The selected financial data set forth below should be read in conjunction with Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, and our financial statements, related notes and other financial information included herein. The selected consolidated financial data set forth below for each of the three years in the period ended December 31, 2014 and for each of the three year period as of December 31, 2014 have been derived from our consolidated financial statements.
Represents service fees from Guarantee Insurance, a related party. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Principal Components of Financial Statements-Revenue.”
Represents a provision for uncollectible fee income recorded in connection with the liquidation in May 2013 of Ullico Casualty Company, one of our insurance carrier clients from April 2009 until we terminated the contract effective March 26, 2012.
We offer two types of services: brokerage, underwriting and policyholder services (or our “brokerage and policyholder services”) and claims administration services (or our “claims administration services”).
We generate fee revenue for our services from our clients based on (1) a percentage of premiums for the policies we service, (2) the cost savings we achieve for our clients or (3) a fixed fee for a particular service. Unlike our insurance and reinsurance carrier clients, we do not generate underwriting income or assume underwriting risk on workers’ compensation plans.
We further expanded our business effective August 6, 2014, through our acquisition from MCMC of the Patriot Care Management Business. The Patriot Care Management Business had been previously controlled by Mr. Mariano and was sold to MCMC in 2011 for approximately $105 million in cash and preferred equity issued by MCMC.
Following the Reorganization and the Acquisitions, we own 100% of the subsidiaries that comprise our insurance services business, with the exception of Contego Services Group, LLC, in which Mr. Mariano maintained a 3% membership interest.
According to the NCCI Report, the total net premium written by state funds and private carriers of workers’ compensation insurance in the United States was $41.9 billion in 2013, an increase from $33.8 billion in 2010, representing a compound annual growth rate of 7.4% 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 $51.8 billion in 2014, an increase from $40.4 billion in 2010, representing a compound annual growth rate of 6.4% 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.
Like other sectors of the insurance industry, the workers’ compensation sector experiences underwriting cyclicality, which generally underpins changes in premium rates. This cyclicality is determined by a number of factors, but there are two notable drivers. First, ultimate loss costs become more difficult to predict when claims remain open for longer periods, generally as a result of wage and medical cost inflation. For example, the NCCI Report indicates that medical costs per claim increased by approximately 6.5% on average per year from 1995 through 2013. Second, the amount of investment income insurance carriers can earn may also influence such carrier’s underwriting practices. Investment income can be sufficiently significant, particularly when claims remain open for longer periods, to compensate for underwriting losses, such as those the workers’ compensation industry has experienced in recent years, as reflected in a greater than 100% combined ratio for all but two years from 1990 to 2013. However, in periods of low interest rates, similar to the current investment environment, insurance carriers cannot generate sufficient investment income to offset underwriting losses, and as a result have demanded higher premium rates. This has led to a modest “hardening” of the workers’ compensation market.
We made payments in the past to Guarantee Insurance Group for rent and certain corporate administrative services costs incurred on our behalf, as well as for fees for management oversight, legal, accounting, human resources and technology support services provided to us. The reimbursements for such costs and payments for such services are reflected as “allocation of marketing, underwriting and policy issuance costs from related party” and “management fees to related party for administrative support services,” respectively, in our historical financial statements. Our administrative functions have been separated from Guarantee Insurance, the agreements pursuant to which such payments were made have been terminated, and such expenses are being incurred directly by us from August 6, 2014. Accordingly, beginning August 6, 2014, such expenses, rather than being reflected in the above items, will be recorded in the line items to which they relate, which are primarily “salaries and salary related expenses,” “outsourced services” and “other operating expenses.”
Gross reference premium written: gross reference premium written refers to the 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.
Adjusted EBITDA: we define Adjusted EBITDA as net income before interest expense, income tax expense (benefit), depreciation and amortization expense and adjusting for certain revenue and expenses attributable to the common units and detachable common stock warrants we have or had issued to our lenders. We currently do not have any common units outstanding.
Adjusted EBITDA margins: we define Adjusted EBITDA margins as Adjusted EBITDA divided by the sum of fee income and fee income from related party.
