Report for a description of the commitments and contingencies.
SCHEDULE II
ACMAT CORPORATION AND SUBSIDIARIES
Valuation and Qualifying Accounts and Reserves
Years ended December 31, 1996, 1995 and 1994
(a) Deductions represent accounts written off.
Schedule V
ACMAT CORPORATION AND SUBSIDIARIES
Supplemental Information concerning property-casualty insurance operations
As of and for the years ended December 31, 1996, 1995 and 1994
ITEM 9.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE: None
PART III
ITEM 10.

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The following table shows for each director (a) his or her age, (b) the year in which the director first served as a director of the Company, (c) position with the Company and business experience during the past five years, including principal occupation, (d) his or her committee assignments, and (e) his or her other directorships. Each director is elected for a term of one year and until his or her successor shall be elected.
(1) Mr. Henry W. Nozko, Sr. and Mrs. Victoria C. Nozko are husband and wife and Mr. Henry W. Nozko, Jr. is their son.
Executive Officers of the Registrant:
The following are the Company's Executive Officers, their age, and offices held. Officers are appointed to serve until the meeting of the Board of Directors following the next Annual Meeting of Stockholders and until their successors have been elected.
ITEM 11.

ITEM 11. EXECUTIVE COMPENSATION
Directors who are not employees of the Company are paid an annual fee of $4,000.
The following table provides certain summary information regarding compensation of the Company's Chief Executive Officer and each of the four most highly compensated executive officers of the Company for the periods indicated.
(A) Amounts shown include cash compensation earned and received by the executive officers. There are no other forms of non-cash compensation or other perquisites for any executive officer.
The Company has a Management Compensation Plan based upon earnings of the Company. As a guideline, the plan provides that participants may share in an incentive fund equal to 12% of pretax earnings, provided such pretax earnings amount to at least a 10% return on the Company's equity. However, both the participants and the amount of bonus are discretionary. In addition, the Company may offer separate incentives and commissions on an individual basis.
(B) Options were granted for ACMAT Class A Stock and Common Stock.
(C) The amounts shown in this column represent contributions made by the Company to the Company's Thrift, Profit Sharing and Retirement Plan ("Plan"). The Plan provides that all nonunion employees employed on a full time or part time salaried basis are eligible to participate on the first day of January or July after twelve consecutive months of employment. The Company contributes amounts, as determined by the Board of Directors, to be allocated among the participants according to a formula based upon the employee's years of service and compensation. A participant becomes vested at the rate of 20% per year commencing after two years of service.
The following table provides information on option grants during 1996 to the named Executive Officers.
OPTIONS GRANTED IN LAST FISCAL YEAR
(A) Options were granted at an exercise price equal to the fair market value per share of ACMAT Corporation's Class A Stock as of the date of grant and are exercisable starting six months after the grant date.
(B) Potential realizable values are net of exercise price, but before taxes associated with exercise. Amounts represent hypothetical gains that could be achieved for the respective options if exercised at the end of the option term. The assumed 5% and 10% rates of stock price appreciation are provided in accordance with rules of the Securities and Exchange Commission and do not represent the Company's estimate or projection of the future stock price. Actual gains, if any, on stock option exercises are dependent on the future performance of the stock, overall market conditions and the option holders' continued employment through the vesting period. This table does not take into account any appreciation in the price of the Class A Stock from the date of grant to date.
The following table provides information on options during 1996 by the named Executive Officers and the value of their unexercised options at December 31, 1996.
AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR END 1996 OPTION VALUES
(1) Represents the number of options held at year end.
(2) Represents the total gain which would have been realized if all options for which the year-end stock price was greater than the exercise price were exercised on the last day of the year.
ITEM 12.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT:
As of March 7, 1996, no person was known to the Company to be the beneficial owner of more than five percent of its outstanding shares of Common Stock or Class A Stock except as set forth in the following table which also shows, as of that date, the total number of shares of each class of stock of the Company beneficially owned, and the percent of the outstanding class of stock so owned, by each director, and by all directors and officers of the Company, as a group:
(1) The person listed has the sole power to vote the shares of Common Stock and Class A Stock listed above as beneficially owned by such person and has sole investment power with respect to such shares.
