UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

For the quarterly period ended June 30, 2015

OR

For the transition period from                      to                     

Commission File Number: 001-36804

 

Patriot National, Inc.

(Exact name of registrant as specified in its charter)

 

 

401 East Las Olas Boulevard, Suite 1650

Fort Lauderdale, Florida 33301

(Address of Principal Executive Offices) (Zip Code)

Registrant’s telephone number, including area code: (954) 670-2900

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.   Yes  x   No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).   Yes  x   No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).   Yes  ¨   No  x

The number of shares of the registrant’s common stock outstanding on August 14, 2015 was 26,701,049.

 

 

 

 

 

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PATRIOT NATIONAL, INC.

FORM 10-Q

TABLE OF CONTENTS

 

 

 

 

 

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PART I — FINANCIAL INFORMATION

 

PATRIOT NATIONAL, INC.

Consolidated Balance Sheets

(In thousands) 

See accompanying notes to consolidated financial statements.

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PATRIOT NATIONAL, INC.

Consolidated Statements of Operations

(In thousands, except per share amounts)

(Unaudited)

 

 

 

 

 

See accompanying notes to consolidated financial statements.

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PATRIOT NATIONAL, INC.

Consolidated Statements of Operations

(In thousands, except per share amounts)

(Unaudited)

 

 

 

 

See accompanying notes to consolidated financial statements.

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PATRIOT NATIONAL, INC.

Consolidated Statements of Cash Flows

(In thousands)

(Unaudited)

 

 

 

See accompanying notes to consolidated financial statements.

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PATRIOT NATIONAL, INC.

Consolidated Statements of Stockholders’ Equity (Deficit)

(In thousands)

(Unaudited)

 

 

See accompanying notes to consolidated financial statements.

 

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PATRIOT NATIONAL, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

 

 

 

Description of Business

Patriot National, Inc. (“Patriot National” or the “Company”) is a national provider of comprehensive technology and outsourcing solutions within the property and casualty marketplace, primarily in workers’ compensation, for insurance companies, employers, local governments and reinsurance captives. We offer an end-to-end portfolio of services to increase business production, contain costs, and reduce claims experience for our clients. We leverage our strong distribution relationships, proprietary business processes, advanced technology infrastructure, and management expertise to deliver valuable solutions to our clients. We strive to deliver these value-added services to our clients in order to help them navigate the workers’ compensation landscape, ensure compliance with state regulations, handle all aspects of the claims process and ultimately contain costs.

The Company offers 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 income for our services from our clients based on (i) a percentage of premiums for the policies we service, (ii) the cost savings we achieve for our clients or (iii) 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. Patriot National is headquartered in Ft. Lauderdale, Florida.

Basis of Presentation

The accompanying unaudited 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. Certain information and footnote disclosures normally included in annual financial statements have been omitted pursuant to such rules and regulations. Included for comparative purposes are our combined financial statements for the six-month period ended June 30, 2014, which combined the financial activity of Patriot National with the results of an acquisition under common control.  This acquisition was completed on August 6, 2014.  The combined financial statements presented for the period ended June 30, 2014 are the Statement of Operations and the Statement of Cash Flows.  This acquisition is discussed fully in our annual report for the year ended December 31, 2014.

The unaudited consolidated financial statements included herein are, in the opinion of management, prepared on a basis consistent with our audited combined financial statements for the year ended December 31, 2014 and include all normal recurring adjustments necessary for a fair presentation of the information set forth. The quarterly results of operations are not necessarily indicative of the results of operations to be reported for subsequent quarters or the full year. These unaudited consolidated financial statements should be read in conjunction with the audited combined financial statements and the notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2014. In the preparation of our unaudited consolidated financial statements as of June 30, 2015, management evaluated all material subsequent events or transactions that occurred after the balance sheet date through the date on which the financial statements were issued for potential recognition or disclosure therein.

For Contego Services Group, LLC (“Contego Services Group”), the Company’s combined subsidiary that is 97% owned, and for DecisionUR, LLC (“DecisionUR”), the Company’s combined 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 and DecisionUR are presented as non-controlling interest in the accompanying consolidated balance sheets as of June 30, 2015 and combined balance sheet as of December 31, 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).

 

 

In April 2015, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("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. Early adoption is permitted but we do not anticipate electing early adoption. We are currently evaluating the financial impact of this standard.

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

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which the entity expects to be entitled in exchange for those goods or services. In July 2015, the FASB approved a proposed ASU to defer the effective date to annual reporting periods beginning after December 15, 2017 using one of two retrospective application methods with earlier adoption permitted for annual periods beginning after December 15, 2016. We are currently evaluating the accounting, transition and disclosure requirements of the standard and cannot currently estimate the financial statement impact of adoption.

 

 

 

The Company completed thirteen acquisitions during the six-month period ended June 30, 2015. We acquired substantially all of the net assets of the following firms in cash transactions. These acquisitions have been accounted for using the acquisition method for recording business combinations, except for DecisionUR, as further discussed.

 

 

The Company acquired DecisionUR from Six Points Investment Partners, LLC, a company under common control.  However, results of operations for DecisionUR are included from acquisition date, as its operations are immaterial with respect to the financial statements taken as a whole for all periods presented.

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 fair value of these 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, Fair Value 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 and these financial projections. We then discounted these payments to present value using a risk-adjusted rate that takes into consideration market-based rates of return that reflect the ability of the acquired entity to achieve the targets. Changes in financial projections, market participant assumptions for revenue growth and/or profitability, or the risk-adjusted discount rate, would result in a change in the fair value of recorded earnout obligations.

The aggregate amount of maximum earnout obligations related to acquisitions made in 2015, as of June 30, 2015 was $9.1 million, of which $7.5 million was recorded in our consolidated balance sheet as of June 30, 2015, based on the aggregate estimated fair value of the expected future payments to be made.

The “recorded payable to seller” disclosed in the foregoing table represents the consideration payable to a seller of TriGen Holding Group, Inc. on the first anniversary of the effective date.  The payable was recorded at present value and reported in our consolidated balance sheet as of June 30, 2015 within accounts payable, accrued expenses and other liabilities.

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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 six months ended June 30, 2015:

 

 

The net assets acquired are preliminary and subject to measurement period adjustments.

In accordance with FASB ASC 350, Intangibles—Goodwill and Other, intangible assets, which are comprised of the estimated fair value of the service contracts acquired, customer and carrier relationships, non-compete agreements, developed technology and trade names are being amortized over the respective estimated life, ranging from two to ten years, in a manner that, in management’s opinion, reflects the pattern in which the intangible asset’s future economic benefits are expected to be realized. Intangible assets are tested for impairment at least annually (more frequently if certain indicators are present). In the event that management determines that the value of the intangible asset has become impaired, the company will incur an accounting charge for the amount of impairment during the fiscal quarter in which the determination is made.

