Our principal executive offices are located in approximately 23,000 square feet of office space we lease in Fort Lauderdale, Florida. We also lease office space for our regional branch offices in California, Florida, Missouri, North Carolina, Pennsylvania and Texas. We do not own any real property. We consider our facilities to be adequate for our current operations.
Represents historical payments made by us to Guarantee Insurance Group as reimbursements for allocated portions of rent and certain administrative costs incurred by Guarantee Insurance Group on our behalf. Our administrative functions have been separated from Guarantee Insurance Group and from August 6, 2014, such reimbursements are no longer made by us in respect of such costs.
We are a national provider of comprehensive outsourcing solutions within the workers’ compensation marketplace for insurance companies, employers, local governments and reinsurance captives. We offer an end-to-end portfolio of services to increase business production, contain costs and reduce claims experience for our clients. We leverage our strong distribution relationships, proprietary business processes, advanced technology infrastructure and management expertise to deliver valuable solutions to our clients. We strive to deliver these value-added services to our clients in order to help them navigate the workers’ compensation landscape, ensure compliance with state regulations, handle all aspects of the claims process and ultimately contain costs.
On January 22, 2015, we consummated our initial public offering (the “IPO”) of common stock, par value $0.001 per share, at a public offering price of $14.00 per share, pursuant to the Company’s registration statement on Form S-1 (File No. 333-200972), as amended, filed with the Securities and Exchange Commision under the Securities Act. In the IPO, we issued and sold 7,350,000 shares of our common stock, and the PennantPark Entities offered and sold 965,700 shares of common stock.
We used the net proceeds from the Offering, together with borrowings under our senior secured credit facility, to repay $67.6 million outstanding under its PennantPark Loan Agreement (as defined below) and to repay $57.2 million outstanding under its UBS Credit Agreement (as defined below), in each case including accrued interest and applicable prepayment premiums. See “-Liquidity and Capital Resources-Indebtedness.”
Patriot National, Inc. (f/k/a Old Guard Risk Services, Inc.) was incorporated in Delaware in November 2013 to consolidate certain insurance services entities controlled by Mr. Mariano. This Reorganization separated our insurance services business from the insurance risk taking operations of Guarantee Insurance Group.
Effective August 6, 2014, we acquired certain contracts to provide marketing, underwriting and policyholder services to certain of our insurance carrier clients, as well as related assets and liabilities, from a subsidiary of Guarantee Insurance Group in the GUI Acquisition. We also acquired a contract to provide a limited subset of our brokerage and policyholder services to Guarantee Insurance, the balance of which had historically been provided without a contract as GUI is a subsidiary of Guarantee Insurance. We refer to the acquisition of these contracts and related assets and liabilities as the “GUI Acquisition.” Immediately following the GUI Acquisition, we entered into a new agreement to provide all of our brokerage and policyholder services to Guarantee Insurance.
The combined financial statements of Patriot National are comprised of (1) the financial statements of us and those of our subsidiaries which became our subsidiaries in the Reorganization, (2) the results of the Patriot Care Management Business which are reflected in our combined financial statements from August 6, 2014, the effective date of the Patriot Care Management Acquisition, and (3) the revenues and expenses associated with the contracts and certain other assets acquired and liabilities assumed in the GUI Acquisition from GUI, a wholly owned subsidiary of Guarantee Insurance Group and a related party by virtue of common control between us and Guarantee Insurance Group, which became effective August 6, 2014.
Because we and the subsidiaries we acquired in the Reorganization are under common control, and the contracts acquired in the GUI Acquisition were acquired from an entity under common control, our combined financial statements are presented as if all of these companies and businesses, were owned by us for all of the periods presented, as further described in the notes to our combined financial statements included elsewhere in this Annual Report on Form 10-K.
Our historical financial results for all periods presented in this Annual Report on Form 10-K include the results of the various businesses previously under the common control of Mr. Mariano and to which we succeeded in connection with the Reorganization, as well as the revenues and expenses associated with the contracts and certain other assets acquired and liabilities assumed through the GUI Acquisition. However, revenues and expenses associated with the new agreement we entered into in August 2014 to provide all of our brokerage and policyholder services to Guarantee Insurance, as well as the financial results associated with the Patriot Care Management Business, are included in our historical financial results beginning August 6, 2014 only and are not reflected in our historical financial statements as of or for any earlier period.
We consummated our Offering on January 22, 2015 and expect to incur additional costs associated with operating as a public company, including hiring additional personnel, improving financial reporting systems, additional directors’ and officers’ liability insurance, director fees and expanding our facilities. We expect that these costs will relate to legal, regulatory, finance, accounting, investor relations and other administrative functions. Sarbanes-Oxley, as well as rules adopted by the SEC and the NYSE, require public companies to implement specified corporate governance practices that are currently inapplicable to us as a private company. We currently estimate that we will incur incremental annual costs, including costs for additional personnel, of approximately $2.5 million to $3.0 million associated with operating as a public company, although it is possible that our actual incremental costs will be higher than we currently estimate.
Operating Cash Flow: we define Operating Cash Flow as Adjusted EBITDA less income tax expense, interest expense, and capital expenditures.
Adjusted Earnings (Loss): we define Adjusted Earnings or Loss and Adjusted Earnings or Loss per share as net income (loss) adjusted for net realized (gains) or losses on investments, increase/(decrease) in fair value of warrant redemption liability and loss on exchange of units and warrants.
Other companies, including companies in our industry, may calculate Adjusted EBITDA, Operating Cash Flow and Adjusted Earnings (Loss) or similarly titled measured differently, which reduce their usefulness as a comparative measure.
