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FORTEGRA FINANCIAL CORP – 10-Q – MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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-------------------------------------------------------------------------------- Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") represents an overview of our results of operations and financial condition and should be read in conjunction with the Consolidated Financial Statements and Notes thereto included in Part I, of this Form 10-Q. Except for the historical information contained herein, the discussions in MD&A contain forward-looking statements that involve risks and uncertainties. Our future results could differ materially from those discussed herein. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in "Item 1A. Risk Factors" of this Form 10-Q. Executive Summary Our net income for the three months ended June 30, 2013 increased $0.5 million , or 12.6%, to $4.4 million from $3.9 million for the three months ended June 30, 2012 and was positively impacted by pre-tax gains of $1.3 million on the sale of investment securities and a pre-tax gain of $0.4 million on the sale of Magna Insurance Company . Earnings per diluted share increased 15.8% to $0.22 for the three months ended June 30, 2013 from $0.19 for the same period in 2012. For the three months ended June 30, 2013 , our total revenues increased $29.1 million</money>, or 40.9%, to $100.1 million from $71.1 million for the same period in 2012, with the increase in revenues primarily attributable to our December 31, 2012 acquisitions of ProtectCELL and 4Warranty, which accounted for $24.9 million and $0.6 million of the increase, respectively. Total revenues for the three months ended June 30, 2013 included $1.3 million of realized investment gains and a $0.4 million gain on the sale of our Magna Insurance Company . 32 -------------------------------------------------------------------------------- Total expenses increased $28.1 million , or 43.2%, to $93.1 million for the three months ended June 30, 2013 from $65.0 million for the same period in 2012. The majority of the increase for the 2013 period was due to our 2012 acquisitions of ProtectCELL and 4Warranty, which added $23.9 million and $0.7 million to expenses, respectively. Total expenses for the 2013 period also include an increase of $0.6 million in amortization of intangibles with the majority of the increase attributable to the 2012 acquisitions. Also, depreciation increased in the 2013 period, compared to the 2012 period, by $0.4 million from additional assets being placed in service during the month of December 2012 . Our net income for the six months ended June 30, 2013 decreased $0.4 million , or 5.7%, to $6.9 million from $7.4 million for the six months ended June 30, 2012 and was positively impacted by pre-tax gains of $1.3 million on the sale of investment securities and a pre-tax gain of $0.4 million on the sale of Magna Insurance Company . The positive factors were nearly offset by the additional $1.2 million in costs associated with our previously announced consolidation of operations plan, discussed below. Earnings per diluted share decreased 5.6% to $0.34 for the six months ended June 30, 2013 from $0.36 for the same period in 2012. For the six months ended June 30, 2013 , our total revenues increased $47.1 million , or 33%, to $190.0 million from $142.9 million for the same period in 2012, with the increase in revenues primarily attributable to our December 31, 2012 acquisitions of ProtectCELL and 4Warranty, which accounted for $40.4 million and $1.3 million of the increase, respectively. Total revenues for the six months ended June 30, 2013 also included $1.3 million of realized investment gains and a $0.4 million gain on the sale of our Magna Insurance Company . Total expenses increased $46.8 million , or 35.6%, to $178.3 million for the six months ended June 30, 2013 from $131.6 million for the same period in 2012. The majority of the increase was due to our 2012 acquisitions of ProtectCELL and 4Warranty, which added $38.0 million and $1.2 million to expenses, respectively. The 2013 expenses also included $1.2 million in costs associated with our previously announced consolidation of operations plan, discussed below. Total expenses for the 2013 period also included an increase of $1.1 million in amortization of intangibles with the majority of the increase attributable to the 2012 acquisitions. Also, depreciation increased in the 2013 period by $1.0 million , compared to the 2012 period, from additional assets being placed in service during the month of December 2012 . In January 2013 , we announced a plan to consolidate our fulfillment, claims administration and information technology functions for all our insurance related products (the "Plan"). Prior to the Plan, such functions resided in individual business units. The decision was part of our efforts to streamline operations, focus resources and provide first in class service to our customers. During the first quarter of 2013, approximately 40 employee and contract positions were eliminated. We estimate that the Plan will result in annual pre-tax savings of approximately $4.0 million . On February 1, 2013 , we acquired 100% of the outstanding stock of RICC, from subsidiaries of the Kemper Corporation ("Kemper") for $4.8 million . RICC is a property/casualty insurance company domiciled and licensed in California , which we intend to use for geographic expansion in our Payment Protection business. RICC had, at the time of purchase, no policies in force, and all remaining claim liabilities for previously issued policies are fully reinsured by Kemper's subsidiary, Trinity Universal Insurance Company . In June 30, 2013 , we sold our wholly owned subsidiary, Magna Insurance Company , for a sales price of $3.0 million and realized a $0.4 million pre-tax gain on the sale which is included in our results for both the three and the six months ended June 30, 2013 . During the three months ended June 30, 2013 we repurchased 200,000 shares under our share repurchase plan at an aggregate value of $1.4 million . We view our share repurchase plan as an effective method of creating stockholder value and a prudent use of available cash. Critical Accounting Policies Fortegra's critical accounting policies involving significant judgments and assumptions used in the preparation of the Consolidated Financial Statements as of June 30, 2013 are unchanged from the disclosures presented in the MD&A of Fortegra's 2012 Annual Report on Form 10-K. Recently Issued Accounting Standards For a discussion of recently issued accounting standards, please see the Note "Recent Accounting Standards" of the Notes to Consolidated Financial Statements of this Form 10-Q. COMPONENTS OF REVENUES AND EXPENSES For a complete discussion of our "Components of Revenues and Expenses," please see the MD&A in Part II, Item 7, of Fortegra's 2012 Annual Report on Form 10-K. 33 -------------------------------------------------------------------------------- RESULTS OF OPERATIONS The following tables set forth our Consolidated Statements of Income for the following periods: (in thousands, except shares, per share amounts and percentages) For the
Three Months Ended
