At December 31, 2010, Fortegra Financial leased its principal executive offices located at 100 West Bay Street, Jacksonville, FL 32202, consisting of approximately 50,000 square feet. In October 2010, Fortegra terminated the aforementioned lease and entered into a new 11 year lease for approximately 58,000 square feet of office space at 10151 Deerwood Park Boulevard, Building 100, Jacksonville, FL, 32256. The new lease will commence upon the substantial completion of all necessary leasehold improvements which occurred on March 1, 2011.
We intend to take advantage of embedded growth opportunities and new market development through geographic expansion, expanding our products and service presence with existing clients and acquiring complementary businesses. To support our growth initiatives, we continue to focus on adding enhanced features to our existing information systems and developing new processes to enhance efficiency, drive economies of scale and provide additional competitive advantages.
In 2003, we continued the expansion of our administrative capabilities for insurance and payment protection products to customers of financial institutions. We utilized our proprietary technology enhancements to support mass marketing and began
In March 2008, we acquired Gulfco Life Insurance Company to expand the presence of our Payment Protection segment in the Louisiana market. In December 2008, we acquired Darby & Associates, a wholesale provider of payment protection products in North Carolina. This acquisition expanded our Payment Protection segment in North Carolina, which is that segment's third largest state in terms of 2009 revenues and an important foothold with our consumer finance company clients (our largest distribution channel within the Payment Protection segment). In April 2009, we acquired Bliss & Glennon, an excess and surplus lines wholesale insurance broker, and entered into the wholesale brokerage business, which continued our strategic expansion of specialized and administration services for insurance carriers and other financial services businesses.
We historically have used a combination of cash on hand and borrowings under our lines of credit to pay the purchase price of our acquisitions. The following table summarizes our acquisition activity for the years ended December 31, 2010, 2009, and 2008:
apply complex principles of accounting to certain transactions, such as acquisitions, in determining the most appropriate accounting treatment. We believe that the significant accounting estimates and policies described below are material to our financial reporting and are subject to a degree of subjectivity and/or complexity.
With respect to securities where the decline in fair value is determined to be temporary and the security's 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.
There are inherent risks and uncertainties involved in making these judgments. Changes in circumstances and critical assumptions such as a continued weak economy, a more pronounced economic downturn or unforeseen events which affect one or more companies, industry sectors or countries could result in additional impairments in future periods for other-than-temporary declines in value. Please see the footnote, "Investments" in the Notes to the Consolidated Financial Statements included in Item 8 of this Annual Report for additional information and Item 1A - "Risk Factors - Risks Related to Our Payment Protection Business - Our investment portfolio is subject to several risks that may diminish the value of our invested assets and affect our business and profitability" and "Liquidity and Capital Resources - Invested Assets" contained elsewhere in this Annual Report.
In the ordinary course of business, we are involved in both the assumption and cession of reinsurance with non-affiliated companies, including reinsurance companies owned by our clients. The following table provides details of the reinsurance receivables balance as of December 31, 2010, and 2009:
We utilize reinsurance for loss protection and capital management. See "Risk Factors - Risks Related to Our Payment Protection Business - Reinsurance may not be available or adequate to protect us against losses, and we are subject to credit risk of reinsurers."
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.
Goodwill resulting from the Summit Partners Transactions and from acquisitions of other businesses is carried as an asset on the balance sheet and is not amortized, but is evaluated annually to determine whether impairment exists. Management assessed goodwill as of December 31, 2010, and 2009 and determined that no impairment existed as of those dates. During the third quarter of 2008, the amount of goodwill recognized as part of the Summit Partners Transactions was determined to be $31.7 million as part of the remeasurement period. During 2008, we recognized approximately $0.6 million of goodwill related to our acquisition of Darby & Associates, Inc. and approximately $1.3 million related to our acquisition of CIRG. As part of the purchase of Bliss & Glennon in April 2009, we recognized $29.9 million of goodwill and $8.7 million of other intangible assets. As part of the purchase of South Bay Acceptance Corporation in February 2010, we recognized $0.5 million of goodwill. As part of the purchase of Continental Car Club in May 2010, we recorded $11.8 million of goodwill and $1.1 million of other intangible assets. In addition, we recorded $8.5 million of goodwill and $1.4 million of other intangible assets associated with the purchase of United Motor Club in September 2010. We recorded amortization expense of $3.2 million, $2.7 million, and $2.1 million for the year ended December 31, 2010, 2009 and 2008, respectively, related to other intangible assets.
When required, we test goodwill for impairment at the reporting unit level. Following the goodwill guidance, which is included within Accounting Standards Codification ("ASC") Topic 350, Intangibles - Goodwill and Other, we have concluded that our reporting units for goodwill testing are equivalent to our reported business segments, excluding the corporate segment.
The following table illustrates the amount of goodwill assigned to each business segment as of December 31, 2010:
Unpaid claims are reserve estimates that are established in accordance with U.S. GAAP using generally accepted actuarial methods. Credit life, credit disability and accidental death and dismemberment ("AD&D") unpaid claims reserves include claims in the course of settlement and incurred but not reported ("IBNR"). For all other product lines, unpaid claims reserves 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. The factors used to develop the IBNR vary by product line. However, in general terms, the factor used to develop IBNR for credit life insurance is a function of the amount of life insurance in force. The factor can vary from $0.60 to $1.00 per $1,000 of in force coverage. The factor used to develop IBNR for credit disability is a function of the pro-rata unearned premium reserve and is typically 5% of unearned premium reserve. Finally, IBNR for AD&D policies is a function of in force coverage and is currently $0.11 per $1,000 of in force coverage.
Our unpaid claims reserves do not represent an exact calculation of exposure, but instead represent our best estimates, generally involving actuarial projections at a given time. The process used in determining our unpaid claims reserves cannot be exact since actual claim costs are dependent upon a number of complex factors such as changes in doctrines of legal liabilities and damage awards. These factors are not directly quantifiable, particularly on a prospective basis. We periodically review and update our methods of making such unpaid claims reserve estimates and establishing the related liabilities based on our actual experience. We have not made any changes to our methodologies for determining unpaid claims reserves in the periods presented. For further information about our reserving methodology, see the footnote, "Unpaid Claims" in the Notes to the Consolidated Financial Statements included in Item 8 of this Annual Report.