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 acquisitions through June 30, 2015. The fair value of non-compete agreements was established using estimated financial projections for the acquired company based on market participant assumptions and various non-compete scenarios.

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 because the pattern of their economic benefits cannot be reasonably determined with any certainty. 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 six-month periods ended June 30, 2015 and 2014, no impairments were required.

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Our consolidated financial statements for the six months ended June 30, 2015 include the operations of the acquired entities from their respective acquisition dates, totaling $8.5 million of revenues and $1.9 million of net income.

The following is a summary of the unaudited pro forma historical results, as if these entities and Patriot Care Management, Inc. (“Patriot Care Management”), which was acquired on August 6, 2014, 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.

 

Equity and fixed income security investments are carried at fair value.  We classify these investments as a trading portfolio with changes to the fair value of investments marked-to-market value and reflected in the aggregate net income or loss for the period incurred.  The trading portfolio is utilized to generate investment income with available cash on hand.

As of June 30, 2015, our major classes of investments consisted of the following:

 

There were no investments as of December 31, 2014.

 

 

Fixed Assets

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 life, respectively. Expenditures for leasehold improvements on office space and facilities are capitalized and amortized on a straight-line basis over the term of the lease.

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As of June 30, 2015 and December 31, 2014, our major classes of fixed assets consisted of the following:

 

 

Other Long Term Assets

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 June 30, 2015 and December 31, 2014, other long term assets consisted of the following:

 

 

We periodically review all fixed assets and other long term assets that have finite lives for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. Upon sale or retirement, the cost and related accumulated depreciation and amortization of assets disposed of are removed from the accounts, and any resulting gain or loss is reflected in earnings.

 

 

Goodwill

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 June 30, 2015.

The Company acquired $24.3 million of goodwill during the six-month period ended June 30, 2015 as a result of the thirteen acquisitions discussed in Note 3, Business Combinations. Changes in goodwill are summarized as follows:

 

 

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Intangible Assets

Intangible assets that have finite lives are amortized over their useful lives. The company acquired $37.3 million of intangible assets during the six-month period ended June 30, 2015 as a result of the thirteen acquisitions discussed in Note 3, Business Combinations. The intangible assets, their original fair values, and their net book values are detailed below as of the dates presented:

 

 

 

 

The table below reflects the estimated amortization expense for the Company’s intangible assets for each of the next five years and thereafter:

 

 

 

 

As of June 30, 2015 and December 31, 2014, notes payable were comprised of the following:

 

 

Senior Secured Credit Facility

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

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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 minimum increments of $5.0 million. As of June 30, 2015, we increased the term loan facility by $20.0 million through two $10.0 million incremental term loans.

As of June 30, 2015, the outstanding balance under the $40.0 million revolving credit facility was $25.6 million. Accordingly, the Company had $14.4 million available to borrow under the revolving credit facility.

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.

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 (as described below) 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.

In addition, all obligations under the Senior Secured Credit Facility (as described below) are guaranteed by all of our existing and future subsidiaries, other than foreign subsidiaries to the extent the assets of such foreign subsidiaries do not exceed 5% of our and our subsidiaries’ total assets on a consolidated basis, and secured by a first-priority perfected security interest in substantially all of 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 ended 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.

As of June 30, 2015, we were in compliance with the financial and other restrictive covenants under our outstanding material debt obligations, including our Senior Secured Credit Facility.

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UBS Credit Agreement

On August 6, 2014, in connection with the Patriot Care Management Acquisition, we and certain of our subsidiaries entered into a credit agreement with UBS Securities LLC (the “UBS Credit Agreement”), which provided for a five-year term loan facility in an aggregate principal amount of $57.0 million that would mature on August 6, 2019. The loan was secured by the common stock of Patriot Care Management and guaranteed by Guarantee Insurance Group and its wholly owned subsidiaries. Following our initial public offering (the “IPO”), we prepaid all outstanding borrowings under the UBS Credit Agreement, including accrued interest and applicable prepayment premium.

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%.  This instrument was repaid in full upon closing on the Senior Secured Credit Facility.

PennantPark Loan Agreement

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 a loan agreement with the PennantPark Entities as lenders (the “PennantPark Loan Agreement”). Following our IPO, we prepaid all outstanding borrowings under the PennantPark Loan Agreement, including accrued interest and applicable prepayment premium.

Borrowings under the PennantPark Loan Agreement were comprised of (i) an initial tranche in an aggregate principal amount of approximately $37.8 million and (ii) an additional tranche in an aggregate principal amount of approximately $30.8 million of new borrowings. Our borrowings under the PennantPark Loan Agreement were funded at a price equal to 97.5% of the par value thereof and bore interest equal to the sum of (i) the greater of 1.0% or LIBOR and (ii) 11.50%. The weighted average interest rate under the PennantPark Loan Agreement for the year ended December 31, 2014 was 12.5%.

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. This instrument was repaid in full upon closing on the Senior Secured Credit Facility.

 

 

Equipment subject to capital lease 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, were approximately $206,000 as of June 30, 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 June 30, 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 and stock-based awards of restricted shares and stock options.

The components of basic and diluted EPS are as follows:

 

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For the three months ended June 30, 2015, potential weighted average outstanding shares from restricted stock and stock option awards of 369,313 were anti-dilutive, and therefore not included in diluted earnings (loss) per share.  Due to the net loss of $3.8 million reported for the six months ended June 30, 2015, weighted average outstanding detachable common stock warrants of 117,865 and restricted shares and stock options of 199,981 were not dilutive.  As a result, basic and diluted earnings per share both reflect a net loss of $0.15 per share for the six months then ended.  

 

 

Omnibus Incentive Plan

On January 15, 2015, the Board of Directors approved the Patriot National 2014 Omnibus Incentive Plan (the “Omnibus Incentive Plan”), subject to and with effect upon approval of such plan by the stockholders of the Company.

The Compensation Committee of our Board of Directors determines the participants under the Omnibus Incentive Plan. The Omnibus Incentive Plan provides for non-qualified and incentive stock options, restricted stock and restricted stock units, any or all of which may be made contingent upon the achievement of performance criteria. Subject to the Omnibus Incentive Plan limits, the compensation committee has the discretionary authority to determine the size of an award.

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. 

Stock Options

In the six months ended June 30, 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:

 

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For the six months ended June 30, 2015, we awarded 1,277,863 options with an estimated fair value of $3.9 million. Option activity for the six months ended June 30, 2015 was as follows:

 

 

As of June 30, 2015, we recognized $0.7 million of stock compensation expense associated with these options, and there was $3.2 million of total unrecognized stock compensation cost related to unvested stock options that is expected to be recognized over a weighted-average period of 2.5 years.

