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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
JUNE 30, 2006
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 shell company (as defined in
Rule 12b-2 of the Exchange 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 August 1, 2006
-------------------- ----------------
Common Stock, $.10 par value 2,758,120
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PART I
FINANCIAL INFORMATION
- 2 -
Item 1 - Financial Statements
AMERICAN PHYSICIANS SERVICE GROUP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(In thousands, except per share data)
Three Months Ended Six Months Ended
June 30, June 30,
--------------------------------- ---------------------------------
2006 2005 2006 2005
------------- ------------- ------------- -------------
Revenues:
Insurance services $3,175 $3,335 $6,830 $6,730
Financial services 4,800 3,698 8,378 6,965
------ ------ ------ ------
Total revenues 7,975 7,033 15,208 13,695
Expenses:
Insurance services 2,647 2,422 5,401 4,925
Financial services 4,158 3,270 7,443 6,220
General and administrative 482 722 1,000 1,389
Gain on sale of assets (Note 4) (2) (49) (2) (84)
----- ----- ----- ------
Total expenses 7,285 6,365 13,842 12,450
----- ----- ------ ------
Operating income 690 668 1,366 1,245
Gain on investments (Note 5) 13 1,346 20 1,976
Loss on impairment of investment (Note 6) - (57) - (96)
----- ----- ------ -----
Income from operations before interest,
income taxes and minority interest 703 1,957 1,386 3,125
Interest income 223 125 420 247
Other income 4 29 10 84
Interest expense 2 - 2 4
Income tax expense 329 742 652 1,219
Minority interests 1 2 2 13
------ ------ ------ ------
Net income $598 $1,367 $1,160 $2,220
====== ====== ====== ======
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 Six Months Ended
June 30, June 30,
---------------------- -----------------------
2006 2005 2006 2005
------ ------ ------ ------
Net income per common share
Basic:
Income from operations $ 0.22 $ 0.51 $ 0.42 $ 0.84
------ ------ ------ ------
Net income $ 0.22 $ 0.51 $ 0.42 $ 0.84
====== ====== ====== ======
Diluted:
Income from operations $ 0.21 $ 0.48 $ 0.40 $ 0.77
------ ------ ------ ------
Net income $ 0.21 $ 0.48 $ 0.40 $ 0.77
====== ====== ====== ======
Basic weighted average shares
outstanding 2,762 2,656 2,762 2,649
====== ====== ====== ======
Diluted weighted average
shares outstanding 2,917 2,876 2,936 2,892
====== ====== ====== ======
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)
June 30, December 31,
2006 2005
---------- -----------
ASSETS
Current Assets:
Cash and cash equivalents $5,780 $6,680
Trade receivables, net 2 42
Notes receivable - current 584 599
Management fees and other receivables 927 3,192
Deposit with clearing organization 501 501
Investment in available-for-sale fixed
income securities - current (Note 8) 11,655 9,662
Federal income tax receivable 590 --
Net deferred income tax asset 345 355
Prepaid expenses and other (Note 9) 1,185 632
--------- --------
Total current assets 21,569 21,663
Notes receivable, less current portion 378 326
Property and equipment, net 638 687
Investment in available-for-sale equity
securities (Note 7) 5,136 5,017
Investment in available-for-sale fixed
income securities - non-current (Note 8) 1,851 3,584
Net deferred income tax asset 435 686
Goodwill 1,247 1,247
Other assets 251 295
-------- --------
Total Assets $31,505 $33,505
======== =======
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)
June 30, December 31,
2006 2005
-------------- ------------
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $977 $736
Accrued incentive compensation 917 2,595
Accrued expenses and other liabilities (Note 10) 1,978 1,912
Federal income tax payable -- 71
Deferred gain 375 469
------ ------
Total current liabilities 4,247 5,783
------ ------
Total liabilities 4,247 5,783
Minority interests 17 15
Commitments and contingencies (Note 3)
Shareholders' Equity:
Preferred stock, $1.00 par value, 1,000,000
shares authorized, none issued or outstanding -- --
Common stock, $0.10 par value, shares authorized 20,000,000;
2,762,831 and 2,784,120 issued and outstanding
at 6/30/06 and 12/31/05, respectively 276 278
Additional paid-in capital 7,333 8,204
Retained earnings 19,077 18,737
Accumulated other comprehensive income,
net of taxes 555 488
------- -------
Total shareholders' equity 27,241 27,707
------- -------
Total Liabilities and Shareholders' Equity $31,505 $33,505
======= =======
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)
Six Months Ended June 30,
2006 2005
------- -------
Cash flows from operating activities:
Net Income $ 1,160 $ 2,220
Adjustments to reconcile net income to cash
provided by (used in) operating activities:
Depreciation and amortization 163 166
Extinguishment of debt and other 201 132
Common stock awarded 102 159
Gain on sale of assets (2) (84)
Deferred gains (92) (244)
Gain on sale of investments (20) (1,976)
Impairment of investment -- 96
Changes in operating assets and liabilities:
Trade receivables 40 11
Income tax receivable (690) (52)
Deferred income tax 261 (226)
Deferred compensation 22 --
Management fees & other receivables 2,265 898
Prepaid expenses & other assets (593) (135)
Trade payables 241 (40)
Accrued expenses & other liabilities (1,594) (2,092)
------ ------
Net cash provided by (used in) operating activities 1,464 (1,167)
Cash flows from investing activities:
Capital expenditures (103) (171)
Proceeds from the sale of available-for-sale equity
and fixed income securities 4,760 4,175
Purchase of available-for-sale equity securities (4,988) (5,281)
Funds loaned to others (248) (770)
Collection of notes receivable 10 146
------ ------
Net cash used in investing activities (569) (1,901)
Cash flows from financing activities:
Exercise of stock options 504 568
Purchase and cancellation of treasury stock (1,991) (1,114)
Stock options expensed 157 --
Excess tax benefits from stock-based compensation 355 --
Dividends paid (820) --
------ ------
Net cash used in financing activities (1,795) (546)
Net change in cash and cash equivalents $ (900) $ (3,614)
Cash and cash equivalents at beginning of period 6,680 9,673
------- -------
Cash and cash equivalents at end of period $ 5,780 $ 6,059
======= =======
The accompanying notes are an integral part of these condensed consolidated
financial statements.