Although depreciations and amortization expense are non-cash charges, the assets being depreciated and amortized may have to be replaced in the future;
Reference premium written for the year ended December 31, 2013 was $357.4 million compared to $305.7 million for the year ended December 31, 2012, an increase of $51.7 million or approximately 17%. The increase was attributable to a $54.8 million increase in Guarantee Insurance reference premium written and a $51.2 million increase in reference premium written on behalf of Zurich. These increases were generally attributable to growth in our distribution force, expansion into additional geographic territories
Adjusted EBITDA for the year ended December 31, 2013 was $6.6 million compared to $2.2 million for the year ended December 31, 2012, an increase of $4.4 million. The increase was comprised of a $17.5 million increase in total fee income and fee income from related party, net of a $13.2 million increase in 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), both of which are discussed more fully below.
Adjusted earnings for the year ended December 31, 2014 was $3.0 million compared to a loss of $(4.5) million for the year ended December 31, 2013, an increase of $7.5 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 $39.8 million increase in total expenses (excluding increase in fair value of warrant redemption liability, loss on exchange of units and warrants, and provision for uncollectible fee income as adjusted for income tax expense on reconciling items), all of which are discussed more fully below.
Total fee income and fee income from related party is comprised of “fee income” and “fee income from related party.” A significant portion of our revenue is generated from service fees earned from a related party, Guarantee Insurance. “Fee income” represents fees earned from parties other than Guarantee Insurance, a related party. “Fee income from related party” represents fees earned from Guarantee Insurance. For brokerage and policyholder services, the distinction between fee income and fee income from related party is based on whether the services are performed for Guarantee Insurance or third party insurance carrier clients, regardless of whether any portion of the risk is subsequently transferred to another insurance company or a captive reinsurer.
In addition to service fee income, we also derive revenue from net investment income and net realized gains (losses) on investments from our investment portfolio, such as the net gain realized upon the redemption of the MCMC preferred equity in connection with the Patriot Care Management Acquisition.
outsourced services provided to us by third party-vendors, which include certain claims investigation and loss control expenses, principally incurred in connection with our workers’ compensation claims investigation, transportation and translation and legal and medical bill review services;
amortization of loan discounts and loan costs associated with loan agreements and of the estimated value of equity interests issued pursuant to loan agreements;
increases in fair value of equity interests for which the holders have a put option to us; and
The following table sets forth certain combined statement of operations data derived from our audited combined financial statements included elsewhere in this Annual Report on Form 10-K.
Year Ended December 31, 2014 Compared to Year Ended December 31, 2013
Fee Income. Fee income, which represents fee income from non-related parties, for the year ended December 31, 2014 was $55.8 million compared to $46.5 million for the year ended December 31, 2013, an increase of $9.3 million.
Fee Income from Related Party. Fee income from related party for the year ended December 31, 2014 was $46.9 million compared to $9.4 million for the year ended December 31, 2013, an increase of $37.5 million.
Net Investment Income. Net investment income was $0.5 million for the year ended December 31, 2014 compared to $0.1 million for the year ended December 31, 2013, an increase of $0.4 million. Net investment income for the year ended December 31, 2014 was principally attributable to interest received in respect of a note receivable from Guarantee Insurance under the Surplus Note, which was retired in connection with the GUI Acquisition effective August 6, 2014.
Net Realized Gains (Losses) on Investments. Net realized gains (losses) on investments was $14.0 million for the year ended December 31, 2014, compared to a loss of $0.1 million for the for the year ended December 31, 2013. The gain recorded in the year ended December 31, 2014 represents the net gain realized upon the redemption of the MCMC preferred equity in connection with the Patriot Care Management Acquisition.
Commission Expense. Commission expense for the year ended December 31, 2014 was $16.9 million compared to $8.8 million for the year ended December 31, 2013, an increase of $8.2 million or 93%. This increase is principally due to our assumption of the obligation to pay commissions to retail agencies producing Guarantee Insurance policies from August 6, 2014 pursuant to the new agreement with Guarantee Insurance to provide all of our brokerage and policyholder services to Guarantee Insurance, as described elsewhere in this 10-K. We did not incur such commission expense for the year ended December 31, 2013. Additionally, we incurred additional 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.
As described above, in connection with the GUI Acquisition effective August 6, 2014, the management services agreement pursuant to which these fees were payable was terminated and all costs associated with our operations began to be incurred directly by us. Accordingly, beginning August 6, 2014, such expenses, rather than being reflected in this item, are recorded in the line items to which they relate, which are primarily “salaries and salary related expenses,” “outsourced services” and “other operating expenses.”
As described above, in connection with the GUI Acquisition effective August 6, 2014, the cost sharing agreement pursuant to which these costs were incurred was terminated and all brokerage and policyholder services costs associated with our operations began to be incurred directly by us. Accordingly, beginning August 6, 2014, such expenses, rather than being reflected in this item, are recorded in the line items to which they relate, which are primarily “salaries and salary related expenses,” “outsourced services” and “other operating expenses.”