% Change June 30, 2013 June 30, 2012 Change from 2012 from 2012 Revenues: Service and administrative fees $ 46,926 $ 21,786$ 25,140 115.4 % Brokerage commissions and fees 9,891 9,364 527 5.6 Ceding commission 6,957 7,210 (253 ) (3.5 ) Net investment income 752 732 20 2.7 Net realized investment gains 1,280 13 1,267 9,746.2 Net earned premium 33,681 31,905 1,776 5.6 Other income 259 48 211 439.6 Gain on sale of subsidiary 402 - 402 100.0 Total revenues 100,148 71,058 29,090 40.9 Expenses: Net losses and loss adjustment expenses 10,604 9,576 1,028 10.7 Member benefit claims 11,114 1,098 10,016 912.2 Commissions 41,611 31,282 10,329 33.0 Personnel costs 14,594 12,367 2,227 18.0 Other operating expenses 10,481 6,937 3,544 51.1 Depreciation and amortization 1,367 975 392 40.2 Amortization of intangibles 1,780 1,166 614 52.7 Interest expense 1,544 1,590 (46 ) (2.9 ) Total expenses 93,095 64,991 28,104 43.2 Income before income taxes and non-controlling interests 7,053 6,067 986 16.3 Income taxes 2,426 2,108 318 15.1 Income before non-controlling interests 4,627 3,959 668 16.9 Less: net income attributable to non-controlling interests 185 15 170 1,133.3 Net income $ 4,442 $ 3,944 $ 498 12.6 % Earnings per share: Basic $ 0.23 $ 0.20 Diluted $ 0.22 $ 0.19 Weighted average common shares outstanding: Basic 19,540,610 19,705,276 Diluted 20,523,090 20,632,233 34
-------------------------------------------------------------------------------- (in thousands, except shares, per share amounts and percentages) For the
Six Months Ended
% Change from June 30, 2013 June 30, 2012 Change from 2012 2012 Revenues: Service and administrative fees $ 85,784 $ 44,297$ 41,487 93.7 % Brokerage commissions and fees 19,622 18,884 738 3.9 Ceding commission 14,120 14,274 (154 ) (1.1 ) Net investment income 1,661 1,475 186 12.6 Net realized investment gains 1,287 10 1,277 12,770.0 Net earned premium 66,823 63,877 2,946 4.6 Other income 350 120 230 191.7 Gain on sale of subsidiary 402 - 402 100.0 % Total revenues 190,049 142,937 47,112 33.0
Expenses:
Net losses and loss adjustment expenses 21,139 20,842 297 1.4 Member benefit claims 20,092 2,401 17,691 736.8 Commissions 76,973 63,270 13,703 21.7 Personnel costs 30,440 23,759 6,681 28.1 Other operating expenses 20,286 13,676 6,610 48.3 Depreciation and amortization 2,685 1,713 972 56.7 Amortization of intangibles 3,728 2,648 1,080 40.8 Interest expense 2,988 3,242 (254 ) (7.8 ) Total expenses 178,331 131,551 46,780 35.6 Income before income taxes and non-controlling interests 11,718 11,386 332 2.9 Income taxes 3,780 3,995 (215 ) (5.4 ) Income before non-controlling interests 7,938 7,391 547 7.4 Less: net income attributable to non-controlling interests 1,003 33 970 2,939.4 Net income $ 6,935 $ 7,358 $ (423 ) (5.7 )% Earnings per share: Basic $ 0.35 $ 0.37 Diluted $ 0.34 $ 0.36 Weighted average common shares outstanding: Basic 19,548,632 19,792,763 Diluted 20,583,951 20,686,812 REVENUES Service and Administrative Fees Service and administrative fees for the three months endedJune 30, 2013 increased$25.1 million , or 115.4%, to$46.9 million from$21.8 million for the three months endedJune 30, 2012 . The increase resulted from$24.9 million and$0.6 million in current period revenues attributable to the 2012 acquisition of ProtectCELL and 4Warranty, respectively. Service and administrative fees for the six months endedJune 30, 2013 increased$41.5 million , or 93.7%, to$85.8 million from$44.3 million for the six months endedJune 30, 2012 . The increase resulted from$40.2 million and$1.3 million in current period revenues attributable to the 2012 acquisition of ProtectCELL and 4Warranty, respectively. Brokerage Commissions and Fees Brokerage commissions and fees for the three months endedJune 30, 2013 increased$0.5 million , or 5.6%, to$9.9 million from$9.4 million for the three months endedJune 30, 2012 . For the 2013 period, eReinsure and B&G increased$0.4 million and$0.2 million , respectively, compared to the same period in 2012, offset by a decline in premium financing, and collateral recovery revenues. Brokerage commissions and fees for the six months endedJune 30, 2013 increased$0.7 million , or 3.9%, to$19.6 million from$18.9 million for the six months endedJune 30, 2012 . For the 2013 period, B&G and eReinsure increased$0.4 million and$0.4 million , respectively, compared to the same period in 2012, offset by a decline in premium financing, and collateral recovery revenues.
Ceding Commission
35 -------------------------------------------------------------------------------- Ceding commission for the three months endedJune 30, 2013 decreased$0.3 million , or 3.5%, to$7.0 million from$7.2 million for the three months endedJune 30, 2012 . This decrease primarily resulted from lower underwriting results on the business ceded, based on mix of product and related losses and commission expenses. Ceding commission for the six months endedJune 30, 2013 decreased$0.2 million , or 1.1%, to$14.1 million from$14.3 million for the six months endedJune 30, 2012 . This decrease primarily resulted from lower underwriting results on the business ceded, based on mix of product and related losses and commission expenses. Net Investment Income Net investment income for the three months endedJune 30, 2013 increased$20.0 thousand , or 2.7%, to$0.8 million compared to$0.7 million for the three months endedJune 30, 2012 and for the six months endedJune 30, 2013 increased$0.2 million , or 12.6%, to$1.7 million compared to$1.5 million for the six months endedJune 30, 2012 . The increase for both periods in 2013 compared with both periods in 2012 was principally due to a higher average balance of fixed income securities, which was partially offset by an overall decrease in yields on our investment portfolio. Net Realized Investment Gains Net realized gains on the sale of investments totaled$1.3 million for the three months endedJune 30, 2013 compared to net realized gains of$13.0 thousand for the three months endedJune 30, 2012 . Net realized gains on the sale of investments totaled$1.3 million for the six months endedJune 30, 2013 compared to net realized gains of$10.0 thousand for the six months endedJune 30, 2012 . Nearly all of the gains for the six months endedJune 30, 2013 were attributable to the sales occurring during the three months endedJune 30, 2013 . Net Earned Premium Net earned premium for the three months endedJune 30, 2013 increased$1.8 million , or 5.6%, to$33.7 million from$31.9 million for the three months endedJune 30, 2012 . For the 2013 period, direct and assumed earned premium increased$7.1 million resulting from increased production from existing clients and new clients distributing our credit insurance and warranty products and geographic expansion. Because of this increase, ceded earned premiums increased$5.3 million , or 10.0%, for the three months endedJune 30, 2013 . On average, we maintained a 63.3% overall cession rate of direct and assumed earned premium for the six months endedJune 30, 2013 compared with 62.4% for the 2012 period. Net earned premium for the six months endedJune 30, 2013 increased$2.9 million , or 4.6%, to$66.8 million from$63.9 million for the six months endedJune 30, 2012 . For the 2013 period, direct and assumed earned premium increased$13.1 million resulting from increased production from existing clients and new clients distributing our credit insurance and warranty products and geographic expansion. Because of this increase, ceded earned premiums increased$10.2 million , or 9.5%, for the six months endedJune 30, 2013 . On average, we maintained a 63.7% overall cession rate of direct and assumed earned premium for the six months endedJune 30, 2013 compared with 62.6% for the 2012 period. Other Income Other income totaled$0.3 million and$48.0 thousand for the three months endedJune 30, 2013 and 2012, respectively.
Other income totaled
Gain on Sale of Subsidiary InJune 2013 , the Company sold its 100% interest inMagna Insurance Company and realized a gain of$0.4 million , which is included in the results for both the three and six months endedJune 30, 2013 .
