10Q Q1 14

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_________________________
FORM 10-Q
(Mark One)
 
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
March 31, 2014
or
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2014
 
Commission File Number: 001-15204
 
Kingsway Financial Services Inc.
(Exact name of registrant as specified in its charter)
_________________________
Ontario, Canada
(State or other jurisdiction of
incorporation or organization)
 
Not Applicable (I.R.S. Employer
Identification No.)
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.

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 May 8, 2014 was 16,429,761.


KINGSWAY FINANCIAL SERVICES INC.

Table Of Contents
PART I - FINANCIAL INFORMATION
 
ITEM 1. FINANCIAL STATEMENTS
 
Consolidated Balance Sheets as of March 31, 2014 (unaudited) and December 31, 2013
 
Consolidated Statements of Operations for the Three Months Ended March 31, 2014 and 2013 (unaudited)
 
Consolidated Statements of Comprehensive Income (Loss) for the Three Months Ended March 31, 2014 and 2013 (unaudited)
 
Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2014 and 2013 (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
 


















 
2
 
KINGSWAY FINANCIAL SERVICES INC.



PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets
(in thousands, except per share data)
 
 
March 31, 2014

 
December 31, 2013

 
 
 (unaudited)

 
 
Assets
 
 
 
 
Investments:
 
 
 
 
Fixed maturities, at fair value (amortized cost of $50,778 and $53,455, respectively)
 
$
51,456

 
$
54,151

Equity investments, at fair value (cost of $5,103 and $3,554, respectively)
 
9,982

 
7,137

Limited liability investments
 
4,701

 
4,406

Other investments, at cost which approximates fair value
 
2,000

 
3,000

Short-term investments, at cost which approximates fair value
 
401

 
501

Total investments
 
68,540

—

69,195

Cash and cash equivalents
 
72,080

 
98,589

Investment in investee
 
7,661

 
—

Accrued investment income
 
1,096

 
614

Premiums receivable, net of allowance for doubtful accounts of $1,839 and $2,123, respectively
 
32,609

 
32,035

Service fee receivable, net of allowance for doubtful accounts of $245 and $0, respectively
 
22,622

 
19,012

Other receivables, net of allowance for doubtful accounts of $1,061 and $1,062, respectively
 
5,106

 
4,097

Reinsurance recoverable
 
7,569

 
10,335

Prepaid reinsurance premiums
 
148

 
6,816

Deferred acquisition costs, net
 
12,559

 
12,392

Property and equipment, net of accumulated depreciation of $15,894 and $15,848, respectively
 
1,671

 
1,662

Goodwill
 
10,588

 
10,588

Intangible assets, net of accumulated amortization of $18,997 and $18,583, respectively
 
48,504

 
48,918

Other assets
 
3,525

 
4,039

Asset held for sale
 
6,347

 
6,347

Total Assets
 
$
300,625

 
$
324,639

Liabilities and Shareholders' Equity
 
 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
Unpaid loss and loss adjustment expenses:
 
 
 
 
Property and casualty
 
$
77,285

 
$
84,534

Vehicle service agreements
 
3,128

 
3,128

Total unpaid loss and loss adjustment expenses
 
80,413

 
87,662

Unearned premiums
 
40,979

 
48,577

Reinsurance payable
 
145

 
1,033

LROC preferred units, at fair value
 
14,291

 
14,854

Senior unsecured debentures, at fair value
 
—

 
14,356

Subordinated debt, at fair value
 
28,471

 
28,471

Deferred income tax liability
 
4,456

 
4,173

Deferred service fees
 
49,262

 
48,788

Income taxes payable
 
921

 
2,984

Accrued expenses and other liabilities
 
37,538

 
36,821

Total Liabilities
 
$
256,476

 
$
287,719

Shareholders' Equity:
 
 
 
 
Class A preferred stock, no par value; unlimited number authorized; 262,876 and zero issued and outstanding at March 31, 2014 and December 31, 2013, respectively
 
$
6,402

 
$
—

Common stock, no par value; unlimited number authorized; 16,429,761 and 16,429,761 issued and outstanding at March 31, 2014 and December 31, 2013, respectively
 
—

 
—

Additional paid-in capital
 
325,427

 
324,803

Accumulated deficit
 
(300,640
)
 
(298,930
)
Accumulated other comprehensive income
 
10,973

 
9,601

Shareholders' equity attributable to common shareholders
 
42,162

 
35,474

Noncontrolling interests in consolidated subsidiaries
 
1,987

 
1,446

Total Shareholders' Equity
 
44,149

 
36,920

Total Liabilities and Shareholders' Equity
 
$
300,625

 
$
324,639

See accompanying notes to unaudited consolidated financial statements.

 
3
 
KINGSWAY FINANCIAL SERVICES INC.


Consolidated Statements of Operations
(in thousands, except per share data)
(Unaudited)
 
 
Three months ended March 31,
 
 
 
2014

 
2013

Revenues:
 
 
 
 
Net premiums earned
 
$
31,920

 
$
28,068

Service fee and commission income
 
14,724

 
13,124

Net investment income
 
413

 
580

Net realized gains (losses)
 
39

 
(1,409
)
Other income
 
2,071

 
2,218

Total revenues
 
49,167

 
42,581

Expenses:
 
 
 
 
Loss and loss adjustment expenses
 
21,061

 
21,831

Commissions and premium taxes
 
6,553

 
6,712

Cost of services sold
 
856

 
—

General and administrative expenses
 
18,524

 
19,604

Restructuring expense
 
20

 
780

Interest expense
 
1,433

 
1,833

Amortization of intangible assets
 
414

 
558

Contingent consideration expense
 
267

 
155

Total expenses
 
49,128

 
51,473

Income (loss) before gain (loss) on change in fair value of debt, loss on disposal of subsidiary, loss on buy-back of debt, equity in net income of investee and income tax expense (benefit)
 
