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EXCEL - IDEA: XBRL DOCUMENT - Fortegra Financial Corp | Financial_Report.xls |
EX-31.1 - CEO302CERT - Fortegra Financial Corp | exhibit311section302ceo10-.htm |
EX-32 - 906CERT - Fortegra Financial Corp | exhibit32section90610-q930.htm |
EX-31.2 - CFO302CERT - Fortegra Financial Corp | exhibit312section302cfo10-.htm |
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One) | |
x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended September 30, 2014 | |
OR | |
o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from ____ to ____ |
Commission file number 001-35009
Fortegra Financial Corporation
(Exact name of Registrant as specified in its charter)
Delaware | 58-1461399 | |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) | |
10151 Deerwood Park Boulevard, Building 100, Suite 330, Jacksonville, FL | 32256 | |
(Address of principal executive offices) | (Zip Code) | |
Registrant's telephone number, including area code: | (866) 961-9529 |
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer o | Accelerated filer o | |
Non-accelerated filer o (Do not check if a smaller reporting company) | Smaller reporting company x |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).Yes o No x
The number of outstanding shares of the registrant's Common Stock, $0.01 par value, outstanding as of October 31, 2014 was 20,055,600.
FORTEGRA FINANCIAL CORPORATION
QUARTERLY REPORT ON FORM 10-Q
SEPTEMBER 30, 2014
TABLE OF CONTENTS
Item Number | Item | Page Number |
PART I - FINANCIAL INFORMATION | ||
Item 1. | Financial Statements | |
Consolidated Balance Sheets (Unaudited) | ||
Consolidated Statements of Income (Unaudited) | ||
Consolidated Statements of Comprehensive Income (Unaudited) | ||
Consolidated Statement of Stockholders' Equity (Unaudited) | ||
Consolidated Statements of Cash Flows (Unaudited) | ||
Notes to Consolidated Financial Statements (Unaudited) | ||
Item 2. | Management's Discussion and Analysis of Financial Condition and Results of Operations | |
Item 3. | Quantitative and Qualitative Disclosures About Market Risk | |
Item 4. | Controls and Procedures | |
PART II - OTHER INFORMATION | ||
Item 1. | Legal Proceedings | |
Item 1A. | Risk Factors | |
Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds | |
Item 3. | Defaults Upon Senior Securities | |
Item 4. | Mine Safety Disclosures | |
Item 5. | Other Information | |
Item 6. | Exhibits | |
Signatures | ||
Exhibit Index |
1
FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q (this "Form 10-Q") contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the "Securities Act"), and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), which are made in reliance upon the protection provided by such acts for forward-looking statements. Such statements are subject to risks and uncertainties. All statements other than statements of historical fact included in this Form 10-Q are forward-looking statements. Forward-looking statements give the Company's current expectations and projections relating to its financial condition, results of operations, plans, objectives, future performance and business. You can identify forward-looking statements by the fact that they do not relate strictly to historical or current facts. These statements may include words such as "anticipate," "estimate," "expect," "project,'' "plan," "intend," "believe," "may," "should," "can have," "will," "likely" and other words and terms of similar meaning in connection with any discussion of the timing or nature of future operating results or financial performance or other events.
The forward-looking statements contained in this Form 10-Q are based on assumptions that the Company has made in light of its industry experience and its perceptions of historical trends, current conditions, expected future developments and other factors it believes are appropriate under the circumstances. As you read this Form 10-Q, you should understand that these statements are not guarantees of performance or results. They involve risks, uncertainties (some of which are beyond the Company's control) and assumptions. Although the Company believes that these forward-looking statements are based on reasonable assumptions, you should be aware that many factors could affect the Company's actual financial results and cause them to differ materially from those anticipated in the forward-looking statements. The Company believes these factors include, but are not limited to, those described under PART I, ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS and PART II, ITEM 1A. RISK FACTORS. Should one or more of these risks or uncertainties materialize, or should any of these assumptions prove incorrect, the Company's actual results may vary materially from those projected in these forward-looking statements.
On August 11, 2014, Fortegra Financial Corporation entered into an agreement and plan of merger to be acquired by subsidiaries of Tiptree Financial Inc. ("Tiptree"). Unless stated otherwise, all forward-looking statements contained in this Form 10-Q do not take into account or give any effect to the impact of the proposed merger. For additional details regarding the proposed merger, see the section "Plan of Merger with Tiptree Financial, Inc." included on Page 8 of this Form 10-Q and the Information Statement (Form DEFM14C) filed with the Securities and Exchange Commission ("SEC") on September 30, 2014.
Any forward-looking statement made by the Company in this Form 10-Q speaks only as of the date of the filing of this Form 10-Q. Factors or events that could cause the Company's actual results to differ may emerge from time to time, and it is not possible for the Company to predict all of them. The Company undertakes no obligation to update any forward-looking statement, whether the result of new information, future developments or otherwise, except as may be required by law.
This Form 10-Q should be read in conjunction with the Company's Annual Report on Form 10-K for the year ended December 31, 2013 ("2013 Form 10-K") along with the Company's other filings with the SEC.
PART I. FINANCIAL INFORMATION
Unless the context requires otherwise, references in this Form 10-Q to "Fortegra Financial," "Fortegra," "we," "us," "the Company" or similar terms refer to Fortegra Financial Corporation and its subsidiaries.
2
ITEM 1. FINANCIAL STATEMENTS
FORTEGRA FINANCIAL CORPORATION
CONSOLIDATED BALANCE SHEETS (Unaudited)
(All Amounts in Thousands, Except Share and Per Share Amounts)
At | |||||||
September 30, 2014 | December 31, 2013 | ||||||
Assets: | |||||||
Investments: | |||||||
Fixed maturity securities available-for-sale, at fair value (amortized cost of $157,497 at September 30, 2014 and $133,288 at December 31, 2013) | $ | 157,735 | $ | 131,751 | |||
Equity securities available-for-sale, at fair value (cost of $7,081 at September 30, 2014 and December 31, 2013, respectively) | 6,947 | 6,198 | |||||
Short-term investments | 871 | 871 | |||||
Total investments | 165,553 | 138,820 | |||||
Cash and cash equivalents | 2,483 | 21,681 | |||||
Restricted cash | 7,579 | 17,293 | |||||
Accrued investment income | 1,259 | 1,175 | |||||
Notes receivable, net | 19,421 | 11,920 | |||||
Accounts and premiums receivable, net | 31,444 | 18,702 | |||||
Other receivables | 32,048 | 33,409 | |||||
Reinsurance receivables | 241,159 | 215,084 | |||||
Deferred acquisition costs | 67,713 | 78,042 | |||||
Property and equipment, net | 12,400 | 14,332 | |||||
Goodwill | 73,701 | 73,701 | |||||
Other intangible assets, net | 45,221 | 49,173 | |||||
Income taxes receivable | 8,728 | — | |||||
Other assets | 8,584 | 6,307 | |||||
Assets of discontinued operations | — | 791 | |||||
Total assets | $ | 717,293 | $ | 680,430 | |||
Liabilities: | |||||||
Unpaid claims | $ | 42,427 | $ | 34,732 | |||
Unearned premiums | 282,348 | 256,380 | |||||
Policyholder account balances | 21,478 | 23,486 | |||||
Accrued expenses, accounts payable and other liabilities | 51,249 | 53,035 | |||||
Income taxes payable | — | 2,842 | |||||
Deferred revenue | 62,748 | 76,927 | |||||
Notes payable | 10,173 | 3,273 | |||||
Preferred trust securities | 35,000 | 35,000 | |||||
Deferred income taxes, net | 31,606 | 19,659 | |||||
Liabilities of discontinued operations | 860 | 8,603 | |||||
Total liabilities | 537,889 | 513,937 | |||||
Commitments and Contingencies (Note 17) | |||||||
Stockholders' Equity: | |||||||
Preferred stock, par value $0.01; 10,000,000 shares authorized; none issued | — | — | |||||
Common stock, par value $0.01; 150,000,000 shares authorized; 21,281,415 and 20,912,853 shares issued at September 30, 2014 and December 31, 2013, respectively, including shares in treasury | 213 | 209 | |||||
Treasury stock, at cost; 1,225,815 at September 30, 2014 and 1,224,182 shares at December 31, 2013. | (8,027 | ) | (8,014 | ) | |||
Additional paid-in capital | 100,380 | 99,398 | |||||
Accumulated other comprehensive loss, net of tax | (1,558 | ) | (3,665 | ) | |||
Retained earnings | 82,294 | 72,532 | |||||
Stockholders' equity before non-controlling interests | 173,302 | 160,460 | |||||
Non-controlling interests | 6,102 | 6,033 | |||||
Total stockholders' equity | 179,404 | 166,493 | |||||
Total liabilities and stockholders' equity | $ | 717,293 | $ | 680,430 |
See accompanying Notes to Consolidated Financial Statements.
3
FORTEGRA FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
(All Amounts in Thousands, Except Share and Per Share Amounts)
For the Three Months Ended September 30, | For the Nine Months Ended September 30, | ||||||||||||||
2014 | 2013 | 2014 | 2013 | ||||||||||||
Revenues: | |||||||||||||||
Service and administrative fees | $ | 40,591 | $ | 45,753 | $ | 126,633 | $ | 126,651 | |||||||
Ceding commissions | 10,022 | 8,731 | 32,567 | 22,851 | |||||||||||
Net investment income | 831 | 766 | 2,315 | 2,415 | |||||||||||
Net realized investment gains | 1 | 756 | 6 | 2,043 | |||||||||||
Net earned premium | 35,187 | 34,106 | 103,278 | 100,929 | |||||||||||
Other income | 1,003 | 165 | 1,888 | 499 | |||||||||||
Total revenues | 87,635 | 90,277 | 266,687 | 255,388 | |||||||||||
Expenses: | |||||||||||||||
Net losses and loss adjustment expenses | 10,267 | 9,957 | 30,970 | 31,096 | |||||||||||
Member benefit claims | 9,929 | 13,834 | 31,111 | 34,624 | |||||||||||
Commissions | 38,813 | 39,876 | 119,726 | 112,224 | |||||||||||
Personnel costs | 10,273 | 9,544 | 30,444 | 29,849 | |||||||||||
Other operating expenses | 9,970 | 9,189 | 26,432 | 25,628 | |||||||||||
Depreciation and amortization | 1,352 | 1,227 | 3,830 | 3,609 | |||||||||||
Amortization of intangibles | 1,317 | 1,389 | 3,952 | 4,156 | |||||||||||
Interest expense | 930 | 923 | 2,784 | 2,722 | |||||||||||
Loss on note receivable | — | — | 1,317 | — | |||||||||||
(Gain) on sale of subsidiary | — | — | — | (402 | ) | ||||||||||
Total expenses | 82,851 | 85,939 | 250,566 | 243,506 | |||||||||||
Income from continuing operations before income taxes | 4,784 | 4,338 | 16,121 | 11,882 | |||||||||||
Income taxes - continuing operations | 924 | 1,852 | 4,624 | 3,927 | |||||||||||
Income from continuing operations before non-controlling interests | 3,860 | 2,486 | 11,497 | 7,955 | |||||||||||
Discontinued operations: | |||||||||||||||
Income from discontinued operations - net of tax | — | 601 | — | 3,070 | |||||||||||
Loss on sale of discontinued operations - net of tax | (42 | ) | — | (42 | ) | — | |||||||||
Discontinued operations - net of tax | (42 | ) | 601 | (42 | ) | 3,070 | |||||||||
Net income before non-controlling interests | 3,818 | 3,087 | 11,455 | 11,025 | |||||||||||
Less: net income (loss) attributable to non-controlling interests | 230 | (135 | ) | 1,693 | 868 | ||||||||||
Net income attributable to Fortegra Financial Corporation | $ | 3,588 | $ | 3,222 | $ | 9,762 | $ | 10,157 | |||||||
Earnings per share - Basic: | |||||||||||||||
Net income from continuing operations - net of tax | $ | 0.18 | $ | 0.14 | $ | 0.50 | $ | 0.36 | |||||||
Discontinued operations - net of tax | — | 0.03 | — | 0.16 | |||||||||||
Net income attributable to Fortegra Financial Corporation | $ | 0.18 | $ | 0.17 | $ | 0.50 | $ | 0.52 | |||||||
Earnings per share - Diluted: | |||||||||||||||
Net income from continuing operations - net of tax | $ | 0.18 | $ | 0.13 | $ | 0.48 | $ | 0.35 | |||||||
Discontinued operations - net of tax | — | 0.03 | — | 0.15 | |||||||||||
Net income attributable to Fortegra Financial Corporation | $ | 0.18 | $ | 0.16 | $ | 0.48 | $ | 0.50 | |||||||
Weighted average common shares outstanding: | |||||||||||||||
Basic | 19,774,263 | 19,405,597 | 19,723,995 | 19,500,430 | |||||||||||
Diluted | 20,625,695 | 20,404,508 | 20,528,052 | 20,531,122 |
See accompanying Notes to Consolidated Financial Statements.
4
FORTEGRA FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)
(All Amounts in Thousands)
For the Three Months Ended September 30, | For the Nine Months Ended September 30, | ||||||||||||||
2014 | 2013 | 2014 | 2013 | ||||||||||||
Net income before non-controlling interests | $ | 3,818 | $ | 3,087 | $ | 11,455 | $ | 11,025 | |||||||
Other comprehensive income (loss), net of tax: | |||||||||||||||
Unrealized gains (losses) on available-for-sale securities: | |||||||||||||||
Unrealized holding (losses) gains arising during the period | (413 | ) | (221 | ) | 2,530 | (3,495 | ) | ||||||||
Related tax benefit (expense) benefit | 145 | 77 | (885 | ) | 1,223 | ||||||||||
Reclassification of (gains) included in net income | (1 | ) | (756 | ) | (6 | ) | (2,043 | ) | |||||||
Related tax expense | — | 265 | 2 | 715 | |||||||||||
Unrealized (losses) gains on available-for-sale securities, net of tax | (269 | ) | (635 | ) | 1,641 | (3,600 | ) | ||||||||
Interest rate swap: | |||||||||||||||
Unrealized gain (loss) on interest rate swap | 124 | (263 | ) | (133 | ) | 301 | |||||||||
Related tax (expense) benefit | (43 | ) | 92 | 46 | (105 | ) | |||||||||
Reclassification of losses included in net income | 290 | 286 | 858 | 845 | |||||||||||
Related tax benefit | (101 | ) | (100 | ) | (300 | ) | (296 | ) | |||||||
Unrealized gain on interest rate swap, net of tax | 270 | 15 | 471 | 745 | |||||||||||
Other comprehensive income (loss), net of tax | 1 | (620 | ) | 2,112 | (2,855 | ) | |||||||||
Comprehensive income | 3,819 | 2,467 | 13,567 | 8,170 | |||||||||||
Less: comprehensive income (loss) attributable to non-controlling interests | 229 | (139 | ) | 1,698 | 853 | ||||||||||
Comprehensive income attributable to Fortegra Financial Corporation | $ | 3,590 | $ | 2,606 | $ | 11,869 | $ | 7,317 |
See accompanying Notes to Consolidated Financial Statements.
5
FORTEGRA FINANCIAL CORPORATION
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (Unaudited)
(All Amounts in Thousands, Except Share Amounts)
Common Stock | Treasury Stock | Additional Paid-in Capital | Accumulated Other Comprehensive Income (Loss) | Retained Earnings | Non-controlling Interests | Total Stockholders' Equity | |||||||||||||||||||||||||||
Shares | Amount | Shares | Amount | ||||||||||||||||||||||||||||||
Balance, December 31, 2013 | 20,912,853 | $ | 209 | (1,224,182 | ) | $ | (8,014 | ) | $ | 99,398 | $ | (3,665 | ) | $ | 72,532 | $ | 6,033 | $ | 166,493 | ||||||||||||||
Net income | — | — | — | — | — | — | 9,762 | 1,693 | 11,455 | ||||||||||||||||||||||||
Other comprehensive income, net of tax | — | — | — | — | — | 2,107 | — | 5 | 2,112 | ||||||||||||||||||||||||
Distributions to non-controlling interest partners | — | — | — | — | — | — | — | (1,380 | ) | (1,380 | ) | ||||||||||||||||||||||
Non-controlling interest attributable to the consolidation of Creative Investigations Recovery Group, LLC | — | — | — | — | — | — | — | (249 | ) | (249 | ) | ||||||||||||||||||||||
Stock-based compensation | 108,695 | 2 | — | — | 870 | — | — | — | 872 | ||||||||||||||||||||||||
Direct stock awards to employees | 403 | — | — | — | 1 | — | — | — | 1 | ||||||||||||||||||||||||
Shares issued for the Employee Stock Purchase Plan | 18,642 | — | — | — | 113 | — | — | — | 113 | ||||||||||||||||||||||||
Treasury stock purchased, net of issuances | — | — | (1,633 | ) | (13 | ) | — | — | — | — | (13 | ) | |||||||||||||||||||||
Options exercised, net of shares surrendered | 240,822 | 2 | — | — | (2 | ) | — | — | — | — | |||||||||||||||||||||||
Balance, September 30, 2014 | 21,281,415 | $ | 213 | (1,225,815 | ) | $ | (8,027 | ) | $ | 100,380 | $ | (1,558 | ) | $ | 82,294 | $ | 6,102 | $ | 179,404 |
See accompanying Notes to Consolidated Financial Statements.
6
FORTEGRA FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(All Amounts in Thousands)
For the Nine Months Ended September 30, | |||||||
2014 | 2013 | ||||||
Operating Activities: | |||||||
Net income attributable to Fortegra Financial Corporation | $ | 9,762 | $ | 10,157 | |||
Adjustments to reconcile net income to net cash flows (used in) provided by operating activities: | |||||||
Change in deferred acquisition costs | 10,329 | (8,209 | ) | ||||
Depreciation and amortization | 7,782 | 9,661 | |||||
Deferred income tax (benefit) - continuing operations | 10,810 | (1,610 | ) | ||||
Deferred income tax expense - discontinued operations | — | 300 | |||||
Net realized investment gains | (6 | ) | (2,043 | ) | |||
Loss on sale of discontinued operations, net of tax | 42 | — | |||||
Loss on note receivable | 1,317 | — | |||||
Gain on sale of subsidiary | — | (402 | ) | ||||
Stock-based compensation expense | 872 | 1,033 | |||||
Direct stock awards to employees | 1 | 29 | |||||
Amortization of premiums and accretion of discounts on investments | 1,347 | 1,097 | |||||
Non-controlling interests | 1,693 | 868 | |||||
Change in allowance for doubtful accounts | (159 | ) | (118 | ) | |||
Changes in operating assets and liabilities, net of the effects of acquisitions and dispositions: | |||||||
Accrued investment income | (149 | ) | 287 | ||||
Accounts and premiums receivable, net | (12,549 | ) | (5,366 | ) | |||
Other receivables | 1,249 | (22,716 | ) | ||||
Reinsurance receivables | (26,075 | ) | (7,647 | ) | |||
Income taxes receivable | (8,728 | ) | 2,919 | ||||
Other assets | (2,276 | ) | (1,395 | ) | |||
Unpaid claims | 7,695 | 264 | |||||
Unearned premiums | 25,968 | 13,771 | |||||
Policyholder account balances | (2,008 | ) | (1,620 | ) | |||
Accrued expenses, accounts payable and other liabilities | (1,255 | ) | 18,942 | ||||
Income taxes payable | (2,842 | ) | 222 | ||||
Deferred revenue | (14,179 | ) | 14,145 | ||||
Change in assets of discontinued operations | 791 | — | |||||
Change in liabilities of discontinued operations | (7,743 | ) | — | ||||
Net cash flows provided by operating activities | 1,689 | 22,569 | |||||
Investing activities: | |||||||
Proceeds from maturities, calls and prepayments of available-for-sale investments | 20,653 | 7,963 | |||||
Proceeds from sales of available-for-sale investments | 3,805 | 54,663 | |||||
Net change in short-term investments | — | 251 | |||||
Purchases of available-for-sale investments | (50,010 | ) | (78,739 | ) | |||
Purchases of property and equipment | (1,900 | ) | (2,971 | ) | |||
Net paid for acquisitions of subsidiaries, net of cash received | 20 | (3,112 | ) | ||||
Sale of subsidiaries, net of cash paid | — | 2,180 | |||||
Net (issuance) from notes receivable | (8,789 | ) | — | ||||
Net proceeds from notes receivable | — | (663 | ) | ||||
Net proceeds from related party note receivable | — | 6,135 | |||||
Change in restricted cash | 9,714 | 2,350 | |||||
Net cash flows (used in) investing activities | (26,507 | ) | (11,943 | ) | |||
Financing activities: | |||||||
Payments on notes payable | (71,139 | ) | (19,188 | ) | |||
Proceeds from notes payable | 78,039 | 12,500 | |||||
Net proceeds from exercise of stock options | — | 49 | |||||
Purchase of treasury stock | (13 | ) | (1,372 | ) | |||
Net proceeds received from stock issued in the Employee Stock Purchase Plan | 113 | 152 | |||||
Distributions to non-controlling interest partners | (1,380 | ) | (720 | ) | |||
Dividends paid to non-controlling interests | — | (43 | ) | ||||
Net cash flows provided by (used in) financing activities | 5,620 | (8,622 | ) | ||||
Net (decrease) increase in cash and cash equivalents | (19,198 | ) | 2,004 | ||||
Cash and cash equivalents, beginning of period | 21,681 | 15,209 | |||||
Cash and cash equivalents, end of period | $ | 2,483 | $ | 17,213 |
See accompanying Notes to Consolidated Financial Statements.
7
FORTEGRA FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
(All Amounts in Thousands, Except Share Amounts, Per Share Amounts or Unless Otherwise Noted)
Nature of Operations
Fortegra Financial Corporation (references in this Form 10-Q to "Fortegra Financial," "Fortegra," "we," "us," "the Company" or similar terms refer to Fortegra Financial Corporation and its subsidiaries), traded on the New York Stock Exchange under the symbol: FRF, is an insurance services company headquartered in Jacksonville, Florida. Fortegra offers a wide array of revenue enhancing products, including payment protection products, motor club memberships, service contracts, device and warranty services, and administration services, to our business partners, including insurance companies, retailers, dealers, insurance brokers and agents and financial services companies. In 2008, the Company changed its name from Life of the South Corporation to Fortegra Financial Corporation. The Company incorporated in the State of Georgia in 1981 and re-incorporated in the State of Delaware in 2010. The Company generates most of its business through networks of small to mid-sized community and regional banks, small loan companies, independent wireless retailers and automobile dealerships. The Company's subsidiaries (owned 100% directly or indirectly by the Company, unless otherwise noted below) at September 30, 2014, are as follows:
• | 4Warranty Corporation ("4Warranty") |
• | Auto Knight Motor Club, Inc. ("Auto Knight") |
• | Continental Car Club, Inc. ("Continental") |
• | CRC Reassurance Company, Ltd. ("CRC") * |
• | Digital Leash, LLC, d/b/a ProtectCELL ("ProtectCELL"), 62.4% owned |
• | Insurance Company of the South ("ICOTS") * |
• | Life of the South Insurance Company ("LOTS") * and its subsidiary, Bankers Life of Louisiana ("Bankers Life") * |
• | LOTS Intermediate Co. ("LOTS IM") |
• | LOTS Reassurance Company ("LOTS RE") * |
• | LOTSolutions, Inc. |
• | Lyndon Southern Insurance Company ("Lyndon Southern") * |
• | Pacific Benefits Group Northwest, LLC ("PBG") |
• | Response Indemnity Company of California ("RICC") * |
• | South Bay Acceptance Corporation ("South Bay") |
• | South Bay Financial Services, LLC ("SBFS") |
• | Southern Financial Life Insurance Company ("SFLAC"), 85.0% owned * |
• | United Motor Club of America, Inc. ("United") |
* = Insurance company subsidiary
Plan of Merger with Tiptree Financial, Inc.
As disclosed on August 12, 2014 in the Company's Current Report on Form 8-K, on August 11, 2014, the Company entered into an Agreement and Plan of Merger, (the "Merger Agreement") to be acquired by subsidiaries of Tiptree Financial Inc. ("Tiptree") for approximately $218.0 million, which would entitle shareholders to receive cash Merger Consideration of $10.00 per common share. Tiptree is a publicly traded diversified holding company (NASDAQ: TIPT), with subsidiaries that operate in four industry segments: insurance and insurance services, specialty finance, asset management and real estate. Following the execution of the merger agreement, stockholders representing approximately 62.0% of the outstanding shares of Fortegra common stock executed a written consent adopting and approving the merger agreement. No additional stockholder approvals are necessary to adopt the merger agreement or consummate the transaction. Consummation of the Merger is subject to the satisfaction of customary conditions including, among other things, insurance regulatory approvals.
The parties to the Merger Agreement expect the transaction to be funded through a combination of debt financing and cash on hand of Tiptree. On August 11, 2014 Tiptree obtained debt financing commitments for the transaction contemplated by the Merger Agreement. A syndicate of lenders led by Wells Fargo Bank, National Association (collectively, the "Lenders") has committed to provide a $90.0 million secured revolving credit facility and a $50.0 million secured term loan, on the terms and subject to the conditions set forth in a debt commitment letter (the "Debt Commitment Letter"). The obligation of the Lenders to provide debt financing under the Debt Commitment Letter is subject to a number of conditions, including consummation of the Merger in accordance with the Merger Agreement.
For additional details regarding the proposed merger, see the Information Statement (Form DEFM14C) filed with the Securities and Exchange Commission ("SEC") on September 30, 2014.
8
FORTEGRA FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
(All Amounts in Thousands, Except Share Amounts, Per Share Amounts or Unless Otherwise Noted)
1. Basis of Presentation
The accompanying unaudited interim Consolidated Financial Statements of Fortegra have been prepared in conformity with generally accepted accounting principles in the United States of America ("U.S. GAAP") promulgated by the Financial Accounting Standards Board ("FASB") through the Accounting Standards Codification ("ASC") for interim financial information, and the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the disclosures and footnotes required by U.S. GAAP for complete financial statements and should be read in conjunction with the Company's 2013 Form 10-K.
The interim consolidated financial statements in this Form 10-Q have not been audited. In the opinion of management, the accompanying unaudited interim financial information reflects all adjustments, including normal recurring adjustments necessary to present fairly Fortegra's financial position, results of operations, comprehensive income and cash flows for each of the interim periods presented. The results of operations for the three and the nine months ended September 30, 2014 are not necessarily indicative of the results that may be expected for the full year ending on December 31, 2014.
2. Summary of Significant Accounting Policies
Fortegra's interim Consolidated Financial Statements as of September 30, 2014 and 2013 are unaudited and have been prepared following the significant accounting policies disclosed in Note 2, "Summary of Significant Accounting Policies," of the Notes to Consolidated Financial Statements of the Company's 2013 Form 10-K.
Principles of Consolidation
The Consolidated Financial Statements include the accounts of Fortegra Financial Corporation and its majority-owned and controlled subsidiaries. The Company eliminates all material intercompany account balances and transactions.
Non-Controlling Interests
The third-party ownership of the common stock of SFLAC and of the ownership interests of ProtectCELL, which is treated as a partnership for income tax purposes, have been reflected as non-controlling interests on the Consolidated Balance Sheets. In addition, the Company's non-controlling interests include the amount for the consolidation of the variable interest entity ("VIE"), Creative Investigations Recovery Group, LLC ("CIRG"). The following table shows the amount outstanding and the percentage of non-controlling interests by entity:
At | |||||||||||
September 30, 2014 | December 31, 2013 | ||||||||||
Amount | Percent | Amount | Percent | ||||||||
ProtectCELL | $ | 5,769 | 37.6 | % | $ | 5,471 | 37.6 | % | |||
SFLAC | 582 | 15.0 | % | 562 | 15.0 | % | |||||
CIRG | (249 | ) | 100.0 | % | — | — | % | ||||
Total non-controlling interests | $ | 6,102 | $ | 6,033 |
Income (loss) attributable to these non-controlling interests are presented on the Consolidated Statements of Income as net income (loss) attributable to non-controlling interests and on the Consolidated Statements of Comprehensive Income as comprehensive income (loss) attributable to non-controlling interests.
Reportable Segment
The Company reports operating results and financial data in one operating and one reportable segment, Protection Products and Services. The Company has determined that its Chief Executive Officer is the Chief Operating Decision Maker. The financial results of the Company's single segment are equal to the net income from continuing operations reported in the Consolidated Statements of Income for all periods presented.
Discontinued Operations
The results of operations of a business of the Company that either has been disposed of or is classified as held-for-sale are reported in discontinued operations if: 1) the operations and cash flows of the component have been or will be eliminated from the ongoing operations of the Company as a result of the disposal transaction; and 2) the Company will not have any significant continuing involvement in the operations of the component after the disposal transaction. The Company presents the operations of business(es) that meet the criteria for reporting as discontinued operations, and retrospectively reclassifies operating results for all prior periods presented.
On December 31, 2013, the Company completed the sale of its 100% ownership of Bliss and Glennon and eReinsure.com ("eReinsure"). The operating results of these businesses are presented in the line "Income from discontinued operations - net of tax" in the Consolidated Statements of Income for the three and the nine months ended September 30, 2013. In accordance with accounting guidance, the Company has elected to not separately disclose the cash flows related to the Bliss and Glennon and eReinsure discontinued operations.
