Item 1. Financial Statements
Consolidated Balance Sheets
(in thousands, except share data)
| | | June 30, 2022 | | | December 31, 2021 | |
| | | (unaudited) | | | | | |
| Assets | | | | | | | | |
| Investments: | | | | | | | | |
| Fixed maturities, at fair value (amortized cost of $38,931 and $35,889, respectively) | | $ | 37,013 | | | $ | 35,666 | |
| Equity investments, at fair value (cost of $187 and $1,147, respectively) | | | 131 | | | | 179 | |
| Limited liability investments | | | 1,215 | | | | 1,901 | |
| Limited liability investments, at fair value | | | 18,986 | | | | 18,826 | |
| Investments in private companies, at adjusted cost | | | 790 | | | | 790 | |
| Real estate investments, at fair value (cost of $10,225 and $10,225, respectively) | | | 10,662 | | | | 10,662 | |
| Other investments, at cost which approximates fair value | | | 222 | | | | 256 | |
| Short-term investments, at cost which approximates fair value | | | 157 | | | | 157 | |
| Total investments | | | 69,176 | | | | 68,437 | |
| Cash and cash equivalents | | | 11,704 | | | | 12,642 | |
| Restricted cash | | | 14,492 | | | | 17,257 | |
| Accrued investment income | | | 1,031 | | | | 1,013 | |
| Service fee receivable, net of allowance for doubtful accounts of $239 and $241, respectively | | | 8,484 | | | | 6,656 | |
| Other receivables, net of allowance for doubtful accounts of $5 and $5, respectively | | | 12,520 | | | | 13,898 | |
| Deferred contract costs | | | 12,617 | | | | 10,930 | |
| Income taxes recoverable | | | 35 | | | | — | |
| Property and equipment, net of accumulated depreciation of $25,211 and $24,224, respectively | | | 107,079 | | | | 108,587 | |
| Right-of-use asset | | | 1,801 | | | | 2,248 | |
| Goodwill | | | 110,247 | | | | 110,247 | |
| Intangible assets, net of accumulated amortization of $23,349 and $20,333, respectively | | | 105,214 | | | | 108,230 | |
| Other assets | | | 15,228 | | | | 15,489 | |
| Total Assets | | $ | 469,628 | | | $ | 475,634 | |
| Liabilities and Shareholders' Equity | | | | | | | | |
| Liabilities: | | | | | | | | |
| Accrued expenses and other liabilities | | $ | 51,977 | | | $ | 47,622 | |
| Income taxes payable | | | — | | | | 294 | |
| Deferred service fees | | | 91,321 | | | | 89,217 | |
| Bank loans | | | 22,818 | | | | 26,717 | |
| Notes payable | | | 201,413 | | | | 205,025 | |
| Subordinated debt, at fair value | | | 57,282 | | | | 60,973 | |
| Lease liability | | | 2,019 | | | | 2,479 | |
| Net deferred income tax liabilities | | | 27,860 | | | | 28,553 | |
| Total Liabilities | | | 454,690 | | | | 460,880 | |
| Redeemable Class A preferred stock, no par value; 1,000,000 authorized; 169,733 issued and outstanding at June 30, 2022 and December 31, 2021; redemption amount of $6,655 and $6,497 at June 30, 2022 and December 31, 2021, respectively | | | 6,655 | | | | 6,497 | |
| Shareholders' Equity: | | | | | | | | |
| Common stock, no par value; 50,000,000 authorized; 23,130,064 issued and 22,882,614 outstanding at June 30, 2022 and December 31, 2021 | | | — | | | | — | |
| Additional paid-in capital | | | 359,536 | | | | 359,138 | |
| Treasury stock, at cost; 247,450 and 247,450 outstanding at June 30, 2022 and December 31, 2021, respectively | | | (492 | ) | | | (492 | ) |
| Accumulated deficit | | | (400,470 | ) | | | (395,149 | ) |
| Accumulated other comprehensive income | | | 36,017 | | | | 30,779 | |
| Shareholders' equity attributable to common shareholders | | | (5,409 | ) | | | (5,724 | ) |
| Noncontrolling interests in consolidated subsidiaries | | | 13,692 | | | | 13,981 | |
| Total Shareholders' Equity | | | 8,283 | | | | 8,257 | |
| Total Liabilities, Class A preferred stock and Shareholders' Equity | | $ | 469,628 | | | $ | 475,634 | |
See accompanying notes to unaudited consolidated financial statements.
| KINGSWAY FINANCIAL SERVICES INC. |
Consolidated Statements of Operations
(in thousands, except per share data)
(Unaudited)
| | | Three months ended June 30, | | | Six months ended June 30, | |
| | | 2022 | | | 2021 | | | 2022 | | | 2021 | |
| Revenues: | | | | | | | | | | | | | | | | |
| Service fee and commission revenue | | $ | 23,590 | | | $ | 18,755 | | | $ | 46,046 | | | $ | 37,329 | |
| Rental revenue | | | 3,633 | | | | 3,341 | | | | 7,300 | | | | 6,682 | |
| Total revenues | | | 27,223 | | | | 22,096 | | | | 53,346 | | | | 44,011 | |
| Operating expenses: | | | | | | | | | | | | | | | | |
| Claims authorized on vehicle service agreements | | | 5,345 | | | | 5,251 | | | | 10,528 | | | | 9,918 | |
| Commissions | | | 1,997 | | | | 1,488 | | | | 3,260 | | | | 2,876 | |
| Cost of services sold | | | 4,246 | | | | 952 | | | | 8,818 | | | | 1,932 | |
| General and administrative expenses | | | 11,595 | | | | 12,127 | | | | 24,210 | | | | 24,717 | |
| Leased real estate segment interest expense | | | 1,663 | | | | 1,500 | | | | 3,354 | | | | 2,968 | |
| Total operating expenses | | | 24,846 | | | | 21,318 | | | | 50,170 | | | | 42,411 | |
| Operating income | | | 2,377 | | | | 778 | | | | 3,176 | | | | 1,600 | |
| Other revenues (expenses), net: | | | | | | | | | | | | | | | | |
| Net investment income | | | 465 | | | | 403 | | | | 1,084 | | | | 824 | |
| Net realized gains | | | 184 | | | | 187 | | | | 238 | | | | 238 | |
| Loss on change in fair value of equity investments | | | (38 | ) | | | (45 | ) | | | (48 | ) | | | (196 | ) |
| Gain on change in fair value of limited liability investments, at fair value | | | 46 | | | | 731 | | | | 173 | | | | 529 | |
| Non-operating other expenses | | | (877 | ) | | | (2,741 | ) | | | (653 | ) | | | (2,634 | ) |
| Interest expense not allocated to segments | | | (1,704 | ) | | | (1,593 | ) | | | (3,068 | ) | | | (3,145 | ) |
| Amortization of intangible assets | | | (1,494 | ) | | | (496 | ) | | | (2,988 | ) | | | (993 | ) |
| Loss on change in fair value of debt | | | (1,330 | ) | | | (738 | ) | | | (3,198 | ) | | | (1,757 | ) |
| Gain on extinguishment of debt | | | — | | | | — | | | | — | | | | 2,494 | |
| Total other expenses, net | | | (4,748 | ) | | | (4,292 | ) | | | (8,460 | ) | | | (4,640 | ) |
| Loss before income tax benefit | | | (2,371 | ) | | | (3,514 | ) | | | (5,284 | ) | | | (3,040 | ) |
| Income tax benefit | | | (6 | ) | | | (3,258 | ) | | | (415 | ) | | | (3,683 | ) |
| Net (loss) income | | | (2,365 | ) | | | (256 | ) | | | (4,869 | ) | | | 643 | |
| Less: net income attributable to noncontrolling interests in consolidated subsidiaries | | | 303 | | | | 428 | | | | 452 | | | | 687 | |
| Less: dividends on preferred stock | | | 79 | | | | 85 | | | | 157 | | | | 323 | |
| Net loss attributable to common shareholders | | $ | (2,747 | ) | | $ | (769 | ) | | $ | (5,478 | ) | | $ | (367 | ) |
| Loss per share – net loss attributable to common shareholders: | | | | | | | | | | | | | | | | |
| Basic: | | $ | (0.12 | ) | | $ | (0.03 | ) | | $ | (0.24 | ) | | $ | (0.02 | ) |
| Diluted: | | $ | (0.12 | ) | | $ | (0.03 | ) | | $ | (0.24 | ) | | $ | (0.02 | ) |
| Weighted-average shares outstanding (in ‘000s): | | | | | | | | | | | | | | | | |
| Basic: | | | 22,883 | | | | 22,366 | | | | 22,883 | | | | 22,292 | |
| Diluted: | | | 22,883 | | | | 22,366 | | | | 22,883 | | | | 22,292 | |
See accompanying notes to unaudited consolidated financial statements.
| KINGSWAY FINANCIAL SERVICES INC. |
Consolidated Statements of Comprehensive Income (Loss)
(in thousands)
(Unaudited)
| |
|
Three months ended June 30, |
|
|
Six months ended June 30, |
|
| |
|
2022 |
|
|
2021 |
|
|
2022 |
|
|
2021 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Net (loss) income |
|
$ |
(2,365 |
) |
|
$ |
(256 |
) |
|
$ |
(4,869 |
) |
|
$ |
643 |
|
| Other comprehensive income (loss), net of taxes(1): |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Unrealized (losses) gains on available-for-sale investments: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Unrealized losses arising during the period |
|
|
(535 |
) |
|
|
(35 |
) |
|
|
(1,702 |
) |
|
|
(110 |
) |
| Reclassification adjustment for amounts included in net (loss) income |
|
|
6 |
|
|
|
2 |
|
|
|
7 |
|
|
|
14 |
|
| Change in fair value of debt attributable to instrument-specific credit risk |
|
|
5,930 |
|
|
|
(3,813 |
) |
|
|
6,889 |
|
|
|
(5,534 |
) |
| Other comprehensive income (loss), net of taxes(1): |
|
|
5,401 |
|
|
|
(3,846 |
) |
|
|
5,194 |
|
|
|
(5,630 |
) |
| Comprehensive income (loss) |
|
|
3,036 |
|
|
|
(4,102 |
) |
|
|
325 |
|
|
|
(4,987 |
) |
| Less: comprehensive income attributable to noncontrolling interests in consolidated subsidiaries |
|
|
301 |
|
|
|
426 |
|
|
|
408 |
|
|
|
682 |
|
| Comprehensive income (loss) attributable to common shareholders |
|
$ |
2,735 |
|
|
$ |
(4,528 |
) |
|
$ |
(83 |
) |
|
$ |
(5,669 |
) |
(1) Net of income tax benefit of $0 for the three and six months ended June 30, 2022 and June 30, 2021.
See accompanying notes to unaudited consolidated financial statements
| KINGSWAY FINANCIAL SERVICES INC. |
Consolidated Statements of Shareholders' Equity
(in thousands, except share data)
| |
|
Three Months Ended June 30, 2022 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accumulated |
|
|
Shareholders' |
|
|
Noncontrolling |
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
Additional |
|
|
|
|
|
|
|
|
|
|
Other |
|
|
Equity Attributable |
|
|
Interests in |
|
|
Total |
|
| |
|
|
|
|
|
|
|
|
|
Paid-in |
|
|
Treasury |
|
|
Accumulated |
|
|
Comprehensive |
|
|
to Common |
|
|
Consolidated |
|
|
Shareholders' |
|
| |
|
Common Stock |
|
|
Capital |
|
|
Stock |
|
|
Deficit |
|
|
Income |
|
|
Shareholders |
|
|
Subsidiaries |
|
|
Equity |
|
| |
|
Shares |
|
|
Amount |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Balance, March 31, 2022 |
|
|
22,882,614 |
|
|
$ |
— |
|
|
$ |
359,346 |
|
|
$ |
(492 |
) |
|
$ |
(397,802 |
) |
|
$ |
30,614 |
|
|
$ |
(8,334 |
) |
|
$ |
13,635 |
|
|
$ |
5,301 |
|
| Net (loss) income |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
(2,668 |
) |
|
|
— |
|
|
|
(2,668 |
) |
|
|
303 |
|
|
|
(2,365 |
) |
| Preferred stock dividends |
|
|
— |
|
|
|
— |
|
|
|
(79 |
) |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
(79 |
) |
|
|
— |
|
|
|
(79 |
) |
| Distributions to noncontrolling interest holders |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
(244 |
) |
|
|
(244 |
) |
| Other comprehensive income (loss) |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
5,403 |
|
|
|
5,403 |
|
|
|
(2 |
) |
|
|
5,401 |
|
| Stock-based compensation |
|
|
— |
|
|
|
— |
|
|
|
269 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
269 |
|
|
|
— |
|
|
|
269 |
|
| Balance, June 30, 2022 |
|
|
22,882,614 |
|
|
$ |
— |
|
|
$ |
359,536 |
|
|
$ |
(492 |
) |
|
$ |
(400,470 |
) |
|
$ |
36,017 |
|
|
$ |
(5,409 |
) |
|
$ |
13,692 |
|
|
$ |
8,283 |
|
| |
|
Three Months Ended June 30, 2021 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accumulated |
|
|
Shareholders' |
|
|
Noncontrolling |
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
Additional |
|
|
|
|
|
|
|
|
|
|
Other |
|
|
Equity Attributable |
|
|
Interests in |
|
|
Total |
|
| |
|
|
|
|
|
|
|
|
|
Paid-in |
|
|
Treasury |
|
|
Accumulated |
|
|
Comprehensive |
|
|
to Common |
|
|
Consolidated |
|
|
Shareholders' |
|
| |
|
Common Stock |
|
|
Capital |
|
|
Stock |
|
|
Deficit |
|
|
Income |
|
|
Shareholders |
|
|
Subsidiaries |
|
|
Equity |
|
| |
|
Shares |
|
|
Amount |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Balance, March 31, 2021 |
|
|
22,365,631 |
|
|
$ |
— |
|
|
$ |
355,999 |
|
|
$ |
(492 |
) |
|
$ |
(394,167 |
) |
|
$ |
36,279 |
|
|
$ |
(2,381 |
) |
|
$ |
14,243 |
|
|
$ |
11,862 |
|
| Net (loss) income |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
(684 |
) |
|
|
— |
|
|
|
(684 |
) |
|
|
428 |
|
|
|
(256 |
) |
| Preferred stock dividends |
|
|
— |
|
|
|
— |
|
|
|
(85 |
) |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
(85 |
) |
|
|
— |
|
|
|
(85 |
) |
| Distributions to noncontrolling interest holders |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
(1 |
) |
|
|
(1 |
) |
| Other comprehensive loss |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
(3,845 |
) |
|
|
(3,845 |
) |
|
|
(1 |
) |
|
|
(3,846 |
) |
| Stock-based compensation |
|
|
— |
|
|
|
— |
|
|
|
417 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
417 |
|
|
|
— |
|
|
|
417 |
|
| Balance, June 30, 2021 |
|
|
22,365,631 |
|
|
$ |
— |
|
|
$ |
356,331 |
|
|
$ |
(492 |
) |
|
$ |
(394,851 |
) |
|
$ |
32,434 |
|
|
$ |
(6,578 |
) |
|
$ |
14,669 |
|
|
$ |
8,091 |
|
| KINGSWAY FINANCIAL SERVICES INC. |
| |
|
Six Months Ended June 30, 2022 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accumulated |
|
|
Shareholders' |
|
|
Noncontrolling |
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
Additional |
|
|
|
|
|
|
|
|
|
|
Other |
|
|
Equity Attributable |
|
|
Interests in |
|
|
Total |
|
| |
|
|
|
|
|
|
|
|
|
Paid-in |
|
|
Treasury |
|
|
Accumulated |
|
|
Comprehensive |
|
|
to Common |
|
|
Consolidated |
|
|
Shareholders' |
|
| |
|
Common Stock |
|
|
Capital |
|
|
Stock |
|
|
Deficit |
|
|
Income |
|
|
Shareholders |
|
|
Subsidiaries |
|
|
Equity |
|
| |
|
Shares |
|
|
Amount |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Balance, December 31, 2021 |
|
|
22,882,614 |
|
|
$ |
— |
|
|
$ |
359,138 |
|
|
$ |
(492 |
) |
|
$ |
(395,149 |
) |
|
$ |
30,779 |
|
|
$ |
(5,724 |
) |
|
$ |
13,981 |
|
|
$ |
8,257 |
|
| Net (loss) income |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
(5,321 |
) |
|
|
— |
|
|
|
(5,321 |
) |
|
|
452 |
|
|
|
(4,869 |
) |
| Preferred stock dividends |
|
|
— |
|
|
|
— |
|
|
|
(157 |
) |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
(157 |
) |
|
|
— |
|
|
|
(157 |
) |
| Distributions to noncontrolling interest holders |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
(697 |
) |
|
|
(697 |
) |
| Other comprehensive income (loss) |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
5,238 |
|
|
|
5,238 |
|
|
|
(44 |
) |
|
|
5,194 |
|
| Stock-based compensation |
|
|
— |
|
|
|
— |
|
|
|
555 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
555 |
|
|
|
— |
|
|
|
555 |
|
| Balance, June 30, 2022 |
|
|
22,882,614 |
|
|
$ |
— |
|
|
$ |
359,536 |
|
|
$ |
(492 |
) |
|
$ |
(400,470 |
) |
|
$ |
36,017 |
|
|
$ |
(5,409 |
) |
|
$ |
13,692 |
|
|
$ |
8,283 |
|
| |
|
Six Months Ended June 30, 2021 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accumulated |
|
|
Shareholders' |
|
|
Noncontrolling |
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
Additional |
|
|
|
|
|
|
|
|
|
|
Other |
|
|
Equity Attributable |
|
|
Interests in |
|
|
Total |
|
| |
|
|
|
|
|
|
|
|
|
Paid-in |
|
|
Treasury |
|
|
Accumulated |
|
|
Comprehensive |
|
|
to Common |
|
|
Consolidated |
|
|
Shareholders' |
|
| |
|
Common Stock |
|
|
Capital |
|
|
Stock |
|
|
Deficit |
|
|
Income (Loss) |
|
|
Shareholders |
|
|
Subsidiaries |
|
|
Equity |
|
| |
|
Shares |
|
|
Amount |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Balance, December 31, 2020 |
|
|
22,211,069 |
|
|
$ |
— |
|
|
$ |
355,242 |
|
|
$ |
(492 |
) |
|
$ |
(394,807 |
) |
|
$ |
38,059 |
|
|
$ |
(1,998 |
) |
|
$ |
14,157 |
|
|
$ |
12,159 |
|
| Vesting of restricted stock awards, net of share settlements for tax withholdings |
|
|
154,562 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
| Net (loss) income |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
(44 |
) |
|
|
— |
|
|
|
(44 |
) |
|
|
687 |
|
|
|
643 |
|
| Preferred stock dividends |
|
|
— |
|
|
|
— |
|
|
|
(323 |
) |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
(323 |
) |
|
|
— |
|
|
|
(323 |
) |
| Distributions to noncontrolling interest holders |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
(170 |
) |
|
|
(170 |
) |
| Other comprehensive loss |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
(5,625 |
) |
|
|
(5,625 |
) |
|
|
(5 |
) |
|
|
(5,630 |
) |
| Stock-based compensation, net of forfeitures |
|
|
— |
|
|
|
— |
|
|
|
1,412 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
1,412 |
|
|
|
— |
|
|
|
1,412 |
|
| Balance, June 30, 2021 |
|
|
22,365,631 |
|
|
$ |
— |
|
|
$ |
356,331 |
|
|
$ |
(492 |
) |
|
$ |
(394,851 |
) |
|
$ |
32,434 |
|
|
$ |
(6,578 |
) |
|
$ |
14,669 |
|
|
$ |
8,091 |
|
See accompanying notes to unaudited consolidated financial statements
| KINGSWAY FINANCIAL SERVICES INC. |
Consolidated Statements of Cash Flows
(in thousands)
(Unaudited)
| |
|
Six months ended June 30, |
|
| |
|
2022 |
|
|
2021 |
|
| Cash provided by (used in): |
|
|
|
|
|
|
|
|
| Operating activities: |
|
|
|
|
|
|
|
|
| Net (loss) income |
|
$ |
(4,869 |
) |
|
$ |
643 |
|
| Adjustments to reconcile net (loss) income to net cash used in operating activities: |
|
|
|
|
|
|
|
|
| Equity in net income of limited liability investments |
|
|
(287 |
) |
|
|
(45 |
) |
| Depreciation and amortization expense |
|
|
4,672 |
|
|
|
3,138 |
|
| Stock-based compensation expense, net of forfeitures |
|
|
628 |
|
|
|
2,407 |
|
| Net realized gains |
|
|
(238 |
) |
|
|
(238 |
) |
| Loss on change in fair value of equity investments |
|
|
48 |
|
|
|
196 |
|
| Gain on change in fair value of limited liability investments, at fair value |
|
|
(173 |
) |
|
|
(529 |
) |
| Loss on change in fair value of debt |
|
|
3,198 |
|
|
|
1,757 |
|
| (Gain) loss on change in fair value of derivatives |
|
|
(276 |
) |
|
|
73 |
|
| Loss on change in fair value of contingent consideration |
|
|
1,502 |
|
|
|
— |
|
| Deferred income taxes |
|
|
(693 |
) |
|
|
(1,052 |
) |
| Amortization of fixed maturities premiums and discounts |
|
|
141 |
|
|
|
88 |
|
| Amortization of notes payable premium, discounts and debt issue costs |
|
|
(496 |
) |
|
|
(430 |
) |
| Gain on extinguishment of debt |
|
|
— |
|
|
|
(2,494 |
) |
| Changes in operating assets and liabilities: |
|
|
|
|
|
|
|
|
| Service fee receivable, net |
|
|
(1,828 |
) |
|
|
(1,567 |
) |
| Other receivables, net |
|
|
1,378 |
|
|
|
2,653 |
|
| Deferred contract costs |
|
|
(1,687 |
) |
|
|
(271 |
) |
| Other assets |
|
|
261 |
|
|
|
(10,786 |
) |
| Deferred service fees |
|
|
2,104 |
|
|
|
501 |
|
| Other, net |
|
|
2,861 |
|
|
|
(5,552 |
) |
| Net cash provided by (used in) operating activities |
|
|
6,246 |
|
|
|
(11,508 |
) |
| Investing activities: |
|
|
|
|
|
|
|
|
| Proceeds from sales and maturities of fixed maturities |
|
|
4,906 |
|
|
|
2,894 |
|
| Proceeds from sales of equity investments |
|
|
— |
|
|
|
23 |
|
| Purchases of fixed maturities |
|
|
(8,111 |
) |
|
|
(3,952 |
) |
| Net proceeds from limited liability investments |
|
|
973 |
|
|
|
168 |
|
| Net proceeds from limited liability investments, at fair value |
|
|
211 |
|
|
|
13,188 |
|
| Net proceeds from investments in private companies |
|
|
62 |
|
|
|
89 |
|
| Net proceeds from other investments |
|
|
34 |
|
|
|
6 |
|
| Acquisition of business, net of cash acquired |
|
|
(83 |
) |
|
|
(50 |
) |
| Net purchases of property and equipment |
|
|
(177 |
) |
|
|
(506 |
) |
| Net cash (used in) provided by investing activities |
|
|
(2,185 |
) |
|
|
11,860 |
|
| Financing activities: |
|
|
|
|
|
|
|
|
| Distributions to noncontrolling interest holders |
|
|
(697 |
) |
|
|
(170 |
) |
| Taxes paid related to net share settlements of restricted stock awards |
|
|
— |
|
|
|
(323 |
) |
| Principal payments on bank loans |
|
|
(3,952 |
) |
|
|
(2,161 |
) |
| Principal proceeds from notes payable, net of debt issuance costs of $1,685 in 2021 |
|
|
— |
|
|
|
13,270 |
|
| Principal payments on notes payable |
|
|
(3,115 |
) |
|
|
(11,280 |
) |
| Net cash used in financing activities |
|
|
(7,764 |
) |
|
|
(664 |
) |
| Net decrease in cash and cash equivalents and restricted cash |
|
|
(3,703 |
) |
|
|
(312 |
) |
| Cash and cash equivalents and restricted cash at beginning of period |
|
|
29,899 |
|
|
|
44,945 |
|
| Cash and cash equivalents and restricted cash at end of period |
|
$ |
26,196 |
|
|
$ |
44,633 |
|
See accompanying notes to unaudited consolidated financial statements.
KINGSWAY FINANCIAL SERVICES INC. Notes to Consolidated Financial Statements (Unaudited) June 30, 2022 |
NOTE 1 BUSINESS
Kingsway Financial Services Inc. (the "Company" or "Kingsway") was incorporated under the Business Corporations Act (Ontario) on September 19, 1989. Effective December 31, 2018 the Company changed its jurisdiction of incorporation from the province of Ontario, Canada, to the State of Delaware. Kingsway is a holding company with operating subsidiaries located in the United States. The Company owns or controls subsidiaries primarily in the extended warranty, business services, asset management and real estate industries.
NOTE 2 BASIS OF PRESENTATION
The accompanying unaudited consolidated interim financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America ("U.S. GAAP") for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and notes required by U.S. GAAP for complete financial statements of the Company. In the opinion of management, all adjustments necessary for a fair presentation have been included and are of a normal recurring nature. Interim results are not necessarily indicative of the results that may be expected for the year.
The accompanying unaudited consolidated interim financial statements and footnotes should be read in conjunction with the audited consolidated financial statements and footnotes included within our Annual Report on Form 10-K ("2021 Annual Report") for the year ended December 31, 2021.
The unaudited consolidated interim financial statements include the accounts of the Company and its subsidiaries, as well as certain variable interest entities as further described in Note 5, "Variable Interest Entities," to the consolidated financial statements in the 2021 Annual Report. All material intercompany transactions and balances have been eliminated in consolidation.
Certain amounts in the unaudited consolidated interim financial statements as of and for the three and six months ended June 30, 2021 have been reclassified in order to conform to the 2022 presentation.
The preparation of consolidated financial statements in accordance with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts and classifications of assets and liabilities, revenues and expenses, and the related disclosures of contingent assets and liabilities in the consolidated financial statements and accompanying notes. Actual results could differ from these estimates. Estimates and their underlying assumptions are reviewed on an ongoing basis. Changes in estimates are recorded in the accounting period in which they are determined.
The critical accounting estimates and assumptions in the accompanying unaudited consolidated interim financial statements include the valuation of fixed maturities and equity investments; impairment assessment of investments; valuation of limited liability investments, at fair value; valuation of real estate investments; valuation of deferred income taxes; accounting for business combinations and asset acquisitions; valuation and impairment assessment of intangible assets; goodwill recoverability; deferred contract costs; fair value assumptions for subordinated debt obligations; fair value assumptions for subsidiary stock-based compensation awards; contingent consideration and revenue recognition.