EXPENSES
Net Losses and Loss Adjustment Expenses Net losses and loss adjustment expenses for the three months endedJune 30, 2013 increased$1.0 million , or 10.7%, to$10.6 million , from$9.6 million for the three months endedJune 30, 2012 . Our net losses and loss adjustment expense ratio increased from 30.0% in 2012 to 31.5% in 2013. The increase in net losses and loss adjustment expense ratio was primarily driven by unfavorable loss experience for the 2013 period. For the 2013 period, our direct and assumed losses increased by$2.4 million , or 12.1%, as compared with the same period in 2012. For the 2013 period, our ceded losses were higher by$1.4 million , or 13.3%, compared with the same period in 2012, partially offsetting the increase in direct and assumed losses and loss adjustment expense. On average, we maintained a 52.8% and 52.3% overall cession rates of direct and assumed losses and loss adjustment expenses for the three months endedJune 30, 2013 and 2012, respectively. Net losses and loss adjustment expenses for the six months endedJune 30, 2013 increased$0.3 million , or 1.4%, to$21.1 million , from$20.8 million for the six months endedJune 30, 2012 . Our net losses and loss adjustment expense ratio improved from 32.6% 36 -------------------------------------------------------------------------------- in 2012 to 31.6% in 2013. The decrease in net losses and loss adjustment expense ratio was primarily driven by favorable loss experience in the first quarter of 2013. For the 2013 period, our direct and assumed losses increased by$0.4 million , or 0.9%, as compared with the same period in 2012. For the 2013 period, our ceded losses were higher by$0.1 million , or 0.4%, compared with the same period in 2012, partially offsetting the increase in direct and assumed losses and loss adjustment expense. On average, we maintained a 51.4% and 51.7% overall cession rates of direct and assumed losses and loss adjustment expenses for the six months endedJune 30, 2013 and 2012, respectively. Member Benefit Claims Member benefit claims for the three months endedJune 30, 2013 increased$10.0 million , to$11.1 million , from$1.1 million for the three months endedJune 30, 2012 . The increase resulted from the 2012 acquisition of ProtectCELL which added$9.9 million in warranty service claims and a$0.1 million increase inMotor Club claims. Member benefit claims for the six months endedJune 30, 2013 increased$17.7 million , to$20.1 million , from$2.4 million for the six months endedJune 30, 2012 . The increase resulted from the 2012 acquisition of ProtectCELL which added$17.7 million .
Commissions
Commissions for the three months endedJune 30, 2013 increased$10.3 million , or 33.0%, to$41.6 million , from$31.3 million for the three months endedJune 30, 2012 . The increase resulted primarily from$8.3 million in commissions attributable to the 2012 acquisition of ProtectCELL, as well as increases of$1.7 million in our credit insurance products due to growth in earned premiums and underwriting profits of those products, and$0.3 million from theMotor Clubs due to growth particularly in products with high commission rates. Commissions for the six months endedJune 30, 2013 increased$13.7 million , or 21.7%, to$77.0 million , from$63.3 million for the six months endedJune 30, 2012 . The increase resulted primarily from$9.7 million in commissions attributable to the 2012 acquisition of ProtectCELL, as well as increases of$2.9 million in our credit insurance products due to growth in earned premiums and underwriting profits of those products, and$1.0 million from theMotor Clubs due to growth particularly in products with high commission rates. Personnel Costs Personnel costs for the three months endedJune 30, 2013 increased$2.2 million , or 18.0%, to$14.6 million from$12.4 million for the three months endedJune 30, 2012 . The 2012 acquisition of ProtectCELL increased personnel costs by$2.3 million , which was partially offset by the impact of the decrease in headcount associated with the Plan during the three months endedJune 30, 2013 . Stock-based compensation expense included in personnel costs totaled$0.2 million and$0.1 million for the three months endedJune 30, 2013 and 2012, respectively. Personnel costs for the six months endedJune 30, 2013 increased$6.7 million , or 28.1%, to$30.4 million from$23.8 million for the six months endedJune 30, 2012 . The increase resulted primarily from$4.3 million and$0.6 million for the 2012 acquisitions of ProtectCELL and 4Warranty, respectively, and <money>$1.2 million in non-recurring costs associated with the Plan. Stock-based compensation expense included in personnel costs totaled$0.4 million and$0.2 million for the six months endedJune 30, 2013 and 2012, respectively. Other Operating Expenses Other operating expenses for the three months endedJune 30, 2013 increased$3.5 million , or 51.1%, to$10.5 million from$6.9 million for the three months endedJune 30, 2012 . This increase was primarily due to the 2012 ProtectCELL and 4Warranty acquisitions, which added$2.7 million and$0.1 million , respectively, while increases in our direct to consumer business andMotor Clubs added$0.3 million and$0.2 million , respectively. Other operating expenses for the six months endedJune 30, 2013 increased$6.6 million , or 48.3%, to$20.3 million from$13.7 million for the six months endedJune 30, 2012 . These expenses increased primarily due to the 2012 ProtectCELL and 4Warranty acquisitions, which added$4.7 million and$0.3 million , respectively, while increases in our payment protection, direct to consumer and motor clubs businesses added$0.6 million ,$0.3 million and$0.3 million , respectively. Depreciation and Amortization Depreciation and amortization expense for the three months endedJune 30, 2013 increased$0.4 million , or 40.2%, to$1.4 million from$1.0 million for the three months endedJune 30, 2012 , while depreciation and amortization expense for the six months endedJune 30, 2013 increased$1.0 million or 56.7% to$2.7 million from$1.7 million for the six months endedJune 30, 2012 . The increase for both periods compared to the same prior year periods was due to higher levels of depreciable and amortizable assets in service during 2013 compared to 2012. 37
-------------------------------------------------------------------------------- Amortization of Intangibles Amortization expense on intangibles for the three months endedJune 30, 2013 increased$0.6 million , or 52.7%, to$1.8 million from$1.2 million for the three months endedJune 30, 2012 . The increase was primarily due to the 2012 acquisitions of ProtectCELL and 4Warranty, which increased amortization expense on intangibles by$0.5 million and$0.1 million , respectively. Amortization expense on intangibles for the six months endedJune 30, 2013 increased$1.1 million , or 40.8%, to$3.7 million from$2.6 million for the six months endedJune 30, 2012 . The increase was primarily due to the 2012 acquisitions of ProtectCELL and 4Warranty, which increased amortization expense on intangibles by$1.2 million and$0.2 million , respectively, which was tempered by lower amortization expense on acquired intangibles at our other subsidiary companies. Interest Expense Interest expense for the three months endedJune 30, 2013 decreased$46.0 thousand , or 2.9%, to$1.5 million from$1.6 million for the three months endedJune 30, 2012 and for the six months endedJune 30, 2013 decreased$0.3 million , or 7.8%, to$3.0 million from$3.2 million for the six months endedJune 30, 2012 . The decrease for both periods in 2013, compared to 2012, was attributable to a lower interest rate on outstanding borrowings during 2013 from our new credit facility withWells Fargo Bank, N.A. , which took effect onAugust 2, 2012 . The decrease in interest expense for both periods in 2013, compared to 2012 was slightly offset by higher outstanding borrowings during both periods in 2013 when compared to the 2012 outstanding borrowings. Income Taxes Income taxes for the three months endedJune 30, 2013 increased$0.3 million , or 15.1%, to$2.4 million from$2.1 million for the three months endedJune 30, 2012 , with the increase primarily attributable to a lower amount of favorable tax preference items and a higher level of pretax income. Our effective tax rate was 34.4% for the three months endedJune 30, 2013 compared to 34.7% for the same period in 2012. Income taxes for the six months endedJune 30, 2013 decreased$0.2 million , or 5.4%, to$3.8 million from$4.0 million for the six months endedJune 30, 2012 , with the decrease primarily attributable to the tax effect of our non-controlling interest in ProtectCELL and a lower level of pretax income. Our effective tax rate was 32.3% for the six months endedJune 30, 2013 compared to 35.1% for the same period in 2012. During the later part of 2012, we were under examination by theInternal Revenue Service ("IRS") for the 2009 and 2010 tax years. InFebruary 2013 , theIRS completed its field audit and inMarch 2013 , we received notice from theIRS that the audit report has been fully approved. We have agreed to those findings and paid$57.0 thousand , which was expensed during the first quarter of 2013.
