At December 31, 2011, Fortegra Financial leased its principal executive offices located at Deerwood Park Boulevard, Building 100, Jacksonville, FL, 32256, consisting of approximately 58,000 square feet, which is used by each of our businesses other than Brokerage. In addition, we lease approximately 85,000 square feet of office space in approximately 22 locations principally in the United States. Most of our leases have lease terms ranging from three to eleven years with provisions for renewals. We believe our properties are adequate for our business as presently conducted. Please see the footnotes, "Property and Equipment" and
"Leases", in the Notes to the Consolidated Financial Statements included in Item 8 of this Annual Report for additional information.
The following table sets forth our consolidated selected financial data for the periods and as of the dates indicated and are derived from our audited Consolidated Financial Statements. On June 20, 2007, affiliates of Summit Partners acquired a majority of our capital stock. All periods prior to June 20, 2007 are referred to as "Predecessor," and all periods including and after such date are referred to as "Successor." The Consolidated Financial Statements for all Successor periods are not comparable to those of the Predecessor periods. The following consolidated financial data should be read in conjunction with Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") in Part II,
MD&A represents an overview of our results of operations and financial condition and should be read in conjunction with, and is qualified in its entirety by reference to, our Consolidated Financial Statements and Notes thereto included in Part II, "Item 8 Financial Statements and Supplementary Data" of this Annual Report. 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” of this Annual Report.
For the year ended December 31, 2011, our overall revenues increased $21.0 million, or 10.3%, to $225.3 million from $204.3 million for the same period in 2010, primarily due to brokerage commissions, service and administrative fees, net realized gains and net earned premiums. Our net income for the year ended December 31, 2011 decreased$1.7 million, or 10.4%, to $14.5 million from $16.2 million for the same period in 2010 and was primarily impacted by higher operating costs. Earnings per diluted share were $0.68 for the year ended December 31, 2011 compared to $0.94 for 2010. Total expenses increased $23.9 million, or 13.3%, to $203.2 million for the year ended December 31, 2011 from $179.4 million for the same period in 2010. The majority of the increase was associated with our own internal expansion and acquired businesses and included increases of $8.2 million in personnel costs, $7.5 million in other operating expenses, $3.2 million in commission expense and a $3.0 million increase in total depreciation and amortization of intangibles.
Our Auto Knight acquisition extended our Roadside Assistance product marketing capabilities to affinity marketing and added new products and services such as Key Replacement and Tire and Wheel protection. eReinsure brought to us a unique platform for transacting facultative reinsurance transactions. The eReinsure platform is a singularly unique provider to the leading insurance and reinsurance companies worldwide.
With the acquisition of Pacific Benefits Group, we significantly expanded our distribution capabilities. We now are able to provide our clients a menu of services that includes direct response marketing and sales, administration, and servicing. This unique capability will be the focal point of our future strategy to capitalize on mass marketing of our complementary products to our client's customers allowing our clients to monetize what was once lost sales opportunities.
Finally, the assumption reinsurance treaty with Magna provided a key Payment Protection client a viable exit strategy for a non-core activity, and afforded our BPO segment some of the servicing capabilities relative to term life and annuity products that we can incorporate into new product and servicing opportunities in the future.
We prepare our Consolidated Financial Statements in accordance with generally accepted accounting principles in the United States of America ("U.S. GAAP") which requires management to make significant estimates and assumptions that affect the reported amounts of our assets, liabilities, revenues and expenses. See "Use of Estimates" and "Summary of Significant Accounting Policies" in the Notes to the Consolidated Financial Statements, included in Item 8 of this Annual Report for additional information.
With respect to securities where the decline in fair value is determined to be temporary and the security's fair value is not written down, a subsequent decision may be made to sell that security and realize a loss. If we do not expect for a security's decline in fair value to be fully recovered prior to the expected time of sale, we would record an other-than-temporary impairment in the period in which the decision to sell is made.
We capitalize internally developed software costs on a project-by-project basis in accordance with Accounting Standards Codification ("ASC") 350-40, Intangibles - Goodwill and Other: Internal-Use Software. All costs to establish the technological feasibility of computer software development are expensed to operations when incurred. Internally developed software development costs are carried at the lower of unamortized cost or net realizable value and are amortized based on the current and estimated useful life of the software. Amortization over the estimated useful life of five years begins when the software is ready for its intended use.
The costs of acquiring new business and retaining existing business, principally commissions, premium taxes and certain underwriting and marketing costs that vary with and are primarily related to the processing of new business, have been deferred and are amortized as the related premium is earned. The amortization of deferred acquisition costs are recorded in commissions expense or other operating expense in our Consolidated Statements of Income. The amortization of deferred acquisition costs related to commissions is classified as commission expense. The amortization of deferred acquisition costs related to premium taxes and certain underwriting and marketing costs is classified as other operating expenses.
Amortization of deferred acquisition costs for the years ended December 31, 2011, 2010 and 2009, totaled $56.0 million, $57.3 million and $57.7 million, respectively. We evaluate whether deferred acquisition costs are recoverable at year-end, 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, 2011, 2010 and 2009.
Goodwill represents the excess cost of an acquisition over the fair value of the net assets acquired in a business combination. Other intangible assets include trademarks, customer related and contract based assets representing primarily client lists and non−compete arrangements and acquired software. Goodwill and other intangible assets are carried as assets on the Consolidated Balance Sheets. Goodwill represented $108.8 million, $74.0 million, and $63.6 million of our total assets as of December 31, 2011, 2010 and 2009, respectively while other intangible assets represented $47.0 million, $40.0 million, and $30.0 million of our total assets as of December 31, 2011, 2010 and 2009, respectively.
Our goodwill is not amortized but is reviewed annually in the fourth quarter for impairment or more frequently if certain indicators arise. Our reporting units for impairment testing purposes are identical to our operating segments. In 2011 we adopted Accounting Standards Update ("ASU") 2011-08, Intangibles - Goodwill and Other (Topic 350): Testing Goodwill for Impairment. ASU 2011-08 allows for the goodwill impairment analysis to start with an assessment of qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If, after assessing the qualitative factors, management determines that it is more likely than not that the fair value of a reporting unit is less than its carrying amount, then we perform the two-part quantitative impairment test under Topic 350. If the carrying amount of the goodwill of the reporting unit exceeds the implied fair value, an impairment charge is recorded equal to the excess.
(2) IBNR reserves represent amounts reserved to pay claims where the insured event has occurred and has not yet been reported. IBNR reserves for credit disability also include the net present value of future claims payment of $1,354, $1,094 and $1,159 as of December 31, 2011, 2010 and 2009, respectively.
