Kingsway(KFS) - 2019 Q2 - Quarterly Report

PART I - FINANCIAL INFORMATION Financial Statements The company's total assets increased to $404.3 million by June 30, 2019, with a shift to $1.8 million net income for the six months, driven by investment gains and acquisitions Consolidated Balance Sheets | Account | June 30, 2019 ($ thousands) | December 31, 2018 ($ thousands) | | :--- | :--- | :--- | | Total Assets | $404,294 | $378,240 | | Total Investments | $72,299 | $59,904 | | Goodwill | $82,104 | $74,659 | | Total Liabilities | $372,790 | $348,182 | | Notes payable | $197,039 | $199,316 | | Subordinated debt, at fair value | $50,224 | $50,023 | | Total Shareholders' Equity | $25,207 | $24,258 | - Total assets grew by $26.1 million, primarily due to an increase in total investments and goodwill, the latter resulting from the Geminus acquisition[9] - Total liabilities increased by $24.6 million, mainly driven by higher deferred service fees and bank loans, partially offset by a reduction in notes payable[9] Consolidated Statements of Operations | Metric | Three Months Ended June 30, 2019 ($ thousands) | Three Months Ended June 30, 2018 ($ thousands) | Six Months Ended June 30, 2019 ($ thousands) | Six Months Ended June 30, 2018 ($ thousands) | | :--- | :--- | :--- | :--- | :--- | | Total Revenues | 15,226 | 12,313 | 28,527 | 25,525 | | Operating Loss | (828) | (1,519) | (1,727) | (2,218) | | Net (Loss) Income | (396) | (10,296) | 2,793 | (12,514) | | Net (Loss) Income Attributable to Common Shareholders | (906) | (10,713) | 1,826 | (13,543) | | Diluted EPS | $(0.04) | $(0.49) | $0.08 | $(0.62) | - Total revenues for the six months ended June 30, 2019, increased to $28.5 million from $25.5 million year-over-year, primarily driven by a 16.6% increase in service fee and commission income[12] - The company shifted from a net loss of $12.5 million in the first six months of 2018 to a net income of $2.8 million in the same period of 2019, largely due to a $6.6 million gain on the change in fair value of limited liability investments, compared to a $1.5 million loss in the prior year[12] Consolidated Statements of Cash Flows | Cash Flow Activity | Six Months Ended June 30, 2019 ($ thousands) | Six Months Ended June 30, 2018 ($ thousands) | | :--- | :--- | :--- | | Net cash used in operating activities | (2,454) | (6,059) | | Net cash (used in) provided by investing activities | (6,694) | 7,212 | | Net cash provided by (used in) financing activities | 5,789 | (2,132) | | Net (decrease) increase in cash and cash equivalents | (3,359) | (980) | - Cash used in investing activities was $6.7 million for the first six months of 2019, primarily due to the acquisition of Geminus for $4.8 million (net of cash acquired) and net purchases of fixed maturities[22] - Cash provided by financing activities was $5.8 million, mainly from $9.0 million in proceeds from a new bank loan, partially offset by principal payments on other bank loans and notes payable[23] Notes to Consolidated Financial Statements - On March 1, 2019, the Company acquired 100% of Geminus Holding Company, Inc. for $8.4 million, recognizing $7.4 million in goodwill and $5.7 million in intangible assets, expanding its vehicle service agreement business portfolio[53][55][56] - The company adopted the new lease accounting standard (ASU 2016-02) on January 1, 2019, recognizing right-of-use assets of approximately $2.7 million and lease liabilities of $2.9 million on the consolidated balance sheet[49][129] - In Q3 2018, the company exercised its right to defer interest payments on its subordinated debt (trust preferred securities) for up to 20 quarters, with deferred interest payable reaching $5.7 million as of June 30, 2019[121] - The company identified the COVID-19 pandemic as a subsequent event, expecting near-term impacts primarily on the Extended Warranty segment due to reduced consumer spending and business closures, which is anticipated to decrease new warranty sales[268][270] Management's Discussion and Analysis of Financial Condition and Results of Operations (MD&A) Management attributes improved first-half 2019 financial performance to core segment operating income and significant investment gains, while actively managing liquidity and future obligations amid potential COVID-19 impacts Reconciliation of Segment Operating Income to Net (Loss) Income | (in thousands of dollars) | For the six months ended June 30, 2019 | For the six months ended June 30, 2018 | | :--- | :--- | :--- | | Total segment operating income | 2,807 | 3,428 | | Gain (loss) on change in fair value of limited liability investments, at fair value | 6,612 | (1,461) | | Interest expense not allocated to segments | (4,441) | (3,561) | | Other income and expenses not allocated to segments, net | (4,361) | (5,625) | | (Loss) income from continuing operations | 2,793 | (6,866) | | Net (loss) income | 2,793 | (12,514) | - The holding company's liquidity was $1.8 million at June 30, 2019, representing approximately four months of operating expenses, with interest payments on trust preferred securities being deferred to manage cash flow[355][356] - The company projects insufficient legally available funds to pay deferred interest on trust preferred securities and redeem all Preferred Shares by April 1, 2021, but notes Delaware law would prohibit such a redemption, allowing ordinary course operations[359] Quantitative and Qualitative Disclosures About Market Risk The company's primary market risk is interest rate exposure, with a 100 basis point increase potentially decreasing fixed maturities by $0.2 million and increasing annual interest expense by $1.0 million, managed through portfolio diversification Interest Rate Sensitivity on Fixed Maturities (as of June 30, 2019) | Scenario | Estimated Fair Value ($ thousands) | Estimated Change in Fair Value ($ thousands) | | :--- | :--- | :--- | | 100 Basis Point Decrease | $21,005 | $218 | | No Change | $20,787 | $— | | 100 Basis Point Increase | $20,569 | $(218) | - The company's subordinated debt and KWH Loan are LIBOR-based, where a 100 basis point increase in LIBOR would result in an approximate $1.0 million increase in annual interest expense[372] - The fixed maturities portfolio consists of predominantly high-quality instruments, with 100% of investments rated 'A' or better as of June 30, 2019[376][377] Controls and Procedures Management concluded that disclosure controls and procedures were ineffective as of June 30, 2019, due to identified material weaknesses in internal control over financial reporting, for which a remediation plan is being developed - The CEO and CFO concluded that disclosure controls and procedures were not effective as of June 30, 2019, due to material weaknesses in internal control over financial reporting[379] - Identified material weaknesses include ineffective controls over the accounting for: - Complex and nonrecurring transactions (e.g., VIEs, ASU 2014-09 adoption, purchase accounting) - Disclosure of related parties and classification of restricted cash - Monitoring the collectability of accounts receivable - Other-than-temporary impairment on equity method investments - Timeliness and precision of certain account reconciliations[379][381][382][383][384][385] - A remediation plan is being developed to strengthen internal controls, including assessing accounting policies, enhancing review procedures for complex transactions, and improving the rigor of account reconciliations and related party tracking[388][389] PART II - OTHER INFORMATION Legal Proceedings The company is involved in legal proceedings, including a lawsuit against its subsidiary TRT LeaseCo, LLC and a breach of contract complaint from Aegis Security Insurance Company, with potential exposure not reasonably determinable as of June 30, 2019 - TRT LeaseCo, LLC, an indirect subsidiary, is a defendant in a lawsuit regarding alleged unpaid fees under a Management Services Agreement, which could materially adversely affect the company's financial position if decided against them[264] - Aegis Security Insurance Company filed a breach of contract complaint related to an indemnity agreement for customs bond losses, subsequently settled in January 2020 for a one-time payment of $0.9 million and potential future reimbursements[265] Risk Factors The COVID-19 pandemic is identified as a significant new risk factor, expected to adversely impact business through macroeconomic effects, reduced consumer demand, and operational disruptions, with uncertain but potentially material duration and magnitude - The COVID-19 pandemic is a new material risk factor expected to adversely impact business, financial condition, operating results, and cash flows[393] - Adverse impacts from COVID-19 include decreased consumer demand for warranty products due to declines in automobile sales and new home construction, alongside disruptions to distribution channels and customers[394] - A difficult economy and market volatility, exacerbated by the pandemic, could lead to substantial investment losses, difficulty in valuing assets, and challenges in obtaining financing for future acquisitions[396][397] Exhibits This section lists exhibits filed with the Form 10-Q, including CEO and CFO certifications pursuant to the Sarbanes-Oxley Act and XBRL interactive data files - Exhibits filed include Sarbanes-Oxley Act Section 302 and 906 certifications from the Principal Executive Officer and Principal Financial Officer[403] - The filing includes XBRL Instance Document and related taxonomy extension files for interactive data[403]