=============================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934 FOR THE PERIOD ENDED
MARCH 31, 2007
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM
to
------------------ ------------------
COMMISSION FILE NUMBER 0-11453
AMERICAN PHYSICIANS SERVICE GROUP, INC.
(Exact name of registrant as specified in its charter)
TEXAS 75-1458323
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) identification No.)
1301 CAPITAL OF TEXAS HIGHWAY AUSTIN, TEXAS 78746
(Address of principal executive offices) (Zip Code)
(512) 328-0888
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d ) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. YES X NO
------ ------
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act.
(Check one):
Large accelerated filer [ ] Accelerated filer [ ]
Non-accelerated filer [ X ]
Indicate by check mark whether the registrant is a well-known seasoned filer,
as defined by Rule 405 of the Securities Act. (Check one) YES [ ] NO [X]
Indicate by check mark if the registrant is not required to file reoprts
pursuant to Section 13 or Section 15(d) of the Act. YES [ ] NO [X]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
NUMBER OF SHARES
OUTSTANDING AT
TITLE OF EACH CLASS MAY 1, 2007
-------------------- ----------------
Common Stock, $.10 par value 4,824,335
=============================================================================
PART 1
FINANCIAL INFORMATION
- 2 -
AMERICAN PHYSICIANS SERVICE GROUP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(In thousands, except per share data)
Three Months Ended
March 31,
-------------------------------------
2007 2006
----------- -----------
Revenues:
Insurance services $3,657 $3,655
Financial services 5,216 3,578
------- ------
Total revenues 8,873 7,233
------- ------
Expenses (Income):
Insurance services 3,823 2,754
Financial services 4,437 3,285
General and administrative 777 518
Gain on sale of assets (5) -
------ ------
Total expenses 9,032 6,557
------ ------
Operating income (loss) (159) 676
Gain on investments 84 7
Loss on impairment of investment (423) -
------ -----
Income (loss) from operations before
interest, income taxes and minority
interest (498) 683
Interest income 334 197
Other income 19 6
Income tax expense (benefit) (49) 323
Minority interests (1) 1
------ ------
Net income (loss) ($95) $562
====== ======
The accompanying notes are an integral part of these condensed consolidated
financial statements.
- 3 -
AMERICAN PHYSICIANS SERVICE GROUP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS, continued
(Unaudited)
(In thousands, except per share amounts)
Three Months Ended
March 31,
----------------------
2007 2006
------ ------
Net income (loss) per common share
Basic:
Net Income (loss) $ (0.03) $ 0.20
====== ======
Diluted:
Net income (loss) $ (0.03) $ 0.19
====== ======
Basic weighted average shares
outstanding 2,822 2,762
====== ======
Diluted weighted average
shares outstanding 2,822 2,909
====== ======
The accompanying notes are an integral part of these condensed consolidated
financial statements.
- 4 -
AMERICAN PHYSICIANS SERVICE GROUP, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
(In thousands)
March 31, December 31,
2007 2006
------------ -------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $4,827 $4,242
Cash - restricted 6,866 1,880
Trade receivables, net 51 1
Notes receivable - current 720 817
Management fees and other receivables 1,484 2,932
Deposit with clearing organization 501 501
Investment in available-for-sale fixed
income securities - current 14,233 14,746
Net deferred income tax asset 117 129
Prepaid expenses and other 485 686
------- ------
TOTAL CURRENT ASSETS 29,284 25,934
Notes receivable, less current portion 279 -
Property and equipment, net 520 556
Investment in available-for-sale securities:
Equity 3,824 4,403
Fixed income 881 1,890
Restricted fixed income 2,498 --
Net deferred income tax asset 1,844 1,192
Goodwill 1,247 1,247
Other assets 1,229 1,054
------- -------
TOTAL ASSETS $41,606 $36,276
======= =======
The accompanying notes are an integral part of these condensed consolidated
financial statements.
- 5 -
AMERICAN PHYSICIANS SERVICE GROUP, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS, continued
(Unaudited)
(In thousands, except share data)
March 31, December 31,
2007 2006
---------- -----------
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $7,302 $2,228
Accrued incentive compensation 533 2,279
Accrued expenses and other liabilities 2,077 1,920
Federal income tax payable 498 136
Deferred gain - current 258 124
------ ------
Total current liabilities 10,668 6,687
------ ------
TOTAL LIABILITIES 10,668 6,687
------ ------
Minority interests 21 21
Commitments and contingencies
Shareholders' Equity:
Preferred stock, $1.00 par value, 1,000,000
shares authorized, none issued or outstanding -- --
Preferred stock, Series A redeemable, $1.00 par value,
10,500 shares authorized, none issued or outstanding -- --
Common stock, $0.10 par value, shares authorized 20,000,000;
2,858,556 and 2,817,746 issued and outstanding
at 03/31/07 and 12/31/06 respectively 286 282
Additional paid-in capital 9,432 7,944
Retained earnings 21,016 21,111
Accumulated other comprehensive income,
net of taxes 183 231
------- -------
TOTAL SHAREHOLDERS' EQUITY 30,917 29,568
------- -------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $41,606 $36,276
======= =======
The accompanying notes are an integral part of these condensed consolidated
financial statements.
- 6 -
AMERICAN PHYSICIANS SERVICE GROUP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Three Months Ended March 31,
2007 2006
------- -------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ (95) $ 562
Adjustments to reconcile net income (loss) to cash
provided by operating activities:
Depreciation and amortization 86 106
Extinguishment of debt and other 77 108
Common stock awarded 915 102
Deferred compensation 540 23
Gain on sale of assets (5) -
Deferred gain on sale of building - (141)
Gain on investment (9) (7)
Impairment of investment 423 -
Excess tax benefits from stock-based compensation (71) -
Deferred income tax (640) 139
Changes in operating assets and liabilities:
Trade receivables (50) (275)
Trading account securities - (90)
Income tax payable 433 (63)
Management fees & other receivables 1,448 2,201
Prepaid expenses & other assets 126 (344)
Deferred income 139 -
Trade payables 88 115
Other long-term assets (198) -
Accrued expenses & other liabilities (1,612) (604)
------ ------
Net cash provided by operating activities 1,595 1,832
CASH FLOWS USED IN INVESTING ACTIVITIES:
Capital expenditures (29) (57)
Proceeds from the sale of available-for-sale equity
and fixed income securities 6,590 2,741
Purchase of available-for-sale equity securities (7,426) (3,987)
Funds loaned to others (275) (243)
Collection of notes receivable 16 10
------ ------
Net cash used in investing activities (1,124) (1,536)
CASH FLOWS FROM (USED IN) FINANCING ACTIVITIES:
Exercise of stock options 80 64
Purchase and cancellation of treasury stock (37) (577)
Excess tax benefits from stock-based compensation 71 3
------ ------
Net cash provided by (used in) financing activities 114 (510)
------ ------
NET CHANGE IN CASH AND CASH EQUIVALENTS 585 (214)
Cash and cash equivalents at beginning of period 4,242 6,680
------ ------
Cash and cash equivalents at end of period $ 4,827 $ 6,466
======= =======
The accompanying notes are an integral part of these condensed consolidated
financial statements.
