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
March 31, 2018
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 May 14, 2018 was 23,660,855.


KINGSWAY FINANCIAL SERVICES INC.

Table Of Contents
PART I - FINANCIAL INFORMATION
 
ITEM 1. FINANCIAL STATEMENTS
 
Consolidated Balance Sheets as of March 31, 2018 (unaudited) and December 31, 2017
 
Consolidated Statements of Operations for the Three Months Ended March 31, 2018 and 2017 (unaudited)
 
Consolidated Statements of Comprehensive Loss for the Three Months Ended March 31, 2018 and 2017 (unaudited)
 
Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2018 and 2017 (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)
 
 
March 31, 2018

 
December 31, 2017

 
 
(unaudited)

 
 
Assets
 
 
 
 
Investments:
 
 
 
 
Fixed maturities, at fair value (amortized cost of $51,403 and $53,746, respectively)
 
$
50,499

 
$
53,214

Equity investments, at fair value (cost of $5,922 and $9,146, respectively)
 
6,472

 
8,994

Limited liability investments
 
25,749

 
25,173

Limited liability investment, at fair value
 
8,925

 
10,314

Other investments, at cost which approximates fair value
 
3,316

 
3,721

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

 
151

Total investments
 
95,112

 
101,567

Cash and cash equivalents
 
47,197

 
44,286

Investment in investee
 
5,331

 
5,230

Accrued investment income
 
358

 
526

Premiums receivable, net of allowance for doubtful accounts of $115 and $115, respectively
 
31,428

 
27,855

Service fee receivable, net of allowance for doubtful accounts of $333 and $318, respectively
 
5,707

 
4,286

Other receivables, net of allowance for doubtful accounts of zero and zero, respectively
 
7,398

 
7,139

Deferred acquisition costs, net
 
10,646

 
13,045

Property and equipment, net of accumulated depreciation of $14,716 and $13,600, respectively
 
107,166

 
108,230

Goodwill
 
80,112

 
80,112

Intangible assets, net of accumulated amortization of $8,605 and $8,333, respectively
 
87,343

 
87,615

Other assets
 
15,202

 
4,709

Total Assets
 
$
493,000

 
$
484,600

Liabilities and Shareholders' Equity
 
 
 
 
Liabilities:
 
 
 
 
Unpaid loss and loss adjustment expenses:
 
 
 
 
Property and casualty
 
$
61,658

 
$
63,652

Vehicle service agreements
 
2,683

 
2,779

Total unpaid loss and loss adjustment expenses
 
64,341

 
66,431

Unearned premiums
 
39,921

 
36,686

Note payable
 
185,530

 
186,469

Bank loan
 
4,667

 
4,917

Subordinated debt, at fair value
 
53,458

 
52,105

Net deferred income tax liabilities
 
30,352

 
30,331

Deferred service fees
 
41,072

 
39,741

Income taxes payable
 
2,876

 
2,644

Accrued expenses and other liabilities
 
24,135

 
15,966

Total Liabilities
 
446,352

 
435,290

 
 
 
 
 
Class A preferred stock, no par value; unlimited number authorized; 222,876 and 222,876 issued and outstanding at March 31, 2018 and December 31, 2017, respectively; redemption amount of $5,572
 
5,469

 
5,461

 
 
 
 
 
Shareholders' Equity:
 
 
 
 
Common stock, no par value; unlimited number authorized; 21,708,190 and 21,708,190 issued and outstanding at March 31, 2018 and December 31, 2017, respectively
 

 

Additional paid-in capital
 
356,313

 
356,021

Accumulated deficit
 
(356,273
)
 
(313,487
)
Accumulated other comprehensive income (loss)
 
35,844

 
(3,852
)
Shareholders' equity attributable to common shareholders
 
35,884

 
38,682

Noncontrolling interests in consolidated subsidiaries
 
5,295

 
5,167

Total Shareholders' Equity
 
41,179

 
43,849

Total Liabilities, Class A preferred stock and Shareholders' Equity
 
$
493,000

 
$
484,600


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,
 
 
 
2018

 
2017

Revenues:
 
 
 
 
Net premiums earned
 
$
28,636

 
$
32,922

Service fee and commission income
 
10,557

 
6,562

Rental income
 
3,348

 
3,347

Net investment (loss) income
 
(682
)
 
714

Net realized gains
 
13

 
398

Gain on change in fair value of equity investments
 
1,176

 

Other income
 
2,660

 
2,798

Total revenues
 
45,708

 
46,741

Operating expenses:
 
 
 
 
Loss and loss adjustment expenses
 
24,422

 
26,410

Commissions and premium taxes
 
5,443

 
6,278

Cost of services sold
 
2,252

 
1,304

General and administrative expenses
 
11,337

 
11,272

Leased real estate segment interest expense
 
1,552

 
1,574

Amortization of intangible assets
 
272

 
291

Impairment of intangible assets
 

 
250

Total operating expenses
 
45,278

 
47,379

Operating income (loss)
 
430

 
(638
)
Other expenses (revenues), net:
 
 
 
 
Interest expense not allocated to segments
 
1,386

 
1,159

Foreign exchange losses, net
 
2

 
4

Loss on change in fair value of debt
 
919

 
1,889

Equity in net income of investee
 
(101
)
 
(2,385
)
Total other expenses, net
 
2,206

 
667

Loss before income tax expense
 
(1,776
)
 
(1,305
)
Income tax expense
 
251

 
179

Net loss
 
(2,027
)
 
(1,484
)
Less: net income attributable to noncontrolling interests in consolidated subsidiaries
 
135

 
105

Less: dividends on preferred stock, net of tax
 
129

 
174

Net loss attributable to common shareholders
 
$
(2,291
)
 
$
(1,763
)
Loss per share – net loss attributable to common shareholders:
 
 
 
 
Basic:
 
$
(0.11
)
 
$
(0.08
)
Diluted:
 
$
(0.11
)
 
$
(0.08
)
Weighted-average shares outstanding (in ‘000s):
 
 
 
 
Basic:
 
21,708

 
21,458

Diluted:
 
21,708

 
21,458


See accompanying notes to unaudited consolidated financial statements.

 
4
 

KINGSWAY FINANCIAL SERVICES INC.


