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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
SEPTEMBER 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. (Check one) 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 NOVEMBER 1, 2006
-------------------- ----------------
Common Stock, $.10 par value 2,796,131
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PART I
FINANCIAL INFORMATION
- 2 -
AMERICAN PHYSICIANS SERVICE GROUP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(In thousands, except per share data)
Item 1 - Financial Statements
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------------------- ---------------------------------
2006 2005 2006 2005
------------- ------------- ------------- -------------
Revenues:
Insurance services $3,726 $3,732 $10,556 $10,462
Financial services 3,043 5,450 11,421 12,415
------ ------ ------ -----
Total revenues 6,769 9,182 21,977 22,877
------ ------ ------ ------
Expenses:
Insurance services 3,147 2,931 8,548 7,856
Financial services 2,905 4,788 10,348 11,009
General and administrative 436 573 1,436 1,961
Gain on sale of assets (Note 4) (13) (47) (15) (131)
----- ----- ----- -----
Total expenses 6,475 8,245 20,317 20,695
----- ----- ------- ------
Operating income 294 937 1,660 2,182
Gain on investments (Note 5) 90 1,114 110 3,091
Loss on impairment of investment (Note 6) - (96) - (193)
Gain on extinguishment of debt (Note 7) - 24 - 24
----- ----- ------ -----
Income from operations before interest,
income taxes and minority interest 384 1,979 1,770 5,104
Interest income 248 166 668 413
Other income 16 3 26 87
Interest expense 9 6 11 10
Income tax expense 230 747 882 1,966
Minority interests - - 2 13
------ ------ ------ -----
Net income $409 $1,395 $1,569 $3,615
====== ====== ====== ======
The accompanying notes are an integral part of these 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 Nine Months Ended
September 30, September 30,
---------------------- -----------------------
2006 2005 2006 2005
------ ------ ------ ------
Net income per common share
Basic:
Net income $ 0.15 $ 0.52 $ 0.57 $ 1.36
====== ====== ====== ======
Diluted:
Net income $ 0.14 $ 0.48 $ 0.53 $ 1.24
====== ====== ====== ======
Basic weighted average shares
outstanding 2,767 2,702 2,773 2,667
====== ====== ====== ======
Diluted weighted average
shares outstanding 2,892 2,885 2,942 2,920
====== ====== ====== ======
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)
September 30, December 31,
2006 2005
---------- -----------
ASSETS
Current Assets:
Cash and cash equivalents $3,590 $6,231
Cash - restricted (Note 8) 3,523 449
Trade receivables, net 503 42
Notes receivable - current 546 599
Management fees and other receivables 960 3,192
Deposit with clearing organization 501 501
Investment in available-for-sale fixed
income securities - current (Note 10) 13,435 9,662
Federal income tax receivable 483 --
Net deferred income tax asset 345 355
Prepaid expenses and other (Note 11) 1,137 632
--------- --------
Total current assets 25,023 21,663
Notes receivable, less current portion 347 326
Property and equipment, net 588 687
Investment in available-for-sale equity
securities (Note 9) 4,663 5,017
Investment in available-for-sale fixed
income securities - non-current (Note 10) 1,883 3,584
Net deferred income tax asset 555 686
Goodwill 1,247 1,247
Other assets 250 295
-------- -------
Total Assets $34,556 $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)
September 30, December 31,
2006 2005
-------------- ------------
LIABILITIES, MINORITY INTERESTS AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 3,879 $ 736
Accrued incentive compensation 1,360 2,595
Accrued expenses and other liabilities (Note 12) 1,343 1,912
Federal income tax payable -- 71
Deferred gain 244 469
------ ------
Total current liabilities 6,826 5,783
------ ------
Total liabilities 6,826 5,783
Minority interests 20 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;
2,793,418 and 2,784,120 issued and outstanding
at 9/30/06 and 12/31/05, respectively 279 278
Additional paid-in capital 7,502 8,204
Retained earnings 19,486 18,737
Accumulated other comprehensive income,
net of taxes 443 488
------- -------
Total shareholders' equity 27,710 27,707
------- -------
Total Liabilities, Minority Interests and Shareholders' Equity $34,556 $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)
(in thousands)
Nine Months Ended September 30,
2006 2005
------- -------
Cash flows from operating activities:
Net Income $ 1,569 $ 3,615
Adjustments to reconcile net income to cash
provided by (used in) operating activities:
Depreciation and amortization 323 264
Extinguishment of debt and other 266 190
Common stock awarded 102 159
Gain on sale of assets (15) (131)