The fair values of the Company's investments in fixed maturities and equity investments, limited liability investments, at fair value, real estate investments, subordinated debt, stock-based compensation liabilities, derivative contracts and contingent consideration are estimated using a fair value hierarchy to categorize the inputs it uses in valuation techniques. Fair values for other investments approximate their unpaid principal balance. The carrying amounts reported in the consolidated balance sheets approximate fair values for cash and cash equivalents, restricted cash, short-term investments and certain other assets and other liabilities because of their short-term nature.
NOTE 3 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Except as set forth below there have been no material changes to our significant accounting policies as reported in our 2021 Annual Report.
COVID-19
The COVID-19 pandemic has had a notable impact on general economic conditions, including but not limited to the temporary closures of many businesses; "shelter in place" and other governmental regulations; and many businesses continue to operate in a work-from-home mode.
The near-term impacts of COVID-19 are primarily with respect to the Company’s Extended Warranty segment. Consumer spending was initially impacted, including a decline in the purchase of new and used vehicles, and many businesses through which the Company distributes its products remained closed or were open but with capacity restraints. More recently, consumer spending has improved but supply-chain issues have caused a shortage of new automobiles which, in turn, has caused demand for used automobiles to increase. This dynamic has had both positive and negative impacts on the Company’s revenues. With respect to homeowner warranties, the Company experienced an initial reduction in new enrollments in its home warranty programs associated with the impact of COVID-19 on new home sales in the United States.
| KINGSWAY FINANCIAL SERVICES INC. Notes to Consolidated Financial Statements (Unaudited) June 30, 2022 |
The Company could experience other potential impacts as a result of the COVID-19 pandemic, including, but not limited to, potential impairment charges to the carrying amounts of goodwill, indefinite-lived intangibles and long-lived assets, the loss in value of investments, as well as the potential for adverse impacts on the Company's debt covenant financial ratios. The Company is not aware of any specific event or circumstance that would require an update to its estimates or judgments or a revision of the carrying value of its assets or liabilities as of the date of issuance of this Quarterly Report on Form 10-Q. Actual results may differ materially from the Company’s current estimates as the scope of the COVID-19 pandemic evolves or if the duration of business disruptions is longer than initially anticipated.
Holding Company Liquidity
The Company's Extended Warranty and Kingsway Search Xcelerator subsidiaries fund their obligations primarily through service fee and commission revenue. The Company's Leased Real Estate subsidiaries fund their obligations through rental revenue.
The liquidity of the holding company is managed separately from its subsidiaries. The obligations of the holding company primarily consist of holding company operating expenses; transaction-related expenses; investments; certain debt and associated interest; and any other extraordinary demands on the holding company.
Actions available to the holding company to generate liquidity in order to meet its obligations include the sale of passive investments; sale of subsidiaries; issuance of debt or equity securities; exercise of warrants; distributions from the Company’s Extended Warranty subsidiaries, subject to certain restrictions; and giving notice to its Trust Preferred trustees of its intention to exercise its voluntary right to defer interest payments for up to 20 quarters on the six subsidiary trusts of the Company’s subordinated debt, which right the Company exercised during the third quarter of 2018.
Historically, dividends from the Leased Real Estate segment were not generally considered a source of liquidity for the holding company, except upon the occurrence of certain events that would trigger payment of service fees. However, as more fully described in Note 21, "Commitments and Contingencies," the holding company is now permitted to receive 20% of the proceeds from the increased rental payments resulting from an earlier amendment to the lease (or any borrowings against such increased rental payments). Refer to Note 11, "Debt," for further information about this borrowing.
The holding company’s liquidity, defined as the amount of cash in the bank accounts of Kingsway Financial Services Inc. and Kingsway America Inc., was $3.6 million and $2.2 million at June 30, 2022 and December 31, 2021, respectively, which excludes future actions available to the holding company that could be taken to generate liquidity. The holding company cash amounts are reflected in the cash and cash equivalents of $11.7 million and $12.6 million reported at June 30, 2022 and December 31, 2021, respectively, on the Company’s consolidated balance sheets.
As of June 30, 2022, there are 169,733 shares of the Company’s Class A Preferred Stock (the "Preferred Shares"), issued and outstanding. The outstanding Preferred Shares were required to be redeemed by the Company on April 1, 2021 ("Redemption Date") if the Company had sufficient legally available funds to do so. Additionally, the Company has exercised its right to defer payment of interest on its outstanding subordinated debt ("trust preferred securities") and, because of the deferral which totaled $21.4 million at June 30, 2022, the Company is prohibited from redeeming any shares of its capital stock while payment of interest on the trust preferred securities is being deferred. If the Company was required to pay either the Preferred Shares redemption value or both the deferred interest on the trust preferred securities and redeem all the Preferred Shares currently outstanding, then the Company has determined that it does not have sufficient legally available funds to do so. However, the Company is prohibited from doing so under Delaware law and, as such, (a) the interest on the trust preferred securities remains on deferral as permitted under the indentures and (b) in accordance with Delaware law the Preferred Shares were not redeemed on the Redemption Date and instead remain outstanding with a redemption value of $6.7 million, as of June 30, 2022, continue to be convertible at the discretion of the holder, and will accrue dividends until such time as the Company has sufficient legally available funds to redeem the Preferred Shares and is not otherwise prohibited from doing so. The Company continues to operate in the ordinary course.
The Company notes there are several variables to consider in such a situation, and management is exploring the following opportunities: negotiating with the holders of the Preferred Shares with respect to key provisions, raising additional funds through capital market transactions, as well as the Company’s strategy of working to monetize its non-core investments while attempting to maximize the tradeoff between liquidity and value received.
Based on the Company’s current business plan and revenue prospects, existing cash, cash equivalents, investment balances and anticipated cash flows from operations are expected to be sufficient to meet the Company’s working capital and operating expenditure requirements, excluding the cash that may be required to redeem the Preferred Shares and deferred interest on its trust preferred securities, for the next twelve months. However, the Company’s assessment could also be affected by various risks and uncertainties, including, but not limited to, the effects of the COVID-19 pandemic.
NOTE 4 RECENTLY ISSUED ACCOUNTING STANDARDS
(a) Adoption of New Accounting Standards:
Effective January 1, 2022, the Company adopted Accounting Standards Update ("ASU") 2021-04, Earnings Per Share (Topic 260), Debt—Modifications and Extinguishments (Subtopic 470-50), Compensation—Stock Compensation (Topic 718), and Derivatives and Hedging—Contracts in Entity’s Own Equity (Subtopic 815-40): Issuer’s Accounting for Certain Modifications or Exchanges of Freestanding Equity-Classified Written Call Options (a consensus of the FASB Emerging Issues Task Force) ("ASU 2021-04"). ASU 2021-04 clarifies and reduces diversity in an issuer’s accounting for modifications or exchanges of freestanding equity-classified written call options (for example, warrants) that remain equity classified after modification or exchange. ASU 2021-04 provides guidance that will clarify whether an issuer should account for a modification or an exchange of a freestanding equity-classified written call option that remains equity classified after modification or exchange as (1) an adjustment to equity and, if so, the related earnings per share (EPS) effects, if any, or (2) an expense and, if so, the manner and pattern of recognition. The adoption of ASU 2021-04 did not have an effect on the Company’s consolidated financial statements.
| KINGSWAY FINANCIAL SERVICES INC. Notes to Consolidated Financial Statements (Unaudited) June 30, 2022 |
(b) Accounting Standards Not Yet Adopted:
In June 2016, the Financial Accounting Standards Board ("FASB") issued ASU 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments ("ASU 2016-13"). ASU 2016-13 replaces the current incurred loss model used to measure impairment losses with an expected loss model for trade, reinsurance, and other receivables as well as financial instruments measured at amortized cost. ASU 2016-13 will require a financial asset measured at amortized cost, including reinsurance balances recoverable, to be presented at the net amount expected to be collected by means of an allowance for credit losses that runs through net income (loss). Credit losses relating to available-for-sale debt securities will also be recorded through an allowance for credit losses. However, the amendments would limit the amount of the allowance to the amount by which fair value is below amortized cost. The measurement of credit losses on available-for-sale investments is similar under current GAAP, but the update requires the use of the allowance account through which amounts can be reversed, rather than through irreversible write-downs. On November 15, 2019, the FASB issued ASU 2019-10, which (1) provides a framework to stagger effective dates for future major accounting standards and (2) amends the effective dates for certain major new accounting standards to give implementation relief to certain types of entities. Specifically, per ASU 2019-10 the Company would adopt ASU 2016-13 beginning January 1, 2023, as the Company is a smaller reporting company. The Company is currently evaluating ASU 2016-13 to determine the potential impact that adopting this standard will have on its consolidated financial statements.
NOTE 5 ACQUISITIONS
On
October 1, 2021, the Company acquired
100% of the outstanding equity interests of Ravix Financial, Inc. ("Ravix"). Ravix, based in San Jose, California, provides outsourced financial services and human resources consulting for short or long duration engagements. As further discussed
in
Note 18
, "
Segmented Information
," Ravix is included in the Kingsway Search Xcelerator segment, which was created as a result of the Ravix acquisition. This acquisition was the Company’s
first acquisition under its novel CEO Accelerator program and further expands the Company’s portfolio of businesses with recurring revenue and low capital intensity.
The Company acquired Ravix for aggregate cash consideration of approximately
$10.9 million, less certain escrowed amounts for purposes of indemnification claims. The final purchase price was subject to a working capital true-up of
$0.1 million that was settled during the
first quarter of
2022. The Company will also pay additional contingent consideration, only to the extent earned, in an aggregate amount of up to
$4.5 million, which is subject to certain conditions, including the successful achievement of gross profit for Ravix during the
three-year period commencing on the
first full calendar month following the acquisition date.
See
Note 19
, "
Fair Value of Financial Instruments
," for further discussion of the contingent consideration.
This acquisition was accounted for as a business combination using the acquisition method of accounting. The purchase price was provisionally allocated to the assets acquired and liabilities assumed based on their estimated fair values at the date of acquisition and were subject to adjustment during a measurement period subsequent to the acquisition date,
not to exceed
one-year as permitted under U.S. GAAP. During the
first quarter of
2022, the Company finalized its fair value analysis of the assets acquired and liabilities assumed with the assistance of a
third-party.
No measurement period adjustments were recorded as a result of finalizing the fair value analysis.
VA Lafayette, LLC (formerly known as
RoeCo Lafayette, LLC)
On
December 30, 2021, the Company acquired
100% of the outstanding membership interests of RoeCo Lafayette, LLC ("RoeCo") from a current holder of the Company’s Preferred Shares, for cash consideration of approximately
$2.4 million. R
efer to
Note 20
, "
Related Parties
," for further disclosure. In
2022, RoeCo changed its name to VA Lafayette, LLC ("VA Lafayette"). VA Lafayette owns real property consisting of approximately
6.5 acres and a
29,224 square foot single-tenant medical office building located in the State of Louisiana (the "LA Real Property"). The LA Real Property serves as a medical and dental clinic for the Department of Veteran Affairs and is subject to a long-term lease. The LA Real Property is also subject to mortgages with a total principal amount of
$13.5 million (the "LA Mortgage") at the date of acquisition plus a premium of
$3.5 million. As further discussed in
Note 18
, "
Segmented Information
, VA Lafayette is included in the Leased Real Estate segment.
This transaction was accounted for as an asset acquisition as substantially all the fair value of the gross assets acquired is concentrated in a single asset comprised of land, building and improvements. The total purchase price, including the transaction costs, were allocated to the individual net assets acquired based on their relative fair values. In connection with the acquisition, the Company recorded
$2.9 million of separately identifiable intangible assets, related to above-market lease and in-place and other lease assets. The above-market lease intangible asset of
$0.8 million resulted from the terms of the acquired operating lease contract being favorable relative to market terms of comparable leases on the date of acquisition. The in-place and other lease intangible assets of
$2.1 million were estimated based on the costs avoided in originating leases comparable to the acquired in-place lease as well as the value associated with lost rental revenue during the assumed lease-up period. The above-market and in-place and other lease assets are amortized on a straight-line basis over the remaining lease term, which expires in
September 2036.
| KINGSWAY FINANCIAL SERVICES INC. Notes to Consolidated Financial Statements (Unaudited) June 30, 2022 |
NOTE 6 INVESTMENTS
The amortized cost, gross unrealized gains and losses, and estimated fair value of the Company's available-for-sale investments at June 30, 2022 and December 31, 2021 are summarized in the tables shown below:
| (in thousands) | | June 30, 2022 | |
| | | Amortized Cost | | | Gross Unrealized Gains | | | Gross Unrealized Losses | | | Estimated Fair Value | |
| Fixed maturities: | | | | | | | | | | | | | | | | |
| U.S. government, government agencies and authorities | | $ | 15,839 | | | $ | 16 | | | $ | 554 | | | $ | 15,301 | |
| States, municipalities and political subdivisions | | | 2,182 | | | | 1 | | | | 101 | | | | 2,082 | |
| Mortgage-backed | | | 8,268 | | | | 7 | | | | 451 | | | | 7,824 | |
| Asset-backed | | | 1,742 | | | | — | | | | 48 | | | | 1,694 | |
| Corporate | | | 10,900 | | | | 3 | | | | 791 | | | | 10,112 | |
| Total fixed maturities | | $ | 38,931 | | | $ | 27 | | | $ | 1,945 | | | $ | 37,013 | |
| (in thousands) | | December 31, 2021 | |
| | | Amortized Cost | | | Gross Unrealized Gains | | | Gross Unrealized Losses | | | Estimated Fair Value | |
| Fixed maturities: | | | | | | | | | | | | | | | | |
| U.S. government, government agencies and authorities | | $ | 16,276 | | | $ | 31 | | | $ | 84 | | | $ | 16,223 | |
| States, municipalities and political subdivisions | | | 1,880 | | | | 3 | | | | 5 | | | | 1,878 | |
| Mortgage-backed | | | 7,679 | | | | 18 | | | | 68 | | | | 7,629 | |
| Asset-backed | | | 449 | | | | — | | | | 4 | | | | 445 | |
| Corporate | | | 9,605 | | | | 15 | | | | 129 | | | | 9,491 | |
| Total fixed maturities | | $ | 35,889 | | | $ | 67 | | | $ | 290 | | | $ | 35,666 | |
The table below summarizes the Company's fixed maturities at June 30, 2022 by contractual maturity periods. Actual results may differ as issuers may have the right to call or prepay obligations, with or without penalties, prior to the contractual maturity of these obligations.
| (in thousands) | | June 30, 2022 | |
| | | Amortized Cost | | | Estimated Fair Value | |
| Due in one year or less | | $ | 7,998 | | | $ | 7,917 | |
| Due after one year through five years | | | 23,147 | | | | 21,954 | |
| Due after five years through ten years | | | 3,570 | | | | 3,244 | |
| Due after ten years | | | 4,216 | | | | 3,898 | |
| Total | | $ | 38,931 | | | $ | 37,013 | |
| KINGSWAY FINANCIAL SERVICES INC. Notes to Consolidated Financial Statements (Unaudited) June 30, 2022 |
The following tables highlight the aggregate unrealized loss position, by security type, of available-for-sale investments in unrealized loss positions as of June 30, 2022 and December 31, 2021. The tables segregate the holdings based on the period of time the investments have been continuously held in unrealized loss positions.
| (in thousands) | | June 30, 2022 | |
| | | Less than 12 Months | | | Greater than 12 Months | | | Total | |
| | | Estimated Fair Value | | | Unrealized Loss | | | Estimated Fair Value | | | Unrealized Loss | | | Estimated Fair Value | | | Unrealized Loss | |
| Fixed maturities: | | | | | | | | | | | | | | | | | | | | | | | | |
| U.S. government, government agencies and authorities | | $ | 7,129 | | | $ | 242 | | | $ | 6,297 | | | $ | 312 | | | $ | 13,426 | | | $ | 554 | |
| States, municipalities and political subdivisions | | | 1,163 | | | | 73 | | | | 822 | | | | 28 | | | | 1,985 | | | | 101 | |
| Mortgage-backed | | | 4,914 | | | | 289 | | | | 2,369 | | | | 162 | | | | 7,283 | | | | 451 | |
| Asset-backed | | | 1,476 | | | | 41 | | | | 123 | | | | 7 | | | | 1,599 | | | | 48 | |
| Corporate | | | 8,577 | | | | 734 | | | | 1,189 | | | | 57 | | | | 9,766 | | | | 791 | |
| Total fixed maturities | | $ | 23,259 | | | $ | 1,379 | | | $ | 10,800 | | | $ | 566 | | | $ | 34,059 | | | $ | 1,945 | |
| (in thousands) | | December 31, 2021 | |
| | | Less than 12 Months | | | Greater than 12 Months | | | Total | |
| | | Estimated Fair Value | | | Unrealized Loss | | | Estimated Fair Value | | | Unrealized Loss | | | Estimated Fair Value | | | Unrealized Loss | |
| Fixed maturities: | | | | | | | | | | | | | | | | | | | | | | | | |
| U.S. government, government agencies and authorities | | $ | 12,077 | | | $ | 84 | | | $ | — | | | $ | — | | | $ | 12,077 | | | $ | 84 | |
| States, municipalities and political subdivisions | | | 846 | | | | 5 | | | | — | | | | — | | | | 846 | | | | 5 | |
| Mortgage-backed | | | 5,388 | | | | 68 | | | | — | | | | — | | | | 5,388 | | | | 68 | |
| Asset-backed | | | 445 | | | | 4 | | | | — | | | | — | | | | 445 | | | | 4 | |
| Corporate | | | 7,542 | | | | 129 | | | | — | | | | — | | | | 7,542 | | | | 129 | |
| Total fixed maturities | | $ | 26,298 | | | $ | 290 | | | $ | — | | | $ | — | | | $ | 26,298 | | | $ | 290 | |
There are approximately 201and 138 individual available-for-sale investments that were in unrealized loss positions as of June 30, 2022 and December 31, 2021, respectively.
The establishment of an other-than-temporary impairment on an investment requires a number of judgments and estimates. The Company performs a quarterly analysis of the individual investments to determine if declines in market value are other-than-temporary. See the "Significant Accounting Policies and Critical Estimates" section of Management's Discussion and Analysis of Financial Condition included in the 2021 Annual Report for further information regarding the Company's detailed analysis and factors considered in establishing an other-than-temporary impairment on an investment.
As a result of the analysis performed by the Company to determine declines in market value that are other-than-temporary, the Company did not record any write-downs for other-than-temporary impairment related to available-for sale investments, limited liability investments, investments in private companies and other investments for the three and six months ended June 30, 2022 and June 30, 2021.
The Company has reviewed currently available information regarding investments with estimated fair values less than their carrying amounts and believes these unrealized losses are not other-than-temporary and are primarily due to temporary market and sector-related factors rather than to issuer-specific factors. The Company does not intend to sell those investments, and it is not likely it will be required to sell those investments before recovery of its amortized cost.
The Company does not have any exposure to subprime mortgage-backed investments.
Limited liability investments include investments in limited liability companies and limited partnerships. The Company's interests in these investments are not deemed minor and, therefore, are accounted for under the equity method of accounting. The most recently available financial statements are used in applying the equity method. The difference between the end of the reporting period of the limited liability entities and that of the Company is no more than three months. As of June 30, 2022 and December 31, 2021, the carrying value of limited liability investments totaled $1.2 million and $1.9 million, respectively. Income or loss from limited liability investments is recognized based on the Company's share of the earnings of the limited liability entities and is included in net investment income in the consolidated statements of operations. At June 30, 2022, the Company had no unfunded commitments related to limited liability investments. One of the Company's limited liability investments is expected to be sold during the third quarter of 2022, resulting in estimated proceeds to the Company of $0.8 million.
Limited liability investments, at fair value represents the underlying investments of the Company’s consolidated entities Net Lease Investment Grade Portfolio LLC ("Net Lease") and Argo Holdings Fund I, LLC ("Argo Holdings"). As of June 30, 2022 and December 31, 2021, the carrying value of the Company's limited liability investments, at fair value was $19.0 million and $18.8 million, respectively. The Company recorded impairments related to limited liability investments, at fair value of less than $0.1 million for the three and six months ended June 30, 2022 (zero and less than $0.1 million for the three and six months ended June 30, 2021, respectively) which are included in gain on change in fair value of limited liability investments, at fair value in the consolidated statements of operations. At June 30, 2022, the Company had no unfunded commitments to fund limited liability investments, at fair value.
| KINGSWAY FINANCIAL SERVICES INC. Notes to Consolidated Financial Statements (Unaudited) June 30, 2022 |
The Company consolidates the financial statements of Net Lease on a three-month lag. Net Lease owns investments in limited liability companies that hold investment properties. During the second quarter of 2021, one of Net Lease’s limited liability companies sold their investment property for $14.3 million. As a result of the three-month lag, the Company recorded this transaction in its third quarter 2021 financial statements. During the fourth quarter of 2020, one of Net Lease's limited liability companies sold their investment property. A portion of the proceeds from the sale were distributed to Net Lease who used them primarily to repay their $9.0 million mezzanine loan. As a result of the distribution, Net Lease recorded a gain of $1.2 million related to its investment in the limited liability company, with an offsetting change in unrealized gain of $1.2 million, which collectively are included in net investment income in the consolidated statement of operations for the six months ended June 30, 2021.
Investments in private companies consist of convertible preferred stocks and notes in privately owned companies and investments in limited liability companies in which the Company’s interests are deemed minor. The Company's investments in private companies do not have readily determinable fair values. The Company has elected to record investments in private companies at cost, adjusted for observable price changes and impairments. As of June 30, 2022 and December 31, 2021, the carrying value of the Company's investments in private companies totaled $0.8 million. For the three and six months ended June 30, 2022 and June 30, 2021, the Company did not record any adjustments to the fair value of its investments in private companies for observable price changes.
The Company performs a quarterly impairment analysis of its investments in private companies. As a result of the analysis performed, the Company did not record any impairments related to investments in private companies for the three and six months ended June 30, 2022 and June 30, 2021.
Net investment income for the three and six months ended June 30, 2022 and June 30, 2021 is comprised as follows:
| (in thousands) | | Three months ended June 30, | | | Six months ended June 30, | |
| | | 2022 | | | 2021 | | | 2022 | | | 2021 | |
| Investment income: | | | | | | | | | | | | | | | | |
| Interest from fixed maturities | | $ | 117 | | | $ | 47 | | | $ | 210 | | | $ | 98 | |
| Dividends | | | 33 | | | | 31 | | | | 64 | | | | 63 | |
| Income from limited liability investments | | | 52 | | | | 54 | | | | 287 | | | | 45 | |
| Income from limited liability investments, at fair value | | | 4 | | | | — | | | | 4 | | | | 81 | |
| Income from real estate investments | | | 200 | | | | 200 | | | | 400 | | | | 400 | |
| Other | | | 87 | | | | 90 | | | | 170 | | | | 180 | |
| Gross investment income | | | 493 | | | | 422 | | | | 1,135 | | | | 867 | |
| Investment expenses | | | (28 | ) | | | (19 | ) | | | (51 | ) | | | (43 | ) |
| Net investment income | | $ | 465 | | | $ | 403 | | | $ | 1,084 | | | $ | 824 | |
Gross realized gains and losses on available-for-sale investments, limited liability investments, at fair value and investments in private companies for the three and six months ended June 30, 2022 and June 30, 2021 are comprised as follows:
| (in thousands) | | Three months ended June 30, | | | Six months ended June 30, | |
| | | 2022 | | | 2021 | | | 2022 | | | 2021 | |
| Gross realized gains | | $ | 200 | | | $ | 261 | | | $ | 259 | | | $ | 312 | |
| Gross realized losses | | | (16 | ) | | | (74 | ) | | | (21 | ) | | | (74 | ) |
| Net realized gains | | $ | 184 | | | $ | 187 | | | $ | 238 | | | $ | 238 | |
Loss on change in fair value of equity investments for the three and six months ended June 30, 2022 and June 30, 2021 is comprised as follows:
| (in thousands) | | Three months ended June 30, | | | Six months ended June 30, | |
| | | 2022 | | | 2021 | | | 2022 | | | 2021 | |
| Net gains recognized on equity investments sold during the period | | $ | — | | | $ | — | | | $ | — | | | $ | 13 | |
| Change in unrealized losses on equity investments held at end of the period | | | (38 | ) | | | (45 | ) | | | (48 | ) | | | (209 | ) |
| Loss on change in fair value of equity investments | | $ | (38 | ) | | $ | (45 | ) | | $ | (48 | ) | | $ | (196 | ) |
Impact of COVID-19 on Investments
The Company continues to assess the impact that the COVID-19 pandemic may have on the value of its various investments, which could result in future material decreases in the underlying investment values. Such decreases may be considered temporary or could be deemed to be other-than-temporary, and management may be required to record write-downs of the related investments in future reporting periods.
NOTE 7 GOODWILL
On a quarterly basis, the Company reviews goodwill to determine whether events occurred or circumstances have changed that would more likely than not reduce the fair value of a reporting unit below its carrying amount (indicating that goodwill may be impaired). For Leased Real Estate as it pertains to CMC (having goodwill of $61.0 million), the Company models a hypothetical sale of the underlying asset in order to arrive at fair value, which, due to the unique nature of Leased Real Estate, the Company views as a technique consistent with the objective of measuring fair value.
The estimated fair value is highly sensitive to discount rates applied. For its second quarter 2022 review of goodwill, the Company developed a range of discount rates that it believes a reasonable market participant would use in determining fair value and noted that using the midpoint of that range resulted in no indication of impairment. The Company also examined qualitative factors, such as tenant credit quality and macro-economic trends, which did not indicate goodwill may be impaired.
| KINGSWAY FINANCIAL SERVICES INC. Notes to Consolidated Financial Statements (Unaudited) June 30, 2022 |
The excess of fair value over the book value of equity of the reporting unit has narrowed as of June 30, 2022. However, underlying assumptions in the future could differ materially due to the inherent uncertainty in making such estimates. Additionally, estimates regarding future cash flows and timing as well as future appraised values could also have a significant impact on the estimated fair value. Finally, if there were sustained increases in the underlying interest rates used in the analysis then the fair value could be reduced to a level that could indicate impairment.