- 7 -
AMERICAN PHYSICIANS SERVICE GROUP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY AND
COMPREHENSIVE INCOME (LOSS)
For the six months ended June 30, 2005 and June 30, 2006
(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, 2004 $ 265 $ 7,919 $ 13,948 $ -- $ 2,081 $ -- $ 24,213
------------------------------------------------------------------------------------------------
Comprehensive income:
Net income -- -- 2,220 $ 2,220 -- -- 2,220
Other comprehensive income:
Unrealized loss on securities,
net of taxes of $229 -- -- -- (445) (445) -- (445)
------
Comprehensive income -- -- -- $1,775 -- -- --
======
Stock options exercised 11 557 -- -- -- -- 568
Tax benefit from exercise
of stock options -- 166 -- -- -- -- 166
Treasury stock purchases -- -- -- -- -- (1,114) (1,114)
Cancelled treasury stock (9) (1,105) -- -- -- 1,114 --
Stock based compensation 1 158 -- -- -- -- 159
------------------------------------------------------------------------------------------------
Balance June 30, 2005 $ 268 $ 7,695 $16,168 $ -- $ 1,636 $ -- $ 25,767
================================================================================================
Balance December 31, 2005 $ 278 $ 8,204 $ 18,737 $ -- $ 488 $ -- $ 27,707
------------------------------------------------------------------------------------------------
Comprehensive income:
Net income -- -- 1,160 $1,160 -- -- 1,160
Other comprehensive income:
Unrealized gain on securities,
net of taxes of $34 -- -- -- 67 67 -- 67
-----
Comprehensive income -- -- -- $1,227 -- -- --
=====
Stock options expensed -- 157 -- -- -- -- 157
Stock options exercised 11 493 -- -- -- -- 504
Tax benefit from exercise
of stock options -- 355 -- -- -- -- 355
Treasury stock purchases -- -- -- -- -- (1,991) (1,991)
Cancelled treasury stock (14) (1,977) -- -- -- 1,991 --
Stock based compensation 1 101 -- -- -- -- 102
Dividend paid (per share-$0.30) -- -- (820) -- -- -- (820)
------------------------------------------------------------------------------------------------
Balance June 30, 2006 $ 276 $ 7,333 $19,077 $ -- $ 555 $ -- $ 27,241
================================================================================================
The accompanying notes are an integral part of these condensed consolidated
financial statements.
- 8 -
AMERICAN PHYSICIANS SERVICE GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2006
(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 for the six months ended June 30, 2006 and
2005 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, 2005 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.
- 9 -
4. GAIN ON SALE OF ASSETS
During the three and six month periods ended June 30, 2006, we recognized
approximately $140,000 and $281,000, respectively, of deferred gain related to
the November 2001 sale and subsequent leaseback of real estate to Prime Medical
(now called HealthTronics, Inc.). Recognition of deferred gains was nearly
identical in both periods in 2005 as well. Due to our continuing involvement in
the property, we deferred recognizing approximately $2,400,000 of the
approximately $5,100,000 gain and are recognizing it in earnings, as a reduction
of rent expense, monthly through September 2006. A total of $141,000 in deferred
gains remains to be recognized in the coming three months, with the final amount
recognized in September, 2006. In addition, 15% of the gain ($760,000) related
to our then 15% ownership in the purchaser, was deferred. As our ownership
percentage in HealthTronics declines through our sales of HealthTronics common
stock, we recognize these gains proportionately to our reduction of our interest
in HealthTronics. During the three and six month periods ended June 30, 2006 we
recognized approximately $2,000 and $2,000, respectively, of these deferred
gains as a result of HealthTronics common stock sold in these periods. As of
June 30, 2006, there remained a balance of approximately $45,000 in deferred
gains to be recognized in future periods.
