The following selected consolidated financial data for each of the four years in the period ended December 31, 2015 have been derived from our consolidated financial statements. Such data should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and notes thereto in Item 8 of this Annual Report on Form 10-K.
The consolidated and combined financial statements of Patriot National are comprised of (1) the financial statements of us and our subsidiaries, which became our subsidiaries in the Reorganization, (2) the results of the Patriot Care Management Business, which are reflected in our consolidated financial statements from August 6, 2014, the effective date of the Patriot Care Management Acquisition, (3) the revenues and expenses associated with the contracts and certain other assets acquired and liabilities assumed effective August 6, 2014 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 and (4) the results of the other entities and businesses acquired by us from time to time.
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 consolidated and 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 consolidated and combined financial statements incorporated by reference into this prospectus. The results of the other entities and businesses acquired by us, including Patriot Care Holdings, Inc. (f/k/a MCRS Holdings, Inc.), our subsidiary operating the Patriot Care Management Business, and the acquisitions we made after our initial public offering are reflected in our consolidated financial statements from the applicable time of acquisition. Because of the inclusion of such results from the applicable time of acquisition, our financial statements are not comparable from period to period.
On December 13, 2015, we entered into a securities purchase agreement (the “Securities Purchase Agreement”) with Steven M. Mariano, our President and Chief Executive Officer, and the PIPE Investors pursuant to which the PIPE Investors purchased (i) 2,500,000 shares of our common stock from Steven M. Mariano, for an aggregate purchase price of approximately $30 million, and (ii) 666,666 shares of our common stock, the Old Series A Warrants to purchase up to an aggregate of 2,083,333 shares of our common stock and the prepaid Old Series B Warrants for 1,000,000 shares of our common stock for an aggregate purchase price of approximately $20 million. In addition, we entered into an agreement (the “Stock Back-to-Back Agreement”) with Mr. Mariano, pursuant to which, upon the exercise of the Old Warrants, we would purchase a number of shares of our common stock owned by Mr. Mariano equal to 60% of the shares to be issued in connection with the exercise by the PIPE Investors of the Old Warrants.
On December 23, 2015, we also entered into a Voting Agreement with Steven M. Mariano, pursuant to which Mr. Mariano agreed to vote in favor of issuances of shares of common stock in the event that, as a result of an increase in the number of shares that may be purchased upon exercise of the New Warrants to the Adjusted Share Amount (as defined in the New Warrants), such number of shares would exceed the Exchange Cap (as defined in the New Warrants).
On January 28, 2016, we entered into that Asset Purchase Agreement by and between Patriot Underwriters, Inc. and Mid Atlantic Insurance Services, Inc. (“Mid Atlantic”) pursuant to which the Company acquired substantially all of the assets of Mid Atlantic for a maximum of $16,500,000. Pursuant to the Asset Purchase Agreement, the Company paid Mid Atlantic $8,000,000 in cash at closing. Mid Atlantic will also be entitled to annual earn-out payments of up to a cumulative maximum of $8,500,000 over approximately five years after closing. Subject to limited exceptions, $7,000,000 of the maximum earn-out is guaranteed.
According to the most recently published NCCI Report, the total net premium written by state funds and private carriers of workers’ compensation insurance in the United States was $44.2 billion in 2014, an increase from $33.8 billion in 2010, representing a compound annual growth rate of 6.9% over that period, and according to data compiled by SNL Financial, total direct premium written by workers’ compensation insurance carriers in the United States, which includes the amount of premium reinsured by insurance carriers, was $55.4 billion in 2014, an increase from $40.4 billion in 2010, representing a compound annual growth rate of 8.3% over that period. In the past several years, premium growth in the workers’ compensation industry has been predominantly driven by the recovery of employment levels to generally at or near pre-recession levels, as well as increasing premium rates.
Reference premium written: reference premium written refers to the earned aggregate premium, grossed up for large deductible credits, written by or for our insurance carrier partners in respect of the policies we produce and service on their behalf. For Guarantee Insurance who records written premium on the effective date of the policy based on the estimated total premium for the term of the policy, reference written premium is equal to written premium based on the estimated total premium for the term of the policy, earned as of the effective date of the policy, grossed up for large deductible credits. Subsequent adjustments to the estimated total premium for the term of the policy are reflected as adjustments to reference written premium when the adjustments become known. For our third party insurance carrier clients who record written premium as premium is collected, reference written premium is equal to collected premium, grossed up for large deductible credits. We evaluate our business (in respect of revenue both from brokerage and policyholder services and from claims administrative services) both in respect of the overall revenue generated by reference premium written, and the margin on such revenue. With respect to our brokerage and policyholder services, changes in reference premium written generally correspond to changes in total revenues.
The policies we write for our insurance and reinsurance carrier clients generally have a term of one year, and reference premium written is earned by our insurance and reinsurance carrier clients on a pro rata basis over the terms of the underlying policies. Likewise, the claims associated with these policies are generally incurred on a pro rata basis over the terms of the underlying policies. Generally, we perform our claims administration services on a claim from the date it is incurred through the date it is closed. We refer to claims that have been incurred, but not yet closed, for a particular period as “managed claims exposures.” With respect to our claims administration services, changes in managed claims exposures generally correspond to changes in total revenues.
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.
We present Adjusted EBITDA, Adjusted EBITDA Margins, Operating Cash Flow and Adjusted Earnings (Loss) in this report because they are key measures used by our management and board of directors to understand and evaluate our core operating performance and trends, to prepare and approve our annual budget and to develop short and long-term operational plans. In particular, we believe that the exclusion of the amounts eliminated in calculating Adjusted EBITDA, Operating Cash Flow and Adjusted Earnings (Loss) can provide useful measures for period-to-period comparisons of our core business. Accordingly, we believe that Adjusted EBITDA, Operating Cash Flow and Adjusted Earnings (Loss) provide useful information to investors and others in understanding and evaluating our operating results in the same manner as our management and board of directors.
Gross reference premium written for the year ended December 31, 2014 was $335.1 million compared to $350.1 million for the year ended December 31, 2013, a decrease of $15.0 million. The decrease was attributable to a $46.0 million decrease in gross reference premium written on behalf of Zurich as a result of Zurich reducing its volumes in California, where business covered by our initial program with Zurich was solely written. In September 2014, we entered into a second program with Zurich that further expands coverage in multiple other states. Additionally, we incurred a decrease of $4.1 million associated with the termination of our contract with Ullico. Ullico was one of our insurance carrier clients from April 2009 until we terminated their contract effective March 26, 2012 in connection with their liquidation. This was partially offset by a $13.0 million increase in Guarantee Insurance gross reference premium written, and the 2014 inception of new contracts with Scottsdale and certain other insurance carrier clients, which generated $22.2 million of gross reference premium written.
Reference premium written for the year ended December 31, 2015 was $462.0 million compared to $359.9 million for the year ended December 31, 2014, an increase of $102.1 million. The increase was attributable to a $19.6 million increase in Guarantee Insurance gross reference premium written, and the inception of new contracts with Scottsdale, AIG and certain other insurance carrier clients, which generated $109.5 million of reference premium written. The increase was partially offset by a $26.9 million decrease in reference premium written on behalf of Zurich as a result of Zurich reducing its volumes in California, where business covered by our initial program with Zurich was solely written. In September 2014, we entered into a second program with Zurich that further expands coverage in multiple other states.
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 written on behalf of Zurich of approximately $28.1 million as a result of Zurich reducing its volumes in California, where business covered by our initial program with Zurich was solely written. In September 2014, we entered into a second program with Zurich that further expands coverage in multiple other states. The increase was also partially offset by a decrease of $4.1 million associated with the termination of our contract with Ullico.