NOTE 8 INTANGIBLE ASSETS
Intangible assets at June 30, 2022 and December 31, 2021 are comprised as follows:
| (in thousands) | | June 30, 2022 | |
| | | Gross Carrying Value | | | Accumulated Amortization | | | Net Carrying Value | |
| Intangible assets subject to amortization: | | | | | | | | | | | | |
| Database | | $ | 4,918 | | | $ | 4,703 | | | $ | 215 | |
| Vehicle service agreements in-force | | | 3,680 | | | | 3,680 | | | | — | |
| Customer relationships | | | 31,645 | | | | 14,240 | | | | 17,405 | |
| In-place lease and other lease assets | | | 3,238 | | | | 447 | | | | 2,791 | |
| Above-market lease | | | 835 | | | | 28 | | | | 807 | |
| Non-compete | | | 266 | | | | 251 | | | | 15 | |
| Intangible assets not subject to amortization: | | | | | | | | | | | | |
| Tenant relationship | | | 73,667 | | | | — | | | | 73,667 | |
| Trade names | | | 10,314 | | | | — | | | | 10,314 | |
| Total | | $ | 128,563 | | | $ | 23,349 | | | $ | 105,214 | |
| (in thousands) | | December 31, 2021 | |
| | | Gross Carrying Value | | | Accumulated Amortization | | | Net Carrying Value | |
| Intangible assets subject to amortization: | | | | | | | | | | | | |
| Database | | $ | 4,918 | | | $ | 4,488 | | | $ | 430 | |
| Vehicle service agreements in-force | | | 3,680 | | | | 3,680 | | | | — | |
| Customer relationships | | | 31,645 | | | | 11,598 | | | | 20,047 | |
| In-place lease and other lease assets | | | 3,238 | | | | 343 | | | | 2,895 | |
| Above-market lease | | | 835 | | | | — | | | | 835 | |
| Non-compete | | | 266 | | | | 224 | | | | 42 | |
| Intangible assets not subject to amortization: | | | | | | | | | | | | |
| Tenant relationship | | | 73,667 | | | | — | | | | 73,667 | |
| Trade names | | | 10,314 | | | | — | | | | 10,314 | |
| Total | | $ | 128,563 | | | $ | 20,333 | | | $ | 108,230 | |
The Company's intangible assets with definite useful lives are amortized either based on the patterns in which the economic benefits of the intangible assets are expected to be consumed or using the straight-line method over their estimated useful lives, which range from 5 to 18 years. Amortization of intangible assets was $1.5 million and $0.5 million for the three months ended June 30, 2022 and June 30, 2021, respectively ($3.0 million and $1.0 million for the six months ended June 30, 2022 and June 30, 2021, respectively). The higher amortization expense for the three and six months ended June 30, 2022 is related to amortization of intangible assets recorded in conjunction with the Company's acquisitions of PWI Holdings, Inc. ("PWI") effective December 1, 2020, Ravix effective October 1, 2021 and VA Lafayette effective December 30, 2021. During the third quarter of 2021, the Company finalized its fair value analysis of the assets acquired and liabilities assumed in its acquisition of PWI.
The tenant relationship and trade names intangible assets have indefinite useful lives and are not amortized. No impairment charges were recorded during the three and six months ended June 30, 2022 and June 30, 2021.
NOTE 9 PROPERTY AND EQUIPMENT
Property and equipment at
June 30, 2022 and
December 31, 2021 are comprised as follows:
| (in thousands) | | June 30, 2022 | |
| | | Cost | | | Accumulated Depreciation | | | Carrying Value | |
| Land | | $ | 25,623 | | | $ | — | | | $ | 25,623 | |
| Site and tenant improvements | | | 92,047 | | | | 23,295 | | | | 68,752 | |
| Buildings | | | 11,805 | | | | 211 | | | | 11,594 | |
| Leasehold improvements | | | 317 | | | | 190 | | | | 127 | |
| Furniture and equipment | | | 534 | | | | 433 | | | | 101 | |
| Computer hardware | | | 1,964 | | | | 1,082 | | | | 882 | |
| Total | | $ | 132,290 | | | $ | 25,211 | | | $ | 107,079 | |
| KINGSWAY FINANCIAL SERVICES INC. Notes to Consolidated Financial Statements (Unaudited) June 30, 2022 |
| (in thousands) | | December 31, 2021 | |
| | | Cost | | | Accumulated Depreciation | | | Carrying Value | |
| Land | | $ | 25,623 | | | $ | — | | | $ | 25,623 | |
| Site and tenant improvements | | | 92,047 | | | | 21,910 | | | | 70,137 | |
| Buildings | | | 11,805 | | | | 79 | | | | 11,726 | |
| Leasehold improvements | | | 286 | | | | 163 | | | | 123 | |
| Furniture and equipment | | | 562 | | | | 442 | | | | 120 | |
| Computer hardware | | | 2,488 | | | | 1,630 | | | | 858 | |
| Total | | $ | 132,811 | | | $ | 24,224 | | | $ | 108,587 | |
For the
three months ended
June 30, 2022 and
June 30, 2021, depreciation expense on property and equipment o
f
$0.8
million and
$1.1
million, respectively ($1.7 million and $2.1 million for the six months ended
June 30, 2022 and
June 30, 2021
, respectively), is included in general and administrative expenses in the consolidated statements of operations.
NOTE 10 DERIVATIVES
On April 1, 2021, the Company entered into an interest rate swap agreement with CIBC Bank USA to convert the variable London interbank offered interest rate for three-month U.S. dollar deposits ("LIBOR") interest rate on a portion of its 2020 KWH Loan (as defined below in Note 11, "Debt,") to a fixed interest rate of 1.18%. On June 10, 2022, the interest rate swap agreement was amended to convert from a variable Secured Overnight Financing Rate ("SOFR") to a fixed interest rate of 1.18%. The interest rate swap had an initial notional amount of $11.9 million and matures on February 29, 2024.
The purpose of this interest rate swap, which is not designated as a cash flow hedge, is to reduce the Company's exposure to variability in cash flows from interest payments attributable to fluctuations in the variable interest rate associated with the 2020 KWH Loan. The Company has not elected hedge accounting for the interest rate swap. The interest rate swap is recorded in the consolidated balance sheets at fair value with changes in fair value recorded in the consolidated statements of operations.
The notional amount of the interest rate swap contract is $9.6 million at June 30, 2022. At June 30, 2022 and December 31, 2021, the fair value of the interest rate swap contract was an asset of $0.3 million and a liability of less than $0.1 million, respectively, which is included in other receivables and accrued expenses and other liabilities, respectively, in the consolidated balance sheets. During the three and six months ended June 30, 2022, the Company recognized a gain of $0.1 million and $0.3 million, respectively (loss of $0.1 million for the three and six months ended June 30, 2021), related to the change in fair value of the interest rate swap, which is included in interest expense not allocated to segments in the consolidated statement of operations and within cash flows from operating activities in the consolidated statement of cash flows. Net cash payments of less than $0.1 million were made during the three and six months ended June 30, 2022 and June 30, 2021, respectively, to settle a portion of the liabilities related to the interest rate swap agreement. These payments are reflected as cash outflows in the consolidated statements of cash flows within net cash provided by (used in) operating activities.
NOTE 11 DEBT
Debt consists of the following instruments at June 30, 2022 and December 31, 2021:
| (in thousands) | | June 30, 2022 | | | December 31, 2021 | |
| | | Principal | | | Carrying Value | | | Fair Value | | | Principal | | | Carrying Value | | | Fair Value | |
| Bank loan: | | | | | | | | | | | | | | | | | | | | | | | | |
| Ravix Loan | | $ | 5,600 | | | $ | 5,460 | | | $ | 5,269 | | | $ | 6,000 | | | $ | 5,847 | | | $ | 5,936 | |
| 2020 KWH Loan | | | 17,634 | | | | 17,358 | | | | 16,572 | | | | 21,186 | | | | 20,870 | | | | 20,815 | |
| Total bank loans | | | 23,234 | | | | 22,818 | | | | 21,841 | | | | 27,186 | | | | 26,717 | | | | 26,751 | |
| Notes payable: | | | | | | | | | | | | | | | | | | | | | | | | |
| Mortgage | | | 159,810 | | | | 166,124 | | | | 154,692 | | | | 161,998 | | | | 168,730 | | | | 182,128 | |
| Additional Mortgage | | | 14,126 | | | | 12,575 | | | | 13,094 | | | | 14,514 | | | | 12,901 | | | | 15,104 | |
| LA Mortgage | | | 13,171 | | | | 16,549 | | | | 14,888 | | | | 13,463 | | | | 16,983 | | | | 16,437 | |
| Flower Note | | | 6,165 | | | | 6,165 | | | | 6,272 | | | | 6,411 | | | | 6,411 | | | | 7,101 | |
| Total notes payable | | | 193,272 | | | | 201,413 | | | | 188,946 | | | | 196,386 | | | | 205,025 | | | | 220,770 | |
| Subordinated debt | | | 90,500 | | | | 57,282 | | | | 57,282 | | | | 90,500 | | | | 60,973 | | | | 60,973 | |
| Total | | $ | 307,006 | | | $ | 281,513 | | | $ | 268,069 | | | $ | 314,072 | | | $ | 292,715 | | | $ | 308,494 | |
| KINGSWAY FINANCIAL SERVICES INC. Notes to Consolidated Financial Statements (Unaudited) June 30, 2022 |
Subordinated debt mentioned above consists of the following trust preferred debt instruments:
| Issuer | | Principal (in thousands) | | Issue date | Interest | Redemption date |
| Kingsway CT Statutory Trust I | | $ | 15,000 | | 12/4/2002 | annual interest rate equal to LIBOR, plus 4.00% payable quarterly | 12/4/2032 |
| Kingsway CT Statutory Trust II | | $ | 17,500 | | 5/15/2003 | annual interest rate equal to LIBOR, plus 4.10% payable quarterly | 5/15/2033 |
| Kingsway CT Statutory Trust III | | $ | 20,000 | | 10/29/2003 | annual interest rate equal to LIBOR, plus 3.95% payable quarterly | 10/29/2033 |
| Kingsway DE Statutory Trust III | | $ | 15,000 | | 5/22/2003 | annual interest rate equal to LIBOR, plus 4.20% payable quarterly | 5/22/2033 |
| Kingsway DE Statutory Trust IV | | $ | 10,000 | | 9/30/2003 | annual interest rate equal to LIBOR, plus 3.85% payable quarterly | 9/30/2033 |
| Kingsway DE Statutory Trust VI | | $ | 13,000 | | 12/16/2003 | annual interest rate equal to LIBOR, plus 4.00% payable quarterly | 1/8/2034 |
(a) Bank loans:
Ravix
As part of the acquisition of Ravix on October 1, 2021, Ravix became a wholly owned subsidiary of Ravix Acquisition LLC ("Ravix LLC"), and together they borrowed from a bank a principal amount of $6.0 million in the form of a term loan, and established a $1.0 million revolver to finance the acquisition of Ravix (together, the "Ravix Loan"). The Ravix Loan has an annual interest rate equal to the greater of the Prime Rate plus 0.5%, or 3.75%. At June 30, 2022, the interest rate was 5.25%. The revolver matures on October 1, 2023 and the term loan matures on October 1, 2027. Subsequent to October 1, 2021, Ravix has borrowed and made payments under the revolver. The carrying values at June 30, 2022 and December 31, 2021 includes $5.5 million and $5.7 million, respectively, related to the term loan and zero and $0.1 million, respectively related to revolver.
The Company also recorded as a discount to the carrying value of the Ravix Loan issuance costs of $0.2 million specifically related to the Ravix Loan. The Ravix Loan is carried in the consolidated balance sheets at its amortized cost, which reflects the monthly pay-down of principal as well as the amortization of the debt discount and issuance costs using the effective interest rate method. The fair value of the Ravix Loan disclosed in the table above is derived from quoted market prices of B and BB minus rated industrial bonds with similar maturities and is categorized within Level 2 of the fair value hierarchy.
The Ravix Loan contains a number of covenants, including, but not limited to, a leverage ratio and a fixed charge ratio, all of which are as defined in and calculated pursuant to the Ravix Loan that, among other things, restrict Ravix’s ability to incur additional indebtedness, create liens, make dividends and distributions, engage in mergers, acquisitions and consolidations, make certain payments and investments and dispose of certain assets.
KWH
In 2019, the Company formed Kingsway Warranty Holdings LLC ("KWH"), whose subsidiaries include IWS Acquisition Corporation ("IWS"), Geminus Holdings Company, Inc. ("Geminus") and Trinity Warranty Solutions LLC ("Trinity"). As part of the acquisition of PWI on December 1, 2020, PWI became a wholly owned subsidiary of KWH, which borrowed a principal amount of $25.7 million from a bank, consisting of a $24.7 million term loan and a $1.0 million revolving credit facility (the "2020 KWH Loan"). The proceeds from the 2020 KWH Loan were used to partially fund the acquisition of PWI and to fully repay the prior outstanding loan at KWH, which occurred on December 1, 2020.
The 2020 KWH Loan had an annual interest rate equal to LIBOR, having a floor of 0.75%, plus 2.75%. During the second quarter of 2022, the 2020 KWH Loan was amended to change the annual interest rate to be equal to SOFR, having a floor of 0.75%, plus spreads ranging from 2.62% to 3.12%. At June 30, 2022, the interest rate was 4.07%. The 2020 KWH Loan matures on December 1, 2025. The Company also recorded as a discount to the carrying value of the 2020 KWH Loan issuance costs of $0.4 million specifically related to the 2020 KWH Loan. The 2020 KWH Loan is carried in the consolidated balance sheets at its amortized cost, which reflects the quarterly pay-down of principal as well as the amortization of the debt discount and issuance costs using the effective interest rate method. The carrying values at June 30, 2022 and December 31, 2021 includes $16.9 million and $20.4 million, respectively, related to the term loan and $0.5 million and $0.5 million, respectively, related to revolver. The fair value of the 2020 KWH Loan disclosed in the table above is derived from quoted market prices of B and BB minus rated industrial bonds with similar maturities and is categorized within Level 2 of the fair value hierarchy. The 2020 KWH Loan is secured by certain of the equity interests and assets of KWH and its subsidiaries.
The 2020 KWH Loan contains a number of covenants, including, but not limited to, a leverage ratio, a fixed charge ratio and limits on annual capital expenditures, all of which are as defined in and calculated pursuant to the 2020 KWH Loan that, among other things, restrict KWH’s ability to incur additional indebtedness, create liens, make dividends and distributions, engage in mergers, acquisitions and consolidations, make certain payments and investments and dispose of certain assets.
| KINGSWAY FINANCIAL SERVICES INC. Notes to Consolidated Financial Statements (Unaudited) June 30, 2022 |
(b) Notes payable:
CMC Industries
As part of the acquisition of CMC Industries, Inc. ("CMC") in July 2016, the Company assumed a mortgage, which is recorded as note payable in the consolidated balance sheets ("the Mortgage"). The Mortgage was recorded at its estimated fair value of $191.7 million, which included the unpaid principal amount of $180.0 million as of the date of acquisition plus a premium of $11.7 million. The Mortgage matures on May 15, 2034 and has a fixed interest rate of 4.07%. The Mortgage is carried in the consolidated balance sheets at its amortized cost, which reflects the monthly pay-down of principal as well as the amortization of the premium using the effective interest rate method. The fair value of the Mortgage disclosed in the table above is derived from quoted market prices of A-rated industrial bonds with similar maturities and is categorized within Level 2 of the fair value hierarchy.
On June 2, 2021, TRT Leaseco ("TRT"), a subsidiary of CMC, entered into an amendment to the Mortgage to borrow an additional $15.0 million, which is recorded as note payable in the consolidated balance sheets ("the Additional Mortgage"). The net proceeds from the Additional Mortgage were used to advance increased rental payments to the parties that had entered into a legal settlement agreement reached during the first quarter of 2021, including the Company which received $2.7 million. See Note 21(a), "Commitments and Contingencies - Legal proceedings," for further discussion of the CMC litigation settlement agreement.
The Additional Mortgage matures on May 15, 2034 and has a fixed interest rate of 3.20%. The Company recorded as a discount to the carrying value of the Additional Mortgage issuance costs of $1.7 million specifically related to the Additional Mortgage. The Additional Mortgage is carried in the consolidated balance sheets at its amortized cost, which reflects the monthly pay-down of principal as well as the amortization of the debt discount and issuance costs using the effective interest rate method. The fair value of the Additional Mortgage disclosed in the table above is derived from quoted market prices of A-rated industrial bonds with similar maturities and is categorized within Level 2 of the fair value hierarchy.
Both the Mortgage and the Additional Mortgage are nonrecourse indebtedness with respect to CMC and its subsidiaries, and the Mortgage and Additional Mortgage are not, nor will it be, guaranteed by Kingsway or its affiliates. The Mortgage and Additional Mortgage are collateralized by a parcel of real property consisting of approximately 192 acres located in the State of Texas (the "Real Property") and the assignment of leases and rents related to a long-term triple net lease agreement with an unrelated third-party.
VA Lafayette (formerly known as RoeCo)
As part of its acquisition of VA Lafayette on December 30, 2021, the Company assumed the LA Mortgage, which is comprised of a senior amortizing note, a senior interest only note and a junior note. The LA Mortgage is nonrecourse indebtedness with respect to the assets of VA Lafayette, and the LA Mortgage is not, nor will it be, guaranteed by Kingsway or its affiliates unless VA Lafayette acts in bad-faith or commits intentional acts with respect to the LA Mortgage. Refer to Note 21(b), "Commitments and Contingencies" for further disclosure. The LA Mortgage is collateralized by a parcel of real property and a single tenant building located in the state of Louisiana (the "LA Real Property") and the assignment of a lease and rent related to a long-term lease agreement with an unrelated third-party. The Company recorded the LA Mortgage at its aggregate unpaid principal amount of $13.5 million as of the date of acquisition plus a premium of $3.5 million. The senior amortizing note, which has unpaid principal of $6.2 million and $6.6 million at June 30, 2022 and December 31, 2021, respectively, matures on September 14, 2036 and has a fixed interest rate of 3.75%. The senior interest only note, which has unpaid principal of $5.0 million at June 30, 2022 and December 31, 2021, matures on October 14, 2036 and has a fixed interest rate of 5.682%. The junior note, which has unpaid principal of $1.9 million and $1.9 million at June 30, 2022 and December 31, 2021, respectively, matures on September 16, 2036 and has a fixed interest rate of 7.0%, of which a fixed amount is payable semi-annually and the remainder is added to the principal balance of the junior note. The LA Mortgage is carried in the consolidated balance sheets at its aggregate unpaid principal balance. The fair value of the LA Mortgage disclosed in the table above is derived from quoted market prices of bonds backed by loans to hospitals and guaranteed by the U.S. Government and A-rated industrial bonds with similar maturities and is categorized within Level 2 of the fair value hierarchy.
Flower
On January 5, 2015, Flower Portfolio 001, LLC ("Flower") assumed a $9.2 million mortgage in conjunction with the purchase of investment real estate properties, which is recorded as note payable in the consolidated balance sheets ("the Flower Note"). The Flower Note requires monthly payments of principal and interest and is secured by certain investments of Flower. The Flower Note matures on December 10, 2031 and has a fixed interest rate of 4.81%. The carrying value of the Flower Note at June 30, 2022 of $6.2 million represents its unpaid principal balance. The fair value of the Flower Note disclosed in the table above is derived from quoted market prices of A and BBB plus rated industrial bonds with similar maturities and is categorized within Level 2 of the fair value hierarchy.
Paycheck Protection Program
In April 2020, certain subsidiaries of the Company received loan proceeds under the Paycheck Protection Program ("PPP"), totaling $2.9 million with a stated annual interest rate of 1.00%. The PPP, established as part of the Coronavirus Aid, Relief, and Economic Security Act and administered by the U.S. Small Business Administration (the "SBA"), provides for loans to qualifying businesses for amounts up to 2.5 times of the average monthly payroll costs (as defined for purposes of the PPP) of the qualifying business. The loans and accrued interest are forgivable as long as the borrower uses the loan proceeds for eligible purposes, including payroll, costs, rent and utilities, during the twenty-four week period following the borrower’s receipt of the loan and maintains its payroll levels and employee headcount. The amount of loan forgiveness will be reduced if the borrower reduces its employee headcount below its average employee headcount during a benchmark period or significantly reduces salaries for certain employees during the covered period.
The Company used the entire loan amount for qualifying expenses. The U.S. Department of the Treasury has announced that it will conduct audits for PPP loans that exceed $2.0 million. If the Company were to be audited and receive an adverse outcome in such an audit, it could be required to return the full amount of the PPP Loan and may potentially be subject to civil and criminal fines and penalties.
On December 21, 2020 the SBA approved the forgiveness of the full amount of one of the five PPP loans, which included principal and interest of $0.4 million. In January 2021 and March 2021, the SBA provided the Company with notices of forgiveness of the full amount of the remaining four loans. The forgiveness in the first quarter of 2021 included total principal and interest of $2.5 million. The loan forgiveness is included in gain on extinguishment of debt, net in the consolidated statement of operations for the six months ended June 30, 2021.
| KINGSWAY FINANCIAL SERVICES INC. Notes to Consolidated Financial Statements (Unaudited) June 30, 2022 |
(c) Subordinated debt:
Between December 4, 2002 and December 16, 2003, six subsidiary trusts of the Company issued $90.5 million of 30-year capital securities to third-parties in separate private transactions. In each instance, a corresponding floating rate junior subordinated deferrable interest debenture was then issued by KAI to the trust in exchange for the proceeds from the private sale. The floating rate debentures bear interest at the rate of LIBOR, plus spreads ranging from 3.85% to 4.20%. The Company has the right to call each of these securities at par value any time after five years from their issuance until their maturity.
The subordinated debt is carried in the consolidated balance sheets at fair value. See Note 19, "Fair Value of Financial Instruments," for further discussion of the subordinated debt. The portion of the change in fair value of subordinated debt related to the instrument-specific credit risk is recognized in other comprehensive income (loss). Of the $3.7 million decrease in fair value of the Company’s subordinated debt between December 31, 2021 and June 30, 2022, $6.9 million is reported as decrease in fair value of debt attributable to instrument-specific credit risk in the Company's consolidated statements of comprehensive income (loss) and $3.2 million reported as loss on change in fair value of debt in the Company’s consolidated statements of operations.
During the third quarter of 2018, the Company gave notice to its Trust Preferred trustees of its intention to exercise its voluntary right to defer interest payments for up to 20 quarters, pursuant to the contractual terms of its outstanding Trust Preferred indentures, which permit interest deferral. This action does not constitute a default under the Company's Trust Preferred indentures or any of its other debt indentures. At June 30, 2022 and December 31, 2021, deferred interest payable of $21.4 million and $18.7 million, respectively, is included in accrued expenses and other liabilities in the consolidated balance sheets.
On August 2, 2022, the Company entered into an agreement with a holder of four of the trust preferred debt instruments ("TruPs") that gives the Company the option to repurchase up to 100% of the holder’s principal and deferred interest for 63% of the outstanding principal and deferred interest. The Company has agreed that any repurchase made will be for no less than 50% of the TruPs held by the holder.
Until the earlier of (i) all four of the preferred debt instruments have been repurchased and (ii) the nine month anniversary of the agreement ("Termination Date"), all interest on four preferred debt instruments will continue to accrue. However, with respect to TruPs that are repurchased prior to the Termination Date, the amount of interest accrued during the term of the agreement will be treated as an offset and reduce the repurchase price for such TruPs. The Company will have no obligation to pay any such accrued interest with respect to any of the TruPs that are repurchased prior to the Termination Date.
The Company paid approximately $2 million to the holder for this option and the Company has until the Termination Date to execute the repurchases. If the Company repurchases less than $30 million of principal and deferred interest, or fails to purchase any principal or deferred interest within one year, then the $2 million paid is forfeited. If the Company repurchases an amount equal to or great than $30 million, then the $2 million paid would be applied to such repurchases.
If the Company is able to secure an agreement with the holders of the remaining two trust preferred debt instruments to repurchase all of their outstanding principal and deferred interest with four months of August 4, 2022, then the price paid to the holder of the four trust preferred debt instruments would increase up to a maximum of 64.5%.
NOTE 12 LEASES
(a) Lessee leases:
The Company has operating leases for office space that include fixed base rent payments, as well as variable rent payments to reimburse the landlord for operating expenses and taxes. The Company’s variable lease payments do not depend on a published index or rate, and therefore, are expensed as incurred. The Company includes only fixed payments for lease components in the measurement of the right-of-use asset and lease liability. There are no residual value guarantees.
Operating lease costs and variable lease costs included in general and administrative expenses for the three months ended June 30, 2022 were $0.2 million and less than $0.1 million, respectively ($0.5 million and $0.1 million for the six months ended June 30, 2022). Operating lease costs and variable lease costs included in general and administrative expenses for the three months ended June 30, 2021 were $0.2 million and $0.1 million, respectively ($0.5 million and $0.1 million for the six months ended June 30, 2021).
The annual maturities of lease liabilities as of June 30, 2022 were as follows:
| (in thousands) | | Lease Commitments | |
| 2022 | | $ | 463 | |
| 2023 | | | 638 | |
| 2024 | | | 550 | |
| 2025 | | | 381 | |
| 2026 | | | 165 | |
| 2027 and thereafter | | | — | |
| Total undiscounted lease payments | | | 2,197 | |
| Imputed interest | | | 178 | |
| Total lease liabilities | | $ | 2,019 | |
The weighted-average remaining lease term for our operating leases was 3.46 years as of June 30, 2022. The weighted average discount rate of our operating leases was 5.15% as of June 30, 2022. Cash paid for amounts included in the measurement of lease liabilities was $0.5 million and $0.5 million for the six months ended June 30, 2022 and June 30, 2021, respectively.
| KINGSWAY FINANCIAL SERVICES INC. Notes to Consolidated Financial Statements (Unaudited) June 30, 2022 |
The Company owns the Real Property that is subject to a long-term triple net lease agreement with an unrelated
third-party. The lease provides for future rent escalations and renewal options. The initial lease term ends in
May 2034. The lessee bears the cost of maintenance and property taxes. Rental income from operating leases is recognized on a straight-line basis, based on contractual lease terms with fixed and determinable increases over the non-cancellable term of the related lease when collectability is reasonably assured. Rental revenue includes a de minimus amount of amortization of below market lease liabilities for the
three and
six months ended June 30, 2022 and
June 30, 2021. The estimated aggregate future amortization of below market lease liabilities is
$0.1 million for
2022,
$0.1 million for
2023,
$0.1 million for
2024,
$0.1 million for
2025 and
$0.1 million for
2026. Realization of the residual values of the assets under lease is dependent on the future ability to market the assets under prevailing market conditions. The lease is classified as an operating lease and the underlying leased assets are included in property and equipment in the consolidated balance sheets. R
efer to
Note 9
, "
Property and Equipment
".
The Company acquired the LA Real Property on December 30, 2021. The LA Real Property is subject to a long-term lease agreement with an unrelated third-party. The lease provides for future rent decreases. The initial lease term ends in March 2035. The lessee bears the cost of maintenance and property taxes. Rental income from operating leases is recognized on a straight-line basis, based on contractual lease terms with fixed and determinable increases over the non-cancellable term of the related lease when collectability is reasonably assured. Rental revenue includes a de minimus amount of amortization of above-market lease asset related to the LA Real Property for the three and six months ended June 30, 2022. The estimated aggregate future amortization of above-market lease asset is $0.1 million for 2022, $0.1 million for 2023, $0.1 million for 2024, $0.1 million for 2025 and $0.1 million for 2026. Realization of the residual values of the assets under lease is dependent on the future ability to market the assets under prevailing market conditions. The lease is classified as an operating lease and the underlying leased assets are included in property and equipment in the consolidated balance sheets. Refer to Note 9, "Property and Equipment".