(3) General liability primarily represents amounts reserved to pay claims on contractual liability policies behind debt cancellation products.
Under ASC Topic 740, Income Taxes, 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.
We earn service and administrative fees for a variety of activities. This includes providing administrative services for other insurance companies, debt cancellation programs, motor club memberships, collateral tracking, and asset recovery services.
We earn brokerage commission and fee income by providing wholesale brokerage services to retail insurance brokers and agents and insurance companies. Brokerage commission income is primarily recognized when the underlying insurance policies are issued. A portion of the brokerage commission income is derived from profit agreements with insurance carriers. These commissions are received from carriers based upon the underlying underwriting profitability of the business that we place with those carriers. Profit commission income is generally recognized as revenue on the receipt of cash based on the terms of the respective carrier contracts. In certain instances, profit commission income may be recognized in advance of cash receipt where the profit commission income due to be received has been calculated or has been confirmed by the insurance carrier. See - "Revenues - Brokerage Commissions and Fees" in this MD&A for a discussion of various factors that impact our brokerage commissions and fees.
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. See - "Revenues - Ceding Commissions" for additional information on our ceding commissions.
We also have investments that carry prepayment risk, such as mortgage-backed and asset-backed securities. Actual net investment income and/or cash flows from investments that carry prepayment risk may differ from estimates at the time of investment as a result of interest rate fluctuations. In periods of declining interest rates, mortgage prepayments generally increase and mortgage-backed securities, commercial mortgage obligations and bonds are more likely to be prepaid or redeemed as borrowers seek to
borrow at lower interest rates. Therefore, we may be required to reinvest those funds in lower interest-bearing investments. Conversely, in times of rising interest rates, prepayments slow as borrowers tend to be less likely to refinance borrowings at higher interest rates, which tends to increase the duration of our investment holdings. With the increase in investment duration, we will have less cash flows from prepayments to invest at higher prevailing market rates.
We currently have stock options outstanding under our 2005 Equity Incentive Plan and stock options and restricted stock awards outstanding under The 2010 Omnibus Incentive Plan. We record stock-based compensation in accordance with ASC 718, Compensation - Stock Compensation, which addresses the accounting for share-based 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 the Company's 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 is based on the market price of our common stock at the grant date. We typically recognize stock-based compensation expense on a straight-line basis over the requisite service period, which is the vesting period. Please see the footnote, "Stock-Based Compensation" in the Notes to the Consolidated Financial Statements included in Item 8 of this Annual Report for additional information.
Gross commission rates for the products that we distribute in our Brokerage segment, whether acting as a wholesale broker or as a Managing General Agent ("MGA"), generally range from 15% to 25% of the annual premium for the policy. Brokerage commissions and fees net of commissions paid to our retail insurance agent and broker clients typically approximate 10%.
Demand for surplus lines insurance products also affects our premium volume and net commissions. State regulations generally require a buyer of insurance to have been turned down by three or more traditional carriers before being eligible to purchase the surplus lines distributed by us. As standard insurance carriers eliminate non-core lines of business and implement more conservative risk selection techniques, demand for excess and surplus lines insurance improves.
Our Brokerage commission and fee revenues fluctuate seasonally based on policy renewal dates. Our Brokerage commissions and fees in the first two calendar quarters of any year historically have been higher than in the last two calendar quarters. In addition, our quarterly Brokerage revenues may be affected by new placements and cancellations or non-renewals of large insurance policies as the revenue stream related to this policy is recognized once per year, as opposed to ratably throughout the year. Seasonal fluctuations may be impacted by the addition of eReinsure, where transaction fees are generally higher in the second and fourth quarters.
Ceding commissions are generally positively correlated with our credit insurance transaction and premium volumes. The portion of our ceding commissions that is related to the underwriting profits of the ceded credit insurance also fluctuates based on the claims made on such policies. The portion of our ceding commissions that is related to investment income can be impacted by the amount of reserves that are maintained in trust accounts and changes in interest rates. Ceding commissions are earned over the life of the policy. Ceding commissions are generated by the Payment Protection segment only for credit insurance.
Net Realized Gains (Losses). We realize gains when invested assets are sold for an amount greater than the amortized cost in the case of fixed maturity securities and cost basis for equity securities. We recognize realized losses for invested assets sold for an amount less than their carrying cost or when fixed maturity securities or equity securities are written down as a result of an other-than-temporary impairment ("OTTI").
Net Investment Income. We earn net investment income from interest payments and dividends received from our investment portfolio, and interest earned on our cash accounts and notes receivable, less portfolio management expenses. Our investment portfolio is primarily invested in fixed maturity securities which tend to produce consistent levels of investment income. The fair value of the fixed maturity securities in our portfolio and the investment income from these securities fluctuate depending on general economic and market conditions. The fair value generally increases or decreases in an inverse relationship with fluctuations in interest rates. Investment income can be significantly impacted by changes in interest rates. Interest rate volatility can increase or reduce unrealized gains or unrealized losses in our portfolios. Interest rates are highly sensitive to many factors, including governmental monetary policies, domestic and international economic and political conditions and other factors beyond our control. Fluctuations in interest rates affect our returns on, and the fair value of, fixed maturity and short-term investments.
Net Losses and Loss Adjustment Expenses. Net losses and loss adjustment expenses include actual paid claims and the change in unpaid claim reserves and consist of direct and assumed losses less ceded losses. Our profitability depends in part on accurately predicting net loss and loss adjustment expenses. Incurred claims are impacted by loss frequency, which is the measure of the number of claims per unit of insured exposure, and loss severity, which is based on the average size of claims. Factors affecting loss frequency and loss severity include changes in claims reporting patterns, claims settlement patterns, judicial decisions, legislation, economic conditions, morbidity patterns and the attitudes of claimants towards settlements.
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 incurred but not reported ("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.
In accordance with applicable statutory insurance company regulations, our unpaid claims reserves are evaluated by appointed actuaries. The appointed actuaries perform this function in compliance with the Standards of Practice and Codes of Conduct of the American Academy of Actuaries. The appointed actuaries perform their actuarial analyses each year and prepare opinions, statements and reports documenting their determinations.
Interest Expense. Interest expense includes interest payable on our credit facilities, mainly our notes payable, preferred trust securities and redeemable preferred stock, and is directly correlated to the levels of and the prevailing interest rates on these debt instruments.