- 7 -
AMERICAN PHYSICIANS SERVICE GROUP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS, continued
(Unaudited)
(in thousands) Three Months Ended March 31,
2007 2006
------- -------
Supplemental information:
Cash paid for taxes $ 140 $ 90
The accompanying notes are an integral part of these condensed consolidated
financial statements.
- 8 -
AMERICAN PHYSICIANS SERVICE GROUP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY AND
COMPREHENSIVE INCOME (LOSS)
For the three months ended March 31, 2007
(Unaudited)
(In thousands)
Accumulated
Additional Other Total
Common Paid-In Retained Comprehensive Comprehensive Treasury Shareholders'
Stock Capital Earnings Income (loss) Income (loss) Stock Equity
------------------------------------------------------------------------------------------------
Balance December 31, 2006 $ 282 $ 7,944 $ 21,111 $ -- $ 231 $ -- $ 29,568
------------------------------------------------------------------------------------------------
Comprehensive income:
Net income (loss) -- -- (95) (95) -- -- (95)
Other comprehensive income:
Unrealized loss on securities,
net of taxes of $(25) -- -- -- (48) (48) -- (48)
------
Comprehensive income: -- -- -- $(143) -- -- --
======
Stock options exercised 1 79 -- -- -- -- 80
Stock options expensed -- 915 -- -- -- -- 915
Tax benefit from exercise
of stock options -- 71 -- -- -- -- 71
Treasury stock purchases -- -- -- -- -- (37) (37)
Cancelled treasury stock -- (37) -- -- -- 37 --
Stock awarded 3 460 -- -- -- -- 463
------------------------------------------------------------------------------------------------
Balance March 31, 2007 $ 286 $ 9,432 $21,016 $ -- $ 183 $ -- $ 30,917
================================================================================================
The accompanying notes are an integral part of these condensed consolidated
financial statements.
- 9 -
AMERICAN PHYSICIANS SERVICE GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2007
(Unaudited)
1. GENERAL
The accompanying unaudited condensed consolidated financial statements
have been prepared in conformity with accounting principles generally accepted
in the United States of America ("GAAP") and pursuant to the rules and
regulations of the Securities and Exchange Commission. Certain information and
footnote disclosures normally included in financial statements prepared in
accordance with GAAP have been condensed or omitted pursuant to such rules and
regulations. The consolidated financial statements as of and for the three month
period ended March 31, 2007 and 2006 reflect all adjustments which are, in the
opinion of management, necessary for a fair presentation of the financial
position, results of operations and cash flows for the periods presented. Such
adjustments consist of only items of a normal recurring nature. These
consolidated financial statements have not been audited by our independent
registered public accounting firm. The operating results for the interim periods
are not necessarily indicative of results for the full fiscal year.
The notes to consolidated financial statements appearing in our Annual
Report on Form 10-K for the year ended December 31, 2006 filed with the
Securities Exchange Commission should be read in conjunction with this Quarterly
Report on Form 10-Q. There have been no significant changes in the information
reported in those notes other than from normal business activities.
2. MANAGEMENT'S ESTIMATES
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the consolidated financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could differ
from those estimates.
3. CONTINGENCIES
We are involved in various claims and legal actions that have arisen in
the ordinary course of business. Management believes that any liabilities
arising from these actions will not have a significant adverse effect on our
financial condition or results of operations.
- 10 -
4. GAIN ON INVESTMENTS
The gain in 2007 represents the receipt of cash in payment for a note
that had been written off as uncollectible in 2005 together with a gain of
approximately $9,000 on the sale of an available-for-sale equity security. The
gain in 2006 represents a small gain on the sale of an available-for-sale fixed
income security.
5. LOSS ON IMPAIRMENT OF INVESTMENT
The loss recorded in the first quarter of 2007 represents a write-down
of our investment in Financial Industries ("FIC") common stock, having
previously resolved that declines in FIC's stock price will be considered to be
"other than temporary" as defined in Statements of Financial Accounting
Standards (SFAS) No. 115, Accounting for Certain Investments in Debt and Equity
Securities, as amended. Our policy in regards to our investment in FIC is that
we will record pretax charges to earnings should the common stock price on the
last day of each interim or annual period fall below the adjusted cost basis of
our investment in FIC. In the first three months of 2007, that charge totaled
$423,000, calculated by multiplying the total number of FIC shares we own
(385,000) by the change in our adjusted basis in FIC common stock at December
31, 2006 ($7.60 per share) and its fair market value at March 31, 2007 ($6.50
per share). While we continue to have the ability and the intent to hold the
stock indefinitely, we concluded that the additional uncertainty created by
FIC's late SEC filings, together with the lack of its current financial
information, dictated that the current quarter decline should be viewed as other
than temporary. We will continue to monitor and evaluate the situation at FIC.
6. CASH - RESTRICTED
Restricted cash represents cash deposits advanced from customers for
trade claim transactions that do not close by the end of the period. It occurs
when a customer remits payment for a transaction by check instead of via wire
transfer. As checks of this size normally take several business days to clear,
we ask our customers to pay in advance for transactions expected to close in the
near future. At the time of receipt, Cash - Restricted and Accounts Payable are
increased for an equal amount as no part of this cash is ours until the
transaction closes.
7. RESTRICTED AVAILABLE-FOR-SALE FIXED INCOME SECURITIES
As a result of the merger between us and American Physicians Insurance
Exchange ("APIE"), the Texas Department of Insurance required that funds be set
aside in an escrow account with a bank to remain until the aggregate remaining
redemption obligation of our Series A redeemable preferred stock is less than
the amount of the escrow balance, with no withdrawals to be made from this
escrow account without prior approval from the Texas Department of Insurance.
Accordingly, in March 2007 we set up an escrow account funded by the purchase of
a fixed income security in the amount of $2,498,000 paying 5% interest and
maturing in March 2008.
- 11 -
8. INVESTMENT IN AVAILABLE-FOR-SALE EQUITY SECURITIES
A portion of this balance sheet account is comprised of our investment
in FIC common stock. As mentioned in Note 5 above, during the three months ended
March 31, 2007, we recognized "other than temporary" impairment losses and,
accordingly, our cost basis in the 385,000 shares of FIC common stock we own has
been reduced from $7.60 per share at December 31, 2006 to $6.50 per share at
March 31, 2007. The effect of any "other than temporary" impairment loss is to
reclassify from accumulated other comprehensive income (loss) the unrealized
loss to realized loss in the statement of operations. We classify all of these
shares as securities available-for-sale and record temporary unrealized changes
in their value, net of tax, in our balance sheet as part of Accumulated Other
Comprehensive Income (Loss) in Stockholders' Equity. Changes in their fair
market value deemed to be "other than temporary" are charged to earnings in the
period that the determination was made. No impairment charges were necessary for
the three month period ended March 31, 2006.
9. INVESTMENT IN AVAILABLE-FOR-SALE FIXED INCOME SECURITIES
We have invested primarily in U.S. government-backed securities with
maturities varying from one to two years, as well as three corporate bonds with
Standard and Poor's ratings of no lower than B (investment grade).