(2) Does not include 14,260 shares of Common Stock nor 16,060 shares of Class A Stock held of record by ACMAT's qualified Thrift, Profit Sharing & Retirement Plan, of which Messrs. Nozko, Sr. and Nozko, Jr. are trustees. Address is 233 Main Street, New Britain, Connecticut 06050-2350.
(3) Does not include 21,200 shares of Class A Stock and 5,500 shares of Common Stock held by Mr. Nozko, Jr. as custodian for his minor children nor 2,800 shares of Class A Stock and 2,750 shares of Common Stock held by his wife, Gloria C. Nozko.
(4) Includes options to purchase 61,000 shares of Class A Stock.
(5) Includes options to purchase 50,000 shares of Common Stock.
(6) Includes options to purchase 81,000 shares of Class A Stock.
(7) Includes options to purchase 15,000 shares of Class A Stock.
(8) Includes options to purchase 24,000 shares of Class A Stock.
(9) Includes options to purchase 18,000 shares of Class A Stock.
(10) Assumes the full conversion of $16,500,000 principal amount of 11.5% Convertible Note into 1,500,000 shares of Class A Stock. The Address of the Fund is Suite 500, 601 North Fairfax Street, Alexandria, VA 22314.
(11) Address of Franklin Resources, Inc. is 777 Mariners Island Blvd. San Mateo, CA 94404
(12) Address of First Manhattan Co. is 437 Madison Avenue, New York, NY 10022.
(13) Address of Investment Counselor's of Maryland, Inc. is 803 Cathedral Street,Baltimore, MD 21201.
(14) Address of EQSF Advisors, Inc. is 767 Third Avenue, New York, NY 10017-2023.
(15) Address of U.S. Bancorp is 111 S.W. Fifth Avenue, Portland, OR 97204.
(16) Based upon one vote for each share of Common Stock and one-tenth vote for each share of Class A Stock.
ITEM 13.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS:
Sheet Metal Workers' National Pension Fund
The Pension Fund has the right to convert indebtedness of ACMAT to the Pension Fund in the principal amount of $16,500,000 into shares of Class A Stock at the current conversion price of $11.00 per share pursuant to the terms of a 30-year unsecured, $16,500,000 subordinated debenture dated July 1, 1992 and bearing interest at the annual rate of 11.5%.
Henry W. Nozko, Sr., Henry W. Nozko, Jr. and the Pension Fund are parties to a voting agreement pursuant to which the parties have agreed to vote their respective shares of Class A Stock in favor of the Pension Fund's nominees to the ACMAT Board of Directors. Michael J. Sullivan, a director of ACMAT, currently serves as the Business Manager and Financial Secretary/Treasurer of the Sheet Metal Workers' Local Union No. 20 and as First General Vice President of the Sheetmetal Workers' International Association.
AIG Life Insurance Company
On July 18, 1989, the Company issued $15,000,000 in principal amount of 10.5% Convertible Senior Notes due June 30, 1999 to AIG Life Insurance Company and its affiliate, American International Life Assurance Company of New York. These Notes are convertible at any time into shares of Class A Stock at a current conversion price of $10.00 per share, subject to adjustment in certain events. At December 31, 1996, the Company had reserved 450,000 shares of Class A Stock for issuance pursuant to such conversion rights, which shares may be deemed beneficially owned by AIG Life Insurance Company and American International Life Assurance Company of New York. American International Group, Inc., a holding company for AIG Life Insurance Company and American International Life Assurance Company of New York, is a substantial owner of Transatlantic Reinsurance Company, a reinsurer to which the Company, through Coastal Insurance and ACSTAR Insurance, ceded $421,000 in reinsurance premiums in the year ended December 31, 1996.
On February 5, 1997, ACMAT Corporation purchased 1,099,996 shares of its own Class A Stock from AIG Life Insurance Company (366,663 shares) and American International Life Assurance Company of New York (733,333 shares). The shares were purchased at an average price of $14.70 per share for a total purchase price of $16,174,942.
The purchase price of $16,174,942 consisted of $4,174,942 in cash and promissory notes totaling $12,000,000. The promissory notes are with AIG Life Insurance Company and American International Life Assurance Company of New York and are payable over eight years with interest at prime rate (8-1/4%). The interest rate is equal to the prime rate, however, it shall not exceed 9-1/4% and it shall not be less than 7-1/4%.