The following table sets forth our Consolidated Statements of Income for the years ending December 31, 2011, 2010 and 2009:
Service and administrative fees for the year ended December 31, 2010 increased $2.3 million, or 7.3%, to $34.1 million from $31.8 million for the year ended December 31, 2009. The increase resulted primarily from a $4.1 million increase in administrative fees in our Payment Protection segment, including the benefit of a $2.9 million increase in administrative fees from our acquisition of Continental in May 2010 and $1.2 million from our September 2010 acquisition of United. The acquisition of South Bay Acceptance Corporation ("South Bay") on February 1, 2010 contributed an additional $1.1 million to this increase for the
Ceding commissions for the year ended December 31, 2010 increased $4.7 million, or 19.5%, to $28.8 million from $24.1 million for the year ended December 31, 2009. This increase was due to additional service and administrative fees of $2.3 million from increased insurance production in 2010. Underwriting profits increased $1.2 million due to positive underwriting performance. In addition, net investment income from assets held in trust by our reinsurers increased $1.1 million during the period. Pursuant to the existing treaties our reinsurer holds assets in trust related to our credit insurance program. If the reinsurers divest these assets our proportional share of the gains or losses flows through the ceding commission. For the year ended December 31, 2010, ceding commissions included $19.6 million in service and administrative fees, $6.0 million in underwriting profits from positive underwriting performance and $3.1 million in net investment income.
Net investment income for the year ended December 31, 2010 decreased $0.7 million, or 14.4%, to $4.1 million from $4.8 million for the year ended December 31, 2009. This decrease was due primarily to lower yields on our fixed maturity securities. Yields have fallen 61 basis points to 4.22% for the year ended December 31, 2010 from 4.83% for the year ended December 31, 2009.
Net realized gains were $0.7 million for the year ended December 31, 2010 compared with $0.1 million for the year ended December 31, 2009. The primary increase for 2010 was due to a lower level of realized losses on the sale of fixed maturity securities.
Net earned premium for the year ended December 31, 2011 increased $3.7 million, or 3.3%, to $115.5 million from $111.8 million for the year ended December 31, 2010. Direct and assumed earned premium increased $13.5 million resulting from an increase in direct and assumed written premium due to new clients distributing our credit insurance and warranty products. Because of this increase, ceded earned premiums increased $9.8 million or 5.0%. On average, we maintained a 64% overall cession rate of direct and assumed earned premium for both the year ended December 31, 2011and 2010, respectively.
Net earned premium for the year ended December 31, 2010 increased $3.7 million, or 3.4%, to $111.8 million from $108.1 million for the year ended December 31, 2009. Direct and assumed earned premium increased $7.7 million resulting from an increase in direct and assumed written premium due to new clients distributing our credit insurance and warranty products. Because of this increase, ceded earned premiums increased $4.0 million or 2.1%. On average, we maintained a 64% overall cession rate of direct
and assumed earned premium for the years ended December 31, 2010 and 2009.
Other income was $0.2 million for the year ended December 31, 2011 and 2010. Other income was $0.2 million for the year ended December 31, 2010 compared with $1.0 million for the year ended December 31, 2009. The difference between 2010 and 2009 other income principally consisted of a non-recurring reserve reduction of $0.5 million from the Bliss & Glennon acquisition.
Net losses and loss adjustment expenses for the year ended December 31, 2010 increased $3.5 million, or 10.7% to $36.0 million from $32.6 million for the year ended December 31, 2009. For the year ended December 31, 2010, our direct and assumed losses decreased by $1.0 million, or 1.2%, as compared with the year ended December 31, 2009, due to slightly more favorable loss development. However, for the year ended December 31, 2010, our ceded losses, which serve to decrease our net losses, were lower by $4.4 million, or 9.3%, as compared with the year ended December 31, 2009, thereby increasing our net losses and loss adjustment expenses by the corresponding amount. On average, we maintained a 55% overall cession rate of direct and assumed losses and loss adjustment expenses for the year ended December 31, 2010 and 59% for the year ended December 31, 2009.
Personnel costs for the year ended December 31, 2010 increased $5.0 million, or 15.9%, to $36.4 million from $31.4 million for the year ended December 31, 2009, due to a net increase in total employees to 460 at December 31, 2010 compared to 423 at December 31, 2009. Headcount increases resulted from acquisitions, which increased personnel costs by $6.9 million, partially offset by a $1.9 million reduction in personnel costs in our other business segments. For the year ended December 31, 2009 we recorded total stock based compensation expense of $0.2 million.
Other operating expenses for the year ended December 31, 2010 increased $0.6 million, or 2.6%, to $22.9 million from $22.3 million for the year ended December 31, 2009. In 2010, the acquisition of South Bay added $0.2 million to other operating expenses while the Continental and United acquisitions added $0.6 million. A full year of Bliss & Glennon expenses accounted for $1.9 million of the 2010 increase. The increase for 2010 was offset principally by a $1.2 million reduction in the BPO segment for processing, policy fulfillment and reduced call center expenses and a $1.1 million decline in corporate expenses.
Depreciation expense for the year ended December 31, 2011 increased $1.7 million, or 120.4%, to $3.1 million from $1.4 million for the year ended December 31, 2010. The increase was primarily due to higher levels of depreciable assets in service at December 31, 2011 compared to December 31, 2010.
Amortization expense increased $1.7 million, or 53.2%, to $5.0 million for the year ended December 31, 2011 from $3.2 million for the year ended December 31, 2010. The increase for both periods presented was primarily due to the 2011 and 2010 acquisitions which increased the level of amortizable intangibles.
Amortization expense for the year ended December 31, 2010 increased $0.5 million, or 19.4%, to $3.2 million from $2.7 million for the year ended December 31, 2009. The increase in the amortization of other intangibles, aggregating $0.4 million, was primarily from the acquisitions of Bliss & Glennon, United and Continental.
On July 1, 2011, we sold our wholly owned subsidiary, CIRG and recorded a $0.5 million loss on the sale for the year ended December 31, 2011. No subsidiaries were sold during 2010 or 2009.
Income tax expense for the year ended December 31, 2010 increased $2.2 million, or 32.8%, to $8.7 million compared to $6.6 million for 2009. The increase in income tax expense was primarily due to a $6.8 million increase in pre-tax income for 2010. The effective tax rate was 34.9% and 36.1% for the year ended December 31, 2010 and 2009, respectively. The decrease in the effective tax rate was attributable to lower levels of non-deductible expenses and an increased amount of deductible goodwill amortization associated with recent acquisitions.
expenses and without taking into account amortization, depreciation, interest expense and income taxes. We refer to these performance measures as segment EBITDA (earnings before interest, taxes, depreciation and amortization) and segment EBITDA margin (segment EBITDA divided by segment net revenues).