10. OTHER LONG TERM ASSETS
In April 2007 we completed a strategic merger with our medical
malpractice partner, APIE. The merger took effect on April 1, 2007. Until then,
we accounted for this transaction consistent with Statement of Financial
Standards No. 141, Business Combinations, whereby direct costs of the business
combination are capitalized and become part of the total purchase price. As of
March 31, 2007, we had capitalized a total of $931,000, comprised primarily of
legal, accounting, auditing and tax consulting fees incurred by us related to
this transaction.
11. ACCRUED EXPENSES AND OTHER LIABILITIES
Accrued expenses and other liabilities consists of the following:
March 31, December 31,
2007 2006
---------- ------------
Commissions payable $ 1,624,000 $ 1,239,000
Taxes payable 154,000 161,000
Vacation 170,000 170,000
401(k) plan matching 79,000 213,000
Other accrued liabilities 50,000 137,000
---------- ----------
$ 2,077,000 $ 1,920,000
========== ==========
- 12 -
12. NET INCOME (LOSS) PER SHARE
Basic income (loss) per share is based on the weighted average shares
outstanding without any dilutive effects considered. Diluted income (loss) per
share reflects dilution from all contingently issuable shares, such as options
and convertible debt. A reconciliation of income and weighted average shares
outstanding used in the calculation of basic and diluted income (loss) per share
from operations follows:
For the Three Months Ended March 31, 2007
-------------------------------------------
Income Shares Per Share
(Numerator) (Denominator) Amount
---------- ----------- ---------
Basic EPS
Net loss $ (95,000) 2,822,000 $ (0.03)
======
Diluted EPS
Effect of dilutive securities -- --
--------- --------
Net loss $ (95,000) 2,822,000 $ (0.03)
========== ========= ======
For the Three Months Ended March 31, 2006
-------------------------------------------
Income Shares Per Share
(Numerator) (Denominator) Amount
Basic EPS
Net income $ 562,000 2,762,000 $ 0.20
======
Diluted EPS
Effect of dilutive securities -- 147,000
-------- ---------
Net income $ 562,000 2,909,000 $ 0.19
========== ========= ======
- 13 -
13. SEGMENT INFORMATION
The Company's segments are distinct by type of service provided. Comparative
financial data for the three month period ended March 31, 2007 and 2006 are
shown as follows:
Three Months Ended March 31,
2007 2006
--------- -----------
Operating Revenue:
Insurance services $ 3,657,000 $ 3,655,000
Financial services 5,216,000 3,578,000
Corporate -- 2,100,000
---------- ----------
Total Segment Revenues $ 8,873,000 $ 9,333,000
========== ==========
Reconciliation to Consolidated
Statement of Operations:
Total segment revenues $ 8,873,000 $ 9,333,000
Less: Intercompany dividends -- (2,100,000)
---------- ----------
Total Revenues $ 8,873,000 $ 7,233,000
========== ==========
Operating Income (Loss)
Insurance services $ (166,000) $ 901,000
Financial services 779,000 293,000
Corporate (772,000) (518,000)
--------- ---------
Total segments operating income (loss) (159,000) 676,000
Gain on investments 84,000 7,000
Loss on impairment of investment (423,000) --
-------- ---------
Income (loss) from operations before interest,
income taxes and minority interest (498,000) 683,000
Interest income 334,000 197,000
Other gain 19,000 6,000
Income tax expense (benefit) (49,000) 323,000
Minority interest (1) 1
-------- -------
Net income (loss) $ (95,000) $ 562,000
======== ========
- 14 -
14. STOCK-BASED COMPENSATION
In December 2004, the Financial Accounting Standards Board ("FASB")
issued Statement of Financial Accounting Standards No. 123 (revised 2004),
Share-Based Payment (SFAS 123 (R)). The standard amends SFAS 123, Accounting for
Stock-Based Compensation, and concludes that services received from employees in
exchange for stock-based compensation results in a cost to the employer that
must be recognized in the financial statements. The cost of such awards should
be measured at fair value at grant date.
On January 1, 2006 we adopted SFAS No. 123R. We use the
Black-Scholes-Merton option-pricing model to determine the fair value of
stock-based awards, consistent with that used for pro forma disclosures under
SFAS No. 123, Accounting for Stock-Based Compensation. We have elected the
modified prospective transition method as permitted by SFAS No. 123R and
accordingly prior periods have not been restated to reflect the impact of SFAS
No. 123R. SFAS No. 123R requires that stock-based compensation be recorded for
all new and unvested stock options expected to vest as the requisite service is
rendered beginning January 1, 2006, the first day of our 2006 fiscal year.
Stock-based compensation expense for awards granted on or before December 31,
2005, but unvested as of that date, is based on the grant date fair value as
determined under the pro forma provisions of SFAS No. 123. For the three months
ended March 31, 2007 we recorded compensation cost related to stock options of
$915,000 and a related reduction in income taxes of $311,000. The compensation
cost is the total fair value, at date of grant, of shares that vested during the
three month period. No compensation costs were capitalized in the three month
period ended March 31, 2007.
During the three month period ended March 31, 2007, 17,000 options were
exercised with an intrinsic value of $209,000. We received proceeds of $80,000
from the exercise of these options during the three month period ended March 31,
2007. Based on unvested options outstanding at March 31, 2007 compensation costs
to be recorded in future periods are expected to be recognized as follows: 2007,
$299,000; 2008, $399,000; 2009, $170,000 and 2010, $14,000.
We have adopted, with shareholder approval, the "2005 Incentive and
Non-Qualified Stock Option Plan" ("Incentive Plan"). The Incentive Plan provides
for the issuance of up to 650,000 shares of common stock to our directors and
key employees. A total of 498,000 of these options have been granted as of March
31, 2007 and 152,000 are available for grants. Of those granted, 6,000 shares
have been exercised, 285,000 options are exercisable and 207,000 are not yet
exercisable. The previous plan, the "1995 Incentive and Non-Qualified Stock
Option Plan", provided for the issuance of 1,600,000 shares of common stock to
our directors and key employees. All of the approved options have been granted
as of March 31, 2007, 1,173,000 shares have been exercised, 268,000 shares are
exercisable and 159,000 options have been cancelled. Upon the exercise of an
option we issue the shares from our authorized, but un-issued shares.
The exercise price for each non-qualified option share is determined by
the Compensation Committee of the Board of Directors ("the Committee"). The
exercise price of a qualified incentive stock option has to be at least 100% of
the fair market value of such shares on the date of grant of the option. We made
an exception to this pricing policy on the recent grants to our new advisory
board members, as the price had been contractually agreed upon before the grant
date. Under the Plans, option grants are limited to a maximum of ten-year terms;
however, the Committee has issued all
- 15 -
currently outstanding grants with five-year terms. The Committee also determines
vesting for each option grant, traditionally vested over two years beginning one
year from the date of grant for directors and vested over three years beginning
one year from the date of grant for non-director employees.
Presented below is a summary of the stock options held by our employees
and our directors and the related transactions for the three months ended March
31, 2007.