Adjusted EBITDA for the year ended December 31, 2015 was $51.5 million compared to $27.1 million for the year ended December 31, 2014, an increase of $24.3 million. The increase was principally attributable to a $107.0 million increase in total fee income and fee income from related party, partially offset by an $82.7 million increase in total expenses (excluding depreciation and amortization, costs from debt payoff, stock compensation expenses, severance expenses, public offering costs, acquisition costs and changes in fair value of assets and liabilities, which are added back to net income to arrive at Adjusted EBITDA), all of which are discussed more fully below.
Adjusted EBITDA for the year ended December 31, 2014 was $27.1 million compared to $6.6 million for the year ended December 31, 2013, an increase of $20.5 million. The increase was principally attributable to a $46.9 million increase in total fee income and fee income from related party and a $0.4 million increase in net investment income, partially offset by a $26.8 million increase in total expenses (excluding depreciation and amortization and changes in fair value of warrant liabilities, which are added back to net income to arrive at Adjusted EBITDA), all of which are discussed more fully below.
Operating cash flow for the year ended December 31, 2014 was $4.5 million compared to $4.7 million for the year ended December 31, 2013, a decrease of $0.2 million. The decrease was principally attributable to an increase of $10.9 million income tax expense, an increase of $8.0 million interest expense, and $1.8 million increased capital expenditures, mostly offset by a $20.5 million increase in Adjusted EBITDA.
Adjusted Earnings (Loss) is a non-GAAP financial measure and is not in accordance with, or an alternative to, the GAAP information provided in this Annual Report on Form 10-K. For further information regarding our use of non-GAAP financial measures and a reconciliation of Operating cash flow to Net income (loss), see “Selected Financial Data.”
Adjusted earnings for the year ended December 31, 2015 was $20.1 million compared to $6.0 million for the year ended December 31, 2014, an increase of $14.1 million. The increase was principally attributable to a $107.0 million increase in total fee income and fee income from related party, partially offset by an $82.7 million increase in total expenses (excluding depreciation and amortization, costs from debt payoff, stock compensation expenses, severance expenses, public offering costs, acquisition costs and changes in fair value of assets and liabilities, which are added back to net income to arrive at Adjusted EBITDA), net of a $9.0 million increase in income tax expense at the statutory rate.
With respect to our claims administration services, we earn service fees for administering workers’ compensation claims for insurance and reinsurance companies. Service fees are generally based on a percentage of reference premiums earned, meaning they are based on a portion of the full premium as it is considered earned by an insurance carrier client on a pro rata basis over the term of the policy. We also earn service fees for other services provided to insurance and reinsurance companies and to our other clients such as employers and local governments, which are based on an hourly rate, a percentage of premiums, percentage of subrogation recovered, percentage of savings or a fixed monthly fee, depending on the service. For example, service fees for telephonic nurse case management services on workers’ compensation claims for insurance and reinsurance companies are based on an hourly rate. Service fees for medical bill review services on workers’ compensation claims for insurance and reinsurance companies, based on either a percentage of savings or a flat fee per bill. We also earn service fees for administering workers’ compensation claims for state guarantee associations responsible for handling the claims of insolvent insurance companies based on a fixed amount per open claims per month.
For claims administration services, the portion of total fee income and fee income from related party that we classify as fee income is based on the net portion of claims expense retained by parties other than Guarantee Insurance. For example, if Guarantee Insurance transfers a portion of the risk under a policy it has written to a captive reinsurer, which is a non-related party, only the fee income from claims administration services associated with the portion retained by Guarantee Insurance is classified as fee income from related party. Likewise, if Zurich, a non-related party, transfers a portion of the risk under a policy it has written to Guarantee Insurance, only the fee income from claims administration services associated with the portion retained by Zurich is classified as fee income, while the fee income from claims administration services associated with the portion transferred to Guarantee Insurance is classified as fee income from related party.
management fees for administrative support services incurred by Guarantee Insurance Group (a related party) for our benefit, including executive management, human resources, accounting, information technology and legal services. The management fees charged to us by Guarantee Insurance Group were based on the amount of reference premium written by us for our third-party insurance carrier clients compared to the amount of reference premium written by Guarantee Insurance Group for the periods presented. Effective August 6, 2014, these support services expenses are being incurred directly by us, and from that date forward we no longer pay management fees to Guarantee Insurance Group;
allocation of marketing, underwriting and policy issuance costs from Guarantee Insurance Group (a related party), representing the amount of marketing, underwriting and policy issuance expenses incurred by Guarantee Insurance Group for our benefit. The allocation costs charged to us by Guarantee Insurance Group were generally based on the amount of reference premium written by us for our third-party insurance carrier clients compared to the amount of reference premium written by Guarantee Insurance Group for the periods presented. Effective August 6, 2014, such costs are being incurred directly by us, and from that date forward Guarantee Insurance Group is no longer allocating these costs to us;
interest expense incurred on our outstanding indebtedness based on applicable interest rates during the relevant periods;
Our prices by customer for our brokerage and policyholder services and claims administration services were unchanged for the year ended December 31, 2015 relative to the year ended December 31, 2014 and, accordingly, the net increase in fee income was related to changes in the volume of business we managed.
Our prices by customer for our brokerage and policyholder services and claims administration services were unchanged for the year ended December 31, 2015 relative to the year ended December 31, 2014 and, accordingly, the net increase in fee income from related party was solely related to changes in the volume of business we managed.
Net Realized Gains (Losses) on Investments. Net realized gains (losses) on investments was a loss of $0.2 million for the year ended December 31, 2015, compared to a gain of $14.0 million for the year ended December 31, 2014. This decrease is a result of the net gain realized upon the redemption of the MCMC preferred equity in connection with the Patriot Care Management Acquisition that was recognized in 2014.
Management Fees to Related Party for Administrative Support Services. Management fees to related party for administrative support services for the year ended December 31, 2015 were $0 compared to $5.4 million for the year ended December 31, 2014, a decrease of $5.4 million or 100%.
Outsourced Services. Outsourced services for the year ended December 31, 2015 were $12.2 million compared to $5.6 million for the year ended December 31, 2014, an increase of $6.6 million or 118%. The increase was principally attributable to outsourced services costs incurred by the Patriot Care Management Business Management Business. We acquired the Patriot Care Management
Other Operating Expenses. Other operating expenses for the year ended December 31, 2015 were $34.6 million compared to $13.8 million for the year ended December 31, 2014, an increase of $20.8 million. This increase was principally due to the fact that effective August 6, 2014, we directly incurred other operating expenses which were previously allocated to us from Guarantee Insurance Group or incurred in the form of a management fee paid to Guarantee Insurance Group as described under “-Salaries and Salary Related Expenses” above.
Additionally, the increase is due to additional other operating expenses incurred and associated with the operations of the Patriot Care Management Business. We did not own the Patriot Care Management Business until August 6, 2014, 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.
Interest Expense. Interest expense for the year ended December 31, 2015 was $3.5 million compared to $9.2 million for the year ended December 31, 2014, a decrease of $5.7 million. Interest expense for the year ended December 31, 2015, is comprised of interest accruing under the UBS Credit Agreement entered into on August 6, 2014. We had a significant reduction of interest expense due to lower debt balances and interest rates associated with our current Senior Secured Credit Facility, as discussed in Note 7 to our consolidated financial statements, “Notes Payable and Lines of Credit.”