Gain on investments (110) (3,091)
Impairment of investment -- 193
Excess tax benefits from stock-based compensation (456) (408)
Stock options expense 189 --
Changes in operating assets and liabilities:
Trade receivables (461) (394)
Income tax receivable (298) 473
Deferred income tax 141 (789)
Receivable from clearing organization -- (331)
Deferred compensation 22 --
Management fees & other receivables 2,232 964
Prepaid expenses & other assets (575) (163)
Deferred income (210) (372)
Trade payables 69 519
Accrued expenses & other liabilities (1,663) (1,148)
------ ------
Net cash provided by (used in) operating activities 1,125 (450)
Cash flows from investing activities:
Capital expenditures (131) (247)
Proceeds from the sale of available-for-sale equity
and fixed income securities 7,357 6,174
Purchase of available-for-sale equity securities (8,946) (8,483)
Funds loaned to others (266) (800)
Collection of notes receivable 32 249
------ ------
Net cash used in investing activities (1,954) (3,107)
Cash flows from financing activities:
Exercise of stock options 791 823
Purchase and cancellation of treasury stock (2,239) (1,574)
Excess tax benefits from stock-based compensation 456 408
Dividends paid (820) (671)
------ ------
Net cash used in financing activities (1,812) (1,014)
Net change in cash and cash equivalents $(2,641) $ (4,571)
Cash and cash equivalents at beginning of period 6,231 9,673
------- -------
Cash and cash equivalents at end of period $ 3,590 $ 5,102
======= =======
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)
Nine Months Ended September 30,
(in thousands) 2006 2005
------- -------
Supplemental information:
Cash paid for taxes $ 754 $1,806
Cash paid for interest 11 10
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
For the nine months ended September 30, 2005 and September 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 -- -- 3,615 $ 3,615 -- -- 3,615
Other comprehensive income:
Unrealized loss on securities,
net of taxes of $789 -- -- -- (1,532) (1,532) -- (1,532)
------
Comprehensive income: -- -- -- $ 2,083 -- -- --
======
Stock options exercised 20 803 -- -- -- -- 823
Tax benefit from exercise
of stock options -- 408 -- -- -- -- 408
Dividend paid (per share - $0.25) -- -- (671) -- -- -- (671)
Treasury stock purchase -- -- -- -- -- (1,574) (1,574)
Cancelled treasury stock (13) (1,561) -- -- -- 1,574 --
Stock based compensation 1 158 -- -- -- -- 159
------------------------------------------------------------------------------------------------
Balance September 30, 2005 $ 273 $ 7,727 $16,892 $ -- $ 549 $ -- $ 25,441
================================================================================================
Balance December 31, 2005 $ 278 $ 8,204 $ 18,737 $ -- $ 488 $ -- $ 27,707
------------------------------------------------------------------------------------------------
Comprehensive income:
Net income -- -- 1,569 $1,569 -- -- 1,569
Other comprehensive income:
Unrealized loss on securities,
net of taxes of $23 -- -- -- (45) (45) -- (45)
-----
Comprehensive income: -- -- -- $1,524 -- -- --
=====
Stock options expensed -- 189 -- -- -- -- 189
Stock options exercised 16 775 -- -- -- -- 791
Tax benefit from exercise
of stock options -- 456 -- -- -- -- 456
Dividend paid (per share - $0.30) -- -- (820) -- -- -- (820)
Treasury stock purchase -- -- -- -- -- (2,239) (2,239)
Cancelled treasury stock (16) (2,224) -- -- -- 2,239 --
Stock based compensation 1 101 -- -- -- -- 102
------------------------------------------------------------------------------------------------
Balance September 30, 2006 $ 279 $ 7,502 $19,486 $ -- $ 443 $ -- $ 27,710
================================================================================================
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
September 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 as of and for the three and
nine month periods ended September 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.
- 10 -
4. GAIN ON SALE OF ASSETS
During the three and nine month periods ended September 30, 2006, we
recognized approximately $141,000 and $422,000, 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 recognized it in earnings, as a reduction
of rent expense, monthly through September 2006. As of September 30, 2006 no
more of these deferred gains remain to be recognized. 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 nine month
periods ended September 30, 2006 we recognized approximately $13,000 and
$15,000, respectively, of these deferred gains as a result of HealthTronics
common stock sold in these periods. As of September 30, 2006, there remained a
balance of approximately $31,000 in deferred gains to be recognized in future
periods.
