At December 31, 2013, Fortegra Financial leased its principal executive offices located at Deerwood Park Boulevard, Building 100, Jacksonville, Florida, 32256, consisting of approximately 58,000 square feet. In addition, we lease approximately 56,000 square feet of office space in approximately seven locations in the United States. We believe our properties, detailed in the table below, are adequate for our business as presently conducted.
(1) - Lease expiration dates represent the current ending date of the current lease period. For some of the leases listed, Fortegra has the option to renew the lease beyond the current expiration date in accordance with the terms set forth in the lease agreement.
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 and should be read in conjunction with the Consolidated Financial Statements and Notes thereto included in ITEM 8 of this Form 10-K. 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 "ITEM 1A. Risk Factors" included in this Form 10-K.
The following provides an overview of events and financial results for the year ended December 31, 2013:
In October 2013, our subsidiary, South Bay entered into a $15.0 million line of credit agreement (the "Line of Credit") with Synovus Bank. The Line of Credit is used for our premium financing product, and allows South Bay to finance up to 90% of the eligible receivable.
On December 31, 2013, we completed the previously announced sale of all of the issued and outstanding stock of our subsidiaries, Bliss and Glennon and eReinsure, to AmWINS (the "Disposition"), pursuant to the terms of the Purchase Agreement, and recognized a $8.8 million gain on the sale of discontinued operations, net of tax, for the year ended December 31, 2013. As consideration for the Disposition, we received net cash proceeds of $81.8 million, which we utilized on December 31, 2013 to pay off the full amount outstanding under our existing credit facility with Wells Fargo Bank, N.A. See the Notes, "Summary of Significant Accounting Policies - Discontinued Operations" and "Divestitures" in the Notes to Consolidated Financial Statements, included in ITEM 8 of this Form 10-K for additional information.
Prior to the fourth quarter of 2013, we operated in three business segments: (i) Payment Protection, (ii) Business Process Outsourcing and (iii) Brokerage. In connection with the Disposition, in the fourth quarter of 2013, we realigned our reporting structure to manage our business as a single profit center called Protection Products and Services. Accordingly, we now have one reportable segment. See the Note, "Summary of Significant Accounting Policies" of the Notes to the Consolidated Financial Statements included in ITEM 8 of this Form 10-K for additional information.
Net income attributable to Fortegra Financial Corporation for the year ended December 31, 2013 increased $7.6 million, or 49.8%, to $22.7 million from $15.2 million for the year ended December 31, 2012. Earnings per diluted share attributable to Fortegra Financial Corporation increased 50% to $1.11 for the year ended December 31, 2013 from $0.74 for the same period in 2012. Our 2013 results include the impact of an $8.8 million gain, net of tax, or $0.43 per diluted share, from the Disposition, while 2012 included the $1.0 million benefit from the change in accounting estimate, or $0.05 per diluted share.
Our net income from continuing operations before non-controlling interests for the year ended December 31, 2013 decreased $1.2 million, or 8.9%, to $11.8 million from $13.0 million for the year ended December 31, 2012. Our 2013 net income was lower due to $0.8 million of expense from the Plan, while our 2012 results included a $1.0 million benefit from a change in accounting estimate. The 2013 net income attributable to the ProtectCELL and 4Warranty acquisitions of $4.8 million on a combined basis was largely offset by competitive pressures in other product lines and regulatory changes influencing our clients' marketing and outsourcing activities.
Total expenses increased $93.7 million, or 39.6%, to $330.4 million for the year ended December 31, 2013 from $236.7 million for the same period in 2012. The majority of the increase was due to the ProtectCELL and 4Warranty acquisitions, which added $89.9 million and $1.5 million to expenses, respectively, as well an $8.5 million increase in commission expense, which corresponds with the rise in revenues. In addition, 2013 expenses also included $1.2 million in costs associated with the Plan.
of the need to make estimates about the effect of matters that are inherently uncertain. If actual performance should differ from historical experience or if the underlying assumptions were to change, our financial condition and results of operations may be materially impacted. In addition, some accounting policies require significant judgment to apply complex principles of accounting to certain transactions, such as acquisitions, in determining the most appropriate accounting treatment. We believe that the significant accounting estimates and policies described below are material to our financial reporting and are subject to a degree of subjectivity and/or complexity. We also discuss our critical accounting policies and estimates with the Audit Committee of the Board of Directors.
During the period ended September 30, 2012, we reviewed our unearned premium reserves in relation to the loss patterns and the related recognition of income for certain types of credit property and vendor single interest payment protection products, and based on our analysis determined that a change to the Rule of 78's method results in a more accurate estimate of net earned premium reserves for these products. The change was accounted for as a change in accounting estimate and was applied prospectively. See the Note, "Summary of Significant Accounting Policies" of the Notes to the Consolidated Financial Statements included in ITEM 8 of this Form 10-K for the effect of this change in accounting estimate on our 2012 results of operations.
We regularly monitor our investment portfolio to ensure investments that may be other-than-temporarily impaired ("OTTI") are identified in a timely fashion, properly valued, and if necessary, written down to their fair value through a charge against earnings in the proper period. The determination that a security has incurred an other-than-temporary decline in fair value requires the judgment of management. The analysis takes into account relevant factors, both quantitative and qualitative in nature. Among the factors considered are the following: the length of time and the extent to which fair value has been less than cost; issuer-specific considerations, including an issuer's short-term prospects and financial condition, recent news that may have an adverse impact on its results, and an event of missed or late payment or default; the occurrence of a significant economic event that may affect the industry in which an issuer participates; and for loan-backed and structured securities, the undiscounted estimated future cash flows as compared to the current book value. When such impairments are determined to be other-than-temporary, the decrease in fair value is reported in net income as a realized investment loss and a new cost basis is established.
There are inherent risks and uncertainties involved in making these judgments. Changes in circumstances and critical assumptions such as a continued weak economy, a more pronounced economic downturn or unforeseen events, which affect one or more companies, industry sectors or countries could result in additional impairments in future periods for other-than-temporary declines in fair value. See the Note, "Investments" in the Notes to Consolidated Financial Statements included in ITEM 8 of this Form 10-K for additional information and ITEM 1A. RISK FACTORS - "Risks Related to Our Products and Services - Our investment portfolio is subject to several risks that may diminish the fair value of our invested assets and cash and may materially and adversely affect our business and profitability" and "Liquidity and Capital Resources - Liquidity" contained elsewhere in this Form 10-K.
We evaluate whether deferred acquisition costs-insurance related are recoverable at year-end, and periodically if deemed necessary, and consider investment income in the recoverability analysis. As a result of our evaluations, no write-offs for unrecoverable deferred acquisition costs were recognized during the years ended December 31, 2013, 2012 and 2011.
Goodwill represents the excess cost of an acquisition over the fair value of the net assets acquired in a business combination, and is carried as an asset on the Consolidated Balance Sheets. Goodwill is not amortized, but is reviewed for impairment annually in the fourth quarter, or more frequently if certain indicators arise.
Our goodwill impairment analysis typically involves an assessment of qualitative factors to determine whether it is more likely than not that fair value of our reporting unit is less than the recorded book value. If it is more likely than not, we must perform a quantitative test to determine fair value. If that fair value is less than the book value of the reporting unit, an impairment charge is recorded equal to the excess of the carrying amount of goodwill over its implied fair value. At its discretion, management may opt to bypass the qualitative analysis and perform the quantitative test.