Consolidated Statements of Comprehensive Loss
(in thousands)
(Unaudited)
 
 
Three months ended March 31,
 
 
 
2018

 
2017

 
 
 
 
 
Net loss
 
$
(2,027
)
 
$
(1,484
)
Other comprehensive loss, net of taxes(1):
 
 
 
 
Unrealized losses on available-for-sale investments:
 
 
 
 
Unrealized losses arising during the period
 
(365
)
 
(163
)
Reclassification adjustment for amounts included in net loss
 
(7
)
 
(507
)
Change in fair value of debt attributable to instrument-specific credit risk
 
(434
)
 

Other comprehensive loss
 
(806
)
 
(670
)
Comprehensive loss
 
(2,833
)
 
(2,154
)
Less: comprehensive income attributable to noncontrolling interests in consolidated subsidiaries
 
129

 
106

Comprehensive loss attributable to common shareholders
 
$
(2,962
)
 
$
(2,260
)
(1) Net of income tax expense of $0 and $0 for the three months ended March 31, 2018 and March 31, 2017, 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,
 
 
 
2018

 
2017

Cash provided by (used in):
 
 
 
 
Operating activities:
 
 
 
 
Net loss
 
$
(2,027
)
 
$
(1,484
)
Adjustments to reconcile net loss to net cash used in operating activities:
 
 
 
 
Equity in net income of investee
 
(101
)
 
(2,385
)
Equity in net income of limited liability investments
 
(283
)
 
(300
)
Loss on change in fair value of limited liability investment
 
1,389

 
367

Depreciation and amortization expense
 
1,388

 
1,440

Stock-based compensation expense, net of forfeitures
 
292

 
292

Net realized gains
 
(13
)
 
(398
)
Gain on change in fair value of equity investments
 
(1,176
)
 

Loss on change in fair value of debt
 
919

 
1,889

Deferred income taxes
 
21

 
(53
)
Intangible asset impairment
 

 
250

Amortization of fixed maturities premiums and discounts
 
45

 
58

Amortization of note payable premium
 
(237
)
 
(242
)
Changes in operating assets and liabilities:
 
 
 
 
Premiums and service fee receivable, net
 
(4,994
)
 
(2,236
)
Other receivables, net
 
(259
)
 
(2,322
)
Deferred acquisition costs, net
 
2,399

 
(504
)
Unpaid loss and loss adjustment expenses
 
(2,090
)
 
(5,736
)
Unearned premiums
 
3,235

 
3,865

Deferred service fees
 
1,331

 
130

Other, net
 
(1,441
)
 
(463
)
Net cash used in operating activities
 
(1,602
)
 
(7,832
)
Investing activities:
 
 
 
 
Proceeds from sales and maturities of fixed maturities
 
1,608

 
5,898

Proceeds from sales of equity investments
 
6,840

 
2,488

Purchases of fixed maturities
 
(2,299
)
 
(2,731
)
Purchases of equity investments
 
(744
)
 
(675
)
Net acquisitions of limited liability investments
 
(293
)
 
(150
)
Net proceeds from other investments
 
405

 
626

Net proceeds from short-term investments
 

 
250

Net purchases of property and equipment
 
(52
)
 
(43
)
Net cash provided by investing activities
 
5,465

 
5,663

Financing activities:
 
 
 
 
Principal payments on bank loan
 
(250
)
 

Principal payments on note payable
 
(702
)
 
(619
)
Net cash used in financing activities
 
(952
)
 
(619
)
Net increase (decrease) in cash and cash equivalents
 
2,911

 
(2,788
)
Cash and cash equivalents at beginning of period
 
44,286

 
36,475

Cash and cash equivalents at end of period
 
$
47,197

 
$
33,687


See accompanying notes to unaudited consolidated financial statements.

 
6
 

KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements (Unaudited) March 31, 2018








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.
Certain prior year amounts have been reclassified to conform to current year presentation. Such reclassifications had no impact on previously reported net loss or total shareholders' equity.
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 ("2017 Annual Report") for the year ended December 31, 2017.
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; and fair value assumptions for subordinated debt obligations.
The fair values of the Company's investments in fixed maturities and equity investments, limited liability investment, at fair value, performance shares and subordinated debt 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 2017 Annual Report.
NOTE 4 RECENTLY ISSUED ACCOUNTING STANDARDS
(a)    Adoption of New Accounting Standards:
Effective January 1, 2018, the Company adopted Accounting Standards Update ("ASU") 2014-09, Revenue from Contracts with Customers ("ASU 2014-09"), and the related amendments, utilizing the modified retrospective approach, which created a new comprehensive revenue recognition standard that serves as the single source of revenue guidance for all contracts with customers to transfer goods or services or contracts for the transfer of nonfinancial assets, unless those contracts are within the scope of other standards. The core principle of ASU 2014-09 is that an entity recognizes revenue to depict the transfer of promised goods or

 
7
 

KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements (Unaudited) March 31, 2018







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. Insurance contracts, lease contracts and investments are not within the scope of ASU 2014-09; therefore, this standard does not apply to the majority of our consolidated revenues. ASU 2014-09 is applicable to the Company's service fee and commission income. Service fee and commission income represents vehicle service agreement fees, maintenance support service fees, warranty product commissions and homebuilder warranty service fees and commissions based on terms of various agreements with credit unions, consumers, businesses and homebuilders. The revenue recognition policy we utilize for our service fee and commission income aligns with the new guidance; therefore, there were no changes to the way we recognize revenue for the three months ended March 31, 2018. Since the adoption of the new standard did not have a material impact on the measurement or recognition of revenue, a cumulative effect adjustment to opening accumulated deficit was not deemed necessary. Refer to Note 12, "Revenue from Contracts with Customers," for further details.
Effective January 1, 2018, the Company adopted 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 (1) 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); and (2) an entity to present separately in other comprehensive income (loss) the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments. Previously, the Company recorded its equity investments at fair value with net unrealized gains or losses reported in accumulated other comprehensive income (loss) and recorded its subordinated debt at fair value with the total change in fair value reported in net income (loss). As a result of the adoption of ASU 2016-01, cumulative net unrealized losses on equity investments of $0.0 million were reclassified from accumulated other comprehensive income (loss) into accumulated deficit and a cumulative $40.5 million change in fair value of subordinated debt attributable to instrument-specific credit risk was reclassified from accumulated deficit to accumulated other comprehensive income (loss). Prior periods have not been restated to conform to the current presentation.
Effective January 1, 2018, the Company adopted 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. The adoption of the standard did not affect the Company's consolidated statements of cash flows.

