424B4 1 d851656d424b4.htm FORM 424B4 Form 424B4
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Filed Pursuant to Rule 424(b)(4)
Registration No. 333-200972

 

PROSPECTUS     January 15, 2015

 

8,315,700 Shares

 

LOGO

COMMON STOCK

 

 

This is the initial public offering of shares of our common stock. No public market currently exists for our common stock. We are offering 7,350,000 shares of our common stock and the selling stockholders named in this prospectus are offering 965,700 shares of our common stock. We will not receive any proceeds from the sale of the shares by the selling stockholders.

Our common stock has been approved for listing, subject to official notice of issuance, on the New York Stock Exchange (the “NYSE”) under the symbol “PN.”

We are an “emerging growth company” under applicable Securities and Exchange Commission rules and, as such, have elected to comply with certain reduced public company reporting requirements for this prospectus and in future reports after consummation of this offering. See “Summary—Implications of Being an Emerging Growth Company.”

Investing in our common stock involves a high degree of risk. Before buying any shares, you should carefully read the discussion of material risks of investing in our common stock in “Risk Factors” beginning on page 24 of this prospectus.

Neither the Securities and Exchange Commission (the “SEC”) nor any state securities commission has approved or disapproved of these securities or passed upon the accuracy or adequacy of this prospectus. Any representation to the contrary is a criminal offense.

 

      Per Share      Total  
Public offering price    $ 14.00       $ 116,419,800   
Underwriting discounts and commissions(1)    $ 0.98       $ 8,149,386   
Proceeds, before expenses, to us    $ 13.02       $ 95,697,000   
Proceeds, before expenses, to the selling stockholders    $ 13.02       $ 12,573,414   

 

(1)   See “Underwriting (Conflicts of Interest)” for additional information regarding underwriter compensation.

The underwriters may also purchase first, from us, up to an additional 1,102,500 shares of our common stock and second, from the selling stockholders, up to an additional 144,855 shares of our common stock, in each case at the public offering price, less the underwriting discounts and commissions, solely to cover over-allotments, if any, within 30 days from the date of this prospectus. If the underwriters exercise this option in full, the total underwriting discounts and commissions will be $9,371,793.90 and our total proceeds, before expenses, will be $110,051,550, and the total proceeds to the selling stockholders, before expenses, will be $14,459,426.10.

The underwriters are offering the common stock as set forth under “Underwriting (Conflicts of Interest).” Delivery of the shares will be made on or about January 22, 2015.

 

UBS Investment Bank   BMO Capital Markets   SunTrust Robinson Humphrey

 

 

 

JMP Securities    William Blair


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You should rely only on the information contained in this prospectus or in any free writing prospectus that we may authorize to be distributed to you. We and the underwriters have not authorized anyone to provide you with additional or different information. Neither we nor the underwriters take responsibility for, nor can provide any assurance as to the reliability of, any other information that others may give you. Neither we nor the underwriters are making an offer to sell these securities in any jurisdiction where an offer or sale is not permitted. You should assume that the information contained in this prospectus is accurate only as of the date of this prospectus.

No action is being taken in any jurisdiction outside the United States to permit a public offering of the shares of our common stock or possession or distribution of this prospectus in any such jurisdiction. Persons who come into possession of this prospectus in jurisdictions outside the United States are required to inform themselves about and to observe any restrictions as to this offering and the distribution of the prospectus applicable to that jurisdiction.

TABLE OF CONTENTS

 

 

      Page  

Prospectus Summary

     1   

Risk Factors

     24   

Cautionary Note Regarding Forward-Looking Statements

     46   

Use of Proceeds

     47   

Dividend Policy

     48   

Capitalization

     49   

Dilution

     51   

Unaudited Pro Forma Financial Information

     53   

Selected Historical Combined Financial Data

     63   

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     65   

Business

     93   

Management

     116   

Certain Relationships and Related Party Transactions

     130   

Principal and Selling Stockholders

     136   

Description of Capital Stock

     139   

Shares Eligible for Future Sale

     147   

Certain United States Federal Income and Estate Tax Consequences to Non-U.S. Holders

     149   

Underwriting (Conflicts of Interest)

     153   

Legal Matters

     161   

Experts

     161   

Where You Can Find More Information

     162   

Index to Financial Statements

     F-1   

 

 

 

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MARKET AND INDUSTRY DATA

This prospectus includes industry and market data derived from internal analyses based upon publicly available data or other proprietary research and analysis, surveys or studies conducted by third parties and industry and general publications, including those by the National Council on Compensation Insurance, SNL Financial and Moody’s Investors Service. While we believe our internal analyses are reliable, they have not been verified by any independent sources. Any such data involves risks and uncertainties and is subject to change based on various factors, including those discussed under “Risk Factors,” “Cautionary Note Regarding Forward-Looking Statements” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this prospectus.

 

 

GLOSSARY

Unless otherwise specified or the context requires otherwise, in this prospectus:

 

Ø   references to “Patriot National,” “our company,” “we,” “us” or “our” refer to Patriot National, Inc. and its direct and indirect subsidiaries, unless otherwise indicated; and

 

Ø   all share and per share information have been adjusted to reflect a 15-to-1 split of our capital stock that will be effected immediately prior to the effectiveness of the registration statement relating to this offering.

Unless otherwise specified or the context requires otherwise, the following terms used in this prospectus have the meanings ascribed to them below:

 

Ø   references to the “Acquisitions” refer to both the GUI Acquisition and Patriot Care Management Acquisition together;

 

Ø   references to “alternative market” refer to arrangements (1) in which workers’ compensation insurance policies are written by our clients and their policyholder or another party bears a substantial portion of the underwriting risk through a reinsurance arrangement between the client and a reinsurance entity or (2) through which our clients share underwriting risk with their policyholders through large deductible policies, retrospectively-rated policies and policyholder dividend arrangements;

 

Ø   references to “combined ratio” refer to the combined ratio comprised of (i) the ratio calculated by dividing net incurred losses plus loss adjustment expenses by net earned premiums and (ii) the ratio calculated by dividing net operating expenses by net written premiums. The combined ratio is a measure of the profitability of an insurance company, and a combined ratio below 100 percent is indicative of an underwriting profit;

 

Ø   references to “Guarantee Insurance” refer to Guarantee Insurance Company and references to “Guarantee Insurance Group” refer to Guarantee Insurance Group, Inc. (f/k/a Patriot National Insurance Group, Inc.), the parent company of Guarantee Insurance, entities that are both controlled by Steven M. Mariano, our founder, Chairman, President and Chief Executive Officer;

 

Ø   references to the “GUI Acquisition” refer to our acquisition, effective August 6, 2014, of contracts to provide marketing, underwriting and policyholder services and related assets and liabilities from a subsidiary of Guarantee Insurance Group, as described in “Business—Our History and Organization” and “Unaudited Pro Forma Financial Information;”

 

Ø   references to the “Patriot Care Management Acquisition” refer to our acquisition, effective August 6, 2014, of a business that provides nurse case management and bill review services (the “Patriot Care Management Business”), as described in “Business—Our History and Organization” and “Unaudited Pro Forma Financial Information;”

 

 

 

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Ø   references to “reference premiums written” refer to the aggregate premiums, grossed up for large deductible credits, written by or for our insurance carrier partners in respect of the policies we produce and service on their behalf;

 

Ø   references to “reinsurance captives” or “reinsurance captive entities” refer to segregated portfolio cell captive entities that assume underwriting risk written initially by an insurance carrier client; and

 

Ø   references to the “Reorganization” refer to Patriot National’s incorporation in Delaware in November 2013 as a holding company and the consolidation of various entities operating our business that had been under the common control of Mr. Mariano, and the separation of our insurance services business from the insurance operations of Guarantee Insurance.

 

 

 

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Prospectus Summary

This summary highlights certain significant aspects of our business and this offering. This is a summary of information contained elsewhere in this prospectus, is not complete and does not contain all of the information that you should consider before making your investment decision. You should carefully read the entire prospectus, including the information presented under the sections entitled “Risk Factors,” “Cautionary Note Regarding Forward-Looking Statements” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and the notes thereto, before making an investment decision. This summary contains forward-looking statements that involve risks and uncertainties. Our actual results may differ significantly from future results contemplated in the forward-looking statements as a result of certain factors such as those set forth in the sections entitled “Risk Factors” and “Cautionary Note Regarding Forward-Looking Statements.”

OVERVIEW

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 work with leading insurance carriers to design workers’ compensation programs according to their preferred risk parameters and specifications. We market the programs through our broad distribution network of over 1,000 independent retail agencies, and underwrite and bind coverage on behalf of our clients. We play a central role in controlling the underwriting, production and administration process, which we believe gives us flexibility in the event of a change in carrier relationships.

Once an insurance program is established with an insurance carrier client, we offer a full suite of additional services, including claims administration and adjudication, cost containment, nurse case management, fraud investigation and subrogation services. We also offer these services individually or as a customized package of services to our other clients such as employers, local governments and reinsurance captives, based on a client’s particular needs. We believe that our proactive approach to claims administration, including our proprietary Swift Working Assessment and Rapid Methodology, or SWARM™ process, results in higher than average claims closure rates versus the industry. Our technology platform provides timely information to our employees and our clients, which allows rapid initial case analysis and response to claims as well as direct access to information across our internal organization. We believe this proactive approach to our business, combined with our industry expertise and distribution relationships, makes us a valued outsourcing partner for our clients.

We generate fee revenue for our services, and we do not write any insurance policies or bear underwriting risk. On a pro forma basis, after giving effect to the Acquisitions, this offering and the application of use of proceeds therefrom, our revenue was $101.1 million for the nine months ended September 30, 2014 and $93.0 million for the year ended December 31, 2013. Our net income (loss) on a pro forma basis for such periods was $14.5 million and $(15.2) million, respectively. See “Unaudited Pro Forma Financial Information” for additional information.

 

 

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OUR SERVICES

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”).

Our brokerage and policyholder services include general agency services and specialty underwriting and policyholder services provided to our insurance carrier clients. For these carrier partners, we produce and administer alternative market and traditional workers’ compensation insurance programs within risk classes and geographies specified by our insurance carrier clients, and earn fees based on a percentage of the premiums for the policies we produce and service. We do not write any insurance policies or bear underwriting risk.

We place the workers’ compensation insurance products of our carrier partners through a national network of over 1,000 independent retail agencies nationwide. Through this independent agency network, we also offer reinsurance captive entity design and management services. We earn fees for management and other services performed for reinsurance captive entities that we design and form.

Our claims administration services relate to the administration and resolution of workers’ compensation claims that are designed to reduce costs for our clients. We provide a comprehensive claims administration platform to our carrier partners that revolves around our proprietary SWARM process. The SWARM process is a high-touch, front-end loaded approach to claims processing that employs a multi-faceted, team-based rapid response to all new claims. When a claim is compensable, our claims management process is designed to result in an optimal net claim cost while ensuring that the injured worker’s medical care is provided in an effective and efficient manner, promoting the early return to work through consistent contact with medical providers and employers and providing appropriate and prompt payment of benefits.

In addition to the full suite of services provided to our insurance carrier clients, we also provide a variety of specialty services individually to our other clients such as employers, local governments and reinsurance captives, as well as insurance carrier clients who may not purchase brokerage and policyholder services from us. These services include:

 

Ø   healthcare cost containment services, including nurse case management and medical bill review, which are designed to contain healthcare costs associated with workers’ compensation claims, a significant and growing component of claim costs, through early intervention and ongoing review of healthcare services and pricing;

 

Ø   investigation services, including onsite investigations into fraud and compensability and evaluation of subrogation opportunities designed to limit claim exposures for our clients and comply with regulatory requirements, certain of which we offer through outside service providers;

 

Ø   loss control services designed to proactively mitigate potential claims costs prior to the occurrence of a compensable injury, including onsite hazard assessments, preemptive evaluation of risk exposures, review of workplace safety policy and procedures and ongoing education, certain of which we offer through outside service providers;

 

Ø   transportation and translation services, including the capability to handle various transportation needs of claimants (such as wheelchair, advanced life support and air ambulance) and onsite and telephonic translation and transcription in connection with claims, which we offer through outside service providers;

 

Ø   lien resolution services in the state of California, including lien negotiation, disputed bill analysis, claim consultation and analysis and bulk settlement services; and

 

 

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Ø   legal bill review services designed to provide cost saving opportunities for claims departments of insurance companies, which we offer through outside service providers.

INDUSTRY OUTLOOK

Workers’ compensation in the United States is a mandated, state-legislated, no-fault insurance program that requires employers to fund medical expenses, lost wages and other costs resulting from work-related injuries and illness. According to the National Council on Compensation Insurance’s State of the Workers Compensation Line 2014 (the “NCCI Report”), projected total net premium written by state funds and private carriers of workers’ compensation insurance in the United States was $41.9 billion in 2013, an increase from $33.8 billion in 2010, representing a compound annual growth rate of 7.4% over that period, and according to data compiled by SNL Financial, total direct premium written by workers’ compensation insurance carriers in the United States, which includes the amount of premium reinsured by insurance carriers, was $52.5 billion in 2013, an increase from $40.4 billion in 2010, representing a compound annual growth rate of 9.2% over that period. In the past several years, premium growth in the workers’ compensation industry has been predominantly driven by the recovery of employment levels to generally at or near pre-recession levels, as well as increasing premium rates.

Like other sectors of the insurance industry, the workers’ compensation sector experiences underwriting cyclicality, which generally underpins changes in premium rates. This cyclicality is caused by a number of factors. First, ultimate loss costs become more difficult to predict when claims remain open for longer periods and they are exposed to wage and medical cost inflation. For example, the NCCI Report indicates that medical costs per claim increased by approximately 6.5% on average per year from 1995 through 2013. Second, the amount of investment income insurance carriers earn, which is a significant contributor of their overall targets, may also influence such carrier’s underwriting practices. Given that workers’ compensation claims have a long duration, insurers can write at higher combined ratios because they are able to invest the assets over a long period and earn significant investment income. This is reflected in a greater than 100% combined ratio for all but two years from 1990 to 2013. However, in periods of low interest rates, similar to the current investment environment, insurance carriers cannot generate sufficient investment income to offset underwriting losses, and as a result have demanded higher premium rates. This has led to a modest “hardening” of the workers’ compensation market. According to the report US Workers’ Compensation: Sector Profile by Moody’s Investors Service (the “Moody’s Report”), rates in 2013 increased 8% and are expected to rise 5.5% in 2014.

Today, the attractive combination of rising employment and an improved underwriting environment has driven new entrants into the market, and caused industry participants who had decreased their activity levels during the previous “soft” market cycle to re-enter the market as macro-economic conditions and the profit outlook for the industry improve.

Because insurance carriers adjust their growth appetite based on the prevailing macro-economic and underwriting cycle, we believe outsourcing certain functions to a company like us is attractive because it allows carriers to maintain production flexibility in response to market conditions without burdensome investment in, or management of, certain necessary services and fixed costs. We are able to take advantage of the current improving market and provide services to carriers who may have previously exited the workers’ compensation market and no longer have the systems in place to resume writing business. Furthermore, we believe the profitability challenges faced by the workers’ compensation insurance industry creates opportunities for specialty service providers like us who can reduce costs and also provide access to alternative market options.

In addition to providing flexibility to carriers, enabling them to opportunistically write workers’ compensation business in an attractive market, we also help our clients navigate the complex state-regulated industry landscape. Ensuring state-by-state compliance is time consuming and expensive,

 

 

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particularly for a carrier whose primary business is not in workers’ compensation. We believe our national presence and experience with each state’s guidelines and requirements position us to deliver significant value and cost savings for our clients.

OUR COMPETITIVE STRENGTHS

We believe we have the following competitive strengths:

 

Ø   National Provider of Full Spectrum of Services Focused on Workers’ Compensation.    We provide a complete range of services, from originating and underwriting policies to claims adjudication, focused exclusively on the workers’ compensation insurance industry. We are able to efficiently deploy these services nationwide on a coordinated and proactive basis. We believe our sector focus and our nationwide footprint allow us to provide superior services and products, higher efficiencies and better cost containment to our clients relative to multiline insurance service providers. In addition, due to the expertise required to comply with a complex, state-based regulatory regime, we believe that we have a business model that is difficult to replicate.

 

Ø   State-of-the-Art Technology Infrastructure.    We developed and implemented our WorkersCompExpert (“WCE”) system, a scalable technology platform that handles the entire billings and claims administration process, from the initial issuance of policies to settlement of claims. Our WCE system is the cornerstone of our services, and we believe it provides:

 

  ·   reduced cost associated with policy initiation by fully automating issuance and underwriting of new policies;

 

  ·   real-time analysis and communication capabilities across functional areas to enhance speed of claims response and resolution;

 

  ·   enhanced data collection and quality, information analysis and identification of trends through ease-of-use and single data-entry principle; and

 

  ·   comprehensive predictive modeling and analytics capabilities.

The WCE system was designed with a robust, modular architecture to provide flexibility to integrate new carriers and acquired businesses. For example, the WCE system is compatible with the legacy systems of our clients. We believe this compatibility allows us to reduce the time required for systems integration and to provide enhanced day-to-day operational interactions securely and with relative ease. We also believe that it can be utilized in lines of business outside of the workers’ compensation insurance industry.

 

Ø   Proven Proprietary Claims Management Process.    Through our proprietary SWARM process, we provide our clients with a high quality, high-touch claims management program that has proven to be effective at settling claims and reducing associated costs. By simultaneously deploying multiple functional areas of expertise, such as claims adjustment, fraud investigation, healthcare cost containment, nurse case management and subrogation, we ensure that appropriate personnel can review and respond to the claim rapidly. The SWARM process enables us to favorably influence the outcome of the claim by addressing potential issues early in its lifecycle, resulting in claims closure rates consistently better than industry averages. For example, as of December 31, 2013, only 0.7% of our claims that occurred in the accident year 2008 remained open, as compared to the industry average of 1.7%, and only 9.0% of our claims that occurred in the accident year 2012 remained open, as compared to the industry average of 10.1%, as reported by A.M. Best’s Global Insurance Database. We believe that rapidly closing claims reduces exposure to litigation risk, medical cost inflation and other factors and will ultimately reduce claims costs for our carrier partners.

 

 

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Ø   Strong Distribution Relationships.    We maintain relationships with our network of over 1,000 independent, non-exclusive retail agencies in all 50 states by emphasizing personal interaction and superior service and maintaining an exclusive focus on workers’ compensation services. Our experienced underwriting service personnel work closely with our independent retail agencies to market the products of our carrier partners and serve the needs of prospective policyholders. We believe that we distinguish ourselves from larger insurance company and brokerage competitors by forming close relationships with these independent retail agencies and focusing on small to mid-sized businesses. We strive to provide excellent customer service to our agencies and potential policyholders, including fast turnaround of policy submissions, in order to attract and retain business.

 

Ø   Philosophy of Customer Service through Innovation.    A core tenet of our culture is a commitment to innovation and customer service focused on finding solutions to deliver superior results for our clients. Since the inception of our workers’ compensation insurance business in 2003, we have continued to develop and expand our capabilities, transforming our individual services into an integrated end-to-end offering on a national scale. We also seek to drive efficiencies in our operations to provide better solutions for our clients. For example, we created our proprietary SWARM claims administration process which brings together our claims management capabilities in a proactive way to drive value for our clients. In addition, we developed our scalable WCE technology platform to enable us to deliver our full suite of services in a cost-efficient manner.

 

Ø   Experienced Management.    Our senior management team is comprised of experienced executives with a track record of financial and operational success, deep experience through multiple industry cycles and strong relationships with our carrier partners. Mr. Mariano, our founder, Chairman, President and Chief Executive Officer, has guided the creation and growth of our company, including the Reorganization and the Acquisitions, as discussed under “—Our History and Organization” below. The members of our senior management team average over 20 years of insurance industry experience, and have developed a proven ability to identify, evaluate and execute successful growth strategies. We foster an entrepreneurial culture focused on customer service, innovation and business generation and have aligned the incentives of our key employees through a merit-based compensation system, which we believe has enabled us to attract and retain superior talent and produce strong results for our clients and our company.

OUR GROWTH STRATEGY

We intend to leverage our competitive strengths to drive sales and profit growth through the following key strategies:

 

Ø   Expand Our Insurance Carrier Client Business Relationships.    We currently offer a broad range of our insurance services to our insurance carrier clients who outsource all or part of their workers’ compensation insurance programs to us. In addition to our primary insurance carrier clients Guarantee Insurance, Zurich Insurance Group Ltd. (“Zurich”) and Scottsdale Insurance Company (“Scottsdale”), we are focused on engaging and establishing relationships with other insurance carriers, including carriers that have not historically written workers’ compensation insurance. We intend to take advantage of the current attractive dynamics in the workers’ compensation industry of increasing employment and premium rates to create partnerships with new or opportunistic market entrants. For example, Scottsdale recently became our insurance carrier client and began writing workers’ compensation insurance at that time. In addition, we recently formed a relationship with American International Group, Inc. (“AIG”), and we expect AIG to become one of our primary insurance carrier clients over time. We continue to seek to expand our carrier partner business relationships.

 

Ø  

Continue to Grow Our Client Base for Individual Services.    We also provide a variety of specialty services individually or as a customized package of services, such as onsite investigations into fraud

 

 

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and compensability and evaluation of subrogation opportunities; loss control services; transportation and translation services; and legal bill review services. While these services are generally provided as part of our integrated claims administration service to our insurance carrier clients, we have grown this business to include more than 80 third-party clients. We intend to continue to focus on marketing these service offerings to new third-party clients, such as other insurance carriers and service providers, self-insured employers and local governments, as well as insurance carriers who do not purchase our brokerage and policyholder services offerings.

 

Ø   Leverage Our Existing Infrastructure.    We serve our clients and policyholders through regional offices in seven states, each of which has been staffed to accommodate growth in our business. Further, we have developed and implemented a robust, vertically integrated modularized information technology platform that is designed to help us grow. This system is highly scalable and adaptable to additional opportunities, with substantial excess capacity, allowing us to grow and service additional clients without the need for substantial additional investment. We plan to realize economies of scale in our workforce and technology infrastructure.

 

Ø   Continue to Develop and Offer Innovative Solutions.    We believe that we can continue to provide superior services and products, higher efficiencies and cost containment to our clients by developing innovative solutions for our clients. For example, we recently began offering workers’ compensation lien resolution services in order to address a specific need for our clients in the state of California, including lien negotiation, disputed bill analysis, claim consultation and analysis and bulk settlement services. We believe that our focus on continuing to seek opportunities to provide potential and existing clients with new services and solutions will allow us to leverage our existing infrastructure to further drive our organic growth.

 

Ø   Acquire Complementary Operations.    We believe there are significant opportunities, through the acquisition of complementary operations, to continue to expand the range of services that we offer to our clients. For example, through our recently completed Patriot Care Management Acquisition, we acquired the capability to provide nurse case management and bill review services, both as a part of our full suite of services that we provide to our insurance carrier clients and also individually or as a customized package of services to third-party clients. We continue to evaluate the possibility of acquiring outsourced services and new complementary services or businesses to further drive the growth of our business.

OUR HISTORY AND ORGANIZATION

Mr. Mariano, our founder, Chairman, President and Chief Executive Officer, initially started our workers’ compensation insurance business and acquired Guarantee Insurance in 2003.

Patriot National, Inc. (f/k/a Old Guard Risk Services, Inc.) was incorporated in Delaware in November 2013 to consolidate certain insurance services entities controlled by Mr. Mariano. These transactions, which we refer to as our “Reorganization,” separated our insurance services business from the insurance risk taking operations of Guarantee Insurance Group.

Effective August 6, 2014, we acquired certain contracts to provide marketing, underwriting and policyholder services to certain of our insurance carrier clients, as well as related assets and liabilities, from a subsidiary of Guarantee Insurance Group. We also acquired a contract to provide a limited subset of our brokerage and policyholder services to Guarantee Insurance, the balance of which had historically been provided without a contract as GUI is a subsidiary of Guarantee Insurance. We refer to the acquisition of these contracts and related assets and liabilities as the “GUI Acquisition.” Immediately following the GUI Acquisition, we entered into a new agreement to provide all of our brokerage and policyholder services to Guarantee Insurance.

 

 

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We further expanded our business effective August 6, 2014, through our acquisition from MCMC LLC (“MCMC”) of its managed care risk services business that provides nurse case management and bill review services. This business, which we refer to as the “Patriot Care Management Business,” had been previously controlled by Mr. Mariano until it was sold to MCMC in 2011. We refer to this acquisition as the “Patriot Care Management Acquisition,” and the GUI Acquisition and the Patriot Care Management Acquisition together as the “Acquisitions.”

Our historical financial results for all periods presented in this prospectus include the results of the various businesses previously under the common control of Mr. Mariano and to which we succeeded in connection with the Reorganization, as well as the revenues and expenses associated with the contracts and certain other assets acquired and liabilities assumed through the GUI Acquisition. Revenues and expenses associated with the new agreement we entered into in August 2014 to provide all of our brokerage and policyholder services to Guarantee Insurance, as well as the financial results associated with the Patriot Care Management Business, are included in our historical financial results beginning August 6, 2014 and are not reflected in our historical financial statements as of or for any earlier period.

Following the Reorganization and the Acquisitions, we own 100% of the subsidiaries that comprise our insurance services business, with the exception of Contego Services Group, LLC, in which Mr. Mariano maintains a 3% membership interest.

For additional information about our history, the Reorganization and the Acquisitions, see “Business—Our History and Organization.”

 

 

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The organizational chart below summarizes our corporate structure and material subsidiaries as of December 31, 2014 after giving effect to the Reorganization, the Acquisitions and this offering.

 

LOGO

 

 

(1)   Represents Contego Services Group, LLC, Contego Recovery LLC and Contego Investigative Services, Inc. Mr. Mariano maintains a 3% direct membership interest in Contego Services Group, LLC (of which Contego Recovery LLC is a subsidiary).

RECENT DEVELOPMENTS

Proposed Senior Secured Credit Facilities

In connection with this offering, we expect to enter into a new senior secured credit facility (the “senior secured credit facility”) in the aggregate principal amount of up to $80.0 million, comprised of a $40.0 million revolving credit facility and a $40.0 million term loan facility, with BMO Harris Bank N.A., an affiliate of BMO Capital Markets Corp., as administrative agent. We have received a commitment letter from BMO Harris Bank N.A. relating to this senior secured credit facility. We cannot assure you that we will enter into this senior secured credit facility on terms acceptable to us or at all, or that if we do so that we will be able to borrow all or any of the amounts committed thereunder. The closing of this offering is not conditioned upon our entry into the senior secured credit facility. Concurrently with the consummation of this offering, assuming we enter into the senior secured credit facility, we intend to make borrowings of $40.0 million (or approximately $37.7 million net of loan fees). We intend to use these borrowings, together with the net proceeds from this offering, to repay outstanding amounts under our existing loan agreements and for general corporate purposes. See “Use of Proceeds,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Indebtedness—Senior Secured Credit Facility” and “Underwriting (Conflicts of Interest).”

Reference Premium Written

Reference premium written for the year ended December 31, 2014 was $359.8 million compared to $357.4 million for the year ended December 31, 2013. The reference premium written for the year ended December 31, 2014 is a preliminary estimate and subject to change. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Key Performance Measures—Reference Premium Written.”

 

 

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Our principal executive offices are located at 401 East Las Olas Boulevard, Suite 1650, Fort Lauderdale, Florida 33301, and our telephone number at that location is (954) 670-2900. Our website address is www.patnat.com. Neither our website nor any information contained on our website is part of this prospectus.

 

 

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IMPLICATIONS OF BEING AN EMERGING GROWTH COMPANY

As a company with less than $1.0 billion in revenue during our last fiscal year, we qualify as an “emerging growth company” as defined in Section 2(a) of the Securities Act of 1933, as amended (the “Securities Act”), as modified by the Jumpstart Our Business Startups Act of 2012 (the “JOBS Act”). An emerging growth company may take advantage of specified reduced disclosure and reporting requirements and is relieved of certain other significant requirements that are otherwise generally applicable to public companies that are not emerging growth companies.

As an emerging growth company, we intend to take advantage of the following provisions of the JOBS Act:

 

Ø   exemption from the auditor attestation requirement in the assessment of our internal control over financial reporting;

 

Ø   exemption from compliance with any new requirements adopted by the Public Company Accounting Oversight Board (the “PCAOB”), requiring mandatory audit firm rotation or a supplement to the auditor’s report in which the auditor would be required to provide additional information about the audit and financial statements;

 

Ø   less extensive disclosure requirements about our executive compensation arrangements; and

 

Ø   no requirement for shareholder non-binding advisory vote on executive compensation or golden parachute arrangements.

We may take advantage of these provisions until the end of the fiscal year following the fifth anniversary of our initial public offering or such earlier time that we are no longer an emerging growth company. We will cease to be an emerging growth company upon the earliest of (i) the last day of the fiscal year in which our annual gross revenues exceed $1.0 billion, (ii) the last day of the fiscal year that we become a “large accelerated filer” as defined in Rule 12b-2 under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), which would occur if the market value of our common stock held by non-affiliates exceeds $700.0 million as of the last business day of our most recently completed second fiscal quarter and we have been publicly reporting for at least 12 months and (iii) the date on which we have issued more than $1.0 billion in non-convertible debt during the preceding three-year period. For as long as we take advantage of the reduced disclosure obligations, the information that we provide stockholders may be different than information provided by other public companies.

The JOBS Act also 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 this extended transition period, and, as a result, our financial statements may not be comparable to those of companies that 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.

CERTAIN RISK AND CHALLENGES

Our company, our business and the industry in which we operate are subject to numerous risks as more fully described in the section of this prospectus entitled “Risk Factors.” As part of your evaluation of our business and prospects, you should consider the challenges and risks we face in implementing our business strategies, including that:

 

Ø   because we have a limited operating history as a stand-alone, combined company and business, our historical and pro forma financial condition and results of operations are not necessarily representative of the results we would have achieved as a stand-alone, combined, publicly-traded company and may not be a reliable indicator of our future results;

 

 

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Ø   our business may be materially adversely impacted by general economic and labor market conditions;

 

Ø   the workers’ compensation insurance industry is cyclical in nature, which may affect our overall financial performance, and we may be more vulnerable to negative developments in the workers’ compensation industry;

 

Ø   our revenues and income are currently substantially dependent on our relationships with Guarantee Insurance and a small number of other insurance carrier clients;

 

Ø   our relationship with Guarantee Insurance may create conflicts of interest, and we cannot be certain that all our transactions with Guarantee Insurance will be conducted on the same terms as those available from unaffiliated third parties; and

 

Ø   we are subject to extensive regulation and supervision and our failure to comply with such regulation or adapt to new regulatory and legislative initiatives may adversely impact our business.

Any of the factors set forth under “Risk Factors” may limit our ability to successfully execute our business strategy. You should carefully consider all of the information set forth in this prospectus and, in particular, should evaluate the specific factors set forth under “Risk Factors” in deciding whether to invest in our common stock.