We have acquired significant other intangible assets through business acquisitions. Our other intangible assets consist of indefinite-lived trademarks and licenses, and of finite-lived intangibles, including customer related and contract based assets representing primarily client lists and non-compete arrangements and acquired software. Finite-lived intangible assets are amortized over periods ranging from 0.3 years to 15 years. Certain trademarks are not amortized since these assets have been determined to have indefinite useful lives. The costs to periodically renew other intangible assets are expensed as incurred.
Management assessed other intangible assets as of December 31, 2013, 2012 and 2011 and determined that no impairment existed as of those dates.
analysis, an aggregate change that is greater than ± 10% (or 5% for each of loss frequency and severity) is not probable. The effect of higher and lower levels of loss frequency and severity levels on our ultimate cost for claims occurring in 2013 would be as follows (dollars in thousands):
Deferred revenues represent the portion of income that will be earned in the future attributable to motor club memberships, mobile device protection plans, and other non-insurance service contracts that are earned over the respective contract periods using Rule of 78's, modified Rule of 78's, pro rata, or other methods as appropriate for the contract. A deficiency reserve would be recorded if anticipated contract benefits, deferred acquisition costs and contract service costs exceed the recorded deferred revenues and anticipated investment income. As of December 31, 2013 and 2012, no deficiency reserve was recorded.
A deferred tax asset should be reduced by a valuation allowance if, based on the weight of all available evidence, it is more likely than not that some portion or all of the deferred tax asset will not be realized. The valuation allowance should be sufficient to reduce the deferred tax asset to the amount that is more likely than not to be realized. In determining whether our deferred tax asset is realizable, we considered all available evidence, including both positive and negative evidence. The realization of deferred tax assets depends upon the existence of sufficient taxable income of the same character during the carry-back or carry-forward period. We considered all sources of taxable income available to realize the deferred tax asset, including the future reversal of existing temporary differences, future taxable income exclusive of reversing temporary differences and carry forwards, taxable income in carry-back years and tax-planning strategies.
Management has evaluated its deferred tax assets to determine realization in the foreseeable future and accordingly, no valuation allowance has been established as of December 31, 2013. The detailed components of our deferred tax assets and liabilities are shown in the Note, "Income Taxes" in the Notes to Consolidated Financial Statements included in ITEM 8 of this Form 10-K.
Management evaluates each contingent matter separately. A loss is reported if reasonably estimable and probable. We establish reserves for these contingencies at the best estimate, or, if no one estimated number within the range of possible losses is more probable than any other, we report an estimated reserve at the midpoint of the estimated range. Contingencies affecting us include litigation matters, which are inherently difficult to evaluate and are subject to significant changes.
We earn service and administrative fees from a variety of activities. Such fees are typically positively correlated with transaction volume and are recognized as revenue as they become both realized and earned.
Service Fees. Service fee revenue is recognized as the services are performed. These services include fulfillment, software development, and claims handling for our customers. Collateral tracking fee income is recognized when the service is performed and billed. Management reviews the financial results under each significant contract on a monthly basis. Any losses that may occur due to a specific contract would be recognized in the period in which the loss occurs. During the years ended December 31, 2013, 2012 and 2011 we have not incurred a loss with respect to a specific significant service fee contract.
We earn ceding commissions on our credit insurance products. Ceding commissions earned under coinsurance agreements are based on contractual formulas that take into account, in part, underwriting performance and investment returns experienced by the assuming companies. As experience changes, adjustments to the ceding commissions are reflected in the period incurred. Experience adjustments are based on the claim experience of the related policy. The adjustment is calculated by adding the earned premium and investment income from the assets held in trust for our benefit less earned commissions, incurred claims and the reinsurer's fee for the coverage.
We elect to cede to reinsurers under coinsurance arrangements a significant portion of the credit insurance that we distribute on behalf of our clients. We continue to provide all policy administration for credit insurance that we cede to reinsurers. Ceding commissions primarily represent the fees we charge the reinsurers for that administration service. In addition, a portion of the ceding commissions is determined based on the underwriting profits of the ceded credit insurance. The credit insurance that we distribute has historically generated attractive underwriting profits. Ceding commissions also include investment income earned on reserves maintained in trust accounts on the balance sheets of the reinsurers.
The principal factors affecting net earned premiums are: (i) the proportion of the risk assumed by our reinsurers as defined in the applicable reinsurance treaty; (ii) increases and decreases in written premium; (iii) the pattern of losses by type of business, (iv) increases and decreases in policy cancellation rates; (v) the average duration of the policies written; and (vi) changes in regulation that would modify the earning patterns for the policies underwritten and administered.
We currently have time-based stock options outstanding under our 2005 Equity Incentive Plan and time-based and performance-based stock options and restricted stock awards outstanding under The 2010 Omnibus Incentive Plan. Time-based stock options and restricted stock awards are grants that vest based on the passage of time whereas performance-based stock options and restricted stock awards are grants that vest based on us attaining certain financial metrics. Stock-based compensation expense is measured using fair value and is recorded over the requisite service or performance period of the awards. We measure stock-based compensation expense using the calculated value method. Under this method, we estimate the fair value of each stock option on the grant date using the Black-Scholes valuation model. We use historical data to estimate expected employee behavior related to stock award exercises and forfeitures. Since there is not sufficient historical market experience for shares of our stock, we have chosen to estimate volatility, by using the average volatility of a selected peer group of publicly traded companies operating in the same industry. Expected dividends are based
on the assumption that no dividends are expected to be distributed in the near future. The risk-free rate is based on the U.S. Treasury yield curve in effect at the time of grant for periods corresponding with the expected life of the options. The fair value of restricted stock awards are based on the market price of our common stock at the grant date. We typically recognize stock-based compensation expense for time-based awards on a straight-line basis over the requisite service and on a graded vesting attribution model for performance-based awards. Our current policy is to issue new shares upon the exercise of stock options. Please see the Note, "Stock-Based Compensation" in the Notes to Consolidated Financial Statements included in ITEM 8 of this Form 10-K for additional information.
The following provides an overview of the components of revenues and expenses that are not discussed in our Critical Accounting Policies section.
Unpaid claims are reserve estimates that are established in accordance with U.S. GAAP using generally accepted actuarial methods. Credit life and AD&D unpaid claims reserves include claims in the course of settlement and IBNR. Credit disability unpaid claims reserves also include continuing claim reserves for open disability claims. For all other product lines, unpaid claims reserves are bulk reserves and are entirely IBNR. We use a number of algorithms in establishing our unpaid claims reserves. These algorithms are used to calculate unpaid claims as a function of paid losses, earned premium, target loss ratios, in-force amounts, unearned premium reserves, industry recognized morbidity tables or a combination of these factors.
Depreciation and amortization expense is the allocation of the capitalized cost of property, equipment and software over the periods benefited by the use of the asset.
The following tables set forth our Consolidated Statements of Income for the following periods:
Service and administrative fees for the year ended December 31, 2013 increased $81.9 million, or 90.4%, to $172.4 million from $90.6 million for the year ended December 31, 2012. The increase resulted primarily from $82.8 million and $3.1 million in 2013 revenues attributable to ProtectCELL and 4Warranty, respectively, which was partially offset by a $3.0 million decrease in our insurance company client revenues and motor club membership revenues of $1.6 million.