Depreciation and Amortization. Depreciation and amortization for the year ended December 31, 2015 was $14.6 million compared to $5.9 million for the year ended December 31, 2014, an increase of $8.7 million. The increase was attributable mainly to an increase in amortization of intangible assets as a result of businesses acquired in the years ended December 31, 2014 and 2015.
Stock Compensation Expense. The Company recognized $10.8 million of stock compensation expense for the year ended December 31, 2015. Stock compensation expense is related to restricted stock and stock option awards. See Note 10 to our consolidated financial statements, “Stock-Based Compensation,” for further details related to these awards and the recognized expense.
Public Offering Costs. The Company recognized $1.2 million in expenses for the year ended December 31, 2015 related to the costs associated with raising equity capital subsequent to the IPO.
Increase in fair value of earn-out liability. For the year ended December 31, 2015, the Company recognized an increase of $0.8 million to the fair value of earnout recorded for the acquisition of CWI Benefits, Inc. The increase in fair value is treated as expense rather than an adjustment to purchase price in accordance with ASC 820.
The fair value of earnout obligations is based on the present value of the expected future payments to be made to the sellers of the acquired entities in accordance with the provisions outlined in the respective purchase agreements, which is a Level 3 fair value measurement, as discussed further in Note 11 to our consolidated financial statements, “Fair Value Measurement of Financial Assets and Liabilities.” In determining fair value, we estimated the acquired entity’s future performance using financial projections developed by management for the acquired entity and market participant assumptions that were derived for revenue growth and/or profitability. We estimated future payments using the earnout formula and performance targets specified in each purchase agreement
Gain on financing transaction. For the year ended December 31, 2015 the Company recognized a gain of $0.6 million with regard to recognition of financing transactions. See Note 15 to our consolidated financial statements, “Warrant Redemption Liability.”
Total fee income and fee income from related party for the year ended December 31, 2014 was $102.7 million compared to $55.9 million for the year ended December 31, 2013, an increase of $46.9 million or approximately 84%. The increase was primarily due to an increase in fee income from related party.
For the year ended December 31, 2014, approximately 71% of our total fee income and fee income from related party was attributable to our contracts with Guarantee Insurance, a related party, and approximately 18% of our total fee income and fee income from related party was attributable to contracts with our second largest client.
The increase was principally attributable to $23.8 million of brokerage and policyholders services fee income from Guarantee Insurance earned from August 6, 2014 to December 31, 2014. On August 6, 2014 we entered into a new agreement with Guarantee Insurance to provide all of our brokerage and policyholder services to Guarantee Insurance, as described elsewhere in this 10-K, with no such contract existing previously during 2014 or 2013. The increase was also partly attributable to an increase in brokerage and policyholder services fee income related to the increase in reference premium written by us for Guarantee Insurance, as described above under “-Key Performance Measures,” and to $6.1 million of claims administration services fee income earned by the Patriot Care Management Business from Guarantee Insurance from the date of acquisition of this service unit on August 6, 2014 to December 31, 2014.
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 from related party was solely related to changes in the volume of business we managed.
commission expense for the year ended December 31, 2014 in connection with new contracts we entered into in 2014 with Scottsdale and certain other insurance clients, as described above.
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.
Other Operating Expenses. Other operating expenses for the year ended December 31, 2014 were $13.3 million compared to $4.6 million for the year ended December 31, 2013, an increase of $8.8 million. This increase was principally due to the fact that from August 6, 2014, we directly incurred other operating expenses which were previously allocated to us from Guarantee Insurance Group or incurred in the form of a management fee paid to Guarantee Insurance Group as described under “-Salaries and Salary Related Expenses” above.
in depreciation related to capitalized policy and claims administration system development costs which we incurred principally in the second half of 2013 and first half of 2014 in connection with our IE platform and, $1.8 million of intangible asset amortization relating to the Patriot Care Management Business for the period August 6, 2014 to December 31, 2014.
Increase in Fair Value of Warrant Redemption Liability. The increase in fair value of warrant redemption liability was $1.8 million for the year ended December 31, 2014 compared to zero for the year ended December 31, 2013, which represents the change in estimated fair value of the detachable common stock warrants issued to the lenders in connection with the Initial Tranche and Additional Tranche of the PennantPark Loan Agreement and the common stock issued to Advantage Capital pursuant to their September 30, 2014 exercise of common stock warrants as described elsewhere in this 10-K. We recorded this liability, and reflect the changes in the estimated fair value thereof, since the warrant holders and stockholders may at specified times require us to redeem the stock or the warrants for cash, in an amount equal to, in the case of stock, the estimated fair value of the stock or, in the case of warrants, the estimated fair value of the warrants less the total exercise price of the redeemed warrants.
Income Tax Expense. Income tax expense was $11.6 million for the year ended December 31, 2014 compared to $0.7 million for the year ended December 31, 2013, an increase in income tax expense of $10.9 million. Income tax expense for the year ended December 31, 2014 and 2013 was principally comprised of federal income tax expense at a statutory federal rate of 35% and 34%, respectively, and state income tax expense, plus the tax expense associated with (i) the gain on redemption of MCMC preferred equity attributable to the difference between tax basis and book basis and (ii) non-deductible expenses incurred in connection with the acquisition of PCM, and the tax associated with the increase in fair value of warrant redemption liability for the year ended December 31, 2014. Prior to November 27, 2013, certain of our subsidiaries were S Corporations or limited liability companies, electing to be taxed as pass through entities and, accordingly, we did not recognize a federal or state income tax provision for these subsidiaries for the previous portion of the year ended December 31, 2013.
As a result of the factors described above, net income (loss) increased by $16.6 million to $10.4 million for the year ended December 31, 2014 as compared to $(6.2) million for the prior year.
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 occurring in the first and third calendar quarters based on the current distribution of such dates.
Although we cannot accurately anticipate the effect of inflation on our operations, we believe that inflation has not had a material impact on our results of operations during the last two fiscal years, nor do we believe it is likely to have such a material impact in the foreseeable future.
Net cash provided by operating activities for the year ended December 31, 2014 was $24.4 million compared to $6.0 million for the year ended December 31, 2013, an increase of $18.4 million. This increase was attributable to a $20.5 million increase in Adjusted EBITDA discussed above, partially offset by an $8.0 million increase in interest expense discussed above and by changes in certain assets and liabilities, principally fee income receivable from related party, income taxes payable and accounts payable, accrued expenses and other liabilities.
Net cash used in investing activities for the year ended December 31, 2015 was $92.7 million compared to $59.5 million for the year ended December 31, 2014, an increase of $33.2 million. The increase was principally attributable to $79.1 million of cash, net of $4.1 million used for the seventeen (17) acquisitions, as described elsewhere in this 10-K.
For the year ended December 31, 2015, Patriot made capital expenditures of $5.9 million, for fixed assets and policy and claims administration system development costs, principally in connection with our IE platform.
For the year ended December 31, 2014, Patriot and GUI made capital expenditures of $1.5 million and $0.3 million, respectively, for fixed assets and policy and claims administration system development costs, principally in connection with our IE platform. For the years ended December 31, 2013, GUI made capital expenditures of $6.1 million for fixed assets and policy and claims administration system development costs, principally in connection with our IE platform.
Our balance sheet as of December 31, 2015 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, 2015, 2014 and 2013. Our IE 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 IE policy and claims administration system, we do not anticipate such further costs to be significant.
