10Q Q3 13
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_________________________
FORM 10-Q
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(Mark One) | |
x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
September 30, 2013 |
or |
o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended September 30, 2013
Commission File Number: 001-15204
Kingsway Financial Services Inc.
(Exact name of registrant as specified in its charter)
_________________________
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Ontario, Canada (State or other jurisdiction of incorporation or organization) | | Not Applicable (I.R.S. Employer Identification No.) |
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45 St. Clair Avenue West, Suite 400 Toronto, Ontario M4V 1K9 |
(Address of principal executive offices and zip code) |
1-416-848-1171 |
(Registrant's telephone number, including area code) |
_________________________
Indicate by checkmark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T ( 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of "large accelerated filer," "accelerated filer," and "smaller reporting company" in Rule 12b-2 of the Exchange Act.
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Large accelerated filer o | Accelerated filer o | Non-accelerated filer o (Do not check if a smaller reporting company) | Smaller Reporting Company x |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o No x
The number of shares outstanding of the registrant's common stock as of November 7, 2013 was 16,429,761.
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KINGSWAY FINANCIAL SERVICES INC. |
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Table Of Contents |
PART I - FINANCIAL INFORMATION | | |
ITEM 1. FINANCIAL STATEMENTS | | |
Consolidated Balance Sheets as of September 30, 2013 (unaudited) and December 31, 2012 | | |
Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2013 and 2012 (unaudited) | | |
Consolidated Statements of Comprehensive Loss for the Three and Nine Months Ended September 30, 2013 and 2012 (unaudited) | | |
Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2013 and 2012 (unaudited) | | |
Notes to Consolidated Financial Statements (unaudited) | | |
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS | | |
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK | | |
ITEM 4. CONTROLS AND PROCEDURES | | |
PART II - OTHER INFORMATION | | |
ITEM 1. LEGAL PROCEEDINGS | | |
ITEM 1A. RISK FACTORS | | |
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS | | |
ITEM 3. DEFAULTS UPON SENIOR SECURITIES | | |
ITEM 4. MINE SAFETY DISCLOSURES | | |
ITEM 5. OTHER INFORMATION | | |
ITEM 6. EXHIBITS | | |
SIGNATURES | | |
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KINGSWAY FINANCIAL SERVICES INC. |
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets
(in thousands, except per share data)
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| | September 30, 2013 |
| | December 31, 2012 |
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| | (unaudited) |
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ASSETS | | | | |
Investments: | | | | |
Fixed maturities, at fair value (amortized cost of $64,362 and $77,858, respectively) | | $ | 65,275 |
| | $ | 79,534 |
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Equity investments, at fair value (cost of $11,520 and $2,305, respectively) | | 16,523 |
| | 3,548 |
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Limited liability investments | | 2,579 |
| | 2,333 |
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Other investments, at cost which approximates fair value | | 3,107 |
| | 2,000 |
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Short-term investments, at cost which approximates fair value | | 586 |
| | 585 |
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Total investments | | 88,070 |
| | 88,000 |
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Cash and cash equivalents | | 86,037 |
| | 80,813 |
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Investment in investee | | — |
| | 41,733 |
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Accrued investment income | | 708 |
| | 2,263 |
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Premiums receivable, net of allowance for doubtful accounts of $4,054 and $4,040, respectively | | 33,536 |
| | 35,598 |
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Service fee receivable | | 17,227 |
| | 15,173 |
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Other receivables, net of allowance for doubtful accounts of $1,002 and $1,002, respectively | | 12,668 |
| | 4,750 |
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Reinsurance recoverable | | 15,308 |
| | 8,557 |
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Prepaid reinsurance premiums | | 8,260 |
| | 7,316 |
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Deferred acquisition costs, net | | 10,691 |
| | 14,102 |
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Property and equipment, net of accumulated depreciation of $24,100 and $22,887, respectively | | 1,952 |
| | 2,709 |
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Goodwill | | 9,484 |
| | 8,421 |
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Intangible assets, net of amortization of $20,837 and $19,263, respectively | | 50,061 |
| | 50,583 |
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Other assets | | 4,073 |
| | 4,045 |
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Asset held for sale | | 7,291 |
| | 8,737 |
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TOTAL ASSETS | | $ | 345,366 |
| | $ | 372,800 |
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LIABILITIES AND EQUITY | | | | |
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LIABILITIES | | | | |
Unpaid loss and loss adjustment expenses: | | | | |
Property and casualty | | $ | 89,986 |
| | $ | 103,116 |
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Vehicle service agreements | | 2,882 |
| | 3,448 |
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Total unpaid loss and loss adjustment expenses | | 92,868 |
| | 106,564 |
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Unearned premiums | | 47,846 |
| | 45,047 |
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Reinsurance payable | | 4,235 |
| | 4,956 |
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LROC preferred units | | 14,286 |
| | 13,655 |
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Senior unsecured debentures | | 26,356 |
| | 23,730 |
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Subordinated debt | | 22,790 |
| | 23,774 |
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Deferred income tax liability | | 3,882 |
| | 3,054 |
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Deferred service fees | | 49,242 |
| | 48,987 |
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Income taxes payable | | 2,944 |
| | 2,879 |
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Accrued expenses and other liabilities | | 31,829 |
| | 34,740 |
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TOTAL LIABILITIES | | $ | 296,278 |
| | $ | 307,386 |
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EQUITY | | | | |
Common stock, no par value; unlimited number authorized; 16,429,761 and 13,148,971 issued and outstanding at September 30, 2013 and December 31, 2012, respectively | | $ | 308,734 |
| | $ | 296,621 |
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Additional paid-in capital | | 15,955 |
| | 15,757 |
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Accumulated deficit | | (287,906 | ) | | (262,069 | ) |
Accumulated other comprehensive income | | 11,222 |
| | 14,762 |
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Shareholders' equity attributable to common shareholders | | 48,005 |
| | 65,071 |
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Noncontrolling interests in consolidated subsidiaries | | 1,083 |
| | 343 |
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TOTAL EQUITY | | 49,088 |
| | 65,414 |
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TOTAL LIABILITIES AND EQUITY | | $ | 345,366 |
| | $ | 372,800 |
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See accompanying notes to unaudited consolidated financial statements.
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KINGSWAY FINANCIAL SERVICES INC. |
Consolidated Statements of Operations
(in thousands, except per share data)
(Unaudited)
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| | | | | | | | | | | | | | | | |
| | Three months ended September 30, | | | Nine months ended September 30, |
| | 2013 |
| | 2012 |
| | 2013 |
| | 2012 |
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Revenue: | | | | | | | | |
Net premiums earned | | $ | 26,041 |
| | $ | 26,501 |
| | $ | 82,406 |
| | $ | 86,753 |
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Service fee and commission income | | 12,156 |
| | 7,648 |
| | 37,332 |
| | 25,315 |
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Net investment income | | 528 |
| | 777 |
| | 1,924 |
| | 2,400 |
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Net realized gains (losses) | | 321 |
| | 1,109 |
| | (1,056 | ) | | 1,359 |
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Other-than-temporary impairment loss | | — |
| | — |
| | (1,800 | ) | | (488 | ) |
Gain (loss) on change in fair value of debt | | 3,801 |
| | (3,177 | ) | | (2,812 | ) | | (9,926 | ) |
Other income | | 2,604 |
| | 1,940 |
| | 6,996 |
| | 5,767 |
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Total revenues | | 45,451 |
| | 34,798 |
| | 122,990 |
| | 111,180 |
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Expenses: | | | | | | | | |
Loss and loss adjustment expenses | | 21,343 |
| | 33,348 |
| | 67,789 |
| | 78,739 |
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Commissions and premium taxes | | 6,683 |
| | 2,458 |
| | 18,566 |
| | 11,624 |
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General and administrative expenses | | 20,136 |
| | 16,819 |
| | 60,184 |
| | 52,774 |
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Restructuring expense | | 223 |
| | 1,972 |
| | 1,150 |
| | 1,972 |
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Interest expense | | 1,808 |
| | 1,887 |
| | 5,568 |
| | 5,652 |
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Amortization of intangible assets | | 508 |
| | — |
| | 1,574 |
| | — |
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Impairment of asset held for sale | | — |
| | — |
| | 1,446 |
| | — |
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Total expenses | | 50,701 |
| | 56,484 |
| | 156,277 |
| | 150,761 |
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Loss from continuing operations before (loss) gain on buy-back of debt, equity in net income (loss) of investee and income tax expense (benefit) | | (5,250 | ) | | (21,686 | ) | | (33,287 | ) | | (39,581 | ) |
(Loss) gain on buy-back of debt | | — |
| | 500 |
| | (24 | ) | | 500 |
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Equity in net income (loss) of investee | | — |
| | 98 |
| | 255 |
| | (2,071 | ) |
Loss from continuing operations before income tax expense (benefit) | | (5,250 | ) | | (21,088 | ) | | (33,056 | ) | | (41,152 | ) |
Income tax expense (benefit) | | 403 |
| | (1,054 | ) | | (398 | ) | | (879 | ) |
Loss from continuing operations | | (5,653 | ) | | (20,034 | ) | | (32,658 | ) | | (40,273 | ) |
Gain on liquidation of subsidiaries, net of taxes | | 7,227 |
| | — |
| | 7,227 |
| | — |
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Net income (loss) | | 1,574 |
| | (20,034 | ) | | (25,431 | ) | | (40,273 | ) |
Less: net (loss) income attributable to noncontrolling interests in consolidated subsidiaries | | (305 | ) | | (1,165 | ) | | 407 |
| | (1,888 | ) |
Net income (loss) attributable to common shareholders | | $ | 1,879 |
| | $ | (18,869 | ) | | $ | (25,838 | ) | | $ | (38,385 | ) |
Loss per share - continuing operations: | | | | | | | | |
Basic: | | $ | (0.41 | ) | | $ | (1.52 | ) | | $ | (2.45 | ) | | $ | (3.07 | ) |
Diluted: | | (0.41 | ) | | (1.52 | ) | | (2.45 | ) | | (3.07 | ) |
Earnings (loss) per share – net income (loss): | | | | | | | | |
Basic: | | $ | 0.12 |
| | $ | (1.52 | ) | | $ | (1.91 | ) | | $ | (3.07 | ) |
Diluted: | | 0.12 |
| | (1.52 | ) | | (1.91 | ) | | (3.07 | ) |
Weighted average shares outstanding (in ‘000s): | | | | | | | | |
Basic: | | 13,684 |
| | 13,149 |
| | 13,329 |
| | 13,133 |
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Diluted: | | 13,684 |
| | 13,149 |
| | 13,329 |
| | 13,133 |
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See accompanying notes to unaudited consolidated financial statements.