Our measures of segment EBITDA and segment EBITDA margin, meet the definition of Non-GAAP financial measures. These measures are not in accordance with, or an alternative to, the U.S. GAAP information provided in this Annual Report. We believe that these Non-GAAP presentations provide useful information to management, analysts and investors regarding financial and business trends relating to our results of operations and financial condition. Our industry peers provide similar supplemental non-GAAP information, although they may not use the same or comparable terminology and may not make identical adjustments. The non-GAAP information we provide should be used in addition to, but not as a substitute for, the U.S. GAAP information provided elsewhere in this Annual Report . The variability of our segment EBITDA and segment EBITDA margin is significantly affected by our segment net revenues because a large portion of our operating expenses are fixed. For additional information regarding segment net revenues and operating expenses, see the footnote, "Segment Results" in the Notes to the Consolidated Financial Statements included in this Annual Report. The following table reconciles segment information to our Consolidated Statements of Income and provides a summary of other key financial information for each of our segments:
As previously reported, starting January 1, 2011 certain BPO and Brokerage distribution channels were re-aligned to better reflect each segment's business focus. The distribution channel results for the years ended December 31, 2010 and December 31, 2009 have been reclassified from their prior period segment presentation. The impact of these reclassifications were $3.9 million in revenues and $3.6 million in expenses being moved from the BPO segment into the Brokerage segment for the year ended December 31, 2010 and $4.7 million in revenues and $3.8 million in expenses being moved from the BPO segment into the Brokerage segment for the year ended December 31, 2009 in order to conform to the presentation for the year ended December 31, 2011.
In addition to the financial covenant requirements under our revolving credit facility, management uses EBITDA and Adjusted EBITDA as measures of operating performance for planning purposes, including the preparation of budgets and projections, the determination of bonus compensation for our executive officers and the analysis of the allocation of resources and to evaluate the effectiveness of business strategies. Further, we believe EBITDA and Adjusted EBITDA are frequently used by securities analysts, investors and other interested parties in the evaluation of companies in industries similar to ours. Adjusted EBITDA is also used by management to measure operating performance and by investors to measure a company's ability to service its debt and other cash needs. Management believes the inclusion of the adjustments to EBITDA and Adjusted EBITDA are appropriate to provide additional information to investors about certain material non-cash items and about unusual items that we do not expect to continue at the same level in the future.
EBITDA and Adjusted EBITDA are not recognized terms under accounting principles generally accepted in the United States, or GAAP. Accordingly, they should not be used as an indicator of, or alternative to, net income as a measure of operating performance. Although we use EBITDA and Adjusted EBITDA as measures to assess the operating performance of our business, EBITDA and Adjusted EBITDA have significant limitations as analytical tools because they exclude certain material costs. For example, they do not include interest expense, which has been a necessary element of our costs. Since we use capital assets, depreciation expense is a necessary element of our costs and ability to generate service revenues. In addition, the omission of the substantial amortization expense associated with our intangible assets further limits the usefulness of this measure. EBITDA and Adjusted EBITDA also do not include the payment of taxes, which is also a necessary element of our operations. Because EBITDA and Adjusted EBITDA do not account for these expenses, its utility as a measure of our operating performance has material limitations. Due to these limitations, management does not view EBITDA and Adjusted EBITDA in isolation or as a primary performance measure and
also uses other measures, such as net income. Because the definitions of EBITDA and Adjusted EBITDA (or similar measures) may vary among companies and industries, they may not be comparable to other similarly titled measures used by other companies.
The table below presents a reconciliation of net income to EBITDA and Adjusted EBITDA for the following periods:
Net revenues for the year ended December 31, 2011 increased $9.7 million, or 19.1%, to $60.5 million from $50.8 million for the year ended December 31, 2010. The 2011 results include a full year of revenues from the acquisitions of Auto Knight, Continental and United, which added $6.9 million of revenue. Net realized gains on the sale of investments increased by $3.5 million. Service and administrative fee income for the core business was $0.6 million above prior year and resulted from increased debt cancellation and service fees primarily in the Consumer Finance channel. Ceding commission increased $0.7 million due to additional service and administrative fees from increased insurance production in 2011. These increases were offset by lower net investment income on our portfolio of $0.7 million due to lower investment yields. In addition, underwriting revenue was $1.3 million below prior year 2010 and resulted from increased commissions in the Consumer Finance channel and an increase in loss ratio in our risk retained business.
Net revenues for the year ended December 31, 2010 increased $8.0 million, or 18.7%, to $50.8 million from $42.8 million for the year ended December 31, 2009. The increase was primarily from the acquisitions of Continental and United, which added $4.1 million of revenue, along with increased ceding commission revenue of $4.7 million due to favorable underwriting results and a realized gain on the sale of assets attributable to our proportionate share of assets sold by our re-insurers.
Operating expenses for the year ended December 31, 2011 increased $9.2 million, or 38.9%, to $32.7 million from $23.6 million for the year ended December 31, 2010. This increase resulted primarily from $2.8 million in expenses associated with being a public company, $1.3 million in non-recurring expenses and additional stock-based compensation expense of $0.6 million. Also contributing to this increase was $3.2 million of expense from the acquisitions of Auto Knight, Continental and United.
Revenues for the year ended December 31, 2011 decreased $1.5 million or 8.7%, to $15.6 million from $17.1 million for the year ended December 31, 2010. The decrease was driven by lower service and administrative fees for our insurance company clients which decreased $2.5 million due to regulatory changes that slowed the production for one of our main customers in 2011. This
EBITDA for the year ended December 31, 2010 decreased $1.8 million, or 20.3%, to $7.1 million from $8.9 million for the year ended December 31, 2009. As a result, EBITDA margin for our BPO segment was 41.4% for the year ended December 31, 2010 compared to 47.2% for the year ended December 31, 2009.
Revenues for the year ended December 31, 2011 of $37.0 million were comprised primarily of $23.7 million in standard commissions and fees, $1.9 million in profit commissions, $8.8 million in fees from eReinsure, and $2.0 million in collateral recovery fees. Revenues for the year ended December 31, 2010 were $29.4 million and were comprised primarily of $23.3 million of standard commissions and fees, $1.2 million of profit commission revenue and $4.9 million of debt collection, premium financing and collateral recovery fees.
Operating expenses for the year ended December 31, 2011 were $29.3 million, which includes a $0.5 million loss on sale of CIRG, compared to $23.5 million for the same period in 2010. For the year ended December 31, 2011 and 2010, the majority of our expenses were personnel costs, which totaled $19.8 million and $16.5 million, respectively. For the year ended December 31, 2011, eReinsure accounted for $3.3 million and $1.4 million of the personnel costs and operating expenses, respectively.