RESULTS OF OPERATIONS - SEGMENTS
We conduct our business through three business segments: (i) Payment Protection; (ii) BPO; and (iii) Brokerage. The revenue for each segment is presented to reflect the operating characteristics of the segment. We allocate certain revenues and costs to our segments. These items consist primarily of corporate-related income, transaction related costs, executive stock compensation and other overhead expenses. For additional information regarding segment net revenues and operating expenses, see the Note, "Segment Results" in the Notes to the Consolidated Financial Statements included in this Form 10-Q. In this Form 10-Q, we present EBITDA, segment EBITDA margin and Adjusted EBITDA. These financial measures as presented in this Form 10-Q are considered Non-GAAP financial measures and are not recognized terms under U.S. GAAP and should not be used as an indicator of, and are not an alternative to, net income as a measure of operating performance. EBITDA as used in this Form 10-Q is net income before interest expense, income taxes, net income attributable to non-controlling interests, depreciation and amortization. Adjusted EBITDA, as used in this Form 10-Q means "Consolidated Adjusted EBITDA" which is defined under our credit facility withWells Fargo Bank, N.A. , which in general terms means consolidated net income before non-controlling interests, consolidated interest expense, consolidated amortization expense, consolidated depreciation expense and consolidated income tax expense. The other items excluded in this calculation may include if applicable, but are not limited to, specified acquisition costs, impairment of goodwill and other non-cash charges, stock-based compensation expense and unusual or non-recurring charges. The calculation below does not give effect to certain additional adjustments permitted under our credit facility, which if included, would increase the amount of Adjusted EBITDA reflected in this table. We believe presenting EBITDA and Adjusted EBITDA provides investors with a supplemental financial measure of our operating performance. In addition to the financial covenant requirements under our credit facility, management uses EBITDA and Adjusted EBITDA as financial measures of operating performance for planning purposes, which may include, but are not limited to, the preparation of budgets and projections, the determination of bonus compensation for executive officers, the analysis of the allocation of resources and the evaluation of the effectiveness of business strategies. Although we use EBITDA and Adjusted EBITDA as financial measures to assess the operating performance of our business, both measures have significant limitations as analytical tools because they exclude certain material expenses. For example, they do not include interest expense and the payment of income taxes, which are both a necessary element of our costs and operations. Since we use property and equipment to generate service revenues, depreciation expense 38 -------------------------------------------------------------------------------- is a necessary element of our costs. In addition, the omission of amortization expense associated with our intangible assets further limits the usefulness of this financial measure. Management believes the inclusion of the adjustments to EBITDA and Adjusted EBITDA are appropriate to provide additional information to investors about certain material non-cash items and about unusual items that we do not expect to continue at the same level in the future. Because EBITDA and Adjusted EBITDA do not account for these expenses, its utility as a financial measure of our operating performance has material limitations. Due to these limitations, management does not view EBITDA and Adjusted EBITDA in isolation or as a primary financial performance measure. We believe EBITDA and Adjusted EBITDA are frequently used by securities analysts, investors and other interested parties in the evaluation of similar companies in similar industries and to measure a company's ability to service its debt and other cash needs. Because the definitions of EBITDA and Adjusted EBITDA (or similar financial measures) may vary among companies and industries, they may not be comparable to other similarly titled financial measures used by other companies. The following tables present segment revenue and expense information, segment EBITDA and EBITDA margin information and a reconciliation to net income: (in thousands, except percentages) For the Three Months Ended Change from % Change from June 30, 2013 June 30, 2012 2012 2012 Payment Protection: Service and administrative fees$ 42,568 $ 16,959 $ 25,609 151.0 % Ceding commission 6,957 7,210 (253 ) (3.5 ) Net investment income 752 732 20 2.7 Net realized investment gains 1,280 13 1,267 9,746.2 Other income (1) 661 48 613 1,277.1 Net earned premium 33,681 31,905 1,776 5.6 Net losses and loss adjustment expenses (10,604 ) (9,576 ) (1,028 ) 10.7 Member benefit claims (11,114 ) (1,098 ) (10,016 ) 912.2 Commissions (41,611 ) (31,282 ) (10,329 ) 33.0 Payment Protection revenue, net 22,570 14,911 7,659 51.4 Operating expenses - Payment Protection 14,778 8,729 6,049 69.3 EBITDA 7,792 6,182 1,610 26.0 EBITDA margin 34.5 % 41.5 % Depreciation and amortization 1,634 865 769 88.9 Interest expense 1,065 971 94 9.7 Income before income taxes and non-controlling interest 5,093 4,346 747 17.2 BPO: BPO revenue 3,969 4,409 (440 ) (10.0 ) Operating expenses 2,780 3,351 (571 ) (17.0 ) EBITDA 1,189 1,058 131 12.4 EBITDA margin 30.0 % 24.0 % Depreciation and amortization 833 498 335 67.3 Interest Expense 175 259 (84 ) (32.4 ) Income before income taxes and non-controlling interest 181 301 (120 ) (39.9 ) Brokerage: Brokerage revenue 10,280 9,782 498 5.1 Operating expenses 7,517 7,224 293 4.1 EBITDA 2,763 2,558 205 8.0 EBITDA margin 26.9 % 26.2 % Depreciation and amortization 680 778 (98 ) (12.6 ) Interest expense 304 360 (56 ) (15.6 ) Income before income taxes and non-controlling interest 1,779 1,420 359 25.3 Segment net revenue 36,819 29,102 7,717 26.5 Net losses and loss adjustment expenses 10,604 9,576 1,028 10.7 Member benefit claims 11,114 1,098 10,016 912.2 39
-------------------------------------------------------------------------------- (in thousands, except percentages) For the
Three Months Ended
% Change from June 30, 2013 June 30, 2012 Change from 2012 2012 Commissions 41,611 31,282 10,329 33.0 Total revenue 100,148 71,058 29,090 40.9 Segment operating expenses 25,075 19,304 5,771 29.9 Net losses and loss adjustment expenses 10,604 9,576 1,028 10.7 Commissions 41,611 31,282 10,329 33.0 Total expenses before depreciation, amortization and interest expense 88,404 61,260 27,144 44.3 Total EBITDA 11,744 9,798 1,946 19.9 Depreciation and amortization 3,147 2,141 1,006 47.0 Interest expense 1,544 1,590 (46 ) (2.9 ) Total income before income taxes and non-controlling interest 7,053 6,067 986 16.3 Income taxes 2,426 2,108 318 15.1 Less: net income attributable to non-controlling interest 185 15 170 1,133.3 Net income $ 4,442 $ 3,944 $ 498 12.6 % (1) - Includes the$402 gain on sale of subsidiary for the three months endedJune 30, 2013 . (in thousands, except percentages) For the Six Months Ended $ Change % Change from June 30, 2013 June 30, 2012 from 2012 2012 Payment Protection: Service and administrative fees$ 76,768 $ 34,762 $ 42,006 120.8 % Ceding commission 14,120 14,274 (154 ) (1.1 ) Net investment income 1,661 1,475 186 12.6 Net realized investment gains 1,287 10 1,277 12,770.0 Other income (1) 752 120 632 526.7 Net earned premium 66,823 63,877 2,946 4.6 Net losses and loss adjustment expenses (21,139 ) (20,842 ) (297 ) 1.4 Member benefit claims (20,092 ) (2,401 ) (17,691 ) 736.8 Commissions (76,973 ) (63,270 ) (13,703 ) 21.7 Payment Protection revenue, net 43,207 28,005 15,202 54.3 Operating expenses - Payment Protection 29,670 16,642 13,028 78.3 EBITDA 13,537 11,363 2,174 19.1 EBITDA margin 31.3 % 40.6 % Depreciation and amortization 3,409 1,714 1,695 98.9 Interest expense 2,022 1,983 39 2.0 Income before income taxes and non-controlling interests 8,106 7,666 440 5.7 BPO: BPO revenue 8,183 8,614 (431 ) (5.0 ) Operating expenses 6,336 6,484 (148 ) (2.3 ) EBITDA 1,847 2,130 (283 ) (13.3 ) EBITDA margin 22.6 % 24.7 % Depreciation and amortization 1,667 1,001 666 66.5 Interest expense 352 526 (174 ) (33.1 ) (Loss) income before income taxes and non-controlling interests (172 ) 603 (775 ) (128.5 ) Brokerage: Brokerage revenue 20,455 19,805 650 3.3 Operating expenses 14,720 14,309 411 2.9 EBITDA 5,735 5,496 239 4.3 EBITDA margin 28.0 % 27.8 % Depreciation and amortization 1,337 1,646 (309 ) (18.8 ) 40