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KINGSWAY FINANCIAL SERVICES INC. |
Consolidated Statements of Comprehensive Loss
(in thousands)
(unaudited)
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| | Three months ended September 30, | | | Nine months ended September 30, | |
| | 2013 |
| | 2012 |
| | 2013 |
| | 2012 |
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Net income (loss) | | $ | 1,574 |
| | $ | (20,034 | ) | | $ | (25,431 | ) | | $ | (40,273 | ) |
Other comprehensive (loss) income, net of taxes(1): | | | | | | | | |
Unrealized (losses) gains on fixed maturities and equity investments: | | | | | | | | |
Unrealized (losses) gains arising during the period | | (281 | ) | | (1,337 | ) | | 855 |
| | (1,140 | ) |
Reclassification adjustment for losses included in net income (loss) | | 1,860 |
| | 1,090 |
| | 2,142 |
| | 723 |
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Foreign currency translation adjustments | | 1 |
| | 539 |
| | — |
| | 566 |
|
Recognition of currency translation gain on liquidation of subsidiaries | | (7,227 | ) | | — |
| | (7,227 | ) | | — |
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Equity in other comprehensive income of investee | | — |
| | 310 |
| | 642 |
| | 649 |
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Other comprehensive (loss) income | | (5,647 | ) | | 602 |
| | (3,588 | ) | | 798 |
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Comprehensive loss | | (4,073 | ) | | (19,432 | ) | | (29,019 | ) | | (39,475 | ) |
Less: comprehensive (loss) income attributable to noncontrolling interests in consolidated subsidiaries | | (312 | ) | | 1,474 |
| | 359 |
| | (1,844 | ) |
Comprehensive loss attributable to common shareholders | | $ | (3,761 | ) | | $ | (20,906 | ) | | $ | (29,378 | ) | | $ | (37,631 | ) |
(1) Net of income tax expense (benefit) of $0 and $0 for the three and nine months ended September 30, 2013 and September 30, 2012, respectively. | | |
See accompanying notes to unaudited consolidated financial statements
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KINGSWAY FINANCIAL SERVICES INC. |
Consolidated Statements of Cash Flows
(in thousands)
(unaudited)
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| | | | | | | | |
| | Nine months ended September 30, | |
| | 2013 |
| | 2012 |
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Cash provided by (used in): | | | | |
Operating activities: | | | | |
Net loss | | $ | (25,431 | ) | | $ | (40,273 | ) |
Adjustments to reconcile net loss to net cash used in operating activities: | | | | |
Gain on liquidation of subsidiaries, net of taxes | | (7,227 | ) | | — |
|
Equity in net (income) loss of investee | | (255 | ) | | 2,071 |
|
Equity in net (income) loss of limited liability investments | | (133 | ) | | 14 |
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Depreciation and amortization | | 2,786 |
| | 1,042 |
|
Stock based compensation expense, net of forfeitures | | 198 |
| | 228 |
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Net realized losses (gains) | | 1,056 |
| | (1,359 | ) |
Loss on change in fair value of debt | | 2,812 |
| | 9,926 |
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Deferred income taxes | | 144 |
| | — |
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Other than temporary impairment loss | | 1,800 |
| | 488 |
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Amortization of fixed maturities premiums and discounts | | 2,302 |
| | 2,679 |
|
Impairment of asset held for sale | | 1,446 |
| | — |
|
Realized loss (gain) on buy-back of debt | | 24 |
| | (500 | ) |
Changes in operating assets and liabilities: | | | | |
Premiums and service fee receivable | | 8 |
| | (7,926 | ) |
Reinsurance recoverable | | (6,751 | ) | | (9,775 | ) |
Deferred acquisition costs | | 3,411 |
| | 77 |
|
Income taxes recoverable | | — |
| | 8,134 |
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Unpaid loss and loss adjustment expenses | | (13,696 | ) | | (15,305 | ) |
Unearned premiums | | 2,799 |
| | 4,647 |
|
Reinsurance payable | | (721 | ) | | 7,194 |
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Deferred service fees | | 255 |
| | 2,903 |
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Other, net | | (3,502 | ) | | (4,955 | ) |
Net cash used in operating activities | | (38,675 | ) | | (40,690 | ) |
Investing activities: | | | | |
Proceeds from sales and maturities of fixed maturities | | 18,725 |
| | 64,578 |
|
Proceeds from sales of equity investments | | 8,799 |
| | 2,459 |
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Proceeds from sales of investment in investee | | 13,638 |
| | — |
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Purchase of fixed maturities | | (4,725 | ) | | (44,555 | ) |
Purchase of equity investments | | (286 | ) | | — |
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Net acquisition of limited liability investments | | (919 | ) | | (2,403 | ) |
Purchase of other investments | | (1,031 | ) | | — |
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Net purchases of short-term investments | | (325 | ) | | — |
|
Acquisition of business, net of cash acquired | | (1,052 | ) | | — |
|
Net purchases of property and equipment and intangible assets | | (455 | ) | | (62 | ) |
Net cash provided by investing activities | | 32,369 |
| | 20,017 |
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Financing activities: | | | | |
Proceeds from issuance of common stock, net | | 12,113 |
| | 132 |
|
Payment of notes payable | | — |
| | (2,418 | ) |
Redemption of senior unsecured debentures | | (583 | ) | | (1,656 | ) |
Net cash provided by (used in) financing activities | | 11,530 |
| | (3,942 | ) |
Net increase (decrease) in cash and cash equivalents | | 5,224 |
| | (24,615 | ) |
Cash and cash equivalents at beginning of period | | 80,813 |
| | 85,486 |
|
Cash and cash equivalents at end of period | | $ | 86,037 |
| | $ | 60,871 |
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See accompanying notes to unaudited consolidated financial statements.
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KINGSWAY FINANCIAL SERVICES INC. Notes to Consolidated Financial Statements (Unaudited) September 30, 2013 |
NOTE 1 BUSINESS
Kingsway Financial Services Inc. (the "Company" or "Kingsway") was incorporated under the Business Corporations Act (Ontario) on September 19, 1989. Kingsway is a holding company and is primarily engaged, through its subsidiaries, in the property and casualty insurance business.
NOTE 2 BASIS OF PRESENTATION
The accompanying unaudited consolidated interim financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America ("U.S. GAAP") for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and notes required by U.S. GAAP for complete financial statements of the Company. In the opinion of management, all adjustments necessary for a fair presentation have been included and are of a normal recurring nature. Interim results are not necessarily indicative of the results that may be expected for the year.
The accompanying unaudited consolidated interim financial statements and footnotes should be read in conjunction with the audited consolidated financial statements and footnotes included within our Annual Report on Form 10-K ("2012 Annual Report") for the year ended December 31, 2012.
The unaudited consolidated interim financial statements include the accounts of the Company and its subsidiaries. All material intercompany transactions and balances have been eliminated in consolidation.