9
FORTEGRA FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
(All Amounts in Thousands, Except Share Amounts, Per Share Amounts or Unless Otherwise Noted)
In addition, certain assets and liabilities associated with the disposition of Bliss and Glennon and eReinsure that are still subject to final settlement are included in the line items "Assets of discontinued operations" and "Liabilities of discontinued operations," in the Consolidated Balance Sheet at September 30, 2014 and at December 31, 2013. See the Note, "Divestitures," for more information on discontinued operations.
Comprehensive Income (Loss)
Comprehensive income (loss) includes net income and other items of comprehensive income (loss). These other items are generally comprised of unrealized gains and losses on investment securities classified as available-for-sale and unrealized gains and losses on the interest rate swap, net of the related tax effects.
Use of Estimates
Preparation of consolidated financial statements in accordance with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Reclassifications
Certain items in prior period consolidated financial statements were reclassified to conform to the current period presentation, which had no impact on net income, comprehensive income or loss, net cash provided by operating activities or stockholders' equity.
Subsequent Events
The Company reviewed all material events subsequent to September 30, 2014 that occurred up to the date on which the Company filed its Consolidated Financial Statements, and determined that no events required recognition or disclosure in these Consolidated Financial Statements and/or disclosure in the notes thereto.
Recently Adopted Accounting Pronouncements
In July 2013, the FASB issued Accounting Standards Update ("ASU") No. 2013-11, Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists, to clarify the presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. ASU No. 2013-11 is effective prospectively for years and interim periods within those years beginning after December 15, 2013. The adoption of ASU No. 2013-11 did not have a material impact on the Company's consolidated financial position, results of operations or cash flows.
Recently Issued Accounting Pronouncements
In August 2014, the FASB issued ASU No. 2014-15, Presentation of Financial Statements - Going Concern (Subtopic 205-40); Disclosure of Uncertainties about an Entity's Ability to Continue as a Going Concern, which requires management of a company to evaluate whether there is substantial doubt about the company’s ability to continue as a going concern. This ASU is effective for the annual reporting period ending after December 15, 2016, and for interim and annual reporting periods thereafter, with early adoption permitted. The Company is currently reviewing ASU No. 2014-15 and assessing the potential effects on its consolidated financial position, results of operations and cash flows.
In June 2014, the FASB issued ASU No. 2014-12, Compensation - Stock Compensation (Topic 718), Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved After the Requisite Service Period. ASU No. 2014-12 requires that awards, which contain a performance target that affects vesting, and that could be achieved after the requisite service period, be treated as a performance condition. ASU No. 2014-12 is effective for annual periods and interim periods within those annual periods beginning after December 15, 2015. Earlier adoption is permitted. ASU No. 2014-12 may be applied using two methods: a) prospectively to all awards granted or modified after the effective date or b) retrospectively to all awards with performance targets outstanding as of the beginning of the earliest annual period presented in the financial statements and to all new or modified awards thereafter. The Company is currently reviewing ASU No. 2014-12 and assessing the potential effects on its consolidated financial position, results of operations and cash flows.
In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606), which supersedes the revenue recognition requirements in ASC 605, Revenue Recognition. ASU No. 2014-09 is based on the principle that revenue is recognized to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. ASU No. 2014-09 also requires additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and assets recognized from costs incurred to obtain or fulfill a contract. ASU No. 2014-09 is effective for annual periods beginning after December 15, 2016 and interim periods within those annual periods, using either the full retrospective adoption or the modified retrospective adoption. ASU No. 2014-09 does not permit early adoption. The Company is currently reviewing ASU No. 2014-09 and assessing the potential effects on its consolidated financial position, results of operations and cash flows.
In April 2014, the FASB issued ASU No. 2014-08, Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360): Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity. ASU No. 2014-08 requires
10
FORTEGRA FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
(All Amounts in Thousands, Except Share Amounts, Per Share Amounts or Unless Otherwise Noted)
that a disposal representing a strategic shift that has (or will have) a major effect on an entity’s financial results or a business activity classified as held for sale should be reported as discontinued operations and also expands the disclosure requirements for discontinued operations and adds new disclosures for individually significant dispositions that do not qualify as discontinued operations. ASU No. 2014-08 is effective prospectively for fiscal years, and interim reporting periods within those years, beginning after December 15, 2014 (early adoption is permitted only for disposals that have not been previously reported). The adoption of ASU No. 2014-08 is not expected to have a material impact on the Company's consolidated financial position, results of operations or cash flows.
3. Earnings Per Share
The following table details the earnings per share calculation: | For the Three Months Ended September 30, | For the Nine Months Ended September 30, | |||||||||||||
2014 | 2013 | 2014 | 2013 | ||||||||||||
Numerator: (for both basic and diluted earnings per share) | |||||||||||||||
Income from continuing operations before non-controlling interests | $ | 3,860 | $ | 2,486 | $ | 11,497 | $ | 7,955 | |||||||
Less: net income (loss) attributable to non-controlling interests | 230 | (135 | ) | 1,693 | 868 | ||||||||||
Net income from continuing operations - net of tax | 3,630 | 2,621 | 9,804 | 7,087 | |||||||||||
Discontinued operations - net of tax | (42 | ) | 601 | (42 | ) | 3,070 | |||||||||
Net income attributable to Fortegra Financial Corporation | $ | 3,588 | $ | 3,222 | $ | 9,762 | $ | 10,157 | |||||||
Denominator: | |||||||||||||||
Total weighted average basic common shares outstanding | 19,774,263 | 19,405,597 | 19,723,995 | 19,500,430 | |||||||||||
Effect of dilutive stock options and restricted stock awards | 851,432 | 998,911 | 804,057 | 1,030,692 | |||||||||||
Total weighted average diluted common shares outstanding | 20,625,695 | 20,404,508 | 20,528,052 | 20,531,122 | |||||||||||
Earnings per share - Basic: | |||||||||||||||
Net income from continuing operations - net of tax | $ | 0.18 | $ | 0.14 | $ | 0.50 | $ | 0.36 | |||||||
Discontinued operations - net of tax | — | 0.03 | — | 0.16 | |||||||||||
Net income attributable to Fortegra Financial Corporation | $ | 0.18 | $ | 0.17 | $ | 0.50 | $ | 0.52 | |||||||
Earnings per share - Diluted: | |||||||||||||||
Net income from continuing operations - net of tax | $ | 0.18 | $ | 0.13 | $ | 0.48 | $ | 0.35 | |||||||
Discontinued operations - net of tax | — | 0.03 | — | 0.15 | |||||||||||
Net income attributable to Fortegra Financial Corporation | $ | 0.18 | $ | 0.16 | $ | 0.48 | $ | 0.50 | |||||||
Weighted average anti-dilutive common shares | 158,268 | 809,870 | 489,331 | 762,081 |
11
FORTEGRA FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
(All Amounts in Thousands, Except Share Amounts, Per Share Amounts or Unless Otherwise Noted)
4. Accumulated Other Comprehensive Income
The following table presents the activity in accumulated other comprehensive income (loss) ("AOCI") for the following periods:
For the Nine Months Ended September 30, 2014 | |||||||||||
Net unrealized gains (losses) on available-for-sale securities | Net unrealized gain (loss) on interest rate swap | Total | |||||||||
Balance at December 31, 2013, net of tax | $ | (1,761 | ) | $ | (1,904 | ) | $ | (3,665 | ) | ||
Other comprehensive income (loss) before reclassifications: | |||||||||||
Pre-tax income (loss) | 2,530 | (133 | ) | 2,397 | |||||||
Income tax (expense) benefit | (885 | ) | 46 | (839 | ) | ||||||
Other comprehensive income (loss) before reclassifications, net of tax | 1,645 | (87 | ) | 1,558 | |||||||
Amounts reclassified from accumulated other comprehensive income (loss): | |||||||||||
Pre-tax (income) loss | (6 | ) | 858 | 852 | |||||||
Income tax expense (benefit) | 2 | (300 | ) | (298 | ) | ||||||
Amounts reclassified from accumulated other comprehensive (loss) income, net of tax | (4 | ) | 558 | 554 | |||||||
Current period other comprehensive income, net of tax | 1,641 | 471 | 2,112 | ||||||||
Less: other comprehensive income attributable to non-controlling interest | 5 | — | 5 | ||||||||
Balance at September 30, 2014, net of tax | $ | (125 | ) | $ | (1,433 | ) | $ | (1,558 | ) | ||
For the Nine Months Ended September 30, 2013 | |||||||||||
Net unrealized gains (losses) on available-for-sale securities | Net unrealized gain (loss) on interest rate swap | Total | |||||||||
Balance at December 31, 2012, net of tax | $ | 2,189 | $ | (2,820 | ) | $ | (631 | ) | |||
Other comprehensive income (loss) before reclassifications: | |||||||||||
Pre-tax (loss) income | (3,495 | ) | 301 | (3,194 | ) | ||||||
Income tax benefit (expense) | 1,223 | (105 | ) | 1,118 | |||||||
Other comprehensive (loss) income before reclassifications, net of tax | (2,272 | ) | 196 | (2,076 | ) | ||||||
Amounts reclassified from accumulated other comprehensive income (loss): | |||||||||||
Pre-tax (income) loss | (2,043 | ) | 845 | (1,198 | ) | ||||||
Income tax expense (benefit) | 715 | (296 | ) | 419 | |||||||
Amounts reclassified from accumulated other comprehensive (loss) income, net of tax | (1,328 | ) | 549 | (779 | ) | ||||||
Current period other comprehensive (loss) income, net of tax | (3,600 | ) | 745 | (2,855 | ) | ||||||
Less: other comprehensive (loss) attributable to non-controlling interest | (15 | ) | — | (15 | ) | ||||||
Balance at September 30, 2013, net of tax | $ | (1,396 | ) | $ | (2,075 | ) | $ | (3,471 | ) |
12
FORTEGRA FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
(All Amounts in Thousands, Except Share Amounts, Per Share Amounts or Unless Otherwise Noted)
The following table presents the reclassifications out of AOCI for the following periods:
For the Three Months Ended September 30, | For the Nine Months Ended September 30, | |||||||||||||||
2014 | 2013 | 2014 | 2013 | Consolidated Statement of Income Location | ||||||||||||
Unrealized gains (losses) on available-for-sale securities: | ||||||||||||||||
Reclassification of gains included in net income | $ | 1 | $ | 756 | $ | 6 | $ | 2,043 | Net realized investment gains (losses) | |||||||
Related tax (expense) | — | (265 | ) | (2 | ) | (715 | ) | Income taxes | ||||||||
Net of tax | $ | 1 | $ | 491 | $ | 4 | $ | 1,328 | Net Income | |||||||
Unrealized gain (loss) on interest rate swap: | ||||||||||||||||
Reclassification of (losses) included in net income | $ | (290 | ) | $ | (286 | ) | $ | (858 | ) | $ | (845 | ) | Interest expense | |||
Related tax benefit | 101 | 100 | 300 | 296 | Income taxes | |||||||||||
Net of tax | $ | (189 | ) | $ | (186 | ) | $ | (558 | ) | $ | (549 | ) | Net Income |
5. Investments
The following table presents the Company's available-for-sale fixed maturity and equity securities:
At September 30, 2014 | |||||||||||||||
Description of Security | Cost or Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Fair Value | |||||||||||
Obligations of the U.S. Treasury and U.S. Government agencies | $ | 54,868 | $ | 375 | $ | (331 | ) | $ | 54,912 | ||||||
Municipal securities | 33,810 | 215 | (29 | ) | 33,996 | ||||||||||
Corporate securities | 67,441 | 425 | (428 | ) | 67,438 | ||||||||||
Obligations of foreign governments | 1,378 | 14 | (3 | ) | 1,389 | ||||||||||
Total fixed maturity securities | $ | 157,497 | $ | 1,029 | $ | (791 | ) | $ | 157,735 | ||||||
Common stock - publicly traded | $ | 39 | $ | 13 | $ | — | $ | 52 | |||||||
Preferred stock - publicly traded | 5,974 | 51 | (196 | ) | 5,829 | ||||||||||
Common stock - non-publicly traded | 59 | 6 | (12 | ) | 53 | ||||||||||
Preferred stock - non-publicly traded | 1,009 | 4 | — | 1,013 | |||||||||||
Total equity securities | $ | 7,081 | $ | 74 | $ | (208 | ) | $ | 6,947 |
At December 31, 2013 | |||||||||||||||
Description of Security | Cost or Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Fair Value | |||||||||||
Obligations of the U.S. Treasury and U.S. Government agencies | $ | 51,971 | $ | 142 | $ | (678 | ) | $ | 51,435 | ||||||
Municipal securities | 24,856 | 104 | (413 | ) | 24,547 | ||||||||||
Corporate securities | 56,050 | 210 | (900 | ) | 55,360 | ||||||||||
Obligations of foreign governments | 411 | — | (2 | ) | 409 | ||||||||||
Total fixed maturity securities | $ | 133,288 | $ | 456 | $ | (1,993 | ) | $ | 131,751 | ||||||
Common stock - publicly traded | $ | 39 | $ | 8 | $ | — | $ | 47 | |||||||
Preferred stock - publicly traded | 5,974 | — | (887 | ) | 5,087 | ||||||||||
Common stock - non-publicly traded | 59 | 5 | (13 | ) | 51 | ||||||||||
Preferred stock - non-publicly traded | 1,009 | 4 | — | 1,013 | |||||||||||
Total equity securities | $ | 7,081 | $ | 17 | $ | (900 | ) | $ | 6,198 |
Pursuant to certain reinsurance agreements and statutory licensing requirements, the Company has deposited invested assets in custody accounts or insurance department safekeeping accounts. The Company cannot remove invested assets from these accounts without prior approval of the contractual party or regulatory authority, as applicable. The following table presents the Company's restricted investments included in the Company's available-for-sale fixed maturity securities:
13
FORTEGRA FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
(All Amounts in Thousands, Except Share Amounts, Per Share Amounts or Unless Otherwise Noted)
At | |||||||
September 30, 2014 | December 31, 2013 | ||||||
Fair value of restricted investments for special deposits required by state insurance departments | $ | 10,301 | $ | 10,339 | |||
Fair value of restricted investments in trust pursuant to reinsurance agreements | 5,665 | 6,134 | |||||
Total fair value of restricted investments | $ | 15,966 | $ | 16,473 |
The following table presents the amortized cost and fair value of fixed maturity securities by contractual maturity. Expected maturities will differ from contractual maturities because borrowers have the right to call or prepay obligations with or without call or prepayment penalties.
At September 30, 2014 | At December 31, 2013 | ||||||||||||||
Amortized Cost | Fair Value | Amortized Cost | Fair Value | ||||||||||||
Due in one year or less | $ | 10,556 | $ | 10,602 | $ | 18,766 | $ | 18,771 | |||||||
Due after one year through five years | 73,489 | 73,641 | 69,380 | 69,355 | |||||||||||
Due after five years through ten years | 51,856 | 51,750 | 22,622 | 21,731 | |||||||||||
Due after ten years | 21,596 | 21,742 | 22,520 | 21,894 | |||||||||||
Total fixed maturity securities | $ | 157,497 | $ | 157,735 | $ | 133,288 | $ | 131,751 |
The following tables present information on unrealized losses on investment securities that have been in an unrealized loss position for less than twelve months, and twelve months or greater:
At September 30, 2014 | ||||||||||||||||||||||||||
Less than Twelve Months | Twelve Months or Greater | Total | ||||||||||||||||||||||||
Description of Security | Fair Value | Unrealized Losses | # of Securities | Fair Value | Unrealized Losses | # of Securities | Fair Value | Unrealized Losses | # of Securities | |||||||||||||||||
Obligations of the U.S. Treasury and U.S. Government agencies | $ | 15,913 | $ | 57 | 34 | $ | 7,686 | $ | 274 | 12 | $ | 23,599 | $ | 331 | 46 | |||||||||||
Municipal securities | 3,120 | 9 | 9 | 1,760 | 20 | 4 | 4,880 | 29 | 13 | |||||||||||||||||
Corporate securities | 18,797 | 110 | 67 | 10,121 | 318 | 15 | 28,918 | 428 | 82 | |||||||||||||||||
Obligations of foreign governments | 388 | 3 | 1 | — | — | — | 388 | 3 | 1 | |||||||||||||||||
Total fixed maturity securities | $ | 38,218 | $ | 179 | 111 | $ | 19,567 | $ | 612 | 31 | $ | 57,785 | $ | 791 | 142 | |||||||||||
Preferred stock - publicly traded | 1,776 | 15 | 2 | 3,019 | 181 | 6 | 4,795 | 196 | 8 | |||||||||||||||||
Common stock - non-publicly traded | — | — | — | 13 | 12 | 1 | 13 | 12 | 1 | |||||||||||||||||
Total equity securities | $ | 1,776 | $ | 15 | 2 | $ | 3,032 | $ | 193 | 7 | $ | 4,808 | $ | 208 | 9 |
At December 31, 2013 | ||||||||||||||||||||||||||
Less than Twelve Months | Twelve Months or Greater | Total | ||||||||||||||||||||||||
Description of Security | Fair Value | Unrealized Losses | # of Securities | Fair Value | Unrealized Losses | # of Securities | Fair Value | Unrealized Losses | # of Securities | |||||||||||||||||
Obligations of the U.S. Treasury and U.S. Government agencies | $ | 37,385 | $ | 672 | 67 | $ | 234 | $ | 6 | 7 | $ | 37,619 | $ | 678 | 74 | |||||||||||
Municipal securities | 10,080 | 413 | 23 | — | — | — | 10,080 | 413 | 23 | |||||||||||||||||
Corporate securities | 27,866 | 734 | 55 | 7,676 | 166 | 8 | 35,542 | 900 | 63 | |||||||||||||||||
Obligations of foreign governments | 409 | 2 | 1 | — | — | — | 409 | 2 | 1 | |||||||||||||||||
Total fixed maturity securities | $ | 75,740 | $ | 1,821 | 146 | $ | 7,910 | $ | 172 | 15 | $ | 83,650 | $ | 1,993 | 161 | |||||||||||
Preferred stock - publicly traded | 5,087 | 887 | 9 | — | — | — | 5,087 | 887 | 9 | |||||||||||||||||
Common stock - non-publicly traded | — | — | — | 31 | 13 | 2 | 31 | 13 | 2 | |||||||||||||||||
Total equity securities | $ | 5,087 | $ | 887 | 9 | $ | 31 | $ | 13 | 2 | $ | 5,118 | $ | 900 | 11 |
The Company does not intend to sell the investments that were in an unrealized loss position at September 30, 2014, and management believes that it is more likely than not that the Company will be able to hold these securities until full recovery of their amortized cost basis for fixed maturity securities or cost for equity securities. As of September 30, 2014, based on the Company's review, none of the
14
FORTEGRA FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
(All Amounts in Thousands, Except Share Amounts, Per Share Amounts or Unless Otherwise Noted)
fixed maturity or equity securities were deemed to be other-than-temporarily impaired based on the Company's analysis of the securities and its intent to hold the securities until recovery.
The following table presents the total gross proceeds from the sale of available-for-sale investment securities:
For the Three Months Ended September 30, | For the Nine Months Ended September 30, | ||||||||||||||
2014 | 2013 | 2014 | 2013 | ||||||||||||
Gross proceeds from sales | $ | 1 | $ | 27,139 | $ | 3,805 | $ | 54,663 |
The following table presents the gross realized gains and gross realized losses for both fixed maturity and equity securities and realized losses for other-than-temporary impairments for available-for-sale investment securities:
For the Three Months Ended September 30, | For the Nine Months Ended September 30, | ||||||||||||||
2014 | 2013 | 2014 | 2013 | ||||||||||||
Gross realized gains | $ | 1 | $ | 756 | $ | 6 | $ | 2,118 | |||||||
Gross realized losses | — | — | — | (75 | ) | ||||||||||
Total net gains from investment sales | 1 | 756 | 6 | 2,043 | |||||||||||
Impairment write-downs (other-than-temporary impairments) | — | — | — | — | |||||||||||
Net realized investment gains | $ | 1 | $ | 756 | $ | 6 | $ | 2,043 |
The following table presents the components of net investment income: | For the Three Months Ended September 30, | For the Nine Months Ended September 30, | |||||||||||||
2014 | 2013 | 2014 | 2013 | ||||||||||||
Fixed income securities | $ | 730 | $ | 664 | $ | 2,023 | $ | 2,076 | |||||||
Cash on hand and on deposit | 7 | 11 | 7 | 47 | |||||||||||
Common and preferred stock dividends | 97 | 98 | 293 | 275 | |||||||||||
Notes receivable | 93 | 99 | 279 | 239 | |||||||||||
Other income | — | 3 | 5 | 117 | |||||||||||
Investment expenses | (96 | ) | (109 | ) | (292 | ) | (339 | ) | |||||||
Net investment income | $ | 831 | $ | 766 | $ | 2,315 | $ | 2,415 |
6. Reinsurance Receivables
The following table presents the effect of reinsurance on premiums written and earned:
Premiums | For the Three Months Ended September 30, | For the Nine Months Ended September 30, | |||||||||||||||||||||||||
2014 | 2013 | 2014 | 2013 | ||||||||||||||||||||||||
Written | Earned | Written | Earned | Written | Earned | Written | Earned | ||||||||||||||||||||
Direct and assumed | $ | 151,204 | $ | 127,635 | $ | 116,452 | $ | 100,193 | $ | 372,881 | $ | 346,913 | $ | 297,940 | $ | 284,169 | |||||||||||
Ceded | (111,147 | ) | (92,448 | ) | (79,580 | ) | (66,087 | ) | (267,565 | ) | (243,635 | ) | (194,067 | ) | (183,240 | ) | |||||||||||
Net | $ | 40,057 | $ | 35,187 | $ | 36,872 | $ | 34,106 | $ | 105,316 | $ | 103,278 | $ | 103,873 | $ | 100,929 |
The following table presents the effect of reinsurance on losses and loss adjustment expenses ("LAE") incurred:
Losses and LAE incurred | For the Three Months Ended September 30, | For the Nine Months Ended September 30, | |||||||||||||
2014 | 2013 | 2014 | 2013 | ||||||||||||
Direct and assumed | $ | 30,269 | $ | 23,354 | $ | 83,410 | $ | 66,879 | |||||||
Ceded | (20,002 | ) | (13,397 | ) | (52,440 | ) | (35,783 | ) | |||||||
Net losses and LAE incurred | $ | 10,267 | $ | 9,957 | $ | 30,970 | $ | 31,096 |
15
FORTEGRA FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
(All Amounts in Thousands, Except Share Amounts, Per Share Amounts or Unless Otherwise Noted)
The following table presents the components of the reinsurance receivables: | At | ||||||
September 30, 2014 | December 31, 2013 | ||||||
Prepaid reinsurance premiums: | |||||||
Life (1) | $ | 50,368 | $ | 51,355 | |||
Accident and health (1) | 40,905 | 36,214 | |||||
Property | 117,131 | 98,650 | |||||
Total | 208,404 | 186,219 | |||||
Ceded claim reserves: | |||||||
Life | 1,584 | 1,594 | |||||
Accident and health | 7,913 | 7,826 | |||||
Property | 19,024 | 12,102 | |||||
Total ceded claim reserves recoverable | 28,521 | 21,522 | |||||
Other reinsurance settlements recoverable | 4,234 | 7,343 | |||||
Reinsurance receivables | $ | 241,159 | $ | 215,084 |
(1) Including policyholder account balances ceded.
The following table presents the aggregate amount included in reinsurance receivables that is comprised of the three largest receivable balances from unrelated reinsurers:
At | |||||||
September 30, 2014 | December 31, 2013 | ||||||
Total of the three largest receivable balances from unrelated reinsurers | $ | 145,876 | $ | 136,061 |
At September 30, 2014 and December 31, 2013, the three unrelated reinsurers from whom the Company has the largest receivable balances were: London Life Reinsurance Company (A. M. Best Rating: A), London Life International Reinsurance Corporation (A. M. Best Rating: Not rated) and Great Western Insurance Company (A. M. Best Rating: B++). The related receivables of London Life International Reinsurance Corporation are collateralized by assets held in trust accounts and letters of credit due to their offshore relationships. At September 30, 2014, the Company does not believe there is a risk of loss as a result of the concentration of credit risk in the reinsurance program.
7. Deferred Acquisition Costs
Deferred Acquisition Costs - Insurance Related
The following table presents the amortization of deferred acquisition costs for the Company's insurance contracts:
For the Three Months Ended September 30, | For the Nine Months Ended September 30, | ||||||||||||||
2014 | 2013 | 2014 | 2013 | ||||||||||||
Total amortization of deferred acquisition costs - insurance related | $ | 17,091 | $ | 16,785 | $ | 50,011 | $ | 49,223 |
Deferred Acquisition Costs - Non-insurance Related
The following table presents the amortization of deferred acquisition costs for the Company's non-insurance products:
For the Three Months Ended September 30, | For the Nine Months Ended September 30, | ||||||||||||||
2014 | 2013 | 2014 | 2013 | ||||||||||||
Total amortization of deferred acquisition costs - non-insurance related | $ | 16,715 | $ | 18,676 | $ | 52,007 | $ | 54,560 |
8. Divestitures
Discontinued Operations
On December 31, 2013, the Company completed the sale of all of the issued and outstanding stock of its subsidiaries Bliss and Glennon and eReinsure, to AmWINS Holdings, LLC, a North Carolina limited liability company ("AmWINS") (collectively, the "Disposition"), pursuant to the terms of the Stock Purchase Agreement (the "Purchase Agreement"), dated December 2, 2013.
The Company received net cash proceeds of $81.8 million for the Disposition, representing gross proceeds of $83.5 million less $1.0 million in transaction fees paid at the time of closing and $0.7 million of cash held by the disposed entities. The proceeds are subject to certain purchase price adjustments as set forth in the Purchase Agreement to reflect fluctuations in working capital, including
16
FORTEGRA FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
(All Amounts in Thousands, Except Share Amounts, Per Share Amounts or Unless Otherwise Noted)
adjustments for any receivable balances as of the disposition date not collected within one year. During the three months ended September 30, 2014, the Company recorded a purchase price adjustment, net of tax, of $42.0 thousand for the settlement of certain components of working capital (excluding receivable and income tax balances), which is recorded on the Consolidated Statements of Income as a Loss on sale of discontinued operations - net of tax.
As a result of the Disposition, the Company no longer operates in the businesses of wholesale insurance brokerage and selling or licensing of a computerized system or platform for the negotiation and/or placement of facultative reinsurance. As of and after December 31, 2013, the Company does not beneficially own the disposed businesses and will no longer consolidate Bliss and Glennon or eReinsure into its financial results. The historical financial results of the disposed businesses for periods prior to the Disposition are presented in the Company's Consolidated Statements of Income as income from discontinued operations - net of tax. The Company allocated interest expense to the discontinued operations based on the anticipated net proceeds that would have been applied to the repayment of the credit facilities outstanding at the respective time, multiplied by the respective interest rate of the credit facilities at the respective time.
