Document
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
For Quarterly Period Ended
June 30, 2017
or
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Transition Period from _____ to _____
 
Commission File Number: 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 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 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" and "emerging growth company" in Rule 12b-2 of the Exchange Act.

Large accelerated filer o
Accelerated filer x
Non-accelerated filer o
(Do not check if a smaller reporting company)
Smaller Reporting Company o
Emerging Growth Company o
 
 
 
 
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o

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, including restricted common shares, outstanding of the registrant's common stock as of August 7, 2017 was 23,410,855.

KINGSWAY FINANCIAL SERVICES INC.

Table Of Contents
PART I - FINANCIAL INFORMATION
 
ITEM 1. FINANCIAL STATEMENTS
 
Consolidated Balance Sheets as of June 30, 2017 (unaudited) and December 31, 2016
 
Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2017 and 2016 (unaudited)
 
Consolidated Statements of Comprehensive Loss for the Three and Six Months Ended June 30, 2017 and 2016 (unaudited)
 
Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2017 and 2016 (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 share data)
 
 
June 30, 2017

 
December 31, 2016

 
 
(unaudited)

 
 
Assets
 
 
 
 
Investments:
 
 
 
 
Fixed maturities, at fair value (amortized cost of $57,172 and $62,136, respectively)
 
$
56,965

 
$
61,764

Equity investments, at fair value (cost of $16,699 and $19,099, respectively)
 
19,441

 
23,230

Limited liability investments
 
25,533

 
22,974

Limited liability investment, at fair value
 
8,220

 
10,700

Other investments, at cost which approximates fair value
 
7,550

 
7,975

Short-term investments, at cost which approximates fair value
 
151

 
401

Total investments
 
117,860

 
127,044

Cash and cash equivalents
 
33,776

 
36,475

Investment in investee
 
5,355

 
3,116

Accrued investment income
 
893

 
790

Premiums receivable, net of allowance for doubtful accounts of $115 and $115, respectively
 
30,113

 
31,564

Service fee receivable, net of allowance for doubtful accounts of $276 and $274, respectively
 
1,408

 
1,320

Other receivables, net of allowance for doubtful accounts of $806 and $806, respectively
 
6,765

 
4,692

Reinsurance recoverable
 
569

 
784

Deferred acquisition costs, net
 
13,709

 
13,609

Property and equipment, net of accumulated depreciation of $12,894 and $10,603, respectively
 
114,809

 
116,961

Goodwill
 
71,061

 
71,061

Intangible assets, net of accumulated amortization of $7,761 and $7,181, respectively
 
88,187

 
89,017

Other assets
 
4,539

 
4,588

Total Assets
 
$
489,044

 
$
501,021

Liabilities and Shareholders' Equity
 
 
 
 
Liabilities:
 
 
 
 
Unpaid loss and loss adjustment expenses:
 
 
 
 
Property and casualty
 
$
45,874

 
$
53,795

Vehicle service agreements
 
2,794

 
2,915

Total unpaid loss and loss adjustment expenses
 
48,668

 
56,710

Unearned premiums
 
40,770

 
40,176

Reinsurance payable
 
87

 
100

Note payable
 
188,328

 
190,074

Subordinated debt, at fair value
 
48,210

 
43,619

Deferred income tax liability
 
49,726

 
48,720

Deferred service fees
 
37,883

 
35,822

Income taxes payable
 
2,352

 
2,051

Accrued expenses and other liabilities
 
19,912

 
20,487

Total Liabilities
 
435,936

 
437,759

 
 
 
 
 
Class A preferred stock, no par value; unlimited number authorized; 262,876 and 262,876 issued and outstanding at June 30, 2017 and December 31, 2016, respectively; redemption amount of $6,572
 
6,444

 
6,427

 
 
 
 
 
Shareholders' Equity:
 
 
 
 
Common stock, no par value; unlimited number authorized; 21,458,190 and 21,458,190 issued and outstanding at June 30, 2017 and December 31, 2016, respectively
 
—

 
—

Additional paid-in capital
 
354,422

 
353,882

Accumulated deficit
 
(307,328
)
 
(297,668
)
Accumulated other comprehensive loss
 
(1,467
)
 
(208
)
Shareholders' equity attributable to common shareholders
 
45,627

 
56,006

Noncontrolling interests in consolidated subsidiaries
 
1,037

 
829

Total Shareholders' Equity
 
46,664

 
56,835

Total Liabilities, Class A preferred stock and Shareholders' Equity
 
$
489,044

 
$
501,021


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 June 30,
 
 
Six months ended June 30,
 
 
 
2017

 
2016

 
2017

 
2016

Revenues:
 
 
 
 
 
 
 
 
Net premiums earned
 
$
33,518

 
$
31,813

 
$
66,440

 
$
61,240

Service fee and commission income
 
6,873

 
5,394

 
13,435

 
10,716

Rental income
 
3,341

 
—

 
6,682

 
—

Net investment (loss) income
 
(2,366
)
 
1,072

 
(1,663
)
 
1,000

Net realized gains (losses)
 
734

 
67

 
1,132

 
(104
)
Other income
 
2,815

 
2,791

 
5,630

 
5,165

Total revenues
 
44,915

 
41,137

 
91,656

 
78,017

Operating expenses:
 
 
 
 
 
 
 
 
Loss and loss adjustment expenses
 
27,468

 
24,838

 
53,878

 
48,335

Commissions and premium taxes
 
6,475

 
6,103

 
12,753

 
11,701

Cost of services sold
 
1,291

 
770

 
2,595

 
1,543

General and administrative expenses
 
11,380

 
10,826

 
22,652

 
20,377

Leased real estate segment interest expense
 
1,569

 
—

 
3,143

 
—

Amortization of intangible assets
 
289

 
307

 
580

 
602

Contingent consideration benefit
 
(212
)
 
(657
)
 
(212
)
 
(657
)
Impairment of intangible assets
 
—

 
—

 
250

 
—

Total operating expenses
 
48,260

 
42,187

 
95,639

 
81,901

Operating loss
 
(3,345
)
 
(1,050
)
 
(3,983
)
 
(3,884
)
Other expenses (revenues), net:
 
 
 
 
 
 
 
 
Interest expense not allocated to segments
 
1,216

 
1,108

 
2,375

 
2,201

Foreign exchange losses, net
 
—

 
9

 
4

 
10

Loss (gain) on change in fair value of debt
 
2,702

 
(1,068
)
 
4,591

 
(3,596
)
Equity in net loss (income) of investees
 
145

 
874

 
(2,240
)
 
943

Total other expenses (revenues), net
 
4,063

 
923

 
4,730

 
(442
)
Loss from continuing operations before income tax expense
 
(7,408
)
 
(1,973
)
 
(8,713
)
 
(3,442
)
Income tax expense
 
1,251

 
26

 
1,430

 
52

Loss from continuing operations
 
(8,659
)
 
(1,999
)
 
(10,143
)
 
(3,494
)
Gain on disposal of discontinued operations, net of taxes
 
1,017

 
1,124

 
1,017

 
1,124

Net loss
 
(7,642
)
 