Restricted Stock Awards

In the six months ended June 30, 2015, we issued 842,737 restricted shares as incentive compensation for officers, directors, and certain key employees. Subsequent to issuance, 22,059 restricted shares were forfeited, leaving 820,678 remaining restricted shares outstanding as of June 30, 2015. Of these remaining shares, 17,752 were fully vested but not settled as of June 30, 2015, due to the initial 180 day-black out period subsequent to the IPO. The fair value of outstanding restricted shares at grant date was $11.6 million. The intrinsic value of these awards as of June 30, 2015 was $1.6 million. Grants of restricted shares for the six months ended June 30, 2015 were as follows:

 

 

As of June 30, 2015, we recognized $5.1 million of stock compensation expense associated with these restricted shares, and there was $6.5 million of total unrecognized stock compensation cost related to unvested restricted stock to be recognized over a weighted average period of 2.5 years.

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Restricted Stock Units

During the six months ended June 30, 2015, we issued 117,735 restricted stock units.  Of those issued, 6,815 were subsequently forfeited, resulting in 110,920 restricted stock units outstanding as of June 30, 2015. The fair value of the outstanding restricted stock units at grant date was $1.6 million. The intrinsic value of these awards at June 30, 2015 was $0.2 million.  During the six months ended June 30, 2015, we recognized $0.4 million of stock compensation expense associated with these restricted stock units.  The weighted average remaining contractual lives of these awards are 2.5 years with a weighted average award value of $14.00.

 

With respect to the Company’s financial assets and liabilities, which include short term investments, notes payable, capital lease obligation, earnout obligations of acquisitions 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 transfer the 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 and liabilities in a fair value hierarchy, which consists of the following three levels:

 

 

The Company’s equity and fixed income security investments for which carrying values were equal to fair values, classified by level within the fair value hierarchy, were as follows as of June 30, 2015:

 

 

There were no equity and fixed income security investments as of December 31, 2014.

The Company’s notes payable, capital lease obligation, earnout obligations of acquisitions and warrant redemption liability, for which carrying values were equal to fair values, classified by level within the fair value hierarchy, were as follows as of June 30, 2015 and December 31, 2014:

 

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The following is a reconciliation of the fair value of the Company’s financial liabilities that were measured using significant unobservable (Level 3) inputs:

 

 

 

 

12. Related Party Transactions

Fee income from related party represents fee income earned from Guarantee Insurance Company (“Guarantee Insurance”), a related party. 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, the third party insurance company customers of Patriot Underwriters, Inc. and the segregated portfolio cell reinsurers that assume business written by

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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.

For the six months ended June 30, 2014, the allocation of marketing, underwriting and policy issuance costs from related party in the accompanying combined statements of operations represents costs reimbursed to Guarantee Insurance Group for salaries and other costs incurred by Guarantee Insurance Group to provide its policyholder services. Management fees paid to related party for administrative support services in the accompanying combined statements of operations represent amounts paid to Guarantee Insurance Group for management oversight, legal, accounting, human resources and technology support services. 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 of June 30, 2015, we had a net payable to related parties of $20,000 due to entities controlled by Mr. Mariano, our founder, Chairman, President and Chief Executive Officer.

On April 17, 2015, the Company acquired Vikaran Solutions, LLC (“Vikaran”).  Prior to 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 Patriot National.

 

For the three months ended June 30, 2015, approximately 70% of total combined 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 9% was attributable to contracts with the Company’s second largest customer. For the three months ended June 30, 2014, approximately 58% of total combined fee income and fee income from related revenues was attributable to contracts with Guarantee Insurance, and approximately 36% and 6% were attributable to contracts with the Company’s second and third largest customers, respectively.

For the six months ended June 30, 2015, approximately 76% of total combined fee income and fee income from related party was attributable to contracts with Guarantee Insurance and approximately 9% was attributable to contracts with the Company’s second largest customer. For the six months ended June 30, 2014, approximately 57% of total combined fee income and fee income from related revenues was attributable to contracts with Guarantee Insurance, and approximately 34% and 6% were attributable to contracts with the Company’s second and third largest customers, respectively.

As of June 30, 2015, approximately 67% of combined fee income receivable and fee income receivable from related party was attributable to contracts with Guarantee Insurance and approximately 3% and 1% of combined fee income receivable and fee income receivable from related party were attributable to contracts with the Company’s second and third largest customers, respectively. As of December 31, 2014, approximately 86% of combined fee income receivable and fee income receivable from related party was attributable to contracts with Guarantee Insurance and approximately 8% and 2% of combined fee income receivable and fee income receivable from related party were attributable to contracts with the Company’s second and third largest customers, respectively.

Because fee income from related party for claims administration services is based on the net portion of claims expense retained by Guarantee Insurance, the Company’s revenues attributable to contracts with Guarantee Insurance do not necessarily represent fee income from related party.

 

 

 

Contractual Obligations and Commitments

 

In connection with the Senior Secured Credit Facility as described in Note 7, Notes Payable and Lines of Credit, the common stock of the Company and the common stock or units of each of the Company’s wholly and majority owned subsidiaries were pledged as collateral.

Off-Balance Sheet Arrangements

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.

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The Company has employment agreements with certain executives and other employees, which provide for compensation and certain other benefits and for severance payments under certain circumstances. The employment agreements contain clauses that become effective upon a change of control of the Company. Upon the occurrence of any of the defined events in the employment agreements, the Company would be obligated to pay certain amounts to the relevant employees.

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.

In the normal course of business, the Company may be party to various legal actions that management believes will not result in any material effect on the Company’s financial position or results of operations.

 

There was no warrant redemption liability as of June 30, 2015.  Concurrent with our IPO and repayment of the PennantPark Debt on January 22, 2015, the PennantPark Entities exercised 965,700 of their 1,110,555 detachable common stock warrants for common stock at an exercise price of $2.67 per share. The PennantPark Entities waived their put right on the remaining 144,855 detachable common stock warrants.  By eliminating the put right, the PennantPark Entities cannot require the Company to redeem the remaining detachable common stock warrants for cash, thereby eliminating the warrant redemption liability previously required. The remaining 144,855 detachable common stock warrants can be used to purchase shares of the Company’s common stock at an exercise price of $2.67 per share and expire on November 27, 2023.

On November 27, 2013, the Company issued 626,295 detachable common stock warrants to new 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. Prior to the exercise and removal of the put right, at the fifth anniversary date of the warrants and any time after the eighth anniversary date of the warrants, the warrant holders could have required 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 value of the warrants was recorded as a discount on the loan and a warrant liability on November 27, 2013. The discount on the loan was amortized as interest expense over the term of the loan. The Company attributed a value to these warrants of approximately $7.3 million as of December 31, 2014.

On August 6, 2014, in connection with the additional tranche described in Note 7, Notes Payable and Lines of Credit, the Company issued 484,260 detachable common stock warrants to the PennantPark Entities 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. Prior to the exercise and removal of the put right, at the fifth anniversary date of the warrants and any time after the eighth anniversary date of the warrants, the warrant holders could have required 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 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 was 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 Company uses an estimated annual effective tax rate method of computing its interim tax provision. Certain items, including those deemed to be unusual, infrequent or that cannot be reliably estimated, are excluded from the estimated annual effective tax rates. In these cases, the actual tax expense or benefit applicable to that item is treated discretely and is reported in the same period as the related item. For the six-month period ended June 30, 2015, the tax effects of warrants were treated as a discrete item.