The following table presents the assets and liabilities of the discontinued operations included on the Consolidated Balance Sheets:
At | |||||||
September 30, 2014 | December 31, 2013 | ||||||
Assets: | |||||||
Other receivables | $ | — | $ | 791 | |||
Assets of discontinued operations | $ | — | $ | 791 | |||
Liabilities: | |||||||
Accrued expenses, accounts payable and other liabilities | $ | 860 | $ | 2,708 | |||
Income taxes payable | — | 5,895 | |||||
Liabilities of discontinued operations | $ | 860 | $ | 8,603 |
The following table presents the amounts related to the Company's discontinued operations in the Consolidated Statements of Income for the following periods:
For the Three Months Ended | For the Nine Months Ended | ||||||
September 30, 2013 | September 30, 2013 | ||||||
Income from discontinued operations: | |||||||
Revenues: | |||||||
Brokerage commissions and fees | $ | 8,787 | $ | 28,409 | |||
Net investment income | 6 | 18 | |||||
Other income | 14 | 30 | |||||
Total revenues | 8,807 | 28,457 | |||||
Expenses: | |||||||
Personnel costs | 5,105 | 15,240 | |||||
Other operating expenses | 1,475 | 4,363 | |||||
Depreciation and amortization | 151 | 454 | |||||
Amortization of intangibles | 481 | 1,442 | |||||
Interest expense | 578 | 1,767 | |||||
Total expenses | 7,790 | 23,266 | |||||
Income from discontinued operations before income taxes | 1,017 | 5,191 | |||||
Income taxes - discontinued operations | 416 | 2,121 | |||||
Income from discontinued operations - net of tax | $ | 601 | $ | 3,070 |
17
FORTEGRA FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
(All Amounts in Thousands, Except Share Amounts, Per Share Amounts or Unless Otherwise Noted)
9. Other Intangible Assets
The following table presents finite-lived other intangible assets and their respective amortization periods:
At September 30, 2014 | At December 31, 2013 | ||||||||||||||||||||||||||
Amortization Period (Years) | Gross Carrying Amount | Accumulated Amortization | Net Carrying Amount | Gross Carrying Amount | Accumulated Amortization | Net Carrying Amount | |||||||||||||||||||||
Customer and agent relationships | 7 | to | 15 | $ | 40,075 | $ | (16,488 | ) | $ | 23,587 | $ | 40,075 | $ | (13,262 | ) | $ | 26,813 | ||||||||||
Tradenames | 8 | to | 10 | 1,460 | (242 | ) | 1,218 | 1,460 | (128 | ) | 1,332 | ||||||||||||||||
Software | 2.25 | to | 10 | 5,336 | (3,491 | ) | 1,845 | 5,336 | (2,930 | ) | 2,406 | ||||||||||||||||
Present value of future profits | 0.3 | to | 0.75 | 548 | (548 | ) | — | 548 | (548 | ) | — | ||||||||||||||||
Non-compete agreements | 1.5 | to | 6 | 1,378 | (946 | ) | 432 | 1,378 | (895 | ) | 483 | ||||||||||||||||
Total finite-lived other intangible assets | $ | 48,797 | $ | (21,715 | ) | $ | 27,082 | $ | 48,797 | $ | (17,763 | ) | $ | 31,034 |
The following table presents the carrying amount of indefinite-lived other intangible assets: | At | ||||||
September 30, 2014 | December 31, 2013 | ||||||
Tradenames | $ | 17,764 | $ | 17,764 | |||
Licenses | 375 | 375 | |||||
Total | $ | 18,139 | $ | 18,139 |
The following table presents the activity in finite- and indefinite-lived other intangible assets:
Balance at December 31, 2013 | $ | 49,173 | |
Less: amortization expense | 3,952 | ||
Balance at September 30, 2014 | $ | 45,221 |
The following table presents estimated amortization of finite-lived other intangible assets for the next five years and thereafter ending December 31:
Estimated Amortization Expense | |||
Remainder of 2014 | $ | 1,317 | |
2015 | 5,115 | ||
2016 | 4,868 | ||
2017 | 3,648 | ||
2018 | 2,230 | ||
Thereafter | 9,904 | ||
Total | $ | 27,082 |
10. Variable Interest Entity
In July 2011, the Company sold its 100% interest in CIRG. The consideration included a note receivable, with a first priority lien security interest in the assets of CIRG and other property of the buyers. As previously disclosed, the Company has a variable interest in CIRG. Prior to March 31, 2014, the Company did not consolidate CIRG into its results, because the Company was not the primary beneficiary.
During 2013, the buyers were unable to make the scheduled payments on the note, and the parties executed a forbearance agreement along with a security agreement and a subordination agreement designed to allow more flexibility in timing of repayment. The Company also provided $0.2 million in short term funding.
In March 2014, the Company notified the buyers of the cessation of forbearance, and began to exercise certain of the rights and remedies afforded by the note and related agreements to preserve its economic interest, including steps to protect assets of CIRG. The Company also provided additional short term funding. The Company has not taken ownership of CIRG, but the Company now has power over the VIE and has consolidated the immaterial balances of CIRG as of March 31, 2014 and forward.
In March 2014, the Company established an allowance for the full value of the note and accrued interest, incurring a charge of $1.3 million during the three months ended March 31, 2014. The Company's maximum exposure to further loss in the VIE is limited to the balance of the short term funding.
18
FORTEGRA FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
(All Amounts in Thousands, Except Share Amounts, Per Share Amounts or Unless Otherwise Noted)
At | |||
September 30, 2014 | |||
The Company's maximum exposure to loss in the VIE | $ | 194 |
11. Notes Payable
The Company's Notes Payable consisted of the following: | At | ||||||
September 30, 2014 | December 31, 2013 | ||||||
Wells Fargo Bank, N.A. credit facility, maturing August 2019 | $ | 1,500 | $ | — | |||
Synovus Bank, revolving line of credit, maturing April 2017 | 8,673 | 3,273 | |||||
Total | $ | 10,173 | $ | 3,273 | |||
Maximum balance allowed on the Wells Fargo Bank, N.A. credit facility | $ | 100,000 | $ | 75,000 | |||
Interest rate at the end of the respective period, Wells Fargo Bank, N.A. credit facility (1) (2) | 1.80 | % | — | % | |||
Maximum balance allowed on the Synovus Bank, revolving line of credit | $ | 15,000 | $ | 15,000 | |||
Interest rate at the end of the respective period, Synovus Bank, revolving line of credit | 3.23 | % | 3.24 | % |
(1) - At September 30, 2014, the full outstanding balance of the Company's borrowing, under the Revolving Facility (defined below), consisted of a one-month term loan at a rate equaling the one-month LIBOR rate plus 1.65%.
(2) - At December 31, 2013, the Company had no borrowings outstanding under the Revolving Facility, thus no interest rate can be defined.
The following table presents the aggregate maturities for the Company's notes payable by year at September 30, 2014:
Maturities | |||
Remainder of 2014 | $ | 6,292 | |
2015 | 3,881 | ||
2016 | — | ||
2017 | — | ||
2018 | — | ||
Thereafter | — | ||
Total maturities | $ | 10,173 |
$100.0 million Secured Credit Agreement - Wells Fargo Bank, N.A.
On April 11, 2014, the Company amended the original credit agreement, entered into on August 2, 2012, (as amended, the "Credit Agreement"), with a syndicate of lenders, among them Wells Fargo Bank, N.A., who also serves as administrative agent ("Wells Fargo" or the "Administrative Agent"). The Credit Agreement matures on August 2, 2019 (subject to earlier termination) and has a revolving credit facility limit of $100.0 million (the "Revolving Facility") with a sub-limit of $10.0 million for swingline loans and $10.0 million for letters of credit. The Credit Agreement includes a provision pursuant to which, from time to time, the Company may request that the lenders in their discretion increase the maximum amount of commitments under the Credit Agreement by an amount not to exceed $50.0 million. The Credit Agreement also contains financial covenants, which the Company must maintain. See the section below, "Financial Covenants" for a presentation of the Company's more significant covenants associated with the Credit Agreement. The amendment to the Credit Agreement reduced the interest rate margin on revolving loans by 0.35% for each pricing level and reduced the unused line fee paid on undrawn revolving commitments by 0.05% for each pricing level. The amendment did not modify the financial covenants.
Financial Covenants - Secured Credit Agreement - Wells Fargo Bank, N.A.
At September 30, 2014 and December 31, 2013, respectively, the Company was required to comply with various financial covenants set forth in the Credit Agreement. The following describes the Credit Agreement's more significant financial covenants in effect at September 30, 2014 and the calculations used to arrive at each ratio (capitalized terms used but not defined in this paragraph are defined in the Credit Agreement or as otherwise provided below):
Total Leverage Ratio - the ratio of (i) Consolidated Total Debt as of such date to (ii) Consolidated Adjusted Earnings Before Interest, Taxes, Depreciation and Amortization ("Adjusted EBITDA") for the Measurement Period ending on or immediately prior to such date.
19
FORTEGRA FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
(All Amounts in Thousands, Except Share Amounts, Per Share Amounts or Unless Otherwise Noted)
Fixed Charge Coverage Ratio - the ratio of (a) Consolidated Adjusted EBITDA less the actual amount paid by the Borrowers and their Subsidiaries in cash on account of Capital Expenditures less cash taxes paid by the Borrowers and their Subsidiaries to (b) Consolidated Fixed Charges, in each case for the Measurement Period ending on or immediately prior to such date.
Reinsurance Ratio - the ratio (expressed as a percentage) of (a) the aggregate amounts recoverable by the Borrowers and its Subsidiaries from reinsurers divided by (b) the sum of (i) policy and claim liabilities plus (ii) unearned premiums, in each case of the Borrowers and their Subsidiaries determined in accordance with U.S. GAAP.
Risk-Based Capital ("RBC") Ratio - the ratio (expressed as a percentage) of NAIC RBC (as defined in the NAIC standards) for any Regulated Insurance Company on an individual basis, calculated at the end of any Fiscal Year, to the "authorized control level" (as defined in the NAIC standards).
The following table presents the Credit Agreement's more significant financial covenants at September 30, 2014, or at December 31, 2013 with respect to the RBC ratios, which under the Credit Agreement reflect the ratios calculated as of the most recent year-end:
Actual At | |||
Covenant | Covenant Requirement | September 30, 2014 | |
Total leverage ratio | not more than 3.25 | 0.80 | |
Fixed charge coverage ratio | not less than 2.00 | 6.16 | |
Reinsurance ratio | not less than 50% | 70.0% | |
Actual At | |||
December 31, 2013 | |||
RBC Ratios: | |||
RBC Ratio - Bankers Life of Louisiana | not less than 250% | 435.0% | |
RBC Ratio - Southern Financial Life Insurance Company | not less than 250% | 2,096.0% | |
RBC Ratio - Insurance Company of the South | not less than 250% | 366.0% | |
RBC Ratio - Lyndon Southern Insurance Company | not less than 250% | 305.0% | |
RBC Ratio - Life of the South Insurance Company | not less than 250% | 430.0% | |
RBC Ratio - Response Indemnity Company of California | not less than 250% | 39,754.0% |
$15.0 million Revolving Line of Credit - Synovus Bank
At September 30, 2014, the Company's subsidiary, South Bay, had a $15.0 million revolving line of credit agreement (the "Line of Credit") with Synovus Bank, entered into in October 2013, with a maturity date of April 2017. The Line of Credit bears interest at a rate of 300 basis points plus 90-day LIBOR, and is available specifically for the South Bay premium financing product. The Line of Credit allows South Bay to finance up to 90% of the eligible receivables, less an applicable reserve of $500,000. At September 30, 2014, the balance of premium financing receivables included in notes receivable, net, on the Consolidated Balance Sheet, totaled $12.6 million, of which $10.7 million were eligible receivables. At September 30, 2014, South Bay was in compliance with the covenants required by the Line of Credit.
12. Derivative Financial Instruments - Interest Rate Swap
The Company has an interest rate swap (the "Swap") with Wells Fargo Bank, N.A., pursuant to which the Company swapped the floating rate portion of its outstanding preferred trust securities to a fixed rate. The Swap, designated as a cash flow hedge, commenced in June 2012 and expires in June 2017.
The following table presents the fair value (including accrued interest) and the related outstanding notional amount of the Company's single derivative instrument and indicates where the Company records each amount within its Consolidated Balance Sheets:
At | |||||||||
Balance Sheet Location | September 30, 2014 | December 31, 2013 | |||||||
Derivative designated as cash flow hedging instrument: | |||||||||
Interest rate swap - notional value | $ | 35,000 | $ | 35,000 | |||||
Fair value of the Swap | Accrued expenses, accounts payable and other liabilities | 2,205 | 2,930 | ||||||
Unrealized loss, net of tax, on the fair value of the Swap | AOCI | 1,433 | 1,904 | ||||||
Variable rate of the interest rate swap | 0.23 | % | 0.24 | % | |||||
Fixed rate of the interest rate swap | 3.47 | % | 3.47 | % |
20
FORTEGRA FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
(All Amounts in Thousands, Except Share Amounts, Per Share Amounts or Unless Otherwise Noted)
The following table presents the pretax impact of the Swap on the Consolidated Financial Statements for the following periods:
For the Three Months Ended September 30, | For the Nine Months Ended September 30, | ||||||||||||||
2014 | 2013 | 2014 | 2013 | ||||||||||||
Gain (loss) recognized in AOCI on the derivative-effective portion | $ | 124 | $ | (263 | ) | $ | (133 | ) | $ | 301 | |||||
Loss reclassified from AOCI into income-effective portion | $ | 290 | $ | 286 | $ | 858 | $ | 845 | |||||||
Gain (loss) recognized in income on the derivative-ineffective portion | $ | — | $ | — | $ | — | $ | — |
The following table presents the estimated amount to be reclassified to earnings from AOCI during the next 12 months. These net losses reclassified into earnings are primarily expected to increase net interest expense related to the respective hedged item.
At | |||
September 30, 2014 | |||
Estimated loss to be reclassified to earnings from AOCI during the next 12 months | $ | 1,101 |
13. Stock-Based Compensation
Stock Options
The Company did not grant stock options during the three months ended September 30, 2014. During the nine months ended September 30, 2014, the Company granted 15,000 time-based stock options, which vest in equal amounts on each of the four anniversaries of the grant date.
The following table presents the Company's time-based and performance-based stock option activity for the current period:
Time-Based | Performance-Based | ||||||||||||||||||||||||||
Options Outstanding | Weighted Average Exercise Price (in dollars per share) | Options Exercisable | Weighted Average Exercise Price (in dollars per share) | Options Outstanding | Weighted Average Exercise Price (in dollars per share) | Options Exercisable | Weighted Average Exercise Price (in dollars per share) | ||||||||||||||||||||
Balance, December 31, 2013 | 1,930,407 | $ | 4.22 | 1,806,251 | $ | 3.98 | 289,306 | $ | 8.46 | — | $ | — | |||||||||||||||
Granted | 15,000 | 8.27 | — | — | — | — | — | — | |||||||||||||||||||
Vested | — | — | 50,405 | 2.89 | — | — | — | — | |||||||||||||||||||
Exercised | (391,389 | ) | 3.10 | (391,389 | ) | 3.10 | — | — | — | — | |||||||||||||||||
Canceled/forfeited | (77,926 | ) | 7.89 | (77,926 | ) | 7.89 | (28,604 | ) | 8.42 | — | — | ||||||||||||||||
Balance, September 30, 2014 | 1,476,092 | $ | 4.36 | 1,387,341 | $ | 4.14 | 260,702 | $ | 8.46 | — | $ | — | |||||||||||||||
Weighted average remaining contractual term at September 30, 2014 (in years) | 3.3 | 2.9 | 8.0 | — |
The following table presents the weighted average assumptions used to estimate the fair values of all stock options granted during the nine months ended September 30, 2014:
Assumptions | ||
Expected term (years) | 6.25 | |
Expected volatility | 33.83 | % |
Expected dividends | — | % |
Risk-free rate | 2.19 | % |
Restricted Stock Awards
The Company did not grant restricted stock awards during the three months ended September 30, 2014. The Company granted 9,944 time-based restricted stock awards to employees during the nine months ended September 30, 2014, which vest in equal amounts on each of the three anniversaries of the grant date. During the nine months ended September 30, 2014, the Company also granted 30,000 time-based restricted stock awards to its Chief Executive Officer and 75,000 time-based restricted stock awards, equally distributed to five of its Directors. These awards will vest in equal amounts on each of the three anniversaries of the grant date.
21
FORTEGRA FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
(All Amounts in Thousands, Except Share Amounts, Per Share Amounts or Unless Otherwise Noted)
The following table presents the Company's time-based and performance-based restricted stock award activity for the current period:
Time-Based | Performance-Based | ||||||||||||
Shares | Weighted Average Grant Date Fair Value | Shares | Weighted Average Grant Date Fair Value | ||||||||||
Balance at December 31, 2013 | 139,680 | $ | 8.59 | 130,629 | $ | 10.20 | |||||||
Grants | 114,944 | 7.24 | — | — | |||||||||
Vests | (56,126 | ) | 8.40 | — | — | ||||||||
Forfeitures | (1,714 | ) | 7.80 | (4,535 | ) | 8.89 | |||||||
Balance at September 30, 2014 | 196,784 | $ | 7.87 | 126,094 | $ | 10.24 |
Stock-based Compensation Expense
The following table presents the total time-based and performance-based stock-based compensation expense and the related income tax benefit recognized on the Consolidated Statements of Income:
For the Three Months Ended September 30, | For the Nine Months Ended September 30, | ||||||||||||||
2014 | 2013 | 2014 | 2013 | ||||||||||||
Personnel costs | $ | 125 | $ | 226 | $ | 440 | $ | 614 | |||||||
Other operating expenses | 135 | 131 | 401 | 373 | |||||||||||
Income tax benefit | (100 | ) | (137 | ) | (322 | ) | (378 | ) | |||||||
Net stock-based compensation expense | $ | 160 | $ | 220 | $ | 519 | $ | 609 |
Additional information on total non-vested stock-based compensation is as follows: | At September 30, 2014 | ||||||
Stock Options | Restricted Stock Awards | ||||||
Unrecognized compensation cost related to non-vested awards | $ | 267 | $ | 1,114 | |||
Weighted-average recognition period (in years) | 3.0 | 3.1 |
For the three and the nine months ended September 30, 2014, the Company did not recognize expense on 135,702 performance-based stock options and 45,233 performance-based restricted stock awards since the attainment of the performance metrics associated with these awards was not probable based on current projections. In accordance with ASC No. 805, Business Combinations, the pending merger with Tiptree is disregarded in the determination of stock-based compensation expense.
Employee Stock Purchase Plan ("ESPP")
The following table presents the information related to the Company's ESPP for the six-month offering period ending on:
Offering Period ending June 30, | |||||||
2014 | 2013 | ||||||
Common stock issued under the ESPP (in shares) | 18,642 | 26,019 | |||||
Weighted-average purchase price per share by participant in the ESPP | $ | 6.04 | $ | 5.83 | |||
Total cash proceeds received from the issuance of common shares under the ESPP | $ | 113 | $ | 152 | |||
ESPP compensation costs recognized | $ | 32 | $ | 46 |
14. Income Taxes
The following table presents the provision for income taxes for both continuing and discontinued operations:
For the Three Months Ended September 30, | For the Nine Months Ended September 30, | ||||||||||||||
2014 | 2013 | 2014 | 2013 | ||||||||||||
Income taxes - continuing operations | $ | 924 | $ | 1,852 | $ | 4,624 | $ | 3,927 | |||||||
Income (benefit) taxes - discontinued operations | (24 | ) | 416 | (24 | ) | 2,121 | |||||||||
Income taxes | $ | 900 | $ | 2,268 | $ | 4,600 | $ | 6,048 |
22
FORTEGRA FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
(All Amounts in Thousands, Except Share Amounts, Per Share Amounts or Unless Otherwise Noted)
The following table presents the provision for income taxes from continuing operations:
For the Three Months Ended September 30, | For the Nine Months Ended September 30, | ||||||||||||||
2014 | 2013 | 2014 | 2013 | ||||||||||||
Current | $ | (11,394 | ) | $ | 2,909 | $ | (6,186 | ) | $ | 5,537 | |||||
Deferred | 12,318 | (1,057 | ) | 10,810 | (1,610 | ) | |||||||||
Income taxes - continuing operations | $ | 924 | $ | 1,852 | $ | 4,624 | $ | 3,927 |
In 2013, the Company applied for changes in tax accounting methods for certain of its subsidiaries with the Internal Revenue Service ("IRS"), and received approval for those method changes in August 2014. The Company applied the method changes to the 2013 tax returns and the September 30, 2014 tax provision. The application of these method changes is the primary cause of the large, substantially offsetting amounts of current and deferred income taxes for the three and nine months ended September 30, 2014 disclosed above, and also the primary cause of the $8.7 million in income taxes receivable as of September 30, 2014. In October 2014, the Company received a $6.8 million refund associated with the 2013 federal tax return.
The following table presents a reconciliation of income taxes from continuing operations calculated at the federal statutory rate of 35.0% and the income tax expense attributable to continuing operations for the following periods:
For the Three Months Ended September 30, | For the Nine Months Ended September 30, | ||||||||||||||||||||||||||
2014 | 2013 | 2014 | 2013 | ||||||||||||||||||||||||
Amount | Percent of Pre-tax Income | Amount | Percent of Pre-tax Income | Amount | Percent of Pre-tax Income | Amount | Percent of Pre-tax Income | ||||||||||||||||||||
Income taxes at federal income tax rate | $ | 1,669 | 35.00 | % | $ | 1,518 | 35.00 | % | $ | 5,634 | 35.00 | % | $ | 4,159 | 35.00 | % | |||||||||||
Effect of: | |||||||||||||||||||||||||||
Small life deduction | (204 | ) | (4.26 | ) | (197 | ) | (4.54 | ) | (414 | ) | (2.57 | ) | (388 | ) | (3.27 | ) | |||||||||||
Non-deductible expenses | 24 | 0.50 | 23 | 0.53 | 68 | 0.42 | 61 | 0.51 | |||||||||||||||||||
Tax exempt interest | (43 | ) | (0.90 | ) | (39 | ) | (0.90 | ) | (116 | ) | (0.72 | ) | (109 | ) | (0.92 | ) | |||||||||||
State taxes | 63 | 1.32 | 110 | 2.54 | 358 | 2.22 | 159 | 1.34 | |||||||||||||||||||
Prior year tax true up | (528 | ) | (11.04 | ) | 312 | 7.19 | (528 | ) | (3.28 | ) | 312 | 2.63 | |||||||||||||||
Non-controlling interest | (76 | ) | (1.59 | ) | 47 | 1.08 | (586 | ) | (3.64 | ) | (304 | ) | (2.56 | ) | |||||||||||||
Other, net | 19 | 0.40 | 78 | 1.80 | 208 | 1.29 | 37 | 0.31 | |||||||||||||||||||
Income taxes - continuing operations | $ | 924 | 19.43 | % | $ | 1,852 | 42.70 | % | $ | 4,624 | 28.72 | % | $ | 3,927 | 33.04 | % |
At September 30, 2014, the Company had a net operating loss carry forward of $0.6 million, which is subject to certain limitations under IRC Section 382 and will begin to expire in December 31, 2025. The Company expects to utilize the full amount of the net operating loss carryforward.
The Company has reviewed its uncertain tax positions and management has concluded that there are no additional amounts required to be recorded.
In 2012, the Company was under examination by the IRS for the 2010 and 2009 tax years. In February 2013, the IRS completed its field audit for those tax years and presented its findings. The Company agreed to those findings and expensed $57.0 thousand in the first quarter of 2013.
The Company's income tax returns are subject to review and examination by federal and state taxing authorities. The Company is currently open to audit under the applicable statutes of limitations by the IRS for the tax years 2011 through 2013. The years open to examination by state taxing authorities vary by jurisdiction. There are no extensions of the statute of limitations to assess income taxes currently in effect.
23
FORTEGRA FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
(All Amounts in Thousands, Except Share Amounts, Per Share Amounts or Unless Otherwise Noted)
15. Fair Value of Financial Instruments
The carrying and fair values of financial instruments are as follows: | At | ||||||||||||||
September 30, 2014 | December 31, 2013 | ||||||||||||||
Carrying Value | Fair Value | Carrying Value | Fair Value | ||||||||||||
Financial assets: | |||||||||||||||
Cash and cash equivalents | $ | 2,483 | $ | 2,483 | $ | 21,681 | $ | 21,681 | |||||||
Restricted cash | 7,579 | 7,579 | 17,293 | 17,293 | |||||||||||
Fixed maturity securities: | |||||||||||||||
Obligations of the U.S. Treasury and U.S. Government agencies | 54,912 | 54,912 | 51,435 | 51,435 | |||||||||||
Municipal securities | 33,996 | 33,996 | 24,547 | 24,547 | |||||||||||
Corporate securities | 67,438 | 67,438 | 55,360 | 55,360 | |||||||||||
Obligations of foreign governments | 1,389 | 1,389 | 409 | 409 | |||||||||||
Equity securities: | |||||||||||||||
Common stock - publicly traded | 52 | 52 | 47 | 47 | |||||||||||
Preferred stock - publicly traded | 5,829 | 5,829 | 5,087 | 5,087 | |||||||||||
Common stock - non-publicly traded | 53 | 53 | 51 | 51 | |||||||||||
Preferred stock - non-publicly traded | 1,013 | 1,013 | 1,013 | 1,013 | |||||||||||
Notes receivable | 19,421 | 19,421 | 11,920 | 11,920 | |||||||||||
Accounts and premiums receivable, net | 31,444 | 31,444 | 18,702 | 18,702 | |||||||||||
Other receivables | 32,048 | 32,048 | 33,409 | 33,409 | |||||||||||
Short-term investments | 871 | 871 | 871 | 871 | |||||||||||
Total financial assets | $ | 258,528 | $ | 258,528 | $ | 241,825 | $ | 241,825 | |||||||
Financial liabilities: | |||||||||||||||
Notes payable | $ | 10,173 | $ | 10,173 | $ | 3,273 | $ | 3,273 | |||||||
Preferred trust securities | 35,000 | 35,000 | 35,000 | 35,000 | |||||||||||
Interest rate swap | 2,205 | 2,205 | 2,930 | 2,930 | |||||||||||
Total financial liabilities | $ | 47,378 | $ | 47,378 | $ | 41,203 | $ | 41,203 |
The Company's financial assets and liabilities accounted for at fair value by level within the fair value hierarchy are as follows:
At September 30, 2014 | ||||||||||||
Fair Value Measurements Using: | ||||||||||||
Quoted prices in active markets for identical assets | Significant other observable inputs | Significant unobservable inputs | ||||||||||
Fair Value | (Level 1) | (Level 2) | (Level 3) | |||||||||
Financial Assets: | ||||||||||||
Fixed maturity securities: | ||||||||||||
Obligations of the U.S. Treasury and U.S. Government agencies | $ | 54,912 | $ | — | $ | 54,912 | $ | — | ||||
Municipal securities | 33,996 | — | 33,996 | — | ||||||||
Corporate securities | 67,438 | — | 67,438 | — | ||||||||
Obligations of foreign governments | 1,389 | — | 1,389 | — | ||||||||
Equity securities: | ||||||||||||
Common stock - publicly traded | 52 | 52 | — | — | ||||||||
Preferred stock - publicly traded | 5,829 | 5,829 | — | — | ||||||||
Common stock - non-publicly traded | 53 | — | — | 53 | ||||||||
Preferred stock - non-publicly traded | 1,013 | — | — | 1,013 | ||||||||
Short-term investments | 871 | 871 | — | — | ||||||||
Total assets | $ | 165,553 | $ | 6,752 | $ | 157,735 | $ | 1,066 | ||||
Financial Liabilities: | ||||||||||||
Interest rate swap | $ | 2,205 | $ | — | $ | 2,205 | $ | — |
24
FORTEGRA FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
(All Amounts in Thousands, Except Share Amounts, Per Share Amounts or Unless Otherwise Noted)
At December 31, 2013 | ||||||||||||
Fair Value Measurements Using: | ||||||||||||
Quoted prices in active markets for identical assets | Significant other observable inputs | Significant unobservable inputs | ||||||||||
Fair Value | (Level 1) | (Level 2) | (Level 3) | |||||||||
Financial Assets: | ||||||||||||
Fixed maturity securities: | ||||||||||||
Obligations of the U.S. Treasury and U.S. Government agencies | $ | 51,435 | $ | — | $ | 51,435 | $ | — | ||||
Municipal securities | 24,547 | — | 24,547 | — | ||||||||
Corporate securities | 55,360 | — | 55,360 | — | ||||||||
Obligations of foreign governments | 409 | — | 409 | — | ||||||||
Equity securities: | ||||||||||||
Common stock - publicly traded | 47 | 47 | — | — | ||||||||
Preferred stock - publicly traded | 5,087 | 5,087 | — | — | ||||||||
Common stock - non-publicly traded | 51 | — | — | 51 | ||||||||
Preferred stock - non-publicly traded | 1,013 | — | — | 1,013 | ||||||||
Short-term investments | 871 | 871 | — | — | ||||||||
Total Assets | $ | 138,820 | $ | 6,005 | $ | 131,751 | $ | 1,064 | ||||
Financial Liabilities: | ||||||||||||
Interest rate swap | $ | 2,930 | $ | — | $ | 2,930 | $ | — |
There were no transfers between Level 1, Level 2 or Level 3 during the three or the nine months ended September 30, 2014. The Company's use of Level 3 unobservable inputs included six individual securities that accounted for 0.6% of total investments at September 30, 2014. The Company valued one of the Level 3 equity securities at $1.0 million by taking into account the strength of the issuer's parent company guaranteeing the dividend of the issuer, and another Level 3 equity security at $13.0 thousand, by estimating the total value of the Class-A shares outstanding by the issuer and a review of the company's audited financial statements. The remaining four Level 3 securities, with a combined fair value of $53.0 thousand were valued based on information obtained from a third-party pricing service. At December 31, 2013, the Company had six individual securities valued under Level 3 that accounted for 0.8% of total investments.