Lease revenue related to operating lease payments was $3.6 million and $3.3 millionfor the three months ended June 30, 2022 and June 30, 2021, respectively ($7.2 million and $6.7 million for the six months ended June 30, 2022 and June 30, 2021, respectively). Lease revenue related to variable lease payments was less than $0.1 million and zero for the three months ended June 30, 2022 and June 30, 2021, respectively ($0.1 million and zero for the six months ended June 30, 2022 and June 30, 2021, respectively).
The following table provides the net book value of operating lease property included in property and equipment in the consolidated balance sheets at June 30, 2022 and December 31, 2021:
| (in thousands) | | June 30, 2022 | | | December 31, 2021 | |
| | | | | | | | | |
| Land | | $ | 25,623 | | | $ | 25,623 | |
| Site improvements | | | 92,047 | | | | 92,047 | |
| Buildings | | | 11,805 | | | | 11,805 | |
| Gross property and equipment leased | | | 129,475 | | | | 129,475 | |
| Accumulation depreciation | | | (23,506 | ) | | | (21,989 | ) |
| Net property and equipment leased | | $ | 105,969 | | | $ | 107,486 | |
As of June 30, 2022, future undiscounted cash flows to be received in each of the next five years and thereafter, on non-cancelable operating leases are as follows:
| (in thousands) | | | | |
| 2022 | | $ | 7,013 | |
| 2023 | | | 14,190 | |
| 2024 | | | 14,475 | |
| 2025 | | | 14,766 | |
| 2026 | | | 14,883 | |
| Thereafter | | | 119,590 | |
NOTE 13 REVENUE FROM CONTRACTS WITH CUSTOMERS
Revenue from contracts with customers relates to the Extended Warranty and Kingsway Search Xcelerator segments and includes: vehicle service agreement fees, guaranteed asset protection products ("GAP") commissions, maintenance support service fees, warranty product commissions, homebuilder warranty service fees, homebuilder warranty commissions and business services consulting revenue. Revenue is based on terms of various agreements with credit unions, consumers, businesses and homebuilders. Customers either pay in full at the inception of a warranty contract, commission product sale, or when consulting services are billed, or on terms subject to the Company’s customary credit reviews.
The following table disaggregates revenues from contracts with customers by revenue type:
| (in thousands) | | | Three months ended June 30, | | | Six months ended June 30, | |
| | | | 2022 | | | 2021 | | | 2022 | | | 2021 | |
| | | | | | | | | | | | | | | | | | |
| Vehicle service agreement fees and GAP commissions | IWS, Geminus and PWI | | $ | 14,832 | | | $ | 14,676 | | | $ | 28,135 | | | $ | 29,350 | |
| Maintenance support service fees | Trinity | | | 1,394 | | | | 1,036 | | | | 3,192 | | | | 2,086 | |
| Warranty product commissions | Trinity | | | 1,096 | | | | 1,063 | | | | 2,228 | | | | 1,992 | |
| Homebuilder warranty service fees | PWSC | | | 1,911 | | | | 1,807 | | | | 3,727 | | | | 3,532 | |
| Homebuilder warranty commissions | PWSC | | | 211 | | | | 173 | | | | 448 | | | | 369 | |
| Business services consulting fees | Ravix | | | 4,146 | | | | — | | | | 8,316 | | | | — | |
| Service fee and commission revenue | | $ | 23,590 | | | $ | 18,755 | | | $ | 46,046 | | | $ | 37,329 | |
| KINGSWAY FINANCIAL SERVICES INC. Notes to Consolidated Financial Statements (Unaudited) June 30, 2022 |
Vehicle service agreement fees include the fees collected to cover the costs of future automobile mechanical breakdown claims and the associated administration of those claims. Vehicle service agreement fees are earned over the duration of the vehicle service agreement contracts as the single performance obligation is satisfied. Vehicle service agreement fees are initially recorded as deferred service fees with revenues recognized over the term of the contract based on the proportion of expected claims to total overall claims to be incurred over the life of the contract. The Company believes this reasonably represents the transfer of services to the vehicle service contract holder over the warranty term. The Company compares the remaining deferred service fees balance to the estimated amount of expected future claims under the vehicle service agreement contracts and records an additional accrual if the deferred service fees balance is less than expected future claims costs.
In certain jurisdictions the Company is required to refund to a customer a pro-rata share of the vehicle service agreement fees if a customer cancels the agreement prior to the end of the term. Depending on the jurisdiction, the Company may be entitled to deduct from the refund a cancellation fee and/or amounts for claims incurred prior to cancellation. While refunds vary depending on the term and type of product offered, historically refunds have averaged 9% to 13% of the original amount of the vehicle service agreement fee. Revenues recorded by the Company are net of variable consideration related to refunds and the associated refund liability is included in accrued expenses and other liabilities. The Company estimates refunds based on the actual historical refund rates by warranty type taking into consideration current observable refund trends in estimating the expected amount of future customer refunds to be paid at each reporting period.
GAP commissions include commissions from the sale of GAP products. The Company acts as an agent on behalf of the third-party insurance company that underwrites and guaranties these GAP contracts. The Company receives a single commission fee as its transaction price at the time it sells a GAP contract to a customer. Each GAP contract contains two separate performance obligations - sale of a GAP contract and GAP claims administration. The first performance obligation is related to the sale of a GAP contract and is satisfied upon closing the sale. The second performance obligation is related to the administration of claims during the GAP contract period. The amount of revenue the Company recognizes is based the costs to provide services during the GAP contract period, including an appropriate estimate of profit margin.
Maintenance support service fees include the service fees collected to administer equipment breakdown and maintenance support services and are earned as services are rendered.
Warranty product commissions include the commissions from the sale of warranty contracts for certain new and used heating, ventilation, air conditioning ("HVAC"), standby generator, commercial LED lighting and commercial refrigeration equipment. The Company acts as an agent on behalf of the third-party insurance companies that underwrite and guaranty these warranty contracts. The Company does not guaranty the performance underlying the warranty contracts it sells. Warranty product commissions are earned at the time of the warranty product sales.
Homebuilder warranty service fees include fees collected from the sale of warranties issued by new homebuilders. The Company receives a single warranty service fee as its transaction price at the time it enters into a written contract with each of its builder customers. Each contract contains two separate performance obligations - warranty administrative services and other warranty services. Warranty administrative services include enrolling each home sold by the builder into the program and the warranty administrative system and delivering the warranty product. Other warranty services include answering builder or homeowner questions regarding the home warranty and dispute resolution services.
Homebuilder warranty commissions include commissions from the sale of warranty contracts for those builders who have requested and receive insurance backing of their warranty obligations. The Company acts as an agent on behalf of the third-party insurance company that underwrites and guaranties these warranty contracts. Homebuilder warranty commissions are earned on the certification date, which is typically the date of the closing of the sale of the home to the buyer. The Company also earns fees to manage remediation or repair services related to claims on insurance-backed warranty obligations, which are earned when the claims are closed.
Ravix consulting revenue includes the revenue from providing outsourced finance and human resources consulting services. The Company invoices for business services consulting revenue based on contracted rates. Revenue is earned as services are provided.
The Company's revenue recognition policies are further described in Note 2(p), "Summary of Significant Accounting Policies - Revenue recognition," to the consolidated financial statements in the 2021 Annual Report.
Receivables from contracts with customers are reported as service fee receivable, net in the consolidated balance sheets and at June 30, 2022 and December 31, 2021 were $8.5 million and $6.7 million, respectively. The increase in receivables from contracts with customers is primarily due to the timing difference between the Company's satisfaction of performance obligations and customer payments. During the six months ended June 30, 2022, increased revenue at IWS, Trinity and Ravix primarily resulted in the increase in receivables from contracts with customers.
The Company records deferred service fees resulting from contracts with customers when payment is received in advance of satisfying the performance obligations. Changes in deferred service fees for the six months ended June 30, 2022 were as follows:
| (in thousands) | | Six months ended June 30, 2022 | |
| Balance, December 31, 2021 | | $ | 89,217 | |
| Deferral of revenue | | | 31,305 | |
| Recognition of deferred service fees | | | (29,201 | ) |
| Balance, June 30, 2022 | | $ | 91,321 | |
The increase in deferred service fees between December 31, 2021 and June 30, 2022 is primarily due to additions to deferred service fees in excess of deferred service fees recognized during the six months ended June 30, 2022.
The Company expects to recognize within one year as service fee and commission revenue approximately 48.2% of the deferred service fees as of June 30, 2022. Approximately $24.8 million and $24.7 million of service fee and commission revenue recognized during the six months ended June 30, 2022 and June 30, 2021 was included in deferred service fees as of December 31, 2021 and December 31, 2020, respectively.
| KINGSWAY FINANCIAL SERVICES INC. Notes to Consolidated Financial Statements (Unaudited) June 30, 2022 |
Deferred contract costs
Deferred contract costs represent the deferred of incremental costs to obtain or fulfill a contract with a customer. Incremental costs to obtain a contract with a customer primarily include sales commissions. The Company capitalizes costs incurred to fulfill a contract if the costs are identifiable, generate or enhance resources used to satisfy future performance obligations and are expected to be recovered. Costs to fulfill a contract include labor costs for set-up activities directly related to the acquisition of vehicle service agreements. Contract costs are deferred and amortized over the expected customer relationship period consistent with the pattern in which the related revenues are earned. Amortization of deferred contract costs are recorded in general and administrative expenses in the unaudited consolidated statements of operations. No impairment charges related to deferred contract costs were recorded during the three and six months ended June 30, 2022 and June 30, 2021.
The deferred contract costs balances and related amortization expense for the three months ended June 30, 2022 and June 30, 2021 are comprised as follows:
| (in thousands) | | Three months ended June 30, 2022 | | | Three months ended June 30, 2021 | |
| | | Costs to Obtain a Contract | | | Costs to Fulfill a Contract | | | Total | | | Costs to Obtain a Contract | | | Costs to Fulfill a Contract | | | Total | |
| Balance at March 31, net | | $ | 11,875 | | | $ | 80 | | | $ | 11,955 | | | $ | 8,766 | | | $ | 77 | | | $ | 8,843 | |
| Additions | | | 2,491 | | | | 5 | | | | 2,496 | | | | 1,679 | | | | 8 | | | | 1,687 | |
| Amortization | | | (1,831 | ) | | | (3 | ) | | | (1,834 | ) | | | (1,420 | ) | | | (4 | ) | | | (1,424 | ) |
| Balance at June 30, net | | $ | 12,535 | | | $ | 82 | | | $ | 12,617 | | | $ | 9,025 | | | $ | 81 | | | $ | 9,106 | |
The deferred contract costs balances and related amortization expense for the six months ended June 30, 2022 and June 30, 2021 are comprised as follows:
| (in thousands) | | Six months ended June 30, 2022 | | | Six months ended June 30, 2021 | |
| | | Costs to Obtain a Contract | | | Costs to Fulfill a Contract | | | Total | | | Costs to Obtain a Contract | | | Costs to Fulfill a Contract | | | Total | |
| Balance at December 31, net | | $ | 10,850 | | | $ | 80 | | | $ | 10,930 | | | $ | 8,759 | | | $ | 76 | | | $ | 8,835 | |
| Additions | | | 4,844 | | | | 11 | | | | 4,855 | | | | 3,021 | | | | 17 | | | | 3,038 | |
| Amortization | | | (3,159 | ) | | | (9 | ) | | | (3,168 | ) | | | (2,755 | ) | | | (12 | ) | | | (2,767 | ) |
| Balance at June 30, net | | $ | 12,535 | | | $ | 82 | | | $ | 12,617 | | | $ | 9,025 | | | $ | 81 | | | $ | 9,106 | |
NOTE 14 INCOME TAXES
Income tax benefit for the three and six months ended June 30, 2022 and June 30, 2021 varies from the amount that would result by applying the applicable U.S. federal corporate income tax rate of 21% to loss before income tax benefit. The following table summarizes the differences:
| (in thousands) | | Three months ended June 30, | | | Six months ended June 30, | |
| | | 2022 | | | 2021 | | | 2022 | | | 2021 | |
| Income tax benefit at United States statutory income tax rate | | $ | (498 | ) | | $ | (738 | ) | | $ | (1,109 | ) | | $ | (638 | ) |
| Valuation allowance | | | 11 | | | | (580 | ) | | | (10 | ) | | | (879 | ) |
| Non-deductible compensation | | | 21 | | | | 198 | | | | 68 | | | | 336 | |
| Non-taxable income | | | — | | | | — | | | | — | | | | (524 | ) |
| Investment income | | | (8 | ) | | | (60 | ) | | | (11 | ) | | | (43 | ) |
| State income tax | | | 158 | | | | 117 | | | | 211 | | | | 170 | |
| Change in unrecognized tax benefits(1) | | | 2 | | | | (2,853 | ) | | | 4 | | | | (2,815 | ) |
| Indemnification receivable | | | (1 | ) | | | 599 | | | | (1 | ) | | | 591 | |
| Indefinite life intangibles | | | 53 | | | | 53 | | | | 107 | | | | 107 | |
| Foreign operations subject to different tax rates | | | 250 | | | | — | | | | 315 | | | | — | |
| Other | | | 6 | | | | 6 | | | | 11 | | | | 12 | |
| Income tax benefit | | $ | (6 | ) | | $ | (3,258 | ) | | $ | (415 | ) | | $ | (3,683 | ) |
(
1) Includes interest and penalty expense related to unrecognized tax benefits.
The Company maintains a valuation allowance for its gross deferred tax assets at
June 30, 2022 and
December 31, 2021. The Company's operations have generated substantial operating losses in prior years. These losses can be available to reduce income taxes that might otherwise be incurred on future taxable income; however, it is uncertain whether the Company will generate the taxable income necessary to utilize these losses or other reversing temporary differences. This uncertainty has caused management to place a full valuation allowance on its
June 30, 2022 and
December 31, 2021 net deferred tax asset, excluding the de
ferred income tax asset and liability amounts set forth in the paragraph below. For the three months ended
June 30, 2022
and
June 30, 2021
, the Company released into income $0.3 million and $0.6 million, respectively ($0.8 million and $1.2 million for the
six
months ended
June 30, 2022
and
June 30, 2021
, respectively), of its valuation allowance associated with business interest expense carryforwards with an indefinite life.
| KINGSWAY FINANCIAL SERVICES INC. Notes to Consolidated Financial Statements (Unaudited) June 30, 2022 |
The Company carries net deferred income tax liab
ilities of
$27.9
million and
$28.6
million at
June 30, 2022 and
December 31, 2021, respectively, that consists of:
| | • | $8.2 million and $8.2 million of deferred income tax liabilities that are scheduled to reverse in periods after the expiration of the Company's consolidated U.S. net operating loss carryforwards; |
| | • | $23.8 million and $23.8 million of deferred income tax liabilities related to land and indefinite lived intangible assets; |
| | • | $4.1 million and $3.3 million of deferred income tax assets associated with business interest expense carryforwards with an indefinite life; |
| | • | $0.5 million and $0.5 million of deferred state income tax assets; and |
| | • | $0.5 million and $0.4 million of deferred state income tax liabilities. |
During the
three and
six
months ended
June 30, 2021
, the Company recorded an income tax benefit of
$2.9
million for the release of a liability for unrecognized tax benefits (including interest and penalties) that had been included in income taxes payable in the consolidated balance sheets. As of
June 30, 2022
and
December 31, 2021
, the Company carried a liability for unrecognized tax benefits of $0.1 million and $0.1 million, respectively, which is included in income taxes payable in the consolidated balance sheets. The Company classifies interest and penalty accruals, if any, related to unrecognized tax benefits as income tax expense. The Company recorded income tax expense of less than $0.1 million and benefit of $1.5 million related to interest and penalty accruals for the three months ended
June 30, 2022
and
June 30, 2021
, respectively (expense of $0.1 million and benefit of $1.5 million for the
six
months ended
June 30, 2022
and
June 30, 2021
, respectively). At
June 30, 2022
and
December 31, 2021
, the Company carried an accrual for the payment of interest and penalties of $0.1 million and $0.1 million, respectively, included in income taxes payable in the consolidated balance sheets.
NOTE 15 LOSS PER SHARE
The following table sets forth the reconciliation of numerators and denominators for the basic and diluted loss per share computation for the three and six months ended June 30, 2022 and June 30, 2021:
| (in thousands, except per share data) | | Three months ended June 30, | | | Six months ended June 30, | |
| | | 2022 | | | 2021 | | | 2022 | | | 2021 | |
| Numerator: | | | | | | | | | | | | | | | | |
| Net (loss) income | | $ | (2,365 | ) | | $ | (256 | ) | | $ | (4,869 | ) | | $ | 643 | |
| Less: net income attributable to noncontrolling interests | | | (303 | ) | | | (428 | ) | | | (452 | ) | | | (687 | ) |
| Less: dividends on preferred stock | | | (79 | ) | | | (85 | ) | | | (157 | ) | | | (323 | ) |
| Net loss attributable to common shareholders used in calculating diluted loss per share | | $ | (2,747 | ) | | $ | (769 | ) | | $ | (5,478 | ) | | $ | (367 | ) |
| | | | | | | | | | | | | | | | | |
| Denominator: | | | | | | | | | | | | | | | | |
| Weighted average basic shares | | | | | | | | | | | | | | | | |
| Weighted average common shares outstanding | | | 22,883 | | | | 22,366 | | | | 22,883 | | | | 22,292 | |
| Weighted average diluted shares | | | | | | | | | | | | | | | | |
| Weighted average common shares outstanding | | | 22,883 | | | | 22,366 | | | | 22,883 | | | | 22,292 | |
| Effect of potentially dilutive securities (a) | | | | | | | | | | | | | | | | |
| Unvested restricted stock awards | | | — | | | | — | | | | — | | | | — | |
| Warrants | | | — | | | | — | | | | — | | | | — | |
| Convertible preferred stock | | | — | | | | — | | | | — | | | | — | |
| Total weighted average diluted shares | | | 22,883 | | | | 22,366 | | | | 22,883 | | | | 22,292 | |
| Basic loss per share | | $ | (0.12 | ) | | $ | (0.03 | ) | | $ | (0.24 | ) | | $ | (0.02 | ) |
| Diluted loss per share | | $ | (0.12 | ) | | $ | (0.03 | ) | | $ | (0.24 | ) | | $ | (0.02 | ) |
| | (a) | Potentially dilutive securities consist of unvested restricted stock awards, warrants and convertible preferred stock. Because the Company is reporting a net loss attributable to common shareholders for the three and six months ended June 30, 2022 and June 30, 2021, all potentially dilutive securities outstanding were excluded from the calculation of diluted loss per share since their inclusion would have been anti-dilutive. |
Basi
c loss per share is calculated using weighted-average common shares outstanding. Diluted
loss per share is calculated using weighted-average diluted shares. Weighted-average diluted shares is calculated by adding the effect of potentially dilutive securities to weighted-average common shares outstanding.
The following weighted-average potentially dilutive securities are
not included in the
diluted loss per share calculations above because they would have had an antidilutive effect on the
loss per share:
| | | Three months ended June 30, | | | Six months ended June 30, | |
| | | 2022 | | | 2021 | | | 2022 | | | 2021 | |
| Unvested restricted stock awards | | | 1,252,754 | | | | 1,340,000 | | | | 1,252,754 | | | | 1,340,000 | |
| Warrants | | | 4,573,765 | | | | 4,923,765 | | | | 4,573,765 | | | | 4,923,765 | |
| Convertible preferred stock | | | 1,060,831 | | | | 1,142,975 | | | | 1,060,831 | | | | 1,142,975 | |
| Total | | $ | 6,887,350 | | | $ | 7,406,740 | | | $ | 6,887,350 | | | $ | 7,406,740 | |
| KINGSWAY FINANCIAL SERVICES INC. Notes to Consolidated Financial Statements (Unaudited) June 30, 2022 |
NOTE 16 STOCK-BASED COMPENSATION
(a) Restricted Stock Awards of the Company
Under the 2013 Equity Incentive Plan, the Company granted 500,000 restricted common stock awards to an officer on September 5, 2018 (the "2018 Restricted Stock Award"). The 2018 Restricted Stock Award shall become fully vested and the restriction period shall lapse as of March 28, 2024 subject to the officer's continued employment through the vesting date. The 2018 Restricted Stock Award is amortized on a straight-line basis over the requisite service period. The grant-date fair value of the 2018 Restricted Stock Award was determined using the closing price of Kingsway common stock on the date of grant. Total unamortized compensation expense related to unvested 2018 Restricted Stock Award at June 30, 2022 was $0.7 million.
Under the 2020 Equity Incentive Plan, the Company granted 1,092,754 restricted common stock awards to certain officers of the Company during 2021 (the "2021 Restricted Stock Awards"). The 2021 Restricted Stock Awards vest according to a graded vesting schedule and shall become fully vested subject to the officers' continued employment through the applicable vesting dates. The 2021 Restricted Stock Awards are amortized on a straight-line basis over the requisite service periods. The grant-date fair values of the 2021 Restricted Stock Awards were determined using the closing price of Kingsway common stock on the date of grant. During the six months ended June 30, 2022, no shares of the 2021 Restricted Stock Awards became fully vested. Total unamortized compensation expense related to unvested 2021 Restricted Stock Awards at June 30, 2022 was $3.0 million.
The following table summarizes the activity related to unvested 2021 Restricted Stock Awards and 2018 Restricted Stock Award (collectively "Restricted Stock Awards") for the six months ended June 30, 2022:
| | | Number of | | | Weighted-Average | |
| | | Restricted | | | Grant Date Fair | |
| | | Stock Awards | | | Value (per Share) | |
| Unvested at December 31, 2021 | | | 1,252,754 | | | $ | 5.09 | |
| Granted | | | — | | | | — | |
| Vested | | | — | | | | — | |
| Cancelled for Tax Withholding | | | — | | | | — | |
| Unvested at June 30, 2022 | | | 1,252,754 | | | $ | 5.09 | |
The unvested balance at June 30, 2022 in the table above is comprised of 752,754 shares of the 2021 Restricted Stock Awards and 500,000 shares of the 2018 Restricted Stock Award.
(b) Restricted Stock Awards of PWSC
The Company's subsidiary, Professional Warranty Service Corporation ("PWSC"), granted 1,000 restricted Class B common stock awards ("2018 PWSC RSA") to an officer of PWSC pursuant to an agreement dated September 7, 2018. The 2018 PWSC RSA contains both a service and a performance condition that affects vesting. On December 18, 2020, the 2018 PWSC RSA was amended to modify the vesting terms related to the service and performance condition ("Modified PWSC RSA").
PWSC granted 250 restricted Class B common stock awards to an officer of PWSC pursuant to an agreement dated December 18, 2020 ("2020 PWSC RSA"). The 2020 PWSC RSA contains both a service and a performance condition that affects vesting.
The service condition for the Modified PWSC RSA and the 2020 PWSC RSA vest according to a graded vesting schedule. The performance condition is based on the internal rate of return of PWSC. The grant-date fair value of the Modified PWSC RSA and the 2020 PWSC RSA were estimated using an internal valuation model. See Note 19, "Fair Value of Financial Instruments," for further discussion related to the valuation of the Modified PWSC RSA and the 2020 PWSC RSA.
| KINGSWAY FINANCIAL SERVICES INC. Notes to Consolidated Financial Statements (Unaudited) June 30, 2022 |
The Modified PWSC RSA and the 2020 PWSC RSA include a noncontingent put option that is exercisable between February 20, 2022 and February 20, 2023. Since the put option is exercisable less than six months after the vesting of certain shares, the compensation expense related to these shares is classified as a liability and included in accrued expenses and other liabilities in the consolidated balance sheets at June 30, 2022 and December 31, 2021.
On February 20, 2022, both the service condition and performance condition of the Modified PWSC RSA became fully vested. During the six months ended June 30, 2022, 437.50 shares of the Modified PWSC RSA became fully vested. At June 30, 2022 and December 31, 2021, there were zero and 437.50 unvested shares, respectively, of the Modified PWSC RSA with a weighted-average grant date fair value of $1,672 per share. Total unamortized compensation expense related to the Modified PWSC RSA at June 30, 2022 was zero.
On February 20, 2022, both the service condition and performance condition of the 2020 PWSC RSA became fully vested. During the six months ended June 30, 2022, 109.38 shares of the 2020 PWSC RSA became fully vested. At June 30, 2022 and December 31, 2021, there were zero and 109.38 unvested shares, respectively, of the 2020 PWSC RSA with a weighted-average grant date fair value of $1,672 per share. Total unamortized compensation expense related to the 2020 PWSC RSA at June 30, 2022 was zero.
(c) Restricted Common Unit Awards of Ravix
Ravix LLC granted 199,000 restricted Class B common unit awards to an officer of Ravix pursuant to an agreement dated October 1, 2021 ("2021 Ravix RUA"). The 2021 Ravix RUA contains both a service and a performance condition that affects vesting.
On October 1, 2021, 83,333 shares, representing one half of the service condition for the 2021 Ravix RUA, became fully vested. The remainder of the service condition vests according to a graded vesting schedule and shall become fully vested on October 1, 2025 subject to the officer's continued employment through the applicable vesting dates. The performance condition vests on October 1, 2025 and is based on the internal rate of return of Ravix. The grant-date fair value of the 2021 Ravix RUA was estimated using the Black-Scholes option pricing model, using the following assumptions: expected term of four years, expected volatility of 75%, expected dividend yield of zero, and risk-free interest rate of 0.93%.
At June 30, 2022, both the service condition and performance condition of the 2021 Ravix RUA were probable of vesting. During the six months ended June 30, 2022, no shares of the 2021 Ravix RUA became fully vested. At June 30, 2022 and December 31, 2021, there were 115,667 unvested shares of the 2021 Ravix RUA with a weighted-average grant date fair value of $3.08 per share. Total unamortized compensation expense related to unvested 2021 Ravix RUA at June 30, 2022 was $0.2 million.
Total stock-based compensation expense, inclusive of Restricted Stock Awards, Restricted Stock Awards of PWSC and Restricted Unit Awards of Ravix described above, net of forfeitures, was $0.2 million and $0.7 million for the three months ended June 30, 2022 and June 30, 2021, respectively ($0.6 million and $2.4 million for the six months ended June 30, 2022 and June 30, 2021, respectively).
