Our principal executive offices are located in approximately 50,000 square feet of office space we lease in Fort Lauderdale, Florida. We also lease office space for our regional branch offices in California, Florida, Missouri, North Carolina, and Pennsylvania. We own our office space in Greenville, South Carolina. We consider our facilities to be adequate for our current operations.
Represents historical fees paid by us to Guarantee Insurance Group for management oversight, legal, accounting, human resources and technology support services provided to us. Our administrative functions have been separated from Guarantee Insurance Group and from August 6, 2014, such payments are no longer made by us in respect of such services.
Costs related to extinguishment of debt include $4.3 million of early payment penalties and $9.3 million associated with the write-off of related deferred financing fees and original issue discounts in connection with the repayment of all outstanding debt under our prior loan agreement with the PennantPark Entities, as lenders (the “PennantPark Loan Agreement”) and our prior credit agreement with UBS Securities LLC and the lenders party thereto (the “UBS Credit Agreement”) on January 22, 2015, with a portion of the proceeds from our initial public offering.
Represents amounts received from our clients to be used exclusively for the payment of claims on behalf of those clients.
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the “Selected Financial Data” and our audited consolidated financial statements and accompanying notes included elsewhere in this filing. This discussion includes forward-looking statements that are subject to risks, uncertainties and other factors described under the captions “Risk Factors” and “Forward-Looking Statements.” These factors could cause our actual results to differ materially from those expressed in, or implied by, those forward-looking statements.
On December 23, 2015, we entered into several rescission and exchange agreements (collectively, the “Exchange Agreement”) with Steven M. Mariano and the PIPE Investors pursuant to which we and the PIPE Investors (i) rescinded the sale and purchase of 666,666 shares of our common stock and prepaid warrants for 1,000,000 shares of our common stock and (ii) exchanged the Old Series A Warrant for the New Series A Warrants to purchase up to an aggregate of 3,250,000 shares of our common stock, and the Old Series B Warrant for the prepaid New Series B Warrants to purchase a number of shares that the holder could purchase at a price equal to 90% of the lowest 10-day volume-weighted average stock price during the period commencing on February 1, 2016 through and including the Adjustment Time (as defined in the New Series B Warrants, which we expect to end at 9:00 A.M. on the tenth trading day after the filing of this Annual Report on Form 10-K) less the number of shares such holder purchased, in each case subject to adjustments and limitations pursuant to their terms. Based on the lowest 10-day volume-weighted average stock price during the period commencing on February 1, 2016 through March 17, 2016 of $4.51, we estimate that 4,895,985 shares of our common stock would be issuable upon exercise of the New Series B Warrants. In addition, we and Steven M. Mariano amended the Stock Back-to-Back Agreement, pursuant to which, upon the exercise of the New Warrants, we would purchase a number of shares of our common stock owned by Mr. Mariano equal to 100% of the shares to be issued in connection with the exercise by the PIPE Investors of the New Warrants, resulting in no dilution for our existing shareholders.
In addition, the Exchange Agreement amended the registration rights agreement to provide the PIPE Investors with registration rights to register the shares issuable upon exercise of the New Warrants, subject to penalties and other customary provisions. We also entered into a third amendment to our existing credit agreement to permit these transactions under the covenants included therein.
On March 3, 2016, our Board of Directors approved a $15 million share repurchase program for the Company's common stock whereby shares may be purchased from time to time, in open market transactions or in negotiated off-market transactions. The program may continue for up to eighteen months. As of March 14, 2016, the Company has repurchased 992,182 shares of our common stock.
We consummated our Public Offering on January 22, 2015 and incurred additional costs associated with operating as a public company, including hiring additional personnel, improving financial reporting systems, additional directors’ and officers’ liability insurance, director fees and expanding our facilities. These costs related to legal, regulatory, compliance, finance, accounting, investor relations and other administrative functions.
We use certain key performance measures in evaluating our business and results of operations and we may refer to one or more of these key performance measures in this “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” These key performance measures include:
Adjusted EBITDA: we define Adjusted EBITDA as net income before interest expense, income tax expense (benefit), excluding depreciation and amortization, costs from debt payoff, stock compensation expenses, severance expenses, public offering costs, acquisition costs and changes in fair value of assets and warrant liabilities.
Operating Cash Flow:we define Operating Cash Flow as Adjusted EBITDA less income tax expense, interest expense, and capital expenditures.
Adjusted EDITDA does not reflect changes in, or cash requirements for, our working capital needs or tax payments that may represent a reduction in cash available to us; and
Gross reference premium written for the year ended December 31, 2015 was $470.2 million compared to $335.1 million for the year ended December 31, 2014, an increase of $135.1 million. The increase was attributable to a $19.6 million increase in Guarantee Insurance gross reference premium written, and the inception of new contracts with Scottsdale, AIG and certain other insurance carrier clients, which generated $128.5 million of gross reference premium written. The increase was partially offset by a $13.0 million decrease in gross reference premium written on behalf of Zurich as a result of Zurich reducing its volumes in California, where business covered by our initial program with Zurich was solely written. In September 2014, we entered into a second program with Zurich that further expands coverage in multiple other states.
Adjusted EBITDA is a non-GAAP financial measure and is not in accordance with, or an alternative to, the GAAP information provided in this Annual Report on Form 10-K. For further information regarding our use of non-GAAP financial measures and a reconciliation of Adjusted EBITDA to Net income (loss), see “Selected Financial Data.”
Operating cash flow is a non-GAAP financial measure and is not in accordance with, or an alternative to, the GAAP information provided in this Annual Report on Form 10-K. For further information regarding our use of non-GAAP financial measures and a reconciliation of Operating cash flow to Net income (loss), see “Selected Financial Data.”
Adjusted earnings for the year ended December 31, 2014 was $6.0 million compared to a loss of $(1.6) million for the year ended December 31, 2013, an increase of $7.6 million. The increase was principally attributable to a $46.9 million increase in total fee income and fee income from related party and a $0.4 million increase in net investment income, partially offset by a $39.8 million increase in total expenses (excluding increase in fair value of warrant redemption liability, loss on exchange of units and warrants, and provision for uncollectible fee income as adjusted for income tax expense on reconciling items), all of which are discussed more fully below.
With respect to our brokerage and policyholder services, we earn service fees for underwriting and administering workers’ compensation insurance plans for insurance companies. Service fees are generally based on a percentage of estimated ultimate reference premiums written, meaning they are based on the full amount of a policy premium as it is booked by an insurance carrier client at the time the policy is issued, reduced by an allowance for estimated commission income that may be returned by us to the client due to estimated net reductions in estimated total premium for the term of the policy, principally associated with mid-term policy cancellations. With respect to our insurance carrier clients who record written premium as premium is collected, we recognize fee income as the premium is written and collected, reduced by an allowance for estimated commission income that may be returned by us to such clients due to net returns of premiums previously written and collected. In each case, we record the revenue effects of subsequent premium adjustments when such adjustments become known. We also earn service fees on a flat annual fee basis for establishing and administering segregated portfolio cell reinsurance arrangements for captive reinsurers that assume a portion of the underwriting risk from our insurance carrier clients.
other operating expenses incurred in connection with our service offerings, consisting primarily of office rent, temporary labor costs, consulting fees and other expenses;
amortization of loan discounts and loan costs associated with loan agreements and of the estimated value of equity interests issued pursuant to loan agreements; and
The following table sets forth certain consolidated statement of operations data derived from our audited consolidated financial statements included elsewhere in this Annual Report on Form 10-K.
