Notes to Consolidated Financial Statements
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 and business services industries.
NOTE 2 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) | Principles of consolidation: |
The accompanying information in the 2022 Annual Report has been prepared in accordance with accounting principles generally accepted in the United States of America ("U.S. GAAP").
The accompanying consolidated financial statements include the accounts of Kingsway and its majority owned and controlled subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation.
In addition, the Company evaluates its relationships or investments for consolidation pursuant to authoritative accounting guidance related to the consolidation of a variable interest entity ("VIE") under the Variable Interest Model prescribed by the Financial Accounting Standards Board ("FASB").
The Company’s investments include certain investments, primarily in limited liability companies and limited partnerships in which the Company holds a variable interest. The Company evaluates these investments for the characteristics of a VIE. The Variable Interest Model identifies the characteristics of a VIE to include investments (1) lacking sufficient equity to finance activities without additional subordinated support or (2) in which the holders of equity at risk in the investments lack characteristics of a controlling financial interest, such as the power to direct activities that most significantly impact the legal entity’s economic performance; the obligation to absorb the legal entity’s expected losses; or the right to receive the expected residual returns of the legal entity. The equity investors as a group are considered to lack the power to direct activities that most significantly impact the legal entity’s economic performance when (1) the voting rights of some investors are not proportional to their obligations to absorb the expected losses of the legal entity or their rights to receive the expected residual returns of the legal entity and (2) substantially all of the activities of the legal entity are conducted on behalf of an investor with disproportionately few voting rights. When evaluating whether an investment lacks characteristics of a controlling financial interest, the Company considers limited liability companies and limited partnerships to lack the power of a controlling financial interest if neither of the following exists: (1) a simple majority or lower threshold of partners or members with equity at risk are able to exercise substantive kick-out rights through voting interest over the general partner(s) or managing member(s) or (2) limited partners with equity at risk are able to exercise substantive participating rights over the general partner(s) or managing member(s).
If the characteristics of a VIE are met, the Company evaluates whether it meets the primary beneficiary criteria. The primary beneficiary is considered to be the entity holding a variable interest that has the power to direct activities that most significantly impact the economic performance of the VIE; the obligation to absorb losses of the VIE; or the right to receive benefits from the VIE that could potentially be significant to the VIE. In instances where the Company is considered to be the primary beneficiary, the Company consolidates the VIE. When the Company is not considered to be the primary beneficiary of the VIE, the VIE is not consolidated and the Company uses the equity method to account for the investment. Under this method, the carrying value is generally the Company’s share of the net asset value of the unconsolidated entity, and changes in the Company’s share of the net asset value are recorded in net investment income.
Certain prior year amounts have been reclassified to conform to current year presentation. Such reclassifications had no impact on previously reported net income or total shareholders' equity.
Subsidiaries
The Company's consolidated financial statements include the assets, liabilities, shareholders' equity, revenues, expenses and cash flows of the holding company and its subsidiaries and have been prepared in accordance with U.S. GAAP. A subsidiary is an entity controlled, directly or indirectly, through ownership of more than 50% of the outstanding voting rights, or where the Company has the power to govern the financial and operating policies so as to obtain benefits from its activities. Assessment of control is based on the substance of the relationship between the Company and the entity and includes consideration of both existing voting rights and, if applicable, potential voting rights that are currently exercisable and convertible. The operating results of subsidiaries that have been disposed are included up to the date control ceased, and any difference between the fair value of the consideration received and the carrying value of a subsidiary that has been disposed is recognized in the consolidated statements of operations. All intercompany balances and transactions are eliminated in full.
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
The consolidated financial statements are prepared as of December 31, 2022 based on individual company financial statements at the same date, or in the case of certain limited liability companies that are consolidated, on a three-month lag basis. Accounting policies of subsidiaries have been aligned where necessary to ensure consistency with those of Kingsway.
The Company's subsidiaries Argo Holdings Fund I, LLC ("Argo Holdings"), Flower Portfolio 001, LLC ("Flower") and Net Lease Investment Grade Portfolio LLC ("Net Lease") meet the definition of an investment company and follow the accounting and reporting guidance in Financial Accounting Standards Codification Topic 946, Financial Services-Investment Companies.
Noncontrolling interests
The Company has noncontrolling interests attributable to certain of its subsidiaries. A noncontrolling interest arises where the Company owns less than 100% of the voting rights and economic interests in a subsidiary. A noncontrolling interest is initially recognized at the proportionate share of the identifiable net assets of the subsidiary at the acquisition date and is subsequently adjusted for the noncontrolling interest's share of the acquiree's net income (loss) and changes in capital. The effects of transactions with noncontrolling interests are recorded in shareholders' equity where there is no change of control.
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 classification 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 consolidated financial statements include, but are not limited to, revenue recognition; valuation of fixed maturities and equity investments; impairment assessment of investments; valuation of limited liability investments, at fair value; 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; fair value assumptions for derivative instruments and contingent consideration.
(c) | Business combinations and asset acquisitions: |
The Company evaluates acquisitions in accordance with Accounting Standards Codification ("ASC") 805, Business Combinations ("ASC 805"), to determine if a transaction represents an acquisition of a business or an acquisition of assets. The results of acquired subsidiaries are included in the consolidated statements of operations from the date of acquisition.
An acquisition of a business represents a business combination. The acquisition method of accounting is used to account for a business combination. The cost of an acquired business is measured as the fair value of the assets received, equity instruments issued and liabilities incurred or assumed at the date of exchange. Identifiable assets acquired and liabilities and contingent liabilities assumed in a business combination are measured initially at their fair values at the acquisition date, irrespective of the extent of any noncontrolling interest. The excess of the cost of an acquired business over the fair value of the Company's share of the identifiable net assets acquired is recorded as goodwill. If the cost of acquired business is less than the fair value of the net assets of the subsidiary acquired, the difference is recognized in the consolidated statements of operations. Noncontrolling interests in the net assets of consolidated entities are reported separately in shareholders' equity and initially measured at fair value. Acquisition costs related to a business combination are expensed as incurred.
When an acquisition does not meet the definition of a business combination either because: (i) substantially all of the fair value of the gross assets acquired is concentrated in a single identifiable asset, or group of similar identified assets, or (ii) the acquired entity does not have an input and a substantive process that together significantly contribute to the ability to create outputs, the Company accounts for the acquisition as an asset acquisition. In an asset acquisition, goodwill is not recognized. Any excess of the total purchase price plus transaction costs over the fair value of the net assets acquired is allocated on a relative fair value basis to the identifiable net assets at the acquisition date.
Investments in fixed maturities are classified as available-for-sale and reported at fair value. Unrealized gains and losses are included in accumulated other comprehensive income, net of tax, until sold or until an other-than-temporary impairment is recognized, at which point cumulative unrealized gains or losses are reclassified to the consolidated statements of operations.
Equity investments include common stocks and warrants and are reported at fair value. Changes in fair value of equity investments are recognized in net income.
Limited liability investments include investments in limited liability companies and limited partnerships in which the Company's interests 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. 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.
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
Limited liability investments, at fair value are accounted for at fair value with changes in fair value included in gain on change in fair value of limited liability investments, at fair value. The difference between the end of the reporting period of the limited liability investments, at fair value and that of the Company is no more than three months.
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. These investments do not have readily determinable fair values and, therefore, are reported at cost, adjusted for observable price changes and impairments. Changes in carrying value are included in net change in unrealized loss on private company investments.
Real estate investments are reported at fair value, which is zero as of December 31, 2022 due to the sale of Flower’s investment real estate properties for $12.2 million on September 29, 2022. Note 7, "Investments," for further details.
Other investments include collateral loans and are reported at their unpaid principal balance, which approximates fair value.
Short-term investments, which consist of investments with original maturities between three months and one year, are reported at cost, which approximates fair value.
Realized gains and losses on sales, determined on a first-in first-out basis, are included in net realized gains.
Dividends and interest income are included in net investment income. Investment income is recorded as it accrues.
The Company accounts for all financial instruments using trade date accounting.
The Company conducts a quarterly review to identify and evaluate investments that show objective indications of possible impairment. Impairment is charged to the consolidated statements of operations if the fair value of an instrument falls below its cost/amortized cost and the decline is considered other-than-temporary. Factors considered in determining whether a loss is other-than-temporary include the length of time and extent to which fair value has been below cost; the financial condition and near-term prospects of the issuer; and the Company's ability and intent to hold investments for a period of time sufficient to allow for any anticipated recovery.
(e) | Cash and cash equivalents: |
Cash and cash equivalents include cash and investments with original maturities of no more than three months when purchased that are readily convertible into cash.
Restricted cash represents certain cash and cash equivalent balances restricted as to withdrawal or use. The Company's restricted cash is comprised primarily of cash held for the payment of vehicle service agreement claims under the terms of certain contractual agreements, funds held in escrow, statutory deposits and amounts pledged to third-parties as deposits or to collateralize liabilities.
(g) | Service fee receivable: |
Service fee receivable includes balances due and uncollected from customers. Service fee receivable is reported net of an estimated allowance for doubtful accounts. The allowance for doubtful accounts is determined based on periodic evaluations of aged receivables, historical business data, management’s experience and current economic conditions.
(h) | Deferred contract costs: |
Deferred contract costs represent the deferral 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 incremental costs to obtain a contract and costs to fulfill a contract with a customer are recorded in commissions and general and administrative expenses, respectively, in the consolidated statements of operations. Changes in estimates, if any, are recorded in the accounting period in which they are determined.
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
(i) | Property and equipment: |
Property and equipment are reported in the consolidated financial statements at cost. Depreciation of property and equipment has been provided using the straight-line method over the estimated useful lives of such assets. Repairs and maintenance are recognized in operations during the period incurred. Land is not depreciated. The Company estimates useful life to be three to ten years for leasehold improvements; three to seven years for furniture and equipment; and three to five years for computer hardware.
(j) | Goodwill and intangible assets: |
When the Company acquires a subsidiary or other business where it exerts significant influence, the fair value of the net tangible and intangible assets acquired is determined and compared to the amount paid for the subsidiary or business acquired. Any excess of the amount paid over the fair value of those net assets is considered to be goodwill.
Goodwill is tested for impairment annually as of November 30, or more frequently if events or circumstances indicate that the carrying value may not be recoverable, to ensure that its fair value is greater than or equal to the carrying value. Any excess of carrying value over fair value is charged to the consolidated statements of operations in the period in which the impairment is determined.
When the Company acquires a subsidiary or other business where it exerts significant influence or acquires certain assets, intangible assets may be acquired, which are recorded at their fair value at the time of the acquisition. An intangible asset with a definite useful life is amortized in the consolidated statements of operations over its estimated useful life. The Company writes down the value of an intangible asset with a definite useful life when the undiscounted cash flows are not expected to allow for full recovery of the carrying value.
Intangible assets with indefinite useful lives are not subject to amortization and are tested for impairment annually as of November 30, or more frequently if events or circumstances indicate that the carrying value may not be recoverable, to ensure that fair values are greater than or equal to carrying values. Any excess of carrying value over fair value is charged to the consolidated statements of operations in the period in which the impairment is determined.
(k) | Derivative financial instruments: |
Derivative financial instruments include an interest rate swap contact and the trust preferred debt repurchase options. The Company measures derivative financial instruments at fair value. The fair value of derivative financial instruments is required to be revalued each reporting period, with corresponding changes in fair value recorded in the consolidated statements of operations. Realized gains or losses are recognized upon settlement of the contracts. Refer to Note 11, "Derivatives," for further information.
The Company entered into a pay fixed, receive variable interest rate swap contract to reduce its exposure to changes in interest rates. The interest rate swap contract is included in other assets and accrued expenses and other liabilities in the consolidated balance sheets at December 31, 2022 and December 31, 2021, respectively. The Company has not elected hedge accounting for the interest rate swap, therefore changes in fair value are recorded in current period earnings and are included in interest expense in the consolidated statements of operations.
During the third quarter of 2022, the Company entered into three trust preferred debt repurchase option agreements. The trust preferred debt repurchase options are included in other assets in the consolidated balance sheet at December 31, 2022 with changes in fair value included in gain on change in fair value of derivative asset option contracts in the consolidated statement of operations.
Bank loans and notes payable are reported in the consolidated balance sheets at par value adjusted for unamortized discount or premium and unamortized issuance costs. Discounts, premiums, and costs directly related to the issuance of debt are capitalized and amortized through the maturity date of the debt using the effective interest rate method and are recorded in interest expense in the consolidated statements of operations. Gains and losses on the extinguishment of debt are recorded in gain on extinguishment of debt.
The Company's subordinated debt is measured and reported at fair value. 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 portion of the change in fair value of subordinated debt related to the instrument-specific credit risk is recognized in other comprehensive loss.
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
(m) | Contingent consideration: |
The consideration for certain of the Company's acquisitions include future payments to 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 at the date of acquisition and are included in accrued expenses and other liabilities in the consolidated balance sheets. 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. These fair value measurements are based on significant inputs not observable in the market. Changes in assumptions could have an impact on the payout of contingent consideration liabilities. Changes in fair value are reported in the consolidated statements of operations as non-operating other (expense) revenue.
The Company follows the asset and liability method of accounting for income taxes, whereby deferred income tax assets and liabilities are recognized for (i) the differences between the financial statement carrying amount of existing assets and liabilities and their respective tax bases and (ii) loss and tax credit carryforwards. Deferred income tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the date of enactment. Future tax benefits are recognized to the extent that realization of such benefits is more likely than not and a valuation allowance is established for any portion of a deferred tax asset that management believes will not be realized. Current federal income taxes are charged or credited to operations based upon amounts estimated to be payable or recoverable as a result of taxable operations for the current year. The Company accounts for uncertain tax positions in accordance with the income tax accounting guidance. The Company recognizes interest and penalties, if any, related to unrecognized tax benefits in income tax expense (benefit).
The Company records a right of use asset and lease liability for all leases in which the estimated term exceeds twelve months. The Company treats contracts as a lease when the contract: (1) conveys the right to use a physically distinct property or equipment asset for a period of time in exchange for consideration, (2) the Company directs the use of the asset and (3) the Company obtains substantially all the economic benefits of the asset. Right-of-use assets and lease liabilities are measured and recognized based on the present value of the future minimum lease payments over the lease term at the commencement date. As the Company’s leases are office leases, the Company is unable to determine an implicit rate; therefore, the Company uses its incremental borrowing rate based on the information available at the lease commencement date in determining the present value of future payments for those leases. The Company includes options to extend or terminate the lease in the measurement of the right-of-use asset and lease liability when it is reasonably certain that such options will be exercised. Lease expense for minimum lease payments is recognized on a straight-line basis over the lease term.
The Company determines lease classification at the commencement date. Leases not classified as sales-type (lessor) or financing leases (lessor and lessee) are classified as operating leases. The primary accounting criteria the Company uses that results in operating lease classification are: (a) the lease does not transfer ownership of the underlying asset to the lessee by the end of the lease term, (b) the lease does not grant the lessee a purchase option that the lessee is reasonably certain to exercise, (c) using a seventy-five percent or more threshold in addition to other qualitative factors, the lease term is not for a major part of the remaining economic life of the underlying asset, (d) using a ninety percent or more threshold in addition to other qualitative factors, the present value of the sum of the lease payments and residual value guarantee from the lessee, if any, does not equal or substantially exceed the fair value of the underlying asset.
As an accounting policy, the Company has elected not to apply the recognition requirements in ASC 842 to short-term leases (generally those with terms of twelve months or less). Instead, the Company recognizes the lease payments as expense on a straight-line basis over the lease term and any variable lease payments in the period in which the obligation for those payments is incurred.
Rental expense for operating leases is recognized on a straight-line basis over the lease term, net of any applicable lease incentive amortization.
Service fee and commission revenue and deferred service fees
Service fee and commission revenue represents 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 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.
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.
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
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.
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.
Standalone selling prices are not directly observable in the contract for each of the separate home warranty performance obligations. As a result, the Company has applied the expected cost plus a margin approach to develop models to estimate the standalone selling price for each of its performance obligations in order to allocate the transaction price to the two separate performance obligations identified.
For the model related to the warranty administrative services performance obligation, the Company makes judgments about which of its actual costs are associated with enrolling each home sold by the builder into the program and the warranty administrative system and delivering the warranty product. For the model related to the other warranty services performance obligation, the Company makes judgments about which of its actual costs are associated with activities, such as answering builder or homeowner questions regarding the home warranty and dispute resolution services, which are performed over the life of the warranty coverage period. The relative percentage of expected costs plus a margin associated with the warranty administrative services performance obligation is applied to the transaction price to determine the estimated standalone selling price of the warranty administrative services performance obligation, which the Company recognizes as earned at the time the home is enrolled and the warranty product is delivered. The relative percentage of expected costs plus a margin associated with the other warranty services performance obligation is applied to the transaction price to determine the estimated standalone selling price of the other warranty services performance obligation, which the Company recognizes as earned as services are performed over the warranty coverage period.