39

 
(8,892
)
Gain (loss) on change in fair value of debt
 
563

 
(8,951
)
Loss on disposal of subsidiary
 
(1,242
)
 
—

Loss on buy-back of debt
 
—

 
(24
)
Equity in net income of investee
 
—

 
255

Loss before income tax expense (benefit)
 
(640
)
 
(17,612
)
Income tax expense (benefit)
 
366

 
(276
)
Net loss
 
(1,006
)
 
(17,336
)
Less: net income attributable to noncontrolling interests in consolidated subsidiaries
 
653

 
95

Less: dividends on preferred stock
 
53

 
—

Net loss attributable to common shareholders
 
$
(1,712
)
 
$
(17,431
)
Loss per share – net loss attributable to common shareholders:
 
 
 
 
Basic:
 
$
(0.10
)
 
$
(1.33
)
Diluted:
 
(0.10
)
 
(1.33
)
Weighted average shares outstanding (in ‘000s):
 
 
 
 
Basic:
 
16,430

 
13,149

Diluted:
 
16,430

 
13,149

See accompanying notes to unaudited consolidated financial statements.



 
4
 
KINGSWAY FINANCIAL SERVICES INC.


Consolidated Statements of Comprehensive Income (Loss)
(in thousands)
(unaudited)
 
 
Three months ended March 31,
 
 
 
2014

 
2013

 
 
 
 
 
Net loss
 
$
(1,006
)
 
$
(17,336
)
Other comprehensive income (loss), net of taxes(1):
 
 
 
 
Unrealized gains (losses) on fixed maturities and equity investments:
 
 
 
 
Unrealized gains (losses) arising during the period
 
1,226

 
(503
)
Reclassification adjustment for amounts included in net loss
 
52

 
248

Foreign currency translation adjustments
 
(18
)
 
1

Equity in other comprehensive loss of investee
 
—

 
(105
)
Other comprehensive income (loss)
 
1,260

 
(359
)
Comprehensive income (loss)
 
254

 
(17,695
)
Less: comprehensive income attributable to noncontrolling interests in consolidated subsidiaries
 
541

 
66

Comprehensive loss attributable to common shareholders
 
$
(287
)
 
$
(17,761
)
 (1) Net of income tax expense (benefit) of $0 and $0 for the three months ended March 31, 2014 and March 31, 2013, respectively.
See accompanying notes to unaudited consolidated financial statements

 
5
 
KINGSWAY FINANCIAL SERVICES INC.

Consolidated Statements of Cash Flows
(in thousands)
(unaudited)
 
 
Three months ended March 31,
 
 
 
2014

 
2013

Cash provided by (used in):
 
 
 
 
Operating activities:
 
 
 
 
Net loss
 
$
(1,006
)
 
$
(17,336
)
Adjustments to reconcile net loss to net cash used in operating activities:
 
 
 
 
Equity in net income of investee
 
—

 
(255
)
Equity in net income of limited liability investments
 
(22
)
 
(50
)
Depreciation and amortization
 
693

 
1,002

Contingent consideration expense
 
267

 
155

Stock based compensation expense, net of forfeitures
 
624

 
—

Net realized (gains) losses
 
(39
)
 
1,409

(Gain) loss on change in fair value of debt
 
(563
)
 
8,951

Deferred income taxes
 
459

 
(416
)
Amortization of fixed maturities premiums and discounts
 
206

 
1,270

Loss on disposal of subsidiary
 
1,242

 
—

Realized loss on buy-back of debt
 
—

 
24

Changes in operating assets and liabilities:
 
 
 
 
Premiums and service fee receivable
 
(4,184
)
 
(6,086
)
Reinsurance recoverable
 
2,766

 
(6,108
)
Prepaid reinsurance premiums
 
6,668

 
(2,922
)
Deferred acquisition costs
 
(167
)
 
1,417

Unpaid loss and loss adjustment expenses
 
(7,249
)
 
(5,360
)
Unearned premiums
 
(7,598
)
 
7,069

Reinsurance payable
 
(888
)
 
5,681

Deferred service fees
 
474

 
(174
)
Other, net
 
(623
)
 
470

Net cash used in operating activities
 
(8,940
)
 
(11,259
)
Investing activities:
 
 
 
 
Proceeds from sales and maturities of fixed maturities
 
5,100

 
9,348

Proceeds from sales of equity investments
 
71

 
175

Proceeds from sales of investment in investee
 
—

 
13,638

Purchase of fixed maturities
 
(5,878
)
 
(879
)
Purchase of equity investments
 
(1,593
)
 
(23
)
Net acquisition of limited liability investments
 
(263
)
 
99

Proceeds from other investments
 
1,000

 
—

Net purchases of short-term investments
 
(103
)
 
(325
)
Acquisition of investee
 
(7,661
)
 
—

Net purchases of property and equipment
 
(288
)
 
(183
)
Net cash (used in) provided by investing activities
 
(9,615
)
 
21,850

Financing activities:
 
 
 
 
Proceeds from issuance of preferred stock, net
 
6,402

 
—

Redemption of senior unsecured debentures
 
(14,356
)
 
(583
)
Net cash used in financing activities
 
(7,954
)
 
(583
)
Net (decrease) increase in cash and cash equivalents
 
(26,509
)
 
10,008

Cash and cash equivalents at beginning of period
 
98,589

 
80,813

Cash and cash equivalents at end of period
 
$
72,080

 
$
90,821

See accompanying notes to unaudited consolidated financial statements.