Total Fee Income and Fee Income from Related Party. Total fee income and fee income from related party for the year ended December 31, 2015 was $209.8 million compared to $102.7 million for the year ended December 31, 2014, an increase of $107.1 million or approximately 104%. The increase was primarily due to increased overall revenue in organic growth, acquisition revenue and fee income from related party.
For the year ended December 31, 2015, approximately 69% of our total fee income and fee income from related party was attributable to our contracts with Guarantee Insurance, a related party, and approximately 7% of our total fee income and fee income from related party was attributable to contracts with our second largest client.
This increase was attributable to non-related party fee income from businesses acquired during 2015 of $26.9 million, an increase in fee income earned by the Patriot Care Management Business from non-related parties of $24.7 million, which was acquired on August 6, 2014, and an increase in brokerage and policyholder services and claims administration services fee income earned from non-related parties of $15.4 million.
The increase was principally attributable to an increase of $41.3 million of brokerage and policyholders services fee income from Guarantee Insurance. On August 6, 2014 we entered into a new agreement with Guarantee Insurance to provide all of our brokerage and policyholder services to Guarantee Insurance, with no such contract existing previously during 2014. The increase was partially offset by a decrease of $3.1 million of claims administration services fee income earned from Guarantee Insurance for the year ended December 31, 2015.
Net Investment Income. Net investment income was $0.1 million for the year ended December 31, 2015 compared to $0.5 million for the year ended December 31, 2014, a decrease of $0.4 million. Net investment income for the year ended December 31, 2015 was principally attributable to investment income of cash on hand.
Salaries and Salary Related Expenses. Salaries and salary related expenses for the year ended December 31, 2015 were $77.6 million compared to $32.4 million for the year ended December 31, 2014, an increase of $45.2 million or approximately 140%.
The increase in salary for the year ended December 31, 2015 is the primarily the result of acquiring seventeen (17) companies during the year and increasing the corporate staff to complete and absorb those acquisitions. Additionally, August 6, 2014, we began to directly incur salary and salary related costs associated with our brokerage and policyholder services, as well as salary and salary related costs associated with administrative support services, including executive management, information technology, accounting, human resources and legal services. Previously, we received an allocation for such brokerage and policyholder services costs from Guarantee Insurance Group as described under “-Allocation of Marketing, Underwriting and Policy Issuance Costs from Related Party” below, and a portion of such administrative support services costs was incurred in the form of a management fee paid to Guarantee Insurance Group as described under “-Management Fees to Related Party for Administrative Support Services” below. Salary and salary related costs further increased in the period since August 6, 2014 as a result of the new agreement we entered into with Guarantee Insurance to provide all of our brokerage and policyholder services to Guarantee Insurance, as described elsewhere in this 10-K. In addition, effective August 6, 2014, we acquired the Patriot Care Management Business, which has notably increased our workforce. Accordingly, we expect further significant increases in salaries and salary related costs going forward.
Business on August 6, 2014 and, accordingly such costs were only incurred for the period of August 6, 2014 through December 31, 2014 during the previous year compared with a full year of expense for the year ending December 31, 2015.
Allocation of Marketing, Underwriting and Policy Issuance Costs from Related Party. Allocation of marketing, underwriting and policy issuance costs from Guarantee Insurance Group, a related party, for the year ended December 31, 2015 was $0.0 million compared to $1.9 million for the year ended December 31, 2014, a decrease of $1.9 million or 100%.
Amortization of Loan Discounts and Loan Costs. Amortization of loan discounts and loan costs was $0.4 million for the year ended December 31, 2015 compared to $2.2 million for the year ended December 31, 2014, a decrease of $1.8 million.
Costs Related to Extinguishment of Debt. The Company recognized expenses for “make-whole” payments upon repayment of the PennantPark Debt and UBS Debt on January 22, 2015. These expenses were comprised of $3.8 million to the PennantPark Entities and $0.6 million to UBS. Additionally, the Company recognized expenses for the write-off of existing deferred financing of $6.3 million and original issue discounts of $3.1 million associated with the PennantPark Debt and UBS Debt upon repayment on January 22, 2015. Due to the non-recurring nature of these expenses, they are presented separately from interest expense and amortization expense, respectively, in our consolidated results for the twelve months ended December 31, 2015. Total cost from debt payoff was $13.7 million for the year ended December 31, 2015.
The “maximum potential earnout payables” of $15.2 million as of December 31, 2015 represents the maximum amount of additional consideration that could be paid pursuant to the terms of the purchase agreement for the applicable acquisition. The “recorded earnout payables” of $11.6 million as of December 31, 2015 are primarily based upon the estimated future operating results of the acquired entities over a one- to three-year period subsequent to the acquisition date. The recorded earnout payables are measured at fair value as of the acquisition date and are included on that basis in the total recorded purchase price in the foregoing table. We will record subsequent changes in these estimated earnout obligations, including the accretion of discount, in our statement of operations when incurred.
Income Tax Expense. Income tax expense was $4.9 million for the year ended December 31, 2015 compared to $11.6 million for the year ended December 31, 2014, a decrease in income tax expense of $6.7 million. Income tax expense for the year ended December 31, 2015 and 2014 was principally comprised of federal income tax expense at a statutory federal rate of 34% and 35%, respectively, and state income tax expense, plus the tax expense associated with the increase in valuation allowance as described in Note 16 to our consolidated financial statements, “Income Taxes.”
Prior to November 27, 2013, certain of our subsidiaries were S Corporations or limited liability companies, electing to be taxed as pass through entities and, accordingly, we did not recognize a federal or state income tax provision for these subsidiaries for the previous portion of the year ended December 31, 2013.
As a result of the factors described above, net income (loss) decreased by $15.8 million to a net loss of $5.4 million for the year ended December 31, 2015 as compared to net income of $10.4 million for the prior year.
Fee Income. Fee income, which represents fee income from non-related parties, for the year ended December 31, 2014 was $55.8 million versus $46.5 million for the year ended December 31, 2013, an increase of $9.3 million.
Our prices by customer for our brokerage and policyholder services and claims administration services were unchanged for the year ended December 31, 2014 relative to the years ended December 31, 2013 and, accordingly, the net increase in fee income was related to changes in the volume of business we managed.
Net Investment Income. Net investment income was $0.1 million for the year ended December 31, 2015 compared to $0.5 million for the year ended December 31, 2014, a decrease of $0.4 million. Net investment income for the year ended December 31, 2015 was principally attributable to investment income of cash on hand. Net investment income was $0.5 million for the year ended December 31, 2014 compared to $0.1 million for the year ended December 31, 2013, an increase of $0.4 million. Net investment income for the year ended December 31, 2014 was principally attributable to interest received in respect of a note receivable from Guarantee Insurance under the Surplus Note, which was retired in connection with the GUI Acquisition effective August 6, 2014.
Net realized gains (losses) on investments was $14.0 million for the year ended December 31, 2014, compared to a loss of $0.1 million for the year ended December 31, 2013. The gain recorded in the year ended December 31, 2014 represents the net gain realized upon the redemption of the MCMC preferred equity in connection with the Patriot Care Management Acquisition.