For the other warranty services performance obligation, the Company applies an input method of measurement, based on the expected costs plus a margin of providing services, to determine the transfer of its services over the warranty coverage period. The Company uses historical data regarding the number of calls it receives and activities performed, in addition to the number of homes enrolled, to estimate the number of complaints and dispute resolution requests to be received by year until coverage expires, which allows the Company to develop a revenue recognition pattern that it believes provides a faithful depiction of the transfer of services over time for the other warranty services performance obligation.
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.
Kingsway Search Xcelerator consulting revenue includes the revenue from providing outsourced finance and human resources consulting services, as well as healthcare professional staffing services. The Company invoices for services revenue based on contracted rates. Revenue is earned as services are provided.
Contingent consideration receivable
The terms of the sale of one of the Company's subsidiaries includes potential receipt by the Company of future earnout payments. The gain related to the earnout payments is recorded when the consideration is determined to be realizable and is reported in the consolidated statements of operations as gain on disposal of subsidiary. The assumptions and methodologies used are continually reviewed and any adjustments are reflected in the consolidated statements of operations in the period in which the adjustments are made. See Note 5, "Disposal and Discontinued Operations," for further discussion.
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
(q) | Stock-based compensation: |
The Company uses the fair-value method of accounting for stock-based compensation awards granted to employees. Expense is recognized on a straight-line basis over the requisite service period during which awards are expected to vest, with a corresponding increase to either additional paid-in capital for equity-classified awards or to a liability for liability-classified awards. Liability-classified awards, included in accrued expenses and other liabilities in the consolidated balance sheets, are measured and reported at fair value on the date of grant and are remeasured each reporting period. Compensation expense related to the change in fair value for liability-classified awards is reported in the consolidated statements of operations as general and administrative expenses. For awards with a graded vesting schedule, expense is recognized on a straight-line basis over the requisite service period for each separately vesting portion of the award. For awards subject to a performance condition, expense is recognized when the performance condition has been satisfied or is probable of being satisfied. For awards subject to a market condition, compensation expense is recognized on a straight-line basis regardless of whether the market condition is satisfied, provided that the requisite service has been provided. Forfeitures are recognized in the period that the award is forfeited.
(r) | Fair value of financial instruments: |
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 financial instruments 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.
(s) | Holding company liquidity: |
The Company's Extended Warranty and Kingsway Search Xcelerator subsidiaries fund their obligations primarily through service fee and commission 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.
The holding company’s liquidity, defined as the amount of cash in the bank accounts of Kingsway Financial Services Inc. and Kingsway America Inc. ("KAI"), was $48.9 million and $2.2 million at December 31, 2022 and December 31, 2021, respectively. The holding company cash amounts are reflected in the cash and cash equivalents of $64.2 million and $10.1 million reported at December 31, 2022 and December 31, 2021, respectively, on the Company’s consolidated balance sheets.
In addition to its collections from subsidiaries and holding company expenditures, the Company anticipates the following cash inflows and outflows over the next twelve months:
| • | Distributions from Net Lease of $8.3 million, from the sale of the last commercial real estate property in February 2023 |
| • | $3.7 million from the exercise of 0.7 million warrants from January 1 through February 28, 2023 |
| • | $1.5 million distribution from Amigo, given that as of early March 2023 it was no longer a regulated insurance company |
| • | $56.5 million to repurchase the trust preferred debt instruments (aka subordinate debt) for which it has the option to repurchase, which outflow is expected no later than March 15, 2023 (see Note 11, "Derivatives," and Note 26, “Subsequent Events ”) |
| • | $4.7 million of deferred interest to the remaining trust preferred debt instrument for which the Company did not have the right to repurchase (see Note 26, “Subsequent Events”); the Company would have the ability to defer interest payments for up to 20 quarters on the remaining trust preferred debt instrument, if it so elected |
| • | $6.1 million required to redeem the Class A Preferred Shares; however, based on discussions with the holders of the Class A Preferred Shares, the Company anticipates that 100% of the Class A Preferred Shares would be converted and, in that case, there would be no cash outlay by the Company (see Note 19, "Redeemable Class A Preferred Stock," and Note 26, “Subsequent Events”) |
The Company notes there are outstanding warrants that expire in September 2023 (see Note 20, “Shareholders' Equity”) and, if all outstanding warrants were exercised, the Company would receive an additional $18.7 million. The Company also notes that it has an additional $10 million available from the second amendment to the 2020 KWH Loan (see Note 12, "Debt," and Note 26, “Subsequent Events”), that is available to be drawn.
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, including the cash that may be required to redeem the Preferred Shares, repurchase its trust preferred securities and to pay the 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 developing macro-economic environment.
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
NOTE 3 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.
In March 2020, the FASB issued ASU No. 2020-04 Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting that provides optional expedients for a limited period of time for accounting for contracts, hedging relationships, and other transactions affected by the London Interbank Offered Rate ("LIBOR") or other reference rates expected to be discontinued. These optional expedients can be applied from March 2020 through December 31, 2022. In December 2022, the FASB issued ASU No. 2022-06 Reference Rate Reform (Topic 848): Deferral of the Sunset Date of Topic 848 which deferred the sunset date of Topic 848 from December 31, 2022 to December 31, 2024. Debt arrangements that were entered into during the year ended December 31, 2022, including the new term loans expiring in November 2028 and the new revolving credit facilities expiring in November 2024, no longer use LIBOR as a reference rate. LIBOR continues to be the reference rate for our trust preferred subordinated debt with maturity dates ranging from December 2032 through January 2034. The phase out of LIBOR reference rates for our subordinated debt will occur beginning in June 2023. The Company's adoption of this new standard occurred during the year ended December 31, 2022, prior to the phase-out of the LIBOR reference rate. There was no material impact to the Company's consolidated financial statements, nor do we expect the adoption of this standard to have a material impact on the consolidated financial statements during the LIBOR transition period.
(b) | Accounting Standards Not Yet Adopted: |
In June 2016, the 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's service fee receivable and other receivables are within the scope of ASU 2016-13, however the Company does not anticipate the impact of adopting this standard will be material to its consolidated financial statements.
NOTE 4 ACQUISITIONS
(a) | Business Combinations |
During the years ended December 31, 2022 and December 31, 2021, the Company incurred acquisition expenses related to business combinations of$1.1 million and $0.4 million, respectively, which are included in general and administrative expenses in the consolidated statements of operations.
CSuite Financial Partners, LLC
On
November
1,
2022, the Company acquired
100% of the outstanding equity interests of CSuite Financial Partners, LLC ("CSuite"). CSuite, based in Manhattan Beach, California, is a national financial executive services firm providing financial management leadership to companies in every industry, regardless of size, throughout the United States. As further discussed in
Note 22
, "Segmented Information," CSuite is included in the Kingsway Search Xcelerator segment. This acquisition was the Company’s
second 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 CSuite for aggregate cash consideration of approximately $8.5 million, less certain escrowed amounts for purposes of indemnification claims and working capital adjustments. The Company will also pay additional contingent consideration, only to the extent earned, in an aggregate amount of up to $3.6 million, which is subject to certain conditions, including the successful achievement of certain financial metrics for CSuite during the three-year period commencing on the first full calendar month following the acquisition date.
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
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 are subject to adjustment during a measurement period subsequent to the acquisition date, not to exceed one-year as permitted under U.S. GAAP. The Company expects to complete its purchase price allocation in early 2023. These estimates, allocations and calculations are subject to change as we obtain further information; therefore, the final fair values of the assets acquired and liabilities assumed could change from the estimates included in these consolidated financial statements.
Refer to Note 9, "Intangible Assets," for further disclosure of the intangible assets related to this acquisition. The goodwill of $4.1 million represents the premium paid over the fair value of the net tangible and intangible assets acquired, which the Company paid to grow its portfolio of companies and acquire an assembled workforce. The goodwill is not deductible for tax purposes. The estimated fair value of the contingent consideration obligation at the acquisition date of zero was determined using a Monte Carlo simulation based on forecasted future results.
The following table summarizes the preliminary estimated allocation of the CSuite assets acquired and liabilities assumed at the date of acquisition:
(in thousands) | | | | |
| | November 1, 2022 | |
Cash and cash equivalents | | $ | 569 | |
Service fee receivable | | | 311 | |
Other receivables | | | 21 | |
Goodwill | | | 4,109 | |
Intangible asset not subject to amortization - trade name | | | 1,500 | |
Intangible asset subject to amortization - customer relationships | | | 2,500 | |
Other assets | | | 53 | |
Total assets | | $ | 9,063 | |
| | | | |
Accrued expenses and other liabilities | | $ | 539 | |
Total liabilities | | $ | 539 | |
| | | | |
Purchase price | | $ | 8,524 | |
The consolidated statements of operations include the earnings of CSuite from the date of acquisition. From the date of acquisition through December 31, 2022, CSuite earned revenue of $1.3 million and had a net loss of less than $0.1 million.
Secure Nursing Service, Inc.
On
November 18, 2022, the Company acquired substantially all of the assets and assumed certain specified liabilities of Secure Nursing Service, Inc. ("SNS") for aggregate cash consideration of
$11.5 million, less certain escrowed amounts for purposes of indemnification claims and working capital adjustments. SNS, based in Los Angeles, California, employs highly skilled and professional per diem and travel Registered Nurses, Licensed Vocational Nurses, Certified Nurse Assistants and Allied Healthcare Professionals with multiple years of acute care hospital experience. SNS places these healthcare professionals in both per diem assignments, and in short-term and long-term travel assignments in a variety of hospitals in southern California. As further discussed in
Note 22, "Segmented Information," SNS is included in the Kingsway Search Xcelerator segment. This acquisition was the Company’s
third acquisition under its novel CEO Accelerator program and further expands the Company’s portfolio of businesses with recurring revenue and low capital intensity.
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 are subject to adjustment during a measurement period subsequent to the acquisition date, not to exceed one-year as permitted under U.S. GAAP. The Company expects to complete its purchase price allocation in early 2023. These estimates, allocations and calculations are subject to change as we obtain further information; therefore, the final fair values of the assets acquired and liabilities assumed could change from the estimates included in these consolidated financial statements.
Refer to Note 9, "Intangible Assets," for further disclosure of the intangible assets related to this acquisition. The goodwill of $1.6 million represents the premium paid over the fair value of the net tangible and intangible assets acquired, which the Company paid to grow its portfolio of companies and acquire an assembled workforce. The goodwill is not deductible for tax purposes.
The following table summarizes the preliminary estimated allocation of the SNS assets acquired and liabilities assumed at the date of acquisition:
(in thousands) | | | | |
| | November 18, 2022 | |
Service fee receivable | | $ | 3,200 | |
Goodwill | | | 1,600 | |
Intangible asset not subject to amortization - trade name | | | 3,100 | |
Intangible asset subject to amortization - customer relationships | | | 3,600 | |
Other assets | | | 6 | |
Total assets | | $ | 11,506 | |
| | | | |
Accrued expenses and other liabilities | | $ | 6 | |
Total liabilities | | $ | 6 | |
| | | | |
Purchase price | | $ | 11,500 | |
The consolidated statements of operations include the earnings of SNS from the date of acquisition. From the date of acquisition through December 31, 2022, SNS earned revenue of $2.4 million and had a net loss of $0.1 million.
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
Ravix Financial, Inc.
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 22, "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. During 2022, Ravix made a cash earn-out payment of $0.8 million.
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.
Refer to Note 9, "Intangible Assets," for further disclosure of the intangible assets related to this acquisition. The goodwill of $7.9 million represents the premium paid over the fair value of the net tangible and intangible assets acquired, which the Company paid to grow its portfolio of companies and acquire an assembled workforce. The goodwill is not deductible for tax purposes. The estimated fair value of the contingent consideration obligation at the acquisition date of $2.2 million was determined using a Monte Carlo simulation based on forecasted future results. See Note 23, "Fair Value of Financial Instruments,"for further discussion related to the contingent consideration.
The following table summarizes the purchase price of Ravix:
(in thousands) | | | | |
Purchase price: | | October 1, 2021 | |
Cash paid at closing | | $ | 10,930 | |
Working capital adjustment | | | 83 | |
Contingent consideration | | | 2,195 | |
Total purchase price | | $ | 13,208 | |
The following table summarizes the estimated allocation of the Ravix assets acquired and liabilities assumed at the date of acquisition:
(in thousands) | | | | |
| | October 1, 2021 | |
Cash and cash equivalents | | $ | 225 | |
Restricted cash | | | 752 | |
Service fee receivable | | | 1,031 | |
Other receivables | | | 17 | |
Right-of-use asset | | | 116 | |
Goodwill | | | 7,905 | |
Intangible asset subject to amortization - customer relationships | | | 4,000 | |
Intangible asset not subject to amortization - trade name | | | 2,500 | |
Other assets | | | 133 | |
Total assets | | $ | 16,679 | |
| | | | |
Accrued expenses and other liabilities | | $ | 1,546 | |
Income taxes payable | | | 13 | |
Lease liability | | | 116 | |
Net deferred income tax liabilities | | | 1,796 | |
Total liabilities | | $ | 3,471 | |
| | | | |
Purchase price | | $ | 13,208 | |
The consolidated statements of operations include the earnings of Ravix from the date of acquisition. From the date of acquisition through December 31, 2021, Ravix earned revenue of $3.5 million and had a net loss of $0.2 million.
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
On December 1, 2020, the Company acquired 100% of the outstanding shares of PWI Holdings, Inc. 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 upon 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 third quarter of 2021, the Company finalized its fair value analysis of the assets acquired and liabilities assumed with the assistance of a third-party.
The Company records measurement period adjustments in the period in which the adjustments occur. During the third quarter of 2021, the Company recorded a cumulative net measurement period adjustment of $18.8 million compared to the amount recorded at December 31, 2020. The measurement period adjustments reflected changes in the estimated fair values of certain assets and liabilities, and the working capital true-up.
The measurement period adjustments resulted in an increase in amortization expense of $1.9 million related to the customer relationships intangible asset and a decrease to service fee and commission revenue of $1.9 million, both of which were recorded during the third quarter of 2021.
Unaudited Pro Forma Summary
The following unaudited pro forma summary presents the Company's consolidated financial statements for the year ended December 31, 2022 and December 31, 2021 as if CSuite, SNS and Ravix had been acquired on January 1 of the year prior to the acquisitions. The pro forma summary is presented for illustrative purposes only and does not purport to represent the results of our operations that would have actually occurred had the acquisitions occurred as of the beginning of the period presented or project our results of operations as of any future date or for any future period, as applicable. The pro forma results primarily include purchase accounting adjustments related to the acquisitions of CSuite, SNS and Ravix, interest expense and the amortization of debt issuance costs and discount associated with the related financing obtained in connection with the CSuite, SNS and Ravix acquisitions (see Note 12, "Debt"), tax related adjustments and acquisition-related expenses.
(in thousands, except per share data) | | Years ended December 31, |
| | 2022 | | 2021 |
Revenues | | $ 121,789 | | $ 113,342 |
Income (loss) from continuing operations attributable to common shareholders | | $ 35,009 | | $ (4,439) |
Basic earnings (loss) per share - continuing operations | | $ 1.52 | | $ (0.20) |
Diluted earnings (loss) per share - continuing operations | | $ 1.40 | | $ (0.20) |
VA Lafayette, LLC (formerly 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. Refer to Note 24, "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 a mortgage in the principal amount of $13.5 million (the "LA Mortgage") at the date of acquisition plus a premium of $3.5 million.
The acquisition 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, was allocated to the individual net assets acquired based on their relative fair values. In connection with the acquisition, the Company recorded an above-market lease intangible asset of $0.8 million and in-place and other lease intangible assets of $2.1 million.
The following table summarizes the allocation of the purchase price to the net assets of VA Lafayette at the date of acquisition:
(in thousands) | | | | |
Purchase price: | | December 30, 2021 | |
Cash | | $ | 2,386 | |
Acquisition costs | | | 249 | |
Liabilities assumed | | | 16,983 | |
Total purchase price | | $ | 19,618 | |
| | | | |
Fair value of net assets acquired: | | December 30, 2021 | |
Cash and cash equivalents | | $ | 365 | |
Other receivables | | | 133 | |
Property and equipment, net | | | 16,466 | |
Intangible asset subject to amortization - Above-market lease | | | 835 | |
Intangible asset subject to amortization - In-place and other lease assets | | | 2,114 | |
Accrued expenses and other liabilities | | | (50 | ) |
Net deferred income tax liabilities | | | (245 | ) |
Total fair value of net assets acquired | | $ | 19,618 | |
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
Since VA Lafayette was acquired on December 30, 2021, the consolidated statement of operations for the year ended December 31, 2021 did not include any revenue or earnings of VA Lafayette, as such items are immaterial.