 
6
 
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements (Unaudited) March 31, 2014


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 Canadian holding company with operating subsidiaries located in the United States. The Company operates as a merchant bank 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 ("2013 Annual Report") for the year ended December 31, 2013.
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, fair value assumptions for debt obligations and contingent consideration.
The fair values of the Company's investments in fixed maturities and equity investments, LROC preferred units, senior unsecured debentures, subordinated debt 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, 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 2013 Annual Report.
NOTE 4 RECENTLY ISSUED 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.

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 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

 
7
 
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements (Unaudited) March 31, 2014

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 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. Effective January 1, 2014, the Company adopted ASU 2013-11. Except for the new disclosure requirements, the adoption of the standard did not have an impact on the consolidated financial statements.

NOTE 5 ACQUISITION AND DISPOSITION
(a)     Acquisition
Trinity Warranty Solutions LLC:
Effective May 22, 2013, the Company's subsidiary, Trinity Warranty Solutions LLC ("Trinity"), acquired certain intangible assets and liabilities of Trinity Warranty Corp. for total consideration consisting of approximately $1.1 million in cash and future contingent payments. As further discussed in Note 18, "Segmented Information," Trinity is included in the Insurance Services segment. Trinity is based in Illinois and is a provider of warranty products and maintenance support to consumers and businesses in the heating, ventilation, air conditioning ("HVAC") and refrigeration industry.

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 2013, the Company completed its fair value analysis on the assets acquired and liabilities assumed. Goodwill of $1.1 million was recognized in addition to $0.5 million of a separately identifiable intangible asset for customer-related relationships. Refer to Note 9, "Intangible Assets," for further disclosure on intangible assets related to this acquisition. The fair value analysis performed resulted in the establishment of a $0.6 million liability effective May 22, 2013 related to present value of future contingent payments. The maximum the Company can pay in future contingent payments is $2.4 million, on an undiscounted basis. The contingent payments are payable annually beginning in 2014 through 2023, are subject to the achievement of certain targets and may be adjusted in future periods based on actual performance achieved. As of March 31, 2014, the recorded value of the contingent payment liability is $0.8 million, which is included in accrued expenses and other liabilities on the consolidated balance sheets.
(b)     Disposition
Effective March 31, 2014, the Company's wholly owned subsidiary, 1347 Property Insurance Holdings, Inc. ("PIH"), formerly known as Maison Insurance Holdings, Inc., completed an initial public offering of its common stock. Total consideration to the Company as a result of this transaction was $7.7 million, consisting of a 28.7% interest in the common shares of PIH. As a result of the disposal, the Company recognized a loss of $1.2 million for the three months ended March 31, 2014. The earnings of PIH are included in the consolidated statements of operations through the March 31, 2014 transaction date. Refer to Note 7, "Investment in Investee," for further disclosure on the Company's investment in PIH at March 31, 2014.




 
8
 
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements (Unaudited) March 31, 2014

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 March 31, 2014 and December 31, 2013 are summarized in the tables shown below:
(in thousands)
 
March 31, 2014
 
 
 
Amortized Cost

 
Gross Unrealized Gains

 
Gross Unrealized Losses

 
Estimated  Fair Value

Fixed maturities:
 
 
 
 
 
 
 
 
U.S. government, government agencies and authorities
 
$
15,255

 
$
531

 
$
21

 
$
15,765

Canadian government
 
4,417

 
—

 
161

 
4,256

States municipalities and political subdivisions
 
6,118

 
138

 
—

 
6,256

Mortgage-backed
 
1,952

 
16

 
1

 
1,967

Asset-backed securities and collateralized mortgage obligations
 
4,489

 
4

 
2

 
4,491

Corporate
 
18,547

 
184

 
10

 
18,721

Total fixed maturities
 
50,778

 
873

 
195

 
51,456

Equity investments:
 
 
 
 
 
 
 
 
Common stock
 
5,103

 
4,972

 
93

 
9,982

Total fixed maturities and equity investments
 
$
55,881

 
$
5,845

 
$
288

 
$
61,438


(in thousands)
 
December 31, 2013
 
 
 
Amortized Cost

 
Gross Unrealized Gains

 
Gross Unrealized Losses

 
Estimated  Fair Value

Fixed maturities:
 
 
 
 
 
 
 
 
U.S. government, government agencies and authorities
 
$
17,777

 
$
591

 
$
30

 
$
18,338

Canadian government
 
4,235

 
—

 
153

 
4,082

States municipalities and political subdivisions
 
6,126

 
105

 
—

 
6,231

Mortgage-backed
 
1,993

 
15

 
2

 
2,006

Asset-backed securities and collateralized mortgage obligations
 
3,996

 
1

 
3

 
3,994

Corporate
 
19,328

 
183

 
11

 
19,500

Total fixed maturities
 
53,455

 
895

 
199

 
54,151

Equity investments:
 
 
 
 
 
 
 
 
Common stock
 
3,554

 
3,623

 
40

 
7,137

Total fixed maturities and equity investments
 
$
57,009

 
$
4,518

 
$
239

 
$
61,288


The table below summarizes the Company's fixed maturities at March 31, 2014 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.