The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect application of policies and the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the year. Actual results could differ from these estimates. Estimates and their underlying assumptions are reviewed on an ongoing basis. Changes in estimates are recorded in the accounting period in which they are determined. The critical accounting estimates and assumptions in the accompanying unaudited consolidated interim financial statements include the provision for unpaid loss and loss adjustment expenses, valuation of fixed maturities and equity investments, valuation of deferred income taxes, valuation of intangible assets, goodwill recoverability, deferred acquisition costs, and fair value assumptions for debt obligations.
The fair values of the Company's investments in fixed maturities and equity investments, LROC preferred units, senior unsecured debentures and subordinated debt 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 balances. The carrying amounts reported in the consolidated balance sheets approximate fair values for cash, short-term investments and certain other assets and other liabilities because of their short-term nature.
The Company's financial results contained herein are reported in U.S. dollars unless otherwise indicated.
NOTE 3 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
There have been no material changes to our significant accounting policies as reported in our 2012 Annual Report.
NOTE 4 RECENTLY ISSUED ACCOUNTING STANDARDS
Adoption of New Accounting Standards:
In July 2012, the FASB issued ASU 2012-02, Intangibles-Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment ("ASU 2012-02"). ASU 2012-02 provides entities with an option to first assess qualitative factors to determine whether events or circumstances indicate that it is more likely than not that the indefinite-lived intangible asset is impaired. If an entity concludes that it is more than 50% likely that an indefinite-lived intangible asset is not impaired, no further analysis is required. However, if an entity concludes otherwise, it would be required to determine the fair value of the indefinite-lived intangible asset to measure the amount of actual impairment, if any, as currently required under US GAAP. Effective January 1, 2013, the Company adopted ASU 2012-02 and the adoption did not have an impact on the consolidated financial statements. There have been no triggering events that would suggest possible impairment or that it is more-likely-than-not that the fair values of indefinite-lived intangible assets are less than their carrying amounts. The Company will utilize the new guidance during its annual impairment testing in December 2013.
In February 2013, the FASB issued ASU 2013-02, Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income ("ASU 2013-02"), which is intended to improve the reporting of reclassifications out of accumulated other comprehensive
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KINGSWAY FINANCIAL SERVICES INC. Notes to Consolidated Financial Statements (Unaudited) September 30, 2013 |
income. The ASU requires an entity to report, either on the face of the income statement or in the notes to the financial statements, the effect of significant reclassifications out of accumulated other comprehensive income on the respective line items in the income statement if the amount being reclassified is required to be reclassified in its entirety to net income. For other amounts that are not required to be reclassified in their entirety to net income in the same reporting period, an entity is required to cross-reference other required disclosures that provide additional detail about those amounts. Effective January 1, 2013, the Company adopted ASU 2013-02. Except for the new disclosure requirements, the adoption of the standard did not have an impact on the consolidated financial statements. The required disclosures are included in Note 17, "Accumulated Other Comprehensive Income."
In July 2013, the FASB issued ASU 2013-11, Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists ("ASU 2013-11"). ASU 2013-11 is effective for the first interim or annual period beginning on or after December 15, 2013 with early adoption permitted. ASU 2013-11 amends ASC Topic 740, Income Taxes, to provide guidance and reduce diversity in practice on the financial statement presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. Except for the changes, if any, in the Company's presentation, the initial application of the standard is not expected to have a material impact on the consolidated financial statements.
NOTE 5 ACQUISITIONS, LIQUIDATIONS, DISPOSITION AND REACQUSITION
(a) Acquisitions
IWS Acquisition Corporation:
Effective November 16, 2012, the Company's subsidiary, IWS Acquisition Corporation ("IWS"), acquired certain tangible and intangible assets and liabilities of Intercontinental Warranty Services, Inc. for total consideration consisting of approximately $4.9 million in cash, future contingent payments and common equity in a newly formed entity.
IWS is based in Florida and is a provider of after-market vehicle protection services distributed by credit unions throughout the United States and Puerto Rico to their members. The acquisition allows the Company to benefit from the institutional knowledge of the credit unions' vehicle loan programs and expand into the vehicle protection service business.
This acquisition was accounted for as a business combination using the purchase method of accounting. The purchase price was allocated to the assets purchased and liabilities assumed based upon their estimated fair values at the date of acquisition. During the fourth quarter of 2012, the Company began its fair value analysis on the assets acquired and liabilities assumed. In accordance with U.S. GAAP, fair value accounting effects may be adjusted up to one year from the acquisition date upon finalization of the valuation process. The Company recorded adjustments related to the acquisition during the first nine months of 2013, which resulted in an increase to goodwill of $1.1 million from the amount recorded at December 31, 2012.
After allocation of additional purchase price, goodwill of $9.0 million was recognized in addition to $12.4 million of separately identifiable intangible assets. Of this amount, $8.7 million of separately identifiable intangible assets related to this acquisition resulted from the valuations of acquired database, customer-related relationships, trade name and non-compete agreement. An additional $3.7 million of separately identifiable intangible assets resulted from the valuation of vehicle service agreements in-force ("VSA in-force"). Refer to Note 10, "Intangible Assets," for further disclosure on intangible assets related to this acquisition. The fair value analysis performed included $3.9 million related to present value of future contingent payments. The maximum the Company can pay in future contingent payments is $11.1 million, on an undiscounted basis. The contingent payments are payable annually beginning in 2013 through 2018 and are subject to the achievement of certain targets and may be adjusted in future periods based on actual performance achieved. As of September 30, 2013, the recorded value of the contingent earn-out agreement is $4.5 million, which is included in accrued expenses and other liabilities on the consolidated balance sheets.
Trinity Warranty Solutions LLC:
Effective May 22, 2013, the Company's subsidiary, Trinity Warranty Solutions LLC ("TWS"), acquired certain intangible assets of Trinity Warranty Corp. for total consideration consisting of approximately $1.1 million in cash and future contingent payments. The consolidated statements of operations include the earnings of TWS from the date of acquisition. As further discussed in Note 18, "Segmented Information," TWS is included in the Insurance Services segment. TWS is based in Illinois and is a provider of warranty products and maintenance support to consumers and businesses in the heating, ventilation, air conditioning and refrigeration industry.
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KINGSWAY FINANCIAL SERVICES INC. Notes to Consolidated Financial Statements (Unaudited) September 30, 2013 |
This acquisition will be accounted for as a business combination using the purchase method of accounting. The purchase price is expected to be allocated during the fourth quarter of 2013 to the assets purchased based upon their estimated fair values at the date of acquisition. Refer to Note 10, "Intangible Assets," for further disclosure on intangible assets related to this acquisition.
(b) Liquidations
During 2013, the Company's subsidiaries, Kingsway Reinsurance (Bermuda) Ltd. ("KRL") and Kingsway 2007 General Partnership ("2007 GP"), were liquidated. As a result of the liquidations of these subsidiaries, the Company realized a net after-tax gain of $7.2 million for the three months ended September 30, 2013. This gain represents the foreign exchange gain previously recorded in accumulated other comprehensive income and now recognized in the statement of operations as a result of the liquidations of KRL and 2007 GP. Summarized financial information for liquidation of subsidiaries is shown below:
|
| | | | | | | | | | | | |
(in thousands) | | Three months ended September 30, | | | Nine months ended September 30, | |
| | 2013 |
| | 2012 |
| | 2013 |
| | 2012 |
|
Liquidations: | | | | | | | | |
Gain on liquidations before income taxes | | 7,227 |
| | — |
| | 7,227 |
| | — |
|
Income tax benefit | | — |
| | — |
| | — |
| | — |
|
Gain on liquidation of subsidiaries, net of taxes | | 7,227 |
| | — |
| | 7,227 |
| | — |
|
(c) Disposition
On March 30, 2011, the Company's subsidiary, Kingsway America Inc. ("KAI"), sold all of the issued and outstanding shares of its wholly owned subsidiary Hamilton Risk Management Company (“Hamilton”) and its subsidiaries, including Kingsway Amigo Insurance Company ("Amigo"), to HRM Acquisition Corp., a wholly owned subsidiary of Acadia Acquisition Partners, L.P. (“Acadia”), in exchange for a $10.0 million senior promissory note due March 30, 2014, a $5.0 million junior promissory note due March 30, 2016, and a Class B partnership interest in Acadia, representing a 40% economic interest. A third-party and members of the Hamilton management team held Class A partnership interests in Acadia representing a 60% economic interest. As a result of this transaction, Hamilton had notes payable balances of $2.2 million maturing in March 2014 with the third-party and $0.2 million maturing in June 2015 with members of the Hamilton management team. On August 14, 2012, Hamilton repaid the note payable from the third-party with a carrying value of $2.2 million for $1.7 million, recording a gain of $0.5 million. On August 31, 2012, Hamilton repaid the notes payable from the members of the Hamilton management team with a carrying value of $0.2 million for $0.2 million, recording a gain of zero.