The following table presents the changes in Level 3 assets measured at fair value: | For the Nine Months Ended September 30, | ||||||
2014 | 2013 | ||||||
Beginning balance, January 1, | $ | 1,064 | $ | 1,123 | |||
Total investment gains or losses (realized/unrealized): | |||||||
Included in other comprehensive (loss) | 2 | (32 | ) | ||||
Transfers (out of) Level 3 | — | (27 | ) | ||||
Ending balance, September 30, | $ | 1,066 | $ | 1,064 |
16. Statutory Reporting and Insurance Company Subsidiaries Dividend Restrictions
The Company's insurance company subsidiaries may pay dividends to the Company, subject to statutory restrictions. Payments in excess of statutory restrictions (extraordinary dividends) to the Company are permitted only with prior approval of the insurance department of the applicable state of domicile. The Company eliminated all dividends from its subsidiaries in the Consolidated Financial Statements. The following table presents the dividends paid to the Company by its insurance company subsidiaries for the following periods:
For the Nine Months Ended September 30, | For the Twelve Months Ended December 31, | ||||||
2014 | 2013 | ||||||
Ordinary dividends | $ | — | $ | 2,383 | |||
Extraordinary dividends | — | — | |||||
Total dividends | $ | — | $ | 2,383 |
25
FORTEGRA FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
(All Amounts in Thousands, Except Share Amounts, Per Share Amounts or Unless Otherwise Noted)
The following table presents the combined statutory capital and surplus of the Company's insurance company subsidiaries, the required minimum statutory capital and surplus, as required by the laws of the states in which they are domiciled, and the combined amount available for ordinary dividends of the Company's insurance company subsidiaries for the following periods:
At | |||||||
September 30, 2014 | December 31, 2013 | ||||||
Combined statutory capital and surplus of the Company's insurance company subsidiaries | $ | 81,292 | $ | 69,269 | |||
Required minimum statutory capital and surplus | $ | 17,200 | $ | 17,200 | |||
Amount available for ordinary dividends of the Company's insurance company subsidiaries | $ | 4,244 | $ | 3,989 |
At September 30, 2014, the maximum amount of dividends that our regulated insurance company subsidiaries could pay under applicable laws and regulations without regulatory approval was $4.2 million. The Company may seek regulatory approval to pay dividends in excess of this permitted amount, but there can be no assurance that the Company would receive regulatory approval if sought.
Under the NAIC's Risk-Based Capital Act of 1995, a company's Risk-Based Capital ("RBC") is calculated by applying certain risk factors to various asset, claim and reserve items. If a company's adjusted surplus falls below calculated RBC thresholds, regulatory intervention or oversight is required. The Company's insurance company subsidiaries' RBC levels, as calculated in accordance with the NAIC's RBC instructions, exceeded all RBC thresholds as of September 30, 2014 and December 31, 2013.
17. Commitments and Contingencies
Commitments
The Company, in the ordinary course of normal business, may enter from time to time into certain contractual obligations or commitments. The Company's commitments as of September 30, 2014 have not materially changed from those disclosed in the note "Commitments and Contingencies," in the Company's 2013 Form 10-K.
Contingencies
The Company is a party to claims and litigation in the normal course of its operations. Management believes that the ultimate outcome of these matters in existence at September 30, 2014 are reserved against, covered by insurance or would not have a material adverse effect on the consolidated financial condition, results of operations or cash flows of the Company.
Litigation Relating to the Proposed Merger
On August 18, 2014, a purported class action, entitled Stein v. Fortegra Financial Corporation, et al., Case No. 16-2014-CA-005825-XXXX-MA, was filed against the Company, the members of its Board of Directors, Parent, Holdings and Merger Sub in the Circuit Court of the Fourth Judicial Circuit in and for Duval County, State of Florida (the "Florida Court"). On September 18, 2014, an amended complaint was filed against the same parties. The amended complaint purports to be brought on behalf of all the Company’s stockholders (excluding the defendants and their affiliates). The amended complaint alleges that the Merger Consideration is inadequate, that the members of the Board of Directors breached their fiduciary obligations to the Company’s stockholders by approving the Merger Agreement and related agreements, engaging in an unfair sales process and failing to make adequate disclosures to the Company's stockholders, and that the other named defendants aided and abetted the breach of those duties. The amended complaint seeks various forms of relief, including injunctive relief that would, if granted, prevent or delay the completion of the Merger and an award of attorneys’ fees and expenses.
On September 15, 2014, a purported class action, entitled Hickey v. Fortegra Financial Corporation, et al., Case No. 16-2014-CA-006485-XXXX-MA, was filed against the Company in the Florida Court containing substantially the same allegations as the Stein case. On October 24, 2014, the Florida Court consolidated the Stein and Hickey actions.
On October 13, 2014, the Company and attorneys for both Stein and Hickey executed a memorandum of understanding that provides for a settlement. The terms of the memorandum of understanding did not require any change to the merger agreement, but did require the Company to provide stockholders with supplemental disclosures about the merger, which the Company completed. Before the settlement is finalized it must be approved by the Florida Court.
Accordingly, in management's opinion, based on information available at this time, the ultimate resolution of this litigation will not be materially adverse to the financial position, results of operations or cash flows of the Company.
26
FORTEGRA FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
(All Amounts in Thousands, Except Share Amounts, Per Share Amounts or Unless Otherwise Noted)
Other Litigation
The Company is currently a defendant in Mullins v. Southern Financial Life Insurance Co., which was filed on February 2, 2006, in the Pike Circuit Court, in the Commonwealth of Kentucky. A class was certified on June 25, 2010. At issue is the duration or term of coverage under certain policies. The action alleges violations of the Consumer Protection Act and certain insurance statutes, as well as common law fraud. The action seeks compensatory and punitive damages, attorney fees and interest. The parties are currently involved in the merits discovery phase and discovery disputes have arisen. Plaintiffs filed a Motion for Sanctions on April 5, 2012 in connection with the Company's efforts to locate and gather certificates and other documents from the Company's agents. While the court did not award sanctions, it did order the Company to subpoena certain records from its agents. In an effort to prevent the trial court from enforcing the order, the Company filed a Writ of Prohibition, which the Kentucky Court of Appeals denied on August 31, 2012. In response, the Company filed a motion for discretionary review of the Writ of Prohibition. The Company also filed a direct appeal of the same order, on the grounds that the order could be construed as a finding of contempt on the part of the Company. The Court of Appeals dismissed the direct appeal on September 13, 2013, which prompted the Company to file a motion for discretionary review of the direct appeal. The Kentucky Supreme Court denied the Writ of Prohibition on November 21, 2013, and subsequently denied the direct appeal in April 2014. No hearings are currently scheduled and no trial date has been set.
The Company considers such litigation customary in its lines of business. In management's opinion, based on information available at this time, the ultimate resolution of such litigation, which it is vigorously defending, should not be materially adverse to the financial position, results of operations or cash flows of the Company. It should be noted that large punitive damage awards, bearing little relation to actual damages sustained by plaintiffs, have been awarded in certain states against other companies in the credit insurance business. The Company may record loss contingencies as developments warrant, although such amounts are not reasonably estimable at this time.
18. Related Party Transactions
In conjunction with the December 31, 2012 acquisition of ProtectCELL, the Company assumed an office space lease between ProtectCELL and 39500 High Pointe, LLC ("High Pointe"). The ownership of High Pointe includes three members who were the founding members of ProtectCELL and are now employees of the Company. The table below presents the lease payments made to High Pointe.
At December 31, 2012, ProtectCELL held a $6.1 million note receivable carrying an interest rate of 8.00% from High Pointe, which was fully secured by a mortgage on the office building owned by High Pointe (see the lease described above). On March 15, 2013, ProtectCELL received $6.1 million from High Pointe, representing the full payoff of the outstanding balance of the note receivable. The Company only recorded interest income on this note receivable during the three months ended March 31, 2013.
An executive officer of ProtectCELL owned multiple wireless retail locations, which sold ProtectCELL protection plans to wireless retail customers. The executive sold these wireless retail locations in February 2014. The table below presents the income recorded on and the commissions paid for this related party agreement through the sale date of the wireless retail locations.
In conjunction with the December 31, 2012 acquisition of 4Warranty, the Company assumed an office space lease between 4Warranty and Source International Incorporated ("Source"), effective January 1, 2013. The ownership of Source is comprised of two individuals who had consulting relationships with the Company. The lease with Source, which expired on December 31, 2013, was not renewed since the operations of 4Warranty were moved to the Company's main office. The table below presents the lease payments made to Source during the three months and the nine months ended September 30, 2013.
In December 2011, the Company entered into a marketing and referral agreement (the "Marketing Agreement") with a company in which a member serving on the Company's Board of Directors also serves on the board of the company providing the marketing services (the "Marketer"). The Marketing Agreement has a five year term and requires the Company to pay the Marketer a per account fee per month based on the number of enrolled customers the Marketer obtains for the Company. In conjunction with the Marketing Agreement, during April 2013, the Company entered into an agreement under which the Marketer began selling insurance-related products of the Company to the Marketer's customers. The Company recorded income and paid claims, associated with the sale of the Company's insurance-related products, which are reflected in the table below.
In addition, during the three months ended September 30, 2014, the Company paid for transportation services provided by the Marketer, which are reflected in the table below.
27
FORTEGRA FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
(All Amounts in Thousands, Except Share Amounts, Per Share Amounts or Unless Otherwise Noted)
The following table presents the amounts recorded on the Company's Consolidated Statements of Income resulting from related party transactions:
For the Three Months Ended September 30, | For the Nine Months Ended September 30, | ||||||||||||||
2014 | 2013 | 2014 | 2013 | ||||||||||||
Income recorded by ProtectCELL for protection plans sold | $ | — | $ | 537 | $ | 307 | $ | 1,639 | |||||||
Income recorded for the sale of the Company's insurance-related products under the Marketing Agreement | 340 | 324 | 972 | 592 | |||||||||||
Total related party income recorded by the Company | $ | 340 | $ | 861 | $ | 1,279 | $ | 2,231 | |||||||
Interest income recorded on the High Pointe note receivable | $ | — | $ | — | $ | — | $ | 21 | |||||||
Lease expense paid to High Pointe | $ | 103 | $ | 103 | $ | 310 | $ | 300 | |||||||
Lease expense paid to Source | — | 29 | — | 87 | |||||||||||
Total related party lease expense | $ | 103 | $ | 132 | $ | 310 | $ | 387 | |||||||
Commissions paid by ProtectCELL for protection plans sold | $ | — | $ | 200 | $ | 122 | $ | 651 | |||||||
Claims paid on the Company's insurance-related products under the Marketing Agreement | $ | 5 | $ | 26 | $ | 67 | $ | 26 | |||||||
Transportation service expenses paid to the Marketer | $ | 126 | $ | — | $ | 126 | $ | — | |||||||
The following table presents the amounts recorded on the Company's Consolidated Balance Sheets from related party transactions: | |||||||||||||||
At | |||||||||||||||
September 30, 2014 | December 31, 2013 | ||||||||||||||
Accounts receivable from related parties | $ | — | $ | 113 |
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") represents an overview of our results of operations and financial condition. The MD&A should be read in conjunction with the Consolidated Financial Statements and Notes thereto included in ITEM 1 of this Form 10-Q. Except for the historical information contained herein, the discussions in MD&A contain forward-looking statements that involve risks and uncertainties. Our future results could differ materially from those discussed herein. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in PART II, "ITEM 1A. Risk Factors" of this Form 10-Q.
Critical Accounting Policies
Our critical accounting policies involving significant judgments and assumptions used in the preparation of the Consolidated Financial Statements as of September 30, 2014 are unchanged from those presented in the MD&A of our 2013 Form 10-K.
Recently Issued Accounting Standards
For a discussion of recently issued accounting standards, see the Note "Summary of Significant Accounting Policies" of the Notes to Consolidated Financial Statements included in ITEM 1 of this Form 10-Q.
Components of Revenues and Expenses
For a complete discussion of our "Components of Revenues and Expenses," see the MD&A in PART II, ITEM 7, of our 2013 Form 10-K.
Use of Non-GAAP Financial Measures
Management uses certain Non-GAAP financial measures in its analysis of our operating performance. See "Use of Non-GAAP Financial Information" in this MD&A for a reconciliation of such financial measures to comparable financial measures based on U.S. GAAP.
EXECUTIVE SUMMARY
The following provides an overview of events and financial results for the three and the nine months ended September 30, 2014:
Overview of Events
On December 31, 2012, we acquired ProtectCELL and 4Warranty. Their impact on our financial results began in 2013.
28
In January 2013, we announced a plan to consolidate our fulfillment, claims administration and information technology functions (the "Plan"). Prior to the Plan, such functions resided in our individual business units. The decision was part of our efforts to streamline operations, focus resources and provide first-in-class service to our customers. During the first quarter of 2013, we eliminated approximately 40 employee and contract positions. Subsequently we cross-trained personnel, further refined our mix of skills, and enhanced our tracking of transaction volumes and related metrics, allowing us to efficiently deploy resources to transaction volumes. As a result of the Plan and these changes, we have reduced costs and improved productivity.
On December 31, 2013, we completed the sale of all of the issued and outstanding stock of our subsidiaries, Bliss and Glennon and eReinsure, to AmWINS (the "Disposition"). See the Note, "Divestitures" in the Notes to Consolidated Financial Statements, included in ITEM 1 of this Form 10-Q for additional information.
In March 2014, in the exercise of our rights as a secured creditor, we took measures to protect certain assets of CIRG, a previously unconsolidated VIE, and booked an allowance for potential non-performance of the underlying note receivable guaranteed by CIRG. See the Note, "Variable Interest Entity" in the Notes to Consolidated Financial Statements, included in ITEM 1 of this Form 10-Q for additional information.
On April 11, 2014, we amended our Credit Agreement with Wells Fargo Bank, N.A., which increased our available line of credit to $100.0 million from $75.0 million, extended the maturity by two years from August 2017 to August 2019 and provided us with a more favorable interest rate schedule and unused line fees.
On August 11, 2014, we entered into an Agreement and Plan of Merger (the "Merger Agreement") to be acquired by subsidiaries of Tiptree Financial Inc. ("Tiptree") for approximately $218.0 million, which would entitle shareholders to receive cash Merger Consideration of $10.00 per share. We expect this amount to be funded by a combination of debt financing (through a proposed amended credit agreement with a syndicate of lenders led by Wells Fargo Bank, N.A.) and cash on hand of Tiptree. Tiptree is a publicly traded diversified holding company (NASDAQ: TIPT), with subsidiaries that operate in four industry segments: insurance and insurance services, specialty finance, asset management and real estate. Following the execution of the merger agreement, stockholders representing approximately 62% of the outstanding shares of our common stock executed a written consent adopting and approving the merger agreement. No additional stockholder approvals are necessary to adopt the merger agreement or consummate the transaction. Closing of the merger is subject to the satisfaction of customary conditions including, among other things, insurance regulatory approvals.
For additional details regarding the proposed merger, see the section "Plan of Merger with Tiptree Financial, Inc." included on Page 8 of this Form 10-Q and the Information Statement (Form DEFM14C) filed with the Securities and Exchange Commission ("SEC") on September 30, 2014.
Overview of Financial Results
The Three Months Ended September 30, 2014 as compared to The Three Months Ended September 30, 2013
Our income from continuing operations before non-controlling interests for the three months ended September 30, 2014 increased $1.4 million, or 55.3%, to $3.9 million from $2.5 million for the three months ended September 30, 2013. Total revenues were lower by $2.6 million despite growth from our payment protection products. However, the revenue decrease was more than offset by a $3.1 million reduction in total expenses. In addition, income taxes decreased $0.9 million caused by favorable tax true-up items in the current year period compared to unfavorable tax true-up items in the prior year period.
For the three months ended September 30, 2014, our total revenues decreased $2.6 million, or 2.9%, to $87.6 million from $90.3 million for the three months ended September 30, 2013. The decrease represents a revenue decrease of $5.8 million, partially offset by $3.2 million as a result of the accounting treatment required under purchase accounting for the ProtectCELL acquisition. The revenue decrease was primarily due to a $3.0 million decrease in motor club revenues and a $5.0 million decrease in ProtectCELL revenues reflecting competitive pressures, and a $1.0 million decrease in client administrative revenues. Also contributing to the decrease was $0.8 million of net realized gains on the sale of investments in 2013 that did not reoccur in 2014. These decreases were partially offset by growth of $1.8 million from our payment protection products, $1.2 million from our auto insurance products and $1.0 million combined from our other product groups.
Total expenses decreased $3.1 million, or 3.6%, to $82.9 million for the three months ended September 30, 2014 from $85.9 million for the same period in 2013. The decrease represents $6.3 million of reductions in expenses, partially offset by $3.2 million as a result of the accounting treatment required under purchase accounting for the ProtectCELL acquisition primarily in commissions. The expense reductions included $3.9 million in member benefit claims and $4.1 million in commissions, partially offset by $0.9 million in transaction costs expense associated with the proposed merger, a $0.7 million increase in personnel costs, and a $0.3 million increase in net losses and loss adjustment expenses.
Net revenues, a Non-GAAP financial measure, increased $2.0 million, or 7.6%, to $28.6 million for the three months ended September 30, 2014 compared to $26.6 million for the same period in 2013, despite the decline in total revenues. This increase reflects strong management of costs to fulfill ProtectCELL member benefit claims, and volume growth in payment protection products reflected mainly in ceding commissions and net earned premium.
29
Earnings Before Interest, Taxes, Depreciation and Amortization ("EBITDA") from continuing operations, a Non-GAAP financial measure, increased $0.5 million, or 6.4%, to $8.4 million for the three months ended September 30, 2014 compared to $7.9 million for the same period in 2013. The EBITDA from continuing operations margin, a Non-GAAP financial measure, was 29.3% for the quarter ended September 30, 2014 compared to 29.6% for the quarter ended September 30, 2013.
Net income attributable to Fortegra Financial Corporation increased $0.4 million, or 11.4%, to $3.6 million for the three months ended September 30, 2014 from $3.2 million for the three months ended September 30, 2013. Earnings per diluted share attributable to Fortegra Financial Corporation increased 12.5% to $0.18 for the three months ended September 30, 2014 from $0.16 for the same period in 2013, with the 2013 amount including $0.6 million, or $0.03 per diluted share, for the results of discontinued operations.
The Nine Months Ended September 30, 2014 as compared to The Nine Months Ended September 30, 2013
Our income from continuing operations before non-controlling interests for the nine months ended September 30, 2014 increased $3.5 million, or 44.5%, to $11.5 million from $8.0 million for the nine months ended September 30, 2013. This increase was primarily due to revenue growth, particularly in our payment protection products, ProtectCELL, and auto insurance products.
For the nine months ended September 30, 2014, our total revenues increased $11.3 million, or 4.4%, to $266.7 million from $255.4 million for the nine months ended September 30, 2013. The increase in revenues for 2014 includes $12.5 million as a result of the accounting treatment required under purchase accounting for the ProtectCELL acquisition, partially offset by a $1.2 million decline in revenues. The decline is primarily attributable to an $8.0 million decrease in motor club revenues, a $3.0 million decrease in our insurance client administrative revenues, a $2.7 million decrease in ProtectCELL revenue, and $2.0 million of net realized gains on the sale of investments in 2013 that did not reoccur in 2014. These declines were substantially offset by increases of $9.0 million from our payment protection products, $4.4 million from our auto insurance products, and $1.1 million from our other product groups. .
Total expenses increased $7.1 million, or 2.9%, to $250.6 million for the nine months ended September 30, 2014 from $243.5 million for the same period in 2013. This increase represented $5.4 million of cost reductions, more than offset by $12.5 million as a result of the accounting treatment required under purchase accounting for the ProtectCELL acquisition (affecting commissions by $11.9 million and other operating costs by $0.6 million). Commission costs decreased $5.0 million due to lower revenues and mix of business, while member benefit claims decreased $3.5 million due to lower revenues and lower average device costs in ProtectCELL claims fulfillment. Personnel costs increased $0.6 million; the 2014 period reflects increased staffing costs, primarily in ProtectCELL operations, to support business objectives, while the 2013 period included $1.2 million of costs associated with the Plan. Other operating costs increased $0.8 million reflecting $0.9 million in transaction costs associated with the proposed merger. Total expenses for the nine months ended September 30, 2014 also included a $1.3 million charge to expense associated with the allowance established against the CIRG note receivable, while the 2013 period included a $0.4 million gain on the sale of a subsidiary which reduced total expenses in that period.
Net revenues, a Non-GAAP financial measure, increased $7.4 million, or 9.6%, to $84.9 million for the nine months ended September 30, 2014 compared to $77.4 million for the same period in 2013. This increase represents the revenue growth in payment protection and auto insurance products, and improved member benefit claims costs in ProtectCELL products, partially offset by lower insurance client administrative revenues and the 2013 net realized investment gains that did not reoccur in 2014.
EBITDA from continuing operations, a Non-GAAP financial measure, increased $4.3 million, or 19.3%, to $26.7 million for the nine months ended September 30, 2014 compared to $22.4 million for the same period in 2013. EBITDA from continuing operations margin, a Non-GAAP financial measure, was 29.3% for the quarter ended September 30, 2014 compared to 29.6% for the quarter ended September 30, 2013.
Net income attributable to Fortegra Financial Corporation decreased $0.4 million, or 3.9%, to $9.8 million for the nine months ended September 30, 2014 from $10.2 million for the nine months ended September 30, 2013. Earnings per diluted share attributable to Fortegra Financial Corporation decreased 4.0% to $0.48 for the nine months ended September 30, 2014 from $0.50 for the same period in 2013. These decreases were attributable to the results of discontinued operations for the nine months ended September 30, 2013 of $3.1 million, or $0.15 per diluted share, partially offset by positive growth in earnings from continuing operations in the current period.
30
RESULTS OF OPERATIONS
The following table presents our Consolidated Statements of Income for the following periods:
For the Three Months Ended September 30, | |||||||||||
(in thousands, except shares, per share amounts and percentages) | 2014 | 2013 | $ Change from 2013 | % Change from 2013 | |||||||
Revenues: | |||||||||||
Service and administrative fees | $ | 40,591 | $ | 45,753 | $ | (5,162 | ) | (11.3 | )% | ||
Ceding commissions | 10,022 | 8,731 | 1,291 | 14.8 | |||||||
Net investment income | 831 | 766 | 65 | 8.5 | |||||||
Net realized investment gains | 1 | 756 | (755 | ) | (99.9 | ) | |||||
Net earned premium | 35,187 | 34,106 | 1,081 | 3.2 | |||||||
Other income | 1,003 | 165 | 838 | 507.9 | |||||||
Total revenues | 87,635 | 90,277 | (2,642 | ) | (2.9 | ) | |||||
Expenses: | |||||||||||
Net losses and loss adjustment expenses | 10,267 | 9,957 | 310 | 3.1 | |||||||
Member benefit claims | 9,929 | 13,834 | (3,905 | ) | (28.2 | ) | |||||
Commissions | 38,813 | 39,876 | (1,063 | ) | (2.7 | ) | |||||
Personnel costs | 10,273 | 9,544 | 729 | 7.6 | |||||||
Other operating expenses | 9,970 | 9,189 | 781 | 8.5 | |||||||
Depreciation and amortization | 1,352 | 1,227 | 125 | 10.2 | |||||||
Amortization of intangibles | 1,317 | 1,389 | (72 | ) | (5.2 | ) | |||||
Interest expense | 930 | 923 | 7 | 0.8 | |||||||
(Gain) on sale of subsidiary | — | — | — | — | |||||||
Total expenses | 82,851 | 85,939 | (3,088 | ) | (3.6 | ) | |||||
Income from continuing operations before income taxes | 4,784 | 4,338 | 446 | 10.3 | |||||||
Income taxes - continuing operations | 924 | 1,852 | (928 | ) | (50.1 | ) | |||||
Income from continuing operations before non-controlling interests | 3,860 | 2,486 | 1,374 | 55.3 | |||||||
Discontinued operations: | |||||||||||
Income from discontinued operations - net of tax | — | 601 | (601 | ) | (100.0 | ) | |||||
Loss on sale of discontinued operations - net of tax | (42 | ) | — | (42 | ) | 100.0 | |||||
Discontinued operations - net of tax | (42 | ) | 601 | (643 | ) | (107.0 | ) | ||||
Net income before non-controlling interests | 3,818 | 3,087 | 731 | 23.7 | |||||||
Less: net income (loss) attributable to non-controlling interests | 230 | (135 | ) | 365 | (270.4 | ) | |||||
Net income attributable to Fortegra Financial Corporation | $ | 3,588 | $ | 3,222 | $ | 366 | 11.4 | % | |||
Earnings per share - Basic: | |||||||||||
Net income from continuing operations - net of tax | $ | 0.18 | $ | 0.14 | |||||||
Discontinued operations - net of tax | — | 0.03 | |||||||||
Net income attributable to Fortegra Financial Corporation | $ | 0.18 | $ | 0.17 | |||||||
Earnings per share - Diluted: | |||||||||||
Net income from continuing operations - net of tax | $ | 0.18 | $ | 0.13 | |||||||
Discontinued operations - net of tax | — | 0.03 | |||||||||
Net income attributable to Fortegra Financial Corporation | $ | 0.18 | $ | 0.16 | |||||||
Weighted average common shares outstanding: | |||||||||||
Basic | 19,774,263 | 19,405,597 | |||||||||
Diluted | 20,625,695 | 20,404,508 |
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For the Nine Months Ended September 30, | |||||||||||
(in thousands, except shares, per share amounts and percentages) | 2014 | 2013 | $ Change from 2013 | % Change from 2013 | |||||||
Revenues: | |||||||||||
Service and administrative fees | $ | 126,633 | $ | 126,651 | $ | (18 | ) | — | % | ||
Ceding commissions | 32,567 | 22,851 | 9,716 | 42.5 | |||||||
Net investment income | 2,315 | 2,415 | (100 | ) | (4.1 | ) | |||||
Net realized investment gains | 6 | 2,043 | (2,037 | ) | (99.7 | ) | |||||
Net earned premium | 103,278 | 100,929 | 2,349 | 2.3 | |||||||
Other income | 1,888 | 499 | 1,389 | 278.4 | |||||||
Total revenues | 266,687 | 255,388 | 11,299 | 4.4 | |||||||
Expenses: | |||||||||||
Net losses and loss adjustment expenses | 30,970 | 31,096 | (126 | ) | (0.4 | ) | |||||
Member benefit claims | 31,111 | 34,624 | (3,513 | ) | (10.1 | ) | |||||
Commissions | 119,726 | 112,224 | 7,502 | 6.7 | |||||||
Personnel costs | 30,444 | 29,849 | 595 | 2.0 | |||||||
Other operating expenses | 26,432 | 25,628 | 804 | 3.1 | |||||||
Depreciation and amortization | 3,830 | 3,609 | 221 | 6.1 | |||||||
Amortization of intangibles | 3,952 | 4,156 | (204 | ) | (4.9 | ) | |||||
Interest expense | 2,784 | 2,722 | 62 | 2.3 | |||||||
Loss on note receivable | 1,317 | — | 1,317 | 100.0 | |||||||
(Gain) on sale of subsidiary | — | (402 | ) | 402 | 100.0 | ||||||
Total expenses | 250,566 | 243,506 | 7,060 | 2.9 | |||||||
Income from continuing operations before income taxes | 16,121 | 11,882 | 4,239 | 35.7 | |||||||
Income taxes - continuing operations | 4,624 | 3,927 | 697 | 17.7 | |||||||
Income from continuing operations before non-controlling interests | 11,497 | 7,955 | 3,542 | 44.5 | |||||||
Discontinued operations: | |||||||||||
Income from discontinued operations - net of tax | — | 3,070 | (3,070 | ) | (100.0 | ) | |||||
Loss on sale of discontinued operations - net of tax | (42 | ) | — | (42 | ) | 100.0 | |||||
Discontinued operations - net of tax | (42 | ) | 3,070 | (3,112 | ) | (101.4 | ) | ||||
Net income before non-controlling interests | 11,455 | 11,025 | 430 | 3.9 | |||||||
Less: net income (loss) attributable to non-controlling interests | 1,693 | 868 | 825 | 95.0 | |||||||
Net income attributable to Fortegra Financial Corporation | $ | 9,762 | $ | 10,157 | $ | (395 | ) | (3.9 | )% | ||
Earnings per share - Basic: | |||||||||||
Net income from continuing operations - net of tax | $ | 0.50 | $ | 0.36 | |||||||
Discontinued operations - net of tax | — | 0.16 | |||||||||
Net income attributable to Fortegra Financial Corporation | $ | 0.50 | $ | 0.52 | |||||||
Earnings per share - Diluted: | |||||||||||
Net income from continuing operations - net of tax | $ | 0.48 | $ | 0.35 | |||||||
Discontinued operations - net of tax | — | 0.15 | |||||||||
Net income attributable to Fortegra Financial Corporation | $ | 0.48 | $ | 0.50 | |||||||
Weighted average common shares outstanding: | |||||||||||
Basic | 19,723,995 | 19,500,430 | |||||||||
Diluted | 20,528,052 | 20,531,122 |
REVENUES
Service and Administrative Fees
Service and administrative fees for the three months ended September 30, 2014 decreased $5.2 million, or 11.3%, to $40.6 million from $45.8 million for the three months ended September 30, 2013. The decrease primarily resulted from declines of $5.4 million in ProtectCELL revenues and $3.0 million in motor club revenues due mainly to competitive pressures. In addition, client administrative revenues decreased $0.9 million due to reduced service opportunities from a key client. These decreases were partially offset by $3.2 million due to the accounting treatment required under purchase accounting for the ProtectCELL acquisition and growth from credit insurance, warranty and auto insurance products of $0.7 million from production gains from existing and new clients, and $0.3 million from the consolidation of CIRG in the 2014 period.
Service and administrative fees for the nine months ended September 30, 2014 totaled $126.6 million compared to $126.7 million for the nine months ended September 30, 2013. The decrease primarily resulted from declines of $3.0 million in ProtectCELL revenues
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and $8.1 million in motor club revenues due mainly to competitive pressures. In addition, client administrative revenues decreased $3.0 million due to reduced service opportunities from a key client and $0.6 million in premium finance loan administration fees due to the change from loan administration to loan issuance in that product. These decreases were partially offset by $12.5 million due to the accounting treatment required under purchase accounting for the ProtectCELL acquisition and growth from credit insurance, warranty and auto insurance products of $1.7 million from production gains from existing and new clients, and $0.5 million from the consolidation of CIRG in the 2014 period.