-------------------------------------------------------------------------------- (in thousands, except percentages) For the Six Months Ended $ Change from % Change June 30, 2013 June 30, 2012 2012 from 2012 Interest expense 614 733 (119 ) (16.2 ) Income before income taxes and non-controlling interests 3,784 3,117 667 21.4 Segment net revenue 71,845 56,424 15,421 27.3 Net losses and loss adjustment expenses 21,139 20,842 297 1.4 Member benefit claims 20,092 2,401 17,691 736.8 Commissions 76,973 63,270 13,703 21.7 Total revenue 190,049 142,937 47,112 33.0 Segment operating expenses 50,726 37,435 13,291 35.5 Net losses and loss adjustment expenses 21,139 20,842 297 1.4 Member benefit claims 20,092 2,401 17,691 736.8 Commissions 76,973 63,270 13,703 21.7 Total expenses before depreciation, amortization and interest expense 168,930
123,948 44,982 36.3
Total EBITDA 21,119 18,989 2,130 11.2 Depreciation and amortization 6,413 4,361 2,052 47.1 Interest expense 2,988 3,242 (254 ) (7.8 ) Total income before income taxes and non-controlling interests 11,718 11,386 332 2.9 Income taxes 3,780 3,995 (215 ) (5.4 ) Less: net income attributable to non-controlling interests 1,003 33 970 2,939.4 Net income $ 6,935 $ 7,358$ (423 ) (5.7 )% (1) - Includes the$402 gain on sale of subsidiary for the six months endedJune 30, 2013 .
The table below presents a reconciliation of net income to EBITDA and Adjusted EBITDA for the following periods:
For the Three Months Ended For the Six Months Ended (in thousands) June 30, 2013 June 30, 2012 June 30, 2013 June 30, 2012 Net income$ 4,442 $ 3,944 $ 6,935 $ 7,358 Depreciation and amortization 1,367 975 2,685 1,713 Amortization of intangibles 1,780 1,166 3,728 2,648 Interest expense 1,544 1,590 2,988 3,242 Income taxes 2,426 2,108 3,780 3,995 Net income attributable to non-controlling interests 185 15 1,003 33 EBITDA 11,744 9,798 21,119 18,989 Transaction costs (a) 55 37 141 134 Restructuring expenses 80 - 1,234 - Gain on sale of subsidiary (402 ) - (402 ) - Legal expenses 243 - 243 - Stock-based compensation expense 328 190 632 369 Adjusted EBITDA$ 12,048 $ 10,025 $ 22,967 $ 19,492 (a) Represents transaction costs associated with acquisitions. Payment Protection Segment Net revenues for the three months endedJune 30, 2013 increased$7.7 million , or 51.4%, to$22.6 million from$14.9 million for the three months endedJune 30, 2012 . The increase resulted primarily from a$6.8 million increase in net revenue attributable to the 2012 acquisition of ProtectCELL and$0.5 million for 4Warranty. In addition, realized gains increased by$1.3 million due to gains on invested assets sold in the second quarter of 2013, while other income included a gain of$0.4 million on the sale ofMagna Insurance Company inJune 2013 . These increases were partially offset by credit and warranty products net revenue decreasing$1.0 million and reducedMotor Club net revenues of$0.4 million . Net revenues for the six months endedJune 30, 2013 increased$15.2 million , or 54.3%, to$43.2 million from$28.0 million for the six months endedJune 30, 2012 . The increase resulted primarily from a$13.0 million increase in net revenue attributable to the 2012 acquisition of ProtectCELL and$1.2 million for 4Warranty. In addition, realized gains increased by$1.3 million due to gains on 41 -------------------------------------------------------------------------------- invested assets sold in the second quarter of 2013, while other income included a gain of$0.4 million on the sale ofMagna Insurance Company inJune 2013 . These increases were partially offset by reducedMotor Club net revenues of$0.7 million . Net investment income on our portfolio increased by$0.2 million due to a higher level of invested assets. Operating expenses for the three months endedJune 30, 2013 increased$6.0 million , or 69.3%, to$14.8 million from$8.7 million for the three months endedJune 30, 2012 . The increase resulted primarily from a$5.0 million increase in expenses attributable to the 2012 acquisition of ProtectCELL and$0.5 million for 4Warranty. In addition, other operating expenses increased$1.0 million to expand our payment protection and motor club businesses and develop direct-to-consumer opportunities, while costs allocated to the segment decreased$0.4 million due to cost saving initiatives. Operating expenses for the six months endedJune 30, 2013 increased$13.0 million , or 78.3%, to$29.7 million from$16.6 million for the six months endedJune 30, 2012 . The increase resulted primarily from a$8.9 million increase in expenses attributable to the 2012 acquisition of ProtectCELL and$0.9 million for 4Warranty. In addition, other operating expenses increased$2.4 million to expand our payment protection and motor club businesses and develop direct-to-consumer opportunities, while costs allocated to the segment increased$0.9 million which included$1.0 million in restructuring costs related to the Plan. EBITDA for the three months endedJune 30, 2013 increased$1.6 million , or 26.0%, to$7.8 million from$6.2 million for the same period in 2012. EBITDA margin was 34.5% and 41.5% for the three months endedJune 30, 2013June 30, 2013 increased$2.2 million , or 19.1%, to$13.5 million from$11.4 million for the same period in 2012. EBITDA margin was 31.3% and 40.6% for the six months endedJune 30, 2013 and 2012, respectively. The lower EBITDA margin for both periods in 2013, compared to the 2012 periods, primarily resulted from a change in the mix of business with the addition of ProtectCELL and higher operating expenses within ourMotor Clubs division. BPO Segment Revenues for the three months endedJune 30, 2013 decreased$0.4 million , or 10.0%, to$4.0 million from$4.4 million for the three months endedJune 30, 2012 . The 2013 revenues reflect an increase of$0.1 million from PBG, offset by lower service and administrative fees for our insurance company clients, which decreased$0.3 million and a one-time setup fee earned in second quarter of 2012 of$0.2 million for our life and annuity products not repeated in 2013. Revenues for the six months endedJune 30, 2013 decreased$0.4 million , or 5.0%, to$8.2 million from$8.6 million for the six months endedJune 30, 2012 . The 2013 revenues reflect an increase of$0.2 million from PBG partially offset by lower service and administrative fees for our insurance company clients, which decreased$0.5 million and a one-time set-up fee earned in second quarter of 2012 of$0.2 million for our life and annuity products not repeated in 2013.