(875
)
 
(9,126
)
 
(2,370
)
Less: net income (loss) attributable to noncontrolling interests in consolidated subsidiaries
 
100

 
(361
)
 
205

 
(400
)
Less: dividends on preferred stock
 
123

 
82

 
244

 
164

Net loss attributable to common shareholders
 
$
(7,865
)
 
$
(596
)
 
$
(9,575
)
 
$
(2,134
)
Loss per share - continuing operations:
 
 
 
 
 
 
 
 
Basic:
 
$
(0.41
)
 
$
(0.09
)
 
$
(0.49
)
 
$
(0.16
)
Diluted:
 
$
(0.41
)
 
$
(0.09
)
 
$
(0.49
)
 
$
(0.16
)
Earnings per share - discontinued operations:
 
 
 
 
 
 
 
 
Basic:
 
$
0.05

 
$
0.06

 
$
0.05

 
$
0.06

Diluted:
 
$
0.05

 
$
0.06

 
$
0.05

 
$
0.06

Loss per share – net loss attributable to common shareholders:
 
 
 
 
 
 
 
 
Basic:
 
$
(0.37
)
 
$
(0.03
)
 
$
(0.45
)
 
$
(0.11
)
Diluted:
 
$
(0.37
)
 
$
(0.03
)
 
$
(0.45
)
 
$
(0.11
)
Weighted-average shares outstanding (in ‘000s):
 
 
 
 
 
 
 
 
Basic:
 
21,458

 
19,818

 
21,458

 
19,764

Diluted:
 
21,458

 
19,818

 
21,458

 
19,764


See accompanying notes to unaudited consolidated financial statements.

 
4
 
KINGSWAY FINANCIAL SERVICES INC.


Consolidated Statements of Comprehensive Loss
(in thousands)
(Unaudited)
 
 
Three months ended June 30,
 
 
Six months ended June 30,
 
 
 
2017

 
2016

 
2017

 
2016

 
 
 
 
 
 
 
 
 
Net loss
 
$
(7,642
)
 
$
(875
)
 
$
(9,126
)
 
$
(2,370
)
Other comprehensive (loss) income, net of taxes(1):
 
 
 
 
 
 
 
 
Unrealized (losses) gains on fixed maturities and equity investments:
 
 
 
 
 
 
 
 
Unrealized (losses) gains arising during the period
 
(1,064
)
 
430

 
(1,227
)
 
705

Reclassification adjustment for amounts included in net loss
 
478

 
(73
)
 
(29
)
 
(505
)
Other comprehensive (loss) income
 
(586
)
 
357

 
(1,256
)
 
200

Comprehensive loss
 
(8,228
)
 
(518
)
 
(10,382
)
 
(2,170
)
Less: comprehensive income (loss) attributable to noncontrolling interests in consolidated subsidiaries
 
102

 
(360
)
 
208

 
(399
)
Comprehensive loss attributable to common shareholders
 
$
(8,330
)
 
$
(158
)
 
$
(10,590
)
 
$
(1,771
)
(1) Net of income tax expense of $0 and $0 for the three and six months ended June 30, 2017, respectively, and $0 and $0 for the three and six months ended June 30, 2016, respectively.

See accompanying notes to unaudited consolidated financial statements

 
5
 
KINGSWAY FINANCIAL SERVICES INC.

Consolidated Statements of Cash Flows
(in thousands)
(Unaudited)
 
 
Six months ended June 30,
 
 
 
2017

 
2016

Cash provided by (used in):
 
 
 
 
Operating activities:
 
 
 
 
Net loss
 
$
(9,126
)
 
$
(2,370
)
Adjustments to reconcile net loss to net cash used in operating activities:
 
 
 
 
Gain on disposal of discontinued operations, net of taxes
 
(1,017
)
 
(1,124
)
Equity in net (income) loss of investee
 
(2,240
)
 
943

Equity in net loss (income) of limited liability investments
 
281

 
(310
)
Loss on change in fair value of investments
 
2,433

 
246

Depreciation and amortization expense
 
2,793

 
697

Contingent consideration benefit
 
(212
)
 
(657
)
Stock-based compensation expense, net of forfeitures
 
588

 
474

Net realized (gains) losses
 
(1,132
)
 
104

Loss (gain) on change in fair value of debt
 
4,591

 
(3,596
)
Deferred income taxes
 
1,005

 
44

Intangible asset impairment
 
250

 
—

Amortization of fixed maturities premiums and discounts
 
112

 
133

Amortization of note payable premium
 
(483
)
 
—

Changes in operating assets and liabilities:
 
 
 
 
Premiums and service fee receivable, net
 
1,363

 
(4,864
)
Other receivables, net
 
(2,073
)
 
682

Reinsurance recoverable
 
215

 
463

Deferred acquisition costs, net
 
(100
)
 
(1,681
)
Income taxes recoverable
 
—

 
(5
)
Unpaid loss and loss adjustment expenses
 
(8,042
)
 
(3,276
)
Unearned premiums
 
594

 
5,888

Reinsurance payable
 
(13
)
 
139

Deferred service fees
 
2,061

 
1,680

Other, net
 
(161
)
 
1,358

Net cash used in operating activities
 
(8,313
)
 
(5,032
)
Investing activities:
 
 
 
 
Proceeds from sales and maturities of fixed maturities
 
9,863

 
13,349

Proceeds from sales of equity investments
 
5,879

 
3,721

Purchases of fixed maturities
 
(4,981
)
 
(19,781
)
Purchases of equity investments
 
(2,644
)
 
(1,541
)
Net acquisitions of limited liability investments
 
(2,870
)
 
(1,017
)
Net proceeds from (purchases of) other investments
 
425

 
(1,357
)
Net proceeds from (purchases of) short-term investments
 
250

 
(533
)
Net proceeds from sale of discontinued operations
 
1,017

 
1,124

Net purchases of property and equipment
 
(61
)
 
(622
)
Net cash provided by (used in) investing activities
 
6,878

 
(6,657
)
Financing activities:
 
 
 
 
Repurchase of common stock for cancellation
 
—

 
(125
)
Principal payments on note payable
 
(1,264
)
 
—

Net cash used in financing activities
 
(1,264
)
 
(125
)
Net decrease in cash and cash equivalents
 
(2,699
)
 
(11,814
)
Cash and cash equivalents at beginning of period
 
36,475

 
51,701

Cash and cash equivalents at end of period
 
$
33,776

 
$
39,887


See accompanying notes to unaudited consolidated financial statements.

 
6
 
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements (Unaudited) June 30, 2017





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 with a focus on long-term value-creation.  The Company owns or controls subsidiaries primarily in the insurance, extended warranty, asset management and real estate industries and pursues non-control investments and other opportunities acting as an advisor, an investor and a financier.