The effective tax rate is based on forecasted annual pre-tax income, permanent differences and statutory tax rates. For the six months ended June 30, 2015, the effective income tax rate was 37.9%. The main drivers of the difference in the effective tax rate from the statutory rate are warrants, success based fees, and meals and entertainment.

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 as of June 30, 2015 was $9.8 million before valuation allowance. 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 June 30, 2015.

At June 30, 2015 and December 31, 2014, the Company had no unrecognized tax benefits and no amounts recorded for uncertain tax positions.

 

 

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17.Subsequent Events

On July 9, 2015, Patriot Risk Services, Inc. (“PRS”), a wholly owned subsidiary of Patriot National, entered into a stock purchase agreement with CWIBenefits, Inc., a Delaware corporation (“CWI”), and the shareholders of CWI, pursuant to which PRS acquired all of the outstanding equity of CWI for a maximum of $7.4 million. Pursuant to the purchase agreement, PRS paid CWI $2.8 million in cash at closing. CWI will also be entitled to an earn-out payment of up to $4.7 million approximately six months after closing, subject to reduction on a pro-rata basis if EBITDA does not meet certain targets. Neither Patriot National nor the Company assumed any material liabilities under the Purchase Agreement.

On July 20, 2015 the Company entered into a membership interest purchase agreement with Global HR Research LLC, a Florida limited liability company (“Global HR”), In Touch Holdings LLC, a Florida limited liability company (“ITH”), the members of Global HR, and Brandon G. Phillips as the sellers’ representative, pursuant to which, subject to the satisfaction or waiver of certain conditions, the Company will acquire all of the outstanding membership interests of Global HR. The Global HR transaction is expected to close on the later of (i) three business days following the satisfaction of certain customary closing conditions and (ii) August 25, 2015. One of the Company’s independent directors, Austin J. Shanfelter, indirectly controls Global HR. Mr. Shanfelter owns 84% of the equity interests in ITH, which owns 75.5% of the equity interests of Global HR. The purchase price for the transaction is (i) $24.0 million in cash and (ii) 1,062,574 shares of common stock of the Company, subject to adjustment based on the estimated net working capital of Global HR on the closing date. The number of shares of common stock of the Company to be issued was determined by dividing $18.0 million by the closing stock price of the Company’s common stock on July 20, 2015, the signing date. If the revenues for Global HR for its fiscal year 2016 are less than $12.8 million, then ITH will forfeit and return 10% of its stock consideration to the Company.

Bank of Montreal has informed the Company that it is in receipt of commitment letters to increase the term loan portion of the Company’s Senior Secured Credit Facility by $50.0 million. The proceeds of this additional term loan financing would be available concurrent with the closing of the Global HR transaction.

 

 

 

 

 

 

 

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The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our Combined Financial Statements and related Notes included elsewhere in this Quarterly Report on Form 10-Q and in our Annual Report on Form 10-K for the year ended December 31, 2014, and with the information under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the year ended December 31, 2014.

Disclosure Regarding Forward-Looking Statements

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 (the “Exchange Act”) relating to our operations, results of operations and other matters that are based on our current expectations, estimates, assumptions and projections. Words such as “may,” “will,” “should,” “likely,” “anticipates,” “expects,” “intends,” “plans,” “projects,” “believes,” “estimates,” “positioned,” “outlook” and similar expressions are used to identify these forward-looking statements. These statements are not guarantees of future performance and involve risks, uncertainties and assumptions that are difficult to predict. Forward-looking statements are based upon assumptions as to future events that may not prove to be accurate. Actual outcomes and results may differ materially from what is expressed or forecast in these forward-looking statements. Risks, uncertainties and other factors that might cause such differences, some of which could be material, include, but are not limited to the following:

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For a more detailed discussion of these factors, see the information under the heading “Risk Factors” herein and in our Annual Report on Form 10-K for the year ended December 31, 2014. Our forward-looking statements speak only as of the date of this report or as of the date they are made, and we undertake no obligation to update any forward-looking statements.

Terms Used in this Quarterly Report on Form 10-Q

Unless otherwise specified or the context requires otherwise, the following terms used in this Quarterly Report on Form 10-Q have the meanings ascribed to them below:

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Overview

Business

We are a national provider of comprehensive outsourcing solutions within the workers’ compensation marketplace for insurance companies, employers, local governments and reinsurance captives. We offer an end-to-end portfolio of services to increase business production, contain costs and reduce claims experience for our clients. We leverage our strong distribution relationships, proprietary business processes, advanced technology infrastructure and management expertise to deliver valuable solutions to our clients. We strive to deliver these value-added services to our clients in order to help them navigate the workers’ compensation landscape, ensure compliance with state regulations, handle all aspects of the claims process and ultimately contain costs.

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”).

Fee income for our services is generated 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.

 

Recent Events

On July 9, 2015, Patriot Risk Services, Inc. (“PRS”), a wholly owned subsidiary of Patriot National, entered into a stock purchase agreement with CWIBenefits, Inc., a Delaware corporation (“CWI”), and the shareholders of CWI, pursuant to which PRS acquired all of the outstanding equity of CWI for a maximum of $7.4 million. Pursuant to the purchase agreement, PRS paid CWI $2.8 million in cash at closing. CWI will also be entitled to an earn-out payment of up to $4.7 million approximately six months after closing, subject to reduction on a pro-rata basis if EBITDA does not meet certain targets. Neither Patriot National nor the Company assumed any material liabilities under the Purchase Agreement.

On July 20, 2015 the Company entered into a membership interest purchase agreement with Global HR Research LLC, a Florida limited liability company (“Global HR”), In Touch Holdings LLC, a Florida limited liability company (“ITH”), the members of Global HR, and Brandon G. Phillips as the sellers’ representative, pursuant to which, subject to the satisfaction or waiver of certain conditions, the Company will acquire all of the outstanding membership interests of Global HR. The Global HR transaction is expected to close on the later of (i) three business days following the satisfaction of certain customary closing conditions and

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(ii) August 25, 2015. One of the Company’s independent directors, Austin J. Shanfelter, indirectly controls Global HR. Mr. Shanfelter owns 84% of the equity interests in ITH, which owns 75.5% of the equity interests of Global HR. The purchase price for the transaction is (i) $24.0 million in cash and (ii) 1,062,574 shares of common stock of the Company, subject to adjustment based on the estimated net working capital of Global HR on the closing date. The number of shares of common stock of the Company to be issued was determined by dividing $18.0 million by the closing stock price of the Company’s common stock on July 20, 2015, the signing date. If the revenues for Global HR for its fiscal year 2016 are less than $12.8 million, then ITH will forfeit and return 10% of its stock consideration to the Company.

