10-Q 1 incstmt.txt QUARTERLY REPORT FOR PERIOD ENDED MARCH 31, 2006 ============================================================================= UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE PERIOD ENDED MARCH 31, 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 the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. NUMBER OF SHARES OUTSTANDING AT TITLE OF EACH CLASS May 1, 2006 -------------------- ---------------- Common Stock, $.10 par value 2,748,172 ============================================================================= 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 March 31, ------------------------------------ 2006 2005 ---------- -------- Financial services $3,578 $3,267 Insurance services 3,655 3,395 ------ ------ Total revenues 7,233 6,662 Expenses: Financial services 3,285 2,950 Insurance services 2,754 2,503 General and administrative 518 667 Gain on sale of assets (Note 4) - (35) ------ ------ Total expenses 6,557 6,085 ------ ------ Operating income 676 577 Gain on investments (Note 5) 7 630 Loss on impairment of investment (Note 6) - (39) ------ ------ Income from operations before interest, income taxes and minority interest 683 1,168 Interest income 197 122 Other income 6 55 Interest expense - 4 Income tax expense 323 477 Minority interests 1 11 ------ ------ Net income $562 $853 ====== ====== The accompanying notes are an integral part of these condensed consolidated financial statements. - 3 - AMERICAN PHYSICIANS SERVICE GROUP, INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS, continued (Unaudited) (In thousands, except per share amounts) Three Months Ended March 31, ------------------------ 2006 2005 ------ ------ Net income per common share Basic: Income from operations $ 0.20 $ 0.32 ------ ------ Net income $ 0.20 $ 0.32 ====== ====== Diluted: Income from operations $ 0.19 $ 0.30 ------ ------ Net income $ 0.19 $ 0.30 ====== ====== Basic weighted average shares outstanding 2,762 2,642 ====== ====== Diluted weighted average shares outstanding 2,909 2,867 ====== ====== The accompanying notes are an integral part of these condensed consolidated financial statements. - 4 - AMERICAN PHYSICIANS SERVICE GROUP, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited) (In thousands)
March 31, December 31, 2006 2005 ------------ ------------ ASSETS Current Assets: Cash and cash equivalents $6,466 $6,680 Trading account securities 90 -- Trade receivables, net 317 42 Notes receivable - current 645 599 Management fees and other receivables 991 3,192 Deposit with clearing organization 501 501 Investment in available-for-sale fixed income securities - current (Note 8) 11,154 9,662 Net deferred income tax asset 342 355 Prepaid expenses and other 966 632 ------- ------ Total current assets 21,472 21,663 Notes receivable, less current portion 405 326 Property and equipment, net 669 687 Investment in available-for-sale equity securities (Note 7) 5,191 5,017 Investment in available-for-sale fixed income securities - non-current (Note 8) 3,353 3,584 Net deferred income tax asset 560 686 Goodwill 1,247 1,247 Other assets 252 295 ------- ------- Total Assets $33,149 $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)
March 31, December 31, 2006 2005 --------- ------------ LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable $851 $736 Accrued incentive compensation 612 2,595 Accrued expenses and other liabilities (Note 9) 3,171 1,912 Federal income tax payable 185 71 Deferred gain - current 328 469 ------- ------- Total current liabilities 5,147 5,783 Long term liabilities -- -- ------- ------- Total liabilities 5,147 5,783 Minority interests 16 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; 2,754,472 and 2,784,120 issued and outstanding at 3/31/06 and 12/31/05, respectively 275 278 Additional paid-in capital 7,826 8,204 Retained earnings 19,300 18,737 Accumulated other comprehensive income, net of taxes 585 488 ------- ------- Total shareholders' equity 27,986 27,707 ------- ------- Total Liabilities and Shareholders' Equity $33,149 $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)
Three Months Ended March 31, 2006 2005 ------ ------ Cash flows from operating activities: Net Income $ 562 $ 853 Adjustments to reconcile net income to cash provided by (used in) operating activities: Depreciation and amortization 106 67 Extinguishment of debt and other 108 63 Common stock awarded 102 159 Gain on sale of assets -- (35) Deferred gain on sale of building (141) (122) Gain on sale of investment (7) (630) Loss on impairment of investment -- 39 Changes in operating assets and liabilities: Trade receivables (275) 15 Trading account securities (90) -- Income tax payable (90) 514 Deferred income tax 139 (278) Deferred compensation 23 -- Management fees & other receivables 2,201 811 Prepaid expenses & other assets (344) (271) Trade payables 115 (41) Accrued expenses & other liabilities (604) (2,311) ------ ------ Net cash provided by (used in) operating activities 1,805 (1,167) Cash flows from investing activities: Capital expenditures (57) (94) Proceeds from the sale of available-for-sale equity and fixed income securities 2,741 1,154 Purchase of available-for-sale equity securities (3,987) (4,616) Funds loaned to others (243) (381) Collection of notes receivable 10 60 ------ ------ Net cash used in investing activities (1,536) (3,877) Cash flows from financing activities: Exercise of stock options 64 17 Purchase and cancellation of treasury stock (577) (258) Stock options expensed 27 -- Excess tax benefits from stock-based compensation 3 -- ------ ------ Net cash provided by (used in) financing activities (483) (241) Net change in cash and cash equivalents $ (214) $ (5,285) Cash and cash equivalents at beginning of period 6,680 9,673 ------ ------ Cash and cash equivalents at end of period $ 6,466 $ 4,388 ====== ======