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 ("2016 Annual Report") for the year ended December 31, 2016.
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 the reported amounts and classifications of assets and liabilities, revenues and expenses, and the related disclosures of contingent assets and liabilities in the consolidated financial statements and accompanying notes. Actual results could differ from these estimates. Estimates and their underlying assumptions are reviewed on an ongoing basis. Changes in estimates are recorded in the accounting period in which they are determined. The critical accounting estimates and assumptions in the accompanying unaudited consolidated interim financial statements include the provision for unpaid loss and loss adjustment expenses; valuation of fixed maturities and equity investments; impairment assessment of investments; valuation of limited liability investment, at fair value; valuation of deferred income taxes; valuation and impairment assessment of intangible assets; goodwill recoverability; deferred acquisition costs; fair value assumptions for performance shares; fair value assumptions for subordinated debt obligations; and contingent consideration.
The fair values of the Company's investments in fixed maturities and equity investments, limited liability investment, at fair value, performance shares, subordinated debt and contingent consideration are estimated using a fair value hierarchy to categorize the inputs it uses in valuation techniques. The fair value of the Company's investment in investee is based on quoted market prices. 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 2016 Annual Report.
NOTE 4 RECENTLY ISSUED ACCOUNTING STANDARDS
(a)    Adoption of New Accounting Standards:
In March 2016, the FASB issued ASU 2016-09, Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting ("ASU 2016-09"). ASU 2016-09 was issued to simplify the accounting for share-based payment awards. The guidance requires, prospectively, all tax effects related to share-based payments be made through the statement of operations at the time of settlement as opposed to excess tax benefits being recognized in additional paid-in-capital under the current guidance. ASU 2016-09 also removes the requirement to delay recognition of a tax benefit until it reduces current taxes payable. This change is required to be applied on a modified retrospective basis, with a cumulative-effect adjustment to opening accumulated deficit. Additionally, all tax related cash flows resulting from share-based payments are to be reported as operating activities on the statement of cash flows, a change from the current requirement to present tax benefits as an inflow from financing

 
7
 
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements (Unaudited) June 30, 2017




activities and an outflow from operating activities. ASU 2016-09 is effective for annual and interim reporting periods beginning after December 15, 2016. Early adoption is permitted with any adjustments reflected as of the beginning of the fiscal year of adoption. Effective January 1, 2017, the Company adopted ASU 2016-09. The adoption of the standard did not affect the Company's consolidated financial statements.
(b)    Accounting Standards Not Yet Adopted:
In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers ("ASU 2014-09"), which outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers. The core principle of ASU 2014-09 is that an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In August 2015, the FASB issued ASU 2015-14, Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date ("ASU 2015-14"). This amendment defers the effective date of the previously issued ASU 2014-09 until the interim and annual reporting periods beginning after December 15, 2017. Earlier application is permitted for interim and annual reporting periods beginning after December 15, 2016. In addition, the FASB has issued four related ASU's on principal versus agent guidance (ASU 2016-08), identifying performance obligations and the licensing implementation guidance (ASU 2016-10),  a revision of certain SEC Staff Observer comments (ASU 2016-11) and implementation guidance (ASU 2016-12). Insurance contracts are not within the scope of ASU 2014-09; therefore, this standard would not apply to the Company's Insurance Underwriting segment. The Company is currently evaluating the potential effect of the adoption of ASU 2014-09 on its consolidated financial statements, but, at this time, the Company does not believe the adoption of ASU 2014-09 will have a material effect on its consolidated financial statements.
In January 2016, the FASB issued ASU 2016-01, Financial Instruments-Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities ("ASU 2016-01"). The amendments in ASU 2016-01 address certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. Most significantly, ASU 2016-01 requires equity investments (except those accounted for under the equity method of accounting or those that result in consolidation of an investee) to be measured at fair value with changes in fair value recognized in net income (loss). For public business entities, the amendments in ASU 2016-01 are effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years, and will be applied using a cumulative-effect adjustment to accumulated deficit as of the beginning of the fiscal year of adoption. The Company currently records its equity investments at fair value with net unrealized gains or losses reported in accumulated other comprehensive loss. Adoption of ASU 2016-01 will require the changes in fair value on equity investments with readily determinable fair values to be recorded in net income (loss). Subsequent to adoption, ASU 2016-01 could have a significant effect on the Company's results of operations and earnings (loss) per share as changes in fair value will be presented in net income (loss) rather than other comprehensive income (loss).
In February 2016, the FASB issued ASU 2016-02, Leases ("ASU 2016-02"). ASU 2016-02 was issued to improve the financial reporting of leasing transactions. Under current guidance for lessees, leases are only included on the balance sheet if certain criteria, classifying the agreement as a capital lease, are met. This update will require the recognition of a right-of-use asset and a corresponding lease liability, discounted to the present value, for all leases that extend beyond 12 months. For operating leases, the asset and liability will be expensed over the lease term on a straight-line basis, with all cash flows included in the operating section of the statement of cash flows. For finance leases, interest on the lease liability will be recognized separately from the amortization of the right-of-use asset in the statement of comprehensive income and the repayment of the principal portion of the lease liability will be classified as a financing activity while the interest component will be included in the operating section of the statement of cash flows. ASU 2016-02 is effective for annual and interim reporting periods beginning after December 15, 2018. Early adoption is permitted. Upon adoption, leases will be recognized and measured at the beginning of the earliest period presented using a modified retrospective approach. The Company does not believe the adoption of ASU 2016-02 will have a material effect on its consolidated financial statements.
In August 2016, the FASB issued ASU 2016-15, Classification of Certain Cash Receipts and Cash Payments ("ASU 2016-15"). The objective of ASU 2016-15 is to reduce diversity in the classification of cash receipts and payments for specific cash flow issues, including debt prepayment or debt extinguishment costs, contingent consideration payments made after a business combination and proceeds from the settlement of insurance claims. ASU 2016-15 is effective for fiscal years beginning after December 31, 2017, and interim periods within those fiscal years. Early adoption of ASU 2016-15 is permitted. The Company does not believe the adoption of ASU 2016-15 will have a material effect on its consolidated financial statements.

In January 2017, the FASB issued ASU 2017-04, Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment ("ASU 2017-04"). ASU 2017-04 was issued to simplify the subsequent measurement of goodwill. This update changes the impairment test by requiring an entity to compare the fair value of a reporting unit with its carrying amount as opposed to

 
8
 
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements (Unaudited) June 30, 2017




comparing the carrying amount of goodwill with its implied fair value. ASU 2017-04 is effective for annual and interim reporting periods beginning after December 15, 2019. Early adoption is permitted. The Company does not believe the adoption of ASU 2017-04 will have a material effect on its consolidated financial statements.