On January 22, 2015, we entered into the Credit Agreement which provides for a $40.0 million revolving credit facility and a $40.0 million term loan facility (the “senior secured credit facility”). The senior secured credit facility has a maturity of five years, and borrowings thereunder bear interest, at our option, at LIBOR plus a margin ranging from 250 basis points to 325 basis points or at base rate plus a margin ranging from 150 basis points to 225 basis points. Margins on all loans and fees will be increased by 2% per annum during the existence of an event of default. The revolving credit facility includes borrowing capacity available for letters of credit and borrowings on same-day notice, referred to as swing line loans. At any time prior to maturity, we have the right to increase the size of the revolving credit facility or the term loan facility by an aggregate amount of up to $20.0 million, but in a minimum amount of $5.0 million. On August 14, 2015, we entered into a second amendment to our $80.0 million senior secured credit facility which provides for an additional $50.0 million of term loans plus the ability to increase the term loan by an additional $50.0 million under certain conditions. The amendment also added a requirement that until we deliver a certificate certifying that (a) the our total
leverage ratio is equal to or less than 2.25 to 1.00 and (b) our Adjusted EBITDA for the twelve-months then ended is at least $70.0 million, the outstanding revolving loans (plus any swing line loans and the aggregate stated amount of all letters of credit) shall not exceed $30.0 million. All other material terms and conditions in the senior secured credit facility were unchanged by the amendment. On December 23,2015 we entered into a third amendment, which permits Patriot to exercise the provisions of the Rescission and Exchange Agreement for the private placement of company stock and warrants, and related Back-to-Back Agreement with the selling shareholder, as described in Related Party transactions.
The term loan facility amortizes quarterly beginning the first full quarter after the closing date at a rate of 5% per annum of the original principal amount during the first two years, 7.5% per annum of the original principal amount during the third and fourth years and 10% per annum of the original principal amount during the fifth year, with the remainder due at maturity. Principal amounts outstanding under the revolving credit facility are due and payable in full at maturity. In the event of any sale or other disposition by us or our subsidiaries guaranteeing the senior secured credit facility of any assets with certain exceptions, we are required to prepay all proceeds received from such a sale towards the remaining scheduled payments of the term loan facility.
Our borrowings under the UBS Credit Agreement bore interest at a rate equal to the greatest of (x) the base rate in effect on such day, (y) the federal funds rate in effect on such day plus 0.50% and (z) the adjusted LIBOR rate on such day for a one-month interest period plus 1.00%, subject to a minimum rate, plus an applicable margin of 8.00%, which may be increased by additional amounts under certain specified circumstances. The weighted average interest rate under the UBS Credit Agreement for the year ended December 31, 2014 was 11.25%.
On August 6, 2014, in connection with the GUI Acquisition, we and certain of our subsidiaries, as borrowers, and certain of our other subsidiaries and certain affiliated entities, as guarantors, entered into the PennantPark Loan Agreement with the PennantPark Entities, as lenders. Following our IPO, we prepaid all outstanding borrowings under the PennantPark Loan Agreement, including accrued interest and applicable prepayment premium.
The table below provides information with respect to our long-term debt and contractual commitments as of December 31, 2015:
Prior to August 6, 2014, our brokerage and policyholder services revenue was derived solely from (1) insurance carrier clients other than Guarantee Insurance (“Other Carriers”), all of which record written premium as premium is collected and (2) Guarantee Insurance under a producer agreement for workers’ compensation policies described below.
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, 2015 and 2014.
Commission expense represents consideration paid by us to insurance agencies for producing business. Services provided by insurance agencies are, in all material respects, provided prior to the issuance or renewal of an insurance policy. With respect to business written for insurance carrier clients who record written premium on the effective date of the policy, we record commission expense on the effective date of the policy based on the estimated total premium for the term of the policy, reduced by an allowance for estimated commission expense that may be returned by the insurance agencies to us due to net reductions in estimated total premium for the term of the policy, principally associated with mid-term policy cancellations. With respect to business written for insurance carrier clients who record written premium as premium is collected, we recognize commission expense as the premium is collected, reduced by an allowance for estimated commission expense that may be returned by the insurance agencies to us due to net returns of premiums previously written and collected. The income effects of subsequent commission expense adjustments are recorded when the adjustments become known.
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 consolidated 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.
Fee income receivable and fee income receivable from related party are based on contracted prices. We assess the collectability of these balances and adjust the receivable to the amount expected to be collected through an allowance for doubtful accounts. As of December 31, 2015, we maintained an allowance for doubtful accounts of approximately $0.3 million.
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 our chief operating decision makers for purposes of assessing the performance of each service or making decisions about resources to be allocated to each service. Accordingly, we consider our business to operate in one segment.
to recognize assets and liabilities for leases with lease terms of more than 12 months. Consistent with current Generally Accepted Accounting Principles (GAAP), the recognition, measurement, and presentation of expenses and cash flows arising from a lease by a lessee primarily will depend on its classification as a finance or operating lease. However, unlike current GAAP-which requires only capital leases to be recognized on the balance sheet-the new ASU will require both types of leases to be recognized on the balance sheet.
The ASU also will require disclosures to help investors and other financial statement users better understand the amount, timing, and uncertainty of cash flows arising from leases. These disclosures include qualitative and quantitative requirements, providing additional information about the amounts recorded in the financial statements. The ASU on leases will take effect for public companies for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. For all other organizations, the ASU on leases will take effect for fiscal years beginning after December 15, 2019, and for interim periods within fiscal years beginning after December 15, 2020. Early application will be permitted for all organizations. The company is currently reviewing the impact that implementing this ASU will have.
In November 2015, the Financial Accounting Standards Board ("FASB") issued new accounting guidance related to income taxes, which simplifies the presentation of deferred income taxes by requiring deferred tax assets and liabilities be classified as noncurrent on the balance sheet. The updated standard is effective for us beginning on January 1, 2017 with early application permitted as of the beginning of any interim or annual reporting period. We plan to adopt the new guidance in 2016, which is not expected to have a material impact on our consolidated financial statements other than reclassifying current deferred tax assets and liabilities to noncurrent in the balance sheet. See Note 16 to our consolidated financial statements for a discussion on income tax balances.
In September 2015, the FASB issued Accounting Standards Update ("ASU") 2015-16, “Simplifying the Accounting for Measurement-Period Adjustments”, an update to Accounting Standard Codification (“ASC”) Topic 805, Business Combinations. This update requires that an acquirer recognize adjustments to the provisional amounts that are identified during the measurement period in the reporting period in which the adjusting amounts are determined. The amendment requires that the acquirer record, in the same period’s financial statements, the effect on earnings of changes in depreciation, amortization, or other income effects, if any, as a result of the change to the provisional amounts, calculated as if the accounting had been completed at the acquisition date. The amendments in this update require an entity to present separately on the face of the income statement or disclose in the notes the portion of the amount recorded in current period earnings by line item that would have been recorded in previous reporting periods if the adjustment to the provisional amounts had been recognized as of the acquisition date. The amendments are effective for fiscal years beginning after December 15, 2015, including interim periods within those fiscal years. The update should be applied prospectively to adjustments to provisional amounts that occur after the effective date of this update with earlier application permitted for financial statements that have not been issued. We will evaluate this guidance as potential adjustments arise.
In May 2014, the FASB issued ASU 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. In August 2015, the FASB issued a deferral of effective date for this standard. For public companies this standard applies to annual reporting period beginning after December 15, 2017, including interim reporting periods within that reporting period, and early adoption is not permitted. We are currently evaluating the accounting, transition and disclosure requirements of the standard and cannot currently estimate the financial statement impact of adoption.
We have audited the accompanying consolidated balance sheets of Patriot National, Inc. as of December 31, 2015 and 2014 and the related consolidated statements of operations, stockholders’ equity (deficit), and cash flows for each of the three years in the period ended December 31, 2015. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Patriot National, Inc. at December 31, 2015 and 2014, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2015, in conformity with accounting principles generally accepted in the United States of America.