Operating expenses for the three months ended
Operating expenses for the six months endedJune 30, 2013 decreased$0.1 million , or 2.3%, to$6.3 million from$6.5 million for the six months endedJune 30, 2012 . The decrease resulted primarily from lower administrative expenses of$0.5 million due to cost saving initiatives implemented in the first quarter of 2013. This decrease was partially offset by additional expenses of$0.3 million from PBG to support growth initiatives. EBITDA for the three months endedJune 30, 2013 was$1.2 million compared to$1.1 million for the same period in 2012. EBITDA margin was 30.0%and 24.0% for the three months endedJune 30, 2013 and 2012, respectively. The higher margin for 2013, compared to the same period in 2012, resulted primarily from decreases in operating expenses. EBITDA for the six months endedJune 30, 2013 was$1.8 million compared to$2.1 million for the same period in 2012. EBITDA margin was 22.6% and 24.7% for the six months endedJune 30, 2013 and 2012, respectively. The lower margin for 2013, compared to the same period in 2012, resulted primarily from the decrease in revenues. Brokerage Segment Revenues for the three months endedJune 30, 2013 increased$0.5 million , or 5.1%, to$10.3 million for the three months endedJune 30, 2013 compared to$9.8 million for the three months endedJune 30, 2012 . Revenues for the three months endedJune 30, 2013 at eReinsure and B&G increased$0.4 million and$0.2 million , respectively, compared to the same period in 2012, partially offset by a decline in premium financing, and collateral recovery revenues.
Revenues for the six months ended
42 -------------------------------------------------------------------------------- and B&G increased$0.5 million and$0.3 million , respectively, compared to the same period in 2012, offset by a decline in premium financing, and collateral recovery revenues. Operating expenses for the three months endedJune 30, 2013 increased$0.3 million , or 4.1%, to$7.5 million , compared to$7.2 million for the same period in 2012. For both periods in 2013 and 2012, the majority of our expenses were personnel costs, which totaled$5.3 million and$5.4 million , respectively.
Operating expenses for the six months ended
EBITDA for the three months endedJune 30, 2013 was$2.8 million compared to$2.6 million for the same period in 2012. EBITDA margin was 26.9% and 26.2% for the three months endedJune 30, 2013 and 2012, respectively. EBITDA for the six months endedJune 30, 2013 was$5.7 million compared to$5.5 million for the same period in 2012. EBITDA margin was 28.0% and 27.8% for the six months endedJune 30, 2013 and 2012, respectively.
Corporate Segment No income or expenses were allocated to the Corporate segment for the three months or the six months ended
Goodwill by Business Segment The following table shows goodwill assigned to each business segment: (in thousands) At June 30, 2013 Payment Protection: Summit Partners Transactions$ 22,763 Darby & Associates 642 Continental 5,427 United 4,581 Auto Knight 4,215 ProtectCELL 19,913 4Warranty 2,691 Total Payment Protection 60,232 BPO: Summit Partners Transactions 8,902 PBG 4,068 Total BPO 12,970 Brokerage: B&G 30,468 South Bay 478 eReinsure 23,512 Total Brokerage 54,458 Total Goodwill$ 127,660 LIQUIDITY AND CAPITAL RESOURCES Liquidity Liquidity describes the ability of a company to generate sufficient cash flows to meet the cash requirements of its business operations, including working capital needs, capital expenditures, debt service, acquisitions and other commitments and contractual obligations. We historically have derived our liquidity from our invested assets, cash flow from operations, ordinary and extraordinary dividend capacity from our subsidiary insurance companies, our credit facility and investments. When considering our liquidity, it is important to note that we hold cash in a fiduciary capacity as a result of premiums received from insured parties that have not yet been paid to insurance carriers. The fiduciary cash is recorded as an asset on our Consolidated Balance Sheets with a corresponding liability, net of our commissions, to insurance carriers. Our primary cash requirements include the payment of our operating expenses, interest and principal payments on our debt, capital expenditures and acquisitions. We may also incur unexpected costs and operating expenses related to any unforeseen disruptions to our facilities and equipment, the loss of key personnel or changes in the credit markets and interest rates, which could increase our immediate cash requirements or otherwise impact our liquidity. 43 -------------------------------------------------------------------------------- Our primary sources of liquidity are our total investments, cash and cash equivalent balances, availability under our revolving credit facility and dividends and other distributions from our subsidiaries. AtJune 30, 2013 , we had total available-for-sale and short-term investments of$132.3 million , which includes restricted investments of$15.8 million , cash and cash equivalents of$15.6 million and$33.8 million of available capacity on our credit facility. AtDecember 31, 2012 , we had total available-for-sale and short-term investments of$118.1 million , which includes restricted investments of$17.9 million , cash and cash equivalents of$15.2 million and$35.6 million of available capacity on our credit facility. Our total indebtedness was$122.5 million atJune 30, 2013 compared to$124.4 million atDecember 31, 2012 . We believe that our cash flow from operations and our availability under our revolving credit facility, combined with our low capital expenditure requirements will provide us with sufficient capital to continue to grow our business over the next several years. We intend to use a portion of our available cash flow to pay interest on our outstanding debt, thus limiting the amount available for working capital, capital expenditures and other general corporate purposes. As we continue to expand our business and make acquisitions, we may in the future require additional working capital to meet our future business needs. This additional working capital may be in the form of additional debt or equity. Although we believe we have sufficient liquidity under our revolving credit facility, as discussed above, under adverse market conditions or in the event of a default under our revolving credit facility, there can be no assurance that such funds would be available or sufficient, and, in such a case, we may not be able to successfully obtain additional financing on favorable terms, or at all, or replace our existing credit facility upon maturity inAugust 2017 . Share Repurchase Plan During the fourth quarter of 2011, our Board of Directors approved a share repurchase plan. The share repurchase plan allows us to purchase up to$10.0 million of our common stock to be purchased from time to time through open market or private transactions. The plan provides for shares to be repurchased for general corporate purposes, which may include serving as a resource for funding potential acquisitions and employee benefit plans. The timing, price and quantity of purchases are at our discretion, and the plan may be discontinued or suspended at any time. For the three months and six months endedJune 30, 2013 , we repurchased 200,000 shares of outstanding common stock at an average price of$6.79 per share at a total cost of$1.4 million . We did not repurchase any shares during the three months endedMarch 31, 2013 . For the three months endedJune 30, 2012 , we repurchased a total of 164,817 shares at an average price of$8.17 per share at a total cost of$1.3 million . For the six months endedJune 30, 2012 , we repurchased a total of 360,577 shares at an average price of$7.60 per share at a total cost of$2.7 million . AtJune 30, 2013 , the total amount still of shares available to be repurchased under the share repurchase plan totaled$2.2 million . All repurchased common shares are held in treasury and none of the repurchased common shares have been retired.See Part II , Item 2 of this Form 10-Q, for more information on the share repurchase plan. Regulatory Requirements We are a holding company and have limited direct operations. Our holding company assets consist primarily of the capital stock of our subsidiaries. Accordingly, our future cash flows depend upon the availability of dividends and other payments from our subsidiaries, including statutorily permissible payments from our insurance company subsidiaries, as well as payments under our tax allocation agreement and management agreements with our subsidiaries. The ability of our insurance company subsidiaries to pay such dividends and to make such other payments are limited by applicable laws and regulations of the states in which our subsidiaries are domiciled, which vary from state to state and by type of insurance provided by the applicable subsidiary. These laws and regulations require, among other things, our insurance subsidiaries to maintain minimum solvency requirements and limit the amount of dividends these subsidiaries can pay to the holding company. Along with solvency regulations, the primary factor in determining the amount of capital available for potential dividends is the level of capital needed to maintain desired financial strength ratings fromA.M. Best for our insurance company subsidiaries. Given recent economic events that have affected the insurance industry, both regulators and rating agencies could become more conservative in their methodology and criteria, including increasing capital requirements for our insurance subsidiaries which, in turn, could negatively affect our capital resources.