(b)    Accounting Standards Not Yet Adopted:
In February 2016, the Financial Accounting Standards Board ("FASB") 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. The accounting treatment for lessors will remain relatively unchanged. 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 is currently evaluating the potential effect of the adoption of ASU 2016-02 on its consolidated financial statements.
In June 2016, the FASB issued ASU 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments ("ASU 2016-13"). ASU 2016-13 replaces the current incurred loss model used to measure impairment losses with an expected loss model for trade, reinsurance, and other receivables as well as financial instruments measured at amortized cost. ASU 2016-13 will require a financial asset measured at amortized cost, including reinsurance balances recoverable, to be presented at the net amount expected to be collected by means of an allowance for credit losses that runs through net loss. Credit losses relating to available-for-sale debt securities will also be recorded through an allowance for credit losses. However, the amendments would limit the amount of the allowance to the amount by which fair value is below amortized cost. The measurement of credit losses on available-for-sale investments is similar under current GAAP, but the update requires the use of the allowance account through which amounts can be reversed, rather than through an irreversible write-down. ASU 2016-13 is effective for annual periods beginning after December 15, 2019, and interim periods within those annual periods with early adoption

 
8
 

KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements (Unaudited) March 31, 2018







permitted for fiscal years beginning after December 31, 2018 and interim periods within such year. The Company is currently evaluating ASU 2016-13 to determine the potential impact that adopting this standard will have 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 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 ACQUISITION
Professional Warranty Service Corporation:

On October 12, 2017, the Company acquired 100% of the outstanding shares of Professional Warranty Service Corporation ("PWSC") for estimated cash consideration of approximately $9.9 million. The final purchase price is subject to a true-up that will be finalized in 2018. As further discussed in Note 17, "Segmented Information," PWSC is included in the Extended Warranty segment. PWSC is based in Virginia and is a leading provider of new home warranty products and administration services to the largest tier of domestic residential construction firms in the United States. This acquisition allows the Company to grow its portfolio of warranty companies and expand into the home warranty business.

The Company intends to finalize during 2018 its fair value analysis of the assets acquired and liabilities assumed. The assets acquired and liabilities assumed are recorded in the consolidated financial statements at their estimated fair market values. These estimates, allocations and calculations are subject to change as we obtain further information; therefore, the final fair market values of the assets acquired and liabilities assumed may not agree with the estimates included in the consolidated financial statements. The following table summarizes the estimated allocation of the assets acquired and liabilities assumed at the date of acquisition:
(in thousands)
 
 
 
 
October 12, 2017

Cash and cash equivalents
 
$
2,071

Other receivables
 
50

Service fee receivable
 
1,422

Property and equipment
 
238

Other assets
 
205

Goodwill
 
$
9,051

Total assets
 
$
13,037

 
 
 
Deferred service fees
 
$
2,079

Accrued expenses and other liabilities
 
1,089

Total liabilities
 
$
3,168

 
 
 
Purchase price
 
$
9,869




 
9
 

KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements (Unaudited) March 31, 2018







NOTE 6 INVESTMENTS

As further discussed in Note 4, "Recently Issued Accounting Standards," effective January 1, 2018, the Company adopted ASU 2016-01. As a result of the adoption, equity investments are no longer classified as available-for-sale. Prior periods have not been restated to conform to the current presentation.
The amortized cost, gross unrealized gains and losses, and estimated fair value of the Company's available-for-sale investments at March 31, 2018 and December 31, 2017 are summarized in the tables shown below:
(in thousands)
 
March 31, 2018
 
 
 
Amortized Cost

 
Gross Unrealized Gains

 
Gross Unrealized Losses

 
Estimated  Fair Value

Fixed maturities:
 
 
 
 
 
 
 
 
U.S. government, government agencies and authorities
 
$
26,201

 
$

 
$
392

 
$
25,809

States, municipalities and political subdivisions
 
3,753

 

 
62

 
3,691

Mortgage-backed
 
7,743

 
5

 
212

 
7,536

Asset-backed securities and collateralized mortgage obligations
 
2,151

 

 
22

 
2,129

Corporate
 
11,555

 

 
221

 
11,334

Total fixed maturities
 
$
51,403

 
$
5

 
$
909

 
$
50,499


(in thousands)
 
December 31, 2017
 
 
 
Amortized Cost

 
Gross Unrealized Gains

 
Gross Unrealized Losses

 
Estimated  Fair Value

Fixed maturities:
 
 
 
 
 
 
 
 
U.S. government, government agencies and authorities
 
$
25,519

 
$

 
$
275

 
$
25,244

States, municipalities and political subdivisions
 
3,826

 
3

 
46

 
3,783

Mortgage-backed
 
7,784

 
7

 
128

 
7,663

Asset-backed securities and collateralized mortgage obligations
 
2,279

 
1

 
11

 
2,269

Corporate
 
14,338

 
22

 
105

 
14,255

Total fixed maturities
 
53,746

 
33

 
565

 
53,214

Equity investments:
 
 
 
 
 
 
 
 
Common stock
 
7,583

 
199

 
363

 
7,419

Warrants - publicly traded
 
603

 
266

 
142

 
727

Warrants - not publicly traded
 
960

 
173

 
285

 
848

Total equity investments
 
9,146

 
638

 
790

 
8,994

Total fixed maturities and equity investments
 
$
62,892

 
$
671

 
$
1,355

 
$
62,208


Net unrealized gains and losses in the tables above are reported as other comprehensive loss with the exception of net unrealized losses of $0.1 million, at December 31, 2017, related to warrants - not publicly traded, which are reported in the consolidated statements of operations.
The table below summarizes the Company's fixed maturities at March 31, 2018 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.