Patriot National, Inc. (“Patriot National” or the “Company”) is an independent national provider of comprehensive technology-enabled outsourcing solutions that help insurance carriers, employers and other clients mitigate risk, comply with complex regulations, and save time and money. We offer a full suite of end-to-end insurance related and specialty services that allow our clients to improve efficiencies and reduce expenses through our value-added processes. The core of our value proposition includes the benefit of a “one-stop” solution with our broad array of offered services, scalable state-of-the-art technology, and solutions to complex business and regulatory processes. Our goal is to be the preferred provider of mandatory employer services such as risk management services, health and welfare services, employee onboarding and compliance services.
Our revenue is primarily fee-based, most of which is contractually committed or highly recurring. Unlike our insurance and reinsurance carrier clients, we do not generate underwriting income or assume underwriting risk on workers’ compensation plans. Patriot National is headquartered in Ft. Lauderdale, Florida.
The consolidated financial statements of Patriot National are comprised of the results of:
the revenues and expenses associated with contracts (the “GUI contracts”) with third party insurance companies and, with respect to one contract, Guarantee Insurance Company (“Guarantee Insurance”, a property and casualty insurance company wholly owned by Guarantee Insurance Group, Inc. (“GIG”, formerly Patriot National Insurance Group, Inc.) and a related party), which PUI acquired, together with certain other assets acquired and liabilities assumed, from Guarantee Underwriters, Inc. (“GUI”), a wholly owned subsidiary of GIG, effective August 6, 2014.
For the years ended December 31, 2014 and 2013, 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 consolidated 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,
Revenues and expenses attributable to Patriot National, PSI, PRS, Contego, Forza and Patriot Captive Management for the years ended December 31, 2014 and 2013 and revenues and expenses associated with the contracts and certain other assets acquired and liabilities assumed from GUI for the period from January 1, 2014 to August 6, 2014 and the year ended 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, together with the note payable associated with the acquisition of the contracts and certain other assets, have been eliminated in consolidation in the accompanying consolidated balance sheets as of December 31, 2014, and
Changes in the fixed assets and other long term assets acquired from GUI, the capital lease obligation assumed from GUI and the note receivable transferred to GUI and balances payable to GUI from the Company, as described above, for the period from January 1, 2014 to August 6, 2014 are presented as “adjustments attributable to changes in assets and liabilities of GUI” in the accompanying consolidated statements of stockholders’ equity (deficit) for the years ended December 31, 2014 and 2013.
PCM provides healthcare cost containment services, including nurse case management, medical bill review and utilization review.
The accompanying consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (GAAP) and pursuant to the rules and regulations of the Securities and Exchange Commission. For Contego Services Group, LLC, the Company’s consolidated subsidiary that is 97% owned, and for DecisionUR, LLC (“DecisionUR”), the Company’s consolidated subsidiary that is 98.8% 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 consolidated balance sheets as of December 31, 2015 and 2014. The Company discloses the following three measures of net income (loss): (i) net income (loss), including non-controlling 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 consolidated 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.
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 year ended December 31, 2013, the fees based on a percentage of premium were waived in their entirety. 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 marketing, underwriting and policyholder services. Guarantee Insurance records written premium on the effective date of the policy based on the estimated total premium for the term of the policy. Accordingly, we recorded an allowance for estimated return commission income of approximately $3.3 million for the year ended December 31, 2015, and $1.5 million for the period from August 6, 2014 to December 31, 2014. We experienced a significant increase in brokerage and policyholder services fee income from Guarantee Insurance as a result of the new agreement. We also generate fee income for establishing and administering segregated portfolio cell reinsurance arrangements for reinsurers that assume a portion of the underwriting risk from our insurance carrier clients, based on a flat annual fee which is recognize as revenue on a pro rata basis.
Claims Administrative Services. We generate fee income for administering workers’ compensation claims for insurance and reinsurance companies, generally based on a percentage of earned premiums, grossed up for large deductible credits. We recognize this revenue over the period of time we are obligated to administer the claims as the underlying claims administration services are provided. For certain insurance and reinsurance carrier clients, the fee, which is based on a percentage of earned premiums grossed up for large deductible credits, represents consideration for our obligation to administer claims for a period of 24 months from the date of the first report of injury. For claims open longer than 24 months from the date of the first report of injury for these clients, we generate fee income for continuing to administer the claims, if so elected by the client, based on a fixed monthly fee which is recognized when earned. For certain other insurance and reinsurance clients, we have an obligation to administer the claims through their duration. We also generate fee income from non-related parties for administering workers’ compensation claims for state associations responsible for handling the claims of insolvent insurance companies based on a fixed amount per open claims per month.
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 experienced further significant increases in fee income from related party as a result of the agreement.
Prior to November 27, 2013, two of our subsidiaries were S Corporations, electing to pass corporate income through to the sole shareholder for federal tax purposes. The then sole shareholder was responsible for reporting his share of the taxable income or loss from such subsidiaries to the Internal Revenue Service. Accordingly, our consolidated statements of operations for the years ended December 31, 2013 and 2012 do not include a provision for federal income taxes attributable to the operations of these subsidiaries for the period from January 1, 2013 to November 27, 2013 or for the year ended December 31, 2012. Effective November 27, 2013, concurrent with the Reorganization, these subsidiaries were converted to C Corporations and their taxable income became subject to U.S. corporate federal income taxes.
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 consolidated 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.
Fee income receivable and fee income receivable from related party are based on contracted prices. We assess the collectability of these balances and adjust the receivable to the amount expected to be collected through an allowance for doubtful accounts. As of December 31, 2015 and 2014, we maintained an allowance for doubtful accounts of approximately $0.3 million and $0.1 million, respectively.
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 operating decision makers for purposes of assessing the performance of each service or making decisions about resources to be allocated to each service. Accordingly, we consider our business to operate in one segment.
Acquisition costs reflect the direct expenses attributable to mergers and acquisitions activities. These include professional services, travel costs, and expenses for incentives paid to executives and key employees associated with completed acquisitions under the Acquisition Incentive Plan.
The company paid an advance of $2.0 million concurrent with the execution of a Managing Producer Agreement, for the purpose of initiating additional programs with certain carrier clients. The advance is subject to a clawback provision related to performance under the agreement effective eighteen months from the execution date of October 29, 2015.
In November 2015, the FASB issued new accounting guidance related to income taxes, which simplifies the presentation of deferred income taxes by requiring deferred tax assets and liabilities be classified as noncurrent on the balance sheet. The updated standard is effective for us beginning on January 1, 2017 with early application permitted as of the beginning of any interim or annual reporting period. We plan to adopt the new guidance in 2016, which is not expected to have a material impact on our consolidated financial statements other than reclassifying current deferred tax assets and liabilities to noncurrent in the balance sheet. See Note 16 to our consolidated financial statements for a discussion on income tax balances
In September 2015, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2015-16, “Simplifying the Accounting for Measurement-Period Adjustments”, an update to Accounting Standard Codification (“ASC”) Topic 805, Business Combinations. This update requires that an acquirer recognize adjustments to the provisional amounts that are identified during the measurement period in the reporting period in which the adjusting amounts are determined. The amendment requires that the acquirer record, in the same period’s financial statements, the effect on earnings of changes in depreciation, amortization, or other income effects, if any, as a result of the change to the provisional amounts, calculated as if the accounting had been completed at the acquisition date. The amendments in this update require an entity to present separately on the face of the income statement or disclose in the notes the portion of the amount recorded in current period earnings by line item that would have been recorded in previous reporting periods if the adjustment to the provisional amounts had been recognized as of the acquisition date. The amendments are effective for fiscal years beginning after December 15, 2015, including interim periods within those fiscal years. The update should be applied prospectively to adjustments to provisional amounts that occur after the effective date of this update with earlier application permitted for financial statements that have not been issued. We will evaluate this guidance as potential adjustments arise.