While our cost of claims has not varied significantly from our reserves in prior periods, if the actual level of loss frequency and severity are higher or lower than expected, our paid claims will be different than management's estimate. We believe that, based on our actuarial analysis, an aggregate change that is greater than ± 10% (or 5% for each of loss frequency and severity) is not probable. The effect of higher and lower levels of loss frequency and severity levels on our ultimate cost for claims occurring in 2010 would be as follows (dollars in thousands):
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. For example, if the credit instrument is 36 months in duration, the credit insurance policy or debt cancellation contract is also 36 months. Because we provide administrative services over the life of the policy or debt cancellation contract, we recognize service and administrative fees over the life of the insurance policy or debt cancellation contract. Accordingly, if there is a pre-term cancellation, no funds would be due to our customer. As a result, we have had no changes in earnings patterns, resulting in no prior period adjustments to total revenues or net income.
The BPO service fee revenue is recognized as the services are performed. These services include fulfillment, BPO software development and claims handling for our 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. 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. For the periods presented, we have not incurred a loss with respect to a specific significant BPO contract.
of various factors that impact our wholesale brokerage commissions and fees.
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. Our experience adjustments, exclusive of investment income, were (in thousands):
The commission costs include the commissions paid to the distributors for selling the policy. The commission costs also include retrospective commission adjustments. These retrospective commission adjustments are payments made or adjustments to future commission expense based on claims experience. Under these retrospective commission arrangements, the commissions paid are adjusted based on actual losses incurred compared to premium earned after a specified net allowance is retained by us.
Net investment income consists of investment income from our invested assets portfolio. We recognize investment income from interest payments, any amortization of premiums and accretion of discounts on securities acquired at other than par value, and dividends on equity securities, less portfolio management expenses. Our investment portfolio is primarily invested in fixed maturity securities. 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 market value of, fixed maturity and short-term investments.
We record stock-based compensation in accordance with ASC 718 - Compensation - Stock Compensation, which addresses the accounting for share-based awards, including stock options, with compensation expense measured using fair value and recorded over the requisite service or performance period of the awards.
We have 296,724 options outstanding as of December 31, 2010 that were issued outside of the existing plans. Total options granted during 2010 were 88,268. No options were granted in 2009 while in 2008, 41,853 options were granted.
The following table summarizes information concerning our outstanding stock options at December 31, 2010:
Payment Protection. Our Payment Protection products are sold as complementary products to consumer retail and credit transactions and are thus subject to the volatility of volume of consumer purchase and credit activities. We receive service and administrative fees for administering Payment Protection products that are sold by our clients, such as credit insurance, debt protection, car club and warranty solutions. We earn administrative fees for administering debt cancellation plans, facilitating the distribution and administration of warranty or extended service contracts, providing car club membership benefits and providing related services for our clients. For credit insurance products, our clients typically retain the risk associated with credit insurance products that they sell to their customers through economic arrangements with us. Our Payment Protection revenue includes revenue earned from reinsurance arrangements with producer owned reinsurance companies owned by our
Wholesale Brokerage Commissions and Fees. Wholesale brokerage commissions and fees consist of commissions paid to us by insurance companies, net of the portion of the commissions we share with retail insurance brokers and agents. The commissions we receive from insurance carriers are typically calculated as a percentage of the premiums paid for the specialized and complex insurance products (commonly known as"surplus lines") we distribute. We typically earn our commissions on the later of the effective date of the policy or the date coverage is bound. We pay our retail insurance agent and broker clients a portion of the gross commissions we receive from insurance carriers for placing insurance. In certain cases, our Wholesale Brokerage segment also charges fees for policy issuance, inspections and other types of transactions.
Wholesale brokerage commissions and fees are generally affected by fluctuations in the amount of premium charged by insurance carriers. The premiums charged fluctuate based on, among other factors, the amount of capital available in the insurance marketplace, the type of risk being insured, the nature of the insured party and the terms of the insurance purchased. If premiums increase or decrease, our revenues are typically affected in a corresponding fashion. In a declining premium rate environment, the resulting decline in our revenue may be offset, in whole or in part, by an increase in commission rates from insurance carriers and by an increased likelihood that insured parties may use the savings generated by the reduction in premium rates to purchase greater coverage. In an increasing pricing environment, the resulting increase in our revenue may be offset, in whole or in part, by a decrease in commission rates by insurance carriers and by an increased likelihood that insured parties may determine to reduce the amount of coverage they purchase. The market for P&C insurance products is cyclical from a capacity and pricing perspective. We refer to a period of reduced capacity and rising premium rates as a "hard" market and a period of increased capacity and declining premium rates as a "soft" market.
Our wholesale brokerage commission and fee revenues fluctuate seasonally based on policy renewal dates. Our wholesale 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 wholesale 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.
Ceding Commissions. We elect to cede to reinsurers under coinsurance arrangements a significant portion of the credit insurance that we distribute on behalf of our clients. We continue to provide all policy administration for credit insurance that we cede to reinsurers. Ceding commissions consist of commissions paid to us by our reinsurers to reimburse us for costs related to the acquisition, administration and servicing of policies and premium that we cede to reinsurers. In addition, a portion of the ceding commission is determined based on the underwriting profits of the ceded credit insurance. The credit insurance that we distribute has historically generated attractive underwriting profits. Furthermore, some reinsurers pay to us a portion or all of the investment income earned on reserves that are maintained in trust accounts.
Other Income. Other income primarily consists of miscellaneous fees generated by our Wholesale Brokerage and Payment Protection segments. In 2009, it also included income in our Wholesale Brokerage segment that was derived from the reversal of a cancellation reserve that was no longer deemed to be applicable subsequent to our acquisition of Bliss & Glennon.
Our most significant operating expenses are commissions, personnel costs, including salaries, bonuses and benefits and net losses and loss adjustment expenses. The commissions expense includes the commissions paid to distributors selling credit insurance policies offered by our Payment Protection division. Commission rates, in many instances, are set by state regulators and are also impacted by market conditions. In certain instances, our commissions are subject to retrospective adjustment based on the profitability of the related policies. These retrospective commission adjustments are payments made or adjustments to future commission expense based on claims experience. Under these retrospective commission arrangements, the producer of the credit insurance policies, which is typically our client, receives a retrospective commission if the premium generated by that producer in the accounting period exceeds the costs associated with those policies, which includes our administrative fees, claims, reserves, and premium taxes. If the net result is negative, we either offset that negative amount against future retrospective commission payments, reduce the producer's up-front commission on a prospective basis to increase the likelihood that it will return to a positive position or request payment of the negative amount from the producer.
A substantial portion of our depreciation and amortization expense consists of amortization of definite-lived intangible assets, such as purchased customer accounts and non-compete agreements, which were acquired as part of our business acquisitions.
We also have interest expense relating to our credit facilities and preferred trust securities. Our interest expense increased as result of our increased indebtedness resulting from the Summit Partners Transactions and recent acquisitions.