5. GAIN ON INVESTMENTS
Our gains resulted primarily from the sales of available-for-sale
equity and fixed income securities. During the three and nine month periods
ended September 30, 2006 we recognized gains of $90,000 and $110,000,
respectively, resulting from sales of Healthtronics common stock and from
scheduled maturities of fixed income securities. These gains are down
substantially from the comparative periods in 2005 where we recognized
$1,114,000 and $3,091,000 in the three and nine 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 has been no loss taken in 2006, we had a loss in 2005
due to the impairment in 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 nine months of 2005, we took additional pre-tax charges to earnings
totaling $135,000 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 and in
October, 2006 FIC filed its 2004 Form 10-K, but it still has yet to file any
2005 Forms 10-Q or 10-K and thus continues to be de-listed on the NASDAQ Stock
Market.
- 11 -
7. GAIN ON FORGIVENESS OF DEBT
The gain of $24,000 during the three and nine months ended September
30, 2005 represents that amount of liability that was released in the respective
periods by participants in our loan to a former affiliate, net of any interest
due them from prior period payments made by that affiliate. Due to poor
operating results, a former affiliate, Uncommon Care, was in default and not
making scheduled payments under its loan agreement with us in which the
participations had been sold. As a result, the loan participants released us
from any obligations under the participation agreements. The $24,000 recorded in
the third quarter of 2005 represents the final loan obligation to be released.
Accordingly, no such gains were recorded during 2006.
8. 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.
9. 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 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 (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. As FIC has traded above $7.65 per share
throughout 2006, no impairment charges were necessary for either the three or
nine month periods ended September 30, 2006.
10. 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).
- 12 -
11. 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 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 is determined that the merger will not occur. As of September 30, 2006,
we have capitalized a total of $532,000, comprised primarily of legal,
accounting, auditing and tax consulting fees incurred by us related to this
proposed, pending transaction.
12. ACCRUED EXPENSES AND OTHER LIABILITIES
Accrued expenses and other liabilities consists of the following:
September 30 December 31
2006 2005
-------------- -------------
Commissions payable $ 920,000 $ 1,258,000
Taxes payable 73,000 219,000
Vacation 171,000 161,000
401(k) plan matching 169,000 208,000
Other accrued liabilities 10,000 66,000
---------- ----------
$ 1,343,000 $ 1,912,000
========== ==========
13. 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:
- 13 -
For the Three Months Ended September 30, 2006
---------------------------------------------
Income Shares Per Share
(Numerator) (Denominator) Amount
---------- ------------ ---------
Basic EPS
Net income $ 409,000 2,767,000 $ 0.15
======
Diluted EPS
Effect of dilutive securities -- 125,000
---------- -----------
Net income $ 409,000 2,892,000 $ 0.14
========== ======== ======
For the Three Months Ended September 30, 2005
---------------------------------------------
Income Shares Per Share
(Numerator) (Denominator) Amount
---------- ------------ ---------
Basic EPS
Net income $ 1,395,000 2,702,000 $ 0.52
======
Diluted EPS
Effect of dilutive securities -- 183,000
----------- ---------
Net income $ 1,395,000 2,885,000 $ 0.48
=========== ========= ======
- 14 -
For the Nine Months Ended September 30, 2006
--------------------------------------------
Income Shares Per Share
(Numerator) (Denominator) Amount
---------- ----------- ---------
Basic EPS
Net income $ 1,569,000 2,773,000 $ 0.57
======
Diluted EPS
Effect of dilutive securities -- 169,000
---------- ---------
Net income $ 1,569,000 2,942,000 $ 0.53
=========== ========= ======
For the Nine Months Ended September 30, 2005
--------------------------------------------
Income Shares Per Share
(Numerator) (Denominator) Amount
---------- ---------- ---------
Basic EPS
Net income $ 3,615,000 2,667,000 $ 1.36
======
Diluted EPS
Effect of dilutive securities -- 253,000
---------- ---------
Net income $ 3,615,000 2,920,000 $ 1.24
=========== ========= ======
- 15 -
14. SEGMENT INFORMATION
The Company's segments are distinct by type of service provided. Comparative
financial data for the three and nine month periods ended September 30, 2006 and
2005 are shown as follows:
Three Months Ended September 30,
2006 2005
--------- ----------
Operating Revenue:
Insurance services $ 3,726,000 $ 3,732,000
Financial services 3,043,000 5,450,000
Corporate 300,000 600,000
---------- ----------
Total Segment Revenues $ 7,069,000 $ 9,782,000
========== ===========
Reconciliation to Consolidated
Statement of Operations:
Total segment revenues $ 7,069,000 $ 9,782,000
Less: Intercompany dividends (300,000) (600,000)