Ceding Commissions
Ceding commissions for the three months ended September 30, 2014 increased $1.3 million, or 14.8%, to $10.0 million from $8.7 million for the three months ended September 30, 2013. This increase primarily resulted from growth in ceded credit insurance service and administrative fees from both higher direct premium volume and increased ceding percentages on our recently amended reinsurance agreements with London Life and London International, which occurred in early 2014 and did not impact our 2013 results. In addition, underwriting profits increased due to favorable loss ratios in the ceded credit insurance business. For the three months ended September 30, 2014, ceding commissions included $8.3 million in service and administrative fees, $1.6 million in underwriting profits, and $0.1 million in net investment income.
Ceding commissions for the nine months ended September 30, 2014 increased $9.7 million, or 42.5%, to $32.6 million from $22.9 million for the nine months ended September 30, 2013. This increase primarily resulted from growth in ceded credit insurance service and administrative fees from both higher direct premium volume and increased ceding percentages on our recently amended reinsurance agreements with London Life and London International, which occurred early in 2014 and did not impact our 2013 results. In addition, underwriting profits increased due to favorable loss ratios in the ceded credit insurance business. For the nine months ended September 30, 2014, ceding commissions included $24.6 million in service and administrative fees, $7.7 million in underwriting profits, and $0.3 million in net investment income.
Net Investment Income
Net investment income for the three months ended September 30, 2014 increased $0.1 million, or 8.5%, to $0.8 million compared to the three months ended September 30, 2013. The increase was primarily attributable to a higher average balance of our fixed maturity securities, which was partially offset by a decrease in the overall yield of the investment portfolio.
Net investment income for the nine months ended September 30, 2014 decreased $0.1 million, or 4.1%, to $2.3 million from $2.4 million for the nine months ended September 30, 2013. The decrease was primarily attributable to $0.1 million of investment income attributable to ProtectCELL recorded in 2013 that was not repeated in 2014, along with a decrease in the overall yield of the investment portfolio. The decrease in the overall yield for the nine months ended September 30, 2014, compared to the same period in 2013, was partially offset by an increase in the average balance of our fixed maturity securities.
Net Realized Investment Gains
Net realized gains on the sale of investments and the gross proceeds from the sales of investments were not material to our results of operations for the three and the nine months ended September 30, 2014. Net realized gains on the sale of investments totaled $0.8 million and $2.0 million for the three and the nine months ended September 30, 2013, respectively.
Net Earned Premium
Net earned premium for the three months ended September 30, 2014 increased $1.1 million, or 3.2%, to $35.2 million from $34.1 million for the three months ended September 30, 2013. This increase resulted primarily from growth in direct and assumed earned premium of $27.4 million attributable to production gains from existing and new clients distributing our credit insurance, warranty and auto insurance products, which also represented geographic expansion particularly in Texas and California. This was offset by an increase in ceded earned premiums of $26.4 million, caused by the growth in direct and assumed premiums, and also by the amendments to our reinsurance agreements with London Life and London International, which occurred early in 2014 and did not impact 2013. On average, we maintained a 72.4% overall cession rate of direct and assumed earned premium for the three months ended September 30, 2014 compared with 66.0% for the same period in 2013.
Net earned premium for the nine months ended September 30, 2014 increased $2.3 million, or 2.3%, to $103.3 million from $100.9 million for the nine months ended September 30, 2013. This increase was primarily due to growth in direct and assumed earned premium of $62.7 million resulting from increased production from existing and new clients distributing our credit insurance, warranty and auto insurance products, and from geographic expansion. Because of this increase in production and the increased ceding percentages on our reinsurance program with London Life and London International, ceded earned premiums increased $60.4 million for the nine months ended September 30, 2014. On average, we maintained a 70.2% overall cession rate of direct and assumed earned premium for the nine months ended September 30, 2014 compared with 64.5% for the same period in 2013.
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Other Income
Other income for the three months ended September 30, 2014 increased $0.8 million, or 507.9%, to $1.0 million from $0.2 million for the three months ended September 30, 2013. The increase was principally due to $0.4 million of interest income from our premium financing program for South Bay, which began late in the fourth quarter of 2013, and $0.4 million of implicit interest income from our ProtectCELL monthly billed product, which began in the third quarter of 2014.
Other income for the nine months ended September 30, 2014 increased $1.4 million, or 278.4%, to $1.9 million from $0.5 million for the nine months ended September 30, 2013. The increase was principally due to $1.0 million of interest income from our premium financing program for South Bay, which began late in the fourth quarter of 2013, and $0.4 million of implicit interest income from our ProtectCELL monthly complete plan, which began in the third quarter of 2014.
EXPENSES
Net Losses and Loss Adjustment Expenses
Net losses and loss adjustment expenses for the three months ended September 30, 2014 increased $0.3 million, or 3.1%, to $10.3 million, from $10.0 million for the three months ended September 30, 2013. Our net losses and loss adjustment expense ratio remained the same at 29.2% for 2013 and 2014, respectively. The increase in net losses and loss adjustment expenses resulted primarily from growth in earned premiums partially offset by an increase in ceded credit insurance losses due to the recently amended reinsurance agreements with London Life and London International, which occurred early in 2014 and did not impact 2013. This change had the effect of lowering net losses and loss adjustment expenses by the corresponding amount ceded to the reinsurers. For the 2014 period, our direct and assumed losses increased by $6.9 million, or 29.6%, as compared with the same period in 2013. For the 2014 period, our ceded losses were higher by $6.6 million, or 49.3%, as compared with the same period in 2013, partially offsetting the increase in direct and assumed losses. The overall cession rate of direct and assumed losses and loss adjustment expenses for the three months ended September 30, 2014 increased to 66.1%, from 57.4% for the same period in 2013, with the increase primarily attributable to the change in the reinsurance program noted above.
Net losses and loss adjustment expenses for the nine months ended September 30, 2014 decreased $0.1 million, or 0.4%, to $31.0 million, from $31.1 million for the nine months ended September 30, 2013. Our net losses and loss adjustment expense ratio improved from 30.8% in the 2013 period to 30.0% in 2014 due to lower incurred claims. The decrease in net losses and loss adjustment expenses resulted primarily from growth in ceded credit insurance losses due to the recently amended reinsurance agreements with London Life and London International, which occurred early in 2014 and did not impact 2013. For the 2014 period, our direct and assumed losses increased by $16.5 million, or 24.7%, as compared with the same period in 2013. For the 2014 period, our ceded losses were higher by $16.7 million, or 46.6%, as compared with the same period in 2013, more than offsetting the increase in direct and assumed losses. The overall cession rate of direct and assumed losses and loss adjustment expenses for the nine months ended September 30, 2014 increased to 62.9%, from 53.5% for the same period in 2013, with the increase primarily attributable to the change in the reinsurance program noted above.
Member Benefit Claims
Member benefit claims for the three months ended September 30, 2014 decreased $3.9 million, or 28.2%, to $9.9 million, from $13.8 million for the three months ended September 30, 2013. This decrease resulted principally from a $4.1 million decrease in ProtectCELL member benefits claims, which was partially offset by a $0.2 million increase in motor club member benefits claims.
Member benefit claims for the nine months ended September 30, 2014 decreased $3.5 million, or 10.1%, to $31.1 million, from $34.6 million for the nine months ended September 30, 2013. This decrease resulted principally from a $4.1 million decrease in ProtectCell member claims, which was partially offset by a $0.6 million increase in motor club member benefits claims due primarily to severe weather affecting motor club claims.
Commissions
Commissions for the three months ended September 30, 2014 decreased $1.1 million, or 2.7%, to $38.8 million from $39.9 million for the three months ended September 30, 2013. This decrease resulted primarily from lower commissions of $2.8 million in motor clubs due to lower motor club revenues and a shift in the relative mix of products sold toward those with lower commission rates. This decrease was partially offset by growth of $0.1 million from auto insurance products. In addition, ProtectCELL commissions increased $1.5 million, of which $3.0 million was due to the accounting treatment required under purchase accounting for the ProtectCELL acquisition.
Commissions for the nine months ended September 30, 2014 increased $7.5 million, or 6.7%, to $119.7 million, from $112.2 million for the nine months ended September 30, 2013. The increase included growth of $4.3 million from payment protection products and $0.7 million from auto insurance products. These increases were partially offset by a decrease of $7.7 million in motor club commissions due to the decrease in motor club revenues and a shift in the relative mix of products sold toward those with lower commission rates. In addition, ProtectCELL commissions increased $10.2 million, of which $11.9 million was due to the accounting treatment required under purchase accounting for the ProtectCELL acquisition.
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Personnel Costs
Personnel costs for the three months ended September 30, 2014 increased $0.7 million, or 7.6%, to $10.3 million from $9.5 million for the three months ended September 30, 2013, as a result of adding staff in the latter part of 2013 to support business objectives. Stock-based compensation expense included in personnel costs decreased to $0.1 million for the three months ended September 30, 2014 from $0.2 million for the three months ended September 30, 2013.
Personnel costs for the nine months ended September 30, 2014 increased $0.6 million, or 2.0%, to $30.4 million from $29.8 million for the nine months ended September 30, 2013. The 2014 period reflects increased staffing costs, primarily in ProtectCELL operations, to support business objectives, while the 2013 period included $1.2 million of costs associated with the Plan. Stock-based compensation expense included in personnel costs decreased to $0.4 million for the nine months ended September 30, 2014 from $0.6 million for the same period in 2013.
Other Operating Expenses
Other operating expenses for the three months ended September 30, 2014 increased $0.8 million, or 8.5% to $10.0 million, from $9.2 million for the three months ended September 30, 2013. Other operating expenses for the nine months ended September 30, 2014 increased $0.8 million, or 3.1%, to $26.4 million, from $25.6 million for the nine months ended September 30, 2013. Both the three month and nine month periods ended September 30, 2014 included $0.9 million in transaction costs associated with the proposed merger.
Depreciation and Amortization
Depreciation and amortization expense for the three months ended September 30, 2014 increased $0.1 million, to $1.4 million from $1.2 million for the three months ended September 30, 2013. Depreciation and amortization expense for the nine months ended September 30, 2014 increased $0.2 million, or 6.1%, to $3.8 million from $3.6 million for the nine months ended September 30, 2013. The increase for both periods in 2014 as compared to the 2013 periods was due to higher levels of depreciable and amortizable assets in service during the 2014 periods compared to the same periods in 2013.
Amortization of Intangibles
Amortization expense on intangibles for the three months ended September 30, 2014 decreased $0.1 million, to $1.3 million from $1.4 million for the three months ended September 30, 2013. Amortization expense on intangibles for the nine months ended September 30, 2014 decreased $0.2 million to $4.0 million from $4.2 million for the nine months ended September 30, 2013. The decrease for both periods in 2014 as compared to the 2013 periods was the result of less amortizable intangibles in the 2014 periods.
Interest Expense
Interest expense for the three months ended September 30, 2014 and 2013, remained consistent at $0.9 million in each period. Interest expense for the nine months ended September 30, 2014 increased $0.1 million, or 2.3%, to $2.8 million from $2.7 million for the nine months ended September 30, 2013, with the increase attributable to the additional interest expense incurred on borrowings under our line of credit with Synovus Bank, which supports our premium receivable product offering by South Bay.
Loss on Note Receivable
For the nine months ended September 30, 2014, we recorded a $1.3 million loss resulting from establishing the allowance against the CIRG note receivable, which we entered into in connection with the sale of CIRG in July of 2011.
Gain on Sale of Subsidiary
In June 2013, we sold our 100% interest in Magna Insurance Company and realized a gain of $0.4 million, which is included in the results for the nine months ended September 30, 2013.
Income Taxes - Continuing Operations
Income taxes for the three months ended September 30, 2014 decreased $0.9 million, or 50.1%, to $0.9 million from $1.9 million for the three months ended September 30, 2013. The decrease was primarily attributable to prior year tax true-up items, which are normally recorded in the third quarter of the year, the impact of the ProtectCELL non-controlling interest, and more favorable tax preference items for the 2014 period compared to the same period in 2013, partially offset by a higher level of pretax income in the 2014 period. These factors caused our effective tax rate to decline to 19.3% for the three months ended September 30, 2014 compared to 42.7% for the same period in 2013.
Income taxes for the nine months ended September 30, 2014 increased $0.7 million, or 17.7%, to $4.6 million from $3.9 million for the nine months ended September 30, 2013, with the increase primarily attributable to a higher level of pretax income and corresponding state income taxes in the 2014 period, partially offset by prior year tax true-up items, which are normally recorded in the third quarter of the year and a more favorable tax rate impact attributable to the ProtectCELL non-controlling interest. These factors caused our effective tax rate to decline to 28.7% for the nine months ended September 30, 2014 compared to 33.0% for the same period in 2013.
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See the Note, "Income Taxes" in the Notes to Consolidated Financial Statements, included in ITEM 1 of this Form 10-Q for additional information and a reconciliation of the items impacting our income taxes and our effective tax rate.
Divestitures - Discontinued Operations
On December 31, 2013, we completed the sale of all of the issued and outstanding stock of our subsidiaries, Bliss and Glennon and eReinsure.com, to AmWINS, pursuant to the terms of the Purchase Agreement. As consideration for the Disposition, we received net cash proceeds of $81.8 million, representing gross proceeds of $83.5 million less $1.0 million in transaction fees paid at the time of closing and $0.7 million of cash held by the disposed entities. We utilized the cash proceeds received on December 31, 2013 to pay off our existing credit facility with Wells Fargo Bank, N.A. Due to the Disposition, we no longer operate in the businesses of wholesale insurance brokerage and selling or licensing of a computerized system or platform for the negotiation and/or placement of facultative reinsurance. During the three months ended September 30, 2014, we recorded a purchase price adjustment, net of tax, of $42.0 thousand for the settlement of certain components of working capital (excluding receivable and income tax balances), which is recorded on the Consolidated Statements of Income as a Loss on sale of discontinued operations - net of tax. See the Notes, "Summary of Significant Accounting Policies - Discontinued Operations" and "Divestitures" in the Notes to Consolidated Financial Statements, included in ITEM 1 of this Form 10-Q for additional information.
The following table presents the amounts related to discontinued operations in our Consolidated Statements of Income:
(in thousands) | For the Three Months Ended | For the Nine Months Ended | |||||
September 30, 2013 | September 30, 2013 | ||||||
Income from discontinued operations: | |||||||
Revenues: | |||||||
Brokerage commissions and fees | $ | 8,787 | $ | 28,409 | |||
Net investment income | 6 | 18 | |||||
Other income | 14 | 30 | |||||
Total revenues | 8,807 | 28,457 | |||||
Expenses: | |||||||
Personnel costs | 5,105 | 15,240 | |||||
Other operating expenses | 1,475 | 4,363 | |||||
Depreciation and amortization | 151 | 454 | |||||
Amortization of intangibles | 481 | 1,442 | |||||
Interest expense | 578 | 1,767 | |||||
Total expenses | 7,790 | 23,266 | |||||
Income from discontinued operations before income taxes | 1,017 | 5,191 | |||||
Income taxes - discontinued operations | 416 | 2,121 | |||||
Income from discontinued operations - net of tax | $ | 601 | $ | 3,070 |
USE OF NON-GAAP FINANCIAL INFORMATION
We present certain financial measures related to our business that are "Non-GAAP financial measures" within the meaning of Item 10 of Regulation S-K in this Form 10-Q. We present these Non-GAAP financial measures to provide investors with additional information to analyze our performance from period to period. Management also uses these measures to assess performance and to allocate resources in managing our businesses. However, investors should not consider these Non-GAAP financial measures as a substitute for the financial information that we report in accordance with U.S. GAAP. These Non-GAAP financial measures reflect subjective determinations by management, and may differ from similarly titled Non-GAAP financial measures presented by other companies.
In this Form 10-Q, we present Net revenues, Operating expenses, EBITDA from continuing operations, EBITDA from continuing operations margin, Adjusted EBITDA from continuing operations and Adjusted EBITDA from continuing operations margin. These financial measures are Non-GAAP financial measures and are not recognized terms under U.S. GAAP and should not be used as an indicator of, and are not an alternative to, net income as a measure of operating performance. Net revenues are total revenues less net losses and loss adjustment expenses, member benefit claims, and commission expenses. Operating expenses are the sum of personnel costs and other operating expenses. EBITDA from continuing operations is net income before interest expense, income taxes, net income attributable to non-controlling interests, depreciation and amortization. Adjusted EBITDA from continuing operations means "Consolidated Adjusted EBITDA" which is defined under our credit facility with Wells Fargo Bank, N.A., which in general terms means consolidated net income from continuing operations before non-controlling interests, consolidated interest expense, consolidated amortization expense, consolidated depreciation expense and consolidated income tax expense, relating to continuing operations. The other items excluded in this calculation may include if applicable, but are not limited to, specified acquisition costs, impairment of goodwill and other non-cash charges, stock-based compensation expense, and unusual or non-recurring charges and items that affect
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comparability of results. The calculations below do not give effect to certain additional adjustments permitted under our credit facility, which if included, would increase the amount of Adjusted EBITDA from continuing operations reflected in the table. We believe presenting EBITDA from continuing operations and Adjusted EBITDA from continuing operations provides investors with supplemental financial measures of our operating performance.
In addition to the financial covenant requirements under our credit facility, management uses Net revenues, Operating expenses, EBITDA from continuing operations and Adjusted EBITDA from continuing operations as financial measures of operating performance for planning purposes, which may include, but are not limited to, the preparation of budgets and projections, the determination of bonus compensation for executive officers, the analysis of the allocation of resources and the evaluation of the effectiveness of business strategies. We use Net revenues as another means of understanding product contributions to our results. We use Operating expenses to reconcile from Net revenues to EBITDA. Although we use EBITDA from continuing operations and Adjusted EBITDA from continuing operations as financial measures to assess the operating performance of our business, both measures have significant limitations as analytical tools because they exclude certain material expenses. For example, they do not include interest expense and the payment of income taxes, which are both a necessary element of our costs and operations. Since we use property and equipment to generate service revenues, depreciation expense is a necessary element of our costs. In addition, the omission of amortization expense associated with our intangible assets further limits the usefulness of these financial measures. Management believes the inclusion of the adjustments to EBITDA from continuing operations and Adjusted EBITDA from continuing operations are appropriate to provide additional information to investors about certain material non-cash items and about unusual items that we do not expect to continue at the same level in the future. Because EBITDA from continuing operations and Adjusted EBITDA from continuing operations do not account for these expenses, its utility as a financial measure of our operating performance has material limitations. Due to these limitations, management does not view EBITDA from continuing operations and Adjusted EBITDA from continuing operations in isolation or as primary financial performance measures.
We believe EBITDA and Adjusted EBITDA are frequently used by securities analysts, investors and other interested parties in the evaluation of similar companies in similar industries and to measure a company's ability to service its debt and other cash needs. Because the definitions of EBITDA and Adjusted EBITDA (or similar financial measures) may vary among companies and industries, they may not be comparable to other similarly titled financial measures used by other companies.
The following table presents a reconciliation of the components of net revenues for the following periods:
For the Three Months Ended September 30, | For the Nine Months Ended September 30, | ||||||||||||||
2014 | 2013 | 2014 | 2013 | ||||||||||||
Total revenues | $ | 87,635 | $ | 90,277 | $ | 266,687 | $ | 255,388 | |||||||
Less : | |||||||||||||||
Net losses and loss adjustment expenses | 10,267 | 9,957 | 30,970 | 31,096 | |||||||||||
Member benefit claims | 9,929 | 13,834 | 31,111 | 34,624 | |||||||||||
Commissions | 38,813 | 39,876 | 119,726 | 112,224 | |||||||||||
Net revenues | $ | 28,626 | $ | 26,610 | $ | 84,880 | $ | 77,444 |
The following table presents a reconciliation of the components of operating expenses for the following periods:
For the Three Months Ended September 30, | For the Nine Months Ended September 30, | ||||||||||||||
2014 | 2013 | 2014 | 2013 | ||||||||||||
Personnel costs | $ | 10,273 | $ | 9,544 | $ | 30,444 | $ | 29,849 | |||||||
Other operating expenses | 9,970 | 9,189 | 26,432 | 25,628 | |||||||||||
Operating expenses | $ | 20,243 | $ | 18,733 | $ | 56,876 | $ | 55,477 |
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The following table presents a reconciliation of income from continuing operations before non-controlling interests to EBITDA from continuing operations and Adjusted EBITDA from continuing operations for the following periods:
For the Three Months Ended September 30, | For the Nine Months Ended September 30, | ||||||||||||||
(in thousands) | 2014 | 2013 | 2014 | 2013 | |||||||||||
Income from continuing operations before non-controlling interests | $ | 3,860 | $ | 2,486 | $ | 11,497 | $ | 7,955 | |||||||
Depreciation | 1,352 | 1,227 | 3,830 | 3,609 | |||||||||||
Amortization of intangibles | 1,317 | 1,389 | 3,952 | 4,156 | |||||||||||
Interest expense | 930 | 923 | 2,784 | 2,722 | |||||||||||
Income taxes | 924 | 1,852 | 4,624 | 3,927 | |||||||||||
EBITDA from continuing operations | 8,383 | 7,877 | 26,687 | 22,369 | |||||||||||
Transaction costs (1) | 930 | 25 | 958 | 166 | |||||||||||
Restructuring expenses | — | — | — | 1,234 | |||||||||||
(Gain) on sale of subsidiary | — | — | — | (402 | ) | ||||||||||
Legal expenses | — | 152 | — | 395 | |||||||||||
Stock-based compensation expense | 260 | 357 | 841 | 989 | |||||||||||
Loss on note receivable | — | — | 1,317 | — | |||||||||||
Adjusted EBITDA from continuing operations | $ | 9,573 | $ | 8,411 | $ | 29,803 | $ | 24,751 | |||||||
EBITDA from continuing operations margin (2) | 29.3 | % | 29.6 | % | 31.4 | % | 28.9 | % | |||||||
Adjusted EBITDA from continuing operations margin (3) | 33.4 | % | 31.6 | % | 35.1 | % | 32.0 | % | |||||||
(1) Represents transaction costs associated with completed and/or potential acquisitions, including seller's costs associated with the proposed Merger. | |||||||||||||||
(2) EBITDA from continuing operations margin is calculated by dividing EBITDA from continuing operations by Net Revenues. | |||||||||||||||
(3) Adjusted EBITDA from continuing operations margin is calculated by dividing Adjusted EBITDA from continuing operations by Net Revenues. |
LIQUIDITY AND CAPITAL RESOURCES
Liquidity
Liquidity describes the ability of a company to generate adequate cash flows to meet the cash requirements of its business operations, including working capital needs, capital expenditures, debt service, acquisitions and other commitments and contractual obligations. We historically have derived our liquidity primarily from our invested assets, cash flows from operations, ordinary and extraordinary dividend capacity from our subsidiary insurance companies and our credit facilities. When considering our liquidity, it is important to note that our restricted cash is held in a fiduciary capacity and is available only to satisfy certain future cash payment obligations that are recorded as liabilities.
Our primary cash requirements include the payment of operating expenses, interest and principal payments on debt, capital expenditures and acquisitions. We may also incur unexpected costs and operating expenses related to any unforeseen disruptions to our facilities and equipment, the loss of key personnel or changes in the credit markets and interest rates, which could increase our immediate cash requirements or otherwise impact our liquidity.
Our primary sources of liquidity include our total investments, cash and cash equivalent balances, and availability under our revolving credit facilities. At September 30, 2014, we had total available-for-sale and short-term investments of $165.6 million (which included restricted investments of $16.0 million), cash and cash equivalents of $2.5 million and $98.5 million of available capacity on our credit facilities. At December 31, 2013, we had total investments of $138.8 million (which included restricted investments of $16.5 million), cash and cash equivalents of $21.7 million and $75.1 million of available capacity on our credit facilities. Our total indebtedness, including notes payable and preferred trust securities, was $45.2 million at September 30, 2014 compared to $38.3 million at December 31, 2013.
We believe that our cash flows from operations and the availability under our credit facilities, combined with our low capital expenditure requirements, will provide us with adequate capital to continue to grow our business over the next several years, although we cannot give any assurances. We intend to use a portion of our available cash flows to pay interest on our outstanding debt, thus limiting the amount available for working capital, capital expenditures and other general corporate purposes. If we continue to expand our business and make acquisitions, we may in the future require additional working capital to meet our future business needs. This additional working capital may be in the form of additional debt or equity. Although we believe we have adequate liquidity under our credit facilities, as discussed above, under adverse market conditions or in the event of a default under our credit facilities, there can be no assurance that such funds would be available or adequate, and, in such a case, we may not be able to successfully obtain additional financing on favorable terms, or at all, or replace our existing credit facilities upon their respective maturity dates.
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Cash Exceeding Federal Deposit Insurance Corporation ("FDIC") Limits
We maintain cash and cash equivalents with major third party financial institutions, including interest-bearing money market accounts, which are insured by the FDIC's standard insurance limit of $250,000 per depositor per institution. Our accounts containing cash and cash equivalents may exceed the FDIC's standard insurance limit from time to time.
Our cash balances, including restricted cash, exceeding the FDIC standard insurance limit totaled $5.7 million at September 30, 2014 and $18.9 million at December 31, 2013. To date, we have not experienced any loss of, or lack of access to, our cash and cash equivalents or our restricted cash. Although we periodically monitor and adjust the balances of these accounts as needed, the balances of these accounts nonetheless remain subject to unexpected, adverse conditions in the financial markets and could be adversely impacted if a financial institution with which we maintain an account fails. We will continue to monitor our accounts held at depository institutions.
We can give no assurances that we will not lose deposited funds exceeding the FDIC standard insurance limit or access to these funds due to adverse conditions in the financial markets or if a financial institution with which we maintain an account fails.
Share Repurchase Plan
We have a share repurchase plan that allows us to purchase up to $15.0 million in total of our common stock from time to time through open market or private transactions. We did not repurchase any of our common stock during the three or the nine months ended September 30, 2014. For the three months ended September 30, 2013, we did not repurchase any of our outstanding common stock.
For the nine months ended September 30, 2013, we repurchased a total of 200,000 shares at an average price of $6.79 per share at a total cost of $1.4 million. At September 30, 2014, we had $7.2 million still available for repurchase under the plan. See PART II, ITEM 2 included in this Form 10-Q, for more information on our share repurchase plan.
Regulatory Requirements
Dividends Limitations
We are a holding company and have limited direct operations. Our holding company assets consist primarily of the capital stock of our subsidiaries. Accordingly, our future cash flows depend upon the availability of dividends and other payments from our subsidiaries, including statutorily permissible payments from our insurance company subsidiaries, as well as payments under our tax allocation agreement and management agreements with our subsidiaries.
The following table sets forth the dividends paid to us by our insurance company subsidiaries during the following periods:
For the Nine Months Ended | For the Twelve Months Ended | ||||||
(in thousands) | September 30, 2014 | December 31, 2013 | |||||
Ordinary dividends | $ | — | $ | 2,383 | |||
Extraordinary dividends | — | — | |||||
Total dividends | $ | — | $ | 2,383 |
Please see the Note, "Statutory Reporting and Insurance Company Subsidiaries Dividend Restrictions" in the Notes to Consolidated Financial Statements included in ITEM 1 of this Form 10-Q, for additional information.
$100.0 million Secured Credit Agreement - Wells Fargo Bank, N.A.
In April 2014, we amended the original credit agreement, entered into on August 2, 2012, (as amended, the "Credit Agreement"), with a syndicate of lenders, among them Wells Fargo Bank, N.A., who also serves as administrative agent ("Wells Fargo" or the "Administrative Agent"). The Credit Agreement matures on August 2, 2019 (subject to earlier termination) and has a revolving credit facility limit of $100.0 million (the "Revolving Facility") with a sub-limit of $10.0 million for swingline loans and $10.0 million for letters of credit. The Credit Agreement includes a provision pursuant to which, from time to time, we may request that the lenders in their discretion increase the maximum amount of commitments under the Credit Agreement by an amount not to exceed $50.0 million. The Credit Agreement also contains financial covenants, which we must maintain. The amendment to the Credit Agreement reduced the interest rate margin on revolving loans by 0.35% for each pricing level and reduced the unused line fee paid on undrawn revolving commitments by 0.05% for each pricing level.
As of September 30, 2014, we were in compliance with the financial covenants contained in the Credit Agreement. Please see the Note, "Notes Payable" in the Notes to Consolidated Financial Statements included in ITEM 1 of this Form 10-Q, for additional information on the Credit Agreement.
$15.0 million Revolving Line of Credit - Synovus Bank
At September 30, 2014, South Bay had a $15.0 million line of credit agreement (the "Line of Credit") with Synovus Bank, entered into on October 2013, with a maturity date of April 2017. The Line of Credit bears interest at a rate of 300 basis points plus the 90-day LIBOR, and is available specifically for the South Bay premium financing product. The Line of Credit allows South Bay to finance
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up to 90% of the eligible receivables, less an applicable reserve of $500,000. At September 30, 2014, the balance of premium financing receivables included in notes receivable, net on the Consolidated Balance Sheet, totaled $12.6 million, of which $9.4 million were eligible receivables, and the balance of the Line of Credit included in notes payable on the Consolidated Balance Sheet was $8.7 million. At September 30, 2014, South Bay was in compliance with the covenants required by the Line of Credit.