Income tax expense is comprised of federal and state taxes based on income in multiple jurisdictions and changes in uncertain tax positions, if any.
Our earnings per share on a fully diluted basis increased 36.2% to $0.94 for the year ended December 31, 2010 from $0.69 for the same period in 2009. Our 2010 performance reflected organic growth and the impact of three business acquisitions completed in 2010. These acquisitions complimented our existing business segments and contributed to $5.2 million our revenue and $1.5 million to our net income in 2010. In December 2010 we also completed our IPO providing us with the funds to eliminate higher interest costs. While the negative economic climate continued in 2010, revenues increased 9.8%. We increased revenues in our Wholesale Brokerage and Payment Protection segments while our BPO segment revenues declined. Total expenses increased 6.8% to $179.4 million with the majority of the increase due to higher levels of personnel costs and net loss and loss adjustments. We managed to increase our net income in 2010.
The following table set forth our Consolidated Statements of Income for the years ended December 31, 2010, 2009 and 2008:
We earn service and administrative fees from a variety of activities, including the administration of credit insurance, the administration of debt cancellation programs, the administration of warranty programs and the administration of collateral tracking and asset recovery programs. Fees are typically positively correlated to transaction volume and are recognized as revenue as they become both realized and earned. Service and administrative fees increased 7.3%, or $2.3 million to $34.1 million for the year ended December 31, 2010 from $31.8 million for the year ended December 31, 2009. The increase resulted from a $4.1 million increase in administrative fees in our Payment Protection segment, principally from $2.9 million from our acquisition of Continental Car Club in May 2010 and $1.2 million from our September 2010 acquisition of United Motor Club. The acquisition of South Bay Acceptance Corporation, on February 1, 2010 contributed an additional $1.1 million to this increase for the administration of premium finance contracts. These increases of $5.2 million were partially offset by a $2.6 million reduction in revenues in our BPO segment.
We earn wholesale brokerage commission and fee income by providing wholesale brokerage services to retail insurance brokers and agents and insurance companies and the commissions and fees are primarily recognized when the underlying insurance policies are issued. Wholesale brokerage commissions and fees increased $8.3 million or 51.0%, to $24.6 million for the year ended December 31, 2010 from $16.3 million for the year ended December 31, 2009. The increase in revenues was attributable to a full year of Bliss & Glennon included in the 2010 results, while 2009 included revenues commencing with the acquisition of Bliss & Glennon on April 15, 2009. Wholesale brokerage commissions and fees for the year ended December 31, 2010 included $23.2 million in standard commissions plus $1.4 million in profit commissions compared with $16.0 million and $0.3 million, respectively, for 2009.
Net investment income decreased $0.7 million, or 14.4%, to $4.1 million for the year ended December 31, 2010 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.
For the year ended December 31, 2009, net realized gains were $0.1 million and included a realized loss of $0.8 million on a sale of a single distressed corporate bond, which was offset by $0.8 million in realized gains on the sale of various fixed income and equity securities. Net realized losses for the year ended December 31, 2008 reflected OTTI write-downs of $1.9 million on a single bond investment of $1.2 million and 15 equity securities totaling $0.7 million.
Personnel costs represent the amounts attributable to wages, salaries, bonuses and benefits for our full and part-time employees. Personnel costs increased $5.0 million, or 15.9%, to $36.4 million for the year ended December 31, 2010 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 with 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.
Personnel costs increased $9.6 million, or 44.3%, to $31.4 million for the year ended December 31, 2009, from $21.7 million for the year ended December 31, 2008. This increase is attributable to the growth in full-time equivalent employees associated with the acquisition of Bliss & Glennon that produced an increase of $10.3 million, which was partially offset by an $0.8 million decrease in personnel costs in our other business segments.
Other operating expenses increased $10.1 million, or 82.3%, to $22.3 million for the year ended December 31, 2009, from $12.2 million for the year ended December 31, 2008. The 2009 increase resulted from increased variable expenses of $4.2 million from the growth in our BPO segment, a $2.9 million increase due to the Bliss & Glennon acquisition and an additional $0.7 million associated with our other acquisitions.
Depreciation is the allocation of the capitalized cost of property and equipment over the periods benefited by the use of the asset. Amortization of intangibles is an expense recorded to allocate the cost of intangible assets, such as purchased customer accounts and non-compete agreements acquired as part of our business acquisitions, over their estimated useful lives. Depreciation expense increased $0.6 million, or 74.3%, to $1.4 million for the year ended December 31, 2010 from $0.8 million for the year ended December 31, 2009. Higher depreciation expense in 2010 was due primarily due to growth in our depreciable software assets. Amortization expense increased $0.5 million, or 19.4%, to $3.2 million for the year ended December 31, 2010 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 Motor Club and Continental Car Club.
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. Interest expense increased $0.7 million, or 8.5%, to $8.5 million for the year ended December 31, 2010 from $7.8 million for the year ended December 31, 2009. This increase was attributable to the increased borrowings associated with the acquisition of Continental Car Club, United Motor Club and South Bay Acceptance Corporation and higher rates on our indebtedness.
Income tax expense is comprised of federal and state taxes based on income and changes in uncertain tax positions, if any. Income tax expense increased $2.2 million, or 32.8%, to $8.7 million for the year ended December 31, 2010 compared with $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.
Income tax expense was $6.6 million and $4.2 million for the years ended December 31, 2009 and 2008, respectively. Our effective tax rate was 36.1% and 34.6% for the years ended December 31, 2009 and 2008, respectively. The increase in our effective tax rate was due to higher applicable state tax rates resulting from our acquisition of Bliss & Glennon, which conducts business in California, and the decrease in the federal small life deduction applicable to our statutory life insurance companies as a result of increased business by those insurance companies.
The following table presents a reconciliation of net income to EBITDA and Adjusted EBITDA for each of the periods presented:
In managing our Payment Protection business, we review the performance of our Payment Protection credit insurance business on the basis of net underwriting revenue, which is comprised of net earned premium less net losses and loss adjustment expenses and commissions. Notably, the presentation of net underwriting revenue in our Payment Protection segment is
intended to reflect the limited underwriting risk assumed by us. In the presentation, we include net losses and loss adjustment expenses and commission costs as contra-revenue items. We write a significant portion of our insurance contracts under reinsurance agreements with PORCs or on a retrospective commission basis. The reinsurance agreements with PORCs allow us to cede the entire risk of the credit insurance policies to the producer. The retrospective commission arrangements allow us to adjust commissions based on claims experience and transfer the underwriting gain or loss to our client net of a specified allowance to us that is reflected in our net underwriting revenue.