(d) Reacquisition
On August 14, 2012 and August 31, 2012, respectively, Hamilton repurchased the Class A partnership interests held by the third-party and members of the Hamilton management team, respectively. The Company recorded no gain or loss related to the repurchase of the Class A partnership interests. As a result of these transactions, Acadia was dissolved, liquidated, and wound down, with all assets being distributed to its sole member KAI, thereby resulting in Hamilton becoming a fully owned subsidiary of KAI.
|
| | |
KINGSWAY FINANCIAL SERVICES INC. Notes to Consolidated Financial Statements (Unaudited) September 30, 2013 |
NOTE 6 INVESTMENTS
The amortized cost, gross unrealized gains and losses, and estimated fair value of the Company's investments in fixed maturities and equity investments at September 30, 2013 and December 31, 2012 are summarized in the tables shown below:
|
| | | | | | | | | | | | | | | | |
(in thousands) | | September 30, 2013 | |
| | Amortized Cost |
| | Gross Unrealized Gains |
| | Gross Unrealized Losses |
| | Estimated Fair Value |
|
Fixed maturities: | | | | | | | | |
U.S. government, government agencies and authorities | | $ | 24,647 |
| | $ | 697 |
| | $ | 6 |
| | $ | 25,338 |
|
Canadian government | | 4,372 |
| | — |
| | 130 |
| | 4,242 |
|
States municipalities and political subdivisions | | 7,134 |
| | 113 |
| | — |
| | 7,247 |
|
Mortgage-backed | | 722 |
| | 14 |
| | — |
| | 736 |
|
Asset-backed securities and collateralized mortgage obligations | | 318 |
| | 1 |
| | — |
| | 319 |
|
Corporate | | 27,169 |
| | 234 |
| | 10 |
| | 27,393 |
|
Total fixed maturities | | 64,362 |
| | 1,059 |
| | 146 |
| | 65,275 |
|
Equity investments: | | | | | | | | |
Common stock | | 11,520 |
| | 5,016 |
| | 13 |
| | 16,523 |
|
Total fixed maturities and equity investments | | $ | 75,882 |
| | $ | 6,075 |
| | $ | 159 |
| | $ | 81,798 |
|
|
| | | | | | | | | | | | | | | | |
(in thousands) | | December 31, 2012 | |
| | Amortized Cost |
| | Gross Unrealized Gains |
| | Gross Unrealized Losses |
| | Estimated Fair Value |
|
Fixed maturities: | | | | | | | | |
U.S. government, government agencies and authorities | | $ | 23,954 |
| | $ | 962 |
| | $ | 1 |
| | $ | 24,915 |
|
Canadian government | | 3,822 |
| | — |
| | 40 |
| | 3,782 |
|
States municipalities and political subdivisions | | 7,158 |
| | 187 |
| | — |
| | 7,345 |
|
Mortgage-backed | | 4,850 |
| | 193 |
| | — |
| | 5,043 |
|
Asset-backed securities and collateralized mortgage obligations | | 1,084 |
| | 8 |
| | — |
| | 1,092 |
|
Corporate | | 36,990 |
| | 391 |
| | 24 |
| | 37,357 |
|
Total fixed maturities | | 77,858 |
| | 1,741 |
| | 65 |
| | 79,534 |
|
Equity investments: | | | | | | | | |
Common stock | | 2,305 |
| | 1,256 |
| | 13 |
| | 3,548 |
|
Total fixed maturities and equity investments | | $ | 80,163 |
| | $ | 2,997 |
| | $ | 78 |
| | $ | 83,082 |
|
Amortized cost, gross unrealized gains and estimated fair value for common stock in the preceding table at September 30, 2013 include $9.3 million, $3.6 million and $12.9 million, respectively, for the Company's investment in the common stock of the Company's former investee, Atlas Financial Holdings, Inc. ("Atlas"). As discussed further in Note 7, Investment in Investee, the Company's investment in the common stock of Atlas was accounted for under the equity method of accounting and reported as investment in investee in the consolidated balance sheets at December 31, 2012.
|
| | |
KINGSWAY FINANCIAL SERVICES INC. Notes to Consolidated Financial Statements (Unaudited) September 30, 2013 |
The table below summarizes the Company's fixed maturities at September 30, 2013 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) | | September 30, 2013 | |
| | Amortized Cost |
| | Estimated Fair Value |
|
Due in one year or less | | $ | 21,812 |
| | $ | 21,881 |
|
Due after one year through five years | | 40,530 |
| | 41,274 |
|
Due after five years through ten years | | 1,328 |
| | 1,417 |
|
Due after ten years | | 692 |
| | 703 |
|
Total | | $ | 64,362 |
| | $ | 65,275 |
|
The following tables highlight the aggregate unrealized loss position, by security type, of fixed maturities and equity investments in unrealized loss positions as of September 30, 2013 and December 31, 2012. The tables segregate the holdings based on the period of time the investments have been continuously held in unrealized loss positions.
|
| | | | | | | | | | | | | | | | | | | | | | | |
(in thousands) | | | | | | | | | September 30, 2013 | |
| Less than 12 Months | | Greater than 12 Months | | Total |
| Estimated Fair Value | | Unrealized Loss | | Estimated Fair Value | | Unrealized Loss | | Estimated Fair Value | | Unrealized Loss |
Fixed maturities: | | | | | | | | | | | |
U.S. government, government agencies and authorities | $ | 1,699 |
| | $ | 6 |
| | $ | — |
| | $ | — |
| | $ | 1,699 |
| | $ | 6 |
|
Canadian government | 4,241 |
| | 130 |
| | — |
| | — |
| | 4,241 |
| | 130 |
|
Mortgage-backed | 582 |
| | — |
| | — |
| | — |
| | 582 |
| | — |
|
Corporate | 2,028 |
| | — |
| | — |
| | 10 |
| | 2,028 |
| | 10 |
|
Total fixed maturities | 8,550 |
| | 136 |
| | — |
| | 10 |
| | 8,550 |
| | 146 |
|
Equity investments: | | | | | | | | |
|
| |
|
|
Common stock | 180 |
| | 2 |
| | 2 |
| | 11 |
| | 182 |
| | 13 |
|
Total | $ | 8,730 |
| | $ | 138 |
| | $ | 2 |
| | $ | 21 |
| | $ | 8,732 |
| | $ | 159 |
|
|
| | |
KINGSWAY FINANCIAL SERVICES INC. Notes to Consolidated Financial Statements (Unaudited) September 30, 2013 |
|
| | | | | | | | | | | | | | | | | | | | | | | |
(in thousands) | | | | | | | | | December 31, 2012 | |
| Less than 12 Months | | Greater than 12 Months | | Total |
| Estimated Fair Value | | Unrealized Loss | | Estimated Fair Value | | Unrealized Loss | | Estimated Fair Value | | Unrealized Loss |
Fixed maturities: | | | | | | | | | | | |
U.S. government, government agencies and authorities | $ | 4,612 |
| | $ | 1 |
| | $ | — |
| | $ | — |
| | $ | 4,612 |
| | $ | 1 |
|
Canadian government | 3,782 |
| | 40 |
| | — |
| | — |
| | 3,782 |
| | 40 |
|
Mortgage-backed | — |
| | — |
| | 267 |
| | — |
| | 267 |
| | — |
|
Corporate | 4,169 |
| | 14 |
| | — |
| | 10 |
| | 4,169 |
| | 24 |
|
Total fixed maturities | 12,563 |
| | 55 |
| | 267 |
| | 10 |
| | 12,830 |
| | 65 |
|
Equity investments: | | | | | | | | | | | |
Common stock | 8 |
| | 1 |
| | 38 |
| | 12 |
| | 46 |
| | 13 |
|
Total | $ | 12,571 |
| | $ | 56 |
| | $ | 305 |
| | $ | 22 |
| | $ | 12,876 |
| | $ | 78 |
|
Fixed maturities and equity investments contain approximately 11 and 19 individual investments that were in unrealized loss positions as of September 30, 2013 and December 31, 2012, 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. The analysis includes some or all of the following procedures as deemed appropriate by the Company:
| |
• | identifying all unrealized loss positions that have existed for at least six months; |
| |
• | identifying other circumstances which management believes may impact the recoverability of the unrealized loss positions; |
| |
• | obtaining a valuation analysis from third-party investment managers regarding the intrinsic value of these investments based on their knowledge and experience together with market-based valuation techniques; |
| |
• | reviewing the trading range of certain investments over the preceding calendar period; |
| |
• | assessing if declines in market value are other-than-temporary for debt instruments based on the investment grade credit ratings from third-party rating agencies; |
| |
• | assessing if declines in market value are other-than-temporary for any debt instrument with a non-investment grade credit rating based on the continuity of its debt service record; |
| |
• | determining the necessary provision for declines in market value that are considered other-than-temporary based on the analyses performed; and |
| |
• | assessing the Company's ability and intent to hold these investments at least until the investment impairment is recovered. |
The risks and uncertainties inherent in the assessment methodology used to determine declines in market value that are other-than-temporary include, but may not be limited to, the following:
| |
• | the opinions of professional investment managers could be incorrect; |
| |
• | the past trading patterns of individual investments may not reflect future valuation trends; |
| |
• | the credit ratings assigned by independent credit rating agencies may be incorrect due to unforeseen or unknown facts related to a company's financial situation; and |
| |
• | the debt service pattern of non-investment grade instruments may not reflect future debt service capabilities and may not reflect a company's unknown underlying financial problems. |
As a result of the analysis performed by the Company to determine declines in market value that are other-than-temporary, there were no write-downs for other-than-temporary impairments related to other investments for the three months ended September 30, 2013 and September 30, 2012 (write-down for other-than-temporary impairment related to other investments of zero and $0.5 million for the nine months ended September 30, 2013 and September 30, 2012, respectively).