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 three months ended March 31, 2005 and March 31, 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 -- -- 853 $ 853 -- -- 853 Other comprehensive income: Unrealized loss on securities, net of taxes of $200 -- -- -- (389) (389) -- (389) ------ Comprehensive income: -- -- -- $ 464 -- -- -- ====== Stock options exercised -- 17 -- -- -- -- 17 Treasury stock purchases -- -- -- -- -- (258) (258) Cancelled treasury stock (2) (256) -- -- -- 258 -- Stock awarded 1 158 -- -- -- -- 159 ------------------------------------------------------------------------------------------------ Balance March 31, 2005 $ 264 $ 7,838 $14,801 $ -- $ 1,692 $ -- $ 24,595 ================================================================================================ Balance December 31, 2005 $ 278 $ 8,204 $ 18,737 $ -- $ 488 $ -- $ 27,707 ------------------------------------------------------------------------------------------------ Comprehensive income: Net income -- -- 562 $ 562 -- -- 562 Other comprehensive income: Unrealized gain on securities, net of taxes of $50 -- -- -- 97 97 -- 97 ----- Comprehensive income: -- -- -- $ 659 -- -- -- ===== Stock options exercised 1 63 -- -- -- -- 64 Stock options expensed -- 27 -- -- -- -- 27 Tax benefit from exercise of stock options -- 3 -- -- -- -- 3 Treasury stock purchases -- -- -- -- -- (577) (577) Cancelled treasury stock (5) (572) -- -- -- 577 -- Stock awarded 1 101 -- -- -- -- 102 ------------------------------------------------------------------------------------------------ Balance March 31, 2006 $ 275 $ 7,826 $19,300 $ -- $ 585 $ -- $ 27,986 ================================================================================================
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 March 31, 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 three months ended March 31, 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. Certain reclassifications have been made to amounts in prior periods to be consistent with the 2006 presentation. A change in segment expenses on page 3 of this report was made which reclassified overhead charges of $181,000 previously allocated to Insurance Services in 2005 to General and Administrative. 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 months ended March 31, 2006, we recognized $141,000 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 $281,000 remains to be recognized in the coming six 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 first three months of 2006 we did not recognize any of these deferred gains as no HealthTronics common stock was sold in the period. As of March 31, 2006, there remained a balance of approximately $46,000 to be recognized. 5. GAIN (LOSS) ON INVESTMENTS Our gains resulted primarily from the sales of available-for-sale equity and fixed income securities. During the three months ended March 31, 2006, we received net cash proceeds of approximately $2,741,000 and recognized gains of $7,000 resulting from these sales and scheduled maturities. 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 currently continue to have the ability and the intent to hold the stock indefinitely, we concluded that the additional uncertainty created by FIC's late 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 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 March 31, 2006, no impairment charges were necessary. 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. ACCRUED EXPENSES AND OTHER LIABILITIES Accrued expenses and other liabilities consists of the following: March 31 December 31 2005 2005 -------- ---------- Commissions payable $ 623,000 $ 1,258,000 Customer deposits 1,960,000 -- Taxes payable 246,000 219,000 Vacation 161,000 161,000 401(k) plan matching 91,000 208,000 Other accrued liabilities 90,000 66,000 ---------- --------- $3,171,000 $ 1,912,000 ========== ========== - 11 - 10. 