---------- -----------
Total Revenues $ 6,769,000 $ 9,182,000
========== ==========
Operating Income
Insurance services $ 579,000 $ 662,000
Financial services 138,000 801,000
Corporate (423,000) (526,000)
---------- ----------
Total segments operating income 294,000 937,000
Gain on investments 90,000 1,114,000
Loss on impairment of investment -- (96,000)
Gain on extinguishment of debt -- 24,000
--------- ---------
Income from operations before interest,
income taxes and minority interest 384,000 1,979,000
Interest income 248,000 166,000
Other gain 16,000 3,000
Interest expense 9,000 6,000
Income tax expense 230,000 747,000
--------- ---------
Net income $ 409,000 $ 1,395,000
========== ==========
- 16 -
Nine Months Ended September 30,
2006 2005
---------- ----------
Operating Revenue:
Insurance services $ 10,556,000 $ 10,462,000
Financial services 11,421,000 12,415,000
Corporate 2,668,000 600,000
----------- -----------
Total Segment Revenues $ 24,645,000 $ 23,477,000
=========== ===========
Reconciliation to Consolidated
Statement of Operations:
Total segment revenues $ 24,645,000 $ 23,477,000
Less: Intercompany dividends (2,668,000) (600,000)
----------- -----------
Total Revenues $ 21,977,000 $ 22,877,000
=========== ===========
Operating Income
Insurance services $ 2,008,000 $2,606,000
Financial services 1,073,000 1,406,000
Corporate (1,421,000) (1,830,000)
----------- ----------
Total segments operating income 1,660,000 2,182,000
Gain on investments 110,000 3,091,000
Loss on impairment of investment -- (193,000)
Gain on extinguishment of debt -- 24,000
---------- ---------
Income from operations before interest,
income taxes and minority interest 1,770,000 5,104,000
Interest income 668,000 413,000
Other gain 26,000 87,000
Interest expense 11,000 10,000
Income tax expense 882,000 1,966,000
Minority interest 2,000 13,000
--------- ---------
Net income $ 1,569,000 $ 3,615,000
========== ==========
15. 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.
- 17 -
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
nine months ended September 30, 2006 we recorded compensation cost related to
stock options of $32,000 and $189,000 and a related reduction in income taxes of
$11,000 and $64,000, respectively. The compensation cost is the total fair
value, at date of grant, of shares that vested during the three and nine month
periods. No compensation costs were capitalized in the three and nine month
periods ended September 30, 2006.
During the three and nine month periods ended September 30, 2006, 48,000
and 159,000 options were exercised with an intrinsic value of $560,000 and
$1,666,000, respectively. We received proceeds of $287,000 and $791,000 from the
exercise of these options during the three and nine month periods ended
September 30, 2006. Based on unvested options outstanding at September 30, 2006
compensation costs to be recorded in future periods are expected to be
recognized as follows: 2006, $32,000; 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
September 30, 2006 and 197,000 are available for grants. Of those granted, 5,000
shares have been exercised, 133,000 options are exercisable and 15,000 are not
yet 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 September 30, 2006, 1,136,000 shares have been exercized, 264,000 shares
are exercisable, 41,000 are not yet 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.
- 18 -
Presented below is a summary of the stock options held by our employees
and our directors and the related transactions for the three and nine months
ended September 30, 2006.
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ ---------------
2006 2006
------------------ ---------------
Weighted Weighted
Average Average
Exercise Exercise
Shares Price Shares Price
------ -------- ------ ------
Balance at January 1 501,000 $9.16 573,000 $7.92
Options granted -- -- 40,000 13.94
Options exercised (48,000) 6.01 (159,000) 4.97
Options forfeited/expired -- -- -- --
------- -------- ------- ------
Balance at end of period 453,000 $9.49 453,000 $9.49
======= ===== ======= =====
Options exercisable 397,000 $9.35 397,000 $9.35
======= ===== ======= =====
The weighted average fair value of Company stock options granted is
$3.87 per option for the nine months ended September 30, 2006. No options were
granted in the three month period ended September 30, 2006. The fair value of
the options was calculated using the Black-Scholes-Merton option pricing model
with the following assumptions:
Nine months
ended
September 30, 2006
------------------
Expected option term: 3.7 years
Expected volatility 0.350
Expected dividend yield 2.01%
Risk-free rate of return 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
September 30, 2006:
- 19 -
Stock Options Outstanding Stock Options Exercisable
------------------------------------------------------------ ---------------------------------------- ------------------
Weighted Aggregate Average Weighted Aggregate Average
Average Remaining Average Remaining
Exercise Intrinsic Contractual Exercise Intrinsic Contractual
Shares Price Value (1) Life Shares Price Value (1) Life
------ ----- --------- ---- ------ ----- --------- ----
453,000 $9.49 3,238,000 2.8 yrs. 397,000 9.35 2,892,000 2.8 yrs.