NOTE 17 ACCUMULATED OTHER COMPREHENSIVE INCOME
The tables below detail the change in the balance of each component of accumulated other comprehensive income, net of tax, for the three and six months ended June 30, 2022 and June 30, 2021 as relates to shareholders' equity attributable to common shareholders on the consolidated balance sheets.
| (in thousands) | | Three months ended June 30, 2022 | |
| | | Unrealized Gains | | | Foreign | | | Change in Fair Value | | | Total | |
| | | (Losses) on | | | Currency | | | of Debt Attributable | | | Accumulated Other | |
| | | Available-for-Sale | | | Translation | | | to Instrument-Specific | | | Comprehensive | |
| | | Investments | | | Adjustments | | | Credit Risk | | | Income | |
| | | | | | | | | | | | | | | | | |
| Balance at March 31, 2022 | | $ | (1,344 | ) | | $ | (3,286 | ) | | $ | 35,244 | | | $ | 30,614 | |
| | | | | | | | | | | | | | | | | |
| Other comprehensive (loss) income arising during the period | | | (533 | ) | | | — | | | | 5,930 | | | | 5,397 | |
| Amounts reclassified from accumulated other comprehensive income | | | 6 | | | | — | | | | — | | | | 6 | |
| Net current-period other comprehensive (loss) income | | | (527 | ) | | | — | | | | 5,930 | | | | 5,403 | |
| | | | | | | | | | | | | | | | | |
| Balance at June 30, 2022 | | $ | (1,871 | ) | | $ | (3,286 | ) | | $ | 41,174 | | | $ | 36,017 | |
| (in thousands) | | Three months ended June 30, 2021 | |
| | | Unrealized Gains | | | Foreign | | | Change in Fair Value | | | Total | |
| | | (Losses) on | | | Currency | | | of Debt Attributable | | | Accumulated Other | |
| | | Available-for-Sale | | | Translation | | | to Instrument-Specific | | | Comprehensive | |
| | | Investments | | | Adjustments | | | Credit Risk | | | Income | |
| | | | | | | | | | | | | | | | | |
| Balance at March 31, 2021 | | $ | 157 | | | $ | (3,286 | ) | | $ | 39,408 | | | $ | 36,279 | |
| | | | | | | | | | | | | | | | | |
| Other comprehensive loss arising during the period | | | (34 | ) | | | — | | | | (3,813 | ) | | | (3,847 | ) |
| Amounts reclassified from accumulated other comprehensive income | | | 2 | | | | — | | | | — | | | | 2 | |
| Net current-period other comprehensive loss | | | (32 | ) | | | — | | | | (3,813 | ) | | | (3,845 | ) |
| | | | | | | | | | | | | | | | | |
| Balance at June 30, 2021 | | $ | 125 | | | $ | (3,286 | ) | | $ | 35,595 | | | $ | 32,434 | |
| KINGSWAY FINANCIAL SERVICES INC. Notes to Consolidated Financial Statements (Unaudited) June 30, 2022 |
| (in thousands) | | Six months ended June 30, 2022 | |
| | | Unrealized Gains | | | Foreign | | | Change in Fair Value | | | Total | |
| | | (Losses) on | | | Currency | | | of Debt Attributable | | | Accumulated Other | |
| | | Available-for-Sale | | | Translation | | | to Instrument-Specific | | | Comprehensive | |
| | | Investments | | | Adjustments | | | Credit Risk | | | Income | |
| | | | | | | | | | | | | | | | | |
| Balance at January 1, 2022 | | $ | (220 | ) | | $ | (3,286 | ) | | $ | 34,285 | | | $ | 30,779 | |
| | | | | | | | | | | | | | | | | |
| Other comprehensive (loss) income arising during the period | | | (1,658 | ) | | | — | | | | 6,889 | | | | 5,231 | |
| Amounts reclassified from accumulated other comprehensive income | | | 7 | | | | — | | | | — | | | | 7 | |
| Net current-period other comprehensive (loss) income | | | (1,651 | ) | | | — | | | | 6,889 | | | | 5,238 | |
| | | | | | | | | | | | | | | | | |
| Balance at June 30, 2022 | | $ | (1,871 | ) | | $ | (3,286 | ) | | $ | 41,174 | | | $ | 36,017 | |
| (in thousands) | | Six months ended June 30, 2021 | |
| | | Unrealized Gains | | | Foreign | | | Change in Fair Value | | | Total | |
| | | (Losses) on | | | Currency | | | of Debt Attributable | | | Accumulated Other | |
| | | Available-for-Sale | | | Translation | | | to Instrument-Specific | | | Comprehensive | |
| | | Investments | | | Adjustments | | | Credit Risk | | | Income | |
| | | | | | | | | | | | | | | | | |
| Balance at January 1, 2021 | | $ | 216 | | | $ | (3,286 | ) | | $ | 41,129 | | | $ | 38,059 | |
| | | | | | | | | | | | | | | | | |
| Other comprehensive loss arising during the period | | | (105 | ) | | | — | | | | (5,534 | ) | | | (5,639 | ) |
| Amounts reclassified from accumulated other comprehensive income | | | 14 | | | | — | | | | — | | | | 14 | |
| Net current-period other comprehensive loss | | | (91 | ) | | | — | | | | (5,534 | ) | | | (5,625 | ) |
| | | | | | | | | | | | | | | | | |
| Balance at June 30, 2021 | | $ | 125 | | | $ | (3,286 | ) | | $ | 35,595 | | | $ | 32,434 | |
It should be noted that the unaudited consolidated statements of comprehensive income (loss) present the components of other comprehensive income (loss), net of tax, only for the three and six months ended June 30, 2022 and June 30, 2021 and inclusive of the components attributable to noncontrolling interests in consolidated subsidiaries.
Components of accumulated other comprehensive income were reclassified to the following lines of the unaudited consolidated statements of operations for the three and six months ended June 30, 2022 and June 30, 2021:
| (in thousands) | | Three months ended June 30, | | | Six months ended June 30, | |
| | | 2022 | | | 2021 | | | 2022 | | | 2021 | |
| Reclassification of accumulated other comprehensive income from unrealized gains (losses) on available-for-sale investments to: | | | | | | | | | | | | | | | | |
| Net realized gains | | $ | (6 | ) | | $ | (2 | ) | | $ | (7 | ) | | $ | (14 | ) |
| Other-than-temporary impairment loss | | | — | | | | — | | | | — | | | | — | |
| Loss before income tax benefit | | | (6 | ) | | | (2 | ) | | | (7 | ) | | | (14 | ) |
| Income tax benefit | | | — | | | | — | | | | — | | | | — | |
| Net (loss) income | | $ | (6 | ) | | $ | (2 | ) | | $ | (7 | ) | | $ | (14 | ) |
NOTE 18 SEGMENTED INFORMATION
The Company reports segment information based on the "management" approach. The management approach designates the internal reporting used by management for making decisions and assessing performance as a source of the Company’s reportable operating segments. The Company conducts its business through the following three reportable segments: Extended Warranty, Leased Real Estate and Kingsway Search Xcelerator.
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements (Unaudited)
June 30, 2022
Extended Warranty Segment
Extended Warranty includes the following subsidiaries of the Company: IWS, Geminus, PWI, PWSC and Trinity (collectively, "Extended Warranty").
IWS is a licensed motor vehicle service agreement company and is a provider of after-market vehicle protection services distributed by credit unions in 25 states and the District of Columbia to their members, with customers in all fifty states.
Geminus primarily sells vehicle service agreements to used car buyers across the United States, through its subsidiaries, Penn and Prime. Penn and Prime distribute these products in 32 and 40 states, respectively, via independent used car dealerships and franchised car dealerships.
PWI markets, sells and administers vehicle service agreements to used car buyers in all fifty states via independent used car and franchise network of approved automobile and motorcycle dealer partners. PWI’s business model is supported by an internal sales and operations team and partners with American Auto Shield in three states with a white label agreement. PWI also has a white label agreement with a third-party that sells and administers a GAP product in certain states.
PWSC sells new home warranty products and provides administration services to home builders and homeowners across the United States. PWSC distributes its products and services through an in-house sales team and through insurance brokers and insurance carriers throughout all states except Alaska and Louisiana.
Trinity sells HVAC, standby generator, commercial LED lighting and commercial refrigeration warranty products and provides equipment breakdown and maintenance support services to companies across the United States. As a seller of warranty products, Trinity markets and administers product warranty contracts for certain new and used products in the HVAC, standby generator, commercial LED lighting and commercial refrigeration industries throughout the United States. Trinity acts as an agent on behalf of the third-party insurance companies that underwrite and guaranty these warranty contracts. Trinity does not guaranty the performance underlying the warranty contracts it sells. As a provider of equipment breakdown and maintenance support services, Trinity acts as a single point of contact to its clients for both certain equipment breakdowns and scheduled maintenance of equipment. Trinity will provide such repair and breakdown services by contracting with certain HVAC providers.
Leased Real Estate Segment
Leased Real Estate includes the Company's subsidiaries, CMC and VA Lafayette.
CMC owns the Real Property that is leased to a third party pursuant to a long-term triple net lease with a single customer. The Real Property is also subject to the Mortgage and Additional Mortgage. When assessing and measuring the operational and financial performance of the Leased Real Estate segment, interest expense related to the Mortgage and Additional Mortgage is included in Leased Real Estate's segment operating income.
VA Lafayette owns the LA Real Property that is leased to a third-party pursuant to a long-term lease with a single customer. The LA Real Property is also subject to the LA Mortgage. When assessing and measuring the operational and financial performance of the Leased Real Estate segment, interest expense related to the LA Mortgage is included in Leased Real Estate's segment operating income.
Kingsway Search Xcelerator Segment
Kingsway Search Xcelerator includes the Company's subsidiary, Ravix. Ravix provides outsourced financial services and human resources consulting for short or long duration engagements for customers in 21 states and 5 countries. All services are delivered by employees who are located in the United States.
Revenues and Operating Income by Reportable Segment
Results for the Company's reportable segments are based on the Company's internal financial reporting systems and are consistent with those followed in the preparation of the unaudited consolidated interim financial statements. The following tables provide financial data used by management. Segment assets are not allocated for management use and, therefore, are not included in the segment disclosures below.
Revenues by reportable segment reconciled to consolidated revenues for the three and six months ended June 30, 2022 and June 30, 2021 were:
| (in thousands) | | Three months ended June 30, | | | Six months ended June 30, | |
| | | 2022 | | | 2021 | | | 2022 | | | 2021 | |
| Revenues: | | | | | | | | | | | | | | | | |
| Extended Warranty: | | | | | | | | | | | | | | | | |
| Service fee and commission revenue | | $ | 19,444 | | | $ | 18,755 | | | $ | 37,730 | | | $ | 37,329 | |
| Total Extended Warranty | | | 19,444 | | | | 18,755 | | | | 37,730 | | | | 37,329 | |
| Leased Real Estate: | | | | | | | | | | | | | | | | |
| Rental revenue | | | 3,633 | | | | 3,341 | | | | 7,300 | | | | 6,682 | |
| Total Leased Real Estate | | | 3,633 | | | | 3,341 | | | | 7,300 | | | | 6,682 | |
| Kingsway Search Xcelerator: | | | | | | | | | | | | | | | | |
| Service fee and commission revenue | | | 4,146 | | | | — | | | | 8,316 | | | | — | |
| Total Kingsway Search Xcelerator | | | 4,146 | | | | — | | | | 8,316 | | | | — | |
| Total revenues | | $ | 27,223 | | | $ | 22,096 | | | $ | 53,346 | | | $ | 44,011 | |
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements (Unaudited)
June 30, 2022
The operating income by reportable segment in the following table is before income taxes and includes revenues and direct segment costs. Total segment operating income reconciled to the consolidated net (loss) income for the three and six months ended June 30, 2022 and June 30, 2021 were:
| (in thousands) | | Three months ended June 30, | | | Six months ended June 30, | |
| | | 2022 | | | 2021 | | | 2022 | | | 2021 | |
| Segment operating income: | | | | | | | | | | | | | | | | |
| Extended Warranty (a) | | $ | 2,936 | | | $ | 2,600 | | | $ | 4,659 | | | $ | 7,910 | |
| Leased Real Estate (b) | | | 851 | | | | (2,302 | ) | | | 2,410 | | | | (1,009 | ) |
| Kingsway Search Xcelerator | | | 893 | | | | — | | | | 1,699 | | | | — | |
| Total segment operating income | | | 4,680 | | | | 298 | | | | 8,768 | | | | 6,901 | |
| Net investment income | | | 465 | | | | 403 | | | | 1,084 | | | | 824 | |
| Net realized gains | | | 184 | | | | 187 | | | | 238 | | | | 238 | |
| Loss on change in fair value of equity investments | | | (38 | ) | | | (45 | ) | | | (48 | ) | | | (196 | ) |
| Gain on change in fair value of limited liability investments, at fair value | | | 46 | | | | 731 | | | | 173 | | | | 529 | |
| Interest expense not allocated to segments | | | (1,704 | ) | | | (1,593 | ) | | | (3,068 | ) | | | (3,145 | ) |
| Other revenue and expenses not allocated to segments, net | | | (3,180 | ) | | | (2,261 | ) | | | (6,245 | ) | | | (5,752 | ) |
| Amortization of intangible assets | | | (1,494 | ) | | | (496 | ) | | | (2,988 | ) | | | (993 | ) |
| Loss on change in fair value of debt | | | (1,330 | ) | | | (738 | ) | | | (3,198 | ) | | | (1,757 | ) |
| Gain on extinguishment of debt not allocated to segments | | | — | | | | — | | | | — | | | | 311 | |
| Loss before income tax benefit | | | (2,371 | ) | | | (3,514 | ) | | | (5,284 | ) | | | (3,040 | ) |
| Income tax benefit | | | (6 | ) | | | (3,258 | ) | | | (415 | ) | | | (3,683 | ) |
| Net (loss) income | | $ | (2,365 | ) | | $ | (256 | ) | | $ | (4,869 | ) | | $ | 643 | |
| | (a) | For the six months ended June 30, 2021, Extended Warranty segment operating income includes gain on extinguishment of debt of $2.2 million, related to PPP loan forgiveness directly associated with the respective warranty businesses. Extended Warranty segment operating income before the gain on extinguishment of debt totaled $5.7 million for the six months ended June 30, 2021. SeeNote 11, "Debt," for further discussion. |
| | (b) | For the three and six months ended June 30, 2021, includes $2.9 million expense due to the release of an indemnification receivable, which is exactly offset in net (loss) income by an income tax benefit of $2.9 million for the release of a liability that had been included in income taxes payable in the consolidated balance sheets. |
NOTE 19 FAIR VALUE OF FINANCIAL INSTRUMENTS
Fair value is the price that would be received upon sale of an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value is best evidenced by quoted bid or ask price, as appropriate, in an active market. Where bid or ask prices are not available, such as in an illiquid or inactive market, the closing price of the most recent transaction of that instrument subject to appropriate adjustments as required is used. Where quoted market prices are not available, the quoted prices of similar financial instruments or valuation models with observable market-based inputs are used to estimate the fair value. These valuation models may use multiple observable market inputs, including observable interest rates, foreign exchange rates, index levels, credit spreads, equity prices, counterparty credit quality, corresponding market volatility levels and option volatilities. Minimal management judgment is required for fair values calculated using quoted market prices or observable market inputs for models. Greater subjectivity is required when making valuation adjustments for financial instruments in inactive markets or when using models where observable parameters do not exist. Also, the calculation of estimated fair value is based on market conditions at a specific point in time and may not be reflective of future fair values. For the Company's financial instruments carried at cost or amortized cost, the book value is not adjusted to reflect increases or decreases in fair value due to market fluctuations, including those due to interest rate changes, as it is the Company's intention to hold them until there is a recovery of fair value, which may be to maturity.
The Company employs a fair value hierarchy to categorize the inputs it uses in valuation techniques to measure the fair value. The following fair value hierarchy is used in selecting inputs, with the highest priority given to Level 1:
| | • | Level 1 – Quoted prices for identical instruments in active markets. |
| | • | Level 2 – Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations in which all significant inputs are observable in active markets. |
| | • | Level 3 – Valuations derived from valuation techniques in which one or more significant inputs are not observable. |
The Company classifies its investments in fixed maturities as available-for-sale and reports these investments at fair value. The Company's equity investments, limited liability investments, at fair value, real estate investments, subordinated debt, stock-based compensation liabilities, derivative contracts (interest rate swap) and contingent consideration are measured and reported at fair value.
Fixed maturities - Fair values of fixed maturities for which no active market exists are derived from quoted market prices of similar instruments or other third party evidence. All classes of the Company’s fixed maturities, primarily consisting of investments in US. Treasury bills and government bonds; obligations of states, municipalities and political subdivisions; mortgage-backed securities; and corporate securities, are classified as Level 2. Level 2 is applied to valuations based upon quoted prices for similar assets in active markets; quoted prices for identical or similar assets in markets that are inactive; or valuations based on models where the significant inputs are observable or can be corroborated by observable market data.
The Company engages a third-party vendor who utilizes third-party pricing sources and primarily employs a market approach to determine the fair values of our fixed maturities. The market approach includes primarily obtaining prices from independent third-party pricing services as well as, to a lesser extent, quotes from broker-dealers. Our third-party vendor also monitors market indicators, as well as industry and economic events, to ensure pricing is appropriate. All classes of our fixed maturities are valued using this technique. The Company has obtained an understanding of our third-party vendor’s valuation methodologies and inputs. Fair values obtained from our third-party vendor are not adjusted by the Company.
| KINGSWAY FINANCIAL SERVICES INC. Notes to Consolidated Financial Statements (Unaudited) June 30, 2022 |
The following is a description of the significant inputs, by asset class, used by the third-party pricing services to determine the fair values of our fixed maturities included in Level 2:
| | • | U.S. government, government agencies and authorities are generally priced using the market approach. Inputs generally consist of trades of identical or similar securities, quoted prices in inactive markets and maturity. |
| | • | States, municipalities and political subdivisions are generally priced using the market approach. Inputs generally consist of trades of identical or similar securities, quoted prices in inactive markets, new issuances and credit spreads. |
| | • | Mortgage-backed and asset-backed securities are generally priced using the market approach. Inputs generally consist of trades of identical or similar securities, quoted prices in inactive markets, expected prepayments, expected credit default rates, delinquencies and issue specific information including, but not limited to, collateral type, seniority and vintage. |
| | • | Corporate securities are generally priced using the market approach using pricing vendors. Inputs generally consist of trades of identical or similar securities, quoted prices in inactive markets, issuer rating, benchmark yields, maturity and credit spreads. |
Equity investments - Fair values of equity investments, including warrants, reflect quoted market values based on latest bid prices, where active markets exist, or models based on significant market observable inputs, where no active markets exist.
Limited liability investments, at fair value - Limited liability investments, at fair value include the underlying investments of Net Lease and Argo Holdings. Net Lease owns investments in limited liability companies that hold investment properties. Argo Holdings makes investments in limited liability companies and limited partnerships that hold investments in search funds and private operating companies.
| | • | The fair value of Net Lease's investments in limited liability companies is based upon the net asset values of the underlying investments in companies as a practical expedient to estimate fair value. The Company applies the net asset value practical expedient to Net Lease's limited liability investments on an investment-by-investment basis unless it is probable that the Company will sell a portion of an investment at an amount different from the net asset value of the investment. Investments that are measured at fair value using the net asset value practical expedient are not required to be classified using the fair value hierarchy. |
| | • | The fair value of Argo Holdings' limited liability investments that hold investments in search funds is based on the initial investment in the search funds. The fair value of Argo Holdings' limited liability investments that hold investments in private operating companies is valued using a market approach including valuation multiples applied to corresponding performance metrics, such as earnings before interest, tax, depreciation and amortization; revenue; or net earnings. The selected valuation multiples were estimated using multiples provided by the investees and review of those multiples in light of investor updates, performance reports, financial statements and other relevant information. These investments are categorized in Level 3 of the fair value hierarchy. |
Real estate investments - The fair value of real estate investments involves a combination of the market and income valuation techniques. Under this approach, a market-based capitalization rate is derived from comparable transactions, adjusted for any unique characteristics of each asset, and applied to the asset under consideration. The cap rates used during underwriting and subsequent valuation incorporate the consideration of risks of vacancy and collection loss, administrative costs of owning net leased assets and possible capital expenditures that could be determined a landlord expense. These investments are categorized in Level 3 of the fair value hierarchy.
Subordinated debt - The fair value of the subordinated debt is calculated using a model based on significant market observable inputs and inputs developed by a third party. These inputs include credit spread assumptions developed by a third party and market observable swap rates. The subordinated debt is categorized in Level 2 of the fair value hierarchy.
Stock-based compensation liabilities- Certain of the restricted stock awards granted by PWSC are classified as a liability. Liability-classified awards are measured and reported at fair value and are included in accrued expenses and other liabilities in the consolidated balance sheets. The fair value of the restricted stock awards granted by PWSC are estimated using an internal valuation model without relevant observable market inputs. The significant inputs used in the model include a valuation multiple applied to trailing twelve month earnings before interest, tax, depreciation and amortization. Liability-classified restricted stock awards are categorized in Level 3 of the fair value hierarchy.
Derivative contracts- As described in Note 10, "Derivatives," the Company entered into an interest rate swap agreement effective April 1, 2021 to convert the variable interest rate on a portion of the 2020 KWH Loan to a fixed interest rate. The interest rate swap contract is measured and reported at fair value and is included in other receivables and accrued expenses and other liabilities in the consolidated balance sheets at June 30, 2022 and December 31, 2021, respectively. The fair value of the interest rate swap contract is estimated using inputs which the Company obtains from the counterparty and is determined using a discounted cash flow analysis on the expected cash flows of the derivative. The discounted cash flow valuation technique reflects the contractual term of the derivative contract, including the period to maturity, and uses observable market based inputs, including quoted mid-market prices or third-party consensus pricing, interest rate curves and implied volatilities. The interest rate swap contract is categorized in Level 2 of the fair value hierarchy.
Contingent consideration - The consideration for Company's acquisition of Ravix includes future payments to the former owners that are contingent upon the achievement of certain targets over future reporting periods. Liabilities for contingent consideration are measured and reported at fair value and are included in accrued expenses and other liabilities in the consolidated balance sheets. The fair value of the Company's contingent consideration liability is estimated by applying the Monte Carlo simulation method to forecast achievement of gross profit which may result in up to $4.5 million in total payments to the former owners of Ravix through October 2024. Key inputs in the valuation include forecasted gross profit, gross profit volatility, discount rate and discount term. Contingent consideration liabilities are revalued each reporting period. Changes in the fair value of contingent consideration liabilities can result from changes to one or multiple inputs, including adjustments to the discount rates or changes in the assumed achievement or timing of any targets. Any changes in fair value are reported in the consolidated statements of operations as non-operating other revenue. The contingent consideration liability is categorized in Level 3 of the fair value hierarchy.