5. GAIN (LOSS) ON INVESTMENTS
Our gains resulted primarily from the sales of available-for-sale equity
and fixed income securities. During the three and six month periods ended June
30, 2006 we received net cash proceeds of approximately $2,055,000 and
$4,795,000, respectively, and recognized gains of $13,000 and $20,000,
respectively, resulting from these sales and scheduled maturities. These gains
are down substantially from the comparative periods in 2005 where we recognized
$1,346,000 and $1,977,000 in the three and six month periods, respectively, as a
result of selling far fewer shares of an equity security in 2006 resulting from
a drop in its market value.
6. LOSS ON IMPAIRMENT OF INVESTMENT
Although there was no loss taken thus far in 2006, the prior year loss
represents an impairment in the value of our investment in FIC common stock.
During 2004, the value of our investment in FIC had declined significantly. In
October 2004, we determined that this decline in market price should be
considered "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. Consequently, we recorded pre-tax charges to
earnings totaling $2,567,000 in 2004. These charges reduced our cost basis in
FIC from $5,647,000, or $14.67 per share, to $3,080,000, or $8.00 per share
which was equal to the quoted market price of FIC shares on December 31, 2004.
During the first three months of 2005, we took additional pre-tax charges to
earnings totaling $39,000, and ultimately a total of $135,000 during all of
2005, further reducing our cost basis in FIC to $2,945,000, or $7.65 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 2004 and 2005 declines should be viewed as other than
temporary. In July 2005, FIC was able to file its 2003 Form 10-K but has yet to
file any 2004 or 2005 Forms 10-Q or 10-K and thus continues to be de-listed on
the NASDAQ Stock Market.
- 10 -
7. 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 Footnote 6 above, during 2005 and 2004, we
recognized "other than temporary" impairment losses and, accordingly, our
original cost basis in the 385,000 shares of FIC common stock we own has been
reduced from $14.67 per share to $7.65 per share during 2004 and 2005. The
effect of any "other than temporary" impairment loss is to reclassify from
accumulated other comprehensive income 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. As FIC was trading above $7.65 per share at June 30,
2006, no impairment charges were necessary for the six month period.
8. 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).
9. PREPAID AND OTHER CURRENT ASSETS
In June, 2006 we announced plans for a strategic merger with our medical
malpractice partner, American Physicians Insurance Exchange ("APIE"). Both ours
and APIE's Boards of Directors voted to approve the transaction, anticipating a
completion prior to the end of 2006, subject to approval by the Texas Department
of Insurance, necessary filings with the SEC and the approval of the
shareholders of APS and subscriber-policyholders of APIE. We account 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. Should the merger not take place,
these direct costs would be expensed in the period that it was determined that
the merger will not occur. As of June 30, 2006, we have capitalized a total of
$364,000, comprised primarily of legal, accounting, auditing and tax consulting
fees.
10. ACCRUED EXPENSES AND OTHER LIABILITIES
Accrued expenses and other liabilities consists of the following:
June 30 December 31
2006 2005
--------- ----------
Commissions payable $ 856,000 $ 1,258,000
Customer deposits 690,000 --
Taxes payable 56,000 219,000
Vacation 161,000 161,000
401(k) plan matching 140,000 208,000
Other accrued liabilities 75,000 66,000
-------- ----------
$1,978,000 $ 1,912,000
========== ===========
- 11 -
11. NET INCOME PER SHARE
Basic income per share is based on the weighted average shares outstanding
without any dilutive effects considered. Diluted income 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 per share from operations follows:
For the Three Months Ended June 30, 2006
------------------------------------------
Income Shares Per Share
(Numerator) (Denominator) Amount
---------- ---------- ---------
Basic EPS
Net income $ 598,000 2,762,000 $ 0.22
======
Diluted EPS
Effect of dilutive securities -- 155,000
--------- ---------
Net income $ 598,000 2,917,000 $ 0.21
========= ========== ======
For the Three Months Ended June 30, 2005
------------------------------------------
Income Shares Per Share
(Numerator) (Denominator) Amount
--------- ----------- ----------
Basic EPS
Net income $ 1,367,000 2,656,000 $ 0.51
======
Diluted EPS
Effect of dilutive securities -- 220,000
----------- ---------
Net income $ 1,367,000 2,876,000 $ 0.48
=========== ========= ======
- 12 -
For the Six Months Ended June 30, 2006
----------------------------------------
Income Shares Per Share
(Numerator) (Denominator) Amount
---------- ----------- ---------
Basic EPS
Net income $ 1,160,000 2,762,000 $ 0.42
======
Diluted EPS
Effect of dilutive securities -- 174,000
----------- ---------
Net income $ 1,160,000 2,936,000 $ 0.40
=========== ========= ======
For the Six Months Ended June 30, 2005
-----------------------------------------
Income Shares Per Share
(Numerator) (Denominator) Amount
---------- ----------- ---------
Basic EPS
Net income $ 2,220,000 2,649,000 $ 0.84
======
Diluted EPS
Effect of dilutive securities -- 243,000
----------- ---------
Net income $ 2,220,000 2,892,000 $ 0.77
=========== ========= ======
- 13 -
12. SEGMENT INFORMATION
The Company's segments are distinct by type of service provided.