Revenues increased $8.0 million, or 18.7%, to $50.8 million for the year ended December 31, 2010 from $42.8 million for the year ended December 31, 2009. The increase was primarily from the acquisitions of Continental Car Club and United Motor Club, 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 decreased $0.2 million, or 1.0%, to $23.6 million for the year ended December 31, 2010 from $23.8 million for the year ended December 31, 2009. The year over year decrease in operating expenses resulted primarily from a $1.6 million decrease in salary and benefits in our Payment Protection business. In addition, our Payment Protection segment incurred operating expenses of $1.4 million associated with the 2010 acquisitions of Continental Car Club and United Motor Club.
Total BPO revenues decreased $2.6 million or 11.0%, to $20.9 million for the year ended December 31, 2010 from $23.5 million for the year ended December 31, 2009. The decrease was driven by lower service and administrative fees on debt cancellation programs of credit card companies and a decrease in asset recovery services, partially offset by increased service and administrative fees for our insurance company clients.
Operating expenses decreased $0.1 million or 1.0%, to $13.6 million for the year ended December 31, 2010 from $13.8 million for the year ended December 31, 2009. This decrease primarily resulted from $1.2 million decreased variable costs for processing and fulfillment of policies and $1.0 million of investment in sales staff (salaries, benefits and travel) growth initiatives.
Operating expenses increased $6.6 million, or 92.7%, to $13.8 million for the year ended December 31, 2009 from $7.1 million for the year ended December 31, 2008. The key factors driving this result were increased call center expenses of $1.8 million for claims and marketing initiatives, a $2.2 million increase in salaries and benefits related to the addition of employees to support the growth of our BPO segment and a $1.6 million increase in investigation fees for our asset recovery business.
EBITDA decreased $2.5 million, or 25.1%, to $7.3 million for the year ended December 31, 2010 from $9.8 million for the year ended December 31, 2009. As a result, EBITDA margin for our BPO segment was 34.9% for the year ended December 31, 2010 compared to 41.5% for the year ended December 31, 2009.
Revenues of $25.5 million for the year ended December 31, 2010 were comprised of $23.2 million in standard commissions plus $1.4 million in profit commissions. Revenues were $16.8 million for the year ended December 31, 2009 and were comprised of $16.0 million of standard commission and $0.3 million of profit commission revenue. In addition, we recorded a reserve reversal of $0.5 million in 2009 for canceled policy commission reserves that were deemed excessive.
EBITDA for years ended December 31, 2010 and 2009 was $5.6 million and $3.9 million, respectively. As a result, EBITDA margin for Wholesale Brokerage segment was 21.9% and 23.4% for the year ended December 31, 2010 and 2009, respectively.
We did not attribute any revenues to the Corporate segment during all periods presented.
Operating expenses attributable to the Corporate segment were $3.2 million and $2.2 million for the years ended December 31, 2009 and 2008, respectively. The 2009 expenses were primarily for the acquisition of Bliss & Glennon in April 2009, other miscellaneous acquisitions costs and executive stock compensation expense not allocated back to business segments. The 2008 expenses were for acquisition related professional fees for non-consummated acquisitions and executive stock compensation expense not allocated back to individual business segments.
Liquidity describes the ability of a company to generate sufficient cash flows to meet the cash requirements of its business operations, including working capital needs, capital expenditures, debt service, acquisitions and other commitments and contractual obligations. We historically have derived our liquidity from our invested assets, cash flow from operations, ordinary and extraordinary dividend capacity from Fortegra's insurance companies, our credit facilities and additional equity investments. When considering our liquidity, it is important to note that we hold cash in a fiduciary capacity as a result of premiums received from insured parties that have not yet been paid to insurance carriers. The fiduciary cash is recorded as an asset on our balance sheet with a corresponding liability, net of our commissions, to insurance carriers.
immediate cash requirements or otherwise impact our liquidity. Dividends and other distributions from our subsidiaries are our principal sources of cash to meet these obligations. See "Revolving Credit Facilities - Revolving Credit Facility" and " Revolving Credit Facilities - South Bay Acceptance Corporation Loan and Security Facility" for details about restrictions on the payment of dividends and other distributions by our subsidiaries.
We anticipate that cash flow from operations and funds available under our revolving credit facilities will be sufficient to meet our working capital requirements and to finance capital expenditures over the next several years. There can be no assurance, however, that cash resources will be available to us in an amount sufficient to enable us to service our indebtedness or to fund our other liquidity needs. Our ability to meet our debt service obligations and other capital requirements, including capital expenditures and acquisitions, will depend upon our future results of operations and our ability to obtain additional debt or equity capital and our ability to stay in compliance with our financial covenants, which, in turn, will be subject to general economic, financial, business, competitive, legislative, regulatory and other conditions, many of which are beyond our control. We may also need to obtain additional funds to finance acquisitions, which 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. See Item 1A - "Risk Factors - Risks Related to Our Indebtedness," included in this Annual Report.
In June 2010, we entered into a $35.0 million revolving credit facility with SunTrust Bank, as administrative agent, which matures in June 2013. On November 30, 2010, Columbus Bank and Trust Company ("CB&T"), a division of Synovus Bank, entered into a joinder agreement to the revolving credit facility and became a new lender under the revolving credit facility with a revolving commitment of $20.0 million, which increased the size of the revolving credit facility to $55.0 million. As of
December 31, 2010, we had $36.7 million in debt outstanding under the revolving credit facility at an interest rate of 6.0%.
We may, so long as no default is continuing under the revolving credit facility, request that the existing lenders or, with the consent of the administrative agent, new lenders increase the revolving commitment by an additional $30.0 million. Any increase will be subject to the consent of (i) the new or existing lenders actually providing such increased or additional commitments, as the case may be, and (ii) to the extent any additional commitment is provided by a new lender, the administrative agent.
The obligations under our revolving credit facility are unconditional and are guaranteed by substantially all of our domestic subsidiaries, other than South Bay Acceptance Corporation and our regulated insurance subsidiaries. The revolving credit facility and related guarantees are secured by a perfected first priority security interest (subject to liens permitted under the revolving credit facility) in substantially all property and assets, subject to certain exceptions, owned by us, LOTS Intermediate Co., our co-borrower under the revolving credit facility, and the subsidiary guarantors, including a pledge of all the capital stock of LOTS Intermediate Co. and, when the indenture governing the preferred trust securities described below is no longer in effect, all other capital stock owned by us, LOTS Intermediate Co. or any guarantor.