(1) Based on the $16.63 closing price of our stock at September 30, 2006.
Prior to the adoption of SFAS No. 123R, we adopted the disclosure-only
provision of SFAS No. 123, but applied APB Opinion No. 25, "Accounting for Stock
Issued to Employees", in accounting for our stock option plans. No compensation
expense was recognized for the three and nine months ended September 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 Nine Months Ended
September 30, 2005 September 30, 2005
------------------ ------------------
Net income as reported $1,395,000 $3,615,000
Deduct: Total additional stock-based employee
compensation expense determined under fair
value based method for all awards, net of
related tax effects (45,000) (180,000)
-------- --------
Pro forma net income $1,350,000 $3,435,000
========== ==========
Net income per share
Basic - as reported $0.52 $1.36
===== =====
Basic - pro forma $0.50 $1.29
===== =====
Diluted - as reported $0.48 $1.24
===== =====
Diluted - pro forma $0.47 $1.18
===== =====
- 20 -
16. 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 clarifies the
accounting and disclosure for uncertainty 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.
We have not yet determined the impact this interpretation will have on our
results from operations or financial position.
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. This Statement applies under
other accounting pronouncements that require or permit fair value measurements,
the Board having previously concluded in those accounting pronouncements that
fair value is the relevant measurement attribute. 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 September, 2006 the Financial Accounting Standards Board (FASB)
issued Statement of Financial Accounting Standards, or SFAS No. 158, "Accounting
for Defined Benefit and Other Postretirement Plans" effective as of the end of
the fiscal year ending after December 15, 2006. This Statement improves
financial reporting by requiring an employer to recognize the overfunded or
underfunded status of a defined benefit postretirement plan (other than a
multiemployer plan) as an asset or liability in its statement of financial
position and to recognize changes in that funded status in the year in which the
changes occur through comprehensive income of a business entity. This Statement
also improves financial reporting by requiring an employer to measure the funded
status of a plan as of the date of its year-end statement of financial position,
with limited exceptions. We do not expect the adoption of this standard to have
a material effect on our financial position, results of operations or cash
flows.
- 21 -
17. PLANS FOR A STRATEGIC MERGER
On June 5, 2006 we announced plans for a strategic merger with our
medical malpractice partner, American Physicians Insurance Exchange ("APIE").
Both APSG's and APIE's boards of directors voted to approve the transaction
subject to approval by the Texas Department of Insurance, necessary filings with
the SEC and the approval of the shareholders of APSG and
subscriber-policyholders of APIE. The original purchase price was $33 million,
comprised of approximately 1.7 million shares of APS common stock issued to the
policyholders of APIE and the assumption of approximately $10.4 million in
obligations, which will be converted to APS preferred stock with a cash
redemption requirement. On August 24, 2006, we announced that we agreed to an
increase in the purchase price of APIE, which was also approved by APIE. The
revised purchase price is $39 million, comprised of approximately 2.1 million
shares of APS common stock issued to the policyholders of APIE and the
assumption of approximately $10.4 million in obligations, which will be
converted to APS preferred stock with a 3% dividend and a cash redemption
requirement payable over ten years. We can give no assurances that this merger
will close, or if it does, that there will not be further changes to the terms
of the deal. We will account for this transaction consistent with the 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.
- 22 -
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) insurance services, including management and agency
services to a medical malpractice insurance company, 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 a medical malpractice insurance company, APIE, 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
- 23 -
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. In addition, APS Financial earns fees
through investment banking transactions, namely, by assisting public and
private corporations in raising funds in capital markets. 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. We
recognize investment banking fees, and the related compensation expense,
when the transaction is closed and we are reasonably assured that we will
collect our fee.
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. Trade claims are private debt instruments
representing a pre-petition claim on a debtor's estate. 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 September 30, 2006, we have the following significant investments
accounted for as available-for-sale securities: (1) we own less than 1% of the
outstanding common stock of HealthTronics, Inc., and (2) we own approximately 4%
of the outstanding common stock of Financial Industries Corporation. We account
for these
- 24 -
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.
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, fees from investment banking transactions, commissions
from clearing of trade claims and fees from asset management. 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. Revenues from investment banking are
recognized when the transaction is closed and we are reasonably assured that we
will collect our fee. 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.