Service and administrative fees for the year ended December 31, 2012 decreased $3.9 million, or 4.1%, to $90.6 million from $94.5 million for the year ended December 31, 2011. The decrease resulted primarily from a $5.6 million decrease in our motor club membership revenues and $0.7 million related to the sale of Creative Investigations Recovery Group, LLC ("CIRG") in July 2011. This decrease was partially offset by a $2.7 million increase in administrative fees from our acquisition of PBG in October 2011.
Ceding commissions for the year ended December 31, 2013 decreased $2.0 million, or 5.7%, to $32.8 million from $34.8 million for the year ended December 31, 2012. This decrease primarily resulted from the change in accounting estimate, which increased 2012 results by $2.8 million. For the year ended December 31, 2013, ceding commissions included $25.0 million in service and administrative fees, $6.9 million in underwriting profits and $0.9 million in net investment income.
Ceding commissions for the year ended December 31, 2012 increased $5.3 million, or 18.1%, to $34.8 million from $29.5 million for the year ended December 31, 2011. This increase primarily resulted from improved underwriting results due to growth in earned premiums and favorable loss experience along with additional administrative fees earned from increased insurance production in 2012, and the change in accounting estimate, which accounted for $2.8 million of the increase. For the year ended December 31, 2012, ceding commissions included $25.6 million in service and administrative fees, $8.6 million in underwriting profits and $0.6 million in net investment income.
Net investment income totaled $3.1 million for the years ended December 31, 2013 and 2012, respectively. The amount of invested assets increased in 2013 compared to 2012, which was offset by a decrease in yields for the 2013 period. The yield on the investment portfolio at December 31, 2013 was 1.83% compared to 2.67% at December 31, 2012.
Net investment income for the year ended December 31, 2012 decreased $0.3 million, or 8.9%, to $3.1 million compared to $3.4 million for the year ended December 31, 2011. The decrease from 2011 was principally due to lower income earned on fixed income securities and to a lesser extent a lower amount of income earned on cash. The yield on the investment portfolio at December 31, 2012 was 2.67% compared to 2.88% at December 31, 2011.
Net realized gains on the sale of investments totaled $2.0 million for the year ended December 31, 2013 compared to net realized gains of $3.0 thousand for the year ended December 31, 2012. The increase for 2013 was due to higher levels of investment sales occurring in 2013. The net gain for 2012 included a $16.0 thousand net realized loss attributable to an OTTI charge for the write-down of a single equity security.
Net realized gains on the sale of investments totaled $3.0 thousand for the year ended December 31, 2012 compared to net realized gains of $4.2 million for the year ended December 31, 2011. The decrease for 2012 was due to higher levels of investment sales occurring in 2011 that were not repeated in 2012. The net gain for 2011 included a $0.2 million net realized loss attributable to an OTTI charge for the write-down of ten equity securities.
Other income for the year ended December 31, 2012 increased $0.1 million, or 58.2%, to $0.3 million from $0.2 million for 2011.
Net losses and loss adjustment expenses for the year ended December 31, 2012 increased $2.3 million, or 6.0% to $40.2 million, from $37.9 million for the year ended December 31, 2011. Our net losses and loss adjustment expense ratio of 31.5% in 2012 was similar to prior periods. The increase in net losses and loss adjustment expenses was primarily driven by increased earned premiums and warranty claims. For the 2012 period, our direct and assumed losses increased by $4.6 million, or 5.6%, as compared with the same period in 2011. For the 2012 period, our ceded losses were higher by $2.3 million, or 5.2%, compared with the same period in 2011, partially offsetting the increase in direct and assumed losses. On average, we maintained a 53.5% and 53.6% overall cession rate of direct and assumed losses and loss adjustment expenses for the years ended December 31, 2012 and 2011, respectively.
Member benefit claims for the year ended December 31, 2013 increased $41.4 million, or 891.4%, to $46.0 million, from $4.6 million for the year ended December 31, 2012. The increase resulted principally from ProtectCELL’s cost of member benefits claims attributable to the cost of replacement devices and associated claims handling and fulfillment costs.
Commissions for the year ended December 31, 2013 increased $25.9 million, or 20.1%, to $154.6 million, from $128.7 million for the year ended December 31, 2012. The increase in 2013 resulted primarily from $16.9 million and $0.4 million in commissions attributable to ProtectCELL and 4Warranty, respectively, and comparable period over period growth of $13.0 million from the revenue increases in credit insurance and warranty service contracts, while 2012 was higher due to the additional $3.9 million of commission expense resulting from the change in accounting estimate.
Commissions for the year ended December 31, 2012 increased $1.8 million, or 1.4%, to $128.7 million, from $126.9 million for the year ended December 31, 2011. The increase for 2012, compared to 2011, resulted from growth in net earned premiums and from the change in accounting estimate, which increased commissions for 2012 by $3.9 million.
Personnel costs for the year ended December 31, 2012 increased $2.5 million, or 9.4%, to $28.5 million from $26.0 million for the year ended December 31, 2011. The increase resulted primarily from $1.9 million for the 2011 PBG acquisition and the increased headcount across the business. In addition, the sale of CIRG in 2011 reduced personnel costs in 2012 by $0.3 million. Total employees of our continuing operations at December 31, 2012 increased to 397 (which excludes the employees of ProtectCELL and 4Warranty) compared to 355 at December 31, 2011. Stock-based compensation expense included in personnel costs totaled $0.7 million and $0.6 million for the year ended December 31, 2012 and 2011, respectively.
Other operating expenses for the year ended December 31, 2012 increased $0.5 million, or 2.1%, to $24.2 million from $23.7 million for the year ended December 31, 2011. Other operating expenses declined by $2.6 million led by transaction costs and other one-time
Depreciation and amortization expense for the year ended December 31, 2013 increased $1.6 million or 48.3% to $4.9 million from $3.3 million for the year ended December 31, 2012. The increase for both periods compared to the same prior year periods was due to higher levels of depreciable and amortizable assets in service during 2013 compared to 2012, with $1.1 million of the increase attributable to internally developed software.
Depreciation and amortization expense for the year ended December 31, 2012 increased $0.6 million or 23.0% to $3.3 million from
$2.7 million for the year ended December 31, 2011, with the increase attributable to higher levels of depreciable and amortizable assets in service during 2012 compared to 2011.
Amortization expense on intangibles for the year ended December 31, 2013 increased $2.8 million or 101.6% to $5.5 million from $2.7 million for the year ended December 31, 2012. The increase was primarily due to the 2012 acquisitions of ProtectCELL and 4Warranty, which increased amortization expense on intangibles by $2.4 million and $0.3 million, respectively.
Interest expense for the year ended December 31, 2012 decreased $0.4 million, or 7.6%, to $4.3 million from $4.7 million for the year ended December 31, 2011 and was positively impacted by a lower interest rate on outstanding borrowings and our new credit facility with Wells Fargo Bank, N.A., which took effect on August 2, 2012. Interest expense in 2011 included the write-off of $0.3 million for capitalized issuance costs associated with the redemption of preferred stock. These decreases were partially offset by a $0.7 million charge to interest expense for previously capitalized transaction costs associated with the termination of the SunTrust Bank, N.A. revolving credit facility in August 2012.
In June 2013, we sold our 100% interest in Magna Insurance Company and realized a gain of $0.4 million.