 

 

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THE OFFERING

 

Common stock offered by us

7,350,000 shares.

 

Common stock offered by the selling stockholders

965,700 shares.

 

Common stock to be outstanding after this offering

26,390,415 shares (or 27,637,770 shares if the underwriters exercise in full their over-allotment option).

 

Over-allotment option

The underwriters have an option for a period of 30 days to purchase first, from us, up to an additional 1,102,500 shares of our common stock and second, from the selling stockholders, up to an additional 144,855 shares of our common stock, in each case to cover over-allotments.

 

Use of proceeds

We estimate that the net proceeds to us from this offering, after deducting underwriting discounts and commissions and estimated offering expenses payable by us, will be approximately $92.7 million (or approximately $107.0 million if the underwriters exercise in full their over-allotment option). We will not receive any proceeds from the sale of shares of our common stock by the selling stockholders.

 

  We intend to use the net proceeds from this offering, together with borrowings under the senior secured credit facility or cash on hand, to repay all outstanding amounts under our PennantPark Loan Agreement (as defined in “Use of Proceeds”) and our UBS Credit Agreement (as defined in “Use of Proceeds”), in each case including accrued interest and applicable prepayment premiums. We will use any remaining net proceeds of this offering for working capital and for general corporate purposes. See “Use of Proceeds.”

 

Dividend policy

We do not currently anticipate paying any dividends on our common stock immediately following this offering. Following this offering and upon repayment of the PennantPark Loan Agreement and the UBS Credit Agreement, we may reevaluate our dividend policy. Any future determinations relating to our dividend policies will be made at the discretion of our board of

 

 

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directors and will depend on various factors, including any restrictions on dividends contained in the senior secured credit facility. See “Dividend Policy.”

 

Concentration of ownership

Upon consummation of this offering, we expect that Mr. Mariano, our founder, Chairman, President and Chief Executive Officer, will own approximately 59.5% of our outstanding common stock. As a result, he will be able to exert substantial influence on us and on all matters involving a vote of our shareholders. Mr. Mariano also owns substantially all of the outstanding equity of Guarantee Insurance Group, the parent company of Guarantee Insurance, which may cause a conflict of interest. We have a significant business relationship with Guarantee Insurance. See “Certain Relationship and Related Party Transactions—Relationship and Transactions with Guarantee Insurance Group and Guarantee Insurance” for additional information.

 

Directed share program

At our request, the underwriters have reserved up to 5% of the common stock being offered by this prospectus for sale at the initial public offering price to our directors, director nominees, officers, employees and other individuals associated with us and members of their families. Any reserved shares not so purchased will be offered by the underwriters to the general public on the same terms as the other shares of common stock. Participants in the directed share program who purchase more than $1 million of shares shall be subject to a 25-day lock-up with respect to any shares sold to them pursuant to that program. Any shares sold in the directed share program to our directors, director nominees or executive officers shall be subject to 180-day lock-ups. Any of these lock-up agreements will have similar restrictions to the lock-up agreements described herein. See “Underwriting (Conflicts of Interest)—Directed Share Program.”

 

Conflicts

Because UBS Securities LLC is a lender under the UBS Credit Agreement and will receive more than 5% of the net proceeds of this offering due to the repayment of borrowings thereunder, UBS Securities LLC is deemed to have a conflict of interest within the meaning of Rule 5121 of the Financial Industry Regulatory Authority, Inc. (“FINRA”). Accordingly, this offering will be conducted in

 

 

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accordance with Rule 5121, which requires, among other things, that a “qualified independent underwriter” participate in the preparation of, and exercise the usual standards of “due diligence” with respect to, the registration statement and this prospectus. SunTrust Robinson Humphrey, Inc. has agreed to act as a qualified independent underwriter for this offering and to undertake the legal responsibilities and liabilities of an underwriter under the Securities Act, specifically including those inherent in Section 11 thereof. SunTrust Robinson Humphrey, Inc. will not receive any additional fees for serving as a qualified independent underwriter in connection with this offering. We have agreed to indemnify SunTrust Robinson Humphrey, Inc. against liabilities incurred in connection with acting as a qualified independent underwriter, including liabilities under the Securities Act. See “Underwriting (Conflicts of Interest)—Conflicts of Interest.”

 

Risk factors

Investing in our common stock involves risks. You should read carefully the “Risk Factors” section of this prospectus for a discussion of factors that you should carefully consider before deciding to invest in shares of our common stock.

 

Proposed ticker symbol

“PN”

Unless we indicate otherwise or the context otherwise requires, all information in this prospectus:

 

Ø   assumes no exercise of the underwriters’ over-allotment option;

 

Ø   reflects 965,700 shares of common stock that will be issued upon the exercise of outstanding warrants held by the selling stockholders (or 1,110,555 shares if the underwriters exercise in full their over-allotment option) at an exercise price of $2.67 per share as of September 30, 2014, which shares are being offered hereby; and

 

Ø   does not reflect (1) 475,658 restricted shares of common stock (292,900 shares of which vest within 180 days of this offering), 125,020 restricted stock units and stock options to acquire 1,030,591 shares of common stock, with an exercise price equal to the price at which shares of common stock are sold in this offering, all of which we intend to issue in connection with this offering under the Patriot National, Inc. 2014 Omnibus Incentive Plan (the “2014 Plan”); and (2) an additional 1,193,699 shares of common stock available for future issuance under our 2014 Plan. See “Management—Executive Compensation—Compensation Arrangements to be Adopted in Connection with this Offering.”

 

 

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SUMMARY HISTORICAL AND PRO FORMA COMBINED FINANCIAL DATA

The following table sets forth our summary historical and pro forma combined financial and other data as of the dates and for the periods indicated below. We have derived the summary historical combined financial data as of December 31, 2013 and 2012 and for the years then ended from our audited combined financial statements, which are included elsewhere in this prospectus. The summary historical interim combined financial data as of September 30, 2014 and for the nine months ended September 30, 2014 and 2013 was derived from our unaudited interim combined financial statements, which are also included elsewhere in this prospectus. Our unaudited interim combined financial statements have been prepared on the same basis as our audited combined financial statements and reflect, in the opinion of management, all adjustments of a normal, recurring nature that are necessary for a fair presentation of the unaudited interim combined financial statements. These historical results are not necessarily indicative of results to be expected in any future period.

The combined financial statements of Patriot National are comprised of (1) the financial statements of us and our subsidiaries, which became our subsidiaries in the Reorganization, (2) the results of the Patriot Care Management Business, which are reflected in our combined financial statements from August 6, 2014, the effective date of the Patriot Care Management Acquisition, and (3) the revenues and expenses associated with the contracts and certain other assets acquired and liabilities assumed effective August 6, 2014 in the GUI Acquisition from GUI, a wholly owned subsidiary of Guarantee Insurance Group and a related party by virtue of common control between us and Guarantee Insurance Group. Because we and the subsidiaries we acquired in the Reorganization are under common control, and the contracts acquired in the GUI Acquisition were acquired from an entity under common control, our combined financial statements are presented as if all of these companies and businesses, were owned by us for all of the periods presented, as further described in the notes to our combined financial statements included elsewhere in this prospectus.

We have derived the summary unaudited pro forma condensed combined financial data as of and for the nine months ended September 30, 2014 from our unaudited combined financial statements, which is included elsewhere in this prospectus, and the unaudited consolidated financial statements of Patriot Care Holdings, Inc. (f/k/a MCRS Holdings, Inc.), our subsidiary operating the Patriot Care Management Business (“PCM”). We have derived the summary unaudited pro forma condensed combined financial data for the year ended December 31, 2013 from our audited combined financial statements and the audited consolidated financial statements of PCM, both of which are also included elsewhere in this prospectus. We have derived the summary unaudited pro forma condensed combined statement of operations data for the twelve months ended September 30, 2014 by adding the summary unaudited pro forma condensed combined statement of operations data for the nine months ended September 30, 2014 and for the year ended December 31, 2013 and subtracting the summary unaudited pro forma condensed combined statement of operations data for the nine months ended September 30, 2013, each of which are included elsewhere in this prospectus; such compilation has not been audited or reviewed.

The unaudited pro forma condensed combined balance sheet data as of September 30, 2014 gives effect, in the manner described under “Unaudited Pro Forma Financial Information” and the notes thereto, to this offering, anticipated borrowings under the senior secured credit facility and the application of a portion of the net proceeds therefrom to repay outstanding indebtedness as described under “Use of Proceeds” as if such events had been completed as of September 30, 2014.

 

 

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The unaudited pro forma condensed combined statement of operations data for the nine and twelve months ended September 30, 2014 and for the year ended December 31, 2013 gives effect, in the manner described under “Unaudited Pro Forma Financial Information” and the notes thereto, to:

 

Ø   the additional statement of operations impact of the financing we incurred in connection with the GUI Acquisition, including the issuance of additional warrants to the lenders;

 

Ø   the Patriot Care Management Acquisition; and

 

Ø   this offering, anticipated borrowings under the senior secured credit facility and the application of a portion of the net proceeds therefrom to repay outstanding indebtedness as described under “Use of Proceeds,”

as if all such events had been completed as of January 1, 2013.

The unaudited pro forma adjustments are based upon available information and certain assumptions that we believe are reasonable under the circumstances. The summary unaudited pro forma condensed combined financial data is presented for informational purposes only and is not necessarily indicative of and does not purport to represent what our financial position or results of operations would actually have been had the transactions been consummated as of the dates indicated. In addition, the summary unaudited pro forma condensed combined financial data is not necessarily indicative of our future financial condition or results of operations.

 

 

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This summary historical and pro forma combined financial data should be read in conjunction with the disclosures set forth under “Capitalization,” “Unaudited Pro Forma Financial Information,” “Selected Historical Combined Financial Data” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and the related notes thereto appearing elsewhere in this prospectus.

 

                Pro Forma(1)  
    Nine Months
Ended
September 30,
    Year Ended
December 31,
    Nine Months
Ended
September 30,
    Year
Ended
December 31,
    Twelve
Months

Ended
September 30,
 
In thousands, except per share
data
  2014     2013     2013     2012             2014                     2013                     2014          
    (Unaudited)           (Unaudited)  
Combined Statement of Operations Data              

Revenues

             

Fee income

  $ 37,896      $ 36,845      $ 46,486      $ 25,821      $ 53,925      $ 75,797      $ 71,469   

Fee income from related party(2)

    24,589        5,238        9,387        12,546        32,668        17,133        38,658   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total fee income and fee income from related party

    62,485        42,083        55,873        38,367        86,593        92,930        110,127   

Net investment income

    496        7        87        62        496        87        576   

Net realized gains (losses) on investments

    14,038        (50     (50     3        14,038        (50     14,038   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Revenues

    77,019        42,040        55,910        38,432        101,127        92,967        124,741   

Expenses

             

Salaries and salary related expenses

    17,907        12,097        15,985        13,189        22,532        23,742        28,038   

Commission expense

    9,491        6,651        8,765        3,216        9,491        8,765        11,605   

Management fees to related party for administrative support services(3)

    5,390        9,200        12,139        8,007        7,152        15,079        9,828   

Outsourced services

    3,118        2,378        3,303        4,452        7,512        10,606        10,404   

Allocation of marketing, underwriting and policy issuance costs from related party(4)

    1,872        3,449        4,687        2,774        1,872        4,687        3,110   

Other operating expenses

    7,701        3,247        4,557        4,587        11,105        6,896        12,956   

Interest expense

    5,427        606        1,174        299        1,069        11,662        6,815   

Depreciation and amortization

    3,699        1,550        2,607        1,330        12,130        15,794        16,484   

 

 

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                Pro Forma  
    Nine Months
Ended
September 30,
    Year Ended
December 31,
    Nine Months
Ended
September 30,
    Year
Ended
December 31,
    Twelve
Months

Ended
September 30,
 
In thousands, except per share
data
  2014     2013     2013     2012             2014             2013     2014  
    (Unaudited)           (Unaudited)  

Amortization of loan discounts and loan costs

    1,295        702        5,553        211        3,312        8,419        8,879   

Loss on exchange of units and warrants

    —          —          152        —          —          152        —     

Increase (decrease) in fair value of warrant redemption liability

    (2,257     300        —          —          (2,257     —          (2,405

Provision for uncollectible fee income

    100        2,544        2,544        —          210        4,255        223   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Expenses

    53,743        42,724        61,466        38,065        74,128        110,057        105,937   

Net Income (Loss) Before Income Tax Expense

    23,276        (684     (5,556     367        26,999        (17,090     18,804   

Income tax expense 

    10,401        31        712        —          12,409        (1,771     13,396   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net Income (Loss) Including Non-Controlling Interest in Subsidiary

    12,875        (715     (6,268     367        14,590        (15,319     5,408   

Net income (loss) attributable to non-controlling interest in subsidiary

    68        19        (82     23        68        (82     (33
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net Income (Loss)

  $ 12,807      $ (734   $ (6,186   $ 344      $ 14,522      $ (15,237   $ 5,441   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net Income (Loss) Per Common Share(5)

             

Basic

  $ .85      $ (.05   $ (.43   $ .02      $ .57      $ (.62   $ .22   

Diluted

  $ .65      $ (.05   $ (.43   $ .02      $ .47      $ (.62   $ .12   

Weighted Average Common Shares Outstanding(5)

             

Basic

    14,981        14,288        14,288        14,288        25,393        24,732        25,266   

Diluted

    16,183        14,288        14,288        14,420        26,054        24,732        25,924   

 

 

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                            Pro Forma(6)          
    September 30,           December 31,     September 30,          
In thousands           2014                   2013     2012     2014          
    (Unaudited)                       (Unaudited)          

Combined Balance Sheet Data

             

Assets

             

Cash

  $ 8,026        $ 1,661      $ 1,684      $ 11,995       

Restricted cash(7)

    5,107          4,435        145        5,107       

Goodwill

    59,385          9,953        9,953        59,385       

Total Assets

    136,997          35,979        28,430        137,566       

Liabilities and stockholders’ deficit

             

Total debt

  $  119,156        $  45,330      $ 4,712      $ 45,341       

Stockholders’ equity (deficit)

    (38,701       (30,888     8,801        44,038       
                Pro Forma
    Nine Months
Ended September 30,
    Year Ended
December 31,
    Nine Months
Ended
September 30,
   

Year

Ended

December 31,

 

Twelve
Months
Ended
September 30,

In thousands, except
percentages
          2014             2013     2013     2012     2014     2013   2014
    (Unaudited)           (Unaudited)

Other Financial and Operating Measures

             

Adjusted EBITDA(8)

  $ 17,334      $ 5,049      $ 6,606      $ 2,181      $ 27,357      $23,324   $34,795

Adjusted EBITDA margins(8)

    27.7     12.0     11.8     5.7     31.6   25.1%   31.6%

Reference premium written(9)

  $ 277,941      $ 277,314      $ 357,376      $ 305,692      $ 277,941     

$357,376

 

$358,003

(footnotes on following page)

 

 

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(1)   Reflects anticipated borrowings of $37.7 million (net of loan fees) under the proposed senior secured credit facility that we intend to enter into concurrently with this offering, and application of a portion of such borrowings, together with the net proceeds from this offering, to the repayment of all outstanding amounts under the PennantPark Loan Agreement and the UBS Credit Agreement. Assuming that we do not enter into the senior secured credit facility, or do not make such borrowings, and that $37.7 million of borrowings remain outstanding under the UBS Credit Agreement, for the twelve months ended September 30, 2014, our pro forma interest expense would be $10.1 million, our pro forma net income would be $3.4 million and our pro forma basic net income per common share would be $.14. See “Unaudited pro Forma Financial Information” for more information on the effect of such changes on other periods. Based on our estimated cash and cash equivalents (excluding restricted cash) as of December 31, 2014, we believe that we will be in a position to repay all amounts under the PennantPark Loan Agreement and the UBS Credit Agreement with the net proceeds from this offering together with cash on hand.
(2)   Represents service fees from Guarantee Insurance, a related party. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Principal Components of Financial Statements—Revenue.”
(3)   Represents historical fees paid by us to Guarantee Insurance Group for management oversight, legal, accounting, human resources and technology support services provided to us. Our administrative functions have been separated from Guarantee Insurance Group and from August 6, 2014, such payments are longer made by us in respect of such services.
(4)   Represents historical payments made by us to Guarantee Insurance Group as reimbursements for allocated portions of rent and certain administrative costs incurred by Guarantee Insurance Group on our behalf. Our administrative functions have been separated from Guarantee Insurance Group and from August 6, 2014, such reimbursements are no longer made by us in respect of such costs.
(5)   See “Prospectus Summary—The Offering” on page 14 of this prospectus for more detail regarding the number of outstanding shares presented.
(6)   Reflects anticipated borrowings of $37.7 million (net of loan fees) under the proposed senior secured credit facility that we intend to enter into concurrently with this offering, and application of a portion of such borrowings, together with the net proceeds from this offering, to the repayment of all outstanding amounts under the PennantPark Loan Agreement and the UBS Credit Agreement and of the remaining portion to cash and cash equivalents. Assuming that we do not enter into the senior secured credit facility, or do not make such borrowings, and that $37.7 million of borrowings remain outstanding under the UBS Credit Agreement, as of September 30, 2014, our pro forma cash would be $30.3 million and our pro forma total debt would be $43.0 million.
(7)   Represents amounts received from our clients to be used exclusively for the payment of claims on behalf of those clients.
(8)   To provide investors with additional information regarding our financial results, we have presented Adjusted EBITDA and Adjusted EBITDA margins, both of which represent non-GAAP financial measures. Adjusted EBITDA is defined by us as net income before interest expense, income tax expense (benefit), depreciation and amortization and amortization of loan discounts and loan costs, further adjusted for the effects of net realized losses (gains) on investments, loss on exchange of units and warrants and changes in fair value of warrant redemption liability. We have provided below a reconciliation of Adjusted EBITDA to net income, the most directly comparable GAAP financial measure. Adjusted EBITDA margins are calculated as Adjusted EBITDA divided by the sum of fee income and fee income from related party.

 

 

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We have presented Adjusted EBITDA and Adjusted EBITDA margins in this prospectus 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 and Adjusted EBITDA margins can provide useful measures for period-to-period comparisons of our core business. Accordingly, we believe that Adjusted EBITDA and Adjusted EBITDA margins 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.

Adjusted EBITDA and Adjusted EBITDA margins have limitations as analytical tools, and you should not consider them in isolation or as a substitute for analysis of our financial results as reported under GAAP. Some of these limitations are as follows:

 

  Ø   although depreciation and amortization expense are non-cash charges, the assets being depreciated and amortized may have to be replaced in the future;

 

  Ø   Adjusted EBITDA does not reflect changes in, or cash requirements for, our working capital needs or tax payments that may represent a reduction in cash available to us; and

 

  Ø   other companies, including companies in our industry, may calculate Adjusted EBITDA or similarly titled measures differently, which reduces its usefulness as a comparative measure.

(footnotes continued on following page)

 

 

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Because of these and other limitations, you should consider Adjusted EBITDA and Adjusted EBITDA margins together with other GAAP-based financial performance measures, including our GAAP financial results. The following table presents a reconciliation of Adjusted EBITDA to net income for each of the periods indicated:

 

                Pro Forma  
    Nine Months
Ended
September 30,
    Year Ended
December 31,
    Nine Months
Ended
September 30,
    Year
Ended
December 31,
    Twelve
Months
Ended
September 30,
 
In thousands, except
percentages
  2014     2013     2013     2012     2014     2013     2014  
    (Unaudited)           (Unaudited)  

Net income (loss)

  $ 12,807      $ (734   $ (6,186   $ 344      $ 14,522      $ (15,237   $ 5,441   

Interest expense

    5,427        606        1,174        299        1,069        11,662        6,815   

Income tax expense

    10,401        31        712        —          12,409        (1,771     13,396   

Depreciation and amortization

    3,699        1,550        2,607        1,330        12,130        15,794        16,484   

Amortization of loan discounts and loan costs(a)

    1,295        702        5,553        211        3,312        8,419        8,879   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

EBITDA

    33,629        2,155        3,860        2,184        43,442        18,867        51,015   

Net realized losses (gains) on investments(b)

    (14,038     50        50        (3     (14,038     50        (14,038

Loss on exchange of units and warrants(c)

    —          —          152        —          —          152        —     

Increase (decrease) in fair value of common stock and warrant redemption liability(d)

    (2,257     300        —          —          (2,257     —          (2,405

Provision for uncollectible fee income(e)

    —          2,544        2,544        —          210        4,255        223   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Adjusted EBITDA (unaudited)

  $ 17,334      $ 5,049      $ 6,606      $ 2,181      $ 27,357      $ 23,324      $ 34,795   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

  (a)   Represents amortization of loan discounts and loan costs associated with loan agreements, and of the estimated value of equity interests issued to lenders pursuant to such loan agreements.
  (b)   Represents, for the nine months ended September 30, 2014, the net gain realized upon the redemption of preferred equity issued by MCMC in connection with the Patriot Care Management Acquisition.
  (c)   Represents a non-recurring loss recorded as part of the Reorganization in connection with the exchange by Advantage Capital Community Development Fund, L.L.C. (“Advantage Capital”), one of our prior lenders, of its common units and detachable common stock warrants issued by certain of our subsidiaries for detachable common stock warrants of ours, which had a higher value.
  (d)  

Represents the change in estimated fair value of the detachable common stock warrants issued to the lenders in connection with (i) the Initial Tranche of the PennantPark Loan Agreement and (ii) the exchange described in (c) above. We recorded this warrant redemption liability, and

 

 

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reflect the changes in the estimated fair value thereof, because the warrant holders may require us to redeem the warrants for cash, in an amount equal to the estimated fair value of the warrants less the total exercise price of the redeemed warrants.

  (e)   Represents a provision for uncollectible fee income recorded in connection with the liquidation in May 2013 of Ullico Casualty Company (“Ullico”), one of our insurance carrier clients from April 2009 until we terminated the contract effective March 26, 2012. See “Risk Factors—Our total fee income and fee income from related party are currently substantially dependent on our relationships with Guarantee Insurance and a small number of other insurance carrier clients.”

 

(9)   Reference premium written represents the aggregate premium, grossed up for large deductible credits, written by or for our insurance carrier partners in respect of the policies we produce and service on their behalf.

 

 

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Risk Factors

An investment in our common stock involves significant risks. Before making a decision to purchase our common stock, you should carefully consider these risks, together with the other information contained in this prospectus. Many factors, including the risks described below, could result in a significant or material adverse effect on our business, financial condition and results of operations. If this were to happen, the price of our shares could decline significantly and you could lose all or part of your investment.

RISKS RELATED TO OUR BUSINESS

Because we have a limited operating history as a stand-alone, combined company and business, our historical and pro forma financial condition and results of operations are not necessarily representative of the results we would have achieved as a stand-alone, combined, publicly-traded company and may not be a reliable indicator of our future results.

The activities comprising our business were historically conducted through various entities under common control with, or as part of the operations of, Guarantee Insurance and its other affiliates, and our business has only recently been consolidated under Patriot National and separated from the insurance risk taking operations of Guarantee Insurance Group. In addition, we have only recently completed the GUI Acquisition and the Patriot Care Management Acquisition. As a result, our history as a stand-alone entity is limited. Our historical and pro forma financial condition and results of operations included in this prospectus may not reflect what our business, financial condition, results of operations and cash flows would have been had we been a stand-alone, combined, publicly-traded company during the periods presented or what our business, financial condition, results of operations and cash flows will be in the future when we are such a company. As a result, you have limited information on which to evaluate our business. This is primarily because:

 

·   Most of our operations were separated from Guarantee Insurance and consolidated under Patriot National, Inc. in the Reorganization in November 2013, and on August 6, 2014 we acquired through the GUI Acquisition contracts to provide marketing, underwriting and policyholder services and through the Patriot Care Management Acquisition a business that provides nurse case management and bill review services.

 

·   Our historical combined financial statements have been derived from the separate financial statements and accounting records of Patriot National, Inc. and the various entities under common control which became its subsidiaries following the Reorganization and reflects assumptions made by us relating to allocations for periods prior to the Reorganization and the GUI Acquisition. The pro forma combined financial data gives effect to certain aspects of the GUI Acquisition not already reflected in our audited combined financial statements and the Patriot Care Management Acquisition. In addition, certain reclassification adjustments have been made in the presentation of the PCM historical amounts to conform PCM’s financial statement basis of presentation to that followed by us. The pro forma adjustments are based on information available at the time of the preparation of this prospectus, which in part includes a number of estimates and assumptions. For example, we have recorded the fair values of the assets acquired and liabilities assumed in the Patriot Care Management Acquisition based on preliminary estimates of their fair values. The determination of such fair values may be modified through August 6, 2015, one year from the consummation of the acquisition, as more information is obtained about the fair value of such assets acquired and liabilities assumed.

 

·   Our capital structure and sources of liquidity will change significantly from our historical capital structure and sources of liquidity presented in our historical combined financial statements following the consummation of this offering.

 

 

 

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·   We may incur increased costs and other significant changes may occur in our cost structure, management, financing, tax status and business operations as a result of our operating as a stand-alone, combined, publicly-traded company.

Our limited operating history as a stand-alone, combined company and business may make it difficult to evaluate our current business and predict our future performance. Any assessment of our profitability or prediction about our future success or viability is subject to significant uncertainty as we may not be able to successfully implement the changes necessary to operate as a stand-alone, combined, publicly-traded company, and we may need to incur more costs, including additional legal, accounting, compliance and other expenses not reflected in our historical results, than anticipated. See “Risks Related to Our Common Stock and this Offering—Transformation into a public company may increase our costs and disrupt the regular operations of our business.”

Our business may be materially adversely impacted by general economic and labor market conditions.

We derive our revenue from the provision of services to the workers’ compensation insurance industry. Given the concentration of our business activities in this industry, we may be particularly exposed to certain economic downturns or other events that impact the labor market. Because a significant portion of the fees that we receive are based on a percentage of the reference premiums written for policies we produce and service, premium levels directly impact our revenues. Premium level growth is dependent in part upon payroll growth, which, in turn, is affected by underlying economic and labor market conditions. A poor economic environment and labor market could result in decreases in demand for our workers’ compensation insurance services as employers hire fewer workers, reduce wages or limit wage increases or curtail operations due to challenging market conditions. General business and economic conditions that could affect us, our carrier partners and our other clients include fluctuations in debt and equity capital markets, the availability and cost of credit, and investor and consumer confidence. In addition to the adverse effects caused by a weak labor market on demand for workers’ compensation insurance and related services, our carrier partners may experience increased losses in weak economic conditions because, among other things, it is more difficult to return injured workers to work when employers are otherwise reducing payrolls. This could cause them to reduce their business levels, which would in turn reduce the level of services we provide for them. In addition, some of our clients may cease offering workers’ compensation products, or cease operations completely, in the event of a prolonged deterioration in the economy, or be acquired by other companies. Any of the foregoing could have a material adverse effect on our business, financial condition and results of operations.

The workers’ compensation insurance industry is cyclical in nature, which may affect our overall financial performance.

Historically, the workers’ compensation insurance market has witnessed cyclical periods of price competition and excess underwriting capacity (known as a “soft market”), followed by periods of high premium rates and shortages of underwriting capacity (known as a “hard market”). Because this cyclicality is due in large part to general economic factors and other events beyond our control, we cannot predict with certainty the timing or duration of changes in the market cycle.

In 2012 and 2013, the workers’ compensation insurance market underwent a modest “hardening” across many lines and geographic areas. In this environment, premium rates increased at a moderate pace across these fiscal years, our clients could still obtain coverage for their workers’ compensation insurance needs and there was adequate capacity in the market. Because a significant portion of the fees that we receive are based on a percentage of the reference premiums written for policies we service, increases in premium rates resulted in corresponding increases in our revenues during this period. It is not clear whether this firming is sustainable given the continued uncertainty of the current economic environment.

 

 

 

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As a provider of services to the workers’ compensation insurance market, our business is likely to be impacted by this cyclical market pattern, although it is difficult to predict, overall, the exact nature and extent of such impact. For example, in a soft market, our agency and other service fees that are based on a percentage of reference premiums written could decline, although demand for our cost containment and other services could increase as insurers seek to decrease expenses and additional insurers enter the market, which increases our potential client base. In a hard market, our service fees that are based on a percentage of reference premiums written could increase, although we could experience less demand for cost containment services. Moreover, in a hard market, insurance companies typically become more selective in the workers’ compensation risks they underwrite and insurance premiums increase. This often results in a reduction in industry-wide claims volumes, which could reduce demand for our claims administration, cost containment and other related services. If we are unable to accurately predict or react to any such market conditions, or if severe or unusual market conditions impact us in an unforeseen manner, our business, financial condition and results of operations could be adversely impacted.

In addition, there have been and may continue to be various trends in the insurance industry toward alternative insurance markets including, among other things, greater recourse to self-insurance, reinsurance captive entities, risk retention groups and non-insurance capital markets-based solutions to traditional insurance. While historically we have been able to participate in reinsurance captive entities solutions on behalf of our clients and obtain fee revenue for such services, there can be no assurance that we will continue to do so or that we will adequately adapt to new trends in this area, or that any potential increase in revenues from such activities would compensate for losses in our other primary businesses.

We may be more vulnerable to negative developments in the workers’ compensation insurance industry than companies that also provide outsourced services for other lines of insurance.

Our business involves providing outsourcing services within the workers’ compensation marketplace for insurance companies and other clients, and we currently do not have plans to focus our efforts on other lines of insurance. As a result, negative developments in the economic, competitive or regulatory conditions affecting the workers’ compensation insurance industry could have a greater adverse effect on our business, financial condition and results of operations than on more diversified companies that also provide outsourced services for other lines of insurance.

If workers’ compensation claims decline, in frequency or severity, our results of operations and financial condition may be adversely affected.

The frequency of workers’ compensation claims has been declining over the past few decades, but the severity of claims, in terms of both indemnity payment costs and medical costs, has generally increased. If, as a result of market conditions, regulatory changes or other factors, claims frequency declines more than anticipated, or if claims severity declines, our business could be adversely impacted. In addition, a prolonged economic downturn could lead to fewer workers on a national level and could lead to fewer work-related injuries. Technological innovations and changes in the character of the U.S. labor market over time could also lead to fewer work-related injuries and thus fewer workers’ compensation claims.

In addition, the impact of changes in the healthcare industry, as a result of the Patient Protection and Affordable Care Act (the “PPACA”) or otherwise, is uncertain, but could include impacts on frequency (for example, by increasing healthcare insurance coverage or the prevalence of preventative treatment) and severity (by impacting the medical costs associated with claims) of workers’ compensation claims.

 

 

 

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If declines in the frequency or the severity of workers’ compensation claims occur and persist in states where we conduct significant business, it could result in lower premium rates, which would reduce the fees that we generate as a percentage of reference premiums written, and lower claims management costs for insurers and employers, which could reduce demand for our claims administration, cost containment and other services. Any of the foregoing could have a material adverse impact on our business, financial condition and results of operations.