Interest Expense. Interest expense for the year ended December 31, 2014 was $9.2 million compared to $1.2 million for the year ended December 31, 2013, an increase of $8.0 million. Interest expense for the year ended December 31, 2014, is comprised of interest accruing under (i) the Initial Tranche of the PennantPark Loan Agreement entered into on November 27, 2013 in connection with the Reorganization, (ii) the Additional Tranche of the PennantPark Loan Agreement, as amended, entered into on August 6, 2014 in connection with the GUI Acquisition and (iii) the UBS Credit Agreement entered into on August 6, 2014 in connection with the Patriot Care Management Acquisition, all described elsewhere in this 10-K. We expect a significant reduction of interest expense in the future, due to lower debt balances and interest rates associated with our current Senior Secured Credit Facility, as discussed in Note 7 to our consolidated financial statements, “Notes Payable and Lines of Credit.”
Depreciation and Amortization. Depreciation and amortization for the year ended December 31, 2014 was $5.9 million compared to $2.6 million for the year ended December 31, 2013, an increase of $3.3 million. The increase was attributable mainly to an increase
Our principal needs for liquidity have been, and for the foreseeable future will continue to be, working capital, capital expenditures and funding potential acquisitions, potential redemption of detachable common stock warrants, as well as servicing our senior secured credit facility. Our primary sources of liquidity include cash flows from operations and available cash and cash equivalents.
We believe that our cash flow from operations and available cash and cash equivalents will be sufficient to meet our liquidity needs for at least the next twelve (12) months. As of December 31, 2015, our unrestricted cash and cash equivalents were $8.4 million, and investments in equity and fixed income securities of $3.2 million. In addition, as of December 31, 2015, we had $16.1 million of restricted cash, which are funds we receive from our insurance carrier clients and that are earmarked exclusively for payments of claims on behalf of such clients. We cannot use such funds for other purposes.
The following table summarizes our cash flow activities for the years ended December 31, 2015, 2014 and 2013.
Net cash provided by operating activities for the year ended December 31, 2015 was $2.6 million compared to $24.4 million for the year ended December 31, 2014, a decrease of $21.8 million. The decrease was attributable to an increase of $24.3 million in Adjusted EBITDA discussed above, partially offset by a $ 5.7 million decrease in interest expense discussed above and by changes in certain assets and liabilities, principally fee income receivable from related party, income taxes payable and accounts payable, accrued expenses, and other liabilities.
Net cash provided by financing activities for the year ended December 31, 2015 was $94.3 million compared to $37.8 million for the year ended December 31, 2014, an increase of $56.5 million. The increase was principally attributable to $107.3 million of net proceeds from borrowings under the BMO Credit Agreement in connection with the seventeen (17) acquisitions described elsewhere (see Note 3 to our consolidated financial statements, “Business Combinations”) in this 10-K, $98.3 million in equity proceeds from the initial public offering, net of $3.7 million in issuance costs, $119.6 million in repayment of notes payable, and repayment of $2.5 million in capital leases.
Net cash provided by financing activities for the year ended December 31, 2014 was $37.8 million compared to $22.7 million for the year ended December 31, 2013, an increase of $15.1 million. The increase was principally attributable to $51.2 million of net proceeds from borrowings under the UBS Credit Agreement in connection with the acquisition of PCM as described elsewhere (see Note 7 to our consolidated financial statements, “Notes Payable and Lines of Credit”) in this 10-K, and a $5.3 million decrease in distributions to members and dividends to common stockholders paid during the year ended December 31, 2013. This was partially offset by a $3.7 million increase in loan financing fees and costs incurred in connection with the initial public offering for the year ended December 31, 2014 versus the year ended December 31, 2013.
The senior secured credit facility contains certain covenants that, among other things and subject to significant exceptions, limit our ability and the ability of our restricted subsidiaries to engage in certain business and financing activities and that require us to maintain certain financial covenants, including requirements to maintain (i) a maximum total leverage ratio of total outstanding debt to adjusted EBITDA for the most recently-ended four fiscal quarters of no more than 300% and (ii) a minimum fixed charge coverage ratio of adjusted EBITDA to the sum of cash interest expense (which amount shall be calculated on an annualized basis for the three, six and nine month periods ending March 31, 2015, June 30, 2015, September 30, 2015 and December 31, 2015) plus income tax expense (or less any income tax benefits) plus capital expenditures plus dividends, share repurchases and other restricted payments plus regularly scheduled principal payments of debt for the same period of a least 150% for the most recently-ended four quarters. The senior secured credit facility allows us to pay dividends in an amount up to 50% of our net income if certain other financial conditions are met. The senior secured credit facility contains other restrictive covenants, including those regarding indebtedness (including capital leases) and guarantees; liens; operating leases; investments and acquisitions; loans and advances; mergers, consolidations and other fundamental changes; sales of assets; transactions with affiliates; no material changes in nature of business; dividends and distributions, stock repurchases, and other restricted payments; change in name, jurisdiction of organization or fiscal year; burdensome agreements;. and capital expenditures. The senior secured credit facility also has events of default that may result in acceleration of the borrowings thereunder, including (i) nonpayment of principal, interest, fees or other amounts (subject to customary grace periods for items other than principal); (ii) failure to perform or observe covenants set forth in the loan documentation (subject to customary grace periods for certain affirmative covenants); (iii) any representation or warranty proving to have been incorrect in any material respect when made; (iv) cross-default to other indebtedness and contingent obligations in an aggregate amount in excess of an amount to be agreed upon; (v) bankruptcy and insolvency defaults (with grace period for involuntary proceedings); (vi) inability to pay debts; (vii) monetary judgment defaults in excess of an agreed upon amount; (viii) ERISA defaults; (ix) change of control; (x) actual invalidity or unenforceability of any loan document, any security interest on any material portion of the collateral or asserted (by any loan party) invalidity or unenforceability of any security interest on any collateral; (xi) actual or asserted (by any loan party) invalidity or unenforceability of any guaranty; (xii) material unpaid, final judgments that have not been vacated, discharged, stayed or bonded pending appeal within a specified number of days after the entry thereof; and (xiii) any other event of default agreed to by us and the Administrative Agent.
The preparation of financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Such estimates and assumptions could
change in the future as more information becomes known and such changes could impact the amounts reported and disclosed herein. Adjustments related to changes in estimates are reflected in our results of operations in the period in which those estimates changed.
Brokerage and Policyholder Services. We generate fee income for underwriting and servicing workers’ compensation insurance policies for insurance companies, based on a percentage of premiums each writes for its customers. Brokerage and policyholder services are, in all material respects, provided prior to the issuance or renewal of the related policy. For insurance carrier clients who record written premium on the effective date of the policy based on the estimated total premium for the term of the policy, we recognize fee income on the effective date of the related insurance policy reduced by an allowance for estimated commission income that may be returned by us to such clients due to estimated net reduction in estimated total premium for the term of the policy, principally associated with mid-term policy cancellations. For insurance carrier clients who record written premium as premium is collected, we recognize fee income as the premium is collected, reduced by an allowance for estimated commission income that may be returned by us to such clients due to net returns of premiums previously written and collected. In each case, we record the revenue effects of subsequent premium adjustments when such adjustments become known.
Generally, as a historical matter, the policies we produced for our Other Carriers featured payment plans that spanned the term of the policy. Because we record the revenue from the brokerage and policyholder services as premium is collected, we estimated nominal commission income would be returned to clients due to net reductions in total premium for the term of the policy, typically associated with mid-term policy cancellations. Accordingly, we did not maintain an allowance for estimated return commission income on business produced for our Other Carriers prior to August 6, 2014.