 
10
 

KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements (Unaudited) March 31, 2018







(in thousands)
 
March 31, 2018
 
 
 
Amortized Cost

 
Estimated Fair Value

Due in one year or less
 
$
14,733

 
$
14,674

Due after one year through five years
 
29,824

 
29,179

Due after five years through ten years
 
2,194

 
2,126

Due after ten years
 
4,652

 
4,520

Total
 
$
51,403

 
$
50,499


The following tables highlight the aggregate unrealized loss position, by security type, of available-for-sale investments in unrealized loss positions as of March 31, 2018 and December 31, 2017. 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, 2018
 
 
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
$
13,306

 
$
138

 
$
12,294

 
$
254

 
$
25,600

 
$
392

States, municipalities and political subdivisions
1,722

 
15

 
1,968

 
47

 
3,690

 
62

Mortgage-backed
3,604

 
70

 
3,886

 
142

 
7,490

 
212

Asset-backed securities and collateralized mortgage obligations
1,309

 
14

 
820

 
8

 
2,129

 
22

Corporate
6,800

 
98

 
4,494

 
123

 
11,294

 
221

Total fixed maturities
$
26,741

 
$
335

 
$
23,462

 
$
574

 
$
50,203

 
$
909



 
11
 

KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements (Unaudited) March 31, 2018







(in thousands)
 
 
 
 
 
 
 
 
December 31, 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
$
17,067

 
$
136

 
$
8,177

 
$
139

 
$
25,244

 
$
275

States, municipalities and political subdivisions
2,092

 
25

 
893

 
21

 
2,985

 
46

Mortgage-backed
5,550

 
86

 
1,789

 
42

 
7,339

 
128

Asset-backed securities and collateralized mortgage obligations
1,158

 
5

 
660

 
6

 
1,818

 
11

Corporate
6,807

 
62

 
2,201

 
43

 
9,008

 
105

Total fixed maturities
32,674

 
314

 
13,720

 
251

 
46,394

 
565

Equity investments:
 
 
 
 
 
 
 
 
 
 
 
Common stock
4,515

 
363

 

 

 
4,515

 
363

Warrants
896

 
427

 

 

 
896

 
427

Total equity investments
5,411

 
790

 

 

 
5,411

 
790

Total
$
38,085

 
$
1,104

 
$
13,720

 
$
251

 
$
51,805

 
$
1,355

There are approximately 194 and 191 individual available-for-sale investments that were in unrealized loss positions as of March 31, 2018 and December 31, 2017, 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.

 
12
 

KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements (Unaudited) March 31, 2018







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 months ended March 31, 2018 and March 31, 2017.
The Company has reviewed currently available information regarding investments with estimated fair values less than their carrying amounts and believes these unrealized losses are not other-than-temporary and are primarily due to temporary market and sector-related factors rather than to issuer-specific factors. The Company does not intend to sell those investments, and it is not likely it will be required to sell those investments before recovery of its amortized cost.
The Company does not have any exposure to subprime mortgage-backed investments.
Limited liability investments include investments in limited liability companies and limited partnerships 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 March 31, 2018 and December 31, 2017, the carrying value of limited liability investments totaled $25.7 million and $25.2 million, respectively. At March 31, 2018, the Company has unfunded commitments totaling $1.0 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 26.7% of the outstanding units of 1347 Investors LLC ("1347 Investors"). The Company has made an irrevocable election to account for this investment at fair value. As of March 31, 2018 and December 31, 2017, the carrying value of the Company's limited liability investment, at fair value was $8.9 million and $10.3 million, respectively. At March 31, 2018, 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 March 31, 2018 and December 31, 2017, the carrying value of other investments totaled $3.3 million and $3.7 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. During the first quarter of 2018, the Company entered into an agreement with PIH to cancel the $10.00 per share Performance Shares Grant Agreement in exchange for cash consideration of $0.3 million. For the three months ended March 31, 2018, the Company recorded a gain of $0.3 million related to this transaction which is included in gain on change in fair value of equity investments in the consolidated statements of operations. No shares were received by the Company under either of the performance share grant agreements as of March 31, 2018. Refer to Note 18, "Fair Value of Financial Instruments," for further details regarding the performance shares.

 
13
 

KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements (Unaudited) March 31, 2018







Net investment (loss) income for the three months ended March 31, 2018 and March 31, 2017 is comprised as follows:
(in thousands)
 
Three months ended March 31,
 
 
 
2018

 
2017

Investment income:
 
 
 
 
  Interest from fixed maturities
 
$
240

 
$
206

Dividends
 
55

 
142

Income from limited liability investments
 
283

 
300

Loss on change in fair value of limited liability investment, at fair value
 
(1,389
)
 
(367
)
  Gain on change in fair value of warrants - not publicly traded
 

 
245

Other
 
162

 
221

Gross investment (loss) income
 
(649
)
 
747

Investment expenses
 
(33
)
 
(33
)
Net investment (loss) income
 
$
(682
)
 
$
714

Gross realized gains and losses on available-for-sale investments and limited liability investments for the three months ended March 31, 2018 and March 31, 2017 are comprised as follows:
(in thousands)
 
Three months ended March 31,
 
 
 
2018

 
2017

Gross realized gains
 
$
13

 
$
424

Gross realized losses
 

 
(26
)
Net realized gains
 
$
13

 
$
398


Gain on change in fair value of equity investments for the three months ended March 31, 2018 and March 31, 2017 is comprised as follows:
(in thousands)
 
Three months ended March 31,
 
 
 
2018

 
2017

Net gains recognized on equity investments sold during the period
 
$
648

 
$

Change in unrealized gains on equity investments held at end of the period
 
528

 

Gain on change in fair value of equity investments
 
$
1,176

 
$

Fixed maturities and short-term investments with an estimated fair value of $11.6 million and $12.1 million were on deposit with state and provincial regulatory authorities at March 31, 2018 and December 31, 2017, 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 $16.0 million and $16.2 million at March 31, 2018 and December 31, 2017, 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. 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 investee at March 31, 2018 and December 31, 2017 were as follows:
(in thousands, except for percentages)
 
 
 
 
 
 
March 31, 2018
 
December 31, 2017
 
 
Equity Percentage
 
Estimated Fair Value
 
Carrying Value
 
Equity Percentage
 
Estimated Fair Value
 
Carrying Value
ICL
 
31.2
%
 
$
3,354

 
$
5,331

 
31.2
%
 
$
3,816

 
$
5,230



 
14
 

KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements (Unaudited) March 31, 2018







The estimated fair value of the Company's investment in ICL at March 31, 2018 in the table above is calculated based on the published closing price of ICL at December 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 March 31, 2018 is $3.5 million.
For the three months ended March 31, 2018 and March 31, 2017, equity in net income of investee was $0.1 million and $2.4 million, respectively.
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, 2018 and March 31, 2017 are comprised as follows:
(in thousands)
 