Our total fee income and fee income from related party are currently substantially dependent on our relationships with Guarantee Insurance and a small number of other insurance carrier clients.

A substantial portion of our total fee income and fee income from related party is generated by providing brokerage and policyholder and claims administration services to Guarantee Insurance. A portion of the fees that we receive from Guarantee Insurance pursuant to our agreements are for Guarantee Insurance’s account (which we recognize as “fee income from related party”) and a portion of the fees are for the account of reinsurance captive entities to which Guarantee Insurance has ceded a portion of its written risk (which we recognize as “fee income”). See “Management’s Discussion and Analysis of Financial Conditions and Results of Operations—Principal Components of Financial Statements—Revenue.” As a result, a substantial portion of fee income we recognize from non-related parties is nevertheless derived from our relationship with Guarantee Insurance. For the nine months ended September 30, 2014, we recognized an aggregate of $41.5 million in total fee income and fee income from related party pursuant to contracts with Guarantee Insurance, and our fee income from related party was $24.6 million. For the year ended December 31, 2013, we recognized an aggregate of $25.0 million in total fee income and fee income from related party pursuant to contracts with Guarantee Insurance, and our fee income from related party was $9.4 million. Our total fee income and fee income from related party pursuant to contracts with Guarantee Insurance and our fee income from related party constituted 66% and 39%, respectively, of our total fee income and fee income from related party for the nine months ended September 30, 2014 and 44% and 17%, respectively, of our total fee income and fee income from related party for the year ended December 31, 2013.

To a lesser but still significant extent, a substantial portion of our total fee income and fee income from related party is generated from our relationship with Zurich. Fee income for services provided to Zurich constituted 22% and 38% of our total fee income and fee income from related party for the nine months ended September 30, 2014 and the year ended December 31, 2013, respectively.

Although we intend to expand our relationships with additional carrier partners and our service offerings to third-party clients in the future, we expect that in the near-term a significant portion of our revenues will continue to be derived through our relationships with Guarantee Insurance, Zurich and Scottsdale. As such, we will continue to be significantly impacted by the overall business levels of these carrier partners. While we have a limited ability to affect their business levels through the services we provide, their business levels are largely impacted by many factors outside of our control. For example, the general effects of economic and labor market conditions on business levels, a variety of market or regulatory factors can impact our carrier partners’ decisions regarding the markets they enter, the products they offer and the industries they target. In addition, their business levels will depend on their ability to attract and retain policyholders, which can be impacted by their competitiveness in terms of financial strength, ratings, reputation, pricing, product offerings (including alternative market offerings) and other factors that independent retail agencies and policyholders consider attractive. A reduction in the business levels of our carrier partners would result in a reduction of the services we provide to them and the amount of revenues we generate from such services, which, assuming we have not expanded our relationships with additional carrier partners or other clients, could represent a significant portion of our revenues.

 

 

 

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Further, if the premium rates assessed by our carrier partners decreased, we would experience a corresponding decrease in the revenues that we derive from these carrier partners because a significant portion of the fee revenue we receive from providing services to them is based on a percentage of reference premiums written for the policies that we produce and service. We do not have any ability to control such rates, and in certain states premium rates are established by regulation. Further, our insurance carrier clients may in the future seek to reduce the service fees paid to us.

Our carrier partners also have the ability to terminate their agreements with us under certain circumstances, as described in more detail under “Business—Clients”. In addition, some of our clients may cease offering workers’ compensation products, or cease operations completely. For example, in March 2012 we were forced to terminate our program administrator agreement with Ullico, one of our insurance carrier clients, and to commence a process to wind-down our program under this agreement. The basis for termination, pursuant to the agreement, was the sudden and substantial deterioration of Ullico’s financial position and results of operations. Subsequent to the termination of the agreement with Ullico, Ullico continued to remit portions of the total fee income receivable to us, and we believed it was more likely than not that all remaining outstanding balances due from Ullico would be paid to us based on the sufficiency of Ullico’s cash and invested assets through and as of December 31, 2012. On March 11, 2013, the Delaware Insurance Commissioner commenced rehabilitation proceedings against Ullico and, subsequently on May 30, 2013, Ullico was liquidated. Based on these developments, we determined in 2013 that it was probable that the remaining outstanding balances due from Ullico were impaired and a provision was established for 100% of these balances due.

In the event our carrier partners terminate their agreements with us, our clients cease offering workers’ compensation products, our clients cease operations completely, or under certain other circumstances, we could experience a significant decrease in revenue. Under such circumstances, we would attempt to replace that relationship and transition the business to another carrier partner. However, there can be no assurance that we would be able to do so successfully or at all.

Further, we are subject to counterparty credit risk due to our dependence on a small number of insurance carrier clients. Although we monitor our exposure to counterparty credit risk, if any of these clients ceases doing business or fails to perform its obligations under our contracts with them, our business, financial position and results of operations would be materially adversely affected.

For more information about Guarantee Insurance, Zurich and Scottsdale, and the terms of our relationships with them, see “Business—Clients” and “Certain Relationships and Related Party Transactions—Relationship and Transactions with Guarantee Insurance Group and Guarantee Insurance.”

Our relationship with Guarantee Insurance may create conflicts of interest, and we cannot be certain that all our transactions with Guarantee Insurance will be conducted on the same terms as those available from unaffiliated third parties.

Immediately upon consummation of this offering, Mr. Mariano, our founder, Chairman, President and Chief Executive Officer, will beneficially own 59.5% of the outstanding shares of our common stock and substantially all of the outstanding equity of Guarantee Insurance Group, the parent company of Guarantee Insurance. As such, we cannot assure you all of our transactions with Guarantee Insurance will be on the same terms as those available with unaffiliated third parties or that the affiliation will not impact otherwise impact our actions in a manner that is adverse to us or our stockholders. Although most of our operations were separated from Guarantee Insurance and consolidated under Patriot National, Inc. in the Reorganization in November 2013, a substantial portion of our revenues is generated through our relationship with Guarantee Insurance. Our total fee income and fee income from related party pursuant to

 

 

 

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contracts with Guarantee Insurance and our fee income from related party constituted 66% and 39%, respectively, of our total fee income and fee income from related party for the nine months ended September 30, 2014 and 44% and 17%, respectively, of our total fee income and fee income from related party for the year ended December 31, 2013. Furthermore, on August 6, 2014, we acquired, through the Acquisitions, contracts to provide marketing, underwriting and policyholder services and our Patriot Care Management Business from entities controlled by Mr. Mariano; concurrently, we also entered into a new agreement with Guarantee Insurance to provide all such services that GUI had provided to Guarantee Insurance, its parent, prior to the GUI Acquisition.

Although Mr. Mariano is no longer a board member or officer of Guarantee Insurance Group or Guarantee Insurance, and we have implemented a related party transaction policy in connection with this offering, because of his ownership position in Guarantee Insurance Group, Mr. Mariano’s interests in our dealings with Guarantee Insurance may not align with our other stockholders. See “Certain Relationships and Related Party Transactions—Relationship and Transactions with Guarantee Insurance Group and Guarantee Insurance.”

If we cannot sustain our relationships with independent retail agencies, we may be unable to operate profitably.

We market and sell the insurance products of our carrier partners primarily through direct contracts with over 1,000 independent, non-exclusive retail agencies, some of which account for a large portion of our revenues. Other insurance companies and insurance service companies compete with us for the services and allegiance of these agencies. These agencies may choose to direct business to our competitors, or may direct less desirable business to us. Our business relationships with these agencies are generally governed by our standard form agreements with them that typically provide that the agreement may be terminated on 30 days’ notice by either party without cause.

For the year ended December 31, 2013, approximately 12% and 5% of our total premiums written for policies issued by Guarantee Insurance and by us on behalf of our carrier partners were derived from various offices of Phoenix Risk Management Insurance Services, Inc. and Appalachian Underwriters, Inc., respectively, and for the nine months ended September 30, 2014, approximately 7% of our total premiums written for policies issued by us on behalf of our carrier partners were derived from various offices of TriGen Insurance Solutions, Inc. No other agencies accounted for more than 5% of our total premiums written.

As a result, our continued profitability depends, in part, on the marketing efforts of our independent agencies and on our ability to offer workers’ compensation insurance products through our carrier partners that meet the requirements and preferences of our independent retail agencies and their clients. A significant decrease in business from, or the entire loss of, our largest agencies or several of our other large agencies would have a material adverse effect on our business, financial condition and results of operations.

Our geographic concentration ties our performance to business, economic and regulatory conditions in certain states, and unfavorable conditions in these states could have a significant adverse impact on our business, financial condition and results of operations.

As of September 30, 2014, a majority of our reference premiums written is concentrated in Florida, California, New Jersey, Georgia, New York and Pennsylvania, with Florida and California being the largest contributors.

Our workers’ compensation insurance service operations could be particularly adversely affected by an economic downturn in one or more of these states. In addition to the various other factors that could

 

 

 

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impact the economic and labor market conditions in these states, conditions could be affected by local or regional events, including natural disasters, such as hurricanes or earthquakes, or other catastrophic events that disrupt the local economy and cause businesses to cease operations or decrease payroll, thus reducing demand for workers’ compensation insurance.

We could also be adversely affected by any material change in law, regulation or any court decision affecting the workers’ compensation insurance industry generally in these states. For example, in Florida and New Jersey where a significant portion of the policies that we service are written, insurance regulators establish the premium rates charged by our carrier partners. If insurance regulators in these states decrease premium rates or prevent them from increasing, it would directly adversely impact our fees that are based on a percentage of reference premiums written. In addition, if regulators set rates below those that our carrier partners require to maintain profitability, our carrier partners may be less willing to write policies in those states or attempt to negotiate lower fees from us, which would adversely impact the revenues we generate through our relationships with our carrier partners.

Any of the foregoing events could have a material adverse effect on our business, financial condition and results of operations.

We are subject to extensive regulation and supervision and our failure to comply with such regulation or adapt to new regulatory and legislative initiatives may adversely impact our business.

We are subject to extensive regulation by the insurance regulatory agencies of the states in which we are licensed and, to a lesser extent, federal regulation. For example, approximately half of the states in the United States have enacted laws that require licensing of businesses which provide medical review services such as ours. Some of these laws apply to medical review of care covered by workers’ compensation. These laws typically establish minimum standards for qualifications of personnel, confidentiality, internal quality control and dispute resolution procedures. We are also subject to state insurance fraud provisions, as well as federal fraud-and-abuse, anti-kickback and false claims statutes. Such laws, regulation and supervision could reduce our profitability or growth by increasing compliance costs or by restricting the products or services we may sell, the markets we may enter, the methods by which we may sell products and services, the prices we may charge for our services and the form of compensation we may accept from our carrier partners and other clients. Failure to comply with these laws and regulation may result in the suspension or revocation of licenses, censures, redress to clients and fines.

Licensing laws and regulations vary from state to state, but in general many of the services that we provide require licensing. For example, our policyholder services and claims administration activities generally require licensing at the state level. In all states, the applicable licensing laws and regulations are subject to amendment or interpretation by regulatory authorities. Generally such authorities are vested with relatively broad and general discretion as to the granting, renewing and revoking of licenses and approvals. Licenses may be denied or revoked for various reasons, including the violation of regulations and conviction of crimes. Possible sanctions which may be imposed by regulatory authorities include the suspension of individual employees, limitations on engaging in a particular business for specified periods of time, revocation of licenses, censures, redress to clients and fines.

Further, state insurance regulators and the National Association of Insurance Commissioners (“NAIC”) continually re-examine existing laws and regulations, and such re-examination may result in the enactment of insurance-related laws and regulations, or the issuance of interpretations thereof, that adversely affect our business. In some instances, we follow practices based on interpretations of laws and regulations generally followed by the industry, which may prove to be different from the interpretations of regulatory authorities.

 

 

 

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In addition, changes in legislation or regulations and actions by regulators, including changes in administration and enforcement policies, could from time to time require operational changes that could result in lost revenues or higher costs or hinder our ability to operate our business. For example, we offer reinsurance captive entity design and management services, and expect to be able to continue offering such services. The NAIC has established a subgroup to study the use of reinsurance captive entities and special purpose vehicles to transfer insurance risk in relation to existing state laws and regulations. Any action by federal, state or other regulators that adversely affects our ability to offer services in relation to reinsurance captive entities, either retroactively or prospectively, could have an adverse effect on our business, financial condition and results of operations.

Additionally, the method by which insurance brokers are compensated has received substantial scrutiny in the past decade because of the potential for conflicts of interest. Adverse regulatory developments regarding the forms of compensation we can receive (for example, contingent commissions), could adversely affect our business, financial condition and results of operations.

In addition to compliance challenges posed by the regulatory environment in which we operate, regulatory changes could also affect the fundamentals of our business if they reduced demand for our services. For example, any change to workers’ compensation laws or regulations that reduced demand for workers’ compensation insurance or resulted in fewer or less severe workers’ compensation claims could adversely impact our business and prospects.

Our carrier partners, as insurance companies, are also heavily regulated by the states in which they operate, as well as by the federal government for participation in government sponsored programs such as Medicare and Medicaid. They are subject to regulations regarding, among other things, solvency, capital levels, loss reserves, investments, pricing, and affiliate transactions. Although we are not subject to regulation as an insurance company, pursuant to our agreements with our insurance carrier clients, we assume liability for compliance with all applicable laws, regulations and regulatory bulletins regarding the reporting of policy data for our clients. We are liable for payments or reimbursements in connection with any fines or penalties imposed on our clients arising out of services we perform for them under the agreements, and we would be required participate fully with our clients in any action plan or other corrective measures required by any regulatory agency or body, which could be costly and divert management’s attention. In addition, we could also be indirectly impacted by regulatory changes that affect our carrier partners if they cause them to terminate or alter their relationships with us.

Our carrier partners can also be impacted by federal legislation. For example, the Terrorism Risk Insurance Act (“TRIA”), which provides a federal backstop insurance program for acts of terrorism, is scheduled to expire at the end of 2020. Because workers’ compensation carriers are not able to exclude acts of terrorism from the coverage they offer, if the TRIA is not extended beyond 2020, its expiration could lead to reduced capacity of private insurers if they are unable to sufficiently increase premium rates or are otherwise unwilling to take on the additional risk. Should the TRIA expire and our carrier partners decrease their business levels in certain markets where we provide services for them, it could decrease the revenues we generate in those markets. We are unable to predict whether the TRIA will be extended beyond 2020 or whether any such extension would include changes to the TRIA that would negatively impact our carrier partners.

In addition, we are required to comply with federal and state laws governing the transmission, security and privacy of individually identifiable health information that we may obtain or have access to in connection with the provision of our services, including the Health Insurance Portability and Accountability Act (“HIPAA”) and the Health Information Technology for Economic and Clinical Health Act (the “HITECH Act”), which sets forth health information security breach notification

 

 

 

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requirements and increased penalties for violation of HIPAA. Despite the security measures that we have in place to ensure compliance with these privacy and data protection laws, our facilities and systems, and those of our insurance carrier clients and other clients, are vulnerable to security breaches, acts of vandalism or theft, computer viruses, misplaced or lost data, programming and human errors or other similar events. Enforcement actions for violation of the applicable privacy and data protection laws against us could be costly and could interrupt regular operations, which may adversely affect our business. While we have not received any notices of any such violation and believe we are in compliance with such laws, there can be no assurance that we will not receive such notices in the future.

We are unable to predict what additional government initiatives, if any, affecting our business may be promulgated in the future. Proposals for healthcare legislative reforms are regularly considered at the federal and state levels. To the extent that such proposals affect workers’ compensation, such proposals may adversely affect our business, financial condition and results of operations. Our business may be adversely affected by failure to comply with existing laws and regulations, failure to obtain necessary licenses and government approvals or failure to adapt to new or modified regulatory requirements. See “Business—Regulation.”

Changes in the healthcare industry could adversely impact our performance.

Our recently acquired Patriot Care Management Business provides healthcare cost containment services in connection with workers’ compensation claims, including bill review and telephonic nurse case management. As a result of the PPACA and other regulatory and industry initiatives, the healthcare industry has been evolving rapidly in recent years and is expected to continue to do so. The impact of these changes on our business is uncertain, but it is possible that they could result in reduced demand for, or effectiveness of, our healthcare cost containment services. For example, if the PPACA is successful in increasing healthcare coverage, improving wellness and/or slowing the growth rate of, or even reducing healthcare costs, it could decrease the frequency and severity of workers’ compensation claims. Alternatively, if an increase in the availability of healthcare insurance coverage resulted in demand for healthcare services outpacing available supply, it could make it more difficult for us to contain healthcare costs.

In addition, healthcare providers have become more active in their efforts to minimize the use of certain cost containment techniques by insurers and are engaging in litigation to avoid application of certain cost containment practices. Recent litigation between healthcare providers and insurers has challenged certain insurers’ claims adjudication and reimbursement decisions. Although these lawsuits do not directly involve us or any services we provide, these cases may affect the use by insurers of certain cost containment services that we provide and may result in a decrease in revenue from our cost containment business.

If we are unable to adapt to healthcare market changes with our existing services or by developing and providing new services, our business would be adversely affected.

If we fail to grow our business organically we may be unable to execute our business plan or adequately address competitive challenges.

As part of our growth strategy, we intend to diversify our business by entering into relationships with additional insurance carrier and other clients. As a result, we are subject to certain growth-related risks, including the risk that we will be unable to retain personnel or acquire other resources necessary to service such growth adequately. While we have recently engaged in relationships with additional insurance carrier and other clients, we cannot be certain that these relationships will be successful in generating revenue or that we will be successful in establishing relationships with other potential insurance carrier and other clients that we identify in the future. In addition, the integration and

 

 

 

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management of new client relationships may divert management time and focus from operating our current businesses, and the development of the technology and other infrastructure necessary to service or facilitate new relationships could require substantial effort and expense.

We have limited experience in acquiring other companies and businesses, and we may have difficulty integrating the operations of companies or businesses that we may acquire and may incur substantial costs in connection therewith.

A significant component of our growth strategy is the acquisition of other insurance services operations. Our experience acquiring companies has been relatively limited to date, and all such experience has been in transactions with related parties. We have evaluated, and expect to continue to evaluate, a wide array of potential strategic transactions. From time to time, we may engage in discussions regarding potential acquisitions. The costs and benefits of future acquisitions are uncertain. Any of these transactions could be material to our business, financial condition and results of operations. In addition, the process of integrating the operations of an acquired company may create unforeseen operating difficulties and expenditures. The key areas where we may face risks and uncertainties include:

 

Ø   the need to implement or remediate controls, procedures and policies appropriate for a public company at companies that, prior to the acquisition, lacked these controls, procedures and policies;

 

Ø   disruption of ongoing business, diversion of resources and of management time and focus from operating our business to acquisitions and integration challenges;

 

Ø   our ability to achieve anticipated benefits of acquisitions by successfully marketing the service offerings of acquired businesses to our existing partners and clients, or by successfully marketing our existing service offerings to clients and partners of acquired businesses;

 

Ø   the negative impact of acquisitions on our results of operations as a result of large one-time charges, substantial debt or liabilities acquired or incurred, amortization or write down of amounts related to deferred compensation, goodwill and other intangible assets, or adverse tax consequences, substantial depreciation or deferred compensation charges;

 

Ø   the need to ensure that we comply with all regulatory requirements in connection with and following the completion of acquisitions;

 

Ø   retaining employees and clients and otherwise preserving the value of the assets of the businesses we acquire; and

 

Ø   the need to integrate each acquired business’s accounting, information technology, human resource and other administrative systems to permit effective management.

Due to the fragmented nature of the workers’ compensation insurance services industry, it may be difficult to identify appropriate acquisition targets. Even if we identify appropriate targets, we may be unable to acquire businesses on terms that we consider acceptable due to a variety of factors, including competition from other strategic buyers or financial buyers. Furthermore, in order to achieve the growth we seek, we may acquire numerous smaller market participants, which could require significant attention from management and increase risks, costs and uncertainties associated with integration.

Our goodwill and intangible assets could become impaired, which could lead to material non-cash charges against earnings.

As of September 30, 2014, we had approximately $59.4 million of goodwill and approximately $20.5 million of net intangible assets (the latter, net of a deferred tax liability of approximately $13.7 million) recorded, which represents, in the aggregate, 58% of our total assets. This goodwill and intangible assets

 

 

 

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are primarily associated with the Acquisitions. We assess potential impairment on our goodwill and intangible asset balances, including client lists, on an annual basis, or more frequently if there is any indication that the asset may be impaired. Any impairment of goodwill or intangible assets resulting from this periodic assessment would result in a non-cash charge against current earnings, which could lead to a material impact on our results of operations, statements of financial position, and earnings per share. Any decline in future revenues, cash flows or growth rates as a result of further adverse changes in the economic environment, the failure of any acquired business to perform in accordance with our expectations or an adverse change resulting from new governmental regulations or other factors could lead to an impairment of goodwill or intangible assets.

We cannot assure you that we will enter into a senior secured credit facility on terms acceptable to us or at all, or that if we do so that we will be able to borrow all or any of the amounts committed thereunder.

In connection with this offering, we expect to enter into a new senior secured credit facility in the aggregate principal amount of up to $80.0 million, comprised of a $40.0 million revolving credit facility and a $40.0 million term loan facility, with BMO Harris Bank N.A., an affiliate of BMO Capital Markets Corp., as administrative agent. We have received a commitment letter from BMO Harris Bank N.A. relating to this senior secured credit facility. Assuming we enter into the senior secured credit facility, we intend to make borrowings of $40.0 million (or approximately $37.7 million net of loan fees). However, we cannot assure you that we will enter into this credit facility on terms acceptable to us or at all, or that if we do so that we will be able to borrow all or any of the amounts committed thereunder. The closing of this offering is not conditioned upon our entry into the senior secured credit facility. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Indebtedness—Senior Secured Credit Facility” and “Underwriting (Conflicts of Interest).”

If we enter into the senior secured credit facility, this facility is likely to contain restrictive covenants that will limit the amount of cash that we may use for other corporate activities, which could negatively affect our growth and cause our financial performance to suffer.

Any credit facility that we may enter into is likely to impose operating and financial restrictions on us. These restrictions may limit our ability, or the ability of our subsidiaries party thereto to, among other things:

 

·   pay dividends and make capital expenditures if we do not repay amounts drawn under our credit facilities or if there is another default under our credit facilities;

 

·   incur additional indebtedness, including the issuance of guarantees;

 

·   merge or consolidate with, or transfer all or substantially all our assets to, another person; or

 

·   enter into a new line of business.

In addition, all obligations under the senior secured credit facility are expected to be guaranteed by all of our existing and future subsidiaries and to be secured by a first-priority perfected security interest in substantially all of our and our subsidiaries’ tangible and intangible assets, whether now owned or hereafter acquired, including a pledge of 100% of the stock of each guarantor.

Any credit facility that we may enter into is likely to require us to maintain specified financial ratios and satisfy financial covenants. These financial ratios and covenants could include requirements that we maintain a maximum total leverage ratio and a minimum fixed charge coverage ratio.

 

 

 

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Therefore, we may need to seek permission from our lenders in order to engage in some corporate actions. Our lenders’ interests may be different from ours and we may not be able to obtain our lenders’ permission when needed. This may limit our ability to pay dividends to you if we determine to do so in the future, to finance our future operations or capital requirements, to make acquisitions or to pursue business opportunities. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Indebtedness—Senior Secured Credit Facility” and “Underwriting (Conflicts of Interest).”

We operate in a highly competitive industry, and others may have greater financial resources to compete effectively.

The market for workers’ compensation insurance services is highly competitive. Competition in our business is based on many factors. In competing to offer our services to insurance carriers, we compete based on pricing, quality and scope of available services, underwriting practices, reputation and reliability, ability to reduce claims expenses, customer service and general experience. In competing to place business on behalf of our carrier partners, competition is also based on the product offerings, premium pricing and financial strength, ratings and reputation of our carrier partners. In some cases, our competitors may offer lower priced products or services than we do. If our competitors offer more competitive prices, payment plans, services or commissions to independent retail agencies, we could lose our market share or have to reduce our prices in order to maintain our market share, which would adversely affect our profitability. If we are unable to reduce claims expenses for our carrier partners or otherwise demonstrate the value of our services to our partners and clients, we could lose our market share or be forced to offer lower priced services to maintain our market share. Our competitors are national and regional insurance companies that provide services similar to ours through in-house capabilities or separate divisions, and other workers’ compensation insurance agencies and service providers, many of which are significantly larger and possess considerably greater financial, marketing and other resources than we do. As a result of this scale, they may be able to capitalize on lower expenses to offer more competitive pricing.

In policyholder services, we believe we compete with numerous national wholesale agents and brokers, as well as insurance companies that sell directly to clients. In claims administration services, we compete with numerous businesses of varying sizes that offer claims management, cost containment, and/or other services that are similar to those that we offer. With respect to our insurance carrier clients in particular, we also compete with insurance companies that service their policies in-house rather than outsourcing to a provider like us. In all of the services we provide, we also compete with numerous smaller market participants that may operate in a particular geographic area or segment of the market, or offer only a particular service.

Many of our competitors are multi-line carriers that can provide workers’ compensation insurance and related services at a loss in order to obtain other lines of business at a profit. While we believe our outsourcing services could offer an attractive alternative to such multi-line carriers, it may be difficult for us and our carrier partners to compete with such carriers if they continue to service their policies in-house at a loss. If we are unable to compete effectively, our business, financial condition and results of operations could be materially adversely affected.

We compete on the basis of the quality of our outcome-driven service model, and our failure to continue to perform at high levels could adversely affect our business.

We believe our ability to deliver demonstrable value and help our clients generate cost savings through our proprietary SWARM process and other cost containment services is a key competitive advantage. As we grow, whether organically or through acquisitions, we may expand into different geographic regions or

 

 

 

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service policies in different industries and risk classes. We will also need to adapt to regulatory and technological changes over time. If we are unable to adapt our processes and services as necessary to maintain our historical performance levels in terms of claims processing and closure rates as a result of this growth and change, it could adversely affect our client relationships and ability to earn and retain business.

Our business is dependent on the efforts of our senior management and other key employees who leverage their industry expertise, knowledge of our markets and services and relationships with independent retail agencies that sell the insurance products of our carrier partners.

We believe our success will depend in substantial part upon our ability to attract and retain qualified executive officers and other skilled employees who are knowledgeable about our business and strategy. We rely substantially on the services of our executive management team and other key employees, including Mr. Mariano, our founder, Chairman, President and Chief Executive Officer, who will beneficially own 59.5% of the outstanding shares of our common stock immediately following the consummation of this offering. Although we are not aware of any planned departures or retirements of any member of our senior management team, if we were to lose the services of one or more such members, our business, financial condition and results of operations could be adversely affected.

Our success will also depend on our ability to attract and retain highly-qualified personnel to operate our claims management and cost containment services. We believe that our ability to deliver a high-quality and cost-effective claims management solution through our proprietary SWARM process is a key competitive advantage, and experienced and knowledgeable managers and personnel are an important component of this process. If we are unable to attract and retain such managers and personnel on satisfactory terms, especially as we grow our business, our performance and results of operations could be adversely affected.

We are reliant on our information processing systems and any failure or inadequate performance of these systems could have a material adverse effect on our business, financial condition and results of operations.

Our business relies on information systems to provide effective and efficient service to our carrier partners and other clients, process claims, and timely and accurately report results to carriers. In particular, our WCE system plays a pivotal role in all aspects of the services we provide, which can range from the issuance of new policies on behalf of carrier partners, to the administration and adjudication of claims. We made a significant investment in this system and deployed it in August 2013 as our primary system, and we believe it is a key factor in our ability to provide a comprehensive range of services to our carrier partners and to differentiate ourselves from our competitors in all aspects of our business. However, we have only used WCE as our primary system since August 2013 and we cannot be certain that we will not experience interruptions or other system failures in the future, or that the system will meet our performance expectations and that of our carrier partners and independent retail agencies, although we have not experienced significant interruptions or issues to date.

An interruption of our access to, or failure in the performance of, our WCE system or our other information technology, telecommunications or other systems could significantly impair our ability to perform essential services on a timely basis. If sustained or repeated, such an interruption or failure could result in a deterioration of our ability to process new and renewal business, provide customer service, manage and investigate claims in a timely and cost-effective manner or perform other necessary business functions. Any of the foregoing could result in a loss of confidence by our carrier partners or otherwise adversely affect our relationships with them. In addition, we expect that a considerable amount of our

 

 

 

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future growth will depend on our ability to process and manage claims data more efficiently and to provide more meaningful healthcare information to clients and payors of healthcare services and expenses. If we experience such interruptions or failures, or if the WCE system does not provide the benefits we anticipate or support our future growth, we could be required to invest significant funds in the upgrade, modification or repair of the system.

Interruption or loss of our information processing capabilities through loss of stored data, breakdown or malfunctioning of computer equipment and software systems, telecommunications failure, or damage caused by fire, tornadoes, lightning, electrical power outage, or other disruption could have a material adverse effect on our business, financial condition and results of operations. Although we have disaster recovery procedures in place and insurance to protect against such contingencies, we cannot be sure that insurance or these services will continue to be available, cover all our losses or compensate us for the possible loss of clients occurring during any period that we are unable to provide business services.

In addition, we developed our WCE system in conjunction with a technology vendor. While we have a license from that vendor and have developed proprietary customizations for the WCE system, there can be no assurance that others have not developed or will not develop similar or superior technologies.

Cyber-attacks or other security breaches involving our computer systems or the systems of one or more of our clients, independent retail agencies or vendors could materially and adversely affect our business.

We manage a large amount of highly sensitive and confidential consumer information including personally identifiable information, protected health information and financial information, and are subject to regulatory requirements regarding data security. Our systems, including our WCE system, like others in the insurance services industry, are vulnerable to cyber security risks, and we are subject to potential disruption caused by cyber-attacks on our systems. Such attacks may have various goals, from seeking confidential information to causing operational disruption. Although to date such activities have not resulted in material disruptions to our operations or, to our knowledge, breach of any security or confidential information, and we have taken, and continue to take, actions to protect the security and privacy of our information, no assurance can be provided that such disruptions or breach will not occur in the future. In addition, in the event that new data security laws are implemented, or our carrier partners or other clients determine to impose new requirements on us relating to data security, we may not be able to timely comply with such requirements, or such requirements may not be compatible with the current processes employed by our WCE system. Any significant violations of data privacy and failure to timely implement required changes could result in the loss of business, litigation, regulatory investigations, penalties or negative publicity that could damage our reputation with existing or potential carrier partners and clients and adversely affect our business.

If we infringe on the proprietary rights of others, our business operations may be disrupted, and any related litigation could be time consuming and costly.