 
9
 
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements (Unaudited) March 31, 2014

(in thousands)
 
March 31, 2014
 
 
 
Amortized Cost

 
Estimated Fair Value

Due in one year or less
 
$
17,500

 
$
17,596

Due after one year through five years
 
30,733

 
31,296

Due after five years through ten years
 
614

 
619

Due after ten years
 
1,931

 
1,945

Total
 
$
50,778

 
$
51,456


The following tables highlight the aggregate unrealized loss position, by security type, of fixed maturities and equity investments in unrealized loss positions as of March 31, 2014 and December 31, 2013. The tables segregate the holdings based on the period of time the investments have been continuously held in unrealized loss positions.
(in thousands)
 
 
 
 
 
 
 
 
March 31, 2014
 
 
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
$
2,514

 
$
19

 
$
861

 
$
2

 
$
3,375

 
$
21

Canadian government
—

 
—

 
4,256

 
161

 
4,256

 
161

Mortgage-backed
603

 
1

 
—

 
—

 
603

 
1

Asset-backed securities and collateralized mortgage obligations
1,273

 
2

 
—

 
—

 
1,273

 
2

Corporate
816

 
10

 
—

 
—

 
816

 
10

Total fixed maturities
5,206

 
32

 
5,117

 
163

 
10,323

 
195

Equity investments:
 
 
 
 
 
 
 
 


 


Common stock
1,618

 
93

 
—

 
—

 
1,618

 
93

Total
$
6,824

 
$
125

 
$
5,117

 
$
163

 
$
11,941

 
$
288



 
10
 
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements (Unaudited) March 31, 2014

(in thousands)
 
 
 
 
 
 
 
 
December 31, 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
$
4,008

 
$
30

 
$
—

 
$
—

 
$
4,008

 
$
30

Canadian government
—

 
—

 
4,082

 
153

 
4,082

 
153

Mortgage-backed
919

 
2

 
—

 
—

 
919

 
2

Asset-backed securities and collateralized mortgage obligations
3,474

 
3

 
—

 
—

 
3,474

 
3

Corporate
408

 
1

 
—

 
10

 
408

 
11

Total fixed maturities
8,809

 
36

 
4,082

 
163

 
12,891

 
199

Equity investments:
 
 
 
 
 
 
 
 
 
 
 
Common stock
969

 
35

 
1

 
5

 
970

 
40

Total
$
9,778

 
$
71

 
$
4,083

 
$
168

 
$
13,861

 
$
239

Fixed maturities and equity investments contain approximately 18 and 27 individual investments that were in unrealized loss positions as of March 31, 2014 and December 31, 2013, 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 investments for the three months ended March 31, 2014 and March 31, 2013.
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

 
11
 
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements (Unaudited) March 31, 2014

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 March 31, 2014 and December 31, 2013, the carrying value of limited liability investments totaled $4.7 million and $4.4 million, respectively. At March 31, 2014, the Company has unfunded commitments totaling $1.5 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 March 31, 2014 and December 31, 2013, the carrying value of other investments totaled $2.0 million and $3.0 million, respectively.
Gross realized gains and losses on fixed maturities, equity investments and limited liability investments for the three months ended March 31, 2014 and March 31, 2013 were as follows:
(in thousands)
 
Three months ended March 31,
 
 
 
2014

 
2013

Gross realized gains
 
$
48

 
$
309

Gross realized losses
 
(9
)
 
—

Total
 
$
39

 
$
309


Gross realized losses for the three months ended March 31, 2013 reported in the preceding table excludes the realized loss on sale of Atlas Financial Holdings Inc. ("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 months ended March 31, 2014 and March 31, 2013, respectively, is comprised as follows:
(in thousands)
 
Three months ended March 31,
 
 
 
2014

 
2013

Investment income
 
 
 
 
  Interest from fixed maturities
 
$
272

 
$
282

Dividends
 
32

 
253

Income from limited liability investments
 
22

 
50

Other
 
142

 
92

Gross investment income
 
468

 
677

Investment expenses
 
(55
)
 
(97
)
Net investment income
 
$
413

 
$
580

At March 31, 2014, fixed maturities and short-term investments with an estimated fair value of $13.4 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 March 31, 2014, the amount of such pledged securities was $17.4 million.

 
12
 
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements (Unaudited) March 31, 2014

NOTE 7 INVESTMENT IN INVESTEE
Investment in investee includes the Company's investment in the common stock of PIH. The carrying value, estimated fair value and approximate voting and equity percentages for the Company's investment in the common stock of PIH, which is accounted for under the equity method of accounting and reported as investment in investee in the Company's consolidated balance sheets at March 31, 2014, were as follows:
(in thousands, except for percentages)
 
 
 
 
 
 
March 31, 2014
 
 
Voting percentage
 
Equity percentage
 
Estimated Fair Value
 
Carrying value
PIH
 
28.7
%
 
28.7
%
 
$
8,000

 
$
7,661


The fair value of the Company's investment in PIH at March 31, 2014 in the table above is calculated based on the initial public offering price of $8.00 per share.
Investment in investee formerly included 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 gains (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. 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.
Equity in net income of investee was zero and $0.3 million for the three months ended March 31, 2014 and March 31, 2013, respectively. The Company also recognized a decrease to shareholders' equity attributable to common shareholders of $0.1 million for the three months ended March 31, 2013, for the Company's pro rata share of its investee's accumulated other comprehensive income.
During the fourth quarter of 2013, the Company further reduced its investment in the common stock of Atlas. The Company's investment in Atlas common stock at March 31, 2014 is included in equity investments and reported at fair value of $1.8 million in the consolidated balance sheets.
NOTE 8 DEFERRED ACQUISITION COSTS
Policy acquisition costs consist primarily of commissions, premium taxes, and underwriting and agency expenses, net of ceding commission income, incurred related to successful efforts to acquire new or renewal insurance contracts 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 months ended March 31, 2014 and 2013, respectively, are comprised as follows:
(in thousands)
 
Three months ended March 31,
 
 
 
2014

 
2013

Balance at January 1, net
 
$
12,392

 
$
14,102

Additions
 
7,274

 
9,172

Amortization
 
(6,064
)
 