During the fourth quarter of 2022, the Company began executing a plan to sell VA Lafayette, and as a result, VA Lafayette is reported as held for sale. Further information is contained in Note 5, "Disposal and Discontinued Operations" to the consolidated financial statements.
NOTE 5 DISPOSAL AND DISCONTINUED OPERATIONS
Professional Warranty Service Corporation
On July 29, 2022, Professional Warranty Services LLC ("PWS LLC"), a subsidiary of the Company entered into an Equity Purchase Agreement (the "Agreement") with Professional Warranty Service Corporation ("PWSC"), an 80% majority-owned, indirect subsidiary of the Company, Tyler Gordy, the president of PWSC and a 20% owner of PWSC ("Gordy") and PCF Insurance Services of the West, LLC ("Buyer"), pursuant to which PWS LLC and Gordy sold PWSC to Buyer.
The purchase price paid by Buyer to PWS LLC and Gordy consisted of $51.2 million in base purchase price, subject to customary adjustments for net working capital, and non-compensation related transaction expenses of approximately $1.7 million. As a result of the sale, the Company incurred compensation expenses of $5.4 million, primarily related to previously-granted awards to PWSC employees that are accounted for on a fair value basis, which are included in disposal of subsidiary transaction expenses in the consolidated statement of operations for the year ended December 31, 2022.
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 LLC and Gordy will also be entitled to receive an earnout payment in an amount equal to five times the EBITDA in excess of 103% of Closing EBITDA. The Company does not have access to the information needed to reasonably estimate the potential earnout payment and accordingly any gain related to the earnout payment will be recorded in the period the consideration is determined to be realizable.
As a result of the sale, the Company recognized a net gain on disposal of $37.9 million, net of direct selling costs of $1.7 million, during the year ended December 31, 2022. The sale of PWSC did not represent a strategic shift that would have a major effect on the Company's operations or financial results; therefore, PWSC is not presented as a discontinued operation. The earnings of PWSC, which is included in the Extended Warranty segment, are included in the consolidated statements of operations through the July 29, 2022 disposal date. The assets, liabilities and equity (including the non-controlling interest) of PWSC were deconsolidated effective July 29, 2022.
The sale of PWSC represents the disposal of a significant subsidiary of the Company, that had contributions to Extended Warranty service fee and commission revenue of $4.9 million and $8.0 million for the years ended December 31, 2022 and December 31, 2021, respectively. Additionally, PWSC had a pre-tax loss of $5.5 million for the year ended December 31, 2022 and pre-tax income of $0.6 million for the for the year ended December 31, 2021. For the years ended December 31, 2022 and December 31, 2021, pre-tax loss of $4.4 million and pre-tax income of $0.5 million was attributable to the controlling interest, respectively. At the July 29, 2022 disposal date, PWSC had service fee receivables totaling $0.7 million, intangible assets, net of $2.3 million, deferred service fees of $7.6 million and a non-controlling interest of ($2.2) million.
As a result of the sale, the Company incurred additional compensation expenses of $5.4 million that are included in disposal of subsidiary transaction expenses in the consolidated statement of operations for the for the year ended December 31, 2022.
(b) | Discontinued Operations |
Leased Real Estate Segment
The Company’s subsidiaries, VA Lafayette and CMC Industries Inc. ("CMC"), which includes CMC’s subsidiaries Texas Rail Terminal LLC and TRT Leaseco, LLC ("TRT"), comprised the Company's entire Leased Real Estate segment. Each of CMC, through indirect wholly owned subsidiary, TRT, and VA Lafayette own a single asset, which is real estate property. As further described below, on December 29, 2022, TRT sold its assets and at December 31, 2022, VA Lafayette was classified as held for sale.
In accordance with ASU No. 2014-08, Reporting of Discontinued Operations and Disclosures of Disposals of Components of an Entity, a disposal is categorized as a discontinued operation if the disposal group is a component of an entity or group of components that meets the held for sale criteria, is disposed of by sale, or is disposed of other than by sale, and represents a strategic shift that has or will have a major effect on an entity’s operations and financial results.
Leased Real Estate is a component of Kingsway since its operations and cash flows can be clearly distinguished, both operationally and for financial reporting purposes, from the rest of the reporting entity. A component of an entity may consist of multiple disposal groups and does not need to be disposed of in a single transaction. The disposal of the Leased Real Estate segment represents a strategic shift that will have a major effect on the Company's operations and financial results, as the disposal of the Leased Real Estate assets is in excess of 20% of the entity's total assets. As a result, the assets, liabilities, operating results and cash flows related to Leased Real Estate have been classified as discontinued operations in the consolidated financial statements for all periods presented.
Sale of CMC Real Property
CMC owned, through its indirect wholly owned subsidiary, TRT, 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 (the "Mortgages").
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
On December 22, 2022, TRT entered into a Purchase and Sale Agreement (the "CMC Agreement") with BNSF Dayton LLC ("Purchaser"), pursuant to which TRT agreed to sell to the Purchaser the Real Property. TRT was also the landlord and an affiliate of the Purchaser was the current tenant under the long-term triple net lease over the Real Property. Under the terms of the CMC Agreement, at the closing on December 29, 2022, TRT assigned, and the Purchaser assumed, the rights and obligations of the landlord under the existing long-term triple net lease.
The purchase price paid by the Purchaser at the closing consisted of $44.5 million in cash plus the assumption of the unpaid principal balance as of the closing of the Mortgages of approximately $170.7 million, netting cash proceeds of $21.4 million to Kingsway after taxes, fees and distribution to the minority shareholder. The Company recognized a gain on disposal of CMC of $0.2 million which is included in loss on disposal of discontinued operations, net of taxes in the consolidated statement of operations for the year ended December 31, 2022.
As discussed above, CMC and TRT are part of the Leased Real Estate disposal group. The sale of the Leased Real Estate's assets represents a strategic shift that will have a major effect on the Company's operations and financial results. As a result, CMC and its subsidiaries, have been classified as a discontinued operation and the results of their operations are reported separately for all periods presented. The assets and liabilities of CMC are presented as discontinued operations in the consolidated balance sheet at December 31, 2021.
VA Lafayette
During the fourth quarter of 2022, the Company began executing a plan to sell its subsidiary, VA Lafayette. VA Lafayette owns the LA Real Property, that is subject to a long-term lease and the LA Mortgage.
As discussed above, VA Lafayette is part of the Leased Real Estate disposal group. In conjunction with the sale of the CMC Real Property, the sale of the Leased Real Estate's assets represents a strategic shift that will have a major effect on the Company's operations and financial results. As a result, VA Lafayette has been classified as a discontinued operation and the results of its operations are reported separately for all periods presented. The assets and liabilities of VA Lafayette are presented as held for sale in the consolidated balance sheets at December 31, 2022 and December 31, 2021.
Summary financial information for Leased Real Estate included in
(loss) income from discontinued operations, net of taxes in the statements of operations for the years ended
December 31, 2022 and December 31, 2021 is presented below:
(in thousands) | Years ended December 31, | |
| 2022 | | 2021 | |
(Loss) income from discontinued operations, net of taxes: | | | | | | |
Revenues: | | | | | | |
Rental revenue | $ | 14,567 | | $ | 13,365 | |
Total revenues | | 14,567 | | | 13,365 | |
Expenses: | | | | | | |
Cost of services sold | | 204 | | | — | |
General and administrative expenses | | 20,778 | | | 3,488 | |
Leased real estate segment interest expense | | 6,387 | | | 6,164 | |
Non-operating other (expense) revenue | | 154 | | | 2,804 | |
Amortization of intangible assets | | 206 | | | 63 | |
Total expenses | | 27,729 | | | 12,519 | |
(Loss) income from discontinued operations before income tax benefit | | (13,162 | ) | | 846 | |
Income tax benefit | | (357 | ) | | (3,728 | ) |
(Loss) income from discontinued operations, net of taxes | $ | (12,805 | ) | $ | 4,574 | |
For the years ended December 31, 2022 and December 31, 2021, pre-tax loss from discontinued operations of $10.7 million and pre-tax income from discontinued operations of $0.7 million was attributable to the controlling interest, respectively.
The assets and liabilities of Leased Real Estate are presented as held for sale and as discontinued operations in the consolidated balance sheets at December 31, 2022 and December 31, 2021.
The carrying amounts of the major classes of assets and liabilities of Leased Real Estate presented as held for sale at December 31, 2022 and December 31, 2021 are as follows:
(in thousands) | | December 31, 2022 | | | December 31, 2021 | |
Assets | | | | | | | | |
Cash and cash equivalents | | $ | 570 | | | $ | 365 | |
Other receivables, net | | | — | | | | 133 | |
Property and equipment, net | | | 16,160 | | | | 16,466 | |
Intangible assets, net | | | 2,748 | | | | 2,949 | |
Assets held for sale | | $ | 19,478 | | | $ | 19,913 | |
Liabilities | | | | | | | | |
Accrued expenses and other liabilities | | $ | 473 | | | $ | 52 | |
Notes payable | | | 16,112 | | | | 16,983 | |
Liabilities held for sale | | $ | 16,585 | | | $ | 17,035 | |
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
The carrying amounts of the major classes of assets and liabilities of Leased Real Estate presented as discontinued operations at December 31, 2021 are as follows:
(in thousands) | | December 31, 2021 | |
Assets | | | | |
Cash and cash equivalents | | $ | 2,193 | |
Other receivables, net | | | 9,733 | |
Property and equipment, net | | | 91,019 | |
Goodwill | | | 60,983 | |
Intangible assets, net | | | 74,448 | |
Other assets | | | 11,096 | |
Assets of discontinued operations | | $ | 249,472 | |
Liabilities | | | | |
Accrued expenses and other liabilities | | $ | 2,596 | |
Notes payable | | | 181,631 | |
Liabilities of discontinued operations | | $ | 184,227 | |
Mendota Insurance Company, Mendakota Insurance Company and Mendakota Casualty Company
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.
During the third quarter of 2022, the buyer provided to the Company an analysis of the claims development that indicated that the Company's potential exposure with respect to the open claims was at the maximum obligation amount. Previous communications from the buyer noted no such development and the buyer was not obligated to provide development information to the Company until the first quarter of 2023. As a result of the newly provided information, the Company recorded a liability of $2.5 million, which is included in accrued expenses and other liabilities in the consolidated balance sheet at December 31, 2022 and loss on disposal of discontinued operations, net of taxes in the consolidated statement of operations for the year ended December 31, 2022. There were no payments made by the Company related to the open claims during the years ended December 31, 2022 and December 31, 2021. During the first quarter of 2023, the $2.0 million that had been previously deposited into an escrow account was released and remitted to the buyer to satisfy the Company's payment with respect to the open claims.
Loss on disposal of discontinued operations, net of taxes, related to Leased Real Estate and Mendota, in the statements of operations for the years ended December 31, 2022 and December 31, 2021 is comprised on the following:
(in thousands) | | Years ended December 31, | |
| | 2022 | | | 2021 | |
Loss on disposal of discontinued operations before income tax benefit | | | (26,751 | ) | | | — | |
Income tax benefit | | | (24,489 | ) | | | — | |
Loss on disposal of discontinued operations, net of taxes | | $ | (2,262 | ) | | $ | — | |
NOTE 6 VARIABLE INTEREST ENTITIES
Argo Holdings Fund I, LLC
The Company holds a 43.4% investment in Argo Holdings at December 31, 2022 and December 31, 2021. Argo Holdings makes investments, primarily in established lower middle market companies based in North America, through investments in search funds. The managing member of Argo Holdings is Argo Management Group, LLC ("Argo Management"), a wholly owned subsidiary of the Company. Argo Holdings is considered to be a VIE as the members holding equity at risk lack characteristics of a controlling financial interest. The Company holds a variable interest in Argo Holdings due to its right to absorb significant economics in Argo Holdings and through its controlling interest in Argo Management, through which the Company holds the power to direct the significant activities of Argo Holdings. As such, the Company was the primary beneficiary of Argo Holdings and consolidated Argo Holdings at December 31, 2022 and December 31, 2021.
Net Lease Investment Grade Portfolio, LLC
The Company holds a 71.0% investment in Net Lease at December 31, 2022 and December 31, 2021. Net Lease holds one commercial property under a triple net lease. The current property is encumbered by a mortgage loan. Net Lease is considered to be a VIE as the members holding equity at risk lack characteristics of a controlling financial interest. The Company holds a variable interest in Net Lease due to its right to absorb significant economics in Net Lease and to control the management decisions of Net Lease, which allows the Company to hold the power to direct the significant activities of Net Lease. As such, the Company is the primary beneficiary of Net Lease and consolidated Net Lease at December 31, 2022 and December 31, 2021.
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
The following table summarizes the assets and liabilities related to VIEs consolidated by the Company at December 31, 2022 and December 31, 2021:
(in thousands) | | December 31, | |
| | 2022 | | | 2021 | |
Assets | | | | | | | | |
Limited liability investments, at fair value | | $ | 17,059 | | | $ | 18,826 | |
Cash and cash equivalents | | | 573 | | | | 944 | |
Accrued investment income | | | 829 | | | | 716 | |
Total Assets | | | 18,461 | | | | 20,486 | |
Liabilities | | | | | | | | |
Accrued expenses and other liabilities | | | 333 | | | | 250 | |
Total Liabilities | | $ | 333 | | | $ | 250 | |
No arrangements exist requiring the Company to provide additional funding to the consolidated VIEs in excess of the Company’s unfunded commitments to its consolidated VIEs. At December 31, 2022 and December 31, 2021, the Company had no unfunded commitments. There are no restrictions on assets consolidated by these VIEs. There are no structured settlements of liabilities consolidated by these VIEs. Creditors have no recourse to the general credit of the Company as the primary beneficiary of these VIEs.
(b) | Non-Consolidated VIEs |
The Company’s investments include certain non-consolidated investments, primarily in limited liability companies and limited partnerships in which the Company holds variable interests, that are considered VIEs due to the legal entities holding insufficient equity; the holders of equity at risk in the legal entities lacking controlling financial interests; and/or the holders of equity at risk having non-proportional voting rights.
The Company’s risk of loss associated with its non-consolidated VIEs is limited and depends on the investment. Limited liability investments accounted for under the equity method are limited to the Company’s initial investments. At December 31, 2022 and December 31, 2021, the Company had no unfunded commitments to its non-consolidated VIEs.
The following table summarizes the carrying value and maximum loss exposure of the Company’s non-consolidated VIEs at December 31, 2022 and December 31, 2021:
(in thousands) | | December 31, | |
| | 2022 | | | 2021 | |
| | | | | | Maximum Loss | | | | | | | Maximum Loss | |
| | Carrying Value | | | Exposure | | | Carrying Value | | | Exposure | |
Investments in non-consolidated VIEs | | $ | 940 | | | $ | 940 | | | $ | 1,514 | | | $ | 1,514 | |
The following table summarizes the Company’s non-consolidated VIEs by category at December 31, 2022 and December 31, 2021:
(in thousands) | | December 31, | |
| | 2022 | | | 2021 | |
| | Carrying | | | | | | | Carrying | | | | | |
| | Value | | | Percent of total | | | Value | | | Percent of total | |
Investments in non-consolidated VIEs: | | | | | | | | | | | | | | | | |
Real estate related | | $ | — | | | | — | % | | $ | 628 | | | | 41.5 | % |
Non-real estate related | | | 940 | | | | 100.0 | % | | | 886 | | | | 58.5 | % |
Total investments in non-consolidated VIEs | | $ | 940 | | | | 100.0 | % | | $ | 1,514 | | | | 100.0 | % |
The following table presents aggregated summarized financial information of the Company’s non-consolidated VIEs at December 31, 2022 and December 31, 2021. For certain of the non-consolidated VIEs, the financial information is presented on a lag basis, consistent with how the changes in the Company’s share of the net asset values of these equity method investees are recorded in net investment income. The difference between the end of the reporting period of an equity method investee and that of the Company is typically no more than three months.