Operating expenses for the year ended December 31, 2011 were $1.8 million compared to $2.1 million for the same period in 2010. The expenses for the year ended December 31, 2011 included professional fees, transaction costs and costs associated with the moving of our Jacksonville, FL based operations. Segment operating expenses for the year ended December 31, 2010 were attributable to acquisition costs and re-audit professional fees and travel costs.
We believe that our cash flow from operations and our availability under our revolving credit facility, combined with our low capital expenditure requirements will provide us with sufficient capital to continue to grow our business over the next several
years. We intend to use a portion of our available cash flow to pay interest on our outstanding debt, thus limiting the amount available for working capital, capital expenditures and other general corporate purposes. As we continue to expand our business and make acquisitions, we may in the future require additional working capital to meet our future business needs. This additional working capital may be in the form of additional debt or equity. Although we believe we have sufficient liquidity under our revolving credit facility, as discussed above, under extreme market conditions or in the event of a default under our revolving credit facility, there can be no assurance that such funds would be available or sufficient, and in such a case, we may not be able to successfully obtain additional financing on favorable terms, or at all, or replace our existing revolving credit facility which matures in June of 2013.
We are a holding company and have limited direct operations. Our holding company assets consist primarily of the capital stock of our subsidiaries. Accordingly, our future cash flows depend upon the availability of dividends and other payments from our subsidiaries, including statutorily permissible payments from our insurance company subsidiaries, as well as payments under our tax allocation agreement and management agreements with our subsidiaries. The ability of our insurance company subsidiaries to pay such dividends and to make such other payments are limited by applicable laws and regulations of the states in which our subsidiaries are domiciled, which vary from state to state and by type of insurance provided by the applicable subsidiary. These laws and regulations require, among other things, our insurance subsidiaries to maintain minimum solvency requirements and limit the amount of dividends these subsidiaries can pay to the holding company. Along with solvency regulations, the primary factor in determining the amount of capital available for potential dividends is the level of capital needed to maintain desired financial strength ratings from A.M. Best for our insurance company subsidiaries. Given recent economic events that have affected the insurance industry, both regulators and rating agencies could become more conservative in their methodology and criteria, including increasing capital requirements for our insurance subsidiaries which, in turn, could negatively affect our capital resources. The following table sets forth the dividends paid to us by our insurance company subsidiaries for the following periods:
In June 2010, we entered into a $35.0 million revolving credit facility with SunTrust Bank, which matures in June 2013 (the "Facility"). The Facility bears interest at a variable rate determined based upon the higher of (i) the prime rate, (ii) the federal funds rate plus 0.50% or (iii) LIBOR plus 1%, plus a margin tied to our leverage ratio. We can select at our discretion to convert the interest rate for all or a portion of the outstanding balance for a period of up to six months to a fixed EURO Dollar Funding rate which is equal to the adjusted LIBOR rate for the elected interest period in effect at the time of election, plus a margin tied to our leverage ratio.
We are required to pay a commitment fee of between 0.45% and 0.60% (based upon our leverage ratio) on the unused portion of the Facility. The purpose of the facility is for working capital and acquisitions. Interest on the line of credit is payable monthly. Our obligations under the Facility are guaranteed by substantially all of our domestic subsidiaries, other than South Bay and the regulated insurance subsidiaries. Under the Facility, we may not assign, sell, transfer or dispose of any collateral or effect certain
changes to its capital structure and the capital structure of our subsidiaries without the Agent's prior consent. Our obligations under the Facility may be accelerated or the commitments terminated upon the occurrence of an event of default under the Facility, 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.
In connection with the Summit Partners Transactions, LOTS Intermediate Co. also issued $20.0 million of subordinated debentures to affiliates of Summit Partners, a related party, maturing December 2013 with an interest rate of 14% per annum on the principal amount of such subordinated debentures. In December 2010, we utilized a portion of the proceeds from the IPO to repay the entire $20.0 million of subordinated debentures for $20.6 million, which included accrued but unpaid interest to the redemption date.
During the year ended December 31, 2011, we paid off the $11.0 million of our Series A, B and C redeemable preferred stock that was outstanding at December 31, 2010. In December 2010, the Company served notice to the holders of Series A, B and C redeemable preferred stock of the intent to redeem the entire amount of each class of redeemable preferred stock, totaling $11.0 million. The early redemption of all outstanding A, B and C redeemable preferred stock began in January 2011. In addition, the Series A, B and C redeemable preferred stock ceased accruing dividends on January 26, 2011. In conjunction with the redemption, the Company recorded a $0.2 million redemption premium during 2011.
Our invested assets consist mainly of high quality investments in fixed maturity securities, short-term investments, and a smaller allocation of common and preferred equity securities. We believe that prudent levels of investments in equity securities within our investment portfolio are likely to enhance long term after-tax total returns without significantly increasing the risk profile of the portfolio. We regularly review our entire portfolio in the context of macroeconomic and capital market conditions. At December 31, 2011, the overall credit quality of the investment portfolio was rated A+ by Standard and Poor's Rating Service.
Our investments must comply with applicable laws and regulations which prescribe the kind, quality and concentration of investments. In general, these laws and regulations permit investments, within specified limits and subject to certain qualifications, in federal, state and municipal obligations, corporate bonds, preferred and common equity securities, mortgage loans, real estate and other investments.
Our investment policy and strategy is reviewed and approved by the board of directors of each of our insurance 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
As of December 31, 2011, we held 35 fixed maturity and 5 equity securities in unrealized loss positions. We do not intend to sell these investments and we believe we will be able to hold these securities until full recovery of their amortized cost basis for fixed maturity securities or cost for equity securities, although we can give no assurances. For the year ended December 31, 2011, management deemed that 10 equity securities were other than temporarily impaired and recorded an impairment charge of $0.2 million. As of December 31, 2010, there were 21 fixed maturity and 13 equity securities in unrealized loss positions. During 2010, based on its quarterly review, management deemed 8 equity securities to be other-than-temporarily impaired and recorded an impairment charge of $0.1 million. For the year ended December 31, 2009, we did not record other-than-temporarily impairments. Please see the footnote, "Investments" in the Notes to the Consolidated Financial Statements included in ITEM 8 of this Annual Report for additional information.
Net cash provided by operating activities was $12.8 million for the year ended December 31, 2011 compared to net cash provided by operating activities of $13.1 million, for the year ended December 31, 2010. For the year ended December 31, 2011, our net cash provided by operating activities was attributable to an increase in unearned premiums and net income, partially offset by payments made for accrued expenses, accounts payable and other liabilities and a decrease in deferred revenue. For the year ended December 31, 2010, our net cash provided from operating activities primarily reflected our net income and collections of reinsurance and other receivables, partially offset by payments made for accrued expenses, accounts payable and other liabilities. In 2009, our net cash provided from operating activities primarily reflected our net income and collections of reinsurance and other receivables offset by a decrease in unearned premiums.