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 earnings and weighted average shares outstanding used in the calculation of basic and diluted earnings per share from operations follows: For the Three Months Ended March 31, 2006 -------------------------------------------- Income Shares Per Share (Numerator) (Denominator) Amount --------- ----------- -------- Basic EPS Net income $ 562,000 2,762,000 $ 0.20 ====== Diluted EPS Effect of dilutive securities -- 147,000 -------- --------- Net income $ 562,000 2,909,000 $ 0.19 ======== ========= ====== For the Three Months Ended March 31, 2005 -------------------------------------------- Income Shares Per Share (Numerator) (Denominator) Amount --------- ---------- ------- Basic EPS Net income $ 853,000 2,642,000 $ 0.32 ====== Diluted EPS Effect of dilutive securities -- 225,000 --------- --------- Net income $ 853,000 2,867,000 $ 0.30 ========= ========== ====== - 12 - 11. SEGMENT INFORMATION The Company's segments are distinct by type of service provided. Comparative financial data for the three months period ended March 31, 2006 and 2005 are shown as follows: Three months ended March 31, 2006 2005 -------- ----------- Operating Revenue: Financial services $ 3,578,000 $ 3,267,000 Insurance services 3,655,000 3,395,000 Corporate 2,100,000 -- ---------- ---------- Total Segment Revenues $ 9,333,000 $ 6,662,000 ========== ========== Reconciliation to Consolidated Statement of Operations: Total segment revenues $ 9,333,000 $ 6,662,000 Less: Intercompany dividends (2,100,000) -- ----------- ----------- Total Revenues $ 7,233,000 $ 6,662,000 =========== =========== Operating Income Financial services $ 293,000 $ 317,000 Insurance services 901,000 892,000 Corporate (518,000) (632,000) ---------- --------- Total segments operating income 676,000 577,000 Gain on investments 7,000 630,000 Loss on impairment of investment -- (39,000) ---------- --------- Income (loss) from operations before interest, income taxes and minority interest 683,000 1,168,000 Interest income 197,000 122,000 Other gain 6,000 55,000 Interest expense -- 4,000 Income tax expense 323,000 477,000 Minority interest 1 11 --------- --------- Net income $ 562,000 $ 853,000 ========= ========= - 13 - 12. STOCK-BASED COMPENSATION In December 2004, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment (SFAS 123 (R)). The standard amends SFAS 123, Accounting for Stock-Based Compensation, and concludes that services received from employees in exchange for stock-based compensation results in a cost to the employer that must be recognized in the financial statements. The cost of such awards should be measured at fair value at grant date. On January 1, 2006 we adopted SFAS No. 123R. We use the Black-Scholes-Merton option-pricing model to determine the fair value of stock-based awards, consistent with that used for pro forma disclosures under SFAS No. 123, Accounting for Stock-Based Compensation. We have elected the modified prospective transition method as permitted by SFAS No, 123R and accordingly prior periods have not been restated to reflect the impact of SFAS No. 123R. SFAS No. 123R requires that stock-based compensation be recorded for all new and unvested stock options expected to vest as the requisite service is rendered beginning January 1, 2006, the first day of our 2006 fiscal year. Stock-based compensation expense for awards granted on or before December 31, 2005, but unvested as of that date, is based on the grant date fair value as determined under the pro forma provisions of SFAS No. 123. For the three months ended March 31, 2006 we recorded compensation cost related to stock options of $27,000 and a related reduction in income taxes of $10,000. The compensation cost is the total fair value, at date of grant, of shares that vested during the three month period. No compensation costs were capitalized in the three month period ended March 31, 2006. During the quarter ended March 31, 2006 7,000 options were exercised with an intrinsic value of $20,000. We received proceeds of $64,000 from the exercise of these options. Based on unvested options outstanding at March 31, 2006 compensation costs to be recorded in future periods are expected to be recognized as follows: 2006, $96,000; 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 128,000 of these options have been granted as of March 31, 2006, 113,000 of which are exercisable. Under the previous plan, the "1995 Incentive and Non-Qualified Stock Option Plan", 453,000 options remain unexercised, of which 412,000 are exercisable at March 31, 2006. 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. - 14 - Presented below is a summary of the stock options held by our employees and our directors and the related transactions for the three months ended March 31. 2006 and the year ended December 31, 2005. Three Months Ended Year Ended March 31, December 31, ------------------ --------------- 2006 2005 ------------------ --------------- Weighted Weighted Average Average Exercise Exercise Shares Price Shares Price ------ -------- ------ ------ Balance at January 1 573,000 $7.92 721,000 $6.04 Options granted 15,000 13.50 113,000 11.60 Options exercised (7,000) 9.84 (251,000) 4.13 Options forfeited/expired -- -- (10,000) 9.10 ------- -------- ------- ------ Balance at end of period 581,000 $8.04 573,000 $7.92 ======= ===== ======= ===== Options exercisable 525,000 $7.78 483,000 $7.96 ======= ===== ======= ===== The weighted average fair value of Company stock options granted is $3.83 and $3.19 per option for the three months ended March 31, 2006 and the year ended December 31, 2005, respectively. The fair value of the options was calculated using the Black-Scholes-Merton option pricing model with the following assumptions: Three months Year ended ended March 31, 2006 December 31, 2005 -------------- ----------------- Expected option term: 3.7 years 3.6 years Expected volatility 0.354 0.363 Expected dividend yield 1.85% 2.15% Risk-free rate of return 4.72% 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 March 31, 2006: - 15 -