Fee income earned from Guarantee Insurance for brokerage and policyholder services historically represents fees for soliciting applications for workers’ compensation insurance for Guarantee Insurance pursuant to a prior producer agreement that we acquired as part of the GUI Acquisition, based on a percentage of premiums written or other amounts negotiated by the parties. This agreement was terminated effective August 6, 2014. Following the GUI Acquisition, we entered into a new agreement with Guarantee Insurance effective August 6, 2014 to provide all of our brokerage and policyholder services. Accordingly, we expect further significant increases in fee income from related party going forward.
The allocation of marketing, underwriting and policy issuance costs from related party in our consolidated statements of operations represents costs reimbursed to Guarantee Insurance Group for rent and certain corporate administrative services. Management fees paid to related party for administrative support services in our consolidated statements of operations represent amounts paid to Guarantee Insurance Group for management oversight, legal, accounting, human resources and technology support services.
Fixed assets are stated at cost, less accumulated depreciation. Expenditures for furniture and fixtures, software and computer equipment are capitalized and depreciated on a straight-line basis over a seven, three, or five-year estimated useful life, respectively. Expenditures for leasehold improvements on office space and facilities leased by Guarantee Insurance Group but utilized by us are capitalized and amortized on a straight-line basis over the term of Guarantee Insurance Group’s lease.
Other long term assets, which are solely comprised of capitalized policy and claims administration system development costs are also stated at cost, net of accumulated depreciation. Expenditures for capitalized policy and claims administration system development costs are capitalized and amortized on a straight line basis over a five-year estimated useful life.
Basic earnings per share is based on weighted average shares outstanding and excludes dilutive effects of detachable common stock warrants. Diluted earnings per share assumes the exercise of all detachable common stock warrants using the treasury stock method.
Due to the net loss of $5.4 million reported for the year ended December 31, 2015, weighted average outstanding equity grants representing 215,865 shares of common stock and weighted average warrants representing 10,685 shares of common stock were not dilutive. As a result, basic and diluted earnings per share both reflect a net loss of $0.20 per share for the year ended December31, 2015. Due to $1.8 million expense resulting from the increase in fair value of warrants for the year ended December 31, 2014, weighted average outstanding detachable common stock warrants representing 1,109,445 shares of common stock outstanding were not dilutive. Due to a net loss for the year ended December 31, 2013 weighted average outstanding detachable common stock warrants representing 646,949 shares of common stock outstanding were not dilutive.
In February, 2016 The FASB issued an Accounting Standards Update (ASU) intended to improve financial reporting about leasing transactions. The ASU affects all companies and other organizations that lease assets such as real estate, airplanes, and manufacturing equipment. The ASU will require organizations that lease assets-referred to as “lessees”-to recognize on the balance sheet the assets and liabilities for the rights and obligations created by those leases. Under the new guidance, a lessee will be required
In April 2014, the FASB issued ASU 2014-08, “Reporting Discontinued Operations”, regarding ASC Topic 205, Presentation of Financial Statements, and ASC Topic 360, Property, Plant and Equipment. The updated guidance related to reporting discontinued operations and disclosures of disposals of components of an entity. Under the amendment, only those disposals of components of an entity that represents a strategic shift that has (or will have) a major effect on an entity’s operations and financial results will be reported as discontinued operations in the financial statements. Additionally, the elimination of the component's operations, cash flows and significant continuing involvement conditions have been removed. Further, an equity method investment could be reported as discontinued operations. The updated guidance is effective prospectively for all disposals or classifications as held for sale that occur
within annual periods beginning after December 15, 2014. The adoption of this guidance has not had a material impact on our consolidated financial statements.
The Company offers two types of services: front-end services, such as brokerage, underwriting and policyholder services, and back-end services, such as claims adjudication and administration. We provide our services either on an individual basis, as bundles of two or more services tailored to a client’s specific needs or on a turnkey basis where we provide a comprehensive set of front-end and back-end services to a client. We also offer specialty services currently including technology outsourcing and other IT services, as well as employment pre-screening and background checks. As a service company, we do not assume any underwriting or insurance risk.
the parent company, Patriot National (formerly Old Guard Risk Services, Inc.), which was formed on November 15, 2013,
Assets and liabilities attributable to Patriot National, PSI, PRS, Contego, Forza and Patriot Captive Management are included in the accompanying consolidated balance sheets as of December 31, 2014,
The fixed assets and other long term assets acquired from GUI, the capital lease obligation assumed from GUI are included in the accompanying consolidated balance sheets as of December 31, 2014, and all other assets and liabilities of GUI, which were not acquired by the Company on August 6, 2014, are not included in the accompanying consolidated balance sheets as of December 31, 2014,
We generate fee income for services for insurance and reinsurance companies and other clients, including (i) claims investigative services, generally based on an hourly rate, (ii) loss control management services, based on a percentage of premium, (iii) workers’ compensation claimant transportation and translation services, generally based on an hourly rate, (iv) workers’ compensation claims subrogation services, based on a percentage of subrogation recovered on the date of recovery, (v) workers’ compensation claims legal bill review, based on a percentage of savings on the date that savings are established and (vi) certain other services, based on a fixed monthly fee. We generate fee income for negotiating and settling liens placed by medical providers on workers’ compensation claims for insurance and reinsurance companies and other clients, based on a percentage of savings resulting from the settlement of the lien. We recognize revenue from claims investigations, loss control service administration, claimant transportation and translation, claims subrogation services, workers’ compensation claims lien negotiations and reinsurance management services in the period that the services are provided.
Fee income earned from Guarantee Insurance for claims administration services is based on the net portion of claims expense retained by Guarantee Insurance pursuant to quota share reinsurance agreements between Guarantee Insurance, our third party insurance carrier clients and the segregated portfolio cell reinsurers that assume business written by Guarantee Insurance and such third party carriers. Certain fee income earned from segregated portfolio cell reinsurers is remitted to us by Guarantee Insurance on behalf of the segregated portfolio cell reinsurers.
Fixed assets are stated at cost, less accumulated depreciation. Expenditures for furniture and fixtures and computer equipment are capitalized and depreciated on a straight-line basis over a seven and five-year estimated useful life. Expenditures for leasehold improvements on office space and facilities are capitalized and amortized on a straight-line basis over the term of the lease.
Another subsidiary of ours is domiciled in a non-U.S. jurisdiction and, accordingly, is not subject to U.S. federal income taxes. We have no current intention of distributing unremitted earnings of this subsidiary to its U.S. domiciled parent. The cumulative net loss from this foreign subsidiary is approximately $0.3 million. Additionally, we believe that it is not practical to calculate the potential liability associated with such distribution due to the fact that dividends received from this subsidiary could bring additional foreign tax credits, which could ultimately reduce the U.S. tax cost of the dividend, and significant judgment is required to analyze any additional local withholding tax and other indirect tax consequences that may arise due to the distribution of these earnings. Accordingly, pursuant to ASC 740 (Tax Provisions), deferred taxes have not been provided for these undistributed foreign earnings in our consolidated statements of operations for the years ended December 31, 2015, 2014 and 2013.
The income tax benefit in our consolidated statements of operations, included elsewhere in this Annual Report on Form 10-K, includes a provision for income taxes attributable to the revenues and expenses associated with the contracts and certain other assets acquired and liabilities assumed in the GUI Acquisition, as if GUI were included in our consolidated federal income tax return.
We recognized $1.2 million of expense for public offering costs in the year ended December 31, 2015, reflecting expenses incurred for the proposed secondary offering, which management terminated prior to completion. Costs incurred for the initial public offering were applied to net proceeds in the computation of equity.