Comparative financial data for the three and six month periods ended June 30,
2006 and 2005 are shown as follows:
Three Months Ended June 30,
2006 2005
----------- -----------
Operating Revenue:
Insurance services $ 3,175,000 $ 3,335,000
Financial services 4,800,000 3,698,000
Corporate 268,000 --
---------- ----------
Total Segment Revenues $ 8,243,000 $ 7,033,000
============ ============
Reconciliation to Consolidated
Statement of Operations:
Total segment revenues $ 8,243,000 $ 7,033,000
Less: Intercompany dividends (268,000) --
----------- ----------
Total Revenues $ 7,975,000 $ 7,033,000
============ ============
Operating Income
Insurance services $ 528,000 $ 913,000
Financial services 642,000 428,000
Corporate (480,000) (673,000)
---------- ----------
Total segments operating income 690,000 668,000
Gain on investments 13,000 1,346,000
Loss on impairment of investment -- (57,000)
---------- ---------
Income from operations before interest,
income taxes and minority interest 703,000 1,957,000
Interest income 223,000 125,000
Other gain 4,000 29,000
Interest expense 2,000 --
Income tax expense 329,000 742,000
Minority interest 1,000 2,000
--------- ---------
Net income $ 598,000 $ 1,367,000
========== ===========
- 14 -
Six Months Ended June 30,
2006 2005
--------- ---------
Operating Revenue:
Insurance services $ 6,830,000 $ 6,730,000
Financial services 8,378,000 6,965,000
Corporate 2,368,000 --
----------- -----------
Total Segment Revenues $ 17,576,000 $ 13,695,000
============ ============
Reconciliation to Consolidated
Statement of Operations:
Total segment revenues $ 17,576,000 $ 13,695,000
Less: Intercompany dividends (2,368,000) --
----------- -----------
Total Revenues $ 15,208,000 $ 13,695,000
============ ============
Operating Income
Insurance services $1,429,000 $ 1,805,000
Financial services 935,000 745,000
Corporate (998,000) (1,305,000)
---------- ----------
Total segments operating income 1,366,000 1,245,000
Gain on investments 20,000 1,976,000
Loss on impairment of investment -- (96,000)
---------- ---------
Income from operations before interest,
income taxes and minority interest 1,386,000 3,125,000
Interest income 420,000 247,000
Other gain 10,000 84,000
Interest expense 2,000 4,000
Income tax expense 652,000 1,219,000
Minority interest 2,000 13,000
--------- ----------
Net income $ 1,160,000 $ 2,220,000
=========== ===========
13. 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.
- 15 -
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 and six
months ended June 30, 2006 we recorded compensation cost related to stock
options of $129,000 and $157,000 and a related reduction in income taxes of
$44,000 and $53,000, respectively. The compensation cost is the total fair
value, at date of grant, of shares that vested during the three and six month
periods. No compensation costs were capitalized in the three and six month
periods ended June 30, 2006.
During the three and six month periods ended June 30, 2006, 105,000 and
111,500 options were exercised with an intrinsic value of $1,086,000 and
$1,106,000, respectively. We received proceeds of $440,000 and $504,000 from the
exercise of these options during the three and six month periods ended June 30,
2006. Based on unvested options outstanding at June 30, 2006 compensation costs
to be recorded in future periods are expected to be recognized as follows: 2006,
$64,000; 2007, $21,000; 2008, $19,000; and 2009, $4,000.
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 350,000 shares of common stock to our directors and
key employees. A total of 153,000 of these options have been granted as of June
30, 2006, 2,000 shares have been exercised and 136,000 options are exercisable.
The previous plan, "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 June 30,
2006, 1,091,000 shares have been exercized, 314,000 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. Under the Plans,
option grants are limited to a maximum of ten-year terms; however, the Committee
has issued all currently outstanding grants with five-year terms. The Committee
also determines vesting for each option grant and traditionally has had options
vest in three approximately equal annual installments beginning one year from
the date of grant.
- 16 -
Presented below is a summary of the stock options held by our employees and
our directors and the related transactions for the three and six months ended
June 30, 2006.