(10,589
)
Acquisition costs disposed of during the year related to PIH
 
(1,043
)
 
—

Balance at March 31, net
 
$
12,559

 
$
12,685


 
13
 
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements (Unaudited) March 31, 2014

NOTE 9 INTANGIBLE ASSETS
Intangible assets are comprised as follows:
(in thousands)
 
 
March 31, 2014
 
 
 
Gross Carrying Value
 
Accumulated Amortization
 
Net Carrying Value
Intangible assets subject to amortization
 
 
 
 
 
 
Database
 
$
4,918

 
$
676

 
$
4,242

Vehicle service agreement in-force
 
3,680

 
2,409

 
1,271

Customer-related relationships
 
3,611

 
441

 
3,170

Non-compete agreement
 
70

 
33

 
37

Intangible assets not subject to amortization
 
 
 
 
 
 
Renewal rights
 
46,756

 
15,438

 
31,318

Insurance licenses
 
7,803

 
—

 
7,803

Trade name
 
663

 
—

 
663

Total
 
$
67,501

 
$
18,997

 
$
48,504


(in thousands)
 
 
December 31, 2013
 
 
 
Gross Carrying Value
 
Accumulated Amortization
 
Net Carrying Value
Intangible assets subject to amortization
 
 
 
 
 
 
Database
 
$
4,918

 
$
554

 
$
4,364

Vehicle service agreement in-force
 
3,680

 
2,220

 
1,460

Customer-related relationships
 
3,611

 
344

 
3,267

Non-compete agreement
 
70

 
27

 
43

Intangible assets not subject to amortization
 
 
 
 
 
 
Renewal rights
 
46,756

 
15,438

 
31,318

Insurance licenses
 
7,803

 
—

 
7,803

Trade name
 
663

 
—

 
663

Total
 
$
67,501

 
$
18,583

 
$
48,918

The Company's intangible assets with definite useful lives are amortized over their estimated useful lives. Amortization of intangible assets was $0.4 million and $0.6 million for the three months ended March 31, 2014 and March 31, 2013, respectively.
The insurance licenses, renewal rights and trade name intangible assets have indefinite useful lives and are not amortized. The renewal rights intangible assets, recognized related to the acquisitions of Northeast Alliance Insurance Agency, LLC ("NEA") and Assigned Risk Solutions Ltd. ("ARS"), were originally being amortized on a straight-line basis over 10 to 15 years. As a result of the acquisition of ARS during 2010, the Company determined that it was necessary to re-examine the useful lives assigned to the renewal rights intangible assets due to the fact that NEA and ARS service the assigned risk business in the states of New York and New Jersey and operate in the New York voluntary markets where there is limited competition for the renewal rights. As a result of the review performed, the Company determined that there were no legal, regulatory, contractual, competitive, economic, or other factors limiting the useful life of the renewal rights intangible assets; therefore, effective January 1, 2011, the renewal rights intangible assets were deemed to have indefinite useful lives and are no longer being amortized. The renewal rights had accumulated amortization of $15.4 million at December 31, 2010.
NOTE 10 ASSET HELD FOR SALE
As of March 31, 2014, property consisting of building and land located in Miami, Florida with a carrying value of $6.3 million was classified as held for sale. At March 31, 2014, the carrying value of the property is equal to its fair value net of estimated selling costs.
 

 
14
 
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements (Unaudited) March 31, 2014

NOTE 11 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.
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 March 31, 2014 and March 31, 2013 were as follows:
(in thousands)
 
March 31, 2014

 
March 31, 2013

Balance at beginning of period, gross
 
$
84,534

 
$
103,116

Less reinsurance recoverable related to property and casualty unpaid loss and loss adjustment expenses
 
7,942

 
5,478

Balance at beginning of period, net
 
76,592

 
97,638

Incurred related to:
 
 
 
 

      Current year
 
19,887

 
20,950

      Prior years
 
(586
)
 
(789
)
Paid related to:
 
 
 
 

      Current year
 
(6,268
)
 
(8,210
)
      Prior years
 
(17,727
)
 
(19,685
)
Disposal of unpaid loss and loss adjustment expenses related to PIH
 
(405
)
 
—

Balance at end of period, net
 
71,493

 
89,904

Plus reinsurance recoverable related to property and casualty unpaid loss and loss adjustment expenses
 
5,792

 
8,019

Balance at end of period, gross
 
$
77,285

 
$
97,923


 
15
 
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements (Unaudited) March 31, 2014

(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 March 31, 2014 and March 31, 2013 were as follows:
(in thousands)
 
March 31, 2014

 
March 31, 2013

Balance at beginning of period
 
$
3,128

 
$
3,448

Incurred related to:
 
 
 
 
      Current year
 
1,760

 
1,670

      Prior years
 
—

 
—

Paid related to:
 
 
 
 
      Current year
 
(1,699
)
 
(1,756
)
      Prior years
 
(61
)
 
(81
)
Balance at end of period
 
$
3,128

 
$
3,281



NOTE 12 DEBT
Debt consists of the following instruments:
(in thousands)
 
March 31, 2014
 
December 31, 2013
 
 
Principal

 
Fair Value

 
Principal

 
Fair Value

7.5% senior notes due 2014
 
$
—

 
$
—

 
$
14,356

 
$
14,356

LROC preferred units due 2015
 
14,291

 
14,291

 
14,854

 
14,854

Subordinated debt
 
90,500

 
28,471

 
90,500

 
28,471

Total
 
$
104,791

 
$
42,762

 
$
119,710

 
$
57,681


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 March 31, 2014, deferred interest payable of $13.9 million is included in accrued expenses and other liabilities in the consolidated balance sheets. 
During the first quarter of 2014, the Company repaid the $14.4 million remaining amount outstanding on its senior unsecured debentures due February 1, 2014. During the three months ended March 31, 2013, the Company purchased for $0.6 million, including accrued interest, $0.6 million of par value of its senior unsecured debentures due February 1, 2014 with a carrying value of $0.6 million, including accrued interest, recording a loss of $0.0 million.