Interest expense for the year ended December 31, 2013, reflects $0.7 million of interest in connection with a loan agreement for $10.0 million entered into on October 9, 2012 with Advantage Capital. On November 27, 2013, this loan was repaid in full with a portion of the proceeds of the Initial Tranche of the PennantPark Loan Agreement. See “Certain Relationships and Related Party Transactions-Financing Transactions.”
Depreciation and Amortization. Depreciation and amortization for the year ended December 31, 2014 was $5.9 million compared to $2.6 million for the year ended December 31, 2013, an increase of $3.3 million. The increase was attributable mainly to an increase 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 WCE 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.
Provision for Uncollectible Fee Income. For the year ended December 31, 2014, we recorded a $0.5 million provision for uncollectible fee income. For the year ended December 31, 2013, we recorded a provision for uncollectible fee income related to our claims administration services, of $2.5 million in connection with the liquidation of Ullico in May 2013. Ullico was one of our insurance carrier clients from April 2009 until we terminated their contract effective March 26, 2012 in connection with their liquidation.
Although our financial statements include the revenues and expenses associated with the GUI contracts and certain other assets and liabilities assumed in the GUI Acquisition, Guarantee Insurance Group will include these revenues and expenses in its consolidated federal income tax return for the period from January 1, 2014 to August 6, 2014 (the effective date of the GUI Acquisition) and has included the revenues and expenses associated with the GUI contracts and certain other assets and liabilities assumed in its consolidated federal income tax return for the year ended December 31, 2013.
Year Ended December 31, 2013 Compared to Year Ended December 31, 2012
Total Fee Income and Fee Income from Related Party. Total fee income and fee income from related party for the year ended December 31, 2013 was $55.9 million compared to $38.4 million for the comparable period in 2012, an increase of $17.5 million or approximately 46%. The increase was principally due to an increase in fee income.
For the year ended December 31, 2012, approximately 42% of our total fee income and fee income from related party was attributable to our contracts with Guarantee Insurance and approximately 35% and 21% of our total fee income and fee income from related party were attributable to our contracts with our second and third largest clients, respectively.
This increase was partly attributable to an increase in brokerage and policyholder services fee income as a result of the growth in reference premiums written by us for Zurich, as described above.
services revenue being classified as fee income rather than fee income from related party), combined with an increase in managed claims exposures as a result of the increase in reference premiums written by us for Zurich, as described above, but partially offset by a decrease in managed claims exposures resulting from the termination the Ullico contract, as described above.
Our prices by customer for brokerage, and policyholder services and claims administration services were unchanged for the year ended December 31, 2013 relative to the year ended December 31, 2012 and, accordingly, the net increase in fee income from related party was solely related to changes in the volume of business we managed.
We did not record any brokerage and policyholder services fee income from related party for the years ended December 31, 2013 and 2012, as described above. Following the GUI Acquisition, we entered into a new agreement with Guarantee Insurance effective August 6, 2014 to provide marketing, underwriting and policyholder services. Accordingly, we expect a significant increase in brokerage and policyholder services fee income from related party going forward.
Our prices by customer for brokerage, underwriting and policyholder services and claims administration services were unchanged for the year ended December 31, 2013 relative to the year ended December 31, 2012 and, accordingly, the net increase in fee income was solely related to changes in the volume of business we managed.
Net Investment Income. We recorded immaterial amounts of net investment income for the year ended December 31, 2013 and 2012.
Salaries and Salary Related Expenses. Salaries and salary related expenses for the year ended December 31, 2013 was $16.0 million compared to $13.2 million for the year ended December 31, 2012, an increase of $2.8 million or approximately 21%. This principally reflects an increase in the size of our claims administration services staff associated with the increase in managed claims exposures as a result of the growth in reference premiums written by Guarantee Insurance and by us for Zurich, as described above. To a lesser degree, the increase was also attributable to efforts by us to perform more claims investigation work in-house rather than through outsourced vendors. These factors were partially offset by a decrease in managed claims exposures resulting from the termination the Ullico contract, as described above.
Commission Expense. Commission expense for the year ended December 31, 2013 was $8.8 million compared to $3.2 million for year ended December 31, 2012, an increase of $5.5 million. The increase was attributable to an increase in commission expense associated with premium produced for Zurich, as described above.