NOTE 5 ACQUISITIONS, DECONSOLIDATION AND DISCONTINUED OPERATIONS
(a)     Acquisitions
CMC Industries, Inc.:

On July 14, 2016, the Company completed the acquisition of 81.0% of CMC Industries, Inc. ("CMC") for cash consideration of $1.5 million. As further discussed in Note 17, "Segmented Information," CMC is included in the Leased Real Estate segment. CMC owns, through an indirect wholly owned subsidiary (the "Property Owner"), a parcel of real property consisting of approximately 192 acres located in the State of Texas (the "Real Property"). The Real Property is leased to a third party pursuant to a long-term triple net lease. Effective beginning the first quarter of 2017, the Company executed a lease amendment between CMC and its tenant under which the tenant will pay an aggregate $25.0 million of additional rental income through May 2034, the remaining term of the lease. The Real Property is also subject to a mortgage, which is recorded as note payable in the consolidated balance sheets (the "Mortgage"). The Mortgage is nonrecourse indebtedness with respect to CMC and its subsidiaries (including the Property Owner), and the Mortgage is not, nor will it be, guaranteed by Kingsway or its affiliates. 
This acquisition was accounted for as a business combination using the acquisition method of accounting. The purchase price was allocated to the assets acquired and liabilities assumed based upon their estimated fair values at the date of acquisition. During the fourth quarter of 2016, the Company completed its fair value analysis on the assets acquired and liabilities assumed. Goodwill of $61.0 million was recognized. The goodwill is not deductible for tax purposes. Separately identifiable intangible assets of $74.8 million were recognized resulting from the valuations of in-place lease and a tenant relationship. Refer to Note 9, "Intangible Assets," for further disclosure of the intangible assets related to this acquisition. The Mortgage was recorded at its estimated fair value of $191.7 million, which included the unpaid principal amount of $180.0 million as of the date of acquisition plus a premium of $11.7 million. Refer to Note 11, "Debt," for further discussion of the Mortgage. The Company also recognized a below market lease liability of $0.9 million, which is included in accrued expenses and other liabilities. The below market lease liability resulted from the terms of the acquired operating lease contract being unfavorable relative to market terms of comparable leases on the date of acquisition. The below market lease liability is amortized on a straight-line basis over the remaining term of the lease, as determined at the acquisition date. Amortization of below market lease liabilities is included in rental income in the consolidated statements of operations.
Argo Management Group LLC:

Effective April 21, 2016, the Company issued 160,000 shares of its common stock to acquire Argo Management Group LLC ("Argo"). The Argo purchase price of $0.7 million was determined using the closing price of Kingsway common stock on the date the 160,000 shares were issued. Argo’s primary business is to act as the Managing Member of Argo Holdings Fund I, LLC, an investment fund organized for purposes of making control-oriented equity investments in established lower middle market companies based in North America, with a focus on search fund investments.

This acquisition was accounted for as a business combination using the acquisition method of accounting. The purchase price was allocated to the assets acquired and liabilities assumed based upon their estimated fair values at the date of acquisition. During the second quarter of 2016, the Company completed its fair value analysis on the assets acquired and liabilities assumed. Separately identifiable intangible assets of $0.7 million were recognized resulting from the valuations of contract-based management fee and promote fee revenues. Refer to Note 9, "Intangible Assets," for further disclosure of the intangible assets related to this acquisition.
(b)     Deconsolidation
1347 Investors LLC:
At June 30, 2016, the Company owned 61.0% of the outstanding units of 1347 Investors LLC ("1347 Investors"). Because the Company owned more than 50% of the outstanding units, 1347 Investors was included in the unaudited consolidated interim financial statements of the Company. 1347 Investors had an investment in the common stock and private units of 1347 Capital Corp., which was reflected in investment in investee in the consolidated balance sheets. 1347 Capital Corp., which completed an initial public offering on July 21, 2014 and had 24 months from the date of the initial public offering to complete a successful

 
9
 
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements (Unaudited) June 30, 2017




business combination, was formed for the purpose of entering into a merger, share exchange, asset acquisition or other similar business combination with one or more businesses or entities.
On March 23, 2016, 1347 Capital Corp. announced the signing of a definitive agreement with Limbach Holdings LLC ("Limbach"), in which 1347 Capital Corp. would merge with Limbach. On July 21, 2016, Limbach announced the closing of the previously announced merger, and 1347 Capital Corp. was renamed Limbach Holdings, Inc. As a result of this transaction, the Company's ownership percentage in 1347 Investors was reduced to 26.7% at the transaction date. Subsequent to the transaction date, the Company is accounting for its remaining noncontrolling investment in 1347 Investors at fair value.
(c)     Discontinued Operations
On April 1, 2015, the Company closed on the sale of its subsidiary, Assigned Risk Solutions Ltd. ("ARS") for $47.0 million in cash.  During the second quarter of 2015, the Company received additional post-closing cash consideration of $2.0 million.  The terms of the sale also provide for potential receipt by the Company of future earnout payments equal to 1.25% of ARS' written premium and fee income during the earnout periods. The earnout payments are payable in three annual installments beginning in April 2016 through April 2018. During the second quarters of 2017 and 2016, the Company received cash consideration, before expenses, of $1.3 million and $1.4 million, respectively, representing the first two annual installment earnout payments. Net of expenses, the Company recorded an additional gain on disposal of ARS of $1.0 million and $1.1 million for the three and six months ended June 30, 2017 and 2016, respectively. As a result of the sale, ARS, previously disclosed as part of the Extended Warranty (formerly Insurance Services) segment, has been classified as a discontinued operation.  The earnings of ARS are disclosed as discontinued operations in the unaudited consolidated statements of operations for all periods presented. Summary financial information included in income from discontinued operations, net of taxes for the three and six months ended June 30, 2017 and June 30, 2016 is presented below:

(in thousands)
 
Three months ended June 30,
 
 
Six months ended June 30,
 
 
 
2017

 
2016

 
2017

 
2016

Gain on disposal of discontinued operations before income tax benefit
 
$
1,017

 
$
1,124

 
$
1,017

 
$
1,124

Income tax benefit
 
—

 
—

 
—

 
—

Gain on disposal of discontinued operations, net of taxes
 
$
1,017

 
$
1,124

 
$
1,017

 
$
1,124



 
10
 
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements (Unaudited) June 30, 2017




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 June 30, 2017 and December 31, 2016 are summarized in the tables shown below:
(in thousands)
 
June 30, 2017
 
 
 
Amortized Cost

 
Gross Unrealized Gains

 
Gross Unrealized Losses

 
Estimated  Fair Value

Fixed maturities:
 
 
 
 
 
 
 
 
U.S. government, government agencies and authorities
 
$
27,033

 
$
24

 
$
153

 
$
26,904

States, municipalities and political subdivisions
 
3,722

 
9

 
37

 
3,694

Mortgage-backed
 
8,419

 
14

 
80

 
8,353

Asset-backed securities and collateralized mortgage obligations
 
2,197

 
4

 
6

 
2,195

Corporate
 
15,801

 
98

 
80

 
15,819

Total fixed maturities
 
57,172

 
149

 
356

 
56,965

Equity investments:
 
 
 
 
 
 
 
 
Common stock
 
15,222

 
2,996

 
602

 
17,616

Warrants - publicly traded
 
517

 
199

 
78

 
638

Warrants - not publicly traded
 
960

 
227

 
—

 
1,187

Total equity investments
 
16,699

 
3,422

 
680

 
19,441

Total fixed maturities and equity investments
 
$
73,871

 
$
3,571

 
$
1,036

 
$
76,406


(in thousands)
 