Income taxes for the year ended December 31, 2013 decreased $1.1 million, or 15.7%, to $5.7 million from $6.7 million for the year ended December 31, 2012, with the decrease primarily attributable to a lower level of pretax income. Our effective tax rate was 32.4% for the year ended December 31, 2013 compared to 34.1% for the same period in 2012 because of the rate impact of the ProtectCELL non-controlling interest.
ended December 31, 2011, with the increase primarily attributable to a higher level of pretax income, and a beneficial tax true-up in 2011. Our effective tax rate was 34.1% for the year ended December 31, 2012 compared to 34.0% for the same period in 2011.
See the Note, "Income Taxes" in the Notes to Consolidated Financial Statements, included in ITEM 8 of this Form 10-K for additional information and a reconciliation of the items impacting our income taxes and our effective tax rate.
On December 31, 2013, we completed the previously announced sale of all of the issued and outstanding stock of our subsidiaries, Bliss and Glennon and eReinsure, to AmWINS (the "Disposition"), pursuant to the terms of the Purchase Agreement, and recognized an $8.8 million gain on the sale of discontinued operations, net of tax, for the year ended December 31, 2013. As consideration for the Disposition, we 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. We utilized the cash proceeds received on December 31, 2013 to pay off our existing credit facility with Wells Fargo Bank, N.A. As a result of 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. Further, we have agreed not to compete with the Bliss and Glennon and eReinsure businesses for five years, and have agreed not to solicit former employees of the divested businesses. The following table provides the amounts related to discontinued operations in the Consolidated Statements of Income for the following periods:
Our primary sources of liquidity include our total investments, cash and cash equivalent balances, availability under our revolving credit facility and dividends and other distributions from our subsidiaries. At December 31, 2013, we had total available-for-sale and short-term investments of $138.8 million, which includes restricted investments of $16.5 million. In addition, we had cash and cash equivalents of $21.7 million and $86.7 million of available capacity on our credit facility. At December 31, 2012, we had total investments of $118.1 million, which included restricted investments of $17.9 million. In addition, we had cash and cash equivalents of $15.2 million and $34.3 million of available capacity on our revolving credit facility. Our total indebtedness was $38.3 million at
December 31, 2013 compared to $124.4 million at December 31, 2012. The decrease in our outstanding indebtedness was due to the utilization of the proceeds from the Disposition to pay off the full balance on the Wells Fargo Bank, N.A. credit facility.
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 FDIC regardless of account balance through the Transaction Account Guarantee ("TAG") program created by Section 343 of the Dodd-Frank Wall Street Reform and Consumer Protection Act ("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 after January 1, 2013 may exceed the FDIC's standard $250,000 insurance limit from time to time.
We have an active share repurchase plan, which allows us to purchase up to $15.0 million in total of our common stock to be purchased from time to time through open market or private transactions. For the year ended December 31, 2013, we repurchased 200,000 common shares with an average price of $6.79 per share and a total cost of $1.4 million compared to 508,080 common shares at an average price of $7.72 per share at a total cost of $3.9 million for same period in 2012. See ITEM 5 and the Note, "Share Repurchase Plan," of the Notes to Consolidated Financial Statements, included in this Form 10-K, for more information on the share repurchase plan.
On August 2, 2012, we entered into a five-year secured credit agreement (the "Credit Agreement"), which had an initial capacity of $125.0 million, with a syndicate of lenders, including Wells Fargo Bank, N.A., who also serves as administrative agent ("Wells Fargo" or the "Administrative Agent"). The Credit Agreement was comprised of a $50.0 million term loan facility (the "Term Loan Facility"), and a $75.0 million revolving credit facility (the "Revolving Facility" and collectively with the Term Loan Facility, the "Facilities") with a sub-limit of $10.0 million for swingline loans and $10.0 million for letters of credit. As required by the terms of the Credit Agreement, we used the proceeds from the Disposition to pay off the balances of both the Term Loan Facility and the Revolving Facility. Accordingly, the Term Loan Facility is no longer available for future borrowings, while the Revolving Facility remains available. Subject to earlier termination, the Credit Agreement terminates on August 2, 2017. 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 Facilities by an amount not to exceed $50.0 million. For the benefit of the Administrative Agent and the lenders, the Credit Agreement contains certain customary representations and warranties, as well as financial covenants, which we are required to maintain as of the end of each fiscal quarter.
As of December 31, 2013, 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 8 of this Form 10-K, for additional information on the Credit Agreement's interest rate, terms and financial covenants.
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. We were not permitted to redeem the preferred trust securities until after the June 2012 interest payment date, and we may now redeem the preferred trust securities, in whole 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 is payable quarterly.
The indenture governing the preferred trust securities contains various affirmative and negative covenants, including limitations on the sale of capital stock of our significant subsidiaries, mergers and consolidations and the ability to grant a lien on the capital stock of our significant subsidiaries unless such security interests are secured indebtedness of not more than $20 million, in the aggregate, at any one time. The limitation on the ability to issue, sell or dispose of the capital stock of significant subsidiaries are not applicable if such transactions are made at fair value and we retain at least 80% of the ownership of such subsidiary.
Our investments must comply with applicable laws and regulations, which prescribe the kind, quality and concentration of investments we are permitted to make. 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.
Our investment policy and strategy is reviewed and approved by the board of directors of each of our insurance company subsidiaries on a regular basis in order to review and consider investment activities, tactics and 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. Our investment portfolio is managed by a third-party provider of asset management services, which specializes in the insurance sector. 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. These holdings are supplemented by 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.
Our Consolidated Statements of Cash Flows includes the cash flows from Bliss and Glennon and eReinsure. Our Consolidated Balance Sheets as of December 31, 2013 reflect Bliss and Glennon and eReinsure as discontinued operations.
Net cash used in financing activities was $88.1 million for the year ended December 31, 2013 compared to net cash provided by financing activities of $11.2 million for the year ended December 31, 2012. The cash used in 2013 primarily reflected the use of $101.9 million to pay off our credit facility, with $81.8 million of those funds received from the Disposition and the use of $1.4 million to repurchase 200,000 shares of our common stock under our share repurchase plan. The cash used in financing activities for 2013 was partially offset by borrowings under our lines of credit of $15.8 million.
Net cash provided by financing activities was $11.2 million and $22.6 million for the years ended December 31, 2012 and December 31, 2011, respectively. The decline in cash provided by financing activities in 2012 reflected lower net borrowings under our lines of credit, which was partially offset by the use of $3.9 million to repurchase 508,080 shares of our common stock under our share repurchase plan. Payments and proceeds from our notes payables were also higher for the year ended December 31, 2012, compared to the same period in 2011, due to the payoff of our SunTrust Bank, N.A. revolving credit facility and the entry into the new Wells Fargo Bank, N.A. credit facility.
(2) - Interest payable on total debt is wholly attributable to the amount due on our preferred trust securities at December 31, 2013, since we did not have an outstanding balance on our Wells Fargo Bank, N.A., credit facility. In addition, we considered the amount of
For interest payable on the preferred trust securities, we used the interest rate swap in effect of 7.57% until June 2017, subsequent to that date we utilized the contractual spread amount of 410 basis points plus the 3-month forward LIBOR curve rate.