Intermediate Co. and our restricted subsidiaries) and a reinsurance ratio (based upon the aggregate amounts recoverable from reinsurers divided by the sum of (i) policy and claim liabilities plus (ii) unearned premiums, in accordance with U.S. GAAP, in each case of us, LOTS Intermediate Co. and our restricted subsidiaries), each of which is tested quarterly. Based upon the formulas set forth under the revolving credit facility, we are required to maintain a total leverage ratio of no more than 3.50 to
We had one $15.0 million and one $6.0 million line of credit with CB&T that were terminated when we entered into the $35.0 million revolving credit facility described above. The lines of credit with CB&T were secured with pledges of stock of various subsidiaries. Under both lines of credit, we could not assign, sell, transfer or dispose of any collateral or effectuate certain changes to our capital structure and the capital structure of our subsidiaries without CB&T's prior consent. The purpose of the lines were for working capital and acquisitions. In connection with the refinancing of the CB&T lines of credit, Lyndon Southern Insurance Company posted $2.0 million of cash collateral to secure our reimbursement obligations (and those of certain of our subsidiaries) in respect of four letters of credit that were secured under the line of credit entered into in 2007, the face of which currently total $5.1 million. We entered into one of the revolving lines of credit at the time of the Summit Partners Transactions ($15.0 million, the "2007 line of credit") and the other line of credit in April 2009 ($15.0 million, which was reduced to $6.4 million, the "2009 line of credit"). The interest rate, in the case of the 2007 line of credit, was based on CB&T's prime lending rate and, in the case of the 2009 line of credit, was based on CB&T's prime lending rate plus 1.0%, with a minimum interest rate threshold of 5.0%. In June 2010, we paid off the $11.5 million balance and closed the line of credit.
Our invested assets consist mainly of of high quality investments (with a minimum overall rating of "AA") 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.
Level 3 - Inputs to the valuation methodology are unobservable for the asset or liability and are significant to the fair value measurement. These unobservable inputs are derived from our own internal calculations, estimates and assumptions and require significant management judgment or estimation.
The use of Level 3 "unobservable inputs" included 5 securities that accounted for 1.6% of total investments at December 31, 2010 and 19 securities that accounted for 3.8% of total investments at December 31, 2009.
Net cash provided by operating activities was $13.1 million, $13.4 million and $13.0 million for , for the years ended December 31, 2010, 2009 and 2008, respectively. In 2010, our net cash provided from operating activities primarily reflected our net income and collections of reinsurance and other receivables offset by payments made for accrued expenses, accounts payable and commissions payable. In 2009, our net cash provided from operating activities primarily reflected our net income and collections of reinsurance and other receivables offset by in part by payments made for accrued expenses, accounts payable and commissions payable. In 2008, our net cash provided by operating activities reflected our net income and policy liabilities offset by growth in our reinsurance receivables.
Net cash provided by financing activities was $30.1 million for the year ended December 31, 2010 and $21.0 million for the year ended December 31, 2009. For the year ended December 31, 2010, net cash provided by financing activities reflected the funds received from our IPO totaling $43.6 million less IPO related costs of $3.3 million and additional borrowings under our lines of credit of $25.2 million offset by the redemption of $20.0 million in subordinated debentures and payment of the liquidation preference of $14.1 million paid to Class A stockholders. For the year ended December 31, 2009, net cash provided by financing activities reflected additional borrowings under our lines of credit and the issuance of common and treasury stock. For the year ended December 31, 2008 net cash used in financing activities reflected our purchase of equity securities and the repayment of indebtedness.
Inflation risk is the possibility that a change in domestic price levels produces an adverse effect on earnings. This typically happens when either invested assets or liabilities, but not both are indexed to inflation. Inflation has not had a material impact on our results of operations in the periods presented in our Consolidated Financial Statements.
On December 31, 2009, we adopted the new subsequent events guidance. This new guidance establishes general standards of accounting for and disclosures of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. The adoption of the new guidance did not have an impact on our financial position, results of operations or cash flows.
On December 31, 2009, we applied the fair value measurements and disclosures guidance for all non-financial assets and liabilities measured at fair value on a non-recurring basis. The application of this guidance for those assets and liabilities did not have an impact on our financial position, results of operations or cash flows. Our non-financial assets measured at fair value on a non-recurring basis include goodwill and intangible assets. In a business combination, the non-financial assets and liabilities of the acquired company would be measured at fair value in accordance with the fair value measurements and disclosures guidance. The requirements of this guidance include using an exit price based on an orderly transaction between market participants at the measurement date assuming the highest and best use of the asset by market participants. To perform a market valuation, we are required to use a market, income or cost approach valuation technique(s). We performed our annual impairment analysis of goodwill and indefinite-lived intangible assets in the fourth quarter of 2010. There was no impairment of intangible assets for the years ended December 31, 2010 and December 31, 2009.
In April 2009, we adopted the new other-than-temporary impairments guidance. This new guidance amends the previous guidance for debt securities and modifies the presentation and disclosure requirements for debt and equity securities. In addition, it amends the requirement for an entity to positively assert the intent and ability to hold a debt security to recovery to determine whether an OTTI exists and replaces this provision with the assertion that an entity does not intend to sell or it is not more likely than not that the entity will be required to sell a security prior to recovery of its amortized cost basis. Additionally, this new guidance modifies the presentation of certain OTTI debt securities to only present the impairment loss within the results of operations that represents the credit loss associated with the OTTI with the remaining impairment loss being presented within other comprehensive income (loss) ("OCI"). At adoption, there was no cumulative effect adjustment to reclassify the non-credit component.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Fortegra Financial Corporation as of December 31, 2010 and 2009, and the consolidated results of its operations and its cash flows for the years ended December 31, 2010, 2009 and 2008 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information set therein.
Fortegra Financial Corporation and its subsidiaries ("Fortegra" or the "Company") is a diversified insurance services company that provides distribution and administration services on a wholesale basis to insurance companies, insurance brokers and agents and other financial services companies in the United States. In 2008, the Company changed its name from Life of the South Corporation to Fortegra Financial Corporation. Most of the Company's business is generated through networks of small to mid-sized community and regional banks, small loan companies and automobile dealerships. The consolidated financial statements include the Company and its majority-owned and controlled subsidiaries, including:
The third party ownership of 15% of the common stock of Southern Financial Life Insurance Company and 52% of the preferred stock of CRC Reassurance Company, Ltd. has been reflected as non-controlling interest on the consolidated balance sheets. Income attributable to those companies' minority shareholders has been reflected on the consolidated statements of income and comprehensive income as income attributable to non-controlling interest.
The following table reconciles assets, stockholders' equity and net income of the Company as presented in the accompanying consolidated financial statements to assets, stockholders' equity and net income as previously presented.