Interest expense for the year ended December 31, 2013, is comprised of $0.4 million of interest accruing under the Initial Tranche of the PennantPark Loan Agreement entered into on November 27, 2013 in connection with the Reorganization and $0.8 million of interest in connection with a $10.0 million loan agreement entered into on October 9, 2012 with Advantage Capital.
Amortization of loan costs for the year ended December 31, 2013 was attributable to the Initial Tranche of the PennantPark Loan Agreement. We incurred no material loan costs for the year ended December 31, 2012.
Income Tax Expense. Income tax expense for the year ended December 31, 2013 was $0.7 million. We did not recognize income tax expense or benefit for the year ended December 31, 2012. Income tax expense (benefit) for the years ended December 31, 2013 and 2012 was principally comprised of federal income tax benefit at a statutory federal rate of 34% and state income tax benefit, excluding the income tax benefit related to the amortization of loan discounts. Prior to November 27, 2013, certain 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 period from January 1, 2013 to November 27, 2013 or for the year ended December 31, 2012.
Although our financial statements include the revenues and expenses associated with the GUI contracts and certain other assets and liabilities assumed in the GUI Acquisition, Guarantee Insurance Group has included these revenues and expenses in its consolidated federal income tax returns for the years ended December 31, 2013 and 2012 and, accordingly, we recognized a $2.7 million and $1.7 million increase in valuation allowance, respectively, equal to 100% of the deferred tax benefit attributable to the GUI contracts for the years ended December 31, 2013 and 2012.
The following table summarizes our cash flow activities for the years ended December 31, 2014, 2013 and 2012.
Net cash provided by operating activities for the year ended December 31, 2013 was $6.0 million compared to $11.4 million for the year ended December 31, 2012, a decrease of $5.4 million. This decrease was principally attributable to a $5.1 million decrease in certain liabilities, principally net payables to related parties and deferred claims administration services income and a $2.3 million decrease in certain other assets, partially offset by a $2.0 million increase in net income (after adjusting for non-cash income and expense items).
Net cash provided by (used in) financing activities for the year ended December 31, 2013 was $22.7 million compared to ($4.6) million for the year ended December 31, 2012, an increase of $27.3 million. The increase was principally attributable to the receipt of the net proceeds from the Initial Tranche of the PennantPark Loan Agreement combined with a $9.0 million decrease in the payment of stockholder and unitholder distributions. These factors were partially offset by the $10.0 million repayment of debt.
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 WCE platform. For the years ended December 31, 2013 and 2012, GUI made capital expenditures of $6.1 million and $6.7 million for fixed assets and policy and claims administration system development costs, principally in connection with our WCE platform.
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. See “Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities-Use of Proceeds from Registered Securities.”
All obligations under the PennantPark Loan Agreement were guaranteed by certain of our subsidiaries as well as several affiliated entities, including GUI, and were generally secured by the tangible and intangible property of the borrowers and the guarantors. In connection with both tranches of the PennantPark Loan Agreement, we issued warrants to the PennantPark Entities to purchase an aggregate of 1,110,555 shares of our common stock.
Brokerage and Policyholder Services. We generate fee income for underwriting and servicing workers’ compensation insurance policies for insurance companies, based on a percentage of premiums each writes for its customers. Brokerage and policyholder services are, in all material respects, provided prior to the issuance or renewal of the related policy. For insurance carrier clients who record written premium on the effective date of the policy based on the estimated total premium for the term of the policy, we recognize fee income on the effective date of the related insurance policy reduced by an allowance for estimated commission income that may be returned by us to such clients due to estimated net reduction in estimated total premium for the term of the policy, principally associated with mid-term policy cancellations. For insurance carrier clients who record written premium as premium is
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, for the period from August 6, 2014 to December 31, 2014, we recorded an allowance for estimated return commission income of approximately $1.5 million. We expect a significant increase in brokerage and policyholder services fee income from Guarantee Insurance going forward. 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.
The allocation of marketing, underwriting and policy issuance costs from related party in our combined statements of operations represents costs reimbursed to Guarantee Insurance Group for rent and certain corporate administrative services. Management fees paid to related party for administrative support services in our combined statements of operations represent amounts paid to Guarantee Insurance Group for management oversight, legal, accounting, human resources and technology support services.