(in thousands) | | December 31, | |
| | 2022 | | | 2021 | |
Assets | | $ | 241,050 | | | $ | 283,432 | |
Liabilities | | $ | 330,470 | | | $ | 299,340 | |
Equity | | $ | (89,420 | ) | | $ | (15,908 | ) |
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
(in thousands) | | December 31, | |
| | 2022 | | | 2021 | |
Net income | | $ | 16,330 | | | $ | 18,647 | |
NOTE 7 INVESTMENTS
The amortized cost, gross unrealized gains and losses, and estimated fair value of the Company's available-for-sale investments at December 31, 2022 and December 31, 2021 are summarized in the tables shown below:
(in thousands) | | December 31, 2022 | |
| | | | | | Gross | | | Gross | | | | | |
| | Amortized | | | Unrealized | | | Unrealized | | | Estimated Fair | |
| | Cost | | | Gains | | | Losses | | | Value | |
Fixed maturities: | | | | | | | | | | | | | | | | |
U.S. government, government agencies and authorities | | $ | 15,797 | | | $ | — | | | $ | 717 | | | $ | 15,080 | |
States, municipalities and political subdivisions | | | 2,390 | | | | — | | | | 158 | | | | 2,232 | |
Mortgage-backed | | | 9,058 | | | | 1 | | | | 647 | | | | 8,412 | |
Asset-backed | | | 1,682 | | | | — | | | | 72 | | | | 1,610 | |
Corporate | | | 11,200 | | | | 1 | | | | 944 | | | | 10,257 | |
Total fixed maturities | | $ | 40,127 | | | $ | 2 | | | $ | 2,538 | | | $ | 37,591 | |
(in thousands) | | December 31, 2021 | |
| | | | | | Gross | | | Gross | | | | | |
| | Amortized | | | Unrealized | | | Unrealized | | | Estimated Fair | |
| | Cost | | | Gains | | | Losses | | | 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 December 31, 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) | | December 31, 2022 | |
| | | | | | Estimated Fair | |
| | Amortized Cost | | | Value | |
Due in one year or less | | $ | 7,163 | | | $ | 7,034 | |
Due after one year through five years | | | 26,317 | | | | 24,628 | |
Due after five years through ten years | | | 2,239 | | | | 1,982 | |
Due after ten years | | | 4,408 | | | | 3,947 | |
Total | | $ | 40,127 | | | $ | 37,591 | |
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
The following tables highlight the aggregate unrealized loss position, by security type, of available-for-sale investments in unrealized loss positions as of December 31, 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) | | | | | | | | | | | | | | | | | | December 31, 2022 | |
| | Less than 12 Months | | | Greater than 12 Months | | | Total | |
| | Estimated | | | Unrealized | | | Estimated | | | Unrealized | | | Estimated | | | Unrealized | |
| | Fair Value | | | Loss | | | Fair Value | | | Loss | | | Fair Value | | | Loss | |
Fixed maturities: | | | | | | | | | | | | | | | | | | | | | | | | |
U.S. government, government agencies and authorities | | $ | 4,543 | | | $ | 126 | | | $ | 10,537 | | | $ | 591 | | | $ | 15,080 | | | $ | 717 | |
States, municipalities and political subdivisions | | | 1,040 | | | | 73 | | | | 937 | | | | 85 | | | | 1,977 | | | | 158 | |
Mortgage-backed | | | 2,248 | | | | 93 | | | | 5,756 | | | | 554 | | | | 8,004 | | | | 647 | |
Asset-backed | | | 1,251 | | | | 39 | | | | 299 | | | | 33 | | | | 1,550 | | | | 72 | |
Corporate | | | 3,244 | | | | 155 | | | | 6,760 | | | | 789 | | | | 10,004 | | | | 944 | |
Total fixed maturities | | $ | 12,326 | | | $ | 486 | | | $ | 24,289 | | | $ | 2,052 | | | $ | 36,615 | | | $ | 2,538 | |
(in thousands) | | | | | | | | | | | | | | | | | | December 31, 2021 | |
| | Less than 12 Months | | | Greater than 12 Months | | | Total | |
| | Estimated | | | Unrealized | | | Estimated | | | Unrealized | | | Estimated | | | Unrealized | |
| | Fair Value | | | Loss | | | Fair Value | | | Loss | | | Fair Value | | | 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 approximately208 and 138 individual available-for-sale investments that were in unrealized loss positions as of December 31, 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. Refer to "Significant Accounting Policies and Critical Estimates" section of Management's Discussion & Analysis 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 years ended December 31, 2022 and December 31, 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.
As of December 31, 2022 and December 31, 2021, the carrying value of limited liability investments totaled $1.0 million and $1.9 million, respectively. At December 31, 2022, the Company has no unfunded commitments related to limited liability investments.
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
Limited liability investments, at fair value represents the underlying investments of the Company’s consolidated entities Net Lease and Argo Holdings. As of December 31, 2022 and December 31, 2021, the carrying value of the Company's limited liability investments, at fair value was $17.1 million and $18.8 million, respectively. The Company recorded impairments related to limited liability investments, at fair value of less than $0.1 million and $0.1 million for the years ended December 31, 2022 and December 31, 2021, respectively, which are included in (loss) gain on change in fair value of limited liability investments, at fair value in the consolidated statements of operations. At December 31, 2022, the Company has no unfunded commitments related to limited liability investments, at fair value.
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 2021, one of Net Lease’s limited liability companies sold their investment property for $14.3 million. A portion of the proceeds from the sale were distributed to Net Lease. As a result of the distribution, Net Lease recorded a gain of $0.8 million related to its investment in the limited liability company, with an offsetting change in unrealized gain of $0.8 million, which collectively are included in net investment income in the consolidated statement of operations for the year ended December 31, 2021. |
| • | During the fourth quarter of 2020, one of Net Lease's limited liability companies sold their investment property. As a result of the three-month lag, the Company recorded this transaction in its first quarter 2021 financial statements. 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 for the year ended December 31, 2021. |
| • | Net Lease sold its final property in February 2023. |
As of December 31, 2022 and December 31, 2021, the carrying value of the Company’s investments in private companies totaled $0.8 million. For the years ended December 31, 2022 and December 31, 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 years ended December 31, 2022 and December 31, 2021.
Real estate investments represent investment real estate properties held by the Company’s consolidated subsidiary, Flower. As of December 31, 2022 and December 31, 2021, the carrying value of the Company’s real estate investments was zero and $10.7 million, respectively. The Company consolidates the financial statements of Flower on a three-month lag. On September 29, 2022, Flower sold their investment real estate properties for $12.2 million. A portion of the proceeds from the sale were used to repay the Flower note payable with an unpaid principal balance of $5.9 million at the transaction date. Flower recorded a gain of $1.5 million related to the sale, which is included in gain on change in fair value of real estate investments in the consolidated statement of operations for the year ended December 31, 2022.
Net investment income for the years ended December 31, 2022 and December 31, 2021, respectively, is comprised as follows:
(in thousands) | | Years ended December 31, | |
| | 2022 | | | 2021 | |
Investment income | | | | | | | | |
Interest from fixed maturities | | $ | 556 | | | $ | 242 | |
Dividends | | | 159 | | | | 125 | |
Income from limited liability investments | | | 293 | | | | 27 | |
Income from limited liability investments, at fair value | | | 4 | | | | 106 | |
Income from real estate investments | | | 795 | | | | 800 | |
Other | | | 612 | | | | 364 | |
Gross investment income | | | 2,419 | | | | 1,664 | |
Investment expenses | | | (114 | ) | | | (89 | ) |
Net investment income | | $ | 2,305 | | | $ | 1,575 | |
Gross realized gains and losses on available-for-sale investments, limited liability investments, limited liability investments, at fair value and investments in private companies for the years ended December 31, 2022 and December 31, 2021 is comprised as follows:
(in thousands) | | Years ended December 31, | |
| | 2022 | | | 2021 | |
Gross realized gains | | $ | 1,648 | | | $ | 1,917 | |
Gross realized losses | | | (439 | ) | | | (108 | ) |
Net realized gains | | $ | 1,209 | | | $ | 1,809 | |
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
(Loss) gain on change in fair value of equity investments for the years ended December 31, 2022 and December 31, 2021 is comprised as follows:
(in thousands) | | Years ended December 31, | |
| | 2022 | | | 2021 | |
Net gain recognized on equity investments sold during the period | | $ | — | | | $ | 13 | |
Change in unrealized losses on equity investments held at end of the period | | | (26 | ) | | | (255 | ) |
Loss on change in fair value of equity investments | | $ | (26 | ) | | $ | (242 | ) |
NOTE 8 GOODWILL
The following table summarizes goodwill activity for the years ended December 31, 2022 and December 31, 2021:
(in thousands) | | Extended Warranty | | | Kingsway Search Xcelerator | | | Corporate | | | Total | |
Balance, December 31, 2020 | | $ | 59,415 | | | $ | — | | | $ | 732 | | | $ | 60,147 | |
Acquisition | | | — | | | | 7,905 | | | | — | | | | 7,905 | |
Measurement period adjustment | | | (18,788 | ) | | | — | | | | — | | | | (18,788 | ) |
Balance, December 31, 2021 | | | 40,627 | | | | 7,905 | | | | 732 | | | | 49,264 | |
Acquisitions | | | — | | | | 5,708 | | | | — | | | | 5,708 | |
Goodwill disposed of related to PWSC | | | (9,474 | ) | | | — | | | | — | | | | (9,474 | ) |
Balance, December 31, 2022 | | $ | 31,153 | | | $ | 13,613 | | | $ | 732 | | | $ | 45,498 | |
As further discussed in Note 4, "Acquisitions," during 2022, the Company recorded goodwill of $4.1 million related to the acquisition of CSuite on November 1, 2021 and $1.6 million related to the acquisition of SNS on November 18, 2022. The goodwill related to these acquisitions is provisional and subject to adjustment during the measurement period. The Company expects to complete its purchase price allocations in early 2023. The estimates, allocations and calculations recorded at December 31, 2022 are subject to change as we obtain further information; therefore, the final fair values of the assets acquired and liabilities assumed may not agree with the estimates included in these consolidated financial statements.
As further discussed inNote 4, "Acquisitions," during 2021, the Company recorded goodwill of$7.9 million related to the acquisition of Ravix on October 1, 2021.
In 2020, the Company recorded goodwill of $39.0 million related to the acquisition of PWI on December 1, 2020 which was provisional and subject to adjustment during the measurement period. As further discussed inNote 4, "Acquisitions," during the third quarter of 2021, the Company recorded a cumulative net measurement period adjustment, related to the acquisition of PWI, that decreased goodwill by $18.8 million.
Goodwill is assessed for impairment annually as of November 30, or more frequently if events or circumstances indicate that the carrying value may not be recoverable. Although the Company believes its estimates of fair value are reasonable, actual financial results could differ from those estimates due to the inherent uncertainty involved in making such estimates. Changes in assumptions concerning future financial results or other underlying assumptions could have a significant impact on either the fair value of the reporting units, the amount of the goodwill impairment charge, or both. Based on the assessment performed, no goodwill impairments were recognized in 2022 and 2021.
NOTE 9 INTANGIBLE ASSETS
Intangible assets at December 31, 2022 and December 31, 2021 are comprised as follows:
(in thousands) | | | | | | December 31, 2022 | |
| | Gross Carrying | | | Accumulated | | | Net Carrying | |
| | Value | | | Amortization | | | Value | |
Intangible assets subject to amortization | | | | | | | | | | | | |
Database | | $ | 4,918 | | | $ | 4,918 | | | $ | — | |
Vehicle service agreements in-force | | | 3,680 | | | | 3,680 | | | | — | |
Customer relationships | | | 32,442 | | | | 13,630 | | | | 18,812 | |
Intangible assets not subject to amortization | | | | | | | | | | | | |
Trade names | | | 14,287 | | | | — | | | | 14,287 | |
Total | | $ | 55,327 | | | $ | 22,228 | | | $ | 33,099 | |
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
(in thousands) | | | | | | December 31, 2021 | |
| | Gross Carrying | | | Accumulated | | | Net Carrying | |
| | Value | | | Amortization | | | 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 | |
Non-compete | | | 266 | | | | 224 | | | | 42 | |
Intangible assets not subject to amortization | | | | | | | | | | | — | |
Trade names | | | 10,314 | | | | — | | | | 10,314 | |
Total | | $ | 50,823 | | | $ | 19,990 | | | $ | 30,833 | |
As discussed in Note 5, "Disposal and Discontinued Operations," the Company disposed of PWSC on July 29, 2022. PWSC had intangible assets with a gross carrying value of $6.2 million and a net carrying value of $2.3 million at the disposal date.
As further discussed in Note 4, "Acquisitions," during the fourth quarter of 2022, the Company recorded $4.0 million of separately identifiable intangible assets, related to acquired customer relationships and trade name, as part of the acquisition of CSuite on November 1, 2022. The customer relationships intangible asset of $2.5 million is being amortized over seven years based on the pattern in which the economic benefits of the intangible asset are expected to be consumed. The trade name intangible asset of $1.5 million is deemed to have indefinite useful life and is not amortized. The intangible assets related to this acquisition are provisional and subject to adjustment during the measurement period. The Company expects to complete its purchase price allocation in early 2023. The estimates, allocations and calculations recorded at December 31, 2022 are subject to change as we obtain further information; therefore, the final fair values of the assets acquired and liabilities assumed may not agree with the estimates included in these consolidated financial statements.
As further discussed in Note 4, "Acquisitions," during the fourth quarter of 2022, the Company recorded $6.7 million of separately identifiable intangible assets, related to acquired customer relationships and trade name, as part of the acquisition of SNS on November 18, 2022. The customer relationships intangible asset of $3.6 million is being amortized over nine years based on the pattern in which the economic benefits of the intangible asset are expected to be consumed. The trade name intangible asset of $3.1 million is deemed to have indefinite useful life and is not amortized. The intangible assets related to this acquisition are provisional and subject to adjustment during the measurement period. The Company expects to complete its purchase price allocation in early 2023. The estimates, allocations and calculations recorded at December 31, 2022 are subject to change as we obtain further information; therefore, the final fair values of the assets acquired and liabilities assumed may not agree with the estimates included in these consolidated financial statements.
As further discussed in Note 4, "Acquisitions," during the fourth quarter of 2021, the Company recorded $6.5 million of separately identifiable intangible assets, related to acquired customer relationships and trade name, as part of the acquisition of Ravix on October 1, 2021. The customer relationships intangible asset of $4.0 million is being amortized over seven years based on the pattern in which the economic benefits of the intangible asset are expected to be consumed. The trade name intangible asset of $2.5 million is deemed to have indefinite useful life and is not amortized.
The Company's other 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 7 to 15 years. Amortization of intangible assets was $6.1 million and $4.8 million for the years ended December 31, 2022 and December 31, 2021, respectively. The estimated aggregate future amortization expense of all intangible assets is $5.6 million for 2023, $4.3 million for 2024, $3.1 million for 2025, $2.2 million for 2026, $1.6 million for 2027 and $2.0 million thereafter.
The trade names intangible assets have indefinite useful lives and are not amortized. All intangible assets with indefinite useful lives are reviewed annually by the Company for impairment. No impairment charges were taken on intangible assets in 2022 or 2021.
NOTE 10 PROPERTY AND EQUIPMENT
Property and equipment at December 31, 2022 and December 31, 2021 are comprised as follows:
(in thousands) | | | | | | December 31, 2022 | |
| | Total Property and Equipment | |
| | | | | | Accumulated | | | | | |
| | Cost | | | Depreciation | | | Carrying Value | |
Leasehold improvements | | $ | 485 | | | $ | 206 | | | $ | 279 | |
Furniture and equipment | | | 375 | | | | 319 | | | | 56 | |
Computer hardware | | | 954 | | | | 516 | | | | 438 | |
Total | | $ | 1,814 | | | $ | 1,041 | | | $ | 773 | |
(in thousands) | | | | | | December 31, 2021 | |
| | Total Property and Equipment | |
| | | | | | Accumulated | | | | | |
| | Cost | | | Depreciation | | | Carrying Value | |
Leasehold improvements | | $ | 286 | | | $ | 163 | | | $ | 123 | |
Furniture and equipment | | | 562 | | | | 442 | | | | 120 | |
Computer hardware | | | 2,488 | | | | 1,630 | | | | 858 | |
Total | | $ | 3,336 | | | $ | 2,235 | | | $ | 1,101 | |
For the years ended December 31, 2022 and December 31, 2021, depreciation expense on property and equipment of $0.3 million and $0.2 million, respectively, is included in general and administrative expenses in the consolidated statements of operations.
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
NOTE 11 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 12, "Debt") to a fixed interest rate of 1.18%. On September 15, 2022, the interest rate swap agreement was amended to convert from a variable Secured Overnight Financing Rate ("SOFR") to a fixed interest rate of 1.103%. 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 statement of operations.