Three Months Ended Six Months Ended
June 30, June 30,
2006 2006
----------------- -----------------
Weighted Weighted
Average Average
Exercise Exercise
Shares Price Shares Price
------ -------- ------ ---------
Balance at Beg. of Period 581,000 $8.04 573,000 $7.92
Options granted 25,000 14.20 40,000 13.94
Options exercised (105,000) 4.19 (112,000) 4.52
Options forfeited/expired -- -- -- --
------- ----- ------- -----
Balance at end of period 501,000 $9.16 501,000 $9.16
======= ===== ======= =====
Options exercisable 450,000 $9.04 450,000 $9.04
======= ===== ======= =====
The weighted average fair value of Company stock options granted is $3.89
and $3.87 per option for the three and six months ended June 30, 2006,
respectively. The fair value of the options was calculated using the
Black-Scholes-Merton option pricing model with the following assumptions:
Three months Six months
ended ended
June 30, 2006 June 30, 2006
--------------- -------------
Expected option term: 3.7 years 3.7 years
Expected volatility 0.348 0.350
Expected dividend yield 2.11% 2.01%
Risk-free rate of return 4.69% 4.33%
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 June 30,
2006:
- 17 -
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
------ --------- --------- --------- ------ --------- --------- ---------
501,000 $9.16 $2,675,000 3.0 yrs. 449,600 $9.04 $2,455,000 3.0 yrs.
(1) Based on the $14.50 closing price of our stock at June 30, 2006.
Prior to the adoption of SFAS No. 123R, we adopted the disclosure-only
provision of SFAS No. 123, but applied APB Option No. 25, "Accounting for Stock
Issued to Employees", in accounting for our stock option plans. No compensation
expense was recognized for the three and six months ended June 30, 2005 under
the provisions of APB No. 25. If we had elected to recognize compensation
expense for options granted based on their fair values at the grant dates,
consistent with Statement 123, net income and earnings per share would have
changed to the pro forma amounts indicated below:
Three Months Ended Six Months Ended
June 30, 2005 June 30, 2005
------------- -------------
Net income as reported $1,367,000 $2,220,000
Deduct: Total additional stock-based
employee compensation expense determined
under fair value based method for all
awards, net of related tax effects (82,000) (134,000)
-------- ---------
Pro forma net income $1,285,000 $2,086,000
========== ==========
Net income per share
Basic - as reported $0.51 $0.84
===== =====
Basic - pro forma $0.48 $0.79
===== =====
Diluted - as reported $0.48 $0.77
===== =====
Diluted - pro forma $0.45 $0.72
===== =====
- 18 -
14. 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. The Company does not expect the adoption of this standard to have a
material effect on its 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 clarifies the
accounting and disclosure for uncertain in tax positions, as defined. FIN 48
seeks to reduce the diversity in practice associated with certain aspects of the
recognition and measurement related to accounting for income taxes. This
interpretation is effective for fiscal years beginning after December 15, 2006.
The Company has not yet determined the impact this interpretation will have on
our results from operations or financial position.
- 19 -
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.
GENERAL
We provide (1) financial services, including brokerage and investment
services to individuals and institutions, and (2) insurance services, including
management and agency services to medical malpractice insurance companies.
INSURANCE SERVICES. Through Insurance Services we provide management and agency
services to medical malpractice insurance companies through the following
subsidiary:
o FMI. APS Facilities Management, Inc., dba APMC Insurance Services,
Inc., or 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
- 20 -
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.
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 CLEARING. APS Clearing is dedicated to the clearing and settlement of
trades involving syndicated bank loans, trade claims and distressed
private loan portfolios. We recognize commissions revenue, and the
related compensation expense, when the transaction is complete and fully
funded.
o ASSET MANAGEMENT. Asset Management 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 June 30, 2006, we have the following significant investments
accounted for as available-for-sale securities: (1) we own approximately 138,000
shares of HealthTronics (formerly Prime Medical) common stock, representing less
than 1% of its outstanding common stock, and (2) we own 385,000 shares of
Financial Industries Corporation, representing approximately 4% of its
outstanding common stock. We account for these investments as available-for-sale
securities, which means they are 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.
- 21 -
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, up 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 is recorded in the fourth quarter based on the audited financial
results of the managed company.
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
- 22 -
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. The adoption
of SFAS No. 123(R) has not had a material effect on our financial position or
cash flow. The effect on our operations is indicated below.
At June 30, 2006, we have several stock-based compensation plans, which are
described more fully in Note 13 to the audited consolidated financial statements
contained in our most recently filed Annual Report on Form 10-K. Prior to
January 1, 2006, we 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, we 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.
As a result of adopting SFAS No. 123(R) on January 1, 2006, our pretax
income for the six months ended June 30, 2006 is $157,000 less than it would
have been if we had continued to account for stock-based compensation under APB
No. 25. Basic and diluted net income per share would be unchanged if the Company
had not adopted SFAS No. 123(R). The adoption of SFAS No. 123(R) had no effect
on our Statement of Cash Flows, as stock option expense is a non-cash charge.
RESULTS OF OPERATIONS
REVENUES
Revenues from operations increased $942,000 (13%) and $1,513,000 (11%) in
the three and six month periods ended June 30, 2006, respectively, compared to
the same periods in 2005. Our operating income increased $22,000 (3%) and
$121,000 (10%) in the current year three and six months, respectively, compared
to the same periods in 2005. Our net income decreased $769,000 (56%) and
$1,060,000 (48%) in the current year three and six months, respectively,
compared to the same periods in 2005. Lastly, our diluted net income per share
decreased $0.28 (58%) and $0.37 (48%) in the current year three and six month
periods ended June 30, 2006, respectively, compared to the same periods in 2005.