We file consolidated federal income tax returns which include the results of our wholly and majority owned subsidiaries, which became our subsidiaries effective November 27, 2013 or as part of the Patriot Care Management Acquisition effective August 6, 2014. The tax liability of our company and its wholly and majority owned subsidiaries is apportioned among the members of the group in accordance with the portion of the consolidated taxable income attributable to each member of the group, as if computed on a separate return. To the extent that the losses of any member of the group are utilized to offset taxable income of another member of the group, we take the appropriate corporate action to “purchase” such losses. To the extent that a member of the group generates any tax credits, such tax credits are allocated to the member generating such tax credits.
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, 2014, we maintained an allowance for doubtful accounts of approximately $0.1 million.
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.
We have audited the accompanying combined balance sheets of Patriot National, Inc. as of December 31, 2014 and 2013 and the related combined statements of operations, stockholders’ equity (deficit), and cash flows for each of the three years in the period ended December 31, 2014. 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.
The combined financial statements of Patriot National, Inc. (“Patriot National” or “the Company”) are comprised of the financial statements of:
Patriot National’s wholly owned subsidiary, Patriot Services, Inc. (“PSI”), and its wholly and majority owned subsidiaries, Patriot Underwriters, Inc. (“PUI”), Patriot Risk Services, Inc. (“PRS”), Contego Services Group, LLC and Contego Investigative Services, Inc. (together, “Contego”), Forza Lien, Inc. (“Forza”) and Patriot Captive Management, Inc. (“Patriot Captive Management”), all of which became subsidiaries of Patriot National effective November 27, 2013,
Patriot Care, Inc.’s wholly owned subsidiary, Patriot Care Holdings, Inc., and its wholly owned subsidiaries, Patriot Care Management, Inc., and Patriot Care Services, Inc. (collectively “PCM”), all of which were acquired on August 6, 2014, and
The fixed assets and other long term assets acquired from GUI, the capital lease obligation assumed from GUI are included in the accompanying combined balance sheets as of December 31, 2014 and December 31, 2013, and all other assets and liabilities of GUI, which were not acquired by the Company on August 6, 2014, are not included in the accompanying combined balance sheets as of December 31, 2014 and December 31, 2013,
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 and the year ended December 30, 2013 are presented as “adjustments attributable to changes in assets and liabilities of GUI” in the accompanying combined statements of stockholders’ equity (deficit) for the years ended December 31, 2014, 2013, and 2012.
Effective August 6, 2014, Six Points Ventures 2, Inc. (“SPV2”) was merged with and into Patriot Care, Inc., a subsidiary of the Company, with Patriot Care, Inc. continuing as the surviving corporation. SPV2 and the Company were under common control. SPV2’s sole asset was its Series C preferred unit investment in MCMC Holdings, LLC (the “MCMC Units”), the ultimate parent company of MCRS Holdings, Inc., which the Company acquired on August 6, 2014, as described more fully in Note 3. SPV2 had no liabilities, revenues or expenses. Accordingly, SPV2’s merger with and into Patriot Care, Inc. was deemed to be an asset acquisition.
PUI provides workers’ compensation brokerage, underwriting and policyholder services to third party insurance company customers. Additionally, PUI historically solicited applications for workers’ compensation insurance for Guarantee Insurance pursuant to a producer agreement between the parties that the Company acquired from GUI effective August 6, 2014 and which was also terminated on such date.
Contego provides claims investigations, loss control service administration, claimant transportation and translation, claims subrogation services and certain other services to Guarantee Insurance, PUI’s third party insurance company customers and the segregated portfolio cell reinsurers that assume business written by Guarantee Insurance and PUI’s third party insurance company customers. Contego also provides these services, on a limited basis, to certain other companies and government agencies.
Patriot Captive Management provides reinsurance management services to the segregated portfolio cell reinsurers that assume business written by Guarantee Insurance and PUI’s third party insurance company customers, as well as certain other segregated portfolio cell reinsurers.
Summary of Significant Accounting Policies and Recently Issued Financial Accounting Standards
The preparation of financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Such estimates and assumptions could change in the future as more information becomes known and such changes could impact the amounts reported and disclosed herein. Adjustments related to changes in estimates are reflected in our results of operations in the period in which those estimates changed.
Fixed assets are stated at cost, less accumulated depreciation. Expenditures for furniture and fixtures and computer equipment are capitalized and depreciated on a straight-line basis over a three-year estimated useful life. Expenditures for leasehold improvements on office space and facilities leased by Guarantee Insurance Group but utilized by us are capitalized and amortized on a straight-line basis over the term of Guarantee Insurance Group’s lease.