The notional amount of the interest rate swap contract is$8.6 million at December 31, 2022. At December 31, 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 years ended December 31, 2022 and December 31, 2021, the Company recognized a gain of $0.3 million and a loss of less than $0.1 million, respectively, related to the change in fair value of the interest rate swap, which is included in interest expense in the consolidated statements of operations and within cash flows (used in) provided by operating activities from continuing operations in the consolidated statements of cash flows. Net cash receipts of $0.1 million were made to the Company during the year ended December 31, 2022 and net cash payments of less than $0.1 million were made by the Company during the year ended December 31, 2021, to settle a portion of the liabilities related to the interest rate swap agreement. These cash receipts and payments are reflected as cash inflows or outflows in the consolidated statements of cash flows within net cash (used in) provided by operating activities from continuing operations.
(b) | Trust preferred debt repurchase options: |
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 a purchase price equal to 63.75% of the outstanding principal and deferred interest ( "August Option"). Originally, the agreement called for a repurchase at 63%, which escalated to 63.75% once the September 26, 2022 agreement (described below) was signed. 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) the date that all four of the preferred debt instruments have been repurchased and (ii) the nine month anniversary of the agreement ( "May Termination Date"), all interest on the four preferred debt instruments will continue to accrue. However, with respect to TruPs that are repurchased prior to the May 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 May Termination Date.
The Company paid approximately $2.0 million to the holder for this option and the Company has until the May Termination Date to execute the repurchases. If the Company repurchases less than $30.0 million of principal and deferred interest, or fails to purchase any principal or deferred interest within one year, then the $2.0 million paid is forfeited. If the Company repurchases an amount equal to or greater than $30.0 million, then the $2.0 million paid would be applied to such repurchases.
On September 20, 2022, the Company entered into an additional agreement with the same party to the August 2, 2022 agreement that gives the Company the option to repurchase up to 100% of the holder’s principal and deferred interest for 63.75% of the outstanding principal and deferred interest relating to a portion of a fifth TruPs held ( "September 20 Option"). The September 20, 2022 agreement is subject to the same terms and conditions as the August 2, 2022 and no additional consideration was paid.
On September 26, 2022, the Company entered into an agreement with a holder of a portion of one of the TruPs that gives the Company the option to repurchase up to 100% of the holder’s principal and deferred interest for a purchase price equal to 63% of the outstanding principal and deferred interest ( "September 26 Option").
Until the earlier of (i) the date that all of the preferred debt instrument has been repurchased and (ii) the May Termination Date, all interest on the preferred debt instrument will continue to accrue. However, with respect to TruPs that are repurchased prior to the May 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 the TruPs that are repurchased prior to the May Termination Date.
The Company paid approximately $0.3 million to the holder for this option and the Company has until the May Termination Date to execute the repurchase. If the Company fails to purchase any principal or deferred interest by the May Termination Date, then the $0.3 million paid is forfeited. If the Company repurchases any of the TruPs, then the $0.3 million paid would be applied to any repurchases.
The August Option, September 20 Option and September 26 Options (collectively "the TruPs Options") are derivative contracts. The Company's accounting policies do not apply hedge accounting treatment to derivative instruments. The TruPs options are recorded in the consolidated balance sheets at fair value with changes in fair value recorded in the consolidated statements of operations.
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
The notional amount of the TruPs Options contracts is $59.7 million at December 31, 2022. At December 31, 2022, the fair value of the TruPs Options contracts was an asset of $19.0 million, which is included in other assets in the consolidated balance sheet. See Note 23, "Fair Value of Financial Instruments," for further discussion. During the year ended December 31, 2022, the Company recognized an initial gain of $11.4 million, equal to the difference between the fair value of the TruPs Options contracts at the date of inception and the cash consideration paid, and a subsequent gain on change in fair value of $5.3 million, both of which are included in gain on change in fair value of derivative asset option contracts in the consolidated statement of operations and as an adjustment to calculate cash flows used in operating activities from continuing operations in the consolidated statement of cash flows. No cash payments were made to repurchase any of the TruPs during the year ended December 31, 2022 with respect to the TruPs Options contracts.
NOTE 12 DEBT
Debt consists of the following instruments at December 31, 2022 and December 31, 2021:
(in thousands) | | December 31, 2022 | | | December 31, 2021 | |
| | Principal | | | Carrying Value | | | Fair Value | | | Principal | | | Carrying Value | | | Fair Value | |
Bank loans: | | | | | | | | | | | | | | | | | | | | | | | | |
2021 Ravix Loan | | $ | 5,300 | | | $ | 5,300 | | | $ | 5,460 | | | $ | 6,000 | | | $ | 5,847 | | | $ | 5,936 | |
2022 Ravix Loan | | | 5,950 | | | | 5,754 | | | | 6,245 | | | | — | | | | — | | | | — | |
SNS Loan | | | 6,850 | | | | 6,755 | | | | 6,921 | | | | — | | | | — | | | | — | |
2020 KWH Loan | | | 16,708 | | | | 16,472 | | | | 16,819 | | | | 21,186 | | | | 20,870 | | | | 20,815 | |
Total bank loans | | | 34,808 | | | | 34,281 | | | | 35,445 | | | | 27,186 | | | | 26,717 | | | | 26,751 | |
Notes payable: | | | | | | | | | | | | | | | | | | | | | | | | |
Flower Note | | | — | | | | — | | | | — | | | | 6,411 | | | | 6,411 | | | | 7,101 | |
Total notes payable | | | — | | | | — | | | | — | | | | 6,411 | | | | 6,411 | | | | 7,101 | |
Subordinated debt | | | 90,500 | | | | 67,811 | | | | 67,811 | | | | 90,500 | | | | 60,973 | | | | 60,973 | |
Total | | $ | 125,308 | | | $ | 102,092 | | | $ | 103,256 | | | $ | 124,097 | | | $ | 94,101 | | | $ | 94,825 | |
Subordinated debt mentioned above consists of the following trust preferred debt instruments:
| | Principal | | | | |
Issuer | | (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 |
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 "2021 Ravix Loan"). The 2021 Ravix Loan requires monthly payments of principal and interest. The 2021 Ravix Loan has an annual interest rate equal to the greater of the Prime Rate plus 0.5%, or 3.75%. At December 31, 2022, the interest rate was 8.00%. The term loan matures on October 1, 2027 and the revolver was scheduled to mature on October 1, 2023 (see discussion below related to the 2022 Ravix Loan). Subsequent to October 1, 2021, Ravix borrowed and made payments under the revolver. The carrying values at December 31, 2022 and December 31, 2021 for the 2021 Ravix Loan includes $5.1 millionand $5.7 million, respectively, related to the term loan and zero and $0.1 million related to the revolver. The Company also recorded as a discount to the carrying value of the 2021 Ravix Loan issuance costs of $0.2 million specifically related to the 2021 Ravix Loan. The 2021 Ravix Loan is carried in the consolidated balance sheet at December 31, 2022 at its unpaid principal balance.
Subsequent to the acquisition of CSuite on November 1, 2022, CSuite became a wholly owned subsidiary of Ravix LLC. As a result of the acquisition of CSuite, on November 16, 2022, the 2021 Ravix Loan was amended to (1) include CSuite as a borrower; (2) borrow an additional principal amount of $6.0 million in the form of a supplemental term loan (the "2022 Ravix Loan"); and (3) amend the maturity date and interest rate of the $1.0 million revolver (the "2022 Revolver"). The 2022 Ravix Loan requires monthly payments of principal and interest. The 2022 Ravix Loan matures on November 16, 2028 and has an annual interest rate equal to the Prime Rate plus 0.75%. At December 31, 2022, the interest rate was 8.25%. The 2022 Revolver matures on November 16, 2024 and has an annual interest rate equal to the Prime Rate plus 0.50%. At December 31, 2022, the balance of the 2022 Revolver was zero.
The Company also recorded as a discount to the carrying value of the 2022 Ravix Loan issuance costs of $0.1 million specifically related to the 2022 Ravix Loan. The 2022 Ravix Loan is carried in the consolidated balance sheet at December 31, 2022 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.
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
The 2022 Ravix Loan and the 2021 Ravix Loan were not deemed to be substantially different; therefore, the 2022 Ravix Loan is accounted for as a modification of the 2021 Ravix Loan and a new effective interest rate was determined based on the carrying amount of the 2021 Ravix Loan. The issuance costs related to the 2022 Ravix Loan, along with the existing unamortized issuance costs from the 2021 Ravix Loan, are being amortized over the remaining term of the 2022 Ravix Loan using the effective interest rate.
The fair values of the 2021 Ravix Loan and the 2022 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 2021 Ravix Loan and the 2022 Ravix Loan are secured by certain of the equity interests and assets of Ravix and CSuite.
The 2021 Ravix Loan and the 2022 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 2021 Ravix Loan and 2022 Ravix Loan that, among other things, restrict Ravix and CSuite’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.
SNS
As part of the asset acquisition of SNS on November 18, 2022, the Company formed Secure Nursing Service LLC, who became a wholly owned subsidiary of Pegasus Acquirer Holdings LLC ("Pegasus LLC"), and together they borrowed from a bank a principal amount of $6.5 million in the form of a term loan, and established a $1.0 million revolver to finance the acquisition of SNS (together, the "SNS Loan"). The SNS Loan has an annual interest rate equal to the greater of the Prime Rate plus 0.5%, or 5.00%. At December 31, 2022, the interest rate was 8.00%. Monthly principal payments on the term loan begin on November 15, 2023. The revolver matures on November 18, 2023 and the term loan matures on November 18, 2028. Subsequent to November 18, 2022, SNS borrowed under the revolver. The carrying value at December 31, 2022 for the SNS Loan includes $6.4 million related to the term loan and $0.4 million related to the revolver.
The Company also recorded as a discount to the carrying value of the SNS Loan issuance costs of $0.1 million specifically related to the SNS Loan. The SNS Loan is carried in the consolidated balance sheet at its amortized cost, which reflects the amortization of the debt discount and issuance costs using the effective interest rate method. The fair value of the SNS 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 SNS Loan is secured by certain of the equity interests and assets of SNS.
The SNS Loan contains a number of covenants, including, but not limited to, a leverage ratio and a fixed charge ratio and limits on annual capital expenditures, all of which are as defined in and calculated pursuant to the SNS Loan that, among other things, restrict SNS’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 original subsidiaries included 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 the Secured Overnight Financing Rate ("SOFR"), having a floor of 0.75%, plus spreads ranging from 2.62% to 3.12%. At December 31, 2022, the interest rate was 6.96%. The 2020 KWH Loan matures on December 1, 2025. The carrying values at December 31, 2022 and December 31, 2021 include $16.0 millionand $20.4 million, respectively, related to the term loan and $0.5 million and $0.5 million, respectively, related to the revolver.
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 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
Flower
On January 5, 2015, 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 sheet at December 31, 2021 ("the Flower Note"). The Flower Note required monthly payments of principal and interest and was secured by certain investments of Flower. The Flower Note was scheduled to mature on December 10, 2031 and had a fixed interest rate of 4.81%. On September 29, 2022, Flower sold its investment real estate properties and used a portion of the sales proceeds to repay the unpaid principal balance of the Flower Note. The carrying value of the Flower Note of $6.4 million at December 31, 2021 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 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. The forgiveness 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 in the consolidated statement of operations for the years ended December 31, 2021.
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 23, "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 loss. Of the $6.8 million increase in fair value of the Company’s subordinated debt between December 31, 2021 and December 31, 2022, $1.9 million is reported as increase in fair value of debt attributable to instrument-specific credit risk in the Company's consolidated statements of comprehensive income (loss) and $4.9 million is reported as loss on change in fair value of debt in the Company’s consolidated statements of operations. Of the $10.0 million increase in fair value of the Company’s subordinated debt between December 31, 2020 and December 31, 2021, $6.8 million is reported as increase 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 is 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 December 31, 2022 and December 31, 2021, deferred interest payable of $25.5 million and $18.7 million, respectively, is included in accrued expenses and other liabilities in the consolidated balance sheets.
The agreements governing the 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.
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
NOTE 13 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 year ended December 31, 2022 were $0.8 million and $0.2 million, respectively. Operating lease costs and variable lease costs included in general and administrative expenses for the year ended December 31, 2021 were $1.0 million and $0.1 million, respectively.
The annual maturities of lease liabilities as of December 31, 2022 were as follows:
(in thousands) | | Lease Commitments | |
2023 | | $ | 438 | |
2024 | | | 405 | |
2025 | | | 231 | |
2026 | | | 167 | |
2027 | | | 107 | |
2028 and thereafter | | | 17 | |
Total undiscounted lease payments | | | 1,365 | |
Imputed interest | | | 148 | |
Total lease liabilities | | $ | 1,217 | |
Lease liabilities are included in accrued expenses and other liabilities in the consolidated balance sheets. The weighted-average remaining lease term for operating leases was 3.57 years as of December 31, 2022. The weighted average discount rate of operating leases was 5.84% as of December 31, 2022. Cash paid for amounts included in the measurement of lease liabilities was $0.8 million and $1.0 million for the years ended December 31, 2022 and December 31, 2021, respectively.
Supplemental non-cash information related to leases for the year ended December 31, 2022 includes right-of-use assets of $0.3 million acquired in exchange for $0.5 million of lease obligations.
NOTE 14 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, 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) | | | Years ended December 31, | |
| | | 2022 | | | 2021 | |
| | | | | | | | | |
Vehicle service agreement fees and GAP commissions | IWS, Geminus and PWI | | $ | 58,775 | | | $ | 57,756 | |
Maintenance support service fees | Trinity | | | 5,815 | | | | 4,871 | |
Warranty product commissions | Trinity | | | 4,564 | | | | 4,317 | |
Homebuilder warranty service fees | PWSC (a) | | | 4,348 | | | | 7,099 | |
Homebuilder warranty commissions | PWSC (a) | | | 540 | | | | 876 | |
Business services consulting fees | Ravix, CSuite and SNS | | | 19,238 | | | | 3,482 | |
Service fee and commission revenue | | $ | 93,280 | | | $ | 78,401 | |
|
|
Through the
July 29, 2022 disposal
|
During the first quarter of 2022, IWS recorded a net charge of $0.9 million relating to a change in estimate in accounting for deferred revenue and deferred contract costs associated with vehicle service agreement fees, resulting in an increase to deferred service fees of $1.1 million and an increase in deferred contract costs of $0.2 million.
Receivables from contracts with customers are reported as service fee receivable, net in the consolidated balance sheets and at December 31, 2022 and December 31, 2021 were$10.3 million and $6.7 million, respectively. The increase in receivables from contracts with customers is primarily due to receivables related to CSuite and SNS, which were acquired on November 1, 2022 and November 18, 2022, respectively, and the timing difference between the Company's satisfaction of performance obligations and customer payments; partially offset by a decrease due to the disposal of PWSC on July 29, 2022.
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
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 years ended December 31, 2022 and December 31, 2021 were as follows:
(in thousands) | | Years ended December 31, | |
Balance, December 31, 2020 | | $ | 87,945 | |
Deferral of revenue | | | 60,415 | |
Recognition of deferred service fees | | | (59,143 | ) |
Balance, December 31, 2021 | | | 89,217 | |
Deferral of revenue | | | 61,058 | |
Recognition of deferred service fees | | | (59,966 | ) |
Deferred service fees disposed of related to PWSC | | | (7,596 | ) |
Balance, December 31, 2022 | | $ | 82,713 | |
The decrease in deferred service fees during the year ended December 31, 2022 is primarily due to the disposal of PWSC on July 29, 2022, partially offset by additions to deferred service fees in excess of deferred service fees recognized during the year ended December 31, 2022 as cash sales have begun to increase. The increase in deferred service fees during the year ended December 31, 2021 is primarily due to additions to deferred service fees in excess of deferred service fees recognized during the year ended December 31, 2021, that was partially offset by the adjustment recorded in the third quarter of 2021 of $3.6 million to reduce PWI’s acquisition date deferred revenue to fair value.
The Company expects to recognize within one year as service fee and commission revenue approximately 52.7% of the deferred service fees as of December 31, 2022. Approximately $43.2 million and $44.2 million of service fee and commission revenue recognized during the years ended December 31, 2022 and December 31, 2021 was included in deferred service fees as of December 31, 2021 and December 31, 2020, respectively.