December 31, 2016
 
 
 
Amortized Cost

 
Gross Unrealized Gains

 
Gross Unrealized Losses

 
Estimated  Fair Value

Fixed maturities:
 
 
 
 
 
 
 
 
U.S. government, government agencies and authorities
 
$
28,312

 
$
22

 
$
186

 
$
28,148

States, municipalities and political subdivisions
 
3,131

 
1

 
44

 
3,088

Mortgage-backed
 
8,610

 
12

 
116

 
8,506

Asset-backed securities and collateralized mortgage obligations
 
3,468

 
4

 
5

 
3,467

Corporate
 
18,615

 
94

 
154

 
18,555

Total fixed maturities
 
62,136

 
133

 
505

 
61,764

Equity investments:
 
 
 
 
 
 
 
 
Common stock
 
17,701

 
4,156

 
431

 
21,426

Warrants - publicly traded
 
438

 
279

 
53

 
664

Warrants - not publicly traded
 
960

 
180

 
—

 
1,140

Total equity investments
 
19,099

 
4,615

 
484

 
23,230

Total fixed maturities and equity investments
 
$
81,235

 
$
4,748

 
$
989

 
$
84,994


Net unrealized gains and losses in the tables above are reported as other comprehensive (loss) income with the exception of net unrealized gains of $0.2 million, at June 30, 2017, and $0.2 million, at December 31, 2016, related to warrants - not publicly traded, which are reported in the consolidated statements of operations.

 
11
 
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements (Unaudited) June 30, 2017




The table below summarizes the Company's fixed maturities at June 30, 2017 by contractual maturity periods. Actual results may differ as issuers may have the right to call or prepay obligations, with or without penalties, prior to the contractual maturity of these obligations.
(in thousands)
 
June 30, 2017
 
 
 
Amortized Cost

 
Estimated Fair Value

Due in one year or less
 
$
7,518

 
$
7,504

Due after one year through five years
 
40,198

 
40,077

Due after five years through ten years
 
3,107

 
3,082

Due after ten years
 
6,349

 
6,302

Total
 
$
57,172

 
$
56,965


The following tables highlight the aggregate unrealized loss position, by security type, of fixed maturities and equity investments in unrealized loss positions as of June 30, 2017 and December 31, 2016. The tables segregate the holdings based on the period of time the investments have been continuously held in unrealized loss positions.
(in thousands)
 
 
 
 
 
 
 
 
June 30, 2017
 
 
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
$
23,371

 
$
153

 
$
—

 
$
—

 
$
23,371

 
$
153

States, municipalities and political subdivisions
2,330

 
37

 
—

 
—

 
2,330

 
37

Mortgage-backed
7,090

 
79

 
136

 
1

 
7,226

 
80

Asset-backed securities and collateralized mortgage obligations
1,092

 
3

 
299

 
3

 
1,391

 
6

Corporate
6,870

 
80

 
—

 
—

 
6,870

 
80

Total fixed maturities
40,753

 
352

 
435

 
4

 
41,188

 
356

Equity investments:
 
 
 
 
 
 
 
 


 


Common stock
1,317

 
146

 
666

 
456

 
1,983

 
602

Warrants
258

 
31

 
1

 
47

 
259

 
78

Total equity investments
1,575

 
177

 
667

 
503

 
2,242

 
680

Total
$
42,328

 
$
529

 
$
1,102

 
$
507

 
$
43,430

 
$
1,036



 
12
 
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements (Unaudited) June 30, 2017




(in thousands)
 
 
 
 
 
 
 
 
December 31, 2016
 
 
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
$
18,509

 
$
186

 
$
—

 
$
—

 
$
18,509

 
$
186

States, municipalities and political subdivisions
2,594

 
44

 
—

 
—

 
2,594

 
44

Mortgage-backed
7,709

 
116

 
58

 
—

 
7,767

 
116

Asset-backed securities and collateralized mortgage obligations
1,830

 
5

 
44

 
—

 
1,874

 
5

Corporate
10,956

 
154

 
—

 
—

 
10,956

 
154

Total fixed maturities
41,598

 
505

 
102

 
—

 
41,700

 
505

Equity investments:
 
 
 
 
 
 
 
 
 
 
 
Common stock
900

 
293

 
868

 
138

 
1,768

 
431

Warrants
31

 
20

 
—

 
33

 
31

 
53

Total equity investments
931

 
313

 
868

 
171

 
1,799

 
484

Total
$
42,529

 
$
818

 
$
970

 
$
171

 
$
43,499

 
$
989

Fixed maturities and equity investments contain approximately 168 and 173 individual investments that were in unrealized loss positions as of June 30, 2017 and December 31, 2016, 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 management believes may affect 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.

 
13
 
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements (Unaudited) June 30, 2017




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 recorded for the three and six months ended June 30, 2017 and June 30, 2016.
The Company has reviewed currently available information regarding investments with estimated fair values less than their carrying amounts and believes these unrealized losses are not other-than-temporary and are primarily due to temporary market and sector-related factors rather than to issuer-specific factors. The Company does not intend to sell those investments, and it is not likely it will be required to sell those investments before recovery of its amortized cost.
The Company does not have any exposure to subprime mortgage-backed investments.
Limited liability investments include investments in limited liability companies, limited partnerships and a general partnership that primarily invest in income-producing real estate or real estate related investments. The Company's interests in these investments are not deemed minor and, therefore, are accounted for under the equity method of accounting. The most recently available financial statements are used in applying the equity method. The difference between the end of the reporting period of the limited liability entities and that of the Company is no more than three months. As of June 30, 2017 and December 31, 2016, the carrying value of limited liability investments totaled $25.5 million and $23.0 million, respectively. At June 30, 2017, the Company has unfunded commitments totaling $1.2 million to fund limited liability investments. Income or loss from limited liability investments is recognized based on the Company's share of the earnings of the limited liability entities and is included in net investment (loss) income.
Limited liability investment, at fair value represents the Company's investment in 1347 Investors. In connection with the deconsolidation of 1347 Investors during the third quarter of 2016, the Company retained a minority investment in 1347 Investors. The Company made an irrevocable election to account for this investment at fair value. As of June 30, 2017 and December 31, 2016, the carrying value of the Company's limited liability investment, at fair value was $8.2 million and $10.7 million, respectively. At June 30, 2017, there was no unfunded commitment related to the limited liability investment, at fair value.
Other investments include mortgage and collateral loans and are reported at their unpaid principal balance. As of June 30, 2017 and December 31, 2016, the carrying value of other investments totaled $7.6 million and $8.0 million, respectively.
The Company had previously entered into two separate performance share grant agreements with 1347 Property Insurance Holdings, Inc. ("PIH"), whereby the Company will be entitled to receive up to an aggregate of 475,000 shares of PIH common stock upon achievement of certain milestones for PIH’s stock price. Pursuant to the performance share grant agreements, if at any time the last sales price of PIH’s common stock equals or exceeds: (i) $10.00 per share (as adjusted for stock splits, stock dividends, reorganizations, recapitalizations and the like) for any 20 trading days within any 30-trading day period, the Company will receive 100,000 shares of PIH common stock; (ii) $12.00 per share (as adjusted for stock splits, stock dividends, reorganizations, recapitalizations and the like) for any 20 trading days within any 30-trading day period, the Company will receive 125,000 shares of PIH common stock (in addition to the 100,000 shares of common stock earned pursuant to clause (i) herein); (iii) $15.00 per share (as adjusted for stock splits, stock dividends, reorganizations, recapitalizations and the like) for any 20 trading days within any 30-trading day period, the Company will receive 125,000 shares of PIH common stock (in addition to the 225,000 shares of common stock earned pursuant to clauses (i) and (ii) herein); and (iv) $18.00 per share (as adjusted for stock splits, stock dividends, reorganizations, recapitalizations and the like) for any 20 trading days within any 30-trading day period, the Company will receive 125,000 shares of PIH common stock (in addition to the 350,000 shares of common stock earned pursuant to clauses (i), (ii) and (iii) herein). To the extent shares of PIH common stock are granted to the Company under either of the performance share grant agreements, they will be recorded at the time the shares are granted and will have a valuation equal to the last sales price of PIH common stock on the day prior to such grant. No shares were received by the Company under either of the performance share grant agreements as of June 30, 2017. Refer to Note 18, "Fair Value of Financial Instruments," for further details regarding the performance shares.
Gross realized gains and losses on fixed maturities and equity investments for the three and six months ended June 30, 2017 and June 30, 2016 are comprised as follows:
(in thousands)
 