The following table sets forth the dividends paid to us by our insurance company subsidiaries during the following periods:
For the Six Months Ended For the Twelve Months Ended (in thousands) June 30, 2013 December 31, 2012 Ordinary dividends $ 231 $ 2,783 Extraordinary dividends - - Total dividends $ 231 $ 2,783$125.0 Million Credit Facility OnAugust 2, 2012 , we entered into a five-year secured credit agreement (the "Credit Agreement"), which had an initial capacity of$125.0 million , with a syndicate of lenders, includingWells Fargo Bank, N.A. , who also serves as administrative agent ("Wells Fargo" 44 -------------------------------------------------------------------------------- or the "Administrative Agent"). The Credit Agreement is comprised of a$50.0 million term loan facility (the "Term Loan Facility"), and a$75.0 million revolving credit facility (the "Revolving Facility" and collectively with the Term Loan Facility, the "Facilities") with a sub-limit of$10.0 million for swingline loans and$10.0 million for letters of credit. Subject to earlier termination, the Credit Agreement terminates onAugust 2, 2017 . The Credit Agreement includes a provision pursuant to which, from time to time, we may request that the lenders in their discretion increase the maximum amount of commitments under the Facilities by an amount not to exceed$50.0 million . In addition, the Term Loan Facility is reduced by mandatory quarterly principal payments. At our election, borrowings under the Revolving Facility will bear interest either at the base rate plus an applicable interest margin or the adjusted LIBO rate plus an applicable interest margin; provided, however, that all swingline loans will be base rate loans. The base rate is a fluctuating interest rate equal to the highest of: (i) Wells Fargo's publicly announced prime lending rate; (ii) the federal funds rate plus 0.50%; and (iii) the adjusted LIBO rate, determined on a daily basis for an interest period of one month, plus 1.0%. The adjusted LIBO rate is the rate per annum obtained by dividing (i) theLondon interbank offered rate ("LIBOR") for such interest period by (ii) a percentage equal to 1.00 minus the Eurodollar Reserve Percentage (as defined in the Credit Agreement). The interest margin over the adjusted LIBO rate, initially set at 2.75%, may increase (to a maximum amount of 3.0%) or decrease (to a minimum amount of 2.0%) based on changes in our leverage ratio. The interest margin over the base rate, initially set at 1.75%, may increase (to a maximum amount of 2.0%) or decrease (to a minimum amount of 1.0%) based on changes in our leverage ratio. In addition to interest payable on the principal amount of indebtedness outstanding from time to time under the Credit Agreement, we are required to pay a commitment fee, initially equal to 0.40% per annum of the unused amount of the Revolving Facility. The percentage rate of such fee may increase (to a maximum amount of .45%) or decrease (to a minimum amount of .25%) based on changes in the Borrowers' leverage ratio. The amount of outstanding swingline loans is not considered usage of the Revolving Facility for the purpose of calculating the commitment fee. We are also required to pay letter of credit participation fees on the undrawn amount of all outstanding letters of credit. We paid fees of approximately$1.7 million to Wells Fargo in connection with the execution of the Credit Agreement, which have been capitalized and are being amortized using a straight line method over the life of the Credit Agreement. We may, at our option, prepay any borrowing, in whole or in part, at any time and from time to time without premium or penalty. However, after the end of our fiscal year (commencing with the fiscal year endingDecember 31, 2015 ), we are required to make mandatory principal prepayments of loans under the Facilities in an amount determined under the Credit Agreement based upon a percentage (from a maximum of 50% to a minimum of 0% based on the Borrowers' leverage ratio) of our Excess Cash Flow (as defined in the Credit Agreement) minus certain off set amounts relating to permitted acquisitions of ours. In addition, we are required to make principal payments upon the occurrence of certain events, including upon certain dispositions of our assets. The Credit Agreement contains certain customary representations, warranties and covenants applicable to us for the benefit of the Administrative Agent and the lenders. We may not assign, sell, transfer or dispose of any collateral or effect certain changes to our capital structure and the capital structure of our subsidiaries without the Administrative Agent's prior consent. Our obligations under the Facilities may be accelerated or the commitments terminated upon the occurrence of an event of default under the Credit Agreement, including payment defaults, defaults in the performance of affirmative and negative covenants, the inaccuracy of representations or warranties, bankruptcy and insolvency related defaults, cross defaults to other material indebtedness, defaults arising in connection with changes in control and other customary events of default. The Credit Agreement also contains the following financial covenants, which require us to maintain, as of the end of each fiscal quarter:
• a maximum Total Leverage Ratio (as defined in the Credit Agreement) of
3.50:1.00, with step-downs to 3.25:1.00 on
on
• a minimum Fixed Charge Coverage Ratio (as defined in the Credit Agreement)
of 2.00:1.00;
• a minimum Reinsurance Ratio (as defined in the Credit Agreement) of 50.0%; and
• a minimum NAIC RBC Ratio (as defined in the NAIC) standards, calculated as
of the end of each fiscal year, to the "authorized control level," as defined by the NAIC in its standards) of 250.0%, applicable to each regulated insurance subsidiary of the Borrowers.