Bank of Montreal has informed the Company that it is in receipt of commitment letters to increase the Term Loan portion of the Company’s Senior Secured Credit Facility by $50.0 million. The proceeds of this additional term loan financing would be available concurrent with the closing of the Global HR transaction.

Key Performance Measures

We use certain key performance measures in evaluating our business and results of operations, and we may refer to one or more of these key performance measures in this “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” These key performance measures include:

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.

We present Adjusted EBITDA, Adjusted EBITDA Margins, Operating Cash Flow and Adjusted Earnings 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 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 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.

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Adjusted EBITDA, Adjusted EBITDA Margins, Operating Cash Flow and Adjusted Earnings have limitations as analytical tools, and should not be considered in isolation or as a substitute for analysis of our financial results under GAAP.  Some of these limitations are as follows:

Reference Premium Written

 

 

Gross reference premium written for the three months ended June 30, 2015 was $102.1 million compared to $74.9 million for the three months ended June 30, 2014, an increase of $27.2 million. The increase was attributable to a $1.5 million increase in Guarantee Insurance gross reference premium written and the inception of new contracts with Scottsdale Insurance Company (“Scottsdale”), AIG and certain other insurance carrier clients, which generated $28.8 million for the three months of gross reference premium written. This increase was partially offset by a $3.2 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.

Gross reference premium written for the six months ended June 30, 2015 was $221.6 million compared to $168.5 million for the six months ended June 30, 2014, an increase of $53.1 million.  This increase was attributable to a $7.2 million increase in Guarantee Insurance gross premium written and the inception of new contracts with Scottsdale, AIG and certain other carrier clients, which generated $55.1 million of gross reference premium written. This increase was partially offset by a $9.2 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.

Reference premium written for the three months ended June 30, 2015 was $103.0 million compared to $82.6 million for the three months ended June 30, 2014, an increase of $20.4 million.  The increase was attributable to a $1.5 million increase in Guarantee Insurance reference premium written and the inception of new contracts with Scottsdale and certain other insurance carrier clients, which generated $26.7 million of  reference premium written. This increase was partially offset by a $7.8 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.

Reference premium for the six months ended June 30, 2015 was $206.1 million compared with $182.1 million for the six months ended June 30, 2014.  The increase of $24.0 million was attributable to $7.2 million in Guarantee Insurance reference premium written and the inception of new contracts with Scottsdale and certain other insurance carrier clients, which generated $32.3 million of reference premium written. This increase was partially offset by a $15.5 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.

Adjusted EBITDA

Adjusted EBITDA is a non-GAAP financial measure and is not in accordance with, or an alternative to, the GAAP information provided in this Quarterly Report on Form 10-Q. For further information regarding our use of non-GAAP financial measures and a reconciliation of Adjusted EBITDA to Net income (loss), see “—Reconciliations to Non-GAAP Key Performance Measures”.

 

 

Adjusted EBITDA for the three months ended June 30, 2015 was $11.4 million compared to $3.8 million for the three months ended June 30, 2014, an increase of $7.5 million. The increase was attributable to a $31.9 million increase in total fee income and fee

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income from related party, partially offset by a $26.5 million increase in total expenses (excluding depreciation and amortization, changes in fair value of warrant liabilities, non-cash stock compensation, interest expense and income tax expense which are added back to net income to arrive at Adjusted EBITDA), all of which are discussed more fully below.

Adjusted EBITDA for the six months ended June 30, 2015 was $22.2 million compared to $8.9 million for the six months ended June 30, 2014, an increase of $13.3 million. The increase was attributable to a $59.3 million increase in total fee income and fee income from related party, partially offset by a $48.6 million increase in total expenses (excluding depreciation and amortization, changes in fair value of warrant liabilities, non-cash stock compensation and costs incurred for the extinguishment of debt, income tax expense and interest expense which are added back to net income to arrive at Adjusted EBITDA), all of which are discussed more fully below.

Operating Cash Flow

Operating cash flow is a non-GAAP financial measure and is not in accordance with, or an alternative to, the GAAP information provided in this Quarterly Report on Form 10-Q. For further information regarding our use of non-GAAP financial measures and a reconciliation of Operating cash flow to Net income (loss), see “—Reconciliations to Non-GAAP Key Performance Measures”.

 

 

 

Operating cash flow for the three months ended June 30, 2015 was $9.2 million compared to $2.1 million for the three months ended June 30, 2014, an increase of $7.1 million.  The increase was primarily attributable to the increase in cash earnings as reflected in the $7.5 million increase in Adjusted EBITDA.

For the six months ended June 30, 2015, operating cash flow was $17.7 million compared to $4.8 million for the six months ended June 30, 2014, an increase of $12.9 million. The increase was primarily attributable to the increase in cash earnings as reflected in the $13.3 million increase in Adjusted EBITDA.

Adjusted Earnings

Adjusted Earnings is a non-GAAP financial measure and is not in accordance with, or an alternative to, the GAAP information provided in this Quarterly Report on Form 10-Q. For further information regarding our use of non-GAAP financial measures and a reconciliation of Operating cash flow to Net income (loss), see “—Reconciliations to Non-GAAP Key Performance Measures”.

 

 

 

Adjusted Earnings for the three months ended June 30, 2015 were $4.7 million as compared to a loss of $1.7 million for the three months ended June 30, 2014, an increase of $6.4 million.  The increase was primarily attributable to a $7.5 million increase in cash earnings as reflected in Adjusted EBITDA, partially offset by the income tax effect related to reconciling items in computing Adjusted Earnings.

For the six months ended June 30, 2015, Adjusted Earnings were $9.3 million compared to a loss of $0.2 million for the six months ended June 30, 2014, an increase of $9.5 million. The increase was primarily attributable to the increase in Adjusted EBITDA of $13.3 million, partially offset by the income tax effect related to reconciling items in computing Adjusted Earnings.

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Results of Operations

The following table sets forth certain combined statement of operations data derived from our unaudited combined financial statements included elsewhere in this Quarterly Report on Form 10-Q.

 

 

 

Three and Six Months Ended June 30, 2015 Compared to Three and Six Months Ended June 30, 2014

 

Revenues:

Total Fee Income and Fee Income from Related Party. Total fee income and fee income from related party for the three months ended June 30, 2015 was $47.4 million compared to $15.5 million for the three months ended June 30, 2014, an increase of $31.9 million or approximately 206%. The increase in fee income and fee income from related party was primarily related to increases in the volume of business we managed as a result of transactions that occurred in August of 2014 and from acquisitions completed in the first two quarters of 2015.