In April 2015, the FASB issued ASU 2015-03, “Simplifying the Presentation of Debt Issuance Costs”. The update requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of the related debt liability instead of being presented as an asset. The update requires retrospective application. ASU 2015-03 is effective for fiscal years, and interim reporting periods within those years, beginning after December 15, 2015. We are currently evaluating the financial impact of this standard.
In August 2014, the FASB issued ASU 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.
In April 2014, the FASB issued ASU 2014-08, “Reporting Discontinued Operations”, regarding ASC Topic 205, Presentation of Financial Statements, and ASC Topic 360, Property, Plant and Equipment. The updated guidance related to reporting discontinued operations and disclosures of disposals of components of an entity. Under the amendment, only those disposals of components of an entity that represents a strategic shift that has (or will have) a major effect on an entity’s operations and financial results will be reported as discontinued operations in the financial statements. Additionally, the elimination of the component's operations, cash flows
and significant continuing involvement conditions have been removed. Further, an equity method investment could be reported as discontinued operations. The updated guidance is effective prospectively for all disposals or classifications as held for sale that occur within annual periods beginning after December 15, 2014. The adoption of this guidance has not had a material impact on our consolidated financial statements.
The Company completed seventeen acquisitions during 2015. We acquired substantially all of the net assets of the following companies in cash and stock transactions. These acquisitions have been accounted for using the acquisition method for recording business combinations, except for DecisionUR, as further discussed below.
The “maximum potential earnout payables” disclosed in the foregoing table represent the maximum amount of additional consideration that could be paid pursuant to the terms of the purchase agreement for the applicable acquisition. The “recorded earnout payables” disclosed in the foregoing table are primarily based upon the estimated future operating results of the acquired entities over a one- to three-year period subsequent to the acquisition date. The recorded earnout payables are measured at fair value as of the acquisition date and are included on that basis in the total recorded purchase price in the foregoing table. We will record subsequent changes in these estimated earnout obligations, including the accretion of discount, in our statement of operations when incurred.
The aggregate amount of maximum earnout obligations related to acquisitions made in 2015, as of December 31, 2015 was $15.0 million, of which $12.4 million was recorded in our consolidated balance sheet as of December 31, 2015, based on the aggregate estimated fair value of the expected future payments to be made. Of the $12.4 million fair value earnout payable on our balance sheet as of December 31, 2015, $11.6 million represents the recorded earnout payable at the time of acquisition, and a $0.8 million increase in the fair value of earnout expensed during the year ended December 31, 2015.
The initial purchase price for our acquisition, effective August 21, 2015, of Global HR Research, LLC consisted of (a) $24 million in cash, of which, $0.5 million is held in escrow, (b) 444,096 shares of our common stock (the “Stock Consideration”) of which 349,645 were issued and 94,451 were held in escrow, plus (c) certain deferred consideration payable, at our sole discretion, in either 618,478 shares of our common stock or $10,477,017 in cash (the “Deferred Consideration”). The Deferred Consideration was subsequently paid to In Touch Holdings LLC, one of the former principal stockholders of Global HR, on November 20, 2015 for $5.2 million in cash and 309,239 shares of our common stock, raising “Cash Paid” to $28.7 million and “Stock Issued” to $10.9 million. Additionally, 22,556 shares of the 94,451 shares of stock consideration that were held in escrow have been cancelled as settlement of a working capital reconciliation pursuant to the purchase agreement. 71,895 shares of the stock consideration remain held for issuance on the anniversary of the acquisition. If the revenues for Global HR for its fiscal year 2016 are less than $12.8 million, then In Touch Holdings LLC will forfeit and return 10% of its Stock Consideration and Deferred Stock Consideration to us.
The following is a summary of the aggregate estimated fair values of the net assets acquired at the date of each of the acquisitions made in the nine months ended December 31, 2015:
Provisional estimates of fair value and the allocation of the purchase price are established at the time of each acquisition and are subsequently reviewed within the first year of operations, the measurement period, following the acquisition date to determine the necessity for adjustments. The fair value of the tangible assets and liabilities for each applicable acquisition at the acquisition date approximated their carrying values. We estimate the fair value as the present value of the benefits anticipated from ownership of the subject customer list in excess of returns required on the investment in contributory assets necessary to realize those benefits. The rate used to discount the net benefits was based on a risk-adjusted rate that takes into consideration market-based rates of return and reflects the risk of the asset relative to the acquired business. These discount rates generally ranged from 17% to 30% for our 2015
Customer and carrier relationships, non-compete agreements and trade names related to our acquisitions are amortized using the straight-line method over their estimated useful lives (ten years for customer and carrier relationships, one to two years for non-compete agreements and five to seven years for trade names), while goodwill is not subject to amortization. We use the straight-line method to amortize these intangible assets. We review all of our intangible assets for impairment periodically (at least annually) and whenever events or changes in business circumstances indicate that the carrying value of the assets may not be recoverable. In reviewing intangible assets, if the fair value is less than the carrying amount of the respective (or underlying) asset, an indicator of impairment would exist, and further analysis would be required to determine whether or not a loss would need to be charged against current period earnings. Based on the results of impairment reviews during the years ended December 31, 2015 and 2014, no impairments were required.
The following is a summary of the unaudited pro forma historical results, as if these entities and the 2014 acquisitions described below had been acquired at January 1, 2014 (in thousands, except per share data):
This unaudited supplemental pro forma financial information includes the results of operations of acquired businesses presented as if they had been combined as of January 1, 2014. 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 completed several acquisitions during 2014. These acquisitions have been accounted for using the acquisition method for recording business combinations.
In connection with the GUI acquisition on August 6, 2014, the Company recognized a deferred tax asset of approximately $19.1 million associated with the purchased intangibles related to the GUI contracts and a valuation allowance of $6.3 million as of, which fully offsets the deferred tax asset in excess of total deferred tax liabilities. Pursuant to FASB ASC 805, Business Combinations, we reduced the deemed dividend by $12.9 million, commensurate with the reduction in valuation allowance, to recognize the updated information obtained about the fair value of assets acquired and liabilities assumed in acquisitions.
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 7.
Revenues and expenses prior to August 6, 2014 are not reflected in the Company’s financial results included herein.
The fair value of net identifiable tangible and intangible assets, as of the acquisition date, was as follows (in thousands):
As of December 31, 2015, our major classes of investments consisted of the following:
Fixed assets are stated at cost, less accumulated depreciation and amortization. Expenditures for computer equipment, software, and furniture and fixtures are capitalized and depreciated on a straight-line basis over a five, three, and seven year estimated useful lives, respectively. Expenditures for building are capitalized and depreciated on a straight-line basis over a thirty-nine year estimated useful life. Expenditures for leasehold improvements on office space and facilities are capitalized and amortized on a straight-line basis over the term of the lease.
As of December 31, 2015 and 2014, major classes of fixed assets consist of the following (in thousands):
Other long term assets, which are solely comprised of capitalized policy and claims administration system development costs, are also stated at cost, net of accumulated depreciation. Expenditures for capitalized policy and claims administration system development costs are capitalized and depreciated on a straight line basis over a five-year estimated useful life.