As of
Preferred Trust Securities In connection with the Summit Partners Transactions, our subsidiary,LOTS Intermediate Co. issued$35.0 million of fixed/floating rate preferred trust securities due in 2037. The preferred trust securities accrued interest at a rate of 9.61% per annum until theJune 2012 interest payment date, thereafter, interest accrues at a rate of 3-month LIBOR plus 4.10% for each interest rate period. We were not permitted to redeem the preferred trust securities until after theJune 2012 interest payment date, thereafter we may redeem the preferred trust securities, in whole or in part, at a price equal to 100% of the principal amount of such preferred trust securities outstanding plus accrued and unpaid interest. Interest is payable quarterly. 45 -------------------------------------------------------------------------------- InApril 2011 , we entered into a forward interest rate swap (the "Swap") withWells Fargo Bank, N.A. , pursuant to which we swapped the floating rate portion of our$35.0 million in outstanding preferred trust securities to a fixed rate of 3.47% per annum payable quarterly resulting in a total rate of 7.57% after adding the applicable margin of 4.10%. The Swap has a five year term, which commenced inJune 2012 when the interest rate on the underlying preferred trust securities began to float, and will expire inJune 2017 . Invested Assets Our invested assets consist mainly of high quality investments in fixed maturity securities, short-term investments, and a smaller allocation of common and preferred equity securities. We believe that prudent levels of investments in equity securities within our investment portfolio are likely to enhance long-term after-tax total returns without significantly increasing the risk profile of our portfolio. We regularly review our entire portfolio in the context of macroeconomic and capital market conditions. The overall average credit quality of our investment portfolio was rated AA- and A+ by Standard and Poor's Rating Service atJune 30, 2013 andDecember 31, 2012 , respectively. Regulatory Requirements Our investments must comply with applicable laws and regulations which prescribe the kind, quality and concentration of investments we are permitted to make. In general, these laws and regulations permit investments, within specified limits and subject to certain qualifications, in federal, state and municipal obligations, corporate bonds, preferred and common equity securities, mortgage loans, real estate and other investments. Investment Strategy Our investment policy and strategy is reviewed and approved by the board of directors of each of our insurance subsidiaries on a regular basis in order to review and consider investment activities, tactics and new investment opportunities. Our investment strategy seeks long-term returns through disciplined security selection, portfolio diversity and an integrated approach to risk management. We select and monitor investments to balance the goals of safety, stability, liquidity, growth and after-tax total return with the need to comply with regulatory investment requirements. Our investment portfolio is managed by a third-party provider of asset management services, which specializes in the insurance sector. Asset liability management is accomplished by setting an asset target duration range that is influenced by the following factors: (i) the estimated reserve payout pattern, (ii) the inclusion of our tactical capital market views into the investment decision making process and (iii) our overall risk tolerance. We aim to achieve a relatively safe and stable income stream by maintaining a broad-based portfolio of investment grade fixed maturity securities. These holdings are supplemented by investments in additional asset types with the objective of further enhancing the portfolio's diversification and expected returns. These additional asset types include common and redeemable preferred stock. We manage our investment risks through consideration of duration of liabilities, diversification, credit limits, careful analytic review of each investment decision, and comprehensive risk assessments of the overall portfolio. As ofJune 30, 2013 , we held 103 individual fixed maturity and 10 individual equity securities in unrealized loss positions. The increase in the number of fixed maturity securities in unrealized loss positions was primarily due to changes in bond yields and the related impact on market prices. We do not intend to sell the investments that are in an unrealized loss position atJune 30, 2013 and it is more likely than not that we will be able to hold these securities until full recovery of their amortized cost basis for fixed maturity securities or cost for equity securities, although we can give no assurances. AtJune 30, 2013 , based on management's quarterly review, none of our fixed maturity or equity securities were deemed to be other than temporarily impaired. As ofJune 30, 2012 , we held 25 individual fixed maturity and 3 individual equity securities in unrealized loss positions. AtJune 30, 2012 , based on management's quarterly review, none of our fixed maturity or equity securities were deemed to be other than temporarily impaired. Please see the Note, "Investments" in the Notes to Consolidated Financial Statements, for additional information. Cash Flows We monitor cash flows at the consolidated, holding company and subsidiary levels. Cash flow forecasts at the consolidated and subsidiary levels are provided on a monthly basis using trend and variance analysis to project future cash needs, with adjustments made as needed. The table below shows our cash flows for the periods presented: (in thousands) For the Six Months Ended Cash provided by (used in): June 30, 2013 June 30, 2012 Operating activities$ 15,965 $ 12,784 Investing activities (11,835 ) (12,200 ) Financing activities (3,749 ) (3,573 )
Net change in cash and cash equivalents
Operating Activities Net cash provided by operating activities was$16.0 million for the six months endedJune 30, 2013 and was primarily attributable 46 -------------------------------------------------------------------------------- to net income and an increase in accrued expenses, accounts payable and other liabilities, and deferred revenue, that was partially offset by increases in other receivables and accounts and premiums receivable, net. Net cash provided by operating activities was$12.8 million for the six months endedJune 30, 2012 and was primarily attributable to net income and an increase in accrued expenses, accounts payable, income taxes and other liabilities, that was partially offset by a increase in accounts and premiums receivable and other receivables. Investing Activities Net cash used in investing activities was$11.8 million for the six months endedJune 30, 2013 and was primarily for the purchase of fixed maturity and equity securities, the acquisition of RICC, which was partially offset by the proceeds we received from the sale of fixed maturity securities, the repayment of a related party note receivable and normal quarterly proceeds from maturities, calls and prepayments of available-for-sale investments. Net cash used in investing activities was$12.2 million for the six months endedJune 30, 2012 and was primarily for the purchase of fixed maturity and equity securities and property and equipment along with an increase in restricted cash, partially offset by the sale and maturity of fixed maturity investments. Financing Activities Net cash used in financing activities was$3.7 million for the six months endedJune 30, 2013 and primarily reflected$12.4 million used to pay down our credit facility and$1.4 million used to repurchase 200,000 shares of our common stock under our stock repurchase plan, which was partially offset by$10.5 million of the borrowings under our credit facility.
Net cash used in financing activities was
Contractual Obligations and Other Commitments We have obligations and commitments to third parties as a result of our operations. These obligations and commitments, as ofJune 30, 2013 , are detailed in the table below by maturity date as of the periods indicated: (in thousands) Payments Due by Period Less than More than Total 1 Year 1-3 Years 4-5 Years 5 Years Note payable (1)$ 87,500 $ 2,500 $ 10,000 $ 75,000 $ - Preferred trust securities 35,000 - - - 35,000
Interest payable on total debt(2) 70,790 5,912 11,470
8,711 44,697 Policyholder account balances 24,840 1,439 2,945 3,008 17,448 Unpaid claims (3) 31,724 26,534 4,965 213 12 Total$ 249,854 $ 36,385 $ 29,380 $ 86,932 $ 97,157 (1) - For more information on our credit facility withWells Fargo Bank, N.A. , please see the section above titled "$125.0 Million Credit Facility" in this MD&A and the Note, "Note Payable" in the Notes to the Consolidated Financial Statements. (2) - Due to the variable interest rate and amortizing payments required on the note payable to Well Fargo and the impact of the interest rate swap on the preferred trust securities interest payable, we made certain assumptions regarding future interest rates. The assumptions we made are as follows: a. For interest payable on the note payable, we assumed scheduled principal payments$1,250 per quarter and used the 1-month forward LIBOR curve rate when estimating interest payable on the outstanding principal balance. b. For interest payable on the preferred trust securities, we used the interest swap in effect of 7.57% untilJune 2017 , subsequent to that date we utilized the contractual spread amount of 410 basis points plus the 3-month forward LIBOR curve rate.
(3) - Estimated. Net unpaid claims are: total
As previously disclosed in our 2012 Annual Report on Form 10-K, we have certain obligations under capital and operating lease agreements to which we are a party. In accordance with U.S. GAAP, the operating lease obligations and the related leased assets are not reported on our Consolidated Balance Sheets. Other than reductions to the capital and operating lease obligations resulting from scheduled lease payments, our obligations under these lease agreements have not changed materially sinceDecember 31, 2012 . As part of the 2012 acquisition of ProtectCELL, we have a conditional commitment to provide up to$10.2 million of additional capital ("Additional Fortegra Capital Contributions") to ProtectCELL if the board of directors of ProtectCELL (the "PC Board") determines that ProtectCELL requires additional funds to support expansion and growth, or other appropriate business needs. 47
--------------------------------------------------------------------------------
We are obligated to evaluate any such funding request received from the PC Board in good faith to determine whether in our reasonable business judgment the requested capital should be contributed. We are not required to honor the funding request from the PC Board if we in good faith deem the request to be imprudent or unjustified. The benefits of such additional funding would inure to us and to the non-controlling ownership interest of ProtectCELL, in proportion to their respective ownership interests. However, in return for each$1,000 of Additional Fortegra Capital Contributions, we would receive one Series A Preferred Unit. Any unreturned Series A Preferred contribution is deducted from ProtectCELL's valuation in determining the option price. Off-Balance Sheet Arrangements We do not have any off-balance sheet arrangements that are reasonably likely to have a material effect on our financial condition, results of operations, liquidity or capital resources.
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AMERINST INSURANCE GROUP LTD – 10-Q – Management’s Discussion and Analysis of Financial Condition and Results of Operations
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