Stock Options Outstanding Stock Options Exercisable ------------------------------------------------------------ ---------------------------------------- ------------------ Shares Weighted Aggregate Average Weighted Aggregate Average ------ Average Remaining Average Remaining Exercise Intrinsic Contractual Exercise Intrinsic Contractual Price Value (1) Life Shares Price Value (1) Life ----- --------- ---- ------ ----- --------- ---- 581,000 $8.04 3,375,000 2.8 yrs. 525,000 7.78 3,184,000 2.7 yrs.
(1) Based on the $13.85 closing price of our stock at March 31, 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 months ended March 31, 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 March 31, 2005 ------------------ Net income as reported $853,000 Deduct: Total additional stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects (53,000) -------- Pro forma net income $800,000 ======== Net income per share Basic - as reported $0.32 ===== Basic - pro forma $0.30 ===== Diluted - as reported $0.30 ===== Diluted - pro forma $0.28 ===== - 16 - 13. 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. 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. - 17 - 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. 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. - 18 - 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. 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 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. OTHER As of March 31, 2006, we have the following significant investments accounted for as available-for-sale securities: (1) we own approximately 143,000 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. - 19 - CRITICAL ACCOUNTING POLICIES AND ESTIMATES The preparation of our consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. On an on-going basis, we evaluate our estimates, including those related to: impairment of assets; bad debts; income taxes; and contingencies and litigation. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. We believe the following critical accounting policies and estimates affect our more significant judgments and estimates used in the preparation of our consolidated financial statements. We periodically review the carrying value of our assets to determine if events and circumstances exist indicating that assets might be impaired. If facts and circumstances support this possibility of impairment, our management will prepare undiscounted and discounted cash flow projections, which require judgments that are both subjective and complex. Management may also obtain independent valuations. Our financial services revenues are composed primarily of commissions on securities trades and clearing of trade claims and asset management fees. Revenues related to securities transactions are recognized on a trade date basis. Revenues from the clearing and settlement of trades involving syndicated bank loans, trade claims and distressed private loan portfolios are recognized when the transaction is complete and fully funded. Asset management fees are recognized as a percentage of assets under management during the period based upon the terms of agreements with the applicable customers. Our insurance service revenues related to management fees are recognized monthly at 13.5% of the earned premiums of the managed company. We also share equally any profits of the managed company, to a maximum of 3% of the earned insurance premiums. Any past losses of the managed company are carried forward and applied against earnings before any profits are shared. The profit sharing component 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 the Company was 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 - 20 - 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 the Company's financial position, operations or cash flow. At March 31, 2006, the Company has several stock-based compensation plans, which are described more fully in Note 12 to the audited consolidated financial statements contained in our most recently filed Annual Report on Form 10-K. Prior to January 1, 2006, the Company accounted for these plans under the recognition and measurement principles of APB No. 25, under which stock-based employee compensation cost was not reflected in net income, as all options granted under these plans had an exercise price equal to the market value of the underlying common stock on the date of grant. In accordance with SFAS No. 123, as amended by SFAS No. 148, the Company provided footnote disclosure of the pro forma stock-based compensation cost, net loss and net loss per share as if the fair-value based method of expense recognition and measurement prescribed by SFAS No. 123 had been applied to all employee options. As a result of adopting SFAS No. 123(R) on January 1, 2006, the Company's net gain for the quarter ended March 31, 2006 is $27,000 less than it would have been if the Company 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 minimal effect on the Company's Statement of Cash Flows, as there were minimal exercises of stock options in the three months ended