On July 8, 2013, the Company announced that it had entered into a non-binding letter of intent with Atlas to sell its holdings of Atlas preferred stock for 90.0% of liquidation value, or $16.2 million. On August 1, 2013, the Company announced that the transaction had closed. As a result, the Company recorded a write-down for other-than-temporary impairment related to its investment in Atlas preferred stock of zero and $1.8 million for the three and nine months ended September 30, 2013, respectively.
|
| | |
KINGSWAY FINANCIAL SERVICES INC. Notes to Consolidated Financial Statements (Unaudited) September 30, 2013 |
Under the terms of the transaction, Atlas paid the Company at closing $7.5 million in cash, plus approximately$0.8 million from cash raised by Atlas from the exercise of certain outstanding Atlas warrants. If any amount of the purchase price remains unpaid as of January 3, 2014, such unpaid amount will be repayable not later than April 30, 2014 pursuant to one or more promissory notes entered into by Atlas.
There were no write-downs related to fixed maturities for other-than-temporary impairments for the three and nine months ended September 30, 2013 and September 30, 2012. There were no other-than-temporary losses recognized in other comprehensive (loss) income for the three and nine months ended September 30, 2013 and September 30, 2012.
The Company has reviewed currently available information regarding investments with estimated fair values that are less than their carrying amounts and believes that 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 that it will be required to sell those investments before recovery of its amortized cost.
The Company does not have any exposure to subprime mortgage-backed investments.
Limited liability investments include investments in limited liability companies and a limited partnership that primarily invest in income-producing real estate. The Company's interests in these investments are not deemed minor and, therefore, are accounted for under the equity method of accounting. As of September 30, 2013 and December 31, 2012, the carrying value of limited liability investments totaled $2.6 million and $2.3 million, respectively. At September 30, 2013, the Company has unfunded commitments totaling $3.7 million to fund limited liability investments. Income 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.
Other investments include collateral loans and are reported at their unpaid principal balance. As of September 30, 2013 and December 31, 2012, the carrying value of other investments totaled $3.1 million and $2.0 million, respectively.
Gross realized gains and losses on fixed maturities, equity investments and limited liability investments for the three and nine months ended September 30, 2013 and September 30, 2012 were as follows:
|
| | | | | | | | | | | | | | | | |
(in thousands) | | Three months ended September 30, | | | Nine months ended September 30, | |
| | 2013 |
| | 2012 |
| | 2013 |
| | 2012 |
|
Gross realized gains | | $ | 321 |
| | $ | 1,109 |
| | $ | 694 |
| | $ | 1,433 |
|
Gross realized losses | | — |
| | — |
| | (32 | ) | | (74 | ) |
Total | | $ | 321 |
| | $ | 1,109 |
| | $ | 662 |
| | $ | 1,359 |
|
Gross realized losses for the nine months ended September 30, 2013 reported in the preceding table excludes the realized loss on sale of Atlas common stock recorded during the first quarter of 2013. Refer to Note 7, Investment in Investee, for further discussion.
Net investment income for the three and nine months ended September 30, 2013 and September 30, 2012, respectively, is comprised as follows:
|
| | | | | | | | | | | | | | | | |
(in thousands) | | Three months ended September 30, | | | Nine months ended September 30, | |
| | 2013 |
| | 2012 |
| | 2013 |
| | 2012 |
|
Investment income | | | | | | | | |
Interest from fixed maturities | | $ | 314 |
| | $ | 529 |
| | $ | 964 |
| | $ | 1,647 |
|
Dividends | | 101 |
| | 239 |
| | 591 |
| | 743 |
|
(Loss) income from limited liability investments | | (22 | ) | | (5 | ) | | 133 |
| | (14 | ) |
Other | | 170 |
| | 121 |
| | 429 |
| | 350 |
|
Gross investment income | | 563 |
| | 884 |
| | 2,117 |
| | 2,726 |
|
Investment expenses | | (35 | ) | | (107 | ) | | (193 | ) | | (326 | ) |
Net investment income | | $ | 528 |
| | $ | 777 |
| | $ | 1,924 |
| | $ | 2,400 |
|
At September 30, 2013, fixed maturities and short-term investments with an estimated fair value of $14.3 million were on deposit with state and provincial regulatory authorities. Also, from time to time, the Company pledges investments to third-parties to collateralize liabilities incurred under its policies of insurance. At September 30, 2013, the amount of such pledged securities was $25.5 million.
|
| | |
KINGSWAY FINANCIAL SERVICES INC. Notes to Consolidated Financial Statements (Unaudited) September 30, 2013 |
NOTE 7 INVESTMENT IN INVESTEE
Investment in investee includes the Company's investment in the preferred and restricted voting common stock of Atlas. On February 12, 2013, the Company executed an underwriting agreement to sell 2,625,000 shares of Atlas common stock. The shares were being offered as part of Atlas' United States initial public offering at a price per share of $5.85. During the first quarter of 2013, the Company received net proceeds of $13.6 million and recognized a loss of $1.7 million, which is included in net realized losses on the consolidated statements of operations, resulting from commissions and other expenses incurred as part of the sale. As a result of this sale, the Company's approximate voting percentage in Atlas was reduced to 16.5%. As a result of this change in ownership and other qualitative factors, the Company determined that its investment in the common stock of Atlas no longer qualified for the equity method of accounting. Accordingly, the Company's investment in Atlas common stock is included in equity investments and reported at fair value of $12.9 million in the consolidated balance sheets at September 30, 2013. The Company's share of its investee's equity adjustments for other comprehensive income of $0.7 million was offset against the carrying value of the Company's investment in Atlas common stock during the second quarter of 2013. Prior to discontinuing the use of the equity method of accounting for Atlas, the Company used a reporting lag of three months to report its proportionate share of Atlas' results.
The carrying value, estimated fair value and approximate voting and equity percentages for the Company's investment in the common stock of Atlas, which was accounted for under the equity method of accounting and reported as investment in investee in the Company's consolidated balance sheets at December 31, 2012, were as follows:
|
| | | | | | | | | | | | | | |
(in thousands, except for percentages) | | | | |
| | December 31, 2012 |
| | Voting percentage | | Equity percentage | | Estimated Fair Value | | Carrying value |
Atlas | | 30.0 | % | | 63.3 | % | | $ | 38,758 |
| | $ | 41,733 |
|
The fair value of the Company's investment in Atlas at December 31, 2012 in the table above is calculated based on the published closing price of Atlas at September 30, 2012 to be consistent with the three-month lag in reporting its carrying value under the equity method.
Equity in net income (loss) of investee was income of zero and $0.1 million for the three months ended September 30, 2013 and September 30, 2012, respectively (income of $0.3 million and loss of $2.1 million, respectively, year to date). The Company also recognized a decrease to shareholders' equity attributable to common shareholders of zero and $0.6 million for the three and nine months ended September 30, 2013, respectively, for the Company's pro rata share of its investee's accumulated other comprehensive income.
NOTE 8 DEFERRED ACQUISITION COSTS
Policy acquisition costs consist primarily of commissions, premium taxes, and underwriting and agency expenses incurred related to successful efforts to acquire new or renewal insurance contracts, net of ceding commission income, and vehicle service agreements. Acquisition costs deferred on both property and casualty insurance products and vehicle service agreements are amortized over the period in which the related revenues are earned.