Third parties may claim that we have violated their intellectual property rights. Any such claim, with or without merit, could subject us to costly litigation and divert the attention of key personnel. To the extent that we violate a patent or other intellectual property right of a third party, we may be prevented from operating our business as planned, and we may be required to pay damages, to obtain a license, if available, to use the right or to use a non-infringing method, if possible, to accomplish our objectives. The cost of such activity could have a material adverse effect on our business.

 

 

 

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We are, and may become, party to lawsuits or other claims that could adversely impact our business.

In the normal course of our business, we are named as a defendant in suits by insureds or claimants contesting decisions by us or our clients with respect to the settlement of claims. There can be no assurance that additional lawsuits will not be filed against us. There also can be no assurance that any such lawsuits will not have a disruptive impact upon the operation of our business, and that the defense of the lawsuits will not consume the time and attention of our senior management and financial resources or that the resolution of any such litigation will not have a material adverse effect on our business, financial condition and results of operations.

RISKS RELATED TO OUR COMMON STOCK AND THIS OFFERING

There has been no prior public market for our common stock, and, therefore, we cannot be certain that an active trading market for our common stock will develop.

Prior to this offering, there has not been a public trading market for our common stock. While our common stock has been approved for listing on the NYSE under the symbol “PN” following this offering, it is possible that an active, liquid trading market will not develop upon consummation of this offering or that the market price of our common stock will decline below the initial public offering price. The initial public offering price per share has been determined by negotiation among us and the underwriters and may not be indicative of the market price of our common stock upon consummation of this offering. Consequently, you may not be able to sell shares of our common stock at prices equal to or greater than the price you paid in this offering, or at all.

The trading price of our common stock may decline after this offering, and you may not be able to resell shares of our common stock at prices equal to or greater than the price you paid or at all.

The trading price of our common stock may decline after this offering for many reasons, some of which are beyond our control, including, among others:

 

Ø   our results of operations and financial condition;

 

Ø   changes in expectations as to our future results of operations and prospects, including financial estimates and projections by securities analysts and investors;

 

Ø   results of operations that vary from those expected by securities analysts and investors;

 

Ø   developments in the workers’ compensation, insurance or healthcare industries;

 

Ø   additions and departures of key personnel;

 

Ø   strategic decisions by us, our carrier partners, our other clients or our competitors, such as acquisitions, divestitures, spin-offs, joint ventures, strategic investments or changes in business strategy;

 

Ø   changes in applicable laws and regulations;

 

Ø   changes in accounting principles;

 

Ø   announcements of claims against us by third parties;

 

Ø   future sales of our common stock by us, significant stockholders or our directors or executive officers;

 

 

 

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Ø   changes in workers’ compensation insurance premium rates or levels or the frequency or severity of claims;

 

Ø   changes in general market and economic and labor market conditions;

 

Ø   volatile and unpredictable developments, including man-made, weather-related and other natural disasters, catastrophes or terrorist attacks in the geographic regions in which we operate; and

 

Ø   increased competition, or the performance, or the perceived or anticipated performance, of our competitors.

In addition, the stock market in general has experienced significant volatility that often has been unrelated to the operating performance of companies whose shares are traded. These market fluctuations could adversely affect the trading price of our common stock, regardless of our actual operating performance. As a result, the trading price of our common stock may be less than the initial public offering price, and you may not be able to sell your shares at or above the price you pay to purchase them, or at all. Further, we could be the subject of securities class action litigation due to any such stock price volatility, which could divert management’s attention and adversely affect our results of operation.

Public investors will suffer immediate and substantial dilution as a result of this offering.

The initial public offering price per share is significantly higher than our pro forma net tangible book value per share of our common stock. Accordingly, if you purchase shares in this offering, you will suffer immediate and substantial dilution of your investment. Based upon the issuance and sale of shares of our common stock at the initial offering price, and the application of the estimated net proceeds therefrom, less an amount equal to the underwriting discounts and commissions and expenses, you will incur immediate dilution of approximately $12.64 in the pro forma net tangible book value per share if you purchase common stock in this offering. See “Dilution” for additional information.

Our founder, Chairman, President and Chief Executive Officer owns a significant percentage of our outstanding capital stock and will be able to influence stockholder and management decisions, which may conflict with your interests as a stockholder.

Immediately upon consummation of this offering, Mr. Mariano, our founder, Chairman, President and Chief Executive Officer will beneficially own 59.5% of the outstanding shares of our common stock. As a result of his ownership position, Mr. Mariano may have the ability to significantly influence matters requiring stockholder approval, including, without limitation, the election or removal of directors, mergers, acquisitions, changes of control of our company and sales of all or substantially all of our assets. In addition, because he is also our Chief Executive Officer, he will have significant influence in our management and affairs. This control may delay, deter or prevent acts that may be favored by our other shareholders, as the interests of Mr. Mariano may not always coincide with the interests of our other shareholders. In particular Mr. Mariano owns substantially all of the outstanding equity of Guarantee Insurance Group, the parent company of Guarantee Insurance. As such, we cannot assure you all of our transactions with Guarantee Insurance will be on the same terms as those available with unaffiliated third parties or that the affiliation will not impact otherwise impact our actions in a manner that is adverse to us or our stockholders. See “Risks Related to Our Business—Our relationship with Guarantee Insurance may create conflicts of interest, and we cannot be certain that all our transactions with Guarantee Insurance will be conducted on the same terms as those available from unaffiliated third parties.” Although Mr. Mariano is no longer a board member or officer of Guarantee Insurance Group or Guarantee Insurance, and we have implemented a related party transaction policy in connection with

 

 

 

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this offering, we cannot provide assurance that he will not be influenced by his interest in Guarantee Insurance Group and seek to cause us to take courses of action that might involve risks to our other shareholders or adversely affect us or our other shareholders. In addition, this concentration of share ownership may adversely affect the trading price of our shares because investors may perceive disadvantages in owning shares in a company with a significant shareholder.

Future sales, or the perception of future sales, by us or our existing stockholders in the public market following this offering could cause the market price for our common stock to decline.

After this offering, the sale of shares of our common stock in the public market, or the perception that such sales could occur, could harm the prevailing market price of shares of our common stock. These sales, or the possibility that these sales may occur, also might make it more difficult for us to sell equity securities in the future at a time and at a price that we deem appropriate.

Upon consummation of this offering we will have a total of 26,390,415 shares of common stock outstanding (or 27,637,770 shares if the underwriters exercise in full their over-allotment option). Of the outstanding shares, the 8,315,700 shares sold in this offering (or 9,563,055 shares if the underwriters exercise in full their over-allotment option) will be freely tradable without restriction or further registration under the Securities Act, except that any shares held by our affiliates, as that term is defined under Rule 144 under the Securities Act (“Rule 144”), including our directors, executive officers and other affiliates may be sold only in compliance with the limitations described in “Shares Eligible for Future Sale.”

The remaining 18,074,715 shares, representing 68.5% of our total outstanding shares of common stock following this offering, will be “restricted securities” within the meaning of Rule 144 and subject to certain restrictions on resale upon consummation of this offering. Restricted securities may be sold in the public market only if they are registered under the Securities Act or are sold pursuant to an exemption from registration such as Rule 144, as described in “Shares Eligible for Future Sale.”

In connection with this offering, we and the selling stockholders, our directors, director nominees and executive officers, and certain other holders of substantially all of our common stock and other equity securities have agreed with the underwriters, subject to certain exceptions, not to offer, sell, contract to sell, pledge or otherwise dispose of, directly or indirectly, or hedge our common stock or securities convertible into or exchangeable or exercisable for our common stock during the period ending 180 days after the date of this prospectus, except with the prior written consent of UBS Securities LLC. See “Underwriting (Conflicts of Interest)” for a description of these lock-up agreements.

We intend to grant equity awards under the 2014 Plan to certain of our employees in connection with this offering. We have filed a registration statement on Form S-8 under the Securities Act to register the shares of common stock subject to issuance under the 2014 Plan to be adopted in connection with this offering. The Form S-8 registration statement automatically became effective upon filing. The registration statement on Form S-8 covers 2,824,968 shares of common stock. Once these shares are registered, they can be sold in the public market upon issuance, subject to restrictions under the securities laws applicable to resales by affiliates and subject to any restrictions imposed by the lock-up agreements described above.

Pursuant to the stockholders agreement, dated as of November 27, 2013, among us, Mr. Mariano, Mr. Del Pizzo, and the PennantPark Entities (as amended and restated on January 5, 2015 in connection

 

 

 

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with this offering, the “Stockholders Agreement”) and the warrants described under “Description of Capital Stock—Warrants,” upon consummation of this offering, PennantPark Investment Corporation and certain of its affiliates (the “PennantPark Entities”), Advantage Capital and Mr. Del Pizzo have registration rights with respect to 926,085 shares of our common stock that they now hold or may acquire upon exercise of warrants. In connection with this offering, we entered into a new registration rights agreement with Mr. Mariano. See “Certain Relationships and Related Party Transactions—Stockholders Agreement.”

Upon the expiration of the lock-up agreements described above, 15,782,449 shares held by our affiliates would be subject to volume, manner of sale and other limitations under Rule 144. Upon consummation of this offering, the shares covered by registration rights would represent approximately 61.7% of our outstanding common stock (or 58.9%, if the underwriters exercise in full their over-allotment option). Registration of any of these outstanding shares of common stock would result in such shares becoming freely tradable without compliance with Rule 144 upon effectiveness of the registration statement. See “Shares Eligible for Future Sale.”

As restrictions on resale end or if these stockholders exercise their registration rights, the market price of our shares of common stock could drop significantly if the holders of these shares sell them or are perceived by the market as intending to sell them. These factors could also make it more difficult for us to raise additional funds through future offerings of our shares of common stock or other securities. In the future, we may also issue our securities in connection with investments or acquisitions. The amount of shares of our common stock issued in connection with an investment or acquisition could constitute a material portion of our then-outstanding shares of our common stock. Any issuance of additional securities in connection with investments or acquisitions may result in additional dilution to you.

Because we have no plans to pay cash dividends on our common stock for the foreseeable future, you may not receive any return on investment unless you sell your common stock for a price greater than that which you paid for it.

We do not expect to pay any cash dividends on our common stock for the foreseeable future. We currently intend to retain any additional future earnings to finance our operations and growth. Any future determination to pay cash dividends or other distributions on our common stock will be at the discretion of our board of directors and will be dependent on our earnings, financial condition, operation results, capital requirements, and contractual, regulatory and other restrictions, including restrictions contained in the senior secured credit facility or agreements governing any existing and future outstanding indebtedness we or our subsidiaries may incur, on the payment of dividends by us or by our subsidiaries to us, and other factors that our board of directors deems relevant. See “Dividend Policy.”

As a result, you may not receive any return on an investment in our common stock unless you sell our common stock for a price greater than that which you paid for it.

Our ability to raise capital in the future may be limited, which could make us unable to fund our capital requirements.

Our business and operations may consume resources faster than we anticipate, or we may require additional funds to pursue acquisition or expansion opportunities. In the future, we may need to raise additional funds through the issuance of new equity securities, debt or a combination of both. Additional financing may not be available on favorable terms or at all. If adequate funds are not available on acceptable terms, we may be unable to fund our capital requirements. If we issue new debt securities, the debt holders would have rights senior to common stockholders to make claims on our assets, and the

 

 

 

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terms of any debt could restrict our operations, including our ability to pay dividends on our common stock. If we issue additional equity securities, existing stockholders may experience dilution. Our board is authorized to issue preferred stock which could have rights and preferences senior to those of our common stock. Because our decision to issue securities in any future offering will depend on market conditions and other factors beyond our control, we cannot predict or estimate the amount, timing or nature of our future offerings. Thus, our stockholders bear the risk of our future securities offerings reducing the market price of our common stock, diluting their interest or being subject to rights and preferences senior to their own.

If securities analysts do not publish research or reports about our business or if they downgrade or provide negative outlook on our stock or our sector, our stock price and trading volume could decline.

The trading market for our common stock will rely in part on the research and reports that industry or financial analysts publish about us or our business. We do not control these analysts. Furthermore, if one or more of the analysts who do cover us downgrade or provide negative outlook on our stock or our industry, or the stock of any of our competitors, or publish inaccurate or unfavorable research about our business, the price of our stock could decline. If one or more of these analysts ceases coverage of our business or fail to publish reports on us regularly, we could lose visibility in the market, which in turn could cause our stock price or trading volume to decline.

We are an “emerging growth company” and we cannot be certain if the reduced disclosure requirements applicable to emerging growth companies will make our common stock less attractive to investors.

We are an “emerging growth company,” as defined in the JOBS Act, and we intend to take advantage of certain exemptions from various reporting requirements that are applicable to other public companies that are not “emerging growth companies” including, but not limited to, not being required to comply with the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act of 2002, as amended (the “Sarbanes-Oxley Act”), which may increase the risk that weaknesses or deficiencies in our internal control over financial reporting go undetected, and reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements, which may make it more difficult for investors and securities analysts to evaluate our company. As a result, our stockholders may not have access to certain information that they may deem important.

The JOBS Act also 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 this extended transition period, and, as a result, our financial statements may not be comparable to those of companies that 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.

We could be an emerging growth company for up to five years following the date of this prospectus, although circumstances could cause us to lose that status earlier, upon the earliest of (i) the last day of the fiscal year in which our annual gross revenues exceed $1.0 billion, (ii) the last day of the fiscal year that we become a “large accelerated filer” as defined in Rule 12b-2 under the Exchange Act, which would occur if the market value of our common stock held by non-affiliates exceeds $700.0 million as of the last business day of our most recently completed second fiscal quarter and we have been publicly reporting for at least 12 months and (iii) the date on which we have issued more than $1.0 billion in non-convertible debt during the preceding three-year period. We cannot predict if investors will find our

 

 

 

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common stock less attractive because we may rely on these exemptions. If some investors find our common stock less attractive as a result, there may be a less active trading market for our common stock and our stock price may be more volatile.

We cannot predict if investors will find our common stock less attractive if we rely on these exemptions. If some investors find our common stock less attractive as a result, there may be a less active trading market for our common stock and our stock price may be more volatile. We may take advantage of these reporting exemptions until we are no longer an emerging growth company, which in certain circumstances could be up to five years. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies and Estimates and Recently Issued Financial Accounting Standards—JOBS Act.”

Transformation into a public company may increase our costs and disrupt the regular operations of our business.

This offering will have a significant transformative effect on us. Our business historically has operated as a privately owned company and we expect to incur additional costs associated with operating as a public company, including hiring additional personnel, improving financial reporting systems, additional directors’ and officers’ liability insurance, director fees and expanding our facilities. We expect that these costs will relate to legal, regulatory, finance, accounting, investor relations and other administrative functions. The Sarbanes-Oxley Act, as well as rules adopted by the SEC and the NYSE, require public companies to implement specified corporate governance practices that are currently inapplicable to us as a private company.

In addition, we will become obligated to file with the SEC annual and quarterly information and other reports. We will also be required to ensure that we have the ability to prepare financial statements that are fully compliant with all SEC reporting requirements on a timely basis. In addition, we will become subject to other reporting and corporate governance requirements, including certain requirements of the NYSE, and certain provisions of the Sarbanes-Oxley Act, and the regulations promulgated thereunder, which will impose significant compliance obligations and costs upon us.

The additional demands associated with being a public company may disrupt regular operations of our business by diverting the attention of some of our senior management team away from revenue producing activities to management and administrative oversight, adversely affecting our ability to attract and complete business opportunities and increasing the difficulty in both retaining professionals and managing and growing our businesses. Any of these effects could harm our business, financial condition and results of operations.

Our internal controls over financial reporting may not be effective and our independent registered public accounting firm may not be able to certify as to their effectiveness, which could have a significant and material adverse effect on our business, financial condition, results of operations or prospects.

We intend to evaluate our internal controls over financial reporting in order to allow management to report on our internal controls over financial reporting, as required by Section 404 of the Sarbanes-Oxley Act, and rules and regulations of the SEC thereunder, which we refer to as “Section 404.” Our internal control over financial reporting does not currently meet all of the standards contemplated by Section 404 of the Sarbanes-Oxley Act. In particular, we have not yet established and adopted all of the formal policies, processes and practices related to financial reporting that will be necessary to comply with Section 404. Such policies, processes and practices are important to ensure the identification of key

 

 

 

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financial reporting risks, assessment of their potential impact and linkage of those risks to specific areas and activities within our organization. The process of documenting and testing our internal control procedures in order to satisfy the requirements of Section 404 requires annual management assessments of the effectiveness of our internal controls over financial reporting. During the course of our testing, we may identify deficiencies, which we may not be able to remediate in time to meet the deadline imposed by Sarbanes-Oxley Act for compliance with the requirements of Section 404. So long as we are an emerging growth company, our independent registered public accounting firm will not be required to attest to the effectiveness of our internal control over financial reporting pursuant to Section 404.

Based on an analysis performed in connection with the preparation of our combined financial statements as of and for the year ended December 31, 2013, a material weakness was identified in connection with the incorrect classification of certain warrants outstanding as equity rather than debt. However, these warrants were reclassified as a liability in the financial statements as of and for the year ended December 31, 2013 and the nine months ended September 30, 2014, and we believe this weakness has been remediated, including through the hiring of additional staff and additional procedures as part of our financial statement close process.

If we fail to achieve and maintain the adequacy of our internal controls, as such standards are modified, supplemented or amended from time to time, we may not be able to ensure that we can conclude on an ongoing basis that we have effective internal controls over financial reporting in accordance with Section 404. We are not currently required to furnish a report on our internal control over financial reporting pursuant to the SEC’s rules under Section 404. We expect that these rules will apply to us when we file our Annual Report on Form 10-K for our fiscal year ending in December 2015, which we will be required to file in March 2016. We cannot be certain as to the timing of completion of our evaluation, testing and any remediation actions or the impact of the same on our operations. We may also need to upgrade our systems, implement additional financial and management controls, reporting systems and procedures or hire additional accounting and finance staff. We expect to incur additional annual expenses for the purpose of addressing these requirements, and those expenses may be significant. If we are not able to implement the requirements of Section 404 in a timely manner or with adequate compliance, we may be subject to sanctions, stock exchange delisting or investigation by regulatory authorities, such as the SEC. As a result, there could be a negative reaction in the financial markets due to a loss of confidence in the reliability of our financial statements. This could harm our reputation and cause us to lose existing clients or fail to gain new clients and otherwise negatively affect our financial condition, results of operations and cash flows. In addition, we may be required to incur costs in improving our internal control system and the hiring of additional personnel.

Anti-takeover provisions in our organizational documents could delay or prevent a change of control.

Certain provisions of our amended and restated certificate of incorporation and amended and restated bylaws may have an anti-takeover effect and may delay, defer or prevent a merger, acquisition, tender offer, takeover attempt or other change of control transaction that a stockholder might consider in its best interest, including those attempts that might result in a premium over the market price for the shares held by our stockholders.

These provisions provide for, among other things:

 

Ø   a classified board of directors with staggered three-year terms;

 

Ø   the ability of our board of directors to issue, and determine the rights, powers and preferences of, one or more series of preferred stock;

 

 

 

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Ø   advance notice for nominations of directors by stockholders and for stockholders to include matters to be considered at our annual meetings;

 

Ø   certain limitations on convening special stockholder meetings;

 

Ø   the removal of directors only for cause and in certain circumstances only upon the affirmative vote of the holders of at least 66 2/3% in voting power of all the then-outstanding shares of stock of the Company entitled to vote thereon, voting together as a single class; and

 

Ø   that certain provisions may be amended in certain circumstances only by the affirmative vote of at least 80% in voting power of all the then-outstanding shares of stock of the Company entitled to vote thereon, voting together as a single class.

These anti-takeover provisions could make it more difficult for a third party to acquire us, even if the third party’s offer may be considered beneficial by many of our stockholders. As a result, our stockholders may be limited in their ability to obtain a premium for their shares. See “Description of Capital Stock.”

 

The common stock is equity and is subordinate to our existing and future indebtedness and preferred stock.

Shares of the common stock are equity interests in us and do not constitute indebtedness. As such, shares of the common stock will rank junior to all our indebtedness and other non-equity claims with respect to assets available to satisfy claims on us, including in our liquidation. Additionally, our board of directors is authorized to issue series of preferred stock without any action on the part of the holders of our common stock. Holders of our common stock are subject to the prior dividend and liquidation rights of any holders of our preferred stock of depositary shares representing such preferred stock then outstanding.

 

 

 

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Cautionary Note Regarding Forward-Looking Statements

This prospectus includes statements that express our opinions, expectations, beliefs, plans, objectives, strategies, assumptions, future revenues or performance, financing needs, business trends or projections regarding future events or future results and therefore are, or may be deemed to be, “forward-looking statements.” These forward-looking statements can generally be identified by the use of forward-looking terminology, including the terms “believes,” “estimates,” “anticipates,” “expects,” “seeks,” “projects,” “intends,” “plans,” “may,” “will” or “should” or, in each case, their negative or other variations or comparable terminology. They appear in a number of places throughout this prospectus and include statements regarding our intentions, beliefs or current expectations concerning, among other things, our results of operations, financial condition, liquidity, prospects, growth, strategies and the industry in which we operate.

By their nature, forward-looking statements involve risks and uncertainties because they relate to events and depend on circumstances that may or may not occur in the future. Accordingly, there are or will be important factors that could cause our actual results to differ materially from those indicated in these statements. We believe that these factors include, but are not limited to, the risks and uncertainties set forth under “Risk Factors.”

Although we base these forward-looking statements on assumptions that we believe are reasonable when made, we caution you that forward-looking statements are not guarantees of future performance and that our actual results of operations, financial condition and liquidity, and industry developments may differ materially from statements made in or suggested by the forward-looking statements contained in this prospectus. In addition, even if our results of operations, financial condition and liquidity, and industry developments are consistent with the forward-looking statements contained in this prospectus, those results or developments may not be indicative of results or developments in subsequent periods.

In light of these risks and uncertainties, we caution you not to place undue reliance on these forward-looking statements. Any forward-looking statement that we make in this prospectus speaks only as of the date of such statement, and we undertake no obligation to update any forward-looking statement or to publicly announce the results of any revision to any of those statements to reflect future events or developments. Comparisons of results for current and any prior periods are not intended to express any future trends or indications of future performance, unless specifically expressed as such, and should only be viewed as historical data.

 

 

 

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Use of Proceeds

We estimate that we will receive net proceeds of approximately $92.7 million from this offering, after deducting underwriting discounts and commissions and estimated offering expenses payable by us (or if the underwriters exercise in full their over-allotment option, we estimate that we will receive net proceeds of approximately $107.0 million). We will not receive any proceeds from the sale of the shares by the selling stockholders.

We intend to use the net proceeds from this offering, together with borrowings under the senior secured credit facility or cash on hand, as follows: (1) $66.8 million to repay all outstanding amounts under the amended and restated first lien term loan agreement, dated as of August 6, 2014 (the “PennantPark Loan Agreement”), between, among others, us and certain of our subsidiaries, as borrowers, certain of our other subsidiaries and certain affiliated entities, as guarantors, and PennantPark Investment Corporation and certain of its affiliates, as lenders, comprising (i) an initial tranche (the “Initial Tranche”) and (ii) an additional tranche (the “Additional Tranche”), and (2) $56.6 million to repay all outstanding amounts under the credit agreement, dated as of August 6, 2014 (the “UBS Credit Agreement”), between, among others, us and certain of our subsidiaries, the lenders party thereto and UBS Securities LLC, as lead arranger, bookmanager, documentation agent and syndication agent, in each case including accrued interest and applicable prepayment premiums.

As of September 30, 2014, we had approximately $66.5 million in outstanding borrowings under our PennantPark Loan Agreement and $56.6 million in outstanding borrowings under our UBS Credit Agreement. The borrowings under the Initial Tranche of the PennantPark Loan Agreement were used primarily in connection with the Reorganization, as described elsewhere in this prospectus. The borrowings under the Additional Tranche of the PennantPark Loan Agreement and the UBS Credit Agreement were used primarily in connection with the Acquisitions, as described elsewhere in this prospectus. During the nine months ended September 30, 2014, on a pro forma basis giving effect to the Acquisitions, outstanding borrowings under our PennantPark Loan Agreement accrued interest at a weighted average rate of 12.5% and outstanding borrowing under our UBS Credit Agreement accrued interest at a weighted average rate of 10.0%. Our PennantPark Loan Agreement requires quarterly amortizations with a final maturity on November 27, 2018. Amounts under our UBS Credit Agreement mature on August 6, 2019. UBS Securities LLC is a lender under our UBS Credit Agreement and will receive a portion of the proceeds of this offering. Accordingly, this offering is being made in compliance with FINRA Rule 5121. See “Underwriting (Conflicts of Interest)—Conflicts of Interest.”

We plan to use the remaining net proceeds remaining after repayment of these borrowings for general corporate purposes, which, consistent with our growth strategy described elsewhere in this prospectus, may include possible acquisitions of, or investments in, businesses or other assets. While we routinely engage in discussions with third parties regarding potential acquisitions in the ordinary course of our business, we have no present understandings, commitments or agreements to enter into any acquisitions or investments. Our management will have broad discretion in the application of remaining net proceeds, and investors will be relying on the judgment of our management regarding the treatment of these proceeds.

In connection with the repayment of the existing debt, we expect to incur, as of the closing of this offering, non-cash charges related to previously deferred and unamortized debt issuance costs. Assuming we borrow under the senior secured credit facility and repay the existing debt in full, we estimate that the non-cash charge will be approximately $8.8 million.

 

 

 

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Dividend Policy

We do not currently anticipate paying any dividends on our common stock immediately following this offering. Following this offering and upon repayment of the PennantPark Loan Agreement and the UBS Credit Agreement, we may reevaluate our dividend policy. Any future determinations relating to our dividend policies and the declaration, amount and payment of any future dividends on our common stock will be at the sole discretion of our board of directors and, if we elect to pay such dividends in the future, we may reduce or discontinue entirely the payment of such dividends at any time. Our board of directors may take into account general and economic conditions, our financial condition and operating results, our available cash and current and anticipated cash needs, capital requirements, contractual, legal, tax and regulatory restrictions and implications on the payment of dividends by us to our stockholders or by our subsidiaries to us, and such other factors as our board of directors may deem relevant.

Because we are a holding company with limited direct operations of our own, our ability to pay dividends in the future depends on our receipt of cash dividends from our operating subsidiaries, which may further restrict our ability to pay dividends as a result of the laws of the respective jurisdictions of organization of our operating subsidiaries, or restrictions contained in the senior secured credit facility or agreements governing any existing and future outstanding indebtedness we or our subsidiaries may incur, and restrictions contained in any other agreements of us or our subsidiaries.

In addition, under Delaware law, we may declare and pay dividends on our capital stock either out of our surplus, as defined in the relevant Delaware statutes, or if there is no such surplus, out of our net profits for the fiscal year in which the dividend is declared and/or the preceding fiscal year. If, however, our capital, computed in accordance with the relevant Delaware statutes, has been diminished by depreciation in the value of our property, or by losses, or otherwise, to an amount less than the aggregate amount of the capital represented by the issued and outstanding stock of all classes having a preference upon the distribution of assets, we are prohibited from declaring and paying out of such net profits any dividends upon any shares of our capital stock until the deficiency has been repaired.

 

 

 

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Capitalization

The following table sets forth our consolidated cash and cash equivalents and our consolidated capitalization as of September 30, 2014:

 

Ø   on an actual basis; and

 

Ø   on an as adjusted basis to give effect to the issuance of common stock in this offering, borrowings under the senior secured credit facility and the application of net proceeds therefrom.

This table should be read in conjunction with “Use of Proceeds,” “Unaudited Pro Forma Financial Information,” “Selected Historical Combined Financial Data,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and related notes appearing elsewhere in this prospectus.

 

    As of September 30, 2014  
In thousands   Actual     As
Adjusted for this
Offering
 
   

(unaudited)

 

Cash and cash equivalents(1)(2)

  $ 8,026      $ 11,995   

Capitalization:

   

Debt:

   

PennantPark Loan Agreement

  $ 58,824      $ —     

UBS Credit Agreement(2)

    54,991        —     

Senior secured credit facility(2)

    —          40,000   

Capital lease obligations

    5,341        5,341   
 

 

 

   

 

 

 

Total debt

    119,156        45,341   

Equity:

   

Preferred stock, $0.001 par value; 100,000 shares authorized; no shares issued and outstanding actual and as further adjusted for this offering

    —          —     

Common stock, $0.001 par value; 1,000,000 shares authorized; 18,075 shares issued and outstanding actual and 26,390 as further adjusted for this offering(3)

    14        21   

Additional paid in capital

    —          95,265   

Accumulated deficit

    (38,380     (50,926
 

 

 

   

 

 

 

Total stockholders’ equity (deficit)

    (38,379     44,360   

Less non-controlling interest

    (322     (322
 

 

 

   

 

 

 

Total Equity (Deficit)

    (38,701     44,038   
 

 

 

   

 

 

 

Total Capitalization

  $ 80,455      $ 89,379   
 

 

 

   

 

 

 

(footnotes on following page)

 

 

 

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(1)   Does not include restricted cash of $5.1 million as of September 30, 2014, which is comprised of amounts received from our clients to be used exclusively for the payment of claims on behalf of those clients.
(2)   Reflects anticipated borrowings of $37.7 million (net of loan fees) under the proposed senior secured credit facility that we intend to enter into concurrently with this offering, and application of a portion of such borrowings, together with the net proceeds from this offering, to the repayment of all outstanding amounts under the PennantPark Loan Agreement and the UBS Credit Agreement and of the remaining portion to cash and cash equivalents. Assuming that we do not enter into the senior secured credit facility, or do not make such borrowings, and that $37.7 million of borrowings remain outstanding under the UBS Credit Agreement, as of September 30, 2014, our cash and cash equivalents (excluding restricted cash) would be $12.3 million, our total debt would be $43.0 million and our total capitalization would be $88.5 million. Based on our estimated cash and cash equivalents (excluding restricted cash) as of December 31, 2014, we believe that we will be in a position to repay all amounts under the PennantPark Loan Agreement and the UBS Credit Agreement with the net proceeds from this offering together with cash on hand. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Indebtedness—Senior Secured Credit Facility.” The senior secured credit facility will also include a $40.0 million revolving credit facility which will be undrawn at the closing of this offering.
(3)   See “Prospectus Summary—The Offering” on page 14 of this prospectus for more detail regarding the number of outstanding shares presented.

 

 

 

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Dilution

If you invest in our common stock in this offering, your ownership interest in us will be diluted to the extent of the difference between the initial public offering price per share of our common stock and the adjusted net tangible book value per share of our common stock after this offering. Dilution results from the fact that the per share offering price of the common stock is substantially in excess of the book value per share attributable to the shares of common stock held by existing stockholders.