Reference premium written for the year ended December 31, 2014 was $359.9 million compared to $357.4 million for the year ended December 31, 2013, an increase of $2.5 million. The increase was attributable to a $13.0 million increase in Guarantee Insurance reference premium written and the 2014 inception of new contracts with Scottsdale and certain other insurance carrier clients, which generated $21.8 million of reference premium written. This was partially offset by a decrease in reference premium
and generally the deployment of our initial program with Zurich. These increases were partially offset by a $54.4 million decrease associated with the termination of the Ullico contract.
Operating cash flow for the year ended December 31, 2013 was $4.7 million compared to $1.8 million for the year ended December 31, 2012, an increase of $2.9 million. The increase was principally attributable to an increase of $4.4 million Adjusted EBITDA, partially offset by increases of $0.7 million income tax expense and $0.9 million interest expense.
Adjusted loss for the year ended December 31, 2013 was $(4.5) million compared to earnings of $0.3 million for the year ended December 31, 2012, a decrease of $4.8 million. The decrease was principally attributable to 2013 amortization of the balance of the discount on the debt associated with the Advantage Capital loan agreement entered into on October 9, 2012, upon the repayment of the loan in full on November 27, 2013, which is discussed more fully below.
We derive substantially all of our revenue from providing brokerage and policyholder services and claims administration services.
commission expense to agencies that produce business in connection with our underwriting services;
For the year ended December 31, 2013, approximately 44% of our total fee income and fee income from related party was attributable to our contracts with Guarantee Insurance, and approximately 38% and 12% of our total fee income and fee income from related party were attributable to our contracts with our second and third largest clients, respectively.
This increase was attributable to an increase in claims administration services fees as a result of $10.7 million of fee income earned by the Patriot Care Management Business from non-related parties from the date of acquisition of this service unit on August 6, 2014 to December 31, 2014, combined with a $1.2 million increase in fee income earned from the California Insurance Guaranty Association, which became a customer of ours in June 2014. The increase in claims administration services fees was largely offset by the decrease in brokerage and policyholder services fee income related to the decrease in reference premium written by us for Zurich, as described above under “-Key Performance Measures.”
Our prices by customer for our brokerage and policyholder services and claims administration services were unchanged for the year ended December 31, 2014 relative to the year ended December 31, 2013 and, accordingly, the net increase in fee income was solely related to changes in the volume of business we managed.
Salaries and Salary Related Expenses. Salaries and salary related expenses for the year ended December 31, 2014 were $32.4 million compared to $16.0 million for the year ended December 31, 2013, an increase of $16.4 million or approximately 103%.
This increase was principally due to additional salary and salary related costs recorded from August 6, 2014, the date on which we began to directly incur salary and salary related costs associated with our brokerage and policyholder services, as well as salary and salary related costs associated with administrative support services, including executive management, information technology, accounting, human resources and legal services. Previously, we received an allocation for such brokerage and policyholder services costs from Guarantee Insurance Group as described under “-Allocation of Marketing, Underwriting and Policy Issuance Costs from Related Party” below, and a portion of such administrative support services costs was incurred in the form of a management fee paid to Guarantee Insurance Group as described under “-Management Fees to Related Party for Administrative Support Services” below. Salary and salary related costs further increased in the period since August 6, 2014 as a result of the new agreement we entered into with Guarantee Insurance to provide all of our brokerage and policyholder services to Guarantee Insurance, as described elsewhere in this 10-K. In addition, effective August 6, 2014, we acquired the Patriot Care Management Business, which has notably increased our workforce. Accordingly, we expect further significant increases in salaries and salary related costs going forward.
Additionally, the increase was in part due to an increase in the size of our claims administration services staff in connection with efforts by us to perform more claims investigation work in-house rather than through outsourced vendors.
Management Fees to Related Party for Administrative Support Services. Management fees to related party for administrative support services for the year ended December 31, 2014 were $5.4 million compared to $12.1 million for the year ended December 31, 2013, a decrease of $6.7 million or 56%. This decrease was in part attributable to a decrease in the proportion of reference premium written by us for our third-party insurance carrier clients relative to reference premium written by Guarantee Insurance (which, as discussed above, generally served as the basis for calculating the management fees).
Outsourced Services . Outsourced services for the year ended December 31, 2014 were $5.6 million compared to $3.3 million for the year ended December 31, 2013, an increase of $2.3 million or 70%. The increase was principally attributable to outsourced services costs incurred by the Patriot Care Management Business from August 6, 2014 (the date of our acquisition of the Patriot Care Management Business) to December 31, 2014. We did not own the Patriot Care Management Business for the year ended December 31, 2013 and, accordingly no such costs were incurred for that period.
Allocation of Marketing, Underwriting and Policy Issuance Costs from Related Party. Allocation of marketing, underwriting and policy issuance costs from Guarantee Insurance Group, a related party, for the year ended December 31, 2014 was $1.9 million compared to $4.7 million for the year ended December 31, 2013, a decrease of $2.8 million or 60%. This decrease was in part attributable to a decrease in the proportion of reference premium produced by us relative to reference premium produced by Guarantee Insurance (which, as discussed above, generally served as the basis for the allocation).
Additionally, the increase is due to additional other operating expenses incurred from August 6, 2014 and associated with the operations of the Patriot Care Management Business. We did not own the Patriot Care Management Business during the year ended December 31, 2013 and, accordingly, we did not record any such other operating expenses for it for that period. The increase was also partially attributable to an increase in consulting and temporary labor costs incurred in connection with an increase in workload in respect of claims administration services.
We expect that other operating expenses will further increase going forward as a result of the new arrangements in respect of costs associated with both brokerage and policyholder services and administrative support services, as described under “-Salaries and Salary Related Expenses” above.