The components of deferred acquisition costs and the related amortization expense for the three and nine months ended September 30, 2013 and 2012, respectively, is comprised as follows:
|
| | | | | | | | | | | | | | | | |
(in thousands) | | Three months ended September 30, | | | Nine months ended September 30, | |
| | 2013 |
| | 2012 |
| | 2013 |
| | 2012 |
|
Beginning balance, net | | $ | 11,797 |
| | $ | 7,634 |
| | $ | 14,102 |
| | $ | 8,116 |
|
Additions | | 4,952 |
| | 5,804 |
| | 20,719 |
| | 14,662 |
|
Amortization | | (6,058 | ) | | (5,399 | ) | | (24,130 | ) | | (14,739 | ) |
Balance at September 30, net | | $ | 10,691 |
| | $ | 8,039 |
| | $ | 10,691 |
| | $ | 8,039 |
|
|
| | |
KINGSWAY FINANCIAL SERVICES INC. Notes to Consolidated Financial Statements (Unaudited) September 30, 2013 |
NOTE 9 GOODWILL
Goodwill was $9.5 million and $8.4 million at September 30, 2013 and December 31, 2012, respectively. As further discussed in Note 5, "Acquisitions, Liquidations, Disposition and Reacquisition," during the first nine months of 2013, the Company continued its evaluation of certain tangible and intangible assets and liabilities of Intercontinental Warranty Services, Inc. that were acquired on November 16, 2012, which resulted in an increase to goodwill of $1.1 million from the amount recorded at December 31, 2012.
NOTE 10 INTANGIBLE ASSETS
Intangible assets are comprised as follows:
|
| | | | | | | | |
(in thousands) | | | | |
| | September 30, 2013 |
| | December 31, 2012 |
|
Intangible assets subject to amortization | | | | |
Database | | $ | 4,487 |
| | $ | 4,907 |
|
VSA in-force | | 1,788 |
| | 2,770 |
|
Customer-related relationships | | 3,953 |
| | 3,056 |
|
Non-compete agreement | | 49 |
| | 66 |
|
Intangible assets not subject to amortization | | | | |
Insurance licenses | | 7,803 |
| | 7,803 |
|
Renewal rights | | 31,318 |
| | 31,318 |
|
Trade name | | 663 |
| | 663 |
|
Intangible assets | | $ | 50,061 |
| | $ | 50,583 |
|
As further discussed in Note 5, "Acquisitions, Liquidations, Disposition and Reacquisition," during the second quarter of 2013, the Company acquired certain intangible assets of Trinity Warranty Corp. for total consideration consisting of approximately $1.1 million in cash and future contingent payments. The purchase price is expected to be allocated to the intangible assets purchased based upon their estimated fair values at the date of acquisition during the fourth quarter of 2013. Accordingly, the customer-related relationships intangible asset in the preceding table includes $1.1 million related to the estimated TWS intangible asset acquired.
The Company's intangible assets with indefinite useful lives are not amortized. The Company's intangible assets with definite useful lives are amortized over their estimated useful lives. Accumulated amortization for these intangibles as of September 30, 2013 and December 31, 2012 was $20.8 million and $19.3 million, respectively. Amortization of intangible assets was $0.5 million and zero for the three months ended September 30, 2013 and September 30, 2012, respectively ($1.6 million and zero for the nine months ended September 30, 2013 and September 30, 2012, respectively).
NOTE 11 ASSET HELD FOR SALE
As of September 30, 2013, property consisting of building and land located in Miami, Florida with a carrying value of $7.3 million was classified as held for sale. For the three and nine months ended September 30, 2013, the Company recorded a write-down of zero and 1.4 million, respectively, related to the asset held for sale. At September 30, 2013, the carrying value of the property is equal to its fair value net of estimated selling costs.
NOTE 12 UNPAID LOSS AND LOSS ADJUSTMENT EXPENSES
The establishment of the provision for unpaid loss and loss adjustment expenses is based on known facts and interpretation of circumstances and is therefore a complex and dynamic process influenced by a large variety of factors. These factors include the Company's experience with similar cases and historical trends involving loss payment patterns, pending levels of unpaid loss and loss adjustment expenses, product mix or concentration, loss severity and loss frequency patterns.
Other factors include the continually evolving and changing regulatory and legal environment; actuarial studies; professional experience and expertise of the Company's claims departments' personnel and independent adjusters retained to handle individual claims; the quality of the data used for projection purposes; existing claims management practices including claims-handling and settlement practices; the effect of inflationary trends on future loss settlement costs; court decisions; economic conditions; and public attitudes.
Consequently, the process of determining the provision necessarily involves risks that the actual results will deviate, perhaps materially, from the best estimates made.
|
| | |
KINGSWAY FINANCIAL SERVICES INC. Notes to Consolidated Financial Statements (Unaudited) September 30, 2013 |
The Company's evaluation of the adequacy of unpaid loss and loss adjustment expenses includes a re-estimation of the liability for unpaid loss and loss adjustment expenses relating to each preceding financial year compared to the liability that was previously established.
(a) Property and Casualty
The results of this comparison and the changes in the provision for property and casualty unpaid loss and loss adjustment expenses, net of amounts recoverable from reinsurers, as of September 30, 2013 and September 30, 2012 were as follows:
|
| | | | | | | | |
(in thousands) | | September 30, 2013 |
| | September 30, 2012 |
|
Balance at beginning of period, gross | | $ | 103,116 |
| | $ | 120,258 |
|
Less reinsurance recoverable related to property and casualty unpaid loss and loss adjustment expenses | | 5,478 |
| | 298 |
|
Balance at beginning of period, net | | 97,638 |
| | 119,960 |
|
Incurred related to: | | | | |
|
Current year | | 63,347 |
| | 67,510 |
|
Prior years | | (427 | ) | | 11,229 |
|
Paid related to: | | | | |
|
Current year | | (35,653 | ) | | (36,751 | ) |
Prior years | | (43,092 | ) | | (60,530 | ) |
Balance at end of period, net | | 81,813 |
| | 101,418 |
|
Plus reinsurance recoverable related to property and casualty unpaid loss and loss adjustment expenses | | 8,173 |
| | 3,535 |
|
Balance at end of period, gross | | $ | 89,986 |
| | $ | 104,953 |
|
(b) Vehicle Service Agreements
The results of the comparison and the changes in the provision for vehicle service agreement unpaid loss and loss adjustment expenses as of September 30, 2013 are presented below. The changes in and the provision for vehicle service agreement unpaid loss and loss adjustment expenses were zero as of September 30, 2012.
|
| | | | |
(in thousands) | | September 30, 2013 |
|
Balance at beginning of period | | $ | 3,448 |
|
Incurred related to: | | |
Current year | | 4,869 |
|
Prior years | | — |
|
Paid related to: | | |
Current year | | (5,354 | ) |
Prior years | | (81 | ) |
Balance at end of period | | $ | 2,882 |
|
NOTE 13 DEBT
Debt consists of the following instruments:
|
| | | | | | | | | | | | | | | | |
(in thousands) | | September 30, 2013 | | December 31, 2012 |
| | Principal |
| | Fair Value |
| | Principal |
| | Fair Value |
|
7.5% senior notes due 2014 | | $ | 26,356 |
| | $ | 26,356 |
| | $ | 26,966 |
| | $ | 23,730 |
|
LROC preferred units due 2015 | | 15,334 |
| | 14,286 |
| | 15,879 |
| | 13,655 |
|
Subordinated debt | | 90,500 |
| | 22,790 |
| | 90,500 |
| | 23,774 |
|
Total | | $ | 132,190 |
| | $ | 63,432 |
| | $ | 133,345 |
| | $ | 61,159 |
|
|
| | |
KINGSWAY FINANCIAL SERVICES INC. Notes to Consolidated Financial Statements (Unaudited) September 30, 2013 |
Subordinated indebtedness mentioned above consists of the following trust preferred debt instruments:
|
| | | | | |
Issuer | Principal |
| 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 |
| 5/23/2003 | annual interest rate equal to LIBOR, plus 4.20% payable quarterly | 5/23/2033 |
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 |
| 1/8/2004 | annual interest rate equal to LIBOR, plus 4.00% payable quarterly | 1/8/2034 |
During the first quarter of 2011, 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 September 30, 2013, deferred interest payable of $11.6 million is included in accrued expenses and other liabilities in the consolidated balance sheets. The cash interest due in 2016 is subject to changes in the London interbank offered interest rate for three-month U.S. dollar deposits ("LIBOR") over the deferral period.
No debt repurchases were made during the third quarter of 2013. During the first quarter of 2013, the Company purchased for $0.6 million, including accrued interest, $0.6 million of par value of its senior unsecured debentures with a carrying value of $0.6 million, including accrued interest, recording a loss of $0.0 million. The Company subsequently canceled the acquired debentures. During the three and nine months ended September 30, 2012, respectively, the Company did not buy-back any of its outstanding debt.