Three months ended March 31,
 
 
 
2018

 
2017

Beginning balance, net
 
$
13,045

 
$
13,609

Additions
 
11,866

 
7,687

Amortization
 
(14,265
)
 
(7,183
)
Balance at March 31, net
 
$
10,646

 
$
14,113

NOTE 9 INTANGIBLE ASSETS
Intangible assets at March 31, 2018 and December 31, 2017 are comprised as follows:
(in thousands)
 
 
March 31, 2018
 
 
 
Gross Carrying Value
 
Accumulated Amortization
 
Net Carrying Value
Intangible assets subject to amortization:
 
 
 
 
 
 
Database
 
$
4,918

 
$
2,644

 
$
2,274

Vehicle service agreements in-force
 
3,680

 
3,647

 
33

Customer relationships
 
3,611

 
2,074

 
1,537

In-place lease
 
1,125

 
108

 
1,017

Contract-based revenues
 
731

 
132

 
599

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

 
$
8,605

 
$
87,343



 
15
 

KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements (Unaudited) March 31, 2018







(in thousands)
 
 
December 31, 2017
 
 
 
Gross Carrying Value
 
Accumulated Amortization
 
Net Carrying Value
Intangible assets subject to amortization:
 
 
 
 
 
 
Database
 
$
4,918

 
$
2,521

 
$
2,397

Vehicle service agreements in-force
 
3,680

 
3,640

 
40

Customer relationships
 
3,611

 
1,965

 
1,646

In-place lease
 
1,125

 
92

 
1,033

Contract-based revenues
 
731

 
115

 
616

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

 
$
8,333

 
$
87,615

The Company's intangible assets with definite useful lives are amortized either based on the patterns in which the economic benefits of the intangible assets are expected to be consumed or using the straight-line method over their estimated useful lives, which range from seven to eighteen years. Amortization of intangible assets was $0.3 million and $0.3 million for the three months ended March 31, 2018 and March 31, 2017, respectively.
The tenant relationship, insurance licenses and trade name intangible assets have indefinite useful lives and are not amortized. No impairment charges were taken on intangible assets during the three months ended March 31, 2018. During the three months ended March 31, 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.

 
16
 

KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements (Unaudited) March 31, 2018







(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, 2018 and March 31, 2017 were as follows:
(in thousands)
 
March 31, 2018

 
March 31, 2017

Balance at beginning of period, gross
 
$
63,652

 
$
53,795

Less reinsurance recoverable related to property and casualty unpaid loss and loss adjustment expenses
 
174

 
681

Balance at beginning of period, net
 
63,478

 
53,114

Incurred related to:
 
 
 
 

      Current year
 
22,570

 
24,979

      Prior years
 
576

 
212

Paid related to:
 
 
 
 

      Current year
 
(5,480
)
 
(7,225
)
      Prior years
 
(20,654
)
 
(23,468
)
Balance at end of period, net
 
60,490

 
47,612

Plus reinsurance recoverable related to property and casualty unpaid loss and loss adjustment expenses
 
1,168

 
589

Balance at end of period, gross
 
$
61,658

 
$
48,201

The Company reported unfavorable development on property and casualty unpaid loss and loss adjustment expenses of $0.6 million and $0.2 million for the three months ended March 31, 2018 and March 31, 2017, respectively. The unfavorable development for the three months ended March 31, 2018 was primarily related to an increase in property and casualty loss and loss adjustment expenses at Kingsway Amigo Insurance Company ("Amigo") and Mendota. The unfavorable development reported for the three months ended March 31, 2017 was primarily related to an increase in property and casualty loss and loss adjustment expenses at Mendota.
(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, 2018 and March 31, 2017 were as follows:
(in thousands)
 
March 31, 2018

 
March 31, 2017

Balance at beginning of period
 
$
2,779

 
$
2,915

Incurred related to:
 
 
 
 
      Current year
 
1,276

 
1,219

      Prior years
 

 

Paid related to:
 
 
 
 
      Current year
 
(1,364
)
 
(1,225
)
      Prior years
 
(8
)
 
(136
)
Balance at end of period
 
$
2,683

 
$
2,773



 
17
 

KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements (Unaudited) March 31, 2018







NOTE 11 DEBT
Debt consists of the following instruments at March 31, 2018 and December 31, 2017:
(in thousands)
 
March 31, 2018
 
December 31, 2017
 
 
Principal

 
Carrying Value

 
Fair Value

 
Principal

 
Carrying Value

 
Fair Value

Note payable
 
$
175,435

 
$
185,530

 
$
165,813

 
$
176,136

 
$
186,469

 
$
168,477

Bank loan
 
4,667

 
4,667

 
4,635

 
4,917

 
4,917

 
4,864

Subordinated debt
 
90,500

 
53,458

 
53,458

 
90,500

 
52,105

 
52,105

Total
 
$
270,602

 
$
243,655

 
$
223,906

 
$
271,553

 
$
243,491

 
$
225,446


(a)          Note payable:
As part of the acquisition of CMC Industries, Inc. ("CMC") in July 2016, the Company assumed a mortgage, which is recorded as note payable in the consolidated balance sheets ("the Mortgage"). The Mortgage is nonrecourse indebtedness with respect to CMC and its subsidiaries, and the Mortgage is not, nor will it be, guaranteed by Kingsway or its affiliates. The Mortgage was recorded at its estimated fair value of $191.7 million, which included the unpaid principal amount of $180.0 million as of the date of acquisition plus a premium of $11.7 million. The Mortgage matures on May 15, 2034 and has a fixed interest rate of 4.07%. The Mortgage is carried in the consolidated balance sheets at its amortized cost, which reflects the monthly pay-down of principal as well as the amortization of the premium using the effective interest rate method. The fair value of the Mortgage disclosed in the table above is derived from quoted market prices of A-rated industrial bonds with similar maturities.