The reasons for these changes are described below.
- 23 -
INSURANCE SERVICES
Total revenues from our insurance services segment decreased $160,000 (5%)
but increased $100,000 (1%) in the three and six month periods ended June 30,
2006, respectively, compared to the same periods in 2005. The current quarter
decrease in revenues is mainly attributable to a management fee revenue decrease
of $106,000 (5%) as a result of lower earned premiums at APIE, our managed
medical malpractice insurance company, due to rate decreases in the latter part
of 2005 earning-out at a lower rate in 2006. Management fee revenues for the six
months ended June 30, 2006 remained even with management fees recorded in 2005.
Pass through commissions decreased by $24,000 (3%) in the current quarter as a
result of lower written premiums for new business as compared to the same period
in 2005. For the six months ended June 30, 2006, pass through commission
revenues were $178,000 (9%) higher than in the same period in 2005 as commission
rates and premiums written through agents for new business at APIE remained
higher in 2006. As noted in the following paragraph, commissions paid to third
party independent agents increased by an equivalent amount, resulting in no
impact on net income. Finally, risk management fees decreased $22,000 (39%) and
$54,000 (40%) in the three and six month periods ended June 30, 2006,
respectively, compared to the same periods in 2005, as a result of a fewer
number of renewals requiring these services and the discontinuation of a high
risk management program at the end of 2005.
Insurance services expenses increased $225,000 (9%) and $476,000 (10%) in
the three and six month periods ended June 30, 2006, respectively, compared to
the same periods in 2005. Payroll expense increased $196,000 (25%) and $260,000
(17%) in the three and six month periods ended June 30, 2006, respectively,
compared to the same periods in 2005 due in part to the addition of two new
managerial positions as well as several new staff additions to our underwriting
and business development departments. Professional fees increased $65,000 (132%)
and $47,000 (37%) in the three and six month periods ended June 30, 2006,
respectively, compared to the same periods in 2005 due to consulting cost
incurred in overhauling our policy and claims software. Lastly, pass through
commissions expense increased $178,000 (9%) for the six months ended June 30,
2006 compared to the same period in 2005 due to the above-mentioned increase in
commissions paid to third party independent agents.
- 24 -
FINANCIAL SERVICES
Our financial services revenue increased $1,102,000 (30%) and $1,413,000
(20%) in the three and six month periods ended June 30, 2006, respectively,
compared to the same periods in 2005. The primary reason for the positive
variances in both comparative periods is increased revenues from our investment
banking division, which increased $988,000 (1,235%) and $1,702,000 (1,105%) in
the three and six month periods ended June 30, 2006, respectively, compared to
the same periods in 2005. Investment banking revenues were up substantially due
to the ramping up of the business in the third quarter of 2005, primarily
through the hiring of an investment banking managing director. In addition,
revenues from our new subsidiary, APS Clearing, contributed positive revenue
variances of $568,000 (507%) and $722,000 (644%) in the three and six month
periods ended June 30, 2006, respectively, compared to the same periods in 2005.
These bank debt trading generated revenues were up in 2006 primarily due to the
fact that APS Clearing was not formed until the second quarter of 2005.
Partially offsetting these revenue increases was a decrease in commission
revenues earned at APS Financial, the broker/dealer, which derives most of its
revenue from transactions in the fixed income market, in both investment and
non-investment grade securities. Commission revenues declined $452,000 (13%) and
$1,020,000 (15%) in the three and six month periods ended June 30, 2006,
respectively, compared to the same periods in 2005. Revenue from investment
grade trading continued to decline in a rising interest rate environment in
which the Fed has raised rates seventeen times since June 2004 (for a total of
425 basis points). Revenue from trading of non-investment grade (high yield
bonds) has also continued to be generally weaker due to the increasing general
level of interest rates and poor fundamentals. Many of our customers have chosen
to remain very liquid, declining to commit funds to additional investments.
Our financial services expenses increased $888,000 (27%) and $1,223,000
(20%) in the three and six month periods ended June 30, 2006, respectively,
compared to the same periods in 2005. The primary reason for the current year
increase is a $529,000 (25%) and $696,000 (18%) increase in commission expense
in the current year three and six month periods, respectively, compared to the
same periods in 2005 resulting from commissions paid on increased investment
banking and bank debt trading revenues mentioned above. In addition, salaries
expense was up $112,000 (27%) and $248,000 (30%) in the three and six month
periods ended June 30, 2006, respectively, compared to the same periods in 2005
due in part to the hiring of two full time managers to head up the investment
banking and bank debt trading divisions. Also, normal annual merit raises as
well as an increase in performance-related forgivable loans contributed to the
increase in salaries expense. Incentive compensation costs increased $194,000
(156%) and $243,000 (195%) in the current year three and six months,
respectively, the result of increased profits generated from our investment
banking division. Partially offsetting these expense increases is a decrease in
professional fees of $14,000 (16%) and $74,000 (37%) in the three month and six
month periods ended June 30, 2006, respectively, compared to the same periods in
2005 primarily as a result of higher fees incurred in 2005 related to Sarbanes
Oxley compliance.