- 25
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. 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 September 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 nine months ended September 30, 2006 is $189,000 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.
BUSINESS COMBINATIONS
In June 2001, the FASB issued SFAS No. 141, "Business Combinations" ("SFAS
No. 141"). This pronounced changed the accounting treatment for all business
combinations to the purchase method. Direct costs of the business combination
are capitalized and become part of the total purchase price.
- 26 -
On June 6, 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 subject to approval by the Texas Department of Insurance, necessary
filings with the SEC and the approval of the shareholders of APSG and
subscriber-policyholders of APIE. The original purchase price was $33 million,
comprised of approximately 1.7 million shares of APS common stock issued to the
policyholders of APIE and the assumption of approximately $10.4 million in
obligations, which will be converted to APS preferred stock with a cash
redemption requirement. On August 24, 2006, we announced that we agreed to an
increase in the purchase price of APIE, which was also approved by APIE. The
revised purchase price is $39 million, comprised of approximately 2.1 million
shares of APS common stock issued to the policyholders of APIE and the
assumption of approximately $10.4 million in obligations, which will be
converted to APS preferred stock with a 3% dividend and a cash redemption
requirement payable over ten years. We can give no assurances that this merger
will close, or if it does, that there will not be further changes to the terms
of the deal. Should the merger not take place, the direct costs of the merger
would be expensed in the period that it is determined that the merger will not
occur. As of September 30, 2006, we have capitalized a total of $532,000,
comprised primarily of legal, accounting, auditing and tax consulting fees
incurred by us related to this proposed, pending transaction.
RESULTS OF OPERATIONS
REVENUES
Revenues from operations decreased $2,413,000 (26%) and $900,000 (4%)
in the three and nine month periods ended September 30, 2006, respectively,
compared to the same periods in 2005. Our operating income decreased $643,000
(69%) and $522,000 (24%) in the current year three and nine months,
respectively, compared to the same periods in 2005. Our net income decreased
$986,000 (71%) and $2,046,000 (57%) in the current year three and nine months,
respectively, compared to the same periods in 2005. Lastly, our diluted net
income per share decreased $0.34 (71%) and $0.71 (57%) in the current year three
and nine month periods ended September 30, 2006, respectively, compared to the
same periods in 2005. The reasons for these changes are described below.
INSURANCE SERVICES
Total revenues from our insurance services segment decreased $6,000
(0%) for the three months but increased $94,000 (1%) for the nine month periods
ended September 30, 2006, compared to the same periods in 2005. The current
quarter decrease in revenues is mainly attributable to a management fee revenue
decrease of $25,000 (1%) as a result
- 27 -
of lower earned premiums at APIE, our managed medical malpractice insurance
company, due to rate decreases implemented in the latter part of 2005. This has
resulted in lower written premium of $1.1 million for the nine months ended
September 30, 2006 as compared to the same period for 2005. While planned rate
decreases have lowered written premium, policyholder retention remains strong at
greater than 90% for APIE. Management fee revenues for the nine months ended
September 30, 2006 decreased $24,000 (0%) over the comparable period for 2005
for the same reasons noted above for the current quarter. Pass through
commissions increased by $58,000 (4%) in the current quarter as a result of
higher effective commission rates paid to third party agents in order to
increase market share as compared to the same period in 2005. For the nine
months ended September 30, 2006, pass through commission revenues were $236,000
(7%) 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 $25,000 (60%) and $79,000 (45%) for the
three and nine month periods ended September 30, 2006, respectively, compared to
the same periods in 2005, as a result of fewer renewals requiring these services
and the discontinuation of a high risk management program at the end of 2005.
This decrease in risk management fees is the result of two key factors. First,
fees are lower due to an improved claims environment following tort reform
legislation enacted in 2003, resulting in fewer new business and renewal
accounts being placed into the risk management program and thus being required
to pay for these services. Second, risk management services continue to be
performed, but due to increased competition APSG has occasionally provided these
services at no charge.
Insurance services expenses increased $216,000 (7%) and $692,000 (9%) for
the three and nine month periods ended September 30, 2006, respectively,
compared to the same periods in 2005. Payroll expense increased $117,000 (15%)
and $377,000 (16%) for the three and nine month periods ended September 30,
2006, respectively, compared to the same periods in 2005 due in part to merit
increases, the addition of new managerial positions, additional staff positions
for business development and physician services departments and expensing stock
options as required by FAS123(R). Professional fees increased $58,000 (102%) and
$105,000 (57%) in the three and nine month periods ended September 30, 2006,
respectively, compared to the same periods in 2005 due to consulting costs
incurred in the analysis of new policy and claims software. Pass through
commissions expense increased $58,000 (4%) and $236,000 (7%) for the three and
nine months ended September 30, 2006 compared to the same period in 2005 due to
the above-mentioned increase in commissions paid to third party independent
agents. Lastly, advertising expense increased $23,000 (141%) and $23,000 (29%)
for the three and nine months ended September 30, 2006 compared to the same
period in 2005 due to consulting costs associated with increased marketing
efforts.