(4) - Estimated. Net unpaid claims are: total $13,074; less than 1 year $10,972; 1-3 years $2,019; 4-5 years $80; and more than 5 years $3.
We have audited the consolidated balance sheet as of December 31, 2012 and the related consolidated statements of income, comprehensive income, shareholders’ equity, and cash flows for the years ended December 31, 2012 and 2011 of Fortegra Financial Corporation (“the Company”). Our audit also included the financial statement schedules as of December 31, 2012 and for the year ended December 31, 2012 and 2011 listed in the Index at Item 15. These financial statements and schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and schedules based on our audit.
Life of the South Insurance Company ("LOTS") * and its subsidiary, Bankers Life of Louisiana ("Bankers Life") *
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. The following table shows the amount outstanding and the percentage of non-controlling interest by entity:
Income (loss) attributable to these non-controlling interests has been reflected 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.
Certain changes to the Consolidated Balance Sheet amounts for December 31, 2012 have been made in accordance with accounting for business combinations, to reflect the retrospective final valuation adjustments made to the fair values of acquired net assets and the non-controlling interests of ProtectCELL. Please see the Note, "Business Acquisitions," for more information on the final valuation adjustments.
The Company reports operating results and financial data in one operating and one reportable segment, Protection Products and Services. Prior to the fourth quarter of 2013, the Company operated in three business segments: (i) Payment Protection, (ii) Business Process Outsourcing and (iii) Brokerage. In connection with the Company's decision to dispose of Bliss and Glennon, Inc. ("Bliss and Glennon") and eReinsure.com, Inc. ("eReinsure") in the fourth quarter of 2013, the Company realigned its reporting structure, to manage its business as a single profit center. Accordingly, we now have one reportable segment. This change is consistent with the Chief Operating Decision Maker's approach to managing the business and related resources. The Company has determined that it's 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.
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, and recognized a gain related to the sale of these businesses in the line "Gain on sale of discontinued operations - net of tax" in the Consolidated Statements of Income for the year ended December 31, 2013. The operating results of these businesses are reported in the line "Income from discontinued operations - net of tax" in the Consolidated Statements of Income for all periods presented. 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.
In addition, certain assets and liabilities associated with the disposition of Bliss and Glennon and eReinsure that are still subject to final settlement have been reclassified into the line items "Assets of discontinued operations" and "Liabilities of discontinued operations," in the Consolidated Balance Sheet at December 31, 2013. See the Note, "Divestitures," for more information on discontinued operations.
During 2011 and 2012, the Company had increased the volume of business related to these product types, thereby increasing the volume of policy and claims data specific to those product types. During the three months ended September 30, 2012, the Company determined it had accumulated a sufficient volume of policy and claims data to be able to perform an actuarial analysis in order to determine the preferable estimation approach. As a result of the analysis of the additional data, the Company gained better insight into its product loss patterns, resulting in improved judgment and estimation to more accurately calculate the unearned premium reserves and the associated recognition of income. Upon completion of the analysis, Management determined that the Rule of 78's applied on a daily basis provides a more accurate representation of historical loss patterns and the recognition of the related income for these products; as such, the estimation method was changed. The change in approach has been accounted for as a change in accounting estimate that is effected by a change in accounting principle and is justifiable in that it is the preferable approach for income recognition based on the Company's actuarial study. This change in accounting estimate was applied prospectively. Summarized below is the effect of the change in accounting estimate on the Consolidated Statement of Income for the following period:
Fair value is defined in the ASC as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The ASC established a three-level hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). If the inputs used to measure the assets or liabilities fall within different levels of the hierarchy, the classification is based on the lowest level input that is significant to the fair value measurement of the asset or liability. Classification of assets and liabilities within the hierarchy considers the markets in which the assets and liabilities are traded and the reliability and transparency of the assumptions used to determine fair value. The hierarchy requires the use of observable market data when available. The levels of the hierarchy and those investments included in each are as follows:
The Company's policy is to recognize transfers between levels as of the actual date of the event or change in circumstances that caused the transfer.
Cash and cash equivalents and restricted cash: The estimated fair value of cash and cash equivalents and restricted cash approximates their carrying value.
Accounts and premiums receivable, net, and other receivables: The carrying amounts approximate fair value since no interest rate is charged on these short duration assets.
The Company earns service and administrative fees from a variety of activities. Such fees are typically positively correlated with transaction volume and are recognized as revenue as they become both realized and earned.
Service Fees. Service fee revenue is recognized as the services are performed. These services include fulfillment, software development, and claims handling for our customers. Collateral tracking fee income is recognized when the service is performed and billed. Management reviews the financial results under each significant contract on a monthly basis. Any losses that may occur due to a specific contract would be recognized in the period in which the loss is determined probable. During the years ended December 31, 2013, 2012 and 2011, the Company has not incurred a loss with respect to a specific significant service fee contract.
Both fixed maturity securities and equity securities are classified as available-for-sale and carried at fair value with unrealized gains and losses reflected in other comprehensive income, net of tax. The cost of investments sold and any resulting gain or loss is based on the specific identification method and is recognized as of the trade date.
evidence supporting that the decline is not other-than-temporary. Supporting evidence could include a recovery in the investment's fair value subsequent to the date of the statement of financial position, a return of the investee to profitability and the investee's improved financial performance and future prospects (such as earnings trends or recent dividend payments), or the improvement of financial condition and prospects for the investee's geographic region and industry;
issuer-specific considerations, including an event of missed or late payment or default, adverse changes in key financial ratios, an increase in nonperforming loans, a decline in earnings substantially below that of the investee's peers, downgrading of the investee's debt rating or suspension of trading in the security;
with regards to commercial mortgage-backed securities ("CMBS"), the Company also evaluates key assumptions such as breakeven constant default rates and credit enhancement levels. The breakeven constant default rate indicates the percentage of the pool's outstanding loans that must default each and every year with 40 percent loss severity (i.e., a recovery rate of 60 percent) for a CMBS class/tranche to experience its first dollar of principal loss. Credit enhancements indicate how much protection, or "cushion," there is to absorb losses in a particular deal before an actual loss would impact a specific security.
When, in the opinion of management, a decline in the estimated fair value of an investment is considered to be other-than-temporary or management intends to sell or is required to sell the investment prior to the recovery of cost, the investment is written down to its estimated fair value with the impairment loss charged to earnings and included in net realized gains (losses) in the Consolidated Statements of Income. OTTI losses on equity securities and losses related to the credit component of the impairment on fixed maturity securities are recorded in the Consolidated Statements of Income as realized losses on investments and result in a permanent reduction of the cost basis of the underlying investment. Losses relating to the non-credit component of OTTI losses on fixed maturity securities are recorded in accumulated other comprehensive income (loss) ("AOCI") in the Consolidated Balance Sheets. The determination of OTTI is a subjective process, and different judgments and assumptions could affect the fair value determination and the timing of loss realization.
Cash and cash equivalents consist primarily of highly liquid investments, with original maturities of three months or less when purchased. At various times throughout the year, the Company may have cash deposited with financial institutions that exceed the federally insured deposit amount. Management reviews the financial viability of these financial institutions on a periodic basis and does not anticipate nonperformance by the financial institutions. The Company had approximately $18.9 million and $8.2 million of cash in interest bearing money market accounts at December 31, 2013 and 2012, respectively, which exceeded the FDIC insurance limit of $250,000.