In February, 2016 The FASB issued an Accounting Standards Update (ASU) intended to improve financial reporting about leasing transactions. The ASU affects all companies and other organizations that lease assets such as real estate, airplanes, and manufacturing
The ASU on leases will take effect for public companies for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. For all other organizations, the ASU on leases will take effect for fiscal years beginning after December 15, 2019, and for interim periods within fiscal years beginning after December 15, 2020. Early application will be permitted for all organizations. The company is currently reviewing the impact that implementing this ASU will have.
The Company acquired DecisionUR from Six Points Investment Partners, LLC, a company under common control. However, results of operations for DecisionUR are included from acquisition date, as its operations are immaterial with respect to the financial statements taken as a whole for all periods presented.
In connection with the acquisition of Vikaran we also agreed to purchase all of the outstanding stock of Mehta and Pazol Consulting Services Private Limited (“MPCS”), an Indian company which holds Vikaran’s software development center located in Pune, India, for a purchase price of approximately $1.5 million. We consummated the purchase of 51% of the MPCS stock, treated as a deemed dividend for the common control interest contributed by Mr. Mariano.
The fair value of these earnout obligations is based on the present value of the expected future payments to be made to the sellers of the acquired entities in accordance with the provisions outlined in the respective purchase agreements, which is a Level 3 fair value measurement, as discussed further in Note 11, Fair Value of Financial Assets and Liabilities. In determining fair value, we estimated the acquired entity’s future performance using financial projections developed by management for the acquired entity and market participant assumptions that were derived for revenue growth and/or profitability. We estimated future payments using the earnout formula and performance targets specified in each purchase agreement and these financial projections. We then discounted these payments to present value using a risk-adjusted rate that takes into consideration market-based rates of return that reflect the ability of the acquired entity to achieve the targets. Changes in financial projections, market participant assumptions for revenue growth and/or profitability, or the risk-adjusted discount rate, would result in a change in the fair value of recorded earnout obligations.
The net assets acquired are preliminary and subject to measurement period adjustments.
In accordance with FASB ASC 350, Intangibles-Goodwill and Other, intangible assets, which are comprised of the estimated fair value of the service contracts acquired, customer and carrier relationships, non-compete agreements, developed technology and trade names are being amortized over the respective estimated life, ranging from two to ten years, in a manner that, in management’s opinion, reflects the pattern in which the intangible asset’s future economic benefits are expected to be realized. Intangible assets are tested for impairment at least annually (more frequently if certain indicators are present). In the event that management determines that the value of the intangible asset has become impaired, the company will incur an accounting charge for the amount of impairment during the fiscal quarter in which the determination is made.
acquisitions. The fair value of non-compete agreements was established using estimated financial projections for the acquired company based on market participant assumptions and various non-compete scenarios.
Our consolidated financial statements for the year ended December 31, 2015 include the operations of the acquired entities from their respective acquisition dates, totaling $36.0 million of revenues and $2.0 million of net loss.
Effective August 6, 2014, the Company acquired (i) all of GUI’s inforce contracts with third party insurance companies and, with respect to the aforementioned producer agreement, Guarantee Insurance and (ii) GUI’s capitalized policy and claims administration system development costs, computer equipment and leasehold improvements for approximately $55.1 million.
Additionally, effective August 6, 2014, the Company entered into an agreement to provide marketing, underwriting and policy issuance services to Guarantee Insurance. Revenues and expenses associated with this agreement are reflected in the accompanying consolidated statement of operation for the years ended December 31, 2015 and 2014.
The consideration paid in excess of SPV2’s carrying amounts for the net assets acquired as of August 6, 2014, which was charged to equity as a deemed dividend, was as follows (in thousands):
The acquisition of PCM was accounted for by application of the acquisition method as required by FASB ASC 805, Business Combinations. Pursuant to FASB ASC 805, Business Combinations, assets acquired and liabilities assumed are generally recorded at their fair values as of the effective date of the acquisition. The fair values of identifiable tangible assets acquired and liabilities assumed were approximately equal to book values. The estimated fair value of the customer contracts acquired from MCRS Holdings, Inc. was recorded as an identifiable intangible asset, and the associated deferred tax liability was recorded as an identifiable liability.
Goodwill as of August 6, 2014, recognized as a result of the acquisition, was as follows (in thousands):
We periodically review all fixed assets and other long term assets that have finite lives for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. Upon sale or retirement, the cost and related accumulated depreciation and amortization of assets disposed of are removed from the accounts, and any resulting gain or loss is reflected in earnings.
Goodwill represents the excess of consideration paid over the fair value of net assets acquired. Goodwill is not amortized, but is tested at least annually for impairment (or more frequently if certain indicators are present or management otherwise believes it is appropriate to do so). In the event that management determines that the value of goodwill has become impaired, we will record a charge for the amount of impairment during the fiscal quarter in which the determination is made. We determined that there was no impairment required as of December 31, 2015.
The Company acquired $56.6 million of goodwill during the year ended December 31, 2015 as a result of the seventeen acquisitions discussed in Note 3, Business Combinations. The company acquired $51.5 million of Goodwill in 2014 as a result of the acquisition of Patriot Care, Inc. There were no Goodwill impairments for the years ended December 31, 2015 or 2014. Changes in goodwill are summarized as follows:
On January 22, 2015, we entered into a Credit Agreement with BMO Harris Bank N.A., as administrative agent (the “Administrative Agent”), and the other lenders party thereto, which provides for a $40.0 million revolving credit facility and a $40.0 million term loan facility (the “Senior Secured Credit Facility”). The Senior Secured Credit Facility has a maturity of five years, and borrowings thereunder bear interest, at our option, at LIBOR plus a margin ranging from 250 basis points to 325 basis points or at base rate plus a margin ranging from 150 basis points to 225 basis points. Margins on all loans and fees will be increased by 2% per annum during the existence of an event of default. The revolving credit facility includes borrowing capacity available for letters of credit and borrowings on same-day notice, referred to as swing line loans. At any time prior to maturity, we have the right to increase the size of the revolving credit facility or the term loan facility by an aggregate amount of up to $20.0 million, but in minimum increments of $5.0 million. As of June 30, 2015, we increased the term loan facility by $20.0 million through two $10.0 million incremental term loans. Additionally, on August 14, 2015, we entered into a second amendment to our Senior Secured Credit Facility (the “Second Amendment”) which provides for an additional $50.0 million of term loans plus the ability to increase the term loan by and additional $50.0 million under certain conditions. The Second Amendment also added a requirement that until we deliver a certificate certifying that (a) our total leverage ratio is equal to or less than 2.25 to 1.00 and (b) our Adjusted EBITDA for the twelve-months then ended is at least $70.0 million, the outstanding revolving loans (plus any swing line loans and the aggregate stated amount of all letters of credit) shall not exceed $30.0 million. On December 23,2015 we entered into a third amendment, which permits Patriot to exercise the provisions of the Rescission and Exchange Agreement for the private placement of company stock and warrants, and related Back-to-Back Agreement with the selling shareholder, as described in Related Party transactions. On March 3, 2016, we entered into a fourth amendment, which permits Patriot to repurchase shares of its outstanding common stock pursuant to certain volume and timing limitations. All other material terms and conditions in the Senior Secured Credit Facility were unchanged by the amendments.
As of December 31, 2015, the outstanding balance under our Senior Secured Credit Facility was $124.5 million (comprised of $106.5 million outstanding under the term loan facility and $18.0 million outstanding under the revolving credit facility). Accordingly, we had $22.0 million available to borrow under the revolving credit facility.
is extended). This latter 0.125% fee is payable to the issuer of the letter of credit for its own account, along with any standard documentary and processing charges incurred in connection with any letter of credit.