- 28 -
FINANCIAL SERVICES
Our financial services revenue decreased $2,407,000 (44%) and $994,000 (8%)
in the three and nine months ended September 30, 2006, respectively compared to
the same periods in 2005. The primary contributing factor to these lower revenue
figures is the fact that commissions earned at our broker/dealer company, APS
Financial, were down in 2006. Commission income, derived mostly from
transactions in the fixed income market in both investment and non-investment
grade securities, were down $2,915,000 (58%) and $3,935,000 (34%) for the three
and nine month periods ended September 30, 2006, respectively, compared to the
same periods in 2005. There continues to be various economic factors causing
this slowdown in trading activity including poor investment fundamentals such as
a rising interest rate environment with an inverted yield curve, volatility in
certain corporate sectors and volatile energy prices. As a result of these
difficult conditions APS Financial consolidated trading into its main office in
Austin, Texas and closed its Houston office in the third quarter of 2006. Though
the Houston office generated commission revenues of approximately $1.2 million
during the first nine months of 2006 and $2.6 million for all of 2005, it had
become unprofitable during the past twelve months. Partially offsetting lower
commissions were revenues derived from other businesses, including investment
banking and distressed bank debt/trade claim trading which contributed in the
aggregate an increase of $508,000 (148%) and $2,943,000 (483%) for the current
year three and nine month periods, respectively, compared to the same periods in
2005.
Our financial services expenses decreased $1,883,000 (39%) and $661,000
(6%) in the three and nine month periods ended September 30, 2006, respectively,
compared to the same periods in 2005. The primary reason for the decrease was a
$1,628,000 (49%) and $932,200 (13%) decrease in commission expense in the
current three and nine month periods, respectively, compared to the same periods
in 2005 as a result of the above-mentioned decline in broker/dealer commissions
earned. Adding to the variance in the current year quarter was a decrease of
$227,000 (57%) in incentive compensation expense, the result of lower net
earnings in the period. Partially offsetting these variances was an increase in
payroll of $43,000 (9%) and $291,000 (23%) for the three and nine months periods
in 2006, respectively, as compared to the same periods in 2005 as a result of
continued personnel expansion in our investment banking and bank debt/trade
claim businesses.
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses decreased $137,000 (24%) and
$525,000 (27%) in the three and nine month periods ended September 30, 2006,
respectively, compared to the same periods in 2005. The current year three month
decrease is primarily due to lower incentive compensation expense. Incentive
compensation, a formula driven expense calculated in part on net earnings,
decreased $109,000 (46%) due to much lower
- 29 -
investment gains in 2006. The current year nine month decrease is due to lower
legal and professional fees, lower salaries and lower management incentive
compensation. Salaries declined $79,000 (13%) in the nine month period ended
September 30, 2006 compared to the same period in 2005 as a result of a
severance payment in 2005 to a former employee who has since been retained as a
tax consultant. Legal and professional fees declined $91,000 (36%) during the
current year nine months 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 nine 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 $299,000 (44%) in the current nine month period
compared to the same period in 2005 for the same reason as described in the
three month variance above.
GAIN ON SALE OF ASSETS
During the three and nine months ended September 30, 2006, we recognized
approximately $141,000 and $422,000, 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. As of September 30, 2006 no more of
these deferred gains remain to be recognized. 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 nine months
ended September 30, 2006 we recognized approximately $13,000 and $15,000,
respectively, of these deferred gains as a result of HealthTronics common stock
sold in the periods. As of September 30, 2006, there remained a balance of
approximately $31,000 to be recognized in future periods.
GAIN ON INVESTMENTS
Gains on investments decreased $1,024,000 (92%) and $2,981,000 (96%) in
the current year three month and nine 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.