As of September 30, 2014, our net tangible book value (deficit) was approximately $(118.6) million, calculated as the total deficit from our combined balance sheet as of September 30, 2014, less goodwill and intangible assets as of September 30, 2014, plus our deferred tax liability related to intangible assets as of September 30, 2014. Our net tangible book value (deficit) as of September 30, 2014 was $(6.56) per share of our common stock based on 18,074,715 shares of common stock outstanding immediately prior to the closing of this offering. We calculate net tangible book value per share by taking the amount of our total tangible assets, reduced by the amount of our total liabilities, and then dividing that amount by the total number of shares of common stock outstanding.

After giving pro forma effect to our sale of the shares in this offering at the initial public offering price and the application of the net proceeds therefrom, and after deducting estimated underwriting discounts and commissions and estimated offering expenses payable by us, our adjusted net tangible book value (deficit) as of September 30, 2014 would have been $(35.9) million, or $(1.36) per share of our common stock. This amount represents an immediate increase in net tangible book value of $5.20 per share to existing stockholders and an immediate and substantial dilution in net tangible book value of $12.64 per share to new investors purchasing shares in this offering at the initial public offering price.

The following table illustrates this dilution on a per share basis:

 

Initial public offering price per share

     $ 14.00   

Net tangible book value (deficit) per share as of September 30, 2014

   $ (6.56  

Increase in tangible book value per share attributable to new investors

     5.20     

Adjusted net tangible book value (deficit) per share after giving effect to this offering

       (1.36
    

 

 

 

Dilution per share to new investors

     $ 12.64   
    

 

 

 

Dilution is determined by subtracting adjusted net tangible book value per share of common stock after giving pro forma effect to this offering from the initial public offering price per share of common stock.

If the underwriters exercise in full their over-allotment option, the adjusted tangible book value (deficit) per share as of September 30, 2014, after giving pro forma effect to the offering would be $(.77) per share. This represents an immediate increase in adjusted net tangible book value (or a decrease in net tangible book value deficit) of $.59 per share to the existing stockholders and an immediate and substantial dilution in adjusted net tangible book value of $12.05 per share to new investors.

 

 

 

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The following table summarizes, as of September 30, 2014, the differences between the number of shares purchased from us, the total consideration paid to us, and the average price per share paid by existing stockholders and by new investors. As the table shows, new investors purchasing shares in this offering will pay an average price per share substantially higher than our existing stockholders paid. The table below reflects the initial public offering price for shares purchased in this offering and excludes underwriting discounts and commissions and estimated offering expenses payable by us:

 

    Shares Purchased     Total Consideration     Average
Price Per
Share
 
         Number              %             Amount              %        

Existing stockholders

    18,074,715         68.5   $ 3,896,989         3.2   $ .22   

New investors

    8,315,700         31.5     116,419,800         96.8   $ 14.00   
 

 

 

      

 

 

      
    26,390,415         100   $ 120,316,789         100   $ 4.56   
 

 

 

      

 

 

      

If the underwriters were to fully exercise their over-allotment option, the percentage of shares of our common stock held by existing stockholders who are directors, officers or affiliated persons would be 65.4% and the percentage of shares of our common stock held by new investors would be 34.6%.

To the extent that we grant options to our employees in the future and those options are exercised or other issuances of common stock are made, there will be further dilution to new investors.

 

 

 

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Unaudited Pro Forma Financial Information

We have derived the following unaudited pro forma condensed combined financial data as of and for the nine months ended September 30, 2014 and 2013 from our unaudited combined financial statements, which is included elsewhere in this prospectus, and the unaudited consolidated financial statements of Patriot Care Holdings, Inc. (f/k/a MCRS Holdings, Inc.), our subsidiary operating the Patriot Care Management Business (“PCM”). We have derived the following unaudited pro forma condensed combined financial data for the year ended December 31, 2013 from our audited combined financial statements and the audited consolidated financial statements of PCM, both of which are also included elsewhere in this prospectus. Our unaudited interim combined financial statements have been prepared on the same basis as our audited combined financial statements and reflect, in the opinion of management, all adjustments of a normal, recurring nature that are necessary for a fair presentation of the unaudited pro forma condensed combined financial statements. The unaudited consolidated financial statements of PCM have been prepared on the same basis as the audited consolidated financial statements of PCM and reflect, in the opinion of management, all adjustments of a normal, recurring nature that are necessary for a fair presentation of the unaudited pro forma condensed combined financial statements.

The unaudited pro forma condensed combined balance sheet data as of September 30, 2014 gives effect to this offering, anticipated borrowings under the senior secured credit facility and the application of a portion of the net proceeds therefrom to repay outstanding indebtedness as described under “Use of Proceeds” as if such events had been completed as of September 30, 2014.

 

The unaudited pro forma condensed combined statements of operations data for the nine months ended September 30, 2014 and 2013 and the year ended December 31, 2013 give effect, to:

 

Ø   the additional statement of operations impact of the financing we incurred in connection with the GUI Acquisition, including the issuance of additional warrants to the lenders;

 

Ø   the Patriot Care Management Acquisition; and

 

Ø   this offering, anticipated borrowings under the senior secured credit facility and the application of a portion of the net proceeds therefrom to repay indebtedness as described under “Use of Proceeds,”

as if all such events had been completed as of January 1, 2013.

The unaudited pro forma condensed combined financial data should be read in conjunction with the disclosures set forth under “Capitalization,” “Selected Historical Combined Financial Data,” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the combined and consolidated financial statements and the related notes thereto appearing elsewhere in this prospectus.

THE GUI ACQUISITION

We and GUI are under common control. Accordingly, as discussed in Note 12 to our audited combined financial statements, we recognized the net assets acquired in the GUI Acquisition at GUI’s carrying amounts as of the acquisition date pursuant to the Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) 805, Business Combinations, and our audited combined financial statements and unaudited interim combined financial statements include the revenues and

 

 

 

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expenses associated with the contracts and certain other assets acquired and liabilities assumed from GUI, retrospectively, as if the transaction had occurred as of January 1, 2013. Additionally, the fixed assets and other long term assets acquired from GUI and the capital lease obligation assumed from GUI are included in our combined balance sheets as of September 30, 2014, December 31, 2013 and December 31, 2012. All other assets and liabilities of GUI, however, that were not acquired by us on August 6, 2014, are not included in our combined balance sheets as of September 30, 2014, December 31, 2013 or December 31, 2012. In addition, we eliminated in consolidation in the accompanying combined balance sheets as of September 30, 2014, December 31, 2013 and December 31, 2012 the following: the note receivable from Guarantee Insurance to us comprising principal and accrued but unpaid interest under a surplus note (the “Surplus Note”) transferred to GUI and balances payable to GUI from us, both of which were included as part of our consideration for the contracts and certain other assets acquired and liabilities assumed, together with the note payable associated with the acquisition of the contracts and certain other assets.

The following unaudited pro forma condensed combined statements of operations give effect to the additional statement of operations impact of the financing we incurred in connection with the GUI Acquisition, including the issuance of additional warrants to the lenders, as if such acquisition had occurred on January 1, 2013.

As part of the GUI Acquisition, we acquired a contract to provide a limited subset of our brokerage and policyholder services to Guarantee Insurance, the balance of which had historically been provided without a contract as GUI is a subsidiary of Guarantee Insurance. The revenues and expenses associated with this contract are accordingly reflected in our historical combined financial statements up to August 6, 2014. Immediately following the GUI Acquisition, we entered into a new agreement with Guarantee Insurance on August 6, 2014 to provide all of our brokerage and policyholder services to Guarantee Insurance. The revenues and expenses associated with this new agreement are reflected in our combined financial statements from August 6, 2014 and are not reflected in our historical financial statements as of or for any earlier period.

THE PATRIOT CARE MANAGEMENT ACQUISITION

The following unaudited pro forma condensed combined statements of operations give effect to our acquisition, effective August 6, 2014, of the Patriot Care Management Business. The Patriot Care Management Business had been previously controlled by Mr. Mariano and was sold to MCMC in 2011. A portion of the consideration received by Mr. Mariano and other shareholders in that sale consisted of preferred equity issued by the parent of MCMC (the “MCMC preferred equity”). The MCMC preferred equity was held by Six Points Ventures 2, Inc. (“SPV2”), an entity controlled by Mr. Mariano.

Our acquisition of the Patriot Care Management Business had two components:

 

1.   the merger of SPV2 into one of our subsidiaries in order to acquire the MCMC preferred equity; and

 

2.   the acquisition of all the MCRS Holdings, Inc. common stock and redemption of the MCMC preferred equity.

The first component was accounted for as an acquisition of an asset, as SPV2’s sole asset was the MCMC preferred equity, and SPV2 had no liabilities, revenues or expenses. The second component was accounted for by application of the acquisition method, applying the assumptions and adjustments described in the accompanying notes to the unaudited pro forma condensed combined financial statements as if such acquisition had occurred as of January 1, 2013 for pro forma statement of operations purposes.

 

 

 

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THE OFFERING AND APPLICATION OF NET PROCEEDS

In addition, the pro forma adjustments give effect to:

 

1.   the issuance of shares of common stock in this offering at the initial public offering price, after deducting underwriting discounts and commissions and estimated offering expenses payable by us of approximately $3.0 million;

 

2.   the $40.0 million of borrowings we intend to make under the senior secured credit facility, or approximately $37.7 million (net of loan fees);

 

3.   the application of a portion of the proceeds from this offering and borrowings under the senior secured credit facility to repay outstanding indebtedness, as described in ‘‘Use of Proceeds;’’

 

4.   the issuance of 475,658 restricted shares of common stock, 125,020 restricted stock units and stock options to acquire 1,030,591 shares of common stock, with an exercise price equal to the price at which shares of common stock are sold in this offering, all of which we intend to issue in connection with this offering under our 2014 Plan; and

 

5.   net proceeds of approximately $2.6 million from the exercise of warrants to purchase 965,700 shares of common stock.

The unaudited pro forma condensed combined financial data presented assumes no exercise by the underwriters of their option for a period of 30 days to purchase up to an additional 1,102,500 shares of our common stock to cover over-allotments, and includes 965,700 shares of common stock that will be issued upon the exercise of outstanding warrants as of September 30, 2014.

Upon consummation of this offering, we expect to incur additional costs associated with operating as a public company, including hiring additional personnel, improving financial reporting systems, additional directors’ and officers’ liability insurance, director fees and expanding our facilities. We expect that these costs will relate to legal, regulatory, finance, accounting, investor relations and other administrative functions. Sarbanes-Oxley, as well as rules adopted by the SEC and the NYSE, require public companies to implement specified corporate governance practices that are currently inapplicable to us as a private company. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Matters Affecting Historical and Future Comparability—Public Company Costs.” The unaudited pro forma condensed combined financial data presented do not include any pro forma adjustments relating to these costs.

LIMITATIONS OF UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL STATEMENTS

The unaudited pro forma condensed combined financial data has been prepared by management for illustrative purposes only and is not necessarily indicative of the consolidated financial position or results of operations in future periods or the results that actually would have been realized had (i) we acquired GUI’s contracts to provide marketing, underwriting and policyholder services and certain other assets on the dates assumed, (ii) SPV2 merged into our subsidiary on the dates assumed and (iii) we and PCM been a combined company during the specified periods. In addition, the unaudited pro forma condensed combined financial data should not be relied upon as being indicative of our results of operations or financial position had the use of the estimated net proceeds from this offering as described under ‘‘Use of Proceeds’’ occurred on the dates assumed. Certain reclassification adjustments have been made in the presentation of the PCM historical amounts to conform PCM’s financial statement basis of presentation to that followed by us. The pro forma adjustments are based on information available at the time of the preparation of this document. The unaudited pro forma condensed combined financial data, including

 

 

 

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the notes thereto, are qualified in their entirety by reference to, and should be read in conjunction with, our historical combined financial statements and PCM’s historical consolidated financial statements, all of which are included in this prospectus. The unaudited pro forma adjustments are based upon available information and certain estimates and assumptions that we believe are reasonable under the circumstances. The unaudited pro forma condensed combined financial data is presented for informational purposes only and is not necessarily indicative of and does not purport to represent what our financial position or results of operations would actually have been had the transactions been consummated as of the dates indicated. In addition, the unaudited pro forma condensed combined financial data is not necessarily indicative of our future financial condition or results of operations.

 

 

 

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UNAUDITED PRO FORMA CONDENSED COMBINED BALANCE SHEET OF PATRIOT NATIONAL, INC.

As of September 30, 2014

 

In thousands, except per share data    Patriot
National
Combined
    Offering
Adjustments
    Combined
As Adjusted
for the
Offering
 

Cash and cash equivalents

   $ 8,026      $ 3,969 (1)    $ 11,995 (1) 

Restricted cash

     5,107        —          5,107   

Fee income receivable

     2,300        —          2,300   

Fee income receivable from related party

     10,170        —          10,170   

Other current assets

     741        —          741   
  

 

 

   

 

 

   

 

 

 

Total current assets

     26,344        3,969        30,313   

Fixed assets, net of depreciation

     2,537        —          2,537   

Deferred loan fees

     5,700        (3,400 )(2)      2,300   

Goodwill

     59,385        —          59,385   

Intangible assets, net

     34,220        —          34,220   

Other long term assets

     8,811        —          8,811   
  

 

 

   

 

 

   

 

 

 

Total Assets

   $ 136,997      $ 569      $ 137,566   
  

 

 

   

 

 

   

 

 

 

Liabilities and Equity

      

Liabilities

      

Deferred claims administration services income

   $ 8,408      $ —        $ 8,408   

Net advanced claims reimbursements

     4,999        —          4,999   

Net payables to related parties

     921        —          921   

Income taxes payable

     9,055        (8,355 )(3)      700   

Accounts payable and accrued expenses

     11,598        —          11,598   

Current portion of notes payable

     14,970        (12,970 )(4)      2,000   

Current portion of capital lease obligation

     2,114        —          2,114   
  

 

 

   

 

 

   

 

 

 

Total current liabilities

     52,065        (21,325 )      30,740   

Notes payable

     98,845        (60,845 )(4)      38,000   

Capital lease obligation

     3,227        —          3,227   

Warrant redemption liability

     8,799        —          8,799   

Deferred tax liability

     12,762        —          12,762   
  

 

 

   

 

 

   

 

 

 

Total Liabilities

     175,698        (82,170     93,528   
  

 

 

   

 

 

   

 

 

 

Equity (Deficit)

      

Preferred stock

     —          —          —     

Common stock

     14        7 (5)      21   

Additional paid in capital

     —          95,265 (5)      95,265   

Accumulated deficit

     (38,393     (12,533 )(5)      (50,926
  

 

 

   

 

 

   

 

 

 

Total stockholders’ equity (deficit)

     (38,379     82,739        44,360   

Less non-controlling interest

     (322     —          (322
  

 

 

   

 

 

   

 

 

 

Total Equity (Deficit)

     (38,701     82,739        44,038   
  

 

 

   

 

 

   

 

 

 

Total Liabilities and Equity (Deficit)

   $ 136,997      $ 569      $ 137,566   
  

 

 

   

 

 

   

 

 

 

 

 

 

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UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF OPERATIONS OF PATRIOT NATIONAL, INC.

For the Nine Months Ended September 30, 2014

 

In thousands, except per share
data
  Patriot
National
Combined
    Adjustments
Attributable to
Financing of
GUI
Acquisition
    PCM     Adjustments
Attributable to
Patriot Care
Management
Acquisition
    Pro Forma
Combined
    Offering
Adjustments
    Pro Forma
Combined As
Further
Adjusted for
the Offering
 

Revenues

             

Fee income

  $ 37,896      $ —        $ 24,108      $ (8,079 )(7)    $ 53,925      $ —        $ 53,925   

Fee income from related party

    24,589        —          —          8,079 (7)      32,668        —          32,668   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total fee income and fee income from related party

    62,485        —          24,108        —          86,593        —          86,593   

Net investment income

    496        —          —          —          496        —          496   

Net realized gains on investments

    14,038        —          —          —          14,038        —          14,038   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Revenues

    77,019        —          24,108        —          101,127        —          101,127   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Expenses

             

Salaries and salary related expenses

    17,907        —          4,625        —          22,532        —          22,532   

Commission expense

    9,491        —          —          —          9,491        —          9,491   

Management fees to related party for administrative support services

    5,390        —          1,762        —          7,152        —          7,152   

Outsourced services

    3,118        —          4,394        —          7,512        —          7,512   

Allocation of marketing, underwriting and policy issuance costs from related party

    1,872        —          —          —          1,872        —          1,872   

Other operating expenses

    7,701        —          3,404        —          11,105        —          11,105   

Interest expense

    5,427        2,885 (6)      5,380        (5,380 )(8)      12,587        (11,518 )(13)      1,069   
          4,275 (9)       

Depreciation and amortization

    3,699        —          5,821        2,610 (10)      12,130        —          12,130   

Amortization of loan discounts and loan costs

    1,295        910 (6)      529        578 (9)      3,312        —          3,312   

Decrease in fair value of warrant redemption liability

    (2,257     —          —          —          (2,257     —          (2,257

Provision for uncollectible fee income

    100        —          110        —          210        —          210   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Expenses

    53,743        3,795        26,025        2,083        85,646        (11,518     74,128   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss) before income tax expense (benefit)

    23,276        (3,795     (1,917     (2,083     15,481        11,518        26,999   

Income Tax Expense (Benefit)

    10,401        (1,480 )(6)      (307     (812 )(11)      7,802        4,607        12,409   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net Income Including Non-Controlling Interest in Subsidiary

    12,875        (2,315     (1,610     (1,271     7,679        6,911        14,590   

Net income attributable to non-controlling interest in subsidiary

    68        —          —          —          68        —          68   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net Income

  $ 12,807      $ (2,315   $ (1,610   $ (1,271   $ 7,611      $ 6,911      $ 14,522   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net Income Per Common Share

             

Basic

  $ .85            $ .44          .57   
 

 

 

         

 

 

     

 

 

 

Diluted

    .65              .29          .47   
 

 

 

         

 

 

     

 

 

 

Weighted Average Common Shares Outstanding

             

Basic

    14,981              18,024 (12)        25,393   
 

 

 

         

 

 

     

 

 

 

Diluted

    16,183              19,226 (12)        26,054   
 

 

 

         

 

 

     

 

 

 

 

 

 

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UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF OPERATIONS OF PATRIOT NATIONAL, INC.

For the Nine Months Ended September 30, 2013

 

In thousands, except per share
data
  Patriot
National
Combined
    Adjustments
Attributable to
Financing of
GUI
Acquisition
    PCM     Adjustments
Attributable to
Patriot Care
Management
Acquisition
    Pro Forma
Combined
    Offering
Adjustments
    Pro Forma
Combined As
Further
Adjusted for
the Offering
 

Revenues

             

Fee income

  $ 36,845      $ —        $ 32,381      $ (5,905 )(7)    $ 58,253      $ —        $ 58,253   
          (5,068 )(14)       

Fee income from related party

    5,238        —          —          5,905 (7)      11,143        —          11,143   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total fee income and fee income from related party

    42,083        —          32,381        (5,068     69,396        —          69,396   

Net investment income

    7        —          —          —          7        —          7   

Net realized losses on investments

    (50     —          —          —          (50     —          (50
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Revenues

    42,040        —          32,381        (5,068     69,353        —          69,353   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Expenses

             

Salaries and salary related expenses

    12,097        —          9,035        (2,896 )(14)      18,236        —          18,236   

Commission expense

    6,651        —          —          —          6,651        —          6,651   

Management fees to related party for administrative support services

    9,200        —          2,205        998 (14)      12,403        —          12,403   

Outsourced services

    2,378        —          6,981        (1,645 )(14)      7,714        —          7,714   

Allocation of marketing, underwriting and policy issuance costs from related party

    3,449        —          —          —          3,449        —          3,449   

Other operating expenses

    3,247        —          2,793        (995 )(14)      5,045        —          5,045   

Interest expense

    606        2,885 (6)      7,628        (7,309 )(8)      7,766        1,850 (13)      5,916   
          4,275 (9)       
          (319 )(14)       

Depreciation and amortization

    1,550        —          8,214        2,610 (10)      11,440        —          11,440   
          (934 )(14)       

Amortization of loan discount and loan cost

    702        910 (6)      662        578 (9)      2,852        —          2,852   

Increase in fair value of warrant redemption liability

    300        —          —          —          300        —          300   

Provision for uncollectible fee income

    2,544        —          1,698        —          4,242        —          4,242   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Expenses

    42,724        3,795        39,216        (5,637     80,098        1,850        78,248   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss) before income tax benefit

    (684     (3,795     (6,835     569        (10,745     1,850        (8,895

Income Tax Expense (Benefit)

    31        (1,480 )(6)      (2,277     228 (11)      (3,498     740        (2,758
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net Income (Loss) Including Non-Controlling Interest in Subsidiary

    (715     (2,315     (4,558     341        (7,247     1,110        (6,137

Net income attributable to non-controlling interest in subsidiary

    19        —          —          —          19        —          19   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net Income (Loss)

  $ (734   $ (2,315   $ (4,558   $ 341      $ (7,266   $ 1,110      $ (6,156
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net Loss Per Common Share

             

Basic

  $ (.05         $ (.42       (.25
 

 

 

         

 

 

     

 

 

 

Diluted

  $ (.05         $ (.42       (.25
 

 

 

         

 

 

     

 

 

 

Weighted Average Common Shares Outstanding

             

Basic

    14,288              17,331 (12)        24,681   
 

 

 

         

 

 

     

 

 

 

Diluted

    14,288              17,331 (12)        24,681   
 

 

 

         

 

 

     

 

 

 

 

 

 

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UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF OPERATIONS OF PATRIOT NATIONAL, INC.

For the Year Ended December 31, 2013

 

In thousands, except per share
data
  Patriot
National
Combined
   

Adjustments
Attributable to
Financing of

GUI
Acquisition

    PCM     Adjustments     Pro Forma
Combined
    Offering
Adjustments
    Pro Forma
Combined As
Further
Adjusted for
the Offering
 

Revenues

             

Fee income

  $ 46,486      $ —        $ 42,125      $ (7,746 )(7)    $ 75,797      $ —        $ 75,797   
          (5,068 )(14)       

Fee income from related party

    9,387        —          —          7,746 (7)      17,133        —          17,133   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total fee income and fee income from related party

    55,873        —          42,125        (5,068     92,930        —          92,930   

Net investment income

    87        —          —          —          87        —          87   

Net realized losses on investments

    (50     —          —          —          (50     —          (50
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Revenues

    55,910        —          42,125        (5,068     92,967        —          92,967   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Expenses

             

Salaries and salary related expenses

    15,985        —          10,653        (2,896 )(14)      23,742        —          23,742   

Commission expense

    8,765        —          —          —          8,765        —          8,765   

Management fees to related party for administrative support services

    12,139        —          1,942        998 (14)      15,079        —          15,079   

Outsourced services

    3,303        —          8,948        (1,645 )(14)      10,606        —          10,606   

Allocation of marketing, underwriting and policy issuance costs from related party

    4,687        —          —          —          4,687        —          4,687   

Other operating expenses

    4,557        —          3,334        (995 )(14)      6,896        —          6,896   

Interest expense

    1,174        3,846 (6)      9,892        (9,573 )(8)      10,720        942 (13)      11,662   
          5,700 (9)       
          (319 )(14)       

Depreciation and amortization

    2,607        —          10,641        (934 )(14)      15,794        —          15,794   
          3,480 (7)       

Amortization of loan discounts and loan costs

    5,553        1,213 (6)      882        771 (9)      8,419        —          8,419   

Loss on exchange of units and warrants

    152        —          —          —          152        —          152   

Provision for uncollectible fee income

    2,544        —          1,711        —          4,255        —          4,255   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Expenses

    61,466        5,059        48,003        (5,413     109,115        942        110,057   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income before income tax expense (benefit)

    (5,556     (5,059     (5,878     345        (16,148     (942     (17,090

Income Tax Expense (Benefit)

    712        (1,973 )(6)      (1,651     138 (11)      (1,394     (377     (1,771
      1,380             
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net Income Including Non-Controlling Interest in Subsidiary

    (6,268     (4,466     (4,227     207        (14,754     (565     (15,319

Net income attributable to non-controlling interest in subsidiary

    (82     —          —          —          (82     —          (82
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net Income (Loss)

  $ (6,186   $ (4,466   $ (4,227   $ 207      $ (14,672   $ (565   $ (15,237
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net Income (Loss) Per Common Share

             

Basic

  $ (.43         $ (.85     $ (.62
 

 

 

         

 

 

     

 

 

 

Diluted

    (.43           (.85       (.62
 

 

 

         

 

 

     

 

 

 

Weighted Average Common Shares Outstanding

             

Basic

    14,288              17,331 (12)        24,732   
 

 

 

         

 

 

     

 

 

 

Diluted

    14,288              17,331 (12)        24,732   
 

 

 

         

 

 

     

 

 

 

 

 

 

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NOTES TO UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL DATA

1.    GUI Acquisition

 

In connection with the GUI Acquisition, on August 6, 2014, we borrowed additional amounts under the PennantPark Loan Agreement, pursuant to the Additional Tranche, the proceeds of which were used to fund the cash portion of the purchase price consideration of the GUI Acquisition, fund an original issue discount on the Additional Tranche of approximately $0.7 million and pay loan fees of approximately $0.3 million. We also issued additional warrants to the lenders in connecting with such borrowings. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Indebtedness.”

2.    Patriot Care Management Acquisition

 

The acquisition of the PCM common stock was accounted for by application of the acquisition method in accordance with FASB ASC 805, Business Combinations. Under the acquisition method assets acquired and liabilities assumed in connection with the acquisition are generally recorded at their fair values as of the effective date of the acquisition.

 

In connection with the Patriot Care Management Acquisition, on August 6, 2014, we entered into the UBS Credit Agreement. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Indebtedness.”

3.    Pro Forma Adjustments

The accompanying unaudited pro forma condensed combined financial statements reflect the following pro forma adjustments:

 

(1)   Reflects anticipated borrowings of $37.7 million (net of loan fees) under the proposed senior secured credit facility that we intend to enter into concurrently with this offering, and application of a portion of such borrowings, together with the net proceeds from this offering, to the repayment of all outstanding amounts under the PennantPark Loan Agreement and the UBS Credit Agreement, including prepayment penalties and make-whole payments, and of the remaining portion to cash and cash equivalents. Assuming that we do not enter into the senior secured credit facility, or do not make such borrowings, and that $37.7 million of borrowings remain outstanding under the UBS Credit Agreement, as of September 30, 2014, our pro forma cash and cash equivalents would be $12.3 million.

 

(2)   Reflects the write-off of unamortized loan fees attributable to the PennantPark Loan Agreement and the UBS Credit Agreement.

 

(3)   Reflects the estimated change in federal and state income tax liability associated with offering adjustments.

 

(4)   Reflects anticipated borrowings under the proposed senior secured credit facility that we intend to enter into concurrently with this offering, and application of the proceeds therefrom, together with the net proceeds from this offering, as described in note 1. Assuming no borrowings under the senior secured credit facility and $37.7 million of borrowings outstanding under the UBS Credit Agreement, as of September 30, 2014, our pro forma current portion of notes payable would be $1.8 million and our pro forma notes payable would be $35.9 million.

 

 

 

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(5)   Reflects the effects on equity (deficit) of this offering and (i) prepayment penalties and make-whole payments, (ii) write-off of unamortized discounts on debt and (iii) write-off of unamortized deferred loan fees, in each case net of federal and state income taxes.

 

(6)   Reflects additional interest expense associated with borrowings under the Additional Tranche of the PennantPark Loan Agreement incurred to finance the GUI Acquisition, based on the effective interest rate in effect as of the date of the Additional Tranche borrowings, and the related amortization of loan cost and discount in respect of additional warrants issued in connection with such borrowings, as well as the federal income tax impact of the additional interest expense, calculated at the statutory federal income tax rate.

 

(7)   Reflects the reclassification, from “fee income” to “fee income from related party,” of the portion of PCM’s fee income received from Guarantee Insurance and other parties related to us.

 

(8)   Reflects elimination of interest expense associated with PCM’s outstanding indebtedness, which was repaid in connection with the Patriot Care Management Acquisition.

 

(9)   Reflects additional interest expense associated with borrowings under our UBS Credit Agreement incurred to finance the Patriot Care Management Acquisition, based on the effective interest rate in effect as of the date of the borrowings, and related amortization of loan cost.

 

(10)   Reflects amortization of intangible assets recorded in connection with the Patriot Care Management Acquisition.

 

(11)   Reflects the federal income tax impact of pro forma revenue and expense adjustments described above and below, calculated at the statutory federal income tax rate.

 

(12)   Reflects the issuance of 3,043,485 shares of Patriot National, Inc. common stock to the holders of SPV2’s equity in connection with the merger of SPV2 into one of our subsidiaries, as part of the Patriot Care Management Acquisition. See “Certain Relationships and Related Party Transactions—Relationships and Transactions with Guarantee Insurance Group and Guarantee Insurance—Patriot Care Management Acquisition.”

 

(13)   Reflects elimination of interest expense associated with outstanding indebtedness under the PennantPark Loan Agreement and the UBS Credit Agreement and additional interest expense and commitment fees associated with anticipated borrowings under the proposed senior secured credit facility that we intend to enter into concurrently with this offering, based on the application of the proceeds from such borrowings, together with the net proceeds from this offering, as described in note 1. Assuming no borrowings under the senior secured credit facility and $37.7 million of borrowings outstanding under the UBS Credit Agreement, our pro forma interest expense for the nine months ended September 30, 2014 and 2013 and the year ended December 31, 2013 would be $4.3 million, $4.9 million and $10.7 million, respectively.

 

(14)   Reflects elimination of the operating results of CompPartners, Inc., an entity acquired by PCM in December 2012 and contributed to MCMC on July 31, 2013, including elimination of interest expense and depreciation and amortization in connection with such acquisition.

In addition to the adjustments described above, certain amounts in the unaudited consolidated financial statements of PCM as of and for the nine months ended September 30, 2014 and 2013 and for the year ended December 31, 2013 have been reclassified for consistency with our financial statement presentation. These reclassifications have no material effect on our pro forma financial condition or results of operations for the periods presented.

 

 

 

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Selected Historical Combined Financial Data

The following table sets forth selected historical combined financial data as of the dates and for the periods indicated. We have derived the selected historical combined financial data as of December 31, 2013 and 2012 for the years then ended from our audited combined financial statements, which are included elsewhere in this prospectus. The historical combined financial data as of September 30, 2014 and for the nine months ended September 30, 2014 and 2013 was derived from our unaudited interim combined financial statements, which are also included elsewhere in this prospectus. Our unaudited interim combined financial statements have been prepared on the same basis as our audited combined financial statements and reflect, in the opinion of management, all adjustments of a normal, recurring nature that are necessary for a fair presentation of the unaudited interim combined financial statements. These historical results are not necessarily indicative of results to be expected in any future period.