NOTE 14 INCOME TAXES
Income tax expense (benefit) for the three months ended September 30, 2013 varies from the amount that would result by applying the applicable United States income tax rate of 34% to loss from continuing operations before income tax expense (benefit) primarily due to a valuation allowance being applied to the Company's operating losses and a tax expense being recorded attributable to the Company's indefinite life intangible assets. Income tax expense (benefit) for the nine months ended September 30, 2013 varies from the amount that would result by applying the applicable United States income tax rate of 34% to loss from continuing operations before income tax expense (benefit) primarily due to a valuation allowance being applied to the Company's operating losses, a tax expense being recorded attributable to the Company's indefinite life intangible assets and a tax benefit being recorded for a Canadian income tax refund. Income tax benefit for the three and nine months ended September 30, 2012 varies from the amount that would result by applying the applicable United States income tax rate of 34% to loss from continuing operations before income tax benefit primarily due to a valuation allowance being applied to the Company's operating losses and a tax benefit being recorded for a prior year Canadian tax return to provision adjustment.
The Company maintains a valuation allowance for its gross deferred tax assets at September 30, 2013 and December 31, 2012. The Company's operations have generated substantial operating losses during the last several years. These losses can be available to reduce income taxes that might otherwise be incurred on future taxable income. The Company's operations, however, remain challenged and, as a result, 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 September 30, 2013 and December 31, 2012 net deferred tax asset. The Company carries a deferred income tax liability of $3.9 million and $3.1 million at September 30, 2013 and December 31, 2012, respectively, all of which relates to indefinite life intangible assets.
As of September 30, 2013 and December 31, 2012, the Company carried a liability for unrecognized tax benefits of $3.1 million and $3.0 million, respectively, that is included in income taxes payable in the consolidated balance sheets. The Company generally recognizes interest and penalties related to unrecognized tax benefits in income tax expense (benefit).
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KINGSWAY FINANCIAL SERVICES INC. Notes to Consolidated Financial Statements (Unaudited) September 30, 2013 |
NOTE 15 NET INCOME (LOSS) PER SHARE
Net income (loss) per share is based on the weighted-average number of shares outstanding. Diluted weighted-average shares is calculated by adjusting basic weighted-average shares outstanding by all potentially dilutive stock options. Since the Company is reporting a net loss for the nine months ended September 30, 2013 and the three and nine months ended September 30, 2012 and because the exercise price of the options was greater than the average market price of the common stock for the three months ended September 30, 2013, all stock options outstanding were excluded from the calculation of both basic and diluted income (loss) per share since their inclusion would have been anti-dilutive.
On July 3, 2012, the Company announced that the Board of Directors of the Company authorized the implementation of a share consolidation at a ratio of one post-consolidation share for every four pre-consolidation shares. The share consolidation, which was approved by the stockholders at the Company's Annual and Special Meeting held on May 31, 2012, was effective as of July 3, 2012 (the "Effective Date"). As a result of the consolidation, every four of the Company's common shares that were issued and outstanding on the Effective Date were automatically combined into one issued and outstanding common share, without any change in the par value of such shares. Any fractional shares resulting from the consolidation were rounded up to the nearest whole. The consolidation had the effect of reducing the number of common shares of the Company issued and outstanding at the Effective Date from 52,595,828 shares pre-consolidation to 13,148,971 shares post-consolidation. The issued and outstanding shares reported in the consolidated balance sheets and the number of weighted-average shares outstanding included in the loss per share computations, as reported in the consolidated statements of operations, have been restated for all periods presented to reflect the impact of the share consolidation.
NOTE 16 SHAREHOLDERS' EQUITY
On May 30, 2013, the Company announced that it had filed a registration statement for a proposed rights offering relating to transferable subscription rights to purchase up to approximately $13.1 million of its shares of common stock (the "Common Shares") and warrants to purchase Common Shares. The rights offering was made in the United States pursuant to a registration statement on Form S-1 that was previously filed with the Securities and Exchange Commission and became effective on July 24, 2013.
Under the rights offering, each shareholder of record as of August 9, 2013 (the "Record Date") received, at no charge, one subscription right for each Common Share owned on the Record Date (the "Subscription Right"). Four Subscription Rights entitled the holder to purchase one unit (a "Unit") consisting of one Common Share, one Series A Warrant (a "Series A Warrant") and one Series B Warrant (a "Series B Warrant", and together with the Series A Warrants, the "Warrants"). Each Warrant entitled the holder to purchase one Common Share. The subscription price was $4.00 per Unit. The exercise price per Common Share for each Series A Warrant is the greater of $4.50 and 120% of the volume weighted average price of the Common Shares ("VWAP") over the twenty trading day period on the New York Stock Exchange ("NYSE") ending on such trading day prior to the issuance date of the Series A Warrants. The exercise price per Common Share for each Series B Warrant is the greater of $5.00 and 120% of the VWAP over the twenty trading day period on the NYSE ending on such trading day prior to the issuance date of the Series B Warrant. Each Series A Warrant is redeemable by the Company and has a term of seven years from its date of issuance. Each Series B Warrant is non-redeemable and has a term of ten years from its date of issuance. The Company may redeem the Series A Warrants at a price of $0.25 per Warrant if, and only if, the closing price of the Common Shares equals or exceeds $6.00 per Common Share for twenty consecutive trading days on the NYSE or such other market or exchange as the Common Shares of the Company trade on or are quoted at the time of redemption; but in any event, no earlier than the first anniversary date of issuance. Subject to applicable securities laws, the Warrants may be exercised at any time starting on the first day of the thirty-seventh month after the date of issuance until any time on or before the seventh anniversary after the date of issuance for the Series A Warrants and the tenth anniversary after the date of issuance for the Series B Warrants. Holders who fully exercise their Subscription Rights will be entitled to subscribe for an additional amount of Units, if any, that are not purchased by other shareholders or their transferees through the exercise of their basic subscription privileges, in an amount equal to up to five Units for each Unit for which such holder was otherwise entitled to subscribe.
On September 16, 2013, the transaction closed. Subscription rights to purchase 3,280,790 units were exercised, resulting in gross proceeds to the Company of $13.1 million. Net proceeds to the Company were $12.1 million after deducting commissions and other offering expenses.
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| | |
KINGSWAY FINANCIAL SERVICES INC. Notes to Consolidated Financial Statements (Unaudited) September 30, 2013 |
NOTE 17 ACCUMULATED OTHER COMPREHENSIVE INCOME
The table below details the components of accumulated other comprehensive income, net of tax, for the three and nine months ended September 30, 2013 and September 30, 2012 as relates to shareholders' equity attributable to common shareholders on the consolidated balance sheets. On the other hand, the unaudited consolidated statements of comprehensive loss present the components of other comprehensive (loss) income, net of tax, only for the three and nine months ended September 30, 2013 and September 30, 2012 and inclusive of the components attributable to noncontrolling interests in consolidated subsidiaries.
|
| | | | | | | | | | | | | | | | |
| | Three months ended September 30, | | | Nine months ended September 30, | |
| | 2013 |
| | 2012 |
| | 2013 |
| | 2012 |
|
Beginning balance | | $ | 16,862 |
| | $ | 13,047 |
| | $ | 14,762 |
| | $ | 12,749 |
|
Unrealized (losses) gains on fixed maturities and equity investments arising during the period | | (274 | ) | | (1,191 | ) | | 878 |
| | (888 | ) |
Reclassification adjustment for losses included in net income (loss) | | 1,860 |
| | 1,090 |
| | 2,142 |
| | 723 |
|
Foreign currency translation adjustments | | 1 |
| | 496 |
| | 25 |
| | 519 |
|
Recognition of currency translation gain on liquidation of subsidiaries | | (7,227 | ) | | — |
| | (7,227 | ) | | — |
|
Equity in other comprehensive income of investee | | — |
| | 310 |
| | 642 |
| | 649 |
|
Balance at September 30 | | $ | 11,222 |
| | $ | 13,752 |
| | $ | 11,222 |
| | $ | 13,752 |
|
Components of accumulated other comprehensive income were reclassified to the following lines of the consolidated statements of operations for the three and nine months ended September 30, 2013 and September 30, 2012:
|
| | | | | | | | | | | | | | | | |
| | Three months ended September 30, | | | Nine months ended September 30, | |
| | 2013 |
| | 2012 |
| | 2013 |
| | 2012 |
|
Reclassification of accumulated other comprehensive income from unrealized (losses) gains on fixed maturities and equity investments to: | | | | | | | | |
Net realized gains (losses) | | $ | (1,860 | ) | | $ | (1,090 | ) | | $ | (2,142 | ) | | $ | (723 | ) |
Other-than-temporary impairment loss | | — |
| | — |
| | — |
| | — |
|
Loss from continuing operations before income tax expense (benefit) | | (1,860 | ) | | (1,090 | ) | | (2,142 | ) | | (723 | ) |
Income tax expense (benefit) | | — |
| | — |
| | — |
| | — |
|
Net income (loss) | | $ | (1,860 | ) | | $ | (1,090 | ) | | $ | (2,142 | ) | | $ | (723 | ) |
NOTE 18 SEGMENTED INFORMATION
The Company is primarily engaged, through its subsidiaries, in the property and casualty insurance business. The Company conducts its business through the following two reportable segments: Insurance Underwriting and Insurance Services.