Deferred contract costs
Deferred contract costs represent the deferral of incremental costs to obtain or fulfill a contract with a customer. The deferred contract costs balances and related amortization expense for the years ended December 31, 2022 and December 31, 2021 are comprised as follows:
(in thousands) | | Years ended December 31, 2022 | | | Years ended December 31, 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 January 1, net | | $ | 10,850 | | | $ | 80 | | | $ | 10,930 | | | $ | 8,759 | | | $ | 76 | | | $ | 8,835 | |
Additions | | | 9,273 | | | | 21 | | | | 9,294 | | | | 8,674 | | | | 27 | | | | 8,701 | |
Amortization | | | (6,949 | ) | | | (18 | ) | | | (6,967 | ) | | | (6,583 | ) | | | (23 | ) | | | (6,606 | ) |
Balance at December 31, net | | $ | 13,174 | | | $ | 83 | | | $ | 13,257 | | | $ | 10,850 | | | $ | 80 | | | $ | 10,930 | |
No impairment charges related to deferred contract costs were recorded in 2022 or 2021.
NOTE 15 INCOME TAXES
The Company and all of its eligible U.S. subsidiaries file a U.S. consolidated federal income tax return ("KFSI Tax Group"). The method of allocating federal income taxes among the companies in the KFSI Tax Group is subject to written agreement, approved by each company's Board of Directors. The allocation is made primarily on a separate return basis, with current credit for any net operating losses or other items utilized in the consolidated federal income tax return. The Company’s non-U.S. subsidiaries file separate foreign income tax returns.
Income tax expense (benefit) consists of the following:
(in thousands) | | Years ended December 31, | |
| | 2022 | | | 2021 | |
| | | | | | | | |
Current income tax expense | | $ | 3,419 | | | $ | 395 | |
Deferred income tax expense (benefit) | | | 1,406 | | | | (4,311 | ) |
Income tax expense (benefit) | | $ | 4,825 | | | $ | (3,916 | ) |
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
Income tax expense (benefit) varies from the amount that would result by applying the applicable U.S. corporate income tax rate of 21% to income (loss) from continuing operations before income tax expense (benefit). The following table summarizes the differences:
(in thousands) | | Years ended December 31, | |
| | 2022 | | | 2021 | |
Income tax expense (benefit) at U.S. statutory income tax rate | | $ | 7,341 | | | $ | (1,393 | ) |
Valuation allowance | | | (10,100 | ) | | | (3,103 | ) |
Indefinite life intangibles | | | 106 | | | | 215 | |
Non-deductible compensation | | | 867 | | | | 649 | |
Investment income | | | (62 | ) | | | (253 | ) |
State income tax | | | 3,052 | | | | 338 | |
Disposition of subsidiary | | | 3,268 | | | | — | |
Non-taxable income | | | — | | | | (524 | ) |
Other | | | 353 | | | | 155 | |
Income tax expense (benefit) for continuing operations | | $ | 4,825 | | | $ | (3,916 | ) |
The tax effects of temporary differences that give rise to significant portions of the deferred income tax assets and liabilities are presented as follows:
(in thousands) | | December 31, | |
| | 2022 | | | 2021 | |
Deferred income tax assets: | | | | | | | | |
Losses carried forward | | $ | 137,155 | | | $ | 181,096 | |
Unpaid loss and loss adjustment expenses and unearned premiums | | | 3,902 | | | | 3,864 | |
Intangible assets | | | 1,380 | | | | 1,050 | |
Debt issuance costs | | | 474 | | | | 789 | |
Investments | | | 2,065 | | | | 1,198 | |
Deferred rent | | | 64 | | | | 586 | |
Deferred revenue | | | 147 | | | | 1,603 | |
Compensation | | | 306 | | | | 520 | |
Other | | | 155 | | | | 131 | |
Valuation allowance | | | (130,596 | ) | | | (169,678 | ) |
Deferred income tax assets | | $ | 15,052 | | | $ | 21,159 | |
Deferred income tax liabilities: | | | | | | | | |
Indefinite life intangibles | | $ | (3,815 | ) | | $ | (19,179 | ) |
Depreciation and amortization | | | (756 | ) | | | (14,485 | ) |
Fair value of debt | | | (7,598 | ) | | | (4,048 | ) |
Land | | | (47 | ) | | | (4,482 | ) |
Intangible assets | | | (2,606 | ) | | | (3,698 | ) |
Deferred revenue | | | (1,188 | ) | | | (1,443 | ) |
Investments | | | — | | | | (35 | ) |
Deferred acquisition costs | | | (2,784 | ) | | | (2,295 | ) |
Other | | | (434 | ) | | | (47 | ) |
Deferred income tax liabilities | | $ | (19,228 | ) | | $ | (49,712 | ) |
Net deferred income tax liabilities | | $ | (4,176 | ) | | $ | (28,553 | ) |
The Company maintains a valuation allowance for its gross deferred income tax assets of $130.6 million (U.S. operations - $130.6 million; Other - less than $0.1 million) and $169.7 million (U.S. operations - $169.7 million; Other - less than $0.1 million) at December 31, 2022 and December 31, 2021, respectively. The Company's businesses 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 December 31, 2022 and December 31, 2021 net deferred income tax assets, excluding the deferred income tax asset and liability amounts set forth in the paragraph below.
In 2022, the Company (i) increased by $2.1 million its valuation allowance associated with business interest expense carryforwards with an indefinite life; and (ii) increased by $0.1 million its valuation allowance relating to a change in indefinite life deferred income tax liabilities.
In2021, the Company (i) released into income $2.0 million of its valuation allowance associated with business interest expense carryforwards with an indefinite life and (ii) released into income $3.3 million and $0.8 million of its valuation allowance, as a result of its acquisitions of PWI and Ravix, respectively, due to net deferred income tax liabilities that are expected to reverse during the period in which the Company will have deferred income tax assets available.
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
The Company carries net deferred income tax liabilities of$4.2 million and $28.6 million at December 31, 2022 and December 31, 2021, respectively, that consists of:
| • | Zero and $8.2 million of deferred income tax liabilities that are scheduled to reverse in periods after the expiration of the KFSI Tax Group's consolidated U.S. net operating loss carryforwards; |
| • | $3.8 million and $23.8 million of deferred income tax liabilities related to land and indefinite life intangible assets; |
| • | Zero and $3.3 million of deferred income tax assets associated with business interest expense carryforwards with an indefinite life; |
| • | Zero and $0.5 million of deferred state income tax assets; and |
| • | $0.4 million and $0.4 of deferred state income tax liabilities. |
The Tax Cuts and Jobs Act (the "Tax Act") modified the U.S. net operating loss deduction, effective with respect to losses arising in tax years beginning after December 31, 2017. The Tax Act, however, did not limit the utilization, in 2018 and later tax years, of U.S. net operating losses generated in 2017 and prior tax years.
Amounts, originating dates and expiration dates of the KFSI Tax Group's consolidated U.S. net operating loss carryforwards, totaling $644.2 million, are as follows:
| | | | Net operating loss | |
Year of net operating loss | | Expiration date | | (in thousands) | |
| | | | | | |
2009 | | 2029 | | $ | 406,477 | |
2010 | | 2030 | | | 92,058 | |
2011 | | 2031 | | | 39,865 | |
2012 | | 2032 | | | 30,884 | |
2013 | | 2033 | | | 30,779 | |
2014 | | 2034 | | | 7,245 | |
2016 | | 2036 | | | 16,006 | |
2017 | | 2037 | | | 20,848 | |
In addition, not reflected in the table above, are net operating loss carryforwards of (i) $8.9 million relating to losses generated in separate U.S. tax return years, which losses will expire over various years through 2037 and (ii) $0.1 million relating to non-U.S. operations, which losses will expire over various years through 2042.
A reconciliation of the beginning and ending unrecognized tax benefits related to discontinued operations, exclusive of interest and penalties, is as follows:
(in thousands) | | December 31, | |
| | 2022 | | | 2021 | |
Unrecognized tax benefits - beginning of year | | $ | 65 | | | $ | 1,381 | |
Gross additions | | | — | | | | — | |
Gross reductions | | | (65 | ) | | | — | |
Impact due to expiration of statute of limitations | | | — | | | | (1,316 | ) |
Unrecognized tax benefits - end of year | | $ | — | | | $ | 65 | |
The amount of unrecognized tax benefits that, if recognized as of December 31, 2022 and December 31, 2021 would affect the Company's effective tax rate on discontinued operations, was a benefit of $0.1 million and $2.8 million, respectively.
During the year ended December 31, 2022, the Company recorded an income tax benefit of $0.2 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. The Company carried a liability for unrecognized tax benefits of zero and $0.1 million as of December 31, 2022 and December 31, 2021, respectively, that 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 (benefit). During the years ended December 31, 2022 and December 31, 2021, the Company recognized a benefit of $0.1 million and $1.5 million, respectively, for interest and penalties, which are included in (loss) income from discontinued operations, net of taxes. At December 31, 2022 and December 31, 2021, the Company carried an accrual for the payment of interest and penalties of zero and $0.1 million, respectively, that is included in income taxes payable in the consolidated balance sheets.
The federal income tax returns of the Company's U.S. operations for the years through 2018 are closed for Internal Revenue Service ("IRS") examination. The Company's federal income tax returns are not currently under examination by the IRS for any open tax years. The federal income tax returns of the Company's Canadian operations for the years through 2017 are closed for Canada Revenue Agency ("CRA") examination. The Company's Canadian federal income tax returns are not currently under examination by the CRA for any open tax years.
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
NOTE 16 EARNINGS (LOSS) PER SHARE
The following table sets forth the reconciliation of numerators and denominators for the basic and diluted earnings (loss) per share computation for the years ended December 31, 2022 and December 31, 2021:
(in thousands, except per share data) | | Years ended December 31, | |
| | 2022 | | | 2021 | |
Numerator: | | | | | | | | |
Income (loss) from continuing operations | | $ | 30,132 | | | $ | (2,714 | ) |
Plus (less): net loss (income) from continuing operations attributable to noncontrolling interests | | | 1,471 | | | | (1,660 | ) |
Less: dividends on preferred stock, net of tax | | | (306 | ) | | | (494 | ) |
Numerator used in calculating basic earnings (loss) per share from continuing operations attributable to common shareholders | | $ | 31,297 | | | $ | (4,868 | ) |
Adjustment to add-back dividends on preferred stock | | | 306 | | | | — | |
Adjustment for proportionate interest in Ravix and SNS's earnings attributable to common stock | | | 76 | | | | — | |
Numerator used in calculating diluted earnings (loss) per share from continuing operations attributable to common shareholders | | $ | 31,679 | | | $ | (4,868 | ) |
Loss (income) from discontinued operations | | | (15,067 | ) | | | 4,574 | |
Plus (less): net loss (income) from discontinued operations attributable to noncontrolling interests | | | 8,186 | | | | (542 | ) |
Numerator used in calculating diluted earnings (loss) per share - net income (loss) attributable to common shareholders | | $ | 24,798 | | | $ | (836 | ) |
Denominator: | | | | | | | | |
Weighted average basic shares | | | | | | | | |
Weighted average common shares outstanding | | | 22,961 | | | | 22,537 | |
Weighted average diluted shares | | | | | | | | |
Weighted average common shares outstanding | | | 22,961 | | | | 22,537 | |
Effect of potentially dilutive securities (a) | | | | | | | | |
Unvested restricted stock awards | | | 596 | | | | — | |
Warrants | | | 811 | | | | — | |
Convertible preferred stock | | | 936 | | | | — | |
Total weighted average diluted shares | | | 25,304 | | | | 22,537 | |
Basic earnings (loss) attributable to common shareholders: | | | | | | | | |
Continuing operations | | $ | 1.36 | | | $ | (0.22 | ) |
Discontinued operations | | $ | (0.30 | ) | | $ | 0.18 | |
Basic earnings (loss) per share - net income (loss) attributable to common shareholders | | $ | 1.06 | | | $ | (0.04 | ) |
Diluted earnings (loss) attributable to common shareholders: | | | | | | | | |
Continuing operations | | $ | 1.25 | | | $ | (0.22 | ) |
Discontinued operations | | $ | (0.27 | ) | | $ | 0.18 | |
Diluted earnings (loss) per share - net income (loss) attributable to common shareholders | | $ | 0.98 | | | $ | (0.04 | ) |
| (a) | Potentially dilutive securities consist of unvested restricted stock awards, warrants and convertible preferred stock. Because the Company is reporting a loss from continuing operations attributable to common shareholders for the year ended December 31, 2021, all potentially dilutive securities outstanding were excluded from the calculation of diluted loss from continuing operations per share since their inclusion would have been anti-dilutive. |
Basic earnings (loss) per share excludes dilution and is computed by dividing income (loss) attributable to common shareholders by the weighted-average number of common shares outstanding for the period. Diluted earnings (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. Potentially dilutive securities are excluded from the diluted earnings (loss) per share computation in loss periods and when the applicable exercise price is greater than the market price on the period end date as their effect would be anti-dilutive.
The following weighted-average potentially dilutive securities are not included in the diluted earnings (loss) per share calculations above because they would have had an antidilutive effect on the earnings (loss) per share:
| | Years ended December 31, | |
| | 2022 | | | 2021 | |
Unvested restricted stock awards | | | 550,528 | | | | 1,252,754 | |
Warrants | | | — | | | | 4,573,765 | |
Convertible preferred stock | | | — | | | | 1,060,831 | |
Total | | | 550,528 | | | | 6,887,350 | |
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
NOTE 17 STOCK-BASED COMPENSATION
On September 21, 2020, the Company's shareholders approved the 2020 Equity Incentive Plan (the "2020 Plan"). The 2020 Plan replaced the Company's previous 2013 Equity Incentive Plan (the "2013 Plan") with respect to the granting of future equity awards. The 2020 Plan permits the grant of Nonqualified Stock Options, Incentive Stock Options, Stock Appreciation Rights, Restricted Shares, Restricted Stock Units, Performance Share Awards, Dividend Equivalent Rights, Other Stock-Based Awards and Cash-Based Awards (collectively "Awards"). Under the 2020 Plan, an aggregate of 1.6 million common shares will be available for all Awards, subject to adjustment in the event of certain corporate transactions.
(a) | Restricted Stock Awards of the Company |
Under the 2013 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 December 31, 2022 was $0.5 million.
Under the 2020 Plan, the Company has granted restricted common stock awards to certain officers of the Company during 2022 and 2021 (the "2020 Plan Restricted Stock Awards"). The 2020 Plan 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 2020 Plan Restricted Stock Awards are amortized on a straight-line basis over the requisite service periods. The grant-date fair values of the 2020 Plan Restricted Stock Awards were determined using the closing price of Kingsway common stock on the dates of grant. During the year ended December 31, 2022, 130,918 shares of the 2020 Plan Restricted Stock Awards became fully vested. Total unamortized compensation expense related to unvested 2020 Plan Restricted Stock Awards at December 31, 2022 was $2.9 million.
The following table summarizes the activity related to unvested 2020 Plan Restricted Stock Awards and 2018 Restricted Stock Award (collectively "Restricted Stock Awards") during the year ended December 31, 2022:
| | | | | | Weighted-Average | |
| | Number of Restricted | | | Grant Date Fair Value | |
| | Stock Awards | | | (per Share) | |
Unvested at December 31, 2021 | | | 1,252,754 | | | $ | 5.09 | |
Granted | | | 25,111 | | | | 7.25 | |
Vested | | | (73,437 | ) | | | 4.67 | |
Cancelled for Tax Withholding | | | (57,481 | ) | | | 4.67 | |
Unvested at December 31, 2022 | | | 1,146,947 | | | $ | 5.19 | |
The unvested balance at December 31, 2022 in the table above is comprised of 646,947 shares of the 2020 Plan Restricted Stock Awards and 500,000 shares of the 2018 Restricted Stock Award.
Stock-based compensation expense related to the Restricted Stock Awards was $1.0 million and $2.1 million for the years ended December 31, 2022 and December 31, 2021, respectively.
(b) | Restricted Stock Awards of PWSC |
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 contained both a service and a performance condition that affected 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 contained both a service and a performance condition that affected vesting.
As discussed in Note 5, "Disposal and Discontinued Operations," the Company sold PWSC on July 29, 2022; therefore there are no outstanding Modified PWSC RSA and 2020 PWSC RSA reported in the consolidated balance sheet at December 31, 2022.
The service condition for the Modified PWSC RSA and the 2020 PWSC RSA vested according to a graded vesting schedule. The performance condition was 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 23, "Fair Value of Financial Instruments," for further discussion related to the valuation of the Modified PWSC RSA and the 2020 PWSC RSA.
The Modified PWSC RSA and the 2020 PWSC RSA included a noncontingent put option that was 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 was classified as a liability and included in accrued expenses and other liabilities in the consolidated balance sheet at December 31, 2021.