- 25 -
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses decreased $240,000 (33%) and $389,000
(28%) in the three and six month periods ended June 30, 2006, respectively,
compared to the same periods in 2005. This decrease is primarily due to lower
salaries, lower legal and professional fees and lower incentive compensation
expenses. Salaries declined $80,000 (31%) and $77,000 (18%) in the three and six
month periods ended June 30, 2006, respectively, resulting from a severance
payment in 2005 to a former employee who has
- 25 -
since been retained as a tax consultant. Legal and professional fees declined
$36,000 (43%) and $90,000 (44%) in the current year three and six months,
respectively, as costs associated with internal controls disclosures and
procedures under the Sarbanes-Oxley Act of 2002 ("SOX 404") compliance are
minimal in 2006 compared to the first six months of 2005 when we were ramping up
our compliance efforts. With the continued uncertainty as to what, if any,
relief is to be granted to non-accelerated filers like us, we have slowed our
efforts in an attempt to control future SOX 404 compliance costs. Incentive
compensation expense decreased $124,000 (50%) and $190,000 (43%) in the current
three and six month periods compared to the same periods in 2005 due to much
lower investment gains in 2006.
GAIN ON SALE OF ASSETS
During the three and six months ended June 30, 2006, we recognized
approximately $140,000 and $281,000, respectively, of deferred gain related to
the November 2001 sale and subsequent leaseback of real estate to Prime Medical
(now called HealthTronics, Inc.). Due to our continuing involvement in the
property, we deferred recognizing approximately $2,400,000 of the approximately
$5,100,000 gain and are recognizing it in earnings, as a reduction of rent
expense, monthly through September 2006. A total of $141,000 remains to be
recognized in the coming three months, with the final amount recognized in
September, 2006. In addition, 15% of the gain ($760,000) related to our then 15%
ownership in the purchaser, was deferred. As our ownership percentage in
HealthTronics declines through our sales of HealthTronics common stock, we
recognize these gains proportionately to our reduction of our interest in
HealthTronics. During the three and six months ended June 30, 2006 we recognized
approximately $2,000 and $2,000, respectively, of these deferred gains as a
result of HealthTronics common stock sold in the periods. As of June 30, 2006,
there remained a balance of approximately $45,000 to be recognized in future
periods.
GAIN ON INVESTMENTS
Gains on investments decreased $1,333,000 (99%) and $1,956,000 (99%) in the
current year three month and six month periods, respectively, due to the sale of
a large number of available-for-sale equity securities in both comparative
periods of 2005 compared to sales in 2006. Sales of these securities are down in
2006 as a result of fewer shares held by us and a decline in their market price.
- 26 -
LOSS ON IMPAIRMENT OF INVESTMENT
The loss recorded in the three months ended June 30, 2005 represents a
write-down of our investment in a bond of $57,000 after determining that market
declines in the value of this security should be considered "other than
temporary". No further impairment charges have occurred in 2006 as these bonds
were sold in February 2006. The loss recorded in the first three months of 2005
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". We 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 2005, that charge totaled $39,000. As our adjusted cost basis in FIC
is $7.65 and with the stock price above $8.00 per share in 2006, there was no
need to take additional charges 2006. We will continue to monitor and evaluate
the situation at Financial Industries.
INTEREST INCOME
Our interest income increased $98,000 (78%) and $173,000 (70%) in the three
and six month periods ended June 30, 2006, respectively, compared to the same
periods in 2005. The current year increases were due to interest earned on a
higher rate as well as on a much higher balance of interest-bearing fixed income
securities. At June 30, 2006 there was a balance in investment securities held
of $13.5 million compared to a balance of $9.1 million held at June 30, 2005.
OTHER INCOME
Our other income decreased $25,000 (86%) and $74,000 (88%) for the three
and six month periods ended June 30, 2006, respectively, compared to the same
periods in 2005. The decrease in the current year six month period is primarily
due to inventory losses on securities held at APS Financial totaling $43,000 in
2006 compared to inventory gains of $18,000 in 2005.