Interest Expense. Interest expense for the year ended December 31, 2014 was $9.2 million compared to $1.2 million for the year ended December 31, 2013, an increase of $8.0 million. Interest expense for the year ended December 31, 2014, is comprised of interest accruing under (i) the Initial Tranche of the PennantPark Loan Agreement entered into on November 27, 2013 in connection with the Reorganization, (ii) the Additional Tranche of the PennantPark Loan Agreement, as amended, entered into on August 6, 2014 in connection with the GUI Acquisition and (iii) the UBS Credit Agreement entered into on August 6, 2014 in connection with the Patriot Care Management Acquisition, all described elsewhere in this 10-K. We expect a significant reduction of interest expense in the future, due to lower debt balances and interest rates associated with our current Senior Secured Credit Facility, as discussed in Note 6, Notes Payable and Lines of Credit.
Amortization of Loan Discounts and Loan Costs. Amortization of loan discounts and loan costs was $2.2 million for the year ended December 31, 2014 compared to $5.6 million for the year ended December 31, 2013, a decrease of $3.4 million. The decrease was attributable to the fiscal 2013 amortization of the balance of the discount on the debt associated with the Advantage Capital loan agreement entered into on October 9, 2012, upon the repayment of the loan in full on November 27, 2013. This decrease was partially offset by an increase in amortization of loan costs related to the Initial Tranche of the PennantPark Loan Agreement entered into on November 27, 2013 and the Additional Tranche of the PennantPark Loan Agreement and the UBS Credit Agreement, each entered into on August 6, 2014 as described above.
Accordingly, we recognized a $16 thousand increase in valuation allowance, which was equal to 100% of the deferred tax expense attributable to the GUI contracts for the year ended December 31, 2014 and a $2.7 million increase in valuation allowance equal to 100% of the deferred tax benefit attributable to the GUI contracts for the year ended December 31, 2013.
For the year ended December 31, 2013, approximately 44% of our total fee income and fee income from related party was attributable to our contracts with Guarantee Insurance, a related party, and approximately 38% and 12% of our total fee income and fee income from related party were attributable to contracts with our second and third largest clients, respectively.
Fee Income. Fee income, which represents fee income from non-related parties, for the year ended December 31, 2013 was $46.5 million compared to $25.8 million for the year ended December 31, 2012, an increase of $20.7 million or approximately 80%.
This increase was also partly due to higher claims administration services fee income, for the most part attributable to a decrease by Guarantee Insurance of the portion of claims expense retained on its business (resulting in corresponding claims administration
Fee Income from Related Party. Fee income from related party for the year ended December 31, 2013 was $9.4 million compared to $12.5 million for the year ended December 31, 2012, a decrease of $3.1 million or approximately 25%.
The decrease in fee income from related party is therefore entirely attributable to lower claims administration fee income from related party principally due to the decrease by Guarantee Insurance of the portion of claims expense retained on its business (resulting in corresponding claims administration services revenue being classified as fee income rather than fee income from related party), partially offset by an increase in managed exposures related to the growth in reference premiums written by Guarantee Insurance, as described above.
Management fees to related party for Administrative Support Services. Management fees to related party for administrative support services for the year ended December 31, 2013 were $12.1 million compared to $8.0 million for the year ended December 31, 2012, an increase of $4.1 million or approximately 51%. The increase was attributable to an increase in the proportion of reference premium written by us for our third-party insurance carrier clients relative to reference premium written by Guarantee Insurance (which, as discussed above, generally served as the basis for calculating the management fees), partially offset by a decrease in total administrative support services incurred by Guarantee Insurance Group for the benefit of both Guarantee Insurance and us.
Outsourced Services. Outsourced services for the year ended December 31, 2013, were $3.3 million compared to $4.5 million for the year ended December 31, 2012, a decrease of $1.1 million or approximately 26%. The decrease was principally attributable to lower outsourcing costs as a result of efforts by us to perform more claims investigation work in-house rather than through outsourced vendors.
Allocation of Marketing, Underwriting and Policy Issuance Costs from Related Party. Allocation of marketing, underwriting and policy issuance costs from Guarantee Insurance Group, a related party, for the year ended December 31, 2013 was $4.7 million compared to $2.8 million for the year ended December 31, 2012, an increase of $1.9 million or approximately 69%. The increase was attributable to an increase in the proportion of reference premium produced by us relative to reference premium produced by Guarantee Insurance (which, as discussed above, generally served as the basis for the allocation).
Other Operating Expenses. Other operating expenses were $4.6 million for both the year ended December 31, 2013 and 2012.
Interest Expense. Interest expense for the year ended December 31, 2013, was $1.2 million compared to $0.3 million for the year ended December 31, 2012, an increase of $0.9 million.
Interest expense for the year ended December 31, 2012 reflects $0.3 million of interest in connection with the $10.0 million Advantage Capital loan as described in “Certain Relationships and Related Transactions and Director Independence-Financing Transactions.” On November 27, 2013, the $10.0 million Advantage Capital loan was repaid in full with a portion of the proceeds of the Initial Tranche of the PennantPark Loan Agreement.
Depreciation and Amortization. Depreciation and amortization for the year ended December 31, 2013, was $2.6 million compared to $1.3 million for the year ended December 31, 2012, an increase of $1.3 million or approximately 100%. The increase was attributable to an increase in depreciation related to capitalized policy and claims administration system development costs in connection with the WCE system, which we incurred principally in the second half of 2013.
Amortization of loan discounts for the year ended December 31, 2013 principally represents amortization of the balance of the discount on the debt associated with the Advantage Capital loan agreement entered into on October 9, 2012, upon the repayment of the loan in full on November 27, 2013. See “Certain Relationships and Related Transactions and Director Independence-Financing Transactions.” Amortization of loan discounts for the year ended December 31, 2012, represents amortization of the discount on the debt associated with the Advantage Capital loan agreement entered into on October 9, 2012, as described above.