The following is a summary of significant accounting policies followed in the preparation of the financial statements:
The guidance establishes a three-level hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). If the inputs used to measure the assets or liabilities fall within different levels of the hierarchy, the classification is based on the lowest level input that is significant to the fair value measurement of the asset or liability. Classification of assets and liabilities within the hierarchy considers the markets in which the assets and liabilities are traded and the reliability and transparency of the assumptions used to determine fair value. The hierarchy requires the use of observable market data when available. The levels of the hierarchy and those investments included in each are as follows:
Level 2 - Inputs to the valuation methodology include quoted prices for similar assets or liabilities in active markets,
During 2009, the Company adopted the new accounting standards related to other-than-temporary impairment ("OTTI") that provide guidance in determining whether impairments in its debt securities are other-than-temporary and require additional disclosures relating to OTTI and unrealized losses on investments. All investments in an unrealized loss position are reviewed at the individual security level to determine whether a credit or interest rate-related impairment is other-than-temporary. For fixed maturity securities, impairment is considered to be other-than-temporary if the Company has the intent to sell the security prior to recovery, if it is more likely than not the Company will be required to sell the security prior to recovery, or if the Company doesn't believe the value of the security will recover. The Company's impairment analysis takes into account factors, both qualitative and quantitative in nature. The new standards did not change the impairment model for equity securities which are assessed for OTTI. Among the factors the Company considers in assessing OTTI for debt and equity securities are the following:
Restricted cash primarily represents unremitted premiums received from agents, unremitted claims received from insurers, fiduciary cash for reinsurers and pledged assets for the protection of policy holders in various state jurisdictions. Restricted cash is generally required to be kept in certain bank accounts subject to guidelines which emphasize capital preservation and liquidity; pursuant to the laws of certain states in which the Company's subsidiaries operate and applicable contractual obligations, such funds are not available to service the Company's debt or for other general corporate purposes. The Company is entitled to retain investment income earned on these fiduciary funds.
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, 2010, 2009 and 2008, totaled $57.3 million, $57.7 million and $60.6 million, respectively. The Company considers investment income in determining whether deferred acquisition costs are recoverable at year-end. No write-offs for unrecoverable deferred acquisition costs were recognized during 2010, 2009 and 2008.
Unpaid claims include estimates for benefits reported prior to the close of the accounting period and other estimates, including amounts for incurred but not reported benefits. These liabilities are continuously reviewed and updated by management.
Commissions include the commissions paid to distributors selling credit insurance policies. Commission rates, in many instances, are set by state regulators and are also impacted by market conditions. In certain instances, commissions are subject to retrospective adjustment based on the profitability of the related policies. Under these retrospective commission arrangements, the producer of the credit insurance policies receives a retrospective commission if the premium generated by that producer in the accounting period exceeds the costs associated with those policies, which includes our administrative fees, claims, reserves, and premium taxes. The Company analyzes the retrospective commission calculation on a monthly basis for each producer and, based on the analysis associated with each such producer, the Company records a liability for any positive net retrospective commission earned and due to the producer or, conversely, records a receivable amount due from such producer for instances where the net result of the retrospective commission calculation is negative.
The Company records a liability which reflects the amount of the retrospective commission earned by the producer, typically on a monthly basis. The settlement with the producer, in a subsequent period (usually the following month), results in a cash payment to the producer, which has the effect of reducing the recorded liability associated with that producer. If the net result is negative, the Company will record a receivable amount due from the producer, which reflects the fact that administrative fees, claims, reserves, and premium taxes exceeded the amount of net earned premium related to that producer. The Company offsets the receivable amount due from the producer by:
Deferred revenues represent unearned fee revenues attributable to our car clubs, and are earned over the period that coverage is provided. Deferred revenues represent the portion of income that will be earned in the future, and are generally calculated using either the pro rata method or sum-of-the-digits.
Income taxes are accounted for under the asset and liability method. Under this method, deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the consolidated statements of income in the period that includes the enactment date. A valuation allowance is recorded to reduce the carrying amounts of deferred tax assets if it is more likely than not that such assets will not be realized.
Comprehensive income includes both net income and other items of comprehensive income. For the years ended December 31, 2010, 2009 and 2008, other comprehensive income was comprised of unrealized gains and losses on securities classified as available-for-sale. The Company has elected to disclose comprehensive income in its consolidated statements of stockholders' equity.
On December 31, 2009, the Company adopted the new guidance on U.S. GAAP, which is within ASC Topic 105, GAAP. The new guidance establishes a single source of authoritative accounting and reporting guidance recognized by the FASB for nongovernmental entities (the "Codification"). The Codification does not change current U.S. GAAP, but is intended to simplify user access to all authoritative U.S. GAAP by providing all the authoritative literature related to a particular topic in one place. All existing accounting standard documents will be superseded and all other accounting literature not included in the Codification will be considered non-authoritative. The adoption of the new guidance did not have an impact on the Company's financial position, results of operations or cash flows. References to accounting guidance contained in the Company's consolidated financial statements and disclosures have been updated to reflect terminology consistent with the Codification. Plain English references to the accounting guidance have been made along with references to the number and name.
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 rollforward 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 fiscal 2010, except for the rollforward of activity on a gross basis for Level 3 fair value measurements, which will be effective for the Company in the first quarter of fiscal 2012. The adoption of this accounting 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.
On December 31, 2009, the Company adopted the new guidance on measuring the fair value of liabilities. When the quoted price in an active market for an identical liability is not available, this new guidance requires that either the quoted price of the identical or similar liability when traded as an asset or another valuation technique that is consistent with the fair value measurements and disclosures guidance be used to fair value the liability. The adoption of this new guidance did not have an impact on the Company's financial position, results of operations or cash flows.
On December 31, 2009, the Company adopted the new subsequent events guidance. This new guidance establishes general standards of accounting for and disclosures of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. The adoption of the new guidance did not have an impact on the Company's financial position, results of operations or cash flows.
On December 31, 2009, the Company applied the fair value measurements and disclosures guidance for all non-financial assets and liabilities measured at fair value on a non-recurring basis. The application of this guidance for those assets and liabilities did not have an impact on the Company's financial position, results of operations or cash flows. The Company's non-financial assets measured at fair value on a non-recurring basis include goodwill and intangible assets. In a business combination, the non-financial assets and liabilities of the acquired company would be measured at fair value in accordance with the fair value measurements and disclosures guidance. The requirements of this guidance include using an exit price based on an orderly transaction between market participants at the measurement date assuming the highest and best use of the asset by market participants. To perform the valuation, the Company is required to use a market, income or cost approach valuation technique. The Company performed its annual impairment analysis of goodwill and indefinite-lived intangible assets in the fourth quarter of 2010. There was no impairment of goodwill or intangible assets for the years ended December 31, 2010 and December 31, 2009.