| KINGSWAY FINANCIAL SERVICES INC. Notes to Consolidated Financial Statements (Unaudited) June 30, 2022 |
Assets and Liabilities Measured at Fair Value on a Recurring Basis
The balances of the Company's financial assets and liabilities measured at fair value on a recurring basis by level within the fair value hierarchy as of June 30, 2022 and December 31, 2021 are as follows. Certain investments in limited liability companies that are measured at fair value using the net asset value practical expedient are not required to be classified using the fair value hierarchy, but are presented in the following tables to permit reconciliation of the fair value hierarchy to the amounts presented in the consolidated balance sheets:
| (in thousands) | | June 30, 2022 | |
| | | Fair Value Measurements at the End of the Reporting Period Using | |
| | | | | | | | | | | | | | | | | | | | | |
| | | | | | | Quoted Prices in | | | Significant | | | Significant | | | | | |
| | | | | | | Active Markets for | | | Other Observable | | | Unobservable | | | | | |
| | | | | | | Identical Assets | | | Inputs | | | Inputs | | | Measured at | |
| | | Total | | | (Level 1) | | | (Level 2) | | | (Level 3) | | | Net Asset Value | |
| Recurring fair value measurements: | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | |
| Assets: | | | | | | | | | | | | | | | | | | | | |
| Fixed maturities: | | | | | | | | | | | | | | | | | | | | |
| U.S. government, government agencies and authorities | | $ | 15,301 | | | $ | — | | | $ | 15,301 | | | $ | — | | | $ | — | |
| States, municipalities and political subdivisions | | | 2,082 | | | | — | | | | 2,082 | | | | — | | | | — | |
| Mortgage-backed | | | 7,824 | | | | — | | | | 7,824 | | | | — | | | | — | |
| Asset-backed | | | 1,694 | | | | — | | | | 1,694 | | | | — | | | | — | |
| Corporate | | | 10,112 | | | | — | | | | 10,112 | | | | — | | | | — | |
| Total fixed maturities | | | 37,013 | | | | — | | | | 37,013 | | | | — | | | | — | |
| Equity investments: | | | | | | | | | | | | | | | | | | | | |
| Common stock | | | 131 | | | | 131 | | | | — | | | | — | | | | — | |
| Total equity investments | | | 131 | | | | 131 | | | | — | | | | — | | | | — | |
| Limited liability investments, at fair value | | | 18,986 | | | | — | | | | — | | | | 3,413 | | | | 15,573 | |
| Real estate investments | | | 10,662 | | | | — | | | | — | | | | 10,662 | | | | — | |
| Derivative contract - interest rate swap | | | 262 | | | | — | | | | 262 | | | | — | | | | — | |
| Total assets | | $ | 67,054 | | | $ | 131 | | | $ | 37,275 | | | $ | 14,075 | | | $ | 15,573 | |
| | | | | | | | | | | | | | | | | | | | | |
| Liabilities: | | | | | | | | | | | | | | | | | | | | |
| Subordinated debt | | $ | 57,282 | | | $ | — | | | $ | 57,282 | | | $ | — | | | $ | — | |
| Contingent consideration | | | 3,959 | | | | — | | | | — | | | | 3,959 | | | | — | |
| Stock-based compensation liabilities | | | 1,475 | | | | — | | | | — | | | | 1,475 | | | | — | |
| Total liabilities | | $ | 62,716 | | | $ | — | | | $ | 57,282 | | | $ | 5,434 | | | $ | — | |
| (in thousands) | | December 31, 2021 | |
| | | Fair Value Measurements at the End of the Reporting Period Using | |
| | | | | | | | | | | | | | | | | | | | | |
| | | | | | | Quoted Prices in | | | Significant | | | Significant | | | | | |
| | | | | | | Active Markets for | | | Other Observable | | | Unobservable | | | | | |
| | | | | | | Identical Assets | | | Inputs | | | Inputs | | | Measured at | |
| | | Total | | | (Level 1) | | | (Level 2) | | | (Level 3) | | | Net Asset Value | |
| Recurring fair value measurements: | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | |
| Assets: | | | | | | | | | | | | | | | | | | | | |
| Fixed maturities: | | | | | | | | | | | | | | | | | | | | |
| U.S. government, government agencies and authorities | | $ | 16,223 | | | $ | — | | | $ | 16,223 | | | $ | — | | | $ | — | |
| States municipalities and political subdivisions | | | 1,878 | | | | — | | | | 1,878 | | | | — | | | | — | |
| Mortgage-backed | | | 7,629 | | | | — | | | | 7,629 | | | | — | | | | — | |
| Asset-backed | | | 445 | | | | — | | | | 445 | | | | — | | | | — | |
| Corporate | | | 9,491 | | | | — | | | | 9,491 | | | | — | | | | — | |
| Total fixed maturities | | | 35,666 | | | | — | | | | 35,666 | | | | — | | | | — | |
| Equity investments: | | | | | | | | | | | | | | | | | | | | |
| Common stock | | | 171 | | | | 171 | | | | — | | | | — | | | | — | |
| Warrants | | | 8 | | | | — | | | | 8 | | | | — | | | | — | |
| Total equity investments | | | 179 | | | | 171 | | | | 8 | | | | — | | | | — | |
| Limited liability investments, at fair value | | | 18,826 | | | | — | | | | — | | | | 4,022 | | | | 14,804 | |
| Real estate investments | | | 10,662 | | | | — | | | | — | | | | 10,662 | | | | — | |
| Total assets | | $ | 65,333 | | | $ | 171 | | | $ | 35,674 | | | $ | 14,684 | | | $ | 14,804 | |
| | | | | | | | | | | | | | | | | | | | | |
| Liabilities: | | | | | | | | | | | | | | | | | | | | |
| Subordinated debt | | $ | 60,973 | | | $ | — | | | $ | 60,973 | | | $ | — | | | $ | — | |
| Contingent consideration | | | 2,458 | | | | — | | | | — | | | | 2,458 | | | | — | |
| Stock-based compensation liabilities | | | 1,402 | | | | — | | | | — | | | | 1,402 | | | | — | |
| Derivative contract - interest rate swap | | | 14 | | | | — | | | | 14 | | | | — | | | | — | |
| Total liabilities | | $ | 64,847 | | | $ | — | | | $ | 60,987 | | | $ | 3,860 | | | $ | — | |
| KINGSWAY FINANCIAL SERVICES INC. Notes to Consolidated Financial Statements (Unaudited) June 30, 2022 |
The following table provides a reconciliation of the fair value of recurring Level 3 fair value measurements for the three and six months ended June 30, 2022 and June 30, 2021:
| (in thousands) | | Three months ended June 30, | | | Six months ended June 30, | |
| | | 2022 | | | 2021 | | | 2022 | | | 2021 | |
| Assets: | | | | | | | | | | | | | | | | |
| Limited liability investments, at fair value: | | | | | | | | | | | | | | | | |
| Beginning balance | | $ | 3,751 | | | $ | 3,374 | | | $ | 4,022 | | | $ | 3,263 | |
| Distributions received | | | (164 | ) | | | (211 | ) | | | (211 | ) | | | (233 | ) |
| Realized gains included in net (loss) income | | | 164 | | | | 188 | | | | 197 | | | | 210 | |
| Change in fair value of limited liability investments, at fair value included in net (loss) income | | | (338 | ) | | | (49 | ) | | | (595 | ) | | | 62 | |
| Ending balance | | $ | 3,413 | | | $ | 3,302 | | | $ | 3,413 | | | $ | 3,302 | |
| Unrealized (gains) losses on limited liability investments, at fair value held at end of period: | | | | | | | | | | | | | | | | |
| Included in net (loss) income | | $ | (338 | ) | | $ | (49 | ) | | $ | (595 | ) | | $ | 62 | |
| Included in other comprehensive income (loss) | | $ | — | | | $ | — | | | $ | — | | | $ | — | |
| Real estate investments: | | | | | | | | | | | | | | | | |
| Beginning balance | | $ | 10,662 | | | $ | 10,662 | | | $ | 10,662 | | | $ | 10,662 | |
| Change in fair value of real estate investments included in net (loss) income | | | — | | | | — | | | | — | | | | — | |
| Ending balance | | $ | 10,662 | | | $ | 10,662 | | | $ | 10,662 | | | $ | 10,662 | |
| Unrealized gains recognized on real estate investments held at end of period: | | | | | | | | | | | | | | | | |
| Included in net (loss) income | | | — | | | | — | | | | — | | | | — | |
| Included in other comprehensive income (loss) | | | — | | | | — | | | | — | | | | — | |
| Ending balance - assets | | $ | 14,075 | | | $ | 13,964 | | | $ | 14,075 | | | $ | 13,964 | |
| Liabilities: | | | | | | | | | | | | | | | | |
| Contingent consideration: | | | | | | | | | | | | | | | | |
| Beginning balance | | $ | 2,767 | | | $ | — | | | $ | 2,458 | | | $ | — | |
| Change in fair value of contingent consideration included in net (loss) income | | | 1,192 | | | | — | | | | 1,501 | | | | — | |
| Ending balance | | $ | 3,959 | | | $ | — | | | $ | 3,959 | | | $ | — | |
| Unrealized gains recognized on contingent consideration liability held at end of period: | | | | | | | | | | | | | | | | |
| Included in net (loss) income | | $ | 1,192 | | | $ | — | | | $ | 1,501 | | | $ | — | |
| Included in other comprehensive income (loss) | | $ | — | | | $ | — | | | $ | — | | | $ | — | |
| Stock-based compensation liabilities: | | | | | | | | | | | | | | | | |
| Beginning balance | | $ | 1,494 | | | $ | 844 | | | $ | 1,402 | | | $ | 443 | |
| Change in fair value of stock-based compensation liabilities included in net (loss) income | | | (19 | ) | | | 290 | | | | 73 | | | | 691 | |
| Ending balance | | $ | 1,475 | | | $ | 1,134 | | | $ | 1,475 | | | $ | 1,134 | |
| Unrealized gains recognized on stock-based compensation liabilities held at end of period: | | | | | | | | | | | | | | | | |
| Included in net (loss) income | | $ | (19 | ) | | $ | — | | | $ | 73 | | | $ | — | |
| Included in other comprehensive income (loss) | | $ | — | | | $ | — | | | $ | — | | | $ | — | |
| Ending balance - liabilities | | $ | 5,434 | | | $ | 1,134 | | | $ | 5,434 | | | $ | 1,134 | |
The following table summarizes the valuation techniques and significant unobservable inputs utilized in determining fair values for the Company's investments that are categorized as Level 3 at June 30, 2022:
| Categories | | Fair Value | | Valuation Techniques | Unobservable Inputs | | Input Value(s) | |
| Limited liability investments, at fair value | | $ | 3,413 | | Market approach | Valuation multiples | | 1.0x - 9.0x | |
| Real estate investments | | $ | 10,662 | | Market and income approach | Cap rates | | | 7.5 | % |
| Contingent consideration | | $ | 3,959 | | Option-based income approach | Discount rate | | | 5.50 | % |
| | | | | | | Risk-free rate | | 2.92 | % |
| | | | | | | Expected volatility | | 16.0 | % |
| Stock-based compensation liabilities | | $ | 1,475 | | Market approach | Valuation multiple | | 6.0x | |
The following table summarizes the valuation techniques and significant unobservable inputs utilized in determining fair values for the Company's investments that are categorized as Level 3 at December 31, 2021:
| Categories | | Fair Value | | Valuation Techniques | Unobservable Inputs | | Input Value(s) | |
| Limited liability investments, at fair value | | $ | 4,022 | | Market approach | Valuation multiples | | 1.0x - 8.0x | |
| Real estate investments | | $ | 10,662 | | Market and income approach | Cap rates | | | 7.5 | % |
| Contingent consideration | | $ | 2,458 | | Option-based income approach | Discount rate | | | 4.0 | % |
| | | | | | | Risk-free rate | | 0.49 | % |
| | | | | | | Expected volatility | | 15.0 | % |
| Stock-based compensation liabilities | | $ | 1,402 | | Market approach | Valuation multiple | | 6.0x | |
| KINGSWAY FINANCIAL SERVICES INC. Notes to Consolidated Financial Statements (Unaudited) June 30, 2022 |
Investments Measured Using the Net Asset Value per Share Practical Expedient
The following table summarizes investments for which fair value is measured using the net asset value per share practical expedient at June 30, 2022:
| | | Fair Value | | | | | | | | Redemption | |
| Category | | (in thousands) | | | Unfunded Commitments | | Redemption Frequency | | | Notice Period | |
| Limited liability investments, at fair value | | $ | 15,573 | | | n/a | | n/a | | | n/a | |
The following table summarizes investments for which fair value is measured using the net asset value per share practical expedient at December 31, 2021:
| | | Fair Value | | | | | | | | Redemption | |
| Category | | (in thousands) | | | Unfunded Commitments | | Redemption Frequency | | | Notice Period | |
| Limited liability investments, at fair value | | $ | 14,804 | | | n/a | | n/a | | | n/a | |
Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis
Certain assets and liabilities are measured at fair value on a nonrecurring basis, including assets that are adjusted for observable price changes or written down to fair value as a result of an impairment. For the three and six months ended June 30, 2022 and June 30, 2021, the Company did not record any adjustments to the fair value of its investments in private companies for observable price changes. The Company did not record any impairments related to investments in private companies for the three and six months ended June 30, 2022 and June 30, 2021. To determine the fair value of investments in these private companies, the Company considered rounds of financing and third-party transactions, discounted cash flow analyses and market-based information, including comparable transactions, trading multiples and changes in market outlook, among other factors. The Company has classified the fair value measurements of these investments in private companies as Level 3 because they involve significant unobservable inputs.
NOTE 20 RELATED PARTIES
Related party transactions, including services provided to or received by the Company's subsidiaries, are measured in part by the amount of consideration paid or received as established and agreed by the parties. Except where disclosed elsewhere in these unaudited consolidated interim financial statements, the following is a summary of related party relationships and transactions.
| (a) | Argo Management Group, LLC |
The Company acquired Argo Management Group, LLC ("Argo Management") in April 2016. Argo Management's primary business is to act as Managing Member of Argo Holdings. At June 30, 2022 and December 31, 2021, each of the Company, John T. Fitzgerald ("Fitzgerald"), the Company's Chief Executive Officer and President, and certain of Fitzgerald’s immediate family members owns equity interests in Argo Holdings, all of which interests were acquired prior to the Company’s acquisition of Argo Management. Subject to certain limitations, Argo Holdings' governing documents require all individuals and entities owning an equity interest in Argo Holdings to fund upon request his/her/its pro rata share of any funding requirements of Argo Holdings up to an aggregate maximum amount equal to his/her/its total capital commitment (each request for funds being referred to as a "Capital Call"). Argo Holdings made no Capital Calls during the six months ended June 30, 2022 and the year ended December 31, 2021.
| (b) | VA Lafayette (formerly RoeCo) |
On December 30 2021, the Company closed on an agreement to acquire 100% of the membership interests in VA Lafayette from a current holder of the Company’s Preferred Shares (refer to Note 5, "Acquisitions," for further detail). The Company determined the acquisition was an arms-length transaction based upon the purchase price paid compared to the pricing of similar third-party transactions.
NOTE 21 COMMITMENTS AND CONTINGENCIES
(a) Legal proceedings:
CMC Industries
In April 2018, TRT LeaseCo, LLC ("TRT LeaseCo"), an indirect subsidiary of Kingsway, was named as a defendant in a lawsuit filed in the United States District Court for the Southern District of New York relating to CMC and its subsidiaries. Kingsway indirectly, through its indirect, wholly-owned subsidiary, CMC Acquisition, LLC ("CMCA"), owns 81% of CMC. TRT LeaseCo (an indirect, wholly-owned subsidiary of CMC) entered into a Management Services Agreement (the "MSA") with DGI-BNSF Corp. ("DGI") (an affiliate of CRIC TRT Acquisition, LLC ("CRIC"), the entity that owns the remaining 19% of CMC) in July 2016 pursuant to which, among other things, DGI agreed to provide services to TRT LeaseCo in exchange for the fees specified in the MSA. The complaint filed by DGI alleged that DGI was owed certain fees under the MSA that had not been paid.
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements (Unaudited)
June 30, 2022
In March 2021, DGI, TRT LeaseCo and various other entities affiliated with each of them entered into a settlement agreement with respect to such litigation and certain other matters ("CMC Settlement Agreement"). Pursuant to the CMC Settlement Agreement, the parties agreed that proceeds from increased rental payments due to an earlier amendment to the lease of the Real Property (or any borrowings against such increased rental payments) would be split 80% to DGI as a management fee under the MSA and 20% to CMCA as a priority distribution on its ownership of CMC, after CMCA received a priority payment of $1.5 million. The parties also agreed that net proceeds from an eventual sale or renewal of the lease of the Real Property (after repayment of outstanding indebtedness and various other fees and expenses) would be split as follows:
(a) if such net proceeds are equal to or greater than $72 million, (i) CMCA would receive the first $40 million as a distribution of a preferred return on its ownership of CMC, (ii) CRIC would receive the next $9.4 million as a distribution on its ownership of CMC, (iii) DGI would receive the next $30.6 million as a management fee under the MSA, and (iv) the remainder of such net proceeds (if any) would be split 48.6% to CMCA as a distribution in respect of its ownership of CMC, 40% to DGI in the form of a management fee under the MSA, and 11.4% to CRIC s a distributions in respect of its ownership of CMC; or
(b) if such net proceeds are less than $72 million, (i) 55% to CMCA as a distribution of a preferred return on its ownership of CMC, (ii) 12.9% to CRIC as a distribution on its ownership of CMC, and (iii) 32.1% to DGI in the form of a management fee to DGI under the MSA.
On June 2, 2021, TRT, a subsidiary of CMC, borrowed $15.0 million under the Additional Mortgage. The Company distributed $10.6 million to DGI during the second quarter of 2021 as a prepaid management fee, representing 80% of the net proceeds from the Additional Mortgage, and $2.7 million (20%) to CMCA as a priority distribution on its ownership of CMC.
Aegis
In May 2016, Aegis Security Insurance Company ("Aegis") filed a complaint for breach of contract and declaratory relief against the Company in the Eastern District of Pennsylvania alleging, among other things, that the Company breached a contractual obligation to indemnify Aegis for certain customs bond losses incurred by Aegis under the indemnity and hold harmless agreements provided by the Company to Aegis for certain customs bonds reinsured by Lincoln General Insurance Company ("Lincoln General") during the period of time that Lincoln General was a subsidiary of the Company. Lincoln General was placed into liquidation in November 2015 and Aegis subsequently invoked its rights to indemnity under the indemnity and hold harmless agreements. Effective January 20, 2020, Aegis and the Company entered into a Settlement Agreement with respect to such litigation pursuant to which the Company agreed to pay Aegis a one-time settlement amount of $0.9 million, and to reimburse Aegis for 60% of future losses that Aegis may sustain in connection with such customs bonds, up to a maximum reimbursement amount of $4.8 million. During 2020, the Company made reimbursement payments to Aegis of $0.5 million in connection with the Settlement Agreement. During the third quarter of 2021, the Company made a reimbursement payment to Aegis of $0.1 million in connection with the Settlement Agreement. During the first quarter of 2022, the Company made a reimbursement payment to Aegis of $0.1 million in connection with the Settlement Agreement, which is included in general and administrative expenses in its consolidated statement of operations for the six months ended June 30, 2022. The Company’s potential exposure under these agreements was not reasonably determinable at June 30, 2022, and no liability has been recorded in the unaudited consolidated interim financial statements at June 30, 2022.
(b) Guarantees:
Mendota
As part of the October 18, 2018 transaction to sell Mendota Insurance Company, Mendakota Insurance Company and Mendakota Casualty Company (collectively "Mendota"), the Company will indemnify the buyer for any loss and loss adjustment expenses with respect to open claims in excess of Mendota's carried unpaid loss and loss adjustment expenses at June 30, 2018 related to the open claims. The maximum obligation to the Company with respect to the open claims is $2.5 million. Per the purchase agreement, a security interest on the Company’s equity interest in its consolidated subsidiary, Net Lease, as well as any distributions to the Company from Net Lease, was to be collateral for the Company’s payment of obligations with respect to the open claims. During the third quarter of 2021, the purchasers of Mendota and the Company agreed to release the Company's equity interest in Net Lease as collateral and allow Net Lease to make distributions to the Company. In exchange, the Company agreed to deposit $2.0 million into an escrow account and advance $0.5 million to the purchaser of Mendota to satisfy the Company's payment obligation with respect to the open claims. There were no payments made related to the open claims during the six months ended June 30, 2022 and June 30, 2021. The Company's potential exposure under these agreements was not reasonably determinable at June 30, 2022, and no liability has been recorded in the unaudited consolidated interim financial statements at June 30, 2022.
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements (Unaudited)
June 30, 2022
CMC Industries
In conjunction with the Additional Mortgage, TRT paid a guarantee fee of $1.1 million to a third-party during the second quarter of 2021, who is serving as a guarantor or indemnitor with respect to certain obligations between TRT and the holder of the Additional Mortgage. The guarantee fee was recorded as a debt issuance cost related to the Additional Mortgage.
VA Lafayette (formerly RoeCo)
The LA Mortgage is nonrecourse indebtedness with respect to the assets of VA Lafayette, and the LA Mortgage is not, nor will it be, guaranteed by Kingsway or its affiliates unless VA Lafayette acts in bad-faith or commits intentional acts with respect to the LA Mortgage. The LA Mortgage is secured in part by a guaranty of recourse liabilities, whereby KAI, as guarantor, would become liable for the recourse liabilities if VA Lafayette, as borrower, violates certain terms of the loan agreement. Under the guarantee, the lender can recover losses from the guarantor for certain bad-faith or other intentional acts of the borrower, such as rents retained by the borrower in violation of the loan documents, fraud or intentional misrepresentation, changes to the lease without the lender's consent, willful misconduct, criminal acts and environmental losses sustained by lender. In addition, the guarantee provides that the LA Mortgage will be the full personal recourse obligation of the guarantor, for certain actions, such as prohibited transfers of the collateral or bankruptcy of the borrower.
(c) Collateral pledged and restricted cash:
Short-term investments with an estimated fair value of $0.2 million at June 30, 2022 and December 31, 2021, were on deposit with state regulatory authorities.
The Company also has restricted cash of $14.5 million and $17.3 million at June 30, 2022 and December 31, 2021, respectively. Included in restricted cash are:
| | • | $9.8 million and $12.6 million at June 30, 2022 and December 31, 2021, respectively, held as deposits by IWS, Geminus, PWI, PWSC and Ravix; |
| | • | $1.9 million at both June 30, 2022 and December 31, 2021, on deposit with state regulatory authorities; and |
| | • | $2.8 million and $2.8 million at June 30, 2022 and December 31, 2021, respectively, pledged to third-parties as deposits or to collateralize liabilities. Collateral pledging transactions are conducted under terms that are common and customary to standard collateral pledging and are subject to the Company's standard risk management controls. |
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements (Unaudited)
June 30, 2022
NOTE 22 SUBSEQUENT EVENT
On July 29, 2022, Professional Warranty Services LLC ("PWS Parent"), a subsidiary of the Company entered into an Equity Purchase Agreement (the "Agreement") with PWSC, a majority-owned, indirect subsidiary of the Company, Tyler Gordy, the current president of PWSC ("Gordy") and PCF Insurance Services of the West, LLC ("Buyer"), pursuant to which PWS Parent and Gordy sold PWSC to Buyer.
The purchase price paid by Buyer to PWS Parent and Gordy consisted of $51.2 million in base purchase price, subject to customary adjustments for net working capital and transaction expenses. To the extent the EBITDA of PWSC (as defined in the Agreement) for the one-year period following the sale transaction exceeds 103% of the EBITDA at the closing of the sale transaction (the "Closing EBITDA"), PWS Parent and Gordy will also be entitled to receive an earn out payment in an amount equal to 5 times the EBITDA in excess of 103% of Closing EBITDA.
The Agreement contains customary representations and warranties of PWS Parent, PWSC and Buyer, including, among others, with respect to corporate organization, capitalization, financial statements, title to assets, intellectual property, material agreements and compliance with laws. The representations and warranties of each party set forth in the Agreement were made solely for the benefit of the other parties to the Agreement, and investors are not third-party beneficiaries of the Agreement. In addition, such representations and warranties (a) are subject to materiality and other qualifications contained in the Agreement, which may differ from what may be viewed as material by investors; (b) were made only as of the date of the Agreement or such other date as is specified in the Agreement; and (c) may have been included in the Agreement for the purpose of allocating risk between the parties rather than establishing matters as facts.
The Agreement also provides for customary indemnification, including with respect to breaches of representations, warranties and covenants. Buyer has obtained a representation and warranty insurance policy which will be Buyer’s sole recourse for losses related to breaches of representations and warranties by PWS Parent or PWSC in excess of the Indemnity Cap (as defined in the Agreement), subject to customary exceptions.
The sale of PWSC represents the disposal of a significant subsidiary of the Company, which had contributions to Extended Warranty service fee and commission revenue of $2.1 million and $2.0 million for the three months ended June 30, 2022 and June 30, 2021, respectively ($4.2 million and $3.9 million for the six months ended June 30, 2022 and June 30, 2021, respectively). Additionally, PWSC had pre-tax income of $0.4 million and less than $0.1 million for the three months ended June 30, 2022 and June 30, 2021, respectively (pre-tax loss of $0.3 million for the six months ended June 30, 2022 and pre-tax income of $0.3 million for the six months ended June 30, 2021). At June 30, 2022, PWSC had Service fee receivables totaling $1.4 million, intangible assets, net of $2.3 million, deferred service fees of $7.5 million and a non-controlling interest of ($0.6) million.
KINGSWAY FINANCIAL SERVICES INC.
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
FORWARD-LOOKING STATEMENTS
Management's Discussion and Analysis includes “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 that are not historical facts, and involve risks and uncertainties that could cause actual results to differ materially from those expected and projected. Words such as “expects,” “believes,” “anticipates,” “intends,” “estimates,” “seeks” and variations and similar words and expressions are intended to identify such forward-looking statements. Such forward-looking statements relate to future events or future performance, but reflect Kingsway management’s current beliefs, based on information currently available. A number of factors could cause actual events, performance or results to differ materially from the events, performance and results discussed in the forward-looking statements. For information identifying important factors that could cause actual results to differ materially from those anticipated in the forward-looking statements, see Kingsway’s securities filings, including its Annual Report on Form 10-K for the year ended December 31, 2021 ("2021 Annual Report"). The Company's securities filings can be accessed on the EDGAR section of the U.S. Securities and Exchange Commission’s website at www.sec.gov, on the Canadian Securities Administrators’ website at www.sedar.com or through the Company’s website at www.kingsway-financial.com. Except as expressly required by applicable securities law, the Company disclaims any intention or obligation to update or revise any forward-looking statements because of new information, future events or otherwise.
OVERVIEW
Kingsway is a Delaware holding company with operating subsidiaries located in the United States. The Company owns or controls subsidiaries primarily in the extended warranty, business services, asset management and real estate industries. Kingsway conducts its business through three reportable segments: Extended Warranty, Leased Real Estate and Kingsway Search Xcelerator.
Extended Warranty includes the following subsidiaries of the Company: IWS Acquisition Corporation ("IWS"), Geminus Holding Company, Inc. ("Geminus"), PWI Holdings, Inc. ("PWI"), Professional Warranty Service Corporation ("PWSC") and Trinity Warranty Solutions LLC ("Trinity"). Throughout Management's Discussion and Analysis, the term "Extended Warranty" is used to refer to this segment.
IWS is a licensed motor vehicle service agreement company and is a provider of after-market vehicle protection services distributed by credit unions in25 states and the District of Columbia to their members, with customers in all fifty states.
Geminus primarily sells vehicle service agreements to used car buyers across the United States, through its subsidiaries, The Penn Warranty Corporation ("Penn") and Prime Auto Care, Inc. ("Prime"). Penn and Prime distribute these products in 32 and 40 states, respectively, via independent used car dealerships and franchised car dealerships.
PWI markets, sells and administers vehicle service agreements to used car buyers in all fifty states via independent used car and franchise network of approved automobile and motorcycle dealer partners. PWI’s business model is supported by an internal sales and operations team and partners with American Auto Shield in three states with a white label agreement. PWI also has a white label agreement with Classic to sell a guaranteed asset protection product ("GAP") in states that Classic is approved in.
PWSC sells home warranty products and provides administration services to homebuilders and homeowners across the United States. PWSC distributes its products and services through an in-house sales team and through insurance brokers and insurance carriers throughout all states except Alaska and Louisiana.
Trinity sells heating, ventilation, air conditioning ("HVAC"), standby generator, commercial LED lighting and commercial refrigeration warranty products and provides equipment breakdown and maintenance support services to companies across the United States. As a seller of warranty products, Trinity markets and administers product warranty contracts for certain new and used products in the HVAC, standby generator, commercial LED lighting and commercial refrigeration industries throughout the United States. Trinity acts as an agent on behalf of the third-party insurance companies that underwrite and guaranty these warranty contracts. Trinity does not guaranty the performance underlying the warranty contracts it sells. As a provider of equipment breakdown and maintenance support services, Trinity acts as a single point of contact to its clients for both certain equipment breakdowns and scheduled maintenance of equipment. Trinity will provide such repair and breakdown services by contracting with certain HVAC providers.
Leased Real Estate includes the Company's subsidiaries, CMC Industries, Inc. ("CMC") and VA Lafayette, LLC, formerly Roeco Lafayette, LLC ("VA Lafayette"). Throughout Management's Discussion and Analysis, the term "Leased Real Estate" is used to refer to this segment.
CMC owns, through an indirect wholly owned subsidiary (the "Property Owner"), a parcel of real property consisting of approximately 192 acres located in the State of Texas (the "Real Property"), which is subject to a long-term triple net lease agreement. The Real Property is also subject to two mortgages, which are recorded as notes payable in the consolidated balance sheets (the "Mortgage" and the "Additional Mortgage").
VA Lafayette owns real property consisting of approximately 6.5 acres and a 29,224 square foot single-tenant medical office building located in the State of Louisiana (the "LA Real Property"). The LA Real Property serves as a medical and dental clinic for the Department of Veteran Affairs and is subject to a long-term lease. The LA Real Property is also subject to mortgages, which are recorded as notes payable in the consolidated balance sheets (the "LA Mortgage").
Kingsway Search Xcelerator includes the Company's subsidiary, Ravix Financial, Inc. ("Ravix"). Ravix provides outsourced financial services and human resources consulting for short or long duration engagements for customers in 21 states and 5 countries. All services are delivered by employees who are located in the United States. Throughout Management's Discussion and Analysis, the term "Kingsway Search Xcelerator" is used to refer to this segment.
| KINGSWAY FINANCIAL SERVICES INC. |
Impact of COVID-19
The COVID-19 pandemic has had a notable impact on general economic conditions, including but not limited to the temporary closures of many businesses; "shelter in place" and other governmental regulations; and many businesses continue to operate in a work-from-home mode.
The near-term impacts of COVID-19 are primarily with respect to our Extended Warranty segment. Consumer spending was initially impacted, including a decline in the purchase of new and used vehicles, and many businesses through which we distribute our products remained closed or were open but with capacity constraints. More recently, consumer spending has improved but supply-chain issues have caused a shortage of new automobiles which, in turn, has caused demand for used automobiles to increase. This dynamic has had both positive and negative impacts on the Company’s revenues. With respect to homeowner warranties, we saw an initial reduction in new enrollments in our home warranty programs associated with the impact of COVID-19 on new home sales in the United States.