Three months ended June 30,
 
 
Six months ended June 30,
 
 
 
2017

 
2016

 
2017

 
2016

Gross realized gains
 
$
735

 
$
214

 
$
1,159

 
$
248

Gross realized losses
 
(1
)
 
(147
)
 
(27
)
 
(352
)
Net realized gains (losses)
 
$
734

 
$
67

 
$
1,132

 
$
(104
)

 
14
 
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements (Unaudited) June 30, 2017





Net investment (loss) income for the three and six months ended June 30, 2017 and June 30, 2016 is comprised as follows:
(in thousands)
 
Three months ended June 30,
 
 
Six months ended June 30,
 
 
 
2017

 
2016

 
2017

 
2016

Investment (loss) income:
 
 
 
 
 
 
 
 
  Interest from fixed maturities
 
$
228

 
$
242

 
$
434

 
$
460

Dividends
 
127

 
126

 
269

 
392

(Loss) income from limited liability investments
 
(581
)
 
511

 
(281
)
 
310

Loss on change in fair value of limited liability investment, at fair value
 
(2,113
)
 
—

 
(2,480
)
 
—

(Loss) gain on change in fair value of warrants - not publicly traded
 
(198
)
 
141

 
47

 
(246
)
Other
 
205

 
100

 
415

 
139

Gross investment (loss) income
 
(2,332
)
 
1,120

 
(1,596
)
 
1,055

Investment expenses
 
(34
)
 
(48
)
 
(67
)
 
(55
)
Net investment (loss) income
 
$
(2,366
)
 
$
1,072

 
$
(1,663
)
 
$
1,000

Fixed maturities and short-term investments with an estimated fair value of $12.8 million and $13.1 million were on deposit with state and provincial regulatory authorities at June 30, 2017 and December 31, 2016, respectively. From time to time, the Company pledges investments to third parties as deposits or to collateralize liabilities incurred under its policies of insurance. The amount of such pledged investments was $16.9 million and $16.4 million at June 30, 2017 and December 31, 2016, respectively.
NOTE 7 INVESTMENT IN INVESTEE
Investment in investee includes the Company's investment in the common stock of Itasca Capital Ltd. ("ICL") and is accounted for under the equity method. Prior to the second quarter of 2016, the Company's investment in ICL was included in equity investments in the consolidated balance sheets. During the second quarter of 2016, the Company's ownership percentage in ICL was increased to 31.2%. As a result of this change in ownership, the Company determined its investment in the common stock of ICL qualified for the equity method of accounting and, thus, is included in investment in investee in the consolidated balance sheets at June 30, 2017 and December 31, 2016. The Company's investment in ICL is recorded on a three-month lag basis. The carrying value, estimated fair value and approximate equity percentage for the Company's investment in ICL at June 30, 2017 and December 31, 2016 were as follows:
(in thousands, except for percentages)
 
 
 
 
 
 
June 30, 2017
 
December 31, 2016
 
 
Equity Percentage
 
Estimated Fair Value
 
Carrying Value
 
Equity Percentage
 
Estimated Fair Value
 
Carrying Value
ICL
 
31.2
%
 
$
4,192

 
$
5,355

 
31.2
%
 
$
4,251

 
$
3,116


The estimated fair value of the Company's investment in ICL at June 30, 2017 in the table above is calculated based on the published closing price of ICL at March 31, 2017 to be consistent with the three-month lag in reporting its carrying value under the equity method. The estimated fair value of the Company's investment in ICL based on the published closing price of ICL at June 30, 2017 is $3.7 million.
Equity in net loss of investee of $0.1 million and equity in net income of investee of $2.2 million for the three and six months ended June 30, 2017, respectively, relates to the Company's investment in ICL.
The Company previously had an investment in the common stock and private units of 1347 Capital Corp., which was included in investment in investee in the consolidated balance sheet at June 30, 2016. Equity in net loss of investees of $0.9 million and $0.9 million for the three and six months ended June 30, 2016, respectively, relates to the Company's investment in 1347 Capital Corp.

 
15
 
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements (Unaudited) June 30, 2017




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 and six months ended June 30, 2017 and June 30, 2016 are comprised as follows:
(in thousands)
 
Three months ended June 30,
 
 
Six months ended June 30,
 
 
 
2017

 
2016

 
2017

 
2016

Beginning balance, net
 
$
14,113

 
$
13,440

 
$
13,609

 
$
12,143

Additions
 
7,011

 
7,180

 
14,698

 
14,769

Amortization
 
(7,415
)
 
(6,796
)
 
(14,598
)
 
(13,088
)
Balance at June 30, net
 
$
13,709

 
$
13,824

 
$
13,709

 
$
13,824

NOTE 9 INTANGIBLE ASSETS
Intangible assets at June 30, 2017 and December 31, 2016 are comprised as follows:
(in thousands)
 
 
June 30, 2017
 
 
 
Gross Carrying Value
 
Accumulated Amortization
 
Net Carrying Value
Intangible assets subject to amortization:
 
 
 
 
 
 
Database
 
$
4,918

 
$
2,275

 
$
2,643

Vehicle service agreements in-force
 
3,680

 
3,597

 
83

Customer relationships
 
3,611

 
1,748

 
1,863

In-place lease
 
1,125

 
60

 
1,065

Contract-based revenues
 
731

 
81

 
650

Intangible assets not subject to amortization:
 
 
 
 
 