On September 17, 2012, the Company announced that it was restructuring its Insurance Underwriting and Insurance Services segments under two separate management teams. As a result of the Company's intent to streamline its non-standard property and casualty insurance business operations under one management team, KAI Advantage Auto, Inc. ("Advantage Auto"), formerly included in Insurance Services, is now part of Insurance Underwriting. All segmented information has been restated for all periods presented to include Advantage Auto in Insurance Underwriting.
Insurance Underwriting Segment
Insurance Underwriting includes the following subsidiaries of the Company: Mendota Insurance Company, Mendakota Insurance Company, Universal Casualty Company, Maison Insurance Company ("Maison"), Kingsway Amigo Insurance Company ("Amigo"), Advantage Auto and Kingsway Reinsurance Corporation (collectively, "Insurance Underwriting"). In October 2012,
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KINGSWAY FINANCIAL SERVICES INC. Notes to Consolidated Financial Statements (Unaudited) September 30, 2013 |
the Company formed Maison, a Louisiana-domiciled property and casualty insurance company, which provides homeowners policies for wind and hail-related property losses of residential dwellings and certain contents. In September 2013, Kingsway Reinsurance (Bermuda) Ltd., formerly included in Insurance Underwriting, was liquidated. Insurance Underwriting principally offers personal automobile insurance to drivers who do not meet the criteria for coverage by standard automobile insurers and actively conducts business in 17 states.
During the fourth quarter of 2012, the Company began taking steps to place all of Amigo into voluntary run-off. On November 19, 2012, the Florida Office of Insurance Regulation (“OIR”) approved Amigo's plan to withdraw from the business of offering commercial lines insurance in Florida. On January 30, 2013, the OIR approved Amigo's plan to withdraw from the business of offering personal lines insurance in Florida. In April 2013, Kingsway filed a comprehensive run-off plan with the OIR, which outlines plans for Amigo's run-off. Kingsway continues to manage Amigo in a manner consistent with its filed run-off plan.
Insurance Services Segment
Insurance Services includes the following subsidiaries of the Company: Assigned Risk Solutions Ltd. ("ARS"), IWS and TWS (collectively, "Insurance Services"). During the first quarter of 2013, Northeast Alliance Insurance Agency, LLC, formerly included in Insurance Services, was merged into ARS.
ARS is a licensed property and casualty agent, full service managing general agent and third-party administrator focused primarily on the assigned risk market. ARS is licensed to administer business in 22 states but generates its revenues primarily by operating in the states of New York and New Jersey.
IWS is a licensed motor vehicle service agreement company and is a provider of after-market vehicle protection services distributed by credit unions in 26 states and Puerto Rico to their members.
TWS is a provider of warranty products and maintenance support to consumers and businesses in the heating, ventilation, air conditioning ("HVAC") and refrigeration industry. TWS distributes its warranty products through original equipment manufacturers, HVAC distributors and commercial and residential contractors. TWS distributes its maintenance support direct through corporate owners of retail spaces throughout the United States.
Results for the Company's reportable segments are based on the Company's internal financial reporting systems and are consistent with those followed in the preparation of the unaudited consolidated interim financial statements. The following tables provide financial data used by management. Segment assets are not allocated for management use and, therefore, are not included in the segment disclosures below.
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| | |
KINGSWAY FINANCIAL SERVICES INC. Notes to Consolidated Financial Statements (Unaudited) September 30, 2013 |
Segment revenues for the three and nine months ended September 30, 2013 and 2012 were:
|
| | | | | | | | | | | | | | | | |
(in thousands) | | Three months ended September 30, | | | Nine months ended September 30, | |
| | 2013 |
| | 2012 |
| | 2013 |
| | 2012 |
|
Revenues: | | | | | | | | |
Insurance Underwriting: | | | | | | | | |
Net premiums earned | | $ | 26,041 |
| | $ | 26,501 |
| | $ | 82,406 |
| | $ | 86,753 |
|
Other income | | 2,314 |
| | 1,926 |
| | 6,970 |
| | 5,679 |
|
Total Insurance Underwriting | | 28,355 |
| | 28,427 |
| | 89,376 |
| | 92,432 |
|
Insurance Services: | | | | | | | | |
Service fee and commission income | | 12,156 |
| | 7,648 |
| | 37,332 |
| | 25,315 |
|
Total Insurance Services | | 12,156 |
| | 7,648 |
| | 37,332 |
| | 25,315 |
|
Total segment revenues | | 40,511 |
| | 36,075 |
| | 126,708 |
| | 117,747 |
|
Net investment income | | 528 |
| | 777 |
| | 1,924 |
| | 2,400 |
|
Net realized gains (losses) | | 321 |
| | 1,109 |
| | (1,056 | ) | | 1,359 |
|
Other-than-temporary impairment loss | | — |
| | — |
| | (1,800 | ) | | (488 | ) |
Gain (loss) on change in fair value of debt | | 3,801 |
| | (3,177 | ) | | (2,812 | ) | | (9,926 | ) |
Other income not allocated to segments | | 290 |
| | 14 |
| | 26 |
| | 88 |
|
Total revenues | | $ | 45,451 |
| | $ | 34,798 |
| | $ | 122,990 |
| | $ | 111,180 |
|
The operating (loss) income of each segment in the following table is before income taxes and includes revenues and direct segment costs. For the three months ended September 30, 2013 and 2012, Insurance Services operating (loss) income includes amortization expense of $0.3 million and zero, respectively ($1.0 million and zero for the nine months ended September 30, 2013 and September 30, 2012, respectively), related to its VSA in-force intangible asset.
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KINGSWAY FINANCIAL SERVICES INC. Notes to Consolidated Financial Statements (Unaudited) September 30, 2013 |
Segment (loss) income for the three and nine months ended September 30, 2013 and 2012 were:
|
| | | | | | | | | | | | | | | | |
(in thousands) | | Three months ended September 30, | | | Nine months ended September 30, | |
| | 2013 |
| | 2012 |
| | 2013 |
| | 2012 |
|
Segment operating (loss) income | | | | | | | | |
Insurance Underwriting | | $ | (4,900 | ) | | $ | (16,742 | ) | | $ | (14,625 | ) | | $ | (23,705 | ) |
Insurance Services | | (871 | ) | | 414 |
| | 418 |
| | 3,138 |
|
Total segment operating loss | | (5,771 | ) | | (16,328 | ) | | (14,207 | ) | | (20,567 | ) |
Net investment income | | 528 |
| | 777 |
| | 1,924 |
| | 2,400 |
|
Net realized gains (losses) | | 321 |
| | 1,109 |
| | (1,056 | ) | | 1,359 |
|
Other-than-temporary impairment loss | | — |
| | — |
| | (1,800 | ) | | (488 | ) |
Gain (loss) on change in fair value of debt | | 3,801 |
| | (3,177 | ) | | (2,812 | ) | | (9,926 | ) |
Other income and expenses not allocated to segments, net | | (2,140 | ) | | (2,180 | ) | | (7,729 | ) | | (6,707 | ) |
Interest expense | | (1,808 | ) | | (1,887 | ) | | (5,568 | ) | | (5,652 | ) |
Amortization of intangible assets not allocated to segments | | (181 | ) | | — |
| | (593 | ) | | — |
|
Impairment of asset held for sale | | — |
| | — |
| | (1,446 | ) | | — |
|
(Loss) gain on buy-back of debt | | — |
| | 500 |
| | (24 | ) | | 500 |
|
Equity in net income (loss) of investee | | — |
| | 98 |
| | 255 |
| | (2,071 | ) |
Loss from continuing operations before income tax expense (benefit) | | $ | (5,250 | ) | | $ | (21,088 | ) | | $ | (33,056 | ) | | $ | (41,152 | ) |
Income tax expense (benefit) | | 403 |
| | (1,054 | ) | | (398 | ) | | (879 | ) |
Loss from continuing operations | | $ | (5,653 | ) | | $ | (20,034 | ) | | $ | (32,658 | ) | | $ | (40,273 | ) |
Net premiums earned by line of business for the three and nine months ended September 30, 2013 and 2012 were:
|
| | | | | | | | | | | | | | | | |
(in thousands) | | Three months ended September 30, | | | Nine months ended September 30, | |
| | 2013 |
| | 2012 |
|