In December 2009, the FASB issued revised guidance for the accounting of variable interest entities. The revised guidance replaces the quantitative-based risks and rewards approach with a qualitative approach that focuses on which enterprise has the power to direct the activities of a variable interest entity that most significantly impact the entity’s economic performance. The
On December 17, 2010, the Company completed is initial public offering (the "IPO"), issuing 6,000,000 shares of common stock at an IPO price of $11.00 per share, of which 4,265,637 shares were sold by us and 1,734,363 shares were sold by selling stockholders, and began trading on the New York Stock exchange under the symbol "FRF". The Company closed the transaction on December 22, 2010, and received $43.6 million in net proceeds from the offering, which reflects underwriting discounts and commissions of $3.3 million. Upon the closing of the Company's IPO, all outstanding shares of our previously issued Class A common stock automatically converted into shares of common stock. At December 31, 2010, the Company had 20,256,735 shares of common stock outstanding.
The amount of goodwill attributable to the 2010, 2009 and 2008 acquisitions that is expected to be tax deductible is $20.2 million, $0 and $0, respectively.
The amortized cost, gross unrealized gains, gross unrealized losses and fair values of fixed maturity securities and equity securities available-for-sale at December 31, 2010 are as follows:
The amortized cost, gross unrealized gains, gross unrealized losses and fair values of fixed maturity securities available for sale and equity securities available-for-sale at December 31, 2009 are as follows:
Pursuant to certain reinsurance agreements and statutory licensing requirements, the Company has deposited invested assets in custody accounts or insurance department safekeeping accounts. The Company is not permitted to remove invested assets from these accounts without prior approval of the contractual party or regulatory authority. At December 31, 2010 and 2009, the Company had restricted investments with carrying values of $17,522 and $20,292, respectively, of which $9,940 and $14,860 are related to special deposits required by various state insurance departments.
The amortized cost and fair value of fixed maturity securities at December 31, 2010 by contractual maturity are shown below. Expected maturities will differ from contractual maturities as borrowers have the right to call or prepay obligations with or without call or prepayment penalties.
The following table summarizes the proceeds from the sale of available-for-sale investment securities, the gross realized gains and gross realized losses for both fixed maturity and equity securities:
At December 31, 2010 and 2009, the aggregate amount of unrealized losses and the aggregate related fair values of investments with unrealized losses were segregated into the following time periods during which the investments had been in unrealized loss positions are as follows:
Fronting arrangements - These arrangements are typically with insurance companies affiliated with banks, auto dealers or financial institutions whereby the Company cedes up to 100% of the business written. The Company generally retains a fee for issuing the policies and for providing administrative services.
Coinsurance - Under coinsurance arrangements, the Company cedes a fixed percentage of business written to reinsurers while continuing to provide all policy administration. The Company receives an administration fee and generally participates in the underwriting profits, in accordance with a contractual formula.
Reinsurance receivables include amounts related to paid, unpaid benefits and prepaid reinsurance premiums. The following reflects the components of the reinsurance receivables:
Goodwill resulting from the Company's acquisitions is carried as an asset on the consolidated balance sheets and is not amortized, but is evaluated annually to determine whether any impairment exists. The Company uses an income approach to estimate the fair value of each reporting unit. The 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. The Company completed its annual assessment of goodwill in 2010, 2009 and 2008 and concluded that the value of its goodwill was not impaired.
In April 2009, the Company acquired Bliss and Glennon, Inc., for $42.1 million resulting in goodwill of $29.9 million and other intangible assets of $8.7 million. The Company recognized $1.7 million of transaction costs associated with the Bliss and Glennon acquisition in 2009 and an immaterial amount of transaction costs in 2008.
During 2010, the Company completed the acquisitions of South Bay Acceptance Corporation, Continental Car Club and United Motor Club recording goodwill of $0.5 million, $11.8 million and $8.5 million, respectively, and recorded other intangibles of $1.1 million on the Continental Car Club acquisition and $1.4 million on the United Motor Club acquisition.
Bliss and Glennon financial results have been included in the Company's results beginning April 15, 2009. Revenue and net income since the acquisition date included in the Company's consolidated statement of income for the year ended December 31, 2009 are as follows:
The following unaudited pro forma summary presents the Company's consolidated financial information as if South Bay Acceptance Corporation, Continental Car Club and United Motor Club had been acquired on January 1, 2010. These amounts
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:
Subordinated Debentures - In connection with the Summit Partners Transactions, LOTS Intermediate Co. issued $20.0 million of subordinated debentures to affiliates of Summit Partners, a related party. The subordinated debentures had an original maturity of June 20, 2012 and bore interest at 14% per annum on the principal amount of such subordinated debentures, payable quarterly. After June 20, 2010,the Company could redeem the subordinated debentures, in whole or in part, at a price equal to 100% of the principal amount of such subordinated debentures outstanding plus accrued and unpaid interest. The agreement governing the subordinated debentures contains non-competition and non-solicitation clauses for a period of five years after the closing date.
In December 2010, the Company utilized a portion of the proceeds received from its IPO to payoff the entire $20.0 million of outstanding subordinated debentures.
In connection with the Summit Partners Transactions, LOTS Intermediate Co. issued $35.0 million of fixed/floating rate preferred trust securities due 2037. The preferred trust securities bear interest at a rate of 9.61% per annum until June 2012. Thereafter, interest on the preferred trust securities will begin to float at a rate of 3-month LIBOR plus 4.10% for each interest rate period. Interest is payable quarterly.
The Company may not redeem the preferred trust securities until after the June 2012 interest payment date. After such date, the Company may redeem the preferred trust securities, in whole or in part, at a price equal to 100% of the principal amount of such preferred trust securities outstanding plus accrued and unpaid interest.
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 2011. The Company will incur a $0.3 million redemption premium that will be recorded as redemptions occur during 2011.
Notes payable, preferred trust securities, redeemable preferred stock: The carrying amounts approximate fair value because the applicable interest rates approximate current rates offered to the Company for similar instruments.
The following table presents the Company's investment securities within the fair value hierarchy, and the related inputs used to measure those securities at December 31, 2010 and 2009:
The Company's use of Level 3 unobservable inputs included 5 securities that accounted for 1.6% of total investments at December 31, 2010 and 19 securities that accounted for 3.8% of total investments at December 31, 2009.
The components of the net deferred tax liability are as follows:
The Company currently has outstanding stock options under its Key Employee Stock Option Plan (1995), 2005 Equity Incentive Plan and 2010 Omnibus Incentive Plan.