The term loan facility amortizes quarterly beginning the first full quarter after the closing date at a rate of 5% per annum of the original principal amount during the first two years, 7.5% per annum of the original principal amount during the third and fourth years and 10% per annum of the original principal amount during the fifth year, with the remainder due at maturity. Principal amounts outstanding under the revolving credit facility are due and payable in full at maturity. In the event of any sale or other disposition by us or our subsidiaries guaranteeing the Senior Secured Credit Facility (as described below) of any assets with certain exceptions, we are required to prepay all proceeds received from such a sale towards the remaining scheduled payments of the term loan facility.
Additionally, all obligations under the Senior Secured Credit Facility (as described below) are guaranteed by all of our existing and future subsidiaries, other than foreign subsidiaries to the extent the assets of such foreign subsidiaries do not exceed 5% of our and our subsidiaries’ total assets on a consolidated basis, and secured by a first-priority perfected security interest in substantially all of our and our guaranteeing subsidiaries’ tangible and intangible assets, whether now owned or hereafter acquired, including a pledge of 100% of the stock of each guarantor.
The Senior Secured Credit Facility contains certain covenants that, among other things and subject to significant exceptions, limit our ability and the ability of our restricted subsidiaries to engage in certain business and financing activities and that require us to maintain certain financial covenants, including requirements to maintain (i) a maximum total leverage ratio of total outstanding debt to adjusted EBITDA for the most recently-ended four fiscal quarters of no more than 300% and (ii) a minimum fixed charge coverage ratio of adjusted EBITDA to the sum of cash interest expense (which amount shall be calculated on an annualized basis for the three-, six-, and nine-month periods ended March 31, 2015, June 30, 2015 and September 30, 2015) plus income tax expense (or less any income tax benefits) plus capital expenditures plus dividends, share repurchases and other restricted payments plus regularly scheduled principal payments of debt for the same period of a least 150% for the most recently ended four quarters. The Senior Secured Credit Facility allows us to pay dividends in an amount up to 50% of our net income if certain other financial conditions are met.
The Senior Secured Credit Facility contains other restrictive covenants, including those regarding: indebtedness (including capital leases) and guarantees; liens; operating leases; investments and acquisitions; loans and advances; mergers, consolidations and other fundamental changes; sales of assets; transactions with affiliates; no material changes in nature of business; dividends and distributions, stock repurchases, and other restricted payments; change in name, jurisdiction of organization or fiscal year; burdensome agreements; and capital expenditures.
As of December 31, 2015, we were in compliance with the financial and other restrictive covenants under our outstanding material debt obligations, including our Senior Secured Credit Facility.
On August 6, 2014, in connection with the GUI Acquisition, we and certain of our subsidiaries, as borrowers, and certain of our other subsidiaries and certain affiliated entities, as guarantors, entered into a loan agreement with the PennantPark Entities as lenders (the “PennantPark Loan Agreement”). Following our IPO, we prepaid all outstanding borrowings under the PennantPark Loan Agreement, including accrued interest and applicable prepayment premium. This instrument was repaid in full on January 22, 2015 upon closing on the Senior Secured Credit Facility.
On January 15, 2015, the Board of Directors approved the Patriot National 2014 Omnibus Incentive Plan (the “Omnibus Incentive Plan”), subject to and with effect upon approval of such plan by the stockholders of the Company.
The Compensation Committee of our Board of Directors determines the participants under the Omnibus Incentive Plan. The Omnibus Incentive Plan provides for non-qualified and incentive stock options, restricted stock and restricted stock units, any or all of which may be made contingent upon the achievement of performance criteria. Subject to the Omnibus Incentive Plan limits, the compensation committee has the discretionary authority to determine the size of an award and on May 11, 2015 delegated the authority to Steven Mariano, our President, to award grants to Non-Section 16 officers without the consent of the Compensation Committee.
For the twelve months ended December 31, 2015, we awarded 1,377,848 options, of which 173,139 were forfeited, leaving 1,204,709 outstanding. As of December 31, 2015, there were 39,706 options that were exercisable with an average exercisable price of $14.00 and unvested options of 1,165,003. At December 31, 2015 the intrinsic value of these options was $0.0.
For the twelve months ended December 31, 2015, we issued 907,919 restricted share awards as incentive compensation for officers, directors, and certain key employees. Subsequent to issuance, 43,052 restricted shares were forfeited and 310,652 were settled leaving 554,215 remaining restricted shares outstanding as of December 31, 2015. The fair value of outstanding restricted shares at December 31, 2015 was $3.7 million.
As of December 31, 2015, we recognized $7.9 million of stock compensation expense associated with these restricted shares, and there was $4.3 million of total unrecognized stock compensation cost related to unvested restricted stock to be recognized over a period of 2.3 years.
inputs other than quoted prices that are observable for the security (e.g., interest rates, yield curves observable at commonly quoted intervals, volatilities, prepayment speeds, credit risks and default rates).
inputs derived from or corroborated by observable market data by correlation or other means.
As of March 14, 2016 Steven M. Mariano, our founder, Chief Executive Officer and Chairman, beneficially owned 53.8% of the outstanding shares of our common stock and substantially all of the outstanding equity of Guarantee Insurance Group. As a result, our transactions with Guarantee Insurance Group and its subsidiaries, including Guarantee Insurance and GUI, are related party transactions. Mr. Mariano received dividends of $3.5 million from Guarantee Insurance Group in 2015.
We provide brokerage and policyholder services and claims administration services to Guarantee Insurance pursuant to the Services Agreements and the Program Administrator Agreement. See “Business-Clients-Guarantee Insurance Company.” We have been providing a full range of brokerage and policyholder services to Guarantee Insurance pursuant to the Program Administrator Agreement since August 6, 2014.
Pursuant to the Services Agreements, we provide our services in connection with claims arising out of insurance policies held or underwritten by Guarantee Insurance. The Services Agreements have various terms and expiration dates ranging from 2018 to 2022, unless otherwise extended or earlier terminated as provided therein. The fees we receive are based, depending on the service provided, upon a percentage of reference premium, flat monthly fees, hourly fees or the savings we achieve, among others.
Because fee income from related party for claims administration services is based on the net portion of claims expense retained by Guarantee Insurance, as described in Note 13, Concentration, the Company’s revenues attributable to contracts with Guarantee Insurance do not necessarily represent fee income from related party.
During the year ended December 31, 2015, Patriot completed and amended agreements between its operating subsidiaries and Guarantee Insurance Company in the normal course of business. These include an agreement and subsequent amendments to the agreement effective January 1, 2015 between Guarantee and Patriot Care Management regarding fees for medical bill review services, and agreements between Guarantee and Patriot Underwriters regarding fees for premium audit services and commission expenses for policy production.
Effective August 6, 2014, in connection with the GUI Acquisition, Guarantee Insurance Group assigned to us its rights, and we assumed its obligations under, the master equipment lease agreement, dated as of December 3, 2013, by and among Fifth Third Bank, as lessor, and Guarantee Insurance Group and Mr. Mariano, as co-lessees, which was incurred in respect of the IE system. As co-lessee, Mr. Mariano has agreed, among other things, to maintain no less than $5.0 million of liquidity as long as any obligations are outstanding under this agreement. As of December 31, 2015, the aggregate amount of lease financings pursuant to this agreement was $2.2 million.