Preferred Trust Securities
In connection with the Summit Partners Transactions, our subsidiary LOTS Intermediate Co. issued $35.0 million of fixed/floating rate preferred trust securities due in 2037. The preferred trust securities accrued interest at a rate of 9.61% per annum until the June 2012 interest payment date; thereafter, interest accrues at a rate of 3-month LIBOR plus 4.10% for each interest rate period. Interest due on the preferred trust securities is payable quarterly. We may redeem the preferred trust securities, completely or in part, at a price equal to 100% of the principal amount of such preferred trust securities outstanding plus accrued and unpaid interest.
Interest Rate Swap
At September 30, 2014, we have a single interest rate swap (the "Swap") designated as a cash flow hedge with Wells Fargo Bank, N.A. This instrument swapped the floating rate portion of our $35.0 million in outstanding preferred trust securities to a fixed rate of 3.47% per annum payable quarterly resulting in a total rate of 7.57% after adding the applicable margin of 4.10%. The Swap has a five year term, which commenced in June 2012 when the interest rate on the underlying preferred trust securities began to float, and will expire in June 2017. Please see the Note, "Derivative Financial Instruments - Interest Rate Swap" in the Notes to Consolidated Financial Statements included in ITEM 1 of this Form 10-Q, for additional information.
Invested Assets
Our invested assets consist mainly of high quality investments in fixed maturity securities, short-term investments, and a smaller allocation of common and preferred equity securities. We believe that prudent levels of investments in equity securities within our investment portfolio are likely to enhance long-term after-tax total returns without significantly increasing the risk profile of the portfolio. We regularly review our entire portfolio in the context of macroeconomic and capital market conditions. The overall credit quality of the investment portfolio was rated AA- by Standard and Poor's Rating Service at September 30, 2014 and December 31, 2013, respectively.
Regulatory Requirements
The investments we make must comply with the applicable laws and regulations for our industry, which prescribe the kind, quality and concentration of permissible investments. In general, these laws and regulations permit investments, within specified limits and subject to certain qualifications, in federal, state and municipal obligations, corporate bonds, preferred and common equity securities, mortgage loans, real estate and other investments.
Investment Strategy
The board of directors, for each of our insurance company subsidiaries, regularly reviews and approves the applicable investment policy in order to monitor and consider various investment activities and tactics as well as new investment opportunities. Our investment strategy seeks long-term returns through disciplined security selection, portfolio diversity and an integrated approach to risk management. We select and monitor investments to balance the goals of safety, stability, liquidity, growth and after-tax total return with the need to comply with regulatory investment requirements. A third-party provider of asset management services manages our investment portfolio. We employ asset/liability management strategies to reduce the adverse effects of interest rate volatility and to increase the likelihood that cash flows are available to pay claims as they become due. Asset/liability management is accomplished by setting an asset target duration range that is influenced by the following factors: (i) the estimated reserve payout pattern, (ii) the inclusion of our tactical capital market views into the investment decision-making process and (iii) our overall risk tolerance. We aim to achieve a relatively safe and stable income stream by maintaining a broad-based portfolio of investment grade fixed maturity securities. We may also make investments in additional asset types with the objective of further enhancing the portfolio's diversification and expected returns. These additional asset types include common and redeemable preferred stock. We manage our investment risks through consideration of duration of liabilities, diversification, credit limits, careful analytic review of each investment decision, and comprehensive risk assessments of the overall portfolio.
At September 30, 2014, we held 142 individual fixed maturity and nine individual equity securities in unrealized loss positions. At September 30, 2013, we held 102 individual fixed maturity and 11 individual equity securities in unrealized loss positions. The decrease in the number of fixed maturity securities in unrealized loss positions was primarily due to changes in bond yields and the related impact on market prices. We do not intend to sell the investments that were in an unrealized loss position at September 30, 2014 and believe that it is more likely than not that we will be able to hold these securities until full recovery of their amortized cost basis for fixed maturity securities or cost for equity securities, although we can give no assurances.
Based on management's quarterly review of our investments, none of our fixed maturity or equity securities were deemed other than temporarily impaired during the periods ended September 30, 2014 and September 30, 2013, respectively. Please see the Note, "Investments" in the Notes to Consolidated Financial Statements included in this Form 10-Q, for additional information.
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Cash Flows
We monitor cash flows at the consolidated, holding company, and subsidiary levels on a monthly basis, using trend and variance analysis to project future cash needs, with adjustments made as needed. The following table presents our consolidated cash flows:
(in thousands) | For the Nine Months Ended September 30, | ||||||
Cash provided by (used in): | 2014 | 2013 | |||||
Operating activities | $ | 1,689 | $ | 22,569 | |||
Investing activities | (26,507 | ) | (11,943 | ) | |||
Financing activities | 5,620 | (8,622 | ) | ||||
Net change in cash and cash equivalents | $ | (19,198 | ) | $ | 2,004 |
Our Consolidated Statement of Cash Flows for the nine months ended September 30, 2013 includes the cash flows from Bliss and Glennon and eReinsure. Our Consolidated Balance Sheet as of December 31, 2013 reflects Bliss and Glennon and eReinsure as discontinued operations.
Operating Activities
Net cash provided by operating activities was $1.7 million for the nine months ended September 30, 2014 compared to $22.6 million for the nine months ended September 30, 2013. In the current period, lower sales volumes of ProtectCELL products, motor club products, and insurance client administrative services resulted in lower cash collections. We also used cash during the nine months ended September 30, 2014 to extinguish $7.7 million of liabilities of discontinued operations, and to pay premium taxes and other liabilities and accrued expenses.
Investing Activities
Net cash used in investing activities was $26.5 million for the nine months ended September 30, 2014 compared to $11.9 million for the nine months ended September 30, 2013. The increase in net cash used in investing activities was primarily attributable to a higher level of net cash used in 2014 for net investment portfolio activity, the issuance of additional notes receivable, net of collections, under the South Bay premium financing program, which started late in the fourth quarter of 2013 and the cash proceeds received in the prior year period for the payoff of the $6.1 million related party note receivable, which was not repeated in 2014. Partially offsetting this increase was a lower level of net cash used in 2014 acquisitions and divestitures compared to the same period in 2013.
Financing Activities
Net cash provided by financing activities was $5.6 million for the nine months ended September 30, 2014 compared to net cash used in financing activities of $8.6 million for the nine months ended September 30, 2013. The change primarily reflected a higher utilization of our credit facilities compared to the 2013 period, which was principally due to the usage of our Line of Credit for the South Bay premium financing program. In addition, during 2014 we did not use cash to repurchase common stock under our stock repurchase plan, while in 2013 we used $1.4 million to repurchase 200,000 shares of our common stock. In the 2014 period, we also paid out more distributions to our ProtectCELL non-controlling partner compared to the same period in 2013.
Contractual Obligations and Other Commitments
We have obligations and commitments to third parties as a result of our operations.
Our contractual obligations and commitments, as of September 30, 2014, have not changed materially from those disclosed in our 2013 Form 10-K. For a discussion of our contractual obligations and other commitments, please see PART II, ITEM 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations," contained in our 2013 Form 10-K.
Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements that are reasonably likely to have a material current or future effect on our financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our markets risks, as of September 30, 2014, have not changed materially from those disclosed in our 2013 Form 10-K. For a discussion of our exposure to market risk, please see PART II, ITEM 7A. "Quantitative and Qualitative Disclosures about Market Risk," contained our 2013 Form 10-K.
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ITEM 4. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
Under the supervision and with the participation of management, including our Chief Executive Officer and Chief Financial Officer, we have evaluated the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), as of September 30, 2014. Based on this evaluation, management, including our Chief Executive Officer and Chief Financial Officer, concluded that our disclosure controls and procedures were effective as of September 30, 2014.
Changes in Internal Control Over Financial Reporting
Management, including our Chief Executive Officer and Chief Financial Officer, identified no change in our internal control over financial reporting that occurred during the quarter ended September 30, 2014, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
Inherent Limitations of Disclosure Controls and Procedures and Internal Control Over Financial Reporting
Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls and internal controls will prevent or detect all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within Fortegra have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple errors or mistakes. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by our management override of the controls. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events. There can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, a control may become inadequate because of changes in conditions or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.
Chief Executive Officer and Chief Financial Officer Certifications
Exhibits 31.1 and 31.2 are the Certifications of our Chief Executive Officer and Chief Financial Officer, respectively, required in accordance with Section 302 of the Sarbanes-Oxley Act of 2002 (the "Section 302 Certifications"). The "Evaluation of Disclosure Controls and Procedures" in this ITEM 4 is the "Evaluation" referred to in the Section 302 Certifications, and accordingly, the above information should be read in conjunction with the Section 302 Certifications for a more complete understanding of the topics presented.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The information set forth in the "Contingencies" section of the Note, "Commitments and Contingencies" of the Notes to Consolidated Financial Statements in ITEM 1 of this Form 10-Q is incorporated herein by reference.
ITEM 1A. RISK FACTORS
The following are certain risks that management believes are specific to our business. Readers should not view these risk factors as an all-inclusive list of risks that may affect our business or as a presentation of the risk factors in any particular order. You should carefully consider the risks described below, together with the other information contained in this Form 10-Q and in our other filings with the SEC when evaluating our Company. The occurrence of any of the events discussed in these risk factors could materially affect our business, financial condition, results of operations and cash flows. Additional risks unknown at this time, or risks we currently deem immaterial, may also affect our business, financial condition, results of operations and cash flows.
Risks Related to our Pending Merger Involving Tiptree Financial, Inc.
On August 11, 2014, we entered into an Agreement and Plan of Merger (the "Merger Agreement") with Tiptree Operating Company, LLC, a Delaware limited liability company ("Parent"), Caroline Holdings LLC, a Delaware limited liability company and a wholly owned subsidiary of Parent ("Holdings"), and Caroline Merger Sub, Inc., a Delaware corporation and a wholly owned subsidiary of Holdings ("Merger Sub"), pursuant to which Merger Sub will merge with and into us (the "Merger") and we will survive as a wholly-owned subsidiary of Holdings. Parent is a subsidiary of Tiptree Financial Inc. ("Tiptree"). There are a number of risks and uncertainties related to the Merger.
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The closing of the Merger is subject to regulatory approval and the satisfaction of certain conditions, which we cannot predict will be satisfied, received or waived and which could cause delays or cause the Merger to be abandoned.
Under the Merger Agreement, consummation of the Merger is subject to satisfaction or waiver of certain customary closing conditions, including, among others: (i) the expiration or early termination of the waiting period applicable to the Merger under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, and any other applicable antitrust laws described in the Merger Agreement, and any required approvals thereunder have been obtained; (ii) filings with, and approvals from, insurance and other regulatory bodies having jurisdiction over any such matters; and (iii) the absence of any law, injunction, judgment or ruling prohibiting or restraining the Merger or making the consummation of the Merger illegal. Moreover, each party’s obligation to consummate the Merger is subject to certain other conditions, including, without limitation: (a) the accuracy of the other party’s representations and warranties contained in the Merger Agreement (subject to certain materiality qualifiers); and (b) the other party’s compliance with its covenants and agreements contained in the Merger Agreement in all material respects.
Although each of the parties to the Merger Agreement have agreed therein to use their respective reasonable best efforts to cause the consummation and effectiveness of the Merger in the most expeditious manner practicable, these and the other conditions to the Merger may fail to be satisfied or the requisite approvals may not be obtained, or if obtained, may not be obtained in a timely manner or on terms desired or anticipated. In addition, satisfying the conditions to, and completion of, the Merger may take longer than, and could cost more than, we expect. Furthermore, we cannot assure you that the Merger will be consummated or that it will close in a timely manner or, if not consummated, that we will enter into a comparable or superior transaction with another party. We have no control over certain conditions in the Merger Agreement and cannot predict whether such conditions will be satisfied or waived. Regulatory authorities may impose conditions on the completion of the Merger or require changes to the terms of the Merger Agreement. Such conditions or changes may prevent the closing of the Merger or cause the Merger to be delayed, and such delays may cause the Company to incur additional, potentially burdensome transaction costs. Any failure to complete the Merger could adversely affect the Company.
Failing to complete the Merger could adversely impact the market price of our stock.
There is no assurance that the Merger will be consummated and failing to complete the Merger could adversely affect the price of our common stock. The failure of or a delay in closing of the Merger could adversely affect the market price of our common stock. A failed transaction may also result in negative publicity and a negative impression of us in the investment community and could result in a decline in our common stock price to the extent that it reflects the market’s assumption that the Merger will be completed.
Failing to complete the Merger could adversely impact our current business operations and results of operations, liquidity and financial condition.
There is no assurance that the Merger will be consummated. The Merger Agreement contains certain termination rights. If the Merger Agreement is terminated under certain other circumstances, we will be required to pay a termination fee in an amount equal to approximately $7.6 million. Our payment of the termination fee could have an adverse impact on our liquidity and financial condition. In addition, if the Merger Agreement is terminated, we may suffer other negative consequences. For example, the Company’s business may be negatively impacted by our management having focused its attention on the Merger instead of pursuing other advantageous business opportunities or plans. We will also have incurred substantial expenses and costs related to the Merger, whether or not it is consummated, including legal, accounting and advisory fees. Failing to consummate the Merger may also result in negative market reactions and have an adverse impact on our future financial results.
While the Merger Agreement is in effect and the Merger is pending, we are subject to restrictions on our business activities, and our pre-merger integration efforts may divert resources from our day-to-day operations and ongoing efforts related to other strategies and initiatives.
While the Merger Agreement is in effect, we are subject to restrictions on our business activities and must generally operate in the ordinary course of business in all material respects (subject to certain exceptions). These restrictions could prevent us from pursuing attractive business opportunities outside the ordinary course of business that arise prior to the completion of the Merger. Furthermore, the pursuit of the Merger and the preparation for the integration may place a burden on management and internal resources. Any significant diversion of management attention away from ongoing business concerns and any difficulties encountered in the transition toward the integration process could affect our financial results. Any substantial diversion of management attention could affect our ability to achieve certain operational, financial and strategic objectives.
Business uncertainties while the Merger is pending may adversely affect our current business operations, results of operations and our relationships with and ability to attract and retain our employees, clients and distributors.
Our efforts to complete the Merger could cause disruptions in our business, which could have an adverse effect on our financial results. Our employees, clients and distributors may have uncertainties about the effects of the Merger. Although we have taken actions designed to reduce any adverse effects of these uncertainties, these uncertainties may impair our ability to attract, retain and motivate employees and could cause clients, distributors and others who deal with us to try to change our existing business relationships.
Among other things, uncertainty as to whether the Merger will be completed may affect our ability to recruit prospective employees or to retain and motivate existing employees. Furthermore, our efforts in pursuit of the Merger and preparations for integration have placed, and will continue to place, a significant burden on many employees and internal resources and may adversely impact employee
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morale. Employee retention may be particularly challenging while the Merger is pending because employees may experience uncertainty about their future roles with the integrated company. If, despite our efforts, employees depart because of these uncertainties and burdens, or because they do not wish to remain with the surviving company, our business and operating results could be adversely affected. Additionally, any significant diversion of management’s attention away from ongoing business concerns or any difficulties encountered in the transition toward integration process could affect our financial results.
Uncertainty as to our future could adversely affect our business, reputation and our relationship with existing, and potential, clients and distributors. For example, while the Merger is pending, some of our clients could delay or forego orders and distributors could seek additional rights or benefits from us. Prospective clients, distributors and others who deal with us may delay or decline to enter into other agreements with us as a result of uncertainties surrounding the Merger. We may also lose current clients and distributors as a result of these uncertainties. Our clients and distributors may also have termination rights that are triggered upon the completion of the Merger and they may terminate or decide not to renew their existing relationship with us and instead select one of our competitors. For these and other reasons, the pendency of the Merger could adversely affect our business, operating results and/or financial condition.
The Merger may be completed on terms different than those contained in the Merger Agreement.
Prior to the completion of the Merger, the parties may, by their mutual agreement, amend or alter the terms of the Merger Agreement, including with respect to, among other things, the merger consideration to be received by our stockholders or any covenants or agreements with respect to the parties’ respective operations pending completion of the Merger. In addition, either party may choose to waive certain requirements of the Merger Agreement, including some conditions to closing the Merger. Any such amendments, alterations or waivers may have negative consequences to the other parties or their respective stockholders.
The Merger may not be completed if sufficient financing is not funded.
Parent, Holdings and Merger Sub have obtained debt financing commitments for the Merger. A syndicate of lenders led by Wells Fargo Bank, National Association (collectively, the "Lenders") has committed to provide a $90 million secured revolving credit facility and a $50 million secured term loan on the terms of and subject to the conditions set forth in a debt commitment letter (the "Debt Commitment Letter"). The funding under the Debt Commitment Letter is subject to conditions, including conditions that do not relate directly to the Merger Agreement and there is no guarantee that the committed amount will be available or sufficient to complete the Merger. The funding under the Debt Commitment Letter might be insufficient if, among other things, Parent, Holdings and Merger Sub have substantially less cash on hand or receive substantially less net proceeds from the debt financing than currently expected. Although obtaining the debt financing is not a condition to the completion of the Merger, the failure of Parent, Holdings and Merger Sub to obtain sufficient financing could result in the failure of the Merger to be completed in a timely manner, if at all.
The outcomes of legal proceedings commenced since the announcement of the Merger are uncertain and could delay the completion of the Merger and have an adverse effect on the results of our operations.
One of the conditions to the closing of the Merger is that no injunction, judgment or other order by any court or other governmental entity shall be in effect that restrains, enjoins or otherwise prohibits or makes illegal the consummation of the Merger.
Following the announcement of the Merger, certain law firms specializing in stockholder lawsuits announced investigations of our Board of Directors for breaches of fiduciary duty and other violations of state law in connection with the Merger. We and our Board of Directors have been named as defendants in putative class action lawsuits filed on behalf of named plaintiffs and other stockholders in the Circuit Court for Duval County, Florida, challenging the proposed Merger and seeking, among other things, to enjoin the Merger. Descriptions of these lawsuits are set forth in Item 1. Legal Proceedings and are incorporated herein by reference.
If a plaintiff in one of those cases or any other litigation that may be filed in the future is successful in obtaining an injunction prohibiting the completion of the Merger on the terms contemplated by the Merger Agreement, the injunction may temporarily or permanently prevent the completion of the Merger. If completion of the Merger is prevented or delayed, it could result in substantial costs to us. In addition, we could incur significant costs in connection with the lawsuits, including costs associated with indemnifying our directors and officers, which could have an adverse impact on our financial results, cash flows and financial condition.
In addition, to complete the Merger, we and Parent, Holdings and Merger Sub may be required to comply with conditions, terms, obligations or restrictions imposed by regulatory agencies and any such conditions, terms, obligations or restrictions may have the effect of delaying completion of the Merger, imposing additional material costs on us, materially limiting revenues after the completion of the Merger or otherwise reducing the anticipated benefits from the Merger. In addition, any such conditions, terms, obligations or restrictions could result in the delay or abandonment of the Merger.
Risks Related to our Business and Industries
General economic and financial market conditions may have a material adverse effect on the business, results of operations, cash flows and financial condition of our business.
General economic and financial market conditions, including the availability and cost of credit, the loss of consumer confidence, reduction in consumer or business spending, inflation, unemployment, energy costs and geopolitical issues, have contributed to increased
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uncertainty and volatility as well as diminished expectations for the U.S. economy and the financial markets. These conditions could have a material and adverse effect on our business. Adverse economic and financial market conditions could result in:
• | a reduction in the demand for, and availability of, consumer credit, which could result in reduced demand by consumers for our products and our clients opting to no longer make such products available; |
• | higher than anticipated loss ratios on our products due to rising unemployment or disability claims; |
• | higher risk of increased fraudulent claims; |
• | individuals terminating loans or canceling credit insurance policies, thereby reducing our revenues; |
• | a reduction in the demand for consumer warranty service contracts, service contract offerings, mobile device protection and motor club memberships; |
• | individuals terminating warranty service contracts, service contracts, mobile device protection contracts or motor club memberships, thereby reducing our revenues; |
• | our clients being more likely to experience financial distress or declare bankruptcy or liquidation, which could have an adverse impact on demand for our services and products and the remittance of premiums from such customers, as well as the collection of receivables from such clients for items such as unearned premiums, commissions or related accounts receivable, which could make the collection of receivables from our clients more difficult; |
• | increased pricing sensitivity or reduced demand for our services and products; |
• | increased costs associated with, or the inability to obtain, debt financing to fund acquisitions or the expansion of our business; and |
• | defaults in our fixed income investment portfolio or lower than anticipated rates of return as a result of low interest rate environments. |
If we cannot successfully anticipate changing economic or financial market conditions, we may be unable to effectively plan for or respond to such changes, and our business, results of operations, financial condition and cash flows could be materially and adversely affected.
We face significant competitive pressures in our business, which could have a material and adverse effect on our business, results of operations, financial condition and cash flows.
We face various competitive factors in our business. These competitive factors may include price, industry knowledge, quality of client service, our ability to efficiently administer claims, the effectiveness of our sales force, technology platforms and processes, the security and integrity of our information systems, the financial strength ratings of our insurance company subsidiaries, office locations, breadth of services and products, brand recognition and reputation. Some competitors may offer a broader array of services and products, may have a greater diversity of distribution resources, may have better brand recognition, may have lower cost structures or, with respect to insurers, may have higher financial strength or claims paying ratings. Some competitors also have larger client bases than we do. In addition, new competitors could enter our markets in the future, and existing competitors may gain strength by forging new business relationships.
We compete with insurance companies, financial institutions, extended service plan providers, membership plan providers, wireless carriers and other insurance and warranty service providers. Our principal competitors include The Warranty Group, American National Insurance Company, Assurant, Inc., Asurion Corporation, eSecuritel Holdings, LLC, Global Warranty Group, LLC, Securian Financial Group, The Plateau Group, Inc. and smaller regional companies. Due to state and federal regulatory developments and changes in prior years, certain financial institutions are able to offer debt cancellation plans and can affiliate with other insurance companies in order to offer services similar to ours. This has resulted in new competitors, some of whom have significant financial resources, entering some of our markets. As competitors gain experience with payment protection and warranty programs, their reliance on our services and products may diminish.
We expect competition to intensify, which may result in lower prices and volumes, higher personnel and sales and marketing costs, increased technology expenditures and lower profitability. We may not be able to supply clients with services or products that they deem superior and at competitive prices and we may lose business to our competitors. If we cannot compete effectively, it would have a material adverse effect on our business, results of operations, financial condition and cash flows.
Our results of operations may fluctuate significantly, which makes our future results of operations difficult to predict. If our results of operations fall below expectations, the price of our common stock could decline.
Our annual and quarterly results of operations have fluctuated in the past and may fluctuate significantly in the future due to a variety of factors, many of which are beyond our control. In addition, our expenses as a percentage of revenues may be significantly different from our historical rates. As a result, comparing our results of operations on a period-to-period basis may not be meaningful. Factors that may cause our results of operations to fluctuate from period-to-period include:
• | demand for our services and products; |
• | the length of our sales cycle; |
• | the amount of sales to new clients; |
• | the timing of implementations of our services and products with new clients; |
• | seasonality; |
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• | the timing of acquisitions; |
• | competitive factors; |
• | prevailing interest rates; |
• | pricing changes by us or our competitors; |
• | transaction volumes in our clients' businesses; |
• | the introduction of new services and products by us and our competitors; |
• | changes in strategic partnerships; |
• | changes in regulatory and accounting standards; and |
• | our ability to control costs. |
In addition, our revenues may vary depending on the level of consumer activity and the success of our clients in selling products.
Our results of operations could be materially and adversely affected if we fail to retain our existing clients, cannot sell additional services and products to our existing clients, do not introduce new or enhanced services and products or are not able to attract and retain new clients.
Our revenue and revenue growth are dependent on our ability to retain clients, to sell those clients additional services and products, to introduce new services and products and to attract new clients. Our ability to increase revenues will depend on a variety of factors, including:
• | the quality and perceived value of our product and service offerings by existing and prospective clients; |
• | the effectiveness of our sales and marketing efforts; |
• | the successful installation and implementation of our services and products for new and existing clients; |
• | availability of capital to complete investments in new or complementary products, services and technologies; |
• | the availability of adequate reinsurance for us and our clients, including the ability of our clients to form, capitalize and operate captive reinsurance companies; |
• | our ability to find suitable acquisition candidates, successfully complete such acquisitions and effectively integrate such acquisitions; |
• | our ability to integrate technology into our services and products to avoid obsolescence and provide scalability; |
• | the reliability, execution and accuracy of our services; and |
• | client willingness to accept any price increases for our services and products. |
In addition, we are subject to risks of losing clients due to consolidation in the markets we serve. Our inability to retain existing clients, sell additional services and products, or successfully develop and implement new and enhanced services and products and attract new clients, and accordingly, increase our revenues, could have a material adverse effect on our results of operations.
We typically face a long selling cycle to secure new clients as well as long implementation periods that require significant resource commitments, which may result in long lead-times before we receive revenues from new client relationships.
The industries in which we compete generally consist of mature businesses and markets and the companies that participate in these industries have well-established business operations, systems and relationships. Accordingly, our business typically faces a long selling cycle to secure a new client. Even if we are successful in obtaining a new client engagement, a long implementation period may follow in which we plan the services in detail and demonstrate to the client that we can successfully integrate our processes and resources with their operations. We also typically negotiate and enter into a contractual relationship with the new client during this period. There is then a long implementation period in order to commence providing the services.
We typically incur significant business development expenses during the selling cycle. We may not succeed in winning a new client's business, in which case we receive no revenues and may receive no reimbursement for such expenses. Even if we succeed in developing a relationship with a potential client and begin to plan the services in detail, such potential client may choose a competitor or decide to retain the work in-house prior to the time a final contract is signed. If we enter into a contract with a client, we will typically receive no revenues until implementation actually begins. In addition, a significant portion of our revenue depends upon the success of our clients' marketing programs, which may not generate the transaction volume we anticipate. Our clients may also experience delays in obtaining internal approvals or delays associated with technology or system implementations, thereby further lengthening the implementation cycle. If we are not successful in obtaining contractual commitments after the selling cycle, in maintaining contractual commitments after the implementation cycle or in maintaining or reducing the duration of unprofitable initial periods in our contracts, it may have a material adverse effect on our business, results of operations and financial condition. Furthermore, the time and effort required to complete the implementation phases of new contracts makes it difficult to predict with accuracy the timing of revenues from new clients as well as our costs.
Acquisitions are a significant part of our growth strategy and we may not be successful in identifying suitable acquisition candidates, completing such acquisitions or integrating the acquired businesses, which could have a material adverse effect on our business, results of operations, financial condition and growth.
Historically, acquisitions have played a significant role in our expansion into new markets and in the growth of some of our operations. Acquiring complementary businesses is a significant component of our growth strategy. Accordingly, we frequently evaluate possible
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acquisition targets for our business. However, we may not be able to identify suitable acquisition targets, and we may not be able to finance and complete such transactions on acceptable terms. We may incur significant expenses in evaluating and completing such acquisitions. Furthermore, any future acquisitions may not be successful. In addition, we may be competing with larger competitors with substantially greater resources for acquisition targets. Any deficiencies in the process of integrating companies we may acquire could have a material adverse effect on our results of operations and financial condition. Acquisitions entail a number of risks including, among other things:
• | failure to achieve anticipated revenues, earnings or cash flows; |
• | increased expenses; |
• | diversion of management time and attention; |
• | failure to retain the acquired business' customers or personnel; |
• | difficulties in realizing projected efficiencies; |
• | ability to realize synergies and cost savings; |
• | difficulties in integrating systems and personnel; and |
• | inaccurate assessment of liabilities. |
Our failure to address these acquisition risks adequately, could have a material adverse effect on our business, results of operations, financial condition and growth. Future acquisitions may reduce our cash resources available to fund our operations and capital expenditures and could result in increased amortization expense related to any intangible assets acquired, potentially dilutive issuances of equity securities or the incurrence of debt, which could increase our interest expense.
We may lose clients or business due to consolidation within the financial services industry.
There has been considerable consolidation in the financial services industry, driven primarily by the acquisition of small and mid-size organizations by larger entities. We expect this trend to continue. We may lose business or suffer decreased revenues if one or more of our significant clients or distributors consolidate or align themselves with other companies. To date, consolidation has not materially affected our business. However, future industry consolidation could affect our business, particularly if organizations that already possess the operations, services and products that we provide acquire any of our significant clients.
Our ability to implement and execute our strategic plans may not be successful and, accordingly, we may not be successful in achieving our strategic goals, which may have a material and adverse effect on our business.