LIQUIDITY AND CAPITAL RESOURCES
WORKING CAPITAL
Our net working capital was $17,322,000 and $15,880,000 at June 30, 2006
and December 31, 2005, respectively. The increase in the current year was due
primarily to cash received from operations. Cash and cash equivalents decreased
$900,000 in the first six months of 2006 as cash provided by operations was more
than offset by net cash used in investing
- 27 -
and financing activities. Cash from operating activities increased primarily due
to cash received from APIE for profit sharing ($2,000,000) that was recorded in
2005 as well as from an advance payment from a trade claim transaction that was
completed in July, 2006 ($690,000). Partially offsetting this was cash paid in
the current quarter for incentive compensation earned and accrued in 2005
($2,200,000). Cash from investing activities decreased $569,000 as purchases of
available-for-sale securities exceeded cash received from the sales of other
available-for-sale securities. In addition, we made a performance driven loan in
January, 2006 in the amount of $238,000 to a high-producing broker. This loan is
forgivable evenly over a period of twenty four months. Cash from financing
activities decreased $1,794,000 due to purchases of treasury stock exceeding
cash received from the exercise of employee stock options as well as from
dividends paid during the second quarter of 2006 in the amount of $820,000. For
details of the amounts described above, refer to the Condensed Consolidated
Statements of Cash Flows on page 7 of this Form 10-Q.
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 2006,
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 $5.8 million comprising 18 percent
of our total assets; (2) our investments in available-for-sale equity and fixed
income securities could provide an additional $15.3 million should the need
arise; and (3) we renewed a line of credit in April 2006 that is described
below.
LINE OF CREDIT
We renewed a $3.0 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, 2007, when the entire amount of
the note, principal and interest then remaining unpaid, is due and payable. At
June 30, 2006, there were no draws taken against this line of credit. We are in
compliance with the covenants of the loan agreement, including requirements for
a minimum of $5.0 million of unencumbered liquidity and a minimum 2 to 1 net
worth ratio.
CAPITAL EXPENDITURES
Our capital expenditures for equipment were $103,000 in the six months of
2006. The majority of these expenditures were primarily hardware and software
upgrades to our computer network. We expect capital expenditures in 2006 to be
approximately $250,000 and to be funded through cash on hand.
- 28 -
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. The Company does not expect the adoption of this standard to have a
material effect on its 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 clarifies the
accounting and disclosure for uncertain in tax positions, as defined. FIN 48
seeks to reduce the diversity in practice associated with certain aspects of the
recognition and measurement related to accounting for income taxes. This
interpretation is effective for fiscal years beginning after December 15, 2006.
The Company has not yet determined the impact this interpretation will have on
our results from operations or financial position.
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 $19 million
would result in a change of $190,000 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
- 29 -
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 2006, 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 2006 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 2006, interest rate changes will have no impact on our financial
position as it pertains to interest expense.
INVESTMENT RISK
As of June 30, 2006, our recorded basis in debt and equity securities was
approximately $18.6 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
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.
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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
Purchased as Part May yet be
(a) Total Number (b) Average of Publicly Purchased under
of shares Price Paid Announced Plans the Plans or
Period Purchased (1) per Share or Programs Programs
------------------------- ------------- ----------- ---------------- ---------------
Apr 1, 2006 - Apr 30, 2006 6,500 $ 14.80 6,500 $ 1,346,000
May 1, 2006 - May 31, 2006 7,710 $ 14.56 7,710 $ 1,234,000
Jun 1, 2006 - Jun 30, 2006 82,431 $ 14.62 82,431 $ 2,029,000
(1) Of the total shares purchased 57,641 were purchased in open market
transactions and 39,000 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
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Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
---------------------------------------------------
On June 6, 2006 the annual meeting of American Physicians Service Group,
Inc. was held in Austin, Texas. Shareholders voted and approved the following
motions:
ELECTION OF DIRECTORS
The names of the directors elected at the meeting along with numbers of
votes for and withheld are as follows:
Name For Withheld
--------------------------- ---------------- ---------
Lew N. Little, Jr. 2,273,847 148,090
Jackie Majors 2,265,562 156,375
William A. Searles 2,286,124 135,813
Kenneth S. Shifrin 2,292,119 129,818
Cheryl Williams 2,265,551 156,386
ALL DIRECTORS WERE RE-ELECTED.
Proposal 2 - TO AMEND THE 2005 INCENTIVE AND NON-QUALIFIED STOCK OPTION PLAN
The Amendment would delete a provision allowing the Committee to exchange or buy
out any previously granted Option for consideration. This provision has never
been utilized and the board believes that deleting it from the 2005 Plan
clarifies its position and better protects shareholders during the life of the
Plan. The votes for, against and abstain are as follows:
For Against Abstain or Non-Vote
--------- ----------- -------------------
1,188,897 152,445 1,080,595
PROPOSAL 2 FAILED TO PASS
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Proposal 3 - TO AMEND THE AMERICAN PHYSICIANS SERVICE GROUP, INC. AFFILIATED
GROUP DEFERRED COMPENSATION MASTER PLAN.
The Amendment would delete a provision which calls for a four year payout
for a participant leaving the Company after signing a non-competition agreement.
The votes for, against and abstain are as follows:
For Against Abstain or Non-Vote
--------- ---------- -------------------
1,177,108 162,234 1,082,595
PROPOSAL 3 FAILED TO PASS
Item 5. OTHER INFORMATION
Not Applicable
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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