(b)          Bank loan:
On October 12, 2017, the Company borrowed a principal amount of $5.0 million from a bank at a fixed interest rate of 5.0%. The bank loan matures on October 12, 2022. The carrying value of the bank loan represents its unpaid principal balance. The fair value of the bank loan disclosed in the table above is derived from quoted market prices of B and B minus rated industrial bonds with similar maturities.
(c)          Subordinated debt:
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. As further discussed in Note 4, "Recently Issued Accounting Standards," effective January 1, 2018, the Company adopted ASU 2016-01. As a result, the portion of the change in fair value of subordinated debt related to the instrument-specific credit risk is now recognized in other comprehensive income (loss), whereas for 2017, the total change in fair value of subordinated debt was recorded in net income (loss). Of the $1.4 million increase in fair value of the Company’s subordinated debt between December 31, 2017 and March 31, 2018, $0.4 million is reported as change in fair value of debt attributable to instrument-specific credit risk in the Company's consolidated statements of comprehensive loss and $0.9 million is reported as loss on change in fair value of debt in the Company’s consolidated statements of operations.

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


 
18
 

KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements (Unaudited) March 31, 2018







NOTE 12 REVENUE FROM CONTRACTS WITH CUSTOMERS
Revenue from contracts with customers relates to Extended Warranty segment service fee and commission income. Service fee and commission income represents vehicle service agreement fees, maintenance support service fees, warranty product commissions and homebuilder warranty service fees and commissions based on terms of various agreements with credit unions, consumers, businesses and homebuilders.
The following table disaggregates revenues from contracts with customers by revenue type:
(in thousands)
 
Three months ended March 31,
 
 
2018
 
 
 
Vehicle service agreement fees - IWS
 
$
4,916

Maintenance support service fees - Trinity
 
2,973

Warranty product commissions - Trinity
 
496

Homebuilder warranty service fees and commissions - PWSC
 
2,172

 
 
 
Service fee and commission income
 
$
10,557


IWS' vehicle service agreement fees include the administrative fees from the sale of vehicle service agreements as well as the fees to administer future claims and are earned over the life of the contract. The administrative fee component is recognized in proportion to the costs incurred in acquiring and administering the vehicle service agreements. The claims fee component is earned over the life of the vehicle service agreements based on the greater of expected claims or actual claims experience.
Trinity’s maintenance support service fees include the service fees collected to administer equipment breakdown and maintenance support services and are earned as services are rendered.
Trinity’s warranty product commissions include the commissions from the sale of warranty contracts for certain new and used heating, ventilation, air conditioning ("HVAC"), standby generator, commercial LED lighting and refrigeration equipment. Warranty product commissions are earned at the time of the warranty product sales.

PWSC’s homebuilder warranty service fees and commissions include the administrative fees, service fees and commissions collected from the sale of warranties issued by new homebuilders. Homebuilder warranty administrative fees are earned when the home is enrolled and services are rendered. Homebuilder warranty service fees are earned over the warranty period, the majority of which is ten years and is based on homes closed by the builder. The Company estimates deferred service fees for years two through ten of the warranty period, based on historical dispute resolution services experience. Homebuilder warranty commissions are recognized as income on the certification date, which is typically the date of the closing of the sale of the home to the buyer. The Company also earns fees to manage remediation or repair services related to claims on insurance-backed warranty obligations, which are earned when the claims are closed; an incentive bonus on eligible warranties, which is based on expected ultimate loss ratio targets; and a profit-sharing percentage on expected profits, which is recognized at the time the bonus is received.

Receivables from contracts with customers are reported as service fee receivable, net in the consolidated balance sheets and at March 31, 2018 and December 31, 2017 were $5.7 million and $4.3 million, respectively.
The Company records deferred service fees resulting from contracts with customers when payment is received in advance of satisfying the performance obligations. We expect to recognize within one year as service fee and commission income approximately 38.9% of the deferred service fees as of March 31, 2018 that are related to contracts with customers. Approximately $6.1 million of service fee and commission income recognized during the three months ended March 31, 2018 was included in deferred service fees as of December 31, 2017.
 
NOTE 13 INCOME TAXES
The Tax Cuts and Jobs Act (the "Tax Act") was enacted on December 22, 2017. The Tax Act makes broad and complex changes to the U.S. tax code, including a permanent reduction in the U.S. federal corporate income tax rate to 21% starting in 2018. Previously, the Company was subject to a 34% U.S. federal corporate income tax rate.

Income tax expense for the three months ended March 31, 2018 and March 31, 2017 varies from the amount that would result by applying the applicable U.S. federal corporate income tax rate of 21% and 34% , respectively, to loss before income tax expense. The following table summarizes the differences:
(in thousands)
 
Three months ended March 31,
 
 
 
2018

 
2017

Income tax benefit at U.S. statutory income tax rate
 
$
(373
)
 
$
(444
)
Valuation allowance
 
376

 
544

Change in unrecognized tax benefits(1)
 
70

 
212

State income tax
 
66

 
13

Non-deductible compensation
 
61

 
99

Indefinite life intangibles
 
20

 
(53
)
Foreign operations subject to different tax rates
 
(15
)
 
(139
)
Other
 
46

 
(53
)
Income tax expense
 
$
251

 
$
179

(1) Includes interest and penalty expense related to unrecognized tax benefits.
The Company maintains a valuation allowance for its gross deferred tax assets at March 31, 2018 and December 31, 2017. 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 March 31, 2018 and December 31, 2017 net deferred tax asset, excluding the deferred income tax asset and liability amounts set forth in the paragraph below.
The Company carries net deferred income tax liabilities of $30.4 million and $30.3 million at March 31, 2018 and December 31, 2017, respectively. At March 31, 2018, $8.0 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, $22.5 million relates to deferred income tax liabilities associated with land and indefinite lived intangible assets and $0.1 million relates to deferred income tax assets associated with alternative minimum tax credits. At December 31, 2017, $8.0 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, $22.4 million relates to deferred income tax liabilities associated with land and indefinite lived intangible assets and $0.1 million relates to deferred

 
19
 

KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements (Unaudited) March 31, 2018







income tax assets associated with alternative minimum tax credits. The Company considered a tax planning strategy in arriving at its March 31, 2018 and December 31, 2017 net deferred income tax liabilities.
As of March 31, 2018 and December 31, 2017, the Company carried a liability for unrecognized tax benefits of $1.4 million and $1.4 million, respectively, that is included in income taxes payable in the consolidated balance sheets. The Company classifies interest and penalty accruals, if any, related to unrecognized tax benefits as income tax expense. The Company recorded income tax expense of $0.1 million and $0.2 million related to interest and penalty accruals for the three months ended March 31, 2018 and March 31, 2017, respectively. At March 31, 2018 and December 31, 2017, the Company carried an accrual for the payment of interest and penalties of $0.9 million and $0.9 million, respectively, included in income taxes payable in the consolidated balance sheets.
NOTE 14 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, 2018 and March 31, 2017:
(in thousands, except per share data)
 