Net cash used in investing activities was $47.5 million for the year ended December 31, 2011 and $29.8 million for the year ended December 31, 2010. For the year ended December 31, 2011, net cash used in investing activities primarily reflected cash used for purchases of fixed maturity securities and our acquisitions of Auto Knight, eReinsure, PBG and Magna , partially offset by the sale and maturity of fixed maturity investments. For the year ended December 31, 2010, net cash used in investing activities primarily reflected cash used for purchases of fixed maturity securities, the acquisitions of South Bay, Continental and United and purchases of property and equipment. For the year ended December 31, 2009, net cash used in investing activities primarily reflected the use of cash for acquisitions and a change in restricted cash offset in part by cash from the sale or maturity of investments.
(1) Estimated. Net unpaid claims are: total $13,151; less than 1 year $11,671; 1-3 years $1,431; 3-5 years $45; and more than 5 years $4.
We have audited the accompanying Consolidated Balance Sheets of Fortegra Financial Corporation and subsidiaries (the "Company") as of December 31, 2011 and 2010, and the related consolidated statements of income, changes in stockholders' equity and cash flows for each of the years in the three-year period ended December 31, 2011. Our audits also included the financial statement schedule listed in Item 15. We also have audited the Company's internal control over financial reporting as of December 31, 2011, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company's management is responsible for these financial statements and financial statement schedule, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management's Annual Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on these financial statements and the financial statement schedule and an opinion on the Company's internal control over financial reporting based on our audits.
A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
The Company has reviewed all material events that occurred up to the date the Company's Consolidated Financial Statements were issued to determine whether any event required recognition or disclosure in the financial statements.
The Consolidated Financial Statements include the accounts of the Company and its majority-owned and controlled subsidiaries. All material intercompany accounts and transactions have been eliminated. The third party ownership of 15% of the common stock of Southern Financial Life Insurance Company("SFLAC") has been reflected as non-controlling interest on the Consolidated Balance Sheets for the years ended December 31, 2011 and 2010. Income(loss) attributable to SFLAC's minority shareholders has been reflected on the Consolidated Statements of Income and Comprehensive Income (Loss) as income attributable to non-controlling interests for the years ended December 31, 2011, 2010 and 2009.
Stock Split, Change in Authorized Shares and Change in Par Value
Certain items in prior financial statements have been reclassified to conform to the current presentation, which had no impact on net income, comprehensive income or loss, net cash provided by operating activities or stockholders' equity.
For the year ending December 31, 2009, the Company revised its consolidated financial statements to correct errors related to stock options and other items. The following table reconciles stockholders' equity and net income of the Company as presented in the accompanying Consolidated Financial Statements to stockholders' equity and net income as previously presented.
In July 2011, the Company sold its 100% interest in Creative Investigations Recovery Group, LLC ("CIRG"). The consideration included a $1.1 million 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, as defined in ASC 810, since the Company has an interest due to the note financing. The Company further determined that its maximum exposure to loss in the VIE is limited to the outstanding balance of the note receivable of $1.1 million at December 31, 2011 and that the Company 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.
The following is a summary of significant accounting policies followed in the preparation of the Consolidated Financial Statements:
(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:
Service and Administrative Fees - The Company earns service and administrative fees for a variety of activities. This includes providing administrative services for other insurance companies, motor club memberships, debt cancellation programs, collateral tracking and asset recovery services. The Payment Protection administrative service revenue is recognized consistent with the earnings recognition pattern of the underlying insurance policy or debt cancellation contract being administered. The BPO service fee revenue is recognized as the services are performed. These services include fulfillment, BPO software development, and claims handling for the Company's customers. Collateral tracking fee income is recognized when the service is performed and billed. Asset recovery service revenue is recognized upon the location of a recovered unit and or the location and delivery of a unit. Management reviews the financial results under each significant BPO 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, 2011, 2010 and 2009, the Company has not incurred a loss with respect to a specific significant BPO contract.
The costs of acquiring new business and retaining existing business, principally commissions, premium taxes and certain underwriting and marketing costs that vary with and are primarily related to the production of new business, have been deferred and are being amortized as the related premium is earned. Amortization of deferred acquisition costs for the years ended December 31, 2011, 2010 and 2009, totaled $56.0 million, $57.3 million and $57.7 million, respectively. The Company evaluates whether deferred acquisition costs 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, 2011, 2010 and 2009
The Company also leases certain office space and equipment under operating leases. The Company evaluates the impact of rent escalation clauses, lease incentives, including rent abatements included in its operating leases. Rent escalation clauses and lease incentives are considered in determining total rent expense to be recognized during the term of the lease, which begins on the date the Company takes control of the leased space. Rent expense related to lease agreements which contain escalation clauses are recorded on a straight-line basis. Renewal options are considered by evaluating the overall term of the lease.
The goodwill impairment review is highly judgmental and involves the use of significant estimates and assumptions. The estimates and assumptions have a significant impact on the amount of any impairment charge recorded. Discounted cash flow methods are dependent upon assumption of future sales trends, market conditions and cash flows of each reporting unit over several years.
The Company completed its annual assessment of goodwill for the years December 31, 2011, and 2010 in December of each respective year and concluded that the value of its goodwill was not impaired as of December 31, 2011 and 2010, respectively.
Considerable uncertainty and variability are inherent in such estimates, and accordingly, the subsequent development of these reserves may not conform to the assumptions inherent in the determination. Management believes that the amounts recorded as the liability for policy and claim liabilities represent its best estimate of such amounts. However, actual loss experience may not conform to the assumptions used in determining the estimated amounts for such liability at the balance sheet date. Accordingly, such ultimate amounts could be significantly in excess of or less than the amounts indicated in the consolidated financial statements. As adjustments to these estimates become necessary, such adjustments are reflected in the Consolidated Statements of Income.
reducing future retrospective commissions earned and payable against the receivable amount due from the producer;
The Company files a consolidated federal income tax return with all majority owned subsidiaries. The Company has a tax sharing agreement with its subsidiaries where each company is apportioned the amount of tax equal to that which would be reported on a separate company basis. The components of other comprehensive income or loss included in the consolidated statements of stockholders' equity have been computed based upon the 35% federal tax rate.
Comprehensive income includes both net income and other items of comprehensive income comprised of unrealized gains and losses on investment securities classified as available-for-sale and unrealized gains and losses on the interest rate swap. The Company has elected to disclose comprehensive income in its Consolidated Statements of Stockholders' Equity.