The combined financial statements of Patriot National are comprised of (1) the financial statements of us and our subsidiaries, which became our subsidiaries in the Reorganization, (2) the results of the Patriot Care Management Business, which are reflected in our combined financial statements from August 6, 2014, the effective date of the Patriot Care Management Acquisition, and (3) the revenues and expenses associated with the contracts and certain other assets acquired and liabilities assumed effective August 6, 2014 in the GUI Acquisition from GUI, a wholly owned subsidiary of Guarantee Insurance Group and a related party by virtue of common control between us and Guarantee Insurance Group. Because we and the subsidiaries we acquired in the Reorganization are under common control, and the contracts acquired in the GUI Acquisition were acquired from an entity under common control, our combined financial statements are presented as if all of these companies and businesses, were owned by us for all of the periods presented, as further described in the notes to our combined financial statements included elsewhere in this prospectus.

This selected historical combined financial data should be read in conjunction with the disclosures set forth under “Capitalization”, “Unaudited Pro Forma Financial Information”, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our combined financial statements and the related notes thereto, all of which appear elsewhere in this prospectus.

 

     Nine Months
Ended September 30,
    Year Ended
December 31,
 
In thousands, except per share data    2014     2013     2013     2012  
     (Unaudited)        

Combined Statement of Operations Data

        

Revenues

        

Fee income

   $ 37,896      $ 36,845      $ 46,486      $ 25,821   

Fee income from related party(1)

     24,589        5,238        9,387        12,546   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total fee income and fee income from related party

     62,485        42,083        55,873        38,367   

Net investment income

     496        7        87        62   

Net realized gains (losses) on investments

     14,038        (50     (50     3   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total Revenues

     77,019        42,040        55,910        38,432   

Expenses

        

Salaries and salary related expenses

     17,907        12,097        15,985        13,189   

Commission expense

     9,491        6,651        8,765        3,216   

Management fees to related party for administrative support services(2)

     5,390        9,200        12,139        8,007   

Outsourced services

     3,118        2,378        3,303        4,452   

Allocation of marketing, underwriting and policy issuance costs from related party(3)

     1,872        3,449        4,687        2,774   

Other operating expenses

     7,701        3,247        4,557        4,587   

Interest expense

     5,427        606        1,174        299   

Depreciation and Amortization

     3,699        1,550        2,607        1,330   

Amortization of loan discounts and loan costs

     1,295        702        5,553        211   

Loss on exchange of units and warrants

     —          —          152        —     

Decrease in fair value of warrant redemption liability

     (2,257     300        —          —     

Provision for uncollectible fee income

     100        2,544        2,544        —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Total Expenses

     53,743        42,724        61,466        38,065   

 

 

 

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     Nine Months
Ended September 30,
    Year Ended
December 31,
 
In thousands, except per share data    2014     2013     2013     2012  
     (Unaudited)        

Net Income (Loss) Before Income Tax Expense

     23,276        (684     (5,556     367   

Income tax expense

     10,401        31        712        —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Net Income (Loss) Including Non-Controlling Interest in Subsidiary

     12,875        (715     (6,268     367   

Net income (loss) attributable to non-controlling interest in subsidiary

     68        19        (82     23   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net Income (Loss)

   $ 12,807      $ (734   $ (6,186   $ 344   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net Income (Loss) Per Common Share

        

Basic

   $ .85      $ (.05   $ (.43   $ .02   

Diluted

     .65        (.05     (.43     .02   

Weighted Average Common Shares Outstanding

        

Basic

     14,981        14,288        14,288        14,288   

Diluted

     16,183        14,288        14,288        14,420   
     September 30,           December 31,  
            2014                  2013     2012  

Combined Balance Sheet Data

        

Assets

        

Cash

   $ 8,026        $ 1,661      $ 1,684   

Restricted cash(4)

     5,107          4,435        145   

Goodwill

     59,385          9,953        9,953   

Total Assets

     136,997          35,979        28,430   

Liabilities and stockholders’ equity (deficit)

        

Total debt

   $ 119,156        $ 45,330      $ 4,712   

Stockholders’ equity (deficit)

     (38,701       (30,888     8,801   

 

(1)   Represents service fees from Guarantee Insurance, a related party. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Principal Components of Financial Statements—Revenue.”
(2)   Represents historical fees paid by us to Guarantee Insurance Group for management oversight, legal, accounting, human resources and technology support services provided to us. Our administrative functions have been separated from Guarantee Insurance Group and from August 6, 2014, such payments are longer made by us in respect of such services.
(3)   Represents historical payments made by us to Guarantee Insurance Group as reimbursements for allocated portions of rent and certain administrative costs incurred by Guarantee Insurance Group on our behalf. Our administrative functions have been separated from Guarantee Insurance Group and from August 6, 2014, such reimbursements are no longer made by us in respect of such costs.
(4)   Represents amounts received from our clients to be used exclusively for the payment of claims on behalf of those clients.

 

 

 

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Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion of our financial condition and results of operations should be read in conjunction with the “Unaudited Pro Forma Financial Information,” “Selected Historical Combined Financial Data” and the audited and unaudited historical combined and consolidated financial statements and related notes thereto of us and PCM, included elsewhere in this prospectus. This discussion includes forward-looking statements that are subject to risks, uncertainties and other factors described under the captions “Risk Factors” and “Cautionary Note Regarding Forward Looking Statements.” These factors could cause our actual results to differ materially from those expressed in, or implied by, those forward-looking statements.

Overview

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”).

We generate fee revenue for our services from our clients based on (1) a percentage of premiums for the policies we service, (2) the cost savings we achieve for our clients or (3) a fixed fee for a particular service. Unlike our insurance and reinsurance carrier clients, we do not generate underwriting income or assume underwriting risk on workers’ compensation plans.

Our History and Organization

Mr. Mariano, our founder, Chairman, President and Chief Executive Officer, initially started our workers’ compensation insurance business and acquired Guarantee Insurance in 2003.

Patriot National, Inc. (f/k/a Old Guard Risk Services, Inc.) was incorporated in Delaware in November 2013 to consolidate certain insurance services entities controlled by Mr. Mariano. This Reorganization separated our insurance services business from the insurance risk taking operations of Guarantee Insurance Group.

Effective August 6, 2014, we acquired certain contracts to provide marketing, underwriting and policyholder services to certain of our insurance carrier clients, as well as related assets and liabilities, from a subsidiary of Guarantee Insurance Group in the GUI Acquisition. We also acquired a contract to provide a limited subset of our brokerage and policyholder services to Guarantee Insurance, the balance of which had historically been provided without a contract as GUI is a subsidiary of Guarantee Insurance. We refer to the acquisition of these contracts and related assets and liabilities as the “GUI Acquisition.” Immediately following the GUI Acquisition, we entered into a new agreement to provide all of our brokerage and policyholder services to Guarantee Insurance.

 

 

 

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We further expanded our business effective August 6, 2014, through our acquisition from MCMC of the Patriot Care Management Business. The Patriot Care Management Business had been previously controlled by Mr. Mariano and was sold to MCMC in 2011 for approximately $105 million in cash and preferred equity issued by MCMC.

The combined financial statements of Patriot National are comprised of (1) the financial statements of us and those of our subsidiaries which became our subsidiaries in the Reorganization, (2) the results of the Patriot Care Management Business which are reflected in our combined financial statements from August 6, 2014, the effective date of the Patriot Care Management Acquisition, and (3) the revenues and expenses associated with the contracts and certain other assets acquired and liabilities assumed in the GUI Acquisition from GUI, a wholly owned subsidiary of Guarantee Insurance Group and a related party by virtue of common control between us and Guarantee Insurance Group, which became effective August 6, 2014.

Because we and the subsidiaries we acquired in the Reorganization are under common control, and the contracts acquired in the GUI Acquisition were acquired from an entity under common control, our combined financial statements are presented as if all of these companies and businesses, were owned by us for all of the periods presented, as further described in the notes to our combined financial statements included elsewhere in this prospectus.

Following the Reorganization and the Acquisitions, we own 100% of the subsidiaries that comprise our insurance services business, with the exception of Contego Services Group, LLC, in which Mr. Mariano maintained a 3% membership interest.

Matters Affecting Historical and Future Comparability

Industry Trends

According to the NCCI Report, the total net premium written by state funds and private carriers of workers’ compensation insurance in the United States was $41.9 billion in 2013, an increase from $33.8 billion in 2010, representing a compound annual growth rate of 7.4% over that period, and according to data compiled by SNL Financial, total direct premium written by workers’ compensation insurance carriers in the United States, which includes the amount of premium reinsured by insurance carriers, was $52.5 billion in 2013, an increase from $40.4 billion in 2010, representing a compound annual growth rate of 9.2% over that period. In the past several years, premium growth in the workers’ compensation industry has been predominantly driven by the recovery of employment levels to generally at or near pre-recession levels, as well as increasing premium rates.

Like other sectors of the insurance industry, the workers’ compensation sector experiences underwriting cyclicality, which generally underpins changes in premium rates. This cyclicality is determined by a number of factors, but there are two notable drivers. First, ultimate loss costs become more difficult to predict when claims remain open for longer periods, generally as a result of wage and medical cost inflation. For example, the NCCI Report indicates that medical costs per claim increased by approximately 6.5% on average per year from 1995 through 2013. Second, the amount of investment income insurance carriers can earn may also influence such carrier’s underwriting practices. Investment income can be sufficiently significant, particularly when claims remain open for longer periods, to compensate for underwriting losses, such as those the workers’ compensation industry has experienced in recent years, as reflected in a greater than 100% combined ratio for all but two years from 1990 to 2013. However, in periods of low interest rates, similar to the current investment environment, insurance carriers cannot generate sufficient investment income to offset underwriting losses, and as a result have demanded higher premium rates. This has led to a modest “hardening” of the workers’ compensation market. According to the Moody’s Report, rates in 2013 increased 8% and are expected to rise 5.5% in 2014.

 

 

 

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Reorganization and Recent Acquisitions

Our historical financial results for all periods presented in this prospectus include the results of the various businesses previously under the common control of Mr. Mariano and to which we succeeded in connection with the Reorganization, as well as the revenues and expenses associated with the contracts and certain other assets acquired and liabilities assumed through the GUI Acquisition. However, revenues and expenses associated with the new agreement we entered into in August 2014 to provide all of our brokerage and policyholder services to Guarantee Insurance, as well as the financial results associated with the Patriot Care Management Business, are included in our historical financial results beginning August 6, 2014 only and are not reflected in our historical financial statements as of or for any earlier period.

Payments to Guarantee Insurance Group

We made payments in the past to Guarantee Insurance Group for rent and certain corporate administrative services costs incurred on our behalf, as well as for fees for management oversight, legal, accounting, human resources and technology support services provided to us. The reimbursements for such costs and payments for such services are reflected as “allocation of marketing, underwriting and policy issuance costs from related party” and “management fees to related party for administrative support services,” respectively, in our historical financial statements. Our administrative functions have been separated from Guarantee Insurance, the agreements pursuant to which such payments were made have been terminated, and such expenses are being incurred directly by us from August 6, 2014. Accordingly, beginning August 6, 2014, such expenses, rather than being reflected in the above items, will be recorded in the line items to which they relate, which are primarily “salaries and salary related expenses,” “outsourced services” and “other operating expenses.”

Public Company Costs

Upon consummation of this offering, we expect to incur additional costs associated with operating as a public company, including hiring additional personnel, improving financial reporting systems, additional directors’ and officers’ liability insurance, director fees and expanding our facilities. We expect that these costs will relate to legal, regulatory, finance, accounting, investor relations and other administrative functions. Sarbanes-Oxley, as well as rules adopted by the SEC and the NYSE, require public companies to implement specified corporate governance practices that are currently inapplicable to us as a private company. We currently estimate that we will incur incremental annual costs, including costs for additional personnel, of approximately $2.5 million to $3.0 million associated with operating as a public company, although it is possible that our actual incremental costs will be higher than we currently estimate.

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:

 

Ø  

Reference premium written: reference premium written refers to the aggregate premium, grossed up for large deductible credits, written by or for our insurance carrier partners in respect of the policies we produce and service on their behalf. For Guarantee Insurance who records written premium on the effective date of the policy based on the estimated total premium for the term of the policy, reference written premium is equal to written premium based on the estimated total premium for the term of the policy, as of the effective date of the policy, grossed up for large deductible credits. Subsequent adjustments to the estimated total premium for the term of the policy are reflected as adjustments to

 

 

 

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reference written premium when the adjustments become known. For our third party insurance carrier clients who record written premium as premium is collected, reference written premium is equal to collected premium, grossed up for large deductible credits. We evaluate our business (in respect of revenue both from brokerage and policyholder services and from claims administrative services) both in respect of the overall revenue generated by reference premium written, and the margin on such revenue. With respect to our brokerage and policyholder services, changes in reference premium written generally correspond to changes in total revenues.

The policies we write for our insurance and reinsurance carrier clients generally have a term of one year, and reference premium written is earned by our insurance and reinsurance carrier clients on a pro rata basis over the terms of the underlying policies. Likewise, the claims associated with these policies are generally incurred on a pro rata basis over the terms of the underlying policies. Generally, we perform our claims administration services on a claim from the date it is incurred through the date it is closed. We refer to claims that have been incurred, but not yet closed, for a particular period as “managed claims exposures.” With respect to our claims administration services, changes in managed claims exposures generally correspond to changes in total revenues.

 

Ø   Adjusted EBITDA: we define Adjusted EBITDA as net income before interest expense, income tax expense (benefit), depreciation and amortization expense and adjusting for certain revenue and expenses attributable to the common units and detachable common stock warrants we have or had issued to our lenders. We currently do not have any common units outstanding.

 

Ø   Adjusted EBITDA margins: we define Adjusted EBITDA margins as Adjusted EBITDA divided by the sum of fee income and fee income from related party.

Reference premium written

 

     Nine Months
Ended September 30,
     Year Ended
December 31,
 
In millions        2014              2013          2013      2012  
     (Unaudited)                

Reference Premium Written

   $ 277.9       $ 277.3       $ 357.4       $ 305.7   
  

 

 

    

 

 

    

 

 

    

 

 

 

Reference premium written for the nine months ended September 30, 2014 was $277.9 million compared to $277.3 million for the comparable period in 2013, an increase of $0.6 million. The increase was attributable to a $13.8 million increase in Guarantee Insurance reference premium written and the 2014 inception of new contracts with Scottsdale and certain other insurance carrier clients, which generated $10.8 million of reference premium written. This was partially offset by a decrease in reference premium written on behalf of Zurich of approximately $20.0 million as a result of Zurich reducing its volumes in California, where business covered by our initial program with Zurich was solely written. In September 2014, we entered into a second program with Zurich that further expands coverage in multiple other states. The increase was also partially offset by a decrease of $4.0 million associated with the termination of our contract with Ullico. Ullico was one of our insurance carrier clients from April 2009 until we terminated their contract effective March 26, 2012 in connection with their liquidation.

Reference premium written for the year ended December 31, 2013 was $357.4 million compared to $305.7 million for the year ended December 31, 2012, an increase of $51.7 million or approximately 17%. The increase was attributable to a $54.8 million increase in Guarantee Insurance reference premium written and a $51.2 million increase in reference premium written on behalf of Zurich. These increases were generally attributable to growth in our distribution force, expansion into additional geographic territories and generally the deployment of our initial program with Zurich. These increases were partially offset by a $54.4 million decrease associated with the termination of the Ullico contract.

 

 

 

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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 prospectus. For further information regarding our use of non-GAAP financial measures and a reconciliation of Adjusted EBITDA to Net income (loss), see “Summary—Summary Historical and Pro Forma Combined Financial Data.”

 

     Nine Months
Ended September 30,
    Year Ended
December 31,
 
In thousands    2014      2013     2013     2012  
     (Unaudited)        

Net income (loss)

   $ 12,807       $ (734   $ (6,186   $ 344   

Adjusted EBITDA

     17,334         5,049        6,606        2,181   
  

 

 

    

 

 

   

 

 

   

 

 

 

Net income increased by $13.5 million to $12.8 million for the nine months ended September 30, 2014 as compared to a net loss of $0.7 million in the same period in the prior year. Net loss for the year ended December 31, 2013 was $6.2 million compared to net income of $0.3 million for the year ended December 31, 2012, a decrease in net income of $6.5 million.

Adjusted EBITDA for the nine months ended September 30, 2014 was $17.3 million compared to $5.0 million for the comparable period in 2013, an increase of $12.3 million. The increase was principally attributable to a $20.4 million increase in total fee income and fee income from related party and a $0.5 million increase in net investment income, partially offset by a $8.6 million increase in total expenses (excluding depreciation and amortization and changes in fair value of warrant liabilities, which are added back to net income to arrive at Adjusted EBITDA), all of which are discussed more fully below.

Adjusted EBITDA for the year ended December 31, 2013 was $6.6 million compared to $2.2 million for the year ended December 31, 2012, an increase of $4.4 million. The increase was comprised of a $17.5 million increase in total fee income and fee income from related party, net of a $13.2 million increase in expenses (excluding depreciation and amortization and changes in fair value of warrant liabilities, which are added back to net income to arrive at Adjusted EBITDA), both of which are discussed more fully below.

Principal Components of Financial Statements

Revenue

We derive substantially all of our revenue from providing brokerage and policyholder services and claims administration services.

With respect to our brokerage and policyholder services, we earn service fees for underwriting and administering workers’ compensation insurance plans for insurance companies. Service fees are generally based on a percentage of estimated ultimate reference premiums written, meaning they are based on the full amount of a policy premium as it is booked by an insurance carrier client at the time the policy is issued, reduced by an allowance for estimated commission income that may be returned by us to the client due to estimated net reductions in estimated total premium for the term of the policy, principally associated with mid-term policy cancellations. With respect to our insurance carrier clients who record written premium as premium is collected, we recognize fee income as the premium is written and collected, reduced by an allowance for estimated commission income that may be returned by us to such

 

 

 

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clients due to net returns of premiums previously written and collected. In each case, we record the revenue effects of subsequent premium adjustments when such adjustments become known. We also earn service fees on a flat annual fee basis for establishing and administering segregated portfolio cell reinsurance arrangements for captive reinsurers that assume a portion of the underwriting risk from our insurance carrier clients.

With respect to our claims administration services, we earn service fees for administering workers’ compensation claims for insurance and reinsurance companies. Service fees are generally based on a percentage of reference premiums earned, meaning they are based on a portion of the full premium as it is considered earned by an insurance carrier client on a pro rata basis over the term of the policy. We also earn service fees for other services provided to insurance and reinsurance companies and to our other clients such as employers and local governments, which are based on an hourly rate, a percentage of premiums, percentage of subrogation recovered, percentage of savings or a fixed monthly fee, depending on the service. For example, service fees for telephonic nurse case management services on workers’ compensation claims for insurance and reinsurance companies are based on an hourly rate. Service fees for medical bill review services on workers’ compensation claims for insurance and reinsurance companies, based on either a percentage of savings or a flat fee per bill. We also earn service fees for administering workers’ compensation claims for state guarantee associations responsible for handling the claims of insolvent insurance companies based on a fixed amount per open claims per month.

Total fee income and fee income from related party is comprised of “fee income” and “fee income from related party.” A significant portion of our revenue is generated from service fees earned from a related party, Guarantee Insurance. “Fee income” represents fees earned from parties other than Guarantee Insurance, a related party. “Fee income from related party” represents fees earned from Guarantee Insurance. For brokerage and policyholder services, the distinction between fee income and fee income from related party is based on whether the services are performed for Guarantee Insurance or third party insurance carrier clients, regardless of whether any portion of the risk is subsequently transferred to another insurance company or a captive reinsurer.

For claims administration services, the portion of total fee income and fee income from related party that we classify as fee income is based on the net portion of claims expense retained by parties other than Guarantee Insurance. For example, if Guarantee Insurance transfers a portion of the risk under a policy it has written to a captive reinsurer, which is a non-related party, only the fee income from claims administration services associated with the portion retained by Guarantee Insurance is classified as fee income from related party. Likewise, if Zurich, a non-related party, transfers a portion of the risk under a policy it has written to Guarantee Insurance, only the fee income from claims administration services associated with the portion retained by Zurich is classified as fee income, while the fee income from claims administration services associated with the portion transferred to Guarantee Insurance is classified as fee income from related party.

In addition to service fee revenue, we also derive revenue from net investment income and net realized gains (losses) on investments from our investment portfolio, such as the net gain realized upon the redemption of the MCMC preferred equity in connection with the Patriot Care Management Acquisition.

 

 

 

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Expenses

Expenses consist primarily of

 

Ø   salaries and salary related expenses, including benefits;

 

Ø   commission expense to agencies that produce business in connection with our underwriting services;

 

Ø   management fees for administrative support services incurred by Guarantee Insurance Group (a related party) for our benefit, including executive management, human resources, accounting, information technology and legal services. The management fees charged to us by Guarantee Insurance Group were based on the amount of reference premium written by us for our third-party insurance carrier clients compared to the amount of reference premium written by Guarantee Insurance Group for the periods presented. Effective August 6, 2014, these support services expenses are being incurred directly by us, and from that date forward we no longer pay management fees to Guarantee Insurance Group;

 

Ø   outsourced services provided to us by third party-vendors, which include certain claims investigation and loss control expenses, principally incurred in connection with our workers’ compensation claims investigation, transportation and translation and legal and medical bill review services;

 

Ø   allocation of marketing, underwriting and policy issuance costs from Guarantee Insurance Group (a related party), representing the amount of marketing, underwriting and policy issuance expenses incurred by Guarantee Insurance Group for our benefit. The allocation costs charged to us by Guarantee Insurance Group were generally based on the amount of reference premium written by us for our third-party insurance carrier clients compared to the amount of reference premium written by Guarantee Insurance Group for the periods presented. Effective August 6, 2014, such costs are being incurred directly by us, and from that date forward Guarantee Insurance Group is no longer allocating these costs to us;

 

Ø   other operating expenses incurred in connection with our service offerings, consisting primarily of office rent, temporary labor costs, consulting fees and other expenses;

 

Ø   interest expense incurred on our outstanding indebtedness based on applicable interest rates during the relevant periods;

 

Ø   depreciation and amortization;

 

Ø   amortization of loan discounts and loan costs associated with loan agreements and of the estimated value of equity interests issued pursuant to loan agreements;

 

Ø   increases in fair value of equity interests for which the holders have a put option to us; and

 

Ø   provision for uncollectible fee income.

 

 

 

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Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

 

Results of Operations

The following tables set forth certain combined statement of operations data derived from our audited combined financial statements and our unaudited interim combined financial statements included elsewhere in this prospectus.

 

     Nine Months
Ended September 30,
    Year Ended
December 31,
 
In thousands    2014     2013     2013     2012  
                 (Unaudited)  

Combined Statement of Operations Data

        

Revenues

        

Fee income

   $ 37,896      $ 36,845      $ 46,486      $ 25,821   

Fee income from related party

     24,589        5,238        9,387        12,546   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total fee income and fee income from related party

     62,485        42,083        55,873        38,367   

Net investment income

     496        7        87        62   

Net realized gains (losses) on investments

     14,038        (50     (50     3   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total Revenues

     77,019        42,040        55,910        38,432   

Expenses

        

Salaries and salary related expenses

     17,907        12,097        15,985        13,189   

Commission expense

     9,491        6,651        8,765        3,216   

Management fees to related party for administrative support services

     5,390        9,200        12,139        8,007   

Outsourced services

     3,118        2,378        3,303        4,452   

Allocation of marketing, underwriting and policy issuance costs from related party

     1,872        3,449        4,687        2,774   

Other operating expenses

     7,701        3,247        4,557        4,587   

Interest expense

     5,427        606        1,174        299   

Depreciation and Amortization

     3,699        1,550        2,607        1,330   

Amortization of loan discounts and loan costs

     1,295        702        5,553        211   

Loss on exchange of units and warrants

     —          —          152        —     

Increase (decrease) in fair value of warrant redemption liability

     (2,257     300        —          —     

Provision for uncollectible fee income

     100        2,544        2,544        —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Total Expenses

     53,743        42,724        61,466        38,065   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net Income (Loss) Before Income Tax Expense

     23,276        (684     (5,556     367   

Income tax expense

     10,401        31        712        —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Net Income (Loss) Including Non-Controlling Interest in Subsidiary

     12,875        (715     (6,268     367   

Net income (loss) attributable to non-controlling interest in subsidiary

     68        19        (82     23   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net Income (Loss)

   $ 12,807      $ (734   $ (6,186   $ 344   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

 

 

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Nine Months Ended September 30, 2014 Compared to Nine Months Ended September 30, 2013

Revenues:

Total Fee Income and Fee Income from Related Party.    Total fee income and fee income from related party for the nine months ended September 30, 2014 was $62.5 million compared to $42.1 million for the nine months ended September 30, 2013, an increase of $20.4 million or approximately 48%. The increase was primarily due to an increase in fee income from related party.

For the nine months ended September 30, 2014, approximately 66% of our total fee income and fee income from related party was attributable to our contracts with Guarantee Insurance, a related party, and approximately 22% of our total fee income and fee income from related party was attributable to contracts with our second largest client.

For the nine months ended September 30, 2013, approximately 42% of our total fee income and fee income from related party was attributable to our contracts with Guarantee Insurance and approximately 37% and 17% of our total fee income and fee income from related party were attributable to our contracts with our second and third largest clients, respectively.

Fee income:    Fee income, which represents fee income from non-related parties, for the nine months ended September 30, 2014 was $37.9 million compared to $36.8 million for the nine months ended September 30, 2013, an increase of $1.1 million.

This increase was attributable to an increase in claims administration services fees as a result of $4.1 million of fee income earned by the Patriot Care Management Business from non-related parties from the date of acquisition of this service unit on August 6, 2014 to September 30, 2014, combined with a $1.4 million increase in fee income earned from the California Insurance Guaranty Association, which became a customer of ours in June 2014. The increase in claims administration services fees was largely offset by the decrease in brokerage and policyholder services fee income related to the decrease in reference premium written by us for Zurich, as described above under “—Key Performance Measures.”

Our prices by customer for our brokerage and policyholder services and claims administration services were unchanged for the nine months ended September 30, 2014 relative to the nine months ended September 30, 2013 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 nine months ended September 30, 2014 was $24.6 million compared to $5.2 million for the nine months ended September 30, 2013, an increase of $19.4 million.

The increase was principally attributable to $9.7 million of brokerage and policyholders services fee income from Guarantee Insurance earned from August 6, 2014 to September 30, 2014. On August 6, 2014 we entered into a new agreement with Guarantee Insurance to provide all of our brokerage and policyholder services to Guarantee Insurance, as described elsewhere in this prospectus, with no such contract existing previously during 2014 or 2013. The increase was also partly attributable to an increase

in brokerage and policyholder services fee income related to the increase in reference premium written by us for Guarantee Insurance, as described above under “—Key Performance Measures”, and to $2.1 million of claims administration services fee income earned by the Patriot Care Management Business from Guarantee Insurance from the date of acquisition of this service unit on August 6, 2014 to September 30, 2014.

 

 

 

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Our prices by customer for our brokerage and policyholder services and claims administration services were unchanged for the nine months ended September 30, 2014 relative to the nine months ended September 30, 2013 and, accordingly, the net increase in fee income from related party was solely related to changes in the volume of business we managed.

Net Investment Income.    Net investment income was $0.5 million for the nine months ended September 30, 2014 compared to zero for the nine months ended September 30, 2013, an increase of $0.5 million. Net investment income for the nine months ended September 30, 2014 was principally attributable to interest received in respect of a note receivable from Guarantee Insurance under the Surplus Note, which was retired in connection with the GUI Acquisition effective August 6, 2014. See “Unaudited Pro Forma Financial Information.”

Net realized gains (losses) on investments.    Net realized gains (losses) on investments was $14.0 million for the nine months ended September 30, 2014, compared to a loss of $0.1 million for the for the nine months ended September 30, 2013. The gain recorded in the nine months ended September 30, 2014 represents the net gain realized upon the redemption of the MCMC preferred equity in connection with the Patriot Care Management Acquisition.

Expenses:

Salaries and Salary Related Expenses.    Salaries and salary related expenses for the nine months ended September 30, 2014 were $17.9 million compared to $12.1 million for the nine months ended September 30, 2013, an increase of $5.8 million or approximately 48%.

This increase was principally due to additional salary and salary related costs recorded from August 6, 2014 the date on which we began to directly incur salary and salary related costs associated with our brokerage and policyholder services, as well as salary and salary related costs associated with administrative support services, including executive management, information technology, accounting, human resources and legal services. Previously, we received an allocation for such brokerage and policyholder services costs from Guarantee Insurance Group as described 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, as described elsewhere in this prospectus. In addition, effective August 6, 2014, we acquired the Patriot Care Management Business, which has notably increased our workforce. Accordingly, we expect further significant increases in salaries and salary related costs going forward.

Additionally, the increase was in part due to an increase in the size of our claims administration services staff in connection with efforts by us to perform more claims investigation work in-house rather than through outsourced vendors.

Commission Expense.    Commission expense for the nine months ended September 30, 2014 was $9.5 million compared to $6.7 million for the nine months ended September 30, 2013, an increase of $2.8 million or 43%. This increase is principally due to our assumption of the obligation to pay commissions to retail agencies producing Guarantee Insurance policies from August 6, 2014 pursuant to the new agreement with Guarantee Insurance to provide all of our brokerage and policyholder services to Guarantee Insurance, as described elsewhere in this prospectus. We did not incur such commission

 

 

 

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expense for the nine months ended September 30, 2013. Additionally, we incurred additional commission expense for the nine months ended September 30, 2014 in connection with new contracts we entered into in 2014 with Scottsdale and certain other insurance clients, as described above.

This increase was partially offset by a decrease in commission expense associated with premium produced for Zurich, as described above.

Management Fees to Related Party for Administrative Support Services.    Management fees to related party for administrative support services for the nine months ended September 30, 2014 were $5.4 million compared to $9.2 million for the nine months ended September 30, 2013, a decrease of $3.8 million or 41%. This decrease was in part attributable to a decrease in the proportion of reference

premium written by us for our third-party insurance carrier clients relative to reference premium written by Guarantee Insurance (which, as discussed above, generally served as the basis for calculating the management fees).

As described above, in connection with the GUI Acquisition effective August 6, 2014, the management services agreement pursuant to which these fees were payable was terminated and all costs associated with our operations began to be incurred directly by us. Accordingly, beginning August 6, 2014, such expenses, rather than being reflected in this item, are recorded in the line items to which they relate, which are primarily “salaries and salary related expenses,” “outsourced services” and “other operating expenses.”

Outsourced Services.    Outsourced services for the nine months ended September 30, 2014 were $3.1 million compared to $2.4 million for the nine months ended September 30, 2013, an increase of $0.7 million or 31%. The increase was principally attributable to outsourced services costs incurred by the Patriot Care Management Business from August 6, 2014 (the date of our acquisition of the Patriot Care Management Business) to September 30, 2014. We did not own the Patriot Care Management Business for the nine months ended September 30, 2013 and, accordingly no such costs were incurred for that period.