Three Months Ended
March 31,
---------------------------
2007
---------------------------
Weighted
Average
Exercise
Shares Price
--------- ---------
Balance at Beg.of Period 467,000 $9.96
Options granted 310,000 15.73
Options exercised (17,000) 4.86
Options forfeited/expired -- --
--------
Balance at end of period 760,000 $12.42
========
Options exercisable 553,000 $10.74
========
The weighted average grant date fair value of Company stock options
granted is $5.23 per option for the three months ended March 31, 2007. The fair
value of the options was calculated using the Black-Scholes-Merton option
pricing model with the following assumptions:
Three months
ended
March 31, 2007
---------------
Expected option term 3.7 years
Expected volatility 31.9%
Expected dividend yield 1.73%
Risk-free rate of return 4.42%
The expected volatility assumptions we used are based on the historical
volatility of our common stock over the most recent period commensurate with the
estimated expected life of our stock options, such estimated life being based on
the historical experience of our stock option exercises. The following table
summarizes the Company's options outstanding and exercisable options at March
31, 2007:
- 16 -
Stock Options Outstanding Stock Options Exercisable
------------------------------------------------------------- --------------------------------------------------------
Weighted Average Weighted Average
Average Aggregate Remaining Average Aggregate Remaining
Exercise Intrinsic Contractual Exercise Intrinsic Contractual
Shares Price Value (1) Life Shares Price Value (1) Life
------- -------- --------- -------- ------ ------- --------- -----
760,000 $12.42 $3,964,000 3.6 yrs. 553,000 $10.74 $3,815,000 3.1 yrs.
(1) Based on the $17.64 closing price of our stock at March 31, 2007.
15. SUBSEQUENT EVENTS
ACQUISTION OF APIE
On April 1, 2007, we acquired all of the issued and outstanding stock
of American Physicians Insurance Company ("API"), the stock company formed as a
result of the demutualization of APIE, in a business combination which will be
accounted for using the purchase method of accounting. The acquisition was done
for the purpose of increasing shareholder value through greater financial
strength and increased growth potential. Combining the revenues, assets and
equity of the two entities should make us more visible in the public
markets, increase our borrowing, buying, marketing and recruitment power, and
enhance our ability to compete in a consolidating industry. Results of
operations of API will be included with those of the Company commencing as of
the acquisition date. The total purchase price was $45,140,000 and consisted of
consideration of $35,000 in cash and 1,982,499 shares of the Company's common
stock, valued at a per share price of $17.64, or $34,961,000 in aggregate,
10,197.95 shares of preferred stock valued at $9,179,000, plus costs to complete
the acquisition of $965,000.
The foregoing purchase price allocation is of a preliminary nature and
will be finalized upon the analysis of all relevant information related to the
net assets acquired.
During the first quarter of 2007, we earned fees totaling $3,718,000
from APIE.
- 17 -
The purchase price will be allocated to the balance sheet of API as follows:
(In thousands)
ASSETS 3-31-07
----------
Investments:
Fixed maturities available for sale, at fair value $145,354
Equities securities, at fair value 6,851
Short-term investments 177
Other invested assets 1,671
--------
Total investments 154,053
Cash and cash equivalents 9,910
Accrued investment income 793
Premium, maintenance fees and receivables 14,647
Other amounts receivable under reinsurance contracts 1,373
Reinsurance recoverables on paid & unpaid loss and
loss adjustment expenses 26,950
Prepaid reinsurance premiums 311
Deferred policy acquisition costs 2,404
Deferred tax asset 4,807
Subrogation recoverables 412
Other assets 358
--------
Total $216,018
========
LIABILITIES AND SHAREHOLDERS' EQUITY 3-31-07
----------
Liabilities:
Reserve for losses and loss adjustment expenses $116,227
Unearned premiums and maintenance fees 36,516
Reinsurance premiums payable 253
Funds held under reinsurance treaties 11,112
Amounts withheld or retained by the Exchange 1,360
Federal income taxes payable 2,263
Other liabilities 3,147
---------
Total Liabilities 170,878
Purchase Price 45,140
---------
Total 216,018
=========
- 18 -
STOCK DIVIDENDS/REDEMPTIONS
COMMON: On May 8, 2007, our board of directors declared a cash dividend
on our common stock of $0.30 to holders of record as of May 18, 2007. In 2006,
2005 and 2004, we declared cash dividends on our common stock of $0.30, $0.25
and $0.20, respectively, per share of common stock resulting in total dividend
payments of approximately $838,000, $671,000 and $518,000, respectively. Prior
to 2004, we had never declared or paid any cash dividends on our common stock.
Our policy has been to retain our earnings to finance growth and development.
The declaration and payment of any future dividends on our common stock is at
the sole discretion of our board of directors, subject to our financial
condition, capital requirements, future prospects and other factors deemed
relevant.
PREFERRED: On May 8, 2007, our board declared its intention to make a
payment to redeem, ratably, $1 million of our Series A redeemable preferred
stock, together with the required cash dividend equal to 3% per annum of the
outstanding redemption value of the Series A redeemable preferred stock, to
holders of record as of May 18, 2007.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
Forward-Looking Statements
Our statements contained in this report that are not purely historical
are forward-looking statements within the meaning of Section 27A of the
Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934,
including statements regarding our expectations, hopes, intentions or strategies
regarding the future. You should not place undue reliance on forward-looking
statements. All forward-looking statements included in this report are based on
information available to us on the date hereof, and we assume no obligation to
update any such forward-looking statements. It is important to note that our
actual results could differ materially from those in the forward-looking
statements. In addition to any risks and uncertainties specifically identified
in the text surrounding the forward-looking statements, you should consult our
reports on Forms 10-K and our other filings under the Securities Act of 1933 and
the Securities Exchange Act of 1934, for factors that could cause our actual
results to differ materially from those presented.
The forward-looking statements included herein are necessarily based on
various assumptions and estimates and are inherently subject to various risks
and uncertainties, including risks and uncertainties relating to the possible
invalidity of the underlying assumptions and estimates and possible changes or
developments in social, economic, business, industry, market, legal and
regulatory circumstances and conditions and actions taken or omitted to be taken
by third parties, including customers, suppliers, business partners and
competitors and legislative, judicial and other governmental authorities and
officials. Assumptions relating to the foregoing involve judgments with respect
to, among other things, future economic, competitive and market conditions and
future business decisions, all of which are difficult or impossible to predict
accurately and many of which are beyond our control. Any of these assumptions
could be inaccurate and, therefore, there can be no assurance that the
forward-looking statements included in this report will prove to be accurate.
- 19 -
GENERAL. We provide (1) insurance services, including management and agency
services to APIE, and (2) financial services, including brokerage and investment
services to individuals and institutions.
INSURANCE SERVICES. Through Insurance Services we provide management and agency
services to APIE through a wholly owned subsidiary:
APS Facilities Management, Inc., dba APMC Insurance Services, Inc., or
FMI. FMI provides management and administrative services to APIE, a
regional insurance exchange that sells medical professional liability
insurance only to its physician subscribers, who pay annual insurance
premiums and maintenance fees to APIE. APIE is governed by a physician
board of directors. Pursuant to a management agreement and the
direction of this board, FMI manages and operates APIE, including
performing policy issuance, claims investigation and settlement, and
all other management and operational functions. As a management fee,
FMI receives a percentage of APIE's earned premiums and a portion of
APIE's profit, subject to a cap based on premium levels. We recognize
revenues for the management fee portion based on a percentage of earned
premium on a monthly basis, and we recognize revenues on profit sharing
in the fourth quarter, when it is certain the managed company will have
an annual profit. FMI's assets are not subject to APIE policyholder
claims. Effective with the acquisition of APIE on April 1, 2007 as
discussed below, management fees will no longer be collected.