 
Tenant relationship
 
73,667

 
—

 
73,667

Insurance licenses
 
7,553

 
—

 
7,553

Trade name
 
663

 
—

 
663

Total
 
$
95,948

 
$
7,761

 
$
88,187


(in thousands)
 
 
December 31, 2016
 
 
 
Gross Carrying Value
 
Accumulated Amortization
 
Net Carrying Value
Intangible assets subject to amortization:
 
 
 
 
 
 
Database
 
$
4,918

 
$
2,029

 
$
2,889

Vehicle service agreements in-force
 
3,680

 
3,554

 
126

Customer relationships
 
3,611

 
1,521

 
2,090

In-place lease
 
1,125

 
29

 
1,096

Contract-based revenues
 
731

 
48

 
683

Intangible assets not subject to amortization:
 
 
 
 
 
 
Tenant relationship
 
73,667

 
—

 
73,667

Insurance licenses
 
7,803

 
—

 
7,803

Trade name
 
663

 
—

 
663

Total
 
$
96,198

 
$
7,181

 
$
89,017


 
16
 
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements (Unaudited) June 30, 2017




As further discussed in Note 5, "Acquisitions, Deconsolidation and Discontinued Operations," during 2016, the Company recorded $74.8 million of separately identifiable intangible assets related to in-place lease and tenant relationship, as part of the acquisition of CMC. The in-place lease intangible asset of $1.1 million is being amortized on a straight-line basis over its estimated useful life of approximately 18 years, which is based on the term of the existing operating lease. The tenant relationship intangible asset of $73.7 million relates to a single long-term tenant relationship. The Company has determined there are no legal, regulatory, contractual, competitive, economic or other factors limiting the useful life of the tenant relationship; therefore, the tenant relationship intangible asset is deemed to have an indefinite useful life and is not amortized.
As further discussed in Note 5, "Acquisitions, Deconsolidation and Discontinued Operations," during the second quarter of 2016, the Company recorded $0.7 million of separately identifiable intangible assets for contract-based management fee and promote fee revenues as part of the acquisition of Argo. The contract-based management fee revenue intangible asset is being amortized over nine years. The contract-based promote fee revenue intangible asset is being amortized over a three-year period beginning in 2022. The amortization periods for the contract-based revenues intangible assets are based on the patterns in which the economic benefits of the intangible assets are expected to be consumed.
The Company's other intangible assets with definite useful lives are amortized either based on the patterns in which the economic benefits of the intangible assets are expected to be consumed or using the straight-line method over their estimated useful lives, which range from seven to fifteen years. Amortization of intangible assets was $0.3 million and $0.3 million for the three months ended June 30, 2017 and June 30, 2016, respectively ($0.6 million and $0.6 million for the six months ended June 30, 2017 and June 30, 2016, respectively).
The tenant relationship, insurance licenses and trade name intangible assets have indefinite useful lives and are not amortized. During the six months ended June 30, 2017, the Company recorded an impairment charge of $0.3 million related to its insurance licenses indefinite lived intangible asset. The impairment recorded was the result of Mendota Insurance Company ("Mendota") and Mendakota Insurance Company ("Mendakota") surrendering their insurance licenses in the state of New Mexico during the first quarter of 2017.
NOTE 10 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 for unpaid loss and loss adjustment expenses necessarily involves risks that the actual loss and loss adjustment expenses incurred by the Company will deviate, perhaps materially, from the estimates recorded.
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.

 
17
 
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements (Unaudited) June 30, 2017




(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 June 30, 2017 and June 30, 2016 were as follows:
(in thousands)
 
June 30, 2017

 
June 30, 2016

Balance at beginning of period, gross
 
$
53,795

 
$
55,471

Less reinsurance recoverable related to property and casualty unpaid loss and loss adjustment expenses
 
681

 
1,207

Balance at beginning of period, net
 
53,114

 
54,264

Incurred related to:
 
 
 
 

      Current year
 
50,324

 
45,614

      Prior years
 
996

 
67

Paid related to:
 
 
 
 

      Current year
 
(23,094
)
 
(22,060
)
      Prior years
 
(35,975
)
 
(26,535
)
Balance at end of period, net
 
45,365

 
51,350

Plus reinsurance recoverable related to property and casualty unpaid loss and loss adjustment expenses
 
509

 
845

Balance at end of period, gross
 
$
45,874

 
$
52,195

The Company reported unfavorable development on property and casualty unpaid loss and loss adjustment expenses of $1.0 million and $0.1 million for the six months ended June 30, 2017 and June 30, 2016, respectively. The unfavorable development for the six months ended June 30, 2017 was primarily related to an increase in property and casualty loss and loss adjustment expenses at Mendota. The unfavorable development reported for the six months ended June 30, 2016 was primarily related to property and casualty loss and loss adjustment expenses at Mendota, partially offset by a decrease in property and casualty unpaid loss and loss adjustment expenses at Amigo.
(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 June 30, 2017 and June 30, 2016 were as follows:
(in thousands)
 
June 30, 2017

 
June 30, 2016

Balance at beginning of period
 
$
2,915

 
$
2,975

Incurred related to:
 
 
 
 
      Current year
 
2,558

 
2,654

      Prior years
 
—

 
—

Paid related to:
 
 
 
 
      Current year
 
(2,616
)
 
(2,502
)
      Prior years
 
(63
)
 
(152
)
Balance at end of period
 
$
2,794

 
$
2,975



 
18
 
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements (Unaudited) June 30, 2017




NOTE 11 DEBT
Debt consists of the following instruments at June 30, 2017 and December 31, 2016:
(in thousands)
 
June 30, 2017
 
December 31, 2016
 
 
Principal

 
Carrying Value

 
Fair Value

 
Principal

 
Carrying Value

 
Fair Value

Note payable
 
$
177,518

 
$
188,328

 
$
186,341

 
$
178,781

 
$
190,074

 
$
190,074

Subordinated debt
 
90,500

 
48,210

 
48,210

 
90,500

 
43,619

 
43,619

Total
 
$
268,018

 
$
236,538

 
$
234,551

 
$
269,281

 
$
233,693

 
$
233,693


As further discussed in Note 5, "Acquisitions, Deconsolidation and Discontinued Operations," as part of the acquisition of CMC, the Mortgage, which is recorded as note payable in the consolidated balance sheets, was recorded at its estimated fair value of $191.7 million, which included the unpaid principal amount of $180.0 million as of the date of acquisition plus a premium of $11.7 million. The Mortgage matures on May 15, 2034 and has a fixed interest rate of 4.07%. The Mortgage is carried in the consolidated balance sheets at its amortized cost, which reflects the monthly pay-down of principal as well as the amortization of the premium using the effective interest rate method. The fair value of the Mortgage disclosed in the table above is derived from quoted market prices of A-rated industrial bonds with similar maturities.