We file consolidated federal income tax returns which include the results of our wholly and majority owned subsidiaries, which became our subsidiaries effective November 27, 2013 or as part of the Patriot Care Management Acquisition effective August 6, 2014. The tax liability of our company and its wholly and majority owned subsidiaries is apportioned among the members of the group in
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 combined 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.
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.
In April 2014, the FASB issued Accounting Standards Update 2014-08 regarding ASC Topics 205 and 360, Reporting Discontinued Operations. The updated guidance related to reporting discontinued operations and disclosures of disposals of components of an entity. Under the amendment only those disposals of components of an entity that represent a strategic shift that has (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. We do not expect the adoption of this guidance to have a material impact on our consolidated financial statements.
Acquisition of GUI’s Contracts and Certain Other Assets and Assumption of Certain Liabilities
Additionally, effective August 6, 2014, the Company entered into an agreement to provide marketing, underwriting and policy issuance services to Guarantee Insurance. Revenues and expenses associated with this agreement are reflected in the accompanying combined statement of operation for the year ended December 31, 2014.
Because the Company and GUI are under common control, as discussed in Note 1, the Company recognized the net identifiable assets acquired at GUI’s carrying amounts pursuant to the FASB ASC 805, Business Combinations for all of the periods presented. The carrying amounts of the net identifiable assets acquired were as follows as of August 6, 2014 (in thousands):
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.
Merger of SPV2 with and into Patriot Care, Inc. and Acquisition of PCM
Effective August 6, 2014, SPV2, which owned the MCMC Units, was merged with and into Patriot Care, Inc., a subsidiary of the Company. Patriot Care, Inc. continued as the surviving corporation.
Total consideration paid by Patriot Care, Inc. for 100% of the outstanding common shares of SPV2 was $20.0 million, comprised of (i) 3,043,485 shares of the Company’s common stock with a fair value of $19.5 million issued to the stockholders of SPV2 and (ii) approximately $471,000 in cash. The fair value of the common stock issued by the Company to SPV2 stockholders and the cash consideration was based on a preliminary estimated valuation of the 3,043,485 shares of the Company’s common stock, made by the board of directors of the Company in consultation with the Company’s management.
Simultaneous with the merger of SPV2 with and into Patriot Care, Inc., the Company, through Patriot Care, Inc., acquired 100% of the outstanding common stock of MCRS Holdings, Inc., a managed care services company, for approximately $77.4 million. The purchase price was comprised of $52.5 million in cash upon closing, and $3.3 million of working capital adjustments payable to the sellers and the redemption of the MCMC Units to MCMC Holdings, LLC, the ultimate parent of MCRS Holdings, Inc. The Company attributed a fair value of $21.6 million to the MCMC Units. The fair value of the MCMC Units was determined by management based on the sum of (1) the fair value of MCMC Holdings, LLC pursuant to a stock purchase agreement entered into between MCMC Holdings, LLC and a third party acquirer on October 21, 2014, multiplied by the percentage of MCMC Holdings, LLC represented by the MCMC Units redeemed by the Company pursuant to the acquisition of PCM and (2) the total purchase price for MCRS Holdings, Inc. of approximately $77.4 million multiplied by the same percentage of MCMC Holdings, LLC represented by the MCMC Units redeemed by the Company pursuant to the acquisition of PCM. The sale of MCMC Holdings, LLC to the third party acquirer, which was consummated effective December 2, 2014, was a 100% consideration arms-length transaction with an unrelated third party for 100% of outstanding membership units of MCMC Holdings, LLC subsequent to the Company’s acquisition of MCRS Holdings, Inc. Accordingly, management deemed the above method of assessing the fair value of the MCMC Units as reasonable under the circumstances.
The excess of the $21.6 million fair value of the MCMC Units over the $7.7 million carrying value, or approximately $13.9 million, is included in net realized gains from investments in the accompanying combined statement of operations for the year ended December 31, 2014.
assumed were approximately equal to book values. The estimated fair value of the customer contracts acquired from MCRS Holdings, Inc. was recorded as an identifiable intangible asset, and the associated deferred tax liability was recorded as an identifiable liability.
The Company’s preliminary estimates of the fair values of the assets acquired and liabilities assumed may be modified through August 6, 2015, as more information is obtained about the fair value of such assets acquired and liabilities assumed.
In connection with the acquisition, on August 6, 2014, PCM entered into a loan agreement with UBS Securities LLC (the “UBS Credit Agreement”) as described more fully in Note 6.
Major classes of fixed assets consist of the following (in thousands):
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 required as of December 31, 2014.