FINANCIAL SERVICES. We provide investment and investment advisory services to
institutions and individuals throughout the United States through the following
subsidiaries:
o APS FINANCIAL. APS Financial is a fully licensed broker/dealer that
provides brokerage and investment services primarily to institutional
and high net worth individual clients. APS Financial also provides
portfolio accounting, analysis, and other services to insurance
companies, banks and public funds. We recognize commissions revenue,
and the related compensation expense, on a trade date basis.
o APS CAPITAL. APS Capital is dedicated to the clearing and settlement of
trades involving syndicated bank loans, trade claims and distressed
private loan portfolios. We seek to develop business with clients who
trade in the high-yield bond market. We recognize commissions revenue,
and the related compensation expense, when the transaction is complete
and fully funded.
o ASSET MANAGEMENT. Asset Management, a registered investment adviser
under the Investment Advisers Act of 1940, manages fixed income and
equity assets for institutional and individual clients on a fee basis.
We recognize fee revenues monthly based on the amount of funds under
management.
OTHER. As of March 31, 2007, we owned 385,000 shares of FIC, representing
approximately 4% of its outstanding common stock. FIC is also considered a
related party as a result of our Chairman/CEO also being a member of the Board
of Directors of FIC. We account for this investment as an available-for-sale
security, which means it is reflected on our consolidated balance sheets at fair
value, and fluctuations in fair value are recognized as unrealized gains or
losses excluded from earnings and reported as a separate component of
stockholders' equity, net of income taxes. An exception to this accounting
policy would be if an available-for-sale security incurs a loss that is deemed
to be other-than-temporary as described in Note 8 to this Form 10-Q.
- 20 -
ACQUISITION. On April 1, 2007, we acquired all of the issued and outstanding
stock of American Physicians Insurance Company, the stock company formed as a
result of the demutualization of APIE, in a business combination which will be
accounted for using the purchase method of accounting. The acquisition was done
for the purpose of increasing shareholder value through greater financial
strength and increased growth potential. The total purchase price was $
44,439,000 and consisted of consideration of $ 35,000 in cash and 1,982,499
shares of the Company's common stock, valued at a per share price of $ 17.28, or
$ 34,260,000 in aggregate, 10,197.95 shares of preferred stock valued at
$9,179,000, plus costs to complete the acquisition of $ 965,000. Though we
cannot comment on the merger's impact upon future earnings, historical proforma
financial statements of the consolidated entities show this transaction to be
accretive to earnings with more than $80 million in annual revenues, total
assets of over $200 million and equity in excess of $50 million.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The preparation of our consolidated financial statements requires us to
make estimates and judgments that affect the reported amounts of assets,
liabilities, revenues and expenses. On an on-going basis, we evaluate our
estimates, including those related to: impairment of assets; bad debts; income
taxes; and contingencies and litigation. We base our estimates on historical
experience and on various other assumptions that we believe to be reasonable
under the circumstances, the results of which form the basis for making
judgments about the carrying values of assets and liabilities that are not
readily apparent from other sources. Actual results may differ from these
estimates under different assumptions or conditions.
We believe the following critical accounting policies and estimates
affect our more significant judgments and estimates used in the preparation of
our consolidated financial statements. We periodically review the carrying value
of our assets to determine if events and circumstances exist indicating that
assets might be impaired. If facts and circumstances support this possibility of
impairment, our management will prepare undiscounted and discounted cash flow
projections, which require judgments that are both subjective and complex.
Management may also obtain independent valuations.
Our financial services revenues are composed primarily of commissions
on securities trades and clearing of trade claims and asset management fees.
Revenues related to securities transactions are recognized on a trade date
basis. Revenues from the clearing and settlement of trades involving syndicated
bank loans, trade claims and distressed private loan portfolios are recognized
when the transaction is complete and fully funded. Asset management fees are
recognized as a percentage of assets under management during the period based
upon the terms of agreements with the applicable customers.
Our insurance service revenues related to management fees are
recognized monthly at 13.5% of the earned premiums of the managed company. We
also share equally any profits of the managed company, to a maximum of 3% of the
earned insurance premiums. Any past losses of the managed company are carried
forward and applied against earnings before any profits are shared. The profit
sharing component has historically been recorded in the fourth quarter based on
the audited financial results of the managed company. Since, the management
contract ended March 31, 2007, we recognized the quarter's profit sharing in
March, based on our ability to fully determine the profit sharing base.
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STOCK-BASED COMPENSATION
In December 2004, the FASB issued a revision ("SFAS No. 123(R)") to SFAS
No. 123, Accounting for Stock-Based Compensation ("SFAS No. 123"), and we were
required to adopt SFAS No. 123(R) in the first quarter of 2006. SFAS No. 123(R)
supersedes Accounting Principles Board Opinion No. 25, Accounting for Stock
Issued to Employees (APB No. 25), and related Interpretations, and requires that
all stock-based compensation, including options, be expensed at fair value, as
of the grant date, over the vesting period. Companies are required to use an
option pricing model (e.g.: Black-Scholes or Binomial) to determine compensation
expense, consistent with the model previously used in the already required
disclosures of SFAS No. 148, Accounting for Stock-Based Compensation-Transition
and Disclosure.
At March 31, 2007, we have several stock-based compensation plans, which
are described more fully in Notes 12 and 13 to the audited consolidated
financial statements contained in our most recently filed Annual Report on Form
10-K. Prior to January 1, 2006, the Company accounted for these plans under the
recognition and measurement principles of APB No. 25, under which stock-based
employee compensation cost was not reflected in net income, as all options
granted under these plans had an exercise price equal to the market value of the
underlying common stock on the date of grant. In accordance with SFAS No. 123,
as amended by SFAS No. 148, the Company provided footnote disclosure of the pro
forma stock-based compensation cost, net loss and net loss per share as if the
fair-value based method of expense recognition and measurement prescribed by
SFAS No. 123 had been applied to all employee options.
- 22 -
RESULTS OF OPERATIONS
REVENUES
Revenues from operations increased $1,640,000 (23%) to $8,873,000 from
$7,233,000 in the three months ended March 31, 2007 compared to the same period
in 2006. Our operating income decreased $835,000 (124%) to a loss of $159,000
from a profit of 676,000 in the current year three months compared to the same
period in 2006. Our net income decreased $657,000 (117%) to a loss of $95,000
from a profit of $562,000 in the current year three months, compared to the same
period in 2006. Lastly, our diluted net income per share decreased $0.22 to a
loss of $0.03 per share from a profit of $0.19 per share in the current year
three months compared to the same period in 2006. The reasons for these changes
are described below.