As of December 31, 2015 and 2014, other long term assets consisted of the following (in thousands):
As of December 31, 2015 the table below is the estimated amortization expense for the Company’s intangible assets for each of the next five years and thereafter:
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
The Senior Secured Credit Facility also has events of default that may result in acceleration of the borrowings thereunder, including: (i) nonpayment of principal, interest, fees or other amounts (subject to customary grace periods for items other than principal); (ii) failure to perform or observe covenants set forth in the loan documentation (subject to customary grace periods for certain affirmative covenants); (iii) any representation or warranty proving to have been incorrect in any material respect when made; (iv) cross-default to other indebtedness and contingent obligations in an aggregate amount in excess of an amount to be agreed upon; (v) bankruptcy and insolvency defaults (with grace period for involuntary proceedings); (vi) inability to pay debts; (vii) monetary judgment defaults in excess of an agreed upon amount; (viii) ERISA defaults; (ix) change of control; (x) actual invalidity or unenforceability of any loan document, any security interest on any material portion of the collateral or asserted (by any loan party) invalidity or unenforceability of any security interest on any collateral; (xi) actual or asserted (by any loan party) invalidity or unenforceability of any guaranty; (xii) material unpaid, final judgments that have not been vacated, discharged, stayed or bonded pending appeal within a specified number of days after the entry thereof; and (xiii) any other event of default agreed to by us and the Administrative Agent.
Equipment subject to capital lease is comprised of computer equipment related to capitalized policy and claims administration software development. Monthly payments on the capital lease, which expires on December 3, 2016, were approximately $206,000 as of December 31, 2015. Payments may be adjusted in connection with a change in the interest rate swap rate quoted in the Bloomberg Swap Rate Report. The Company’s obligations for future payments on the capital lease as of December 31, 2015, based on the interest rate swap rate in effect on that date, are as follows:
Basic earnings per share is computed based on the weighted average number of shares of common stock outstanding during the period. Diluted earnings per share is computed based on the weighted average number of shares of common stock plus the effect of dilutive potential common shares outstanding during the period using the treasury stock method. Dilutive potential common shares include detachable common stock warrants, stock-based awards of restricted shares and stock options, and contingent shares attributable to deferred purchase consideration.
Basic earnings per share is based on weighted average shares outstanding and excludes dilutive effects of detachable common stock warrants and stock options. Diluted earnings per share assumes the exercise of all detachable common stock warrants and stock options using the treasury stock method. Due to the net loss of $5.4 million reported for the year ended December 31, 2015, weighted average outstanding equity grants representing 215,865 shares of common stock and weighted average warrants representing 10,685 shares of common stock were not dilutive. As a result, basic and diluted earnings per share both reflect a net loss of $0.20 per share for the year ended, December 31, 2015. Due to $1.8 million expense resulting from the increase in fair value of warrants for the year ended December 31, 2014, weighted average outstanding detachable common stock warrants representing 1,109,445 shares of common stock outstanding were not dilutive. Due to a net loss for the year ended December 31, 2013 weighted average outstanding detachable common stock warrants representing 646,949 shares of common stock outstanding were not dilutive.
Shares of our common stock available for issuance under the Omnibus Incentive Plan include authorized and unissued shares of common stock or authorized and issued shares of common stock reacquired and held as treasury shares or otherwise, or a combination thereof. The number of available shares is reduced by the aggregate number of shares that become subject to outstanding awards granted under the Omnibus Incentive Plan. To the extent that shares subject to an outstanding award granted under either the Omnibus Incentive Plan are not issued or delivered by reason of the expiration, termination, cancellation or forfeiture of such award or by reason of the settlement of such award in cash, then such shares will again be available for grant under the Omnibus Incentive Plan. Shares withheld to satisfy tax withholding requirements upon the vesting of awards other than stock options will also be available for grant under the Omnibus Incentive Plan. Shares that are used to pay the exercise price of an option, shares delivered to or withheld by us to pay withholding taxes related to stock options, and shares that are purchased on the open market with the proceeds of an option exercise, may not again be made available for issuance.
In the twelve months ended December 31, 2015, we issued stock options as incentive compensation for officers and certain key employees. The exercise price of each stock option is the closing market price of our common stock on the date of grant. The options will vest in three equal annual installments on the first, second and third anniversaries of grant and expire 10 years after the grant date. The fair values of these stock options were estimated using the Black-Scholes valuation model with the following weighted-average assumptions:
The risk-free interest rate for the periods within the contractual term of the options is based on the U.S. Treasury yield curve in effect at the time of the grant.
The expected volatility is a measure of the amount by which a stock price has fluctuated or is expected to fluctuate based primarily on our and our peers' historical data.
The expected life is the period of time, on average, that participants are expected to hold their options before exercise based primarily on our historical data.
Option activity for the twelve months ended December 31, 2015 was as follows:
As of December 31, 2015, we recognized $1.7 million of stock compensation expense associated with these options, and there was $1.9 million of total unrecognized stock compensation cost related to unvested stock options that is expected to be recognized over a period of 3 years.
Grants of restricted shares for the twelve months ended December 31, 2015 were as follows:
During the twelve months ended December 30, 2015, we issued 200,490 restricted stock units. Of those issued, 31,560 were subsequently forfeited, resulting in 168,930 restricted stock units outstanding as of December 31, 2015. The fair value of these awards at December 31, 2015 was $1.1 million. During the twelve months ended December 31, 2015, we recognized $1.1 million of stock compensation expense associated with these restricted stock units. Unrecognized stock compensation expense associated with RSUs is $1.3 million and will be recognized over the remaining contractual lives of these awards of 2.3 years.
With respect to the Company’s financial assets, which include equity and fixed income security investments and forward purchase assets, and financial liabilities, which include acquisition earnouts, deferred purchase consideration, 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:
Unobservable inputs, including the reporting entity’s own data, as long as there is no
The forward purchase asset is maintained at equal value to the Series A and B Warrants, as created by the Back-to-Back Agreement with the selling stockholder. There were no equity and fixed income security investments or forward purchase assets as of December 31, 2014.
The following is a reconciliation of the fair value of the Company’s financial assets that were measured using significant unobservable (Level 3) inputs:
The following is a reconciliation of the fair value of the Company’s financial liabilities that were measured using significant unobservable (Level 3) inputs:
A portion of the fees that we receive from Guarantee Insurance pursuant to the Services Agreements and the Program Administrator Agreement are for Guarantee Insurance’s account (which we recognize as “fee income from related party”) and a portion of the fees are for the account of reinsurance captive entities to which Guarantee Insurance has ceded a portion of its written risk (which we recognize as “fee income”). See “Management’s Discussion and Analysis of Financial Conditions and Results of Operations-Principal Components of Financial Statements-Revenue.” As a result, a substantial portion of fee income we recognize from non-related parties is nevertheless derived from our relationship with Guarantee Insurance. For the year ended December 31, 2015, we recognized $144.1 million in total fee income and fee income from related party derived from our contracts and relationships with Guarantee Insurance, and our fee income from related party was $86.9 million. Our total fee income and fee income from related party pursuant to contracts with Guarantee Insurance and our fee income from related party constituted 69% and 41%, respectively, of our total fee income and fee income from related party for the year ended December 31, 2015.
Fee income from related party for the year ended December 31, 2015 was $86.9 million compared to $46.9 million for the year ended December 31, 2014.
Fee income receivable from related party was $27.0 million as of December 31, 2015, and $12.0 million at December 31, 2014.