Loss on Exchange of Units and Warrants. We recorded a loss on exchange of units and warrants of $0.2 million for the year ended December 31, 2013, attributable to the fact that in connection with the Reorganization, Advantage Capital, one of our prior lenders, exchanged common units and detachable common stock warrants issued by certain of our subsidiaries for detachable common stock warrants of ours, which had a higher value.
Provision for Uncollectible Fee income. For the year ended December 31, 2013, we recorded a provision for uncollectible fee income of $2.5 million in connection with the liquidation of Ullico in May 2013. Ullico was one of our insurance carrier clients from April 2009 until we terminated the contract effective March 26, 2012. For the year ended December 31, 2012, we determined that no provision for uncollectible fee income was required.
As a result of the factors described above, net loss for the year ended December 31, 2013 was $6.2 million compared to net income of $0.3 million for the year ended December 31, 2012, a decrease in net income of $6.5 million.
Our revenue and operating results associated with our brokerage and policyholder services are generally subject to seasonal variations as a result of the distribution of renewal dates of existing policies throughout the year, with slightly more renewals in occurring in the first and third calendar quarter based on the current distribution of such dates.
We believe that our cash flow from operations and available cash and cash equivalents will be sufficient to meet our liquidity needs for the foreseeable future. As of December 31, 2014, our unrestricted cash and cash equivalents were $4.3 million. In addition, as of December 31, 2014, we had $6.9 million of restricted cash, which are funds we receive from our insurance carrier clients and that are earmarked exclusively for payments of claims on behalf of such clients. We cannot use such funds for other purposes.
To the extent we require additional liquidity, we anticipate that it will be funded through the incurrence of other indebtedness (which may include capital markets indebtedness, our senior secured credit facility or indebtedness under other credit facilities), equity financings or a combination thereof. Although we have no specific current plans to do so, if we decide to pursue one or more significant acquisitions, we may incur additional debt or sell additional equity to finance such acquisitions.
Net cash used in investing activities for the year ended December 31, 2014 was $59.5 million compared to $28.8 million for the year ended December 31, 2013, an increase of $30.7 million. The increase was principally attributable to $54.9 million of cash used for the Patriot Care Management Acquisition, as described elsewhere in this 10-K.
Net cash used in investing activities for the year ended December 31, 2013 was $28.8 million compared to $3.5 million for the year ended December 31, 2012, an increase of $25.3 million. The increase was principally attributable to a $28.3 million decrease in note receivable from related party, partially offset by a $4.8 million increase in restricted cash.
Our balance sheet as of December 31, 2014 includes balances attributable to these capital expenditures, which we acquired from GUI effective August 6, 2014. Our balance sheet as of December 31, 2013 do not include balances attributable to these capital expenditures. However, amortization associated with these capital expenditures is included in our operating results for the year ended December 31, 2014, 2013 and 2012. Our WCE policy and claims administration system was placed into production in August 2013. Although we expect to make additional capital expenditures related to the development of additional features and functionality related to our WCE policy and claims administration system, we do not anticipate such further costs to be significant.
In addition to paying interest on outstanding principal under the senior secured credit facility, we are required to pay a commitment fee to the Administrative Agent for the ratable benefit of the lenders under the revolving credit facility in respect of the unutilized commitments thereunder, ranging from 35 basis points to 50 basis points, depending on specified leverage ratios. With respect to letters of credit, we are also required to pay a per annum participation fee equal to the applicable LIBOR margin on the face amount of
each letter of credit as well as a fee equal to 0.125% on the face amount of each letter of credit issued (or the term of which is extended). This latter 0.125% fee is payable to the issuer of the letter of credit for its own account, along with any standard documentary and processing charges incurred in connection with any letter of credit.
On August 6, 2014, in connection with the Patriot Care Management Acquisition, we and certain of our subsidiaries entered into the UBS Credit Agreement, which provided for a five-year term loan facility in an aggregate principal amount of $57.0 million that would mature on August 6, 2019. The loan was secured by the common stock of PCM and guaranteed by Guarantee Insurance Group and its wholly owned subsidiaries. Following our IPO, we prepaid all outstanding borrowings under the UBS Credit Agreement, including accrued interest and applicable prepayment premium. See “Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities-Use of Proceeds from Registered Securities.”
Borrowings under the PennantPark Loan Agreement were comprised of (i) an Initial Tranche in an aggregate principal amount of approximately $37.8 million, and (ii) an Additional Tranche in an aggregate principal amount of approximately $30.8 million of new borrowings. Our borrowings under the PennantPark Loan Agreement were funded at a price equal to 97.5% of the par value thereof and bore interest equal to the sum of (i) the greater of 1.0% or LIBOR and (ii) 11.50%. The weighted average interest rate under the PennantPark Loan Agreement for the year ended December 31, 2014 was 12.5%.
Critical Accounting Policies and Estimates and Recently Issued Financial Accounting Standards
collected, we recognize fee income as the premium is collected, reduced by an allowance for estimated commission income that may be returned by us to such clients due to net returns of premiums previously written and collected. In each case, we record the revenue effects of subsequent premium adjustments when such adjustments become known.
We have also historically recorded fee income for soliciting applications for workers’ compensation policies for Guarantee Insurance, a related party, pursuant to a producer agreement between GUI and Guarantee Insurance that we acquired as part of the GUI Acquisition, based on a percentage of premiums procured. The producer agreement provided that the percentage may be amended from time to time upon the mutual consent of the parties. For the years ended December 31, 2013 and 2012, the fees based on a percentage of premium were waived in their entirety and for the year ended December 31, 2012, fees of approximately $0.4 million were agreed. This agreement was terminated effective August 6, 2014.