The table below is the estimated amortization expense for the Company’s intangible assets for each of the next five years and thereafter:
Notes payable, including accrued interest thereon, were comprised of the following (in thousands):
On January 22, 2015, we entered into a Credit Agreement with BMO Harris Bank N.A., as administrative agent (the “Administrative Agent”) and the other lenders party thereto, 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.
In addition to paying interest on outstanding principal under the senior secured credit facility, we are required to pay a commitment fee to the Administrative Agent for the ratable benefit of the lenders under the revolving credit facility in respect of the unutilized commitments thereunder, ranging from 35 basis points to 50 basis points, depending on specified leverage ratios. With respect to letters of credit, we are also required to pay a per annum participation fee equal to the applicable LIBOR margin on the face amount of each letter of credit as well as a fee equal to 0.125% on the face amount of each letter of credit issued (or the term of which is extended). This latter 0.125% fee is payable to the issuer of the letter of credit for its own account, along with any standard documentary and processing charges incurred in connection with any letter of credit.
In addition, all obligations under the senior secured credit facility are guaranteed by all of our existing and future subsidiaries, other than foreign subsidiaries to the extent the assets of all foreign subsidiaries that are not guarantors do not exceed 5% of the total assets of us and our subsidiaries on a consolidated basis, and secured by a first-priority perfected security interest in substantially all our and our guaranteeing subsidiaries’ tangible and intangible assets, whether now owned or hereafter acquired, including a pledge of 100% of the stock of each guarantor.
The senior secured credit facility contains certain covenants that, among other things and subject to significant exceptions, limit our ability and the ability of our restricted subsidiaries to engage in certain business and financing activities and that require us to maintain certain financial covenants, including requirements to maintain (i) a maximum total leverage ratio of total outstanding debt to adjusted EBITDA for the most recently-ended four fiscal quarters of no more than 300% and (ii) a minimum fixed charge coverage ratio of adjusted EBITDA to the sum of cash interest expense (which amount shall be calculated on an annualized basis for the three, six and nine month periods ending March 31, 2015, June 30, 2015 and September 30, 2015) plus income tax expense (or less any income tax benefits) plus capital expenditures plus dividends, share repurchases and other restricted payments plus regularly scheduled principal payments of debt for the same period of a least 150% for the most recently-ended four quarters. The senior secured credit facility allows us to pay dividends in an amount up to 50% of our net income if certain other financial conditions are met. The senior secured credit facility contains other restrictive covenants, including those regarding indebtedness (including capital leases) and guarantees; liens; operating leases; investments and acquisitions; loans and advances; mergers, consolidations and other fundamental changes; sales of assets; transactions with affiliates; no material changes in nature of business; dividends and distributions, stock repurchases, and other restricted payments; change in name, jurisdiction of organization or fiscal year; burdensome agreements;. and capital expenditures. 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 assumed is comprised of capitalized policy and claims administration software development costs and related computer equipment. Monthly payments on the capital lease, which expires on December 3, 2016, are approximately $206,000 as of August 6, 2014. 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, 2014, based on the interest rate swap rate in effect on that date, are as follows (in thousands):
Observable inputs other than quoted prices in active markets for identical securities,
Fee income from related party represents fee income earned from Guarantee Insurance, a related party as described above. Fee income from Guarantee Insurance for claims administration services is based on the net portion of claims expense retained by Guarantee Insurance pursuant to quota share reinsurance agreements between Guarantee Insurance, PUI’s third party insurance company customers and the segregated portfolio cell reinsurers that assume business written by Guarantee Insurance. Certain fee income from third-party segregated portfolio cell reinsurers is remitted to the Company by Guarantee Insurance on behalf of the segregated portfolio cell reinsurers. Fee income from Guarantee Insurance for brokerage, underwriting and policyholder services represents fees for soliciting applications for workers’ compensation insurance for Guarantee Insurance, based on a percentage of premiums written or other amounts negotiated by the parties.
In connection with the note payable outstanding at December 31, 2014 as described in Note 6 and the amendment to this note, effective August 6, 2014, associated with the acquisition of GUI’s contracts and certain other assets as described in Note 3 herein, the common stock of the Company and the common stock or units of each of the Company’s wholly and majority owned subsidiaries, other than PCM, are pledged as collateral.
In connection with the loan, effective August 6, 2014, associated with the merger of Six Points Ventures 2, Inc. with and into Patriot Care, Inc. and the simultaneous acquisition of PCM as described in Note 3 herein, the common stock of PCM is pledged as collateral.