Allocation of Marketing, Underwriting and Policy Issuance Costs from Related Party.    Allocation of marketing, underwriting and policy issuance costs from Guarantee Insurance Group, a related party, for the nine months ended September 30, 2014 was $1.9 million compared to $3.4 million for the nine months ended September 30, 2013, a decrease of $1.5 million or 46%. This decrease was in part attributable to a decrease in the proportion of reference premium produced by us relative to reference premium produced by Guarantee Insurance (which, as discussed above, generally served as the basis for the allocation).

As described above, in connection with the GUI Acquisition effective August 6, 2014, the cost sharing agreement pursuant to which these costs were incurred was terminated and all brokerage and policyholder services costs associated with our operations began to be incurred directly by us. Accordingly, beginning August 6, 2014, such expenses, rather than being reflected in this item, are recorded in the line items to which they relate, which are primarily “salaries and salary related expenses,” “outsourced services” and “other operating expenses.”

Other Operating Expenses.    Other operating expenses for the nine months ended September 30, 2014 were $7.7 million compared to $3.2 million for the nine months ended September 30, 2013, an increase of $4.5 million. This increase was principally due to the fact that from August 6, 2014, we directly incurred other operating expenses which were previously allocated to us from Guarantee Insurance Group or incurred in the form of a management fee paid to Guarantee Insurance Group as described under “—Salaries and Salary Related Expenses” above.

 

 

 

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Additionally, the increase is due to additional other operating expenses incurred from August 6, 2014 and associated with the operations of the Patriot Care Management Business. We did not own the Patriot Care Management Business during the nine months ended September 30, 2013 and, accordingly, we did not record any such other operating expenses for it for that period. The increase was also partially attributable to an increase in consulting and temporary labor costs incurred in connection with an increase in workload in respect of claims administration services.

We expect that other operating expenses will further increase going forward as a result of the new arrangements in respect of costs associated with both brokerage and policyholder services and administrative support services, as described under “—Salaries and Salary Related Expenses” above.

Interest Expense.    Interest expense for the nine months ended September 30, 2014 was $5.4 million compared to $0.6 million for the nine months ended September 30, 2013, an increase of $4.8 million.

Interest expense for the nine months ended September 30, 2014, is comprised of interest accruing under (i) the Initial Tranche of the PennantPark Loan Agreement entered into on November 27, 2013 in connection with the Reorganization, (ii) the Additional Tranche of the PennantPark Loan Agreement, as amended, entered into on August 6, 2014 in connection with the GUI Acquisition and (iii) the UBS Credit Agreement entered into on August 6, 2014 in connection with the Patriot Care Management Acquisition, all described elsewhere in this prospectus.

Interest expense for the nine months ended September 30, 2013, reflects $0.6 million of interest in connection with a loan agreement for $10.0 million entered into on October 9, 2012 with Advantage Capital. On November 27, 2013, this loan was repaid in full with a portion of the proceeds of the Initial Tranche of the PennantPark Loan Agreement. See “Certain Relationships and Related Party Transactions—Financing Transactions.”

Depreciation and Amortization.    Depreciation and amortization for the nine months ended September 30, 2014 was $3.7 million compared to $1.6 million for the nine months ended September 30, 2013, an increase of $2.1 million. The increase was attributable mainly to an increase in depreciation related to capitalized policy and claims administration system development costs which we incurred principally in the second half of 2013 and first half of 2014 principally in connection with our WCE platform and, to a lesser extent, intangible asset amortization relating to the Patriot Care Management Business for the period August 6, 2014 to September 30, 2014.

Amortization of Loan Discounts and Loan Costs.    Amortization of loan discounts and loan costs was $1.3 million for the nine months ended September 30, 2014 compared to $0.7 million for the nine months ended September 30, 2013, an increase of $0.6 million. The increase was attributable to an increase in amortization of loan costs related to the Initial Tranche of the PennantPark Loan Agreement entered into on November 27, 2013 and the Additional Tranche of the PennantPark Loan Agreement and the UBS Credit Agreement, each entered into on August 6, 2014 as described above.

Increase (Decrease) in Fair Value of Warrant Redemption Liability.    The increase (decrease) in fair value of warrant redemption liability was $(2.3) million for the nine months ended September 30, 2014 compared to $0.3 million for the nine months ended September 30, 2013, a decrease of $2.6 million, which represents the change in estimated fair value of the detachable common stock warrants issued to the lenders in connection with the Initial Tranche and Additional Tranche of the PennantPark Loan Agreement and the common stock issued to Advantage Capital pursuant to their September 30, 2014 exercise of common stock warrants as described elsewhere in this prospectus. We recorded this liability, and reflect the changes in the estimated fair value thereof, since the warrant holders and stockholders

 

 

 

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may at specified times require us to redeem the stock or the warrants for cash, in an amount equal to, in the case of stock, the estimated fair value of the stock or, in the case of warrants, the estimated fair value of the warrants less the total exercise price of the redeemed warrants.

Provision for Uncollectible Fee Income.    For the nine months ended September 30, 2014, we recorded a $0.1 million provision for uncollectible fee income. For the nine months ended September 30, 2013, we recorded a provision for uncollectible fee income related to our claims administration services, of $2.5 million in connection with the liquidation of Ullico in May 2013. Ullico was one of our insurance carrier clients from April 2009 until we terminated their contract effective March 26, 2012 in connection with their liquidation.

Income Tax Expense.    Income tax expense was $10.4 million for the nine months ended September 30, 2014 compared to no income tax expense for the nine months ended September 30, 2013, an increase in income tax expense of $10.4 million. Income tax expense for the nine months ended September 30, 2014 and 2013 was principally comprised of federal income tax expense at a statutory federal rate of 34% and state income tax expense, plus the tax expense associated with (i) the gain on redemption of MCMC preferred equity attributable to the difference between tax basis and book basis and (ii) non-deductible expenses incurred in connection with the acquisition of PCM, less the tax benefit associated with the decrease in fair value of warrant redemption liability for the nine months ended September 30, 2014. Prior to November 27, 2013, certain of our subsidiaries were S Corporations or limited liability companies, electing to be taxed as pass through entities and, accordingly, we did not recognize a federal or state income tax provision for these subsidiaries for the nine months ended September 30, 2013.

Although our financial statements include the revenues and expenses associated with the GUI contracts and certain other assets and liabilities assumed in the GUI Acquisition, Guarantee Insurance Group will include these revenues and expenses in its consolidated federal income tax return for the period from January 1, 2014 to August 6, 2014 (the effective date of the GUI Acquisition) and has included the revenues and expenses associated with the GUI contracts and certain other assets and liabilities assumed in its consolidated federal income tax return for the year ended December 31, 2013.

Accordingly, we recognized a $0.0 million decrease in valuation allowance, which was equal to 100% of the deferred tax expense attributable to the GUI contracts for the nine months ended September 30, 2014 and a $1.9 million increase in valuation allowance equal to 100% of the deferred tax benefit attributable to the GUI contracts for the nine months ended September 30, 2013.

Net Income (loss)

As a result of the factors described above, net income (loss) increased by $13.5 million to $12.8 million for the nine months ended September 30, 2014 as compared to $(0.7) million for the same period in the prior year.

Year Ended December 31, 2013 Compared to Year Ended December 31, 2012

Total Fee Income and Fee Income from Related Party.    Total fee income and fee income from related party for the year ended December 31, 2013 was $55.9 million compared to $38.4 million for the comparable period in 2012, an increase of $17.5 million or approximately 46%. The increase was principally due to an increase in fee income.

For the year ended December 31, 2013, approximately 44% of our total fee income and fee income from related party was attributable to our contracts with Guarantee Insurance, a related party, and approximately 38% and 12% of our total fee income and fee income from related party were attributable to contracts with our second and third largest clients, respectively.

 

 

 

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For the year ended December 31, 2012, approximately 42% of our total fee income and fee income from related party was attributable to our contracts with Guarantee Insurance and approximately 35% and 21% of our total fee income and fee income from related party were attributable to our contracts with our second and third largest clients, respectively.

Fee income.    Fee income, which represents fee income from non-related parties, for the year ended December 31, 2013 was $46.5 million compared to $25.8 million for the year ended December 31, 2012, an increase of $20.7 million or approximately 80%.

This increase was partly attributable to an increase in brokerage and policyholder services fee income as a result of the growth in reference premiums written by us for Zurich, as described above.

This increase was also partly due to higher claims administration services fee income, for the most part attributable to a decrease by Guarantee Insurance of the portion of claims expense retained on its business (resulting in corresponding claims administration services revenue being classified as fee income rather than fee income from related party), combined with an increase in managed claims exposures as a result of the increase in reference premiums written by us for Zurich, as described above, but partially offset by a decrease in managed claims exposures resulting from the termination the Ullico contract, as described above.

Our prices by customer for brokerage, and policyholder services and claims administration services were unchanged for the year ended December 31, 2013 relative to the year ended December 31, 2012 and, accordingly, the net increase in fee income from related party was solely related to changes in the volume of business we managed.

Fee income from related party.    Fee income from related party for the year ended December 31, 2013 was $9.4 million compared to $12.5 million for the year ended December 31, 2012, a decrease of $3.1 million or approximately 25%.

We did not record any brokerage and policyholder services fee income from related party for the years ended December 31, 2013 and 2012, as described above. Following the GUI Acquisition, we entered into a new agreement with Guarantee Insurance effective August 6, 2014 to provide marketing, underwriting and policyholder services. Accordingly, we expect a significant increase in brokerage and policyholder services fee income from related party going forward.

The decrease in fee income from related party is therefore entirely attributable to lower claims administration fee income from related party principally due to the decrease by Guarantee Insurance of the portion of claims expense retained on its business (resulting in corresponding claims administration services revenue being classified as fee income rather than fee income from related party), partially offset by an increase in managed exposures related to the growth in reference premiums written by Guarantee Insurance, as described above.

Our prices by customer for brokerage, underwriting and policyholder services and claims administration services were unchanged for the year ended December 31, 2013 relative to the year ended December 31, 2012 and, accordingly, the net increase in fee income was solely related to changes in the volume of business we managed.

Net Investment Income.    We recorded immaterial amounts of net investment income for the year ended December 31, 2013 and 2012.

 

 

 

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Expenses:

Salaries and Salary Related Expenses.    Salaries and salary related expenses for the year ended December 31, 2013 was $16.0 million compared to $13.2 million for the year ended December 31, 2012, an increase of $2.8 million or approximately 21%. This principally reflects an increase in the size of our claims administration services staff associated with the increase in managed claims exposures as a result of the growth in reference premiums written by Guarantee Insurance and by us for Zurich, as described above. To a lesser degree, the increase was also attributable to efforts by us to perform more claims investigation work in-house rather than through outsourced vendors. These factors were partially offset by a decrease in managed claims exposures resulting from the termination the Ullico contract, as described above.

Commission Expense.    Commission expense for the year ended December 31, 2013 was $8.8 million compared to $3.2 million for year ended December 31, 2012, an increase of $5.5 million. The increase was attributable to an increase in commission expense associated with premium produced for Zurich, as described above.

Management fees to related party for Administrative Support Services.    Management fees to related party for administrative support services for the year ended December 31, 2013 were $12.1 million compared to $8.0 million for the year ended December 31, 2012, an increase of $4.1 million or approximately 51%. The increase was attributable to an increase in the proportion of reference premium written by us for our third-party insurance carrier clients relative to reference premium written by Guarantee Insurance (which, as discussed above, generally served as the basis for calculating the management fees), partially offset by a decrease in total administrative support services incurred by Guarantee Insurance Group for the benefit of both Guarantee Insurance and us.

Outsourced Services.    Outsourced services for the year ended December 31, 2013, were $3.3 million compared to $4.5 million for the year ended December 31, 2012, a decrease of $1.1 million or approximately 26%. The decrease was principally attributable to lower outsourcing costs as a result of efforts by us to perform more claims investigation work in-house rather than through outsourced vendors.

Allocation of Marketing, Underwriting and Policy Issuance Costs from Related Party.    Allocation of marketing, underwriting and policy issuance costs from Guarantee Insurance Group, a related party, for the year ended December 31, 2013 was $4.7 million compared to $2.8 million for the year ended December 31, 2012, an increase of $1.9 million or approximately 69%. The increase was attributable to an increase in the proportion of reference premium produced by us relative to reference premium produced by Guarantee Insurance (which, as discussed above, generally served as the basis for the allocation).

 

Other Operating Expenses.    Other operating expenses were $4.6 million for both the year ended December 31, 2013 and 2012.

Interest Expense.    Interest expense for the year ended December 31, 2013, was $1.2 million compared to $0.3 million for the year ended December 31, 2012, an increase of $0.9 million.

Interest expense for the year ended December 31, 2013, is comprised of $0.4 million of interest accruing under the Initial Tranche of the PennantPark Loan Agreement entered into on November 27, 2013 in connection with the Reorganization and in $0.8 million of interest connection with a loan agreement for $10.0 million entered into on October 9, 2012 with Advantage Capital.

Interest expense for the year ended December 31, 2012 reflects $0.2 million of interest in connection with the $10.0 million Advantage Capital loan and $0.1 million of interest on a loan from our largest

 

 

 

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shareholder, as described in “Certain Relationships and Related Party Transactions—Loan Arrangements.” On November 27, 2013, the $10.0 million Advantage Capital loan was repaid in full with a portion of the proceeds of the Initial Tranche of the PennantPark Loan Agreement.

Depreciation and Amortization.    Depreciation and amortization for the year ended December 31, 2013, was $2.6 million compared to $1.3 million for the year ended December 31, 2012, an increase of $1.3 million or approximately 100%. The increase was attributable to an increase in depreciation related to capitalized policy and claims administration system development costs in connection with the WCE system, which we incurred principally in the second half of 2013.

Amortization of Loan Discounts and Loan Costs.    Amortization of loan discounts and loan costs was $5.6 million for the year ended December 31, 2013 compared to $0.2 million for the year ended December 31, 2012, an increase of $5.4 million.

Amortization of loan discounts for the year ended December 31, 2013 principally represents amortization of the balance of the discount on the debt associated with the Advantage Capital loan agreement entered into on October 9, 2012, upon the repayment of the loan in full on November 27, 2013. See “Certain Relationships and Related Party Transactions—Financing Transactions.” Amortization of loan discounts for the year ended December 31, 2012, represents amortization of the discount on the debt associated with the Advantage Capital loan agreement entered into on October 9, 2012, as described above.

Amortization of loan costs for the year ended December 31, 2013 was attributable to the Initial Tranche of the PennantPark Loan Agreement. We incurred no material loan costs for the year ended December 31, 2012.

Loss on Change in Fair Value of Warrants.    We recorded a loss on change in fair value of warrants of $0.2 million for the year ended December 31, 2013, attributable to the fact that in connection with the Reorganization, Advantage Capital, one of our prior lenders, exchanged common units and detachable common stock warrants issued by certain of our subsidiaries for detachable common stock warrants of ours, which had a higher value.

Provision for Uncollectible Fee income.    For the year ended December 31, 2013, we recorded a provision for uncollectible fee income of $2.5 million in connection with the liquidation of Ullico in May 2013. Ullico was one of our insurance carrier clients from April 2009 until we terminated the contract effective March 26, 2012. For the year ended December 31, 2012, we determined that no provision for uncollectible fee income was required.

Income Tax Expense.    Income tax expense for the year ended December 31, 2013 was $0.7 million. We did not recognize income tax expense or benefit for the year ended December 31, 2012. Income tax expense (benefit) for the years ended December 31, 2013 and 2012 was principally comprised of federal income tax benefit at a statutory federal rate of 34% and state income tax benefit, excluding the income tax benefit related to the amortization of loan discounts. Prior to November 27, 2013, certain subsidiaries were S Corporations or limited liability companies, electing to be taxed as pass through entities and, accordingly, we did not recognize a federal or state income tax provision for these subsidiaries for the period from January 1, 2013 to November 27, 2013 or for the year ended December 31, 2012.

Although our financial statements include the revenues and expenses associated with the GUI contracts and certain other assets and liabilities assumed in the GUI Acquisition, Guarantee Insurance Group has

 

 

 

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included these revenues and expenses in its consolidated federal income tax returns for the years ended December 31, 2013 and 2012 and, accordingly, we recognized a $2.7 million and $1.7 million increase in valuation allowance, respectively, equal to 100% of the deferred tax benefit attributable to the GUI contracts for the years ended December 31, 2013 and 2012.

Net loss

As a result of the factors described above, net loss for the year ended December 31, 2013 was $6.2 million compared to net income of $0.3 million for the year ended December 31, 2012, a decrease in net income of $6.5 million.

SEASONALITY

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 in 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, as well as potential redemption of detachable common stock warrants. Our primary sources of liquidity include cash flows from operations and available cash and cash equivalents. In addition, we intend to enter into a new senior secured credit facility as an additional source of liquidity. See “—Indebtedness—Senior Secured Credit Facility.”

We believe that our cash flow from operations, available cash and cash equivalents and the proceeds from this offering will be sufficient to meet our liquidity needs for the foreseeable future. As of September 30, 2014, our unrestricted cash and cash equivalents were $8.0 million. In addition, as of September 30, 2014, we had $5.1 million of restricted cash, which are funds we receive from our insurance carrier clients and that are earmarked exclusively for payments of claims on behalf of such clients. We cannot use such funds 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, the new 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.

 

 

 

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Operating Activities

Nine Months Ended September 30, 2014 Compared to Nine Months Ended September 30, 2013

Net cash provided by operating activities for the nine months ended September 30, 2014 was $15.5 million compared to $10.8 million for the nine months ended September 30, 2013, an increase of $4.7 million or 44%. This increase was attributable to a $16.9 million increase in certain liabilities, principally income taxes payable and accounts payable, accrued expenses and other liabilities, partially offset by a $9.5 million decrease in net income (after adjusting for non-cash income and expense items) and a $2.7 million increase in certain assets, principally fee income receivable from related party.

Year Ended December 31, 2013 Compared to Year Ended December 31, 2012

Net cash provided by operating activities for the year ended December 31, 2013 was $6.0 million compared to $11.4 million for the year ended December 31, 2012, a decrease of $5.4 million. This decrease was principally attributable to a $5.1 million decrease in certain liabilities, principally net payables to related parties and deferred claims administration services income and a $2.3 million decrease in certain other assets, partially offset by a $2.0 million increase in net income (after adjusting for non-cash income and expense items).

Investing Activities

Nine Months Ended September 30, 2014 Compared to Nine Months Ended September 30, 2013

Net cash used in investing activities for the nine months ended September 30, 2014 was $54.2 million compared to $5.8 million for the nine months ended September 30, 2013, an increase of $48.4 million. The increase was principally attributable to $52.7 million of cash used for the PCM Acquisition, as described elsewhere in this prospectus.

Year Ended December 31, 2013 Compared to Year Ended December 31, 2012

Net cash used in investing activities for the year ended December 31, 2013 was $28.8 million compared to $3.5 million for the year ended December 31, 2012, an increase of $25.3 million. The increase was principally attributable to a $28.3 million decrease in note receivable from related party, partially offset by a $4.8 million increase in restricted cash.

Financing Activities

Nine Months Ended September 30, 2014 Compared to Nine Months Ended September 30, 2013

Net cash provided by (used in) financing activities for the nine months ended September 30, 2014 was $45.1 million compared to $(5.1) million for the nine months ended September 30, 2013, an increase of $50.2 million. The increase was principally attributable to $55.3 million of net proceeds from borrowings under the UBS Credit Agreement in connection with the acquisition of PCM as described elsewhere in this prospectus, and a $4.9 million decrease in distributions to members and dividends to common stockholders during the nine months ended September 30, 2014. This was partially offset by $6.7 million in repayment of outstanding borrowings and a $3.2 million increase in payment of loan fees for the nine months ended September 30, 2014 for the nine months ended September 30, 2013.

Year Ended December 31, 2013 Compared to Year Ended December 31, 2012

Net cash provided by (used in) financing activities for the year ended December 31, 2013 was $22.7 million compared to ($4.6) million for the year ended December 31, 2012, an increase of $27.3

 

 

 

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million. The increase was principally attributable to the receipt of the net proceeds from the Initial Tranche of the PennantPark Loan Agreement combined with a $9.0 million decrease in the payment of stockholder and unitholder distributions. These factors were partially offset by the $10.0 million repayment of debt.

Capital Expenditures

For the nine months ended September 30, 2014 and 2013, GUI made capital expenditures of $0.3 million and $2.6 million, respectively, for policy and claims administration system development costs, principally in connection with our WCE platform. For the years ended December 31, 2013 and 2012, GUI made capital expenditures of $6.1 million and $6.7 million for policy and claims administration system development costs, principally in connection with our WCE platform.

Our balance sheet as of September 30, 2014 includes balances attributable to these capital expenditures, which we acquired from GUI effective August 6, 2014. Our balance sheets as of December 31, 2013 and 2012 do not include balances attributable to these capital expenditures. However, amortization associated with these capital expenditures is included in our operating results for the nine months ended September 30, 2014 and 2013 and the years ended December 31, 2013 and 2012. Our WCE policy and claims administration system was placed into production in August 2013. Although we expect to make additional capital expenditures related to the development of additional features and functionality related to our WCE policy and claims administration system, we do not anticipate such further costs to be significant.

Indebtedness

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 provides for a five-year term loan facility in an aggregate principal amount of $57.0 million that will mature on August 6, 2019. The loan is secured by the common stock of PCM and guaranteed by Guarantee Insurance Group and its wholly owned subsidiaries.

Our borrowings under the UBS Credit Agreement bear 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 nine months ended September 30, 2014 was 10.0%.

As of September 30, 2014, we were in compliance with the covenants contained in the UBS Credit Agreement. We intend to use a portion of the net proceeds of this offering, together with the anticipated borrowings under the senior secured facility or cash on hand, to prepay in full the borrowings outstanding under the UBS Credit Agreement as required thereunder, including accrued interest and applicable prepayment premium. See “Use of Proceeds.”

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, which amended and restated

 

 

 

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the First Lien Term Loan Agreement, dated as of November 27, 2013 (the “Existing Loan Agreement”), by increasing the aggregate principal amount of the term loans under the Existing Loan Agreement to approximately $68.6 million.

Borrowings under the PennantPark Loan Agreement are comprised of (i) the Initial Tranche in an aggregate principal amount of approximately $37.8 million, which represents the unpaid portion of the original principal amount of $42.0 million under the Existing Loan Agreement and (ii) the 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 bear 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 nine months ended September 30, 2014 was 12.5%.

All obligations under the PennantPark Loan Agreement are guaranteed by certain of our subsidiaries as well as several affiliated entities, including GUI, and are generally secured by the tangible and intangible property of the borrowers and the guarantors. In addition, the PennantPark Loan Agreement includes certain covenants that, among other things, 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 the borrowers to maintain certain financial covenants. 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.

As of September 30, 2014, we were in compliance with the covenants contained in the PennantPark Loan Agreement. We intend to use a portion of the net proceeds of this offering to prepay in full the borrowings outstanding under the PennantPark Loan Agreement, including accrued interest and applicable prepayment premium. See “Use of Proceeds.”

Proposed Senior Secured Credit Facility

In connection with this offering, we expect to enter into a new senior secured credit facility in the aggregate principal amount of up to $80.0 million, comprised of a $40.0 million revolving credit facility and a $40.0 million term loan facility, with BMO Harris Bank N.A., an affiliate of BMO Capital Markets Corp., as administrative agent. The senior secured credit facility is expected to have a maturity of five years, and borrowings thereunder will 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 is expected to include 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 revolving credit facility or the term loan facility by an aggregate amount of up to $20.0 million, but in a minimum amount of $5.0 million.

In addition to paying interest on outstanding principal under the senior secured credit facility, we are expected to be 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 expected 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.

 

 

 

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The term loan facility is expected to amortize 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 expected to be 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 expected to be guaranteed by all of our existing and future subsidiaries and to be secured by a first-priority perfected security interest in substantially all of our and our 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 is expected to contain 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 plus income tax expense plus capital expenditures plus regularly scheduled principal payments of debt for the same period of a least 150% for the most recently-ended four quarters. We expect that the senior secured credit facility will contain 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 is also expected to have 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 amount to be agreed upon; (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.

OFF-BALANCE SHEET OBLIGATIONS

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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CONTRACTUAL OBLIGATIONS AND COMMITMENTS

The table below provides information with respect to our long-term debt and contractual commitments as of December 31, 2013, giving pro forma effect to the Acquisitions:

 

     Payment Due by Period  
In thousands    Total      Less Than
1 Year
     1-3 Years      3-5 Years      More Than
5 Years
 

Debt obligations(1)

   $ 55,780       $ 13,256       $ 23,362       $ 19,162       $ —     

Operating lease obligations(2)

     11,240         2,928         4,974         2,473         865   

Capital lease obligation(3)

     7,211         2,473         4,738         —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
   $ 74,231       $ 18,657       $ 33,074       $ 21,635       $ 865   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1)   Reflects principal and interest on borrowings under the Initial Tranche of the Pennant Park Loan Agreement. Does not reflect borrowings under the Additional Tranche of the PennantPark Loan Agreement and the UBS Credit Agreement incurred on August 6, 2014. In addition, does not reflect warrant redemption liabilities. We intend to repay all borrowings under the PennantPark Loan and the UBS Credit Agreement with the proceeds of this offering.

Does not reflect the senior secured credit facility, which we intend to enter into in connection with this offering. The closing of this offering is not conditioned upon entry into the senior secured credit facility. See “—Liquidity and Capital Resources—Indebtedness—Senior Secured Credit Facility.”.

 

(2)   Reflects lease obligations in respect of our head office and regional offices, certain of which have been assigned to us by Guarantee Insurance Group effective August 6, 2014.

 

(3)   Reflects capital lease obligations assumed from GUI effective August 6, 2014.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES AND RECENTLY ISSUED FINANCIAL ACCOUNTING STANDARDS

Significant Accounting Policies

Use of Estimates

The preparation of financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Such estimates and assumptions could change in the future as more information becomes known and such changes could impact the amounts reported and disclosed herein. Adjustments related to changes in estimates are reflected in our results of operations in the period in which those estimates changed.

Significant estimates inherent in the preparation of our combined financial statements include useful lives and impairments of long-lived tangible and intangible assets, accounting for income taxes and related uncertain tax positions, the valuation of warrant liabilities and accounting for business combinations.

Revenue Recognition

Brokerage and Policyholder Services.    We generate fee income for underwriting and servicing workers’ compensation insurance policies for insurance companies, based on a percentage of premiums each writes

 

 

 

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for its customers. Brokerage and policyholder services are, in all material respects, provided prior to the issuance or renewal of the related policy. For insurance carrier clients who record written premium on the effective date of the policy based on the estimated total premium for the term of the policy, we recognize fee income on the effective date of the related insurance policy reduced by an allowance for estimated commission income that may be returned by us to such clients due to estimated net reduction in estimated total premium for the term of the policy, principally associated with mid-term policy cancellations. For insurance carrier clients who record written premium as premium is collected, we recognize fee income as the premium is collected, reduced by an allowance for estimated commission income that may be returned by us to such clients due to net returns of premiums previously written and collected. In each case, we record the revenue effects of subsequent premium adjustments when such adjustments become known.

Prior to August 6, 2014, our brokerage and policyholder services revenue was derived solely from (1) insurance carrier clients other than Guarantee Insurance, all of which record written premium as premium is collected and (2) Guarantee Insurance under a producer agreement for workers’ compensation policies described below.

We have also historically recorded fee income for soliciting applications for workers’ compensation policies for Guarantee Insurance, a related party, pursuant to a producer agreement between GUI and Guarantee Insurance that we acquired as part of the GUI Acquisition, based on a percentage of premiums procured. The producer agreement provided that the percentage may be amended from time to time upon the mutual consent of the parties. For the years ended December 31, 2013 and 2012, the fees based on a percentage of premium were waived in their entirety and for the year ended December 31, 2012, fees of approximately $0.4 million were agreed. This agreement was terminated effective August 6, 2014.

Generally, as a historical matter, the policies we produced for our insurance carrier clients other than Guarantee Insurance featured payment plans spread across the terms of the respective policies. Because we record brokerage and policyholder services revenue on this business as premium is collected, the commission income we estimate that may be returned by us to such clients due to estimated net reductions in total premium for the term of the policy, principally associated with mid-term policy cancellations, was nominal. Accordingly, we did not maintain an allowance for estimated return commission income on business produced by us for insurance carrier clients other than Guarantee Insurance prior to August 6, 2014.

Additionally, upon termination of our producer agreement with Guarantee Insurance, we and Guarantee Insurance agreed that there would be no further adjustments to commission income associated with changes in total premium for the term of the policy. Accordingly, we did not maintain an allowance for estimated return commission income pursuant to our producer agreement with Guarantee Insurance.

Following the GUI Acquisition, we entered into a new agreement with Guarantee Insurance effective August 6, 2014 to provide marketing, underwriting and policyholder services. Guarantee Insurance records written premium on the effective date of the policy based on the estimated total premium for the term of the policy. Accordingly, for the period from August 6, 2014 to September 30, 2014, we recorded an allowance for estimated return commission income of approximately $850,000. We expect a significant increase in brokerage and policyholder services fee income from Guarantee Insurance going forward.

We also generate fee income for establishing and administering segregated portfolio cell reinsurance arrangements for reinsurers that assume a portion of the underwriting risk from our insurance carrier clients, based on a flat annual fee which is recognize as revenue on a pro rata basis.

 

 

 

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Claims Administrative Services.    We generate fee income for administering workers’ compensation claims for insurance and reinsurance companies, generally based on a percentage of earned premiums, grossed up for large deductible credits. We recognize this revenue over the period of time we are obligated to administer the claims as the underlying claims administration services are provided. For certain insurance and reinsurance carrier clients, the fee, which is based on a percentage of earned premiums grossed up for large deductible credits, represents consideration for our obligation to administer claims for a period of 24 months from the date of the first report of injury. For claims open longer than 24 months from the date of the first report of injury for these clients, we generate fee income for continuing to administer the claims, if so elected by the client, based on a fixed monthly fee which is recognized when earned. For certain other insurance and reinsurance clients, we have an obligation to administer the claims through their duration. We also generate fee income from non-related parties for administering workers’ compensation claims for state associations responsible for handling the claims of insolvent insurance companies based on a fixed amount per open claims per month.

We generate fee income for services for insurance and reinsurance companies and other clients, including (i) claims investigative services, generally based on an hourly rate, (ii) loss control management services, based on a percentage of premium, (iii) workers’ compensation claimant transportation and translation services, generally based on an hourly rate, (iv) workers’ compensation claims subrogation services, based on a percentage of subrogation recovered on the date of recovery, (v) workers’ compensation claims legal bill review, based on a percentage of savings on the date that savings are established and (vi) certain other services, based on a fixed monthly fee. We generate fee income for negotiating and settling liens placed by medical providers on workers’ compensation claims for insurance and reinsurance companies and other clients, based on a percentage of savings resulting from the settlement of the lien. We recognize revenue from claims investigations, loss control service administration, claimant transportation and translation, claims subrogation services, workers’ compensation claims lien negotiations and reinsurance management services in the period that the services are provided.