INSURANCE SERVICES. Total revenues from our insurance services segment were
virtually unchanged in the three month period ended March 31, 2007 compared to
the same period in 2006, increasing approximately $2,000 to $3,657,000 from
$3,655,000. The individual components of total revenues did, however, vary
significantly. As a result of the merger between APIE and us, effective April 1,
2007, we earned and recorded contingent management fees through March 31, 2007.
Prior to the merger, we historically recognized a full year's contingent
management fee in the fourth quarter of each year for this profit sharing
component of management fees. With the merger, we recorded approximately
$496,000 for the three months ended March 31, 2007 compared to zero during the
same period in 2006. Since the management contract ended March 31, 2007, we
recognized the quarter's profit sharing in March, based on our ability to fully
determine the profit sharing base. Basic management fees were down $138,000 (6%)
to $2,233,000 from 2,371,000 in the three months ended March 31, 2007 compared
to the same period in 2006 as a result of $1.2 million lower earned premiums for
APIE over this same period. Earned premiums were $17.5 million for the three
months ended March 31, 2007 compared to $16.3 million for the same period in
2006. The decrease in earned premiums for APIE was the result of lower written
premiums of $4.0 million (23%) to $13.5 million from $17.5 million for the three
months ended March 31, 2007 as compared to the same period in 2006. This
decrease in written premiums was primarily due to increased competition and
premium rate decreases. Of the $4.0 million in lower written premiums for the
current quarter as compared to the same period in 2006, new business written
premiums for APIE decreased $3.7 million (91%) and renewal premiums decreased
$405,000 (3%), respectively. The decline in renewal premiums was primarily the
result of continued rate pressure created by increased competition, which caused
renewal rates to decline an average of 18% for the quarter ending March 31, 2007
as compared to the same period in 2006. While rate decreases and increased
competition continue to create downward pressure on written and earned premiums
for APIE, the exchange increased overall policyholder headcount by 1.5% to 4,775
from 4,712 for the current quarter, driven predominately by headcount retention
on renewal business which was in excess of 90% and the addition of new business
in the current quarter. Pass through commission income was down $287,000 (23%)
to $989,000 from $1,277,000 in the current quarter compared to the same period
in 2006 as a result of the above discussed decrease in premiums written for
APIE. As noted in the following paragraph, commissions paid to third party
independent agents decreased by an equivalent amount, resulting in no impact on
net income.
- 23 -
Insurance services expenses increased $1,069,000 (39%) to $3,823,000
from $2,754,000 in the three months ended March 31, 2007 compared to the same
period in 2006. The current quarter increase was primarily due to an expense
recognized for the fully-vested stock options awarded to the former board
members of APIE pursuant to the terms of the merger agreement between APIE and
us. The cost recognized during the current quarter for these stock options
amounted to approximately $891,000. In addition, deferred compensation awards
totaling approximately $260,000 were granted during the current quarter to
certain individuals as additional incentive for their individual efforts in
effectuating the merger. In addition, payroll and professional fees were higher
in the first quarter of 2007 compared to the same period in 2006. Payroll
increased $89,000 (11%) to $925,000 from $836,000 due to regular annual employee
merit raises as well as the hiring of additional personnel. Professional fees
were $65,000 (107%) higher in 2007 to $126,000 from $61,000 due primarily to
consulting fees related to the selection of new policy and claims software for
our newly acquired subsidiary. Partially offsetting these increases is the
previously discussed decrease in commissions paid to third party independent
agents. These pass through commission expenses declined $287,000 (23%) to
$989,000 from $1,277,000 during the first quarter of 2007 compared to the same
period in 2006.
FINANCIAL SERVICES. Our financial services revenue increased $1,638,000
(46%) to $5,216,000 from $3,578,000 in the first three months of 2007 compared
to the same period in 2006. APS Financial, our broker/dealer subsidiary, derives
most of its revenue from transactions in the fixed income market, in both
investment and non-investment grade securities. Commission revenue at APS
Financial was up by $2,013,100 (78%) to $4,595,000 from $2,582,000 reflecting an
increase in the general trading activity of debt securities as well as some
specific trading that resulted from customer profit taking of prior positions.
These broker/dealer commission revenues were up despite the closure of our
Houston office which had accounted for $470,000 in commissions in the first
quarter of 2006. This revenue gain was partially offset by an aggregate $375,000
(38%) decrease in revenues, to $621,000 from $996,000, from other operations,
including investment banking and bank debt / trade claim transactions, which was
largely the result from timing of the closing of various investment banking
placements. The environment for trading in both investment grade and
non-investment grade securities remains difficult due to various factors
including low level of interest rates combined with low volatility, a flat
treasury curve, low corporate default rates and price transparency.
Our financial services expenses increased $1,152,000 (35%) to
$4,437,000 from $3,285,000 in the three months ended March 31, 2007 compared to
the same period in 2006. The primary reason for the current year increase is a
$1,002,000 (51%) increase to $2,985,000 from $1,983,000 in commission expense in
the current year three month period compared to the same period in 2006
resulting from commissions paid on increased commission revenues earned. In
addition, incentive compensation expense increased $171,000 (346%) to $221,000
from $50,000 in the current quarter as a result of an $840,000 (257%) increase
to $1,166,000 from $326,000 in pre-tax earnings net of incentive compensation
expense. Finally, stock option expense in the current three months totaled
$46,000 in 2007 compared to zero in the same three months in 2006. Partially
offsetting these increases in expenses are decreases in payroll, benefits and
rent. Payroll was down $55,000 (10%) to $483,000 from $537,000, employee
benefits was down $38,000 (13%) to $256,000 from $295,000 and rent was down
$22,000 (40%) to $33,000 from $56,000 in the three months ended March 31, 2007
compared to the same period in 2006 as a result of the decision made in the
third quarter of 2006 to close the Houston office and consolidate trading into
our Austin, Texas office.
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GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative
expenses increased $259,000 (50%) to $777,000 from $518,000 in the three month
period ended March 31, 2007 compared to the same period in 2006. The increase is
due in part to deferred compensation awards resulting primarily from the
recruitment and hiring during the quarter of our new company president and chief
operating officer, Tim LaFrey. The cost associated with these deferred shares in
the current quarter totaled $162,000. In addition, board fees increased $28,000
(69%) to $70,000 from $42,000 in the current quarter as a result of additional
board meetings held in 2007 to primarily discuss and prepare for the merger.
Lastly, professional fees increased $19,000 (172%) to $30,000 from $11,000 in
the current quarter as a result of accruals for the independent audit of our
internal controls to comply with the Sarbanes-Oxley Act of 2002.
GAIN ON INVESTMENTS. The gain in 2007 primarily represents the receipt
of cash in payment for a note that had been written off as uncollectible in
2005. In addition, a gain of approximately $9,000 was recorded resulting from
the sale of shares of available-for-sale equity securities. The gain in 2006
represents a small gain on the sale of an available-for-sale fixed income
security.