Generally, as a historical matter, the policies we produced for our insurance carrier clients other than Guarantee Insurance featured payment plans spread across the terms of the respective policies. Because we record brokerage and policyholder services revenue on this business as premium is collected, the commission income we estimate that may be returned by us to such clients due to estimated net reductions in total premium for the term of the policy, principally associated with mid-term policy cancellations, was nominal. Accordingly, we did not maintain an allowance for estimated return commission income on business produced by us for insurance carrier clients other than Guarantee Insurance prior to August 6, 2014.
Additionally, upon termination of our producer agreement with Guarantee Insurance, we and Guarantee Insurance agreed that there would be no further adjustments to commission income associated with changes in total premium for the term of the policy. Accordingly, we did not maintain an allowance for estimated return commission income pursuant to our producer agreement with Guarantee Insurance.
Goodwill represents the excess of consideration paid over the fair value of net assets acquired. Goodwill is not amortized, but is tested at least annually for impairment (or more frequently if certain indicators are present or management otherwise believes it is appropriate to do so). In the event that management determines that the value of goodwill has become impaired, we will record a charge for the amount of impairment during the fiscal quarter in which the determination is made. We determined that there was no impairment as of December 31, 2014.
Another subsidiary of ours is domiciled in a non-U.S. jurisdiction and, accordingly, is not subject to U.S. federal income taxes. We have no current intention of distributing unremitted earnings of this subsidiary to its U.S. domiciled parent. Additionally, we believe that it is not practical to calculate the potential liability associated with such distribution due to the fact that dividends received from this subsidiary could bring additional foreign tax credits, which could ultimately reduce the U.S. tax cost of the dividend, and significant judgment is required to analyze any additional local withholding tax and other indirect tax consequences that may arise due to the distribution of these earnings. Accordingly, pursuant to ASC 740, Tax Provisions, the income tax benefit in our combined statements of operations for the years ended December 31, 2014, 2013 and 2012 do not include a provision for federal income taxes attributable to that entity’s operations.
In determining the quarterly provision for income taxes, management uses an estimated annual effective tax rate based on forecasted annual pre-tax income (loss), permanent tax differences, statutory tax rates and tax planning opportunities in the various jurisdictions in which we operate. The impact of significant discrete items is separately recognized in the periods in which they occur.
We deliver our services to our customers through local offices in each region and financial information for our operations follows this service delivery model. All regions provide brokerage, underwriting and policyholder services as well as claims administration services. ASC 280, Segment Reporting, Section 280-10, establishes standards for the way that public business enterprises report information about operating segments in annual and interim consolidated financial statements. Our internal financial reporting is organized geographically, as discussed above, and managed on a geographic basis, with virtually all of our operating revenue generated within the United States. In accordance with ASC 280-10, multiple product offerings may be aggregated into a single operating segment for financial reporting purposes if aggregation is consistent with the objective and basic principles, if the segments have similar economic characteristics, and if the segments are similar in terms of (i) the nature of products and services, (ii) the nature of the production processes, (iii) the type or class of customer for their products and services and (iv) the methods used to distribute their products or provide their services. We believe each of our regional office operations meet these criteria, as each provides similar services and products to similar customers using similar methods of production and similar methods to distribute the services and
We recognize compensation expense for awards of equity instruments to employees based on the grant-date fair value of those awards, with limited exceptions, over the requisite service period.
In May, 2014, the FASB issued Accounting Standards Update 2014-09 regarding ASC Topic 606, Revenue from Contracts with Customers. The standard provides principles for recognizing revenue for the transfer of promised goods or services to customers with the consideration to which the entity expects to be entitled in exchange for those goods or services. For a publicly-held entity, this guidance will be effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period, and early adoption is not permitted. For nonpublic entities, this guidance will be effective for annual reporting periods beginning after December 15, 2017, and interim periods within annual periods beginning after December 15, 2018, and early adoption (no earlier than annual reporting periods beginning after December 15, 2016) is permitted. We are currently evaluating the accounting, transition and disclosure requirements of the standard and cannot currently estimate the financial statement impact of adoption.
In April 2014, the FASB issued Accounting Standards Update 2014-08 regarding ASC Topics 205 and 360, Reporting Discontinued Operations. The updated guidance related to reporting discontinued operations and disclosures of disposals of components of an entity. Under the amendment only those disposals of components of an entity that represent a strategic shift that has
In our opinion, the combined financial statements referred to above present fairly, in all material respects, the financial position of Patriot National, Inc. at December 31, 2014 and 2013, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2014, in conformity with accounting principles generally accepted in the United States of America.
Because Patriot National, PSI, PRS, Contego, Forza and Patriot Captive Management are under common control, and the contracts and certain other assets acquired and liabilities assumed from GUI constitute the acquisition of a business under common control, the combined financial statements are presented as if all of these companies and the assets acquired and liabilities assumed from GUI were wholly or majority owned subsidiaries of the Company for all of the periods presented. Specifically,
Assets and liabilities attributable to Patriot National, PSI, PRS, Contego, Forza and Patriot Captive Management are included in the accompanying combined balance sheets as of December 31, 2014 and December 31, 2013,
The note receivable transferred to GUI and balances payable to GUI from the Company, both of which were included as part of the Company’s consideration for the contracts and certain other assets acquired and liabilities assumed (as described more fully in Note 7), together with the note payable associated with the acquisition of the contracts and certain other assets, have been eliminated in consolidation in the accompanying combined balance sheets as of December 31, 2014 and December 31, 2013, and
PRS provides workers’ compensation claims administration services to (i) Guarantee Insurance, (ii) PUI’s third party insurance company customers and (iii) segregated portfolio cell reinsurers that assume business written by Guarantee Insurance and PUI’s third party insurance company customers.
Forza provides claim lien negotiation services to PUI’s third party insurance and reinsurance company customers.