Fee income from related party represents fee income earned from Guarantee Insurance on brokerage and policyholder services and on claims administration services.

Fee income earned from Guarantee Insurance for brokerage and policyholder services historically represents fees for soliciting applications for workers’ compensation insurance for Guarantee Insurance pursuant to a prior producer agreement that we acquired as part of the GUI Acquisition, based on a percentage of premiums written or other amounts negotiated by the parties. This agreement was terminated effective August 6, 2014. Following the GUI Acquisition, we entered into a new agreement with Guarantee Insurance effective August 6, 2014 to provide all of our brokerage and policyholder services. Accordingly, we expect further significant increases in fee income from related party going forward.

Fee income earned 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, our third party insurance carrier clients and the segregated portfolio cell reinsurers that assume business written by Guarantee Insurance and such third party carriers. Certain fee income earned from segregated portfolio cell reinsurers is remitted to us by Guarantee Insurance on behalf of the segregated portfolio cell reinsurers.

The allocation of marketing, underwriting and policy issuance costs from related party in our combined statements of operations represents costs reimbursed to Guarantee Insurance Group for rent and certain corporate administrative services. Management fees paid to related party for administrative support services in our combined statements of operations represent amounts paid to Guarantee Insurance Group for management oversight, legal, accounting, human resources and technology support services.

 

 

 

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Restricted Cash

Restricted cash is comprised of amounts received from our clients to be used exclusively for the payment of claims on behalf of such clients.

Fixed Assets and Other Long Term Assets

Fixed assets are stated at cost, less accumulated depreciation. Expenditures for furniture and fixtures and computer equipment are capitalized and depreciated on a straight-line basis over a three-year estimated useful life. Expenditures for leasehold improvements on office space and facilities leased by Guarantee Insurance Group but utilized by us are capitalized and amortized on a straight-line basis over the term of Guarantee Insurance Group’s lease.

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 amortized on a straight line basis over a five-year estimated useful life.

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 September 30, 2014 or December 31, 2013.

Commission Expense

Commission expense represents consideration paid by us to insurance agencies for producing business. Services provided by insurance agencies are, in all material respects, provided prior to the issuance or renewal of an insurance policy. With respect to business written for insurance carrier clients who record written premium on the effective date of the policy, we record commission expense on the effective date of the policy based on the estimated total premium for the term of the policy, reduced by an allowance for estimated commission expense that may be returned by the insurance agencies to us due to net reductions in estimated total premium for the term of the policy, principally associated with mid-term policy cancellations. With respect to business written for insurance carrier clients who record written premium as premium is collected, we recognize commission expense as the premium is collected, reduced by an allowance for estimated commission expense that may be returned by the insurance agencies to us due to net returns of premiums previously written and collected. The income effects of subsequent commission expense adjustments are recorded when the adjustments become known.

Income Taxes

We file or will file consolidated federal income tax returns which include the results of our wholly and majority owned subsidiaries, which became our subsidiaries effective November 27, 2013 or as part of the Patriot Care Management Acquisition effective August 6, 2014. The tax liability of our company and

 

 

 

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its wholly and majority owned subsidiaries is apportioned among the members of the group in accordance with the portion of the consolidated taxable income attributable to each member of the group, as if computed on a separate return. To the extent that the losses of any member of the group are utilized to offset taxable income of another member of the group, we take the appropriate corporate action to “purchase” such losses. To the extent that a member of the group generates any tax credits, such tax credits are allocated to the member generating such tax credits.

Prior to November 27, 2013, two of our subsidiaries were S Corporations, electing to pass corporate income through to the sole shareholder for federal tax purposes. The then sole shareholder was responsible for reporting his share of the taxable income or loss from such subsidiaries to the Internal Revenue Service. Accordingly, our combined statements of operations for the years ended December 31, 2013 and 2012 do not include a provision for federal income taxes attributable to the operations of these subsidiaries for the period from January 1, 2013 to November 27, 2013 or for the year ended December 31, 2012, nor do our combined statements of operations for the nine months ended September 30, 2014 and 2013. Effective November 27, 2013, concurrent with the Reorganization, these subsidiaries were converted to C Corporations and their taxable income became subject to U.S. corporate federal income taxes.

Another subsidiary of ours has identified its tax status as a limited liability company, electing to be taxed as a pass through entity. Prior to November 27, 2013, such subsidiary’s members were responsible for reporting their share of the entity’s taxable income or loss to the Internal Revenue Service. Accordingly, our combined statements of operations for the years ended December 31, 2013 and 2012 do not include a provision for federal income taxes attributable to this subsidiary’s operations for the period from January 1, 2013 to November 27, 2013 or for the year ended December 31, 2012, nor do our combined statements of operations for the nine months ended September 30, 2014 and 2013. Effective November 27, 2013, following the Reorganization, we are responsible for reporting our share of that entity’s taxable income.

Another subsidiary of ours is domiciled in a non-U.S. jurisdiction and, accordingly, is not subject to U.S. federal income taxes. We have no current intention of distributing unremitted earnings of this subsidiary to its U.S. domiciled parent. Additionally, we believe that it is not practical to calculate the potential liability associated with such distribution due to the fact that dividends received from this subsidiary could bring additional foreign tax credits, which could ultimately reduce the U.S. tax cost of the dividend, and significant judgment is required to analyze any additional local withholding tax and other indirect tax consequences that may arise due to the distribution of these earnings. Accordingly, pursuant to ASC 740, Tax Provisions, the income tax benefit in our combined statements of operations for the years ended December 31, 2013 and 2012 and the income tax expense in our combined statement of operations for the nine months ended September 30, 2014 and 2013 do not include a provision for federal income taxes attributable to that entity’s operations.

The income tax benefit in our combined statements of operations, included elsewhere in this prospectus, includes a provision for income taxes attributable to the revenues and expenses associated with the contracts and certain other assets acquired and liabilities assumed in the GUI Acquisition, as if GUI were included in our consolidated federal income tax return.

In determining the quarterly provision for income taxes, management uses an estimated annual effective tax rate based on forecasted annual pre-tax income (loss), permanent tax differences, statutory tax rates and tax planning opportunities in the various jurisdictions in which we operate. The impact of significant discrete items is separately recognized in the periods in which they occur.

 

 

 

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Fee Income Receivable and Fee Income Receivable from Related Party

Fee income receivable and fee income receivable from related party are based on contracted prices. We assess the collectability of these balances and adjust the receivable to the amount expected to be collected through an allowance for doubtful accounts. As of December 31, 2013, we maintained an allowance for doubtful accounts of approximately $2.5 million in connection with fee income receivables from Ullico, a third-party insurance carrier client from April 2009 until we terminated the contract effective March 26, 2012. Ullico went into liquidation effective May 30, 2013. On August 6, 2014, these fee income receivable balances from Ullico, net of allowance for uncollectible fee income receivable of approximately $2.5 million, were transferred to GUI as part of the consideration we paid for the GUI Acquisition.

Segment Considerations

We deliver our services to our customers through local offices in each region and financial information for our operations follows this service delivery model. All regions provide brokerage, underwriting and policyholder services as well as claims administration services. ASC 280, Segment Reporting, Section 280-10, establishes standards for the way that public business enterprises report information about operating segments in annual and interim consolidated financial statements. Our internal financial reporting is organized geographically, as discussed above, and managed on a geographic basis, with virtually all of our operating revenue generated within the United States. In accordance with ASC 280-10, multiple product offerings may be aggregated into a single operating segment for financial reporting purposes if aggregation is consistent with the objective and basic principles, if the segments have similar economic characteristics, and if the segments are similar in terms of (i) the nature of products and services, (ii) the nature of the production processes, (iii) the type or class of customer for their products and services and (iv) the methods used to distribute their products or provide their services. We believe each of our regional office operations meet these criteria, as each provides similar services and products to similar customers using similar methods of production and similar methods to distribute the services and products. Our products and services are generally offered as a complete and comprehensive outsourcing solution to its customers through a production process utilizing an integrated sales channel and technology platform that handles the entire brokerage, underwriting, policyholder services and claim administration services process. The operating results derived from the sale of brokerage and policyholder services and claims administration services are generally not reviewed separately by the our chief operating decision makers for purposes of assessing the performance of each service or making decisions about resources to be allocated to each service. Accordingly, we consider our business to operate in one segment.

Earnings per Share

Basic earnings per share is based on weighted average shares outstanding and excludes dilutive effects of detachable common stock warrants. Diluted earnings per share assumes the exercise of all detachable common stock warrants using the treasury stock method. Because we had a net loss for the year ended December 31, 2013, and nine months ended September 30, 2013 weighted average outstanding detachable common stock warrants representing 1,370,325 and 588,060 shares of common stock outstanding, respectively, were not dilutive.

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

 

 

 

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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.

Recently Issued Financial Accounting Standards

On May 28, 2014, the FASB issued Accounting Standards Update 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. For a publicly-held entity, this guidance will be effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period, and early adoption is not permitted. For nonpublic entities, this guidance will be effective for annual reporting periods beginning after December 15, 2017, and interim periods within annual periods beginning after December 15, 2018, and early adoption (no earlier than annual reporting periods beginning after December 15, 2016) is permitted. We are currently evaluating the accounting, transition and disclosure requirements of the standard and cannot currently estimate the financial statement impact of adoption.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We are not currently subject to any material interest rate risk or credit risk. In addition, we currently have no exposure to foreign currency risk.

 

 

 

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Business

OVERVIEW

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 work with leading insurance carriers to design workers’ compensation programs according to their preferred risk parameters and specifications. We market the programs through our broad distribution network of over 1,000 independent retail agencies, and underwrite and bind coverage on behalf of our clients. We play a central role in the underwriting, production and administration process, which we believe gives us flexibility in the event of a change in carrier relationships.

Once an insurance program is established with an insurance carrier client, we offer a full suite of additional services, including claims administration and adjudication, cost containment, nurse case management, fraud investigation and subrogation services. We also offer these services individually or as a customized package of services to our other clients such as employers, local governments and reinsurance captives, based on a client’s particular needs. We believe that our proactive approach to claims administration, including our proprietary SWARM process, results in higher than average claims closure rates versus the industry. Our technology platform provides timely information to our employees and our clients, which allows rapid initial case analysis and response to claims as well as direct access to information across our internal organization. We believe this proactive approach to our business, combined with our industry expertise and distribution relationships, makes us a valued outsourcing partner for our clients.

We generate fee revenue for our services, and we do not write any insurance policies or bear underwriting risk. On a pro forma basis, after giving effect to the Acquisitions (as defined below), this offering and the application of use of proceeds therefrom, our revenue was $101.1 million for the nine months ended September 30, 2014 and $93.0 million for the year ended December 31, 2013. Our net income (loss) on a pro forma basis for such periods was $14.5 million and $(15.2) million, respectively. See “Unaudited Pro Forma Financial Information” for additional information.

OUR COMPETITIVE STRENGTHS

We believe we have the following competitive strengths:

 

Ø   National Provider of Full Spectrum of Services Focused on Workers’ Compensation.    We provide a complete range of services, from originating and underwriting policies to claims adjudication, focused exclusively on the workers’ compensation insurance industry. We are able to efficiently deploy these services nationwide on a coordinated and proactive basis. We believe our sector focus and our nationwide footprint allow us to provide superior services and products, higher efficiencies and better cost containment to our clients relative to multiline insurance service providers. In addition, due to the expertise required to comply with a complex, state-based regulatory regime, we believe that we have a business model that is difficult to replicate.

 

 

 

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Ø   State-of-the-Art Technology Infrastructure.    We developed and implemented our WCE system, a scalable technology platform that handles the entire billings and claims administration process, from the initial issuance of policies to settlement of claims. Our WCE system is the cornerstone of our services, and we believe it provides:

 

  ·   reduced cost associated with policy initiation by fully automating issuance and underwriting of new policies;

 

  ·   real-time analysis and communication capabilities across functional areas to enhance speed of claims response and resolution;

 

  ·   enhanced data collection and quality, information analysis and identification of trends through ease-of-use and single data-entry principle; and

 

  ·   comprehensive predictive modeling and analytics capabilities.

The WCE system was designed with a robust, modular architecture to provide flexibility to integrate new carriers and acquired businesses. For example, the WCE system is compatible with the legacy systems of our clients. We believe this compatibility allows us to reduce the time required for systems integration and to provide enhanced day-to-day operational interactions securely and with relative ease. We also believe that it can be utilized in lines of business outside of the workers’ compensation insurance industry.

 

Ø   Proven Proprietary Claims Management Process.    Through our proprietary SWARM process, we provide our clients with a high quality, high-touch claims management program that has proven to be effective at settling claims and reducing associated costs. By simultaneously deploying multiple functional areas of expertise, such as claims adjustment, fraud investigation, healthcare cost containment, nurse case management and subrogation, we ensure that appropriate personnel can review and respond to the claim rapidly. The SWARM process enables us to favorably influence the outcome of the claim by addressing potential issues early in its lifecycle, resulting in claims closure rates consistently better than industry averages. For example, as of December 31, 2013, only 0.7% of our claims that occurred in the accident year 2008 remained open, as compared to the industry average of 1.7%, and only 9.0% of our claims that occurred in the accident year 2012 remained open, as compared to the industry average of 10.1%, as reported by A.M. Best’s Global Insurance Database. We believe that rapidly closing claims reduces exposure to litigation risk, medical cost inflation and other factors and will ultimately reduce claims costs for our carrier partners.

 

Ø   Strong Distribution Relationships.    We maintain relationships with our network of over 1,000 independent, non-exclusive retail agencies in all 50 states by emphasizing personal interaction and superior service and maintaining an exclusive focus on workers’ compensation services. Our experienced underwriting service personnel work closely with our independent retail agencies to market the products of our carrier partners and serve the needs of prospective policyholders. We believe that we distinguish ourselves from larger insurance company and brokerage competitors by forming close relationships with these independent retail agencies and focusing on small to mid-sized businesses. We strive to provide excellent customer service to our agencies and potential policyholders, including fast turnaround of policy submissions, in order to attract and retain business.

 

Ø  

Philosophy of Customer Service through Innovation.    A core tenet of our culture is a commitment to innovation and customer service focused on finding solutions to deliver superior results for our clients. Since the inception of our workers’ compensation insurance business in 2003, we have continued to develop and expand our capabilities, transforming our individual services into an integrated end-to-end offering on a national scale. We also seek to drive efficiencies in our operations to provide better solutions for our clients. For example, we created our proprietary SWARM claims administration

 

 

 

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process which brings together our claims management capabilities in a proactive way to drive value for our clients. In addition, we developed our scalable WCE technology platform to enable us to deliver our full suite of services in a cost-efficient manner.

 

Ø   Experienced Management.    Our senior management team is comprised of experienced executives with a track record of financial and operational success, deep experience through multiple industry cycles and strong relationships with our carrier partners. Mr. Mariano, our founder, Chairman, President and Chief Executive Officer, has guided the creation and growth of our company, including the Reorganization and the Acquisitions, as discussed under “—Our History and Organization” below. The members of our senior management team average over 20 years of insurance industry experience, and have developed a proven ability to identify, evaluate and execute successful growth strategies. We foster an entrepreneurial culture focused on customer service, innovation and business generation and have aligned the incentives of our key employees through a merit-based compensation system, which we believe has enabled us to attract and retain superior talent and produce strong results for our clients and our company.

OUR GROWTH STRATEGY

We intend to leverage our competitive strengths to drive sales and profit growth through the following key strategies:

 

Ø   Expand Our Insurance Carrier Client Business Relationships.    We currently offer a broad range of our insurance services to our insurance carrier clients who outsource all or part of their workers’ compensation insurance programs to us. In addition to our primary insurance carrier clients Guarantee Insurance, Zurich and Scottsdale, we are focused on engaging and establishing relationships with other insurance carriers, including carriers that have not historically written workers’ compensation insurance. We intend to take advantage of the current attractive dynamics in the workers’ compensation industry of increasing employment and premium rates to create partnerships with new or opportunistic market entrants. For example, Scottsdale recently became our insurance carrier client and began writing workers’ compensation insurance at that time. In addition, we recently formed a relationship with AIG, and we expect AIG to become one of our primary insurance carrier clients over time. We continue to seek to expand our carrier partner business relationships.

 

Ø   Continue to Grow Our Client Base for Individual Services.    We also provide a variety of specialty services individually or as a customized package of services, such as onsite investigations into fraud and compensability and evaluation of subrogation opportunities; loss control services; transportation and translation services; and legal bill review services. While these services are generally provided as part of our integrated claims administration service to our insurance carrier clients, we have grown this business to include more than 80 third-party clients. We intend to continue to focus on marketing these service offerings to new third-party clients, such as other insurance carriers and service providers, self-insured employers and local governments, as well as insurance carriers who do not purchase our policyholder services offerings.

 

Ø   Leverage Our Existing Infrastructure.    We serve our clients and policyholders through regional offices in seven states, each of which has been staffed to accommodate growth in our business. Further, we have developed and implemented a robust, vertically integrated modularized information technology platform that is designed to help us grow. This system is highly scalable and adaptable to additional opportunities, with substantial excess capacity, allowing us to grow and service additional clients without the need for substantial additional investment. We plan to realize economies of scale in our workforce and technology infrastructure.

 

Ø  

Continue to Develop and Offer Innovative Solutions.    We believe that we can continue to provide superior services and products, higher efficiencies and cost containment to our clients by developing

 

 

 

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innovative solutions for our clients. For example, we recently began offering workers’ compensation lien resolution services in order to address a specific need for our clients in the state of California, including lien negotiation, disputed bill analysis, claim consultation and analysis and bulk settlement services. We believe that our focus on continuing to seek opportunities to provide potential and existing clients with new services and solutions will allow us to leverage our existing infrastructure to further drive our organic growth.

 

Ø   Acquire Complementary Operations.    We believe there are significant opportunities, through the acquisition of complementary operations, to continue to expand the range of services that we offer to our clients. For example, through our recently completed Patriot Care Management Acquisition, we acquired the capability to provide nurse case management and bill review services, both as a part of our full suite of services that we provide to our insurance carrier clients and also individually or as a customized package of services to third-party clients. We continue to evaluate the possibility of acquiring outsourced services and new complementary services or businesses to further drive the growth of our business.

OUR HISTORY AND ORGANIZATION

Mr. Mariano, our founder, Chairman, President and Chief Executive Officer, initially started our workers’ compensation insurance business and acquired Guarantee Insurance in 2003.

Patriot National, Inc. (f/k/a Old Guard Risk Services, Inc.) was incorporated in Delaware in November 2013 to consolidate certain insurance services entities controlled by Mr. Mariano. These transactions, which we refer to as our “Reorganization,” separated our insurance services business from the insurance risk taking operations of Guarantee Insurance Group.

Effective August 6, 2014, we acquired certain contracts to provide marketing, underwriting and policyholder services, to certain of our insurance carrier clients, as well as related assets and liabilities, from a subsidiary of Guarantee Insurance Group. We also acquired a contract to provide a limited subset of our brokerage and policyholder services to Guarantee Insurance, the balance of which had been provided without a contract as GUI is a subsidiary of Guarantee Insurance. We refer to the acquisition of these contracts and related assets and liabilities as the “GUI Acquisition.” Immediately following the GUI Acquisition, we entered into a new agreement to provide all of our brokerage and policyholder services to Guarantee Insurance.

We further expanded our business effective August 6, 2014, through our acquisition from MCMC of its managed care risk services business that provides nurse case management and bill review services. This business, which we refer to as the “Patriot Care Management Business,” had been previously controlled by Mr. Mariano until it was sold to MCMC in 2011. We refer to this acquisition as the “Patriot Care Management Acquisition,” and the GUI Acquisition and the Patriot Care Management Acquisition together as the “Acquisitions.”

Our historical financial results for all periods presented in this prospectus include the results of the various businesses previously under the common control of Mr. Mariano and to which we succeeded in connection with the Reorganization, as well as the revenues and expenses associated with the contracts and certain other assets acquired and liabilities assumed through the GUI Acquisition. Revenues and expenses associated with the new agreement we entered into in August 2014 to provide all of our brokerage and policyholder services to Guarantee Insurance, as well as the financial results associated with the Patriot Care Management Business, are included in our historical financial results beginning August 6, 2014 and are not reflected in our historical financial statements as of or for any earlier period.

 

 

 

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Following the Reorganization and the Acquisitions, we own 100% of the subsidiaries that comprise our insurance services business, with the exception of Contego Services Group, LLC, in which Mr. Mariano maintains a 3% membership interest.

INDUSTRY

Workers’ compensation in the United States is a mandated, state-legislated, no-fault insurance program that requires employers to fund medical expenses, lost wages and other costs resulting from work-related injuries and illness. Providing workers’ compensation insurance requires significant administrative and regulatory resources, primarily as a result of separate regulatory requirements imposed by each state, including with respect to base rates, licensing, forms, filings, electronic data exchange and other matters. These rules and guidelines change frequently, which creates significant administrative cost and burden an insurance company must bear in order to remain compliant in each of the states in which it does business.

According to the NCCI Report, projected total net premium written by state funds and private carriers of workers’ compensation insurance in the United States was $41.9 billion in 2013, an increase from $33.8 billion in 2010, representing a compound annual growth rate of 7.4% over that period, and according to data compiled by SNL Financial, total direct premium written by workers’ compensation insurance carriers in the United States, which includes the amount of premium reinsured by insurance carriers, was $52.5 billion in 2013, an increase from $40.4 billion in 2010, representing a compound annual growth rate of 9.2% over that period. In the past several years, premium growth in the workers’ compensation industry has been predominantly driven by the recovery of employment levels to generally at or near pre-recession levels, as well as increasing premium rates.

Net Written Premium

 

LOGO

Source: 1990–2012, Annual Statement data; 2013P, NCCI

Note:     p = Preliminary

Includes state insurance fund data for the following states: AZ, CA, CO, HI, ID, KY, LA, MD, MO, MT, NM, OK, OR, RI, TX, and UT

Each calendar year total for state funds includes all funds operating as a state fund in that year

 

 

 

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Like other sectors of the insurance industry, the workers’ compensation sector experiences underwriting cyclicality, which generally underpins changes in premium rates. This cyclicality is caused by a number of factors. First, ultimate loss costs become more difficult to predict when claims remain open for longer periods and they are exposed to wage and medical cost inflation. For example, the NCCI Report indicates that medical costs per claim increased by approximately 6.5% on average per year from 1995 through 2013.

Workers’ Compensation Combined Ratios—Private Carriers

 

LOGO

Source: 1990–2012, Annual Statement data; 2013P, NCCI; chart data estimated

Note:     p = Preliminary

Second, the amount of investment income insurance carriers earn, which is a significant contributor of their overall targets, may also influence such carrier’s underwriting practices. Given that workers’ compensation claims have a long duration, insurers can write at higher combined ratios because they are able to invest the assets over a long period and earn significant investment income. This is reflected in a greater than 100% combined ratio for all but two years from 1990 to 2013. However, in periods of low interest rates, similar to the current investment environment, insurance carriers cannot generate sufficient investment income to offset underwriting losses, and as a result have demanded higher premium rates. This has led to a modest “hardening” of the workers’ compensation market. According to the Moody’s Report, rates in 2013 increased 8% and are expected to rise 5.5% in 2014.

 

 

 

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Today, the attractive combination of rising employment and an improved underwriting environment has driven new entrants into the market, and caused industry participants who had decreased their activity levels during the previous “soft” market cycle to re-enter the market as macro-economic conditions and the profit outlook for the industry improve.

Changes in Workers’ Compensation Premium Rates

 

LOGO

Source:     Council of Insurance Agents and Brokers

Because insurance carriers adjust their growth appetite based on the prevailing macro-economic and underwriting cycle, we believe outsourcing certain functions to a company like us is attractive because it allows carriers to maintain production flexibility in response to market conditions without burdensome investment in, or management of, certain necessary services and fixed costs. We are able to take advantage of the current improving market and provide services to carriers who may have previously exited the workers’ compensation market and no longer have the systems in place to resume writing business. Furthermore, we believe the profitability challenges faced by the workers’ compensation insurance industry creates opportunities for specialty service providers like us who can reduce costs and also provide access to alternative market options.

In addition to providing flexibility to carriers, enabling them to opportunistically write workers’ compensation business in an attractive market, we also help our clients navigate the complex state-regulated industry landscape. Ensuring state-by-state compliance is time consuming and expensive, particularly for a carrier whose primary business is not in workers’ compensation. We believe our national presence and experience with the guidelines and requirements of each state where our carrier clients provide workers’ compensation coverage position us to deliver significant value and cost savings for our clients. Our insurance carrier clients conduct workers’ compensation business in all states and the District of Columbia, except the four states (North Dakota, Ohio, Washington State and Wyoming) where workers’ compensation coverage is provided through state programs and insurance through private insurance companies is not allowed.

OUR SERVICES

We offer two types of services: brokerage, underwriting and policyholder services (or our “brokerage and policyholder services”) and claims administration services (or our “claims administration services”).

We offer an end-to-end portfolio of services to increase business production, contain costs and reduce claims experience for our insurance carrier clients. In operating our business, we leverage our strong distribution relationships, proprietary business processes, advanced technology infrastructure and management expertise to deliver valuable solutions to our clients.

 

 

 

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Brokerage and Policyholder Services

Agency and Underwriting Services

Our brokerage and policyholder services include general agency services and specialty underwriting and policyholder services provided to our insurance carrier clients. We produce and administer traditional and alternative market workers’ compensation insurance programs within risk classes and geographies specified by our insurance carrier clients, and earn fees based on a percentage of the premiums for the policies we produce and service. We do not write any insurance policies or bear underwriting risk.

The activities we perform in this capacity for our carrier partners may include marketing, underwriting and appointment of other agents.

We place the workers’ compensation insurance products of our carrier partners through a national network of over 1,000 independent retail agencies nationwide. We invest a substantial amount of time in developing relationships with our agencies, and we believe that these relationships are instrumental in allowing us to successfully place policies on behalf of our carrier partners. For additional information about our independent retail agency network, see “—Marketing and Distribution—Underwriting Business Production.”

We provide a variety of underwriting services that we believe provide value to our insurance carrier clients. Our underwriting services consist of investigation and analysis of potential loss exposures related to each policyholder’s operations in order to produce insurance programs designed and priced appropriately for our carrier clients. We compare the policyholder’s operations to the operations that would be expected for similar businesses in order to determine available premium rates. We also review the quality of operations, including management’s attention to safety, hazard controls and loss mitigation support, as well as past loss information to validate our loss exposure and quality of operations analysis. Assuming such review of the policyholder’s operations satisfies our insurance carrier client’s specifications for risk acceptance, we offer our insurance carrier clients a price for our services commensurate with our loss exposure and quality of operations analysis.

We believe that our focus on workers’ compensation insurance, the quality of our services and the range of workers’ compensation insurance products available through our carrier partners, allow us to compete with larger insurance company and brokerage competitors by forming close relationships with our agencies and concentrating on small to mid-sized businesses. We strive to provide excellent customer service to our agencies and potential policyholders, including fast turnaround of policy submissions, in order to attract and retain business. In addition, our carrier partners can offer “pay-as-you-go” plans through us, pursuant to which we partner with payroll service companies and their clients to collect premiums and payroll information on a monthly basis, which we believe are attractive to our agencies’ smaller business customers. Using this program, we are able to produce policies for smaller businesses without requiring a large premium down payment, which eases the cash flow burden for these companies.

We also conduct premium audits on policyholders annually upon the expiration or renewal of a policy. The purpose of these audits is to verify that policyholders have accurately reported their payroll expenses and employee job classifications, and therefore have paid the correct premium as required under the terms of their policies. In addition to annual audits, we selectively perform interim audits on certain classes of business if significant or unusual claims are filed or if the monthly reports submitted by a policyholder reflect a payroll pattern or any aberrations that cause underwriting, safety or fraud concerns.

 

 

 

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Reinsurance Captive Entity Management Services

Through our independent retail agency network, we also offer reinsurance captive entity design and management services. Owners of a reinsurance captive entity can participate in the underwriting results of a policy by sharing a portion of the risk with an insurance carrier. We earn fees for management and other services performed for reinsurance captive entities that we design and form.

These services include the formation and management of segregated portfolio cell captives. Owners of a reinsurance captive entity are required to post collateral in order to absorb a portion of the insurance losses along with the ceding insurance carrier. Formation of segregated portfolio cell captives involves the submission of an application for regulatory approval by the relevant domiciliary regulatory body, together with supporting financial information and a business plan, and the creation and execution of participation agreements, subscription agreements and reinsurance agreements pertaining to such captives. Management of segregated portfolio cell captives includes compliance monitoring, financial reporting and investment portfolio management services.

We believe our offering of reinsurance captive entity management services is attractive to potential policyholders and independent retail agencies who seek to participate in underwriting results. The owners of reinsurance captives entities that we provide services to are generally independent retail agencies, policyholders or investor groups (typically made up of individual agents). Although certain insurance carriers offer alternative market products, such as reinsurance captive entity services, to their large corporate customers, we offer alternative market workers’ compensation solutions, including the facilitation and management of reinsurance captive entities, to small and medium-sized employers as well. For policyholders, this can be an attractive option to reduce workers’ compensation costs over the long term, and for agencies, this allows them to participate in the underwriting results on business produced.

As of September 30, 2014, we were providing services to 20 reinsurance captive entities with $129.0 million of combined premiums in force. These reinsurance captive entities are generally domiciled in the Cayman Islands or the State of Delaware.

Technology Services

We intend to offer the capabilities of our technology platform, the WCE system, to our carrier partners and other clients, allowing them to take advantage of the various benefits of the platform. This offering is expected to operate under a software-as-a-service model. See “—Information Technology—Workers’ Compensation Expert, or WCE” for more information about our WCE system.

Claims Administration Services

Our claims administration services relate to the administration and resolution of workers’ compensation claims that are designed to reduce costs for our clients. We provide a comprehensive claims administration platform to our carrier partners that revolves around our proprietary SWARM process.

Our claims administration process begins even before we receive notice of a claim. Once a policy becomes effective and we are engaged to provide claims administration services, we send a claims kit to the insured outlining the policy provisions, mandated posting notices, information on how to report a claim, the importance of reporting all claims on a timely basis and answers to frequently asked questions. We make available a toll-free reporting line, as well as a website, for insureds or employees to report injuries, available 24 hours a day, seven days a week.

 

 

 

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Once a claim is reported to us, the faster such claim is processed and closed, the lower the overall claim cost, both to us and the relevant carrier client, tends to be. In order to address reported claims quickly, we apply our SWARM claims administration process upon receiving notice of a claim.

SWARM—Our Claims Administration Process