LOSS ON IMPAIRMENT OF INVESTMENT. The loss recorded in the first quarter
of 2007 represents a write-down of our investment in Financial Industries
Corporation, or FIC, common stock, having previously resolved that declines in
FIC's stock price will be considered to be "other than temporary". Our policy in
regards to our investment in FIC is that we will record pretax charges to
earnings should the common stock price on the last day of each interim or annual
period fall below the adjusted cost basis of our investment in FIC. In the first
three months of 2007, that charge totaled approximately $423,000, calculated by
multiplying the total number of FIC shares we own (385,000) by the change in our
adjusted basis in FIC common stock at December 31, 2006 ($7.60 per share) and
its fair market value at March 31, 2007 ($6.50 per share). FIC is also
considered a related party as a result of our Chairman/CEO also being a member
of the Board of Directors of FIC. We will continue to monitor and evaluate the
situation at Financial Industries.
INTEREST INCOME. Our interest income increased $137,000 (70%) to $334,000
from 197,000 in the three month period ended March 31, 2007 compared to the same
period in 2006. The current year three month increase was primarily due to
higher rates as well as a much higher balance of interest-bearing fixed income
securities. At March 31, 2007 there was a balance in investment securities held
of $17.6 million compared to a balance of $14.5 million held at March 31, 2006.
In addition, in the current quarter we received interest on a loan that had been
defaulted upon during 2006 totaling $23,900.
OTHER INCOME. Our other income increased $13,000 (217%) to $19,000 from
$6,000 for the three month period ended March 31, 2007 compared to the same
period in 2006. The increase in the current year three month period is due in
part to small inventory gains on securities held at APS Financial in 2007
compared to small inventory losses in 2006.
MINORITY INTEREST. For the three months ended March 31, 2007 and 2006,
minority interest represents a 3% interest in Asset Management, a subsidiary
within our financial services segment, owned by key individuals within Asset
Management.
- 25 -
CASH FLOWS. Our total cash and cash equivalents balance at March 31, 2007
increased $585,000 (14%) to $4,827,000 from $4,242,000 in the current year as
cash provided by operating and financing activities more than offset by net cash
used in investing activities. Our cash flows provided from operating activities
totaled $1,595,000 for the current quarter due in part to cash received from
APIE for 2006 profit sharing ($2.0 million) that was recorded in 2006. Partially
offsetting this was cash paid in the current quarter for incentive compensation
earned and accrued in 2006 ($2.2 million). Our cash flows used in investing
activities totaled $1,124,000 in the first three months of 2007 primarily as a
result of purchases of available-for-sale fixed income securities in excess of
proceeds from their sale. Our cash provided by financing activities totaled
$114,000 in the first quarter of 2007 primarily as a result of cash received
from the exercise of stock options. For details of the amounts described above,
refer to the Condensed Consolidated Statements of Cash Flows on page 7 of this
Form 10-Q.
LIQUIDITY AND CAPITAL RESOURCES
WORKING CAPITAL. Our net working capital was $18,616,000 and
$19,247,000 at March 31, 2007 and December 31, 2006, respectively. The decrease
in the current year was due primarily to the purchase of a restricted available
for sale fixed income security that will be held in escrow as part of the terms
of the merger required by the Texas Department of Insurance. These funds are to
remain in escrow until the aggregate remaining redemption obligation of our
Series A redeemable preferred stock is less than the amount of the escrow
balance. As this is not likely to occur within the next twelve months, the $2.5
million security is classified as long-term, thus reducing working capital.
Historically, we have maintained a strong working capital position and,
as a result, we have been able to satisfy our operational and capital
expenditure requirements with cash generated from our operating and investing
activities. These same sources of funds have also allowed us to pursue
investment and expansion opportunities consistent with our growth plans.
Although there can be no assurance our operating activities will provide
positive cash flow in 2007, we are optimistic that our working capital
requirements will be met for the foreseeable future for the following reasons:
(1) our current cash position is very strong, with a balance of approximately
$4.8 million comprising 12 percent of our total assets; (2) our investments in
available-for-sale equity and fixed income securities could provide an
additional $18.9 million should the need arise; and (3) we renewed a line of
credit effective April 2007 that is described below.
LINE OF CREDIT. We renewed a $3 million line of credit that was originally
established in November 2003 with PlainsCapital Bank. The loan calls for
interest payments only to be made on any amount drawn until April 15, 2008, when
the entire amount of the note, principal and interest then remaining unpaid,
became due and payable. At March 31, 2007, there have never been any draws taken
against this line of credit. We are in compliance with the covenants of the loan
agreement, including requirements for a minimum of $5 million of unencumbered
liquidity and a minimum 2 to 1 net worth ratio.
CAPITAL EXPENDITURES. Our capital expenditures for equipment were $44,000
in the three months of 2007. The majority of these expenditures were primarily
hardware and software upgrades to our computer network. We expect capital
expenditures in 2007 to be approximately $1,600,000, the majority of which will
be spent in the latter half of 2007 for the installation of new policy and
claims administration hardware and software. All capital expenditures are
expected to be funded through cash on hand.
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ADOPTION OF RECENT ACCOUNTING PRONOUNCEMENTS
In February, 2006 the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards, or SFAS, No. 155, Accounting for
Certain Hybrid Financial Instruments, an amendment of FASB Statements No. 133
and 140. SFAS 155 becomes effective for all financial instruments acquired or
issued after the beginning of an entity's first fiscal year that begins after
September 15, 2006. This Statement permits fair value remeasurement for any
hybrid financial instrument that contains an embedded derivative that otherwise
would require bifurcation; clarifies which interest-only strips and
principal-only strips are not subject to the requirements of Statement 133;
establishes a requirement to evaluate interests in securitized financial assets
to identify interests that are freestanding derivatives or that are hybrid
financial instruments that contain an embedded derivative requiring bifurcation;
clarifies that concentrations of credit risk in the form of subordination are
not embedded derivatives; and amends Statement 140 to eliminate the prohibition
on a qualifying special-purpose entity from holding a derivative financial
instrument that pertains to a beneficial interest other than another derivative
financial instrument. We do not expect the adoption of this standard to have a
material effect on our financial position, results of operations or cash flows.
In July 2006, the Financial Accounting Standards Board (FASB) issued FASB
Interpretation No. 48, Accounting for Uncertainty in Income Taxes--an
interpretation of FASB Statement No. 109 (FIN 48), which we adopted on January
1, 2007. FIN 48 clarifies the accounting for income tax uncertainties. The
company has developed and implemented a process based on the guidelines of FIN
48 to ensure that uncertain tax positions are identified, analyzed and properly
reported in the company's financial statements in accordance with SFAS 109.
Based on all known facts and circumstances and current tax law, the company
believes that the total amount of unrecognized tax benefits as of January 1, and
April 1, 2007, is not material to its results of operations, financial condition
or cash flows. The company also believes that the total amount of unrecognized
tax benefits as of January 1, and March 31, 2007, if recognized, would not have
a material effect on its effective tax rate. The company further believes that
there are no tax positions for which it is reasonably possible that the
unrecognized tax benefits will significantly increase or decrease over the next
12 months producing, individually or in the aggregate, a material effect on the
company's results of operations, financial condition or cash flows.