On August 6, 2014, in connection with the Patriot Care Management Acquisition, we and certain of our subsidiaries entered into the UBS Credit Agreement, which provided for a five-year term loan facility in an aggregate principal amount of $57.0 million that would mature on August 6, 2019. The loan was secured by the common stock of PCM and guaranteed by Guarantee Insurance Group and its wholly owned subsidiaries. Following our IPO, we prepaid all outstanding borrowings under the UBS Credit Agreement, including accrued interest and applicable prepayment premium. On January 22, 2015, in connection with our IPO, we repaid all outstanding borrowings under the Agreement.
On August 6, 2014, in connection with the GUI Acquisition, we and certain of our subsidiaries, as borrowers, and certain of our other subsidiaries and certain affiliated entities, as guarantors, entered into the PennantPark Loan Agreement with the PennantPark Entities, as lenders. Following our IPO, we prepaid all outstanding borrowings under the PennantPark Loan Agreement, including accrued interest and applicable prepayment premium. On January 22, 2015, in connection with our IPO, we repaid all outstanding borrowings under the Agreement.
On August 6, 2014, we acquired the Patriot Care Management Business. The Patriot Care Management Business had been previously controlled by Mr. Mariano and was sold to MCMC, a third party, in 2011. A portion of the consideration received by Mr. Mariano and other stockholders in that sale consisted of MCMC preferred equity. As part of the Patriot Care Management Acquisition we issued 3,043,485 of our shares in exchange for MCMC preferred equity to the holders of such preferred equity, including Mr. Mariano, Mr. Del Pizzo and his spouse Arlene Del Pizzo, Mr. Shanfelter, Mr. Ermatinger, Mr. Grandstaff and Mr. Pesch, as consideration for such preferred equity. See “Business -Our History and Organization.”
Pursuant to a managed care services agreement, dated as of August 6, 2014, we outsource certain medical bill review and related services to MCMC. Mr. Mariano is party to the agreement with respect to certain exclusivity and non-compete provisions. The agreement remains in effect through December 31, 2019 unless earlier terminated by us or MCMC upon 30 days’ written notice for material breach. Subsequent to such initial term the agreement may be terminated by either party upon 90 days’ prior written notice to the other party.
On August 21, 2015, we acquired Global HR Research LLC (“Global HR”) for an aggregate purchase price of $42.0 million payable in cash and shares of our common stock. One of our independent directors, Austin J. Shanfelter, indirectly controlled Global HR through his ownership of owned 84% of the equity interests in ITH, which owned 75.5% of the equity interests of Global HR. Upon closing, Mr. Shanfelter, through In Touch, received aggregate proceeds of approximately $28.2 million from the sale of Global HR to us, comprised of shares of our common stock and cash. In addition, In Touch will forfeit and return a portion of the consideration to us if Global HR does not meet certain targets.
Del Pizzo & Associates P.C., a tax advisory firm wholly owned by Mr. Del Pizzo, one of our directors, has received payments from us in the amount of approximately $185,100 in the year ended December 31, 2015 for tax advisory services it performed in fiscal year 2015 in respect of entities that are now our subsidiaries. Del Pizzo & Associates P.C. will continue providing similar services for fiscal year 2016.
In addition, on December 23, 2015, we and Steven M. Mariano amended the Stock Back-to-Back Agreement, pursuant to which, upon the exercise of the New Warrants, we would purchase a number of shares of our common stock owned by Steven M. Mariano equal to 100% of the shares to be issued in connection with the exercise by the PIPE investors of the New Warrants.See Item 7, “Management’s Discussion and Analysis of Financial Conditions and Results of Operations-Recent Events.”
In addition, we and Steven M. Mariano amended the Stock Back-to-Back Agreement, pursuant to which, upon the exercise of the New Warrants, we would purchase a number of shares of our common stock owned by Steven M. Mariano equal to 100% of the shares to be issued in connection with the exercise by the PIPE investors of the New Warrants, resulting in no dilution for our existing shareholders.
In addition, the Exchange Agreement amended the registration rights agreement to provide the PIPE investors with registration rights to register the shares issuable upon exercise of the New Warrants, subject to penalties and other customary provisions. We also entered into a third amendment to our existing credit agreement to permit these transactions under the covenants included therein.
On December 23, 2015, we also entered into a Voting Agreement with Steven M. Mariano, pursuant to which Steven M. Mariano agreed to vote in favor of issuances of shares of common stock in the event that, as a result of an increase in the number of shares that may be purchased upon exercise of the New Warrants to the Adjusted Share Amount (as defined in the New Warrants), such number of shares would exceed the Exchange Cap (as defined in the New Warrants).
Our board of directors has adopted a written Related Person Transaction Policy to assist it in reviewing, approving and ratifying transactions with related persons and to assist us in the preparation of related disclosures required by the SEC. This Related Person Transaction Policy supplements our other policies that may apply to transactions with related persons, such as the Corporate Governance Guidelines of our board of directors and our Code of Business Conduct and Ethics.
The Related Person Transaction Policy provides that all transactions with related persons covered by the policy must be reviewed and approved and ratified by the Audit Committee or disinterested members of the board of directors and that any employment relationship or transaction involving an executive officer and any related compensation must be approved or recommended for the approval of the board of directors by the Compensation Committee.
the importance of the transaction both to the Company and to the related person;
any other matters that management or the Audit Committee or disinterested directors, as applicable, deem appropriate.
Generally, the Related Person Transaction Policy applies to any current or proposed transaction in which:
any related person (i.e., a director, director nominee, executive officer, greater than 5% beneficial owner and any immediate family member of such person) had or will have a direct or indirect material interest.
As of December 31, 2015, approximately 77% of fee income receivable and fee income receivable from related party was attributable to contracts with Guarantee Insurance, the Company’s largest customer and a related party, and approximately 3% of fee income receivable and fee income receivable from related party were attributable to contracts with the Company’s second largest customer. As of December 31, 2014, approximately 86% of fee income receivable and fee income receivable from related party was attributable to contracts with Guarantee Insurance, the Company’s largest customer and a related party, and approximately 8% and 2% of fee income receivable and fee income receivable from related party were attributable to contracts with the Company’s second and third largest customers, respectively. As of December 31, 2013, approximately 62% of fee income receivable and fee income receivable from related party was attributable to contracts with Guarantee Insurance, the Company’s largest customer and a related party, and approximately 23% and 11% of fee income receivable and fee income receivable from related party were attributable to contracts with the Company’s second and third largest customers, respectively. Management believes that the receivable balances
Because fee income from related party for claims administration services is based on the net portion of claims expense retained by Guarantee Insurance, the Company’s revenues attributable to contracts with Guarantee Insurance do not necessarily represent fee income from related party.
In connection with the Senior Secured Credit Facility as described in Note 7, Notes Payable and Lines of Credit, the common stock of the Company and the common stock or units of each of the Company’s wholly and majority owned subsidiaries were pledged as collateral.
In the normal course of business, the Company may be party to various legal actions that management believes will not result in any material effect on the Company’s financial position or results of operations.
As of December 31, 2015, the estimated fair value of Series A and Series B warrant redemption liabilities was $28.1 million. Our analysis of Series A and Series B warrant value was calculated using a Monte Carlo simulation of Patriot's daily common stock price in the adjustment period. The stock price was assumed to follow Geometric Brownian Motion with drift equal to the risk-free rate and
volatility estimated from Patriot's historical volatility and volatilities of comparable companies. The fair value of the warrants were estimated as the average value from all 100,000 simulations using Black Scholes.