The Company could experience other potential impacts as a result of COVID-19, including, but not limited to, potential impairment charges to the carrying amounts of goodwill, indefinite-lived intangibles and long-lived assets, the loss in value of investments, as well as the potential for adverse impacts on the Company's debt covenant financial ratios. The Company is not aware of any specific event or circumstance that would require an update to its estimates or judgments or a revision of the carrying value of its assets or liabilities as of the date of issuance of this Quarterly Report on Form 10-Q. Actual results may differ materially from the Company’s current estimates as the scope of COVID-19 evolves or if the duration of business disruptions is longer than initially anticipated. We continue to monitor the impact of the COVID-19 pandemic closely. However, the extent to which the COVID-19 pandemic will impact our operations or financial results is uncertain. There remain many unknowns and the Company continues to monitor the expected trends and related demand for its services and will continue to adjust its operations accordingly.
NON-U.S. GAAP FINANCIAL MEASURE
Throughout this quarterly report, we present our operations in the way we believe will be most meaningful, useful and transparent to anyone using this financial information to evaluate our performance. Our unaudited consolidated interim financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America ("U.S. GAAP") for interim financial information. In addition to the U.S. GAAP presentation of net (loss) income, we present segment operating income as a non-U.S. GAAP financial measure, which we believe is valuable in managing our business and drawing comparisons to our peers. Below is a definition of our non-U.S. GAAP measure and its relationship to U.S. GAAP.
Segment Operating Income (Loss)
Segment operating income (loss) represents one measure of the pretax profitability of our segments and is derived by subtracting direct segment expenses from direct segment revenues. Revenues and expenses are presented in the unaudited consolidated statements of operations, but are not subtotaled by segment; however, this information is available in total and by segmentin Note 18, "Segmented Information," to the unaudited consolidated interim financial statements, regarding reportable segment information. The nearest comparable U.S. GAAP measure to total segment operating income is loss before income tax benefit that, in addition to segment operating income, includes net investment income, net realized gains, loss on change in fair value of equity investments, gain on change in fair value of limited liability investments, at fair value, interest expense not allocated to segments, other revenue and expenses not allocated to segments, net, amortization of intangible assets, loss on change in fair value of debt and gain on extinguishment of debt not allocated to segments. A reconciliation of total segment operating income to loss before income tax benefit for the three and six months ended June 30, 2022 and June 30, 2021 is presented below in Table 1 of the "Results of Continuing Operations" section of Management's Discussion and Analysis.
SIGNIFICANT ACCOUNTING POLICIES AND CRITICAL ESTIMATES
The preparation of unaudited consolidated interim financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts and classifications of assets and liabilities, revenues and expenses, and the related disclosures of contingent assets and liabilities in the consolidated financial statements and accompanying notes. Actual results could differ from these estimates. Estimates and their underlying assumptions are reviewed on an ongoing basis. Changes in estimates are recorded in the accounting period in which they are determined.
The Company’s most critical accounting policies are those that are most important to the portrayal of its financial condition and results of operations, and that require the Company to make its most difficult and subjective judgments, often as a result of the need to make estimates of matters that are inherently uncertain. The critical accounting policies and judgments in the accompanying unaudited consolidated interim financial statements include the valuation of fixed maturities and equity investments; impairment assessment of investments; valuation of limited liability investments, at fair value; valuation of real estate investments; valuation of deferred income taxes; accounting for business combinations and asset acquisitions; valuation and impairment assessment of intangible assets; goodwill recoverability; deferred contract costs; fair value assumptions for subordinated debt obligations; fair value assumptions for subsidiary stock-based compensation awards; contingent consideration; and revenue recognition. Although management believes that its estimates and assumptions are reasonable, they are based upon information available when they are made, and therefore, actual results may differ from these estimates under different assumptions or conditions.
The Company’s significant accounting policies and critical estimates are described in Management's Discussion and Analysis of Financial Condition and Results of Operations included in the 2021 Annual Report. There has been no material change subsequent to December 31, 2021 to the information previously disclosed in the 2021 Annual Report with respect to these significant accounting policies and critical estimates.
| KINGSWAY FINANCIAL SERVICES INC. |
RESULTS OF CONTINUING OPERATIONS
A reconciliation of total segment operating income to net (loss) income for the three and six months ended June 30, 2022 and June 30, 2021 is presented in Table 1 below:
Table 1 Segment Operating Income
(in thousands of dollars)
| |
|
For the three months ended June 30, |
|
|
For the six months ended June 30, |
|
| |
|
2022 |
|
|
2021 |
|
|
Change |
|
|
2022 |
|
|
2021 |
|
|
Change |
|
| Segment operating income: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Extended Warranty |
|
$ |
2,936 |
|
|
$ |
2,600 |
|
|
$ |
336 |
|
|
$ |
4,659 |
|
|
$ |
7,910 |
|
|
$ |
(3,251 |
) |
| Leased Real Estate |
|
|
851 |
|
|
|
(2,302 |
) |
|
|
3,153 |
|
|
|
2,410 |
|
|
|
(1,009 |
) |
|
|
3,419 |
|
| Kingsway Search Xcelerator |
|
|
893 |
|
|
|
— |
|
|
|
893 |
|
|
|
1,699 |
|
|
|
— |
|
|
|
1,699 |
|
| Total segment operating income |
|
|
4,680 |
|
|
|
298 |
|
|
|
4,382 |
|
|
|
8,768 |
|
|
|
6,901 |
|
|
|
1,867 |
|
| Net investment income |
|
|
465 |
|
|
|
403 |
|
|
|
62 |
|
|
|
1,084 |
|
|
|
824 |
|
|
|
260 |
|
| Net realized gains |
|
|
184 |
|
|
|
187 |
|
|
|
(3 |
) |
|
|
238 |
|
|
|
238 |
|
|
|
— |
|
| Loss on change in fair value of equity investments |
|
|
(38 |
) |
|
|
(45 |
) |
|
|
7 |
|
|
|
(48 |
) |
|
|
(196 |
) |
|
|
148 |
|
| Gain on change in fair value of limited liability investments, at fair value |
|
|
46 |
|
|
|
731 |
|
|
|
(685 |
) |
|
|
173 |
|
|
|
529 |
|
|
|
(356 |
) |
| Interest expense not allocated to segments |
|
|
(1,704 |
) |
|
|
(1,593 |
) |
|
|
(111 |
) |
|
|
(3,068 |
) |
|
|
(3,145 |
) |
|
|
77 |
|
| Other revenue and expenses not allocated to segments, net |
|
|
(3,180 |
) |
|
|
(2,261 |
) |
|
|
(919 |
) |
|
|
(6,245 |
) |
|
|
(5,752 |
) |
|
|
(493 |
) |
| Amortization of intangible assets |
|
|
(1,494 |
) |
|
|
(496 |
) |
|
|
(998 |
) |
|
|
(2,988 |
) |
|
|
(993 |
) |
|
|
(1,995 |
) |
| Loss on change in fair value of debt |
|
|
(1,330 |
) |
|
|
(738 |
) |
|
|
(592 |
) |
|
|
(3,198 |
) |
|
|
(1,757 |
) |
|
|
(1,441 |
) |
| Gain on extinguishment of debt not allocated to segments |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
311 |
|
|
|
(311 |
) |
| Loss before income tax benefit |
|
|
(2,371 |
) |
|
|
(3,514 |
) |
|
|
1,143 |
|
|
|
(5,284 |
) |
|
|
(3,040 |
) |
|
|
(2,244 |
) |
| Income tax benefit |
|
|
(6 |
) |
|
|
(3,258 |
) |
|
|
3,252 |
|
|
|
(415 |
) |
|
|
(3,683 |
) |
|
|
3,268 |
|
| Net (loss) income |
|
$ |
(2,365 |
) |
|
$ |
(256 |
) |
|
$ |
(2,109 |
) |
|
$ |
(4,869 |
) |
|
$ |
643 |
|
|
$ |
(5,512 |
) |
Segment Operating Income and Net (Loss) Income
In the second quarter of 2022, we reported segment operating income of $4.7 million, an increase of $4.4 million from the same period in 2021 ($8.8 million year to date, an increase of$1.9 million compared to prior year to date). The increase is primarily due to the following items:
| |
• |
2021 operating loss for the quarter and year to date in Leased Real Estate segment includes a $2.9 million expense recorded during the second quarter of 2021 to write-off an indemnification receivable (which is exactly offset by a tax benefit of $2.9 million); |
| |
• |
Increased operating income in Leased Real Estate and operating income from Kingsway Search Xcelerator (resulting from the Ravix acquisition in October 2021; both of which were partially offset by |
| |
• |
2021 operating income for the year to date in Extended Warranty segment includes a gain on extinguishment of debt of $2.2 million, related to Paycheck Protection Program ("PPP") loan forgiveness; and |
| |
• |
2022 operating income for the year to date includes a reduction to IWS operating income of $0.9 million, due to a change in estimate of IWS' deferred revenue and deferred contract costs associated with vehicle service contract fees. |
In the second quarter of 2022, we reported net loss of $2.4 million compared to $0.3 million in the second quarter of 2021. The net loss for the three months ended June 30, 2022is primarily due to an increase in segment operating income of $4.4 million that was more than offset by:
| |
• |
Interest expense not allocated to segments which increased by $0.1 million; |
| |
• |
Other revenue and expenses not allocated to segments, net, which includes $1.3 million of expense due to the increase in fair value of the Ravix contingent consideration; |
| |
• |
Amortization of intangible assets, which increased by $1.0 million due to the finalization of PWI purchase accounting in the third quarter of 2021 and the acquisition of Ravix in the fourth quarter of 2021; and |
| |
• |
Loss on change in fair value of debt which increased by $0.6 million. |
The net loss for the three months ended June 30, 2021 is primarily due to operating loss in Leased Real Estate, interest expense not allocated to segments and other revenue and expenses not allocated to segments, net, partially offset by operating income in Extended Warranty and income tax benefit. The net loss for the three months ended June 30, 2021 includes a $2.9 million reduction to Leased Real Estate operating income to write-off an indemnification receivable, which is exactly offset by a tax benefit of $2.9 million.
| KINGSWAY FINANCIAL SERVICES INC. |
For the six months ended June 30, 2022, we reported net loss of $4.9 million compared to net income of $0.6 million for the six months ended June 30, 2021. The net loss for the six months ended June 30, 2022 is primarily due to segment operating income which increased by $1.9 million and net investment income which increased by $0.3 million that was more than offset by:
| |
• |
Interest expense not allocated to segments; |
| |
• |
Other revenue and expenses not allocated to segments, net, which includes $1.3 million of expense due to the increase in fair value of the Ravix contingent consideration; |
| |
• |
Amortization of intangible assets, which increased by $2.0 million due to the finalization of PWI purchase accounting in the third quarter of 2021 and the acquisition of Ravix in the fourth quarter of 2021; |
| |
• |
Loss on change in fair value of debt which increased by $1.4 million; and |
| |
• |
Income tax benefit which decreased by $3.3 million due to the resolution of certain uncertain tax positions during the period ended June 30, 2021. |
The net income for the six months ended June 30, 2021 is primarily due to operating income in Extended Warranty (which includes gain on extinguishment of debt of $2.2 million, related to PPP loan forgiveness) and net investment income, partially offset by operating loss in Leased Real Estate, interest expense not allocated to segments, other revenue and expenses not allocated to segments, net, loss on change in fair value of debt and income tax benefit. The net loss for the six months ended June 30, 2021 includes a $2.9 million reduction to Leased Real Estate operating income to write-off an indemnification receivable, which is exactly offset by a tax benefit of $2.9 million. See Note 11 "Debt," to the unaudited consolidated interim financial statements, for further discussion on PPP.
Extended Warranty
The Extended Warranty service fee and commission revenue increased 3.2% (or $0.6 million) to $19.4 million for the three months ended June 30, 2022 compared with $18.8 million for the three months ended June 30, 2021 ($37.7 million year to date compared to $37.3 million prior year to date). Service fee and commission revenue was impacted by the following for the three and six months ended June 30, 2022:
| |
• |
A $0.4 million increase at Trinity for the three months ended June 30, 2022 (an increase of $1.3 million year to date) primarily driven by a $0.4 million increase in its equipment breakdown and maintenance support services, as Trinity continues to recover from the original impacts of the COVID-19 pandemic ($1.1 million increase year to date); |
| |
• |
A $0.4 million increase at IWS for the three months ended June 30, 2022 (a decrease of $0.4 million year to date). During the first quarter of 2022, there was a change in estimate of IWS' deferred revenue associated with vehicle service contract fees, which resulted in a reduction to IWS year to date revenue of $1.2 million. This reduction was partially offset by an increase in revenue due primarily to an increase in the number of VSAs written in 2022, as sales volume continues to trend up towards pre-COVID levels. While IWS’ market is impacted by macro-economic conditions brought on by the continued COVID-19 pandemic, IWS sells a substantial amount of VSAs for new automobiles but, more importantly, its products are distributed through credit unions at the point of vehicle financing, which has been less impacted by the recent macro-economic conditions; |
| |
• |
A $0.1 million increase at PWI for the three months ended June 30, 2022 (a decrease of $0.2 million year to date). The continued COVID-19 pandemic has caused supply-chain issues in the automotive industry, resulting in significant increases in the prices of used automobiles (PWI’s primary market), making it difficult for smaller automobile dealers to obtain inventory and, therefore, putting downward pressure on PWI’s revenue; and |
| |
• |
A $0.3 million decrease at Geminus for the three months ended June 30, 2022 (a decrease of $0.6 million year to date), which is being impacted by similar macro-economic conditions brought on by the continued COVID-19 pandemic as explained above for PWI. |
The Extended Warranty operating income was $2.9 million for the three months ended June 30, 2022 compared with $2.6 million for the three months ended June 30, 2021 ($4.7 million year to date compared to $7.9 million prior to date). Operating income was primarily impacted by the following:
| |
• |
Inclusion of Paycheck Protection Program ("PPP") loan forgiveness related to Extended Warranty companies of $2.2 million for the six months ended June 30, 2021; |
| |
• |
A $0.1 million increase at Trinity to $0.4 million for the three months ended June 30, 2022 (an increase of $0.2 million year to date to $0.8 million), primarily due to an increase in revenue that was partially offset by an increase in claims authorized on vehicle service agreements and higher general and administrative expenses compared with the same periods in 2021; |
| |
• |
A $0.4 million increase at IWS to $1.0 million for the three months ended June 30, 2022 (a decrease of $0.1 million year to date to $1.3 million), primarily due to increased revenue. During the first quarter of 2022, there was a change in estimate of IWS' deferred revenue and deferred contract costs associated with vehicle service contract fees, which resulted in a reduction to IWS operating income of $0.9 million for the six months ended June 30, 2022. For the quarter and year to date, claims authorized on vehicle service agreements increased slightly, as a decrease in the number of claims was slightly more than offset by an increase in the average cost of a claim; |
| |
• |
A $0.2 million increase at PWSC to $0.7 million for the three months ended June 30, 2022 (an increase of $0.1 million year to date to $1.0 million), primarily due to a slight increase in revenue that was partially offset by lower general and administrative expenses compared with the same periods in 2021; |
| |
• |
A $0.3 million decrease at PWI to $0.5 million for the three months ended June 30, 2022, primarily due to an increase in commission expense compared with the three months ended June 30, 2021 (a decrease of $1.0 million year to date to $1.0 million, primarily due to an increase in claims authorized on vehicle service agreements compared with the six months ended June 30, 2021 (decreased volume of claims that was offset by a higher average cost per claim)); and |
| |
• |
A $0.1 million decrease at Geminus to $0.3 million for the three months ended June 30, 2022 (a decrease of $0.3 million year to date to $0.6 million), due to a decrease in revenue that was partially offset by a slight decrease in claims authorized on vehicle service agreements and slightly lower general and administrative expenses compared with the with the same periods in 2021. |
| KINGSWAY FINANCIAL SERVICES INC. |
Leased Real Estate
Leased Real Estate rental revenue was $3.6 million and $3.3 million for the three months ended June 30, 2022 and June 30, 2021, respectively ($7.3 million and $6.7 million for the six months ended June 30, 2022 and June 30, 2021, respectively). The rental income is derived from Leased Real Estate's long-term leases. The increase in rental income is due to the inclusion of VA Lafayette during 2022 following its acquisition on December 30, 2021.
Leased Real Estate operating income was$0.9million for the three months ended June 30, 2022 compared with operating loss of $2.3 million for the three months ended June 30, 2021 (operating income of $2.4 million year to date compared to operating loss of $1.0 million prior year to date). Leased Real Estate operating income includes interest expense of $1.7 million and $1.5 million for the three months ended June 30, 2022 and June 30, 2021, respectively ($3.4 million and $3.0 million for the six months ended June 30, 2022and June 30, 2021, respectively).
The increase in operating income for the three and six months ended June 30, 2022 is primarily due to the following:
| |
• |
The operating loss for the three and six months ended June 30, 2021 includes a $2.9 million expense recorded during the second quarter of 2021 to write-off an indemnification receivable (which is exactly offset by a tax benefit of $2.9 million in net (loss) income), as well as management expense of $0.2 million for the three months ended June 30, 2021 as a result of the March settlement agreement. The operating loss for the six months ended June 30, 2021 also includes a $0.6 million benefit recorded in 2021 related to the finalization of management fees and legal expenses associated with the settlement of CMC litigation (see Note 21, "Commitments and Contingencies," to the unaudited consolidated interim financial statements, for further information on the settlement); and |
| |
• |
An increase in rental revenue for the three and six months ended June 30, 2022 due to the inclusion of VA Lafayette in 2022 following its acquisition on December 30, 2021. |
Kingsway Search Xcelerator
The Kingsway Search Xcelerator revenue was $4.1 million and $8.3 million for the three and six months ended June 30, 2022, respectively, and is derived from the Company's subsidiary, Ravix, that was acquired on October 1, 2021. Kingsway Search Xcelerator operating income was $0.9 million and $1.7 million for the three and six months ended June 30, 2022, respectively.
Net Investment Income
Net investment income was $0.5 million in the second quarter of 2022 compared to $0.4 million in the second quarter of 2021 ($1.1 million year to date compared to $0.8 million prior year to date). The increase in net investment income for the three months ended June 30, 2022 relates to slightly higher investment income from fixed maturities as a result of general changes in market conditions. The increase in net investment income for the six months ended June 30, 2022 relates primarily to higher investment income from the Company's limited liability investments and fixed maturities, partially offset by a decrease in investment income from the Company's limited liability investments, at fair value. Income from limited liability investments is recognized based on the Company's share of the earnings of the limited liability entities.
Gain on Change in Fair Value of Limited Liability Investments, at Fair Value
Gain on change in fair value of limited liability investments, at fair value was less than $0.1 million in the second quarter of 2022 compared to $0.7 million in the second quarter of 2021 ($0.2 million year to date compared to $0.5 million prior year to date). The gain for the three months ended June 30, 2022 represents an increase in fair value of $0.4 million related to Net Lease Investment Grade Portfolio LLC ("Net Lease"), partially offset by a decrease in fair value of $0.3 million related to Argo Holdings Fund I, LLC ("Argo Holdings"). The gain for the three months ended June 30, 2021 represents an increase in fair value of $0.8 million related to Net Lease due to an increase in fair value of the properties held by the underlying LLC's and a reduction in debt at one of the underlying LLC's, partially offset by a decrease in fair value of $0.1 million related to Argo Holdings.
The gain for the six months ended June 30, 2022 represents an increase in fair value of $0.8 million related to Net Lease, partially offset by a decrease in fair value of $0.6 million related to Argo Holdings. The gain for the six months ended June 30, 2021 represent increases in fair value of $0.4 million related to Net Lease and $0.1 million related to Argo Holdings.
| KINGSWAY FINANCIAL SERVICES INC. |
Interest Expense not Allocated to Segments
Interest expense not allocated to segments for the second quarter of 2022 was $1.7 million compared to $1.6 million in the second quarter of 2021 ($3.1 million year to date compared to $3.1 million prior year to date). This includes interest on all debt except for interest on the Mortgage, Additional Mortgage, and LA Mortgage, which is included in the Real Estate Segment.
The increase for the three months ended June 30, 2022 is primarily attributable higher interest expense related to the Company's subordinated debt, which resulted from higher London interbank offered interest rates for three-month U.S. dollar deposits ("LIBOR") during the three months ended June 30, 2022 compared to the same period in 2021, partially offset by an increase in fair value of the interest rate swap related to the Company's 2020 KWH bank loan, which resulted in lower interest expense of $0.2 million during the second quarter of 2022 compared to the same period in 2021.
During the second quarter of 2022, the 2020 KWH Loan was amended to change the annual interest rate from LIBOR, having a floor of 0.75%, plus 2.75%, to the Secured Overnight Financing Rate ("SOFR"), having a floor of 0.75%, plus spreads ranging from 2.62% to 3.12%.
Other Revenue and Expenses not Allocated to Segments, Net
Other revenue and expenses not allocated to segments, net was a net expense of $3.2 million in the second quarter of 2022 compared to $2.3 million in the second quarter of 2021 ($6.2 million year to date compared to $5.8 million prior year to date). Included are revenue and expenses associated with our various other investments that are accounted for on a consolidated basis, our insurance company that has been in run-off since 2012, and and expenses associated with our corporate holding company.
The increase in net expense for the three months ended June 30, 2022 is primarily attributable to an increase in the fair value of the Ravix contingent consideration liability of $1.2 million during the three months ended June 30, 2022, partially offset by lower expense related to restricted stock awards of officers of the Company and previously-granted awards to subsidiary employees that are accounted for on a fair value basis, during the three months ended June 30, 2022 compared to same period in 2021.
The increase in net expense for the six months ended June 30, 2022 is primarily attributable to an increase in the fair value of the Ravix contingent consideration liability of $1.5 million, partially offset by lower expense related to restricted stock awards of officers of the Company during the six months ended June 30, 2022 compared to same period in 2021.
Amortization of Intangible Assets
Amortization of intangible assets was $1.5 million in the second quarter of 2022 compared to $0.5 million in the second quarter of 2021 ($3.0 million year to date compared to $1.0 million prior year to date). The higher amortization expense for the three and six months ended June 30, 2022 is related to amortization of intangible assets recorded in conjunction with the Company's acquisitions of PWI effective December 1, 2020, Ravix effective October 1, 2021 and VA Lafayette effective December 30, 2021. During the third quarter of 2021, the Company finalized its fair value analysis of the assets acquired and liabilities assumed in its acquisition of PWI and recorded a measurement period adjustment related to PWI’s customer relationship intangible asset. As a result, $0.6 million and $1.2 million of the amortization expense recorded in the third quarter of 2021 related to the three and six months ended June 30, 2021, respectively. During the three and six months ended June 30, 2022, the Company recorded $1.1 million and $2.2 million, respectively, of amortization expense related to the intangible assets identified as part of the acquisitions of PWI, Ravix and VA Lafayette.
See Note 5, "Acquisitions" to the consolidated financial statements in the 2021 Annual Report for further details on the Company’s acquisitions of PWI, Ravix and VA Lafayette.
Loss on Change in Fair Value of Debt
Loss on change in fair value of debt was $1.3 million in the second quarter of 2022 compared to $0.7 million in the second quarter of 2021 ($3.2 million year to date compared to $1.8 million prior year to date). The loss for three and six months ended June 30, 2022 and June 30, 2021 reflect increases in the fair value of the subordinated debt resulting primarily from changes in interest rates used (not related to instrument-specific credit risk). The following summarizes the impacts:
| Impact of Rate Change on Fair Value |
|
Three months ended June 30, 2022 |
|
Three months ended June 30, 2021 |
|
Six months ended June 30, 2022 |
|
Six months ended June 30, 2021 |
| |
|
Result |
|
Result |
|
Result |
|
Result |
| LIBOR: |
|
|
|
|
|
|
|
|
| increase causes fair value to increase; decrease causes fair value to decrease |
|
Increase to fair value |
|
Decrease to fair value |
|
Decrease to fair value |
|
Decrease to fair value |
| Risk free rate: |
|
|
|
|
|
|
|
|
| increase causes fair value to decrease; decrease causes fair value to increase |
|
Decrease to fair value |
|
Increase to fair value |
|
Increase to fair value |
|
Increase to fair value |
See "Debt" section below for further information.
Gain on Extinguishment of Debt not Allocated to Segments
For the six months ended June 30, 2021, gain on extinguishment of debt not allocated to segments consists of a $0.3 million gain (recorded in the first quarter of 2021) on forgiveness of the balance of the holding company's loan obtained through the PPP. See Note 11 "Debt," to the unaudited consolidated interim financial statements, for further discussion.
| KINGSWAY FINANCIAL SERVICES INC. |
Income Tax Benefit
Income tax benefit for the second quarter of 2022 was less than $0.1 million compared to $3.3 million in the second quarter of 2021 ($0.4 million year to date compared to $3.7 million prior year to date). For the three months ended June 30, 2022 and June 30, 2021, the Company released into income $0.3 million and $0.6 million, respectively, of its valuation allowance associated with business interest expense carryforwards with an indefinite life ($0.8 million year to date and $1.2 million prior year to date). During the three months ended June 30, 2021, the Company recorded an income tax benefit of $2.9 million for the release of a liability that had been included in income taxes payable in the consolidated balance sheets. See Note 14, "Income Taxes," to the unaudited consolidated interim financial statements, for additional detail of the income tax benefit recorded for the three and six months ended June 30, 2022 and June 30, 2021.
INVESTMENTS
Portfolio Composition
See Note 2(d), "Summary of Significant Accounting Policies - Investments," to the consolidated financial statements in the 2021 Annual Report for an overview of how we account for our various investments.
At June 30, 2022, we held cash and cash equivalents, restricted cash and investments with a carrying value of $95.4 million.
Investments held by our insurance subsidiary, Kingsway Amigo Insurance Company ("Amigo"), must comply with domiciliary state regulations that prescribe the type, quality and concentration of investments. Our U.S. operations typically invest in U.S. dollar-denominated instruments to mitigate their exposure to currency rate fluctuations.
Table 2 below summarizes the carrying value of investments, including cash and cash equivalents and restricted cash, at the dates indicated.