 
16
 
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements (Unaudited) March 31, 2014

NOTE 13 INCOME TAXES
Income tax expense (benefit) for the three months ended March 31, 2014 varies from the amount that would result by applying the applicable United States income tax rate of 34% to loss 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, a tax benefit being recorded for a Canadian income tax refund, a tax benefit being recorded for non-taxable dividend income, a state income tax expense being recorded, a tax expense being recorded for a loss on the disposal of a subsidiary and a tax expense being recorded for stock option expense. Income tax expense (benefit) for the three months ended March 31, 2013 varies from the amount that would result by applying the applicable United States income tax rate of 34% to loss 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 non-taxable dividend income.
The Company maintains a valuation allowance for its gross deferred tax assets at March 31, 2014 and December 31, 2013. 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 March 31, 2014 and December 31, 2013 net deferred tax asset. The Company carries a deferred income tax liability of $4.5 million and $4.2 million at March 31, 2014 and December 31, 2013, respectively, all of which relates to indefinite life intangible assets.
As of March 31, 2014 and December 31, 2013, the Company carried a liability for unrecognized tax benefits of $1.5 million and $3.2 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).
NOTE 14 NET LOSS PER SHARE
The following table sets forth the reconciliation of numerators and denominators for the basic and diluted loss per share computation for the three months ended March 31, 2014 and March 31, 2013:
(in thousands)
 
Three months ended March 31,
 
 
 
2014
 
2013
Numerator:
 
 
 
 
Net loss
 
$
(1,006
)
 
$
(17,336
)
Less: net income attributable to noncontrolling interests
 
(653
)
 
(95
)
Less: dividends on preferred stock
 
(53
)
 
—

Net loss attributable to common shareholders
 
(1,712
)
 
(17,431
)
Denominator:
 
 
 
 
Weighted average basic shares
 
 
 
 
Weighted average common shares outstanding
 
16,430

 
13,149

Weighted average diluted shares
 
 
 
 
Weighted average common shares outstanding
 
16,430

 
13,149

Effect of potentially dilutive securities
 
—

 
—

Total weighted average diluted shares
 
16,430

 
13,149

Basic loss per common share
 
$
(0.10
)
 
$
(1.33
)
Diluted loss per common share
 
$
(0.10
)
 
$
(1.33
)
Net 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 securities. Potentially dilutive securities consist of stock options, unvested restricted stock awards, warrants and convertible preferred stock. Since the Company is reporting a net loss for the three months ended March 31, 2014 and March 31, 2013, all potentially dilutive securities outstanding were excluded from the calculation of both basic and diluted loss per share since their inclusion would have been anti-dilutive.

 
17
 
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements (Unaudited) March 31, 2014

NOTE 15 STOCK-BASED COMPENSATION
(a)     Stock Options
The following table summarizes the stock option activity during the three months ended March 31, 2014:
(in thousands, except for share data)
 
 
 
 
 
 
 
 
 
Number of Options Outstanding
 
Weighted-Average Exercise Price
 
Weighted-Average Remaining Contractual Term (in Years)
 
Aggregate Intrinsic Value
Outstanding at December 31, 2013
 
355,625

 
C$
18.35

 
 
 
—

Granted
 
611,875

 
$
4.50

 
 
 
 
Exchanged and Cancelled
 
(351,875
)
 
C$
18.12

 
 
 
 
Expired
 
(1,875
)
 
C$
40.12

 
 
 
 
Forfeited
 
(1,875
)
 
C$
40.12

 
 
 
 
Outstanding at March 31, 2014
 
611,875

 
$
4.50

 
4.0

 
—

Exercisable at March 31, 2014
 
611,875

 
$
4.50

 
4.0

 
—

The intrinsic value of a stock option grant is the difference between the March 31, 2014 market price for the Company's common shares and the exercise price of the option. The aggregate intrinsic value for the stock options outstanding at March 31, 2014 was zero. The aggregate intrinsic value for stock options exercisable at March 31, 2014 was zero.
The Company uses the Black-Scholes option pricing model to estimate the fair value of each option on the date of grant. The assumptions used in the Black-Scholes pricing model for options granted or exchanged during the three months ended March 31, 2014 were as follows:
 
 
March 31, 2014

Risk-free interest rate
 
0.06% - 1.4%

Dividend yield
 
—

Expected volatility
 
0.4
%
Expected term (in years)
 
0.78 - 4

(b)     Restricted Stock Awards
Under the 2013 Equity Incentive Plan, the Company made grants of restricted stock to certain officers of the Company. The restricted stock vests after a ten-year period and is subject to the officer's continued employment through the vesting date. The restricted stock is amortized on a straight-line basis over the ten-year requisite service period. Total unamortized compensation expense related to unvested awards at March 31, 2014 was $8.2 million. The grant-date fair value of restricted stock awards is determined using the closing price of Kingsway common stock on the date of grant. The following table summarizes the activity related to unvested restricted stock for the three months ended March 31, 2014:
(in thousands, except for share data)
 
 
 
 
 
 
Restricted stock awards
 
Weighted-average grant date fair value (per share)
Unvested at December 31, 2013
 
—

 
—

Granted
 
$
1,972,345

 
$
4.14

Unvested at March 31, 2014
 
$
1,972,345

 
$
4.14

Total stock-based compensation expense, net of forfeitures was $0.6 million and $0.0 million for the three months ended March 31, 2014 and March 31, 2013, respectively.