Restricted cash primarily represents unremitted premiums received from agents, unremitted claims received from insurers, fiduciary cash for reinsurers and pledged assets for the protection of policy holders in various state jurisdictions. Restricted cash is generally required to be kept in certain bank accounts subject to guidelines, which emphasize capital preservation and liquidity; pursuant to the laws of certain states in which the Company's subsidiaries operate and applicable contractual obligations, such funds are not available to service the Company's debt or for other general corporate purposes. The Company is entitled to retain investment income earned on these fiduciary funds. At December 31, 2013 and 2012, none of the Company's restricted cash was held in interest bearing money market accounts subject to the FDIC insurance limit of $250,000.
Other receivables primarily represent amounts due to the Company from its business partners for retrospective commissions net of allowance and for motor club membership fees.
The Company has various reinsurance agreements in place whereby the amount of risk in excess of the Company's retention goals is reinsured by unrelated domestic and foreign insurance companies. The Company remains liable to policyholders in the event that the assuming companies are unable to meet their obligations. Reinsurance receivables include amounts related to paid benefits, unpaid benefits and prepaid reinsurance premiums. Reinsurance receivables are based upon estimates and are reported on the Consolidated Balance Sheets separately as assets, as reinsurance does not relieve the Company of its legal liability to policyholders. The Company is required to pay losses even if a reinsurer fails to meet its obligations under the applicable reinsurance agreement. Management continually monitors the financial condition and agency ratings of the Company's reinsurers and believes that the reinsurance receivables accrued are collectible. Balances recoverable from reinsurers and amounts ceded to reinsurers relating to the unexpired portion of reinsured policies are presented as assets. Experience refunds from reinsurers are recognized based on the underwriting experience of the underlying contracts.
The Company evaluates whether deferred acquisition costs-insurance related are recoverable at year-end, and considers investment income in the recoverability analysis. As a result of the Company's evaluations, no write-offs for unrecoverable deferred acquisition costs were recognized during the years ending December 31, 2013, 2012 and 2011.
The Company defers certain costs of acquiring new and renewal business related to non-insurance subsidiary transactions. These costs are limited to prepaid direct costs, typically commissions and contract transaction fees, that resulted from successful contract transactions and would not have been incurred by the Company had the transactions not occurred. These capitalized costs are amortized as the related service and administrative fees are earned. The following table shows the amortization of deferred acquisition costs for the Company's non-insurance products:
The Company evaluates whether deferred acquisition costs - non-insurance related are recoverable at year-end. As a result of the Company's evaluations, no write-offs for unrecoverable deferred acquisition costs were recognized during the years ending December 31, 2013, 2012 and 2011.
Property and equipment is carried at cost, net of accumulated depreciation and amortization. Gains and losses on sales and disposals of property and equipment are based on the net book value of the related asset at the disposal date using the specific identification method with the corresponding gain or loss recorded to operations when incurred. Maintenance and repairs, which do not materially extend asset useful life and minor replacements, are charged to earnings when incurred. Depreciation expense is computed using the straight-line method over the estimated useful lives of the respective assets with three years for computers and five years for furniture,
The Company leases certain equipment under a single capital lease. The assets and liabilities under the capital lease are recorded at the lower of the present value of the minimum lease payments or the fair value of the asset. The assets under the capital lease are depreciated over the lesser of the remaining life of the lease or their estimated productive lives.
The Company capitalizes internally developed software costs on a project-by-project basis. Software development costs are carried at unamortized cost and are amortized using the straight-line method over the estimated useful life of the software, typically five years. Amortization begins when the software is ready for its intended use.
Business combinations are accounted for using the purchase method with the related net assets and results of operations being included in the Company’s Consolidated Financial Statements as of the respective acquisition date(s).
The assets acquired may consist of a book of business, management contracts, customer relationships, non-compete agreements, trade name, and the excess of purchase price over the fair value of identifiable net assets acquired, or goodwill (see Summary of Significant Accounting Policies, "Goodwill" for more information ). The determination of estimated useful lives and the allocation of the purchase price to the intangible assets requires significant judgment and affects the amount of future amortization and possible impairment charges.
The Company's goodwill impairment analysis typically involves an assessment of qualitative factors to determine whether it is more likely than not that fair value of our reporting unit is less than the recorded book value. If it is more likely than not, management must perform a quantitative test to determine fair value. If that fair value is less than the book value of the reporting unit, an impairment charge is recorded equal to the excess of the carrying amount of goodwill over its implied fair value. At its discretion, management may opt to bypass the qualitative analysis and perform the quantitative test.
The Company has acquired significant other intangible assets through business acquisitions. The Company's other intangible assets consist indefinite-lived trademarks and licenses, and of finite-lived intangibles, including customer related and contract based assets representing primarily client lists and non-compete arrangements and acquired software. Finite-lived intangible assets are amortized over periods ranging from 0.3 years to 15 years. Certain trademarks are not amortized since these assets have been determined to have indefinite useful lives. The costs to periodically renew other intangible assets are expensed as incurred.
reducing the producer's up-front commission associated with current period written premium production, which is credited against the receivable amount due from the producer; or
invoicing the producer for an amount equal to the amount due to the Company.
The Company uses interest rate swaps as part of its risk management strategy to manage interest rate risk and cash flow risk that may arise in connection with the variable interest rate provision of the Company's preferred trust securities. The Company's derivative financial instruments are carried at fair value on the balance sheet.
The Company records the fair value of the derivative instrument in other assets or other liabilities. To the extent a derivative is an effective hedge of the cash flow risk of the hedged debt obligation, any change in the derivative's fair value is recorded in AOCI, net of income tax. To the extent the derivative is an ineffective hedge, that portion of the change in fair value is recorded in other operating expenses or interest expense as appropriate. The Company is not a party to leveraged derivatives and does not enter into derivative financial instruments for trading or speculative purposes.
Basic earnings per share is computed by dividing net income available to common stockholders by the weighted average number of common shares outstanding for the period. Diluted earnings per share is computed by dividing net income available to common stockholders by the weighted average number of common shares outstanding adjusted to include the effect of potentially dilutive common shares, which includes outstanding stock options and non-vested restricted stock awards, using the treasury stock method. Common shares that are considered anti-dilutive are excluded from the computation of diluted earnings per share.
In July 2013, the FASB issued ASU No. 2013-10, Derivatives and Hedging (Topic 815): Inclusion of the Fed Funds Effective Swap Rate (or Overnight Index Swap Rate) as a Benchmark Interest Rate for Hedge Accounting Purposes (a consensus of the FASB Emerging Issues Task Force). ASU No. 2013-10 allows the use of the Fed Funds Effective Swap Rate (or Overnight Index Swap Rate) as a benchmark interest rate for hedge accounting purposes in addition to interest rates on direct Treasury obligations of the United States government and London Interbank Offered Rate and also removes the restriction on using different benchmark rates for similar hedges. ASU No. 2013-10 became effective on a prospective basis for qualifying new or designated hedging relationships entered into on or after July 17, 2013. The adoption of ASU No. 2013-10 did not have an impact on the Company's consolidated financial position, results of operations or cash flows.
In July 2012, the FASB issued ASU No. 2012-02, Intangibles-Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment. ASU No. 2012-02 permits entities to perform an optional qualitative assessment for determining whether it is more likely than not that an indefinite-lived intangible asset is impaired. ASU No. 2012-02 is effective for annual and interim impairment tests performed for years beginning after September 15, 2012. The adoption of ASU No. 2012-02 did not impact the Company's consolidated financial position, results of operations or cash flows.