Three months ended March 31,
 
 
 
2018

 
2017

Numerator:
 
 
 
 
Net loss
 
$
(2,027
)
 
$
(1,484
)
Less: net income attributable to noncontrolling interests
 
(135
)
 
(105
)
Less: dividends on preferred stock, net of tax
 
(129
)
 
(174
)
Net loss attributable to common shareholders
 
$
(2,291
)
 
$
(1,763
)
Denominator:
 
 
 
 
Weighted average basic shares
 
 
 
 
       Weighted average common shares outstanding
 
21,708

 
21,458

Weighted average diluted shares
 
 
 
 
Weighted average common shares outstanding
 
21,708

 
21,458

        Effect of potentially dilutive securities
 

 

Total weighted average diluted shares
 
21,708

 
21,458

Basic loss per share
 
$
(0.11
)
 
$
(0.08
)
Diluted loss per share
 
$
(0.11
)
 
$
(0.08
)
Basic loss per share is calculated using weighted-average common shares outstanding. Diluted loss per share is calculated using weighted-average diluted shares. Weighted-average diluted shares is calculated by adding the effect of potentially dilutive securities to weighted-average common shares outstanding. Potentially dilutive securities consist of stock options, unvested restricted stock awards, unvested restricted stock units, warrants and convertible preferred stock. Because the Company is reporting a net loss for the three months ended March 31, 2018 and March 31, 2017, all potentially dilutive securities outstanding were excluded from the calculation of diluted loss per share since their inclusion would have been anti-dilutive.

 
20
 

KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements (Unaudited) March 31, 2018







NOTE 15 STOCK-BASED COMPENSATION
(a)     Stock Options
The following table summarizes the stock option activity during the three months ended March 31, 2018:
 
 
 
 
 
 
 
 
 
 
Number of Options Outstanding
 
Weighted-Average Exercise Price
 
Weighted-Average Remaining Contractual Term (in Years)
 
Aggregate Intrinsic Value (in Thousands)
Outstanding at December 31, 2017
 
651,875

 
$
4.51

 
0.4

 
$
352

Granted
 

 

 
 
 
 
Expired
 

 

 
 
 
 
Outstanding at March 31, 2018
 
651,875

 
$
4.51

 
0.1

 
$

Exercisable at March 31, 2018
 
651,875

 
$
4.51

 
0.1

 
$

The aggregate intrinsic value of stock options outstanding and exercisable is the difference between the March 31, 2018 market price for the Company's common shares and the exercise price of the options, multiplied by the number of options where the fair value exceeds the exercise price.
The Company uses the Black-Scholes option pricing model to estimate the fair value of each option on the date of grant. No options were granted during the three months ended March 31, 2018.
(b)     Restricted Stock Awards
Under the 2013 Equity Incentive Plan, the Company made grants of restricted common stock awards ("Restricted Stock Awards") to certain officers of the Company on March 28, 2014. The Restricted Stock Awards shall become fully vested and the restriction period shall lapse as of March 28, 2024 subject to the officers' continued employment through the vesting date. The Restricted Stock Awards are amortized on a straight-line basis over the ten-year requisite service period. Total unamortized compensation expense related to unvested Restricted Stock Awards at March 31, 2018 was $4.8 million. The grant-date fair value of the Restricted Stock Awards was 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 Awards for the three months ended March 31, 2018:
 
 
 
 
 
 
 
Number of Restricted Stock Awards
 
Weighted-Average Grant Date Fair Value (per Share)
Unvested at December 31, 2017
 
1,952,665

 
$
4.14

Granted
 

 

Forfeited
 

 

Unvested at March 31,2018
 
1,952,665

 
$
4.14

(c)     Restricted Stock Units
The Company granted restricted common stock units ("Restricted Stock Units") to an officer of the Company pursuant to a Restricted Stock Unit Agreement dated August 24, 2016. Each Restricted Stock Unit represents a right to receive one common share on the vesting date. The Restricted Stock Units shall become fully vested and the restriction period shall lapse as of March 28, 2024 subject to the officer's continued employment through the vesting date. The Restricted Stock Units are amortized on a straight-line basis over the requisite service period. Total unamortized compensation expense related to unvested Restricted Stock Units at March 31, 2018 was $2.3 million. The grant-date fair value of the Restricted Stock Units was 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 Units for the three months ended March 31, 2018:

 
21
 

KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements (Unaudited) March 31, 2018







 
 
 
 
 
 
 
Number of Restricted Stock Units
 
Weighted-Average Grant Date Fair Value (per Share)
Unvested at December 31, 2017
 
500,000

 
$
5.73

Granted
 

 

Vested
 

 

Forfeited
 

 

Unvested at March 31, 2018
 
500,000

 
$
5.73

Total stock-based compensation expense, net of forfeitures, was $0.3 million and $0.3 million for the three months ended March 31, 2018 and March 31, 2017, respectively.

NOTE 16 ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)
The tables below detail the changes in the balances of each component of accumulated other comprehensive income (loss), net of tax, for the three months ended March 31, 2018 and March 31, 2017 as relates to shareholders' equity attributable to common shareholders on the consolidated balance sheets. On the other hand, the unaudited consolidated statements of comprehensive loss present the components of other comprehensive loss, net of tax, only for the three months ended March 31, 2018 and March 31, 2017 and inclusive of the components attributable to noncontrolling interests in consolidated subsidiaries.
As further discussed in Note 4, "Recently Issued Accounting Standards," effective January 1, 2018, the Company adopted ASU 2016-01. As a result of the adoption, equity investments are no longer classified as available-for-sale with unrealized gains and losses recognized in other comprehensive income (loss); rather, changes in the fair value of equity investments are now recognized in net income (loss). Also as a result of the adoption, the portion of the total change in the fair value of our subordinated debt resulting from the change in instrument-specific credit risk is no longer recognized in net income (loss) and is now presented in other comprehensive income (loss). Prior periods have not been restated to conform to the current presentation.
(in thousands)
 
 
 