 
18
 
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements (Unaudited) March 31, 2014

NOTE 16 SHAREHOLDERS' EQUITY
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 will 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 will have priority over the common shares.
On February 3, 2014, the Company closed on its previously announced private placement totaling $6.6 million. At closing, the Company received gross proceeds of $6.6 million, resulting from the sale and issuance of 262,876 units for a purchase price of $25.00 per unit. Net proceeds to the Company were $6.4 million after deducting expenses.
Each unit consists of one class A convertible preferred share, series 1 (the "Preferred Shares"), and 6.25 common share class C purchase warrants. 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 April 1, 2021. The maximum number of common shares issuable upon conversion of the Preferred Shares is 1,642,975 common shares. Each warrant will entitle the subscriber to purchase one common share of Kingsway at a price of $5.00 per common share at any time after September 16, 2016 and prior to expiry on September 15, 2023.
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 all outstanding Preferred Shares on April 1, 2021 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.

NOTE 17 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 three months ended March 31, 2014 and March 31, 2013 as relates to shareholders' equity attributable to common shareholders on the unaudited consolidated balance sheets. On the other hand, the unaudited consolidated statements of comprehensive income (loss) present the components of other comprehensive income (loss), net of tax, only for the three months ended March 31, 2014 and March 31, 2013 and inclusive of the components attributable to noncontrolling interests in consolidated subsidiaries.
(in thousands)
 
 
 
 
 
 
Unrealized Gains (Losses) on Fixed Maturities and Equity Investments
 
Foreign Currency Translation Adjustments
 
Equity in Other Comprehensive Loss of Investee
 
Total Accumulated Other Comprehensive Income
 
 
 
 
 
 
 
 
 
Balance, January 1, 2014
 
15,583

 
(5,982
)
 
—

 
9,601

 
 
 
 
 
 
 
 
 
Other comprehensive income before reclassifications
 
1,276

 
44

 
—

 
1,320

Amounts reclassified from accumulated other comprehensive income
 
52

 
—

 
—

 
52

Net current-period other comprehensive income
 
1,328

 
44

 
—

 
1,372

 
 
 
 
 
 
 
 
 
Balance, March 31, 2014
 
16,911

 
(5,938
)
 
—

 
10,973


 
19
 
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements (Unaudited) March 31, 2014

(in thousands)
 
 
 
 
 
 
Unrealized Gains (Losses) on Fixed Maturities and Equity Investments
 
Foreign Currency Translation Adjustments
 
Equity in Other Comprehensive Loss of Investee
 
Total Accumulated Other Comprehensive Income
 
 
 
 
 
 
 
 
 
Balance, January 1, 2013
 
14,194

 
1,210

 
(642
)
 
14,762

 
 
 
 
 
 
 
 
 
Other comprehensive (loss) income before reclassifications
 
(498
)
 
26

 
(105
)
 
(577
)
Amounts reclassified from accumulated other comprehensive income
 
248

 
—

 
—

 
248

Net current-period other comprehensive (loss) income
 
(250
)
 
26

 
(105
)
 
(329
)
 
 
 
 
 
 
 
 
 
Balance, March 31, 2013
 
13,944

 
1,236

 
(747
)
 
14,433

Components of accumulated other comprehensive income were reclassified to the following lines of the unaudited consolidated statements of operations for the three months ended March 31, 2014 and March 31, 2013:
 
 
Three months ended March 31,
 
  
 
2014

 
2013

Reclassification of accumulated other comprehensive income from unrealized (losses) gains on fixed maturities and equity investments to:
 
 
 
 
Net realized gains (losses)
 
$
(52
)
 
$
(248
)
Other-than-temporary impairment loss
 
—

 
—

Loss before income tax expense (benefit)
 
(52
)
 
(248
)
Income tax expense (benefit)
 
—

 
—

Net loss
 
$
(52
)
 
$
(248
)
NOTE 18 SEGMENTED INFORMATION
The Company operates as a merchant bank 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.
Insurance Underwriting Segment
Effective March 31, 2014, the Company's wholly owned subsidiary, PIH, completed an initial public offering of its common stock. Upon completion of the transaction, the Company maintained a 28.7% interest in the common shares of PIH, which is reported as investment in investee in the consolidated balance sheets. The earnings of PIH are included in the consolidated statements of operations through the March 31, 2014 transaction date. Prior to the transaction, PIH was included in the Insurance Underwriting segment. As a result of the disposal of the Company's majority interest in PIH on March 31, 2014, all segmented information has been restated to exclude PIH from the Insurance Underwriting segment.

Insurance Underwriting includes the following subsidiaries of the Company: Mendota Insurance Company, Mendakota Insurance Company, Universal Casualty Company ("UCC"), Kingsway Amigo Insurance Company ("Amigo") and Kingsway Reinsurance Corporation (collectively, "Insurance Underwriting"). 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 15 states.