We may not be successful in developing and implementing our strategic plans for our business or the operational plans that have been or need to be developed to implement these strategic plans. If the development or implementation of such plans is not successful, we may not produce the revenue, margins, earnings or synergies that we need to be successful. We may also face delays or difficulties in implementing service, product, process and system improvements, which could adversely affect the timing or effectiveness of margin improvement efforts in our business and our ability to compete successfully in the markets we serve. The execution of our strategic and operating plans, to some extent, will also be dependent on external factors that we cannot control. In addition, these strategic and operational plans need continual assessment and reassessment to meet the challenges and needs of our business in order for us to remain competitive. Our failure to implement, execute, assess and reassess our strategic and operating plans in a timely manner or at all, could have a material and adverse effect on our business or results of operations. In addition, we may not realize the cost savings, benefits or improvements associated with such plans, or we may incur excess costs associated with such plans or not have the financial resources available to fund the costs associated with such plans, which could each have a material and adverse effect on our business or results of operations.
We may not effectively manage our growth, which could materially harm our business.
The growth of our business has placed and may continue to place significant demands on our management, personnel, systems and resources. To manage our growth, we must continue to improve our operational and financial systems and managerial controls and procedures, and we will need to continue to expand, train and manage our personnel. We must also maintain close coordination among our technology, compliance, legal, risk management, accounting and finance, marketing and sales departments. We may not manage our growth effectively, and if we fail to do so, our business could be materially and adversely harmed.
If we continue to grow, we may be required to increase our investment in facilities, personnel and financial and management systems and controls. Continued growth, especially in connection with expansion into new business lines, may also require expansion of our procedures for monitoring and assuring our compliance with applicable regulations and that we recruit, integrate, train and manage a growing employee base. The expansion of our existing business, our expansion into new businesses and the resulting growth of our employee base increase our need for internal audit and monitoring processes that are more extensive and broader in scope than those we have historically required. We may not be successful in implementing all of the processes that are necessary. Further, unless our growth results in an increase in our revenues that is proportionate to the increase in our costs associated with this growth, our operating margins and profitability will be materially and adversely affected.
As a holding company, we depend on the ability of our subsidiaries to transfer funds to us to pay dividends and to meet our obligations.
We act as a holding company for our subsidiaries and do not have any significant operations of our own. Dividends from our subsidiaries are our principal sources of cash to meet our obligations and pay dividends, if any, on our common stock. These obligations include
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our operating expenses and interest and principal payments on our current and any future borrowings. The agreements governing our credit facilities restrict our subsidiaries' ability to pay dividends or otherwise transfer cash to us. Under our credit facility, our subsidiaries cannot make distributions to us if a default or an event of default has occurred and is continuing at the time of such distribution. If the cash we receive from our subsidiaries pursuant to dividends or otherwise is insufficient for us to fund any of these obligations, or if a subsidiary is unable to pay dividends to us, we may be required to raise cash through the incurrence of additional debt, the issuance of additional equity or the sale of assets.
The insurance laws and regulations of the states in which our regulated insurance company subsidiaries operate regulate the amount of dividends and distributions we receive from our insurance company subsidiaries. In general, dividends in excess of prescribed limits are deemed "extraordinary" and require insurance regulatory approval. Ordinary dividends, for which no regulatory approval is generally required, are limited to amounts determined by a formula, which varies by state. Some states have an additional stipulation that dividends may only be paid out of earned surplus. States also regulate transactions between our insurance company subsidiaries and our other subsidiaries, such as those relating to the shared services, and in some instances, require prior approval of such transactions within the holding company structure. If insurance regulators determine that payment of an ordinary dividend or any other payments by our insurance company subsidiaries to us (such as payments for employee or other services) would be adverse to policyholders or creditors, the regulators may block or otherwise restrict such payments that would otherwise be permitted without prior approval. In addition, there could be future regulatory actions restricting the ability of our insurance company subsidiaries to pay dividends or share services. Please see the Note, "Statutory Reporting and Insurance Company Subsidiaries Dividend Restrictions," in the Notes to Consolidated Financial Statements included in ITEM 1 of this Form 10-Q for additional information relating to dividend restrictions for our insurance company subsidiaries.
Our success is dependent upon the retention and acquisition of talented people and the skills and abilities of our management team and key personnel.
Our business depends on the efforts, abilities and expertise of our senior executives, particularly our Chairman, President and Chief Executive Officer, Richard S. Kahlbaugh, and our other key personnel. Mr. Kahlbaugh and our other senior executives are important to our success because they have been instrumental in setting our strategic direction, operating our business, identifying, recruiting and training key personnel, maintaining relationships with our clients, and identifying business opportunities. The loss of one or more of these executives or other key individuals could impair our business and development until we find qualified replacements. We may not be able to replace these individuals quickly or with persons of equal experience and capabilities. Although we have employment agreements with certain of these individuals, we cannot prevent them from terminating their employment with us. In addition, our non-compete agreements with such individuals may not be enforced by the courts. We do not maintain key man life insurance policies on any of our executive officers except for Mr. Kahlbaugh. If we are unable to attract and retain talented employees, it could have a material adverse effect on our business, operating results and financial condition.
We may need to raise additional capital in the future, but there is no assurance that such capital will be available on a timely basis, on acceptable terms or at all.
We may need to raise additional funds in order to grow our business or fund our strategy or acquisitions. Additional financing may not be available in sufficient amounts or on terms acceptable to us and may be dilutive to existing stockholders if raised through additional equity offerings. A significant portion of our funding is under our existing credit facility, which matures in August 2017. Additionally, any securities issued to raise such funds may have rights, preferences and privileges senior to those of our existing stockholders. If adequate funds are not available on a timely basis or on acceptable terms, our ability to expand, develop or enhance our services and products, enter new markets, consummate acquisitions or respond to competitive pressures could be materially limited.
Risks Related to Our Products and Services
Our products and services rely on independent financial institutions, lenders and retailers for distribution, and the loss of these distribution sources, or the failure of our distribution sources to sell our products could materially and adversely affect our business and results of operations.
We distribute our products and services through financial institutions, lenders and retailers. Although our contracts with these clients are typically exclusive, they are subject to cancellation on relatively short notice. In addition, the distributors typically do not have any minimum performance or sales requirements and our revenue is dependent on the level of business conducted by the distributor as well as the effectiveness of their sales efforts, each of which is beyond our control. The following factors are among those that could materially reduce our sales and revenues:
• | the impairment of our distribution relationships; |
• | the loss of a significant number of our distribution relationships; |
• | the failure to offer increasingly competitive products; |
• | the increase in sales of competitors' services and products by these distributors; |
• | the decline in the distributors overall business activity; or |
• | the effectiveness of their sales of our products. |
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In addition, our growth is dependent in part on our ability to identify, attract and retain new distribution relationships and successfully implement our information systems with those of our new distributors.
Reinsurance may not be available or adequate to protect us against losses, and we are subject to the credit risk of reinsurers.
As part of our overall risk and capacity management strategy for our insurance products, we purchase reinsurance for a substantial portion of the risks underwritten through third party reinsurance companies. Market conditions beyond our control determine the availability and cost of the reinsurance protection we seek to renew or purchase. States also could impose restrictions on these reinsurance arrangements, such as requiring our insurance company subsidiaries to retain a minimum amount of underwriting risk, which could affect our profitability and results of operations. Reinsurance for certain types of catastrophes generally could become unavailable or prohibitively expensive. Such changes could substantially increase our exposure to the risk of significant losses from natural or man-made catastrophes and could hinder our ability to write future business.
Although the reinsurer is liable to the respective insurance company subsidiary to the extent of the ceded reinsurance, the insurance company remains liable to the insured as the direct insurer on all risks reinsured. Ceded reinsurance arrangements, therefore, do not eliminate the obligations of our insurance company subsidiaries to pay claims. While the captive reinsurance companies owned by our clients are generally required to maintain trust accounts with sufficient assets to cover the reinsurance liabilities and we manage these trust accounts on behalf of these reinsurance companies, we are subject to credit risk with respect to our ability to recover amounts due from reinsurers. The inability to collect amounts due from reinsurers could have a material adverse effect on our results of operations and financial condition.
Our reinsurance facilities are generally subject to annual renewal. We may not be able to maintain our current reinsurance facilities and our clients may not be able to continue to operate their captive reinsurance companies. As a result, even where highly desirable or necessary, we may not be able to obtain other reinsurance facilities in adequate amounts and at favorable rates. If we are unable to renew our expiring facilities or to obtain or structure new reinsurance facilities, either our net exposures would increase or, if we are unwilling to bear an increase in net exposures, we may have to reduce the level of our underwriting commitments. Either of these potential developments could have a material adverse effect on our results of operations and financial condition.
The structure of some of our commissions exposes us to risks related to the creditworthiness of some of our agents.
We are subject to the credit risk of some of the agents with which we contract to sell our products and services. We typically advance agents' commissions as part of our product offerings. These advances are a percentage of the premium charged. If we over-advance such commissions to agents, they may not be able to fulfill their payback obligations, which could have a material adverse effect on our results of operations and financial condition.
A downgrade in the ratings of our insurance company subsidiaries may materially and adversely affect relationships with clients and adversely affect our results of operations.
Claims paying ability and financial strength ratings are each a factor in establishing the competitive position of our insurance company subsidiaries. A ratings downgrade, or the potential for such a downgrade, could, among other things, materially and adversely affect relationships with clients, brokers and other distributors of our services and products, thereby negatively affecting our results of operations, and materially and adversely affect our ability to compete in our markets. Rating agencies can be expected to continue to monitor our financial strength and claims paying ability, and no assurances can be given that future ratings downgrades will not occur, whether due to changes in our performance, changes in rating agencies' industry views or ratings methodologies, or a combination of such factors.
Our actual claims losses may exceed our reserves for claims, which may require us to establish additional reserves that may materially and adversely reduce our business, results of operations and financial condition.
We maintain reserves to cover our estimated ultimate exposure for claims with respect to reported claims and incurred but not reported claims as of the end of each accounting period. Reserves, whether calculated under accounting principles generally accepted in the United States or statutory accounting principles, do not represent an exact calculation of exposure. Instead, they represent our best estimates, generally involving actuarial projections, of the ultimate settlement and administration costs for a claim or group of claims, based on our assessment of facts and circumstances known at the time of calculation. Future trends in claims severity, frequency, judicial theories of liability and other factors may affect the adequacy of reserves. These variables are affected by external factors such as changes in the economic cycle, unemployment, changes in the social perception of the value of work, emerging medical perceptions regarding physiological or psychological causes of disability, emerging health issues, new methods of treatment or accommodation, inflation, judicial trends, legislative changes, as well as changes in claims handling procedures. Many of these items are not directly quantifiable, particularly on a prospective basis. Reserve estimates are refined as experience develops. We reflect adjustments to reserves, both positive and negative, in the statement of income in the period in which we update such estimates. Because the establishment of reserves is an inherently uncertain process involving estimates of future losses, we can give no assurances that ultimate losses will not exceed existing claims reserves. In general, future loss development could require reserves to be increased, which could have a material adverse effect on our business, results of operations and financial condition.
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Our investment portfolio is subject to several risks that may diminish the fair value of our invested assets and cash, which could have a material and adverse effect on our business and profitability.
Investment returns are an important part of our overall profitability and significant interest rate fluctuations, or prolonged periods of low interest rates, could impair our profitability. Interest rates are highly sensitive to many factors, including governmental monetary policies, domestic and international economic and political conditions and other factors beyond our control. We have a significant portion of our investments in cash and liquid short-term investments. Accordingly, during prolonged periods of declining or low market interest rates, such as those we have been experiencing since 2008, the interest we receive on such investments decreases and affects our profitability. In addition, certain factors affecting our business, such as volatility of claims experience, could force us to liquidate securities prior to maturity, causing us to incur capital losses. If we do not structure our investment portfolio so that it matches our insurance liabilities, we may have to liquidate investments prior to maturity at a significant loss to cover such liabilities.
We classify all of our fixed maturity securities as available-for-sale with any changes in the fair value of these securities reflected on our Consolidated Balance Sheets. The fair value of the fixed maturity securities in our portfolio and the investment income from these securities fluctuate depending on general economic and market conditions. The fair value generally increases or decreases in an inverse relationship with fluctuations in interest rates, while net investment income realized by us from future investments in fixed maturity securities will generally increase or decrease with interest rates. In addition, actual net investment income and/or cash flows from investments that carry prepayment risk may differ from those anticipated at the time of investment due to interest rate fluctuations.
We employ asset/liability management strategies to reduce the adverse effects of interest rate volatility and to increase the likelihood that cash flows are available to pay claims as they become due. Our asset/liability management strategies may fail to eliminate or reduce the adverse effects of interest rate volatility, and significant fluctuations in the level of interest rates may therefore have a material adverse effect on our results of operations and financial condition.
We are subject to credit risk in our investment portfolio, primarily from our investments in corporate bonds, preferred securities and municipal bonds. Defaults by third parties in the payment or performance of their obligations could reduce our investment income and realized investment gains or result in the recognition of investment losses. The fair value of our investments may be materially and adversely affected by increases in interest rates, downgrades in the corporate bonds included in the portfolio and by other factors that may result in the recognition of other-than-temporary impairments. Each of these events may cause us to reduce the fair value of our investment portfolio.
Further, the fair value of any particular fixed maturity security is subject to impairment based on the creditworthiness of a given issuer. Our fixed maturity portfolio may include below investment grade securities (rated "BB" or lower by nationally recognized securities rating organizations). These investments generally provide higher expected returns, but present greater risk and are typically less liquid than investment grade securities. A significant increase in defaults and impairments on our fixed maturity investment portfolio could have a material adverse effect on our results of operations and financial condition.
Risks Related to Regulatory and Legal Matters
We are subject to extensive governmental laws and regulations, which increase our costs and could restrict the conduct of our business.
Our operations are subject to extensive regulation and supervision in the jurisdictions in which we do business. Such regulation or compliance could reduce our profitability or limit our growth by increasing the costs of compliance, limiting or restricting the products or services we sell, or the methods by which we sell our services and products, or subjecting our business to the possibility of regulatory actions or proceedings. In all jurisdictions, the applicable laws and regulations are subject to amendment or interpretation by regulatory authorities. Generally, such authorities have broad discretion to grant, renew or revoke licenses and approvals and to implement new regulations. The jurisdictions in which we operate may prohibit or temporarily suspend us from carrying on some or all of our activities or otherwise fine or penalize us. We can give no assurances that we can continue our business in each jurisdiction as we have in the past. Regulatory authorities generally design laws and regulations to protect the interests of policyholders. To that end, the laws of the various states establish insurance departments and other regulatory agencies with broad powers with respect to matters, such as:
• | licensing and authorizing companies and agents to transact business; |
• | regulating capital and surplus and dividend requirements; |
• | regulating underwriting limitations; |
• | regulating the ability of companies to enter and exit markets; |
• | imposing statutory accounting requirements and annual statement disclosures; |
• | approving changes in control of insurance companies; |
• | regulating premium rates, including the ability to increase or maintain premium rates; |
• | regulating trade billing and claims practices; |
• | regulating certain transactions between affiliates; |
• | regulating reinsurance arrangements, including the balance sheet credit that may be taken by the ceding or direct insurer; |
• | mandating certain terms and conditions of coverage and benefits; |
• | regulating the content of disclosures to consumers; |
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• | regulating the type, amounts and valuation of investments; |
• | mandating assessments or other surcharges for guaranty funds and the ability to recover such assessments in the future through premium increases; |
• | regulating market conduct and sales practices of insurers and agents, including compensation arrangements; and |
• | regulating a variety of other financial and non-financial components of an insurer's business. |
Our non-insurance products and certain aspects of our insurance products are subject to various other federal and state regulations, including state and federal consumer protection, privacy and other laws.
An insurer's ability to write new business is partly a function of its statutory surplus. Maintaining appropriate levels of surplus as measured by statutory accounting principles is important to insurance regulatory authorities and the private agencies that rate insurers' claims-paying abilities and financial strength. Failure to maintain certain levels of statutory surplus could result in increased regulatory scrutiny, a downgrade by rating agencies or enforcement action by regulatory authorities.
We may be unable to maintain all required licenses and approvals and, despite our best efforts, our business may not fully comply with the wide variety of applicable laws and regulations or the relevant regulators' interpretations of such laws and regulations. In addition, some regulatory authorities have relatively broad discretion to grant, renew or revoke licenses and approvals or to limit or restrain operations in their jurisdiction. If we do not have the requisite licenses and approvals or do not comply with applicable regulatory requirements, the insurance regulatory authorities could prohibit or temporarily suspend us from operating, limit some or all of our activities or financially penalize us. These types of actions could have a material adverse effect on our results of operations and financial condition.
Failure to protect our clients' confidential information and privacy could result in the loss of our reputation and customers, reduction in our profitability and subject us to fines, penalties and litigation, which could adversely affect our results of operations and financial condition.
We retain confidential information in our information systems, and we are subject to a variety of privacy regulations and confidentiality obligations. For example, some of our activities are subject to the privacy regulations of the Gramm-Leach-Bliley Act. We also have contractual obligations to protect confidential information we obtain from our clients. These obligations generally require us, in accordance with applicable laws, to protect such information to the same extent that we protect our own confidential information. We have implemented physical, administrative and logical security systems with the intent of maintaining the physical security of our facilities and systems and protecting our clients' and their customers' confidential information and personally-identifiable information against unauthorized access through our information systems or by other electronic transmission or through misdirection, theft or loss of data. Despite such efforts, we may be subject to a breach of our security systems that results in unauthorized access to our facilities and/or the information we are trying to protect. Anyone who is able to circumvent our security measures and penetrate our information systems could access, view, misappropriate, alter or delete any information in the systems, including personally identifiable customer information and proprietary business information. In addition, most states require that customers be notified if a security breach results in the disclosure of personally-identifiable customer information. If our information systems security is compromised resulting in the inappropriate disclosure of such information our results of operations and financial condition could be materially affected due to, among other things, unfavorable publicity, reputational damage, governmental inquiry and oversight, difficulty in marketing our services, loss of clients, significant civil and criminal liability and the incurrence of significant technical, legal and other expenses.
Changes in regulation may adversely affect our business, results of operations and financial condition and limit our growth.
Legislation or other regulatory reform that increases the regulatory requirements imposed on us or that changes the way we are able to do business may significantly harm our business or results of operations in the future. If we were unable for any reason to comply with these requirements, our noncompliance could result in substantial costs to us and may have a material adverse effect on our results of operations and financial condition. Legislative or regulatory changes that could significantly harm us include, but are not limited to:
• | prohibiting our clients from providing debt cancellation policies or offering other ancillary products; |
• | prohibiting insurers from fronting captive reinsurance arrangements; |
• | placing or reducing interest rate caps on the consumer finance products our clients offer or including voluntary products in the annual percentage rate calculation; |
• | limitations or imposed reductions on premium levels or the ability to raise premiums on existing policies; |
• | increases in minimum capital, reserves and other financial viability requirements; |
• | impositions of increased fines, taxes or other penalties for improper licensing, the failure to promptly pay claims, however defined, or other regulatory violations; |
• | increased licensing requirements; |
• | restrictions on the ability to offer certain types of products; |
• | new or different disclosure requirements on certain types of products; and |
• | imposition of new or different requirements for coverage determinations. |
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In recent years, the state insurance regulatory framework has come under increased federal scrutiny and some state legislatures have considered or enacted laws that may alter or increase state authority to regulate insurance companies and insurance holding companies. Further, the NAIC and state insurance regulators are re-examining existing laws and regulations, specifically focusing on modifications to holding company regulations, interpretations of existing laws and the development of new laws and regulations. Additionally, there have been attempts by the NAIC and several states to limit the use of discretionary clauses in policy forms. The elimination of discretionary clauses could increase our product costs. New interpretations of existing laws and the passage of new legislation may harm our ability to sell new services and products and increase our claims exposure on policies we issued previously. In addition, the NAIC's proposed expansion of the Market Conduct Annual Statement could increase the likelihood of examinations of insurance companies operating in niche markets. Court decisions that affect the insurance industry could result in the release of previously protected confidential and privileged information by departments of insurance, which could increase the risk of litigation.
Traditionally, the U.S. federal government has not directly regulated the business of insurance. However, federal legislation and administrative policies in several areas can have a significant and adverse effect on insurance companies. These areas include financial services regulation, securities regulation, privacy, tort reform legislation and taxation. For example, the Dodd-Frank Act provides for the enhanced federal supervision of financial institutions, including insurance companies in certain circumstances, and financial activities that represent a systemic risk to financial stability or the U.S. economy.
The Dodd-Frank Act established the Federal Insurance Office within the U.S. Treasury Department to monitor all aspects of the insurance industry and its authority would likely extend to all lines of insurance that our insurance company subsidiaries write. The director of the Federal Insurance Office serves in an advisory capacity to the Financial Stability Oversight Council. The director has the ability to recommend that an insurance company or an insurance holding company be subject to heightened prudential standards by the Federal Reserve, if it is determined that financial distress at the company could pose a threat to the financial stability of the U.S. economy. The Dodd-Frank Act can also preempt state laws when inconsistent with certain international agreements and would streamline the regulation of reinsurance and surplus lines insurance. At this time, we cannot assess whether any other proposed legislation or regulatory changes will be adopted, or what impact, if any, the Dodd-Frank Act or any other legislation or changes could have on our results of operations, financial condition or liquidity.
With regard to our payment protection products, there are federal and state laws and regulations that govern the disclosures related to lenders' sales of those products. Our ability to offer and administer those products on behalf of financial institutions is dependent upon their continued ability to sell those products. To the extent that federal or state laws or regulations change to restrict or prohibit the sale of these products, our revenues would be adversely affected. The Dodd-Frank Act created a new Consumer Financial Protection Bureau ("CFPB") designed to add new regulatory oversight for the sales practices of these products. Recently, the CFPB's enforcement actions have resulted in large refunds and civil penalties against financial institutions in connection with their marketing of payment protection and other products. Due to such regulatory actions, some lenders may reduce their sales and marketing of payment protection and other ancillary products, which may adversely affect our revenues. The full impact of the CFPB's oversight is unpredictable and continues to evolve.
Further, in a time of financial uncertainty or a prolonged economic downturn, regulators may choose to adopt restrictive insurance laws and regulations. For example, insurance regulators may choose to restrict the ability of insurance company subsidiaries to make payments to their parent companies or reject rate increases due to the economic environment.
With respect to the property and casualty insurance policies we underwrite, federal legislative proposals regarding National Catastrophe Insurance, if adopted, could reduce the business need for some of the related products we provide. Additionally, as the U.S. Congress continues to respond to the recent housing foreclosure crisis, it could enact legislation placing additional barriers on creditor-placed insurance.
In recent years, several large organizations became subjects of intense public scrutiny due to high-profile data security breaches involving sensitive financial and health information. These events focused national attention on identity theft and the duty of organizations to notify impacted consumers in the event of a data security breach. Existing legislation in most states requires customer notification in the event of a data security breach. In addition, some states are adopting laws and regulations requiring minimum information security practices with respect to the collection and storage of personally identifiable consumer data, and several bills before Congress contain provisions directed to national information security standards and breach notification requirements. Several significant legal, operational and reputational risks exist with regard to a data breach and customer notification. A breach of data security requiring public notification can result in regulatory fines, penalties or sanctions, civil lawsuits, loss of reputation, loss of clients and reduction of our profitability.
Our business is subject to risks related to litigation and regulatory actions.
We may be materially and adversely affected by judgments, settlements, unanticipated costs or other effects of legal and administrative proceedings now pending or that may be instituted in the future, or from investigations by regulatory bodies or administrative agencies. From time to time, we have had inquiries from regulatory bodies and administrative agencies relating to the operation of our business. Such inquiries may result in various audits, reviews and investigations. An adverse outcome of any investigation by, or other inquiries from, such bodies or agencies could have a material adverse effect on us and result in the institution of administrative or civil proceedings,
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sanctions, the payment of fines and penalties, changes in personnel, increased review and scrutiny of us by our clients, regulatory authorities, potential litigants, the media and others.
In particular, our insurance operations and certain of our membership and warranty operations are subject to comprehensive regulation and oversight by insurance departments in jurisdictions in which we do business. These insurance departments have broad administrative powers with respect to all aspects of the insurance business and, in particular, monitor the manner in which an insurance company offers, sells and administers its products. Therefore, we may from time to time be subject to a variety of legal and regulatory actions relating to our current and past business operations, including, but not limited to:
• | disputes over coverage or claims adjudication; |
• | disputes over claim payment amounts and compliance with individual state regulatory requirements; |
• | disputes regarding sales practices, disclosures, premium refunds, licensing, regulatory compliance, underwriting and compensation arrangements; |
• | disputes with taxation and insurance authorities regarding our tax liabilities; |
• | periodic examinations of compliance with applicable federal and state laws; and |
• | industry-wide investigations regarding business practices including, but not limited to, the use of finite reinsurance and the marketing and refunding of insurance policies or certificates of insurance. |
The prevalence and outcomes of any such actions cannot be predicted, and such actions or any litigation may have a material adverse effect on our results of operations and financial condition. In addition, if we were to experience difficulties with our relationship with a regulatory body in a given jurisdiction, it could have a material adverse effect on our ability to do business in that jurisdiction.
In addition, plaintiffs continue to bring new types of legal claims against insurance and related companies. Current and future court decisions and legislative activity may increase our exposure to these types of claims. Multi-party or class action claims may present additional exposure to substantial economic, non-economic and/or punitive damage awards. The success of even one of these claims, if it resulted in a significant damage award or a detrimental judicial ruling, could have a material adverse effect on our results of operations and financial condition. This risk of potential liability may make reasonable settlements of claims more difficult to obtain. We cannot determine with any certainty what new theories of liability or recovery may evolve or what their impact may be on our business.
We cannot predict at this time the effect that current litigation, investigations and regulatory activity will have on the industries in which we operate or our business. In light of the regulatory and judicial environments in which we operate, we will likely become subject to further investigations and lawsuits from time to time in the future. Our involvement in any investigations and lawsuits could cause us to incur legal and other costs, and if found to have violated any laws, we could be required to pay fines and damages, perhaps in material amounts. In addition, we could be materially and adversely affected by the negative publicity for the insurance and other financial services industries related to any such proceedings and by any new industry-wide regulations or practices that may result from any such proceedings.
Our cash and cash equivalents could be adversely affected if the financial institutions with which our cash and cash equivalents are deposited fail.
We maintain cash and cash equivalents with major third party financial institutions, including interest-bearing money market accounts.
In the United States, these accounts were fully insured by the Federal Deposit Insurance Corporation ("FDIC") regardless of account balance through the Transaction Account Guarantee ("TAG") program created by Section 343 of the Dodd-Frank Act. The expiration of the TAG program on December 31, 2012, caused the FDIC's standard insurance limit of $250,000 per depositor per institution to be reimposed on January 1, 2013. Thus, our accounts containing cash and cash equivalents may exceed the FDIC's standard $250,000 insurance limit from time to time.
We may be subject to assertions that taxes must be collected based on sales and use of our services in various states, which could expose us to liability and cause material harm to our business, financial condition and results of operations.
Whether sales of our services are subject to state sales and use taxes is uncertain, due in part to the nature of our services and the relationships through which we offer our services, as well as changing state laws and interpretations of those laws. One or more states may seek to impose sales tax, use tax or other tax collection obligations on us, whether based on sales by us or our resellers or clients, including for past sales. A successful assertion that we should be collecting sales or other related taxes on our services could result in substantial tax liabilities for past sales, discourage customers from purchasing our services, discourage clients from offering or billing for our services, or otherwise cause material harm to our business, financial condition and results of operations.
Risks Related to Our Indebtedness
Our indebtedness may limit our financial and operating activities and may materially and adversely affect our ability to incur additional debt to fund future needs.
Our debt service obligations vary annually based on the amount of our indebtedness and the associated fixed and floating interest rates. See "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -
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Liquidity and Capital Resources - Liquidity" in this Form 10-Q, regarding the amount of outstanding debt and our annual debt service. Although we believe that our current cash flows will be adequate to cover our annual interest expense, any increase in our indebtedness or any decline in the amount of cash available to service our indebtedness increases the possibility that we could not pay, when due, the principal of, interest on or other amounts due with respect to our indebtedness. In addition, our indebtedness and any future indebtedness we may incur could:
• | make it more difficult for us to satisfy our obligations with respect to our indebtedness, including financial and other restrictive covenants, which could result in an event of default under the agreements governing our indebtedness; |
• | make us more vulnerable to adverse changes in general economic, industry and competitive conditions and adverse changes in government regulation; |
• | require us to dedicate a substantial portion of our cash flows from operations to payments on our indebtedness, thereby reducing the availability of our cash flows to fund working capital, capital expenditures, acquisitions and other general corporate purposes; |
• | limit our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate; |
• | place us at a competitive disadvantage compared to competitors that have less debt; and |
• | limit our ability to borrow additional amounts for working capital, capital expenditures, acquisitions, debt service requirements, and execution of our business strategy or other purposes. |
Any of the above-listed factors could have a material adverse effect on our business, financial condition, results of operations and cash flows.
Increases in interest rates could increase interest payable under our variable rate indebtedness.