Total fee income and fee income from related party for the six months ended June 30, 2015 was $90.4 million compared with $31.1 million for the same period in 2014, an increase of $59.3 million or 191%.  The increase in fee income and fee income from related party was primarily related to increases in the volume of business we managed as a result of transactions that occurred in August of 2014 and from acquisitions completed in the first two quarters of 2015.

For the three and six months ended June 30, 2015, approximately 70% and 76%, respectively, of our total fee income and fee income from related party was attributable to our contracts with Guarantee Insurance, a related party, and approximately 9% of our

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total fee income and fee income from related party was attributable to contracts with our second largest client for both the three and six months ended June 30, 2015.

For the three and six months ended June 30, 2014, approximately 58% and 57%, respectively, of our total fee income and fee income from related party was attributable to our contracts with Guarantee Insurance, and approximately 36% and 34%, respectively, of our total fee income and fee income from related party were attributable to our contracts with our second largest client.

Fee Income. Fee income, which represents fee income from non-related parties, for the three months ended June 30, 2015 was $26.9 million compared to $9.2 million for the three months ended June 30, 2014, an increase of $17.7 million.  For the six months ended June 30, 2015, fee income was $45.3 million compared to $22.3 million for the six months ended June 30, 2014, an increase of $23.0 million.

Our prices by customer for our brokerage and policyholder services and claims administration services were unchanged for the six-month period ended June 30, 2015 relative to the six-month period ended June 30, 2014, and, accordingly, the net increase in fee income was solely related to changes in the volume of business we managed.

Fee Income from Related Party. Fee income from related party for the three months ended June 30, 2015 was $20.5 million compared to $6.3 million for the three months ended June 30, 2014, an increase of $14.2 million. For the six months ended June 30, 2015, fee income from related party was $45.1 million compared to $8.8 million for the six months ended June 30, 2014, an increase of $36.3 million.

Our prices by customer for our brokerage and policyholder services and claims administration services were unchanged for the six-month period ended June 30, 2015 relative to the six-month period ended June 30, 2014, and, accordingly, the net increase in fee income was solely related to changes in the volume of business we managed.

“Fee income from related party” represents a portion of fee income earned from Guarantee Insurance, a related party as described in Note 12, Related Party Transactions. 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.

Because fee income from related party for claims administration services is based on the net portion of claims expense retained by Guarantee Insurance, as described in Note 13, Concentration, the Company’s revenues attributable to contracts with Guarantee Insurance do not necessarily represent fee income from related party.

Net Investment Income. Net investment income was $35,000 for the three months ended June 30, 2015 compared to $211,000 for the three months ended June 30, 2014, a decrease of $176,000.  For the six months ended June 30, 2015, net investment income was $36,000 compared with $420,000 for the six months ended June 30, 2014. Net investment income for the three- and six-month periods ended June 30, 2014 was principally attributable to a surplus note from prior years.

Expenses:

Salaries and Related Expenses. Salaries and related expenses for the three months ended June 30, 2015 were $17.8 million compared to $4.3 million for the three months ended June 30, 2014, an increase of $13.5 million.

Salaries and related expenses for the six months ended June 30, 2015 were $32.2 million compared to $8.2 million for the six months ended June 30, 2014, an increase of $24.0 million.

This increase was principally due to additional salary and salary related costs, beginning August 6, 2014 (as discussed elsewhere in this Quarterly Report on Form 10-Q), as a result of directly incurring salary and salary related costs associated with our brokerage and policyholder services and administrative support services, including executive management, information technology, accounting, human resources and legal services. Prior to August 6, 2014, we received an allocation for such brokerage and policyholder services costs from Guarantee Insurance Group as described below under “—Allocation of Marketing, Underwriting and Policy Issuance Costs from Related Party” below, and a portion of such administrative support services costs was incurred in the form of a management fee paid to Guarantee Insurance Group as described under “—Management Fees to Related Party for Administrative Support Services” below. Salary and salary related costs further increased in the period since August 6, 2014 as a result of the new agreement we entered into with Guarantee Insurance to provide all of our brokerage and policyholder services to Guarantee Insurance. In addition, the increase was in part due to an increase in the volume of business we manage.

Commission Expense. Commission expense for the three months ended June 30, 2015 was $8.5 million compared to $1.9 million for the three months ended June 30, 2014, an increase of $6.6 million. For the six months ended June 30, 2015, commission expense was $17.4 million compared to $3.6 million for the six months ended June 30, 2014, an increase of $13.8 million. This increase was a

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direct result of the increased fee income and fee income from related party recognized as a result of the increased volume in business we manage.

Management Fees to Related Party for Administrative Support Services. There were no management fees to related party for administrative support services for the three and six months ended June 30, 2015 compared to $2.3 million and $4.5 million, respectively, for the three and six months ended June 30, 2014. Effective August 6, 2014, these support services expenses became incurred directly by us, and from that date forward we no longer pay management fees to Guarantee Insurance Group. 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 related expenses,” “outsourced services” and “other operating expenses.”

Outsourced Services. Outsourced services for the three months ended June 30, 2015 were $2.8 million compared to $0.7 million for the three months ended June 30, 2014, an increase of $2.1 million or approximately 300%. For the six months ended June 30, 2015 outsourced services were $5.3 million compared to $1.4 million for the six months ended June 30, 2014, an increase of $3.8 million or approximately 271%. This increase was principally due to the acquisition of Patriot Care Management, effective August 6, 2014.

Allocation of Marketing, Underwriting and Policy Issuance Costs from Related Party. There was no allocation of marketing, underwriting and policy issuance costs from Guarantee Insurance Group, a related party, for the three and six months ended June 30, 2015 compared to $0.9 million and $1.5 million for the three and six months ended June 30, 2014, respectively. Effective August 6, 2014, such costs became incurred directly by us, and from that date forward, Guarantee Insurance Group is no longer allocating these costs to 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.

Other Operating Expenses. Other operating expenses for the three months ended June 30, 2015 were $7.0 million compared to $1.6 million for the three months ended June 30, 2014, an increase of $5.4 million or approximately 338%.  For the six months ended June  30, 2015, other operating expenses were $13.3 million compared with $3.3 million for the six months ended June 30, 2014. The increase of other operating expense corresponds to the direct costs incurred as a result of eliminating management fees and expense allocations from Guarantee Insurance and from increased volume in business we manage.

Acquisition Costs. For the three and six months ended June 30, 2015, we incurred $2.3 million and $2.9 million of acquisition costs, respectively. These costs were predominantly comprised of salary expense, salary related costs and other fees.

Interest Expense. Interest expense for the three months ended June 30, 2015 was $0.5 million compared to $1.3 million for the three months ended June 30, 2014, a decrease of $0.8 million. Interest expense for the six months ended June 30, 2015, was $1.7 million compared to $2.6 million for the six months ended June 30, 2014, a decrease of $0.9 million.  The interest expense for the six months ended June 30, 2015 was comprised of $0.9 million of interest accrued for the PennantPark Debt and the UBS Debt prior to repayment on January 22, 2015 and $0.8 million on the Senior Secured Credit Facility from January 22, 2015 until June 30, 2015. Interest expense for the six months ended June 30, 2014 was comprised of interest on the PennantPark Debt then outstanding. The decrease in interest expense was a result of the refinancing of our debt with more favorable terms.