The accompanying combined financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (GAAP). For Contego Services Group, LLC, the Company’s combined subsidiary that is 97% owned, the third party holdings of equity interests are referred to as non-controlling interest. The portion of the third party members’ equity (deficit) of Contego Services Group, LLC is presented as non-controlling interest in the accompanying combined balance sheets as of December 31, 2014 and 2013. The Company discloses the following three measures of net income (loss): (i) net income (loss), including noncontrolling interest in subsidiary, (ii) net income (loss) attributable to non-controlling interest in subsidiary, and (iii) net income (loss).
Significant estimates inherent in the preparation of our combined financial statements include useful lives and impairments of long-lived tangible and intangible assets, accounting for income taxes and related uncertain tax positions, the valuation of warrant liabilities and accounting for business combinations.
Prior to August 6, 2014, our brokerage and policyholder services revenue was derived solely from (1) insurance carrier clients other than Guarantee Insurance, all of which record written premium as premium is collected and (2) Guarantee Insurance under a producer agreement for workers’ compensation policies described below.
Fee income earned from Guarantee Insurance for brokerage and policyholder services historically represents fees for soliciting applications for workers’ compensation insurance for Guarantee Insurance pursuant to a prior producer agreement that we acquired as part of the GUI Acquisition, based on a percentage of premiums written or other amounts negotiated by the parties. This agreement was terminated effective August 6, 2014. Following the GUI Acquisition, we entered into a new agreement with Guarantee Insurance
effective August 6, 2014 to provide all of our brokerage and policyholder services. Accordingly, we expect further significant increases in fee income from related party going forward.
Restricted cash is comprised of amounts received from our clients to be used exclusively for the payment of claims on behalf of such clients.
Another subsidiary of ours has identified its tax status as a limited liability company, electing to be taxed as a pass through entity. Prior to November 27, 2013, such subsidiary’s members were responsible for reporting their share of the entity’s taxable income or loss to the Internal Revenue Service. Accordingly, our combined statements of operations for the years ended December 31, 2013 and 2012 do not include a provision for federal income taxes attributable to this subsidiary’s operations for the period from January 1, 2013 to November 27, 2013 or for the year ended December 31, 2012. Effective November 27, 2013, following the Reorganization, we are responsible for reporting our share of that entity’s taxable income.
Another subsidiary of ours is domiciled in a non-U.S. jurisdiction and, accordingly, is not subject to U.S. federal income taxes. We have no current intention of distributing unremitted earnings of this subsidiary to its U.S. domiciled parent. The cumulative net loss from this foreign subsidiary is approximately $13 thousand. Additionally, we believe that it is not practical to calculate the potential liability associated with such distribution due to the fact that dividends received from this subsidiary could bring additional foreign tax credits, which could ultimately reduce the U.S. tax cost of the dividend, and significant judgment is required to analyze any additional local withholding tax and other indirect tax consequences that may arise due to the distribution of these earnings. Accordingly, pursuant to ASC 740, Tax Provisions, deferred taxes have not been provided for these undistributed foreign earnings in our combined statements of operations for the years ended December 31, 2014, 2013 and 2012.
The income tax benefit in our combined statements of operations, included elsewhere in this Annual Report on Form 10-K, includes a provision for income taxes attributable to the revenues and expenses associated with the contracts and certain other assets acquired and liabilities assumed in the GUI Acquisition, as if GUI were included in our consolidated federal income tax return.
We deliver our services to our customers through local offices in each region and financial information for our operations follows this service delivery model. All regions provide brokerage, underwriting and policyholder services as well as claims administration services. ASC 280, Segment Reporting, Section 280-10, establishes standards for the way that public business enterprises report information about operating segments in annual and interim consolidated financial statements. Our internal financial reporting is organized geographically, as discussed above, and managed on a geographic basis, with virtually all of our operating revenue generated within the United States. In accordance with ASC 280-10, multiple product offerings may be aggregated into a single operating segment for financial reporting purposes if aggregation is consistent with the objective and basic principles, if the segments have similar economic characteristics, and if the segments are similar in terms of (i) the nature of products and services, (ii) the nature of the production processes, (iii) the type or class of customer for their products and services and (iv) the methods used to distribute their products or provide their services. We believe each of our regional office operations meet these criteria, as each provides similar services and products to similar customers using similar methods of production and similar methods to distribute the services and products. Our products and services are generally offered as a complete and comprehensive outsourcing solution to its customers through a production process utilizing an integrated sales channel and technology platform that handles the entire brokerage, underwriting, policyholder services and claim administration services process. The operating results derived from the sale of brokerage and policyholder services and claims administration services are generally not reviewed separately by the our chief
In August 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update 2014-15 regarding ASC Topic 205, Presentation of Financial Statements - Going Concern. The updated guidance related to determining whether substantial doubt exists about an entity's ability to continue as a going concern. The amendment provides guidance for determining whether conditions or events give rise to substantial doubt that an entity has the ability to continue as a going concern within one year following issuance of the financial statements, and requires specific disclosures regarding the conditions or events leading to substantial doubt. The updated guidance is effective for annual reporting periods and interim periods within those annual periods beginning after December 15, 2016. Earlier adoption is permitted but we do not anticipate electing early adoption. We do not expect the adoption of this guidance to have a material impact on our consolidated financial statements.
At December 31, 2014, upon further completing our income tax analysis from the preliminary estimate at September 30, 2014, we concluded that the full valuation allowance of $19.1 million is no longer required. Accordingly, the Company reduced the valuation allowance to $6.3 million as of December 31, 2014, which fully offsets the deferred tax asset in excess of total deferred tax liabilities.
In connection with the acquisition, on August 6, 2014, the Company amended the loan agreement (the “PennantPark Loan Agreement”) originally entered into on November 27, 2013, with PennantPark Investment Corporation and certain of its affiliates (collectively, the “PennantPark Entities”), as described more fully in Note 6.