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
On February 20, 2022, both the service condition and performance condition of the Modified PWSC RSA became fully vested. During the year ended December 31, 2022, 437.50 shares of the Modified RSA became fully vested. At December 31, 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 December 31, 2022 was zero.
On February 20, 2022, both the service condition and performance condition of the 2020 PWSC RSA became fully vested. During the year ended December 31, 2022, 109.38 shares of the 2020 PWSC RSA became fully vested. At December 31, 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 December 31, 2022 was zero.
Stock-based compensation expense related to the Restricted Stock Awards of PWSC was $2.8 million and $1.2 million for the years ended December 31, 2022 and December 31, 2021, respectively.
(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 vests based on service and the achievement of criteria based on the internal rate of return ("IRR") 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%.
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 subject to the officer's continued employment through the applicable vesting dates.
On November 1, 2022, the Company modified the inputs related to the IRR portion of the 2021 Ravix RUA to be based on the combined internal rate of return of Ravix and CSuite. The modified portion of the awards was probable of vesting both immediately before and after the modification. As a result, the fair value of the award that is subject to the IRR was measured at the modification date and compared to the fair value of the modified portion of the award immediately prior to the modification, with the difference resulting in incremental compensation expense of less than $0.1 million. The incremental fair value was estimated using the Monte Carlo simulation model, using the following assumptions at the modification date: expected term of 2.92 years, expected volatility of 72% and risk-free interest rate of 4.44%; and the following assumptions prior to the modification: expected term of 2.92 years, expected volatility of 58% and risk-free interest rate of 4.44%.
During the year ended December 31, 2022, 24,306 shares of the 2021 Ravix RUA became fully vested. At December 31, 2022, there were 91,361 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 December 31, 2022 was $0.3 million.
Stock-based compensation expense related to the 2021 Ravix RUA was $0.1 million and $0.3 million for the years ended December 31, 2022 and December 31, 2021, respectively.
(d) | Restricted Common Unit Awards of SNS |
Pegasus LLC granted
75,000 restricted Class B common unit awards to an officer of SNS pursuant to an agreement dated
November 18, 2022 ("SNS RUA"). The SNS RUA vests based on service and the achievement of criteria based on the IRR of SNS.
The grant-date fair value of the SNS RUA was estimated using the Monte Carlo simulation model, using the following assumptions
: expected term of four years, expected volatility of 85%
and risk-free interest rate of 4.09%.
On November 18, 2022, 25,000 shares, representing one half of the service condition for the SNS RUA, became fully vested. The remainder of the service condition vests according to a graded vesting schedule and shall become fully vested subject to the officer's continued employment through the applicable vesting dates.
At December 31, 2022, there were 50,000 unvested shares of the SNS RUA with a weighted-average grant date fair value of $5.95 per share. Total unamortized compensation expense related to unvested SNS RUA at December 31, 2022was $0.3 million.
Stock-based compensation expense related to the SNS RUA was $0.2 million for the year ended December 31, 2022.
(e) | Employee Share Purchase Plan |
The Company has an employee share purchase plan ("ESPP Plan") whereby qualifying employees can choose each year to have up to 5% of their annual base earnings withheld to purchase the Company's common shares. After one year of employment, the Company matches 100% of the employee contribution amount, and the contributions vest immediately. All contributions are used by the plan administrator to purchase common shares in the open market. The Company's contribution is expensed as paid and for the years ended December 31, 2022 and December 31, 2021 totaled $0.2 million and $0.2 million, respectively.
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
NOTE 18 EMPLOYEE BENEFIT PLAN
The Company maintains a defined contribution plan in the United States for all of its qualified employees. Qualifying employees can choose to voluntarily contribute up to 60% of their annual earnings subject to an overall limitation of $20,500 and $19,500 in 2022 and 2021, respectively. The Company matches an amount equal to 50% of each participant's contribution, limited to the lesser of contributions up to 5% of a participant's earnings or $7,250.
The contributions for the plan vest based on years of service with 100% vesting after five years of service. The Company's contribution is expensed as paid and for the years ended December 31, 2022 and December 31, 2021 totaled $0.5 million and $0.4 million, respectively. All Company obligations to the plans were fully funded as of December 31, 2022.
NOTE 19 REDEEMABLE CLASS A PREFERRED STOCK
On May 13, 2013, the Company's shareholders approved an amendment to the Company's Articles of Incorporation to create an unlimited number of zero par value class A preferred shares. The Company's Board of Directors have the ability to fix the designation, rights, privileges, restrictions and conditions attaching to the shares of each series of preferred shares. The preferred shares have priority over the common shares.
There were 149,733 and 169,733 shares of Preferred Shares outstanding at December 31, 2022 and December 31, 2021, respectively. Each Preferred Share is convertible into 6.25 common shares at a conversion price of $4.00 per common share any time at the option of the holder prior to the redemption date. During 2022 and 2021, 20,000 and 13,143 Preferred Shares, respectively, were converted into 125,000 and 82,143 common shares, respectively, at the conversion price of $4.00 per common share, or $0.5 million and $0.3 million, respectively, at the option of the holders. As of December 31, 2022, the maximum number of common shares issuable upon conversion of the Preferred Shares is 935,831 common shares.
The Preferred Shares are not entitled to vote. The holders of the Preferred Shares are entitled to receive fixed, cumulative, preferential cash dividends at a rate of $1.25 per Preferred Share per year. The cash dividend rate shall be revised to $1.875 per Preferred Share per year if the dividend accumulates for a period greater than 30 consecutive months from the date of the most recent dividend payment. On and after February 3, 2016, the Company may redeem all or any part of the then outstanding Preferred Shares for the price of $28.75 per Preferred Share, plus accrued but unpaid dividends thereon, whether or not declared, up to and including the date specified for redemption. The Company will redeem any Preferred Shares not previously converted into common shares, and which remain outstanding on the redemption date, for the price of $25.00 per Preferred Share, plus accrued but unpaid dividends, whether or not declared, up to and including the date specified for redemption.
As discussed in "Note 2(s), "Summary of Significant Accounting Policies - Holding company liquidity," the outstanding Preferred Shares were required to be redeemed by the Company on April 1, 2021 ("Redemption Date"). However, the Company has exercised its right to defer payment of interest on its outstanding subordinated debt ("trust preferred securities") and, therefore is prohibited from redeeming any shares of its capital stock while payment of interest on the trust preferred securities is being deferred. As such, the Preferred Shares were not redeemed on the Redemption Date and instead remain outstanding with a redemption value of $6.0 million as of December 31, 2022. None of the terms of the Preferred Shares have changed after the Redemption Date. The Preferred Shares continue to be convertible into common shares at the discretion of the holder, and will accrue dividends until such time that either (i) the shares are converted at the discretion of the holder or (ii) the interest on the trust preferred securities is no longer deferred and the Company redeems the outstanding Preferred Shares at that time.
The Company accrues dividends through additional paid-in-capital at the stated coupon. At December 31, 2022 and December 31, 2021, accrued dividends of $2.3 million and $2.3 million were included in Class A preferred stock in the consolidated balance sheets. The redemption amount of the Preferred Shares was $6.0 million and $6.5 million at December 31, 2022 and December 31, 2021, respectively.
In accordance with FASB ASC Topic 480-10-S99-3A, SEC Staff Announcement: Classification and Measurement of Redeemable Securities, redemption features not solely within the control of the issuer are required to be presented outside of permanent equity on the consolidated balance sheets. As described above, the holder has the option to convert the Preferred Shares at any time; however, if not converted, they are required to be redeemed when the Company has sufficient legally available funds and is not otherwise prohibited from doing so. As such, the Preferred Shares are presented in temporary or mezzanine equity on the consolidated balance sheets.
NOTE 20 SHAREHOLDERS' EQUITY
The Company is authorized to issue 50,000,000 shares of zero par value common stock. There were 23,190,080 and 22,882,614 shares of common stock outstanding at December 31, 2022 and December 31, 2021, respectively.
There were no dividends declared during the years ended December 31, 2022 and December 31, 2021.
As described in Note 19, "Redeemable Class A Preferred Stock", during 2022 and 2021, 20,000 and 13,143 Preferred Shares, respectively, were converted into 125,000 and 82,143 common shares, respectively. As a result, $0.8 million and $0.5 million was reclassified from redeemable Class A preferred stock to additional paid-in capital on the consolidated balance sheets at December 31, 2022 and December 31, 2021, respectively.
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
There were 247,450 shares of treasury stock outstanding at December 31, 2022 and December 31, 2021. The Company records treasury stock at cost.
At December 31, 2022, the Company has 4,464,736 warrants outstanding that expire on September 15, 2023. The warrants are recorded in shareholders' equity and entitle each subscriber to purchase one common share of Kingsway at an exercise price of $5.00 for each warrant. During 2022 and 2021, warrants to purchase 109,029 and 350,000 shares of common stock, respectively, were exercised, resulting in cash proceeds of $0.5 million and $1.8 million, respectively.
In early January 2023, a holder exercised 611,547 of warrants, resulting in cash proceeds to the Company of $3.1 million. The Company has seen an increase in warrant exercises in 2023, compared to prior periods.
NOTE 21 ACCUMULATED OTHER COMPREHENSIVE INCOME
The table below details the change in the balance of each component of accumulated other comprehensive income, net of tax, for the years ended December 31, 2022 and December 31, 2021 as it relates to shareholders' equity attributable to common shareholders on the consolidated balance sheets.
(in thousands) | | | | | | | | | | | | | | | | |
| | | | | | | | | | Change in | | | | | |
| | | | | | | | | | Fair Value of | | | | | |
| | Unrealized | | | | | | | Debt | | | | | |
| | Gains | | | | | | | Attributable | | | Total | |
| | (Losses) on | | | Foreign | | | to | | | Accumulated | |
| | Available- | | | Currency | | | Instrument- | | | Other | |
| | for-Sale | | | Translation | | | Specific | | | Comprehensive | |
| | Investments | | | Adjustments | | | Credit Risk | | | Income (Loss) | |
Balance, December 31, 2020 | | $ | 216 | | | $ | (3,286 | ) | | $ | 41,129 | | | $ | 38,059 | |
| | | | | | | | | | | | | | | | |
Other comprehensive loss arising during the period | | | (463 | ) | | | — | | | | (6,844 | ) | | | (7,307 | ) |
Amounts reclassified from accumulated other comprehensive income | | | 27 | | | | — | | | | — | | | | 27 | |
Net current-period other comprehensive loss | | | (436 | ) | | | — | | | | (6,844 | ) | | | (7,280 | ) |
Balance, December 31, 2021 | | $ | (220 | ) | | $ | (3,286 | ) | | $ | 34,285 | | | $ | 30,779 | |
| | | | | | | | | | | | | | | | |
Other comprehensive loss arising during the period | | | (2,266 | ) | | | — | | | | (1,930 | ) | | | (4,196 | ) |
Amounts reclassified from accumulated other comprehensive income | | | 22 | | | | — | | | | — | | | | 22 | |
Net current-period other comprehensive loss | | | (2,244 | ) | | | — | | | | (1,930 | ) | | | (4,174 | ) |
Balance, December 31, 2022 | | $ | (2,464 | ) | | $ | (3,286 | ) | | $ | 32,355 | | | $ | 26,605 | |
It should be noted that the consolidated statements of comprehensive income (loss) present the components of other comprehensive loss, net of tax, only for the years ended December 31, 2022 and December 31, 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 consolidated statements of operations for the years ended December 31, 2022 and December 31, 2021:
(in thousands) | | Years ended December 31, | |
| | 2022 | | | 2021 | |
Reclassification of accumulated other comprehensive income from unrealized gains (losses) on available-for-sale investments to: | | | | | | | | |
Net realized gains | | $ | (22 | ) | | $ | (27 | ) |
Other-than-temporary impairment loss | | | — | | | | — | |
Income (loss) from continuing operations before income tax expense (benefit) | | | (22 | ) | | | (27 | ) |
Income tax expense (benefit) | | | — | | | | — | |
Income (loss) from continuing operations | | | (22 | ) | | | (27 | ) |
(Loss) income from discontinued operations, net of taxes | | | — | | | | — | |
Net income | | $ | (22 | ) | | $ | (27 | ) |
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
NOTE 22 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 two reportable segments: Extended Warranty and Kingsway Search Xcelerator.
Prior to the fourth quarter of 2022, the Company conducted its business through a third reportable segment, Leased Real Estate. Leased Real Estate included the following subsidiaries of the Company: CMC and VA Lafayette. As further discussed in Note 5, "Disposal and Discontinued Operations," both CMC and VA Lafayette have been classified as discontinued operations and the results of their operations are reported separately for all periods presented. As such, the Leased Real Estate segment no longer exists and all segmented information has been restated to exclude the Leased Real Estate segment for all periods presented.
Extended Warranty Segment
Extended Warranty includes the following subsidiaries of the Company: IWS, Geminus, PWI, PWSC and Trinity (collectively, "Extended Warranty"). As discussed in Note 5, "Disposal and Discontinued Operations," the Company disposed of PWSC on July 29, 2022. The earnings of PWSC are included in the consolidated statements of operations and the segment disclosures through the disposal date.
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 50 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 39 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 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 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.
Kingsway Search Xcelerator Segment
Kingsway Search Xcelerator includes the Company's subsidiaries CSuite, Ravix and SNS.
CSuite provides financial executive services, for project and interim-staffing engagements, and search services for full-time placements for customers throughout the United States.
Ravix provides outsourced financial services and human resources consulting for short or long duration engagements for customers in several states.
SNS provides healthcare staffing services to acute healthcare facilities on a contract or per diem basis in the United States, primarily in California.
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 consolidated 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.
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
Revenues by reportable segment reconciled to consolidated revenues for the years ended December 31, 2022 and December 31, 2021 were:
(in thousands) | | Years ended December 31, | |
| | 2022 | | | 2021 | |
Revenues: | | | | | | | | |
Service fee and commission revenue - Extended Warranty | | $ | 74,042 | | | $ | 74,919 | |
Service fee and commission revenue - Kingsway Search Xcelerator | | | 19,238 | | | | 3,482 | |
Total revenues | | $ | 93,280 | | | $ | 78,401 | |
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 income (loss) from continuing operations for the years ended December 31, 2022 and December 31, 2021 were:
(in thousands) | | Years ended December 31, | |
| | 2022 | | | 2021 | |
Segment operating income | | | | | | | | |
Extended Warranty (a) | | $ | 9,879 | | | $ | 12,636 | |
Kingsway Search Xcelerator | | | 3,548 | | | | 484 | |
Total segment operating income | | | 13,427 | | | | 13,120 | |
Net investment income | | | 2,305 | | | | 1,575 | |
Net realized gains | | | 1,209 | | | | 1,809 | |
Loss on change in fair value of equity investments | | | (26 | ) | | | (242 | ) |
(Loss) gain on change in fair value of limited liability investments, at fair value | | | (1,754 | ) | | | 2,391 | |
Gain on change in fair value of real estate investments | | | 1,488 | | | | — | |
Gain on change in fair value of derivative asset option contracts | | | 16,730 | | | | — | |
Interest expense | | | (8,092 | ) | | | (6,161 | ) |
Other revenue and expenses not allocated to segments, net | | | (17,206 | ) | | | (11,395 | ) |
Amortization of intangible assets | | | (6,133 | ) | | | (4,837 | ) |
Loss on change in fair value of debt | | | (4,908 | ) | | | (3,201 | ) |
Gain on disposal of subsidiary | | | 37,917 | | | | — | |
Gain on extinguishment of debt not allocated to segments | | | — | | | | 311 | |
Income (loss) from continuing operations before income tax expense (benefit) | | | 34,957 | | | | (6,630 | ) |
Income tax expense (benefit) | | | 4,825 | | | | (3,916 | ) |
Income (loss) from continuing operations | | $ | 30,132 | | | $ | (2,714 | ) |
| (a) | For the year ended December 31, 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 of extinguishment of debt totaled $10.5 million for the year ended December 31, 2021, respectively. See Note 12, "Debt" for further discussion. |
NOTE 23 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. |
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
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 trust preferred debt repurchase options) 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.
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 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 were classified as a liability prior to the sale of PWSC on July 29, 2022. 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 liability-classified awards granted by PWSC were 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 PWSC restricted stock awards were categorized in Level 3 of the fair value hierarchy.
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
Derivative contract interest rate swap - As described in Note 11, "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 December 31, 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.
Derivative contracts - trust preferred debt repurchase options - As described in Note 11, "Derivatives," the Company entered into three TruPs Options contracts during the third quarter of 2022. The TruPs Options contracts are measured and reported at fair value and are included in other assets in the consolidated balance sheet at December 31, 2022. The fair value of the TruPs Options contracts are estimated using the binomial lattice model. Key inputs in the valuation include credit spread assumptions, interest rate volatility, debt coupon interest rate and time to maturity. The TruPs Options contracts are categorized in Level 3 of the fair value hierarchy.