In September 2006, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards, or SFAS No. 157, "Accounting for
Fair Value Measurements", effective for fiscal years beginning after November
15, 2007. This Statement defines fair value, establishes a framework for
measuring fair value in generally accepted accounting principles (GAAP) and
expands disclosures about fair value measurements. Accordingly, this Statement
does not require any new fair value measurements. However, for some entities,
the application of this Statement will change current practice. We do not expect
the adoption of this standard to have a material effect on our financial
position, results of operations or cash flows.
In February, 2007 the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards, or SFAS, No. 159, "Accounting for
The Fair Value Option for Financial Assets and Financial Liabilities" an
amendment of FASB Statement No. 115. This Statement permits entities to choose
to measure many financial instruments and certain other items at fair value. The
objective is to improve financial reporting by providing entities with the
opportunity to mitigate volatility in reported earnings caused by measuring
related assets and liabilities differently without having to apply complex hedge
accounting provisions. We do not expect the adoption of this standard to have a
material effect on our financial position, results of operations or cash flows.
- 27 -
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK
We have exposure to changes in interest rates and the market values of
our investments but have no material exposure to fluctuations in foreign
currency.
INTEREST RATE RISK. Our exposure to market risk for changes in interest
rates relates to both our investment portfolio and our revenues generated
through commissions at our financial services segment. A one percent change in
interest rates on our current cash and fixed income securities balance of
approximately $22.4 million would result in a change of approximately $224,000
annually in interest income. All of our marketable fixed income securities are
designated as available-for-sale and, accordingly, are presented at fair value
on our balance sheets. Fixed rate securities may have their fair market value
adversely affected due to a rise in interest rates, and we may suffer losses in
principal if forced to sell securities that have declined in market value due to
changes in interest rates.
Changes in interest rates could have an impact at our broker/dealer
subsidiary, APS Financial. The general level of interest rates may trend higher
or lower in 2007, and this move may impact our level of business in different
fixed-income sectors. If a generally improving economy is the impetus behind
higher rates, then while our investment grade business may drop off, our high
yield business might improve with improving credit conditions. A volatile
interest rate environment in 2007 could also impact our business as this type of
market condition can lead to investor uncertainty and their corresponding
willingness to commit funds.
As we currently have no debt and do not anticipate the need to take on
any debt in 2007, interest rate changes will have no impact on our financial
position as it pertains to interest expense.
INVESTMENT RISK. As of March 31, 2007, our recorded basis in debt and
equity securities was approximately $21.4 million. We regularly review the
carrying value of our investments and identify and record losses when events and
circumstances indicate that such declines in the fair value of such assets below
our accounting basis are other-than-temporary.
Item 4. CONTROLS AND PROCEDURES
We maintain disclosure controls and procedures that are designed to
ensure that information required to be disclosed by us in reports that we file
or submit under the Securities Exchange Act, is recorded, processed, summarized
and reported within the time periods specified in the SEC's rules and forms and
that such information is accumulated and communicated to our management,
including our Chief Executive Officer and Chief Financial Officer, as
appropriate, to allow timely decisions regarding required disclosures. In
designing and evaluating the disclosure controls and procedures, management
recognizes that any controls and procedures, no matter how well designed and
operated, can provide only reasonable assurances of achieving the desired
control objectives, and management necessarily is required to apply its judgment
in evaluating the cost-benefit relationship of possible controls and procedures.
As of the end of the period covered by this report, and under the supervision
and with the participation of our management, including our Chief Executive
Officer and Chief
- 28 -
Financial Officer, we evaluated the effectiveness of the design and operation of
these disclosure procedures. Based on this evaluation and subject to the
foregoing, our Chief Executive Officer and Chief Financial Officer concluded
that our disclosure controls and procedures were effective in reaching a
reasonable level of assurance of achieving management's desired controls and
procedures objectives.
There have been no changes in internal controls over financial
reporting that occurred during our most recent fiscal quarter that have
materially affected, or are reasonably likely to affect, our internal control
over financial reporting.
As part of a continuing effort to improve our business processes we are
evaluating our internal controls and may update certain controls to accommodate
any modifications to our business processes or accounting procedures.
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PART II
OTHER INFORMATION
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Item 1. LEGAL PROCEEDINGS
We are involved in various claims and legal actions that have arisen in
the ordinary course of business. Management believes that any liabilities
arising from these actions will not have a significant adverse effect on our
financial condition or results of operations.
Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Items 2(a) through(d) are inapplicable.
(e) Stock Repurchases
(d) Maximum
(c) Total Number Dollar Value
of Shares of Shares that
(a) Total Purchased as Part May Yet be
Number (b) Average of Publicly Purchased under
of shares Price Paid Announced Plans The Plans
Period Purchased Per Share or Programs Programs
----------- ---------- -------------- --------------- -------------
Jan 1, 2007 - Jan 31, 2007 2,301 $15.99 2,301 1,593,000
Feb 1, 2007 - Feb 28, 2007 - 0 - $ - 0 - - 0 - 1,593,000
Mar 1, 2007 - Mar 31, 2007 - 0 - $ - 0 - - 0 - 1,593,000
(1) Of the total shares purchased 2,301 were purchased in open market
transactions and none were purchased in private transactions. Our
original share repurchase program was announced August 17, 2004
and was increased in $2,000,000 increments on December 12, 2005
and on June 30, 2006.
Item 3. DEFAULTS UPON SENIOR SECURITIES
Not Applicable
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On March 22, 2007 a Special Meeting of Shareholders was held at the
Company's home office in Austin, Texas. At the meeting, the shareholders were
asked to approved the following three items:
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1. To consider and vote upon a proposal for the Company's
shareholders to approve the issuance of the Company's common stock
to the persons entitled to receive stock, as a result of the
conversion of American Physicians Insurance Exchange, or APIE,
into a Texas stock insurance company called American Physicians
Insurance Company, or APIC, immediately followed by the merger of
a wholly owned subsidiary of the Company with and into APIC, with
APIC becoming a wholly owned subsidiary of the Company as a result
of the transactions contemplated by the Merger Agreement and Plan
of Merger, dated June 1, 2006, as amended.
The votes for, against and abstained are as follows:
For Against Abstain
--- ------- -------
2,294,258 8,520 404
The merger passed and the acquisition will close effective April 1,
2007.
2. To consider and vote upon a proposed amendment to our 2005
Incentive and Non-Qualified Stock Option Plan to increase the
number of shares of common stock that may be granted under the
plan from 350,000 to 650,000.
The votes for, against and abstained are as follows:
For Against Abstain
--- ------- -------
2,008,189 173,484 121,509
The measure passed.
3. To consider and vote upon a proposed amendment to our 2005
Incentive and Non-Qualified Stock Option Plan to eliminate the
exchange provision allowing us to exchange or buy out any
previously granted stock option at any time.
The votes for, against and abstained are as follows:
For Against Abstain
--- ------- -------
2,142,358 158,815 2,009
The measure passed
Item 5. OTHER INFORMATION
Not Applicable
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Item 6. EXHIBITS
Exhibits
31.1 Section 302 Certification of Chief Executive Officer
31.2 Section 302 Certification of Chief Financial Officer
32.1 Section 906 Certification of Chief Executive Officer
32.2 Section 906 Certification of Chief Financial Officer
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