The subordinated debt is carried in the consolidated balance sheets at fair value. See Note 18, "Fair Value of Financial Instruments," for further discussion of the subordinated debt. Subordinated debt consists of the following trust preferred debt instruments:
Issuer
Principal (in thousands)
Issue date
Interest
Redemption date
Kingsway CT Statutory Trust I
$
15,000

12/4/2002
annual interest rate equal to LIBOR, plus 4.00% payable quarterly
12/4/2032
Kingsway CT Statutory Trust II
$
17,500

5/15/2003
annual interest rate equal to LIBOR, plus 4.10% payable quarterly
5/15/2033
Kingsway CT Statutory Trust III
$
20,000

10/29/2003
annual interest rate equal to LIBOR, plus 3.95% payable quarterly
10/29/2033
Kingsway DE Statutory Trust III
$
15,000

5/22/2003
annual interest rate equal to LIBOR, plus 4.20% payable quarterly
5/22/2033
Kingsway DE Statutory Trust IV
$
10,000

9/30/2003
annual interest rate equal to LIBOR, plus 3.85% payable quarterly
9/30/2033
Kingsway DE Statutory Trust VI
$
13,000

1/8/2004
annual interest rate equal to LIBOR, plus 4.00% payable quarterly
1/8/2034

NOTE 12 FINANCE LEASE OBLIGATION LIABILITY
On October 2, 2014, the Company completed a sale and leaseback transaction involving building and land located in Miami, Florida, which was previously recorded as asset held for sale. The transaction did not qualify for sales recognition and was accounted for as a financing due to the Company's continuing involvement with the property as a result of nonrecourse financing provided to the buyer in the form of prepaid rent. A finance lease obligation liability equal to the selling price of the property was established at the date of the transaction. During the lease term, the Company will record interest expense on the finance lease obligation at its incremental borrowing rate and will increase the finance lease obligation liability by the same amount.

During the second quarter of 2017, the Company was informed of the landlord's intent to terminate the lease agreement effective October 10, 2017. The Company has the option to vacate the property and effectively terminate the lease earlier than October 10, 2017. Upon termination of the lease, the Company will no longer have continuing involvement with the property and will, then, recognize the sale of the property as well as a related gain of approximately $0.7 million. The gain will result primarily from removing the carrying values of the land, building and finance lease obligation liability from the consolidated balance sheets and from the return of part of the original prepaid rent. At June 30, 2017 and December 31, 2016, finance lease obligation liability of $5.1 million and $5.1 million, respectively, is included in accrued expenses and other liabilities in the consolidated balance sheets. At June 30, 2017 and December 31, 2016, the carrying value of the land and building of $4.7 million and $4.8 million, respectively, is included in property and equipment in the consolidated balance sheets.


 
19
 
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements (Unaudited) June 30, 2017




NOTE 13 INCOME TAXES
Income tax expense for the three and six months ended June 30, 2017 and June 30, 2016 varies from the amount that would result by applying the applicable United States corporate income tax rate of 34% to loss before income tax expense. The following table summarizes the differences:
(in thousands)
 
Three months ended June 30,
 
 
Six months ended June 30,
 
 
 
2017

 
2016

 
2017

 
2016

Income tax benefit at United States statutory income tax rate
 
$
(2,519
)
 
$
(671
)
 
$
(2,962
)
 
$
(1,170
)
Valuation allowance
 
2,401

 
251

 
2,945

 
640

Indefinite life intangibles
 
1,058

 
22

 
1,005

 
44

Change in unrecognized tax benefits(1)
 
160

 
—

 
372

 
—

Non-deductible compensation
 
101

 
381

 
200

 
449

Foreign operations subject to different tax rates
 
45

 
38

 
(94
)
 
74

Other
 
5

 
5

 
(36
)
 
15

Income tax expense
 
$
1,251

 
$
26

 
$
1,430

 
$
52

(1) Includes interest and penalty expense related to unrecognized tax benefits.
The Company maintains a valuation allowance for its gross deferred tax assets at June 30, 2017 and December 31, 2016. The Company's operations have generated substantial operating losses in prior years. These losses can be available to reduce income taxes that might otherwise be incurred on future taxable income; however, it is uncertain whether the Company will generate the taxable income necessary to utilize these losses or other reversing temporary differences. This uncertainty has caused management to place a full valuation allowance on its June 30, 2017 and December 31, 2016 net deferred tax asset, excluding the deferred income tax liability amounts set forth in the paragraph below.
The Company carries a deferred income tax liability of $49.7 million and $48.7 million at June 30, 2017 and December 31, 2016, respectively. At June 30, 2017, $13.4 million relates to deferred income tax liabilities scheduled to reverse in periods after the expiration of the Company's consolidated U.S. net operating loss carryforwards and $36.3 million relates to land and indefinite lived intangible assets. At December 31, 2016, $13.4 million relates to deferred income tax liabilities scheduled to reverse in periods after the expiration of the Company's consolidated U.S. net operating loss carryforwards and $35.3 million relates to land and indefinite lived intangible assets. The Company considered a tax planning strategy in arriving at its June 30, 2017 and December 31, 2016 deferred income tax liability.
As of June 30, 2017 and December 31, 2016, the Company carried a liability for unrecognized tax benefits of $1.3 million and $1.3 million, respectively, included in income taxes payable in the consolidated balance sheets. The Company classifies interest and penalty accruals, if any, related to unrecognized tax benefits as income tax expense. The Company recorded income tax expense of $0.2 million and zero related to interest and penalty accruals for the three months ended June 30, 2017 and June 30, 2016, respectively ($0.4 million and zero for the six months ended June 30, 2017 and June 30, 2016, respectively). At June 30, 2017 and December 31, 2016, the Company carried an accrual for the payment of interest and penalties of $0.8 million and $0.4 million, respectively, included in income taxes payable in the consolidated balance sheets.

 
20
 
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements (Unaudited) June 30, 2017




NOTE 14 LOSS FROM CONTINUING OPERATIONS PER SHARE
The following table sets forth the reconciliation of numerators and denominators for the basic and diluted loss from continuing operations per share computation for the three and six months ended June 30, 2017 and June 30, 2016:
(in thousands, except per share data)
 
Three months ended June 30,
 
 
Six months ended June 30,
 
 
2017

 
2016

 
2017
 
2016
Numerator:
 
 
 
 
 
 
 
 
Loss from continuing operations
 
$
(8,659
)
 
$
(1,999
)
 
$
(10,143
)
 
$
(3,494
)
(Less) plus: net (income) loss attributable to noncontrolling interests
 
(100
)
 
361

 
(205
)
 
400

Less: dividends on preferred stock
 
(123
)
 
(82
)
 
(244
)
 
(164
)
Loss from continuing operations attributable to common shareholders
 
$
(8,882
)
 
$
(1,720
)
 
$
(10,592
)
 
$
(3,258
)
Denominator:
 
 
 
 
 
 
 
 
Weighted-average common shares outstanding
 
21,458

 
19,818

 
21,458

 
19,764

Effect of potentially dilutive securities
 
—

 
—

 
—

 
—

Weighted-average diluted shares
 
21,458

 
19,818

 
21,458

 
19,764

Basic loss from continuing operations per share
 
$
(0.41
)