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.
On November 27, 2013, the Company issued 743,730 detachable common stock warrants to one of its previous lenders in exchange for warrants and units in certain subsidiaries of the Company which were held by the previous lender. The warrants have an exercise price of $.001 per share and expire on October 9, 2022. The Company attributed a value to these warrants of approximately $4.5 million as of December 31, 2013. The warrants were exercised by the lender on September 30, 2014 and converted to 743,730 shares of common stock of Patriot National for an exercise price of $.001 per share. Under the terms of the warrant agreement between the Company and the lender, the lender may require the Company to redeem these shares of common stock of Patriot National for cash after November 27, 2018, in an amount equal to the estimated fair value of the stock as determined by an independent appraisal. The Company attributed no value to the redemption liability associated with this common stock as of September 30, 2014, based on the fact that, (i) in the event an initial public offering is not consummated prior to November 27, 2018, the Company’s majority owner, Chairman and Chief Executive Officer has the ability and intent to cause a “Sale of the Company” to occur through a single transaction or a series of related transactions with an independent third party or a group of independent third parties, pursuant to which such independent third party or group of independent third parties acquires (a) a majority of the Company’s common stock on a fully-diluted basis (whether by merger, consolidation, sale or transfer of common stock, reorganization, recapitalization or otherwise) or (b) all or substantially all of the assets of the Company constitutes a sale and (ii) in the event an initial public offering is consummated prior to November 27, 2018, the security holder has waived its put right.
On August 6, 2014, in connection with the Additional Tranche described in Note 6, the Company issued 484,260 detachable common stock warrants to the lenders to purchase shares of the Company’s common stock at an exercise price of $2.67 per share. The warrants expire on November 27, 2023. At the fifth anniversary date of the warrants and any time after the eighth anniversary date of the warrants, the warrant holders may require the Company to redeem the warrants for cash, in an amount equal to the estimated fair value of the warrants, as determined by an independent appraisal, less the total exercise price of the redeemed warrants. The Company attributed a value to the warrants of approximately $4.1 million as of August 6, 2014. The value of the warrants was recorded as a discount on the loan and a warrant liability on August 6, 2014. The discount on the loan is amortized as interest expense over the term of the loan. The Company attributed a value to these warrants of approximately $5.6 million as of December 31, 2014.
The components of the consolidated income tax provision are as follows:
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. Based on the initial and preliminary information available to us as of September 30, 2014, the Company fully offset the 19.1 million deferred tax assets with a valuation allowance. The results of operations related to the GUI contracts subsequent to August 6, 2014 are included in our consolidated tax return for the year ended December 31, 2014. There were no significant deferred tax assets or deferred tax liabilities generated by the GUI contracts between the August 6, 2014 acquisition date and December 31, 2014.
The unaudited supplemental pro forma income tax benefit has been presented in accordance with Section 3410.1 (under the headings 3400, Special Applications and 3410, Sub-Chapter S Corporations and Partnerships) of the SEC Division of Corporation Finance Financial Reporting Manual. The unaudited supplemental pro forma income tax benefit gives effect to the tax treatment of the Company’s Subchapter S corporation and limited liability company subsidiaries as if they were subject to federal and state income taxes for the years ended December 31, 2013 and 2012.
The pro forma net income tax benefit is comprised of the following (in thousands):
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 (amounts in thousands):
Quarterly operating results for 2014 and 2013 were as follows (in thousands, except per share data):
On January 22, 2015, Patriot National, Inc. (the “Company”) entered into the Credit Agreement (the “Credit Agreement”), by and among the Company, BMO Harris Bank N.A., as administrative agent (the “Administrative Agent”) and the other lenders party thereto, which provides for a $40.0 million revolving credit facility and a $40.0 million term loan facility, and fully drew down the $40.0 million term loan facility.
On January 31, 2015, we entered into an asset purchase agreement with Phoenix Risk Management, Inc., a California corporation (“Phoenix”), pursuant to which the Company agreed to acquire substantially all of the assets of Phoenix for $1,099,000 in cash plus a performance-based cash earn-out of up to $3,000,000. Pursuant to the acquisition agreement, Phoenix will be entitled to an annual earn-out payment of up to $1,000,000 for the next three years subject to reduction on a pro-rata basis if the level of premium earned within the first year does not meet certain targets. The Company did not assume any material liabilities. The transaction closed on February 4, 2015.