For the year ended December 31, 2014, approximately $1.9 million was paid to Guarantee Insurance Group pursuant to an expense reimbursement agreement dated January 1, 2012, as amended and restated from time to time. We reimbursed Guarantee Insurance Group for rent and certain corporate administrative services costs incurred on our behalf for such costs and are reflected as “allocation of marketing, underwriting and policy issuance costs from related party” in our combined statements of operations.
In addition, pursuant to a management services agreement with Guarantee Insurance Group dated January 1, 2012, we paid management fees to Guarantee Insurance Group for management oversight, legal, accounting, human resources and technology support services provided to us. For the year ended December 31, 2014, approximately $5.4 million was paid to Guarantee Insurance Group for such services and are reflected as “management fees paid to related party for administrative support services” in our combined statements of operations.
Our administrative functions have been separated from Guarantee Insurance, the expense reimbursement and management services agreements have been terminated, and such expenses are being incurred directly by us from August 6, 2014, including through a sublease agreement with Guarantee Insurance Group, as described below.
On August 6, 2014, we consummated the GUI Acquisition pursuant to which we acquired GUI’s contracts in force and certain other assets, for a total consideration of approximately $55.1 million. The consideration consisted of $30 million in cash, the assumption of certain of GUI’s liabilities, settlement of certain intercompany balances and the retirement of the receivable in the amount of approximately $28.8 million from Guarantee Insurance comprising principal and accrued but unpaid interest under the Surplus Note made to Guarantee Insurance on November 27, 2013 in connection with the Reorganization. See “Business -Our History and Organization” and “Selected Financial Data.”
On February 5, 2015, we purchased 98.8% of the membership interests in DecisionUR, LLC for a purchase price of $2.2 million in cash, from Six Points Investment Partners, LLC, a company wholly owned by Mr. Mariano. Accordingly, upon closing, Mr. Mariano received all of the proceeds from the sale of DecisionUR, LLC.
On April 17, 2015, we acquired Vikaran Solutions, LLC (“Vikaran”) for a purchase price of $8.5 million in cash. Prior to the acquisition, Mr. Mariano held a non-controlling, 45% interest in Vikaran. Upon closing, Mr. Mariano received proceeds of $3.8 million from the sale of Vikaran to us. In connection with the acquisition of Vikaran we also agreed to purchase all of the outstanding stock of Mehta and Pazol Consulting Services Private Limited (“MPCS”), an Indian company which holds Vikaran’s software development center located in Pune, India, for a purchase price of approximately $1.5 million. We consummated the purchase of 51% of the MPCS stock, and Mr. Mariano received proceeds of $749,850 therefrom.
In addition, in connection with the closing of the Global HR Acquisition, we entered into a registration rights agreement with the sellers, including Mr. Shanfelter, pursuant to which we provided the sellers with certain customary “piggyback” registration rights in respect of their shares received as part of the acquisition consideration, subject to cutbacks and other customary provisions.
In connection with the warrants issued to the PennantPark Entities as part of our reorganization in 2013, we entered into the Stockholders Agreement, which was amended and restated on January 5, 2015 in connection with our IPO. Pursuant to the Stockholders Agreement, Mr. Del Pizzo has certain customary “piggyback” registration rights with respect to 184,490 shares of our common stock that he now holds. All expenses incurred in connection with a “piggyback” registration will be borne by us, excluding underwriters’ discounts and commissions, which will be borne by the selling party. In addition, we will indemnify the registration rights holders against certain liabilities which may arise under the Securities Act in connection with any offering made pursuant to such registration rights.
In connection with our IPO, we also entered into a new registration rights agreement with Mr. Mariano. This agreement provides him with an unlimited number of “demand” registrations as well as customary “piggyback” registration rights. This new registration rights agreement also provides that we will pay certain expenses relating to such registrations, excluding underwriters’ discounts and commissions, and indemnify Mr. Mariano against certain liabilities which may arise under the Securities Act in connection with any offering made pursuant to such registration rights.
In reviewing transactions with related persons, the Audit Committee or disinterested members of the board of directors will consider all relevant facts and circumstances, including, without limitation:
whether the value and the terms of the transaction are substantially similar as compared to those of similar transactions previously entered into by the Company with non-related persons, if any; and
The Audit Committee or disinterested members of the board of directors, as applicable, will not approve or ratify any related person transaction unless it shall have determined in good faith that, upon consideration of all relevant information, the related person transaction is in, or is not inconsistent with, the best interests of the Company. The Audit Committee or the disinterested members of the board of directors, as applicable, may also conclude, upon review of all relevant information, that the transaction does not constitute a related person transaction and thus that no further review is required under this policy.
For the year ended December 31, 2015, approximately 69% 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 7% was attributable to contracts with the Company’s second largest customer. 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.
from these largest customers do not represent significant credit risk based on cash flow forecasts, balance sheet analysis and past collection experience.
We have no off-balance sheet arrangements that have, or are reasonably likely to have, a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures, or capital resources.
The Company maintains cash at various financial institutions, and, at times, balances may exceed federally insured limits. Management does not believe this results in any material effect on the Company’s financial position or results of operations.
The estimated fair value of the redeemable warrants is reflected as warrant redemption liability in the accompanying consolidated balance sheets as of December 31, 2015 and 2014, and the change in the liability is reflected as an increase (decrease) in fair value of warrant redemption liability in the accompanying consolidated statements of operations for the years ended December 31, 2015, 2014 and 2013. In estimating the value of the redeemable warrants and common stock, giving consideration to all valuation approaches and methods in its analysis and ultimately relying on a variety of established appraisal methods and techniques, applying a Monte Carlo simulation of estimated value, the guideline public company method in combination with the discounted future returns method and, as appropriate, the option pricing model using Black Scholes. Various valuation indications are weighted using the Probability-Weighted Expected Return Method (PWERM) in accordance with the AICPA’s Accounting and Valuation Guide: Valuation of Privately-Held-Company Equity Securities Issued as Compensation.
Patriot Captive Management’s business is conducted through two operational subsidiaries 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, the income tax expense in the accompanying consolidated statements of operations for the years ended December 31, 2015, 2014, and 2013 do not include a provision for federal income taxes attributable to Patriot Captive Management’s operations.
We assess uncertain tax positions in accordance with ASC 740 on the basis of a two-step process whereby (1) we determine whether it is more likely than not that the tax positions will be sustained on the basis of the technical merits of the position and (2) for those tax positions that meet the more-likely-than-not recognition threshold, we recognize the largest amount of tax benefit that is more than 50 percent likely to be realized upon ultimate settlement with the related tax authority.
The Company and its subsidiaries are subject to U.S. federal income tax, as well as income tax in multiple states with heavy concentration in Florida, California, and Pennsylvania. The net deferred tax asset before valuation allowance as of December 31, 2015 and 2014 was $12.2 million and $6.3 million, respectively. A valuation allowance related to deferred tax assets is required when it is considered more likely than not that all or part of the benefit related to such assets will not be realized. In assessing the need for a valuation allowance, the Company considered both positive and negative evidence in concluding that a full valuation allowance was necessary against its net deferred tax assets at December 31, 2015 and 2014.
The pro forma net income tax benefit is comprised of the following:
The Company’s pro forma income tax rates, expressed as a percent of net income before income tax expense, vary from statutory federal income tax rates due to the following:
Quarterly operating results for 2015 and 2014 were as follows (in thousands, except per share data):
Year over year quarterly as well as quarter to quarter results may not be comparable due to timing of the inclusion of acquistions.
On March 3, 2016, our Board of Directors approved a $15 million share repurchase program for the Company's common stock whereby shares may be purchased from time to time, in open market transactions or in negotiated off-market transactions. The program may continue for up to eighteen months.