March 31, 2006. RESULTS OF OPERATIONS REVENUES Revenues from operations increased $571,000 (9%) in the three months ended March 31, 2006, respectively, compared to the same period in 2005. Our operating income increased $99,000 (17%) in the current year three months compared to the same period in 2005. Our net income decreased $291,000 (34%) in the current year three months, compared to the same period in 2005. Lastly, our diluted net income per share decreased $0.11 (37%) in the current year three months compared to the same period in 2005. The reasons for these changes are described below. - 21 - FINANCIAL SERVICES Our financial services revenue increased $311,000 (10.0%) in the first three months of 2006 compared to the same period in 2005. Revenues from our investment banking division increased $725,000 (967%) while those from our new subsidiary, APS Clearing, contributed $154,000. 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. Bank debt trading generated revenues were not recorded in the first quarter of 2005 as APS Clearing was not formed until later in 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 fell $568,000 (18%) in the first three months of 2006 compared to the same period in 2005. Revenue from our investment grade trading continued to be flat in a rising interest rate environment in which the Fed has raised rates fifteen times since June 2004 (for a total of 375 basis points). Revenue from trading of non-investment grade (high yield bonds) has also been generally weaker due to the increasing general level of interest rates, poor fundamentals and price transparency created by automated reporting processes such as TRACE. Our financial services expenses increased $335,000 (11%) in the three months ended March 31, 2006 compared to the same period in 2005. The primary reason for the current year increase is a $167,000 (9%) increase in commission expense in the current year three month period compared to the same period in 2005 resulting from commissions paid on increased investment banking and bank debt trading revenues mentioned above. In addition, salaries expense was up $136,000 (34%) due primarily 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 totaled $50,000 in the current year quarter compared to zero in the same period in 2005 as a result of the profits generated from our investment banking division. Partially offsetting these expense increases is a decrease in professional fees of $60,000 (54%) in the three month period ended March 31, 2006 compared to the same period in 2005 primarily as a result of higher fees incurred in 2005 related to Sarbanes Oxley compliance. INSURANCE SERVICES Total revenues from our insurance services segment increased $260,000 (8%) in the three month period ended March 31, 2006 compared to the same period in 2005. Current year increases in commission income and in management fees were the primary reasons for this growth. Pass through commission income was up $202,000 (19%) in 2006 as a result of higher commission rates and higher new business written at our managed - 22 - medical malpractice insurance company, APIE, compared to the same period in 2005. 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. Management fee revenues increased $108,000 (5%) in the three months ended March 31, 2006 compared to the same period in 2005 primarily due to writing a large extended reporting period policy that earns out immediately instead of earning out pro-rata over twelve months, as is normally the case. New written business at APIE was up $2.7 million (208%) in the current quarter, but despite our more intense marketing effort and an overall 13% increase in the number of doctors insured, premiums from renewal business were down $2.8 million (17%) compared to the same period in the prior year. This decline in renewal business was caused by increased competition. Insurance services expenses increased $251,000 (10%) in the three months ended March 31, 2006 compared to the same period in 2005. The current quarter increase is primarily due to a $202,000 (19%) increase in commissions expense due to the above-mentioned increase in commissions paid to third party independent agents during the first quarter of 2006 compared to the same period in 2005. Also, payroll increased $64,000 (8%) in the three months ended March 31, 2006 compared to the same period in 2005 as a result of normal merit raises as well as the addition of two new managerial positions. GENERAL AND ADMINISTRATIVE EXPENSES General and administrative expenses decreased $150,000 (22%) in the three month period ended March 31, 2006 compared to the same period in 2005. This decrease is primarily due to lower professional fees and lower incentive compensation expenses. Professional fees declined $67,000 (66%) in the current quarter as costs associated with internal controls disclosures and procedures under the Sarbanes-Oxley Act of 2002 ("SOX 404") compliance are minimal in the first quarter of 2006 compared to the first quarter of 2005 when we were ramping up our compliance efforts. With the most recent deadline delay and 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 $66,000 (35%) in the current year three month periods compared to the same