Three months ended March 31, 2018
 
 
 
Unrealized Gains (Losses) on Available-for-Sale Investments
 
Foreign Currency Translation Adjustments
 
Change in Fair Value of Debt Attributable to Instrument-Specific Credit Risk
 
Total Accumulated Other Comprehensive Income (Loss)
 
 
 
 
 
 
 
 
 
Balance at January 1, 2018
 
$
(566
)
 
$
(3,286
)
 
$

 
$
(3,852
)
Cumulative effect of adoption of ASU 2016-01
 
40

 

 
40,455

 
40,495

Balance at January 1, 2018, as adjusted
 
(526
)
 
(3,286
)
 
40,455

 
36,643

 
 
 
 
 
 
 
 
 
Other comprehensive loss arising during the period
 
(358
)
 

 
(434
)
 
(792
)
Amounts reclassified from accumulated other comprehensive income (loss)
 
(7
)
 

 

 
(7
)
Net current-period other comprehensive loss
 
(365
)
 

 
(434
)
 
(799
)
 
 
 
 
 
 
 
 
 
Balance at March 31, 2018
 
$
(891
)
 
$
(3,286
)
 
$
40,021

 
$
35,844


 
22
 

KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements (Unaudited) March 31, 2018







(in thousands)
 
 
 
Three months ended March 31, 2017
 
 
 
Unrealized Gains (Losses) on Available-for-Sale Investments
 
Foreign Currency Translation Adjustments
 
Total Accumulated Other Comprehensive Loss
 
 
 
 
 
 
 
Balance at January 1, 2017
 
$
3,572

 
$
(3,780
)
 
$
(208
)
 
 
 
 
 
 
 
Other comprehensive loss arising during the period
 
(164
)
 

 
(164
)
Amounts reclassified from accumulated other comprehensive income (loss)
 
(507
)
 

 
(507
)
Net current-period other comprehensive loss
 
(671
)
 

 
(671
)
 
 
 
 
 
 
 
Balance at March 31, 2017
 
$
2,901

 
$
(3,780
)
 
$
(879
)
Components of accumulated other comprehensive income (loss) were reclassified to the following lines of the unaudited consolidated statements of operations for the three months ended March 31, 2018 and March 31, 2017:
(in thousands)
 
Three months ended March 31,
 
  
 
2018

 
2017

Reclassification of accumulated other comprehensive income (loss) from unrealized gains (losses) on available-for-sale investments to:
 
 
 
 
Net realized gains
 
$
7

 
$
507

Other-than-temporary impairment loss
 

 

Loss before income tax expense
 
7

 
507

Income tax expense
 

 

Net loss
 
$
7

 
$
507

NOTE 17 SEGMENTED INFORMATION
The Company conducts its business through the following three reportable segments: Insurance Underwriting, Extended Warranty and Leased Real Estate.
Insurance Underwriting Segment
Insurance Underwriting includes the following subsidiaries of the Company: Mendota, Mendakota, Mendakota Casualty Company ("MCC"), Amigo and Kingsway Reinsurance Corporation (collectively, "Insurance Underwriting"). Insurance Underwriting principally offers personal automobile insurance to drivers who do not meet the criteria for coverage by standard automobile insurers. Insurance Underwriting has policyholders in 12 states; however, new business is currently accepted in only seven states.
The Company previously placed Amigo and MCC into voluntary run-off in 2012 and 2011, respectively. Each of Amigo and MCC entered into a comprehensive run-off plan that was approved by its respective state of domicile. Kingsway continues to manage Amigo and MCC in a manner consistent with the run-off plans. During the first quarter of 2015, MCC sent a letter of intent to the Illinois Department of Insurance to resume writing private passenger automobile policies in the state of Illinois.  MCC began writing these policies on April 1, 2015.
Extended Warranty Segment
Extended Warranty includes the following subsidiaries of the Company: IWS Acquisition Corporation ("IWS"), Trinity Warranty Solutions LLC ("Trinity") and PWSC (collectively, "Extended Warranty").

IWS is a licensed motor vehicle service agreement company and is a provider of after-market vehicle protection services distributed by credit unions in 23 states and the District of Columbia to their members.

 
23
 

KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements (Unaudited) March 31, 2018







Trinity sells warranty products and provides maintenance support to consumers and businesses in the heating, ventilation, air conditioning ("HVAC"), standby generator, commercial LED lighting and refrigeration industries. 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.
PWSC sells new home warranty products and provides administration services to home builders and homeowners across the United States. PWSC distributes its products and services through an in house sales team and through insurance brokers and insurance carriers throughout all states except Alaska and Louisiana.
Leased Real Estate Segment
Leased Real Estate includes the Company's subsidiary, CMC, which was acquired on July 14, 2016. CMC owns a parcel of real property consisting of approximately 192 acres located in the State of Texas (the "Real Property") that is leased to a third party pursuant to a long-term triple net lease. The Real Property is also subject to the Mortgage. When assessing and measuring the operational and financial performance of the Leased Real Estate segment, interest expense related to the Mortgage is included in Leased Real Estate's segment operating income.

Revenues and Operating Income (Loss) by Reportable Segment
Results for the Company's reportable segments are based on the Company's internal financial reporting systems and are consistent with those followed in the preparation of the unaudited consolidated interim financial statements. The following tables provide financial data used by management. Segment assets are not allocated for management use and, therefore, are not included in the segment disclosures below.
Revenues by reportable segment reconciled to consolidated revenues for the three months ended March 31, 2018 and March 31, 2017 were:
(in thousands)
 
Three months ended March 31,
 
 
 
2018

 
2017

Revenues:
 
 
 
 
Insurance Underwriting:
 
 
 
 
Net premiums earned
 
$
28,636

 
$
32,922

Other income
 
2,427

 
2,473

Total Insurance Underwriting
 
31,063

 
35,395

Extended Warranty:
 
 
 
 
Service fee and commission income
 
10,557

 
6,562

Other income
 
66

 
85

Total Extended Warranty
 
10,623

 
6,647

Leased Real Estate:
 
 
 
 
Rental income
 
3,342

 
3,341

Other income
 
147

 
212

Total Leased Real Estate
 
3,489

 
3,553

Total segment revenues
 
45,175

 
45,595

Rental income not allocated to segments
 
6

 
6

Net investment (loss) income
 
(682
)