Because Patriot Care, Inc. and SPV2 were under common control, Patriot Care, Inc. recognized the net identifiable assets acquired at SPV2’s carrying amounts as of the acquisition date pursuant to the FASB ASC 805, Business Combinations. The net identifiable assets acquired, which had a carrying value of approximately $7.7 million, were solely comprised of SPV2’s investment in the MCMC Units issued by MCMC Holdings, LLC, the privately held parent company of MCMC, LLC from which the Company acquired MCRS Holdings, Inc. on August 6, 2014. SPV2 had no liabilities, revenues or expenses. Accordingly, SPV2’s transaction was deemed to be an asset acquisition.
The acquisition of PCM was accounted for by application of the acquisition method as required by FASB ASC 805, Business Combinations. Pursuant to FASB ASC 805, Business Combinations, assets acquired and liabilities assumed are generally recorded at their fair values as of the effective date of the acquisition. The fair values of identifiable tangible assets acquired and liabilities
In accordance with FASB ASC 350, Intangibles-Goodwill and Other, intangible assets, which are comprised solely of the estimated fair value of the service contracts acquired, are being amortized over the estimated life of the customer contracts, ranging from 2 to 10 years, in a manner that, in management’s opinion, reflects the pattern in which the intangible asset’s future economic benefits are expected to be realized. The intangible asset is tested for impairment at least annually (more frequently if certain indicators are present). In the event that the management determines that the value of the intangible asset has become impaired, the combined company will incur an accounting charge for the amount of impairment during the fiscal quarter in which the determination is made.
Also in accordance with FASB ASC 350, Intangibles-Goodwill and Other, goodwill will not be amortized but instead will be tested for impairment at least annually (more frequently if certain indicators are present). In the event that the management of the combined company determined that the value of goodwill has become impaired, the combined company will incur an accounting charge for the amount of impairment during the fiscal quarter in which the determination is made.
Our consolidated financial statements for the year ended December 31, 2014 include the operations of the acquired entities from their respective acquisition dates.
The following is a summary of the unaudited pro forma historical results, as if these entities had been acquired at January 1, 2013 (in thousands, except per share data):
This unaudited supplemental pro forma financial information includes the results of operations of PCM, and is presented as if PCM had been consolidated as of January 1, 2013. The unaudited supplemental pro forma financial information has been provided for illustrative purposes only. The unaudited supplemental pro forma financial information does not purport to be indicative of the actual results that would have been achieved by the combined companies for the periods presented, or of the results that may be achieved by the combined companies in the future. Future results may vary significantly from the results reflected in the following unaudited supplemental pro forma financial information because of future events and transactions, as well as other factors, many of which are beyond the Company’s control.
The company acquired $51.5 million of Goodwill in 2014 as a result of the acquisition of Patriot Care, Inc., as discussed in Note 3, Business Combinations. Changes in Goodwill are summarized as follows (in thousands):
Intangible assets that have finite lives are amortized over their useful lives. The company acquired $34.8 million of intangible assets as a result of the acquisition of Patriot Care, Inc., as discussed in Note 3. The intangible assets, their original fair values, and their net book values are detailed below as of the dates presented (in thousands):
On August 6, 2014, in connection with the Patriot Care Management Acquisition, we and certain of our subsidiaries entered into the UBS Credit Agreement, which provided for a five-year term loan facility in an aggregate principal amount of $57.0 million that would mature on August 6, 2019. The loan was secured by the common stock of PCM and guaranteed by Guarantee Insurance Group and its wholly owned subsidiaries. Following our IPO, we prepaid all outstanding borrowings under the UBS Credit Agreement, including accrued interest and applicable prepayment premium.
On August 6, 2014, in connection with the GUI Acquisition, we and certain of our subsidiaries, as borrowers, and certain of our other subsidiaries and certain affiliated entities, as guarantors, entered into the PennantPark Loan Agreement with the PennantPark Entities, as lenders. Following our Offering, we prepaid all outstanding borrowings under the PennantPark Loan Agreement, including accrued interest and applicable prepayment premium. See “Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities-Use of Proceeds from Registered Securities.”
With respect to the Company’s financial liabilities, which include notes payable, capital lease obligation and warrant redemption liability, the Company has adopted current accounting guidance which establishes the authoritative definition of fair value, establishes a framework for measuring fair value, creates a fair value hierarchy based on the quality of inputs used to measure fair value and enhances disclosure requirements for fair value measurements. This guidance defines fair value as the price that would be paid to warrant redemption liability in an orderly transaction between market participants at the measurement date. As required under current accounting guidance, the Company has identified and disclosed its financial assets in a fair value hierarchy, which consists of the following three levels:
quoted prices for identical or similar securities in markets that are not active.
The Company’s notes payable, capital lease obligation and warrant redemption liability, for which carrying values were equal to fair values, classified by level within the fair value hierarchy, was as follows as of December 31, 2014 and 2013 (in thousands):
The following is a reconciliation of the fair value of the Company’s financial liabilities that were measured using significant unobservable (Level 3) inputs (in thousands):
The allocation of marketing, underwriting and policy issuance costs from related party in the accompanying combined statements of operations represents costs reimbursed to GIG for salaries and other costs incurred by GIG to provide its policyholder services. Management fees paid to related party for administrative support services in the accompanying combined statements of operations represent amounts paid to GIG for management oversight, legal, accounting, human resources and technology support services.
As of December 31, 2014, we had a net receivable from related parties amount of approximately $1.0 million and $0.8 million due from Mr. Mariano and entities controlled by Mr. Mariano, our founder, Chairman, President and Chief Executive Officer, respectively.