The Company accounts for stock-based compensation in accordance with FASB Topic ASC 718, Compensation-Stock Compensation ("ASC 718"), which addresses accounting for stock-based awards, including stock options and restricted stock. Under ASC 718, compensation expense is measured using fair value and is recorded over the requisite service or performance period of the awards. The Company measures stock-based compensation expense using the calculated value method. Under this method, the Company estimates the fair value of each stock option on the grant date using the Black-Scholes valuation model. The Company used 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 the Company's stock, the Company has 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 were 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 is based on the market price of Fortegra's common stock at the grant date. The Company typically recognizes stock-based compensation expense on a straight-line basis over the requisite service period, which is the
The Company expenses all advertising and promotional costs as incurred. Advertising costs incurred were not material to the Company’s Consolidated Financial Statements for the years ending December 31, 2011, 2010 and 2009.
In January 2010, the FASB issued revised guidance intended to improve disclosures related to fair value measurements. This guidance requires new disclosures and clarifies certain existing disclosure requirements. New disclosures under this guidance require separate information about significant transfers into and out of Level 1 and Level 2, and the reasons for such transfers, and also require purchases, sales, issuances, and settlements information for Level 3 measurements to be included in the roll forward of activity on a gross basis. The guidance also clarifies the requirement to determine the level of disaggregation for fair value measurement disclosures and the requirement to disclose valuation techniques and inputs used for both recurring and nonrecurring fair value measurements in either Level 2 or Level 3. This accounting guidance became effective for the Company beginning in the second quarter of 2010, except for the roll forward of activity on a gross basis for Level 3 fair value measurements, which will be effective for the Company in the first quarter of 2012. The adoption of this guidance is reflected in the Footnote, "Fair Value of Financial Instruments" and did not have a material impact on the Company’s financial statement disclosures.
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. Potentially dilutive common shares for which the exercise price was greater than the average market price of common shares are excluded from the computation of diluted earnings per share as the effect would be anti-dilutive.
In October 2011, the Company acquired Pacific Benefits Group Northwest, LLC ("PBG"), a leading U.S. independent insurance agency. PBG markets and sells health, accident, critical illness and life insurance policies. PBG is headquartered in Beaverton, OR and is licensed as an agent in 42 states.
Effective December 1, 2011, the Company's Payment Protection subsidiary, Life of the South Insurance Co.("LOTS"), entered into an assumption reinsurance transaction with Magna Insurance Company ("Magna") in which LOTS assumed all the outstanding liabilities for insurance policies underwritten by Magna, including its credit, annuity and mortgage life policies. The value of the insurance liabilities assumed, net of reinsurance was approximately $11.3 million. These policies are running off and no new policies are being underwritten.
The following unaudited pro forma summary presents the Company's consolidated financial information as if Auto Knight, eReinsure, PBG and Magna had been acquired on January 1, 2010. These amounts have been calculated after applying the Company's accounting policies and adjusting the results of the acquired company to reflect the additional interest expense associated
The values of certain assets and liabilities acquired in acquisitions are preliminary in nature, and are subject to adjustment as additional information is obtained, including, but not limited to, valuation of separately identifiable intangibles, fixed assets, deferred taxes and loss reserves. The valuations will be finalized within 12 months of the close of the acquisition. When the valuations are finalized, any changes to the preliminary valuation of assets acquired or liabilities assumed may result in adjustments to separately identifiable intangible assets and goodwill. A change to the acquisition date value of the identifiable net assets during the measurement period (up to one year from the acquisition date) affects the amount of the purchase price allocated to goodwill. Changes to the purchase price allocation are adjusted retrospectively in the consolidated financial results.
In conjunction with the eReinsure acquisition in 2011, the Company initially recorded goodwill of $32.1 million. During 2011, the Company made preliminary adjustments to goodwill based on information available regarding the values of assets and liabilities of eReinsure as of the acquisition date. These adjustments reduced the amount of goodwill by $6.0 million and increased other intangible assets by $7.3 million and increased deferred tax liabilities by $1.3 million. The Company will determine the final valuation for eReinsure in 2012.
(1) The amount of goodwill attributable to acquisitions that is expected to be tax deductible for acquisitions completed in 2010 has been revised from the amount presented in the 2010 Annual Report resulting from adjustments to goodwill for final valuations obtained in 2011 for the 2010 acquisitions.
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.
During 2011, the Company determined final valuations for the 2010 acquisitions of Continental and United. The final valuations resulted in a total decrease in goodwill of $10.3 million. The December 31, 2010 balance of goodwill has been revised to include the effect of these measurement period adjustments, in accordance with accounting requirements under ASC 805.
Other intangible assets and their respective amortization periods are as follows:
The estimated amortization of other intangible assets for the next five years and thereafter ending December 31 are presented below:
The Company has various reinsurance agreements in place whereby the amount of risk in excess of the Company's retention 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. The effects of reinsurance on premiums written and earned and losses and loss adjustment expenses ("LAE") incurred are presented in the tables below:
The Company entered into an assumption reinsurance agreement with Magna effective December 1, 2011. Under the agreement, all the insurance liabilities of Magna's run-off insurance contracts were assumed by the Company. These contracts are substantially reinsured, and ceded balances from these reinsurance arrangements are reflected in the tables above.
In June 2010, the Company entered into a $35.0 million revolving credit facility with SunTrust Bank, N.A., as administrative agent (the "Agent"), which matures in June 2013 (the "Facility"). The Facility bears interest at a variable rate determined based upon the higher of (i) the prime rate, (ii) the federal funds rate plus 0.50% or (iii) LIBOR plus 1%, plus a margin tied to the Company's leverage ratio. The Company can select at its discretion to convert the interest rate for all or a portion of the outstanding balance for a period of up to six months to a fixed EURO Dollar Funding rate which is equal to the adjusted LIBOR rate for the elected interest period in effect at the time of election, plus a margin tied to the Company's leverage ratio.
The Company is required to pay a commitment fee of between 0.45% and 0.60% (based upon the Company's leverage ratio) on the unused portion of the Facility. The purpose of the line is for working capital and acquisitions. Interest on the line of credit is payable monthly. The Company's obligations under the Facility are guaranteed by substantially all of its domestic subsidiaries, other than South Bay and the regulated insurance subsidiaries. Under the Facility, the Company may not assign, sell, transfer or dispose of any collateral or effect certain changes to its capital structure and the capital structure of its subsidiaries without the Agent's prior consent. The Company's obligations under the Facility may be accelerated or the commitments terminated upon the occurrence of an event of default under the Facility, 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 following is a summary of the Company's more significant financial covenants related to the Facility at:
Wells Fargo Capital Finance, LLC Line of Credit - On February 7, 2011, the Company terminated its existing revolving $40.0 million credit facility with Wells Fargo Capital Finance, LLC, which was never drawn upon. Upon termination, South Bay
paid the fees and expenses owed under the Loan Agreement of $0.1 million, including interest on the Minimum Funding Amount (as defined in the Loan Agreement), unused line fees and monthly loan administration fees. The Company continues to amortize previously capitalized costs with a remaining balance of $0.2 million at December 31, 2011 associated with the Wells Fargo Capital Finance, LLC Line of Credit in connection with the Wells Fargo Joinder to the Facility.