period in 2005 due to lower investment gains in 2006. GAIN ON SALE OF ASSETS During the three months ended March 31, 2006, we recognized $141,000 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 - 23 - $5,100,000 gain and are recognizing it in earnings, as a reduction of rent expense, monthly through September 2006. A total of $281,000 remains to be recognized in the coming six 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 first three months of 2006 we did not recognize any of these deferred gains as no HealthTronics common stock was sold in the period. As of March 31, 2006, there remained a balance of approximately $46,000 to be recognized. GAIN ON INVESTMENTS The decrease in the current three month period of is due to the sale of a large number of available-for-sale equity securities in 2005 compared to a small gain on the sale of an available-for-sale fixed income security in the first three months of 2006. LOSS ON IMPAIRMENT OF INVESTMENT The loss recorded in the first quarter 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". As explained on page 19 of this report, 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 an additional charge in the current period. We will continue to monitor and evaluate the situation at Financial Industries. INTEREST INCOME Our interest income increased $75,000 (61%) in the three month period ended March 31, 2006 compared to the same period in 2005. The current year three month increase was due to interest earned on a higher rate as well as on a much higher balance of interest-bearing fixed income securities. At March 31, 2006 there was a balance in investment securities held of $14.5 million compared to a balance of $9.3 million held at March 31, 2005. - 24 - OTHER INCOME (LOSS) Our other income decreased $49,000 (89%) for the three month period ended March 31, 2006 compared to the same period in 2005. The decrease in the current year three month period is primarily due to inventory losses on securities held at APS Financial totaling $6,000 in 2006 compared to inventory gains of $18,000 in 2005. LIQUIDITY AND CAPITAL RESOURCES WORKING CAPITAL Our net working capital was $16,325,000 and $15,880,000 at March 31, 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 $214,000 during this period as cash provided by operations was more than offset by net cash used in investing and financing activities. Cash from operating activities increased primarily due to cash received from APIE for profit sharing ($2.0 million) that was recorded in 2005 as well as from an advance payment from a trade claim transaction that was completed in April, 2006 ($2.0 million). Partially offsetting this was cash paid in the current quarter for incentive compensation earned and accrued in 2005 ($2.2 million). Cash from investing activities decreased $1.5 million as purchases of available-for-sale securities exceeded cash received from the sales of other available-for-sale securities. Cash from financing activities decreased $483,000 due to purchases of treasury stock exceeding cash received from the exercise of employee stock options. For details of the amounts described above, refer to the Condensed Consolidated Statements of Cash Flows on page 7 of this Form 10-Q. 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 $6.5 million comprising 20 percent of our total assets; (2) our investments in available-for-sale equity and fixed income securities could provide an additional $16.4 million should the need arise; and (3) we renewed a line of credit in April 2006 that is described below. - 25 - LINE OF CREDIT We renewed a $3.0 million line of credit that was originally established in November 2003 with PlainsCapital Bank. The loan called 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, became due and payable. At March 31, 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 $57,000 in the three 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 is expected 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. 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. - 26 - 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 $21 million would result in a change of $210,000 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. 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 March 31, 2006, our recorded basis in debt and equity securities was approximately $19.7 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 - 27 - 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. - 28 - PART II OTHER INFORMATION - 29 - 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 ------------- ----------- ---------------- --------------- Jan 1, 2006 - Jan 31, 2006 20,600 $ 13.01 20,600 $ 1,750,000 Feb 1, 2006 - Feb 28, 2006 12,856 $ 12.86 12,856 $ 1,585,000 Mar 1, 2006 - Mar 31, 2006 10,800 $ 13.28 10,800 $ 1,442,000
(1) Of the total shares purchased 44,256 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 by an additional 2,000,000 on December 12, 2005. Item 3. DEFAULTS UPON SENIOR SECURITIES -------------------------------- Not Applicable Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS --------------------------------------------------- Not Applicable - 30 - 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 - 31 -