Contingent consideration - The consideration for the Company's acquisitions of Ravix and CSuite 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. 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 (expense) revenue. The contingent consideration liabilities are categorized in Level 3 of the fair value hierarchy.
| • | The fair value of Ravix'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. |
| • | The fair value of CSuite's contingent consideration liability is estimated by applying the Monte Carlo simulation method to forecast achievement of gross revenue which may result in up to $3.6 million in total payments to the former owners of CSuite through November 2025. Key inputs in the valuation include forecasted gross revenue, gross revenue volatility, discount rate and discount term. |
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 December 31, 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) | | | | | | | | | | December 31, 2022 | |
| | Fair Value Measurements at the End of the Reporting Period Using | |
| | | | | | | | | | | | | | | | | | | | |
| | | | | | Quoted | | | | | | | | | | | | | |
| | | | | | Prices in | | | | | | | | | | | | | |
| | | | | | Active | | | Significant | | | | | | | | | |
| | | | | | Markets for | | | Other | | | Significant | | | | | |
| | | | | | Identical | | | Observable | | | Unobservable | | | Measured at | |
| | | | | | Assets | | | Inputs | | | Inputs | | | Net Asset | |
| | Total | | | (Level 1) | | | (Level 2) | | | (Level 3) | | | Value | |
Recurring fair value measurements | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | |
Assets: | | | | | | | | | | | | | | | | | | | | |
Fixed maturities: | | | | | | | | | | | | | | | | | | | | |
U.S. government, government agencies and authorities | | $ | 15,080 | | | $ | — | | | $ | 15,080 | | | $ | — | | | $ | — | |
States, municipalities and political subdivisions | | | 2,232 | | | | — | | | | 2,232 | | | | — | | | | — | |
Mortgage-backed | | | 8,412 | | | | — | | | | 8,412 | | | | — | | | | — | |
Asset-backed | | | 1,610 | | | | — | | | | 1,610 | | | | — | | | | — | |
Corporate | | | 10,257 | | | | — | | | | 10,257 | | | | — | | | | — | |
Total fixed maturities | | | 37,591 | | | | — | | | | 37,591 | | | | — | | | | — | |
Equity investments: | | | | | | | | | | | | | | | | | | | | |
Common stock | | | 153 | | | | 153 | | | | — | | | | — | | | | — | |
Total equity investments | | | 153 | | | | 153 | | | | — | | | | — | | | | — | |
Limited liability investments, at fair value | | | 17,059 | | | | — | | | | — | | | | 3,196 | | | | 13,863 | |
Derivative contract - interest rate swap | | | 326 | | | | — | | | | 326 | | | | — | | | | — | |
Derivative contract - trust preferred debt repurchase options | | | 19,034 | | | | — | | | | — | | | | 19,034 | | | | — | |
Total assets | | $ | 74,163 | | | $ | 153 | | | $ | 37,917 | | | $ | 22,230 | | | $ | 13,863 | |
| | | | | | | | | | | | | | | | | | | | |
Liabilities: | | | | | | | | | | | | | | | | | | | | |
Subordinated debt | | $ | 67,811 | | | $ | — | | | $ | 67,811 | | | $ | — | | | $ | — | |
Contingent consideration | | | 3,218 | | | | — | | | | — | | | | 3,218 | | | | — | |
Total liabilities | | $ | 71,029 | | | $ | — | | | $ | 67,811 | | | $ | 3,218 | | | $ | — | |
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
(in thousands) | | | | | | | | | | December 31, 2021 | |
| | Fair Value Measurements at the End of the Reporting Period Using | |
| | | | | | | | | | | | | | | | | | | | |
| | | | | | Quoted | | | | | | | | | | | | | |
| | | | | | Prices in | | | | | | | | | | | | | |
| | | | | | Active | | | Significant | | | | | | | | | |
| | | | | | Markets for | | | Other | | | Significant | | | | | |
| | | | | | Identical | | | Observable | | | Unobservable | | | Measured | |
| | | | | | Assets | | | Inputs | | | Inputs | | | at Net | |
| | Total | | | (Level 1) | | | (Level 2) | | | (Level 3) | | | 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
The following table provides a reconciliation of the fair value of recurring Level 3 fair value measurements for the years ended December 31, 2022 and December 31, 2021:
(in thousands) | | Years ended December 31, | |
| | 2022 | | | 2021 | |
Assets: | | | | | | | | |
Limited liability investments, at fair value: | | | | | | | | |
Beginning balance | | $ | 4,022 | | | $ | 3,263 | |
Distributions received | | | (621 | ) | | | (658 | ) |
Realized gains included in net income | | | 607 | | | | 631 | |
Change in fair value of limited liability investments, at fair value included in net income | | | (812 | ) | | | 786 | |
Ending balance | | $ | 3,196 | | | $ | 4,022 | |
Unrealized (gains) losses on limited liability investments, at fair value held at end of period: | | | | | | | | |
Included in net income | | $ | (812 | ) | | $ | 786 | |
Included in other comprehensive loss | | $ | — | | | $ | — | |
Real estate investments: | | | | | | | | |
Beginning balance | | $ | 10,662 | | | $ | 10,662 | |
Realized gains on sale of real estate investments included in net income | | | 1,488 | | | | — | |
Sale of real estate investments | | | (12,150 | ) | | | — | |
Ending balance | | $ | — | | | $ | 10,662 | |
Unrealized gains recognized on real estate investments held at end of period: | | | | | | | | |
Included in net income | | $ | — | | | $ | — | |
Included in other comprehensive loss | | | — | | | | — | |
Derivative - trust preferred debt repurchase options: | | | | | | | | |
Beginning balance | | $ | — | | | $ | — | |
Purchase of options | | | 2,304 | | | | — | |
Initial valuation of options included in net income | | | 11,412 | | | | — | |
Change in fair value of derivative assets included in net income | | | 5,318 | | | | — | |
Ending balance | | $ | 19,034 | | | $ | — | |
Unrealized gains recognized on derivative assets held at end of period: | | | | | | | | |
Included in net income | | $ | 16,730 | | | $ | — | |
Included in other comprehensive loss | | | — | | | | — | |
Ending balance - assets | | $ | 22,230 | | | $ | 14,684 | |
Liabilities: | | | | | | | | |
Contingent consideration: | | | | | | | | |
Beginning balance | | $ | 2,458 | | | $ | — | |
Issuance of contingent consideration in connection with acquisition | | | — | | | | 2,195 | |
Settlements of contingent consideration liabilities | | | (750 | ) | | | — | |
Change in fair value of contingent consideration included in net income | | | 1,510 | | | | 263 | |
Ending balance | | $ | 3,218 | | | $ | 2,458 | |
Unrealized gains recognized on contingent consideration liabilities held at end of period: | | | | | | | | |
Included in net income | | $ | 1,510 | | | $ | 263 | |
Included in other comprehensive loss | | $ | — | | | $ | — | |
Stock-based compensation liabilities: | | | | | | | | |
Beginning balance | | $ | 1,402 | | | $ | 443 | |
Issuance of stock-based compensation awards | | | — | | | | — | |
Change in fair value of stock-based compensation liabilities included in net income | | | 2,780 | | | | 959 | |
Stock-based compensation liabilities disposed of related to PWSC | | | (4,182 | ) | | | — | |
Ending balance | | $ | — | | | $ | 1,402 | |
Unrealized gains recognized on stock-based compensation liabilities held at end of period: | | | | | | | | |
Included in net income | | $ | 2,780 | | | $ | 959 | |
Included in other comprehensive loss | | $ | — | | | $ | — | |
Ending balance - liabilities | | $ | 3,218 | | | $ | 3,860 | |
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
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, 2022:
Categories | | Fair Value | | Valuation Techniques | Unobservable Inputs | | Input Value(s) | |
Limited liability investments, at fair value | | $ | 3,196 | | Market approach | Valuation multiples | | 1.0x - 9.0x | |
Derivative - trust preferred debt repurchase options | | $ | 19,034 | | Binomial lattice option approach | Credit spread | | | 8.95 | % |
| | | | | | Interest rate volatility | | 2.3 | % |
| | | | | | Debt coupon interest rate | | 8.72%-8.87% | |
| | | | | | Time to maturity (in years) | | 10.4 - 10.59 | |
Contingent consideration | | $ | 3,218 | | Option-based income approach | Discount rate | | | 8.25 | % |
| | | | | | Risk-free rate | | 4.44 | % |
| | | | | | Expected volatility | | 13.0 | % |
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 | |
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 December 31, 2022:
| | Fair Value | | | | | | | | | | | Redemption | |
Category | | (in thousands) | | | Unfunded Commitments | | | Redemption Frequency | | | Notice Period | |
Limited liability investments, at fair value | | $ | 13,863 | | | | 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 years ended December 31, 2022 and December 31, 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 years ended December 31, 2022 and December 31, 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.
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
As further discussed in Note 4, "Acquisitions," the Company acquired Ravix on October 1, 2021 and allocated the purchase price to the assets acquired and liabilities assumed. The fair values of intangible assets associated with the acquisition of Ravix were determined to be Level 3 under the fair value hierarchy.
The following table summarizes the valuation techniques and significant unobservable inputs utilized in determining fair values for these Level 3 measurements:
Categories | | Fair Value | | Valuation Techniques | Unobservable Inputs | | Input Value(s) | |
Customer relationships | | $ | 4,000 | | Multi-period excess earnings | Growth rate | | | 3.0 | % |
| | | | | | Attrition rate | | | 15.0 | % |
| | | | | | Discount rate | | | 21.0 | % |
Trade name | | $ | 2,500 | | Relief from royalty | Royalty rate | | | 3.0 | % |
| | | | | | Discount rate | | | 21.0 | % |
As further discussed in Note 4, "Acquisitions," the Company acquired CSuite on November 1, 2022 and provisionally allocated the purchase price to the assets acquired and liabilities assumed. The fair values of intangible assets associated with the acquisition of CSuite were determined to be Level 3 under the fair value hierarchy.
The following table summarizes the valuation techniques and significant unobservable inputs utilized in determining fair values for these Level 3 measurements:
Categories | | Fair Value | | Valuation Techniques | Unobservable Inputs | | Input Value(s) | |
Customer relationships | | $ | 2,500 | | Multi-period excess earnings | Growth rate | | | 3.0 | % |
| | | | | | Attrition rate | | | 25.0 | % |
| | | | | | Discount rate | | | 16.5 | % |
Trade name | | $ | 1,500 | | Relief from royalty | Royalty rate | | | 2.5 | % |
| | | | | | Discount rate | | | 15.5 | % |
As further discussed in Note 4, "Acquisitions," the Company acquired SNS on November 18, 2022 and provisionally allocated the purchase price to the assets acquired and liabilities assumed. The fair values of intangible assets associated with the acquisition of SNS were determined to be Level 3 under the fair value hierarchy.
The following table summarizes the valuation techniques and significant unobservable inputs utilized in determining fair values for these Level 3 measurements:
Categories | | Fair Value | | Valuation Techniques | Unobservable Inputs | | Input Value(s) | |
Customer relationships | | $ | 3,600 | | Multi-period excess earnings | Growth rate | | | 3.0 | % |
| | | | | | Attrition rate | | | 10.0 | % |
| | | | | | Discount rate | | | 21.0 | % |
Trade name | | $ | 3,100 | | Relief from royalty | Royalty rate | | | 3.0 | % |
| | | | | | Discount rate | | | 21.0 | % |
NOTE 24 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 consolidated financial statements, the following is a summary of related party relationships and transactions.
(a) | Argo Management Group, LLC |
The Company acquired Argo Management in April 2016. Argo Management's primary business is to act as Managing Member of Argo Holdings. At December 31, 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 years ended December 31, 2022 and December 31, 2021.
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 4, "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.
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
NOTE 25 COMMITMENTS AND CONTINGENT LIABILITIES
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, which the Company reported in its consolidated statement of operations during the first quarter of 2020, 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 2022 and 2021, the Company made reimbursement payments to Aegis of $0.4 million and $0.1 million, respectively, in connection with the Settlement Agreement, which is included in general and administrative expenses in its consolidated statements of operations for the years ended December 31, 2022 and December 31, 2021, respectively. The Company’s potential exposure under these agreements was not reasonably determinable at December 31, 2022, and no liability has been recorded in the in the consolidated financial statements at December 31, 2022.
Mendota
As part of the October 18, 2018 transaction to sell 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.
During the third quarter of 2022, the buyer provided to the Company an analysis of the claims development that indicated that the Company's potential exposure with respect to the open claims was at the maximum obligation amount. Previous communications from the buyer noted no such development and the buyer was not obligated to provide development information to the Company until the first quarter of 2023. As a result of the newly provided information, the Company recorded a liability of $2.5 million during the third quarter of 2022, which is included in accrued expenses and other liabilities in the consolidated balance sheet at December 31, 2022 and loss on disposal of discontinued operations in the consolidated statement of operations for the year ended December 31, 2022. There were no payments made by the Company related to the open claims during the years ended December 31, 2022 and December 31, 2021. During the first quarter of 2023, the $2.0 million that had been previously deposited into an escrow account was released and remitted to the buyer to satisfy the Company's payment with respect to the open claims.
VA Lafayette
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 December 31, 2022 and December 31, 2021, were on deposit with state regulatory authorities.
The Company also has restricted cash of $13.1 million and $17.3 million at December 31, 2022 and December 31, 2021, respectively. Included in restricted cash are:
| • | $7.6 million and $12.6 million at December 31, 2022 and December 31, 2021, respectively, held as deposits by IWS, Geminus, PWI, PWSC ( December 31, 2021 only), Ravix and CSuite; |
| • | $1.9 million at December 31, 2022 and December 31, 2021, on deposit with state regulatory authorities; and |
| • | $3.5 million and $2.8million at December 31, 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
NOTE 26 SUBSEQUENT EVENTS
Exercise of TruPs Repurchase Options and Payment of Deferred Interest
In February 2023, the Company entered into amendments to the repurchase agreements described in Note 11, "Derivatives,", that would give the Company an additional discount on the total repurchase price if the Company effected a 100% repurchase on or before March 15, 2023. On March 2, 2023, the Company gave notice to the holders that it intends to exercise its options to repurchase 100% of the principal no later than March 15, 2023. The total amount to be paid will be $56.5 million, which includes a credit for the $2.3 million that the Company previously paid at the time of entering into the repurchase agreements. As a result, the Company will have repurchased $75.5 million of principal and $21.2 million of deferred interest (valued as of December 31, 2022). The Company intends to use currently available funds from working capital to fund the repurchases.
In order to execute the repurchase, the Company will have to pay an estimated $4.7 million of deferred interest to the remaining trust preferred debt instrument for which the Company did not have the right to repurchase. After the repurchase is completed, the Company will continue to have $15 million of principal outstanding related to remaining trust preferred debt instrument.
Notice of Redemption of Class A Preferred Stock
On March 1, 2023, the Company notified holders of its Preferred Shares of its intention to redeem all the outstanding Class A Preferred Stock on March 15, 2023 (the “Anticipated Redemption Date”). The Company anticipates redeeming all Class A Preferred Stock that remain outstanding on, and is not converted by, the Anticipated Redemption Date for the price of $25.00 per Preferred Share, plus accrued and unpaid dividends thereon, whether or not declared, up to and including the Anticipated Redemption Date.
In the event 100% of the Preferred Shares are redeemed by the Company on the Anticipated Redemption Date, the Company estimates that the aggregate amount required to redeem will be approximately $6.1 million, which would be paid using cash on hand. However, based on discussions with the holders of the Preferred Shares, the Company anticipates that 100% of the Preferred Shares would be converted and, in that case, there would be no cash outlay by the Company.
Second Amendment to 2020 KWH Loan
On February 28, 2023, KWH entered into a second amendment to the 2020 KWH Loan (the “KWH DDTL”) that provides for an additional delayed draw term loan in the principal amount of up to $10 million, with a maturity date of December 1, 2025. All or any portion of the KWH DDTL, subject to a $2 million minimum draw amount, may be requested at any time through February 27, 2024. The proceeds are evidenced by an intercompany loan and guarantee between KAI and KWH. The principal amount shall be repaid in quarterly installments in an amount equal to 3.75% of the original amount of the drawn DDTL. Proceeds from certain assets dispositions, as defined, may be required to be used to repay outstanding draws under the DDTL. The KWH DDTL also increases the senior cash flow leverage ratio maximum permissible for certain periods.
KINGSWAY FINANCIAL SERVICES INC.