Common and preferred stock: The fair value of publicly traded common and preferred stocks were obtained from market value quotations provided by an independent pricing service. The fair values of non-publicly traded common stocks were based on prices obtained from an independent pricing service.
Notes receivable: The carrying amounts approximate fair value because the interest rates charged approximate current market
rates for similar credit risks. These values are net of allowance for doubtful accounts.
Other receivables: The carrying amounts approximate fair value because of the short duration there is no associated interest rate charged.
Interest rate swap: The fair value of the Company's interest rate swap is determined using widely accepted valuation techniques including discounted cash flow analysis on the expected cash flows of the interest rate swap. This analysis reflects the contractual terms of the interest rate swap, including the period to maturity, and uses observable market-based inputs, including interest rate curves and implied volatilities.
The following tables set forth the Company's financial assets and liabilities that were accounted for at fair value by level within the fair value hierarchy at December 31, 2011 and December 31, 2010:
The Company's use of Level 3 unobservable inputs included 12 securities that accounted for 1.3% of total investments at December 31, 2011 and 5 securities that accounted for 1.6% of total investments at December 31, 2010.
The reconciliation of the income tax expense at the federal statutory income tax rate of 35% in 2011, 2010 and 2009 is as follows:
The Company had no unrecognized tax benefits for the years ended December 31, 2011, 2010 and 2009. The Company has reviewed its uncertain tax positions and has concluded that they are immaterial and did not require an adjustment to equity upon adoption of ASC 740-10. The Company is no longer subject to U.S. federal or state tax examinations by tax authorities for 2007 or prior years.
At December 31, 2011, the Company had net operating loss carry forwards of $3.6 million, which are subject to certain limitations under IRC Section 382 and will begin to expire in 2019. In addition, the Company has research tax credit carry forwards for federal and state income tax purposes in the amount of $0.5 million and $0.2 million, respectively, which are also subject to certain limitations under IRC Section 382 and will begin to expire in 2019.
At December 31, 2011 the Company has outstanding stock options under its 2005 Equity Incentive Plan ("2005 Plan") and 2010 Omnibus Incentive Plan ("2010 Plan").
The following summarizes information about the Company's outstanding and exercisable stock options at December 31, 2011:
At December 31, 2011, the number of shares vested and expected to vest total approximately 1,879,394, have a weighted average remaining contractual life of 5.6 years, a weighted average exercise price of $4.12 and an intrinsic value of $5.5 million.
Total unrecognized compensation cost related to non-vested stock options at December 31, 2011 was $0.8 million with a weighted-average recognition period of approximately 3.2 years.
At December 31, 2011, the Company has restricted stock awards outstanding under the 2010 Plan. In 2011, the Company granted 7,000 restricted stock awards to key employees at an average price of $7.64, with 50% of the awards vesting on the grant date and the remaining 50% vesting on the first anniversary of the grant date.
The Company also has deferred bonus agreements with several key executives whereby funds are contributed to "rabbi" trusts held for the benefit of the executives. The funds held in the rabbi trusts are included in cash and cash equivalents and the corresponding deferred compensation obligation is included in accrued expenses, accounts payable and other liabilities on the Consolidated Balance Sheets . Pursuant to U.S. GAAP, the portion of the rabbi trusts invested in shares of the Company has been reflected as treasury stock on the Consolidated Balance Sheets at December 31, 2011 and 2010.
The Company has a 401(k) plan (the "Plan") available to employees meeting certain eligibility requirements. The Plan allows employees to contribute, at their discretion, a percentage of their pre-tax annual compensation and allows for employees to select from various investment options based on their individual investment goals and risk tolerances. Under the Plan, the Company will match 100% of each dollar of the employee contribution up to the maximum of 5% of the employee's annual compensation. The contributions of the Plan are invested at the election of the employee in one or more investment options by a third party plan administrator. In July 2009, the Company suspended the matching contribution. The matching contribution was reinstated in January 2010 and subsequently suspended in August 2010.
The Company's insurance subsidiaries may pay dividends to the Company, subject to statutory restrictions. Payments in excess of statutory restrictions (extraordinary dividends) to the Company are permitted only with prior approval of the insurance departments of the applicable state of domicile. For the year ended December 31, 2011, $7.6 million in ordinary dividends were paid. In 2011, Life of the South Insurance Company received approval from the insurance department of its state of domicile to
The combined statutory capital and surplus of the Company's insurance subsidiaries was $50.2 million and $46.2 million as of December 31, 2011 and December 31, 2010, respectively. The combined amount available for ordinary dividends of the Company's insurance subsidiaries was $2.3 million and $1.6 million as of December 31, 2011 and December 31, 2010, respectively.
The Company is a party to claims and litigation in the normal course of our operations. Management believes that the ultimate outcome of these matters will not have a material adverse effect on the consolidated financial condition, results of operations or cash flows of the Company.
Also in the Payment Protection business segment, the Company is currently a defendant in Mullins v. Southern Financial Life Insurance Co, which was filed on February 2, 2006, in the Pike Circuit Court, in the Commonwealth of Kentucky. This matter is a class-action, as a class was certified on June 25, 2010. At issue is the duration or term, of coverage under certain policies. The action alleges violations of the Consumer Protection Act and certain insurance statutes, as well as common law fraud. The action seeks compensatory and punitive damages, attorney fees and interest. The parties are currently involved in the discovery phase. No trial date has been set.
As of January 1, 2011, certain BPO and Brokerage distribution channels were re-aligned to better reflect the segments business focus. The distribution channel results for the years ended December 31, 2010 and December 31, 2009 have been reclassified from their prior period segment presentation. The impact of these reclassifications were $3.9 million in revenues and $3.6 million in expenses being moved from the BPO segment into the Brokerage segment for the year ended December 31, 2010 and $4.7
During 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 addition the Company paid an upfront fee of $0.1 million to the Marketer as part of the Marketing Agreement, which is recorded in prepaid expense and will be amortized over the five year term.
Subsequent events have been measured through the date on which the Consolidated Financial Statements were filed.