For the year ended December 31, 2014, approximately 71% of total fee income and fee income from related party was attributable to contracts with Guarantee Insurance, the Company’s largest customer and a related party, and approximately 18% was attributable to
contracts with the Company’s second largest customer. For the year ended December 31, 2013, approximately 44% of total fee income and fee income from related revenues was attributable to contracts with Guarantee Insurance and approximately 38% and 12% were attributable to contracts with the Company’s second and third largest customers, respectively. For the year ended December 31, 2012, approximately 42% of total fee income and fee income from related revenues was attributable to contracts with Guarantee Insurance and approximately 35% and 21% were attributable to contracts with the Company’s second and third largest customers, respectively.
As of December 31, 2014, approximately 86% of fee income receivable and fee income receivable from related party was attributable to contracts with Guarantee Insurance, the Company’s largest customer and a related party, and approximately 8% and 2% of fee income receivable and fee income receivable from related party were attributable to contracts with the Company’s second and third largest customers, respectively. As of December 31, 2013, approximately 62% of fee income receivable and fee income receivable from related party was attributable to contracts with Guarantee Insurance, the Company’s largest customer and a related party, and approximately 23% and 11% of fee income receivable and fee income receivable from related party were attributable to contracts with the Company’s second and third largest customers, respectively. As of December 31, 2012, approximately 28% of fee income receivable and fee income receivable from related party was attributable to contracts with Guarantee Insurance and approximately 51% and 19% of fee income receivable and fee income receivable from related party were attributable to contracts with the Company’s second and third largest customers, respectively. Management believes that the receivable balances from these largest customers do not represent significant credit risk based on cash flow forecasts, balance sheet analysis and past collection experience.
Because fee income from related party for claims administration services is based on the net portion of claims expense retained by Guarantee Insurance, as described in Note 9, the Company’s revenues attributable to contracts with Guarantee Insurance do not necessarily represent fee income from related party.
The table below provides information with respect to our long-term debt and contractual commitments as of December 31, 2014:
The Company has employment agreements with certain executives and other employees, which provide for compensation and certain other benefits and for severance payments under certain circumstances. The employment agreements contain clauses that become effective upon a change of control of the Company. Upon the occurrence of any of the defined events in the employment agreements, the Company would be obligated to pay certain amounts to the relevant employees.
Our analysis of warrant value and put value is based on a combination of the market approach and the income approach to determine the value of PNI common stock at the Valuation Date, and the application of an option pricing model using Black Scholes to determine the value of one warrant at the Valuation Date. We relied in part upon the estimated IPO value developed by the underwriter, which was based on the underwriter’s comparative company analysis, a market approach; the discounted future returns method primarily relies on the Company’s financial estimates; the terminal values used in the discounted future returns method are derived using the underwriter’s estimate based upon its analysis of comparative public companies, and the guideline public company method.
The Company accounts for income taxes under FASB ASC 740, “Accounting for Income Taxes” (“ASC 740”). Deferred income tax assets and liabilities are determined based upon differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse.
GIG has included the revenues and expenses associated with the GUI contracts and certain other assets acquired and liabilities assumed through the acquisition date of August 6, 2014 in its consolidated federal income tax returns for the years ended December 31, 2014, 2013 and 2012.
Patriot Captive Management is domiciled in non-U.S. jurisdictions. The Company has no current intention of distributing unremitted earnings of Patriot Captive Management to its U.S. domiciled parent, PSI. Additionally, it is not practical to calculate the potential liability associated with such distribution due to the fact that dividends received from Patriot Captive Management could bring additional foreign tax credits, which could ultimately reduce the U.S. tax cost of the dividend, and significant judgment is required to analyze any additional local withholding tax and other indirect tax consequences that may arise due to the distribution of these earnings. Accordingly, pursuant to FASB ASC 740, Tax Provisions, the income tax expense in the accompanying combined statements of operations for the years ended December 31, 2014, 2013 and 2012 do not include a provision for federal income taxes attributable to Patriot Captive Management’s operations.
The Company had no reserve for uncertain tax positions or accrued interest or penalties related thereto as of December 31, 2014 or 2013. The Company’s policy is to recognize interest and penalties related to uncertain tax positions within the income tax expense line in the accompanying Consolidated Statement of Operations. The tax period from inception (November 15, 2013) to December 31, 2013 remains subject to examination by all of the Company’s tax jurisdictions.
Significant components of our deferred tax assets and liabilities are as follows (in thousands):
In establishing the $6.3 million valuation allowance, the Company considered factors involving the company’s tax planning strategies and both recent and projected financial results. Based on the Company’s analysis, it was determined that the realization of $6.3 million in net deferred taxes as of December 31, 2014 was not more likely than not.
Valuation and qualifying accounts deducted from the assets to which they apply:
On January 22, 2015, we consummated the initial public offering (the “IPO”) of our common stock, par value $0.001 per share, at a public offering price of $14.00 per share, pursuant to the registration statement on Form S-1 (File No. 333-200972) (the “Prospectus”), as amended, filed with the Securities and Exchange Commission under the Securities Act of 1933, as amended (the “Securities Act”). We issued and sold 7,350,000 shares of our common stock in the offering, and the PennantPark Entities offered and sold 965,700 shares of common stock in the offering.
As contemplated in the Prospectus, we generated aggregate proceeds of approximately $116.4 million and net proceeds to us of approximately $98.3 million, after deducting $8.1 million in underwriting discounts and commissions and other expenses. We used proceeds from the IPO, together with borrowings under our senior secured credit facility, to repay $67.6 million outstanding under its PennantPark Loan Agreement (as defined below) and to repay $57.2 million outstanding under its UBS Credit Agreement (as defined below), in each case including accrued interest and applicable prepayment premiums. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Liquidity and Capital Resources-Indebtedness.”