Depreciation and Amortization. Depreciation and amortization for the three months ended June 30, 2015 was $3.4 million compared to $1.0 million for the three months ended June 30, 2014, an increase of $2.4 million. For the six months ended June 30, 2015 and 2014, depreciation and amortization was $5.7 million and $2.0 million, respectively, representing a period over period increase of $3.7 million. The increase was attributable mainly to the increased intangible asset amortization associated with our acquisitions.

Amortization of Loan Discounts and Loan Costs. Amortization of loan discounts and loan costs was $0.1 million for the three months ended June 30, 2015, compared to $0.3 million for the three months ended June 30, 2014, a decrease of $0.2 million. For the six-month periods ended June 30, 2015 and 2014, amortization of loan discounts and loan costs was $0.1 million and $0.6 million, respectively. The decrease was attributable to the write-off of loan discounts and deferred loan costs upon repayment of the PennantPark Debt and UBS Debt on January 22, 2015.

Stock Compensation Expense. The Company recognized $3.7 million of stock compensation expense during the three months ended June 30, 2015 and $6.2 million of stock compensation expense for the six months ended June 30, 2015.  Stock compensation expense is related to restricted stock and stock option awards. See Note 10, Stock-Based Compensation, for further detail related to these awards and the recognized expense.

Decrease (Increase) in Fair Value of Warrant Redemption Liability. The decrease in fair value of warrant redemption liability was $1.4 million for the six months ended June 30, 2015 which reflects the change in fair value from estimated valuation on December 31, 2014 to the exercise of the detachable common stock warrants on January 22, 2015. The increase to the fair value of the warrant redemption liability for the six months ended June 30, 2014 was $6.5 million. Additionally, there was no remaining warrant redemption liability as of June 30, 2015, and no future fair value adjustments are required.

Cost from Debt Payoff. The Company recognized expenses for “make-whole” payments upon repayment of the PennantPark Debt and UBS Debt on January 22, 2015. These expenses were comprised of $3.8 million to the PennantPark Entities and $0.6 million to UBS.  Additionally, the Company recognized expenses for the write-off of existing deferred financing of $6.3 million and original issue discounts of $3.1 million associated with the PennantPark Debt and UBS Debt upon repayment on January 22, 2015.  Due to the

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non-recurring nature of these expenses, they are presented separately from interest expense and amortization expense, respectively, in our combined results for the six months ended June 30, 2015. Total cost from debt payoff was $13.7 million for the six months ended June 30, 2015.

Income Tax Expense. Income tax expense was $0.3 million for the three months ended June 30, 2015 compared to income tax expense of $0.4 million for the three months ended June 30, 2014, a decrease in income tax expense of $0.1 million. For the six months ended June 30, 2015 we had an income tax benefit of $3.1 million compared to a $1.3 million income tax expense for the six months ended June 30, 2014. For both the three and six months ended June 30, 2015, the effective income tax rates were approximately 42% and 38%, respectively.  The effective tax rate is based on forecasted annual pre-tax income, permanent differences and statutory tax rates.  The main difference in the effective tax rate from the statutory rate is warrants, success based fees, and meals and entertainment.

 

Net Income:

As a result of the factors described above, net income increased by $6.6 million to $1.0 million for the three months ended June 30, 2015 as compared to a net loss of $5.6 million for the three months ended June 30, 2014.  For the six months ended June 30, 2015, there was a $3.8 million net loss compared to a $4.1 million net loss for the six months ended June 30, 2014, a decrease of $0.3 million.

Seasonality

Although our revenue and operating results associated with our claims administration services are generally not subject to seasonality, 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 quarter based on the current distribution of such dates.

Impact of Inflation

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.

Liquidity and Capital Resources

Sources and Uses of Funds

Our principal needs for liquidity have been, and for the foreseeable future will continue to be, working capital, capital expenditures and funding potential acquisitions, potential redemption of detachable common stock warrants, as well as servicing our Senior Secured Credit Facility. Our primary sources of liquidity include cash flows from operations and available cash and cash equivalents.

We believe that our cash flow from operations and available cash and cash equivalents will be sufficient to meet our liquidity needs for the foreseeable future. As of June 30, 2015, our unrestricted cash and cash equivalents were $9.9 million. In addition, as of June 30, 2015, we had $3.3 million of equity and fixed income security investments and $15.1 million of restricted cash, which are funds we receive from our insurance carrier clients and are earmarked exclusively for payments of claims on behalf of such clients. We cannot use restricted cash for other purposes.

To the extent we require additional liquidity, we anticipate that it will be funded through the incurrence of other indebtedness (which may include capital markets indebtedness, our Senior Secured Credit Facility or indebtedness under other credit facilities), equity financings or a combination thereof. Although we have no specific current plans to do so, if we decide to pursue one or more significant acquisitions, we may incur additional debt or sell additional equity to finance such acquisitions.

Cash Flows

The following table summarizes our cash flow activities for the three months ended June 30, 2015 and 2014.

 

 

 Operating Activities

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Net cash provided by operating activities for the six months ended June 30, 2015 was $4.6 million compared to $7.1 million for the six months ended June 30, 2014, a decrease of $2.5 million. This decrease was largely attributable to $11.6 million of income tax payments made in 2015 related to the 2014 tax year.  This decrease was partially offset by an increase in cash earnings as reflected in the earlier discussion of Adjusted EBITDA, net of working capital fluctuations.

Investing Activities

Net cash used in investing activities for the six months ended June 30, 2015 was $57.7 million compared to $1.1 million for the six months ended June 30, 2014, an increase of $56.6 million. This increase was attributable to an increase in restricted cash of $4.0 million, the purchase of fixed assets and other intangible assets of $2.8 million, purchase of equity securities of $3.6 million which was partially offset by the sale of equity securities of $0.3 million, and funding for acquisitions of $47.5 million, net of $2.2 million of cash acquired.

Financing Activities

Net cash provided by financing activities for the six months ended June 30, 2015 was $58.7 million compared to net cash used in financing activities of $4.3 million for the six months ended June 30, 2014, an increase of $63.0 million. This increase was attributable to the proceeds from the IPO and our new debt structure less the repayment of previous debt and capital lease payments.

Capital Expenditures

For the six months ended June 30, 2015, we made capital expenditures of $2.8 million primarily attributable to capitalized software development. For the six months ended June 30, 2014, we made capital expenditures of $0.3 million.

Indebtedness

As of June 30, 2015, we had a total of $59.3 million of term loan debt outstanding under our Senior Secured Credit Facility, $25.6 million outstanding under our revolving credit facility, and $3.7 million of capital leases outstanding.