TABLE 2 Carrying value of investments, including cash and cash equivalents and restricted cash
(in thousands of dollars, except for percentages)
| Type of investment |
|
June 30, 2022 |
|
|
% of Total |
|
|
December 31, 2021 |
|
|
% of Total |
|
| Fixed maturities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| U.S. government, government agencies and authorities |
|
|
15,301 |
|
|
|
16.0 |
% |
|
|
16,223 |
|
|
|
16.5 |
% |
| States, municipalities and political subdivisions |
|
|
2,082 |
|
|
|
2.2 |
% |
|
|
1,878 |
|
|
|
1.9 |
% |
| Mortgage-backed |
|
|
7,824 |
|
|
|
8.2 |
% |
|
|
7,629 |
|
|
|
7.8 |
% |
| Asset-backed |
|
|
1,694 |
|
|
|
1.8 |
% |
|
|
445 |
|
|
|
0.5 |
% |
| Corporate |
|
|
10,112 |
|
|
|
10.6 |
% |
|
|
9,491 |
|
|
|
9.7 |
% |
| Total fixed maturities |
|
|
37,013 |
|
|
|
38.8 |
% |
|
|
35,666 |
|
|
|
36.4 |
% |
| Equity investments: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Common stock |
|
|
131 |
|
|
|
0.1 |
% |
|
|
171 |
|
|
|
0.2 |
% |
| Warrants |
|
|
— |
|
|
|
— |
% |
|
|
8 |
|
|
|
0.0 |
% |
| Total equity investments |
|
|
131 |
|
|
|
0.1 |
% |
|
|
179 |
|
|
|
0.2 |
% |
| Limited liability investments |
|
|
1,215 |
|
|
|
1.3 |
% |
|
|
1,901 |
|
|
|
1.9 |
% |
| Limited liability investments, at fair value |
|
|
18,986 |
|
|
|
19.9 |
% |
|
|
18,826 |
|
|
|
19.1 |
% |
| Investments in private companies |
|
|
790 |
|
|
|
0.8 |
% |
|
|
790 |
|
|
|
0.8 |
% |
| Real estate investments |
|
|
10,662 |
|
|
|
11.2 |
% |
|
|
10,662 |
|
|
|
10.8 |
% |
| Other investments |
|
|
222 |
|
|
|
0.2 |
% |
|
|
256 |
|
|
|
0.3 |
% |
| Short-term investments |
|
|
157 |
|
|
|
0.2 |
% |
|
|
157 |
|
|
|
0.1 |
% |
| Total investments |
|
|
69,176 |
|
|
|
72.5 |
% |
|
|
68,437 |
|
|
|
69.6 |
% |
| Cash and cash equivalents |
|
|
11,704 |
|
|
|
12.3 |
% |
|
|
12,642 |
|
|
|
12.9 |
% |
| Restricted cash |
|
|
14,492 |
|
|
|
15.2 |
% |
|
|
17,257 |
|
|
|
17.5 |
% |
| Total |
|
|
95,372 |
|
|
|
100.0 |
% |
|
|
98,336 |
|
|
|
100.0 |
% |
Other-Than-Temporary Impairment
The Company performs a quarterly analysis of its investments to determine if declines in market value are other-than-temporary. Further information regarding our detailed analysis and factors considered in establishing an other-than-temporary impairment on an investment is discussed within the "Significant Accounting Policies and Critical Estimates" section of Management's Discussion and Analysis of Financial Condition included in the 2021 Annual Report.
As a result of the analysis performed, the Company recorded write downs for other-than-temporary impairment related to limited liability investments, at fair value of less than$0.1 million and zero for the three months ended June 30, 2022 and June 30, 2021, respectively (less than $0.1 million for each of the six months ended June 30, 2022 and June 30, 2021), which are included in gain on change in fair value of limited liability investments, at fair value in the consolidated statements of operations.
There were no write-downs recorded for other-than-temporary impairments related to available-for sale investments, limited liability investments, investments in private companies and other investments for the three and six months ended June 30, 2022 and June 30, 2021.
| KINGSWAY FINANCIAL SERVICES INC. |
The length of time a fixed maturity investment may be held in an unrealized loss position may vary based on the opinion of the investment manager and their respective analyses related to valuation and to the various credit risks that may prevent us from recapturing the principal investment. In the case of a fixed maturity investment where the investment manager determines that there is little or no risk of default prior to the maturity of a holding, we would elect to hold the investment in an unrealized loss position until the price recovers or the investment matures. In situations where facts emerge that might increase the risk associated with recapture of principal, the Company may elect to sell a fixed maturity investment at a loss.
At June 30, 2022 and December 31, 2021, the gross unrealized losses for fixed maturities amounted to $1.9 million and $0.3 million, respectively, and there were no unrealized losses attributable to non-investment grade fixed maturities. At each of June 30, 2022 and December 31, 2021, all unrealized losses on individual investments were considered temporary.
Impact of COVID-19 on Investments
The Company continues to assess the impact that the COVID-19 pandemic may have on the value of its various investments, which could result in future material decreases in the underlying investment values. Such decreases may be considered temporary or could be deemed to be other-than-temporary, and management may be required to record write-downs of the related investments in future reporting periods.
DEBT
See Note 11, "Debt," to the unaudited consolidated interim financial statements for further details to those provided below.
Bank Loans
In 2019, the Company formed Kingsway Warranty Holdings LLC ("KWH"), whose subsidiaries at the time included IWS, Geminus and Trinity. As part of the acquisition of PWI on December 1, 2020, PWI became a wholly owned subsidiary of KWH, which borrowed a principal amount of $25.7 million from a bank to partially finance its acquisition of PWI and to fully repay the prior outstanding loan at KWH (the "2020 KWH Loan"). The 2020 KWH Loan had an annual interest rate equal to LIBOR, having a floor of 0.75%, plus 2.75%. During the second quarter of 2022, the 2020 KWH Loan was amended to change the annual interest rate to be equal to SOFR, having a floor of 0.75%, plus spreads ranging from 2.62% to 3.12%. At June 30, 2022, the interest rate was 4.07%. The 2020 KWH Loan is carried in the consolidated balance sheets at its amortized cost, which reflects the quarterly pay-down of principal as well as the amortization of the debt discount and issuance costs using the effective interest rate method. The 2020 KWH Loan matures on December 1, 2025.
The 2020 KWH Loan contains a number of covenants, including, but not limited to, a leverage ratio, a fixed charge ratio and limits on annual capital expenditures, all of which are as defined in and calculated pursuant to the 2020 KWH Loan that, among other things, restrict KWH’s ability to incur additional indebtedness, create liens, make dividends and distributions, engage in mergers, acquisitions and consolidations, make certain payments and investments and dispose of certain assets.
As part of the acquisition of Ravix on October 1, 2021, Ravix became a wholly owned subsidiary of Ravix Acquisition LLC ("Ravix LLC"), and together they borrowed from a bank a principal amount of $6.0 million in the form of a term loan, and established a $1.0 million revolver to finance the acquisition of Ravix (together, the "Ravix Loan"). The Ravix Loan has an annual interest rate equal to the greater of the Prime Rate plus 0.5%, or 3.75% (current rate of 5.25%) and is carried in the consolidated balance sheets at its amortized cost, which reflects the monthly pay-down of principal as well as the amortization of the debt discount and issuance costs using the effective interest rate method. The revolver matures on October 1, 2023 and the term loan matures on October 1, 2027.
The Ravix Loan contains a number of covenants, including, but not limited to, a leverage ratio and a fixed charge ratio, all of which are as defined in and calculated pursuant to the Ravix Loan that, among other things, restrict Ravix’s ability to incur additional indebtedness, create liens, make dividends and distributions, engage in mergers, acquisitions and consolidations, make certain payments and investments and dispose of certain assets.
Notes Payable
As part of its acquisition of CMC in July 2016, the Company assumed the Mortgage and recorded the Mortgage at its estimated fair value of $191.7 million, which included the unpaid principal amount of $180.0 million as of the date of acquisition plus a premium of $11.7 million. The Mortgage matures on May 15, 2034 and has a fixed interest rate of 4.07%. The Mortgage is carried in the consolidated balance sheets at its amortized cost, which reflects the monthly pay-down of principal as well as the amortization of the premium using the effective interest rate method.
On June 2, 2021, TRT Leaseco ("TRT"), a subsidiary of CMC, entered into an amendment to the Mortgage to borrow an additional $15.0 million, which is recorded as note payable in the consolidated balance sheets ("the Additional Mortgage"). The net proceeds from the Additional Mortgage were used to advance increased rental payments to the parties that had entered into a legal settlement agreement reached during the first quarter of 2021, including the Company which received $2.7 million. The Additional Mortgage matures on May 15, 2034 and has a fixed interest rate of 3.20%. The Additional Mortgage is carried in the consolidated balance sheets at its amortized cost, which reflects the monthly pay-down of principal as well as the amortization of the debt discount and issuance costs using the effective interest rate method. See Note 21(a), "Commitments and Contingencies - Legal proceedings," to the unaudited consolidated interim financial statements for further discussion of the CMC litigation settlement agreement.
As part of its acquisition of VA Lafayette on December 30, 2021, the Company assumed the LA Mortgage, which is comprised of a senior amortizing note, a senior interest only note and a junior note. The Company recorded the LA Mortgage at its aggregate unpaid principal amount of $13.5 million as of the date of acquisition plus a premium of $3.5 million. The senior amortizing note matures on September 14, 2036 and has a fixed interest rate of 3.75%. The senior interest only note matures on October 14, 2036 and has a fixed interest rate of 5.682%. The junior note matures on September 16, 2036 and has a fixed interest rate of 7.0%, of which a fixed amount is payable semi-annually and the remainder is added to the principal balance of the junior note. The LA Mortgage is carried in the consolidated balance sheets at its aggregate unpaid principal balance.
On January 5, 2015, Flower Portfolio 001, LLC assumed a $9.2 million mortgage in conjunction with the purchase of investment real estate properties ("the Flower Note"). The Flower Note matures on December 10, 2031 and has a fixed interest rate of 4.81%. The Flower Note is carried in the consolidated balance sheets at its unpaid principal balance.
| KINGSWAY FINANCIAL SERVICES INC. |
In April 2020, certain subsidiaries of the Company received loan proceeds under the PPP, totaling $2.9 million with a stated annual interest rate of 1.00%. The PPP, established as part of the CARES Act and administered by the U.S. Small Business Administration (the "SBA"), provides for loans to qualifying businesses for amounts up to 2.5 times of the average monthly payroll costs (as defined for purposes of the PPP) of the qualifying business. The loans and accrued interest are forgivable as long as the borrower uses the loan proceeds for eligible purposes, including payroll, costs, rent and utilities, during the twenty-four week period following the borrower’s receipt of the loan and maintains its payroll levels and employee headcount. The amount of loan forgiveness will be reduced if the borrower reduces its employee headcount below its average employee headcount during a benchmark period or significantly reduces salaries for certain employees during the covered period.
The Company used the entire loan amount for qualifying expenses. The U.S. Department of the Treasury has announced that it will conduct audits for PPP loans that exceed $2.0 million. If we were to be audited and receive an adverse outcome in such an audit, we could be required to return the full amount of the PPP Loan and may potentially be subject to civil and criminal fines and penalties.
On December 21, 2020 the SBA approved the forgiveness of the full amount of one of the five PPP loans, which included principal and interest of $0.4 million. In January 2021 and March 2021, the SBA provided the Company with notices of forgiveness of the full amount of the remaining four loans. The forgiveness in the first quarter of 2021 included total principal and interest of $2.5 million.
Subordinated Debt
Between December 4, 2002 and December 16, 2003, six subsidiary trusts of the Company issued $90.5 million of 30-year capital securities to third parties in separate private transactions. In each instance, a corresponding floating rate junior subordinated deferrable interest debenture was then issued by Kingsway America Inc. to the trust in exchange for the proceeds from the private sale. The floating rate debentures bear interest at the rate of LIBOR, plus spreads ranging from 3.85% to 4.20%. The Company has the right to call each of these securities at par value any time after five years from their issuance until their maturity.
During the third quarter of 2018, the Company gave notice to its Trust Preferred trustees of its intention to exercise its voluntary right to defer interest payments for up to 20 quarters, pursuant to the contractual terms of its outstanding Trust Preferred indentures, which permit interest deferral. This action does not constitute a default under the Company's Trust Preferred indentures or any of its other debt indentures. At June 30, 2022 and December 31, 2021, deferred interest payable of $21.4 million and $18.7 million, respectively, is included in accrued expenses and other liabilities in the consolidated balance sheets.
On
August 2, 2022, the Company entered into an agreement with a holder of four of the trust preferred debt instruments ("TruPs") that gives the Company the option to repurchase up to 100% of the holder’s principal and deferred interest f
or 63% of the outstanding principal and deferred interest. The Company has agreed that any repurchase made will be for no less than 50% of the TruPs held by the holder.
Until the earlier of (i) all four of the preferred debt instruments have been repurchased and (ii) the nine month anniversary of the agreement ("Termination Date"), all interest on four preferred debt instruments will continue to accrue. However, with respect to TruPs that are repurchased prior to the Termination Date, the amount of interest accrued during the term of the agreement will be treated as an offset and reduce the repurchase price for such TruPs. The Company will have no obligation to pay any such accrued interest with respect to any of the TruPs that are repurchased prior to the Termination Date.
The Company paid approximately $2 million to the holder for this option and the Company has until the Termination Date to execute the repurchases. If the Company repurchases less than $30 million of principal and deferred interest, or fails to purchase any principal or deferred interest within one year, then the $2 million paid is forfeited. If the Company repurchases an amount equal to or great than $30 million, then the $2 million paid would be applied to such repurchases.
If the Company is able to secure an agreement with the holders of the remaining two trust preferred debt instruments to repurchase all of their outstanding principal and deferred interest with four months of August 4, 2022, then the price paid to the holder of the four trust preferred debt instruments would increase up to a maximum of 64.5%.
The agreements governing our subordinated debt contain a number of covenants that, among other things, restrict the Company’s ability to incur additional indebtedness, make dividends and distributions, and make certain payments in respect of the Company’s outstanding securities.
The Company's subordinated debt is measured and reported at fair value. At June 30, 2022, the carrying value of the subordinated debt is $57.3 million. The fair value of the subordinated debt is calculated using a model based on significant market observable inputs and inputs developed by a third party. For a description of the market observable inputs and inputs developed by a third party used in determining fair value of debt, see Note 19, "Fair Value of Financial Instruments," to the unaudited consolidated interim financial statements.
During the six months ended June 30, 2022, the market observable swap rates changed, and the Company experienced an increase in the credit spread assumption developed by the third-party. Changes in the market observable swap rates affect the fair value model in different ways. An increase in the LIBOR swap rates has the effect of increasing the fair value of the Company's subordinated debt while an increase in the risk-free swap rates has the effect of decreasing the fair value. The increase in the credit spread assumption has the effect of decreasing the fair value of the Company's subordinated debt while a decrease in the credit spread assumption has the effect of increasing the fair value. The other primary variable affecting the fair value of debt calculation is the passage of time, which will always have the effect of increasing the fair value of debt. The changes to the credit spread and swap rate variables during the six months ended June 30, 2022, along with the passage of time, contributed to the $3.7 million decrease in fair value of the Company’s subordinated debt between December 31, 2021 and June 30, 2022.
Of the $3.7 million decrease in fair value of the Company’s subordinated debt between December 31, 2021 and June 30, 2022, $6.9 million is reported as decrease in fair value of debt attributable to instrument-specific credit risk in the Company's unaudited consolidated statements of comprehensive income (loss) and $3.2 million is reported as loss on change in fair value of debt in the Company’s unaudited consolidated statements of operations.
Though changes in the market observable swap rates will continue to introduce some volatility each quarter to the Company’s reported gain or loss on change in fair value of debt, changes in the credit spread assumption developed by the third party does not introduce volatility to the Company’s consolidated statements of operations. The fair value of the Company’s subordinated debt will eventually equal the principal value totaling $90.5 million of the subordinated debt by the time of the stated redemption date of each trust, beginning with the trust maturing on December 4, 2032 and continuing through January 8, 2034, the redemption date of the last of the Company’s outstanding trusts.
| KINGSWAY FINANCIAL SERVICES INC. |
RECENTLY ISSUED ACCOUNTING STANDARDS
SeeNote 4, "Recently Issued Accounting Standards," to the unaudited consolidated interim financial statements, for discussion of certain accounting standards that may be applicable to the Company's current and future consolidated financial statements.
LIQUIDITY AND CAPITAL RESOURCES
The purpose of liquidity management is to ensure there is sufficient cash to meet all financial commitments and obligations as they fall due. The liquidity requirements of the Company and its subsidiaries have been met primarily by funds generated from operations, capital raising, disposal of discontinued operations, investment maturities and investment income, and other returns received on investments and from the sale of investments.
A significant portion of the cash provided by our Extended Warranty companies is required to be placed into restricted trust accounts, as determined by the insurers who back-up our service contracts, in order to fund future expected claims. On a periodic basis (quarterly or annually), we may be required to contribute more into the restricted accounts or we may be permitted to draw additional funds from the restricted accounts, dependent upon actuarial analyses performed by the insurers regarding sufficiency of funds to cover future expected claims. A substantial portion of the restricted trust accounts are invested in fixed maturities and other instruments that have durations similar to the expected future claim projections.
Cash provided from these sources is used primarily for warranty expenses, business service expenses, debt servicing, acquisitions and operating expenses of the holding company.
The Company's Extended Warranty and Kingsway Search Xcelerator subsidiaries fund their obligations primarily through service fee and commission revenue. The Company's Leased Real Estate subsidiaries fund their obligations through rental revenue.
Cash Flows
During the six months ended June 30, 2022, the Company reported $6.2 million of net cash provided by operating activities, primarily due to operating income from the Extended Warranty and Kingsway Search Xcelerator segments. During the six months ended June 30, 2021, the Company reported $11.5 million of net cash used in operating activities, primarily due to $10.6 million prepaid management fees recorded during the second quarter of 2021. The $10.6 million was only paid because of the gross proceeds received under the Additional Mortgage (see explanation of cash provided by financing activities below), of which the Company retained $2.7 million.
During the six months ended June 30, 2022, the net cash used in investing activities was $2.2 million. This use of cash was primarily attributed to purchases of fixed maturities in excess of proceeds from limited liability investments and from sales and maturities of fixed maturities. During the six months ended June 30, 2021, the net cash provided by investing activities was $11.9 million. This source of cash was primarily attributed to a distribution received by Net Lease from one of its limited liability investment companies of $12.9 million during the first quarter of 2021, partially offset by purchases of fixed maturities in excess of proceeds from sales and maturities of fixed maturities.
During the six months ended June 30, 2022, the net cash used in financing activities was $7.8 million. This use of cash was attributed to principal repayment on bank loans of $4.0 million, principal repayments on notes payable of $3.1 million and distributions to noncontrolling interest holders of $0.7 million. During the six months ended June 30, 2021, the net cash used in financing activities was $0.7 million. This use of cash was primarily attributed to principal repayment on bank loan of $2.2 million and principal repayments of $11.3 million on the notes payable, of which $9.0 million relates to the repayment of Net Lease's $9.0 million mezzanine loan and $2.3 million relating to principal paydowns on the Mortgage, Additional Mortgage and the Flower Note; partially offset by net proceeds from notes payable of $13.3 million related to the Additional Mortgage.
Holding Company Liquidity
The liquidity of the holding company is managed separately from its subsidiaries. The obligations of the holding company primarily consist of holding company operating expenses; transaction-related expenses; investments; and any other extraordinary demands on the holding company.
Actions available to the holding company to increase liquidity in order to meet its obligations include the sale of passive investments; sale of subsidiaries; issuance of debt or equity securities; exercise of warrants; distributions from the Company’s Extended Warranty and Kingsway Search Xcelerator subsidiaries, as further described below; and giving notice to its Trust Preferred trustees of its intention to exercise its voluntary right to defer interest payments for up to 20 quarters on the six subsidiary trusts of the Company’s subordinated debt, which right the Company exercised during the third quarter of 2018.
On December 1, 2020, the Company closed on the acquisition of PWI, a full-service provider of vehicle service agreements. Related to the PWI acquisition, the Company secured the 2020 KWH Loan with IWS, Trinity, Geminus and PWI (the "KWH Subs") as borrowers under the 2020 KWH Loan. Pursuant to satisfying the covenants under the 2020 KWH Loan, the KWH Subs were permitted to make distributions to the holding company in an aggregate amount not to exceed $1.5 million in any 12-month period.
Beginning in 2022, the holding company is permitted to receive a portion of the excess cash flow (as defined in the 2020 KWH Loan document) generated by the KWH Subs in the previous year. Based on current covenants, the holding company is entitled to 50% of the excess cash flow with the other 50% used to pay down the 2020 KWH Loan. The holding company received $1.7 million and in March 2022 paid down the KWH 2020 Loan by $1.7 million.
The amount of excess cash flow the Company is entitled to retain is dependent upon the leverage ratio (as defined in the 2020 KWH Loan document):
| |
|
Percent of excess cash flow |
| If leverage ratio is |
|
retained by the Company |
| Greater than 1.75:1.00 |
|
50% |
| Less than 1.75:1.00 but greater than 0.75:1.00 |
|
75% |
| Less than 0.75:1.0 |
|
100% |
| KINGSWAY FINANCIAL SERVICES INC. |
On October 1, 2021, the Company closed on the acquisition of Ravix. Related to the Ravix acquisition, the Company secured the Ravix Loan with Ravix and Ravix LLC as borrowers under the Ravix Loan. Pursuant to the covenants under the Ravix Loan, Ravix is permitted to make distributions to the holding company so long as doing such would not cause non-compliance with the various covenants outlined within the Ravix Loan.
Historically, dividends from the Leased Real Estate segment were not generally considered a source of liquidity for the holding company. However, as more fully described inNote 21(a), "Commitments and Contingencies," to the unaudited consolidated interim financial statements, the holding company is now permitted to receive 20% of the proceeds from the increased rental payments resulting from an earlier amendment to the CMC lease (or any borrowings against such increased rental payments). Refer toNote 11, "Debt," to the unaudited consolidated interim financial statements, for further information about this borrowing. In conjunction with the Additional Mortgage, TRT paid a guarantee fee of $1.1 million to a third-party during the second quarter of 2021, who is serving as a guarantor or indemnitor with respect to certain obligations between TRT and the holder of the Additional Mortgage. Refer toNote 21(b), "Commitments and Contingencies," to the unaudited consolidated interim financial statements for further discussion of this off-balance sheet guarantee.
On October 18, 2018, the Company completed the previously announced sale of its non-standard automobile insurance companies Mendota Insurance Company, Mendakota Insurance Company and Mendakota Casualty Company (collectively "Mendota"). As part of the transaction, the Company will indemnify the buyer for any loss and loss adjustment expenses with respect to open claims in excess of Mendota's carried unpaid loss and loss adjustment expenses at June 30, 2018 related to the open claims. The maximum obligation to the Company with respect to the open claims is $2.5 million. Per the purchase agreement, a security interest on the Company’s equity interest in its consolidated subsidiary, Net Lease, as well as any distributions to the Company from Net Lease, was to be collateral for the Company’s payment of obligations with respect to the open claims. During the third quarter of 2021, the purchasers of Mendota and the Company agreed to release the Company's equity interest in Net Lease as collateral and allow Net Lease to make distributions to the Company. In exchange, the Company agreed to deposit $2.0 million into an escrow account and advance $0.5 million to the purchaser of Mendota to satisfy the Company's payment obligation with respect to the open claims. There is no maximum obligation to the Company with respect to the specified claims. Refer to Note 21, "Commitments and Contingencies," to the unaudited consolidated interim financial statements for further discussion of this off-balance sheet guarantee.
The holding company’s liquidity, defined as the amount of cash in the bank accounts of Kingsway Financial Services Inc. and Kingsway America Inc., was $3.6 millionand $2.2 million at June 30, 2022 and December 31, 2021, respectively, which excludes future actions available to the holding company that could be taken to generate liquidity. The holding company cash amounts are reflected in the cash and cash equivalents of $11.7 million and $12.6 million reported at June 30, 2022 and December 31, 2021, respectively, on the Company’s consolidated balance sheets.
The holding company’s liquidity at June 30, 2022 represents only actual cash on hand and does not include cash that would be made available to the holding company from the sale of investments owned by the holding company. In addition, the holding company has access to some of the operating cash generated by the Extended Warranty and Kingsway Search Xcelerator subsidiaries as described above. While these sources do not represent cash of the holding company, they do represent future sources of liquidity.
As of June 30, 2022, there are 169,733 shares of the Company’s Class A Preferred Stock (the "Preferred Shares"), issued and outstanding. The outstanding Preferred Shares were required to be redeemed by the Company on April 1, 2021 ("Redemption Date") if the Company had sufficient legally available funds to do so. Additionally, the Company has exercised its right to defer payment of interest on its outstanding subordinated debt ("trust preferred securities") and, because of the deferral which totaled $21.4 million at June 30, 2022, the Company is prohibited from redeeming any shares of its capital stock while payment of interest on the trust preferred securities is being deferred. If the Company was required to pay either the Preferred Shares redemption value or both the deferred interest on the trust preferred securities and redeem all the Preferred Shares currently outstanding, then the Company has determined that it does not have sufficient legally available funds to do so. However, the Company is prohibited from doing so under Delaware law and, as such, (a) the interest on the trust preferred securities remains on deferral as permitted under the indentures and (b) in accordance with Delaware law the Preferred Shares were not redeemed on the Redemption Date and instead remain outstanding with a redemption value of $6.7 million as of June 30, 2022, continue to be convertible at the discretion of the holder, and will accrue dividends until such time as the Company has sufficient legally available funds to redeem the Preferred Shares and is not otherwise prohibited from doing so. The Company continues to operate in the ordinary course.
The Company notes there are several variables to consider in such a situation, and management is exploring the following opportunities: negotiating with the holders of the Preferred Shares with respect to the key provisions, raising additional funds through capital market transactions, as well as the Company’s strategy of working to monetize its non-core investments while attempting to maximize the tradeoff between liquidity and value received.
Based on the Company’s current business plan and revenue prospects, existing cash, cash equivalents, investment balances and anticipated cash flows from operations are expected to be sufficient to meet the Company’s working capital and operating expenditure requirements, excluding the cash that may be required to redeem the Preferred Shares and deferred interest on its trust preferred securities, for the next twelve months. However, the Company’s assessment could also be affected by various risks and uncertainties, including, but not limited to, the effects of the COVID-19 pandemic.
Regulatory Capital
In the United States, a risk-based capital ("RBC") formula is used by the National Association of Insurance Commissioners ("NAIC") to identify property and casualty insurance companies that may not be adequately capitalized. In general, insurers reporting surplus as regards policyholders below 200% of the authorized control level, as defined by the NAIC, at December 31 are subject to varying levels of regulatory action, including discontinuation of operations. As of December 31, 2021, surplus as regards policyholders reported by Amigo exceeded the 200% threshold.
During the fourth quarter of 2012, the Company began taking steps to place all of Amigo into voluntary run-off. In April 2013, Kingsway filed a comprehensive run-off plan with the Florida Office of Insurance Regulation, which outlines plans for Amigo's run-off. Amigo remains in compliance with that plan.
Kingsway Reinsurance Corporation ("Kingsway Re"), our reinsurance subsidiary domiciled in Barbados, is required by the regulator in Barbados to maintain minimum statutory capital of $125,000. Kingsway Re is currently operating with statutory capital near the regulatory minimum, requiring us to periodically contribute capital to fund operating expenses. Kingsway Re incurs operating expenses of approximately $0.1 million per year.
| KINGSWAY FINANCIAL SERVICES INC. |