In July 2013, the FASB issued 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 is not expected to have a material impact on the Company's consolidated financial position, results of operations or cash flows.
As disclosed on January 18, 2013 in the Company's Current Report on Form 8-K, effective January 14, 2013, the Company committed to a plan to consolidate the Company's fulfillment, claims administration and information technology functions (the "Plan"). Prior to the Plan, such functions resided in the Company's individual business units. The decision is part of the Company's efforts to streamline its operations, focus its resources and provide first in class service to its customers. The following is a summary of the charges incurred by the Company:
In July 2011, the Company sold its 100% interest in Creative Investigations Recovery Group, LLC ("CIRG"). The consideration included a note receivable, included on the Consolidated Balance Sheets, with a first priority lien security interest in the assets of CIRG and other property of the buyers. The Company performed a detailed analysis of the CIRG sale transaction and determined that CIRG is considered a VIE because the Company has an interest due to the note financing. The Company further determined that it is not the primary beneficiary because the Company does not have the power to direct the activities of the VIE and has no right to receive the residual returns of CIRG. Therefore, CIRG is not consolidated in the Company's results of operations for any of the periods presented. During 2013, the Company suspended recognition of interest income on the note and engaged the buyer in discussions, because the buyer was experiencing short-term cash flow constraints. The Company determined that it would not pursue remedies available under the note at this time, 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 principal amount and interest rate are unchanged. These contracts do not give the Company control over the business, and the Company may still leverage the remedies of the note should it deem such action necessary. The Company also provided an additional $0.1 million in short term funding, and the buyer has begun to repay that balance.
The Company's maximum exposure to loss in the VIE is limited to the outstanding balance of the note receivable (including accrued interest receivable) and the remaining balance of the short term funding, presented in the table below:
On February 1, 2013, the Company acquired 100% of the outstanding stock of RICC, from subsidiaries of the Kemper Corporation ("Kemper") for $4.8 million. RICC is a property/casualty insurance company domiciled and licensed in California, which the Company intends to use for geographic expansion. RICC had, at the time of purchase, no policies in force. All remaining claim liabilities for previously issued policies are fully reinsured by Kemper's subsidiary, Trinity Universal Insurance Company.
(2) - The purchase consideration of $20.0 million for the ProtectCELL acquisition represents the 62.4% ownership interest acquired in the transaction, comprised of 62,400 common units and 20,000 preferred units, valued at $7.9 million and $12.1 million respectively.
The following table presents goodwill attributable to acquisitions that is expected to be tax deductible by year of acquisition:
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. Further, the Company has agreed not to compete with the Bliss and Glennon and eReinsure businesses for five years, and has agreed not to solicit former
The Company completed the following divestitures that were not considered to be discontinued operations:
In June 2013, the Company sold its wholly owned subsidiary Magna for a gross sales price of $3.0 million, less cash held by Magna, transferred in the sale, of $0.8 million. For the year ended December 31, 2013, the Company recorded a $0.4 million pre-tax gain on the sale of Magna, which is included on the Consolidated Statements of Income line item, "Gain on sale of subsidiary."
In July 2011, the Company sold its wholly owned subsidiary, CIRG, for a sales price of $1.2 million, comprised of cash and a $1.1 million secured note receivable. For the year ended December 31, 2011, the Company recorded a $0.5 million loss on the sale of CIRG. This sale resulted in a non-consolidated VIE. For more information, see the Note, "Variable Interest Entity."
In 2012, the Company recorded goodwill in conjunction with the ProtectCELL and 4Warranty acquisitions. During 2013, the Company determined the final valuations for the 2012 acquisitions of ProtectCELL and 4Warranty acquisitions. The following table presents the activity in goodwill and includes the retrospective adjustments made to the balance of goodwill at December 31, 2012 to reflect the effect of the final valuation adjustments made for the acquisitions of ProtectCELL and 4Warranty and the reduction to goodwill attributable to the 2013 Disposition.
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 is not permitted to remove invested assets from these accounts without prior approval of the contractual party or regulatory authority, as applicable. The following table details the Company's restricted investments included in the Company's available-for-sale fixed maturity securities:
The effects of reinsurance on premiums written and earned and on losses and loss adjustment expenses ("LAE") incurred are presented in the tables below:
At December 31, 2013 and December 31, 2012, respectively, 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 Spartan Property Insurance Company (A. M. Best Rating: Not rated). The related receivables of Spartan Property Insurance Company and London Life International Reinsurance Corporation are collateralized by assets held in trust accounts and letters of credit due to their offshore relationships. At December 31, 2013, the Company does not believe there is a risk of loss as a result of the concentration of credit risk in the reinsurance program.
The Company leases certain office space and equipment under operating leases expiring on various dates from 2014 through 2022. The Company assumed operating leases for office space from related parties in conjunction with the ProtectCELL and 4Warranty acquisitions. The terms of the related party leases are substantially the same as those offered for comparable transactions with non-related parties. Please see the Note, "Related Party Transactions," for more information on the amount of related party lease payments made in 2013. The following table shows the Company's future minimum lease payments under operating leases with initial or remaining non-cancelable lease terms in excess of one year at:
The Company leases equipment and software under a single capital lease expiring in 2014. The following table shows the Company's future minimum lease payments for its capital lease at:
The Company, at its option, may prepay any borrowing, in whole or in part, at any time and from time to time without premium or penalty. However, after the end of the Company's fiscal year (commencing with the fiscal year ending December 31, 2015), the Company is required to make mandatory principal prepayments of loans under the Facilities in an amount determined under the Credit Agreement based upon a percentage of the Company's Excess Cash Flow (as defined in the Credit Agreement) minus certain offset amounts relating to permitted acquisitions. In addition, the Company is required to make principal payments upon the occurrence of certain events, including upon certain dispositions of the Company's assets.
The Credit Agreement contains certain customary representations, warranties and covenants applicable to the Company for the benefit of the Administrative Agent and the lenders. The Company may not assign, sell, transfer or dispose of any collateral or effect certain changes to the Company's capital structure and the capital structure of its subsidiaries without the Administrative Agent's prior consent. The Company's obligations under the Facilities may be accelerated or the commitments terminated upon the occurrence of an event of default under the Credit Agreement, including payment defaults, defaults in the performance of affirmative and negative covenants, the inaccuracy of representations or warranties, bankruptcy and insolvency related defaults, cross defaults to other material indebtedness, defaults arising in connection with changes in control and other customary events of default. 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.
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.
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 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, which is designated as a cash flow hedge, commenced in June 2012 and expires in June 2017. The following table summarizes the fair value (including accrued interest) and the related outstanding notional amount of the Company's single derivative instrument and indicates where within the Consolidated Balance Sheets each amount is reported:
The following table summarizes the pretax impact of the Swap on the Consolidated Financial Statements for the following periods:
At December 31, 2013, the Company had outstanding time-based stock options under its 2005 Plan and outstanding time-based and performance-based stock options and restricted stock awards under its 2010 Plan. The 2005 Plan permits awards of (i) Incentive Stock Options, (ii) Non-qualified Stock Options, (iii) Stock Appreciation Rights, (iv) Restricted Stock and (v) Restricted Stock Units. The 2010 Plan permits awards of (i) Incentive Stock Options, (ii) Non-qualified Stock Options, (iii) Stock Appreciation Rights, (iv) Restricted Stock, (v) Other Stock-Based Awards and (vi) Performance-Based Compensation Awards.