 
20
 
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements (Unaudited) March 31, 2014

The Company previously placed Amigo and UCC into voluntary run-off in 2012 and 2011, respectively. Each of Amigo and UCC has entered into a comprehensive run-off plan which has been approved by its respective state of domicile. Kingsway continues to manage Amigo and UCC in a manner consistent with the run-off plans.
Insurance Services Segment
Insurance Services includes the following subsidiaries of the Company: ARS, IWS Acquisition Corporation ("IWS") and Trinity (collectively, "Insurance Services").
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 to their members.
Trinity is a provider of warranty products and maintenance support to consumers and businesses in the HVAC and refrigeration industry. Trinity distributes its warranty products through original equipment manufacturers, HVAC distributors and commercial and residential contractors. Trinity distributes its maintenance support directly 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.
Revenue by reportable segment reconciled to consolidated revenues for the three months ended March 31, 2014 and 2013 were:
(in thousands)
 
Three months ended March 31,
 
 
 
2014

 
2013

Revenues:
 
 
 
 
Insurance Underwriting:
 
 
 
 
Net premiums earned
 
$
27,806

 
$
27,153

Other income
 
2,134

 
2,291

Total Insurance Underwriting
 
29,940

 
29,444

Insurance Services:
 
 
 
 
Service fee and commission income
 
14,724

 
13,124

Other income
 
99

 
86

Total Insurance Services
 
14,823

 
13,210

Total segment revenues
 
44,763

 
42,654

Net premiums earned not allocated to segments
 
4,114

 
915

Net investment income
 
413

 
580

Net realized gains (losses)
 
39

 
(1,409
)
Other income not allocated to segments
 
(162
)
 
(159
)
Total revenues
 
$
49,167

 
$
42,581

The operating income (loss) of each segment in the following table is before income taxes and includes revenues and direct segment costs.

 
21
 
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements (Unaudited) March 31, 2014

Segment operating income (loss) reconciled to the consolidated net loss for the three months ended March 31, 2014 and 2013 were:
(in thousands)
 
Three months ended March 31,
 
 
 
2014

 
2013

Segment operating income (loss)
 
 
 
 
Insurance Underwriting
 
$
257

 
$
(3,045
)
Insurance Services
 
1,914

 
1,916

Total segment operating income (loss)
 
2,171

 
(1,129
)
Net investment income
 
413

 
580

Net realized gains (losses)
 
39

 
(1,409
)
Other income and expenses not allocated to segments, net
 
(470
)
 
(4,388
)
Interest expense
 
(1,433
)
 
(1,833
)
Amortization of intangible assets
 
(414
)
 
(558
)
Contingent consideration expense
 
(267
)
 
(155
)
Gain (loss) on change in fair value of debt
 
563

 
(8,951
)
Loss on disposal of subsidiary
 
(1,242
)
 
—

Loss on buy-back of debt
 
—

 
(24
)
Equity in net income of investee
 
—

 
255

Loss before income tax expense (benefit)
 
$
(640
)
 
$
(17,612
)
Income tax expense (benefit)
 
366

 
(276
)
Net loss
 
$
(1,006
)
 
$
(17,336
)
Net premiums earned by line of business for the three months ended March 31, 2014 and 2013 were:
(in thousands)
 
Three months ended March 31,
 
 
 
2014

 
2013

Insurance Underwriting:
 
 
 
 
Private passenger auto liability
 
$
18,556

 
$
18,661

Auto physical damage
 
9,250

 
7,843

Total non-standard automobile
 
27,806

 
26,504

Commercial auto liability
 
—

 
649

Total Insurance Underwriting
 
27,806

 
27,153

Net premiums earned not allocated to segments:
 
 
 
 
Allied lines
 
1,944

 
—

Homeowners
 
2,159

 
915

Other
 
11

 
—

Total net premiums not allocated to segments
 
$
4,114

 
$
915

Total net premiums earned
 
$
31,920

 
$
28,068

NOTE 19 RESTRUCTURING
On September 17, 2012, the Company announced that it was restructuring its Insurance Underwriting and Insurance Services segments. As part of the restructuring, the Company intends to streamline its non-standard property and casualty insurance business operations. Specific to Insurance Underwriting, during the fourth quarter of 2012, the Company began taking steps to place all of Amigo into voluntary run-off. Amigo has entered into a comprehensive run-off plan which has been approved by the Florida Office of Insurance Regulation. Kingsway continues to manage Amigo in a manner consistent with its filed run-off plan.

 
22
 
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements (Unaudited) March 31, 2014

As part of the restructuring, the Company will reduce staffing levels to be consistent with placing Amigo into run-off. The Company estimated that Insurance Underwriting would incur approximately $2.0 million in cash severance expenses due to reductions-in-force as part of the restructuring during the period beginning with the announcement through the end of 2013. From the time the restructuring was announced on September 17, 2012 through March 31, 2014, the Company has incurred severance expense of $2.1 million, $2.0 million of which has been paid through March 31, 2014.
Changes in the restructuring liability, which is included in accrued expenses and other liabilities in the consolidated balance sheets, and the related restructuring expense for the three months ended March 31, 2014 and March 31, 2013 is as follows:

(in thousands)
 
 
 
March 31, 2014
 
 
 
 Restructuring liability, beginning of period
 
 Restructuring expense
 
 Cash payments
 
 Restructuring liability, end of period
Insurance Underwriting:
 
 
 
 
 
 
 
 
Severance
 
236

 
—

 
(127
)
 
109

Lease abandonment
 
648

 
16

 
(92
)
 
572

Total Insurance Underwriting
 
884

 
16

 
(219
)
 
681

Insurance Services:
 
 
 
 
 
 
 
 
Lease abandonment
 
100

 
4

 
(15
)
 
89

Total Insurance Services
 
100

 
4

 
(15
)
 
89

Severance expense not allocated to segments
 
146

 
—

 
(146
)
 
—

Total
 
1,130

 
20

 
(380
)
 
770


(in thousands)
 
 
 
March 31, 2013
 
 
 
 Restructuring liability, beginning of period
 
 Restructuring expense
 
 Cash payments
 
 Restructuring liability, end of period
Insurance Underwriting:
 
 
 
 
 
 
 
 
Severance
 
214

 
759

 
(487
)
 
486

Lease abandonment
 
1,207

 
21

 
(89
)
 
1,139

Total
 
1,421