The Key Employee Stock Option Plan (1995), which was effective January 26, 1995, permits awards of incentive stock options and non-qualified stock options. The Company was permitted to issue up to 1,102,500 shares under this plan. Each option granted under this plan has a maximum contractual term of 10 years. The 1995 plan (but not the outstanding options granted under the plan) terminated on January 25, 2005. As of December 31, 2010, there were 258,300 options outstanding under the 1995 plan.
The 2005 Equity Incentive Plan was established on October 18, 2005 and permits awards of (i) Incentive Stock Options, (ii) Non-qualified Stock Options, (iii) Stock Appreciation Rights, (iv) Restricted Stock and (v) Restricted Stock Units. The Company was permitted to issue up to 1,312,500 shares under this plan. Each option granted under this plan has a maximum contractual term of 10 years. As of December 31, 2010, there were 1,312,500 options outstanding under the 2005 plan.
The Company measures stock-based compensation related to options using the calculated value method. Under that method, the Company estimates the fair value of each option on the grant date using the Black-Scholes valuation model incorporating the assumptions noted in the following table. 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 its volatility, by using the average volatility of the Company's peers. 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. Assumptions related to stock option awards:
Additional information regarding options granted, vested and exercised is presented below:
During 2010, the Company granted 100,000 shares of restricted stock to key employees pursuant to the 2010 Omnibus Incentive Plan. These shares vest when the Payment Protection and BPO segments of the Company meet a combined EBITDA (Earnings before interest, taxes, depreciation and amortization) target of $36.5 million. An additional 60,000 shares of restricted stock were granted pursuant to the 2010 Omnibus Incentive Plan to members of the board of directors which vest annually over three years.
Stock-based compensation costs related to restricted stock is measured at the grant date based upon the fair value of the award and is typically recognized as expense on a straight-line basis over the requisite service period, which is the expected vesting period. Compensation cost related to restricted shares granted to non-employee directors is re-measured at each reporting period until a measurement date has been established which is typically the vesting date. Total stock-based compensation related to restricted stock recognized on the consolidated statements of income was as follows:
As of December 31, 2010, there were no further payments required under the plan. At December 31, 2009, total liabilities of $21 were accrued under the plan. The liabilities were estimated using a discount rate of 5.00% for both 2010 and 2009. The amounts are reflected in the consolidated balance sheets as accrued expenses and accounts payable.
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 reflected in the consolidated balance sheets as cash and cash equivalents. The corresponding deferred compensation obligation is recorded in the consolidated balance sheets as accrued expenses and accounts payable. In 2009, the executives elected to invest a portion of the funds held in the rabbi trusts in shares of common stock of the Company. Pursuant to U.S. GAAP, the portion of the rabbi trusts invested in shares of the Company has been reflected as treasury stock in the consolidated balance sheets at December 31, 2010 and December 31, 2009.
The combined statutory capital and surplus of the Company's insurance subsidiaries was $46,183 and $48,210 as of December 31, 2010 and 2009, respectively. The combined amount available for ordinary dividends of the Company's insurance subsidiaries was $1,575 and $1,486 as of December 31, 2010 and 2009, respectively.
The Company's insurance subsidiaries are required by the laws of the states in which they are domiciled to maintain certain
Under the National Association of Insurance Commissioners ("NAIC") Risk-Based Capital Act of 1995, a company's risk-based capital ("RBC") is calculated by applying certain risk factors to various asset, claims and reserve items. If a company's adjusted surplus falls below calculated RBC thresholds, regulatory intervention or oversight is required. The insurance companies' RBC level as calculated in accordance with the NAIC's RBC instructions exceeded all RBC thresholds as of December 31, 2010 and December 31, 2009.
The Company is party to claims and litigation in the normal course of its operations. Management believes that the ultimate outcome of these matters will not have a material adverse effect on the consolidated financial position, results of operations or cash flows of the Company.
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 then current statement of income. The changes in unpaid claims for each of the years ending December 31 are summarized as follows:
The Company conducts its business through three business segments: (i) Payment Protection; (ii) BPO; and (iii) Wholesale Brokerage. The Company does not allocate certain revenues and costs to its segments. These items primarily consist of
corporate-related income and overhead expenses, which are reflected as "Corporate" in the following table, amortization, depreciation, interest income and expense and income taxes. The Company measures the profitability of its operating segments without allocation of these expenses. The Company refers to this measure of profitability as segment EBITDA (earnings before interest, taxes, depreciation and amortization) and segment EBITDA margin. The variability of segment EBITDA and segment EBITDA margin is significantly affected by segment revenues due to a large component of operating expenses being fixed. The following table reconciles segment information to the Company's consolidated results of operations and provides a summary of other key financial information for each of the Company's segments:
In connection with the Summit Partners acquisition of the Company on June 20, 2007, $20.0 million of subordinated debentures were issued to affiliates of Summit Partners and reported in the notes payable line of the balance sheets. The subordinated debentures mature on December 13, 2013 and bear interest at 14% per annum of the principal amount of such subordinated debentures. The Company may redeem the subordinated debentures, in whole or in part, at a price equal to 100% of the principal amount of such subordinated debentures outstanding plus accrued and unpaid interest. The Company recorded interest expense on the subordinated debentures totaling $2,769, $2,839 and $2,847 for the years ended December 31, 2010,
On January 3, 2011, the Company acquired Auto Knight Motor Club, Inc. ("Auto Knight"), of Palm Springs, CA. Auto Knight provides motor club memberships, vehicle service plans and tire and wheel programs, which are offered by automobile and truck dealerships and retailers. The acquisition expands the Company's geographic reach to Canada, where Auto Knight offers its products through retailers as a subscription benefit. The transaction is effective January 1, 2011.
In January 2011, we redeemed our Series A, B and C redeemable preferred stock totaling $11.0 million in principal amount. Management anticipates that the payment of all $11.0 million of outstanding A, B and C redeemable preferred stock will be completed in the first quarter of 2011 at a total cost of $11.3 million, which includes a $0.3 million early redemption premium.
On March 1, 2011, Wells Fargo Bank, N.A., entered into a joinder agreement to the revolving credit facility with SunTrust and became a new lender under the revolving credit facility with a revolving commitment of $30.0 million, which increased the size of the revolving credit facility to $85.0 million.
On March 3, 2011, the Company agreed to acquire eReinsure, Inc. ("eReinsure") for a cash purchase price of $37 million. eReinsure develops web-hosted applications for the reinsurance market by leveraging new Internet technologies in application architecture, network communication and information delivery.