The Company granted 60,000 time-based stock options to employees during the year ended December 31, 2013, which vest in equal portions on each of the four anniversaries of the grant date. During the year ended December 31, 2013, the Company granted 228,981 performance-based stock options under the Company's Long-Term Incentive Plan ("LTIP"). The performance-based awards will vest, if at all, should the Company achieve three-year performance goals on or before December 31, 2015 for (i) net revenue (Compound Annual Growth Rate), (ii) earnings growth (Net Income) and (iii) profitable growth (Return on Average Equity). The performance metrics are equally weighted such that achievement of any one target results in vesting of one-third of the total equity award. If any of the target(s) are not attained by December 31, 2015, the one-third portion(s) of the award associated with the unattained target(s) will be canceled. The Company's time-based and performance-based stock option activity for the following periods is presented below:
(1) The performance-based stock options granted during the year ended December 31, 2012 will begin to vest equally over three years upon the Company's compensation committee determining that the Company has attained an Adjusted EBITDA of $46.0 million.
The Company has an Employee Stock Purchase Plan ("ESPP"), which allows the Company to issue up to 1,000,000 shares of common stock to all eligible employees, including the Company's named executive officers, under the same offering and eligibility terms. The ESPP qualifies under Section 423 of the Internal Revenue Code and allows eligible employees to contribute, at their discretion, up to 10% of their payroll, up to $25,000 per year, to purchase up to a maximum of 3,500 shares of the Company's common stock per offering period. The purchase price of Fortegra's common stock is equal to 85% of the lesser of the fair market value of the closing stock price of Fortegra's common stock on either the first day of the offering period or the last day of the offering period. Each offering period has a duration of six months and begins on January 1st and July 1st of each year.
million share repurchase plan in November 2011 and in August 2013 increased the size of the plan by $5.0 million. At December 31, 2013, the Company had $7.2 million still available for repurchase under the plan. 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 the discretion of Fortegra. The plan may be discontinued or suspended at any time and has no expiration date. None of the shares repurchased during the years ended December 31, 2013 and 2012, respectively, have been retired. The following table shows the shares repurchased during the following periods:
The Company has a nonqualified deferred compensation plan for certain officers. Provision has been made for the compensation which is payable upon their retirement or death. The deferred compensation is to be paid to the individual or their beneficiaries over a period of ten years commencing with the first year following retirement or death. As of December 31, 2013, there were no further payments required under the plan.
The provision for income taxes for both continuing and discontinued operations consisted of the following:
The following table shows a reconciliation of income taxes from continuing operations calculated at the federal statutory rate of 35% and the income tax expense attributable to continuing operations for the following periods:
The components of the Company's deferred income taxes are as follows:
At December 31, 2013, 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 2025. The Company expects to fully utilize the net operating loss carryforward.
At December 31, 2012, the Company had research and experimentation (research) tax credit carry forwards for federal and state income tax purposes in the amount of $0.5 million and $0.2 million, respectively that were subject to certain limitations under IRC Section 382 and were to begin to expire in 2019. As part of the valuation determinations of the subsidiary in which the research credit was generated, the Company recorded a $0.2 million liability against the research credit carryforward deferred tax asset. At December 31, 2013, the research credits were no longer available to the Company since they were generated by eReinsure, which was sold on December 31, 2013.
In 2012, the Company was under examination by the Internal Revenue Service ("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 has agreed to those findings and paid $57.0 thousand, which was expensed in the first quarter of 2013.
There were no transfers between Level 1 and Level 2 for the year ended December 31, 2013. For the year ended December 31, 2013, one corporate security was transferred from Level 3 to Level 2. This transfer occurred due to the availability of Level 2 pricing for the equity security, which was unavailable in prior periods. The Company's use of Level 3 unobservable inputs included six individual securities that accounted for 0.8% of total investments at December 31, 2013. The Company utilized an independent third party pricing service to value four of the Level 3 securities. The values of two equity securities in Level 3, which are non-publicly traded preferred stocks, were calculated by the Company. One of the equity securities, with a value of $1.0 million was valued by taking into account the strength of the issuer's parent company guaranteeing the dividend of the issuer. While one of the Level 3 equity securities, with a value of $13.0 thousand, was valued by estimating the total value of the Class-A shares outstanding by the issuer and a review of the
company's audited financial statements. At December 31, 2012, the Company had seven individual securities valued under Level 3 that accounted for 1.0% of total investments.
For the year ended December 31, 2013, the maximum amount of dividends that our regulated insurance company subsidiaries could pay under applicable laws and regulations without regulatory approval was $4.0 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 December 31, 2013 and 2012, respectively.
The Company may, from time to time and in the ordinary course of normal business, enter into certain contractual obligations or commitments.
The benefits of such additional funding would inure to the Company and to the non-controlling ownership interest of ProtectCELL, in proportion to their respective ownership interests. However, in return for each $1,000 of Additional Fortegra Capital Contributions, the Fortegra Members shall receive one Series A Preferred Unit. Any unreturned Series A Preferred contribution is deducted from ProtectCELL's valuation in determining the option price.
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 Company made lease payments to High Pointe during the year ended December 31, 2013, which are reflected in the table below. The Company did not make any lease payments to High Pointe for the year ended December 31, 2012.
At December 31, 2012, ProtectCELL held a $6.1 million note receivable carrying an interest rate of 8.00% from High Pointe, which is fully secured by a mortgage on the office building owned by High Pointe (see the lease described above). For the year ending December 31, 2012, the Company did not receive payments from High Pointe on the note receivable. 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.
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 have consulting relationships with the Company. The Company made lease payments to Source for the year ended December 31, 2013, which are reflected in the table below. The Company did not make any lease payments to Source for the year ended December 31, 2012.
In January 2012, the Company recorded a note receivable due from an officer of the Company relating to the 2010 acquisition of South Bay Acceptance Corporation, which has a balance of $0.1 million at December 31, 2012.
In December 2011, the Company entered into an information technology support services agreement (the "IT Agreement") with a company for which a member serving on the Company's Board of Directors also serves on the board of the company receiving the information technology support services from the Company. The IT Agreement has no set term and calls for a total of $0.3 million plus reimbursement of expenses to be received by the Company over the duration of the agreement. The Company only recorded income from the IT Agreement during the year ended December 31, 2012, which is reflected in the table below.
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 this 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, for the year ended December 31, 2013, which are reflected in the table below.
In February 2014, the Company 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. The restricted stock vests equally on each of the three anniversaries of the grant date.
(2) - During 2013, certain immaterial reclassifications were identified that impacted amounts for service and administrative fees in total revenues and commissions and other operating expenses in total expenses that were previously reported in the Company's Form 10-Q's for the quarters ended June 30, 2013 and September 30, 2013. These reclassification adjustments, separately and in the aggregate did not have a material impact on results previously reported for those quarterly periods and had no effect on reported net income. For the quarters ended June 30, 2013 and September 30, 2013, total revenues were decreased by $4.9 million and $3.5 million, respectively, while total expenses were reduced by the same amounts for the respective periods.