The 1,099,996 shares of Class A Stock were acquired throughout the past two years by AIG Life Insurance Company and American International Life Assurance Company of New York pursuant to the conversion options of the Convertible Senior Notes.
Other Relationships
During the year ended December 31, 1996, the Company paid to Dr. Arthur Cosmas $137,300 in fees in connection with consulting services rendered by Dr. Cosmas with respect to inspection and engineering services relating to ACMAT's asbestos abatement activities. Dr. Cosmas is the son-in-law of Henry W. Nozko, Sr. and Victoria C. Nozko and the brother-in-law of Henry W. Nozko, Jr.
PART IV
ITEM 14.

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) 1. Consolidated Financial Statements
Included in Part II of this Report: Independent Auditors' Report Consolidated Statements of Earnings for the years ended December 31, 1996, 1995 and 1994 Consolidated Balance Sheets as of December 31, 1996 and 1995 Consolidated Statements of Stockholders' Equity for the years ended December 31, 1996, 1995 and 1994 Consolidated Statements of Cash Flows for the years ended December 31, 1996, 1995 and 1994 Notes to Consolidated Financial Statements - December 31, 1996, 1995 and 1994
2. Financial Statement Schedules
Consolidated Schedules included in Part II of this Report-Years ended December 31, 1996, 1995 and 1994:
I - Condensed Financial Information of Registrant II - Valuation and Qualifying Accounts and Reserves V - Supplemental Information Concerning Property-Casualty Insurance Operations
All other schedules are omitted as the required information is not applicable or the information is presented in the Consolidated Financial Statements or related notes.
(b) Reports on Form 8-K
The Company did not file a report on Form 8-K during the fourth quarter of 1996.
(c) Exhibits
(3) Certificate Amending and Restating the Company's Bylaws as filed as an Exhibit to the Company's Form 10-Q for the Quarter ended March 31, 1989 is incorporated herein by reference.
(3a) Certificate Amending and Restating the Company's Certificate of Incorporation as amended May 1, 1991 as filed as an Exhibit to the Company's Form 10-Q for the Quarter ended March 31, 1991 is incorporated by reference.
(4) Note Purchase Agreements between ACMAT Corporation and AIG Life Insurance Company and American International Life Assurance Company of New York dated July 18, 1989 regarding 10-1/2% Convertible Senior notes due June 30, 1999 as filed as Exhibits to the Company's Form 10-Q for the Quarter ended June 30, 1989 are incorporated by reference.
(4a) Promissory Note between ACMAT Corporation and The Bank of Boston Connecticut as filed as an Exhibit to the Company's Form 10-K for the year ended December 31, 1995 is incorporated herein by reference.
(4b) Promissory Note between ACMAT Corporation and The Manufacturers Life Insurance Company filed as an Exhibit to the Company's Form 10-Q for the Quarter ended March 31, 1990 are incorporated by reference.
(4c) Open-end Mortgage Deed and Security Agreement between ACMAT Corporation and The Manufacturers Life Insurance Company filed as an Exhibit to the Company's Form 10-Q for the Quarter ended March 31, 1990 are incorporated by reference.
(4d) Loan Agreement dated as of June 30, 1994 between ACMAT Corporation and Shawmut Bank Connecticut, N.A. filed as an Exhibit to the Company's Amendment No. 1 to Form S-1 dated July 13, 1994 is incorporated by reference.
(10a) Annual Management Compensation Plan filed as an Exhibit to the Company's 1984 Form 10-K is incorporated herein by reference.
(10b) Stock Purchase Agreement dated as of July 1, 1992 between ACMAT Corporation and the Sheet Metal Workers' National Pension Fund together with Note Agreement Re: $16,500,000 11-1/2% Convertible Subordinated Notes due 2012 filed as Exhibit 10g to the Company's Form 10-K for the year ended December 31, 1992 is incorporated herein by reference.
(21) Subsidiaries of ACMAT.
(27) Financial Data Schedule.
(28) Information from Reports Furnished to State Insurance Regulatory Authorities. Schedule P of the Annual Statements of ACSTAR Insurance Company and United Coastal Insurance Company for 1996.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant had duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.
ACMAT CORPORATION
Dated: March 28, 1997 By: /s/ Henry W. Nozko, Sr. ------------------------------- Henry W. Nozko, Sr., President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
INDEX TO EXHIBITS