Senior Secured Credit Facility

On January 22, 2015, we entered into a 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 minimum increments of $5.0 million. As of June 30, 2015, we increased the term loan facility by $20.0 million through two $10.0 million incremental term loans.

As of June 30, 2015, the outstanding balance under the $40 million revolving credit facility was $25.6 million. Accordingly, the Company had $14.4 million available to borrow under the revolving credit facility.

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.

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.

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 such foreign subsidiaries do not exceed 5% of our and our subsidiaries’ total

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assets on a combined basis, and secured by a first-priority perfected security interest in substantially all of 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 ended 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.

As of June 30, 2015, we were in compliance with the financial and other restrictive covenants under our outstanding material debt obligations, including our Senior Secured Credit Facility.

Repayment of UBS Credit Agreement

On August 6, 2014, in connection with the Patriot Care Management Acquisition, we and certain of our subsidiaries entered into the UBS Credit Agreement, which provided for a five-year term loan facility in an aggregate principal amount of $57.0 million that would mature on August 6, 2019. The loan was secured by the common stock of Patriot Care Management, Inc. and guaranteed by Guarantee Insurance Group and its wholly owned subsidiaries. Following our initial public offering, we prepaid all outstanding borrowings under the UBS Credit Agreement, including accrued interest and applicable prepayment premium.

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.

Repayment of PennantPark Loan Agreement

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 initial public offering, we prepaid all outstanding borrowings under the PennantPark Loan Agreement, including accrued interest and applicable prepayment premium.

Borrowings under the PennantPark Loan Agreement were comprised of (i) an Initial Tranche in an aggregate principal amount of approximately $37.8 million and (ii) an Additional Tranche in an aggregate principal amount of approximately $30.8 million of new borrowings. Our borrowings under the PennantPark Loan Agreement were funded at a price equal to 97.5% of the par value thereof and bore interest equal to the sum of (i) the greater of 1.0% or LIBOR and (ii) 11.50%.

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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.

Off-Balance Sheet Arrangements

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 has employment agreements with certain executives and other employees, which provide for compensation and certain other benefits and for severance payments under certain circumstances.  The employment agreements contain clauses that become effective upon a change of control of the Company.  Upon the occurrence of any of the defined events in the employment agreements, the Company would be obligated to pay certain amounts to the relevant employees.

The Company maintains cash at various financial institutions, and, at times, balances may exceed federal insured limits.  Management does not believe this results in any material effect on the Company’s financial position or results of operations.  In the normal course of business, the Company may be party to various legal actions that management believes will not result in any material effect on the Company’s financial position or results of operations.

Recently Issued Financial Accounting Standards

 

In April 2015, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("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. Early adoption is permitted.  We are currently evaluating the requirements of the standard, but we do not anticipate electing early adoption.

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 July 2015, the FASB approved a proposed ASU to defer the effective date to annual reporting periods beginning after December 15, 2017 using one of two retrospective application methods with earlier adoption permitted for annual periods beginning after December 15, 2016. We are currently evaluating the accounting, transition and disclosure requirements of the standard and cannot currently estimate the financial statement impact of adoption.

 

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JOBS Act

The JOBS Act contains provisions that, among other things, allows an emerging growth company to take advantage of specified reduced reporting requirements. In particular, the JOBS Act provides that an emerging growth company can utilize the extended transition period provided in Section 7(a)(2)(B) of the Securities Act for complying with new or revised accounting standards. We have elected to take advantage of such extended transition period, and, as a result, we will not be required to comply with new or revised accounting standards on the relevant dates on which adoption of such standards is required for companies that are not emerging growth companies.

Reconciliations to Non-GAAP Key Performance Measures

 

 

 

 

 

 

 

 

 

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As of June 30, 2015, we were not subject to any material interest rate risk or credit risk, and we had no exposure to foreign currency risk.

 

 

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Disclosure Controls and Procedures

The Company maintains disclosure controls and procedures (as that term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) that are designed to ensure that information required to be disclosed in the Company’s reports under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and that such information is accumulated and communicated to the Company’s management, including its Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. Any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. The Company’s management, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Company’s disclosure controls and procedures as of the end of the period covered by this report. Based upon that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that, as of the end of the period covered by this report, the Company’s disclosure controls and procedures were effective at the reasonable assurance level.

Changes in Internal Control Over Financial Reporting

There was no change in the Company’s internal control over financial reporting (as that term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the Company’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

 

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PART II — OTHER INFORMATION

 

 

We are not a party to any pending legal proceedings that we believe are material to us. We may, from time to time, be party to litigation and subject to claims incident to the ordinary course of our business. In the normal course of the workers’ compensation insurance services business, we have been named as a defendant in suits related to decisions by us or our clients with respect to the settlement of claims or other matters arising out of the services we provide. In the opinion of management, adequate reserves have been provided for such matters. However, we cannot provide any assurances that the result of any such actions, claims or proceedings, now known or occurring in the future, individually or in the aggregate, will not result in a material adverse effect on our business, financial condition or results of operations.

 

 

For a discussion of our potential risks and uncertainties, see the information under the heading “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2014. Other than as described below, there have been no material changes to the risk factors disclosed in our Annual Report on Form 10-K for the year ended December 31, 2014.

We have acquired a number of insurance services firms in a short period of time, and there are risks associated with such acquisitions, which could adversely affect our growth and results of operations.

     We have recently acquired a number of insurance services firms in a short period of time. We believe that similar acquisition activity will be important to maintaining comparable growth in the future. Failure to successfully identify and complete acquisitions likely would likely result in slower growth. Even if we are able to identify appropriate acquisition targets, we may not be able to execute transactions on favorable terms or integrate targets in a manner that allows us to fully realize the anticipated benefits from these acquisitions. Our ability to finance and integrate acquisitions may also suffer if we expand the number or size of our acquisitions.

     Post-acquisition risks include those relating to retention of personnel, retention of clients, entry into unfamiliar markets or lines of business, contingencies or liabilities, such as violations of sanctions laws or anti-corruption laws, risks relating to ensuring compliance with licensing and regulatory requirements, tax and accounting issues, distractions to  management and personnel from our existing business and integration difficulties relating to accounting, information technology, human resources, or organizational culture and fit, some or all of which could have an adverse effect on our results of operations and growth. Post-acquisition deterioration of targets could also result in lower or negative earnings contribution and/or goodwill impairment charges.

 

 

None.

 

 

None.

 

 

Not applicable.

 

 

(a) None.

(b) None.

 

 

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The agreements and other documents filed as exhibits to this report are not intended to provide factual information or other disclosure other than with respect to the terms of the agreements or other documents themselves, and you should not rely on them for that purpose. In particular, any representations and warranties made by us in these agreements or other documents were made solely within the specific context of the relevant agreement or document and may not describe the actual state of affairs as of the date they were made or at any other time.

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

 

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