We are subject to interest rate risk in connection with our variable rate indebtedness. See "QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK - Interest Rate Risk" in our 2013 Form 10-K, regarding our interest rate risk and "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Liquidity and Capital Resources - Liquidity" in this Report, regarding the amount of outstanding variable rate debt. Interest rate changes could increase the amount of our interest payments and thus negatively affect our future earnings and cash flows. If we do not have sufficient earnings, we may be required to refinance all or part of our existing debt, sell assets, borrow more money or sell more securities, none of which we can guarantee we will be able to do.
We may enter into hedging transactions that may become ineffective, which may adversely affect our financial condition.
Part of our interest rate risk strategy involves entering into hedging transactions to mitigate the risk of variable interest rate instruments by converting the variable interest rate to a fixed interest rate. We regularly evaluate each hedging item for hedge effectiveness. If it is determined that a hedging transaction is ineffective, we may be required to record losses reflected in our results of operations which could adversely impact our financial condition.
Despite our indebtedness levels, we may still be able to incur more indebtedness, which could further exacerbate the risks related to our indebtedness described above.
We may be able to incur substantial additional indebtedness in the future subject to the limitations contained in the agreements governing our indebtedness. If we incur additional debt, the risks that we now face due to our indebtedness could intensify.
Restrictive covenants in the agreements governing our indebtedness may restrict our ability to pursue our business strategies.
The agreements governing our indebtedness contain a number of restrictive covenants that impose significant operating and financial restrictions on us and may limit our ability to pursue our business strategies or undertake actions that may be in our best interests. The agreements governing our indebtedness include covenants restricting, among other things, our ability to:
• | incur or guarantee additional debt; |
• | incur liens; |
• | complete mergers, consolidations and dissolutions; |
• | sell certain of our assets that have been pledged as collateral; and |
• | undergo a change in control. |
We pledged our assets to secure some of our existing indebtedness.
Our credit facility, entered into in August 2012, with Wells Fargo Bank, N.A. is secured by substantially all of our property and assets and property and assets owned by LOTS Intermediate Co. and certain of our subsidiaries that act as guarantors of our existing indebtedness. Such assets include the stock of LOTS Intermediate Co. and the right, title and interest of the borrowers and each guarantor in their respective material real estate property, fixtures, accounts, equipment, investment property, inventory, instruments, general intangibles, intellectual property, money, cash or cash equivalents, software and other assets and, in each case, the proceeds thereof, subject to certain exceptions. In the event of a default under our indebtedness, the lender could foreclose against the assets securing such obligations. A foreclosure on these assets would have a material adverse effect on our business, financial condition, results of operations and cash flows.
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Risks Related to Our Technology and Intellectual Property
Our information systems may fail or their security may be compromised, which could damage our business and materially and adversely affect our results of operations and financial condition.
Our business is highly dependent upon the effective operation of our information systems and our ability to store, retrieve, process and manage significant databases and expand and upgrade our information systems. We rely on these systems throughout our business for a variety of functions, including marketing and selling our products and services, performing our services, managing our operations, processing claims and applications, providing information to clients, performing actuarial analyses and maintaining financial records. The interruption or loss of our information processing capabilities through the loss of stored data, programming errors, the breakdown or malfunctioning of computer equipment or software systems, telecommunications failure or damage caused by weather or natural disasters or any other significant disruptions could harm our business, ability to generate revenues, client relationships, competitive position and reputation. As part of our disaster recovery procedures, we have additional data processing locations in Jacksonville, Florida and Atlanta, Georgia. Although we have disaster recovery procedures and insurance to protect against certain contingencies, such measures may not be effective or insurance may not continue to be available at reasonable prices to cover all such losses or be sufficient to compensate us for the loss of business that may result from any failure of our information systems. In addition, our information systems may be vulnerable to physical or electronic intrusions, computer viruses or other attacks, which could disable our information systems and our security measures may not prevent such attacks. The failure of our systems due to any security breaches, intrusions or attacks could cause significant interruptions to our operations, which could result in a material adverse effect on our business, results of operations and financial condition.
The failure to effectively maintain and modernize our systems to keep up with technological advances could materially and adversely affect our business.
Our business is dependent upon our ability to ensure that our information systems keep up with technological advances. Our ability to keep our systems integrated with those of our clients is critical to the success of our business. If we do not effectively maintain our systems and update them to address technological advancements, our relationships and ability to do business with our clients may be materially and adversely affected. Our business depends significantly on effective information systems, and we have many different information systems utilized to conduct our business. We must commit significant resources to maintain and enhance existing information systems and develop new systems that allow us to keep pace with continuing changes in information processing technology, evolving industry, regulatory and legal standards and changing client preferences. A failure to maintain effective and efficient information systems, or a failure to efficiently and effectively consolidate our information systems and eliminate redundant or obsolete applications, could have a material adverse effect on our results of operations and financial condition or our ability to do business in particular jurisdictions. If we do not effectively maintain adequate systems, we could experience adverse consequences, including:
• | the inability to effectively market and price our services and products and make underwriting and reserving decisions; |
• | the loss of existing clients; |
• | difficulty attracting new clients; |
• | regulatory problems, such as a failure to meet prompt payment obligations; |
• | internal control problems; |
• | exposure to litigation; |
• | security breaches resulting in loss of data; and |
• | increases in administrative expenses. |
Our success will depend, in part, on our ability to protect our intellectual property rights and our ability not to infringe upon the intellectual property rights of third parties.
The success of our business will depend, in part, on preserving our trade secrets, maintaining the security of our know-how and data and operating without infringing upon patents and proprietary rights held by third parties. Failure to protect, monitor and control the use of our intellectual property rights could cause us to lose a competitive advantage and incur significant expenses. We rely on a combination of contractual provisions, confidentiality procedures and copyright, trademark, service mark and trade secret laws to protect the proprietary aspects of our brands, technology and data. These legal measures afford only limited protection, and competitors or others may gain access to our intellectual property and proprietary information.
Our trade secrets, data and know-how could be subject to unauthorized use, misappropriation, or disclosure. Third parties may challenge our trademarks, forcing us to re-brand our services or products, resulting in loss of brand recognition and requiring us to devote resources to advertising and marketing new brands or licensing. If we are found to have infringed upon the intellectual property rights of third parties, we may be subject to injunctive relief restricting our use of affected elements of intellectual property used in the business. In addition, we may be required to, among other things, pay royalties or enter into licensing agreements in order to obtain the rights to use necessary technologies, which may not be possible on commercially reasonable terms, or we may be required to redesign our systems, which may not be feasible.
Furthermore, litigation may be necessary to enforce our intellectual property rights to protect our trade secrets and to determine the validity and scope of our proprietary rights. The intellectual property laws and other statutory and contractual arrangements we currently depend upon may not provide sufficient protection in the future to prevent the infringement, use or misappropriation of our trademarks, data, technology and other services and products. Policing unauthorized use of intellectual property rights can be difficult and expensive,
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and adequate remedies may not be available. Any future litigation, regardless of outcome, could result in substantial expense and diversion of resources with no assurance of success and could have a material adverse effect on our business, financial condition, results of operations, and cash flows.
Risks Related to Our Common Stock
There may not be an active, liquid trading market for our common stock.
Prior to our Initial Public Offering, there had been no public market for shares of our common stock. The trading activity in our securities is relatively low and our company has a relatively small public float. We cannot predict the extent to which investor interest in our Company will continue to maintain an active and liquid trading market. If an active trading market in our common stock does not continue, you may have difficulty selling shares of our common stock that you own or purchase.
As a public company, we are subject to additional financial and other reporting and corporate governance requirements that may be difficult for us to satisfy.
We are required to file with the SEC, annual and quarterly information and other reports specified in the Exchange Act. We are required to ensure that we have the ability to prepare financial statements that are fully compliant with all SEC reporting requirements on a timely basis. We are subject to other reporting and corporate governance requirements, including the requirements of the NYSE and certain provisions of the Sarbanes-Oxley Act of 2002 ("SOX") and the regulations promulgated thereunder, which impose significant compliance obligations upon us. Should we fail to comply with these rules and regulations we may face de-listing from the NYSE and face disciplinary actions from the SEC, which may adversely affect our stock price.
If our internal controls are found to be ineffective, our financial results or our stock price may be adversely affected.
Our most recent evaluation resulted in our conclusion that as of September 30, 2014, we were in compliance with Section 404 of SOX and our internal control over financial reporting was effective. We believe that we currently have adequate internal control procedures in place for future periods. However, in the future, if our internal controls over financial reporting are found ineffective or if we identify a material weakness in our financial reporting, investors may lose confidence in the reliability of our financial statements, which may adversely affect our financial results or our stock price.
Our principal stockholder has substantial control over us.
Affiliates of Summit Partners collectively and beneficially own approximately 62.0% of our outstanding common stock at September 30, 2014. Therefore, Summit Partners or its affiliates continue to be able to exert a significant degree of influence or actual control over our management and affairs and matters requiring stockholder approval, including the election of directors, a merger, consolidation or sale of all or substantially all of our assets, and any other significant transaction. The interests of this stockholder may not always coincide with our interests or the interests of our other stockholders. For instance, this concentration of ownership may have the effect of delaying or preventing a change in control of us otherwise favored by our other stockholders and could depress our stock price.
We expect that our stock price will fluctuate significantly, which could cause a decline in the stock price, and holders of our common stock may not be able to resell shares at or above the cost of such shares.
Securities markets worldwide have experienced significant price and volume fluctuations, which may likely continue. This market volatility, as well as general economic, market or political conditions, could reduce the market price of our common stock regardless of our operating performance. The trading price of our common stock may be volatile and subject to wide price fluctuations in response to various factors, including:
• | market conditions in the broader stock market; |
• | actual or anticipated fluctuations in our quarterly financial and operating results; |
• | introduction of new products or services by us or our competitors; |
• | issuance of new or changed securities analysts' reports or recommendations; |
• | investor perceptions of us and the industries in which we operate; |
• | sales, or anticipated sales, of large blocks of our stock; |
• | additions or departures of key personnel; |
• | regulatory or political developments; |
• | litigation and governmental investigations; and |
• | changing economic conditions. |
These and other factors may cause the market price and demand for our common stock to fluctuate substantially, which may limit or prevent investors from readily selling their shares of common stock and may otherwise negatively affect the liquidity of our common stock. In addition, in the past, when the market price of a stock has been volatile, holders of that stock have sometimes instituted securities class action litigation against the company that issued the stock. If any of our stockholders brought a lawsuit against us, we could incur substantial costs defending the lawsuit. Such a lawsuit could also divert the time and attention of our management from our business, which could significantly harm our results of operations and reputation.
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If a substantial number of shares become available for sale and are sold in a short period of time, the market price of our common stock could decline.
At September 30, 2014, we had 21,281,415 shares of common stock issued, including shares held in treasury, with our directors, executive officers and affiliates holding a significant majority of these shares. If our stockholders sell substantial amounts of our common stock in the public market, the market price of our common stock could decrease significantly. The perception in the public market that our existing stockholders might sell shares of common stock could also depress the market price of our common stock. A decline in the market price of our common stock might impede our ability to raise capital through the issuance of additional shares of our common stock or other equity securities.
If securities or industry analysts do not publish research or reports about our business, publish research or reports containing negative information about our business, adversely change their recommendations regarding our stock or if our results of operations do not meet their expectations, our stock price and trading volume could decline.
The trading market for our common stock is influenced by the research and reports that industry or securities analysts publish about us or our business. If one or more of these analysts cease coverage of our Company or fail to publish reports on us regularly, we could lose visibility in the financial markets, which in turn could cause our stock price or trading volume to decline. Moreover, if one or more of the analysts who cover us, downgrade our stock, or if our results of operations do not meet their expectations, our stock price could decline.
Some provisions of Delaware law and our amended and restated certificate of incorporation and bylaws may deter third parties from acquiring us and diminish the value of our common stock.
Our amended and restated certificate of incorporation and bylaws provide for, among other things:
• | restrictions on the ability of our stockholders to call a special meeting and the business that can be conducted at such meeting; |
• | restrictions on the ability of our stockholders to remove a director or fill a vacancy on the Board of Directors; |
• | our ability to issue preferred stock with terms that the Board of Directors may determine, without stockholder approval; |
• | the absence of cumulative voting in the election of directors; |
• | a prohibition of action by written consent of stockholders unless such action is recommended by all directors then in office; and |
• | advance notice requirements for stockholder proposals and nominations. |
These provisions in our amended and restated certificate of incorporation and bylaws may discourage, delay or prevent a transaction involving a change in control of the Company that is in the best interest of our non-controlling stockholders. Even in the absence of a takeover attempt, the existence of these provisions may adversely affect the prevailing market price of our common stock if they are viewed as discouraging future takeover attempts.
Applicable insurance laws may make it difficult to effect a change in control of us.
State insurance regulatory laws contain provisions that require advance approval, by the state insurance commissioner, of any change in control of an insurance company that is domiciled, or, in some cases, having such substantial business that it is deemed to be commercially domiciled, in that state. We own, directly or indirectly, all of the shares of stock of insurance companies domiciled in California, Delaware, Georgia and Louisiana, and 85% of the shares of stock of an insurance company domiciled in Kentucky. Because any purchaser of shares of our common stock representing 10% or more of the voting power of the capital stock of Fortegra generally are presumed to have acquired control of these insurance company subsidiaries, the insurance change in control laws of California, Delaware, Georgia, Louisiana and Kentucky would apply to such a transaction.
In addition, the laws of many states contain provisions requiring pre-notification to state agencies prior to any change in control of a non-domestic insurance company subsidiary that transacts business in that state. While these pre-notification statutes do not authorize the state agency to disapprove the change in control, they do authorize issuance of cease and desist orders with respect to the non-domestic insurer if it is determined that conditions, such as undue market concentration, would result from the change in control.
These laws may discourage potential acquisition proposals and may delay, deter or prevent a change of control of the Company, including through transactions, and in particular unsolicited transactions, that some or all of our stockholders might consider desirable.
We do not anticipate paying any cash dividends for the foreseeable future.
We currently intend to retain our future earnings, if any, for the foreseeable future, to repay indebtedness and for general corporate purposes. We do not intend to pay any dividends for the foreseeable future to holders of our common stock. As a result, capital appreciation in the price of our common stock, if any, will be your only source of gain on an investment in our common stock.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
(a) Not Applicable.
(b) Not Applicable.
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(c) Issuer Purchases of Equity Securities
At September 30, 2014, Fortegra had a share repurchase plan, which allows the Company to purchase up to $15.0 million of the Company's common stock from time to time through open market or private transactions. The Board of Directors approved a $10.0 million share repurchase plan in November 2011 and increased the size of the plan by $5.0 million in August 2013. The share repurchase plan has no expiration date and provides for shares to be repurchased for general corporate purposes, which may include serving as a resource for funding potential acquisitions and employee benefit plans. The timing, price and quantity of purchases are at our discretion. In addition, we can discontinue or suspend the share repurchase plan at any time. There were no repurchases during the three months ended September 30, 2014.
The following table shows Fortegra's share repurchase plan activity for the three months ended September 30, 2014:
Period | Total Number of Shares Purchased | Average Price Paid Per Share | Total Number of Shares Purchased as Part of Publicly Announced Plan | Maximum Approximate Dollar Value of Shares that May Yet Be Purchased Under the Plan | ||||||||||||
July 1, 2014 | to | July 31, 2014 | — | $ | — | — | $ | 7,167,376 | ||||||||
August 1, 2014 | to | August 31, 2014 | — | — | — | 7,167,376 | ||||||||||
September 1, 2014 | to | September 30, 2014 | — | — | — | 7,167,376 | ||||||||||
Total | — | $ | — | — |
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
ITEM 5. OTHER INFORMATION
None.
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ITEM 6. EXHIBITS
See the Exhibit Index following the signature page of this Form 10-Q for a list of exhibits filed with, furnished with or incorporated
by reference into this Form 10-Q.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.
Fortegra Financial Corporation | ||||
Date: | November 12, 2014 | By: | /s/ Richard S. Kahlbaugh | |
Richard S. Kahlbaugh | ||||
Chairman, President and Chief Executive Officer | ||||
(Duly authorized officer) | ||||
Date: | November 12, 2014 | By: | /s/ Walter P. Mascherin | |
Walter P. Mascherin | ||||
Executive Vice President and Chief Financial Officer | ||||
(Duly authorized officer and Principal Financial and Accounting Officer) |
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EXHIBIT INDEX | |||||||
Incorporated by Reference | |||||||
Exhibit Number | Description of Exhibits | Form | File Number | Date Filed | Original Exhibit Number | Filed Herewith | Furnished Herewith |
2.1 | Agreement and Plan of Merger, dated as of March 7, 2007, by and among Summit Partners Private Equity Fund VII-A, L.P., Summit Partners Private Equity Fund VII-B, L.P., Summit Subordinated Debt Fund III-A, L.P., Summit Subordinated Debt Fund III-B, L.P., Summit Investors VI, L.P., LOS Acquisition Co., the Signing Stockholders and Life of the South Corporation and N.G. Houston III, as Stockholder Representative. | S-1 | 333-169550 | 9/23/2010 | 2.1 | ||
2.2 | First Amendment to Merger Agreement, dated as of June 20, 2007 by and among Summit Partners Private Equity Fund VII-A, L.P., Summit Partners Private Equity Fund VII-B, L.P., Summit Subordinated Debt Fund III-A, L.P., Summit Subordinated Debt Fund III-B, L.P., Summit Investors VI, L.P., LOS Acquisition Co., the Signing Stockholders, and Life of the South Corporation and N.G. Houston, III, as Stockholder Representative. | S-1 | 333-169550 | 9/23/2010 | 2.2 | ||
2.3 | Stock Purchase Agreement, dated as of April 15, 2009, by and among Willis HRH, Inc., Bliss and Glennon, Inc., LOTS Intermediate Co., Willis North America Inc. and Fortegra Financial Corporation. | S-1 | 333-169550 | 9/23/2010 | 2.3 | ||
2.4 | Agreement and Plan of Merger, dated March 3, 2011 by and among eReinsure.com, Inc., a Delaware corporation, Alpine Acquisition Sub., Inc., a Delaware corporation, and Century Capital Partners III, L.P., as Agent solely for the purposes of Section 10.02, and LOTS Intermediate Co., a Delaware corporation. | 8-K | 001-35009 | 3/7/2011 | 2.1 | ||
2.5 | Stock Purchase Agreement, dated December 2, 2013, by and among Fortegra Financial Corporation, a Delaware corporation, LOTS Intermediate Co., a Delaware corporation, Bliss and Glennon, Inc., a California corporation, eReinsure.com, Inc., a Delaware corporation, and AmWINS Holdings, LLC, a North Carolina limited liability company. | 8-K | 001-35009 | 1/7/2014 | 2.1 | ||
2.6 | Agreement and Plan of Merger, dated August 11, 2014, among Tiptree Operating Company, LLC, Caroline Holdings LLC, Caroline Merger Sub, Inc. and Fortegra Financial Corporation. | 8-K | 001-35009 | 8/12/2014 | 2.1 | ||
3.1 | Third Amended and Restated Certificate of Incorporation of Fortegra Financial Corporation. | S-1/A | 333-169550 | 12/13/2010 | 3.3 | ||
3.2 | Amended and Restated Bylaws of Fortegra Financial Corporation. | S-1/A | 333-169550 | 11/29/2010 | 3.4 | ||
4.1 | Form of Common Stock Certificate. | S-1/A | 333-169550 | 12/13/2010 | 4.1 | ||
4.2 | Stockholders Agreement, dated as of March 7, 2007, among Life of the South Corporation (together with its successors), the Rollover Stockholders (as defined therein), Employee Stockholders (as defined therein) and Investors (as defined therein). | S-1/A | 333-169550 | 10/29/2010 | 4.2 | ||
10.1 | Indenture, dated as of June 20, 2007, between LOTS Intermediate Co. and Wilmington Trust Company. | S-1 | 333-169550 | 9/23/2010 | 10.1 | ||
10.2 | Form of Fixed/Floating Rate Senior Debenture (included in Exhibit 10.1). | S-1 | 333-169550 | 9/23/2010 | 10.2 | ||
10.3 | Form of Fortegra Financial Corporation Director Indemnification Agreement for John R. Carroll and J.J. Kardwell. | S-1/A | 333-169550 | 11/29/2010 | 10.18 | ||
10.4 | Form of Fortegra Financial Corporation Director Indemnification Agreement for Francis M. Colalucci, Frank P. Filipps, Arun Maheshwari, Ted W. Rollins and Sean S. Sweeney. | S-1/A | 333-169550 | 11/29/2010 | 10.19 | ||
10.5 | Form of Fortegra Financial Corporation Officer Indemnification Agreement. | S-1/A | 333-169550 | 12/3/2010 | 10.20 | ||
10.6 | Form of Indemnity Agreement between Fortegra Financial Corporation, as Indemnitor, and the executive officers serving as plan committee members for the Fortegra Financial Corporation 401(k) Savings Plan, as Indemnitees. | S-1/A | 333-169550 | 10/29/2010 | 10.21 | ||
10.7* | Executive Employment and Non-Competition Agreement, dated as of March 7, 2007, by and between Life of the South Corporation and Richard S. Kahlbaugh. | S-1/A | 333-169550 | 12/3/2010 | 10.22 | ||
10.7.1* | Amendment No. 1 to Executive Employment and Non-Competition Agreement, dated as of November 1, 2010, by and between Fortegra Financial Corporation and Richard S. Kahlbaugh. | S-1/A | 333-169550 | 12/3/2010 | 10.22.1 |
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EXHIBIT INDEX | |||||||
Incorporated by Reference | |||||||
Exhibit Number | Description of Exhibits | Form | File Number | Date Filed | Original Exhibit Number | Filed Herewith | Furnished Herewith |
10.8* | Executive Employment and Non-Competition Agreement, dated as of October 1, 2010, by and between Fortegra Financial Corporation and Walter P. Mascherin. | S-1/A | 333-169550 | 12/3/2010 | 10.27 | ||
10.9* | Life of the South Corporation 2005 Equity Incentive Plan. | S-1/A | 333-169550 | 10/29/2010 | 10.28 | ||
10.10* | 1995 Key Employee Stock Option Plan. | S-1/A | 333-169550 | 10/29/2010 | 10.29 | ||
10.11* | Stock Option Agreement by and between Life of the South Corporation and Richard S. Kahlbaugh, dated as of November 18, 2005, as amended on March 7, 2007 and June 20, 2007. | S-1/A | 333-169550 | 11/16/2010 | 10.30 | ||
10.12* | Stock Option Agreement by and between Life of the South Corporation and Richard Kahlbaugh, dated as of October 25, 2007. | S-1/A | 333-169550 | 11/16/2010 | 10.31 | ||
10.13* | 2010 Omnibus Incentive Plan. | S-1/A | 333-169550 | 12/3/2010 | 10.32 | ||
10.14* | Employee Stock Purchase Plan. | S-1/A | 333-169550 | 12/3/2010 | 10.33 | ||
10.15* | Deferred Compensation Agreement, dated January 1, 2006, between Life of the South Corporation and Richard S. Kahlbaugh. | S-1/A | 333-169550 | 10/29/2010 | 10.35 | ||
10.16* | Form of Restricted Stock Award Agreement for Directors. | S-1/A | 333-169550 | 12/3/2010 | 10.47 | ||
10.16.1* | Amended - Form of Restricted Stock Award Agreement for Directors, effective February 2013. | 10-K | 001-35009 | 4/1/2013 | 10.26.1 | ||
10.17* | Form of Restricted Stock Award Agreement for Employees. | S-1/A | 333-169550 | 12/3/2010 | 10.48 | ||
10.17.1* | Amended - Form of Restricted Stock Award Agreement for Employees, effective February 18, 2013. | 10-Q | 001-35009 | 5/15/2013 | 10.27.1 | ||
10.18* | Form of Restricted Stock Award Agreement (Bonus Pool). | S-1/A | 333-169550 | 12/3/2010 | 10.49 | ||
10.19* | Form of Nonqualified Stock Option Award Agreement. | S-1/A | 333-169550 | 12/3/2010 | 10.50 | ||
10.19.1* | Amended - Form of Nonqualified Stock Option Award Agreement, effective February 18, 2013. | 10-Q | 001-35009 | 5/15/2013 | 10.29.1 | ||
10.20* | Executive Employment and Non-Competition Agreement, dated as of January 1, 2009, by and between Fortegra Financial Corporation and Joseph McCaw. | 10-Q | 001-35009 | 5/15/2012 | 10.39 | ||
10.21 | Credit Agreement, dated August 2, 2012, as amended by amendment to Credit Agreement, dated October 4, 2013, among Fortegra Financial Corporation and LOTS Intermediate Co., as Borrowers; the initial Lenders named therein; Wells Fargo Bank, N.A., as Administrative Agent, Swingline Lender, and Issuing Lender; Wells Fargo Securities, LLC, as Bookrunner and Joint Lead Arranger; and Synovus Bank as Joint Lead Arranger and Syndication Agent. (Conformed Copy). | 10-Q | 001-35009 | 11/14/2013 | 10.34 | ||
10.21.1 | Second Amendment to the Credit Agreement, dated April 11, 2014, by and among Fortegra Financial Corporation and LOTS Intermediate Co., as Borrowers; the Subsidiaries (as defined in the Credit Agreement) party thereto, each of the Lenders (as defined in the Credit Agreement) and Wells Fargo Bank, National Association, as administrative agent. | 8-K | 001-35009 | 4/16/2014 | 10.1 | ||
10.22 | Subsidiary Guaranty Agreement, dated August 2, 2012, among certain subsidiaries, as Guarantors, of Fortegra Financial Corporation and LOTS Intermediate Co., as Borrowers, and Wells Fargo Bank, N.A., as Administrative Agent, and each of the Guaranteed Parties. | 8-K | 001-35009 | 8/7/2012 | 10.2 | ||
10.23 | Pledge Agreement, dated August 2, 2012, by Fortegra Financial Corporation and LOTSoluntions, Inc., as Pledgors, and Wells Fargo Bank, N.A., as Administrative Agent for its benefit and the benefit of other Lenders. | 8-K | 001-35009 | 8/7/2012 | 10.3 | ||
10.24 | Security Agreement, dated August 2, 2012, among Fortegra Financial Corporation, LOTS Intermediate Co. and certain of its subsidiaries, as Grantors, and Wells Fargo Bank, N.A., as Administrative Agent for its benefit and the benefit of the Secured Creditors. | 8-K | 001-35009 | 8/7/2012 | 10.4 | ||
10.24.1 | Security Agreement Joinder, dated April 11, 2014, to the Security Agreement dated as of August 2, 2012, by and among Fortegra Financial Corporation and LOTS Intermediate Co., as Borrowers, certain subsidiaries of the Borrowers, as Grantors, and Wells Fargo Bank, N.A., as Administrative Agent for its benefit and the benefit of the Secured Creditors. | 10-Q | 001-35009 | 5/14/2014 | 10.24.1 |
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EXHIBIT INDEX | |||||||
Incorporated by Reference | |||||||
Exhibit Number | Description of Exhibits | Form | File Number | Date Filed | Original Exhibit Number | Filed Herewith | Furnished Herewith |
10.25 | Trademark Security Agreement, dated August 2, 2012, among the Fortegra Financial Corporation, LOTSolutions, Inc., Pacific Benefits Group Northwest, L.L.C., eReinsure.com, Inc., as Grantors, and Wells Fargo Bank, N.A., as Administrative Agent and Grantee, for the benefit of the Secured Creditors. | 8-K | 001-35009 | 8/7/2012 | 10.5 | ||
10.26* | 2013 Executive Annual Incentive Plan. | 10-Q | 001-35009 | 8/14/2013 | 10.41 | ||
10.27* | Quarterly Incentive Plan. | 10-Q | 001-35009 | 8/14/2013 | 10.42 | ||
10.28* | Executive Employment and Non-Competition Agreement, dated as of March 6, 2007, by and between Life of the South Corporation and W. Dale Bullard. | S-1/A | 333-169550 | 11/29/2010 | 10.25 | ||
10.29* | Amended and Restated Deferred Compensation Agreement, dated May 1, 2005, by and between Life of the South Corporation and W. Dale Bullard. | S-1/A | 333-169550 | 10/29/2010 | 10.34 | ||
10.30* | Long Term Incentive Plan. | 10-Q | 001-35009 | 5/14/2014 | 10.30 | ||
10.31* | 2014 Executive Annual Incentive Plan. | 10-Q | 001-35009 | 5/14/2014 | 10.31 | ||
11.1 | Statement Regarding Computation of Per Share Earnings (incorporated by reference to Notes to Consolidated Financial Statements in PART I, ITEM 1 of this Quarterly Report on Form 10-Q). | X | |||||
31.1 | Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer. | X | |||||
31.2 | Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer. | X | |||||
32 | Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | X | |||||
101.INS | XBRL Instance Document. | X | |||||
101.SCH | XBRL Taxonomy Extension Schema Document. | X | |||||
101.CAL | XBRL Taxonomy Extension Calculation Linkbase Document. | X | |||||
101.DEF | XBRL Taxonomy Extension Definition Linkbase Document. | X | |||||
101.LAB | XBRL Taxonomy Extension Label Linkbase Document. | X | |||||
101.PRE | XBRL Taxonomy Extension Presentation Linkbase Document. | X | |||||
* | Management contract or compensatory plan or arrangement. |
62