On December 13, 2015 we entered into a securities purchase agreement (the “Securities Purchase Agreement”) with Steven M. Mariano, our President and Chief Executive Officer, and the PIPE investors pursuant to which the PIPE investors purchased (i) 2,500,000 shares of our common stock from Steven M. Mariano, for an aggregate purchase price of approximately $30 million, and (ii) 666,666 shares of our common stock, warrants to purchase up to an aggregate of 2,083,333 shares of our common stock (the “Old Series A Warrants”) and prepaid warrants for 1,000,000 shares of our common stock (the “Old Series B Warrants” and, together with the Old Series A Warrants, the “Old Warrants”), for an aggregate purchase price of approximately $20 million. In addition, we entered into an agreement (the “Stock Back-to-Back Agreement”) with Steven M. Mariano, pursuant to which, upon the exercise of the Old Warrants, we would purchase a number of shares of our common stock owned by Steven M. Mariano equal to 60% of the shares to be issued in connection with the exercise by the PIPE investors of the Old Warrants.
On December 23, 2015 we entered into several rescission and exchange agreements (collectively, the “Exchange Agreement”) with Steven M. Mariano and the PIPE investors pursuant to which (i) we and the PIPE investors rescinded the sale and purchase of 666,666 shares of our common stock and prepaid warrants for 1,000,000 shares of our common stock and (ii) we exchanged the Old Series A Warrant for new warrants to purchase up to an aggregate of 3,250,000 shares of our common stock (the “New Series A Warrants”), and the Old Series B Warrant for new prepaid warrants to purchase a number of shares that the holder could purchase at a price equal to 90% of the lowest 10-day volume-weighted average stock price during the period commencing on February 1, 2016 through and including the Adjustment Time (as defined in the New Series B Warrants, which we expect to end at 9:00 A.M. on the tenth trading day after the filing of this Annual Report on Form 10-K) less the number of shares such holder purchased, in each case subject to adjustments and limitations pursuant to their terms. Based on the 10-day volume-weighted average stock price during the period commencing on February 1, 2016 through March 17, 2016 of $4.51, we estimate that 4,895,985 shares of our common stock would be issuable upon exercise of the New Series B Warrants.
The New Series A Warrants are exercisable at an exercise price of the lesser of (i) $10.00 and (ii) 85% of the market price of the shares (as defined in the New Warrants), from July 1, 2016 to December 31, 2020. The New Series B Warrants are exercisable at an exercise price of $0.01 from December 16, 2015 to December 31, 2020. The exercise price of the New Warrants is subject to adjustment in the case of stock splits, stock dividends, combinations of shares and similar recapitalization transactions.
There was no PennantPark warrant redemption liability as of December 31, 2015. Concurrent with our IPO and repayment of the PennantPark Loan Agreement on January 22, 2015, the PennantPark Entities exercised 965,700 of their 1,110,555 detachable common stock warrants for common stock at an exercise price of $2.67 per share. The PennantPark Entities waived their put right on the remaining 144,855 detachable common stock warrants. By eliminating the put right, the PennantPark Entities could not require the Company to redeem the remaining detachable common stock warrants for cash, thereby eliminating the warrant redemption liability previously required. The remaining 144,855 detachable common stock warrants were exercised on November 24, 2015 in a cashless exercise to purchase shares of the Company’s common stock at an exercise price of $2.67.
On November 27, 2013, the Company issued 626,295 detachable common stock warrants to new lenders to purchase shares of the Company’s common stock at an exercise price of $2.67 per share. The warrants expire on November 27, 2023. Prior to the exercise and removal of the put right, at the fifth anniversary date of the warrants and any time after the eighth anniversary date of the warrants, the warrant holders could have required the Company to redeem the warrants for cash, in an amount equal to the estimated fair value of the warrants, as determined by an independent appraisal, less the total exercise price of the redeemed warrants. The value of the warrants was recorded as a discount on the loan and a warrant liability on November 27, 2013. The discount on the loan was amortized as interest expense over the term of the loan. The Company attributed a value to these warrants of approximately $7.3 million as of December 31, 2014.
On August 6, 2014, in connection with the additional tranche described in Note 7, Notes Payable and Lines of Credit, the Company issued 484,260 detachable common stock warrants to the PennantPark Entities to purchase shares of the Company’s common stock at an exercise price of $2.67 per share. The warrants expire on November 27, 2023. Prior to the exercise and removal of the put right, at
the fifth anniversary date of the warrants and any time after the eighth anniversary date of the warrants, the warrant holders could have required the Company to redeem the warrants for cash, in an amount equal to the estimated fair value of the warrants, as determined by an independent appraisal, less the total exercise price of the redeemed warrants. The value of the warrants was recorded as a discount on the loan and a warrant liability on August 6, 2014. The discount on the loan was amortized as interest expense over the term of the loan. The Company attributed a value to these warrants of approximately $5.6 million as of December 31, 2014.
Our analysis of PennantPark warrant value and put value is based on a combination of the market approach and the income approach to determine the value of PNI common stock at the Valuation Date, and the application of an option pricing model using Black Scholes to determine the value of one warrant at the Valuation Date. We relied in part upon the estimated IPO value developed by the underwriter, which was based on the underwriter’s comparative company analysis, a market approach; the discounted future returns method primarily relies on the Company’s financial estimates; the terminal values used in the discounted future returns method are derived using the underwriter’s estimate based upon its analysis of comparative public companies, and the guideline public company method.
A reconciliation of the provision for income taxes with the U.S. Federal statutory income tax rate is as follows (in thousands, except percentages):
At December 31, 2015 we assessed the tax rates used to compute our deferred tax assets and liabilities. We made adjustments to reflect the appropriate realizable benefit which resulted in a $1.4 million impact on our effective tax rate as detailed above.
At December 31, 2015 and 2014, the Company had no unrecognized tax benefits and no amounts recorded for uncertain tax positions. The Company’s policy is to recognize interest and penalties related to uncertain tax positions within the income tax expense line in the accompanying Consolidated Statement of Operations. The tax period from inception (November 15, 2013) to December 31, 2013 remains subject to examination by all of the Company’s tax jurisdictions.
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of our deferred tax assets and liabilities are as follows (in thousands):
The unaudited supplemental pro forma income tax benefit has been presented in accordance with Section 3410.1 (under the headings 3400, Special Applications and 3410, Sub-Chapter S Corporations and Partnerships) of the SEC Division of Corporation Finance Financial Reporting Manual. The unaudited supplemental pro forma income tax benefit gives effect to the tax treatment of the Company’s Subchapter S corporation and limited liability company subsidiaries as if they were subject to federal and state income taxes for the year ended December 31, 2013.
The sum of quarterly EPS may not agree with the years’ EPS.
On February 9, 2016, pursuant to the Securities Purchase Agreement, the Exchange Agreement and the registration rights agreement, as amended by the Exchange Agreement, a registration statement initially filed on January 15, 2016 was declared effective pursuant to which we registered 10,348,794 shares of our common stock under the Securities Act, which includes 7,848,794 shares of common stock issuable upon exercise of the New Warrants held by the PIPE Investors.
On March 1, 2016, we entered into an Amendment No. 3 to the TriGen Stock Purchase Agreement accelerating and reducing the final payment to the Class B Seller.
On March 3, 2016, we entered into a fourth amendment to our existing credit agreement to permit Patriot to repurchase shares of its outstanding common stock pursuant to certain volume and timing limitations.