- 30 -
LOSS ON IMPAIRMENT OF INVESTMENT
The losses recorded in the three and nine month periods in 2005
represented write-downs of our investments an equity security and in a bond held
for investment after determining that market declines in the value of these
securities should be considered "other than temporary". No further impairment
charges have occurred in 2006 as the bonds were sold in February 2006 and the
common stock price of the equity security has not declined further. The equity
investment referred to is the shares of common stock we own in Financial
Industries Corporation ("FIC"). We record pretax charges to earnings should the
common stock price of the security on the last day of each interim or annual
period fall below the adjusted cost basis of our investment in FIC. In the first
nine months of 2005, that charge totaled $136,000. As our adjusted cost basis in
FIC had been lowered to $7.65 and with the stock price trading above $8.00 per
share in 2006, there had been 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 $82,000 (49%) and $255,000 (62%) in the
three and nine month periods ended September 30, 2006, respectively, compared to
the same periods in 2005. The current year increases were due to higher interest
rates as well as a much higher balance of interest-bearing fixed income
securities. At September 30, 2006 there was a balance in investment securities
held of $15.3 million compared to a balance of $12.3 million held at September
30, 2005.
OTHER INCOME
Our other income increased $13,000 (433%) but decreased $61,000 (70%)
for the three and nine month periods ended September 30, 2006, respectively,
compared to the same periods in 2005. The increase in the current year three
month period was due to the receipt of management fees from a former affiliate
in excess of the fees received from them during this same period in 2005. The
decrease in the current year nine month period is primarily due to inventory
losses on securities held at APS Financial totaling $38,000 in 2006 compared to
inventory gains of $20,000 in 2005.
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LIQUIDITY AND CAPITAL RESOURCES
WORKING CAPITAL
Our net working capital was $18,197,000 and $15,880,000 at September
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 $2,641,000 in the first nine months of 2006 as cash provided by
operations was more than offset by net cash used in investing and financing
activities. Cash from operating activities increased $1,125,000 primarily due to
cash received from current year earnings plus cash received from APIE for profit
sharing ($2,000,000) that was recorded in 2005. Partially offsetting this was
cash paid in 2006 for incentive compensation earned and accrued in 2005
($2,200,000) and estimated 2006 federal income tax payments ($754,000). Cash
from investing activities decreased $1,954,000 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, the life of the loan.
Cash from financing activities decreased $1,812,000 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. Restricted
cash in the amount of $3,523,000 did not affect working capital as an equal
amount of current trade payables was recorded as of September 30, 2006. See Note
8 for an explanation of restricted cash.
Historically, we have maintained strong liquidity 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 $3.6 million; (2) our investments
in long term available-for-sale equity and short and long term fixed income
securities could provide an additional $16.7 million should the need arise; and
(3) we renewed a line of credit in April 2006 that is described below.
LINE OF CREDIT
In April 2006 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 September 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.
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CAPITAL EXPENDITURES
Our capital expenditures for equipment were $131,000 in the
nine 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 $175,000 and to be funded through cash on hand.
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 clarifies the
accounting and disclosure for uncertainty 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.
We have not yet determined the impact this interpretation will have on our
results from operations or financial position.
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. This Statement applies under
other accounting pronouncements that require or permit fair value measurements,
the Board having previously concluded in those accounting pronouncements that
fair value is the relevant measurement attribute.
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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 September, 2006 the Financial Accounting Standards Board (FASB)
issued Statement of Financial Accounting Standards, or SFAS No. 158, "Accounting
for Defined Benefit and Other Postretirement Plans" effective as of the end of
the fiscal year ending after December 15, 2006. This Statement improves
financial reporting by requiring an employer to recognize the overfunded or
underfunded status of a defined benefit postretirement plan (other than a
multiemployer plan) as an asset or liability in its statement of financial
position and to recognize changes in that funded status in the year in which the
changes occur through comprehensive income of a business entity. This Statement
also improves financial reporting by requiring an employer to measure the funded
status of a plan as of the date of its year-end statement of financial position,
with limited exceptions. We do not expect the adoption of this standard to have
a material effect on our financial position, results of operations or cash
flows.
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 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.
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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 September 30, 2006, our recorded basis in debt and equity
securities was approximately $20.0 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.
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
Period (a) Total Number (b) Average of Publicly Purchased under
of shares Price Paid Announced Plans the Plans or
Purchased (1) per Share or Programs Programs
------------- ----------- ---------------- ---------------
Jul 1, 2006 - Jul 31, 2006 4,711 $ 14.39 4,711 $ 1,961,000
Aug 1, 2006 - Aug 31, 2006 11,402 $ 14.34 11,402 $ 1,797,000
Sep 1, 2006 - Sep 30, 2006 1,000 $ 17.12 1,000 $ 1,780,000
(1) Of the total shares purchased 17,113 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
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Item 4. Submission of Matters to a Vote of Security Holders
---------------------------------------------------
Not Applicable
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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